DLF Universal vs. DCIT (ITAT Delhi Special Bench)

Even introduction of stock-in-trade as capital contribution into firm attracts s. 45(3)

The assessee was engaged in the business of real estate development. It held land as stock in trade with a book value of Rs. 4.4 crs. The said land was introduced at its market value of Rs. 11.50 crs as capital contribution into a new firm. The surplus of Rs. 6.01 crore was credited to the profit and loss account. Relying on Hind Construction 83 ITR 211 (SC), it was claimed that the surplus of Rs. 6.01 crs was not liable to tax as the introduction of an asset into a partnership was not a sale. It was also claimed that s. 45 (3) was applicable only to capital assets and not to stock-in-trade. The AO and the CIT (A) took a contrary view relying on Sunil Siddharthbhai 156 ITR 509 (SC) & McDowell 154 ITR 148 (SC). On appeal by the assessee, HELD by the majority, dismissing the appeal:

(i) In Sunil Siddharthbhai it was held that when a partner introduces his asset into a firm as capital contribution, there is a “transfer” though the gains are not chargeable to tax as the consideration is not determinable. It was clarified that this principle did not apply if the partnership was non-genuine or sham or where the transaction of transferring the personal asset to the partnership firm was a device or ruse to convert personal assets into money while evading tax on capital gains;

(ii) On facts, though there was no material to hold that the partnership was non-genuine or a sham, the assessee had adopted a calculated device of converting land into money by withdrawing substantial sums from the firm and debiting the same to its current account. Accordingly, though the partnership firm was genuine, the contribution by the assessee of its personal land to the share capital of the firm was a device or ruse for converting land into money for its benefit. Thus, the entry of Rs. 11.50 crs being the value of land credited in assessee’s capital account was not imaginary or notional. The surplus was chargeable to tax;

(iii) S. 45 (3) applies when a capital asset is introduced into a firm as capital contribution. This provision applies also when stock-in-trade is introduced into a firm because the transaction is on the capital account and stock-in-trade does not retain its character as stock-in-trade at the point of time of introduction. This is also shown by the fact that the assessee revalued the stock-in-trade to its market value prior to the introduction into the firm. Consequently, the gains on such transfer is taxable u/s 45(3);

(iv) The AO, having assessed the gain as business profits, is entitled to urge before the Tribunal that the gains should be assessed as capital gains u/s 45(3) because this is merely an alternative argument on the same set of facts and not the making out of a new case against the assessee. In Sumit Bhattacharya 112 ITD 1 (Mum)(SB) it was held that the Tribunal was competent to change the head of income even at the instance of the respondent;

(v) Consequently, the surplus arising to the assessee from the contribution of land to the firm as capital was assessable u/s 45 (3). Even otherwise, the surplus was taxable as the transaction was a colourable device. Without prejudice, if it was held that the land should be treated as stock in trade, the surplus is assessable as business income.

HELD by Deepak R. Shah, AM, dissenting:

(i) S. 45 (3) was inserted to supercede Sunil Siddharthbhai. However, it applies only to a “capital asset” which is defined in s. 2 (14) to exclude ‘stock-in-trade’. In the absence of any specific provision, tax cannot be imposed on the ground of morality or equity;

(ii) The majority view that the transaction is colourable because the assessee has withdrawn huge sums from the firm in subsequent years is not acceptable because withdrawal in subsequent years does not make the transaction colourable in the year of introduction. Further, it was not a case where the introducing partner had walked off with the funds but the land was developed by the firm by constructing building thereon. Therefore, neither the firm was non-genuine nor the transaction of contributing to the capital of the firm was non-genuine;

(iii) The majority view that the stock-in-trade was converted into a capital asset on introduction and attracted s. 45 (3) is not acceptable because the question whether a capital asset or stock-in-trade was transferred was never the subject matter of dispute before the lower authorities. On the contrary, the finding by the AO & CIT (A) is that stock-in-trade was introduced and it was chargeable as profits & gains of business. Given the scope of its powers u/s 254 (2) and the fact that the AO was not in appeal, the Tribunal could not go into the question whether the asset introduced in the firm was a capital asset or not. An appellant cannot be worse off as a result of filing the appeal;

(iv) Further the finding that the stock-in-trade was converted into a capital asset on introduction is not acceptable because the stock-in-trade could also be dealt with by the assessee in partnership given that partnership is not a distinct legal entity. The introduced asset continues to be stock-in-trade and its character does not change as a result of introduction into partnership;

(v) The majority view of treating the transaction as ‘colourable’ by relying on McDowell is not acceptable in view of the subsequent judgements in Arvind Narottam 173 ITR 479 (SC) & Azadi Bachao Andolan 263 ITR 706 (SC);

(vi) The majority view that the surplus is a capital gain and in the alternative a business profit is against the basic law giving power to the Tribunal to decide as final fact finding authority. The Tribunal cannot give alternative findings;

(vi) Consequently, in accordance with Hind Construction and Sunil Siddharthbhai, the transaction was not chargeable to tax under the head ‘Profits and Gains”.