Facts

D was carrying on the business of a transporter as an individual up to financial  year 1966-67. From 01.04.1967, he converted his proprietary business into a partnership firm, taking his two nephews as partners and giving each 1/4th share  in the firm.

The ITO treated such conversion of proprietary into partnership as transfer of assets for less than fair market value and taxed the difference between the market value determined by him and the book value as capital gains. The Commissioner granted part relief to the assessee by reducing the quantum of capital gains. On further appeal, the Tribunal concluded that on conversion of individual business into a partnership it did not result in any transfer as envisaged by section 45 read with section 2(47).

On a reference application, the following question was referred to the Madras High Court: “Whether, on the facts and in the circumstances of the case, it has  been rightly held that there was no transfer of assets in the assessee’s case within the meaning of section 2(47) read with section 45 of the Income-tax Act, 1961?” The High Court came to the conclusion that there was no transfer of assets and, therefore, no capital gains could be levied. CIT v. H. Rajan and H. Kannan [1984] 149 ITR 545 (Mad) (HC). TheRevenue approached the Supreme Court.

Issue

Two questions arose (1) Whether it has been rightly held that there was no transfer of assets on conversion of proprietary business into partnership firm?, and (2) If no, then would such a transfer result in there being any gains or profit taxable under section 45 of the Act? (additional question raised by the Supreme Court)

Views

In the case of Sunil Siddharthbhai v.  CIT [1985] 156 ITR 509 (SC), introduction  of capital assets into a partnership firm was held to be a transfer of capital asset under section 2(47) on the ground that the exclusive interest of a partner in personal asset was reduced and the said asset became an asset of the firm, in which the other partners got an interest. However, it also held that onsuch a

transfer, no consideration was received within the meaning of section 48 and, therefore, no profit or gain accrued to the transferor and thus, there was no capital gains which could be taxed.

Held

In so far as the first question, the Court held that the exclusive business of the assessee was imparted with a character of a partnership business with induction   of two nephews of the assessee, which was a transfer of the assets under section 2(47) by the assessee in favour of his nephews. However, for the second question, the Court concluded that such a transfer did not yield any profits or   gains to the assessee which could be subjected to tax under section 45. For  this,  the Court followed its decision in Sunil Siddharthbhai v. CIT[1985] 156 ITR 509 (SC). (AY. 1968-69) (CA No. 3644 of 1983 dt. 12-2-1998)

Editorial: After amendment in sub-section (3) in section 45 by the Finance Act, 1987, the amount recorded in the books of account of the firm/AOP/BOI as the value of the capital asset is deemed to be the ‘full value of the consideration’ received or accruing as a result of the transfer of the capital asset by an assessee towards his capital contribution in the firm/AOP/BOI. However, the ratio in so     far as the second question is concerned remains relevant for cases where no consideration is received by the assessee of transfer of a capital asset and the Revenue seeks to invoke the deeming provisions of sections 50CA and 50D of the Act. Also see CIT v. Texspin  Engg. & Mfg. Works  (2003) 263 ITR 345 (Bom) (HC)  for the same proposition.

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