Income Tax Appellate Tribunal - Ahmedabad
Deputy Commissioner Of Income-Tax vs Jayendra V. Sharma on 13 May, 1993
Equivalent citations: [1994]48ITD1A(AHD)
ORDER
R.L. Sangani, Judicial Member
1. These appeals were heard together and are being decided by this common order.
2. We shall first narrate facts in ITA No. 4616/Ahd./1989. Assessee Jayendra V. Sharma was one of the six partners of firm M/s. Variety Engineers. The said firm carried on business of manufacturing machinery.
3. A company by name Variety Engineers Pvt. Ltd. was incorporated on 18-2-1981 with the object of taking over the business of the above firm as going concern and if necessary to enter said firm as partner.
4. Revaluation of assets of said firm was undertaken and as a result thereof appreciation in value amounting to Rs. 8,57,328 was credited on 1-1-1981 in the capital accounts of the partners in their respective profit-sharing ratio. The amount which was credited in the present assessee's account on this score was Rs. 85,732. Technical know-how was valued at Rs. 3,00,000 on 31-3-1981 and this amount was credited on that date in the capital accounts of the partners in their respective profit-sharing ratio, the amount which was credited in the present assessee's account regarding this item was Rs. 33,000.
5. The abovementioned company joined the said firm as its seventh partner with effect from 1-4-1981. The firm was dissolved with effect from 30-9-1981 and its business was taken over as going concern by the abovementioned company. The partners of the firm became directors of the abovementioned company and shares of the company were allotted as against credit balances in the capital accounts.
6. The ITO held that amount of Rs. 85,732 represented short-term capital gains in the hands of assessee and Rs. 33,000 represented taxable income. He accordingly added these amounts in the total income of the assessee.
7. Facts in other five appeals are identical. The assessees in those appeals are family members of abovementioned assessee and they were also partners in the abovementioned firm and their accounts were also credited with similar amounts proportionate to their profit-sharing ratio. The ITO made additions of those amounts in their respective total income.
8. All the six assessees filed appeals which were allowed by CIT (A) by identical orders relying on the following extract in the decision of Madras Bench of the Tribunal in the case of IACv. Jagadishchandran & Co. [1987] 23 ITD 354:
The properly belonging to a firm can be converted into property belonging to a company in two ways. The first is the right royal method of executing a deed of transfer and in the case where immovable property is involved it has to be by way of an instrument in writing duly registered as required by Section 54 of the Transfer of Property Act, 1982 then of course it will be a transfer within the meaning of Section 43 and the capital gains arising therefrom would be taxable. Such was admittedly not the case in the instant case. The other well recognised method is that for a firm to convert its property into the property of a company by itself becoming a company. In other words, individual partners themselves form a company which becomes a partner of the firm and upon dissolution of the firm the entire property is allotted to the company which holds it as the property of the company. In the case of Malabar Fisheries Co. v. CIT [1979] 120 ITR 49, it was held by the Supreme Court that upon dissolution of the firm and the distribution of the assets to one or the other partners there is no transfer in law. The underlying principle is not far to seek especially in a case like present where the same individuals who were the partners were the share-holders of the company which had taken over the property and it was that the ownership had never changed. This principle has been reiterated by Section 47(ii). Therefore, in the present case, it was not possible for the revenue to assess the capital gains in the instant transaction deeming it to be a sale by the firm to the company when in fact the property was converted from firm's holding into a company's holding by reason of the dissolution of the firm in which the company was a partner. The order of the Commissioner (Appeals) was, therefore, justified.
The CIT (A) also relied on the decision of Ahmedabad Bench of the Tribunal in the case of Vosant J. Thakkar [IT Appeal No. 1217 (Ahd.) of 1983, dated 29-1-1988]. The department is now in appeal before the Tribunal and following grounds have been raised:
On the facts and in the circumstances of the case and in law, the learned CIT (A) erred in holding that there was no 'transfer' within the meaning of Section 2(47) of the Act and that amount credited to partners' capital accounts on revaluation of assets, etc., are not exigible to capital gains tax.
9. The submission on behalf of department was that this was a case of tax planning and principle in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 (SC) was applicable. It was submitted that additions were rightly made. The learned Counsel for assessee has relied on reasons given in the appellate order and also on decisions in (i) CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393 (Guj.), (ii) Addl CJTv. Mohanbhai Pamabhai [1987] 165 ITR 166 (SC), (iii) CITv. Dewas Cine Corpn. [1968] 68 ITR 240 (SC); and (iv) Sana Siddharthbhai v. CIT [1985] 156 ITR 509 (SC).
10. We have considered rival submissions and facts on record. We are dealing with assessment year 1982-83 for which relevant accounting year ended on 31-3-1982. The material dates to which our attention has been drawn are 1-1-1981, 30-3-1981 and 30-9-1981. The first date relates to revaluation done by the firm of its assets and consequent credits given to partrers in their capital accounts in their respective profit-sharing ratio. The second date relates to credits given in the capital account of partners regarding value of technical know-how. The third is the date on which the firm stood dissolved and company took over the running business.
11. As far as first two dates are concerned, they fall in accounting year relevant to assessment year" 1981-82 with which we are not concerned. If the credits given to partners in their respective capital accounts as a result of revaluation of assets and valuation of technical know-how are treated as taxing events, i.e., events which attracted provisions relating taxing of the amounts in question, those events took place in earlier year and not in the year under consideration and hence, irrespective of merits, no addition could have been made in the year under consideration and hence impugned additions would be liable to be deleted on this short ground.
12. The above aspect was specifically brought to the notice of learned departmental representative and he realised the correctness of this legal effect. He, however, submitted that date 30-9-1981, which is date of dissolution of the firm should be regarded as taxing event and hence relevant year would be assessment year 1982-83. We find that on dissolution, the assets were distributed amongst partners and it is difficult to see how distribution of assets of dissolved firm amongst partners would attract taxing provisions in the hands of the partners. Provisions regarding capital gains cannot be attracted because there is no transfer of any capital asset by the partners. Amount credited on 31-3-1981 in respect of share in technical know-how would not be regarded as income of concerned partner on dissolution of firm on 30-9-1981. On the facts of the present case decision in the case of McDowell & Co. Ltd. (supra) would not at all be attracted.
13. In fact assessment order does not at all indicate as to in what manner amounts credited on 1-1-1981 and 31-3-1981 (which relate to assessment year 1981-82) could be regarded as short-term capital gains and income for assessment year 1982-83. The decision of Gujarat High Court in CIT v. Smt. Minal Rameshchandra [1987] 167 ITR 507 on which ITO has relied is of no assistance. What has been laid down in said case is that tax authorities have power to unravel device.
14. It is true that in the order of the Tribunal in the appeal of the company for assessment year 1983-84 [ITA No. 2151/Ahd./1988, dated 24-1-1992] there is an observation to the effect that the question whether surplus realised by the erstwhile firm or by the outgoing partners would attract liability of tax would have to be decided in the case of the firm and the partners and that the said question did not arise in the case of the company. Thus, the Tribunal had left that question open for being decided in the relevant appeals. We have examined the said question in the present appeals and could find that the abovementioned amounts which had been credited in the capital accounts of the partners do not attract taxing provisions.
15. In this connection, it is significant that revaluation of the assets on 1-1-1981 has been made on the basis of valuation report and that report had been submitted before the ITO in the course of assessment of the company for assessment year 1983-84 as observed in the decision of the Tribunal in the appeal of that company. The Tribunal has observed in said order that the ITO had not doubted the correctness of the value of the assets adopted by the valuer in the said report and had no adverse comments in relation to the said valuation report. It is well established that revaluation of assets does not result in realisation of income by the partners [see CIT v. Hirid Construction Ltd. [1972] 83 ITR 211 (SC)]. On the basis of the principles laid down in the decisions to which our attention has been drawn on behalf of the assessee, it must be held that the amounts credited on 1-1-1981 in the capital accounts of the partners on revaluation of assets do not represent short-term capital gains for assessment year 1982-83 on dissolution of the firm and that amounts credited on 31-3-1981 in the capital accounts of the partners in respect of technical know-how do not represent income of the partners for assessment year 1982-83 as held by the ITO. We hold that on dissolution of firm there has been no transfer of any capital assets. We reject the ground raised by the department.
16. The appeals are dismissed.