1987 (7) TMI 178 - AT - Income Tax

Summary

Issues Involved:
1. Taxability of capital gains and profit under section 41(2) upon dissolution of the firm.
2. Validity of the transactions leading to the dissolution of the firm and transfer of assets to the company.
3. Whether the transactions were a device to avoid capital gains tax.
4. Applicability of section 47(ii) and section 2(47) of the Income-tax Act.

Detailed Analysis:

1. Taxability of Capital Gains and Profit under Section 41(2):
The Revenue contended that the dissolution of the firm amounted to a sale of the business as a going concern by the firm to the company, resulting in taxable capital gains and profit under section 41(2). The ITO initially assessed Rs. 16,31,492 as profit under section 41(2) and Rs. 23,69,208 as capital gains. However, the CIT (Appeals) held that there was no transfer in the case of the distribution of assets upon dissolution, and thus no capital gains tax could be levied. The Tribunal confirmed this view, stating that the property was converted from a firm's holding to a company's holding due to the dissolution, and not through a registered transfer deed, which would have been taxable.

2. Validity of Transactions Leading to Dissolution and Transfer of Assets:
The transactions included the incorporation of a company by the same partners, the company becoming a partner in the firm, the dissolution of the firm, and the transfer of shares to a third party. The CIT (Appeals) found these transactions to be valid acts in the eye of law. The Tribunal confirmed that these transactions were genuine and not sham, emphasizing that the ownership of the assets remained with the same individuals, whether as partners of the firm or as shareholders of the company.

3. Device to Avoid Capital Gains Tax:
The Revenue argued that the transactions were a device to avoid capital gains tax, citing the revaluation of assets and the subsequent transfer of shares. However, the Tribunal noted that revaluation by itself does not give rise to profit as long as the ownership remains unchanged. The Tribunal also referenced the Supreme Court's decision in Malabar Fisheries Co. v. CIT, which held that distribution of assets upon dissolution does not constitute a transfer in law, and thus, no capital gains tax could be levied.

4. Applicability of Section 47(ii) and Section 2(47):
The Tribunal highlighted that section 47(ii) of the Income-tax Act explicitly states that the distribution of capital assets upon dissolution does not attract section 45, which deals with capital gains. The Tribunal also noted that section 2(47), as it stood at the relevant time, did not include such transactions as transfers. The Tribunal cited the Supreme Court's decision in Sunil Siddharthbhai v. CIT, which allows scrutiny of transactions to determine if they are genuine or a device to avoid tax. However, in this case, the Tribunal concluded that the transactions were genuine and did not amount to a transfer that would attract capital gains tax.

Conclusion:
The Tribunal confirmed the order of the CIT (Appeals), holding that there was no taxable transfer of assets upon the dissolution of the firm. The transactions were deemed genuine and not a device to avoid capital gains tax. The appeal by the Revenue was dismissed.