Income Tax Appellate Tribunal - Ahmedabad
Well Pack Packaging vs Deputy Commissioner Of Income Tax on 22 May, 2001
Equivalent citations: (2003)78TTJ(AHD)448
ORDER
R.K. Bali, A.M.
1. This is an appeal by the assessee against the order dt. 21st Sept., 2000 passed by the CIT(A), XIII, Ahmedabad.
2. Briefly the facts as emerging from the order of the Assessing Officer (AO) and the learned CIT(A) are that the assessee was a partnership concern. It filed its original return of income on 30th Aug., 1995, declaring income of Rs.
1,93,930. This return was processed under Section 143(1)(a) of the IT Act, on 29th Jan., 1996, and the returned income stood accepted. Thereafter, the AO noticed that the assessee had revalued the depreciable assets and enhanced the value at Rs. 1,28,13,831. The AO further noticed that the partnership-firm was converted into a company under Part DC of the Companies Act, 1956, and it was registered as such under Section 567 of the Companies Act. The AO further noticed that while the assessee had claimed depreciation on the actual cost, the additional value of depreciable assets available on enhancement on account of revaluation on date of conversion of firm into a company was not offered as capital gain though according to the AO, there was a transfer of assets from partnership firm to the company, a separate entity. In this view of the matter, the. AO initiated reassessment proceedings by issue of notice under Section 148 of the IT Act on 27th Dec., 1996, and thereafter, he took up the proceedings and after issuing notices under Section 143(2)/143(3) of the IT Act and after considering the explanation given by the assessee, the AO finally determined the total income of the assessee at Rs. 1,30,07,761.
2.1. As mentioned earlier, after the initiation of the assessment proceedings, the AO issued letter dt. 11th Feb., 1999, requiring the assessee to furnish written explanation as to why capital gain should not be taxed in the hands of the assessee for the additional income of the depreciable assets on enhancement of the price and thereafter conversion of the firm into a company which has resulted in transfer of assets from the assessee-firm to the company under Part IX of the Companies Act.
2.2. The assessee furnished the written explanation, dt. 22nd March, 1999, wherein it inter alia made the following submissions :
(i) That the partnership-firm was converted into a company under Part DC of the Companies Act with the same existing assets and liabilities at book value and the same partners became shareholders of the company. As such there was no transfer of assets which would attract capital gain.
(ii) Relying on the decision in the case of V.P. Rao v. Ramanuja Ginning and Rice Factory (P) Ltd. (1986) 60 Comp. Cas. 568 (AP), it was stated that property of the partnership-firm gets statutorily vested in the company as a consequence of registration under Chapter IX of the Companies Act. The basic requirement for incidence of capital gain to arrive is that there must be transfer within the meaning of Section 2(47) of the IT Act which would require two parties, the transferor and the transferee. Since in the instant case, as soon as the registration took place under Part-IX of the Companies Act, the erstwhile partnership-firm ceased to exist and the converted company steps into its shoes. Thus, there being no two entities available on the date of conversion, there was no transfer and there was merely a change of status of the assessee from firm to company. Further, in view of the decision of Hon'ble Supreme Court in the case of Vania Silk Mitts (P) Ltd. v. CIT (1991) 191 ITR 647 (SC), two conditions are required to be satisfied viz. (a) mere extinguishment of rights does not result in transfer, and (b) there must be existence of assets at the time of transfer and since these conditions are not satisfied, there is no transfer and capital gain liability does not arise.
(iii) Since the firm was converted into a company under Chapter IX of the Companies Act with all its assets and liabilities, there was no cost of acquisition and as such the computation provision for calculation of capital gain will fail and no capital gain liability would arise in view of the decision of Hon'ble Supreme Court in the case of CIT v. B.C. Srinivasa Shetty (1981) 128 ITR 294 (SC).
(iv) The depreciation is claimed and allowed only on the WDV and not on the enhanced value of the assets due to revaluation and as such there is no question of levying any short-term capital gains.
2.3. The AO, however, considered the explanation given by the assessee as unsatisfactory and held that (i) decisions relied upon by the assessee in the submissions were not applicable to the facts of the case, (ii) on conversion of partnership-firm, the original partners became the directors of the company, and (iii) the value of the depreciable assets stood enhanced on conversion and, therefore, the shareholding of the directors has increased in comparison with their capital available with the partners. Therefore, the increase in shareholding arising out of the revaluation of assets is sought to be kept beyond the tax liability by the assessee and as such it was a tax planning device only. Accordingly, the AO held that capital gain was leviable.
2.4. The AO further, held that the contention of the assessee founded on the ground that partnership properties got statutorily vested in the company as a consequence of registration under Part-IX of the Companies Act, was not acceptable because under Part-IX of the Companies Act, there was transfer of capital assets in view of the decision of the Hon'ble Gujarat High Court in the case of Artex Manufacturing Co. v. CIT (1981) 131 ITR 589 (Guj) and the decision of Ahmedabad Bench of the Tribunal in the case of ITO v. Ahmedabad Engineering and Services Co-operative Society (1992) 44 TTJ (Ahd) 383.
2.5. The AO further observed that the chargeability of capital gain arises because of the application of Section 45(4) of the IT Act. He, accordingly, held that whatever may be the position under the Companies Act regarding registration, the moment the firm ceased to exist in the eye of law under the Partnership Act as well as under the IT Act and the business was run and managed by a distinct and separate legal entity, the legal position was that the firm got dissolved and as such provisions of Section 45(4) stood immediately attracted. Accordingly, the AO held that the income earned on such transfer at the agreed price to the firm over and above the book value was liable to be taxed in view of the decision of Hon'ble Supreme Court in the case of A.L.A. Firm v. CIT (1991) 189 ITR 285 (SC) as well as decision of Hon'ble Gujarat High Court in the case of Vadilal Soda Ice Factory v. CIT (1971) 80 ITR 711 (Quj). The AO further observed that the definition of "transfer of property" under Section 2(47) was very wide and when the company takes over the properties of the firm by whatever mode, two different entities come into existence, firm and company, and there was a transfer of property from one person to another in this context. The AO, accordingly, relying on the decisions of Hon'ble Supreme Court in the case of CIT v. B.M. Kharwar (1969) 72 ITR 603 (SC), CIT v. Artex Manufacturing Co. (1997) 227 ITR 260 (SC) and CIT v. Electric Control Gear Mfg. Co. (1997) 227 ITR 278 (SC) held that there was a transfer and when the enhanced depreciation was claimed in the hands of the company and which was allowed by the AO, the difference between the original WDV and the value at which the depreciation was allowed in the hands of the company was liable to short-term capital gain and the AO, accordingly, determined such additional value of the depreciable assets at Rs. 1,28,13,831 and taxed the same as short-term capital gain.
3. Aggrieved with the order of the AO, the assessee filed appeal the CIT(A) and made very detailed written submissions dt. 28th Oct., 1999, and then dt. 30th Nov., 1999, and then dt. 7th Feb., 2000, reiterating and elaborating the submissions made earlier before the AO. The learned CIT(A), however, upheld the action of the AO more or less endorsing his view although the learned CIT(A) did observe in para 8 of the impugned order that the ratio given in the case of Artex Mfg. Co. (supra) and Electric Control Gear Mfg. Co. (supra) are not applicable to the facts of the present case as in the said two cases, there was no dispute regarding the transfer whereas in the instant case, the assessee is disputing the very factum of transfer within the meaning of Section 2(47) of the IT Act. The learned CIT(A), however, held that the decision in the case of Vania Silk Mills (P) Ltd. (supra) relied upon by the assessee was not applicable whereas the decision of the Hon'ble Gujarat High Court in the case of Vadilal Soda and Ice Factory (supra) was applicable wherein it was held that where there is a vesting of rights by operation of law by a unilateral act of State, it constitutes 'transfer'. The learned CIT(A) confirmed the action of the AO on the ground that there was a transfer within the meaning of Section 2(47) r/w Section 45 of the IT Act. He, therefore, upheld the action of the AO by relying on the view expressed by the JM of the Tribunal in the case of Rita Mechanical Works v. Asstt. CYT a decision of the Chandigarh Bench of the Tribunal reported in (2000) 111 Taxman 92 (Chd) (Mag). There was another ground taken by the assessee regarding the charging of interest under Sections 234B and 234C of the IT Act which was held to be not maintainable by the learned CIT(A).
4. Aggrieved with the order of the learned CIT(A), the assessee has filed this appeal before the Tribunal.
5. Shri S.N. Divatia, the learned authorised representative of the assessee, has challenged the action of the AO as well as the learned CIT(A) mainly on the following grounds :
(i) There is no 'transfer' within the meaning of Section 2(47) of the IT Act r/w Section 45(1) of the IT Act, when the entire business of the assessee-firm has been converted into a joint stock company under the provisions of Part-IX of the Companies Act, 1956, more particularly when no separate price has been paid or attributable to the depreciable assets. Accordingly, it was pleaded that the computation provision would fail because it is not possible to ascertain the profit in respect of slump price paid for the business. It was pleaded that the recent amendments made by way of insertion of Section 50B by the Finance Act, 1999, w.e.f. 1st April, 2000, go to indicate that earlier such transaction was not liable to capital gain. Reliance was placed on the decision of Ahmedabad Bench 'A' of Tribunal in ITA No. 1421/Ahd/2000, order dt. 23rd Jan., 2001 in the case of Industrial Machinery Associates v. CIT [reported at (2003) 78 TTJ (Ahd) 434--ED.].
(ii) It was further submitted that the provisions of Section 45(4) are not attracted because (a) there is no transfer by way of distribution of assets, (b) no individual asset has been allotted to partners of the firm, and (c) neither revaluation or the shares allotted can be said to be 'consideration' for transfer of the capital assets.
(iii) It was further submitted that in order to attract liability to capital gain tax either under Section 45(1) or even under Section 50 of the IT Act, it is a precondition that there should be transfer of a capital asset from the transferor to the transferee and it implies bilateral transaction, but in the present case, the partnership-firm has been converted into a company under Part-IX of the Companies Act, 1956 and the firm shed its character as a firm and adorn a new robe of a limited company. Therefore, the moment company takes birth, the firm dies and both are not in existence at the same point of time. Accordingly, it was submitted that since there is no transfer on conversion of firm into company under Part-IX of the Companies Act, there does not arise any question of applicability of Section 50 or any other provision of the IT Act.
(iv) Alternatively, it was pleaded that even assuming, though not admitting, that the provisions of Section 45(4) are attracted, even then, the provision requires the following conditions to be satisfied : (a) there should be profit and gain, (b) it should arise from the transfer of a capital asset, (c) the transfer should be by way of a distribution of the capital assets, (d) such distribution should be on the dissolution of a firm or otherwise, and (e) profit and gain should be chargeable to tax in the hands of firm, AOP or BOI. It was submitted that even assuming that there was a dissolution of firm at the time of conversion into company under Part DC of the Companies Act, there should be distribution of capital assets in specie among the partners which has not happened in the present case because the capital assets stood vested in the joint stock company and the same cannot be said to be distributed among the partners of the erstwhile firm. Accordingly, there could not be any liability to capital gains tax. Reliance was placed on the decision of the Bombay Bench of the Tribunal in the case of Texspin Engineering & Mfg. Works v. Jt. CIT (2001) 70 TTJ (Mumbai) 789.
(v) As regards the quantum of income computed by the AO, it was pleaded that the AO as well as the learned CIT(A) have brought to tax the entire sum of revaluation of Rs. 1,28,13,831 which is credited to the partners capital account in proportion of profit-sharing ratio and debited to their respective fixed assets account. It was submitted that the assessee-company has allotted shares worth Rs. 1 crore only to the erstwhile partners. As such, the erstwhile firm has not been paid the consideration for the transfer of any capital assets by the company. It was pleaded that the amount of revaluation cannot be taxed since one cannot make profit out of onself. Relying on the decision of Hon'ble Supreme Court in the case of CIT v. Hind Construction Co. (1972) 83 ITR 211 (SC), it was further pleaded that even assuming that there is transfer under Section 2(47) of the IT Act, a sum of Rs. 1 crore has been paid by the company by way of allotment of shares to the erstwhile partners in respect of the entire undertaking and the levy of capital gain tax would still fail on account of no cost having been incurred by the firm for the undertaking as the business was developed by it and the date of acquisition of the business is not ascertainable. Reliance was placed on the decisions of Hon'ble Supreme Court in the case of B.C. Srinivasa Shetty (supra) and Syndicate Bank Ltd v. Addl. CIT (1985) 155 ITR 681 (Kar). Accordingly, it the pleaded that the Departmental authorities were not justified in taxing the assessee for an amount of Rs. 1,28,13,831.
6. Shri Prithilal, the learned Departmental Representative, supported the orders of the AO as well as the learned CIT(A). It was submitted that the facts are not disputed that the assessee-firm has revalued its assets by increasing the valuation to the extent of Rs. 1,28,13,831. When the firm is converted into a joint stock company, there is a transfer of the assets from the firm to the company within the meaning of Section 2(47) and Section 45 of the IT Act and the Departmental authorities were justified in bringing to tax the enhanced valuation put on the assets of the firm which were taken over by the company for which consideration was paid by way of allotment of shares to the erstwhile partners of the firm who became the directors of the joint stock company. He, accordingly, submitted that the AO as well as the learned CIT(A) were perfectly justified in taxing the disputed amount as short-term capital gain because the revaluation of assets of the firm was done on 31st July, 1994, and the firm was converted into a joint stock company under Part-IX of the Companies Act on 17th Oct., 1994, when the certificate of incorporation was issued by the Registrar of Companies. Reliance was placed on the decision of Hon'ble Delhi High Court in the case of Jagdev Singh Mumick v. CIT (1971) 81 ITR 500 (Del). Reliance was also placed on the decision of Ahmedabad Bench of the Tribunal in ITA No. 5108/Ahd/1996 order dt. 14th Aug., 2000 in the case of Shri Kishorechand K. Bansal v. Dy. CIT [reported at (2003; 78 TTJ (Ahd) 429--Ed.] as well as the decision of the learned J.M. of the Tribunal in the case of Pita Mechanical Works (supra).
7. We have considered the rival submissions and have also gone through the orders passed by the AO as well as the learned CIT(A). The facts which emerge from the orders of the AO as well as the learned CIT(A) are that the assessee is a partnership-firm carrying on business of manufacturing corrugated boxes in Chhatral, Tal. Kalol in Mehsana district. The firm initially consisted of seven partners, but thirteen family members had joined and four partners retired. On 1st April, 1993, the firm consisted of sixteen partners.
7.1. The assets of the partnership-firm were revalued from Rs. 46.90 lakhs to Rs. 175.10 lakhs on 31st July, 1994, and thereafter on 1st Aug., 1994, the firm was converted into a joint stock company with Well Pack Paper and Containers Ltd. under Part-IX of the Companies Act, 1956, and the company received certificate of incorporation from the Registrar of Companies on 17th Oct., 1994.
7.2. The fact of revaluation has been given in the books of the firm on 31st July, 1994, by crediting partners' capital account in their profit-sharing ratio to the extent of Rs. 128.14 lakhs. These facts are apparent from the copies of the auditors report pp. 5 to 7 of the paper book furnished to us.
7.3. Subsequently, on conversion of firm into a company on 1st Aug., 1994, equity shares of Rs. 100 lakhs were issued to sixteen partners of the firm in the same proportion of partners capital account and thus all sixteen partners became shareholders of the company and they still continued to hold the same share, and the same management took over the business of the firm after conversion under Part-IX of the Companies Act.
7.4. Against the above factual backdrop, it is quite clear that simple revaluation of assets does not lead to incidence of capital gain inasmuch as the revaluation is made in the hands of the assessee by writing up the value of assets in the books. The Hon'ble Supreme Court in the case of CIT v. Hind Construction Co. (supra) has held as follows :
"No one can sell his goods to himself, Sale contemplates a seller and a purchaser. If a person revalues his goods and shows higher value for that in his books of accounts, he cannot be considered as having sold his goods and made profits therefrom."
Accordingly, it has to be held that mere revaluation of assets of the firm will not result into any liability under the IT Act.
7.5. The next point for consideration is whether on registration of the firm as a limited company under Part-IX of the Companies Act, 1956, and consequently vesting of the properties of the firm into the company under Section 575 of the Companies Act would make the firm liable to pay any capital gain tax and whether the registration under Part-IX involves a 'transfer', The Departmental authorities are of the view that the provisions of Section 45(1)745(4) are also attracted as there was an "extinguishment" of the rights of the firm over the assets transferred to the company which fell within the decision of the word 'transfer' under Section 2(47) of the IT Act. The assessee has converted the partnership-firm into a joint stock company by adopting the procedures laid down in Part-IX of the Companies Act. Section 565 of the Companies Act provides for the company capable of being registered in Part-IX. It states that any company consisting of seven or more members may, at any time, register under the Act, is an unlimited company or a company limited by guarantee. Section 566 defines a joint stock company for the purposes of this part, Sections 567 and 568 list out the documents that are to be submitted to the Registrar of Companies for registration. Under both these sections, there is specific mention of deed of partnership as a document to be submitted before the Registrar. Section 574 provides that on compliance with the requirement of Part-IX with respect to registration formality, the Registrar will certify that applicant is a company incorporated under the Companies Act. Section 576 makes it clear that the registration of a company under Part-IX shall not affect its rights and liabilities in respect of any deed or obligation incurred before registration and Section 577 provides for continuation of the pending suits and legal proceedings taken by or against the company. As per Section 575, all properties including actionable claim belonging to or vested in a company at the date of. its registration shall, on such registration, pass to and vest in the company as incorporated. Thus, in view of the relevant provisions of the Companies Act discussed above, it has to be held that there is no 'transfer' involved when the company gets itself registered under Part-IX and it has been so held by the Hon'ble Andhra Pradesh High Court in the case of V.P. Rao v. Ramanuja Ginning and Pice Factory (P) Ltd. (supra). In this connection, it will be useful to refer to the observations of Sir Francis Palmer as under:
"The method by which a company obtained incorporation is not free from some of the complications attendant on the conversion in the ordinary way of sale or transfer. This method was preferred by businessmen as it avoids the sale by partners to the company consisting of themselves which to the ordinary men seem absurd. Under this method, registration would follow as of course without any need for sale or conveyance or without any breach of continuity of the concern."
Thus, it has to be held that since there is no transfer on conversion of the firm into company under Part-IX of the Companies Act, there does not arise any question of applicability of Section 50, 45 or any other provision of the IT Act. The reliance of the AO and the learned Departmental Representative on the decision of Hon'ble Supreme Court in the case of Artex Mfg, Co. (supra) is distinguishable on facts as in that case there was no dispute about the factum of transfer of the assets from the firm to the company and the question was whether the provisions of Section 41(2) were attracted. However, even in that case, the Hon'ble Supreme Court held that when the transfer took place from the firm to the company and the assets were transferred for which consideration was paid by the company by allotment of shares t6 the erstwhile partners of the firm, the Revenue could tax only the erstwhile partners as an AOP or BOI and not the firm.
7.6. In the instant case, there is no sale or conveyance from the firm to the company and the firm has neither been dissolved nor come to an end on account of conversion into a joint stock company under Part-IX of the Companies Act whereas in the cases relied upon by the AO, the firm had come to an end due to transfer by sale.
7.7. It is also important to note that the erstwhile partners of the firm have not been allotted shares of M/s Well Pack Packers and Containers Ltd. of the value of Rs. 1,28,13,831, but only of Rs. 1 crore so that it clearly indicates that the assets were not taken over at the revalued price and it does not refer to the value allotted to different assets. As such, it cannot be said that the firm through their partners has received price equal to the revaluation on conversion.
7.8. Further, we have to observe that a business undertaking as a going concern includes all rights, assets contingent or definite and all interest at the present or future. It also includes the management, executive employees and anything which goes as part of organisation including the potentiality of the organisation to grow. It contains a variety of elements both tangible and intangible. A going concern is a dynamic concept characterised by perennial change influenced by socio-economic ecology. A going concern is essentially a functioning living organisation possessing attributes of vitality, growth and evolution and it would not be possible to conceptualise the cost of acquisition of such a going concern as well as date of acquisition thereof. Thus, the cost of acquisition and/or the date of acquisition of the assets of the partnership which was converted into a joint stock company cannot be determined and as such it cannot be brought within the purview of Section 45 for levy of computation of capital gain in terms of the ratio of Hon'ble Supreme Court decision in the case of B.C. Srinivasa Shetty (supra). Therefore, taking into consideration the totality of facts and circumstances of the case and the legal position discussed above, we are of the opinion that the assessee-appellant is not liable to any capital gain tax either under Section 45(1) or under Section 45(4) of the IT Act.
7.9. In the result, addition of Rs. 1,28,13,831 is directed to be deleted.
8. As far as ground relating to chargeability of interest under Sections 234B and 234C is concerned, the same is restored to the file of the AO for fresh adjudication in accordance with law taking into consideration the decision of the Hon'ble Supreme Court in the case of CIT and Ors. v. Ranchi Club Ltd.
9. In the result, assessee's appeal is allowed.