Income Tax Appellate Tribunal - Bangalore
The Asst. Commissioner Of Income-Tax vs Unity Care And Health Services on 17 June, 2005
Equivalent citations: (2007)106TTJ(BANG)1086
ORDER
Deepak R. Shah, Accountant Member
1. These cross appeals by revenue as well as by the assessee are directed against the order of learned CIT(A), Mangalore dated 18.2.2005.
2. The issues involved in the appeal by the assessee is against charging of capital gain invoking provisions of Section 45(4) of the Income-tax Act (The Act) and disallowance of commission paid of Rs. 1,53,000/- in the appeal of revenue. The revenue challenges the allowance of depreciation on the assets on pro-rata basis.
3. The assessee is a partnership firm. It was formerly known as Yenepoya Health Institute. The appellant had filed the return of income for the period 01.04.2000 to 02.10.2000 corresponding to the AY 2001-2002 on 31.10.2001 declaring a total loss of Rs. 13,93,613/-. The above return was processed Under Section 143(1) on 26.03.2002. Subsequently, the case was taken up for scrutiny by issuing notices Under Section 143(2) and 142(1) of the Act. It is stated that the partnership firm was converted into a private limited company, known as Unity Care and Health Services Pvt. Ltd. w.e.f. 03.10.2000, in accordance with a revised Partnership Deed, which was drawn up on 07.09.2000. The above conversion of the partnership firm into a private limited company is stated to have been done under Chapter IX of the Companies Act. The appellant firm had revalued its assets at Rs. 20,03,21,670/- as against the written down value of the same at Rs. 3,96,67,634/- as on 30.09.2000, that is, prior to its conversion into a private limited company. The appellant had advanced various arguments before the Assessing Officer in support of its contention that there was no 'transfer' in the conversion of the partnership firm into a private limited company under Chapter IX of the Companies Act as well as under the provisions contained in the Income-tax Act. The Assessing Officer has, however, held that there has been a transfer in this case and accordingly he has brought to tax a sum of Rs. 15,67,18,702/- as short term capital gains.
3.1. Learned CIT(A) held that there is a conversion of partnership firm into private limited company. This amounts to dissolution of firm. Accordingly, provisions of Section 45(4) are applicable. The shares received on conversion are a constructive receipt of consideration by the firm as a result of the transfer. The market value of assets transferred is the value of shares received by the partners. Thus, the difference between the value of shares received being the net consideration accruing as a result of transfer in case of asset is to be charged to tax. Learned CIT(A) held that the decision of Hon'ble High Court of Bombay in the case of CIT v. Texspin Engg. and Mfg. Works 263 ITR 345 is not applicable to the facts of the case.
4. Learned Counsel for assessee Shri Sarangan, Senior Advocate explained the fact in detail. He submitted that the firm was originally registered as a partnership firm. Subsequently, the partners decided to register the same as private limited company under Part IX of the Companies Act, 1956. This kind of registration does not involve transfer of assets by the firm to the company. In such a situation, neither Section 45(1) nor 45(4) are applicable. For this proposition, he relied upon the decision of Hon'ble High Court of Bombay in the case of Texspin Engg. & Mfg. Works 263 ITR 345 wherein it was held thus:
In this matter, we are concerned with assessment year 1996-97. Section 45(1) is a charging section as far as capital gains is concerned. Under Section 45(4), profits arising from transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm is chargeable to tax as income of the firm in a previous year in which the transfer takes place and for the purposes of Section 48, the fair market value of the asset on the date of such transfer is deemed to be the full value of the consideration received or accruing as a result of the transfer. Section 48 deals with mode of computation. It, inter alia, lays down that the income chargeable under the head 'capital gains' shall be computed by deducting from the full value of the consideration, the expenditure incurred in connection with the transfer and the cost of acquisition of the asset. Therefore, Under Section 45(4), two conditions are, required to be satisfied viz. transfer by way of distribution of capital assets and secondly, such transfer should be on dissolution of the firm or otherwise. Once these two conditions are satisfied then, in that event, for the purposes of computation of capital gains Under Section 48, the market value on the date of the transfer shall be deemed to be the full value of consideration received or accruing as a result of the transfer.
Now, according to the Assessing Officer, in this case, on vesting of the properties of the firm in the Limited Company, there was a transfer by way of distribution of capital assets. Further, according to The Assessing Officer, on vesting of the properties of the firm in the company, there was a resultant dissolution of the firm. Therefore, according to the Assessing Officer, both the conditions Under Section 45(4) stood satisfied and, therefore, he was entitled to take the fair market value of the asset on the date of the transfer to be the full value of the consideration received as a result of the transfer. It is for this reason that the Assessing Officer has computed the capital gains Under Section 48 by referring to the comparative figures of the book value and the market value. As stated above, in this connection, the Assessing Officer has computed capital gains arising to the assessee-firm at Rs. 9 lakhs on the basis of the difference between the market value and the written down value. The Assessing Officer has taken the written down value as on 1st April, 1995 and he has taken the market value as on 8th November, 1995 (alleged date of transfer) and on that basis, he has computed the capital gains. However, stated, computation Under Section 45(4) read with Section 48 would arise only if the aforestated two conditions are satisfied to attract Section 5(4).
In this case, the erstwhile firm has been treated as a Limited Company by virtue of Section 575 of the Companies Act. It is not in dispute that in this case, the erstwhile firm became a Limited Company under Part IX of the Companies Act. Now, Section 45(4) clearly stipulates that there should be transfer by way of distribution of capital assets. Under Part IX of the Companies Act, when a partnership firm is treated as a Limited Company, the properties of the erstwhile firm vests in the Limited Company. The question is whether such vesting stands covered by the expression 'transfer by way of distribution' in Section 45(4) of the Act. There is a difference between vesting of the property, in this case, in the limited Company and distribution of the property. On vesting in the Limited Company under Part IX of the Companies Act, the properties vest in the company, as they exist. On the other hand, distribution on dissolution presupposes division, realization, encashment of assets and appropriation of the realized amount as per the priority like payment of taxes to the Government, BMC etc., payment to unsecured creditors etc. This difference is very important. This difference is amply brought out conceptually in the judgment of the Supreme Court in the case of Malabar Fisheries Co. v. CIT . In the present case, therefore, we are of the view that Section 45(4) is not attracted as the very first condition of transfer by way of distribution of capita assets is not satisfied. In the circumstances, the latter part of Section 45(4), which refers to computation of capital gains Under Section 48 by treating fair market value of the asset on the date of transfer, does not arise.
Shri Sarangan further submitted that even Section 45(1) is held not applicable in such a situation. Though provisions of Section 47(xiii) were not subsisting during the asst. year in appeal before Hon'ble Bombay High Court, the same are brought on the statute book w.e.f. 1.4.1999 and the present asst. year is being 2001-02. Even under the provisions of Section 47(xiii), the conversion of partnership firm into a company do not attract capital gain. Learned CIT(A) erred in holding that conversion of firm into a company do not amount to succession and hence exemption available Under Section 47(xiii) will not apply. Since there is no transfer between a firm and a company, neither Section 45(1) nor 45(4) applies and even if it is held that there is a transfer, by virtue of Section 47(xiii), the capital gain is not chargeable to tax. He further submitted that at any rate since there is also transfer of land, the transfer thereof does not give rise to short term capital gain as computed by the Assessing Officer.
5. Learned DR Shri Rajguru strongly relied upon the appellate order. He firstly submitted that at first instance, the partnership firm revalued its assets from the small sum of Rs. 3.96 crores to Rs. 20 crores and more. The surplus was credited to the capital accounts of the partners. Thereafter, the firm is dissolved and the company is incorporated. The assets are transferred to the company. In such a situation, provisions of Section 45(4) are clearly applicable. Once Section 45(4) is applicable, the result is obvious, resulting into computation of capital gain as per Section 45(4) itself. Section 45(4) can be invoked when there is distribution of capital assets on dissolution of firm or otherwise. The word 'or otherwise' will be attracted even when the firm is converted into a company and hence learned CIT(A) was justified in holding that Section 45(4) is applicable. He further submitted that situation like conversion of firm into a company under Part IX of the Companies Act, 1956 is not envisaged in Section 47(xiii) of the Act and accordingly, such conversion do not amount to succession within the meaning of Section 47(xiii) and accordingly, the capital gain is not exempt on the ground that there is no transfer.
6. We have carefully considered the relevant facts and arguments advanced. We find sufficient force in the submission by learned senior counsel Shri Sarangan. Under the partnership Act, 1932, the partners individually are called as partner and collectively, a firm. Persons, who join in to carry on the business, may register themselves under the partnership -Act. Under Section 565 of the Companies Act, any company consisting of 7 or more members, may at any time register under the Companies Act as a Company Limited by shares. As per Section 575 of the Companies Act, 1956, all properties vest in a company at the date of registration pursuant to Part IX of the Companies Act and shall vest in the Company as incorporated, Hon'ble Andhra Pradesh High Court in the case of Vali Pattabhirama Rao v. Sri Ramanuja Ginning & Rice Factory Pvt. Ltd. 60 Com. Cases 568, held thus:
The property brought into the stock of a firm by a partner becomes the property of the firm and no words of dispositive character are necessary to bring the property to the common stock. The deed of formation of partnership is enough to make the property of the partner the property of the firm.
The word 'company' occurring in Section 263 of the Companies Act, 1956, is not a company registered under the Act. It is used in the sense of a group, assembly or association of persons. In fact, the word 'company' is used in several sections of the Act in the general sense of association of persons. In fact. Section 11 of the present Act (Section 4 of the 1913 Act) itself, which enacts the prohibition of associations exceeding a certain members from carrying on trade, starts with saying that no company, association or partnership consisting of more than ten members shall Be formed. Section 253 of the 1913 Act corresponds to Section 565 of the 1956 Act. Section 565(1)(b) of the 1956 Act corresponds to Section 253(1)(ii) of the 1913 Act, which permits any company otherwise duly constituted according to law consisting of seven or more members to be registered as a company. A partnership must be one such. This is made clear by the provisions of Section 255 of the 1913 Act (Section 568 of the 1956 Act) where under a deed of partnership has to be filed before the Registrar before seeking the registration. Hence, a partnership which was treated as a company for the purpose of the Companies Act can be registered under Part 8 of the 1913 Act (Part 9 of the 1956 Act) and the vesting is provided by Section 263 of the 1913 (Section 575 of the 1956 Act). The provision is mandatory and there will be statutory vesting in the corporation so incorporated under the provisions of the Companies Act. The Registrar is bound to give a certificate of registration Under Section 262 of the 1913 Act (Section 574 of the 1956 Act) which is a conclusive proof of incorporation: vide Section 35 of the 1956 Act which corresponds to Section 24 of the 1913 Act. Hence, it is clear that no conveyance is necessary when a partnership is converted and registered as a company. However, it is not possible to acquire such title statutorily under this section if the erstwhile firm purports to convey title to the company in which event a separate deed of conveyance is necessary. Thus, if the constitution of a partnership firm is changed into that of a company by registering it under Part 9 of the 1956 Act (Part 8 of the 1913 Act), there shall be statutory vesting of title of all the property of the previous firm in the newly incorporated company without any need for a separate conveyance.
Similar view has been taken by Hon'ble Madras High Court in the case of L K S Gold Palace and Ors. v. L K S Sold House P. Ltd. 122 Company Cases 896. The Company Law Department in its press release dated 5.8.1999, has clarified that a partnership firm will continue to be registered as a company provided it fulfills the conditions prescribed under the Companies Act, 1956. Courts have also acted under the provisions of the Companies Act in matters of dissolution of a firm by treating it as a liquidation of an unincorporated company, so as to apply the provisions relating to liquidation under the Companies Act especially because of the provisions in Part X providing for winding up of unregistered companies as was held by Hon'ble Karnataka High Court in the case of Vasantrao v. Shyamarao 47 Comp Cases 666 and in the case of Mangalore Ganesh Beedi Works. From the above Scheme of Part IX of the Companies Act, 1956, it is clear that the partners who were either to register as 'firm' can register themselves under the Companies Act. On such registration what was earlier called 'the firm' is now called 'a company'. However, both entities are not different. Both the entities do not exist simultaneously. When the firm comes to an end, the company takes birth. Thus, in the present case, upto 2.10.2000, the partners were registered under the partnership Act. On 3.10.2000, the partners are registered under the Companies Act. The word 'transfer', presuppose existence of transferor and transferee simultaneously. In the present case, if we hold that the firm is transferor, the transferee is not in existence. If it can be hold that the transferees is the Company which came in existence on 3.10.2000, the firm i.e. the transferor is not in existence in 3.10.2000. Thus, it is not the case of transfer by one person to another; it is merely a change under the Act under which the persons are registered to carry on the business. The decision of Hon'ble Bombay High Court is squarely applicable. We do not find any reason to hold any other view than that taken by Hon'ble Bombay High Court.
6.1 It is not the case that Section 45(1) can be invoked to tax the capital gain in the present situation. The interest of a partner in a firm is not an interest in any specific item of the partnership property. It is a right to obtain his share of profits from time to time during the subsistence of the partnership and on dissolution of the firm or on his retirement from the partnership, to get the value of his share in the net assets of the firm. When, therefore, on dissolution or retirement, a partner's share in the net partnership asset is determined on taking accounts, what he receives is his share in the partnership and not any consideration for transfer of his interest in the partnership. In such a situation, there is no transfer of interest within the definition of Section 2(47) of the Act. This proposition are clearly laid down by Hon'ble Supreme Court in the case of Malabar Fisheries Co. v. CIT 120 ITR 49 and in the case of CIT v. Mahanbhai Pamabhai 91 ITR 393 has affirmed by Hon'ble Supreme Court in the case of CIT v. Mohanbhai Pamabhai 165 ITR 166. Thus, when upon retirement of a partner or dissolution of a firm when the partnership accounts are adjusted by payment of cash op any partnership asset, there would be no capital gain to be attached Under Section 45(1) in the hands of the partners. This principle has been laid down by Hon'ble Supreme Court in the case of CIT v. Bankeylal 79 ITR 594. It is only to overcome such a situation, Sub-section(4) of Section 45 was inserted by Finance Act, 1987 w.e.f. 1.4.1988.
6.2 The insertion of Section 47(xii) has not changed the situation. Section 47(xiii) merely excludes certain transfer from the purview of the definition of the word 'transfer' as provided in Section 2(47) of the Act. To bring to charge the capital gain Under Section 45(4), what is required is distribution of capital asset on dissolution of firm or otherwise. In the present case it is seen that there is no distribution of capital asset to the partners. There is no dissolution of the firm. The persons who were either to register under the parinership Act are now registered under the Companies Act and accordingly, Section 45(4) will not apply in such a situation. We accordingly hold that no capital gain is chargeable in such "a situation as there is no distribution of capital asset on dissolution of firm or otherwise.
6.3 When a conversion of a firm into company takes place under the provisions of Companies Law, such conversion can be construed only as occasioned by operation of law. Hence, no controversy can arise on the application of this principle even for purposes of capital gains Under Section 45(4) of the Act. By insertion of Section 47(xiii) in the Act, it cannot be said that the conversion of a firm into a company under Part IX is to be first treated as dissolution of firm within the meaning of Section 45(4) and only if condition as contained in Section 47(xiii) are complied, the exemption will be available. Section 47(xiii) applies only to a case of transfer by sale, but there is no authority for capital gain at all in the absence of a transfer under Part IX of the Companies Act in as much as such conversions do not fall within the definition of transfer Under Section 2(47) of the Act. Section 45(4) would have application only when there is distribution of assets to the partners so that its application cannot be justified, firstly because it can apply only, when there is transfer and secondly only when there is distribution of assets to the partners. This is neither in the conversion of a firm into a company. It is also seen that Section 47(xiii) is also complied with if it is held That There is transfer of capital asset to a company. AW the clauses of Section 47(xiii) are fulfilled and thus even if it is held that there is a transfer of capital asset by a firm to a company as a result of succession, the same is not chargeable, as the condition prescribed therein are complied with. Thus, looking at either angle, the capital gain is not chargeable to tax.
7. The next ground of appeal is regarding disallowance of a sum of Rs. 1,53,000/- by way of commission paid to certain persons who helped in procuring the students to the School of Nursing run by the assessee. Learned CIT(A) observed that necessary vouchers in support of the claim was not furnished. The primary responsibility of proving the genuineness of the claim rests upon the assessee. The assessee having failed to prove the genuineness by furnishing necessary supporting evidence, the disallowance is to be upheld.
8. We now take up the appeal of revenue.
8.1 Revenue has raised following grounds before us:
i) That the learned CIT(A) erred by not appreciating the fact that the assets of the firm were transferred to the company midway during the year and hence, the claim for the depreciation amounting to Rs. 39,453,356/- being 50% of the admissible depreciation is absolutely disallowable.
ii) That the learned CIT(A) erred in holding a view that assessee's claim for depreciation to be allowed in case of firm @ 50% of the admissible depreciation upto the period of transfer of assets to the company as the company M/s Unity Core and Health Services Pvt. Ltd. have claimed the balance 50% of the admissible depreciation.
iii) That the learned CIT(A) has erred in not appreciating the fact that the assessee firm has transferred all its assets to the company w.e.f. 3.10.2000 and the claim for depreciation is not admissible in the hands of the firm, since there were no assets on which depreciation can be allowed.
9. Learned CIT(A), in this regard, observed as under:
It is stated by the ARs present that the Assessing Officer has erred in observing that the appellant has claimed depreciation at the rate of 200%. It is stated that the appellant had claimed only 50% of the depreciation and the balance 50% had been claimed by the company. The Assessing Officer is directed to allow proportionate depreciation in the hands of the appellant for the period of user in respect of all the eligible assets on the basis of the written down value/actual cost thereof, as the case may be, upto the period prior to the conversion of the firm into a private limited company.
10. Whereas learned DR Shri Rajguru relied upon the assessment order and grounds of appeal, learned senior counsel for assessee relied upon the appellate order.
11. The 5th Proviso to Section 32(1) prescribes thus:
Provided also that the aggregate deduction, in respect of depreciation of buildings, machinery, plant or furniture, being tangible assets or know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets allowable to the predecessor and the successor in the case of succession referred to in Clause (xiii) and Clause (xiv) of Section 47 of Section 170 or to the amalgamating company and the amalgamated company in the case of amalgamation, or to the demerged company and the resulting company in the case of demerger, as the case may be, shall not exceed in any previous year the deduction calculated at the prescribed rates as if the succession or the amalgamation or the demerger, as the case may be, had not taken place, and such deduction shall be apportioned between the predecessor and the successor, or the amalgamating company and the amalgamated company, or the demerged company and the resulting company, as the case may be, in the ratio of the number of days for which the assets were used by them.
From the aforesaid proviso, it is clear that when the depreciation is allowable on the assets to the predecessor and the successor, the depreciation has to be apportioned between the predecessor and successor in the ratio of number of days for which the assets were used by them. This proviso will apply not only when the succession is as per Section 47(xiii) and 47(xiv) of the Act but also where succession is as per Section 170 of the Act. Clearly, in this case, the firm is entitled to depreciation for the number of days the assets were used by it. We accordingly do not find any reason to dislodge the finding of the learned CIT(A).
In the result, the appeal of assessee is portly allowed and that of revenue is dismissed.