2003 (7) TMI 46 - HC - Income Tax

Whether the deed of family settlement dated January 30, 1997, amounts to dissolution of partnership formed by agreement as contemplated under section 40 of the Indian Partnership Act? - Whether the distribution of assets of the firm amongst the retiring partners dated January 30, 1997, and the deed of reconstitution dated January 30, 1997, would amount to transfer of the capital assets which is in the nature of capital gains and business profits chargeable to tax under section 45(4)? - finding by the Income-tax Appellate Tribunal that the deed of reconstitution by inducting a partner in the assessee-firm was not a device to avoid tax has to be upheld Thus question is answered in affirmitive

Issues Involved:
1. Whether the deed of family settlement dated January 30, 1997, amounts to dissolution of partnership formed by agreement as contemplated under section 40 of the Indian Partnership Act?
2. Whether the distribution of assets of the firm amongst the retiring partners dated January 30, 1997, and the deed of reconstitution dated January 30, 1997, would amount to transfer of the capital assets which is in the nature of capital gains and business profits chargeable to tax under section 45(4) of the Income-tax Act?
3. Whether the word 'otherwise', in section 45(4) takes into its sweep not only cases akin to dissolution of the firm but also cases of reconstitution of firm?
4. Whether the deed of reconstitution of partnership by the assessee-firm is a device to avoid tax?
5. Whether, on the facts and circumstances of the case, the Income-tax Appellate Tribunal was justified in law in setting aside the assessment order by holding that there is no dissolution?

Detailed Analysis:

Issue 1: Dissolution of Partnership
The court examined whether the deed of family settlement dated January 30, 1997, amounted to the dissolution of the partnership under section 40 of the Indian Partnership Act. The court found that the documents showed the partnership continued with new partners inducted before the old partners retired. Thus, there was no dissolution of the firm, and the partnership subsisted. The order of the Income-tax Appellate Tribunal was upheld, confirming there was no dissolution of the partnership.

Issue 2: Transfer of Capital Assets
The court considered whether the distribution of assets among retiring partners and the deed of reconstitution amounted to a transfer of capital assets chargeable to tax under section 45(4) of the Income-tax Act. The court referred to various judgments, including Malabar Fisheries Co. v. CIT, which held that on dissolution, the firm's rights in the partnership assets are not extinguished but are mutual adjustments among partners. The court concluded that the transfer of assets to retiring partners falls under the purview of section 45(4), and thus, it amounts to a transfer of capital assets chargeable to tax.

Issue 3: Interpretation of 'Otherwise' in Section 45(4)
The court addressed whether the term 'otherwise' in section 45(4) includes reconstitution of the firm. The court held that the expression 'otherwise' must be read with the words 'transfer of capital assets' and not ejusdem generis with 'dissolution of a firm.' This interpretation aligns with the legislative intent to tax transactions where assets are transferred within a subsisting partnership. Thus, the transfer of assets to a retiring partner is covered under 'otherwise' and is taxable.

Issue 4: Device to Avoid Tax
The court examined whether the deed of reconstitution was a device to avoid tax. The Income-tax Appellate Tribunal had found that the firm existed since 1985 and the family settlement was genuine, not a tax avoidance scheme. The court agreed with this finding, noting that the family settlement aimed to separate family assets and was not designed to avoid tax. The deed of reconstitution was not a device to avoid tax.

Issue 5: Justification of the Tribunal's Order
The court evaluated whether the Tribunal was justified in setting aside the assessment order by holding there was no dissolution. Given the findings on the other issues, particularly the interpretation of 'otherwise' and the nature of the family settlement, the court held that the Tribunal's order should be set aside. The distribution of assets was indeed a transfer subject to capital gains tax under section 45(4).

Conclusion:
The court allowed the appeals, set aside the Tribunal's order, and restored the assessment order, holding that the distribution of assets among retiring partners constituted a taxable transfer under section 45(4) of the Income-tax Act. Each party was ordered to bear their own costs.

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