1998 (2) TMI 9 - SC - Income Tax

Damodaran Nair carrying on business as an individual converted the individual business into a partnership business in which he admitted two of his nephews as partners - impugned conversion amount to Transfer within the meaning of Section 45 read with section 2(47) of the Income Tax and hence subject to capital gains - but gains u/s 45 of the IT Act has arisen

Summary

Issues:
Assessment of transfer of assets in a conversion of individual business into a partnership business for taxation under Income-tax Act, 1961.

Detailed Analysis:

The Supreme Court addressed the issue of transfer of assets in the conversion of an individual business into a partnership business for taxation purposes under the Income-tax Act, 1961. In the case under consideration, one individual converted his business into a partnership, admitting two nephews as partners. The Income-tax Officer valued the assets at a higher value than the book value, resulting in a tax liability on the difference. The Appellate Assistant Commissioner reduced the capital gains, but the Tribunal ultimately concluded that the conversion did not constitute a transfer as per the relevant sections of the Income-tax Act. The High Court upheld this decision, ruling that no transfer of assets had occurred, and therefore, no capital gains tax could be levied.

In a previous case, Sunil Siddharthbhai v. CIT [1985] 156 ITR 509, the Supreme Court had considered a similar scenario where a partner introduced capital assets into a firm. The court determined that such an introduction of assets constituted a transfer of interest in law, but since no consideration was received, no profit or gain accrued to the transferor for tax purposes under section 45 of the Act. Drawing parallels to this precedent, the Supreme Court in the present case held that the conversion of the individual business into a partnership business involved a transfer of assets to the nephews, but no profit or gain was realized by the original owner, thus not subjecting the transaction to capital gains tax.

To address the specific aspect missed in the original question framed by the Tribunal, the Supreme Court reframed the questions for consideration. Question No. 1 queried whether there was a transfer of assets, which was answered in the negative in favor of the Revenue. Question No. 2 inquired whether such a transfer would result in taxable gains or profit under section 45 of the Act, which was also answered in the negative in favor of the assessee. The Court's decision aligned with the precedent set in Sunil Siddharthbhai's case, emphasizing that the conversion did not lead to taxable capital gains. As a result, no costs were awarded in the case.