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2016 (1) TMI 581 - GUJARAT HIGH COURT

2016 (1) TMI 581 - GUJARAT HIGH COURT - [2016] 381 ITR 180 - 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 .....

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he transfer by way of conversion by the owner of a capital asset 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 tra .....

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converted into stock in trade. Under the circumstances, in the 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. .....

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unal ) in I.T.A. No.2731/RJT/2000. 2. By an order dated 31st 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 .....

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4 were submitted. 4. In the note below the said Schedule 4 with 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 .....

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o pay a sum of ₹ 16,000/- to the lessor. The assessee was 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 S .....

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partners capital account in ratio of profit sharing during the 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 ar .....

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nership on 18th October, 1995 between seventeen partners who 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 compan .....

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Limited Company. All the assets and liabilities of the firm 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 .....

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cannot be said to be a transfer as the asset had remained in 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 .....

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sidered. The value of Sarita Shopping Centre as on 1st April, 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 .....

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added the same to its total income. Alternatively, the Assessing 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 hol .....

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s: Cost of acquisition Rs.12,00,000/- Capital Gain Rs.49,00,000/- 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 a .....

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ncome within the meaning assigned to the term income under the 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 wh .....

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if the transaction is held to be a transfer, it should be allowed 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 .....

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The Commissioner (Appeals), after considering the material on 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 ent .....

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t where a firm is succeeded by a company in the business carried 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 wit .....

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set are chargeable to income tax under the head capital gains. 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 sectio .....

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f the decision in the case of Texspin Eng. (supra) [decision 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 th .....

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would not be liable to tax. 18. If it is assumed to be transfer 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 diffic .....

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ocate, learned counsel for the appellant assailed the impugned 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 .....

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soever) which has the effect of transferring, or enabling the 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 conv .....

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. It was submitted that in the present case Sarita Shopping Centre 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 ta .....

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cause of transfer of this asset to the company . 14.2 It was 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 th .....

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rt held that as the business as a going concern was the capital 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 t .....

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pon the decision of the Supreme Court in Commissioner of Income-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 th .....

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or the opinion of the High Court: 1. Whether, on the facts and 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 .....

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s 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 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 allotmen .....

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nder section 45(2) of the Act. 14.7 It was, accordingly, urged 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 th .....

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guishment of any rights therein. The court observed that in the 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 .....

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atutorily in the Company, the cloak given to the Firm is replaced 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 .....

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h Court in Artex Manufacturing Co. s case was a matter where 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 a .....

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upreme Court in the case of PNB Finance Ltd. v. Commissioner 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 .....

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arrived at, Section 41(2) had no application. It is interesting 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 considere .....

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ng section and the computation provisions together constituted 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 nee .....

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items of an undertaking. Business undertaking can consist of 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 .....

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manpower and value of banking licence. On facts, we find that 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 und .....

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the proposition that where what was sold by the assessee-firm 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 .....

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wenty years that contention of section 45(2) is taken. 15.7 Reliance 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 .....

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n rejoinder, Mr. M.R. Bhatt, learned counsel for the appellant 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, .....

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he extent of mutuality the decision of the Gujarat High Court 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 .....

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es, the question of invoking section 41(2) of the Act would not 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 .....

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not indicated and hence, section 41(2) of the Act cannot be 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 .....

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eals) has held that there was long term capital gain in respect 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 .....

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or accruing as a result of the transfer of the capital asset. 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 treate .....

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eing a company or a cooperative 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. The inquiry that is now required to be made is as to whether the ingredients of section (1) or (4) of .....

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), profits arising from transfer of a capital asset by way of 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 in .....

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for the purposes of computation of capital gains under Section 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, .....

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ket value. As stated above, in this connection, the Assessing 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) re .....

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Partnership Firm is treated as a Limited Company, the properties 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 .....

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view that Section 45(4) is not attracted as the very first condition 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 c .....

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th effect from 1st April, 1999 in order to encourage more and 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 .....

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capital asset" in Section 45(1) is required to be read with 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 .....

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capital assets and, therefore, it was chargeable to income-tax 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 o .....

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not consequent or incidental to a transfer. It is a statutory 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 t .....

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, that the income chargeable under the head "Capital gains" 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 .....

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" in Section 48 cannot be the market value of the capital 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 part .....

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ly means the full value of the things received by the transferor 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 .....

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ull value of consideration provided there is transfer by distribution 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 .....

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he Legislature, in its wisdom, has amended only Section 45(4) 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 .....

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