2012 (5) TMI 403 - HC - Income Tax

Reconstitution of firm - relinquishment of right and interest in the erstwhile firm - transfer u/s 2(47) - admission of the new partners and assignment of right in the firm to the new partners out of the rights of the assessee for consideration - held that - the firm is not taxed. It is the individual partners who are taxed. More over, in the instant case, the erstwhile partners have not retired, they also continued to be the partners along with the incoming partners. All that has happened is that the shares of the erstwhile partners are reduced. - No transfer - decided in favor of assessee. Decision in the matter of Commissioner of Income-tax v. Gurunath Talkies (2009 (7) TMI 738 (HC)) distinguished.

Summary

Issues Involved:
1. Whether the admission of new partners and assignment of rights in the firm to the new partners amounts to a transfer under Section 2(47) of the Income Tax Act, 1961, and consequently liable to tax under Section 45 of the Act.

Issue-wise Detailed Analysis:

1. Admission of New Partners and Assignment of Rights:
The firm M/s. Kamal Industries, originally constituted on 05.04.1961, reconstituted by admitting four new partners on 12.10.1995. The new partners contributed Rs. 3.50 crores towards the capital, reducing the share of the original three partners from 1/3rd to 1/6th each. The Assessing Authority held this reconstitution as a transfer under Section 2(47) of the Income Tax Act, 1961, leading to a capital gain of Rs. 3,46,84,942/- apportioned among the three original partners.

2. Assessing Authority's Stand:
The Assessing Authority viewed the reduction in the original partners' share as relinquishment of rights, amounting to a transfer under Section 2(47). The authority taxed the amount withdrawn by the partners as capital gains, citing the judgment in Malbar Fisheries Co. v. CIT, which held that the partnership firm has no separate legal existence, and the property of the firm vests in all partners.

3. Appellate Authority's Decision:
The Commissioner of Income Tax (Appeals) reversed the Assessing Authority's order, stating that the property belonged to the firm and not the individual partners. The reduction in share due to the induction of new partners did not constitute a transfer, as no specific provision in the Income Tax Act envisages capital gains on such reduction. The judgment in Malbar Fisheries Co. was cited, emphasizing no transfer of assets upon reconstitution of the firm.

4. Tribunal's Findings:
The Tribunal upheld the Appellate Authority's decision, noting that the firm continued to exist after the induction of new partners. The reduction in the original partners' share was not equivalent to a transfer of property. The firm was genuine and the transaction did not lead to tax evasion.

5. Revenue's Argument:
The revenue contended that the withdrawal of Rs. 1,16,66,666/- by each original partner represented consideration for the reduction in their share, constituting a transfer under Section 45(1). They relied on judgments supporting the view that relinquishment or extinguishment of rights amounts to a transfer.

6. Court's Analysis:
The court examined the definitions and provisions under Sections 2(47) and 45 of the Income Tax Act, and the Indian Partnership Act, 1932. The court referred to the judgments in Narayanappa v. Bhaskara Krishnappa and Sunil Siddharthbhai v. CIT, which clarified the concept of partnership and the nature of partners' rights in partnership property.

7. Key Judgments Considered:
- Narayanappa v. Bhaskara Krishnappa: Partnership property is a trading asset in which all partners have a joint interest.
- Malbar Fisheries Co. v. CIT: Distribution of assets upon dissolution does not amount to a transfer.
- Sunil Siddharthbhai v. CIT: Introduction of personal assets into the partnership does not constitute a transfer of assets.
- Kartikeya V. Sarsbhai v. CIT: Relinquishment or extinguishment of rights amounts to a transfer.
- Commissioner of Income-tax v. Gurunath Talkies: Reconstitution leading to transfer of assets attracts capital gains tax.

8. Conclusion:
The court concluded that the original partners did not transfer any capital assets, as the property was owned by the firm. The reduction in their share due to the reconstitution did not constitute a transfer under Section 2(47). The substantial question of law was answered in favor of the assessees, dismissing the revenue's appeals.

Final Judgment:
The appeals were dismissed, and the substantial question of law was answered in favor of the assessees. The court held that the admission of new partners and assignment of rights did not amount to a transfer under Section 2(47) of the Income Tax Act, and thus, was not liable to tax under Section 45.