2018 (10) TMI 1708 - AT - Income Tax

Capital gain u/s 45 - conversion of partnership firm into a private limited company - credit of difference between the revaluation value and book value of the asset as loan in the capital account of the partners - HELD THAT - When the assets and liabilities and business of the partnership firm as a going concern were taken over by a private limited company incorporated and the partners of the erstwhile partnership firm were allotted shares in the same proportion of the capital as it stood in the books of the firm on the date of succession there was no transfer at all. Hence there is no question of levy of tax on capital gain would arise for consideration at all. The main contention of the Revenue is that on revaluation of the asset of the erstwhile partnership firm the difference between revaluation and book value was credited in the capital account of the respective partners in the same proportion of their capital as loan therefore there was indirect benefit to the shareholders and erstwhile partners. The question arises for consideration is whether there was any transfer on revaluation? Revaluation of existing asset of the partnership firm by itself does not amount to any transfer as held by the Madras High Court in CADD Centre 2016 (5) TMI 422 - MADRAS HIGH COURT after considering the provisions of Section 47(xiii) of the Act held that Section 47(xiii) applies only to a case of transfer by sale. Moreover Section 45(4) would apply only when there is distribution of asset to the partners. In view of this judgment of Madras High Court there is no violations of the conditions stipulated in Section 47(xiii) of the Act. If we accept that the difference between the revaluation and book value credited in the capital account of the erstwhile partners in the same proportion as their capital as a loan amounts to indirect benefit to the erstwhile partners under the scheme of Income-tax Act capital gain tax cannot be levied on the assessee-company. Under the scheme of Income-tax Act only transferor is liable to pay tax on capital gain. In the case before us the assessee-company succeeded to assets and liabilities of the partnership firm. Therefore the assessee-company may at the best be considered as transferee and certainly not transferor. Therefore considering the facts of the case in all respects this Tribunal is of the considered opinion that capital gain tax cannot be levied in the hands of the assessee-company which succeeded to the assets and liabilities of the partnership firm. Hence we are unable to uphold the orders of the lower authorities. It may not be necessary for this Tribunal to go into the contention of the assessee regarding validity of assessment order passed under Section 143(3) read with Section 147 of the Act when there was search operation and proceedings were initiated under Section 153C of the Act. We are unable to uphold the orders of the lower authorities. Accordingly orders of both the authorities below are set aside and the addition made by the Assessing Officer as capital gain is deleted. - Decided in favour of assessee.

Summary

Issues Involved:
1. Validity of the assessment order under Section 143(3) read with Section 147 of the Income-tax Act, 1961.
2. Applicability of capital gains tax on the revaluation of assets during the conversion of a partnership firm into a private limited company under Section 47(xiii) and Section 45(4) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Validity of the Assessment Order:
The assessee contended that the assessment order under Section 143(3) read with Section 147 of the Income-tax Act, 1961, was invalid. The argument was based on the fact that a search operation under Section 132 of the Act was conducted on 26.09.2012, and documents related to the registration of the assessee-company were found. Consequently, a notice under Section 153C was issued on 26.09.2014. However, the proceedings initiated under Section 153C were dropped by the Assessing Officer without framing an assessment under that section. The assessee argued that once proceedings under Section 153C were initiated, the Assessing Officer could not resort to Sections 147 and 148 for reopening the assessment. The assessee relied on the decision of the Amritsar Bench in ITO v. Arun Kumar Kapoor and the Delhi High Court judgment in CIT v. Anil Kumar Bhatia, which stated that Sections 147 and 148 are ousted when Section 153C is applicable.

2. Applicability of Capital Gains Tax:
The core issue was whether the revaluation of assets and subsequent conversion of a partnership firm into a private limited company resulted in a taxable transfer under the Income-tax Act. The assessee argued that the conversion did not constitute a transfer of capital assets under Section 47(xiii) of the Act, which exempts such transfers from capital gains tax if specific conditions are met. The conditions include the transfer of all assets and liabilities to the company, partners becoming shareholders in the same proportion, and no consideration other than shares being received by the partners.

The Assessing Officer rejected the assessee's claim, stating that the condition under Section 47(xiii)(c) was violated because the revaluation amount was credited as a loan to the partners' capital accounts. The Revenue argued that this credit amounted to an indirect benefit, thus constituting a transfer subject to capital gains tax.

The Tribunal referred to the judgment of the Madras High Court in CADD Centre v. ACIT, which held that the conversion of a partnership firm into a private limited company does not constitute a transfer of assets and hence does not attract capital gains tax. The High Court observed that revaluation of assets and subsequent conversion does not amount to a transfer, and Section 45(4) applies only in cases of dissolution and distribution of assets, not in cases of succession.

Tribunal's Conclusion:
The Tribunal concluded that the conversion of the partnership firm into a private limited company did not result in a transfer of capital assets. The revaluation of assets and crediting the difference as a loan in the partners' capital accounts did not constitute an indirect benefit that would violate Section 47(xiii). Moreover, even if it were considered a transfer, the capital gains tax could not be levied on the assessee-company, which is the transferee, not the transferor. The Tribunal set aside the orders of the lower authorities and deleted the addition made by the Assessing Officer as capital gain.

Final Order:
The appeal filed by the assessee was allowed, and the assessment order under Section 143(3) read with Section 147 was invalidated. The addition of capital gains tax by the Assessing Officer was deleted. The order was pronounced in the court on 29th October 2018 at Chennai.