An overview:

–         The assessee, in the present case was a partnership firm. Assessee-firm purchased a property for a consideration of Rs. 6.5 crores.

–         After arriving at a settlement with most of the tenants occupying the said property and obtaining permission of the concerned competent authority for construction of a five-star hotel, the said property was revalued at Rs. 193,90,60,000 as per the valuation report, prepared by Registered Valuer.

–         The resultant revaluation surplus was credited to the capital accounts of the partners in their profit sharing ratio and accordingly a sum of Rs. 30,87,98,087 each came to be credited to the capital accounts of the two partners having 20% profit share each. Thereafter one partners retired from the partnership firm on 27-3-2006 while second one retired from the partnership firm on 22-5-2006.

–         On their retirement, both these partners were paid the amounts standing to the credit of their capital accounts in the partnership firm including the amount of Rs. 30,87,98,087 credited on account of revaluation surplus.

–         The question that had arisen and which was referred to the Third Member was whether, in these facts and circumstances of the case, the money equivalent to enhanced portion of the assets revalued constitutes capital asset and whether there was any transfer of such capital asset on dissolution of firm or otherwise within the meaning of section 45(4) read with section 2(14).

–         Both the members of Bench differred in their conclusion and JM held that it was not chargeable to tax as capital gain under section 45(4) read with section 2(14).

It is categorically held that

–         There was no transfer of capital assets by the partnership firm to the retiring partners even after reconstitution and the partnership firm continued to remain the owner of the property.

–         There was only a reconstitution of partnership firm on their retirement without there being any dissolution and the land properly acquired by the partnership firm continued to be owned by the said firm even after reconstitution without any extinguishment of rights in favour of the retiring partners.

–         The retiring partners did not acquire any right in the said property and what they got on retirement was only the money equivalent to their share of revaluation surplus (enhanced portion of the asset revalued) which was credited to their capital accounts.

–         There was thus no transfer of capital asset by way of distribution of capital asset either on dissolution or otherwise within the meaning of section 45(4) read with section 2(14).

–         The money equivalent to enhanced portion of the assets re-valued does not constitute capital asset within the meaning of section 2(14) and the payment of the said money by the assessee-firm to the retiring partners cannot give rise to capital gain under section 45(4) read with section 2(14).

–         Accordingly, the view taken by the Judicial Member was agreed and the question referred under section 254(4) was answered in the negative and in favour of the assessee.

In short, the money equivalent to enhanced portion of the assets being immovable property re-valued by firm does not constitute capital asset within the meaning of section 2(14) and the payment of the said money by the assessee-firm to the retiring partners cannot give rise to capital gain under section 45(4) read with section 2(14).

IN THE ITAT, MUMBAI BENCH

P.M. JAGTAP, V.P. (KZ) (THIRD MEMBER)

D.S. Corporation v. ITO

I.T.A. Nos. 3526 & 3527/MUM/2012, I.T.A. Nos. 3882 & 3883/MUM/2012

10 January, 2019

Assessee by: K. Shivaram & Rahul Hakani

Department by: Ajay Kumar

ORDER

On account of difference of opinion between the learned Accountant Member and learned Judicial Member, Mumbai Benches, this matter has been referred to me by the Hon’ble President, ITAT for consideration and decision under section 254(4) of the Income Tax Act, 1961 (hereinafter “the Act”). While referring the matter to Third Member, separate three questions each were framed by both the differing Members. In order to settle and finalise the questions that are required to be considered and decided by the Third Member, the learned Representatives of both sides were required to propose draft questions in such a manner that the same shall project the exact controversy involved in the point of reference. They were directed to confine themselves to the order of reference while preparing the draft questions and not to enlarge or modify the point of difference referred by the differing Members to the Third Member. Accordingly the learned Representatives of both the sides have proposed draft questions and after a detailed discussion and deliberation, it is agreed that question Nos. 2 & 3 as suggested by the Sr. Departmental Representative correctly incorporate the exact controversy in the point of difference. It is accordingly settled and finalised that the said two questions are required to be considered and decided by the Third Member in this case to resolve the controversy in the point of difference between the differing Members. The said two questions are as under:–

“1. Whether on the facts and in the circumstances of case, where on revaluation of asset being land held by the partnership firm which resulted into enhancement of value of asset and this enhanced amount credited in capital account of partners and when a retiring partner takes amount in his capital account including enhanced value of asset, it gives rise to Capital Gain under section 45(4) read with section 2(14) of the Income Tax Act.

2. Whether on the facts and in the circumstances of the case, is there any transfer of capital asset on dissolution of firm or “otherwise” within the meaning of section 45(4) read with section 2(14), in case the money equivalent is paid by partnership firm to the retiring partner and whether this money equivalent to enhanced portion of the asset revalued constitutes capital asset for the purpose of section 45(4) read with section 2(14) of the Income Tax Act.

2. Although the learned Accountant Member and learned Judicial Member both have narrated the facts relevant to the controversy referred to the Third Member as involved in the present case, I recapitulate the same in brief for the sake of completeness and ready reference. The assessee in the present case is a partnership firm which was originally constituted vide Deed of Partnership entered into on 1-8-2005. The object of the partnership firm was to carry on the business of development and construction in partnership and the said partnership was originally constituted by two partners, namely Shri Rakesh Kumar Wadhwan and Shri Sudhakar M. Shetty with profit sharing ratio of 60% and 40% respectively. On 16-9-2005, the partnership was reconstituted by admitting Smt. Hemlata S. Shetty as partner with a revised profit sharing ratio of Shri Rakesh Kumar Wadhwan, Shri Sudhakar M. Shetty and Smt. Hcmlata S. Shetty being 60%, 20% and 20% respectively. Thereafter on 23-9-2005, the assessee firm purchased from Shri Percival Joseph Pereira a property bearing Survey No. 28A and B 1, Plot No. 2 and CTS No. 956,956/1 to 956/83 of Village Juhu, Tagluka Andheri, Mumbai Suburb, Grater Mumbai for a consideration of 6.5 crores. The said property admeasuring 14022 sq. yards, formerly known as Perieria Estate and later known as Unit Compound, comprised of land and buildings and structures occupied by tenants. Immediately after purchase of the said property, the partnership was again reconstituted by admitting two new partners, namely Prithvi Realtors & Capital (P) Ltd. and Shri Sarang R. Wadhwan. While the profit sharing ratio in the reconstituted partnership of Shri Sudhakar Shetty and Smt. Hemlata S. Shetty remained at 20% each, the same in the case of Shri Rakesh Kumar Wadhwan was reduced to 35% with M is. Pi ithvi Realtors & Capital (P) Ltd. and Shri 8arang R. Wadhwan getting 20% and 5%. With the efforts of the partnership firm, Maharashtra Tourism Development Corporation vide Letter, dated 18.0 1.2006 and the Government of India, Ministry of Tourism vide Letter, dated 18-1-2006 granted permission to the assessee firm to construct five star hotel on the property purchased by it at Juhu Tara Road. Meanwhile the assessee firm also arrived at a settlement with 77 of the 81 tenants who had occupied the said property. Thereafter the assessee firm decided to revalue the property and as per the valuation made by a Registered Valuer, Shri A.R. Nigam vide valuation report, dated 25-3-2006, the property was revalued at 1,93,90,60,000. On the basis of the said valuation done by the Registered Valuer, revaluation surplus was created in the books of account of the assessee firm and the same was credited to the capital accounts of all the partners in their profit sharing ratio. On 27-3-2006, the partnership was again reconstituted whereby Smt. Hemlata Shetty retired from the partnership firm and her profit sharing ratio of 20% was given to four new partners at 5% each, who were admitted to the partnership firm. On retirement, Smt. Hemlata Shetty was paid the entire amount of 31,40,48,088 standing to the credit of her capital account including the amount of 30,87,98,087 credited on account of revaluation surplus. Similarly Shri Sudhakar Shetty retired from the partnership on 22-5-2006 getting the amount of 35,59,84,050 standing to the credit of his capital account including his share of revaluation surplus amounting to 30,87,98,807. In their respective returns of income, the retiring partners Shri Sudhakar Shetty and Smt. Hemlata Shetty claimed the amount received by them from the assessee firm on retirement as exempt under section 10(2A) of the Act.

3. The assessing officer received the information regarding retirement of the two partners, namely, Smt. Hemlata Shetty and Shri Sudhakar Shetty on 27 03.2006 and 25-5-2006 respectively. He also received information about the amounts of 31,40,48,088 & Fts.35,59,84,050 received by them from the assessee firm on retirement. Based on this information, the assessing officer was of the prima facie view that there was transfer of capital asset by way of distribution by the assessee firm to the retiring partners in terms of section 45(4) of the Act and assessee firm was liable to tax on the capital gain arising from such transfer as held by the Hori’ble Bombay High Court in the case of CIT v. A.N. Naik Associates (265 nil 346). Since such capital gain was not declared by the assessee in the returns of income filed for assessment years 2007-07 and 2007-08, he reopened the assessments for the said two years after recording the reasons. In pursuance of the assessments reopened by him, reassessments were completed by the assessing officer under section 143(3)/147 of the Act. In the said assessments, he held that it was not only the retiring partners whose capital accounts had been credited by their share of revaluation surplus, but the capital accounts of all the partners were also credited. He held that if the retiring partners had got equivalent rights in the form of their money, the other partners also got their increased capital in the assessee firm as a result of crediting of revaluation surplus. He held that the equivalent amount of money standing to their capital accounts on account of revaluation surplus as well as to the continuing partners capital account credited as a result of revaluation of assets of the assessment in was nothing but distribution of capital assets of the assessee firm among the partners on dissolution or otherwise and the valuation surplus of 1,54,39,90,435 worked out on the basis of market value of the assets was chargeable to tax as capital gain in the hands of the assessee firm being distribution of capital assets by way of dissolution of the partnership firm or otherwise in terms of section 45(4) of the Act. To arrive at this conclusion, the assessing officer relied on the decisions of the Hon’ble Supreme Court in the case of CIT v. Bankey Lal Vaidya (1971) 79 ITR 594 (SC) : 1971 TaxPub(DT) 316 (SC) and Dewas Chic Corporation (1968) 68 ITR 240 (SC) : 1968 TaxPub(DT) 304 (SC) and the decision of the Hon’ble Bombay High Court in the case of A.N. Naik Associates (supra).

4. The action of the assessing officer in bringing to tax the revaluation surplus of 1,54,39,90,435 as capital gain by applying provisions of section 45(4) of the ALL was challenged by the assessees in the appeals filed before the learned Commissioner (Appeals) and after considering the submissions made by the assessees as well as the material available on record, the learned Commissioner (Appeals) held that there was no dissolution of partnership firm either at the time of retirement of Smt. Hemlata Shetty on 26-3-2006 or at the time of retirement of Shri Sudhakar Shetty on 25-5-2006. According to him, there was only reconstitution of the partnership firm with change of partners and there was nothing in the retirement deed to suggest any intention to liquidate the assets of the firm and distribute the capital assets of the firm to the partners of the firm. He also held that Shri Sudhakar Shetty and Snit. Hemlata Shetty had retired from the partnership firm without any distribution of assets of the partnership firm. He held that it was not the case where all the old partners of the erstwhile firm had retired and the old firm was succeeded by new firm and new partners. He held that the surplus on the revaluation of assets was notionally credited to the capital account of the five original partners on 26-3-2006 for mutual adjustment of rights of partners and the retiring partners were paid only the sum standing to the credit of their capital accounts. He held that while the firm was succeeding, there could not be any transfer of rights in the assets of the firm amongst the retiring partners, subsisting partners and the new partners. He held that there could be no transfer to oneself and this can happen only when there is a dissolution of partnership firm, which had not happened in the case of the assessee. He observed that there was no change of ownership of the capital assets in assessee’s case after revaluation in as much as partnership firm continued to be the absolute owner of the said assets. He held that it was thus not a case of dissolution of the partnership firm or transfer of assets of the partnership firm and provisions of section 45(4) were not attracted. Reliance was placed by the learned Commissioner (Appeals) on the decision of the Hon’ble Kerala High Court in the case of CIT v. Kunnankulam Mill Board (2002) 257 ITR 544 (Ker) : 2002 TaxPub(DT) 1305 (Ker-HC) to hold that unless and until there is a change in the ownership of the capital asset, there cannot be any distribution of capital assets as contemplated in section 45(4) of the Act. He also held that revaluation or retirement alone does not trigger provisions of section 45(4) of the Act unless and until it is coupled with distribution of capital assets. The learned Commissioner (Appeals) also placed reliance on the decision of the Hon’ble Bombay High Court in the case of A.N. Naik Associates (supra) to hold that in order to bring any even