Addition of partners in a firm and applicability of Provisions of Sec. 56(2)
Shrilekha Business Consultancy (P.) Ltd.
[2020] 121 taxmann.com 150 (Hyderabad – Trib.)
Short Overview of the case:
Assessee (SFS) was a partnership firm. Its total partner’s capital was Rs.7,49,926 of which, SOT contributed Rs.7,49,701 and other three partners contributed Rs.75 each.
Company PEL decided to acquire an effective 20% equity stake in SCL, a group company of assessee’s firm. PEL joined SFS as a 5th partner with 74% share and made investment through it. PEL brought in capital contribution of Rs. 2,014.20 crores. Out of capital contribution, as per partnership deed, Rs. 5.92 crores was allocated to partner’s capital account and remaining amount of Rs. 2,008.28 crores was credited to ‘capital reserve’ account. SOT brought in fresh capital of Rs. 2,00,50,299 taking its total capital contribution to Rs. 2.08 crores with share of 25.9997%.
Capital of other 3 partners remained same at rate of Rs. 75 with share of 0.0001% each.
There was infusion of further capital and readjustment of profit sharing ratio among partners.
Out of capital contribution brought into firm by partners, Rs. 2,118.96 crores was utilised to make investment in shares of Novus.
In turn, Novus invested fund in 11,91,64,806 shares of SCL through private placement. SCL increased its authorised and paid up equity share capital to enable it to issue shares to Novus through private placement. Novus merged/amalgamated with SCL.
In lieu of merger/amalgamation, SCL allotted its shares on private placement basis to SFS which were earlier held by Novus. AO observed that total capital of firm was Rs.8.30 Crores, out of which Rs.2.08 Crores was invested by one of partners namely SOT.
AO observed that to acquire 74% of Rs.8.30 Crores what was required to be contributed by PEL was only Rs.6.22 Crores. Hence, additional amount of Rs. 2,111.23 Crores received by assessee firm was over and above required capital of Rs.6.22 Crores.
AO concluded that what was shown as reserve in balance sheet amounting to Rs.2,111.23 Crores was not at all reserves but consideration received by assessee on behalf of SCL from PEL.
AO observed that assessee’s Group as a whole was supposed to pay tax on aggregate consideration received of Rs.2,100 Crores from PEL and that in order to avoid tax liability on same, SCL and assessee firm had devised new method to avoid tax liability.
AO made addition of amounts credited in capital reserve treating same as income under section 56. On appeal, CIT(A) deleted said addition.
It observed that Supreme Court had held that where part of ownership rights in property gets transferred to other partners, such contribution amounts to transfer of capital asset under section 45.
In instant case, share in profits of firm during its subsistence and share in assets after its dissolution were consideration for capital contribution.
‘Consideration’ was ‘indeterminate’ and as such computation provisions of Section 48 would fail and hence, no capital gain would arise thereon.
Credit entry made in partners’ capital account would not represent true value of consideration and that it was only a notional entry intended to be taken into account at time of determining value of partners’ share in net assets of firm at time of dissolution of firm.
Hence, in these circumstances, Supreme Court held that consideration which a partner acquires on making over his personal asset to partnership firm as his contribution to its capital account does not fall within terms of Section 48.
Aforesaid reasoning and observations of Supreme Court could be made applicable to facts of instant case inasmuch as ‘consideration’ in respect of capital contribution made by a partner was ‘indeterminate’ for purpose of Section 56(2)(viia) also.
When consideration is indeterminate, computation provisions of Section 56(2)(viia) to determine inadequacy or otherwise of ‘such consideration’ also fail.
Hence, on this count, provisions of Section 56(2)(viia) could not be made applicable to capital contribution of a partner made in firm.
Value of shares were recorded by way of credit to partners capital account in form of capital contribution in terms of Section 45(3).
Though provisions of Section 45(3) are applicable for levy of capital gains in hands of transferor i.e. partner in instant case, consideration fixed thereon could not be different in hands of transferee i.e. assessee firm as same was emanating from same transaction.
Transfer of asset by a partner to firm as capital contribution, no doubt constituted a transfer in hands of partner, but value recorded in books of firm by way of credit to partners capital account would be conclusive proof of consideration received in hands of partner towards transfer of capital asset.
Provision of section 56(2)(viia) could not be made applicable at all in case of capital contribution made by a partner in kind.
It held as under –
“Where consideration for capital contribution made by a partner in a firm is share in profits of firm during firm’s subsistence and share in assets after firm’s dissolution, consideration was ‘indeterminate’ and as such computation provisions of section 48 would fail and hence, no capital gain would arise thereon; further, when consideration is indeterminate, computation provisions of section 56(2)(viia) to determine inadequacy or otherwise of ‘such consideration’ also fail and provisions of section 56(2)(viia) could not be made applicable to capital contribution of a partner made in firm”.
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