2019 (5) TMI 354 - HC - Income Tax

Capital gain u/s 45(4) in partnership firm on retirement of a partner - dissolution/reconstitution of partnership firm - valuation of the assets and liabilities of the firm and allottment of assets among the retiring and continuing partners took place - as per assessee properties obtained by the retiring partners through a family arrangement was not transfer for the purpose of capital gain - whether Section 45(4) applies on retirement of a partner from the partnership business? - whether the word otherwise , it would take into its sweep not only cases of dissolution of partnership firm but also cases of reconstitution of a partnership firm on retirement of a partner - HELD THAT - Hon'ble Supreme Court in CIT VERSUS R. LINGMALLU RAGHUKUMAR 1997 (1) TMI 74 - SUPREME COURT had held that on retirement, the settlement to a partner of his share in the assets of the partnership after deduction of liabilities is not assessable to capital gains. In the present case, very significantly, there was only a reconstitution of the partnership firm by retirement of two partners and admission of another partner. The partnership firm continued. It must also be further noted that the assets of the firm originally belonged to the father of the retiring / continuing partners and there was only a division of the assets on retirement in accordance with their entitlement on the shares in the partnership. As pointed out earlier, the National Company was originally a sole proprietorship concern started by N.Munuswamy Mudaliar. It was in the business of construction and assets had been acquired even at that particular point of time. The two daughters and two sons-in-laws of N.Munuswamy Mudaliar were subsequently admitted as partners and on division of the assets, it can also be arguably pointed out that one daughter and one son-in-law were allotted a share which they were otherwise legally entitled to out of the holdings N.Munuswamy Mudaliar. In view of the peculiar facts of the case in hand, we hold that the provisions of Section 45(4) would not be attracted on the retirement of the two partners and consequential allotment of their share in the assets in the Assessee Firm. We therefore answer the substantial question of law in favour of the Assessee and against the Revenue.

Summary

Issues Involved:
1. Applicability of Section 45(4) of the Income Tax Act, 1961 to the retirement of a partner from a partnership business.
2. Interpretation and application of the rule of ejusdem generis to Section 45(4) of the Income Tax Act, 1961.
3. Scope of the term 'otherwise' in Section 45(4) of the Income Tax Act, 1961.
4. Requirement of 'transfer' within the meaning of Section 2(47) for capital gains under Section 45(4).

Detailed Analysis:

1. Applicability of Section 45(4) of the Income Tax Act, 1961 to the retirement of a partner from a partnership business:
The core issue revolves around whether Section 45(4) applies when a partner retires from a partnership firm. The Tribunal had held that Section 45(4) applied to the Assessee, considering the retirement as a "transfer" of assets. However, the Assessee argued that Section 45(4) should only apply in cases of dissolution and not retirement, as the firm continued its business with new partners. The court examined the nature of partnership and the interests of a retiring partner, concluding that the retirement does not constitute a "transfer" of assets as the retiring partner receives his share in the partnership, not as consideration for transfer.

2. Interpretation and application of the rule of ejusdem generis to Section 45(4) of the Income Tax Act, 1961:
The Tribunal applied the rule of ejusdem generis to interpret Section 45(4), suggesting that the term "otherwise" should be read in conjunction with "dissolution," implying that retirement falls under this provision. However, the court disagreed, emphasizing that the term "otherwise" should not be read ejusdem generis with "dissolution." Instead, it should be interpreted to include any form of distribution of capital assets, not limited to dissolution.

3. Scope of the term 'otherwise' in Section 45(4) of the Income Tax Act, 1961:
The term "otherwise" in Section 45(4) was debated whether it includes reconstitution of a firm due to retirement. The Tribunal's view, based on the A.N. Naik Associates case, was that "otherwise" includes reconstitution scenarios. The court, however, referred to the Prashant S. Joshi case, which held that retirement does not attract Section 45(4) unless it involves a transfer of interest in partnership assets. The court concluded that "otherwise" should not extend to retirement cases where the firm continues its business.

4. Requirement of 'transfer' within the meaning of Section 2(47) for capital gains under Section 45(4):
For Section 45(4) to apply, there must be a "transfer" as defined under Section 2(47). The court examined whether the allotment of assets to retiring partners constitutes a "transfer." It referred to precedents like CIT Vs. Mohanbhai Pamabhai and CIT Vs. R.Lingmallu Raghukumar, which held that the settlement of a retiring partner's share does not amount to a transfer. The court emphasized that the retiring partner receives his share in the partnership, not as consideration for relinquishing his interest, thus not fulfilling the definition of "transfer."

Conclusion:
The court concluded that Section 45(4) does not apply to the retirement of partners from a partnership firm when the firm continues its business. The term "otherwise" in Section 45(4) does not extend to such reconstitution scenarios. The settlement of a retiring partner's share is not considered a "transfer" under Section 2(47), and thus, capital gains under Section 45(4) are not attracted. The court allowed the Assessee's appeals, setting aside the Tribunal's order and restoring the CIT (Appeals) order.