2022 (2) TMI 186 - HC - Income Tax

Reopening of assessment u/s 147 - Short Term Capital Gain - applicability of Section 45(3) - capital gain arose from transfer of land to the partnership firm by way of capital contribution as the assets was converted to Fixed Capital Asset by the partnership firm on March 31, 2008 - Whether Tribunal, erred in law in upholding the order of the CIT (Appeals) in deleting the Short Term Capital Gainignoring the sham arrangement between the ground concerned wherein the nomenclature of the impugned asset was intentionally shown as stock-in-trade and undervalued to escape the provision of Section 45(3) whereas it is evident from the audited accounts of the year that the asset taken over by the firm was nothing but a capital asset? - As contended that Section 45(3) not come into operation for the assessment year 2008-09 and by reason of conversion of the developed land and building into fixed asset by the firm or due to revaluation by the firm of the asset so converted during the previous year ended March 31, 2008. HELD THAT - After elaborately considering the facts the tribunal held that, if at all any income accrues or arises owing to such revaluation, it is an issue which had to be dealt with in the assessment of the firm M/S. Salapuria Soft Zone which is the separate taxable entity. After noting the facts the tribunal held that in terms of the Section 10 (2A) of the Act partners share in the total income of the firm is not to be included in the total income of the partner. Therefore, it was held that the there was no reason for initiating proceedings under section 147 of the Act. Section 45(3) applicability in the year of transfer by the partner of his capital asset to the partnership firm by way of capital contribution - In the instant case, the year of transfer was the financial year ended March 31, 2006. The ITO was wholly unjustified in invoking Section 45(3) which had no application in the assessment year 2008-09 or for that matter in the assessment year 2006-07. Even otherwise, Section 45(3) seeks to determine the capital gains with reference to the value of the asset recorded in the books of account of the firm. The value so recorded is statutorily deemed to be the full value of consideration received or accruing to the partner as a result of the transfer of the capital asset to the firm. Thus, Section 45(3) does not seek to substitute by any other figure the value agreed between the partners at which the asset is transferred by a partner to the firm. With regard to the revaluation, tribunal re-appreciated the facts which were considered by the CIT-A. With regard to the development of the area in question, as to how there was steep rise in the value of the properties and the state government revised the guideline value for the purpose of stamp duty several times between 2004-07 and after noting the price rise the tribunal held notwithstanding the said fact in accordance with the accounting principles the land held as inventory was shown at its cost and therefore it cannot be said that under valuation was done by the assessee as alleged by the Assessing Officer. Tribunal agreed with CIT(A) that after conversion of inventory into fixed asset the firm revalued the developed land including construction thereon in order to bring it in line with the current market value to justify the business assistance secured by the firm from the banks to extent of nearly ₹ 250 crores. Therefore, on facts the tribunal concluded that the revaluation was not a colourable device. There was no withdrawal by the partners from capital accounts and therefore there cannot be any income liable to tax in their hands. No substantial questions of law arises for consideration in this appeal. In the result, the appeals are dismissed

Issues Involved:
1. Validity of the reassessment proceedings under Section 147 of the Income Tax Act, 1961.
2. Applicability of Section 45(3) of the Income Tax Act, 1961 to the transfer of land to the partnership firm.
3. Alleged sham arrangement and undervaluation of assets.
4. Taxability of revaluation profit.

Detailed Analysis:

1. Validity of the Reassessment Proceedings Under Section 147:
The tribunal examined whether the initiation of reassessment proceedings under Section 147 was justified. The tribunal noted that the partnership firm, M/S. Salapuria Soft Zone, had revalued its assets and credited the revalued reserve to the partners' accounts. The Assessing Officer (AO) believed that this revaluation led to income escaping assessment. However, the tribunal held that any income arising from such revaluation should be assessed in the hands of the partnership firm, not the individual partners. It was further noted that partners' share in the total income of the firm is exempt under Section 10(2A) of the Act. Therefore, the tribunal concluded that the AO had no valid reason to initiate proceedings under Section 147 for the partners.

2. Applicability of Section 45(3) to the Transfer of Land:
The tribunal scrutinized whether Section 45(3) applied to the transfer of land to the partnership firm. The tribunal recorded that the land was transferred by the partners to the firm as part of their capital contribution during the financial year ending March 31, 2006. The land was shown as "work in progress" under "Current Assets" in the balance sheets of the companies and the firm. The tribunal held that Section 45(3) applies only to the transfer of a capital asset, whereas the land was transferred as a current asset. Thus, Section 45(3) was not applicable for the assessment year 2008-09, as the transfer occurred in the financial year 2005-06.

3. Alleged Sham Arrangement and Undervaluation of Assets:
The revenue contended that the arrangement was a sham to undervalue the assets and avoid tax under Section 45(3). The tribunal, however, found no basis for this allegation. It was noted that the land was purchased at a price significantly higher than the government guideline value for stamp duty purposes. The tribunal observed that the land was held as inventory and shown at cost in accordance with accounting principles. The revaluation was done to reflect the market value and justify the bank loan of ?250 crores obtained by the firm. The tribunal concluded that the revaluation was not a colorable device.

4. Taxability of Revaluation Profit:
The AO had added the revaluation profit to the income of the partners, arguing that it was real profit and not notional. The tribunal disagreed, noting that the revaluation of an asset does not result in a pecuniary gain that can be taxed. The tribunal emphasized that the revaluation was done to align the asset's book value with its market value and support the bank loan. Furthermore, there was no withdrawal by the partners from their capital accounts, which would have triggered tax liability. The tribunal upheld the CIT(A)'s decision to delete the addition of revaluation profit.

Conclusion:
The tribunal and CIT(A) thoroughly examined the factual and legal aspects of the case. The reassessment proceedings under Section 147 were deemed invalid, and Section 45(3) was found inapplicable. The alleged sham arrangement and undervaluation claims were dismissed, and the revaluation profit was not considered taxable. The appeals were dismissed as no substantial questions of law arose for consideration.

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