Income Tax Appellate Tribunal - Amritsar
Sachdeva And Sons (E.O.U.) vs Deputy Commissioner Of Income Tax on 30 June, 2003
Equivalent citations: (2004)82TTJ(ASR)847
ORDER
1. This is an appeal by the assessee against the order of the learned CIT(A), Jammu dt. 29th Jan., 2002, relating to the asst. yr. 1998-99.
2. The first three grounds of appeal relate to the legal issue, which are reproduced hereinbelow :
"1. That both the CIT(A), Amritsar and the Dy. CIT, CCI, Amritsar have grossly erred in applying the provisions of Section 2(47) r/w Section 45(4) of the IT Act, 1961, to the conversion of the assessee-firm into a company under Section 565 of the companies Act.
2. That both the CIT(A), Amritsar and the Dy. CIT, CCI, Amritsar have failed to appreciate that the case of the assessee was covered by Section 565 of the Companies Act and the conversion of the erstwhile firm into company did not tantamount to "transfer" within the meaning of Section 2(47) of the IT Act, 1961.
3. That both the CIT(A), Amritsar and the learned Dy. CIT, CCI, Amritsar have failed to appreciate that the deed of settlement made on 22nd April, 1997, did not tantamount to any transfer within the meaning of Section 2(47) of the IT Act, 1961."
3. Briefly stated, the facts of the case are that the assessee-firm carried on the business of manufacturing of rice and remains into existence upto 5th May, 1997, on which it was converted into a private limited company in the name of M/s Sachdeva & Sons Industries (P) Ltd. A certificate of incorporation issued by the Registrar of Companies on 5th May, 1997. The assessee-firm was consisted of seven partners. As per the memorandum of association, a deed of settlement was made on 22nd April, 1997, by all the seven partners when they had settled that their 'holding of the subscribed capital in the new company would be in the shape of shares in the company. During the assessment proceedings, the AO required the assessee to explain as to whether the provisions of Section 45(2) were not applicable in its case. He further requested the assessee to intimate the exact address of land worth Rs. 28,45,845 as per balance-sheet dt. 5th May, 1997. He also directed the assessee to supply the details of area of land, date, cost of acquisition and fair market value of the land as at the time of taking over the assets of the firm by the company. In response to above, the assessee had filed written reply on 19th March, 2001 and 27th March, 2001. It was submitted that the assessee-firm consisted of seven partners and was converted into a registered company on 5th May, 1997 and this conversion did not tantamount to a transfer under Section 2(47) of the Act and there was no deemed transfer within the meaning of Section 45(4) of the Act. It was explained that there was no distribution of capital assets and dissolution of a firm in this case, It was stated that there was an automatic vesting and divesting of the assets of the firm because the firm was divested of the assets which in turn were vested in the company. Accordingly, it was submitted that there was no transfer within the meaning of Section 2(47) r/w Section 45(4) of the Act. The AO did not accept the above contention of the assessee and held that the firm M/s Sachdeva & Sons consisted of seven partners and was converted into a company on 5th May, 1997. According to the AO all the assets of the firm were taken over by the company not the depreciated value or the book value. The shares of all the seven persons in the company continued to be the same which they had in the old firm. The AO was of the view that the word "transfer" in relation to the capital asset included any transaction which has the effect of transferring or enabling the enjoyment of the immovable property. He further held that Sub-clause (vi) of Section 2(47) clarifies that such a transaction may be by way of acquiring shares in a company under an agreement or any arrangement or in any other manner whatsoever. He took the view that all the assets of M/s Sachdeva & Sons were transferred when the assessee-firm was converted into company on 5th May, 1997, and all the seven persons of the assessee-firm had acquired the shares in the new company under an agreement dt. 22nd April, 1997, in the same proportion in which they were sharing the profits of the firm. He further noted that all the immovable properties of the assessee-firm had become the properties of the company on that date. He, therefore, took the view that the provisions of Section 45(4) of the Act were clearly applicable in this case, and fair market value of the assets as on 5th May, 1997, was held to be the full value of the consideration received or accruing as a result of the transfer. The AO computed the long-term capital gain on the land at Amritsar at Rs. 41,35,250. Similarly, the long-term capital gain on the land at Delhi came to Rs. 17,51,300. The total amount of capital gain was worked out at Rs. 58,86,550. The AO after allowing business loss of Rs. 4,580 relating to the current year worked out the balance capital gain at Rs. 58,81,970.
4. The assessee carried the matter in appeal to the CIT(A). Before the CIT(A), the assessee filed the written submissions, which is reproduced hereunder:
"The AO did not appreciate the fact that conversion of the erstwhile firm M/s Sachdeva & Sons EOU into a company under Section 565 of the Companies Act, 1956, did not tantamount to transfer within the meaning of Section 2(47) of the IT Act.
This conversion does not tantamount to transfer under Section 2(47) of the IT Act, 1961. There is also no deemed transfer within the meaning of Section 45(4) of the Act, as no distribution of capital assets on dissolution of a firm has taken place.
It is submitted that the same entity viz. M/s Sachdeva & Sons has emerged with a different mantle. A transfer presupposes existence of two parties i.e. a transferor and a transferee before as well as at the time of transfer. The deed of co-partner is a declaration by a firm to a company which is yet to come into existence. In other words, there is no transferee in existence.
It is submitted that under Section 566 of the Companies Act, 1956, there was automatic vesting and divesting of the assets of the firm because the firm was divested of these assets which in turn were vested in the company, Such a vesting and divesting did not tantamount to transfer within the meaning of Section 2(47) of the IT Act, 1961.
It is further submitted that no dissolution deed was executed and there was no severance of relationship between the partners. The firm continues to exist till the incorporation of the company.
It is also submitted that assessee-firm had done no revaluation of assets and that the conversion took place at the net book value of the assets.
The provisions of Section 45(4) provide for existence of these conditions before it is made applicable :
1. There is a transfer of capital assets.
2 Such transfer is by way of distribution of capital assets.
3. Such distribution is on dissolution of a firm.
None of the above conditions is fulfilled in this case and therefore, Section 45(4) is not applicable.
It is further submitted that in a similar case of Chaman Lal Setia Exports Ltd. which is being assessed by Dy. CIT, Spl. Range, Amritsar, the above position has been accepted.
The appellant's counsel in this regard placed reliance on the decision of the Tribunal, Mumbai Bench in the case of Texspin Engineering and Manufacturing Works v. Jt. CIT (2001) 70 TTJ (Mum) 789 which Bench has relied upon the decision of Andhra Pradesh High Court in the case of V.P. Rao v. Ramanuja Ginning and -Rice Factory (P) Ltd. 60 Comp. Cas 568 (AP).
It is, therefore submitted that in view of decision reported above, there is no transfer within the meaning of Section 2(47) r/w Section 45(4) in the case of the assessee and as such no capital gains had resulted subject to capital gains tax." .
4.1 After considering the submissions made by the assessee, the learned CIT(A) held that:
"(a) That there is no dispute about the fact that all the assets in entirety of the firm, M/s Sachdeva & Sons were transferred to the company, M/s Savhdeva & Sons Inds. (P) Ltd.
(b) That there cannot be any doubt that on 5th May, 1997, when the new company came into existence, the firm, M/s Sachdeva & Sons ceased to exist.
(c) The only inference that could be drawn from this situation is that the said firm, M/s Sachdeva & Sons was dissolved on 5th May, 1997, by the partners and all the properties of the firm were taken over by the company, M/s Sachdeva & Sons Inds.(P) Ltd.
(d) That the said company is a distinct and separate legal entity as distinguished from the assessee firm, M/s Savhdeva & Sons.
(e) The firm, M/s Sachdeva & sons stands dissolved having no existence after 5th May, 1997, although the shareholdings in the new company are in exactly the same proportion as it was with the shares in the partnership firm, yet it cannot be denied that the assets of the firm has been taken over by a distinct legal entity in the form of a company and this act of transfer of assets from the firm to the company is a deliberate act on the part of the partners and this cannot be taken as anything except dissolution of the partnership firm."
In view of the above, the learned CIT(A) held that the provisions of Section 45(4) were clearly applicable to the facts of the present case. He, further observed that from the asst. yrs. 1988-89 profit and gains arising from any transfer of the assets are chargeable to tax as income of the firm, an association or BOI of previous year in which the said transfer took place. He further observed that upto the asst. yr. 1987-88, any transfer involving any distribution of capital assets on the dissolution of the firm or BOI was not to be regarded as a transfer for the purposes of capital gains tax levy by virtue of specific provision in this regard as contained in Section 47(ii) as it existed at that time. He further held that although distribution of the assets in the present company are in the same proportion as in the case of the erstwhile firm yet it cannot be said that this does not amount to transfer because the same persons are involved in both the company as well as the firm. It was also held by the CIT(A) that there was a distribution of assets of the dissolved firm amongst the partners in the same proportion as their shares in the erstwhile firm, the shares held by the share-holders in the present company are nothing but the redistribution of the assets of the firm in the form of shares. He also took the view that since the company is a distinct artificial jurisdical person and, therefore, there was clear transfer of assets from partner ship firm to company. He, therefore, rejected the claim of the assessee that the provisions of Section 45(4) of the Act were not applicable.
5. We have heard both the parties at length and have also carefully gone through the material available on record. There is no dispute as regards the facts of the present case are concerned. It is true that the partnership-firm was converted into private limited company on 5th May, 1997, in the name of M/s Sachdeva & Sons Inds. (P) Ltd. It is noticed that for the assessment year under consideration i.e. period between 1st April, 1997 to 5th May, 1997, the assessee-firm filed its return of income on 31st July, 1998 declaring a loss of Rs. 4,580. It seems that the return for the remaining period was filed by the company. Admittedly, the assessee had not shown any capital gain in its return of income. However, the AO took the view that there was dissolution of the firm and there was transfer of assets and, therefore, the assessee was liable to capital gains as per the provisions of Section 45(4) of the Act, On the contrary, the contention of the assessee was that the provisions of Section 45(4) are not applicable in the facts and the circumstances of the present case. The learned CIT(A) held that there was a dissolution of the firm and, therefore, the profits or gains from such transfer was liable to tax under Section 45(4) of the Act. From the records, it would be clear that the AO has computed the capital gains at Rs. 50,81,970 after allowing a reduction of Rs. 4,580 on account of business loss. It is relevant to point out here that a similar case has been decided by the Hon'ble Bombay High Court in the case of CIT v. Texspin Engg. and Mfg. Works (2003) 129 Taxman 1 (Bom) (IT Appeal No. 222 of 2001 dt. 5th March, 2003). The Hon'ble Bombay High Court has held as under:
"Sec. 45(1) provides that where any profit, arising from transfer of a capital asset is effected in the previous year then such profit shall be chargeable to income-tax under the head "Capital gains". The expression "transfer of a capital asset" in Section 45(1) is required to be r/w Section 2(47)(ii) which states that transfer in relation to a capital asset shall include extinguishment of any rights therein. The moot point which arose on interpretation of Section 45(1) in numerous matters was that on extinguishment of the rights in the capital assets, there was a transfer and in certain cases of reconstitution of firms and introduction of new partners, there was a resultant extinguishment of the rights in the capital assets proportionately. In order to get over this controversy, and keeping in mind the object of encouraging firms being treated as companies, the controversy is resolved by the legislature by introducing Clause (xiii) in Section 47 w.e.f. 1st April, 1999.
Now, in the present case, it is argued on behalf of the Department before the Tribunal, for the first time, that in this case, on vesting of the properties of the erstwhile firm in the limited company, there was a transfer of capital assets and, therefore, it was chargeable to income-tax under the head "Capital gains" as, on such vesting, there was extinguishment of .all right, title and interest in the capital assets qua the firm. We do not find any merit in this argument. In the present case, we are concerned with a partnership firm being treated as a company under the statutory provisions of Part-IX of the Companies Act. In such cases, the company succeeds the firm. Generally, in the case of a transfer of a capital asset, two important ingredients are : existence of a party and a counter-party and, secondly, incoming consideration qua the transferor. In our view, when a firm is treated as a company, the said two conditions are not attracted. There is no conveyance of the property executable in favour of the limited company. It is no doubt true that all properties of the firm vests in the limited company on the firm being treated as a company under Part-IX of the Companies Act, but that vesting is not consequent or incidental to a transfer. It is a statutory vesting of properties in the company as the firm is treated as a limited company. On vesting of all the properties statutorily in the company, the cloak given to the firm is replaced by a different cloak and the same firm is now treated as a company, after a given date. In the circumstances, in our view, there is no transfer of a capital asset as contemplated by Section 45(1) of the Act. Even assuming for the sake of argument that there is a transfer of a capital asset under Section 45(1) because of the definition of the word "transfer" in Section 2(47)(ii), even then we are of the view that liability to pay capital gains would not arise because Section 45(1) is required to be read with Section 48, which provides for mode of computation. These two sections are required to be read together as the charging section and the computation section constitute one package. Now, under Section 48 it is laid down, inter alia, that the income chargeable under the head "Capital gains" shall be computed by deducting from the full value of the consideration received or accrued as a result of the transfer, the cost of acquisition of the asset and the expenditure incurred in connection with the transfer. Section 45(4) is mutually exclusive to Section 45(1). Section 45(4) categorically states that where there is a transfer by way of distribution of capital assets and where such transfer is due to dissolution or otherwise of the firm, the AO was entitled to treat the market value of the asset on the date of the transfer as full value of the consideration received. This latter part of Section 45(4) is not there in Section 45(1). Therefore, one has to read the expression "full value of the consideration received/accruing" under Section 48 de hors Section 45(4) and if one reads Section 48 with Section 45(1) de hors Section 45(4) then the expression "full value of consideration" in Section 48 cannot be the market value of the capital asset on the date of transfer. In such a case, we have to read the said expression in the light of the two judgments of the Supreme Court in the cases of George Henderson & Co. Ltd. (supra) and Gillanders Arbuthnot & Co. (supra) in which it has been held that the expression "full value of the consideration" does not mean the market value of the asset transferred, but it shall mean the price bargained for by the parties to the transaction. It has been further held that consideration for the transfer of a capital asset is what the transferor receives in lieu of the assets he parts with viz., money or money's worth and, therefore, the very asset transferred or parted with cannot be the consideration for the transfer and, therefore, the expression "full value of the consideration" cannot be construed as having a reference to the market value of the asset transferred and that the said expression only means the full value of the things received by the transferor in exchange of the capital asset transferred by him. In the circumstances, even if we were to proceed on the basis that vesting in the company under Part-IX constituted transfer under Section 45(1), still the assessee ought to succeed because the firm can be assessed only if the full value of the consideration is received by the firm or if it accrues to the firm. In the present case, the company had allotted shares to the partners of the erstwhile firm, but that was in proportion to the capital of the partners in the erstwhile firm. That allotment of shares had no correlation with the vesting of the properties in the limited company under Part-IX of the Act. Lastly, Section 45(1) and Section 45(4) are mutually exclusive. Under Section 45(4) in cases of transfer by way of distribution and where such transfer is as a result of dissolution, the Department is certainly entitled to take the full market value of the asset as full value of consideration provided there is transfer by distribution of assets. In this case, we have held that there is no such transfer by way of distribution and, therefore, Section 45(1) is not applicable."
Similarly, the Hon'ble High Court has held as under :
"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 vest 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 pre-supposes division, realisation, encashment of assets and appropriation of the realised 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 (1979) 120 1TR 49 (SC). In the present case, therefore, Section 45(4) is not attracted as the very first condition of transfer by way of distribution of capital 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."
5.1 At this stage, we may also refer to a decision of the Tribunal Ahmedabad Bench in the case of Well Pack Packaging v. Dy. CIT (2003) 78 TTJ (AM) 448. The Tribunal, Ahmedabad Bench while interpretting the provisions of Sections 575, 576, and 577 of the Companies Act, 1956 held that there was no transfer involved when a company gets itself registered under Part IX of the Companies Act. The relevant findings are reproduced hereunder:
"7,5 The next point for consideration is whether on registration of the firm as a limited company under Part-DC 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)/45(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 Rice 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 to the erstwhile partners of the firm, the Revenue could tax only the erstwhile partners as an AOP or BOI and not the firm."
(emphasis, italicised in print, supplied) In view of the above decisions, we are of the view that there was no transfer within meaning of Section 45(4) r/w Section 2(47) of the Act. It would also be relevant to point out here that in the instant case, the firm has been converted into a private limited company and all the partners were the only shareholders in the company and the shares were allotted in the same proportion as they were having in the erstwhile firm, which shows that the nomenclature was coverted from a firm into a private limited company and the business was carried out by the partners in the newly formed company. In our view, the very first condition for application of Section 45(4), i.e., transfer by way of distribution of capital asset has not been satisfied since there was no distribution of the assets amongst the partners. In fact, the partners carried on the business, however, the title of the business has been changed from the firm to a private limited company. Therefore, there was no justification in applying the provisions of Section 45(4) of the Act. It is also true that the ITAT Ahmedabad Bench has held in the case of Well Pack Packaging (supra) that in view of the provisions of companies Act, particularly Sections 575, 576 and 577 there was no transfer involved when the company is registered under Part-IX of the Companies Act. In the instant case, the shares to the existing partners of the firm had not been allotted by the company on the revised value of the assets. In other words, the shares were allotted on the basis of value of existing assets in proportion to their profit sharing ratio in the partnership firm, which shows that there was no transfer of the assets. However, the firm was converted into a private limited company without revaluing the assets.
5.2 In view of the above discussion, we are of the considered view that the provisions of Section 45(4) are not applicable to the facts of the present case. As such, the learned CIT(A) was not justified in confirming the action of the AO for charging tax on capital gain. Accordingly, we allow ground Nos. 1 to 3.
6. Ground No. 4 to 8 read as under:
"4. That both the CIT(A), Amritsar and the learned Dy. CIT, C.C.I, Amritsar having grossly erred in determining the fair market value of land situated at Amritsar at Rs. 9,00,000 per acre.
5. That both the CIT(A), Amritsar and the learned AO have failed to appreciate that the plot of the land of the assessee was a large piece of land and the fair market value of a larger piece had to be lower as compared to smaller plots.
6. That the CIT(A), Amritsar has failed to appreciate that the learned AO has failed to lead any evidence about the fair market value of land situated at Amritsar estimated at Rs. 1,12,500 per kanal a against the evidence filed by the assessee of Rs. 96,741 per kanal for a 30 kanal plot and claim of the assessee to value the same at Rs. 70,000 per kanal.
7. That both the CIT(A), Amritsar and the learned AO have grossly erred in taking the fair market value of land as on 1st April, 1981, at Rs. 11,29,833 only although the land had been purchased in 1978 and the fair market value as on 1st April, 1981, had to be on the higher side.
8. That both the CIT(A), Amritsar and the learned AO have grossly erred in determining the fair market value at land situated at Delhi at Rs. 1,000 per square yard."
Since we have allowed the appeal of the assessee on the legal issue and, therefore, we do not think it appropriate to consider and discuss the issue relating to the value of the property and hence no specific findings are being given as the issue becomes academic in nature.
7. Ground No. 9 reads as under :
"9. That both the CIT(A), Amritsar and the learned AO have grossly erred in coming to the conclusion that interest under Sections 234A, 234B and 234C is chargeable in the case."
At the time of hearing of the appeal, it was the common contention of the learned representatives of both the parties that the issue is consequential in nature and we hold accordingly. This ground of appeal is also disposed of.
8. In the result, the appeal is allowed partly.