2016 (5) TMI 326 - AT - Income Tax

Taxability of amount withdrawn by the partner from the firm - Applicability of section 2(47) - receipt on relinquishment of Right as Long Term Capital Gains - Held that - On the reconstitution of firm, the profit share of assessee got reduced to 0.25%. The assessee (along with other two partners i.e. Smt. K Amin and Shri D Amin), on reconstitution, chose to withdraw the amount lying to his credit. The assessee continued as partner and had not retired from firm. As per MOU between parties a goodwill account was to be created. However, after partnership deed no goodwill was credited or paid was not done. As per the partnership deed the rights and duties of partners have been decided interse. The AO treated the revaluation of asset and introduction of new partners as estinguishment of assessee s shares in the asst of the firm by treating the same as transfer within the meaning of Section 2(47) and tax the difference as capital gain in the hands of each of the partners. We found that even after introduction of the new partners and revaluation of the asset the partnership firm was continued and the assessee was continued as partner in the same firm and land remained the assets of the firm. Merely because the partners have withdrawn money from the firm does not constitute consideration for proportionate reduction in their share in firm. There was neither a transfer of assets of the firm to the partner nor the assets ceased to be owned by the firm. CIT(A) has dealt with the issue threadbare and after applying to provision of law laid down by various High Courts recorded a finding that there was no transfer of assets on extinguishment of right of the assessee partner merely on introduction of new partner in the firm. Accordingly amount withdrawn by the assessee partner was not liable to tax as capital gain. We do not find any infirmity in the order of CIT(A) for deleting the addition so made - Decided in favour of assessee

Summary

Issues Involved:

1. Applicability of Section 2(47) of the Income Tax Act.
2. Treatment of revaluation of assets and withdrawal of capital by partners as Long Term Capital Gains.
3. Whether the reconstitution of a partnership firm and introduction of new partners constitute a transfer under Section 2(47).

Issue-wise Detailed Analysis:

1. Applicability of Section 2(47) of the Income Tax Act:

The primary issue revolves around whether the revaluation of the firm's assets and the subsequent withdrawal of capital by the partners can be considered a "transfer" under Section 2(47) of the Income Tax Act, thereby attracting capital gains tax. The Assessing Officer (AO) argued that the revaluation of the land and the withdrawal of the revalued amount by the partners constituted an extinguishment of the partners' rights in the land, thus qualifying as a transfer under Section 2(47). However, the CIT(A) and the Tribunal disagreed, holding that the revaluation and withdrawal did not amount to a transfer since the partners continued to hold their interest in the firm, and the firm retained ownership of the land.

2. Treatment of Revaluation of Assets and Withdrawal of Capital by Partners as Long Term Capital Gains:

The AO treated the revaluation of assets and the withdrawal of the revalued amount by the partners as long-term capital gains. The CIT(A) and the Tribunal examined the facts and concluded that the revaluation of assets and the withdrawal of the revalued amount did not constitute income. The Tribunal cited several legal precedents, including the Supreme Court's decision in Commissioner of Income Tax v. R. Lingmallu Raghukumar, which held that the amount received by a partner upon retirement or reconstitution of the firm did not represent consideration for the extinguishment of interest in partnership assets and, therefore, was not taxable as capital gains.

3. Whether the Reconstitution of a Partnership Firm and Introduction of New Partners Constitute a Transfer under Section 2(47):

The AO argued that the reconstitution of the firm and the introduction of new partners constituted a transfer of rights in the firm's assets. However, the CIT(A) and the Tribunal found that the reconstitution of the firm and the admission of new partners did not amount to a transfer under Section 2(47). The Tribunal referred to the decision in ITO v. Smt. Paru D. Dave, which held that the revaluation of partnership assets and the credit of the revalued amount to the partners' capital accounts did not entail any transfer as defined under Section 2(47). The Tribunal also noted that the firm and its partners are treated as separate entities under the Income Tax Act, and the firm's assets remained with the firm even after the reconstitution.

Conclusion:

The Tribunal upheld the CIT(A)'s decision, concluding that the revaluation of assets and the withdrawal of the revalued amount by the partners did not constitute a transfer under Section 2(47) and, therefore, were not taxable as capital gains. The Tribunal dismissed the revenue's appeals, affirming that the reconstitution of the firm and the introduction of new partners did not result in a transfer of rights in the firm's assets. The Tribunal's decision was based on a thorough analysis of the facts, the provisions of the Income Tax Act, and relevant judicial precedents.