1986 (1) TMI 385 - AT - Income Tax

Summary

Issues Involved:

1. Whether capital gains arose to the assessees on their contribution of shares to a newly formed partnership firm.
2. Whether the transfer of shares to the partnership firm constitutes a transfer of capital assets.
3. Whether the transaction was bona fide or a device to avoid tax liability.
4. Whether the firm was genuine and had substantial business operations.

Detailed Analysis:

1. Capital Gains on Contribution of Shares:

The primary issue was whether capital gains arose to the assessees when they contributed shares to the partnership firm, J.K. & Sons, which was constituted on 1-10-1974. The Income Tax Officer (ITO) determined that the difference between the market value of the shares (Rs. 5,40,000) and their cost of acquisition (Rs. 28,000) attracted capital gains tax. The Tribunal had to decide if this difference constituted taxable capital gains.

2. Transfer of Shares as Capital Assets:

The Tribunal referred to the Supreme Court's decision in Sunil Siddharthbhai/Kartikeya V. Sarabhai v. CIT, which established that when a partner brings personal assets into a partnership firm as capital contribution, it constitutes a transfer of capital assets under section 45 of the Income-tax Act, 1961. However, the Supreme Court also held that while there is consideration for such transfer, it is impossible to evaluate it at the time of transfer due to various uncertain factors. Thus, no capital gains charge is attracted because the scheme of computation of capital gains cannot be applied.

3. Bona Fides of the Transaction:

The Tribunal examined whether the transfer of shares was a bona fide transaction or a device to avoid tax liability. The firm had been registered and assessed on sizeable profits from share dealings for over ten years. The Tribunal found no evidence that the transaction was a ruse to avoid tax, as the shares were not sold immediately after their transfer to the firm. The sales of shares were minimal and dictated by the necessity to raise funds for the firm's business, indicating that the transaction was genuine.

4. Genuineness and Business Operations of the Firm:

The Tribunal assessed whether the partnership firm was genuine and had substantial business operations. The firm dealt in shares selectively and had been assessed on profits arising from these dealings. The firm's need for capital contribution was justified as it enabled the firm to carry on its business. The Tribunal noted that the firm was initially refused registration by the ITO on technical grounds, but the appellate authority eventually granted registration, reinforcing the firm's genuineness.

Conclusion:

The Tribunal concluded that the capital gains charge sustained by the departmental authorities could not stand. The facts showed that the partnership firm was genuine, had substantial business operations, and the contribution of shares as capital was not a device to avoid tax. The appeals were allowed, setting aside the charge of capital gains in the hands of each of the partners.