2019 (4) TMI 220 - HC - Income Tax

Capital gain u/s 45(4) - scope of word dissolution of the firm or otherwise - reconstitution of the firm - share payment to retiring partners - whether transfer of capital asset by way of distribution is involved in payment to the retiring partners - HELD THAT - The KARNATAKA HIGH in CIT Vs. M/S DYNAMIC ENTERPRISES 2013 (11) TMI 731 - KARNATAKA HIGH COURT has held that after retirement of partners, the partnership continued and the business was also carried on by the remaining partners. There was thus no dissolution of the firm and there was no distribution of capital asset. What is given to the retiring partners was money representing the value of their share in the partnership. No capital asset was transferred on the date of retirement. In absence of distribution of capital asset and in absence of transfer of capital asset in favour of retiring partners, no profit of gain arose in the hands of partnership firm. In the present case, admittedly there was no transfer of capital asset upon reconstitution of the firm. All that happened was the firm s assets were evaluated and the retiring partners were paid their share of the partnership asset. There was clearly no transfer of capital asset. Revenue has not argued that the reconstitution of the firm was a colourable device to avail tax liability. - Decided against revenue

Summary

Issues:
1. Interpretation of Section 45(4) of the Income Tax Act, 1961 regarding the transfer of capital asset by a partnership firm.
2. Application of Section 45(4) in a case involving retirement of partners and redistribution of partnership assets.

Analysis:
1. The High Court considered the appeal filed by the Revenue challenging the ITAT's judgment on the interpretation of Section 45(4) of the Income Tax Act, 1961. The main issue was whether there was a transfer of capital asset by way of distribution at the time of making payment to the retiring partners. The firm reconstituted itself by admitting three new partners and retiring the original two partners, redistributing their shares. The Assessing Officer argued that the goodwill credited by the firm was a capital gain on the distribution of the capital asset. However, the Tribunal, relying on the Karnataka High Court judgment in Dynamic Enterprises, held that Section 45(4) did not apply as the conditions were not met.

2. The Court analyzed the provisions of Section 45(4) which state that profits or gains arising from the transfer of a capital asset on dissolution of a firm or otherwise shall be chargeable to tax. The Court referred to the A. N. Naik Associates case, where it was held that reorganization of a partnership would not amount to dissolution, and transfer of assets to a partner falls within the term "otherwise." The Karnataka High Court in Dynamic Enterprises further clarified that if there is no distribution or transfer of capital asset upon retirement of partners, no profit or gain arises in the hands of the firm. The retiring partners in this case received cash representing the value of their share, not a capital asset.

3. The Court distinguished the case at hand from A. N. Naik Associates, emphasizing that there was no transfer of capital asset upon reconstitution of the firm. The assets were evaluated, and retiring partners were paid their share without any transfer of capital asset. The Court found no error in the Tribunal's view and dismissed the Income Tax Appeal, concluding that there was no transfer of capital asset in this case, and Section 45(4) did not apply due to the absence of such a transfer.