2003 (4) TMI 94 - SC - Income Tax

Whether even though the reconstitution of the firm resulted in the reduction of the share of profit of the assessee-trust, there was no gift exigible to tax in its hands ? Whether even though there was a transfer by the assessee in favour of the incoming partner and existing partners, the consideration for the transfer could not be evaluated during the subsistence of the partnership and so the question of adequacy or inadequacy of consideration could not be quantified and so there was no gift exigible to tax ? Held that - The facts found in the present case are that the incoming partner (M. U. Indira) had contributed Rs. 25,000 towards her share of the capital. The value of her services or usefulness to the firm as partner has not been disputed by the Revenue authorities. As pointed out by this court in D. C. Sitah s case 1996 (9) TMI 120 - SUPREME Court , the mere fact that upon reconstitution of the firm the share of one partner decreased and that of another increased cannot lead to the inference that the former had gifted the difference to the incoming partner. There is no other material placed on record by the Revenue to show that, in the facts and circumstances of the case, particularly taking into consideration the obligations of all the partners in the partnership deed dated October 1, 1982, there was inadequate consideration for the reallocation of 12 per cent. of the share in favour of the incoming partner. In our view, the contribution of Rs. 25,000 towards the capital together with the obligations undertaken of sincerely and faithfully carrying on the business for the common advantage of the firm was adequate, consideration for reallocating the share of the profits and giving 12 per cent. of the share in favour of the incoming partner, M. U. Indira. That C. K. jinan was the managing partner and C. N. Purushuthaman was the administrative head, did not take away the obligations of the other partners including those of M. U. Indira which arose generally under the Partnership Act, as well as under the partnership deed dated October 1, 1982. We are of the view that even assuming that there was a transfer of 12 per cent. of the share of profit/loss in favour of the incoming partner, M. U. Indira by the appellant-assessee, it was not a situation of transfer for inadequate consideration so as to amount to a taxable gift within the meaning of section 4(1)(a) of the Gift-tax Act, 1958. In the result, we answer question No. 1 against the Revenue and in favour of the assessee. In view of our answer thereto, it is not necessary to answer the second question.

Summary

Issues Involved:
1. Whether the reduction of the appellant's share of profit/loss in the partnership firm amounted to a taxable gift under the Gift-tax Act.
2. Whether the consideration for the transfer of the share could be evaluated during the subsistence of the partnership, impacting the question of adequacy or inadequacy of consideration.

Detailed Analysis:

Issue 1: Taxable Gift Due to Reduction of Share

The appellant, a charitable institution and partner in "Chandrika Enterprises," saw its share of profit/loss reduced from 45% to 30% following the induction of a new partner, Smt. M. U. Indira, who contributed Rs. 25,000 to the firm's capital. The Gift-tax Officer considered this reduction as a gift and issued a notice under section 16 of the Gift-tax Act, assessing the relinquished share as a taxable gift. The appellant's appeal to the Commissioner of Gift-tax (Appeals) was dismissed, and the matter was taken to the Income-tax Appellate Tribunal.

The Tribunal, referencing the Supreme Court judgment in Sunil Siddharth bhai v. CIT [1985] 156 ITR 509, held that the evaluation of a partner's interest could not be isolated during the partnership's subsistence, making it impossible to quantify the adequacy of consideration. Consequently, it ruled that there was no taxable gift.

The High Court, however, answered the referred questions in the negative, against the appellant, prompting an appeal to the Supreme Court.

The Supreme Court, analyzing the facts, concluded that even if there was a transfer of the share, it was not for inadequate consideration. The incoming partner's capital contribution and obligation to participate in the business constituted adequate consideration. The Court also referenced the Karnataka High Court's judgment in D. C. Shah v. CGT [1982] 134 ITR 492, which held that reallocation of shares upon reconstitution of a firm does not result in a taxable gift if adequate consideration is provided.

Issue 2: Evaluation of Consideration During Partnership

The Supreme Court addressed whether the consideration for the transfer could be evaluated during the partnership's subsistence. The Court noted that during the partnership's existence, the value of each partner's interest could not be isolated from the total partnership assets. The Court reiterated the principle from Sunil Siddharth bhai's case that the evaluation of a partner's interest happens only upon dissolution or retirement from the firm.

The Revenue's reliance on CGT v. Chhotalal Mohanlal [1987] 166 ITR 124 and B. T. Patil and Sons v. CGT [2001] 247 ITR 588 was distinguished. In Chhotalal Mohanlal, the transfer was without consideration, making it a taxable gift. In B. T. Patil, the transfer of partnership assets to individual partners for less than their value was deemed a taxable gift. However, in the present case, the Court found that the incoming partner's capital contribution and obligations provided adequate consideration.

Conclusion:

The Supreme Court answered the first question in favor of the appellant, concluding that the reduction in the appellant's share did not amount to a taxable gift due to adequate consideration. Consequently, the second question was not addressed. The appeal was allowed, and the High Court's judgment was set aside, with no order as to costs.