2016 (5) TMI 422 - HC - Income Tax

Capital gain - transfer of assets from the firm to the company - whether there is a transfer as contemplated under sections 2(47) and 45(4) of the Income-tax Act, 1961? - Held that - The Finance Act, 2001, has amended clause (xiii) of section 47 of the Income-tax Act to provide that any transfer of a capital asset, from an association or persons or body of individuals to a company, under a scheme of corporatisation of a recognized stock exchange, shall not be regarded as transfer for the purpose of capital gains tax. The proviso to clause (xiii) has also been amended to provide that this one time exemption from capital gains tax is available only if all the assets and liabilities of stock exchange immediately before the succession, become the assets and liabilities of corporatised stock exchange, and the scheme of corporatisation is approved by the Securities and Exchange Board of India. This case is concerned, there is no transfer of asset as (a) no consideration was received or accrued on transfer of assets from the firm to the company ; (b) the firm has only revalued its assets which will not amount to transfer ; (c) the provision of section 45(4) of the Act is applicable only when the firm is dissolved. In the instant case, there is no distribution of asset, but only taking over of the assets from the firm to the company. Therefore, it is clear that the vesting of the property in the private limited company is not consequent or incidental to a transfer. There is no transfer of capital assets as contemplated by section 45 (1) of the Income- tax Act. - Decided in favour of assessee.

Issues Involved:

1. Whether the transformation of a partnership firm into a private limited company constitutes a "transfer" under sections 2(47) and 45(4) of the Income-tax Act, 1961.
2. Whether such transformation attracts capital gains tax.
3. Whether the expression "otherwise" in section 45(4) should be read ejusdem generis with "dissolution of a firm or body or association of persons."
4. Whether the omission of clause (2) of section 47 by the Finance Act, 1987, implies that any transaction resulting in the distribution on dissolution of a firm amounts to a "transfer."
5. Validity of reopening the assessment based on expert opinion.

Issue-wise Detailed Analysis:

1. Transformation of Partnership Firm into Private Limited Company:

The court examined whether the transformation of a partnership firm into a private limited company constitutes a "transfer" under sections 2(47) and 45(4) of the Income-tax Act, 1961. The appellant firm, engaged in software trading, was converted into a private limited company with the same partners becoming shareholders. The Assessing Officer deemed this transformation as a distribution of assets attracting capital gains tax under section 45(4). However, the court noted that under Part IX of the Companies Act, the properties of the firm vest in the company without any actual transfer. The court referred to precedents like CIT v. Texspin Engg. and Mfg. Works and Malabar Fisheries Co. v. CIT, which clarified that such statutory vesting does not amount to a "transfer" as there is no distribution of assets.

2. Capital Gains Tax Applicability:

The court analyzed whether the transformation attracts capital gains tax. The appellant argued that there was no dissolution or distribution of assets, hence no capital gains tax liability. The court supported this view, citing that the transformation did not involve any consideration or actual transfer of assets, and thus, section 45(4) was not applicable. The court emphasized that the statutory vesting of assets in the company does not constitute a "transfer" under section 2(47).

3. Interpretation of "Otherwise" in Section 45(4):

The court deliberated on whether the term "otherwise" in section 45(4) should be read ejusdem generis with "dissolution of a firm." The respondent argued that "otherwise" includes any mode of transfer, not just dissolution. However, the court found that the term should be interpreted in the context of actual distribution of assets, which did not occur in this case. The court referred to CIT v. A. N. Naik Associates, emphasizing that "otherwise" should be read with "transfer of capital assets by way of distribution," which was not applicable here.

4. Omission of Clause (2) of Section 47:

The court examined whether the omission of clause (2) of section 47 by the Finance Act, 1987, implies that any transaction resulting in the distribution on dissolution of a firm amounts to a "transfer." The court clarified that the omission does not affect the current case as there was no dissolution or actual distribution of assets. The court cited Suvardhan v. CIT, which supported that the omission does not automatically imply a transfer in cases of mere transformation.

5. Validity of Reopening the Assessment:

The court addressed the validity of reopening the assessment based on expert opinion. The appellant contended that the reopening was unjustified as all necessary information was provided initially. The court referred to National Thermal Power Co. Ltd. v. CIT, establishing that the Tribunal has jurisdiction to examine legal questions arising from the facts. However, the appellant chose not to press this issue further, rendering the discussion on reopening unnecessary.

Conclusion:

The court concluded that the transformation of the partnership firm into a private limited company did not constitute a "transfer" under sections 2(47) and 45(4) of the Income-tax Act. Consequently, the appellant was not liable to pay capital gains tax. The appeal was allowed, and the orders of the Income-tax Appellate Tribunal were set aside.

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