2014 (8) TMI 1056 - HC - Income Tax

Conversion of partnership firm into public limited company - Applicability of provisions of Section 45(1) or Section 45(4) of the Income Tax Act - - transfer of movable and immovable assets of the firm to company - Held that - In the instant case, the partnership firm, which came into existence on 31.08.1995 having seven partners. Later, it became a joint stock company within the meaning of Section 566 of the Companies Act and the same was registered on 08.04.1996. The share holding of the erstwhile firm remained with the same seven persons who became Directors. Thus, There was no transfer of assets of the firm to the company. It was only that the business was taken over by the company. It cannot be valued at market price, it had the value at a cost price. In view of above, no condition of Section 45 of the Act is applicable in the instant case, hence, no capital gain tax attracted in the instant case. Therefore, we find no reason to interfere with the impugned order passed by the Tribunal. - Decided in favour of assessee.

Summary

Issues:
1. Interpretation of Section 45(1) and Section 45(4) of the Income Tax Act, 1961 in the context of transfer of assets from a partnership firm to a limited company.
2. Determination of capital gain tax liability on the transfer of assets from a partnership firm to a public limited company.
3. Application of Section 566 of the Companies Act, 1956 in the conversion of a partnership firm to a public limited company.

Analysis:
The High Court of Allahabad addressed the appeal filed by the department against the Income Tax Appellate Tribunal's order regarding the assessment year 1997-98. The primary issue revolved around the transfer of assets from a partnership firm to a public limited company and the applicability of Section 45(1) and Section 45(4) of the Income Tax Act, 1961. The Tribunal had ruled in favor of the assessee, leading to the department's appeal.

The court examined the conversion process where a partnership firm was transformed into a public limited company under Section 566 of the Companies Act, 1956. It was noted that all partners of the firm became directors of the company, and the assets of the firm were transferred to the company. The department imposed capital gain tax on this transfer, which was upheld by the First Appellate Authority but later overturned by the Tribunal.

The court emphasized that for capital gain to arise under Section 45(1) of the Income Tax Act, the full value of consideration must be received for the capital assets. In this case, shares were issued to the partners-turned-directors, not to the firm itself. The court highlighted the two conditions for Section 45 to apply: transfer of capital assets and transfer on dissolution of the firm or otherwise.

Regarding the department's argument of a transfer of a business as a going concern, the court found that no transfer of assets occurred; rather, the business was taken over by the company. The court clarified that the value of the business should be considered at cost price, not market price. As a result, the court concluded that no capital gain tax was applicable in this scenario, as the conditions of Section 45 were not met.

Ultimately, the court upheld the Tribunal's decision, ruling in favor of the assessee and dismissing the department's appeal. The judgment favored the interpretation that no capital gain tax liability arose from the transfer of assets from the partnership firm to the public limited company.