IN THE HIGH COURT OF JUDICATURE AT BOMBAY
\nORDINARY ORIGINAL CIVIL JURISDICTION
\nINCOME TAX APPEAL NO. 137 OF 2017<\/p>\n
Principal Commissioner of Income Tax30,
\nRoom No. 402, 4th Floor, Pratyaksh Kar …..Appellant
\nBhavan BKC, Bandra Mumbai 400 051
\nV\/s.<\/p>\n
Electroplast Engineers,
\n143, Garuda House, Upper …..Respondent
\nGovind Nagar, Malad (E),
\nMumbai 400097<\/p>\n
Mr. Arvind Pinto a\/w Mr. N. C. Ranganayakulu
\nMr. R. Murlidhar i\/b Mr. Vaibhav Pandya for Respondent<\/p>\n
CORAM : AKIL KURESHI &
\nSARANG V. KOTWAL, JJ.
\nDATE : 26th MARCH, 2019.<\/p>\n
ORAL JUDGMENT: (PER AKIL KURESHI, J.)<\/p>\n
This appeal is filed by the Revenue to challenge the Judgment
\nof Income Tax Appellate Tribunal (\u201cITAT\u201d for short). Following
\nquestion was presented for our consideration:
\n\u201cWhether in law and on the facts of the instant
\ncase, was the Tribunal correct in holding that
\nthere was no transfer of capital asset by way of
\ndistribution at the time of making payment to
\nthe retiring partners\u201d.<\/p>\n
2 Brief facts are as under.
\n(I) Respondent assessee a partnership firm, had filed return of
\nincome for the assessment year 20102011.<\/p>\n
The assessee was
\nengaged in manufacturing of tubelight fittings and other lighting
\naccessories for over 13 years. The firm was constituted under
\nPartnership Deed dated 16\/11\/1996, originally consisting of two
\npartners. On 15\/01\/2010, constitution of the firm underwent a
\nchange under a Deed of Reconstitution of partnership. Three new
\npartners were admitted. On 16\/01\/2010, another Deed of
\nRetirement cum Reconstitution of the partnership was executed by
\nwhich the original two partners retired from the firm and the
\nremaining three partners redistributed
\ntheir share in a partnership
\nfirm. The partnership created a goodwill account and a sum of Rs.
\n3.75 Crores (rounded of) was credited in the books of the firm in the
\nsaid account. The retiring parters were paid sums of Rs. 2.97 Crores
\n(rounded of) and 77.27 Lakhs (rounded of) respectively in proportion
\nof their shares in the partnership business.<\/p>\n
(II) The Assessing Officer was of the opinion that in terms of
\nsection 45(4) of the Income Tax Act, 1961, (\u201cthe Act\u201d for short) the
\nfirm had to pay short term capital gain tax on such amounts. The
\nAssessing Officer was of the opinion that the goodwill credited by the
\nfirm of Rs. 3.75 Crores was nothing but the capital gain arising on
\ndistribution of the capital asset by way of \u201cdissolution of the firm or
\notherwise\u201d.<\/p>\n
(III) The assessee carried the matter in appeal in which heavy
\nreliance was placed on Full Bench Judgment of Karnataka High
\nCourt in the case of Commissioner of IncomeTax
\nand Another v.
\nDynamic Enterprises1. The Commissioner agreed with the
\ncontention of the assessee that there was neither dissolution of the
\nfirm nor the firm was discontinued. He, however, held that the rights
\nand interests in assets of the firm were transferred to the new
\nmembers and in this manner there was transfer of capital asset. He
\nwas further of the opinion that Section 45(4) of the Act would apply
\n1 [2013] 359 ITR 83 (Karn) [FB]<\/p>\n
in the present case which would cover even a case of transfer of
\ncapital asset otherwise than by dissolution of the firm.<\/p>\n
(IV) The assessee carried the matter in further appeal before the
\nTribunal. The Tribunal by the impugned Judgment allowed the
\nassessee’s appeal. The Tribunal was of the opinion that the
\nconditions required for applying section 45(4) of the Act were not
\nsatisfied in the present case. The Tribunal placed reliance on the
\ndecision of the Karnataka High Court in the case of Dynamic
\nEnterprises (Supra). The Revenue has filed this appeal against the
\nsaid Judgment of the Tribunal.<\/p>\n
3 The counsel for the appellant submitted that decision of this
\nCourt in the case of Commissioner of IncomeTax
\nv. A. N. Naik
\nAssociates and Another2 would be applicable in the present case.
\nThe Tribunal has committed an error in proceeding on the basis that
\nSection 45(4) of the Act would apply only in a case where there has
\nbeen dissolution of the firm.
\n2 [2004] 265 ITR 346 (Bom)<\/p>\n
4 On the other hand, the learned counsel for the assessee
\nopposed the appeal contending that decision of this Court in the
\ncase of A. N. Naik Associates (Supra) concerned a question whether
\nSection 45(4) of the Act would apply only in a case of dissolution of
\nthe firm and not in case of retirement of a partner. The Court was
\nnot concerned with the question of applicability of Section 45(4) of
\nthe Act without there being any transfer of capital asset. The
\nKarnataka High Court in the case of Dynamic Enterprises (Supra)
\nhas noticed the decision of this Court in the case of A. N. Naik
\nAssociates (Supra) and held that when there is no transfer of capital
\nasset, Section 45(4) will not apply.<\/p>\n
5 Having thus heard the learned counsel for the parties, we may
\nsummarise the undisputed facts:
\n(I) Assessee firm was registered partnership firm, initially
\ncomprising of two partners. After carrying on the business for about
\n13 years, partnership was reconstituted to bring in three new
\npartners. Almost immediately thereafter, a new Deed was executed<\/p>\n
under which the original two partners retired. Newly inducted three
\npartners of the firm continued the business of the firm and the
\nassets were redistributed. While doing so, the partnership evaluated
\nits goodwill. The retiring partners were paid their share in the
\ngoodwill in proportion of their existing shares in the partnership
\nbusiness.
\n(II) Section 45 of the Act pertains to computation of the capital
\ngains. Sub Section 4 of Section 45 reads as under:
\n\u201c45 (4) The profits or gains arising from the transfer of a
\ncapital asset by way of distribution of capital assets on the
\ndissolution of a firm or other association of persons or body
\nof individuals (not being a company or a cooperative
\nsociety)
\nor otherwise, shall be chargeable to tax as the income of the
\nfirm, association or body, of the previous year in which the
\nsaid transfer takes place and, for the purposes of section 48,
\nthe fair market value of the asset on the date of such
\ntransfer shall be deemed to be the full value of the
\nconsideration received or accruing as a result of the
\ntransfer\u201d.<\/p>\n
6 As per this provision, profits or gains arising from transfer of
\ncapital asset by way of distribution of capital asset on dissolution of
\nfirm or otherwise shall be chargeable to tax as income of the firm.
\nFor application of this provision, thus, transfer of capital asset is
\nnecessary. Provisions of Section 45(4) of the Act came up for
\nconsideration before this Court in the case of A. N. Naik Associates
\n(Supra). It was a case in which there was reorganization
\nof the
\npartnership in quick succession. The Court held that such reorganization
\nwould not amount to dissolution of the firm. The
\nquestion in such background was whether Section 45(4) of the Act
\nwould apply in case there has been transfer of capital asset. The
\nCourt referred to legislative changes and observed that when the
\nasset is transferred to the partner, that falls within the expression
\n\u201cotherwise\u201d and the rights of the other partners in that asset of the
\npartnership are extinguished. It was held that transfer of assets of
\nthe partnerhsip of the retiring partners would amount to transfer of
\ncapital assets.<\/p>\n
7 This decision of the Court in the case of A. N. Naik Associates
\n(Supra) was considered by the Karnataka High Court in the Full
\nBench Judgment in the case of Dynamic Enterprises (Supra). The
\nquestion considered by the court was when retiring partner takes
\nonly money towards value of his share, whether the firm should be
\nmade liable to pay capital gains even when there is no distribution of
\ncapital asset among the partners under section 45(4) of the Act. In
\nthe said case of Dynamic Enterprises (Supra), the partnership firm
\nwas engaged in the business of buying land and properties and
\nconstruction of buildings thereon. The firm underwent
\nreconstitution. Before such reconstitution the assets of the firm were
\nrevalued as per the report of the registered valuer. Three erstwhile
\npartners retired. Retiring partners received enhanced value of the
\nproperty upon retirement. In this context, the Court considered the
\nabove noted question. The Court held that after retirement of
\npartners, the partnership continued and the business was also
\ncarried on by the remaining partners. There was thus no dissolution
\nof the firm and there was no distribution of capital asset. What is
\ngiven to the retiring partners was money representing the value of
\ntheir share in the partnership. No capital asset was transferred on
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\nthe date of retirement. In absence of distribution of capital asset and
\nin absence of transfer of capital asset in favour of retiring partners,
\nno profit of gain arose in the hands of partnership firm. Following
\nobservations of the court may be noted:<\/p>\n
\u201c25. In the instant case, the partnership firm had purchased
\nthe property under a registered sale deed in the name of the
\nfirm. The property did not stand in the name of any
\nindividual partners. No individual partners brought that
\ncapital asset as capital contribution into the firm. Five
\npartners brought in cash by way of capital when the firm
\nwas reconstituted on April 28,1993. Nearly a year thereafter
\non April 1,1994, by way of retirement, the erstwhile three
\npartners took their share in the partnership asset and went
\nout of the partnership. After the retirement of three partners,
\nthe partnership continued to exist and the business was
\ncarried on by the remaining five partners. There was no
\ndissolution of the firm or at any rate there was no
\ndistribution of capital asset on April 1,1994, when the three
\npartners retired from the partnership firm. What was given
\nto the retiring partners is cash representing the value of their
\nshare in the partnership. No capital asset was transferred
\non the date of retirement under the deed of retirement deed
\ndated April 1,1994. In the absence of distribution of capital
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\nasset and in the absence of transfer of capital asset in
\nfavour of the retiring partners, no profit or gain arose in the
\nhands of the partnership firm. Therefore, the question of the
\nfirm being assessed under Section 45(4) and charging them
\ntax for the profits or gains which did not accrue to them
\nwould not arise.<\/p>\n
26. It was contended on behalf of the revenue that the five
\nincoming partners brought money into the firm. Three
\nerstwhile partners who retired from the partners on April 1,
\n1994, took money and left the property to the incoming
\npartners. It is a device adopted by these partners in order to
\nevade payment of profits or gains. As rightly held by this
\nCourt in Gurunath’s case (supra) it is taxable. This argument
\nproceeds on the premise that the immovable property
\nbelongs to the erstwhile partners and that after the
\nretirement the erstwhile partners have taken cash and given
\nthe property to the incoming partners. The property belongs
\nto the partnership firm. It did not belong to the partners. The
\npartners only had a share in the partnership asset. When
\nthe five partners came into the partnership and brought cash
\nby way of capital contribution to the extent of their
\ncontribution, they were entitled to the proportionate share in
\nthe interest in the partnership firm. When the retiring
\npartners took cash and retired, they were not relinquishing
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\ntheir interest in the immovable property. What they
\nrelinquished is their share in the partnership. Therefore,
\nthere is no transfer of a capital asset, as such, no capital
\ngains or profit arises in the facts of this case. In that view of
\nthe matter, Section 45(4) has no application to the facts of
\nthis case.
\n29. In the instant case, the partnership firm did not transfer
\nany right in the capital asset in favour of the retiring partner.
\nThe partnership firm did not cease to hold the property and
\nconsequently, its right to the property is not extinguished.
\nConversely, the retiring partner did not acquire any right in
\nthe property as no property was transferred in their favour.
\nThe Division Bench in Gurunath’s case (supra) did not
\nappreciate this distinguishing factor and by wrong
\napplication of the law laid down by the Bombay High Court
\nheld the assessee in that case is also liable to pay capital
\ngains tax under Section 45(4). Therefore, the said judgment
\ndoes not lay down the correctlaw\u201d.
\n8 The issue is thus similar to one considered by the Full Bench
\nof Karnataka High Court and with which we are in respectful
\nagreement. The decision of this Court in the case of A. N. Naik
\nAssociates (Supra) was rendered in slightly different background.
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\nCentral question was, would Section 45(4) apply even if there was no
\ndissolution of the firm. Issue of transfer of capital asset was not the
\nfocal point. In the present case, admittedly there was no transfer of
\ncapital asset upon reconstitution of the firm. All that happened was
\nthe firm’s assets were evaluated and the retiring partners were paid
\ntheir share of the partnership asset. There was clearly no transfer of
\ncapital asset. Revenue has not argued that the reconstitution of the
\nfirm was a colourable device to avail tax liability.
\n9 In the result, we do not find any error in the view of Tribunal.
\n10 Income Tax Appeal is dismissed.
\n[SARANG V. KOTWAL, J.] [AKIL KURESHI, J.]
\n::: Uploaded on – 30\/03\/2019 ::: Downloaded on – 03\/04\/2019 10:12:33 :::<\/p>\n","protected":false},"excerpt":{"rendered":"
The property belongs to the partnership firm. It did not belong to the partners. The partners only had a share in the partnership asset. When the five partners came into the partnership and brought cash by way of capital contribution to the extent of their contribution, they were entitled to the proportionate share in the interest in the partnership firm. When the retiring partners took cash and retired, they were not relinquishing their interest in the immovable property. What they relinquished is their share in the partnership. Therefore, there is no transfer of a capital asset, as such, no capital gains or profit arises in the facts of this case. In that view of the matter, Section 45(4) has no application to the facts of this case<\/p>\n