A) ABSTRACT / HEADNOTE

This landmark case, Sohan Pathak and Sons v. Commissioner of Income-Tax, U.P., [1954] SCR 158, deals with the intricate interplay between a partial partition within a Hindu Undivided Family (HUF) and the applicability of the Excess Profits Tax Act, 1940. The Supreme Court explored whether a legitimate business reorganization, through a recognized legal process of partial partition and the subsequent formation of partnership firms, could be construed as a tax evasion strategy under Section 10-A of the Act. The Revenue authorities attempted to treat the restructured business as a mere continuation of the original HUF business and impose excess profits tax accordingly. The Court held otherwise, emphasizing the discontinuance of the original business and the establishment of new, legally independent partnerships. It ruled that the business of the HUF, having been wound up and its assets and liabilities partitioned among coparceners, could no longer attract tax under the same legal identity. This decision not only offered clarity on the interpretation of Sections 4, 5, and 10-A of the Act but also reaffirmed the validity of genuine partition under Hindu law. The judgment holds significance in both tax law and Hindu personal law, especially on the treatment of HUFs in tax matters.

Keywords: Excess Profits Tax Act, Hindu Undivided Family, partial partition, tax evasion, Section 10-A, partnership firm, Indian Income-tax Act, discontinuance of business.

B) CASE DETAILS

i) Judgement Cause Title: Sohan Pathak and Sons v. Commissioner of Income-Tax, U.P.

ii) Case Number: Civil Appeals Nos. 47 to 50 of 1952

iii) Judgement Date: September 23, 1953

iv) Court: Supreme Court of India

v) Quorum: Patanjali Sastri C.J., Mukherjea J., Vivian Bose J., Ghulam Hasan J., and Jagannadhadas J.

vi) Author: Chief Justice Patanjali Sastri

vii) Citation: [1954] SCR 158

viii) Legal Provisions Involved:
Sections 4, 5, and 10-A of the Excess Profits Tax Act, 1940;
Section 25(3) and Section 25(4) of the Indian Income-tax Act, 1922

ix) Judgments overruled by the Case: None

x) Case is Related to:
Taxation Law, Hindu Personal Law, Corporate Reorganization, Constitutional Validity of Fiscal Measures, Income Tax & Business Structure

C) INTRODUCTION AND BACKGROUND OF JUDGEMENT

The background of the case lies in the fiscal policies implemented during World War II, when the Government of India introduced the Excess Profits Tax Act, 1940 to capture wartime gains. Amidst this, the appellants—a Hindu Undivided Family (HUF)—undertook a partial partition of their business in Banaras brocade and money lending. They divided the business assets on July 16, 1943, and, the very next day, formed two separate partnership firms, each consisting of members from the four branches of the original HUF. This restructuring was treated by the Income Tax Officer as a valid discontinuance of the original HUF business under Section 25(3) of the Indian Income-tax Act, thereby exempting it from further tax on its cessation. However, the Excess Profits Tax Officer treated the act as an artificial transaction aimed at avoiding excess profits tax, invoking Section 10-A to treat the business as continuous, thus aggregating the profits earned by the new firms into the tax net.

D) FACTS OF THE CASE

The family business, run under the name Sohan Pathak & Sons, was carried on by a Hindu Undivided Family comprising four branches. On July 16, 1943, the members executed a partial partition, dividing the assets and liabilities of the brocade business among the four branches equally. The very next day, two partnerships were formed under different names, with adult members as partners and minors admitted to the benefits of the firm. The Revenue initially accepted the discontinuation and allowed relief under Section 25(3) of the Indian Income-tax Act. However, under the Excess Profits Tax Act, the Officer took a contrary stance, holding that the main purpose of the reorganization was tax avoidance, and that the original business had in effect continued unbroken. Consequently, he made adjustments under Section 10-A, taxing profits of the new firms along with the family’s earlier business income. The Appellate Assistant Commissioner and the Tribunal upheld this interpretation. The matter was then referred to the Allahabad High Court, which ruled in favour of the Department. However, on appeal to the Supreme Court, the matter turned on whether Section 10-A could override the finding of discontinuance of business under Sections 4 and 5.

E) LEGAL ISSUES RAISED

i) Whether the partial partition accepted under the Indian Income-tax Act could still be treated as a non-genuine transaction under Section 10-A of the Excess Profits Tax Act.

ii) Whether the old business, despite actual discontinuance, could be deemed to have continued unbroken for the purpose of applying excess profits tax.

iii) Whether the restructuring was a transaction designed to reduce liability within the meaning of Section 10-A of the Excess Profits Tax Act.

F) PETITIONER/ APPELLANT’S ARGUMENTS

i) The counsels for the Petitioner/Appellant submitted that the partial partition was bona fide and recognized under Hindu law, dividing both assets and liabilities. They argued that the restructured entities were entirely new legal partnerships, not a continuation of the old business. They also emphasized that the Income Tax Officer had granted relief under Section 25(3), recognizing discontinuation, and this conclusion ought to bind the Excess Profits Tax Officer.

They also relied on the legal principle that a HUF and its members are distinct legal entities, and once the business ceased under the HUF framework, any subsequent activity by individual branches could not retroactively revive the old entity. Additionally, the petitioner pointed out that the new partnerships were registered and included minors only to the extent of their share of benefits, consistent with established law under CIT v. Dwarkadas Khetan & Co., AIR 1961 SC 680[1].

G) RESPONDENT’S ARGUMENTS

i) The counsels for Respondent submitted that the restructuring was strategically timed, coinciding with rising profits. They argued that it was an artificial transaction intended to evade excess profits tax, and therefore, subject to scrutiny under Section 10-A. The respondent argued that the objective of the statute should be given effect—to prevent the avoidance of wartime taxation. They pointed out that although legally a partial partition had occurred, substantively, the same business continued, and hence the Revenue was justified in aggregating the profits under Section 10-A.

They cited the case of Commissioner of Excess Profits Tax v. Shri Lakshmi Silk Mills Ltd., (1951) 20 ITR 451 (SC), where substance prevailed over form, reinforcing that merely cloaking an old business in a new legal form does not preclude tax scrutiny.

H) RELATED LEGAL PROVISIONS

i) Section 4 of the Excess Profits Tax Act: Levies tax only on profits of businesses to which the Act applies.
ii) Section 5 of the Excess Profits Tax Act: Defines applicability—only if profits during chargeable accounting periods are assessable under income tax.
iii) Section 10-A of the Excess Profits Tax Act: Allows adjustments for transactions designed to avoid liability.
iv) Section 25(3) and (4) of the Indian Income-tax Act, 1922: Provides relief in cases of business discontinuance.
v) Section 8(1) of the Excess Profits Tax Act: Treats businesses carried on by different persons after discontinuance as separate units.

H) JUDGEMENT

a. RATIO DECIDENDI

i) The Court held that Sections 4 and 5 of the Excess Profits Tax Act limit the scope of the tax to businesses that earned profits during chargeable accounting periods. Since the old business of the HUF was legally discontinued on July 16, 1943, and earned no profit thereafter, the Act did not apply to it. Therefore, invoking Section 10-A was untenable, as that section presupposes that the Act applies to the business in the first place. The Court clarified that Section 10-A cannot override Sections 4 and 5, and hence, it was inapplicable in the present case.

b. OBITER DICTA 

i) The Court noted, hypothetically, that even if Section 10-A did apply, the findings must be rooted in material evidence, and any inference of avoidance must be reasonable, not speculative. They expressed skepticism about extending Section 10-A to every valid reorganization, which would be counter-intuitive and discourage legitimate legal structuring under Hindu law.

c. GUIDELINES 

• Business restructuring through partial partition is legally valid and recognized in Indian tax law.

• Section 10-A applies only when the business continues, not when it is legally discontinued.

• Income-tax treatment under Section 25(3) may have persuasive value for other fiscal statutes.

• The Excess Profits Tax Act must be interpreted in a narrow and strict manner, given its extraordinary nature.

I) CONCLUSION & COMMENTS

The Supreme Court’s verdict is a critical reaffirmation of the boundaries of tax interpretation. It clarified that legitimate exercises of rights under personal law cannot be nullified merely due to fiscal suspicions. The Court ensured that statutory interpretation remains within the letter of the law, particularly in fiscal matters where taxing provisions must be construed strictly. This case remains a significant precedent in tax avoidance jurisprudence, balancing legitimate business autonomy with anti-abuse provisions.

J) REFERENCES

a. Important Cases Referred

[1] CIT v. Dwarkadas Khetan & Co., AIR 1961 SC 680
[2] Commissioner of Excess Profits Tax v. Shri Lakshmi Silk Mills Ltd., (1951) 20 ITR 451 (SC)
[3] Commissioner of Excess Profits Tax, Bombay City v. Moholal Maganlal, [1953] 23 ITR 45 (Bom)

b. Important Statutes Referred

[1] Excess Profits Tax Act, 1940, Sections 4, 5, 10-A
[2] Indian Income-tax Act, 1922, Sections 25(3), 25(4), 8(1)