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D.C.I.T. Versus R.L. KALATHIA AND CO

2016 (1) TMI 581 - GUJARAT HIGH COURT

Sale of business of firm as a going concern to the company for a consideration of paid up share capital whether does not amount to transfer liable to tax as capital gains? - Held that:- In the facts of the present case, capital gains tax is sought to be levied in respect of immovable property being land and building. Insofar as the building being Sarita Shopping Centre is concerned the same was for the first time brought into the books of account after revaluation only in the year under consider .....

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set into, or its treatment by him as stock-in-trade of a business carried on by him shall be chargeable to income tax as his income of the previous year in which such stock-in-trade is sold or otherwise transferred by him and, for the purposes of section 48, the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset. Insofar as invocation of subsecti .....

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e absence of any factual foundation having been laid in that regard, the question of invoking sub-section (2) to section 45 of the Act would not arise. Thus the provisions of section 45(4) of the Act would not be attracted in the present case as the provisions of section 45(1) and section 45(4) of the Act would not be attracted in the present case - Decided in favour of the assessee - TAX APPEAL NO. 69 of 2003 - Dated:- 8-1-2016 - MS. HARSHA DEVANI AND MR. A.G.URAIZEE, JJ. FOR THE APPELLANT : MR .....

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March, 2003, this appeal came to be admitted on the following substantial question of law: Whether on the facts and in the circumstances of the case the Income-tax Appellate Tribunal was justified in law in holding that the sale of business of firm as a going concern to the company for a consideration of paid up share capital does not amount to transfer liable to tax as capital gains? 3. The assessment year is 1996-97 and the relevant accounting period is the financial year 1995-96. The assessee .....

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ith regard to fixed assets, a note was given as below: 2. Land has been revalued during the year and reserves created credited to Partner s Capital A/c. 3. The firm was having Shopping Center at Sarita Society, Bhavnagar, the cost of which was not recorded in the earlier year. During 95/96 the asset known as Sarita Shopping Centre is revalued with Land & Building for ₹ 1,16,40,000/- and during 95/96 same amount is considered as assets of the firm. The revaluation reserve is credited to .....

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as assigned the right to transfer, assign or sub-lease the land alongwith constructions thereon. It kept the land and the shopping centres and godowns built thereon as non-business asset outside the balance sheet, and had shown the rental income from the said source as income from House Property. 6. In the enclosures to Form No.3CD, in the notes to the accounts, it had been mentioned that the firm was having shopping centre at Sarita Society at Bhavnagar, the cost of which was not recorded in th .....

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e year. The assessee had acquired land in assessment year 1995-96 for ₹ 12,00,000/- which came to be revalued at ₹ 61,00,000/-. In assessment year 1996-97, the assessee appropriated the capital account of the partners in the same ratio as mentioned in the partnership deed. In the enclosures to Form No.3CD, in the notes to the accounts, it had been mentioned that land has been revalued during the year and reserves created are credited to partners capital account. Thus, the resultant v .....

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represented both the partnership firm and the intended formation of joint stock Company in the name of M/s. Kalathia Engineering & Construction Ltd. incorporated on February 16, 1996 with a view to convert the firm into a company. The company was incorporated with the same objects to deal in land, building, construction, etc. There was a further stipulation as sale consideration of the business of the firm transferred to the company by allotment of paid up share capital of ₹ 2,00,00,00 .....

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upon its registration as a company under Chapter IX of the Companies Act, 1956 came to be taken over by M/s. Kalathia Engineering & Construction Ltd. For the land which was acquired in assessment year 1995-96 at the value of ₹ 12,00,000/- which had been revalued at ₹ 61,00,000/- in assessment year 1996-97, shares to the extent of revaluation came to be allotted to the partners as was done in the case of Sarita Shopping Centre. 9. The assessee was asked as to why the capital gain .....

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the firm. The assessee also made an application under section 144A of the Act before the Additional Commissioner of Income-tax on this issue claiming that capital gain does not arise as there is no transfer. The Additional Commissioner of Income-tax directed the Assessing Officer to consider the issue after looking into the submissions of the assessee. The assessee submitted that there was no transfer of property inasmuch as immovable property cannot be transferred without registration, and in .....

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1981 was ₹ 46,00,000/- and after giving effect of indexation the value comes to ₹ 1,29,26,000/- which is more than the revaluation and hence no capital gain is to be levied. 10. The Assessing Officer observed that Sarita Shopping Centre was introduced for the first time in the books of accounts at the value of ₹ 1,16,40,000/- which was nothing but the income of the assessee in the form of an asset which the assessee had earned in assessment year 1996-97. The Assessing Officer .....

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ing Officer observed that in this transaction the assessee has transferred an asset where the cost of acquisition is nil for a consideration of ₹ 1,16,40,000/- for Sarita Shopping Centre and for the land which had acquisition value of ₹ 12,00,000/- for a consideration of ₹ 65,00,000/-. The consideration received from Kalathia Engg. & Const. Co. Ltd. is in the form of shares of the company in the ratio of share holding in the company which is the same as the profit sharing r .....

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00/- This was also treated as short term capital gain as the asset had been transferred within three years of acquisition and was added to the income of the assessee. 11. The assessee carried the matter in appeal before the Commissioner (Appeals). Before the Commissioner (Appeals), it was contended on behalf of the assessee that the need for revaluation of the assets of the firm represented by Sarita Shopping Centre arose because the assessee firm was to be converted into a joint stock company a .....

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e Act. The provisions of section 28(iv) were not applicable as neither the act of bringing an asset into the books or revaluation thereof would amount to benefit or perquisite because the asset was already owned by the assessee, though not reflected in its books. The fact that the asset had been brought into its books did not amount to obtaining any benefit by the assessee. It was further contended that no capital gains had occurred when it had converted the firm into a joint stock company as in .....

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lowed deduction of the indexed cost of acquisition of the asset, namely, Sarita Shopping Centre. Various other contentions as detailed in the order passed by the Commissioner (Appeals) were raised. The written submissions were forwarded to the Assessing Officer for his comments thereon. The Assessing Officer in his remarks inter alia submitted that within a period of fifteen years from the date of acquisition of lease hold rights vide lease deed dated 18th July, 1980, a benefit or perquisite had .....

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n record, found that the assessee had acquired the asset of lease hold interest in the two plots on which shops and godowns were subsequently built on 18th July, 1980. It was only on 16th February, 1996 on which date the assessee firm was succeeded to a company known as M/s Kalathia Engineering & Construction Limited that the asset was transferred from the firm to the company for an amount of ₹ 1,16,40,000/- The making of entries on 31st July, 1995 was not relevant to the date on which .....

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ied on by it as a result of which the firm sells or otherwise transfers any capital asset to the company, the provisions of section 45 would not apply to such a transaction subject to certain conditions. Therefore, the aforesaid amendment is not applicable to such transfers made in the accounting period relevant to assessment year 1996-97. The capital gains arising on the transfer of a capital asset are to be computed in accordance with the provisions of section 48 read with section 55 of the Ac .....

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. Under the provisions of the Income Tax Act, a firm and a company are two separate persons. He, accordingly, held that a transfer of assets by a partnership firm to a company comprising only of share holders who were earlier partners of the firm attracts liability under section 45 of the Act [without reference to any particular sub-section] and directed the Assessing Officer to compute the capital gains as per the provisions of section 48 (18) read with section 55 of the Act. Insofar as the tra .....

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of the Tribunal in Texspin Engineering & Manufacturing Works, 70 TTJ 789], this ground need not detain us too long. Firstly, it is not clear from the order of the revenue authorities as to under which sub-section of sec. 45, the amounts have been treated as capital gains. The authorities below have taxed it as capital gains on the ground that there was transfer of assets from the firm to the company. Therefore, it can be assumed that this must have been treated as a transfer u/s.45(1) of the .....

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fer u/s.45(4) of the Act, then also it is difficult to fit in the facts of the present case to the provisions of sec. 45(4). One of the essential requirements to attract sec. 45(4) is that there must be distribution of capital assets belonging to the firm. Moreover, the sub-section implies distribution of capital assets in specie . In the instant case, no such distribution has taken place. Therefore, viewed from any angle, it is difficult to accept the contention of the revenue that capital gain .....

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d order by submitting that the assessee was a partnership firm and a separate legal entity and once it had transferred its assets to a different legal entity, viz. a private limited company, the transfer of assets took place and thereby capital gains tax became payable. The attention of the court was invited to section 2(47) of the Act which defines transfer and more particularly clauses (ii), (iv) and (vi) thereof, which provide that transfer in relation to a capital asset, includes,- (ii) the .....

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enjoyment of, any immoveable property. It was submitted that upon conversion of the firm to a company, there is a transfer of assets as envisaged under the above provisions and hence, the transaction is exigible to capital gains tax. 14.1 Reference was made to sub-section (2) of section 45 of the Act which provides that notwithstanding anything contained in sub-section (1), the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into, or its treatment .....

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entre has been revalued and brought to the books of the firm and hence section 45(2) of the Act can be clearly invoked upon the sale and at least the revaluation cost minus cost of acquisition will have to be brought to tax. Thus, the capital asset has been converted into stock in trade and thereafter transferred to the company and hence, in view of section 45(2) read with section 2(47)(iv), that amount was exigible to capital gains tax. Also land which was acquired in the assessment year 1995-9 .....

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pointed out that section 47(xiii) of the Act which provides that a transaction involving any transfer of a capital asset or intangible asset by a firm to a company as a result of succession of the firm by a company in the business carried on by the firm is not regarded as a transfer was brought on the statute book with effect from 1st April, 1999 and would therefore, not be applicable in the present case. It was submitted that since the assets of the firm have been transferred as a going concern .....

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al asset which was the subject of the transfer and not the individual assets, the gain, if any, on the transfer of the business as a whole had to be computed and brought to tax. 14.4 Reliance was placed upon the decision of the Supreme Court in Commissioner of Income-tax v. Artex Manufacturing Co., (1997) 227 ITR 260, wherein the assessee, a partnership firm, and a private limited company which was formed to take over the business of the assessee as a running concern, entered into an agreement w .....

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me-tax v. B.M. Kharwar, (1969) 72 ITR 603 and held that tax was payable under section 41(2) on the surplus amount, that is, the difference in the written down value of the plant, machinery and dead stock as per the assessee s books and the value of the same as revalued by Hargovandas Girdharlal. The Appellate Commissioner, on appeal, held that the surplus was assessable under the head Capital Gains and not Business . The Tribunal in the appeals filed by the assessee as well as the revenue, rejec .....

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d in the circumstances of the case, the Tribunal was right in holding that the principle of mutuality will not apply and, therefore, the assessee was liable to be taxed? 2. Whether, on the facts and in the circumstances of the case, section 41(2) was applicable? 3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the surplus was not capital gains, but was business income? The High Court answered the first question in favour of the revenue and the .....

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lue and the actual cost, if the amount of surplus exceeds the difference between the written down value and the actual cost, then the surplus amount to the extent of such excess will have to be treated as capital gain for the purpose of taxation. 14.5 It was submitted that the Tribunal has ignored the glaring fact that the transfer of business as a going concern by the firm to the company was for a consideration in the form of allotment of shares to its partners. Therefore, the same would fall w .....

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d that the impugned order passed by the Tribunal being erroneous and contrary to the settled legal position deserves to be set aside to the extent the same has been challenged in this appeal and the appeal deserves to be allowed 15. Opposing the appeal, Ms. Niyati Shah, learned advocate for the respondent assessee, supported the impugned order and submitted that the same is just, legal and proper and does not warrant interference by this court. It was submitted that for the purpose of applying s .....

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he case before it, it was concerned with a Partnership Firm being treated as a Company under the statutory provisions of Part IX of the Companies Act. In such cases, the Company succeeds the Firm. Generally, in the case of a transfer of capital asset, two important ingredients are: existence of a party and a counter party and, secondly, incoming consideration qua the transferor. The court was of the view that when a Firm is treated as a Company, the said two conditions are not attracted. There i .....

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aced by the different cloak and the same Firm is now treated as a Company, after a given date. The court was accordingly of the view that there was no transfer of a capital asset as contemplated under section 45(1) of the Act. 15.1 Ms. Shah accordingly, urged that when a partnership firm is converted to a company and the assets and liabilities are taken over, it is not a transfer of a capital asset within the meaning of such expression as envisaged under section 2(47) of the Act. 15.2 Reliance w .....

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the entire assets and liabilities of the partnership were not transferred to the limited company. The business of the firm as a whole was not transferred for a lump sum to the limited company but only the machinery used in manufacturing of the business of the firm was transferred to the newly formed limited company and the consideration was received by the partners of the firm in the shape of shares of the company and the shares were allotted to the partners on the same basis as their shares in .....

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of Income-tax-I New Delhi, (2008) 307 ITR 75, wherein the court held thus: 18. In Artex Mfg. Co.1 this Court found that a valuer was appointed, that valuer submitted his valuation report in which itemised valuation was carried out and on that basis the consideration was fixed at ₹ 11,50,400. Therefore, the sale consideration had been arrived at after taking into account the value of plant, machinery and dead stock as computed by the valuer and, consequently, it was held that the surplus ar .....

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ng to note that the judgment in Electric Control Gear Mfg. Co.3 is given by the same Bench which decided the case of Artex Mfg. Co.1 In fact, both the judgments are reported one after other in 227 ITR at pp. 260 and 278 respectively. 20. In the present case, as can be seen from the impugned judgment of the Delhi High Court, the judgment of this Court in Electric Control Gear Mfg. Co.3 is missed out. That judgment has not been considered by the High Court. As stated above, this Court has clarifie .....

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d an integrated code. Therefore, where the computation provisions cannot apply, it is evident that such a case was not intended to fall within the charging section, which, in the present case, is Section 45. That section contemplates that any surplus accruing on transfer of capital assets is chargeable to tax in the previous year in which transfer took place. In this case, transfer took place on 18-7-1969. 22. The second test which needs to be applied is the test of allocation/attribution. This .....

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not only tangible items but also intangible items like, goodwill, manpower, tenancy rights and value of banking licence. However, the cost of such items (intangibles) is not determinable. 24. In CIT v. B.C. Srinivasa Setty4 this Court held that Section 45 charges the profits or gains arising from the transfer of a capital asset to income tax. In other words, it charges surplus which arises on the transfer of a capital asset in terms of appreciation of capital value of that asset. In the said jud .....

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item wise earmarking was not possible. On facts, we find that the compensation (sale consideration) of ₹ 10.20 crore was not allocable item wise as was the case in Artex Mfg. Co.1 25. For the aforestated reasons, we hold that on the facts and circumstances of this case, which concerns Assessment Year 1970-1971, it was not possible to compute capital gains and, therefore, the said amount of ₹ 10.20 crore was not taxable under Section 45 of the 1961 Act. Accordingly, the impugned judg .....

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m to the limited company was its running business as a going concern together with all the assets and liabilities and the provision of section 41(2) of the Act cannot be invoked. Reliance was also placed upon the decision of this court in Assistant Commissioner of Income Tax v. Patel Specific Family Trust, (2011) 330 ITR 397 (Guj), for the proposition that in case of sale of the entire business, including all assets and liabilities, as a going concern, it was not possible to bifurcate the consid .....

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eliance was also placed upon an unreported decision dated 3rd December, 2014 of this court rendered in the case of Dy. C.I.T. v. Well Pack Packaging, in Tax Appeal No.368 of 2001, wherein the court agreed with the view adopted by the Bombay High Court in Commissioner of Income-tax v. Texspin Engineering and Manufacturing Works (supra) as well as the decision of the Punjab and Haryana High Court in the case of Commissioner of Income-tax v. Rita Mechanical Works (supra) and answered the questions .....

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t submitted that the Bombay High Court in Commissioner of Income-tax v. Texspin Engineering and Manufacturing Works (supra) has held that firm and company are one and the same meaning thereby that the principle of mutuality is attracted. It was submitted that in the present case, the assessee contends that the transaction is not at all exigible to tax on the ground of mutuality, whereas in Artex Mfg. Co. v. Commissioner of Income-tax, (1981) 131 ITR 559, this High Court has held that the princip .....

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in Artex Mfg. Co. v. Commissioner of Income-tax stands confirmed by the Supreme Court, that firm and company are distinct entities. It was argued that the Bombay High Court in Commissioner of Income-tax v. Texspin Engineering and Manufacturing Works does not consider words or otherwise appearing in section 45(4). To that extent the view taken by the Bombay High Court is not correct. 17. It is in the backdrop of the aforesaid facts and contentions that the controversy involved in the present cas .....

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ot arise in the present case. Strong reliance has been placed by the learned counsel for the appellant on the decision of the Supreme Court in the case of Commissioner of Income-tax v. Artex Manufacturing Co. (supra) for the purpose of contending that the transaction would be exigible to capital gains tax. In the facts of that case, it may be noted that the High Court had held that the principle of mutuality would not be attracted and since such finding was in favour of the revenue the same was .....

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applied. The court, however, held that the liability under section 41(2) is limited to the amount of surplus to the extent of the difference between the written down value and the actual cost. If the amount of surplus exceeds the difference between the written down value and the actual cost, then the surplus amount to that extent of such excess will have to be treated as capital gain for the purpose of taxation. It may be noted that in the facts of the said case, while all the assets and liabili .....

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ct of Sarita Shopping Centre and short term capital gain in respect of the land. The question that, therefore, requires to be addressed is as to whether the provisions of section 45 of the Act are attracted in the facts of the present case. For the purpose of attracting sub-section (1) of section 45 of the Act profit or gain should have arisen from the transfer of a capital asset. Sub-section (2) of section 45 of the Act provides that the profits or gains arising from the transfer by way of conv .....

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. Insofar as invocation of subsection (2) of section 45 of the Act is concerned, while the Assessing Officer has briefly referred to the said provision in paragraph 5.7 of his order, no factual foundation has been laid down in that regard to establish that the said properties had been brought into the books as stock-in-trade. On the contrary the learned counsel for the assessee has maintained that the said properties were always treated as capital assets and were never converted into stock in tr .....

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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. The inquiry that is now required to be made is as to whether the ingredients of section (1) or (4) of section 45 of the Act are satisfied in the present case. 19. .....

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distribution of capital assets on the dissolution of a firm is chargeable to tax as income of the firm in a previous year in which the transfer takes place and for the purposes of Section 48, the fair market value of the asset on the date of such transfer is deemed to be the full value of the consideration received or accruing as a result of the transfer. Section 48 deals with mode of computation. It, inter alia, lays down that the income chargeable under the head "Capital gains" shal .....

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n 48, the market value on the date of the transfer shall be deemed to be the full value of consideration received or accruing as a result of the transfer. Now, according to the Assessing Officer, in this case, on vesting of the properties of the firm in the Limited Company, there was a transfer by way of distribution of capital assets. Further, according to the Assessing Officer, on vesting of the properties of the firm in the company, there was a resultant dissolution of the firm. Therefore, ac .....

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Officer has computed capital gains arising to the assessee-firm at ₹ 9 lakhs on the basis of the difference between the market value and the written down value. The Assessing Officer has taken the written down value as on 1st April, 1995 and he has taken the market value as on 8th November, 1995 (alleged date of transfer) and on that basis, he has computed the capital gains. However, as stated, computation under Section 45(4) read with Section 48 would arise only if the aforestated two co .....

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ties of the erstwhile firm vests in the Limited Company. The question is whether such vesting stands covered by the expression "transfer by way of distribution" in Section 45(4) of the Act. There is a difference between vesting of the property, in this case, in the Limited Company and distribution of the property. On vesting in the Limited Company under Part IX of the Companies Act, the properties vest in the company as they exist. On the other hand, distribution on dissolution presupp .....

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ondition of transfer by way of distribution of capital assets is not satisfied. In the circumstances, the latter part of Section 45(4), which refers to computation of capital gains under Section 48 by treating fair market value of the asset on the date of transfer, does not arise. [B] On Section 45(1) 6. As stated above, in this case we are concerned with the assessment year 1996-97. Therefore, in this case, we are not concerned with clause (xiii) inserted by Finance (No. 2) Act, 1998 in Section .....

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more Firms becoming Limited Companies. It also indicates the difference between transfer and transmission. Basically, when a Firm is treated as a company under Part IX, it is a case similar to transmission. This is amply made clear by clause (xiii) to Section 47, which states that where a Firm is succeeded by a company in the business, the transaction shall not be treated as a transfer. Now, this amendment has been made in Section 47 in view of the controversy arising on Section 45(1) read with .....

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ith Section 2(47)(ii) which states that transfer in relation to a capital asset shall include extinguishment of any rights therein. The moot point which arose on interpretation of Section 45(1) in numerous matters was that on extinguishment of the rights in the capital assets, there was a transfer and in certain cases of reconstitution of firms and introduction of new partners, there was a resultant extinguishment of the rights in the capital assets proportionately. In order to get over this con .....

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ax under the head "Capital gains" as, on such vesting, there was extinguishment of all right, title and interest in the capital assets qua the Firm. We do not find any merit in this argument. In the present case, we are concerned with a Partnership Firm being treated as a company under the statutory provisions of Part IX of the Companies Act. In such cases, the Company succeeds the Firm. Generally, in the case of a transfer of a capital asset, two important ingredients are: existence o .....

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y vesting of properties in the Company as the Firm is treated as a Limited Company. On vesting of all the properties statutorily in the Company, the cloak given to the Firm is replaced by a different cloak and the same Firm is now treated as a Company, after a given date. In the circumstances, in our view, there is no transfer of a capital asset as contemplated by Section 45(1) of the Act . Even assuming for the sake of argument that there is a transfer of a capital asset under Section 45(1) bec .....

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ns" shall be computed by deducting from the full value of the consideration received or accrued as a result of the transfer, the cost of acquisition of the asset and the expenditure incurred in connection with the transfer. Section 45(4) is mutually exclusive to Section 45(1). Section 45(4) categorically states that where there is a transfer by way of distribution of capital assets and where such transfer is due to dissolution or otherwise of the firm, the Assessing Officer was entitled to .....

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l asset on the date of transfer. In such a case, we have to read the said expression in the light of the two judgments of the Supreme Court in the cases of George Henderson & Co. Ltd. (supra) and Gillanders Arbuthnot & Co. (supra) in which it has been held that the expression "full value of the consideration" does not mean the market value of the asset transferred, but it shall mean the price bargained for by the parties to the transaction. It has been further held that conside .....

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ror in exchange of the capital asset transferred by him. In the circumstances, even if we were to proceed on the basis that vesting in the company under Part IX constituted transfer under Section 45(1) , still the assessee ought to succeed because the Firm can be assessed only if the full value of the consideration is received by the Firm or if it accrues to the Firm. In the present case, the Company had allotted shares to the Partners of the erstwhile Firm, but that was in proportion to the cap .....

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ribution of assets. In this case, we have held that there is no such transfer by way of distribution and, therefore, Section 45(4) is not applicable. This deeming provision, regarding full value of consideration, is not there in Section 45(1) read with Section 48. If one reads Section 45(1) with Section 48, it is clear that the former is a charging section and if that section is applicable, the computation has to be done under Section 48, which only refers to deductions from full value of consid .....

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by which the market value of the asset on the date of the transfer is deemed to be the full value of consideration. However, such amendment is not there in Section 45(1). In the circumstances, neither Section 45(1) nor Section 45(4) stand attracted. [Emphasis supplied] 19.1 This court is in complete agreement with the view adopted by the Bombay High Court in the above decision and is further of the view that the said decision applies on all fours to the present case. In the opinion of this cour .....

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