2018 (12) TMI 217 - HC - Income Tax

Liability to capital gains tax - dissolution of the firm as on 31st March 2002 - Held that - On perusal of the audited balance sheet of the partnership firm as on 31.03.2002, and the balance sheet of the de-merged as well as the existing business as on 1st April 2002, concluded that the audited accounts of the assessee firm as on March 31, 2002 shall be the basis for de-merging the business in to an independent unit and it is clear that the de-merger of business has not taken place on 31.03.2002. CIT(A) held that there is a mention of three balance sheets, i.e., the assessee s as on 31.03.2002 and the assessee s de-merged business as on 01.04.2002 and that the later two balance sheets came into existence only on 01.04.2002 and not on 31.03.2002. After appreciating the documents placed before it, the CIT(A) held that the assessee firm was never dissolved much less on 31.03.2002 and on the other hand, got itself re-constituted with three of the continuing partners and therefore, the case is squarely covered by Section 187(2) of the Act. Further, the assets and liabilities relating to the civil construction business remained with the assessee firm and were not distributed among anybody. Even the assets and liabilities relating to the software education business and real estate project were not distributed among any partners but, were transferred to a new firm and transfer of a business should be construed as distribution of assets and liabilities among the partners. We are of the clear view that the decision in the case of A.L.A. Firm 1991 (2) TMI 1 - SUPREME COURT which was heavily relied upon by the learned counsel for the Revenue, can have no application to the case on hand - the partnership firm deed dated 03.08.2005, is a good piece of evidence to show that the assessee firm continued to be in existence after re-constitution, that is, even after 31.03.2002 without getting dissolved. Tribunal erred in reversing the order passed by the CIT(A) and therefore, the order passed by the Tribunal calls for interference. - Decided in favour of the assessee

Summary

Issues Involved:
1. Whether the Tribunal was correct in law in holding that there was a dissolution of the firm as on 31st March 2002.
2. Whether there was a liability to capital gains tax for the Assessment Year 2002-03.

Detailed Analysis:

1. Dissolution of the Firm:

The primary issue revolves around whether the assessee firm was dissolved on 31st March 2002. The Assessing Officer (AO) concluded that the firm was dissolved on this date, leading to the creation of two new firms from 1st April 2002. This conclusion was based on the Memorandum of Understanding (MOU) dated 1st August 2002, which indicated a reorganization of the business, with some partners retiring and new ones joining. The AO applied the Supreme Court decision in A.L.A. Firm v. Commissioner of Income-tax, valuing the closing work in progress at market value and adding ?6,43,43,000 to the income returned. The AO also invoked Section 45(4) of the Income-tax Act, computing long-term capital gains at ?26,98,202.

However, the CIT(A) disagreed, stating that the firm was reconstituted, not dissolved, as the business continued with the existing partners. The Tribunal later reversed this, agreeing with the AO that the MOU indicated a dissolution. The High Court found contradictions in the AO's findings, noting that if the firm ceased to exist after 31st March 2002, it could not have been dissolved on that date. The High Court emphasized that the assessee's firm was reconstituted, not dissolved, and continued its business.

2. Liability to Capital Gains Tax:

The High Court examined whether the reconstitution led to a liability for capital gains tax. The AO had revised the assessment, excluding long-term capital gains, which the CIT(A) upheld, agreeing that there was no dissolution. The Tribunal, however, sided with the AO, applying the A.L.A. Firm decision and holding that the firm was dissolved, thus liable for capital gains tax.

The High Court disagreed, stating that the decision in A.L.A. Firm did not apply as there was no dissolution in the assessee's case. The firm was reconstituted with new partners, and the business continued uninterrupted. The High Court referenced the Supreme Court decision in Sakthi Trading Co., which held that if there is no cessation of business, the closing stock should not be valued at market value. The CIT(A) had correctly noted that the reconstitution did not lead to a distribution of assets among partners, further supporting the view that there was no dissolution.

Conclusion:

The High Court concluded that the Tribunal erred in reversing the CIT(A)'s decision. The assessee firm was not dissolved on 31st March 2002; it was reconstituted and continued its business. Consequently, there was no liability for capital gains tax for the assessment year 2002-03. The High Court restored the CIT(A)'s order, answering the substantial question of law in favor of the assessee. The appeal was allowed, and no costs were imposed.