2010 (12) TMI 754 - HC - Income Tax

Sale of partnership firm as going concern after its dissolution - Computation of capital gain - Slump sale - Sale of the business of the firm as a going concern - Relinquishment of right - Held that - once the partnership is dissolved the partners would become entitled to specific share in the assets of the firm which is proportionate to their shares in sharing the profits of the firm and they are placed in the same position as tenants in common and for the purpose of dissolution and under section 47 of the Indian Partner- ship Act 1932 it is clear that even after the dissolution of the firm the authority of each partner to bind the firm and the other mutual rights and obligations of the partners continues notwithstanding the dissolution so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution. After dissolution of the firm on December 6 1987 the firm has never filed any return and in view of the order of this court permitting the partners to carry on the business in the interest of employees return was filed by AOP-13 consisting of the erstwhile 13/12 partners for accounting profits and seeking depreciation in the assets of the firm. AOP-3 have purchased the business of the old firm - the appellants as erstwhile partners are liable to pay capital gains tax on the amounts received by them towards the value of their shares in the net assets of the firm and are liable for payment of capital gains under section 45 of the Act. - Answered the substantial question of law in favour of the Revenue and against the assessee. Slump sale - Held that - contention of the assessee that the sale is in the nature of slump sale and is not in respect of the separate valuation made and therefore not assessable to capital gains cannot also be accepted as it is clear from the perusal of the material on record that the sale that was conducted on the direction of this court among the partners and the consideration received by sale was not by slump sale as the shares of all the partners in the firm which were fixed in proportion to the profit-sharing ratio after the dissolution of the firm and they continued the business as an AOP and not as partners. - Decided in favor of revenue.

Summary

Issues Involved:
1. Taxability of capital gains in the hands of individual outgoing partners.
2. Existence and ownership of assets by an AOP comprised of 7 outgoing partners.
3. Nature of the transfer of business to the association of three persons.
4. Assessment of capital gains arising from the sale of the business in the hands of individual partners.
5. Classification of the sale as a slump sale and its tax implications.
6. Error in the computation of capital gains by the Vice-President of the Tribunal.
7. Assessment of income earned by an association of 13 persons.

Detailed Analysis:

1. Taxability of Capital Gains in the Hands of Individual Outgoing Partners:
The Tribunal held that the capital gains arising from the sale of the assets of the firm were assessable in the hands of the outgoing individual partners. The court noted that after the dissolution of the firm, the assets were required to be distributed among the partners in proportion to their profit-sharing ratio. The assets were sold as a going concern, and the proceeds were distributed among the partners. The court concluded that the individual outgoing partners received the value of their net assets, which constituted a transfer of capital assets, thereby attracting capital gains tax.

2. Existence and Ownership of Assets by an AOP Comprised of 7 Outgoing Partners:
The court examined whether any AOP comprised of 7 outgoing partners came into existence and owned the assets of the firm. It was found that after the dissolution of the firm, the business was continued by an AOP-13 (later AOP-12), which was recognized by the Department for tax purposes. The assets were ultimately sold to an AOP-3, which made the highest bid. The court concluded that the AOP-13/12 was the owner of the assets until the sale to the AOP-3.

3. Nature of the Transfer of Business to the Association of Three Persons:
The court considered whether the transfer of the business to the association of three persons (AOP-3) was merely a relinquishment of shares by the outgoing partners. It was determined that the sale was conducted as per the directions of the court, and the assets were sold to the highest bidder. The outgoing partners received their share of the sale proceeds, which constituted a transfer of capital assets.

4. Assessment of Capital Gains Arising from the Sale of the Business in the Hands of Individual Partners:
The court held that the capital gains arising from the sale of the business as a going concern were liable to be assessed in the individual hands of the erstwhile partners. The assets were sold for Rs. 92 crores, and the proceeds were distributed among the partners after deducting their liabilities. The court noted that the individual partners received the value of their net assets, which attracted capital gains tax.

5. Classification of the Sale as a Slump Sale and Its Tax Implications:
The court rejected the contention that the sale was a slump sale. It was found that the assets were sold based on a valuation conducted by a chartered accountant, and the highest bid was accepted. The court concluded that the sale was not a slump sale, as the assets were sold individually, and the consideration was not a lump sum.

6. Error in the Computation of Capital Gains by the Vice-President of the Tribunal:
The court set aside the directions issued by the Vice-President of the Tribunal regarding the computation of capital gains. It was noted that the Vice-President had issued certain directions that were unnecessary and contrary to the provisions of section 45 of the Income-tax Act. The court quashed these directions and upheld the computation of capital gains as per the market value on the date of transfer.

7. Assessment of Income Earned by an Association of 13 Persons:
The court held that the income earned by the association of 13 persons (AOP-13) for the period till November 20, 1994, was assessable in the hands of those 13 persons. The AOP-13 continued the business of the dissolved firm as per the directions of the court, and the income earned during this period was assessable in their hands.

Conclusion:
The appeals filed by the assessee were dismissed, and the appeals filed by the Revenue were allowed. The court upheld the assessment of capital gains in the hands of the individual outgoing partners and rejected the classification of the sale as a slump sale. The directions issued by the Vice-President of the Tribunal regarding the computation of capital gains were set aside. The income earned by the association of 13 persons was held to be assessable in their hands.