CAPITAL ASSETS

The provision of Section 45(4) is applied at the time of dissolution of the firm, further the provision is as under:

When the Capital Assets is distributed on dissolution of firm to the partners, then Section 45(4) is applicable only if the following conditions are satisfied.

1 Taxpayer is a firm

2 There must be a transfer of capital assets

3 Transfer is by way of distribution of Capital Assets on Dissolution of firm

If the above conditions mentioned are satisfied, then the capital gains is taxable in the hands of the firm under Section 45(4).It would be taxable income in the year of transfer itself And the FMV of the asset on the date of transfer is taken as full value of consideration in the hands of partners, however cost shall be the agreed consideration.The rule is also applicable when the assets are transferred by association of Person/body of individual and not by company or cooperative society. When the assets of the firm are vested to the limited company at the time of conversion, then it does not amount to distribution and transfer of such assets On dissolution of the firm u/s Section45(4).

Section 45(4) is also not applicable where some partner retires and the amount credited in the capital account of the retired partner upon revaluation of assets is

 Not taxable as capital gain as there is no transfer-ITO v. Ramesh M. Shah (2004).  On revaluation of asset of firm and credit the amount in the capital account of the partners in profit sharing ratio does not entail any transfer under sec2(47) cannot be brought to tax by invoking section45(4)- Ravinshankar R. Singh v. ITO.

        Thus for attracting section45(4),there must be transfer of capital assets from the firm  and whereby the firm ceases to have any right in the property which is so transferred.

        The Bombay high court in CIT v. A.N Naik Associates has held that the word “otherwise” not only includes cases of dissolution but also takes into account the cases of retirement of partners even though there is no dissolution and the business is continuing one. However if the wording of Bombay high court is accepted then the relevance of Section 45(4) is lost.

        Section45(4) is not applicable on inclusion of new partner, shares of existing partner are reduced as there is no provision in the Act for levying Capital gain tax on  consideration received by partners on reduction of shares. Also when the firm has purchased property under registered sales deed, later on reconstitutions takes place and there after erstwhile partner withdraw their share and go out of the firm, so if this device is adopted merely to transfer the immovable property capital gain is not chargeable to tax.

        The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.

         Thus Section 45(4) is applied when the capital assets are distributed to the partners at the time of dissolution of the firm and not retirement or reconstitution of the firm.

COMMISSIONER OF INCOME TAX vs. TEXSPIN ENGG. & MFG. WORKS

HIGH COURT OF BOMBAY

S.H. Kapadia & J.P. Devadhar, JJ.

IT Appeal No. 222 of 2001

5th March, 2003

(2003) 71 CCH 0222 MumHC

(2003) 180 CTR 0497 : (2003) 263 ITR 0345 : (2003) 129 TAXMAN 0001

Legislation Referred to

Sections 2(47), 43(6)(c)(i)(B), 45(1), 45(4), 48

Case pertains to

Asst. Year 1996-97

Decision in favour of:

Assessee

Capital gains—Applicability of s. 45(4) and chargeability—Conversion of partnership firm into joint stock company under Part IX of the Companies Act—First requirement of s. 45(4) that there should be a distribution of capital assets of the firm not satisfied—Properties of the erstwhile firm vested in the limited company and there is difference between distribution on dissolution and vesting—Therefore, s. 45(4) is not attracted—Although all the properties of the firm vested in the limited company on the firm being treated as a company under Part IX of the Companies Act such vesting is not consequent or incidental to a transfer—It is a statutory vesting of properties in the company as the firm is treated as a limited company—Thus, there is no transfer of a capital asset as contemplated by s. 45(1)—Even if it is assumed that such vesting amounts to transfer, computation of capital gains as envisaged by s. 48 is not possible because full value of consideration cannot be construed to mean market value of the assets transferred, as in the case of s. 45(4)—Hence, s. 45(1) is also not attracted

Held :

Under s. 45(4), two conditions are required to be satisfied viz., transfer by way of distribution of capital assets, and secondly, such transfer should be on dissolution of the firm or otherwise. Once these two conditions are satisfied then, in that event, for the purposes of computation of capital gains under s. 48, the market value on the date of the transfer shall be deemed to be the full value of consideration received or accruing as a result of the transfer. In this case, the erstwhile firm has been treated as a limited company by virtue of s. 575 of the Companies Act. The erstwhile firm became a limited company under Part IX of the Companies Act. Under Part IX of the Companies Act, when a partnership firm is treated as a limited company, the properties of the erstwhile firm vest in the limited company. There is a difference between vesting of the property, in this case, in the limited company and distribution of the property. On vesting in the limited company under Part IX of the Companies Act, the properties vest in the company as they exist. On the other hand, distribution on dissolution pre-supposes division, realisation, encashment of assets and appropriation of the realised amount as per the priority like payment of taxes to the Government, BMC, etc., payment to unsecured creditors, etc. This difference is very important. In the present case, therefore, s. 45(4) is not attracted as the very first condition of transfer by way of distribution of capital assets is not satisfied. In the circumstances, the latter part of s. 45(4), which refers to computation of capital gains under s. 48 by treating fair market value of the asset on the date of transfer, does not arise.—Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC) applied.

(Para 5)

Clause (xiii) of s. 47 though not applicable here, it provides a clue to the legislative intent. It has been introduced w.e.f. 1st April, 1999, in order to encourage more and more firms becoming limited companies. It also indicates the difference between transfer and transmission. Basically, when a firm is treated as a company under Part-IX, it is a case similar to transmission. This is amply made clear by cl. (xiii) to s. 47, which states that where a firm is succeeded by a company in the business, the transaction shall not be treated as a transfer. The expression “transfer of a capital asset” in s. 45(1) is required to be read with s. 2(47)(ii) which states that transfer in relation to a capital asset shall include extinguishment of any rights therein. In certain cases of reconstitution of firms and introduction of new partners, there is a resultant extinguishment of the rights in the capital assets proportionately. In order to get over this controversy, and keeping in mind the object of encouraging firms being treated as companies, the controversy is resolved by the legislature by introducing cl. (xiii) in s. 47 w.e.f. 1st April, 1999.

(Para 6)

When a partnership firm is treated as a company under the statutory provisions of Part-IX of the Companies Act, the company succeeds the firm. Generally, in the case of a transfer of a capital asset, two important ingredients are : existence of a party and a counter-party and, secondly, incoming consideration qua the transferor. When a firm is treated as a company, the said two conditions are not attracted. There is no conveyance of the property executable in favour of the limited company. It is no doubt true that all properties of the firm vest in the limited company on the firm being treated as a company under Part-IX of the Companies Act, but that vesting is not consequent or incidental to a transfer. It is a statutory vesting of properties in the company as the firm is treated as a limited company. On vesting of all the properties statutorily in the company, the cloak given to the firm is replaced by a different cloak and the same firm is now treated as a company, after a given date. In the circumstances, there is no transfer of a capital asset as contemplated by s. 45(1). Even assuming for the sake of argument that there is a transfer of a capital asset under s. 45(1) because of the definition of the word “transfer” in s. 2(47)(iii), even then liability to pay capital gains would not arise because s. 45(1) is required to be read with s. 48, which provides for mode of computation. These two sections are required to be read together as the charging section and the computation section constitute one package. Now, under s. 48 it is laid down, inter alia, that the income chargeable under the head “Capital gains” shall be computed by deducting from the full value of the consideration received or accrued as a result of the transfer, the cost of acquisition of the asset and the expenditure incurred in connection with the transfer. Sec. 45(4) is mutually exclusive to s. 45(1). One has to read the expression “full value of the consideration received/accruing” under s. 48 de hors s. 45(4) and if one reads s. 48 with s. 45(1) de hors s. 45(4) then the expression “full value of consideration” in s. 48 cannot be the market value of the capital asset on the date of transfer. In the circumstances, even if one were to proceed on the basis that vesting in the company under Part-IX constituted transfer under s. 45(1), still the assessee ought to succeed because the firm can be assessed only if the full value of the consideration is received by the firm or if it accrues to the firm. In the present case, the company had allotted shares to the partners of the erstwhile firm, but that was in proportion to the capital of the partners in the erstwhile firm. That allotment of shares had no correlation with the vesting of the properties in the limited company under Part-IX of the Act. If one reads s. 45(1) with s. 48, it is clear that the former is a charging section and if that section is applicable, the computation has to be done under s. 48, which only refers to deductions from full value of consideration received or accruing. Sec. 48 does not empower the AO to take market value as full value of consideration as in the case of s. 45(4). In the circumstances, even if one were to hold that vesting amounts to transfer, the computation is not possible because full consideration cannot be construed to mean market value of the asset transferred. The legislature, in its wisdom, has amended only s. 45(4) by which the market value of the asset on the date of the transfer is deemed to be the full value of consideration. However, such amendment is not there in s. 45(1). In the circumstances, neither s. 45(1) nor s. 45(4) stand attracted.—CIT vs. George Henderson & Co. Ltd. (1967) 66 ITR 622 (SC) and CIT vs. Gillanders Arbuthnot & Co. 1973 CTR (SC) 138 : (1973) 87 ITR 407 (SC) relied on.

(Para 6)

Conclusion :

Conversion of partnership firm into company under Part IX of the Companies Act did not attract the provisions of s. 45(4) as there was no distribution of capital assets on dissolution; provisions of s. 45(1) also could not be applied as the vesting of the properties of the firm in the company was not consequent or incidental to a transfer as contemplated by s. 45(1).

In favour of :

Assessee

Depreciation—Allowability—Conversion of partnership firm into joint stock company under Part IX of the Companies Act—Firm’s claim for depreciation could not be disallowed by invoking the provisions of s. 43(6)(c)(i)(B) on the ground that the assets of the firm stood transferred during the year to the limited company—Further, there is no requirement for the firm to remain owner for the entire year—A.M. Ponnurangam Mudaliar vs. CIT (1997) 140 CTR (Mad) 589 : (1997) 228 ITR 454 (Mad) relied on

(Para 7)

Conclusion :

On conversion of partnership firm into joint stock company under Part IX of the Companies Act, firm’s claim for depreciation could not be disallowed by invoking the provisions of s. 43(6)(c)(i)(B) on the ground that the assets of the firm stood transferred during the year to the limited company.

In favour of :

Assessee

Cases referred:

CIT vs. Bhanodaya Industries (2002) 173 CTR (AP) 363 : (2002) 253 ITR 350 (AP)

Texspin Engineering & Mfg. Works vs. Jt. CIT (2001) 70 TTJ (Mumbai) 789

Counsel appeared:

R.V. Desai with P.S. Jetley & K.R. Chaudhari i/b K.B. Rao, for the Appellant : V.H. Patil with V.B. Joshi & Mrs. Jyoti Dialani, for the Respondent

S.H. KAPADIA, J.:

Judgment

Being aggrieved by the order of the Tribunal dt. 11th Dec., 2000, in Appeal No. 5814/Bom/99 [reported as Texspin Engineering & Manufacturing Works vs. Jt. CIT (2001) 70 TTJ (Mum) 789—Ed.], the Department has come by way of appeal under s. 260A of the IT Act for the asst. yr. 1996-97 with the following questions of law for our opinion :

“(i) Whether, on the facts and in the circumstances of the case, the Hon. Tribunal was justified in holding that the provisions of ss. 45(1) and (4) are not attracted even though there was transfer of assets from the firm to the newly constituted company on conversion of firm to company under Part IX of the Companies Act, 1956 ?”

(ii) Whether, on the facts and in the circumstances of the case and in law, the Hon’ble Tribunal was justified in directing to allow depreciation for the year even though the W.D.V. of the block of the assets at the end of the year was NIL as per the provisions of s. 32 r/w s. 43(6)(c)(i)(B) of the Act ?”

Facts

2. A firm by the name M/s Texspin Engineering & Manufacturing Works was engaged in the business of manufacturing ball bearings. The said firm filed its return of income for the period 1st April, 1995, upto 7th Nov., 1995, stating that it had been thereafter converted into a limited company. The return of the remaining period from 7th Nov., 1995 to 31st March, 1996, was filed by the limited company at Ahmedabad. While examining the return of income filed by the assessee, it was observed that the assessee-firm had filed its return of income upto 7th Nov., 1995. On enquiry, the AO was informed that the partnership firm was converted into a limited company under Part IX of the Companies Act, 1956. No capital gain was shown in the return of income. Therefore, the assessee-firm was asked to show cause why capital gain has not been shown under s. 45(4) of the IT Act. The assessee-firm was also directed to submit market value of the assets for computation of capital gains under s. 45(4) of the IT Act. In reply, the assessee-firm contended that in order to apply s. 45(4), two conditions were required to be fulfilled viz. (i) dissolution of the partnership firm, and (ii) distribution of the assets of the partnership firm, and since there was no dissolution of the partnership firm, s. 45(4) was not attracted. This argument was rejected by the AO, who took the view that there was a transfer of the capital assets by way of distribution and such transfer was on dissolution of the firm and, therefore, profits or gains from such transfer became chargeable to tax under s. 45(4) of the Act. Further, for the purposes of computation of capital gains under s. 48 of the Act, the AO took into account written down value as on 1st April, 1995, of the assets which stood transferred in favour of the company. Accordingly, the AO computed the capital gains on the difference between the market value and the written down value of the assets transferred to the company to the tune of Rs. 9 lakhs.

There is one more point which needs to be mentioned. During the assessment year in question, the assessee claimed depreciation of Rs. 27,67,000, which was disallowed on the ground that on vesting of the assets in the company, there was a sale. That, when the firm was converted into a limited company under Part IX of the Companies Act, there was a sale of assets and, therefore, at the end of the accounting year ending 31st March, 1996, no assets existed as the entire assets stood transferred and, therefore, the AO disallowed the claim for depreciation. Being aggrieved by the assessment order, the matter was carried in appeal to the CIT(A), who confirmed the order of the AO. Being aggrieved, the assessee carried the matter in appeal to the Tribunal, which took the view on question No. 1 that s.

45(4) was not applicable as there was no distribution of capital assets amongst the partners of the firm on vesting of their capital assets of the firm in the company. That, s. 45(1) was also not attracted as no consideration was received by the assessee-firm on vesting of the capital assets in the limited company. On non-allowance of depreciation, the Tribunal took the view that vesting of capital assets in the company did not amount to sale and, therefore, the conditions of s. 43(6)(c)(i)(B) were not satisfied. In the circumstances, the Tribunal allowed the claim for depreciation. Being aggrieved by the decision of the Tribunal, the matter has come in appeal before us under s. 260A of the IT Act.

Arguments

3. Mr. R.V. Desai, learned senior counsel appearing on behalf of the Department, contended that on vesting of the properties of the firm in the limited company, the partners of the erstwhile firm became shareholders of the company. That, on such vesting, the erstwhile firm stood dissolved. That, on such vesting, every asset of the firm was taken over by the limited company. That, on vesting, the firm ceased to exist. That, as a result of vesting, the company became the owner of all the properties of the firm and in lieu thereof, shares were allotted to the partners by the company. He, therefore, contended that, in this case, s. 45(4) was applicable. In the alternative, he contended that on dissolution of the firm, there was extinguishment of all the rights of the firm in the capital assets and, therefore, there was a transfer as contemplated under s. 2(47)(ii) r/w s. 45(1) of the IT Act. That, on dissolution of the erstwhile firm and on account of extinguishment of all rights in the capital assets of the firm, profits/gains arose. That, such vesting resulted in transfer of capital assets under s. 45(1) of the Act. He contended that on such vesting of the capital assets of the firm in the company, there was dissolution and extinguishment of all rights and since the firm’s assets vested in the company, there was a transfer as contemplated by s. 45(1) of the Act. That, on vesting, the firm’s existence came to an end. That on vesting, there was dissolution of the firm. He, therefore, contended that profits/gains arose from transfer of the capital assets under s. 45(1) of the Act. Mr. Desai contended further that once the conditions under s. 45(1) stood satisfied then the Department was right in computing capital gains under s. 48 of the Act. In this connection, it was argued that the fair market value of the assets on the date of the transfer represented the full value of the consideration received/accrued under s. 48 of the Act. In the circumstances, it was argued that the value of the assets transferred to the limited company represented full value of the consideration which expression finds place in s. 48 of the IT Act. He, therefore, contended that the Department was right in computing capital gains under s. 45(1) r/w s. 48 of the IT Act. He contended that the fair market value of the assets, on the date of vesting, represented full value of consideration from which the AO has rightly deducted the written down value as on 1st April, 1995, with additions made during the year and, therefore, the capital gains was rightly calculated at Rs. 9 lakhs on the basis of the difference between the market value of the assets on the date of vesting, i.e., 7th Nov., 1995, and the written down value at the beginning of the year i.e., on 1st April, 1995. On question No. 2, it was submitted that on 31st March, 1996, the assessee-firm was not the owner of the assets as the assets stood sold during the accounting year ending 31st March, 1996, and, therefore, the AO was right in disallowing the assessee’s claim for depreciation amounting to Rs. 27,76,000. (27,67,000)
4. Mr. Patil, learned counsel for the assessee, submitted that under s. 45(4) of the Act, two conditions are required to be satisfied. Firstly, there must be a transfer by way of distribution of capital assets and secondly, that, such transfer should be either on account of dissolution of the firm or otherwise. Mr. Patil contended that in this case, there was no transfer because under Part IX of the Companies Act, the firm is merely treated as a company statutorily. He submitted that under Part IX of the Companies Act, the same entity viz., the firm is treated as a company and, therefore, there was no transfer as contemplated by s. 45(4) of the Act. He further contended that in this case, the first condition to attract s. 45(4) is that there should be a transfer by way of distribution of capital assets. He contended that vesting of capital assets in the limited company did not amount to distribution of capital assets. In the circumstances, s. 45(4) was not applicable.

Mr. Patil further contended that even s. 45(1) was not attracted in this case because s. 45(1) contemplates accrual of profits or gains from transfer of a capital assets. He contended that under Part IX of the Companies Act, the firm is treated as a company whereas s. 45(1) presupposes existence of two parties between whom the transfer takes place. He contended that when the firm is treated as a company, there is no existence of two separate parties amongst whom the transfer takes place. In the circumstances, he contended that s. 45(1) of the Act is not applicable. He further contended that even assuming for the sake of argument that there was a transfer under s. 45(1) still, in the present case, one has to compute the capital gain, which in this case is not possible. He contended that the capital assets parted with by the firm in favour of the limited company cannot represent “full value of the consideration”, which expression finds place in s. 48 of the IT Act. He contended that the expression “full value of the consideration” connotes payment of actual consideration and “full value of the consideration” cannot cover assets parted with. In this connection, he placed reliance on the judgments of the Supreme Court in the case of CIT vs. George Henderson & Co. Ltd. (1967) 66 ITR 622 (SC) and in the case of CIT vs. Gillanders Arbuthnot & Co. 1973 CTR (SC) 138 : (1973) 87 ITR 407 (SC). He, therefore, submits that in this case s. 48 of the IT Act fails even if one assumes transfer under s. 45(1) of the Act.

Mr. Patil next contended that it is true that the partners of the erstwhile firm received shares of the limited company in whom capital assets vested but, the partners received shares because of the credit balance in the erstwhile firm. Therefore, there was no consideration received by the assessee-firm on vesting of the capital assets in the limited company. That, there was no co-relationship between receipt of shares by partners on one hand and the vesting of the assets in the limited company on the other hand.

Under the circumstances, Mr. Patil contended that even if one assumes accrual of capital gains, computation of capital gains can be done only under s. 48, which as stated above, was not attracted. He, therefore, contended that there is no merit in this appeal.

On question of depreciation, it was submitted that under s. 32, an assessee is entitled to depreciation once he makes use of the assets. That, there is no requirement that the assessee should continue to hold the capital assets till the end of the year. He contended that depreciation to be calculated on actual costs or written down value. He contended that in the present case, the Department has invoked s. 43(6)(c)(i)(B) to justify its conclusion that in the case of block of assets, the written down value has got to be adjusted by deduction of monies payable in respect of any asset falling within the block of assets, which is sold, discarded, demolished or destroyed during the previous year. He contended that in the present case, none of the conditions are applicable. He contended that vesting was not a sale as construed by the Department. He, therefore, contended that s. 43(6)(c)(i)(B) was not attracted. In this connection, he also relied upon the judgment of the Madras High Court in the case of A.M. Ponnurangam Mudaliar vs. CIT (1997) 140 CTR (Mad) 589 : (1997) 228 ITR 454 (Mad) and the judgment of the Andhra Pradesh High Court in the case of CIT vs. Bhanodaya Industries (2002) 173 CTR (AP) 363 : (2002) 253 ITR 350 (AP).

Findings

(A) On s. 45(4)

5. In this matter, we are concerned with asst. yr. 1996-97. Sec. 45(1) is a charging section as far as capital gains is concerned. Under s. 45(4), profits arising from transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm is chargeable to tax as income of the firm in a previous year in which the transfer takes place and for the purposes of s. 48, the fair market value of the asset on the date of such transfer is deemed to be the full value of the consideration received or accruing as a result of the transfer. Sec. 48 deals with mode of computation. It, inter alia, lays down that the income chargeable under the head “Capital gains” shall be computed by deducting from the full value of the consideration, the expenditure incurred in connection with the transfer and the cost of acquisition of the asset. Therefore, under s. 45(4), two conditions are required to be satisfied viz., transfer by way of distribution of capital assets, and secondly, such transfer should be on dissolution of the firm or otherwise. Once these two conditions are satisfied then, in that event, for the purposes of computation of capital gains under s. 48, the market value on the date of the transfer shall be deemed to be the full value of consideration received or accruing as a result of the transfer.

Now, according to the AO, in this case, on vesting of the properties of the firm in the limited company, there was a transfer by way of distribution of capital assets. Further, according to the AO, on vesting of the properties of the firm in the company, there was a resultant dissolution of the firm. Therefore, according to the AO, both the conditions under s. 45(4) stood satisfied and, therefore, he was entitled to take the fair market value of the asset on the date of the transfer to be the full value of the consideration received as a result of the transfer. It is for this reason that the AO has computed the capital gains under s. 48 by referring to the comparative figures of the book value and the market value. As stated above, in this connection, the AO has computed capital gains arising to the assessee-firm at Rs. 9 lakhs on the basis of the difference between the market value and the written down value. The AO has taken the written down value as on 1st April, 1995, and he has taken the market value as on 8th Nov., 1995 (alleged date of transfer), and on that basis, he has computed the capital gains. However, as stated, computation under s. 45(4) r/w s. 48 would arise only if the aforestated two conditions are satisfied to attract s. 45(4) .

In this case, the erstwhile firm has been treated as a limited company by virtue of s. 575 of the Companies Act. It is not in dispute that in this case, the erstwhile firm became a limited company under Part-IX of the Companies Act. Now, s. 45(4) clearly stipulates that there should be transfer by way of distribution of capital assets. Under Part-IX of the Companies Act, when a partnership firm is treated as a limited company, the properties of the erstwhile firm vests in the limited company. The question is whether such vesting stands covered by the expression “transfer by way of distribution” in s. 45(4) of the Act. There is a difference between vesting of the property, in this case, in the limited company and distribution of the property. On vesting in the limited company under Part IX of the Companies Act, the properties vest in the company as they exist. On the other hand, distribution on dissolution pre-supposes division, realisation, encashment of assets and appropriation of the realised amount as per the priority like payment of taxes to the Government, BMC, etc., payment to unsecured creditors, etc. This difference is very important. This difference is amply brought out conceptually in the judgment of the Supreme Court in the case of Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC). In the present case, therefore, we are of the view that s. 45(4) is not attracted as the very first condition of transfer by way of distribution of capital assets is not satisfied. In the circumstances, the latter part of s. 45(4), which refers to computation of capital gains under s. 48 by treating fair market value of the asset on the date of transfer, does not arise.

(B) On s. 45(1)

6. As stated above, in this case we are concerned with the asst. yr. 1996-97. Therefore, in this case, we are not concerned with cl. (xiii) inserted by Finance Act (No. 2) of 1998 in s. 47 under which it is provided that where a firm is succeeded by a company in the business carried on by it as a result of sale or otherwise, of any capital assets, then such transaction shall not be regarded as transfer. This clause was inserted w.e.f. 1st April, 1999. Therefore, we are not concerned with that amendment. However, it provides a clue to the legislative intent. In our opinion, this clause has been introduced w.e.f. 1st April, 1999, in order to encourage more and more firms becoming limited companies. It also indicates the difference between transfer and transmission. Basically, when a firm is treated as a company under Part-IX, it is a case similar to transmission. This is amply made clear by cl. (xiii) to s. 47, which states that where a firm is succeeded by a company in the business, the transaction shall not be treated as a transfer. Now, this amendment has been made in s. 47 in view of the controversy arising on s. 45(1) r/w s. 2(47)(ii).

As stated above, s. 45(1) is a charging section. Sec. 45 read with the computation section viz., 48, etc., form one composite scheme. This point is very important. Sec. 45(1) provides that where any profit, arising from transfer of a capital asset is effected in the previous year then such profit shall be chargeable to income-tax under the head “Capital gains”. The expression “Transfer of a capital asset” in s. 45(1) is required to be r/w s. 2(47)(ii) which states that transfer in relation to a capital asset shall include extinguishment of any rights therein. The moot point which arose on interpretation of s. 45(1) in numerous matters was that on extinguishment of the rights in the capital assets, there was a transfer and in certain cases of reconstitution of firms and introduction of new partners, there was a resultant extinguishment of the rights in the capital assets proportionately. In order to get over this controversy, and keeping in mind the object of encouraging firms being treated as companies, the controversy is resolved by the legislature by introducing cl. (xiii) in s. 47 w.e.f. 1st April, 1999.

Now, in the present case, it is argued on behalf of the Department before the Tribunal, for the first time, that in this case, on vesting of the properties of the erstwhile firm in the limited company, there was a transfer of capital assets and, therefore, it was chargeable to income-tax under the head “Capital gains” as, on such vesting, there was extinguishment of all right, title and interest in the capital assets qua the firm. We do not find any merit in this argument. In the present case, we are concerned with a partnership firm being treated as a company under the statutory provisions of Part-IX of the Companies Act. In such cases, the company succeeds the firm. Generally, in the case of a transfer of a capital asset, two important ingredients are : existence of a party and a counter-party and, secondly, incoming consideration qua the transferor. In our view, when a firm is treated as a company, the said two conditions are not attracted. There is no conveyance of the property executable in favour of the limited company. It is no doubt true that all properties of the firm vests in the limited company on the firm being treated as a company under Part-IX of the Companies Act, but that vesting is not consequent or incidental to a transfer. It is a statutory vesting of properties in the company as the firm is treated as a limited company. On vesting of all the properties statutorily in the company, the cloak given to the firm is replaced by a different cloak and the same firm is now treated as a company, after a given date. In the circumstances, in our view, there is no transfer of a capital asset as contemplated by s. 45(1) of the Act. Even assuming for the sake of argument that there is a transfer of a capital asset under s. 45(1) because of the definition of the word “transfer” in s. 2(47)(iii), even then we are of the view that liability to pay capital gains would not arise because s. 45(1) is required to be read with s. 48, which provides for mode of computation. These two sections are required to be read together as the charging section and the computation section constitute one package. Now, under s. 48 it is laid down, inter alia, that the income chargeable under the head “Capital gains” shall be computed by deducting from the full value of the consideration received or accrued as a result of the transfer, the cost of acquisition of the asset and the expenditure incurred in connection with the transfer. Sec. 45(4) is mutually exclusive to s. 45(1). Sec. 45(4) categorically states that where there is a transfer by way of distribution of capital assets and where such transfer is due to dissolution or otherwise of the firm, the AO was entitled to treat the market value of the asset on the date of the transfer as full value of the consideration received. This latter part of s. 45(4) is not there in s. 45(1). Therefore, one has to read the expression “full value of the consideration received/accruing” under s. 48 de hors s. 45(4) and if one reads s. 48 with s. 45(1) de hors s. 45(4) then the expression “full value of consideration” in s. 48 cannot be the market value of the capital asset on the date of transfer. In such a case, we have to read the said expression in the light of the two judgments of the Supreme Court in the case of CIT vs. George Henderson & Co. Ltd. (supra) and in the case of CIT vs. Gillanders Arbuthnot & Co. (supra) in which it has been held that the expression “full value of the consideration” does not mean the market value of the asset transferred, but it shall mean the price bargained for by the parties to the transaction. It has been further held that consideration for the transfer of a capital asset is what the transferor receives in lieu of the assets he parts with viz., money or money’s worth and, therefore, the very asset transferred or parted with cannot be the consideration for the transfer and, therefore, the expression “full value of the consideration” cannot be construed as having a reference to the market value of the asset transferred and that the said expression only means the full value of the things received by the transferor in exchange of the capital asset transferred by him. In the circumstances, even if we were to proceed on the basis that vesting in the company under Part-IX constituted transfer under s. 45(1), still the assessee ought to succeed because the firm can be assessed only if the full value of the consideration is received by the firm or if it accrues to the firm. In the present case, the company had allotted shares to the partners of the erstwhile firm, but that was in proportion to the capital of the partners in the erstwhile firm. That allotment of shares had no correlation with the vesting of the properties in the limited company under Part-IX of the Act. Lastly, s. 45(1) and s. 45(4) are mutually exclusive. Under s. 45(4) in cases of transfer by way of distribution and where such transfer is as a result of dissolution, the Department is certainly entitled to take the full market value of the asset as full value of consideration provided there is transfer by distribution of assets. In this case, we have held that there is no such transfer by way of distribution and, therefore, s. 45(1) is not applicable. This deeming provision, regarding full value of consideration, is not there in s. 45(1) r/w s. 48. If one reads s. 45(1) with s. 48, it is clear that the former is a charging section and if that section is applicable, the computation has to be done under s. 48, which only refers to deductions from full value of consideration received or accruing. Sec. 48 does not empower the AO to take market value as full value of consideration as in the case of s. 45(4). In the circumstances, even if we were to hold that vesting amounts to transfer, the computation is not possible because it has been laid down in the above judgment of the Supreme Court that full consideration cannot be construed to mean market value of the asset transferred. The legislature, in its wisdom, has amended only s. 45(4) by which the market value of the asset on the date of the transfer is deemed to be the full value of consideration. However, such amendment is not there in s. 45(1).

In the circumstances, neither s. 45(1) nor s. 45(4) stand attracted.

(C) On disallowance of claim for depreciation

7. In this case we are concerned with asst. yr. 1996-97. Sec. 32 provides for allowance of depreciation in respect of assets owned by the assessee and used for the purpose of the business. Prior to 1st April, 1988, the allowance was subject to conditions prescribed in s. 34. At that time, s. 34(2)(ii) provided that no depreciation shall be allowed in respect of assets sold, discarded, demolished or destroyed. After 1st April, 1988, s. 34(2)(ii) is succeeded by s. 43(6)(c)(i)(B). There is no difference in the phraseology between s. 34(2)(ii) and s. 43(6)(c)(i)(B). According to the Department, on 1st April, 1995, the assets stood in the name of the former firm, but on 8th Nov., 1995, they stood transferred by virtue of vesting to the limited company and, therefore, on 31st March, 1995, the assets were not owned by the assessee, because they were transferred during the year to the limited company and in the circumstances, the assessee was not entitled to claim depreciation. An identical point arose before the Madras High Court in the case of A.M.F. Mudaliar vs. CIT (supra). In that matter, s. 34(2)(ii) came for interpretation. As stated above, the language of s. 34(2)(ii) is similar to s. 43(6)(c)(i)(B). It was held that s. 34(2)(ii) provided that no depreciation was to be allowed in respect of assets sold, discarded, demolished or destroyed, whereas the term “transfer” in s. 2(47) is only in relation to capital assets as defined under s. 2(14). That the term “transfer” was in relation to computation of capital gains under Chapter IV-E of the Act and, therefore, s. 2(47) cannot be invoked for the purposes of s. 32, particularly because the words used in s. 34(2)(ii) were “sold, discarded, demolished or destroyed” and not “transfer”. This judgment of the Madras High Court applies to the facts of our case. Lastly, there is no requirement for the firm to remain owner for the entire year. Hence disallowance by the AO on this count was erroneous.

Conclusion

8. Under the above circumstances, both the aforestated questions are answered in the affirmative i.e., in favour of the assessee and against the Department .
9. Accordingly, the appeal is disposed of. No order as to costs.

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INCOME TAX OFFICER vs. RAMESH M. SHAH

ITAT, MUMBAI ‘D’ BENCH

Satish Chandra, A.M. & H.S. Sidhu, J.M.

ITA No. 6098/Mum/1997

30th June, 2003

(2003) 22 CCH 0339 MumTrib

(2004) 2 SOT 0558

Legislation Referred to

Section 2(47), 45

Case pertains to

Asst. Year 1994-95

Decision in favour of:

Assessee

Capital gains—Transfer—Credit to capital account of retired partner on revaluation—Credit of amount to capital account of partner on his retirement on revaluation of assets as per partnership law does not involve ‘transfer’ hence no capital gains arise—CIT vs. R. Lingmallu Raghukumar (2001) 166 CTR (SC) 398 : (2001) 247 ITR 801 (SC) and Tribuvandas G. Patel vs. CIT (1999) 157 CTR (SC) 519 : (1999) 236 ITR 515 (SC) followed

(Para 6)

Conclusion:

Credit of amount to capital account of partner on his retirement on revaluation of assets as per partnership law does not involve ‘transfer’ hence no capital gains arise.

In favour of:

Assessee

Case referred to

Addl. CIT vs. Smt. Mahinderpal Bhasin 1978 CTR (All) 96 : (1979) 117 ITR 26 (All)

Addl. CIT vs. Mohanbhai Pamabhai (1987) 165 ITR 166 (SC)

Associated Engg. Construction Co. vs. Fourth ITO (1988) 27 ITD 380 (Bom)

CIT vs. Bhaichand H. Gandhi (1983) 141 ITR 67 (Bom)

CIT vs. H.R. Aslot (1978) 115 ITR 255 (Bom)

CIT vs. Hind Construction Ltd. 1974 CTR (SC) 157 : (1972) 83 ITR 211 (SC)

CIT vs. Madan Lal Bhargava (1980) 122 ITR 545 (All)

CIT vs. Tribhuvandas G. Patel (1978) 115 ITR 95 (Bom)

CIT vs. V.N. Palaniappa Gounder (1982) 31 CTR (Mad) 7 : (1983) 143 ITR 343 (Mad)

Hasmukhlal Mansukhlal Shah BCAJ 812 Jan. 1995

ITO vs. Suresh Sood (1990) 33 ITD 62 (Chd)

Sunil Siddarthbhai vs. CIT (1985) 49 CTR (SC) 172 : (1985) 156 ITR 509 (SC)

Counsel appeared:

Ajit Korde, for the Appellant : Jignesh R. Shah, for the Respondent

ORDER

SATISH CHANDRA, AM. :

ORDER

The appeal by the Revenue is directed against the order of the CIT(A)-XXXI, Mumbai, pertaining to the asst. yr. 1994-95.

2. The only grievance of the Revenue is that the CIT(A) erred in holding that the amount credited in the capital account of retired partner upon revaluation of assets of the firm is not taxable as capital gain.
3. The assessee is an individual. During the previous year relevant to the asst. yr. 1994-95, he retired from the firm, M/s Kevin Enterprises in which he had 25 per cent profit sharing ratio. The AO found that the assets of the firm are revalued and an amount of Rs. 12,50,000 was credited to the assessee’s capital account as his share of revaluation surplus. On query, it was stated before the AO in writing that revaluation of the assets by the firm was merely by book entries not involving any sale or transfer of assets and that proposition of taxing this share in revaluation surplus would amount to taxing notional profit. This was not acceptable to the AO who relying on the decisions in CIT vs. Tribhuvandas G. Patel (1978) 115 ITR 95 (Bom) and CIT vs. H.R. Aslot (1978) 115 ITR 255 (Bom) held that the assessee’s share of revaluation surplus arising on revaluation of assets of the partnership firm as on 13th Sept., 1993, is for assessing or relinquishing his interest on share in favour of the continuing partners and this transaction tantamount to transfer within the meaning of s. 2(47) of the Act and the gains arising therefrom is taxable as capital gains. Accordingly, he brought to tax, the amount of Rs. 12,50,000 as short-term capital gains.
4. On appeal, it was contended that the action of the AO was contrary to the Supreme Court decision in the case of Addl. CIT vs. Mohanbhai Pamabhai (1987) 165 ITR 166 (SC) and Sunil Siddarthbhai vs. CIT (1985) 49 CTR (SC) 172 : (1985) 156 ITR 509 (SC). Reference was also made to the decision of the Bombay Tribunal in Hasmukhlal Mansukhlal Shah BCAJ 812 Jan. 1995 and Associated Engg. Construction Co. vs. Fourth ITO (1988) 27 ITD 380 (Bom). Reliance was also placed on the decision of the Chandigarh Bench of the Tribunal in the case of ITO vs. Suresh Sood (1990) 33 ITD 62 (Chd). It was submitted before the CIT(A) that during assessment proceedings, it was stated before the AO that revaluation of the assets was merely by book entries not involving any sale or transfer and in CIT vs. Hind Construction Ltd. 1974 CTR (SC) 157 : (1972) 83 ITR 211 (SC), the apex Court held that mere revaluation of assets do not give rise to any taxable profits or gains. It was also pointed out that before the AO reliance was also placed on the decisions of Allahabad High Court reported at Addl. CIT vs. Smt. Mahinderpal Bhasin 1978 CTR (All) 96 : (1979) 117 ITR 26 (All), CIT vs. Madan Lal Bhargava (1980) 122 ITR 545 (All), Andhra Pradesh High Court decision in the case of CIT vs. Bhaichand H. Gandhi (1983) 141 ITR 67 (Bom) and Madras High Court decision in CIT vs. V.N. Palaniappa Gounder (1982) 31 CTR (Mad) 7 : (1983) 143 ITR 343 (Mad). The CIT(A) considered the submissions of the assessee. He perused the decisions relied upon by the parties and reached the conclusion that there is no case for the AO to hold that any capital gains arose when the assessee retired from the partnership firm in which he was a partner. Accordingly, he deleted the impugned addition. The Revenue is aggrieved.
5. The learned representatives of the parties have been heard, their arguments considered and records perused.
6. The learned Departmental Representative conceded that the issue is covered in favour of the assessee by the decision of the apex Court in Tribuvandas G. Patel vs. CIT (1999) 157 CTR (SC) 519 : (1999) 236 ITR 515 (SC) wherein their Lordships held that any sum received by the assessee as his share of value of goodwill is not assessable as capital gains, following the decision in CIT vs. B.C. Srinivas Setty (1981) 21 CTR (SC) 138 : (1981) 128 ITR 294 (SC) and that even where a partner retires and some amount is paid to him towards his share in the assets, it should be treated as falling under cl. (ii) of s. 47 and accordingly, cannot be assessed as capital gains, following the decision in Mohanbhai Pamabhai’s case (supra). In the subsequent decision in CIT vs. R. Lingmallu Raghukumar (2001) 166 CTR (SC) 398 : (2001) 247 ITR 801 (SC), their Lordships held that when a partner retires from a firm and the amount of his share in the partnership assets after deduction of liabilities and prior charges is determined on taking accounts in the manner prescribed by the partnership law, there is no element of transfer of interest in the partnership assets by the retired partner to the continuing partners and the amount received by the retiring partner is not capital gain under s. 45 of the IT Act, 1961. In this view of the matter, we do not find any substance in the appeal of the Revenue which we hereby reject.
7. In the result, the appeal is dismissed.

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ASSISTANT COMMISSIONER OF INCOME TAX vs. GOYAL DRESSES

ITAT, CHENNAI ‘A’ BENCH

H.S. Sidhu, J.M. & Shamim Yahya, A.M.

ITA No. 1478/Mad/2007; Asst. yr. 2004-05

22nd August, 2008

(2008) 27 CCH 0617 ChenTrib

(2009) 30 DTR 0075 : (2010) 126 ITD 0131

Legislation Referred to

Section 2(47), 45(1), 45(4)

Case pertains to

Asst. Year 2004-05

Decision in favour of:

Assessee

Capital gains—Applicability of s. 45(4)—Allotment of firm’s property to a retiring partner—Term used in s. 45(4) ‘distribution of capital assets on the dissolution of a firm or otherwise’ cannot be extrapolated to bring retirement of one partner into the ambit of this section—Hence, s. 45(4) has no application in the case of retirement of one partner—That apart, capital gain is not chargeable to tax also for the reason that the transfer of property to the retiring partner was necessitated on account of family arrangement to avoid a possible dispute—Dy. CIT vs. G.K. Enterprises (2003) 79 TTJ (Mad) 82, Kay Arr Enterprises vs. Jt. CIT (2006) 99 TTJ (Chennai) 411 : (2005) 97 ITD 291 (Chennai) and CIT vs. Kay Arr Enterprises & Ors. (2008) 215 CTR (Mad) 244 : (2008) 299 ITR 348 (Mad) followed; CIT vs. Kunnamkulam Mill Board (2002) 178 CTR (Ker) 356 : (2002) 257 ITR 544 (Ker) and Punjab Distilling Industries Ltd. vs. CIT (1965) 57 ITR 1 (SC) relied on

(Paras 9, 10 & 16)

Conclusion:

Sec. 45(4) has no application in the case of retirement of one partner; capital gain is not chargeable to tax on the facts of the case also for the reason that the transfer of property to the retiring partner was necessitated on account of family arrangement to avoid a possible dispute.

In favour of:

Assessee

Case referred to

CIT vs. A.L. Ramanathan (2000) 159 CTR (Mad) 255 : (2000) 245 ITR 494 (Mad)

CIT vs. A.N. Naik Associates & Ors. (2004) 187 CTR (Bom) 162 : (2004) 265 ITR 346 (Bom)

CIT vs. Podar Cement (P) Ltd. (1997) 141 CTR (SC) 67 : (1997) 226 ITR 625 (SC)

Mysore Minerals Ltd. vs. CIT (1999) 156 CTR (SC) 1 : (1999) 239 ITR 775 (SC)

Counsel appeared:

Shaji P. Jacob, for the Revenue : R. Vijayaraghavan, for the Assessee

ORDER

SHAMIM YAHYA, A.M. :

ORDER

This appeal by the Revenue is directed against the order of CIT(A)-VI, Chennai, dt. 16th March, 2007 and pertains to asst. yr. 2004-05.

2. The issue raised is that CIT(A) erred in deleting the addition made on account of long-term capital gains on the ground that s. 45(4) cannot be invoked in the present case.
3. In this case, the assessee is a partnership firm engaged in the business of manufacture and export of garments. The assessee has been carrying on its business for many decades (from the year 1960). There were seven partners in the assessee firm. During the relevant accounting year, Smt. Parama Devi, aged about 80 years, retired from the assessee firm. The remaining six partners continued the assessee’s business. Accordingly, the partnership was reconstituted vide a deed dt. 23rd Sept., 2003. It has been stated that Smt. Parama Devi due to her old age had been regularly expressing her desire to be relieved of her partnership on the condition that one property of the assessee firm is to be given to her in lieu of the amount payable to her on her retirement from the partnership. She also apprehended that disputes may arise in the family in relation to different properties which, in turn, may jeopardize the family peace and also the security of the family. She, therefore, desired that with a view to protecting the honour of the family and preserving its harmony, it was necessary that during her lifetime she made suitable arrangements in respect of her property/assets/interest in partnership, etc. so that the amity and goodwill are ensured among the family members. When Smt. Parama Devi expressed her desire about the retirement from the firm, the other partners thought that her retirement at this juncture might affect the financial interests of the assessee firm’s business, because her retirement would cause withdrawal of her capital from the firm. Therefore, other partners initially turned down her request. But, subsequently in view of the persistent claim made by Smt. Parama Devi, the other partners finally agreed to release one property of the firm in favour of the retiring partner in consideration of family arrangement and accordingly decided to execute a release deed dt. 22nd Sept., 2003. The property which was released in favour of Smt. Parama Devi represented a vacant land situated at Door Nos. 46 and 47, Chamiers Road (New No. 2, Arch Bishop Mathias Avenue), Chennai-28. As a result of this allotment of the impugned property to the retiring partner, capital gain was, however, not computed by the assessee firm because it was of the opinion that there was no dissolution of the firm at the time of retirement of Smt. Parama Devi and hence the transaction did not attract the provisions of s. 45(4) of the IT Act.
4. However, AO did not agree with the above contentions. AO also did not accept the contention that on analogical situation, Tribunal ‘B’ Bench, Chennai, in the case of Dy. CIT vs. G.K. Enterprises (2003) 79 TTJ (Mad) 82 had decided similar issue in favour of the assessee. AO was of the opinion that judgment of Hon’ble Bombay High Court in the case of CIT vs. A.N. Naik Associates & Ors. (2004) 187 CTR (Bom) 162 : (2004) 265 ITR 346 (Bom) brought the cases such as the present one under the purview of s. 45(4) of the IT Act. The AO also did not accept the contention that family arrangement involving transfer of assets could not be taken to be exigible to capital gains tax.
5. Upon assessee’s appeal learned CIT(A) elaborately considered the issue. He placed reliance upon Tribunal’s decision in G.K. Enterprises case (supra), above for the proposition that s. 45(4) would have no application in the case of retirement of a partner. He also held that a family arrangement cannot be considered as a ‘transfer’ for the purpose of capital gains. For this proposition, he placed reliance upon Hon’ble jurisdictional High Court decision in the case of CIT vs. A.L. Ramanathan (2000) 159 CTR (Mad) 255 : (2000) 245 ITR 494 (Mad) and also Tribunal, Chennai Bench ‘D’, decision in the case of Kay Arr Enterprises vs. Jt. CIT (2006) 99 TTJ (Chennai) 411 : (2005) 97 ITD 291 (Chennai). The learned CIT(A) further placed reliance upon Hon’ble Kerala High Court decision in the case of CIT vs. Kunnamkulam Mill Board (2002) 178 CTR (Ker) 356 : (2002) 257 ITR 544 (Ker) for the proposition that s. 45(4) is not attracted in the case of retirement. Accordingly, learned CIT(A) directed for deletion of the addition made under s. 45(4) on account of long-term capital gains. Against this order the Revenue is in appeal before us.
6. We have heard both the counsel and perused the relevant records. Learned counsel of the assessee argued that s. 45(4) cannot apply in this case where the case is only of retirement of one partner. The learned counsel further contended that in this case the ‘transfer’ occurred on account of family arrangement and in such a case, no ‘transfer’ so as to attract capital gain can be envisaged. In this regard, he relied upon decision of the Tribunal in Kay Arr Enterprises’ case (supra) and submitted that the same was confirmed by the Hon’ble jurisdictional High Court in the case of CIT vs. Kay Arr Enterprises & Ors. (2008) 215 CTR (Mad) 244 : (2008) 299 ITR 348 (Mad). The learned counsel further contended that s. 45(4) would not apply also because there is no consideration for the ‘transfer’ except for amicable family settlement. The learned counsel further argued that s. 45(4) uses the term ‘distribution’. He referred to Hon’ble apex Court exposition on ‘distribution’ in the case of Punjab Distilling Industries Ltd. vs. CIT (1965) 57 ITR 1 (SC). The Hon’ble apex Court had expounded on p. 9 that the expression ‘distribution’ necessarily involves the idea of division between several persons which is the same as payment to several persons. Accordingly, he claimed that ‘distribution’ cannot be said to be applicable to retirement of a single person.
7. The learned Departmental Representative, on the other hand vehemently supported the order of the AO. He argued that the decision of Hon’ble Bombay High Court in the case of A.N. Naik Associates & Ors.’ case (supra) above, is applicable. Hence, he argued that the G.K. Enterprises case (supra) of the Tribunal cited above and relied upon by the assessee would not apply. He contended that ‘judicial discipline’ requires that the ratio from Hon’ble Bombay High Court decision be applied in this case and the ‘transfer’ be treated as falling under s. 45(4) and accordingly exigible to long-term capital gains.
8. We have carefully considered the submissions and perused the relevant records. It would be gainful to reproduce hereunder s. 45(4) of the IT Act which reads as under :

“The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other AOP or BOI (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of s. 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.”

9. Now, the core of dispute here is whether the term ‘distribution of capital assets on the dissolution of a firm or other AOP or BOI or otherwise’ would include retirement of a partner from a firm. Hon’ble Bombay High Court in A.N. Naik Associates & Ors.’ case (supra) above was dealing with a case of transfer of assets to retiring partners. The Hon’ble High Court had held that the transfer of assets of the partnership to the retiring partners would amount to the transfer of capital assets in the nature of capital gains and business profits which were chargeable to tax under s. 45(4). Tribunal, Chennai Benches, in the case of G.K. Enterprises case (supra) had held that s. 45(4) would have no application in the case of retirement of a partner.
10. Hon’ble Kerala High Court in the Kunnamkulam Mill Board case (supra) above was dealing with a case where there was a change in the constitution of the firm with the retirement of five partners after receiving the credit balance in their accounts, that there had been a revaluation of the assets and it was the enhanced value of the assets that was credited equally in their accounts. The AO was of the opinion that five partners taking enhanced value for the assets on retirement amounted to a transfer of capital asset under s. 45(4). The CIT(A) and the Tribunal were of the opinion that s. 45(4) was not applicable in this case and this view was confirmed by the Hon’ble Kerala High Court. The Hon’ble High Court on p. 547 has held as under :

“Likewise, if a partner retires he does not transfer any right in the immovable property in favour of the surviving partner because he had no specific right with respect to the properties of the firm. What transpires is the right to share the income of the properties stood transferred in favour of the surviving partners, and there is no transfer of ownership of the property in such cases.”

In the background of aforesaid discussion, we find that in the cases being dealt with by the Hon’ble High Courts above, there was retirement of more than one partner. However, in the present case, there is retirement of only one partner. Hon’ble apex Court exposition on the meaning of the term ‘distribution’ in the Punjab Distilling Industries Ltd. case (supra) above is relevant here. Hon’ble apex Court has expounded that the expression ‘distribution’ necessarily involves the idea of division between several persons which is the same as payment to several persons. In this view of the matter, the term used in s. 45(4) ‘distribution of capital assets on the dissolution of a firm or otherwise’ cannot be extrapolated to bring retirement of one partner into the ambit of this section.

11. Though there is a decision of the Chennai Tribunal in G.K. Enterprises case (supra) above which favours the assessee, the decision of Hon’ble Bombay High Court in A.N. Naik Associates & Ors.’ case (supra) above has been claimed to be in favour of Revenue. We further find that there is a decision of Hon’ble Kerala High Court in the case of CIT vs. Kunnamkulam Mill Board (supra) which is in favour of the assessee. Admittedly, there is no Hon’ble jurisdictional High Court decision on the issue. It is also not the case of the Revenue that Tribunal decision in the G.K. Enterprises case (supra) has been reversed by the Hon’ble High Court. It has been only claimed that the case is pending before the Hon’ble High Court. We further find that Hon’ble apex Court has held that in cases where two views are possible, the one favourable to the assessee should be adopted. CIT vs. Podar Cement (P) Ltd. (1997) 141 CTR (SC) 67 : (1997) 226 ITR 625 (SC) and Mysore Minerals Ltd. vs. CIT (1999) 156 CTR (SC) 1 : (1999) 239 ITR 775 (SC). In the background of aforesaid discussion and precedent, we are of the opinion that there is no infirmity in the order of the learned CIT(A) in holding that s. 45(4) is not attracted on the facts of this case.
12. Another limb of assessee’s argument is that this is a case of family arrangement and hence capital gain would not be exigible. The detailed facts in this regard are already mentioned in para 3 above of this order. The submission of the assessee in this regard is briefly stated as under :

“A family arrangement cannot be considered as a transfer for the purpose of capital gains. A family settlement may be an arrangement or even an understanding between the members which resolves the family disputes and the rival claims of the members of family provided the settlement is bona fide and fair in the allotment of the properties amongst the family members. It is the settled proposition of law that settlement of bona fide dispute, the purpose of which is to bring about harmony or maintaining peace and tranquility amongst the members of family is a valid and sufficient consideration for a family settlement so arrived at by the members of the family. The family settlement need not be necessarily in writing nor registration thereof is necessary. There can be oral family settlement also. Memorandum of settlement does not require registration. No transfer is involved in a family arrangement wherein each party takes a share in the property by virtue of the independent title which is admitted to the extent by the other parties.”

13. In this regard the AO had held that the transfer of asset is effected by the release and retirement deed and thereafter there was reconstruction of the partnership of the firm. Therefore, the assessee claimed that transfer of asset is solely because of family settlement does not hold good. He further held that provisions of s. 45(4) of the IT Act are attracted.
14. Learned CIT(A) in this regard accepted the contentions of the assessee. He observed that the nature of business and the address of the business premises of the firm remained unchanged. Hence, it was clear that the allotment of the immovable property to the retired partner, Smt. Parama Devi arose solely out of a family agreement. He further held that this kind of allotment arising out of family arrangement has been held to be not a ‘transfer’ for the purpose of capital gains by various Hon’ble Courts and Tribunals. In this case the assessee firm was in existence right from 1960 and was regularly assessed to tax. The family agreement/release deed did not contemplate dissolution of the firm on retirement of Smt. Parama Devi. There was no denial of the fact that there was possible family dispute among the partners and in order to resolve the said dispute, family arrangement was resorted to, the genuineness of which was not disputed by the AO. He further held that Smt. Parama Devi became a partner in the year 1982. The impugned property which was allotted was not brought by her into the partnership business. On the contrary, the property was purchased by the firm in the year 1973-74. There was no bar in the family arrangement to reconstitute the firm. Under these circumstances, the reconstitution of firm cannot be held to be a colourable device, just because this arrangement had resulted in saving of tax on account of capital gain. Hence, the learned CIT(A) finally concluded that no business income, which would have otherwise been taxed, was found to have been avoided on account of this family arrangement/release of property/reconstitution of the firm.
15. From the above, it is amply clear that there is considerable cogency in the plea that the transfer was necessitated under a family arrangement. We find that this Tribunal in the case of Kay Arr Enterprises vs. Jt. CIT (2006) 99 TTJ (Chennai) 411 : (2005) 97 ITD 291 (Chennai) : (2005) 279 ITR 163 (Chennai)(AT) to which one of us AM was a party, had held that transfers in case of family arrangement could not be said to be falling under s. 2(47) and hence the same was not exigible to capital gains tax. Hon’ble Madras High Court in (2008) 215 CTR (Mad) 244 : (2008) 299 ITR 348 (Mad) (supra) had affirmed the said order. The Hon’ble High Court held as under :

“It is settled law that when parties enter into a family arrangement, the validity of the family arrangement is not to be judged with reference to whether the parties who raised disputes or rights or claimed rights in certain properties had in law any such right or not.

Held, dismissing the appeal, that the Tribunal had rightly found that the transfer of shares by way of family arrangement would not attract capital gains tax, as the same was a prudent arrangement to avoid possible litigation among the family members and was made voluntarily and not induced by any fraud or coercion and therefore, could not be doubted. The Tribunal was justified in arriving at the conclusion that the family arrangement among the assessees did not amount to any transfer and hence was not exigible to capital gains tax.”

16. Thus, the angle of consideration that the ‘transfer’ was necessitated on account of family arrangement, also supports the view that no capital gain is attracted in this case. Hence, we do not find any infirmity in the order of the learned CIT(A) in this aspect also. Hence, the order of the learned CIT(A) is confirmed and the issue is decided in favour of the assessee.
17. In the result, this appeal by the Revenue is dismissed.

*******

COMMISSIONER OF INCOME TAX vs. A.N. NAIK ASSOCIATES*

HIGH COURT OF BOMBAY : PANAJI BENCH

F.I. Rebello & P.V. Hardas, JJ.

Tax Appeal No. 50 of 2002

23rd July, 2003

(2003) 71 CCH 0628 MumHC

(2004) 187 CTR 0162 : (2004) 265 ITR 0346 : (2004) 136 TAXMAN 0107

Legislation Referred to

Sections 2(47), 45(3), 45(4), 47(ii)

Case pertains to

Asst. Year 1997-98

Decision in favour of:

Revenue

Capital gains—Applicability of s. 45(4)—Reconstitution of firm—Expression “otherwise” in s. 45(4) is not to be read ejusdem generis with the expression “dissolution of a firm or body or AOP”—Expression “otherwise” has to be read with the words “transfer of capital assets” by way of distribution of capital assets—Therefore, the word “otherwise” takes within its sweep not only cases of dissolution but also cases of subsisting partners of a partnership transferring assets in favour of a retiring partner—Contention that s. 2(47) has not been amended and consequently even if s. 45(4) has been brought in by the amendment yet there is no transfer on distribution of assets by firm is not correct—Instead of amending s. 2(47), amendment was carried out by Finance Act, 1987, by omitting cl. (ii) of s. 47, the result of which is that the distribution of capital assets on the dissolution of a firm would be regarded as “transfer”—Thus, there was clearly a transfer on distribution of assets on retirement of partners and same was liable to tax as capital gains

Held :

The documents would clearly show that before the continuing partners retired there was an induction of a new partner in the morning of the said day and the outgoing partners retired at the closing of business hours on that day. In other words, the partnership subsisted but with two partners and the business also continued. That would, therefore, not amount to dissolution of the firm and clearly, therefore, the order of the Tribunal cannot be faulted. It has recorded a finding that there is no dissolution of the partnership as contemplated under s. 40 of the Indian Partnership Act.—Erach F.D. Mehta vs. Minoo F.D. Mehta AIR 1971 SC 1653 and Mir Abdul Khaliq vs. Abdul Gaffar Sheriff AIR 1985 SC 608 distinguished.

(Para 9)

The Tribunal has held that the firm was in existence right from 1985 and it was not a device to avoid tax. It was noted that there was no denial that there were family disputes amongst the partners and the genesis of family arrangement was not disputed. The arrangement by way of division of the assets and business interest was clearly defined and were not an isolated transaction in respect of the appellant firms. The Tribunal noted that from the memorandum of family arrangement, there was no contemplation of dissolution of the firm but reconstitution of the firm. The saving of tax was only a consequence of a normal event. The family settlement only provides the manner in which the assets of the family would be separated. The settlement itself contemplated various steps to be taken for giving effect to the family settlement. Therefore, the finding by the Tribunal that the deed of reconstitution by inducting a partner in the assessee-firm was not a device to avoid tax has to be upheld.

(Para 11)

Sec. 45 is a charging section. The purpose and object of the Act of 1987 was to charge tax arising on distribution of capital assets of firms which otherwise was not subject to taxation. If the language of sub-s. (4) is construed to mean that the expression “otherwise” has to partake of the nature of dissolution or deemed dissolution, then the very object of the amendment could be defeated by the partners, by distributing the assets to some partners who may retire. The firm then would not be liable to be taxed thus defeating the very purpose of the Amending Act. Parliament with the avowed object of blocking escape route for avoiding capital gains tax by the Finance Act, 1987, has introduced sub-s. (3) to s. 45. The effect of this was that the profits and gains arising from the transfer of a capital asset by a partner to a firm are chargeable as the partner’s income of the previous year in which the transfer took place. Conversion of the partnership assets into individual assets on dissolution or otherwise also formed part of the same scheme of tax avoidance. To plug this loophole the Finance Act, 1987, brought on the statute book a new sub-s. (4) in s. 45. The effect is that the profits or gains arising from the transfer of a capital asset by a firm to a partner on dissolution or otherwise would be chargeable as the firm’s income in the previous year in which the transfer took place and for the purposes of computation of capital gains, the fair market value of the asset on the date of transfer would be deemed to be the full value of the consideration received or accrued as a result of the transfer. Therefore, if the object of the Act is seen and the mischief it seeks to avoid, it would be clear that the intention of Parliament was to bring into the tax net transactions whereby assets were brought into a firm or taken out of the firm. The expression “otherwise” has not to be read ejusdem generis with the expression, “dissolution of a firm or body or AOP”. The expression “otherwise” has to be read with the words “transfer of capital assets” by way of distribution of capital assets. If so read, it becomes clear that even when a firm is in existence and there is a transfer of capital assets it comes within the expression “otherwise” as the object of the Amending Act was to remove the loophole which existed whereby capital gain tax was not chargeable. Therefore, when the asset of the partnership is transferred to a retiring partner, the partnership which is assessable to tax ceases to have a right or its right in the property stands extinguished in favour of the partner to whom it is transferred. If so read it will further the object and the purpose and intent of the amendment of s. 45. Once, that be the case, it has to be held that the transfer of assets of the partnership to the retiring partners would amount to the transfer of the capital assets in the nature of capital gains and business profits which is chargeable to tax under s. 45(4). Therefore, the word “otherwise” takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner.—A.L.A. Firm vs. CIT (1991) 93 CTR (SC) 133 : (1991) 189 ITR 285 (SC), Sakti Trading Co. vs. CIT (2001) 169 CTR (SC) 297 : (2001) 250 ITR 871 (SC), Sunil Siddharthbhai vs. CIT (1985) 49 CTR (SC) 172 : (1985) 156 ITR 509 (SC), CIT vs. Vijayalakshmi Metal Industries (2002) 177 CTR (Mad) 43 : (2002) 256 ITR 540 (Mad), CIT vs. Kunnamkulam Mill Board (2002) 178 CTR (Ker) 356 : (2002) 257 ITR 544 (Ker) and Tribhuvandas G. Patel vs. CIT (1999) 157 CTR (SC) 519 : (1999) 236 ITR 515 (SC) distinguished.

(Paras 25 & 26)

The contention that s. 2(47) has not been amended and consequently even if s. 45(4) has been brought in by the amendment yet there is no transfer, is not sustainable. Firstly, the definition of transfer itself is inclusive. Before the introduction of sub-s. (4), there was cl. (ii) of s. 47. Clause (ii) as earlier contained in s. 47, meant that the distribution of capital assets on the dissolution of a firm, etc., were not regarded as “transfer”. The Finance Act, 1987, w.e.f. 1st April, 1988, omitted this clause, the effect of which is that distribution of capital assets on the dissolution of a firm would henceforth be regarded as “transfer”. Therefore, instead of amending s. 2(47), the amendment was carried out by the Finance Act, 1987, by omitting s. 47(ii), the result of which is that distribution of capital assets on the dissolution of a firm would be regarded as “transfer”. Therefore, the contention that it would not amount to a transfer has to be rejected. It is now clear that when the asset is transferred to a partner, that falls within the expression “otherwise” and the rights of the other partners in that asset of the partnership are extinguished. That was also the position earlier but considering that on retirement the partner only got his share, it was held that there was no extinguishment of right. Considering the amendment, there is clearly a transfer and if, there be a transfer, it would be subject to capital gains tax.

(Para 27)

Conclusion :

Word “otherwise” in s. 45(4) takes within its sweep not only cases of dissolution but also cases of subsisting partners of a partnership transferring assets in favour of a retiring partner and, therefore, transfer of assets of the partnership to the retiring partners would amount to transfer of capital assets chargeable to tax under s. 45(4).

Cases referred:

Addl. CIT vs. Mohanbhai Pamabhai (1987) 165 ITR 166 (SC)

B.T. Patil & Sons vs. CGT (1996) 134 CTR (Kar) 77 : (1997) 224 ITR 431 (Kar)

B.T. Patil & Sons vs. CGT (2000) 163 CTR (SC) 363 : (2001) 247 ITR 588 (SC)

CGT vs. N.S. Getti Chettiar 1972 CTR (SC) 349 : (1971) 82 ITR 599 (SC)

CIT vs. B.C. Srinivasa Setty (1981) 21 CTR (SC) 138 : (1981) 128 ITR 294 (SC)

CIT vs. L. Raghu Kumar (1982) 31 CTR (AP) 192 : (1983) 141 ITR 674 (AP)

CIT vs. Mohanbhai Pamabhai (1973) 91 ITR 393 (Guj)

CIT vs. P. Lingamullu Raghukumar (2001) 166 CTR (SC) 398 : (2001) 247 ITR 801 (SC)

CIT vs. Trustees of Abdulcadar Ebrahim Trust (1975) 100 ITR 85 (Bom)

Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC)

McDowell & Co. Ltd. vs. CTO (1985) 47 CTR (SC) 126 : (1985) 154 ITR 148 (SC)

1. Bagavathy Ammal vs. CIT (2003) 179 CTR (SC) 458 : (2003) 259 ITR 678 (SC)

Ram Charan Das vs. Girja Nandini Devi AIR 1966 SC 323

Counsel appeared:

S.R. Rivonkar, for the Appellant : A.N.S. Nadkarni with H.D. Naik, for the Respondents

F.I. REBELLO, J.:

*Also, CIT vs. Rangavi Realtors (Tax Appeal No. 55 of 2002)

Judgment

Both these appeals can be disposed of by a common order as the facts involved are the same and similar questions of law arise.

The respondents hereto were parties to a family settlement dt. 30th Jan., 1997. Pursuant to the said family settlement, there was a deed of reconstitution of various partnerships as set out under the family settlement. For the asst. yr. 1997-98, the partnerships were taxed for capital gains under s. 45(4) of the IT Act, 1961. An appeal was preferred against the said order by the assessee which came to be dismissed by the appellate authority by order dt. 16th June, 2000. An appeal was then preferred to the Tribunal, by the assessee. The appeal was allowed. The Tribunal held that there was no dissolution but only reconstitution. The Tribunal also held that the expression “otherwise” had to be read ejusdem generis and would contemplate situations like a deemed dissolution and consequently held that tax on capital gains was not chargeable. On the facts, it was held that the business continued to be run and there was no dissolution of the firm and consequently s. 45(4) of the Act was not attracted.

2. The present appeals are preferred by the Revenue and various questions were framed. At the time of hearing, however, the following questions of law have been formulated for consideration which are as under :

“1. Whether the deed of family settlement dt. 30th Jan., 1997, amounts to dissolution of partnership formed by agreement as contemplated under s. 40 of the Indian Partnership Act ?

2. Whether the distribution of assets of the firm amongst the retiring partners dt. 30th Jan., 1997, and the deed of reconstitution dt. 30th Jan., 1997, would amount to transfer of the capital assets which is in the nature of capital gains and business profits chargeable to tax under s. 45(4) of the IT Act ?
3. Whether the word ‘otherwise’, in s. 45(4) takes into its sweep not only cases akin to dissolution of the firm but also cases of reconstitution of firm ?
4. Whether the deed of reconstitution of partnership by the assessee-firm is a device to avoid tax ?
5. Whether, on the facts and circumstances of the case, the Tribunal was justified in law in setting aside the assessment order by holding that there is no dissolution ?”
6. By the memorandum of family settlement dt. 30th Jan., 1997, it was agreed between the parties thereto, that business of six firms as set out therein would be distributed in terms of the family settlement as the parties desired that various matters concerning the business and assets thereto be divided separately and partitioned. The deed also recited that resorting to civil suits would damage the family since the entire business is a family business, the nucleus having been inherited. Under the terms and conditions of the settlement, it was set out that the assets which are proposed to be divided in partition under the settlement are held by the aforesaid firms and individual partners. With reference to the firms, the manner in which the firms were to be reconstituted by retirement and admission of new partners was also set out. It also provided that such of those assets or liabilities belonging to or due from any of the firms allotted to parties thereto in the schedule annexed shall be transferred or assigned irrevocably and possession made over and all such documents, deeds, declarations, affidavits, petitions, letters and alike as are reasonably required by the party entitled to such transfer would be effected. It is based on this document and the subsequent deeds of retirement of partnership that the order of assessment was made holding that the appellants are liable for tax on capital gains.
7. The relevant portion of s. 45, with which we are concerned is sub-s. (4) which reads as under :

“The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other AOP or BOI (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of s. 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of he transfer.”

5. Sub-s. (4) along with sub-s. (3) were introduced by the Finance Act, 1987, w.e.f. 1st April, 1988. From a reading of the above sub-section to attract capital gains what would be required would be as under :

“1. Transfer of capital asset by way of distribution of capital assets :

(a) on account of dissolution of a firm;

(b) or other AOP;

(c) or BOI ;

(d) or otherwise;

shall be chargeable to tax as the income of the firm, association or body of persons.”

6. On behalf of the Revenue, it is contended that the deed of family settlement dt. 30th Jan., 1997, amounts to dissolution of the partnership and the distribution of assets amongst the partners, even if it may be, by entries in the books, would amount to transfer of capital assets, to which the provisions of s. 45(4) would be attracted. Independently, it is contended that even if there be no dissolution, the expression “otherwise” would have to be read to mean any transfer of assets of the firms in favour of any of the partners. It is also contended that the deed of reconstitution of partnership by the assessee-firm was merely a device to avoid tax and the Court should not encourage the same. In these circumstances, it is contended that the order in appeal be set aside and the reference answered in favour of the Revenue. On behalf of the Revenue, learned counsel for the Revenue from the deed of family settlement drew our attention to various terms wherein apart from some of the assets remaining with the firm, assets of the firm were allotted as part of the settlement to other partners. Reliance is placed on various judgments which would be adverted to in the course of the discussion.
7. On the other hand, on behalf of the assessee/respondents, it is contended that there was no dissolution of the firm nor discontinuance of business at any point of time. The registration of the firm continues to be the same. The written agreement would show that the partnership continued without dissolution. The business of the firm continued without any closing and assets of the firm remained with the partners without disruption. Family settlement in law does not result in transfer of assets or transfer of interest in property. The schedule of allocation of assets clearly states that a firm shall be taken over by the partners named therein. Even otherwise, the family arrangements arrived at did not suggest that there should be dissolution of the firm. Reliance has also been placed on various judgments which will be adverted to in the course of the discussion.
8. With the above, we may now proceed to answer the questions as formulated. Sec. 45 is the charging section. Under s. 45, there must be a transfer of a capital asset by way of distribution of assets in the first instance. Capital asset under s. 2(14) of the IT Act, 1961, has been defined to mean property of any kind held by an assessee. In other words, the property transferred must fall within the ambit of capital asset. The next relevant section is the expression “transfer” as set out in s. 2(47) which in relation to a capital asset includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein. We need not refer for the present discussion to the other part of the said definition. Therefore, transfer will also include relinquishment of the asset or extinguishment of any rights therein.
9. We first propose to answer the issue whether the deed of family settlement dt. 30th Jan., 1997, amounts to dissolution of the partnership firm by agreement under s. 40 of the Indian Partnership Act. The Revenue has firstly placed reliance in the case of Erach F.D. Mehta vs. Minoo F.D. Mehta AIR 1971 SC 1653. There the apex Court held on the facts therein that the agreement that one of the partners will retire amounts to dissolution of the partnership. In that case there were only two partners. The facts in our case are different. In Mir Abdul Khaliq vs. Abdul Gaffar Sheriff AIR 1985 SC 608, the apex Court held on the facts that the documents clearly showed that not only the named partner had retired from the partnership but, the firm consisting of three partners was dissolved on the date on which the partner was intimated. In that case, one of the persons had sent a letter to the bank intimating retirement of named partner and requesting for closing the account of the firm and opening a new account. It was on those facts that it was held that there was both retirement and dissolution of the partners. In the instant case, the documents would clearly show that before the continuing partners retired there was an induction of a new partner in the morning of the said day and the outgoing partners retired at the closing of business hours on that day. In other words, the partnership subsisted but with two partners and the business also continued. That would, therefore, not amount to dissolution of the firm and clearly, therefore, the order of the Tribunal cannot be faulted. It has recorded a finding that there is no dissolution of the partnership as contemplated under s. 40 of the Indian Partnership Act.
10. Before addressing ourselves to issues Nos. 2 and 3, we may now consider whether the deed of reconstitution by the parties of the assessee-firm is a device to avoid tax. It is contended that in fact, it is the family settlement under which the assets have been transferred and the purported deed of reconstitution is merely a device to avoid tax and in that context, reliance is placed on a judgment of the apex Court in McDowell & Co. Ltd. vs. CTO (1985) 47 CTR (SC) 126 : (1985) 154 ITR 148 (SC). The apex Court therein had observed as under :

“We must recognise that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is a pretence to say that avoidance of taxation is not unethical and that it stands on no less a moral plane than honest payment of taxation. In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it. A hint of this approach is to be found in the judgment of Desai J. in Wood Polymer Ltd., In re and Bengal Hotels Ltd. In re (1977) 47 Comp. Cas. 597 (Guj), where the learned Judge refused to accord sanction to the amalgamation of companies as it would lead to avoidance of tax.

It is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the Court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of ’emerging’ techniques of interpretation as was done in Ramsay, Burma Oil and Dawson, to expose the devices for what they really are and to refuse to give judicial benediction.”

11. This issue was an issue before the Tribunal. The Tribunal has held that the firm was in existence right from 1985 and it was not a device to avoid tax. It was noted that there was no denial that there were family disputes amongst the partners and the genesis of family arrangement was not disputed. The arrangement by way of division of the assets and business interest was clearly defined and were not an isolated transaction in respect of the appellant firms. The Tribunal noted that from the memorandum of family arrangement, there was no contemplation of dissolution of the firm but reconstitution of the firm. The saving of tax was only a consequence of a normal event. We are in agreement with the view taken that the family settlement only provides the manner in which the assets of the family would be separated. The settlement itself contemplated various steps to be taken for giving effect to the family settlement. In our opinion, therefore, the finding by the Tribunal that the deed of reconstitution by inducting a partner in the assessee-firm was not a device to avoid tax has to be upheld.
12. That leads us to the questions formulated under Nos. 2, 3 and 5, which will be required to be answered together. Let us examine whether a family settlement amounts to a transfer. The law on the subject is no longer res integra. In Ram Charan Das vs. Girja Nandini Devi AIR 1966 SC 323, the apex Court noted that a consideration for a family settlement is the expectation that such a settlement will result in establishing or ensuring amity and goodwill amongst the relations and that a family settlement does not amount to a transfer as in the family arrangement each party takes a share in the property by virtue of the independent title which is admitted to that extent by the other parties. Every party who takes benefit under it need not necessarily be shown to have a share in the property. All that is necessary to show is that the parties are related to each other in some way and have a possible claim to the property or a claim or even a semblance of a claim on some other ground as say affection.
13. The position in law in respect of transfer of assets of a subsisting partnership to a partner as his share or on dissolution of the firm before its amendment needs now to be considered. Let us first consider the judgment of the apex Court in Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC). In that case, there was a dissolution of firm and distribution of assets. The issue was whether the same amounts to transfer within the meaning of s. 2(47) of the IT Act, 1961. The apex Court considered the definition of expression “transfer” under s. 2(47) and noted that s. 2(47) gives an artificial meaning to the expression “transfer” for it not merely includes transactions of “sale” and “exchange” in ordinary parlance but would also mean “relinquishment” or “extinguishment of rights” which are ordinarily not included in that concept. In that context, the apex Court posed the question whether the dissolution of a firm extinguishes the firm’s rights in the assets of the partnership so as to constitute a transfer of assets under s. 2(47). After considering various judgments and the provisions of the Indian Partnership Act, the Court observed that a partnership under the Indian Partnership Act is not a distinct entity. If that be the position, the apex Court noted it would be difficult to accept the contention that upon dissolution the firm’s rights in the partnership assets are extinguished. The firm as such has no separate rights of its own in the partnership assets but it is the partners who own jointly or in common the assets of the partnership. Therefore, the consequence of the distribution, division or allotment of assets to the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm’s rights in the partnership assets amounting to a transfer of assets within the meaning of s. 2(47) of the Act. Proceeding further, the Court observed that every dissolution must be anterior to the actual distribution, division or allotment of the assets that takes place after making up accounts and discharging the debts and liabilities due by the firm and thereupon distribution, division or allotment of assets takes place. The distribution to the partners is not done by the dissolved firm and in that sense there is no transfer of assets by the assessee to any person.
14. In CIT vs. B.C. Srinivasa Setty (1981) 21 CTR (SC) 138 : (1981) 128 ITR 294 (SC), the apex Court was considering the question whether goodwill generated in a newly commenced business cannot be an “asset” within the meaning of s. 45 of the IT Act, 1961. Considering the provisions of s. 45(1) as it then stood and the definition of “capital asset” in s. 2(14) the Court came to the conclusion that goodwill generated in a newly commenced business cannot be described within the terms of s. 45 and, therefore, its transfer is not subject to income-tax under the head “Capital gains”.
15. In CIT vs. P. Lingamullu Raghukumar (2001) 166 CTR (SC) 398 : (2001) 247 ITR 801 (SC), in respect of an order of the Andhra Pradesh High Court dt. 21st July, 1982 [CIT vs. L. Raghu Kumar (1982) 31 CTR (AP) 192 : (1983) 141 ITR 674 (AP)], the apex Court once again reiterated that there is no element of transfer of interest in the partnership assets by the retired partner to the continuing partners. Reliance for that was placed in the judgment of CIT vs. Mohanbhai Pamabhai (1973) 91 ITR 393 (Guj) which had been affirmed by the apex Court in Addl. CIT vs. Mohanbhai Pamabhai (1987) 165 ITR 166 (SC). The Gujarat High Court had taken the view that when a retired partner receives a share of amount calculated on the value of the net goodwill of the firm there was no transfer of interest of the partner in the goodwill and no part of the amount received by him would be assessed as capital gain under s. 45 of the IT Act, 1961.
16. It may be noted that all these judgments were previous to the amendment brought about by the Act of 1987 which introduced sub-ss. (3) and (4) in s. 45, w.e.f. 1st April, 1988. Those judgments proceeded on the footing that a partnership firm is not a distinct legal entity and the partnership property in law belongs to all the partners constituting the firm, though the partnership firm may possess a personality distinct from the persons constituting it and, therefore, on dissolution, as the firm has no separate rights of its own in the partnership assets, the consequence of distribution, division or allotment of assets of the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm’s rights in the partnership assets amounting to a transfer of assets within the meaning of s. 2(47) of the Act.

Pursuant to the inclusion of sub-s. (4) in s. 45, on the dissolution of a partnership the profits or gains arising from the transfer of capital asset are chargeable to tax as income of the firm. It is contended on behalf of the assessee that even after introduction of s. 45(4), the position will be the same as the definition clause, i.e., namely, s. 2(47), has not been amended. Secondly, it is contended that the expression “otherwise” must be read ejusdem generis with the expression dissolution of firm. So considered, there is no dissolution on the facts of the case. On behalf of the Revenue, it was, however, argued that the amendment was brought about to remove the mischief occasioned by parties avoiding to pay tax, considering the law as declared and to plug the loopholes. The expression otherwise must be read to include transfer of capital assets of the assessee-firm to a partner. As the section is a self-contained code, there was no need to amend the definition of transfer under s. 2(47) of the Act. The position therefore, will have to be examined in the context of the law as amended after 1988. Before elaborating on the issue we may examine some judgments relied upon to find out, whether they are of assistance in answering the issue.

17. Our attention was invited to a judgment in A.L.A. Firm vs. CIT (1991) 93 CTR (SC) 133 : (1991) 189 ITR 285 (SC). A perusal of the said judgment would clearly show that what was an issue in that case is really not an issue in this case. What was really an issue in that case was the valuation of the stock-in-trade on dissolution of the firm.
18. In Sakti Trading Co. vs. CIT (2001) 169 CTR (SC) 297 : (2001) 250 ITR 871 (SC), the issue was whether on dissolution or death of one partner and reconstitution with the remaining partners without discontinuance of business how the valuation of the closing stock should be done. This judgment again in our opinion, also does not assist us in consideration of the issue which is before us.
19. In Sunil Siddharthbhai vs. CIT (1985) 49 CTR (SC) 172 : (1985) 156 ITR 509 (SC), the issue was as to what happens when the assessee brought the shares of the limited companies into the partnership firm as his contribution to its capital and whether there was a transfer of a capital asset within the meaning of s. 45 of the IT Act. It was answered in the affirmative as when the assessee transferred his shares to the partnership firm he received no consideration within the meaning of s. 48 of the IT Act, 1961, nor did any profit or gain accrue to him for the purpose of s. 45 of the Act, because the consideration received by the assessee on the transfer of his shares to the partnership firm does not fall within the contemplation of s. 48 and no profit or gain can be said to arise for the purposes of the Act. The apex Court considered two situations, one when a personal asset is brought by a partner into a partnership as his contribution to the partnership capital and that which arises when on dissolution of the firm or on retirement a share in the partnership assets passes to the partner. The Court held that on dissolution or on retirement what the partner gets is a shared interest in all the assets of the firm which is replaced by an exclusive interest in an asset of equal value. This judgment was in respect of an assessment before the amendment to s. 45.
20. In CIT vs. Vijayalakshmi Metal Industries (2002) 177 CTR (Mad) 43 : (2002) 256 ITR 540 (Mad), the real issue before the learned single Judge was as to when capital gain is to be brought to tax. The learned Judge held that until such time such capital asset is transferred by way of distribution of the assets on the dissolution of the firm no occasion arises for bringing to tax any capital gain on a transfer which has not taken place. The section itself gives no room for doubt as the year in which the capital gain is to be brought to tax is the previous year in which the said transfer takes place. This judgment would again be of no assistance.
21. In CIT vs. Kunnamkulam Mill Board (2002) 178 CTR (Ker) 356 : (2002) 257 ITR 544 (Ker) the assessment was for the year 1989-90. In that case, the real controversy was whether by retirement of a partner of the firm there is a transfer of the assets of the firm in favour of the surviving partners within the meaning of s. 45(4) of the Act. The Division Bench of the Kerala High Court answered the same in the negative by holding that there was no transfer of assets, by holding that as long as there is no change in ownership of the firm and its properties, there is no transfer of ownership on reconstitution of the firm. This is therefore, not a case, where the assets were allotted to a retiring partner.
22. Reliance has been placed in a judgment of the apex Court in CGT vs. N.S. Getti Chettiar 1972 CTR (SC) 349 : (1971) 82 ITR 599 (SC) to understand the expression “transfer”. It is observed therein that in spelling out the meaning one must take into consideration the setting in which those terms are used and the purpose that they are intended to serve. If so understood, it is clear that the word “disposition”, in the context, means giving away or giving up by a person of something, which was his own. Assignment means the transfer of the claim, right or property to another. In that case, the Court held that a partition in an HUF can be considered either as “disposition” or “conveyance” or “assignment” or “settlement” or “delivery” or “payment” or “alienation”. It is no doubt true that on behalf of the assessee, their learned counsel have placed reliance on Tribhuvandas G. Patel vs. CIT (1999) 157 CTR (SC) 519 : (1999) 236 ITR 515 (SC). Firstly, in that case, the matter pertains to an assessment before the Amendment Act came into force in 1988. The issue was in respect of the retirement of a partner from a partnership. The real issue in that case was whether a partner who has retired and had received his share of the assets would be liable to be taxed under s. 47.
23. We may now consider the judgment in B.T. Patil & Sons vs. CGT (1996) 134 CTR (Kar) 77 : (1997) 224 ITR 431 (Kar). We will advert to some facts. In that case, the issue before the Division Bench of the Karnataka High Court was, charging of gift-tax. In that case, there was a firm with five partners which owned several assets in the form of machinery. Certain debits were made to the respective accounts in July, 1977, stated to be the value of certain machinery distributed by the firm to the partners. Some machinery was given to the partners individually and one machine was given to all the five partners to be held by them jointly as co-owners. As a result, the firm ceased to be the owner of the said machinery and the five partners became the owners of the machinery so distributed either individually or as co-owners. The five partners shortly thereafter formed another partnership and contributed the machinery which was distributed to them by the assessee-firm to the new firm by doing valuation. The new firm thereafter sold the machinery for a price. The GTO treated the difference at the price at which the machinery was distributed by the assessee-firm to its partners as deemed gift and subjected the same to gift-tax. The issue was whether distribution of machinery was a transfer in the nature of sale, for a consideration. The Division Bench of the Karnataka High Court considered the expression of “transfer” under s. 2(xxiv) of the GT Act, which defines “transfer of property” as any disposition, conveyance, assignment, settlement, delivery or other alienation of property. The Division Bench noted that the Act was self-contained and the definition of “property” is to rope in artificial devices which may include mere agreements or arrangements, intended to confer gifts, which may not however, fall under the normal meaning of “transfer” as gifts and the definition of “gift” in s. 2(xii) to include many transactions which could not ordinarily be described as transfers of property and has a wider import than the meaning given to “gift” in s. 122 of the Transfer of Property Act. The Court after considering various judgments, held that the decisions which hold that there is no transfer of property when there is a distribution of assets on dissolution or when an asset is allotted to a partner on his retirement from the firm, will be inapplicable where an asset is brought in by the partner into the partnership. The Court then observed that it follows therefrom that they will be inapplicable, even in a converse situation where a firm distributes or gives its assets to its partner by debiting the value thereof to the respective partner’s account, without there being either dissolution or retirement. The Court noted that while dealing with the value of interest of each partner qua an asset cannot be isolated or carved out from the value of the partner’s interest in the totality of the partnership assets, once it is allotted, it becomes the individual property of the partner. The Court then proceeded to hold that, thus, the shared interest becomes the exclusive interest of a partner. When an asset of the firm is allotted to a partner during the subsistence/continuation of the partnership firm (as contrasted from an allotment on dissolution of the firm or retirement of the partner), the shared interest of all the partners in the said asset, is replaced by the exclusive interest of the allottee, for consideration. To that extent, there is an extinguishment of the interests of the other partners of the firm, in the partnership asset in question and enlargement of the limited interest of the allottee into a full exclusive right in the asset. When the asset is a partnership asset, a partner cannot claim or exercise any specific share or right over such asset to the extent of his share in the business of the partnership (as a co-owner can do in respect of a co-ownership property), as his right during the subsistence of the partnership is only to get his share of profits. But, on allotment of the asset by the firm to the partner, such partner becomes entitled to exercise over the asset, all rights of an absolute owner. The Court then proceeded to observe what was a mere interest on allotment by the firm, enlarges into an absolute right, title and interest. The extinguishment of the common interest of the partners of the firm and creation of absolute ownership of the partner to whom it is allotted. Such a transaction is, therefore, a transfer of property as defined in the GT Act. We may note that the partnership was subsisting and an asset of the partnership was made the absolute ownership of one of the subsisting partners.

This judgment came up for consideration before the apex Court in B.T. Patil & Sons vs. CGT (2000) 163 CTR (SC) 363 : (2001) 247 ITR 588 (SC) upholding the judgment of the Karnataka High Court. The apex Court observed as under :

“In our view, when there is a dissolution of a partnership or a partner retires and obtains in lieu of his interest in the firm, an asset of the firm, no transfer is involved .. . But the position is different when, during the subsistence of a partnership, an asset of the partnership becomes the asset of only one of the partners thereof; there is, in such a case, a transfer of that asset by the partnership to the individual partners.”

The ratio of the judgment as can be culled out is that when a subsisting partner receives from the firm an asset then there is a transfer of that asset from the partnership to the individual partner. In other words under the WT (sic) Act when an asset of the partnership becomes the asset of one of the partners it amounts to a transfer.

24. Before proceeding to further examine the matter, we may consider the judgment in N. Bagavathy Ammal vs. CIT (2003) 179 CTR (SC) 458 : (2003) 259 ITR 678 (SC). The apex Court therein took the view that in construing the provisions of s. 46(2) of the IT Act, 1961, the definition of “capital asset” in s. 2(14) had no relevance. In that case, no doubt what was in issue was s. 46(2) and what the apex Court was considering there was the distinction between “transfer of assets” and the distribution of the assets of the company under liquidation. The Court also observed that s. 46(2) is in terms an independent charging section and also provides for a distinct method of calculating capital gains.
25. With the above, we may now proceed to answer the issue. On retirement of a partner or partners from an existing firm, and who receives assets from the firm, the law before 1988 would really be of no support, as by s. 45(4) what was otherwise not taxable has been made taxable. Sec. 45(4) seems to have been introduced with a view to overcome the judgment of the apex Court in Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC) and other judgments which took a view that the firm on its own has no right but it is the partners who own jointly or in common the asset and thereby remedy the mischief occasioned. Distribution of capital assets on dissolution now is subject to capital gains tax unless it does not fall within the definition of transfer under s. 2(47). What would be the effect of partners of a subsisting partnership distributing assets to partners who retire from the partnership ? Does the asset of the partnership, on being allotted to the retired partner/partners fall within the expression “otherwise” ? As noted earlier on behalf of the assessee it has been contended that the expression “otherwise” would have to be read “ejusdem generis” with “dissolution of partnership or BOI” and for that purpose reliance was placed on a judgment of the Division Bench in CIT vs. Trustees of Abdulcadar Ebrahim Trust (1975) 100 ITR 85 (Bom). Sec. 45 is a charging section. The purpose and object of the Act of 1987 was to charge tax arising on distribution of capital assets of firms which otherwise was not subject to taxation. If the language of sub-s. (4) is construed to mean that the expression “otherwise” has to partake of the nature of dissolution or deemed dissolution, then the very object of the amendment could be defeated by the partners, by distributing the assets to some partners who may retire. The firm then would not be liable to be taxed thus defeating the very purpose of the Amending Act. Prior to the Finance Act, 1987, in the case of a partnership it was held that the assets are of the partners and not of the partnership. Therefore, if on retirement, a partner received his share of the assets, may be in the form of a single asset, it was held that there was no transfer and similarly on dissolution of the partnership. Another device resorted to by an assessee was to convert an asset held independently as an asset of the firm in which the individual was a partner. The decision of the Supreme Court in Sunil Siddharthbai vs. CIT/Kartikeya V. Sarabhai vs. CIT (supra) took a view that this would not amount to transfer and, therefore, fell outside the scope of the capital gain. The rationale being that the consideration for the transfer of the personal asset was indeterminate, being the right which arose or accrued to the partner during the subsistence of the partnership to get his share of profit from time to time and on dissolution of the partnership to get the value of his share from the net partnership asset. Parliament with the avowed object of blocking this escape route for avoiding capital gains tax by the Finance Act, 1987, has introduced sub-s. (3) to s. 45. The effect of this was that the profits and gains arising from the transfer of a capital asset by a partner to a firm are chargeable as the partner’s income of the previous year in which the transfer took place. On a conversion of the partnership assets into individual assets on dissolution or otherwise also formed part of the same scheme of tax avoidance. To plug this loophole the Finance Act, 1987, brought on the statute book a new sub-s. (4) in s. 45 of the Act. The effect is that the profits or gains arising from the transfer of a capital asset by a firm to a partner on dissolution or otherwise would be chargeable as the firm’s income in the previous year in which the transfer took place and for the purposes of computation of capital gains, the fair market value of the asset on the date of transfer would be deemed to be the full value of the consideration received or accrued as a result of the transfer. Therefore, if the object of the Act is seen and the mischief it seeks to avoid, it would be clear that the intention of Parliament was to bring into the tax net transactions whereby assets were brought into a firm or taken out of the firm.
26. The expression “otherwise” in our opinion, has not to be read ejusdem generis with the expression, “dissolution of a firm or body or AOP”. The expression “otherwise” has to be read with the words “transfer of capital assets” by way of distribution of capital assets. If so read, it becomes clear that even when a firm is in existence and there is a transfer of capital assets it comes within the expression “otherwise” as the object of the Amending Act was to remove the loophole which existed whereby capital gain tax was not chargeable. In our opinion, therefore, when the asset of the partnership is transferred to a retiring partner the partnership which is assessable to tax ceases to have a right or its right in the property stands extinguished in favour of the partner to whom it is transferred. If so read it will further the object and the purpose and intent of the amendment of s. 45. Once, that be the case, we will have to hold that the transfer of assets of the partnership to the retiring partners would amount to the transfer of the capital assets in the nature of capital gains and business profits which is chargeable to tax under s. 45(4) of the IT Act. We will, therefore, have to answer question No. 3 by holding that the word “otherwise” takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner.
27. The only other contention advanced is that s. 2(47) has not been amended and consequently even if s. 45(4) has been brought in by the amendment yet there is no transfer. In our opinion, that would not be the correct position. Firstly, the definition of transfer itself is inclusive. Before the introduction of sub-s. (4), there was cl. (ii) of s. 47 which read as under:

“any distribution of capital assets on the dissolution of a firm, BOI or other AOP.”

Considering this clause as earlier contained in s. 47, it meant that the distribution of capital assets on the dissolution of a firm, etc. were not regarded as “transfer”. The Finance Act, 1987, w.e.f. 1st April, 1988, omitted this clause, the effect of which is that distribution of capital assets on the dissolution of a firm would henceforth be regarded as “transfer”. Therefore, instead of amending s. 2(47), the amendment was carried out by the Finance Act, 1987, by omitting s. 47(ii), the result of which is that distribution of capital assets on the dissolution of a firm would be regarded as “transfer”. Therefore, the contention that it would not amount to a transfer has to be rejected. It is now clear that when the asset is transferred to a partner, that falls within the expression “otherwise” and the rights of the other partners in that asset of the partnership are extinguished. That was also the position earlier but considering that on retirement the partner only got his share, it was held that there was no extinguishment of right. Considering the amendment, there is clearly a transfer and if, there be a transfer, it would be subject to capital gains tax.

28. Considering the answers to questions Nos. 2 and 3, the orders of the Tribunal allowing the assessee’s appeal must be set aside and the order of assessment has to be restored. Question No. 5 has to be answered accordingly.
29. Both the appeals are accordingly allowed. In the circumstances of the case each party to bear their own costs.

*******

COMMISSIONER OF INCOME TAX vs. P.N. PANJAWANI

High court of Karnataka

1. Kumar &Ravi Malimath, JJ.

ITA Nos. 1316 to 1318/2006

12th March, 2012

(2012) 81 CCH 0114 KarHC

(2012) 80 DTR 0200 : (2013) 356 ITR 0676 (Karn) : (2012) 208 TAXMAN 0022

Legislation Referred to

Section2(47)

Case pertains to

Asst. Year1992-93

Decision in favour of:

Assessee

Relinquishment of right and interest—Transfer within terms of s. 2(47)—Long-term capital gain—Non-liability to tax u/s 45—AO held that there was relinquishment of right and interest insofar as 50% of interest of each of partners in erstwhile firm by means of assets made over to reconstituted firm which amounted to transfer within terms of s. 2(47)—Further, AO held that Rs. 3,46,84,942 was capital gain and accordingly, apportioned same from each of partners at Rs. 1,16,66,656 and called upon them to pay income tax on long-term capital gain of Rs. 23,04,329 with interest under s 234(A) and 234(B), in all in sum of Rs. 59,56,689—Further, CIT(A) held that property in form of land or landed property was not held by assessee partners in their own personal capacity—CIT(A) set aside order passed by assessing authority taxing assessee for capital gain—Further, Tribunal held that instant case was not case of transfer of property by three partners because firm was still subsisting and had not been dissolved—Therefore, it declined to interfere with well-considered order passed by appellate authority—Order upheld—Held, identity of firm as well as that of partners for taxability of income were separate and distinct—Firm was not taxed—It was individual partners who were taxed—As assessee was not owner of this capital asset, question of relinquishing their interest in that asset or extinguishment of their right in their asset would not arise—Moreover, erstwhile partners had not retired, they also continued to be partners along with incoming partners—Therefore, it was held that appellate authorities were right in holding that admission of new partners and assignment of right in firm to new partners out of rights of assessee for consideration did not amount to transfer in hands of assessee u/s 2(47) of Act and consequently not liable to tax u/s 45 of Act

Held :

Under the provisions of the Indian Partnership Act, 1932, the firm is not recognised as a legal entity. However, the Act recognises the firm as a distinct legally assessable entity apart from its partners in the context of the Act, the identity of the firm as well as that of the partners for taxability of income are separate and distinct. The firm is a separate taxable entity liable to pay tax on income arising or accruing to it because of its own distinct set of income earning activities and factors. Similarly, in the case of individual partners also. If there is a transfer effected by a firm of capital assets, ie property held by the firm, the capital gain tax arises in the hands of the firm and not in the hands of the partners and vice versa.

Section 45(3) of the Act, which was inserted by the Finance Act, 1987, which came into effect from 1 April 1988, deals with a person who transfers a capital assets to a firm as a capital contribution and becomes a partner of a firm. The income so derived is liable to be taxed at the hands of such member or partner. Whereas sub-s (4) of s 45 deals with profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm chargeable to tax as the income of the firm. Therefore, a clear distinction has been made between the income of the firm and income of the partner and the person who is transferring the capital assets being liable to pay capital gains.

The partnership firm came into existence in the year 1962. It acquired property in the year 1967. It carried on business up to 1992–1993 and returns were filed from time to time. It was only in the year 1995, revaluation was done, four new partners inducted who brought in cash and the firm was not dissolved, the incoming partners did not retire from the firm and it only reduced their share in the partnership firm. The erstwhile partners only reduced their share in the partnership firm and continued to be the partners of the reconstituted firm also. Therefore, it could not be said that either the firm was a dubious one or the entire transaction was a colourable device and the only object was to avoid payment of tax. As the assessee was not the owner of this capital asset, the question of relinquishing their interest in that asset or extinguishment of their right in their asset would not arise. The assets belong to the firm. The incoming partners paid money to the firm by way of their capital contribution. The firm as such had not relinquished its interest in favour of the incoming partners. On the contrary, by inducting them, they were also entitled to interest in the said assets.

Thus, the firm was not taxed. It was the individual partners who were taxed. Moreover, in the instant case, the erstwhile partners had not retired; they also continued to be the partners along with the incoming partners. All that had happened is that the shares of the erstwhile partners were reduced.

Therefore, it was held that the appellate authorities were right in holding that the admission of the new partners and assignment of right in the firm to the new partners out of the rights of the assessee for consideration did not amount to transfer in the hands of assessee under s 2(47) of the Act and consequently not liable to tax under s 45 of the Act. — McDowell Co Ltd v CIT AIR 1986 SC 649 ; Kartikeya V Sarsbhai v Commissioner of Income-tax [1997] 228 ITR 163 ; Commissioner of Income-tax v Gurunath Talkies [2010] 328 ITR 59 distinguished

Conclusion :

Admission of new partners and assignment of right in the firm to the new partners out of the rights of the assessee for consideration does not amount to transfer in the hands of assessee u/s 2(47) and consequently not liable to tax u/s 45.

In favour of :

Assessee

Cases referred:

Malbar Fisheries Co v CIT [1979] 120 ITR 49

Narayanappa v Bhaskara Krishnappa AIR 1966 SC 1300

Sunil Siddharthbhai v Commissioner of Income Tax [1985] 156 ITR 509 (SC)

Counsel appeared:

1. Kamaladharfor the Petitioner.:A. Shankar & M. Lava for the Respondent

JUDGMENT

1. As a common question of law is involved in all these three appeals, they are taken up for consideration together and disposed off by this common order.
2. The firm M/s.Kamal Industries was dealing in manufacturing and marketing of audio and video cassettes. The partnership was constituted on 05.04.1961. The firm owned property in the form of land situated at 6/2 and 6/3, Doddanakundi Industrial Road, Tubbarahalli village, Marathahaili measuring 1,67,765 sq.ft. The firm filed its return of income for the assessment year 1992-93. Afterwards, no returns were filed on the ground that the firm had stopped its activities and there was no income. In the books of account, the value of the land shown is at Rs.25,747/-, the value at which it was purchased in the year 1967. The value of the borewell, dining room and factory building along with the value of the land were shown at Rs.1,93,510/-. The firm revalued the assets as on 01.04.1995 and the opening value was at Rs.7/- crores. As on 31.03.1995, the firm consisted three partners each having equal share. The said partnership was reconstituted by a partnership deed dated 12.10.1995 admitting four more new partners. The four new partners contributed Rs.3.50 crores towards their share of capital. As a result of reconstitution of the firm, the assets hitherto owned by the firm of three partners were made over to the reconstituted firm, of seven partners. The result was that the interest of the three partners of the erstwhile firm which in the immovable property was reduced from 1/3rd to 1/6th or 16.67%. Therefore, the Assessing Authority held that there was a relinquishment of right and interest insofar as 50% of the interest of each of the partners in the erstwhile firm by means of assets made over to the reconstituted firm which amounted to transfer within the terms of Section 2(47) of the Income Tax Act, 1961 (for short hereinafter referred to as ‘the Act’). The erstwhile three partners after reconstitution of the firm have withdrawn a sum of Rs. 1,16,66,666/- each on 14.10.1995. According to the Assessing Authority, this amount represented the capital gain for relinquishment of their 50% of the right in the erstwhile partnership firm and its assets. Therefore, he framed an assessment order and accordingly held that Rs. 3,46,84,942/- is the capital gain and accordingly, apportioned the same from each of the partners at Rs. 1,16,66,656/- and called upon them to pay income tax on long term capital gain of Rs. 23,04,329/-with interest under Section 234(A) and 234(B), in all in a sum of Rs. 59,56,689/-. Aggrieved by the said order, the assessee preferred an appeal to the Commissioner of Income Tax (Appeals). The Appellate Authority after referring to Sections 45(1), 45(3) and 45(4) of the Act held that the facts of the case clearly suggest that the property in the form of the land or the landed property was certainly not held by the assessee partners in their own personal capacity. This landed property was actually an asset of the firm in its capacity as legal owner. This landed property belonged to the firm and stood in its name in the relevant legal documents of ownership and was reflected as such in its books of account also. Therefore, if at all there was a transfer of these assets or landed property from the firm to the incoming partners in which event it is the firm, which is to be taxed, and not the individual partners, It also held that reduction in the share of profit and loss of the firm on account of induction of new partners qualifies to be categorized as “capital gains” in the hands of the old and continuing partners, is not correct. None of the provisions of the Income Tax Act specifically envisages a situation where capital gains would be chargeable on account of reduction in the share of a partner in the firm following the reconstitution of the firm by way of induction of new partners. Therefore, a reduction in the share in a partnership firm on account of reconstitution of the firm by way of induction of new partners cannot be said to have effected a transfer of any kind even by an act of extinguishment. In view of the judgment of the Apex Court in the case of Malbar Fisheries Co. v. CIT [1979] 120 ITR 49, where it has been held that there is no transfer of assets even when distribution takes place upon dissolution of the firm. Therefore how can it be justified that there is a transfer of asset merely on reconstitution of the firm through induction of new partners and therefore, the Appellate Authority set aside the order passed by the Assessing Authority taxing the assessee for the capital gain. Aggrieved by the said order, the revenue preferred an appeal to the Tribunal. The Tribunal after taking note of the relevant provisions of the Income Tax Act as well as the Indian Partnership Act, 1932 and the judgments of the Apex Court held that the judgments relied on by the revenue would apply to a case where the firm, the assessee is not genuine and the action taken by the firm should lead to a situation of tax evasion. In the instant case, it is nobody’s case that the firm is not genuine. The firm even after the induction of new partners, continues to exist. Merely because, they did not carry on any business after induction of new partners is no ground to hold that it is not a genuine firm. Further held that the admission of a partner to the firm results in the reduction of the share of interest from the profit of the firm by virtue of reduction in the share of profit, but it is not the same as in transfer of property for valuable consideration in favour of the newly admitted partners. Therefore, in the instant case, it is not a case of transfer of property by the three partners because the firm is still subsisting and has not been dissolved. Therefore, it declined to interfere with the well-considered order passed by the Appellate Authority. Aggrieved by the said order, the revenue is in appeal.
3. The learned Counsel for the revenue assailing the impugned order contended that it is not disputed that the partnership firm was reconstituted by induction of four partners on 12.10.1985 who brought in Rs.3.50 crores towards share of capital. Prior to their induction, the three partners had 1/3rd share in the partnership firm and consequently, the property was owned by the partnership firm. After reconstitution, within two days i.e., on 14.10.1985 all the three assessees who are erstwhile partners of the old firm have withdrawn a sum of Rs. 1,16,66,666/- each, as their drawings i.e., the entire Rs.3.5 crores brought in by the incoming partners. After such reconstitution, the firm is not carrying on any business. Under these circumstances, the amount withdrawn by the partners represents the consideration for the reduction of their share capital percentage in the partnership and therefore, it falls within Section 45 (1) of the Act and they are liable to pay capital gains. In support of their contention, they relied on two judgments, one is of the Apex Court and another of this Court and contended that the impugned orders are liable to be set aside.
4. Per contra, the learned Counsel appearing for the assessee submitted that the aforesaid facts are not in dispute but it does not constitute transfer as defined under Section 2(47) read with Section 45(1) of the Act. Assuming it is to be treated as a transfer, then, the tax is to be levied at the hands of the firm and hot on individual partners. Admittedly, the partnership continues and the erstwhile partners continue to have interest in the partnership assets. Merely because, they have withdrawn money from the partnership firm, it does not constitute consideration for proportionate reduction in their share in the firm. Both the appellate authorities on a careful consideration of the facts and the law on the point have rightly upheld the contention of the assessee and it does not call for any interference and therefore, he submits that there is no merit in these appeals and are liable to be dismissed.
5. These appeals were admitted to consider the following substantial question of law
   “Whether the appellate authorities were right in holding that the admission of the new partners and assignment of right in the firm to the new partners out of the rights of the assessee for consideration does not amount to transfer in the hands of assessee under Sec. 2(47) of the Act and consequently not liable to tax under Sec.45 of the Act?”
6. The Assessing Authority relying on the judgment of the Apex Court in the case of Malbar Fisheries Co., (supra) has proceeded on the assumption that the partnership firm has no legal existence. The partnership property will vest in all the partners and in that sense, every partner has an interest in the property of the partnership. The partnership firm under the Indian Partnership Act, 1932 is not a distinct legal entity apart from the partners constituting it and equally in law, the firm as such has no separate rights on its own in the partnership assets and when one talks of the firm’s property or firm’s assets all that is meant is properties or assets in which all the partners have a joint or common interest. Therefore, he was of the view that the ownership of the properties vest in all the partners of the firm and no partner of a firm has got any independent interest in respect of the assets of the firm. But at the same time, the firm as such has no will of its own although, it is an assessable entity under the provisions of the Act. Therefore, he was of the view that when the existing three partners having a share of 1/3rd each in the assets of the firm have relinquished their 50% share i.e., from 1/3rd to 16.67% in favour of the four new partners on account of which each of the three partners were able to gain a sum of Rs. 1,16,66,666/- each. By the said relinquishment of their share by 50% it has resulted in a capital gain accrued even though the firm continued after its reconstitution. Further, he held that the capital gains arising in the hands of the partners of the erstwhile firm computed on the basis of reduction in their respective shares consequent to the admission of the new partners has to be brought to tax by holding that the reconstitution of the firm had the effect or relinquishment of the part of the rights of the old partners. He further relied on the judgment in McDowell Co. Ltd. v. CIT AIR 1986 SC 649 wherein it was held that tax planning may be legitimate, provided it is within the frame work of law. Colourable devices cannot be a part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay taxes honestly, without resorting to subterfuges. Therefore according to him, the assessee being one of the partners of the erstwhile firm having derived a gain in the process of revaluation and reconstitution of the firm is liable to capital gain tax to the extent of relinquishment of his rights in the assets of the erstwhile firm in favour of the four partners of the reconstituted firm. It is the correctness of this finding, which is before us.
7. The assessees are sought to be taxed under Section 45(1) of the Act on the ground that there is a transfer. The word ‘transfer’ has been defined in Section 2(47) of the Act as under-

“transfer”, in relation to a capital asset, includes,-

the sale, exchange or relinquishment of the asset; or

the extinguishment of any rights therein; or

the compulsory acquisition thereof under any law; or

in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment;][or]

[(iva) the maturity or redemption of a zero coupon bond; or]

[(v) any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882); or

(vi) any transaction (whether by way of becoming a member of, or acquiring shares in, or co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.

Explanation.- For the purpose of sub-clauses (v) and (vi), “immovable property” shall have the same meaning as in clause (d) of section 269UA;]”

8. Section 14 of the Indian Partnership Act, 1932 deals with the property of the firm, which reads as under:-

“14. The property of the firm – Subject to contract between the partners, the property of the firm includes all property and rights and interests in property originally brought into the stock of the firm, or acquired, by purchase or otherwise, by or for the firm, or for the purposes and in the course of the business of the firm, and includes also the goodwill of the business.

Unless the contrary intention appears, property and rights and interest in property acquired with money belonging to the firm are deemed to have been acquired for the firm.”

9. The Apex Court in the case of Narayanappa v. BhaskaraKrishnappa AIR 1966 SC 1300 dealing with the concept of partnership held as under:-

“The Whole concept of partnership is to embark upon a joint venture and for that purpose to bring in as capital money or even property including immovable property. Once that is done, whatever is brought in would cease to be the exclusive property of the person who brought it in. It would be the trading asset of the partnership in which all the partners would have interest in proportion to their share. The person who brought it in would, therefore, not be able to claim or exercise any exclusive right over any property which he has brought in, much less over any other partnership property. He would not be able to exercise his right even to the extent of his share in the partnership. His right during the subsistence of the partnership is to get his share of profits from time to time as may be agreed upon among the partners and after the dissolution of the partnership or with his retirement from the partnership, of the value of his share in the net partnership assets as on the date of dissolution or retirement after a deduction of liabilities and other prior charges.”

10. The Supreme Court in the case of Malbar Fisheries Co. v. CIT [1979] 120 ITR 49 explaining the position of a partnership under the Partnership Act as well as Income Tax Act held as under:-

“A Partnership Firm under the Indian Partnership Act, 1932, is not a distinct legal entity apart from the partners constituting it and equally in law the Firm as such has no separate rights of its own in the Partnership Assets and when one talks of firm’s property or the firm’s assets all that is meant is property or assets in which all partners have a joint or common interest. It cannot, therefore, be said that, upon dissolution, the firm’s rights in the partnership assets are extinguished. It is the partners who own jointly or in common the assets of the partnership and, therefore, the consequence of the distribution, division or allotment of assets to the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between partners and there is no question of any extinguishment of the firm’s rights in the partnership assets amounting to a transfer of assets within the meaning of sec.2(47) of the IT Act, 1961 There is no transfer of assets involved even in the sense of any extinguishment of the firm’s rights in the partnership assets when distribution takes place upon dissolution.

In order to attract S.34(3)(b) it is necessary that the sale or transfer of asset must be by the assessee to a person. Dissolution of a firm must, in point of time, be anterior to the actual distribution, division or allotment of the assets that takes place after making accounts and discharging the debts and liabilities due by the Firm. Upon dissolution the firm ceases to exist; then follows the making up of accounts, then the discharge of debts and liabilities and thereupon distribution, division or allotment of assets takes place inter se between the erstwhile partners by way of mutual adjustment of rights between them. The distribution, division, or allotment of assets of the erstwhile partners, it not done by the dissolved firm.”

11. The Apex Court in the case of Sunil Siddharthbhai v. Commissioner of Income Tax [1985] 156 ITR 509 (SC) at pages 518, 519, 520 and 522 held as under:-

”When a partner brings in his personal asset into a partnership firm as his contribution to its capital, an asset which originally was subject to the entire ownership of the partner becomes now subject to the rights of other partners in it. It is not an interest which can be evaluated immediately. It is an interest which is subject to the operation of future transactions of the partnership, and it may diminish in value depending on accumulating liabilities and losses with a fall in the prosperity of the partnership firm. The evaluation of a partner’s interest takes place only when there is a dissolution of the firm or upon his retirement from it. It has some times been said, and we think erroneously, that the right of a partner to a share in the assets of the partnership firm arises upon dissolution of the firm or upon the partner retiring from the firm. We think it necessary to state that what is envisaged here is merely the right to realise the interest and receive its value. What is realised is the interest, which the partner enjoys in the assets during the subsistence of the partnership firm by virtue of his status as a partner and in accordance with the terms of the partnership agreement.

What the partner gets upon dissolution or upon retirement is the realisation of a preexisting right or interest. It is nothing strange in the law that a right or interest should exist in praesenti but its realisation or exercise should be postponed. Therefore, what was the exclusive interest of a partner in his personal asset is, upon its introduction into the partnership firm as his share to the partnership capital, transformed into an interest shared with the other partners in that asset. Qua that asset, there is a shared interest. During the subsistence of the partnership, the value of the interest of each partner qua that asset cannot be isolated or carved out from the value of the partner’s interest in the totality of the partnership assets. And in regard to the latter, the value will be represented by his share in the net assets on the dissolution of the firm or upon the partner’s retirement.

What is the profit or gain which can be said to accrue or arise to the assessee when he makes over his personal asset to the partnership firm as his contribution to its capital? The consideration, as we have observed, is the right of a partner during the subsistence of the partnership to get his share of profits from time to time and after the dissolution of the partnership or with his retirement from the partnership to receive the value of the share in the net partnership assets as on the date of dissolution or retirement after a deduction of liabilities and prior charges. When his personal asset merges into the capital of the partnership firm a corresponding credit entry is made in the partner’s capital account in the books of the partnership firm, but that entry is made merely for the purpose of adjusting the rights of the partners inter se when the partnership is dissolved or the partner retires. It evidences no debt due by the firm to the partner. Indeed, the capital represented by the notional entry to the credit of the partner’s account may be completely wiped out by losses which may be subsequently incurred by the firm, even in the very accounting year in which the capital account is credited. Having regard to the nature and quality of the consideration which the partner may be said to acquire on introducing his personal asset into the partnership firm as his contribution to its capital it cannot be said that any income or gain arises or accrues to the assessee in the true commercial sense which a business man would understand as real income or gain.”

12. From the aforesaid judgments, it is clear that under the provisions of the Indian Partnership Act, 1932, the firm is not recognised as a legal entity. However, the Income Tax Act recognises the firm as a distinct legally assessable entity apart from its partners. This is clear from Sections 45(1), (3) and (4), of the Income Tax Act which reads as under :

“45. [(1)] Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections [***] [54, [54B, [***], [54D, [54E, [54EA, 54EB,] 54F [, 54G and 54H]]]]], be chargeable to income tax under the head “Capital gains”, and shall be deemed to be the income of the previous year in which the transfer took place.

[(1A) Notwithstanding anything contained in sub-section (1), where any person receives at any time during any previous year any money or other assets under an insurance from an insurer on account of damage to, or destruction of, any capital asset, as a result of-

(i) flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or

(ii) riot or civil disturbance; or

(iii) accidental fire or explosion; or

action by an enemy or action taken in combating an enemy (whether with or without a declaration of war),

then, any profits or gains arising from receipt of such money or other assets shall be chargeable to income-tax under the head “Capital gains” and shall be deemed to be the income of such person of the previous year in which such money or other asset was received and for the purposes of section 48, value of any money or the fair market value of other assets on the date of such receipt shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital asset.

Explanation,- For the purposes of this sub-section, the expression “insurer” shall have the meaning assigned to it in clause (9) of section 2 of the Insurance Act, 1938 (4 of 1938)]

(2) xxx

[(3) The profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a co-operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48, the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.

(4) The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as result of the transfer]”

13. Section 2(31) of the Income Tax Act defines ‘person’ as follows:-

(31) ” person” includes-

an individual,

a Hindu undivided family,

a company,

a firm,

(v) an association of persons or a body of individuals, whether incorporated or not,

(vi) a local authority, and

(vii) every artificial juridical person, not falling within any of the preceding sub- clauses;

[Explanation – For the purposes of this clause, an association of persons or a body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits or gains;]”

14. Therefore, from the aforesaid provisions, it is clear that in the context of the Income Tax Act, the identity of the firm as well as that of the partners for taxability of income are separate and distinct. The firm is a separate taxable entity liable to pay tax on income arising or accruing to it because of its own distinct set of income earning activities and factors. Similarly, in the case of individual partners also. If there is a transfer effected by a firm of capital assets i.e., property held by the firm, the capital gain tax arises in the hands of the firm and not in the hands of the partners and vice versa.
15. Section 45(3) of the Act, which was inserted by the Finance Act, 1987, which came into effect from 01.04.1988, deals with a person who transfers a capital assets to a firm as a capital contribution and becomes a partner of a firm. The income so derived is liable to be taxed at the hands of such member or partner. Whereas sub-Section (4) of Section 45 deals with profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm chargeable to tax as the income of the firm. Therefore, a clear distinction has been made between the income of the firm and income of the partner and the person who is transferring the capital assets being liable to pay capital gains.
16. It is in this background if we look at the background of this case, the landed property was not owned by the erstwhile partners. It was owned by the partnership firm. May be the erstwhile partners had l/3rd share each in all the partnership assets including this assets. On reconstitution of the firm, four more partners were inducted, who contributed Rs.2.50 crores as their capital contribution. Thus, the inducted partners also became partners in the firm and the firm continue to assets own, including .this, landed property. The erstwhile partners withdrew the money brought in by the incoming partners as drawings, They did not retire from the partnership firm. They continued to be the partners of the firm. However, their share got reduced. In other words, 50% of their share held before reconstitution became the share of the incoming partners. As the property was not owned by this erstwhile partners, it cannot be said they transferred 50% in favour of incoming partners and any amount represents the consideration received for such transfer and as such it is liable for payment of capital gains under Section 45 (1) of the Act. It is because they did not transfer the capital assets. Insofar as arguments with regard to the reconstitution, their share got reduced and the amount which was withdrawn and partnership represents inducted partners along with erstwhile partners.
17. As rightly pointed by the appellate authorities in the scheme of the Income Tax Act, there is no provision for levying capital gains on such consideration received for reduction of the share in the partnership firm. The provisions of Section 45(3) or 45(4) is not applicable to the facts of the case. Insofar as the contention that this is a colourable device adopted by the firm as well as the assessees to avoid payment of tax is concerned, it has no substance because tax planning is legitimate. However, it has to be done within the frame work of law.
18. The partnership firm came into existence in the year 1962. It acquired property in the year 1967. It carried on business up to 1992-93 and returns were filed from time to time. It is only in the year 1995, revaluation was done, four new partners inducted who brought in cash and the firm was not dissolved, the incoming partners did not retire from the firm and it only reduced their share in the partnership firm. The erstwhile partners only reduced their share in the partnership firm and continued to be the partners of the reconstituted firm also.
19. Therefore, it cannot be said that either the firm is a dubious one or the entire transaction is a co-lour able device and the only object is to avoid payment of tax. Therefore, the law laid down by the Apex Court in the case of McDowell Company Limited’s case (supra) .(Distinguished) has no application to the facts of this case.(Distinguished)
20. The learned Counsel for the revenue relied on the judgment of the Apex Court in the case of Kartikeya V. Sarsbhai v. Commissioner of Income-tax [1997] 228 ITR 163, (Distinguished) where it was held as follows:

“Section 2(47) of the Income-tax Act, 1961, defines “transfer” in relation to a capital asset. It is an inclusive definition which, inter alia, provides that relinquishment of an asset or extinguishment of any right therein amounts to a transfer of a capital asset. It is not necessary for a capital gain to arise, that there must be a sale of a capital asset, Sale is only one of the modes of transfer envisaged by Section 2(47) of the Act. Relinquishment of the asset or extinguishment of any right in it, which may not amount to sale, can also be considered as a transfer and any profit or gain which arises from the transfer of a capital asset is liable to be taxed under section 45 of the Act.”

19. In the instant case, as the assessee was not the owner of this capital asset, the question of relinquishing their interest in that asset or extinguishment of their right in their asset would not arise. The assets belong to the firm. The incoming partners paid money to the firm by way of their capital contribution. The firm as such has not relinquished its interest in favour of the incoming partners. On the contrary, by inducting them, they are also entitled to interest in the said assets and therefore, the said judgment has no application to the facts of this case. (Distinguished)
20. Further, reliance was placed on the judgment of this Court in the case of Commissioner of Income-tax v. Gurunath Talkies [2010] 328 ITR 59, (Distinguished) where it was held as follows: –

“Section 47 of the Income-tax Act, 1961, was introduced to take out certain transactions which otherwise are transfers of capital assets and otherwise taxable under section 45, from being taxed. On the reintroduction of sub-sections (3) and (4) by the Finance Act, 1987 in section 45 clause (ii) of section 47 has been expressly omitted removing the protective umbrella. The legislative intent is quite clear and this takes care of any situation where in effect there is transfer of a capital asset, by any mode and to ensure the gain being taxed.”

21. In the aforesaid case, a reconstitution of the firm took place in July 1994 by addition of two partners to the firm, who brought in about Rs. 17 lakhs towards their capital contribution to the firm. Thereafter, again the firm was reconstituted with the erstwhile four partners retiring from the partnership and newly added partners remaining in the firm and continuing the firm. It is in that context, it was held that the series of transactions such as reconstitution of firm twice; once in July 1994, and again in December 1994 and entire assets retained. Ithe hands of the newly added two partners, resulted in transfer of assets of the firm in the sense that the assets of the firm as had been held by the erstwhile partners were transferred to the newly added two partners though all along the assets of the firm continued in the hands of the firm. Therefore, it was held that there was transfer of capital assets within the meaning of Section 2(47) attracting capital gains tax in terms of Section 45(4) of the Act.
22. In the instant case, the firm is not taxed. It is the individual partners who are taxed. More over, in the instant case, the erstwhile partners have not retired, they also continued to be the partners along with the incoming partners. All that has happened is that the shares of the erstwhile partners are reduced. Therefore, the said judgment also has no application to the facts of this case. (Distinguished)
23. For the aforesaid reasons, we do not see any merit in these appeals. The substantial question of law is answered in favour of the assessees and against the revenue. Consequently, the appeals are dismissed.

Parties to bear their own costs.

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