Firm, AOP and BOI: Some special cases of deemed transfer of ‘capital asset’

[CA DEV KUMAR KOTHARI]

Special provisions of the Income-tax Act, 1961:

Capital gains.

Sub-sections (3) and (4) of 45 are reproduced with highlights by way of underlining for purpose of analysis:  

(3) The profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a co-operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48, the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.

(4) The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.]

Notes and history of provision:

Present sub-sections (3) and (4), as above were Inserted by the Finance Act, 1987, w.e.f. 1-4-1988.  Earlier original sub-sections (3) and (4) were inserted by the Finance Act, 1964, w.e.f. 1-4-1964 and later on omitted by the Finance Act, 1966, w.e.f. 1-4-1966.

Purpose of these sub-sections:

 In absence of provisions of  present sub-sections (3) and (4)  and in the circumstances covered by these sub-sections the capital gains will  not be taxable for various reasons like no case of transfer, no case of presently ascertainable consideration, no ascertainable cost of acquisition and cost of improvement, … etc. The Courts have held that in such circumstances gains will not fall under the scheme of S. 45  read with S. 48. Therefore, to overcome these rulings these subsections were inserted for deemed transfer and deemed consideration  and impliedly deemed cost of acquisition etc.

Some of leading cases laws directly on issue and related issues in this regard are as follows:

Sunil Siddharthbhai Versus Commissioner of Income-Tax, Ahmedabad, 1985 (9) TMI 7 - SUPREME Court

Malabar Fisheries Co. v. Commissioner of Income Tax, Kerala, 1979 (9) TMI 1 - SUPREME Court;

Commissioner of Income-Tax, West Bengal Versus Hind Construction Limited 1971 (9) TMI 16 - SUPREME Court.

Commissioner of Income Tax, Madras v. Janab N. Hyath Batcha Sahiv, 1968 (6) TMI 6 - MADRAS High Court;

Commissioner of Income Tax (Madras) - I v. Abdul Khader Motor and Lorry Service 1976 (9) TMI 14 - MADRAS High Court;

Dr. M.C. Kackkar v. Commissioner of Income Tax, Kanpur and Ors. 1972 (8) TMI 30 - ALLAHABAD High Court;

Commissioner of Income Tax, Kerala v. C.M. Khunhameed 1972 (1) TMI 41 - KERALA High Court

Special provisions:

Therefore it is clear that these provisions were inserted to cover certain cases of transactions between partner/member  and firm or AOP/ BOI as the case may be. These special provisions have specific purpose and are exceptions to general rules about transfer between partner/ member and firm /AOP/BOI as the case may be.

The above provisions are special provisions applicable in the case of introduction of capital asset in a partnership firm AOP or BOI by partner or member as the case may be. And in case of distribution of capital asset from firm/ AOP /BOI to partner / member.

In absence of such a provision such transactions may not be taxable because a firm, AOP or BOI are not  separate and distinct from its partner or member, though in the Income-tax Act, they may be treated separate assesses.

In these cases  special provisions  of charging tax on deemed transfer and  full value of consideration  deemed as  accruing  to transferor is provided in S. 45 (3) when a capital asset is introduced in firm, BOI or AOP . According to this provision,  amount recorded in books of account of firm  is deemed to be the full value of consideration of the capital asset transferred.

The special provision has its own purposes like (a)  to deem such transaction  as a  transfer and a taxable event,  (b)  to tax such transfer at consideration recorded by firm in its books of account  and (c) correspondingly the amount so recorded in books of account of the firm will be considered as  ‘the cost of acquisition’ in hands of the firm. As and when the firm transfers such asset, the same amount will be considered as ‘the cost of acquisition’ for the purpose of computing capital gains in hands of the firm.

Non applicability of other provisions:

In view of specific provisions of S. 45 (3) and 45 (4) deeming certain transactions as  transfers and ascertainment of consideration accruing on such deemed transfer,  general provisions will not be applicable. This is for the following reasons:

In case of introduction of capital assets in firm / AOP/ BOI a reference to Divisional Valuation Officer (DVO) will not be required, because it will serve no purpose. In such facts any reference to the DVO u/s 142A or other valuation authority is not at all called for, because consideration is to be ascertained as recorded in books of the firm.

Sections 43CA and  50C will also not be applicable. This is for the reasons that specific provision of deemed transfer and deemed consideration are applied  as per sub-sections (3) and (4) of S. 45.

In case of such transactions, a registration of documents  like transfer deed or conveyance deed may  not required (or compulsory), therefore there is no role of state stamp authorities to make a valuation of such properties, for the purposes of levy of stamp duty.

Value adopted by stamp authorities is not necessarily ‘fair market value’,  [(in fact in most of cases it is much more than ‘fair market value’] therefore, even for the purpose of sub-section (4) the value adopted by stamp authorities will not be applicable. In fact in such situation also value as negotiated by the firm and partners can only be regarded as ‘fair market value’, because of limited marketability of such assets when a question of distribution of assets from firm to partners arise. Therefore, the value recorded in books of firm can be considered as ‘fair market value’, and off course the same value will be ‘cost of acquisition’ in hands of partner who receive capital assets in distribution. 

Therefore, in case of cases covered by sub-sections (3) and (4) of S. 45,  S. 43CA and 50C  should not be applied.