2010 (1) TMI 54 - AT - Income Tax

Chargeability - transfer of land by way of capital contribution to the partnership - Nature of asset - stock-in-trade vs. capital asset - conversion of asset from one nature to another - genuine or a sham transaction - Applicability of the provisions contained u/s 45(3) - Whether, the surplus arising from the transaction of contributing the said land as capital by the assessee in a newly constituted partnership firm in which assessee became a partner, is liable to be taxed in the hands of the assessee as its income under IT Act, 1961 - Whether the surplus credited to the P L a/c on introduction of the land as its capital contribution, held by the assessee as stock-in-trade is chargeable to tax or not - HELD THAT - From the calculated device adopted, by the assessee, by withdrawing substantial amount of money for its benefit and debiting the same in its current account, it becomes clear that though the partnership firm as such is genuine, the transfer or contribution by the assessee of its personal land to the share capital of the firm represent a device or ruse for converting the land into money substantially withdrawn by the assessee from the firm for its benefit. Thus, the entry of Rs. 11.50 crores being value of land credited in assessee's capital account cannot be considered to be imaginary or notional one with no benefit or gain to the assessee. Therefore, the assessee's contention that the amount of Rs. 11.50 crores credited in assessee's capital account cannot be made a basis to work out any gain or profit arising to the assessee from the transaction of transferring its personal asset as capital contribution to a firm in which the assessee became a partner is not acceptable and is thus rejected. Therefore, even the partnership firm is considered to be genuine, the transaction of transferring assessee's land by way of capital contribution to the partnership at a market value more than the cost to the assessee represents a devise or ruse to convert the personal land of the assessee into money substantially for the benefit of the assessee while evading tax on a surplus amount arising to the assessee from the said transaction. Thus, which we have taken in the light of word of caution mentioned by the Hon'ble Supreme Court in the case of Sunil Siddharthbhai 1985 (9) TMI 7 - SUPREME COURT , the amount representing the value of land contributed by the assessee as its capital in a firm in which the assessee became a partner and which has been credited in the assessee's capital account, is to be considered as a consideration received by the assessee on the transfer of its personal asset to a partnership firm. We, therefore, hold that the surplus arising from making over assessee's personal asset, i.e., said plot of land in question, to the firm as his contribution to its capital account is a profit or gain accrued to the assessee and is chargeable to tax. Whether transaction is on capital field or the revenue - The land has been contributed to firm as capital by the assessee partner in its capacity as a partner and not as a trader in any trading transaction. We are, therefore, in agreement with the contentions of the learned counsel for the assessee that the land in question belonging to the assessee was contributed to a partnership firm as assessee partner's contribution towards capital in the partnership when the assessee entered into a partnership with five other partners, and so, the transaction cannot be regarded as a trading or commercial transaction in the business sense. Resultantly, the transaction of making over of any personal assets of a partner to a firm as his contribution towards capital is, therefore, to be regarded as made on a capital field. Whether a partner hands over his business asset to a firm as his capital contribution, he can be said to have effected a sale - The expression used in s. 2(14) of the Act is any stock-in-trade, consumable stores or materials held for the purposes of his business or profession . Thus, the emphasis has been given to the criteria that any stock-in-trade, consumable stores, or raw materials must be held for the purpose of his business or profession in order to treat the same as such. As a natural corollary, if one claims that any asset is/are either acquired or disposed of or otherwise dealt with as stock-in-trade, or consumable stores or raw materials, he must prove that the transaction of that asset effected by him is in the course of his business or profession, so as to treat the asset in question as stock-in-trade, consumable stores or raw materials, at the time when the transaction was made. We, therefore, hold that in order to treat any asset as stock-in-trade, it must be established and proved that the asset was involved in the course of any commercial or trading transaction of a business carried out by the assessee, and that is to be considered and decided with reference to the transaction in which such asset is employed and not with reference to any past or subsequent act of the assessee, qua that asset. Having regard to the nature of right acquired by a partner of a firm when he becomes a partner, his share in the firm undoubtedly constitutes property , and share of a partner in a partnership firm would certainly be a capital asset within the meaning of s. 2(14) of the Act. Such an asset being a share of a partner in a partnership firm can be transferred, like any other property, and, on transfer being completed, the charge on capital gain tax would be attracted. As already observed, when a partner of a firm makes over his personal asset to a firm as its contribution towards capital, the partner acquires a right to receive share in profit of the firm during the subsistence of the partnership and upon its dissolution or on his retirement, a right to share in the net asset of the firm. It thus, makes it clear that the partner has acquired a capital asset in the nature of his share in the partnership firm in consideration of his making over his personal asset to a firm. The transaction of making over personal assets to a firm, or receiving or realization of his share in assets on dissolution of the firm or on retirement of the partner, is undoubtedly to be held on a capital field. Therefore, having regard to the nature of the transaction of contributing asset by a partner to a partnership firm towards his capital, the nature of the right that the partner acquires when he contributes his personal asset to a partnership firm as its capital, and such transactions being not in the nature of any commercial or trading transaction, notwithstanding the fact that the said land contributed by the assessee to a partnership firm as its capital was held as stock-in-trade for the purpose of assessee's business before the same was so contributed as capital in a firm, it ceases to be stock-in-trade at the time when the same was contributed into a partnership firm by the assessee partner towards its capital, and it gets converted from stock-in-trade into capital asset at that material point of time. Conversion of stock-in-trade into capital asset - From all the factors as discussed, if taken together, along with the position of law as to the nature of the transaction and rights acquired by the assessee on becoming a partner in a firm, it is clearly established and proved that the land held by the assessee as stock-in-trade before the same was contributed to a firm as capital has been converted into a capital asset at the time when the same was contributed as capital contribution to a firm in which the assessee became a partner. Thus, we, therefore, hold that the land in question contributed by the assessee as capital to a firm in which assessee became a partner was a capital asset in nature at that relevant point of time, and all the incidence of taxation would thus follow accordingly. In the light of our finding that the transfer or contribution by the assessee of its personal land to the share capital of the firm represent a device or ruse for converting the land into money substantially withdrawn by the assessee from the firm for its benefit and even otherwise in view of our finding that the provisions contained in s. 45(3) of the Act inserted with effect from asst. yr. 1988-89, are applicable to the present case in this asst. yr. 1992-93 under consideration and in view of other findings we have given above, we hold that the earlier decisions of the Tribunal passed in the asst. yr. 1985-86 in the assessee's case shall have no application to the present case. We, therefore, reject the claim of the assessee that the issue involved in ground Nos. 1.1 to 1.7 should be decided in the terms of earlier order of the Tribunal passed in the asst. yr. 1985-86. We, therefore, direct the AO to compute the capital gain arising from the transfer of the said land by the present assessee to a partnership firm, in which it became a partner, by way of capital contribution, after taking the value of the consideration received or accruing as a result of such transfer at Rs. 11.50 crores being the amount recorded in the books of account of the firm as well as in the books of the assessee. The capital gain to be so computed shall be chargeable to tax in the year under consideration as per provisions of computation of capital gain and rate of tax provided in the Act or the respective Finance Act, as the case may be. DEEPAK R. SHAH, A.M. - In the present case, the fact, as also the draft order reveal that the firm is genuine and even the transfer by the partner of his asset to the partnership firm is a genuine intention to contribute to the capital of the firm for the purpose of carrying on the partnership business. It is not a case that the land was not contributed in the firm for the intended purpose but merely to walk away with the fund introduced by other partners. On the contrary the land has been developed by the firm by constructing building thereon and also subsequent sale thereof. Therefore, neither the firm is ingenuine nor the transaction of contributing to the capital of the firm is an ingenuine intention. The assessee holding the land can either develop it itself or the land can be developed by the firm in which the assessee is a partner. In both the cases the intended purpose of developing the land by the assessee is carried on and cannot be viewed with suspicion or to hold it as a colourable device. After the decision of Hon'ble Supreme Court in the case of Sunil Siddharthbhai the law as regards charging of capital gain has been amended by introduction of s. 45(3) of the Act. Even the definition of word transfer in s. 2(47) of the Act is substituted w.e.f.1st April, 1985but the definition is only in relation to a 'capital asset' and not for 'stock-in-trade'. The definition of 'capital asset' itself excludes the 'stock-in-trade'. In absence of any specific provision in the IT Act to tax such nature of transaction within the ambit of taxation, the tax cannot be imposed merely on the ground of morality. If the charge fails, no words of morality or equity can bring to tax a transaction. I therefore hold that the above nature of transaction cannot be considered as chargeable to tax under the head 'Profits and gains of business or profession'. In the draft order it is also held that what was transferred was a capital asset and hence in view of s. 45(3) of the Act the surplus is also taxable under the head 'Capital gains'. In view of the above finding in the draft order the surplus is treated as capital gain and brought to tax under s. 45(3) of the Act. Tribunal's power to change the head of income - It is never demonstrated or claimed by the assessee that such land was ever converted from stock-in-trade to capital asset. When the assessee held the land as stock-in-trade, he could deal with such land either himself alone or in partnership with other partners. The partnership is not a distinct legal entity from the partners constituting it. The assessee chose to deal with the land in partnership. In such a situation the assessee continues to deal with such land as its stock-in-trade only. A partner may contribute his part of capital in any form and bring different nature of assets whether stock-in-trade or capital asset. But in absence of any specific action on the part of assessee to convert such land from stock-in-trade to capital asset, the Tribunal is not competent to change such nature when it was never an issue before it. The draft order while holding that it has widest power u/s 254(1) so as to pass such orders thereon as it thinks fit fail to notice that the powers are limited by the word 'thereon' contained in s. 254(1) of the Act itself. Thus, I am of the opinion that the Tribunal cannot go into the question whether the asset introduced in the firm as capital contribution was a capital asset or not. I therefore hold that the Tribunal should have restricted itself to the controversy as raised by the appellant and to give a finding only to the extent whether the surplus realized on introduction of land being held by it as stock-in-trade in the form of its capital contribution was chargeable as business income or not. Since I have earlier held that such introduction do not amount to giving rise to business income as no legal right is accruing in favour of assessee because of the credit to the account of partner by the firm, no income can be brought to tax. The law laid down by Hon'ble Supreme Court in the case of Hind Construction Ltd. 1971 (9) TMI 16 - SUPREME COURT and the decision of Hon'ble Supreme Court in the case of Sunil Siddharthbhai are squarely applicable. Since the land was always held as stock-in-trade, which continued to be stock-in-trade even at the time of introduction and subsequently by the firm also, s. 45(3) which is applicable in respect of the capital asset cannot be applied to the stock-in-trade held by the assessee and introduced as capital contribution. It is also to be noted that in these years there is no finding that any amount was withdrawn by the assessee from the firm even though the accounts of the firm record the capital of the assessee as brought in. On the contrary, the facts remain that after introduction of land held as stock-in-trade as capital contribution, no part of the amount credited to capital account has been withdrawn till date. Therefore, the situation in this year is distinct than the situation prevailing for asst. yr. 1992-93 which has been extensively discussed in para 16.21 of the draft order and heavily relied upon to hold that the transaction is a colourable device. Thus even the word of caution as found in the case of Sunil Siddharthbhai 1985 (9) TMI 7 - SUPREME COURT case is not applicable in all these years which is heavily relied upon to hold the introduction of capital as colourable device and for applying the ratio of McDowell case 1985 (4) TMI 64 - SUPREME COURT . This factual situation is absent in relation to appeal for asst. yrs. 1997-98, 1998-99, 1999-2000 and 2000-01. Therefore even the finding for 1992-93 given in para 16 of the draft order will not apply in relation to other years as the factual situation differs materially. Thus, the surplus is not chargeable to tax for asst. yrs. 1997-98, 1998-99, 1999-2000 and 2000-01. Accordingly grounds raised in this regard as tabulated above are allowed and are decided in favour of the assessee.

Summary

Issues Involved:

1. Taxability of surplus arising from revaluation and contribution of land as capital to a partnership firm.
2. Applicability of Section 45(3) of the IT Act to the transaction.
3. Genuineness of the partnership firm and the transaction.
4. Treatment of revaluation surplus in the Profit & Loss account.
5. Interest on FDRs made from internal development account.
6. Disallowance of various expenses.
7. Reworking of cost of land at average purchase price.
8. Accrued interest on FDRs.
9. Taxability of surplus in subsequent assessment years.

Summary:

1. Taxability of Surplus Arising from Revaluation and Contribution of Land as Capital to a Partnership Firm:

The assessee, engaged in real estate development, contributed land held as stock-in-trade to a newly constituted partnership firm. The land was revalued, resulting in a surplus which was credited to the Profit & Loss account but claimed as exempt from tax. The AO and CIT(A) treated the surplus as taxable profit derived from the transfer of lands to the firm, relying on the judgment in Sunil Siddharthbhai vs. CIT and the provisions of Section 45(3) of the IT Act. The Tribunal upheld this view, stating that the surplus arising from the transaction is chargeable to tax as capital gain u/s 45(3) of the IT Act, 1961.

2. Applicability of Section 45(3) of the IT Act to the Transaction:

The Tribunal concluded that the transaction of contributing land to the partnership firm amounted to a transfer of a capital asset, and the surplus should be taxed as capital gains under Section 45(3) of the IT Act. The amount recorded in the books of the partnership firm as the value of the land was deemed to be the full value of the consideration received or accruing as a result of the transfer.

3. Genuineness of the Partnership Firm and the Transaction:

The Tribunal examined whether the partnership firm was genuine or a sham transaction. It was found that the firm was assessed to tax as such from year to year, and there was no material to hold that the creation of the partnership was not genuine. However, the transaction of transferring the land to the partnership firm represented a device to convert the land into money for the benefit of the assessee while evading tax on the surplus amount.

4. Treatment of Revaluation Surplus in the Profit & Loss Account:

The Tribunal held that the entries in the books of accounts are not conclusive or determinative in deciding the taxability of an item. The surplus credited to the Profit & Loss account does not necessarily represent taxable income. However, in this case, the surplus was treated as taxable profit because the transaction was found to be a device to evade tax.

5. Interest on FDRs Made from Internal Development Account:

The issue of whether the interest received on FDRs made from the internal development account is eligible for deduction and not to be included in the assessee's assessable income was remitted back to the AO for fresh adjudication in accordance with earlier Tribunal directions.

6. Disallowance of Various Expenses:

The Tribunal upheld the disallowance of various expenses such as local conveyance, incidental expenses, guest house expenses, and foreign traveling expenses based on earlier decisions and findings.

7. Reworking of Cost of Land at Average Purchase Price:

The Tribunal decided that the Revenue was not justified in reworking the cost of land at the average purchase price of land in Phases I to IV of Qutab Enclave Complex. The assessee was justified in taking Phases I to IV as one project and writing off the cost of land accordingly.

8. Accrued Interest on FDRs:

The issue of accrued interest on FDRs made after withdrawal under the authority of the Haryana Government from the internal development bank account was restored to the AO for fresh adjudication in line with earlier Tribunal decisions.

9. Taxability of Surplus in Subsequent Assessment Years:

For the subsequent assessment years (1997-98 to 2000-01), the Tribunal followed the same reasoning as in the assessment year 1992-93, holding that the surplus arising from the contribution of land to the partnership firm is chargeable to tax as capital gain u/s 45(3) of the IT Act. The Tribunal also addressed the issue of whether the transaction was a device to evade tax and found that substantial amounts were withdrawn by the assessee from the firm for its benefit, supporting the view that the transaction was a device to convert the land into money while evading tax on the surplus amount.