Assets Revalued Credit into capital accounts of partners can be said to be transfer, provisions of section 45(4) of Income Tax Shall Apply: Supreme Court

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The Supreme Court held that the assets revalued and credit into capital accounts of the respective partners can be to be transfer and and the provisions of section 45(4) inserted by the Finance Act 1987 with effect from 01.04.1988 shall be applicable.

Facts

The respondent assessee, a partnership firm originally consisted of four partners (all brothers) engaged in the business of Dyeing and Printing, Processing, Manufacturing and Trading in Clothing. Under the Family Settlement dated 02.05.1991, the share of one of the existing partners – Shri M.H. Doshi having 25% profit share in the firm was reduced to 12% and, for his balance 13% share, three new partners were admitted namely, viz., Smt. Ranjan Doshi (11%), Shri Prakash Doshi (1%) and Shri Rajeev Doshi (1%). It appears that thereafter, Shri M.H. Doshi, Shri Manohar Doshi and Shri V.H. Doshi retired from the partnership and reconstituted the partnership firm consisted of the partners namely, viz., Shri Hasmukhlal H. Doshi, Smt. Rajan H. Doshi, Shri Prakash H. Doshi & Shri Rajiv H. Doshi.

The respondent filed its Return of Income for the relevant assessment years. The Return of Income was filed for A.Y. 1993-1994 @ Rs. 3,18,760/-. The same was accepted under Section 143(1) of the Income Tax Act, 1961. However, thereafter, the assessment was reopened under Section 147 of the Income Tax Act by issuance of the notice under Section 148. The assessment was reassessed under Section 143(3) read with Section 147 determining the total income of Rs. 2,55,19,490/-. Addition of Rs. 17,34,86,772/- was made towards short term capital gain under Section 45(4) of the Income Tax Act. Similar addition was made for A.Y. 1994-1995.

As per the A.O., the assessee revalued the land and building and enhanced the valuation from Rs. 21,13,225/- to Rs. 17,56,00,000/- for A.Y. 1993-1994 thereby increasing the value of the assets by Rs. 17,34,86,772/- and therefore the revaluing of the assets, and subsequently crediting it to the respective partners’ capital accounts constitutes transfer, which was liable to capital gains tax under Section 45(4) of the Income Tax Act. 

As land and building was involved, the assessee had claimed the depreciation on building, and the Assessing Officer assessed the amount of short-term capital gain under Section 50. 2.6 The Commissioner of Income Tax (Appeals) [CIT(A)] by order dated 30.07.2004 confirmed the addition on account of Short-Term Capital Gains and held that there is a clear distribution of assets as partners have also withdrawn amounts from the capital account. CIT(A) also observed that value of the assets of the firm which commonly belonged to all the partners of the partnership have been irrevocably transferred in their profit-sharing ratio to each partner. To the extent that the value has been assigned to each partner, the partnership has effectively relinquished its interest in the assets and such relinquishment can only be termed as transfer by relinquishment. 

Therefore, according to the CIT(A), conditions of Section 45(4) are satisfied and therefore, the assets to the extent of their value distributed would be deemed as income by capital gains in the hands of the assessee firm. The CIT (A) also observed that the transfer of the revalued assets had taken place during the previous year and, therefore, the liability to capital gains arises in the A.Y. 1993-1994.

Arguments

The department submitted that both, the ITAT as well as the High Court have seriously erred in deleting the additions made by the A.O. towards short term capital gain. It is vehemently submitted that in the present case as the assets of the firm were revalued to increase the value by an amount of Rs. 17.34 crores on 01.01.1993 relevant to A.Y. 1993-1994 and the revalued amount was credited to the accounts of the partners in their profit-sharing ratio and the credit of the asset’s revaluation amount to the capital account of the partner was in effect distribution of the assets valued at Rs. 17.34 crores to the partners and that during the years, some new partners were inducted by introduction of small amounts of capital ranging between 2.5 to 4.5 lakhs and these partners have huge credits to their capital accounts immediately after joining the partnership, which amount was available to the partners for withdrawal, the amount so revalued and credited in the capital accounts of the respective partners can be said to be “transfer” and therefore, the provisions of Section 45(4) inserted into the Income Tax Act w.e.f. 01.04.1988 shall be applicable.

The assessee submitted that there was no dissolution of partnership firm and/or revaluation on dissolution of the partnership firm. There was reconstitution of the partnership firm and on revaluation, the surplus amount on account of such revaluation was credited to the partners’ capital account. The surplus on account of revaluation credited to the partners’ capital account cannot be said to be transfer as per the provisions of Section 45(4) of the Income Tax Act.

Provisions 

Section 45(4) of the Income Tax Act, two conditions were required to be fulfilled. Firstly, there must be a transfer by way of distribution of capital assets, secondly, that such transfer should be either on account of dissolution of partnership firm or otherwise.

Court’s Observation

The division bench of Justice M.R. Shah and Justice M.M. Sundresh has held that the assets of the partnership firm were revalued to increase the value by an amount of Rs. 17.34 crores on 01.01.1993 (relevant to A.Y. 1993-1994) and the revalued amount was credited to the accounts of the partners in their profit-sharing ratio and the credit of the assets’ revaluation amount to the capital accounts of the partners can be said to be in effect distribution of the assets valued at Rs. 17.34 crores to the partners and that during the years, some new partners came to be inducted by introduction of small amounts of capital ranging between Rs. 2.5 to 4.5 lakhs and the said newly inducted partners had huge credits to their capital accounts immediately after joining the partnership, which amount was available to the partners for withdrawal and in fact some of the partners withdrew the amount credited in their capital accounts. 

Therefore, the assets so revalued and the credit into the capital accounts of the respective partners can be said to be “transfer” and which fall in the category of “OTHERWISE” and therefore, the provision of Section 45(4) inserted by Finance Act, 1987 w.e.f. 01.04.1988 shall be applicable.

“The impugned judgment and order passed by the High Court and that of the ITAT are unsustainable and the same deserves to be quashed and set aside and are accordingly quashed and set aside. The order passed by the Assessing Officer is hereby restored,” the order read.

Case title: The Commissioner of Income Tax – 23 v/s M/s. Mansukh Dyeing and Printing Mills

Citation: Civil appeal no. 8258 of 2022 

Date: 24.11.2022

Click here to read the Order/Judgment 

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