Bombay High Court
Texpin Engineering & Manufacturing ... vs Joint Commissioner Of Income Tax on 11 December, 2000
Equivalent citations: (2001)70TTJ(MUMBAI)789
ORDER
R.V. Easwar, J.M. The first question that arises in this appeal is whether the assessee is liable to capital gains tax under section 45(4) of the Income Tax Act.
2. The assessee is a partnership firm consisting of seven partners. It was engaged in the manufacture of ball and roller bearings. It applied under Part IX of the Companies Act, 1956, for becoming a joint-stock company under the said Act. A balance sheet was prepared showing the assets and liabilities of the firm as on 7-11-1995. There was no revaluation of any of the assets and the liabilities of the firm. After its application was accepted by the authorities under the Companies Act, the partners of the erstwhile firm were allotted shares equal to their respective capitals and became shareholders of the joint-stock company. There were no other shareholders. A certificate of incorporation was issued to the company by the Registrar of Companies on 8-11-1995, certifying that the company has been incorporated effective from that date.
3. The firm filed its return of income for the period ending 7-11-1995. While making the assessment under section 143(3), the assessing officer was of the view that the provisions of section 45(4) were attracted and that the firm was liable to capital gains. In short, it was his view that there was a distribution of the assets of the firm on dissolution or otherwise within the meaning of the said provision and the fair market value of the assets on the date of the distribution shall be taken to be the full value of the consideration for the transfer. He proceeded to compute the capital gains at Rs. 9,00,000, being the difference between the market value, which he estimated, of the assets and the WDV of the assets.
4. The assessing officer, in the course of the assessment order, remarked that the provisions of section 45(1) 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 definition of the word "transfer" under section 2(47)(ii).
5. On appeal, the Commissioner (Appeals) upheld the assessment, substantially endorsing the view taken by the assessing officer.
6. The assessee is in further appeal before the Tribunal. Section 45(4) was inserted by the Finance Act, 1987, with effect from 1-4-1988. It provides for certain conditions before liability to capital gains tax attaches. They are (i) that there should be profits and gains; (ii) that such profit and gains should arise from the transfer of a capital asset by way of distribution of capital assets; and (iii) that such distribution shall take place on the dissolution of a firm or otherwise. If these conditions are satisfied, the fair market value of the assets may be taken as the full value of the consideration received or accruing as a result of the transfer.
7. It is thus clear that the first requirement is that there should be distribution of the capital assets, it may take place on dissolution of the firm or otherwise. It was urged on behalf of the revenue that there was a dissolution of the firm by operation of law. Even if it is assumed for the sake of argument that there was a dissolution of the firm by operation of lawthe element of agency between the erstwhile partners having come to an end once the firm became a joint-stock companywithin the meaning of section 42 of the Partnership Act, the question still remains to be considered whether there was any distribution of capital assets belonging to the firm. Obviously the sub-section refers to distribution of capital assets amongst the erstwhile partners because the legislative background shows that the sub-section was inserted to get over the decisions of the Supreme Court in the case of Malabar Fisheries Co. v. CIT (1979) 120 ITR 49 (SC), CIT v. Dewas Cine Corporation (1968) 68 ITR 240 (SC) and CIT v. Bankey Lal Vaidya (1971) 79 ITR 594 (SC). In these cases, it was held that the distribution of the assets of the firm on dissolution does not involve a "transfer" as it represents only an act of adjustment of the mutual rights of the partners. The sub-section, having been introduced to get over these decisions, provided that the "transfer of a capital asset by way of distribution of capital assets" would attract liability to capital gains tax. The question whether in the absence of a definition of the word "transfer" as including a distribution of the capital assets on the dissolution of the firm the sub-section would still serve its purpose need not detain us because the learned counsel for the assessee fairly submitted that two views are possible, one view being that the sub-section itself contains a sort of an in-built definition when it says "transfer .... by way of distribution" (italicised is ours). Thus, even assuming that there is an in-built definition of the word "transfer" roping in the act of distribution of capital assets on the dissolution of the firm or otherwise and again, as stated earlier, assuming that there was a dissolution of the firm by operation of law, still the requirement that there should be a distribution of the capital assets of the firm has not been fulfilled in the case before us. What has really happened is that the firm as such has ceased to own the assets from the date of incorporation as a joint-stock company and from that date it is the joint-stock company which became the owner of the assets. It is common ground that no conveyance deed was executed by the firm or the partners on its behalf in favour of the company transferring the ownership of the assets. That was indeed unnecessary and is taken care of by section 575 of the Companies Act which provides that on incorporation as a joint-stock company the assets and liabilities of the firm automatically vest in the company. It has also been held in Vali Pattabirama Rao v. Sri Ramanuja Ginning & Rice Factory (1986) 60 Comp Cas 568 (AP) that no formal conveyance deed is required for the purpose. The assets remain intact and undistributed, but with the company. The departmental authorities have not established as a fact that there was a distribution of the capital assets in specie amongst the partners. Indeed, it would be a contradiction in terms to say that what has been vested in the joint-stock company and shown in its balance sheet had been distributed amongst the partners of the erstwhile firm.
8. Perhaps faced with this difficultythat is, the absence of any distribution of the capital assets in specie amongst the partnersMr. Kedia for the department suggested that there was a "symbolic" distribution of the capital assets when shares were allotted to the erstwhile partners of the company. The difficulty in accepting the submission is that the sub-section unmistakably implies distribution of capital assets "in specie" and any "symbolic" distribution would not suffice. Further, as already noted, the very purpose of introducing the sub-section was to nullify the decisions of the Supreme Court (supra) where distribution of assets amongst the partners on dissolution was held not a "transfer". The requirement of the sub-section, in our view, is a distribution of capital assets in specie on dissolution (or otherwise) and not merely any "symbolic" distribution.
9. It was then said that the capital assets themselves cannot be distributed for reasons of practicality and, therefore, the distribution of shares must be held equivalent to distribution of capital assets themselves. Our view that the sub-section envisages an actual distribution of the capital assets themselves and not any substituted assets is sufficient to dispose of this contention.
10. It was then suggested that no distinction can be made between the firm and its partners and a firm is merely a collective name for its partners and does not have a distinct personality of its own and, therefore, the allotment of shares to the partners should be construed as some sort of distribution of the assets to the firm itself so that sub-section (4) of section 45 is attracted. It is, however, too late in the day to accept the contention under the income-tax law, for, as far back in CIT v. A.W Figgies & Co. (1953) 24 ITR 405 (SC) Hon'ble Justice Mahajan, speaking for the Supreme Court held that the technical view of the nature of a partnership, under the English law or Indian law, cannot be taken in applying the law of income-tax, that the position under the income-tax law is "somewhat different", that under the Income Tax Act a firm "can be charged as a distinct assessable entity as distinct from its partners who can be assessed individually" and further that "the firm as such is a separate and distinct, unit for purposes of assessment" (see p. 409). The.Act of 1961 also maintains the same position. It is only in recognition of this position that section 45(4) makes the firm liable for capital gains in the event of a distribution of the capital assets amongst the partners on dissolution.
11. We, therefore, hold that there is no distribution of capital assets, actual, notional or symbolic, amongst the partners of the firm and, therefore, section 45(4) is not attracted.
12. Mr. Kedia then raised the alternative argument that section 45(1) is attracted as there was an "extinguishment" of the firm's rights over the assets which is a "transfer" as defined in section 2(47)(ii) of the Act. But even under these provisions, the capital gains can be brought to assessment only if the full value of the consideration is received by or accrues to the transferor (of the capital asset) and even if it is assumed for the sake of argument that the firm's rights over the assets were "extinguished" once it became a company, the firm can be assessed only if the full value of consideration is received by or accrues to the firm. But the shares were issued by the company not to the firm but to its partners and even if we consider that the shares some how represented the consideration the firm would not be liable to tax. Further, the shares cannot be said to represent the firm market value of the capital assets; they were issued proportionate to the respective capitals of the partners.
13. It is, therefore, conceptually impossible to fit in the facts of the present case to the provisions of either sub-section (1) or (4) of section 45 of the Act.
14. The other ground in the appeal relates to the non-allowance of depreciation. In the return of the firm, it claimed depreciation of Rs. 27,67,005. The assessing officer was of the view that the firm was not entitled to depreciation since the assets have been transferred to the joint-stock company with effect from 8-11-1995, and they were not in existence on 31-3-1996, which he took as the last day of the previous year. He noted that with the introduction of the concept of "block of assets" from 1-4-1988, and the provisions of section 43(6)(c)(i)(B) with effect from the same date, the WDV (written-down value) or a particular block of assets available at the beginning of the previous year is to be taken and this is to be adjusted by adding the purchases and reducing the sales/discard/demolition, etc., made during the previous year and depreciation would be allowed only on the balance, if any, remaining after carrying out the above exercise. Since the previous year was the financial year ended 31-3-1996, and since on that day there was no asset in the hands of the firm (the entire assets having been transferred), no depreciation was allowable. So ran the argument of the assessing officer.
15. The Commissioner (Appeals) endorsed the view of the assessing officer and confirmed the disallowance.
16. The assessee is in further appeal before us. It was claimed on behalf of the appellant that the user of the assets for a single day during the year was sufficient to entitle the assessee to depreciation. It was also contended that the conditions of section 43(6)(c)(i)(B) relied upon by the assessing officer were not fully satisfied. Reliance was placed on the judgment of the Madras High Court in A.M. Ponnurangam Mudaliar v. CIT (1997) 228 ITR 454 (Mad). It was also contended that it cannot be said that the assets were either "sold or discarded or demolished or destroyed during the previous year as contemplated by section 43(6)(c)(i)(B). There were also no "moneys payable" in respect of the assets as envisaged by Explanation 4 to section 43 read with Explanation below sub-section (4) of section 41. It was submitted that the language of section 43(6)(c)(i)(B) was identical with that employed in section 34(2)(ii) which was omitted from 1-4-1988, and, therefore, the interpretation placed by the Madras High Court in the decision cited supra on section 34(2)(ii) must be applied to the interpretation of section 43(6)(c)(i)(n). Attention was also drawn to the following Supreme Court judgments :
1. CIT v. Artex Mfg. Co. (1997) 227 ITR 260 (SC), and
2. CIT v. Electric Control Gear Co. (1997) 227 ITR 278 (SC).
17. On behalf of the department, Mr. Kedia pointed out that the whole block of assets has been transferred and as per section 45(4) the fair market value is deemed to be the consideration for the transfer and, therefore, the written down value of the block becomes 'NIL' and if that is so, there is no question of allowing depreciation. He relied on the following decisions :
1. A. L. M. Firm v. CIT (1991) 189 ITR 285 (SC), and
2. Suvardhan v. Assistant CIT (1998) 67 ITD 104 (Bang-Trib).
18. Section 32 provides for allowance of depreciation in respect of assets owned by the assessee and used for the purposes of the business. The allowance is subject to the conditions prescribed by section 34. Section 34(2)(ii) provided that no depreciation shall be allowed for any previous year in respect of any asset which is "sold, discarded, demolished or destroyed in that year. With the introduction of the concept of "block of assets" from 1-4-1988, section 34(2) in its entirety was omitted. Instead, the provisions of section 43(6) were amended by inserting clause (c). Sub-clause (i)(B) provided that the aggregate of the WDVs of all assets falling within a block of assets at the beginning of the previous year, reduced by the "moneys payable" in respect of any asset falling within the block, which is "sold or discarded or demolished or destroyed" during the previous year shall be the WDV for purposes of allowing depreciation.
19. It cannot be disputed that since we are concerned with the assessment years 1996-97 the provisions of section 43(6)(c) are applicable and not section 34(2)(ii). The question, therefore, is whether any asset was "sold or discarded or demolished or destroyed" by the firm and moneys were payable to it for the sale, etc., Since there is no difference in the language employed in the old section 34(2)(ii) and the new section 43(6)(c)(i)(B), the interpretation placed by the Madras High Court (supra) on the old provision has to be adopted while interpreting the new provision. In the decision, it was held that the definition of the word "transfer" under section 2(47) is confined to transfer of capital assets and cannot be invoked for the purpose of section 32 (viz., allowance of depreciation). It was noticed that the words used in section 34(2)(ii) were "sold, discarded, demolished or destroyed" and not "transferred". Therefore, the argument of Mr. Kedia that since section 45(4) deemed the market value of the assets as the full value of the consideration the provisions of section 43(6)(c)(i)(B) are attracted cannot be accepted. Instead, we have to see if there is a sale, discard, etc., of the assets. Now each one of these words has a different connotation. The vesting of the title in the assets in the company by virtue of section 575 of the Companies Act is by operation of law and not as a result of any act of sale, discard, demolishing or destruction of the assets in question. As we have already seen, there is no requirement of a formal conveyance deed and in fact there was no conveyance executed by the firm or partners in favour of the company. Further, there are no "moneys payable" for the sale, etc. Explanation 4 to section 43(6) in this connection says that the expressions "sold" and "moneys payable" shall have the meanings assigned to them by the Explanation below section 41(4). When we turn to the Explanation, we find that neither the definition of "sold" nor that of "moneys payable" can be said to rope in the present case. The definition indicates that the money must be in the form of monetary consideration. There has been no "sale" of the assets of the firm, as the expression is generally understood, to the company sale involves the idea of consideration and when the firm's assets became the property of the company by virtue of section 575 of the Companies Act, it is difficult to visualise the same as a sale. The transaction clearly does not fall under the expressions such as discard, demolishing and destruction. Therefore, the assets held by the firm till 7-11-1995, will be entitled to depreciation.
20. The decision of the Supreme Court in ALA Firm (supra) cited by Mr. Kedia is not applicable to the facts of the case before us because in that case the principle laid down was that on dissolution the firm's assets have to be valued only at market value.
21. For these reasons, we hold that the assessee-firm is (i) not liable to any capital gains tax either under section 45(1) or section 45(4) and (ii) is eligible for depreciation on the assets held till 7-11-1995, as the conditions laid down section 43(6)(c)(i)(B) have not been violated.
22. The appal is allowed.