TMI Blog2003 (7) TMI 46X X X X Extracts X X X X X X X X Extracts X X X X ..... ed are the same and similar questions of law arise. The respondents hereto were parties to a family settlement dated January 30, 1997. Pursuant to the said family settlement, there was a deed of reconstitution of various partnerships as set out under the family settlement. For the assessment year 1997-98, the partnerships were taxed for capital gains under section 45(4) of the Income-tax Act, 1961. An appeal was preferred against the said order by the assessee which came to be dismissed by the appellate authority by order dated June 16, 2000. An appeal was then preferred to the Income-tax Appellate Tribunal, by the assessee. The appeal was allowed. The Income-tax Appellate Tribunal held that there was no dissolution but only reconstitution. The Income-tax Appellate Tribunal also held that the expression "otherwise" had to be read ejusdem generis and would contemplate situations like a deemed dissolution and consequently held that tax on capital gains was not chargebale. On the facts, it was held that the business continued to be run and there was no dissolution of the firm and consequently section 45(4) of the Act was not attracted. The present appeals are preferred by the Revenu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent and the subsequent deeds of retirement of partnership that the order of assessment was made holding that the appellants are liable for tax on capital gains. The relevant portion of section 45, with which we are concerned is subsection (4) which reads as under: "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." Sub-section (4) along with sub-section (3) were introduced by the Finance Act, 1987, with effect from April I, 1988. From a reading of the above subsection to attract capital gains what would be required would be as under: "1. Transfer of capital asset by way of distribution of capital assets: (a) On account of dissolution o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there must be a transfer of a capital asset by way of distribution of assets in the first instance. Capital asset under section 2(14) of the Income-tax Act, 1961, has been defined to mean property of any kind held by an assessee. In other words, the property transferred must fall within the ambit of capital asset. The next relevant section is the expression "transfer" as set out in section 2(47) which in relation to a capital asset includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein. We need not refer for the present discussion to the other part of the said definition. Therefore, transfer will also include relinquishment of the asset or extinguishment of any rights therein. We first propose to answer the issue whether the deed of family settlement dated January 30, 1997, amounts to dissolution of the partnership firm by agreement under section 40 of the Indian Partnership Act. The Revenue has firstly placed reliance in the case of Erach F.D. Mehta v. Minoo F.D. Mehta, AIR 1971 SC 1653. There the apex court held on the facts therein that the agreement that one of the partners will retire amounts to dissolution of the partnership. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ether the transaction is such that the judicial process may accord its approval to it. A hint of this approach is to be found in the judgment of Desai J. in Wood Polymer Ltd., In re and Bengal Hotels Limited, In re [1977] 109 ITR 177; [1977] 47 Comp Cas 597 (Guj), where the learned judge refused to accord sanction to the amalgamation of companies as it would lead to avoidance of tax. It is neither fair nor desirable to expect the Legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of 'emerging' techniques of interpretation as was done in Ramsay, Burma Oil and Dawson, to expose the devices for what they really are and to refuse to give judicial benediction." This issue was an issue before the Income-tax Appellate Tribunal. The Income-tax Appellate Tribunal has held that the firm was in existence right from 1985 and it was not a device to avoid tax. It was noted that there was no denial that there were family disputes a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e apex court considered the definition of expression "transfer" under section 2(47) and noted that section 2(47) gives an artificial meaning to the expression "transfer" for it not merely includes transactions of "sale" and "exchange" in ordinary parlance but would also mean "relinquishment" or "extinguishment of rights" which are ordinarily not included in that concept. In that context, the apex court posed the question whether the dissolution of a firm extinguishes the firm's rights in the assets of the partnership so as to constitute a transfer of assets under section 2(47). After considering various judgments and the provisions of the Indian Partnership Act, the court observed that a partnership under the Indian Partnership Act is not a distinct entity. If that be the position, the apex court noted it would be difficult to accept the contention that upon dissolution the firm's rights in the partnership assets are extinguished. The firm as such has no separate rights of its own in the partnership assets but it is the partners who own jointly or in common the assets of the partnership. Therefore, the consequence of the distribution, division or allotment of assets to the partners ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 45, with effect from April 1, 1988. Those judgments proceeded on the footing that a partnership firm is not a distinct legal entity and the partnership property in law belongs to all the partners constituting the firm, though the partnership firm may possess a personality distinct from the persons constituting it and, therefore, on dissolution, as the firm has no separate rights of its own in the partnership assets, the consequence of distribution, division or allotment of assets of the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm's rights in the partnership assets amounting to a transfer of assets within the meaning of section 2(47) of the Act. Pursuant to the inclusion of sub-section (4) in section 45, on the dissolution of a partnership the profits or gains arising from the transfer of capital asset are chargeable to tax as income of the firm. It is contended on behalf of the assessee that even after introduction of section 45(4), the position will be the same as the definition clause, i.e., namely, section 2(47), has not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct. The apex court considered two situations, one when a personal asset is brought by a partner into a partnership as his contribution to the partnership capital and that which arises when on dissolution of the firm or on retirement a share in the partnership assets passes to the partner. The court held that on dissolution or on retirement what the partner gets is a shared interest in all the assets of the firm which is replaced by an exclusive interest in an asset of equal value. This judgment was in respect of an assessment before the amendment to section 45. In CIT v. Vijayalakshmi Metal Industries [2002] 256 ITR 540 (Mad), the real issue before the learned single judge was as to when capital gain is to be brought to tax. The learned judge held that until such time such capital asset is transferred by way of distribution of the assets on the dissolution of the firm no occasion arises for bringing to tax any capital gain on a transfer which has not taken place. The section itself gives no room for doubt as the year in which the capital gain is to be brought to tax is the previous year in which the said transfer takes place. This judgment would again be of no assistance. In CIT v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ers. Some machinery was given to the partners individually and one machine was given to all the five partners to be held by them jointly as co-owners. As a result, the firm ceased to be the owner of the said machinery and the five partners became the owners of the machinery so distributed either individually or as co-owners. The five partners shortly thereafter formed another partnership and contributed the machinery which was distributed to them by the assessee-firm to the new firm by doing valuation. The new firm thereafter sold the machinery for a price. The Gift-tax Officer treated the difference at the price at which the machinery was distributed by the assessee-firm to its partners as deemed gift and subjected the same to gift-tax. The issue was whether distribution of machinery was a transfer in the nature of sale, for a consideration. The Division Bench of the Karnataka High Court considered the expression of "transfer" under section 2(xxiv) of the Gift-tax Act, which defines "transfer of property" as any disposition, conveyance, assignment, settlement, delivery or other alienation of property. The Division Bench noted that the Act was self-contained and the definition of " ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the partner, such partner becomes entitled to exercise over the asset, all rights of an absolute owner. The court then proceeded to observe what was a mere interest on allotment by the firm, enlarges into an absolute right, title and interest. The extinguishment of the common interest of the partners of the firm and creation of absolute ownership of the partner to whom it is allotted. Such a transaction is, therefore, a transfer of property as defined in the Gift-tax Act. We may note that the partnership was subsisting and an asset of the partnership was made the absolute ownership of one of the subsisting partners. This judgment came up for consideration before the apex court in B.T. Patil and Sons v. CGT [2001] 247 ITR 588 upholding the judgment of the Karnataka High Court. The apex court observed as under: "In our view, when there is a dissolution of a partnership or a partner retires and obtains in lieu of his interest in the firm, an asset of the firm, no transfer is involved...But the position is different when, during the subsistence of a partnership, an asset of the partnership becomes the asset of only one of the partners thereof; there is, in such a case, a transf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on Bench in CIT v. Trustees of Abdulcadar Ebrahim Trust [1975] 100 ITR 85 (Bom). Section 45 is a charging section. The purpose and object of the Act of 1987 was to charge tax arising on distribution of capital assets of firms which otherwise was not subject to taxation. If the language of sub-section (4) is construed to mean that the expression "otherwise" has to partake of the nature of dissolution or deemed dissolution, then the very object of the amendment could be defeated by the parthers, by distributing the assets to some partners who may retire. The firm then would not be liable to be taxed thus defeating the very purpose of the Amending Act. Prior to the Finance Act, 1987, in the case of a partnership it was held that the assets are of the partners and not of the partnership. Therefore, if on retirement a partner received his share of the assets, may be in the form of a single asset, it was held that there was no transfer and similarly on dissolution of the partnership. Another device resorted to by an assessee was to convert an asset held independently as an asset of the firm in which the individual was a partner. The decision of the Supreme Court in Kartikeya V. Sarabhai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re, when the asset of the partnership is transferred to a retiring partner the partnership which is assessable to tax ceases to have a right or its right in the property stands extinguished in favour of the partner to whom it is transferred. If so read it will further the object and the purpose and intent of the amendment of section 45. Once, that be the case, we will have to hold that the transfer of assets of the partnership to the retiring partners would amount to the transfer of the capital assets in the nature of capital gains and business profits which is chargeable to tax under section 45(4) of the Income-tax Act. We will, therefore, have to answer question No. 3 by holding that the word "otherwise" takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner. The only other contention advanced is that section 2(47) has not been amended and consequently even if section 45(4) has been brought in by the amendment yet there is no transfer. In our opinion, that would not be the correct position. Firstly, the definition of transfer itself is inclusive. Before the introduction of su ..... X X X X Extracts X X X X X X X X Extracts X X X X
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