1986 (10) TMI 52 - AT - Income Tax

Summary

Issues Involved:
1. Taxability under Section 41(2) of the Income Tax Act on the transfer of machinery from a firm to a partner.
2. Definition and interpretation of "sale" and "transfer" under the Income Tax Act.
3. Applicability of judicial precedents and legal principles to the transaction in question.

Detailed Analysis:

1. Taxability under Section 41(2) of the Income Tax Act on the transfer of machinery from a firm to a partner:
The primary issue in this case is whether the authorities were justified in taxing a sum of Rs. 1,03,708 as profit under Section 41(2) of the Income Tax Act on the transfer of machinery from the assessee-firm to one of its partners. The assessee firm argued that the machinery was taken over by the partner at book value, and the transaction did not result in a sale or exchange, thus not attracting tax under Section 41(2). However, the Income Tax Officer (ITO) rejected this contention, stating that the transaction was covered by the definition of "sale" as per Section 32(1) of the Act. The ITO brought the sum to tax under Section 41(2), which was upheld by the Commissioner of Income Tax (Appeals) [CIT(A)].

2. Definition and interpretation of "sale" and "transfer" under the Income Tax Act:
The assessee firm contended that the transaction did not amount to a "sale" as per the definition in Section 32(1) and argued that the term "transfer" is broader than "sale." The firm relied on judicial precedents, including the Supreme Court's decision in Sunil Siddharth Bhai vs. CIT, which emphasized that a firm cannot sell its property to a partner because the firm and its partners are not distinct entities. The firm also cited the Malabar Fisheries case, where the Supreme Court held that distribution of assets among partners upon dissolution is not a "transfer" or "sale."

The Tribunal examined these arguments and noted that Section 41(2) applies when an asset is "sold," "discarded," "demolished," or "destroyed." The term "sold" is defined in Section 32(1) to include transfers by way of exchange or compulsory acquisition but excludes transfers in amalgamation schemes. The Tribunal referred to several Supreme Court decisions, including CIT vs. Dewas Cine Corpn. and CIT vs. Bankey Lal Vaidya, which held that distribution of assets on dissolution does not constitute a sale or transfer.

3. Applicability of judicial precedents and legal principles to the transaction in question:
The Tribunal considered whether the transaction in question, where a partner took over an asset during the firm's subsistence, constituted a sale. The Tribunal noted that if the transaction were part of dissolution or retirement, it would not present any difficulty. However, since the firm and the partner continued their business relationship, the Tribunal had to determine if the transaction met the criteria for a sale.

The Tribunal referred to the Supreme Court's decision in Addanki Narayanappa vs. Bhaskara Krishnappa, which clarified that partnership property belongs to the firm, and partners have no exclusive rights over it during the partnership's subsistence. The Tribunal also considered the Madras High Court's decision in Bharani Pictures, which held that a partner's acquisition of firm assets for consideration constitutes a sale.

The Tribunal concluded that the transaction involved a transfer of property for a price, satisfying the criteria for a sale. The partner's account was adjusted to reflect the consideration, indicating that the transaction was not merely a mutual adjustment of rights but a sale. The Tribunal upheld the authorities' decision to tax the sum under Section 41(2), as the transaction met the definition of a sale.

Conclusion:
The Tribunal dismissed the appeal, affirming that the transfer of machinery from the firm to the partner constituted a sale under Section 41(2) of the Income Tax Act. The decision was based on the interpretation of "sale" and "transfer" and the application of judicial precedents, concluding that the transaction involved a transfer of property for consideration, thus attracting tax under Section 41(2).