2017 (8) TMI 1385 - HC - Income Tax

Exigibility to tax under section 4 of the Gift-tax Act, 1958 - gift-tax on surrender of share on a reconstitution of the firm - transfer of shares effected by some partners of the firm in favour of a newly inducted partner, virtually suffering a reduction in the share of profit simultaneously facilitating extension/increase of profits to the incoming partner by itself - sufficient consideration for the purpose of the exemption - Held that - Reduction of shares at the hands of the assessee at the time of reconstitution of the firm, to the extent the same has been transferred in favour of the newly inducted partners, is for adequate consideration and that it is not a gift in terms of section 4(1)(a) of the Gift- tax Act so as to suffer any tax liability. Answering the question as above, the matter is remitted to the Tribunal in terms of section 26(6) of the Act for further steps.

Issues Involved:
1. Whether the transfer of shares by existing partners to newly inducted partners constitutes a "gift" under section 4 of the Gift-tax Act, 1958.
2. Whether the additional contributions and undertakings by the newly inducted partners can be considered as adequate consideration under section 5(1)(xiv) of the Gift-tax Act.

Detailed Analysis:

1. Transfer of Shares as a "Gift":
The primary issue addressed by the court was whether the transfer of shares by existing partners to newly inducted partners, resulting in a reduction of the existing partners' profit shares, constituted a "gift" under section 4 of the Gift-tax Act, 1958. The court examined the sequence of events where the partnership firm was reconstituted, and two new partners were inducted, leading to a reduction in the profit shares of the existing partners by 8.33% each. The assessing authorities treated this reduction as a "gift" and sought to tax it under the Gift-tax Act. The court referred to previous judicial precedents, including decisions from the Supreme Court and various High Courts, which had ruled that a mere reallocation of profit-sharing ratios does not constitute a gift unless there is evidence of a transfer without adequate consideration.

2. Adequate Consideration for Exemption:
The court also considered whether the additional contributions and undertakings by the newly inducted partners could be regarded as adequate consideration for the transfer of shares, thereby qualifying for exemption under section 5(1)(xiv) of the Gift-tax Act. The newly inducted partners had made an initial capital contribution of ?25,000 each, followed by additional contributions totaling ?3.5 lakhs and ?3.15 lakhs, respectively. They also provided personal guarantees for financial transactions and undertook to work for the firm's benefit. The court noted that the adequacy of consideration is a factual question and held that the contributions and undertakings by the new partners were sufficient to constitute adequate consideration, thus negating the existence of a taxable gift.

Tribunal's Decision and Reference to Higher Courts:
The Assessing Officer's decision to treat the reduction in shares as a gift was initially overturned by the Commissioner of Income-tax (Appeals), but the Tribunal later reinstated the assessment, albeit allowing a 50% deduction of the capital contribution for tax calculation. The assessees challenged this decision, leading to a reference to the High Court. The High Court analyzed the Tribunal's reasoning and found it lacking in proper appreciation of the legal precedents and facts. The court referred to the Supreme Court rulings in CGT v. D. C. Shah and Sree Narayana Chandrika Trust v. CGT, which had established that a reallocation of profit-sharing ratios does not constitute a gift if there is adequate consideration.

Supreme Court Precedents:
The court highlighted the Supreme Court's decision in CGT v. D. C. Shah, which held that a reduction in a partner's profit share does not imply a gift unless there is evidence of a transfer without consideration. Similarly, in Sree Narayana Chandrika Trust v. CGT, the Supreme Court ruled that a reallocation of profit shares with adequate consideration does not amount to a taxable gift. The High Court found that the Tribunal had not properly considered these precedents and the factual circumstances, such as the additional contributions and undertakings by the new partners.

Conclusion:
The High Court concluded that the reduction in shares at the time of the firm's reconstitution was for adequate consideration and did not constitute a "gift" under section 4(1)(a) of the Gift-tax Act. The court remitted the matter to the Tribunal for further steps in accordance with this finding, effectively ruling in favor of the assessees and against the Revenue. The court emphasized the importance of considering both the legal precedents and the factual context in determining the existence of adequate consideration for the transfer of shares.

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