2006 (12) TMI 168 - AT - Income Tax

Addition u/s 45(4) on account of revaluation of assets - relinquishment of rights in the firm s assets on the reconstitution of the firm - whether short-term capital gain arises on surrender of rights in the revalued partnership assets - HELD THAT - the partnership asset was revalued by the partners at the start of the year and the difference on account of revaluation of asset was credited to the partners account. The revaluation of partnership assets was anterior to the introduction of new partners. Revaluation of assets by partnership firm does not attract capital gains. The revaluation of assets of partnership and the credit of revalued amount to the capital account of partners in their respective share ratio does not entail any transfer as defined u/s 2(47) of the Income-tax Act. The introduction of new partners to a partnership firm owning immovable assets and consequent reduction in the share ratio of present partners does not entail any relinquishment of their rights in the partnership property. On introduction of new partners there is realignment of share ratio inter se between the partners only to the extent of sharing the profits or losses if any of the partnership business. When any new partner is introduced into an existing partnership firm the profit sharing ratios undergo a change which does not amount to transfer as defined under section 2(47) of the Act as there is no change in the ownership of assets by the partnership firm. As during the subsistence of the partnership firm the partners have no defined share in the assets of the partnership and thus on realignment of profit sharing ratio on introduction of new partners there is no relinquishment of any non-existent share in the partnership assets as the asset remained with the firm. Such an arrangement is not covered by the provisions of section 45(4) of the Act which covers the case of dissolution of partnership firm. Accordingly no capital gains arises on such relinquishment of share ratio in the partnership firm. We confirm the order of CIT(A) and dismiss the grounds of appeal raised by the revenue. In the result the appeals filed by the revenue are dismissed.

Summary

Issues Involved:
1. Deletion of addition of short-term capital gains on account of assignment and relinquishment of rights in the firm's assets.
2. Reopening of assessment under section 147 of the Income-tax Act.

Issue-wise Detailed Analysis:

1. Deletion of Addition of Short-term Capital Gains:

The revenue challenged the deletion of short-term capital gains assessed in the hands of the assessees due to the assignment and relinquishment of rights in the firm's assets upon the reconstitution of the partnership firm. The firm revalued its factory premises from Rs. 79,452 to Rs. 23 lakhs, and the difference was credited to the capital accounts of the partners. Upon reconstitution, the old partners' shares were reduced, and they withdrew significant amounts from their capital accounts. The Assessing Officer treated the revaluation difference as short-term capital gains, arguing that the original partners extinguished their rights in the partnership property for a consideration.

The CIT(A) observed that the revaluation and subsequent capital withdrawal did not constitute a transfer of rights in the property, as the asset remained with the firm. It was held that revaluation is a mere book entry and does not generate income. The CIT(A) relied on several Supreme Court judgments, including CIT v. Hind Construction Ltd. and Addl. CIT v. Mohanbhai Pamabhai, which established that partners have no specific rights in the firm's assets during the subsistence of the partnership. Therefore, no capital gains arose from the revaluation and reconstitution.

2. Reopening of Assessment under Section 147:

The assessees filed cross-objections against the reopening of assessments under section 147. However, during the appellate proceedings, the learned AR for the assessees stated that these grounds were not pressed. Consequently, the cross-objections were dismissed as not pressed.

Conclusion:

The Tribunal upheld the CIT(A)'s decision, confirming that no short-term capital gains arose from the revaluation and reconstitution of the partnership firm. The revaluation was deemed a book entry without any transfer of rights in the property. The appeals by the revenue were dismissed, and the cross-objections by the assessees were also dismissed as not pressed.