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2016 (5) TMI 422 - MADRAS HIGH COURT

2016 (5) TMI 422 - MADRAS HIGH COURT - [2016] 383 ITR 258 - Capital gain - transfer of assets from the firm to the company - whether there is a "transfer" as contemplated under sections 2(47) and 45(4) of the Income-tax Act, 1961? - Held that:- The Finance Act, 2001, has amended clause (xiii) of section 47 of the Income-tax Act to provide that any transfer of a capital asset, from an association or persons or body of individuals to a company, under a scheme of corporatisation of a recognized sto .....

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ere is no transfer of asset as (a) no consideration was received or accrued on transfer of assets from the firm to the company ; (b) the firm has only revalued its assets which will not amount to transfer ; (c) the provision of section 45(4) of the Act is applicable only when the firm is dissolved. In the instant case, there is no distribution of asset, but only taking over of the assets from the firm to the company.

Therefore, it is clear that the vesting of the property in the priva .....

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of members or in the value of assets, with no dissolution of the firm and no distribution of assets, with change in legal status alone, whether there is a "transfer" as contemplated under sections 2(47) and 45(4) of the Income-tax Act, 1961 and whether the assessee is liable to be taxed, are the issues canvassed in this case. 1.1 Under Part IX of the Companies Act, 1956 when a partnership firm is treated as a limited company, the properties of the erstwhile firm vests in the limited c .....

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Whether omission of clause (2) of section 47 "any distribution of capital assets on the dissolution of a firm, body of individuals or other association of persons" by the Finance Act, 1987 with effect from April 1, 1988, would lead to the conclusion that any transaction resulting in distribution on dissolution of a firm would amount to "transfer" in terms of section 47 ? 2. This appeal has been preferred by the assessee under section 260A of the Income-tax Act, 1961 (hereina .....

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dra (mother), who were holding equal stakes in the firm. 3.1 During the year 1991, the partners of the firm felt the necessity of having a corporate identity and therefore, decided to incorporate a private limited company and vest the business of the firm along with the assets in the newly formed private limited company, M/s. CADD Centre India Pvt. Ltd. A company by name M/s. CADD Centre India Pvt. Ltd. was incorporated on November 21, 1991 and all the partners of the firm immediately before the .....

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the firm by private limited company, the shares were held in parity between V. Sathyamoorthy (son) and Chandra (mother), who were equal partners in the firm CADD India. 3.2 For the assessment year 1992-93, the appellant filed its return of income on October 23, 1992, declaring an income of ₹ 1,85,000. From the records, the Assessing Officer found that the accounts of the appellant firm was closed on November 30, 1991 and its existing business was taken over by a company M/s. CADD Centre I .....

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ommissioner of Income-tax allowed the appeal holding that when a partnership firm is transformed into a private limited company, there is no transfer of capital assets as contemplated under section 45(4) of the Act. 5. Against the order of the first appellate authority, the Revenue preferred an appeal, before the Income-tax Appellate Tribunal. The Income-tax Appellate Tribunal allowed the appeal, holding that the transfer of assets of a partnership firm, without dissolution, to a private limited .....

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m is converted into equity shares in pro portion, in a newly formed private limited company, in which, the partners of the firm are the only shareholders ? (b) Whether the Income-tax Appellate Tribunal is right in law in finding that section 45(4) of the Act is attracted in case where the taking over of the partnership firm as a whole as a going concern by a private limited company amounts to transfer of capital assets even when no consideration has been received within the meaning of section 48 .....

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ate authority and the same not being adjudicated ? (e) Whether the Assessing Officer is right in reopening the assessment based on an expert opinion and not based on an additional material ?" 6. A preliminary objection has been raised by the Revenue stating that the substantial question of law, pertaining to reopening of assessment, will not arise for consideration, as the issue was not raised before the Commissioner of Income-tax, that is before the first appellate authority. It is further .....

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The learned counsel for the assessee submitted that there is no failure on the part of the assessee to submit all the information required for the completion of the assessment before the Assessing Officer and all the information were available in the return of income and the balance- sheet filed along with the return of income and hence the Assessing Officer was not justified in reopening the assessment. We find that this issue does not arise out of the order of the Commissioner of Income-tax ( .....

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the Income-tax Appellate Tribunal is right in saying that, as the issue was not raised before the Commissioner of Income-tax (Appeals), the Tribunal can decline to entertain this ground. 7.2 This issue is squarely answered by the decision of the hon'ble Supreme Court in National Thermal Power Co. Ltd. v. CIT [1998] 229 ITR 383 (SC) ; [1999] 157 CTR 249 (SC), in which, it has been held that, the Tribunal is not confined only to issues arising out of the appeal before the Commissioner of Inco .....

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tions of law (c), (d) and (e), pertaining to reopening of assessment. 8. However, the learned counsel for the appellant submitted that at this stage, they are not pressing the issue, regarding the reopening of the assessment. Hence, deciding issue Nos. (c) (d) and (e) have become unnecessary and it remains answered only to the extent of the right to raise the issue before this court, in the absence of the issue, having not been raised, before the Commissioner of Income-tax (Appeals). 9. As a gen .....

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ains are deemed to be income, under section 2(24)(vi) of the Income-tax Act. 9.1 One of the pre-conditions to be fulfilled is that there should be transfer of a capital asset for a gain to be taxed as capital gains. In other words, in order to bring a transaction under the ambit of capital gains, it is a must that the receipt or accrual must have originated in a "transfer" within the meaning of section 45(1) read with section 2(47) of the Act. The transfer presumes the existence of bot .....

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two partners, and later, the partners transformed the partnership firm into a private limited company, by name, M/s. CADD India Pvt. Ltd., with the same two partners becoming shareholders of the company. The case of the assessee is that all the assets of the firm got vested with the private limited company and on succession of the firm by a private limited company, there was no transfer of assets and therefore, capital gains as contemplated under section 45(4) of the Income- tax Act, would not .....

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contemplated under section 45(4) of the Income-tax Act and therefore, the assessee is liable to pay tax on the capital gains on the transfer of assets. 12. In order to appreciate, the contentions raised on both sides, it is necessary to look into the definition of transfer under section 2(47), and also section 45(4) and section 47(13) of the Income-tax Act, dealing with capital gains. 13. In order to appreciate, the contentions raised on both sides, it is necessary to look into the definition o .....

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in ; or (iii) the compulsory acquisition thereof under any law ; or (iv) (w.e.f. April 1, 1985) in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment ; or (iva) (w.e.f. April 1, 2006) the maturity or redemption of a zero coupon bond [as defined in s. 2(48)]. (v) (w.e.f. April 1, 1988) any transaction involving the allowing of the possession of any immovable property (as defined) to b .....

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efined)." Before a levy on the capital gain can be imposed, it is a must to ensure that, such a gain has arisen from the disposal of the asset, by any one of the mode, referred to in the definition of the term "transfer" in section 2(47). 13.2. Section 45(4) of the Income-tax Act reads as under : "45.(4) 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 or other association of persons or bod .....

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sfied : (i) transfer by way of distribution of capital assets ; (ii) such transfer should be on dissolution of the firm or otherwise. 13.3. Section 47 of the Income-tax Act deals with the transactions not regarded as transfer. The opening sentence of section 47 reads that, nothing contained in section 45 shall apply to the following transfers : . . . "(xiii) 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 b .....

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and therefore, there is no transfer of capital assets and hence, the assessee is not liable to pay tax on capital gains, the learned counsel for the assessee relied upon the following decisions : (i) CIT v. Texspin Engg. and Mfg. Works [2003] 263 ITR 345 (Bom) (page 352) : "under section 45(4), two conditions are required to be satisfied, viz., transfer by way of distribution of capital assets and secondly, such transfer should be on dissolution of the firm or otherwise. Once these two cond .....

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the properties of the firm in the company, there was a resultant dissolution of the firm. Therefore, according to the Assessing Officer, both the conditions under section 45(4) stood satisfied and, therefore, he was entitled to take the fair market value of the asset on the date of the transfer to be the full value of the consideration received as a result of the transfer . . . In this case, the erstwhile firm has been treated as a limited company by virtue of section 575 of the Companies Act. I .....

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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 presupposes division, realisation, encashment of assets and appropriation of the realised amount as per the priority like payment of taxes to the Government, BMC, etc., payment .....

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ion of capital gains under section 48 by treating fair market value of the asset on the date of transfer, does not arise." (ii) Malabar Fisheries Co. v. CIT [1979] 120 ITR 49, 59 (SC). ". . . it seems to us clear that a partnership firm under the Indian Partnership Act, 1932 is not a distinct legal entity apart from the partners constituting it and equally in law the firm as such has no separate rights of its own in the partnership assets and when one talks of the firm's property. .....

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tment of assets to the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm's rights in the partnership assets amounting to a transfer of assets within the meaning of section 2(47) of the Act. In our view, therefore, there is no transfer of assets involved even in the sense of any extinguishment the firm's rights in the partnership assets when distr .....

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of a transfer of a capital asset, two important ingredients are : existence of a party and a counter-party and, secondly, incoming consideration qua the transferor. In our view, when a firm is treated as a company, the said two conditions are not attracted. There is no conveyance of the property executable in favour of the limited company. It is no doubt true that all properties of the firm vest in the limited company on the firm being treated as a company under Part IX of the Companies Act, bu .....

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anta Raj Dairy [2014] 90 CCH 170 AllHC. "(a) where there was no transfer of assets of the partnership firm to a company, no capital gain tax is warranted (b) where the shares were issued by the company not to the firms, but to the individuals, who were partners of the erstwhile firm and became shareholders of the company, the provisions of section 45 of the Act will not be applicable." (v) CIT v. United Fish Nets [2015] 372 ITR 67 (T&AP). "When there is no tangible act of phys .....

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cal with those in the present case. There also an existing firm was transformed into a company under Part IX of the Indian Companies Act. When dealing with the identical situation, wherein the Assessing Officer proposed to levy capital gains tax, the Bombay High Court held (page 352 of 263 ITR) : 'In this case, the erstwhile firm has been treated as a limited company by virtue of section 575 of the Companies Act. It is not in dispute that in this case, the erstwhile firm became a limited com .....

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perty, 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 presupposes division, realisation, encashment of assets and appropriation of the realised amount as per the priority like payment of taxes to the Government, BMC etc., payment to unsecured creditors etc. This difference is very important. This difference .....

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transfer, does not arise.' The underlined portion, in a way, signifies the basic tenets of transfer of assets. The distribution must result in some tangible act of the physical transfer of properties or the intangible act of conferring exclusive rights vis-a-vis an item of property on the erstwhile share holder. Unless these or other legal correlatives take place, it cannot be inferred that there was any distribution of assets. In the instant case, the shares of the respective shareholders .....

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y covers the facts of the case and the orders passed by the Appellate Commissioner and the Tribunal accords with the same. The appeal is accordingly dismissed." (vi) L. K. S. Gold House (P.) Ltd. v. L. K. S. Gold Palace Application No. 376 of 2004 and C. S. No. 934 of 2003-[2005] 57 SCL 362 (Mad). "The question that arose in the above case was, whether inasmuch as plaintiff-company had come to be incorporated under Part IX, after complying with all relevant requirements and registered .....

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while firm into that private limited company under section 575 of Act without involving any transfer." 14.1. From the dictum laid down in the above cases, it is clear that when a partnership firm is transformed into a private limited company, there is no distribution of assets and as such, there is no transfer and therefore, the assessee is not liable to pay any tax on capital gains. 15. But, the contention of the learned counsel for the respondent is that even though the transfer is not co .....

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is a "deemed transfer" attracting capital gains. 15.1 Further contention of the learned counsel for the respondent is that the Legislature has used the expression 'or otherwise' and not 'and otherwise' ; therefore, the intention of the Legislature is to cover cases of capital gains even where there is no dissolution of the firm at all and when the transfer takes place in other mode also. In support of this and other legal contentions, the following decisions are relied .....

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he scope of the section is such that if the result of arrangement or agreement of a transaction is a transfer of assets or enabling enjoyment of any immovable property, then the transaction which led to such result is a transfer." Even according to this decision, only if the transaction involves transfer of assets, the liability arises and not otherwise. Hence, this decision is not applicable to the facts of this case. (ii) CIT v. A. N. Naik Associates [2004] 265 ITR 346, 359 (Bom) : " .....

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l assets of firms which otherwise was not subject to taxation. If the language of sub-section (4) is construed to mean that the expression 'otherwise' has to partake of the nature of dissolution or deemed dissolution, then the very object of the amendment could be defeated by the partners, by distributing the assets to some partners who may retire. The firm then would not be liable to be taxed thus defeating the very purpose of the Amending Act . . . Therefore, if the object of the Act i .....

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ion of capital assets. If so read, it becomes clear that even when a firm is in existence and there is a transfer of capital assets, it comes within the expression 'otherwise' as the object of the amending Act was to remove the loophole which existed whereby capital gain tax was not chargeable. In our opinion, therefore, when the asset of the partnership is transferred to a retiring partner the partnership which is assessable to tax ceases to have a right or its right in the property sta .....

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No. 3 by holding that the word 'otherwise' takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner." This decision has been followed by the honourable Madras High Court in the case of CIT v. Nathan and Co. (TC (A) No. 1458 of 2005 (Mad). In the reported case, there was a transfer of asset in favour of retiring partner. That is not the situation contemplated in the facts of this cas .....

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9;no transfer', there is no need for any further amendment to section 2(47) of the Act as argued before us. In our view, despite no amendment to section 2(47), in the light of removal of clause (ii) of section 47, transaction certainly would call for tax at the hands of the authorities." This decision is not applicable to the facts of this case. The Finance Act, 2001, has amended clause (xiii) of section 47 of the Income-tax Act to provide that any transfer of a capital asset, from an a .....

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corporatisation is approved by the Securities and Exchange Board of India. The very purpose of one time exemption was towards facilitating corporatisation of stock exchange and therefore, the deletion of section 47(xiii) will not have an impact, on the liability to pay capital gains tax, under section 45(4) of the Income-tax Act. (iv) Hotel Luciya Drive-in-Restaurant v. CIT [2010] 48 DTR (Ker) 44. "In other words, the execution of the transfer deed of the property on April 24, 1995, the rec .....

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Act without reference to section 45(3) or section 45(4) of the Act. We, therefore, uphold in principle the order of the Tribunal holding that the transaction by the appellants amounts to transfer of capital asset which attracts liability for tax for capital gains." The transaction in this case involves sale of partnership business along with retirement of two partners. Therefore, this case is distinguishable on fact. (v) Ana Labs v. Deputy CIT [2015] 371 ITR 295, 301 (T&AP) : "An .....

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e essential to attract clause (xiii) of section 47 of the Act. The appellant is not able to demonstrate that the figures mentioned by the Assessing Officer are incorrect." In the reported case, there is a factual finding that sale took place before the dissolution of the firm and therefore, there was an obligation to pay tax. It is not so in this case. (vi) Rajlaxmi Trading Co. v. CIT [2001] 250 ITR 581 (AP) ; [2001] 117 Taxman 50 (AP). "In this case also, the assessee-firm was dissolv .....

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here was a transfer of capital assets within the meaning of section 2(47)." (viii) CIT v. Kumbazha Tourist Home (Dissolved) [2010] 328 ITR 600 (Ker) ; [2010] 190 Taxman 40 (Ker) : "In this case, on the dissolution of the partnership, the land and building were distributed among the partners of the dissolved firm and it was held that the transaction fell under section 45(4) of the Act which attracted capital gains." So far as decision Nos. 6, 7 and 8 are concerned, the portion extr .....

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ities, with different legal liability. In other words, the liability of a partner is different from that of the liability of a director of a company. The company has an independent legal entity, de hors its share- holders, whereas the partnership firm has no such independent existence, de hors the partners. Therefore, when a partnership firm is transformed into a limited company with no change in the number of partners and the extent of property, there is no transfer of assets involved and hence .....

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al assets and consequently, whether there is a liability to pay tax on capital gains. On facts, the finding is that there is no dissolution of partnership firm. It is not in doubt that, in case of dissolution of partnership firm, there is transfer of assets and consequently, the assessee is liable to pay tax on capital gains. 18. It would be appropriate to quote the decision in Asst. CIT v. Unity Care and Health Services [2006] 286 ITR (AT) 121 (Bang) ; [2006] 106 TTJ 1086 (Bang.), whereunder, i .....

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en for purposes of capital gains under section 45(4) of the Act. By insertion of section 47(xiii) in the Act, it cannot be said that the conversion of a firm into a company under Part IX is to be first treated as dissolution of firm within the meaning of section 45(4) and only if condition as contained in section 47(xiii) are complied, the exemption will be available. Section 47(xiii) applies only to a case of transfer by sale, but there is no authority for capital gain at all in the absence of .....

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