1998 (7) TMI 83 - HC - Income Tax

Summary

Issues Involved:
1. Dissolution of the assessee-firm by virtue of the court's compromise decree.
2. Nature of the auction of the assessee-firm's property held among the partners.
3. Applicability of section 47(ii) of the Income-tax Act to exclude capital gains from the assessee-firm.

Detailed Analysis:

Question No. 1: Dissolution of the Assessee-Firm
The primary issue was whether the firm stood dissolved by the court's compromise decree. The Appellate Tribunal found that the firm was dissolved by the court's decree. Under section 44 of the Partnership Act, a court may dissolve a partnership on various grounds, including unsound mind, incapability, misconduct, breach of agreement, transfer of interest, business loss, or any just and equitable cause. The court noted that the exact date of the civil court's decree and the terms of the compromise were not provided. However, based on the sequence of events, including the auction held on August 21, 1973, and the subsequent sale of the property, it was inferred that the firm was dissolved pursuant to the court decree. The Tribunal's finding was upheld, distinguishing it from the case of E.M. Muthappa Chettiar v. ITO, where the dissolution date was disputed and fixed by the court. Thus, the firm was considered dissolved by the court's decree.

Questions Nos. 2 and 3: Nature of Auction and Applicability of Section 47(ii)
These questions were addressed jointly as they were interrelated. The assessee contended that the relinquishment of property after the firm's dissolution was a distribution of the capital asset, not a sale, and thus exempt under section 47(ii) of the Income-tax Act. The Revenue argued that the transaction was an outright sale, not a distribution of capital assets in specie, and thus subject to capital gains tax.

Section 47(ii) exempts the distribution of capital assets on the dissolution of a firm from capital gains tax. The court noted that the auction conducted on August 21, 1973, resulted in the sale of the property to one of the partners, G. Venkateswarlu, for Rs. 3,10,000. The proceeds were to be distributed among the partners. The court held that this transaction was an outright sale for gains, not a distribution of capital assets in kind. Citing the Supreme Court's decision in James Anderson v. CIT, the court emphasized the distinction between capital assets and their sale proceeds. The sale of capital assets followed by the distribution of proceeds constitutes a taxable transfer, not exempt under section 47(ii).

The court also rejected the assessee's argument that the relinquishment of rights over the property did not constitute a sale. Under section 2(47) of the Act, relinquishment of rights over a capital asset is considered a transfer, making the gains taxable under section 45. Therefore, the assessee's claim for exemption under section 47(ii) was unsustainable.

Conclusion:
The court upheld the Appellate Tribunal's finding that the firm was dissolved by the court's compromise decree. It also held that the auction of the property was an outright sale, not a distribution of capital assets, and thus subject to capital gains tax. The reference was answered in favor of the Revenue and against the assessee.