2019 (1) TMI 1551 - AT - Income Tax

Taxability of capital gain in firm - revaluation of asset being land held by the partnership firm - reference to third member - money equivalent to enhanced portion of the assets revalued paid to retiring partners constitute capital asset within the meaning of section 2(14) - Transfer of capital asset by way of distribution of capital asset either on dissolution or otherwise within the meaning of section 45(4) r.w.s 2(14) - HELD THAT - There was only a reconstitution of partnership firm on their retirement without there being any dissolution and the land properly acquired by the partnership firm continued to be owned by the said firm even after reconstitution without any extinguishment of rights in favour of the retiring partners. The retiring partners did not acquire any right in the said property and what they got on retirement was only the money equivalent to their share of revaluation surplus (enhanced portion of the asset revalued which was credited to their capital accounts. There was thus no transfer of capital asset by way of distribution of capital asset either on dissolution or otherwise within the meaning of section 45(4) read with section 2(14) of the Act. I also hold that the money equivalent to enhanced portion of the assets re-valued does not constitute capital asset within the meaning of section 2(14) and the payment of the said money by the assessee-firm to the retiring partners cannot give rise to capital gain under section 45(4) read with section 2(14) . I accordingly agree with the view taken by the Id. judicial Member and answer both the question referred under section 254(4) in the negative and in favour of the assessee.

Issues Involved:
1. Whether the revaluation of land held by a partnership firm and the payment to retiring partners based on this revaluation gives rise to capital gains under section 45(4) read with section 2(14) of the Income Tax Act.
2. Whether there is a transfer of capital assets on the dissolution of the firm or otherwise when the partnership firm pays money equivalent to the enhanced value of the revalued asset to the retiring partner.

Detailed Analysis:

Issue 1: Capital Gains on Revaluation and Retirement
The primary issue revolves around whether the revaluation of a partnership firm's land and the subsequent payment to retiring partners based on this revaluation constitutes capital gains under section 45(4) read with section 2(14) of the Income Tax Act. The partnership firm revalued its property and credited the revaluation surplus to the capital accounts of all partners. Upon retirement, the retiring partners received amounts including their share of the revaluation surplus. The Assessing Officer (AO) treated this as a transfer of capital assets, invoking section 45(4) to levy capital gains tax.

The CIT(A) and Judicial Member held that there was no dissolution of the firm, only reconstitution, and no distribution of capital assets. They concluded that the surplus credited to the capital accounts was not a transfer of assets, thus section 45(4) was not applicable. The Judicial Member relied on the Full Bench decision of the Karnataka High Court in CIT vs. Dynamic Enterprises, which held that if retiring partners receive cash and there is no distribution of capital assets, section 45(4) does not apply.

The Accountant Member, however, argued that the revaluation surplus credited to the retiring partners' capital accounts constituted a transfer of capital assets under section 45(4). He relied on the Bombay High Court decision in A.N. Naik Associates, which interpreted "otherwise" in section 45(4) to include reconstitution scenarios where assets are transferred to retiring partners.

Issue 2: Transfer of Capital Assets on Dissolution or Otherwise
The second issue is whether the payment of money equivalent to the enhanced value of the revalued asset to the retiring partner constitutes a transfer of capital assets under section 45(4) read with section 2(14). The AO contended that the payment to retiring partners was a distribution of capital assets, thus taxable as capital gains. The CIT(A) and Judicial Member disagreed, stating that there was no actual transfer of assets, as the partnership continued to own the property, and only cash was paid to the retiring partners.

The Judicial Member emphasized that the term "otherwise" in section 45(4) should not be read to include reconstitution without asset transfer. He cited the Karnataka High Court's decision in Dynamic Enterprises, which held that without a transfer of capital assets, section 45(4) does not apply. The Accountant Member, however, interpreted "otherwise" broadly to include reconstitution events where money equivalent to asset value is distributed.

Conclusion:
The Third Member agreed with the Judicial Member, concluding that:
1. The partnership firm continued to exist after the retirement of the partners, and the property remained with the firm.
2. There was no transfer of capital assets as defined under section 45(4) read with section 2(14), as the retiring partners received only money equivalent to their share of the revaluation surplus.
3. The revaluation surplus credited to the retiring partners' capital accounts did not constitute a transfer of capital assets, and thus no capital gains arose under section 45(4).

Final Decision:
The Third Member's agreement with the Judicial Member resulted in the conclusion that the payment to the retiring partners did not give rise to capital gains under section 45(4) read with section 2(14) of the Income Tax Act. The matter was resolved in favor of the assessee.

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