Karnataka High Court
The Commr Of Income Tax vs M/S Dynamic Enterprise on 16 September, 2013
Equivalent citations: 2014 (1) AKR 244
Bench: N.Kumar, S.Abdul Nazeer
®
IN THE HIGH COURT OF KARNATAKA AT BANGALORE
DATED THIS THE 16TH DAY OF SEPTEMBER 2013
PRESENT
THE HON'BLE MR. JUSTICE N. KUMAR
AND
THE HON'BLE MR. JUSTICE S. ABDUL NAZEER
AND
THE HON'BLE MR. JUSTICE V. SURI APPA RAO
I.T.A.NO.1414/2006
BETWEEN:
1. THE COMMISSIONER OF INCOME TAX
CENTRAL CIRCLE, C.R.BUILDING
QUEENS ROAD, BANGALORE
2. THE INCOME TAX OFFICER
WARD - 10(1), C.R.BUILDING
QUEENS ROAD, BANGALORE ...APPELLANTS
(BY SRI K. V. ARAVIND, ADVOCATE)
AND:
M/s DYNAMIC ENTERPRISES
38/3, BLOCK - 2
SRI LAKSHMI INDUSTRIAL COMPLEX
2
HOSUR MAIN ROAD, GARVEBHAVI PALYA
BOMMANAHALLI, MADIVALA POST
BANGALORE - 560068 ...RESPONDENT
(BY SRI G.SARANGAN, SR. COUNSEL FOR
SRI K.S.RAMABADRAN, ADVOCATE)
THIS ITA IS FILED 260-A OF I.T.ACT, 1961 ARISING
OUT OR ORDER DATED 02.03.2006 PASSED IN ITA
No.1295/BANG/2004, FOR THE ASSESSMENT YEAR 1995-
1996, PRAYING THAT THIS HON'BLE COURT MAY BE
PLEASED TO FORMULATE THE SUBSTANTITAL QUESTION
OF LAW STATED THEREIN, ETC.
THIS ITA COMING ON FOR HEARING THIS DAY,
N.KUMAR J., DELIVERED THE FOLLOWING:
JUDGM ENT
A Division Bench of this Court felt that there is a
conflict between the proposition of law laid down in the case
of Commissioner of Income Tax Vs. Mangalore Ganesh
Beedi Works reported in (2004) 265 ITR 658 and in the
case of Commissioner of Income Tax And Another Vs.
Gurunath Talkies reported in (2010) 328 ITR 59. In order
to resolve the said conflict, this matter was referred to the
Full Bench by order dated 31.07.2012. On such reference,
3
Hon'ble Chief Justice has passed an order on 27.08.2013
directing the matter to be listed before this Bench.
SUBSTANTIAL QUESTION OF LAW
2. The substantial questions of law referred for our
consideration are as under:
"When a retiring partner takes only the money
towards the value of his share, whether the firm
should be made liable to pay capital gains even when
there is no distribution of capital asset/assets among
the partners under Section 45(4) of the I.T. Act?
or
Whether the retiring partner would be liable to
pay for the capital gains?"
FACTUAL MATRIX
3. Before we proceed to answer the said substantial
questions of law, it is necessary to have a look at the factual
background.
4
4. M/s.Dynamic Enterprises-the respondent herein
is a partnership firm which came into existence on
09.01.1985 with Sri Anurag Jain and Sri Nirmal Kumar
Dugar as its partners. The firm was engaged in the business
of buying landed properties, constructions of buildings
thereon, construction of industrial sheds, commercial
complexes etc. On 13.04.1987, the firm was reconstituted by
which Sri Nirmal Kumar Dugar retired from the partnership
and L.P. Jain (father of Anurag Jain) entered the partnership
as he showed his willingness to contribute capital for
purchase of land to construct housing complex. The firm
purchased land bearing Sy.No.13/1, Jakkasandra Village,
Begur Hobli, Bangalore South Taluk under a registered sale
deed dated 13.5.1987 for a consideration of Rs.2,50,000/-.
Another reconstitution took place on 1.7.1991 by which Sri
L.P.Jain retired from the firm and Smt. Pushpa Jain and
Smt. Shree Jain were inducted as partners. The firm was
reconstituted and five partners belonging to Khemka Group
were inducted into the firm by a deed dated 28.04.1993.
5
Before the reconstitution, the assets of the firm were
revalued as per the report of the registered valuer on
28.03.1993. The three old partners retired through deed of
retirement dated 01.04.1994. The old partners received the
enhanced value of property in financial year 1994-95.
5. As per the Assessing Officer there is transfer of
property from old firm to the new firm on 01.04.1994.
Hence, it is a transfer within the meaning of Section 2(47) of
the I.T.Act. Accordingly, notice under Section 148 was issued
on 27.03.2002. In reply to the said notice, the assessee-firm
contended that it has paid the amount to the retiring
partners standing on credit side in respect of capital
accounts. There is no transfer of asset and therefore, they
are not liable to pay any capital gains tax.
6. The Assessing Officer held that the land was
purchased when the firm was having two partners, namely,
Shri Anurag Jan and Shri L.P.Jain. The firm had done no
6
business all through its existence. The receipt of rents and
commission for assessment year 1994-95 were found as
bogus. The immovable property was not utilized to earn
paltry sums during the existence of the firm. The new
partners were introduced and the old partners retired. This
is a device adopted to transfer the immovable property. The
incoming partners tried to evade capital gains tax as well as
stamp duty and therefore, he held the capital gains tax is
liable to be paid by the firm. In appeal, the appellate
authority has affirmed the said order. The appellate
authority held that the reconstitution of firm has taken place
on 01.04.1994 i.e., nearly one year after the members of the
Khemka family were introduced as partners. Therefore, it
accepted the genuineness of the old firm as well as the new
firm but it held it is a colourable device to evade payment of
tax.
7
FINDING OF THE TRIBUNAL
7. Aggrieved by the said order, the assessee
preferred an appeal to the Tribunal. The Tribunal held that
reconstitution of the firm has taken place on 01.04.1994 i.e.,
nearly one year after the members of the Khemka family
were introduced as partners. The difference between the
value determined on account of the revaluation and the book
value was credited in the capital account of the partners in
the profit share ratio on reconstitution of the firm as on
01.04.1994. The retiring partners have withdrawn their
capital as standing in the books of accounts of the firm. As
per Section 45 of the Income Tax Act, profit and gains arising
from the transfer of a capital asset is chargeable under the
head "capital gains". Hence to levy capital gains tax there
should be an asset and there should be transfer in respect of
that asset. The word 'transfer' is defined in Section 2(47) of
the I.T. Act. As per this definition, transfer includes sale,
exchange or relinquishment of the asset. It also includes
extinguishment of any rights in the asset. Hence to complete
8
the process of transfer there should be a person who is
having a right in an asset and then such right is either sold,
exchanged or relinquished to another person. In the instant
case, the firm was reconstituted as on 01.04.1994 to
continue the same business. The firm has not relinquished
any right in the land. The land is being owned by the firm.
The return filed by the firm for the assessment year 1995-
1996 was of the reconstituted firm and not of the old firm
and therefore, there is no transfer as on 01.04.1994 by the
reconstituted firm. The revenue has charged capital gains
tax in the hands of the reconstituted firm. Relying on the
judgments of several High Courts as well as the Supreme
Courts it held that the reconstituted firm cannot be termed
as a transferor even for the arguments sake. There is no
transfer and the firm is not liable to pay capital gains tax.
Aggrieved by the said order the present appeal is filed.
9
RIVAL CONTENTIONS
8. The learned counsel for the revenue contended
that five partners brought money into the firm as their
capital contribution and the erstwhile partners received the
money and relinquished their interest in the capital asset in
favour of the incoming partners, and accordingly it amounts
to transfer of the capital asset, which results in capital gain
as such they are liable to tax under Section 45(4) of the Act.
The transaction falls within the ambit of the word
"otherwise" in Section 45(4) of the Act. Even otherwise it is a
devise adopted by the partners to evade payment of profits or
gains and taxable.
9. Per contra, the learned counsel for the assessee
contended that in order to attract Section 45(4), the
condition precedent is that there should be a dissolution of
the firm and distribution of capital asset in which the
outgoing partners should acquire interest in the capital asset
and consequently the firm should cease to have any interest
10
in the capital asset so transferred. The profit or gain arising
from such transfer of a capital asset is taxable, under
Section 45(4) of the Act, which is not the case on hand.
10. It is in this background we have to notice the
conflicting judgments of this Court, which resulted in this
reference and resolve the conflict.
CONFLICTING JUDGMENTS
11. Before the Division Bench reliance was placed
on the judgment of this Court in the case of Commissioner
of Income Tax and Another Vs. Gurunath Talkies
reported in (2010) 328 ITR 59. This Court in paras 24 to
28 has made the following observations:
"24. In this view of the matter we answer the first
question in the affirmative in favour of the
Revenue holding that there was a transfer of
capital asset attracting the capital gain transaction
in terms of s.45(4) of the Act.
11
25. The second question is answered in the
negative in favour of the Revenue and against the
assessee holding that the judgments which were
noticed by the Tribunal were in the context of the
law as it existed prior to its amendment in the
year 1987. Finance Act of 1987 having expressly
and with definite purpose brought about the
amendment to IT Act reintroducing sub-ss. (3) and
(4) to s. 45 of the Act, the Tribunal should have
examined the appeal before it merely by applying
the statutory provisions as it prevailed during the
accounting period relevant to the assessment year
1994-95 and not merely by following the
principles, the ratio of the judgment of the
Supreme Court which had been rendered slightly
in a different context. Though
Mr.Shankaranarayana Rao, learned counsel for
the assessee would submit that the assessee had
not indulged in any suppression or mis-
representation and that the transactions were
genuine and has been clearly disclosed in the
return and therefore in the situation never
warranted a levy of penalty as it was proposed in
the assessment order and also does not warrant
levy of interest, as a consequence of this appeal
12
being allowed, it automatically restores the levy of
interest; we are afraid that the Tribunal having not
looked into this aspect and having merely
examined merits of the appeal before it as to there
being loss and there being gain and as this
question is now answered against the assessee,
there is no scope for us to independently examine
the question of levy of interest. It remains.
26. However, we notice the question of penalty is
an independent proceeding and it is open to the
assessee to urge such defence as is available to
the assessee in an appropriate proceeding rather
than to elicit a finding in this appeal.
27. Mr.Rao has brought to our notice that in
respect of judgment of the Bombay High Court in
A.N.Naik's case (supra)and also the judgment of
our High Court in Suvardhan's case (supra) SLPs
have been preferred by the assessee and leave
has been granted to appeal and appeals are
pending.
28. May be the position is that but on that premise
we do not think we should keep this appeal
13
pending without answering the questions raised in
this appeal as the law which governs the field has
been applied and questions are answered herein.
There is no question of postponing the decision in
this appeal any further."
12. Then the Division Bench noticed the judgment of
this Court in the case of Commissioner of Income Tax Vs.
Mangalore Ganesh Beedi Works reported in (2004) 265
ITR 658 held at para-20 as under:
"20. In view of the above statutory provisions and
the law laid down by the Supreme Court it appears
reasonable to hold that though the firm stood
dissolved on 5th December 1987, for a limited
purpose of winding up of the affairs of the firm, it
continued till its assets and business were sold as a
going concern on 20th November 1994. Therefore, the
firm continued to hold the properties as owner till
20th November 1994.
For the foregoing reasons, we hold that there
was no distribution of capital assets of the firm
despite its dissolution and, therefore, the firm could
14
not have been made liable for paying capital gains
tax in terms of s.45(4) of the Act."
13. In Gurunath's case (supra), this Court held in
view of the series of transactions such as reconstitution of
firm twice; once in July, 1994 and another in December,
1994 and the entire assets retained in the hands of the
newly added two partners, results in transfer of assets of the
firm in the sense that the assets of the firm as had been held
by the erstwhile partners is 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 is transfer of capital assets within the meaning of
Section 2(47).
14. In Mangalore Ganesh Beedi Works's case
(supra), after the dissolution of the firm, its business was
continued by association of persons comprised of all the
erstwhile 13 partners by using the assets as well as the
name of the dissolved firm. Therefore, till the date of
15
dissolution, the name "Mangalore Ganesh Beedi Works" was
of the partnership firm. Whereas, after the dissolution, it
became the name of the association of persons comprised of
all the erstwhile partners of the dissolved firm. In that
context it was held though the firm stood dissolved on
December 5th 1987, for a limited purpose of winding up of
the affairs of the firm, it continued till its assets and
business were sold as a going concern on November 20th
1994. Therefore, the firm continued to hold the properties
as owner till November 20th 1994. In those circumstances,
there was no distribution of capital assets of the firm despite
its dissolution and therefore the firm could not have been
made liable for paying capital gains tax in terms of Section
45(4) of the Act. It is in this background, we have to resolve
the conflict between these two decisions.
STATUTORY PROVISIONS
15. In the instant case, the assessee is sought to be
taxed under Section 45(4) of the Act on the ground that there
16
is a transfer of the properties of the partnership firm. Section
45(1), (3) and (4) of the Income Tax Act reads as under:
"45. Capital Gains.- [(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.
xxx xxx xxx
(2) xxxx
[(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
17
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]"
16. The word 'transfer' has been defined in Section
2(47) of the Act as under:-
"Transfer", in relation to a capital asset,
includes,-
18
(i) the sale, exchange or relinquishment of
the asset; or
(ii) the extinguishment of any rights therein;
or
(iii) the compulsory acquisition thereof under
any law; or
(iv) 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
19
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;]"
17. 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.
20
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."
18. The Apex Court in the case of Narayanappa vs.
Bhaskara Krishnappa reported in 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
21
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."
19. The Supreme Court in the case of Malbar
Fisheries Co. vs. CIT reported in (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 can not, therefore, be said that, upon
22
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
23
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."
20. The Apex Court in the case of Sunil
Siddharthbhai vs. Commissioner of Income Tax,
Ahmedabad reported in (1985) Vol. 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
24
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 pre-
existing 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.
25
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
26
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."
21. Under the provisions of the Partnership Act,
1932, the firm is not recognized as a legal entity. A
Partnership Firm is not a distinct legal entity apart from
the partners constituting it. In law the Firm as such has
no separate rights of its own in the Partnership Assets.
When one talks of firm's property or the firm's assets all
27
that is meant is property or assets in which all partners
have a joint or common interest. 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
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. Property and rights and interest in property
acquired with money belonging to the firm are deemed to
have been acquired for the firm. When a partner brings in
his personal asset into a partnership firm as his
contribution to its capital, an asset which originally was
28
subject to the entire ownership of the partner becomes
now subject to the rights of other partners in it. 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. 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. 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. The distribution, division, or allotment
29
of assets of the erstwhile partners, is not done by the
dissolved firm. 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.
22. However, the Income Tax Act recognizes the
firm as a distinct assessable legal entity apart from its
partners. Sub-sections (3) and (4) of Section 45 were
introduced by Finance Act, 1987, which came into effect
from 01.04.1988. In sub-section (3) what is sought to be
taxed is 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. After such transfer, he is
or becomes a partner or member, by way of capital
contribution or otherwise. Then the said capital
30
contribution 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. When a partner
brings in his personal asset into a partnership firm as his
contribution to its capital, an asset which was originally
exclusively belonging to him, becomes the trading asset of
the firm, in which all partners acquire interest in
proportion to their respective share in the firm. His right
during the subsistence of the partnership is to get his
share of profits from time to time as agreed upon among
the partners. On dissolution of the firm or on retirement
from the firm to get the value of his share in the net
partnership asset as on the date of dissolution or
retirement. Therefore, this is a case of a partner bringing
31
capital asset to a partnership firm as his capital
contribution.
23. Sub-section (4) of Section 45 deals with a
distribution of capital assets on the dissolution of a firm or
other association of persons or body of individuals or
otherwise. If in the course of such distribution of capital
asset there is a transfer of a capital asset by the firm in
favour of a person and it results in profits or gains to the
firm, then the said profits or gains shall be chargeable to tax
as income of the firm and again for computing such income,
Section 48 is attracted. In other words, in the process of a
dissolution of a firm, if a capital asset is transferred to a
partner which results in profits or gains, then that income is
chargeable at the hands of the firm under this provision. In
order to attract sub-section (4) of Section 45, the condition
precedent is,
(1) There should be a distribution of capital assets of
a firm;
(2) Such distribution should result in transfer of a
capital asset by firm in favour of the partner; and
32
(3) On account of the transfer there should be a profit
or gain derived by the firm.
(4) Such distribution should be on dissolution of the
firm or otherwise.
24. Therefore, in order to attract Section 45(4) of the
Act, the capital asset of the firm should be transferred in
favour of a partner, resulting in firm ceasing to have any
interest in the capital asset transferred and the partners
should acquire exclusive interest in the capital asset. In
other words, the interest the firm has in the capital asset
should be extinguished and the partners in whose favour the
transfer is made should acquire that interest. Then only the
profits or gains arising from such transfer is liable to tax
under Section 45(4) of the Act.
25. In the instant case, the partnership firm had
purchased the property under a registered sale deed in the
name of the firm. The property did not stand in the name of
any individual partners. No individual partners brought that
capital asset as capital contribution into the firm. Five
33
partners brought in cash by way of capital when the firm
was reconstituted on 28.04.1993. Nearly a year thereafter on
01.04.1994 by way of retirement, the erstwhile three
partners took their share in the partnership asset and went
out of the partnership. After the retirement of three
partners, the partnership continued to exist and the
business was carried on by the remaining five partners.
There was no dissolution of the firm or at any rate there was
no distribution of capital asset on 01.04.1994 when three
partners retired from the partnership firm. What was given
to the retiring partners is cash representing the value of their
share in the partnership. No capital asset was transferred
on the date of retirement under the deed of retirement deed
dated 01.04.1994. In the absence of distribution of capital
asset and in the absence of transfer of capital asset in favour
of the retiring partners, no profit or gain arose in the hands
of the partnership firm. Therefore, the question of the firm
being assessed under Section 45(4) and charging them tax
34
for the profits or gains which did not accrue to them would
not arise.
26. It was contended on behalf of the revenue that
five incoming partners brought money into the firm. Three
erstwhile partners who retired from the partners on
01.04.1994 took money and left the property to the incoming
partners. It is a device adopted by these partners in order to
evade payment of profits or gains. As rightly held by this
Court in Gurunath's case (supra) it is taxable. This
argument proceeds on the premise that the immovable
property belongs to the erstwhile partners and that after the
retirement the erstwhile partners have taken cash and given
the property to the incoming partners. The property belongs
to the partnership firm. It did not belong to the partners.
The partners only had a share in the partnership asset.
When the five partners came into the partnership and
brought cash by way of capital contribution to the extent of
their contribution, they were entitled to the proportionate
35
share in the interest in the partnership firm. When the
retiring partners took cash and retired, they were not
relinquishing their interest in the immovable property. What
they relinquished is their share in the partnership.
Therefore, there is no transfer of a capital asset, as such, no
capital gains or profit arises in the facts of this case. In that
view of the matter, Section 45(4) has no application to the
facts of this case.
27. In Gurunath's case (supra), the Division Bench
of this Court followed the judgment of the Bombay High
Court in the case Commissioner of Income Tax Vs.
A.N.Naik Associate - (2004) 265 ITR 346 (BOMBAY). In
Naik's case, the asset of the partnership firm was
transferred to a retiring partner by way of a deed of
retirement. A memorandum of family settlement was entered
into and the business of those firms as set out therein was
distributed in terms of the family settlement as the party
desired that various matters consisting the business and
36
assets thereto be divided separately and partitioned. The
term has also provided that such of those assets or liabilities
belonging to or due from any of the firms allotted, the 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 subsequent deeds of retirement of
partnership that the order of assessment was made holding
that the assesses are liable for tax on capital gains.
28. In that context, the Bombay High Court held
that when the assets 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 Section 45. Once
37
that be the case, 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 is chargeable to tax under Section 45(4) of the Income
Tax Act. In that context, it was held 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. It is in this context the
Bombay High Court held that Section 45(4) was attracted.
Therefore, to attract Section 45(4) there should be a transfer
of a capital asset from the firm to the retiring partners, by
which the firms ceases to have any right in the property
which is so transferred. In other words, its right to the
property should stand extinguished and the retiring partners
acquires absolute title to the property.
29. In the instant case, the partnership firm did not
transfer any right in the capital asset in favour of the retiring
partner. The partnership firm did not cease to hold the
38
property and consequently, its right to the property is not
extinguished. Conversely, the retiring partner did not
acquire any right in the property as no property was
transferred in their favour. The Division Bench in
Gurunath's case (supra) did not appreciate this
distinguishing factor and by wrong application of the law laid
down by the Bombay High Court held the assessee in that
case is also liable to pay capital gains tax under Section
45(4). Therefore, the said judgment does not lay down the
correct law.
30. We would like to add that several other aspects
of Section 45(4) was addressed in the course of the
arguments by both sides which are not relevant to
adjudicate the present issue, as in the present case there is
no distribution of assets and hence, one of the condition
precedent for invoking Section 45(4) does not exist and
hence Section 45(4) is not attracted to the facts of this case.
39
ANSWER
31. The reference is answered as
under:
"When a retiring partner takes only money
towards the value of his share and when there is
no distribution of capital asset/assets among
the partners there is no transfer of a capital
asset and consequently no profits or gains is
payable under Section 45(4) of the Income Tax
Act?"
32. In so far as the substantial question of law
"whether the retiring partner would be liable to pay capital
gain" is concerned, the said question does not arise for
consideration in the appeal as the only question which arose
for consideration was, whether the firm is liable to pay
capital gain tax. Therefore, the said question of law is not
answered.
33. For the aforesaid reasons, we pass the
following:
40
ORDER
(i) The substantial question of law is answered in favour of the assessee and against the revenue.
(ii) Consequently, the appeal stands dismissed.
(iii) No costs.
Sd/-
JUDGE Sd/-
JUDGE Sd/-
JUDGE JT/BMM/-