TMI Blog2006 (1) TMI 458X X X X Extracts X X X X X X X X Extracts X X X X ..... three new partners to the appellant-firm." 2. The main grievance of the assessee is that the Assessing Officer has charged capital gains on the firm on the pretext that there is a transfer of assets by the firm at the time of its restructuring. The facts of the case are that return was filed by the firm on 29-9-1997 and it was processed, accordingly. The firm was constituted on 21-3-1981. Subsequently, the Assessing Officer noted that the assessee-firm was liable to capital gains. There were three partners in the assessee-firm, viz., Mr. Sharad A. Doshi, Mr. Vikram A. Doshi and Mr. Vineet A. Doshi. The assets of the firm were revalued and assessee-firm was converted into a private limited company on 22-10-1996. According to the Assessing Officer, on revaluation of the assets on conversion of firm into company, the firm was liable to pay tax on capital gains. The case was reopened under section 147/148. The assets of the firm were revalued on 15-1-1996. The assessee-firm held tenancy right in a property being plot No. 14, Lalwani Industrial Estate, Wadala, Mumbai. The tenancy rights, which was valued at nil prior to revaluation, was valued at Rs. 401.3 lakhs. Other assets su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... art thereof to or in favour of any body or part with the possession use of occupation of the said premises or any part thereof as licensee, caretaker or otherwise howsoever." 4. The Assessing Officer inferred that sub-letting to M/s. Atco Industries vide agreement dated 1-4-1996 was illegal. Though the said premise was sub-let for a period of 11 months, it was renewed after every 11 months and continued thereafter. Thus, the security deposit of Rs. 450 lakhs was still remained deposit with assessee-company. According to the Assessing Officer, it is not possible that tenancy rights valued at Rs. Nil as on 1-4-1989 would appreciate to Rs. 401.3 lakhs as on 15-1-1996. 5. The Assessing Officer then applied the provisions of section 45(4) and held that the assessee has transferred an asset to the company for a sum of Rs. 416.5 lakhs and, therefore, there are short-term capital gains on that sum. According to him, the conversion took place in the year relevant to assessment year 1997-98. Therefore, the short-term capital gains are taxable in the year. 6. Before the CIT(A), it was submitted that conversion of firm into company on 22-10-1996 does not amount to transfer or d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that there was dissolution of firm by the operation of law - the element of agency between the erstwhile partners having come to an end once the firm became a company. However, the learned AR of the appellant had vehemently argued that 3rd condition of the distribution of capital assets belonging to the firm has not been satisfied because in the absence of definition of the word transfer as including the distribution of capital on the dissolution of the firm may have two possible views. One view is an in-built definition of the word transfer roping in the Act of distribution of capital asset on the dissolution of the firm or otherwise and again assuming that there was dissolution of firm by operation of law, is still requirement that there should be distribution of capital asset of the firm has not been fulfilled. According to appellant what has really happened is that when firm was converted into company all the assets and liabilities of the firm became the company s assets and liabilities and, therefore, there was no distribution of capital asset in specific accounts of partners. However, I am not agreeable to the contention of learned AR. In view of the recent decisions of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... constitution of the firm which is covered by the expression otherwise . The various Court citations as relied upon by the learned AR gets nullified by the recent Hon ble Bombay High Court decision in the case of CIT v. A.N. Naik Associates . However, I am not agreeable with the Assessing Officer that the short-term capital gains has arisen on 23-10-1996 when the firm was converted into Private Ltd. Company. In conclusion, I direct the Assessing Officer to work out the long-term capital gains in the hands of the appellant-firm which has arisen on 1-4-1996 on account of the distribution of the capital assets amongst 3 partners of the appellant-firm and restitution of the firm on 1-4-1996 which is covered by the expression otherwise under section 45(4) of the Income-tax Act, 1961." 7. The main thrust of the order of the CIT(A) is that : ( i )There is transfer of asset in the form of tenancy right, which was received by partners in rupee terms. ( ii )There is a distribution of asset - money has gone to partners. ( iii )The word "otherwise" used in section 45(4) takes into consideration not only the cases of dissolution of the firm but also the cases of subsisting partn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsfer of sub-tenancy rights to "ATCO". The capital gains are at least chargeable on this transfer. He heavily relied on the order of CIT(A) and Assessing Officer. He also submitted that the CIT(A) had supported the finding of the Assessing Officer that a capital gain is chargeable, on alternative ground when he says that there is transfer of an asset and money has been withdrawn by the old partners. This is covered by words "otherwise" under section 45(4). He relied on the decision in CIT v. A.N. Naik Associates [2004] 265 ITR 346 1 (Bom.) referred by CIT(A) in his order. 10. We have carefully considered the rival submissions, material on record and case-laws cited by the parties. Let us analyse what are the events that took place and whether there is only transfer on any of these dates and if yes, of what are to whom and whether provisions of section 45(4) are applicable on any of the events : (1)15-1-1996 : Asset in the form of tenancy right was created in the firm it was valued at Rs. 401.03 lakhs. Other assets were revalued at Rs. 18.6 lakhs as against book value of Rs. 3.80 lakhs. Difference between book value and valued on revaluation was credited equals in current ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of that capital asset from the firm. Event No. 2 : On 15-1-1996 : When the difference between book value of assets and revalued values, is credited into partners accounts, again there is no transfer as tenancy right remained the property of the firm. It was continued to be shown as asset in the balance sheet of the firm. Event No. 3 : On 1-4-1996 : When the firm was reconstituted and four new partners were inducted there is no transfer of any capital asset. On reconstitution of the firm, there is no transfer of asset as held in Kunnamkulam Mill Board s case ( supra ) as under : "What is postulated under section 45(4) of the Income-tax Act, 1961, is that 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 would be chargeable to tax as the income of the firm. Ownership of property does not change with the change in the constitution of the firm. As long as there is no change in ownership of the firm and its properties, for the simple reason that the partnership of the firm stood reconstituted, there is no transfer of capital assets. Likewise, if a partner retires he does not transfer any rig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the landlord, as such consent in the present case is admittedly not available as per clause No. 10 of the agreement with the landlord referred above. But same cannot be said about sub-tenancy rights. Owner of tenancy right is the assessee-firm. Practically this was transferred under a veil, called sub-tenancy right, to "Atco" for which a sum of Rs. 4.50 crores was received by the firm. Tenancy right is a right to use a property and if such right is given to some one else, that too at a cost, then such right, though technically not a tenancy right in the hands of "ATCO" vis-a-vis the landlord of the property but it is a tenancy right vis-a-vis the assessee. Creation and allocation of sub-tenancy right in favour of "Atco" is clearly a transfer at a cost within the meaning of section 45(4). This amount was distributed by the firm to the old partners. The money received by the firm from "Atco" is the sale consideration of sub-tenancy right. This is clearly a transfer within the meaning of section 2( 47 ). Event No. 5 : On 1-4-1996 : When the old partners withdrew the money, the withdrawal of such money cannot be said to transfer of capital asset. For the sake of argument, even if ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... took the view that there was no distribution of capital assets amongst the partners of the firm on the vesting of the capital assets of the firm in the company and the firm had received no consideration on the vesting of the capital assets in the company and held that neither section 45(4) nor section 45(1) was applicable to the case of the assessee. The Tribunal allowed the claim of depreciation and held that the vesting of the capital assets in the company did not amount to sale. On appeal : Held, ( i ) that this was a case of a partnership firm being treated as a company under the provisions of Part IX of the Companies Act. Section 45(4) was not attracted in the case of the assessee because the very first condition of transfer by way of distribution of capital assets was not satisfied. In the circumstances, the second condition treating the fair market value of the asset on the date of transfer did not arise. In the case of a transfer of a capital asset, the two important ingredients are : existence of a party and counterparty and, secondly, incoming consideration qua the transferor. When a firm is treated as a company the two conditions are not attracted. There was no co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en to one person and other parts either remain with the original entity or given to other entities. When all the assets are taken over by one entity, it cannot be said to be distribution. Thus, even though there was transfer of asset from the firm to a company but it was not on account of distribution of capital asset. However, in the fourth event there is a transfer of sub-tenancy right by the firm to "Atco". There is no dispute with the proposition highlighted by the CIT(A) that section 45(4) can be invoked if there is a transfer of asset by way of distribution on dissolution of the firm or otherwise. This otherwise would include reconstitution of the firm or even formation of a company. To this extent the inference drawn by CIT(A) is right. But he ignored that sub-tenancy rights were transferred by firm to "Atco". It is a transfer of capital asset by way of distribution. Even though, section 47( xiii ) has been enacted with effect from 1-4-1999 by Finance (Amendment) Act, 1998 to exempt from the definition of transfer, the take over of the firm by a company, but with certain conditions. In fact company law treats a firm as an un-incorporated company. Section 575 of the Com ..... X X X X Extracts X X X X X X X X Extracts X X X X
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