1987 (7) TMI 188 - AT - Income Tax

Summary

Issues Involved:
1. Taxability of capital gains and profit under Section 41(2) of the Income Tax Act.
2. Validity of the transaction involving the dissolution of the firm and transfer of assets to a company.
3. Assessment of the transaction as a device to avoid capital gains tax.

Issue-wise 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 to the company, thus realizing profit and capital gains which should be taxed. The ITO initially assessed a sum of Rs. 16,31,492 as profit under Section 41(2) and Rs. 23,69,208 as capital gains. However, the CIT(A) held that tax was not exigible on either capital gains or profit under Section 41(2) because there was no transfer in the case of the distribution of assets on the dissolution of the firm. This view was supported by the Supreme Court's decision in Malabar Fisheries Co. vs. CIT, which stated that upon dissolution of the firm and distribution of the assets, there is no transfer in law.

2. Validity of the Transaction Involving the Dissolution of the Firm and Transfer of Assets to a Company:
The facts reveal that the firm was reconstituted by admitting a company as the eighth partner, which later led to the dissolution of the firm and the transfer of its assets to the company. The CIT(A) found that the incorporation of the company, its induction into the firm, the dissolution of the firm, and the transfer of shares were all valid acts in the eye of the law. It was held that since the depreciated assets had not been sold or otherwise transferred when the firm was dissolved, it was not possible to withdraw the depreciation and development rebate. The Tribunal confirmed this view, stating that the property belonging to a firm could be converted into property belonging to a company either by executing a deed of transfer or by the firm becoming a company, which is a well-recognized method.

3. Assessment of the Transaction as a Device to Avoid Capital Gains Tax:
The Revenue argued that the transaction was a device to avoid capital gains tax, citing the Supreme Court's decisions in McDowell & Co. Ltd. vs. CTO and Sunil Siddharthbhai vs. CIT. They contended that the method adopted by the assessee to convert the property from a firm's holding into a company's holding was a camouflage for a sale. However, the Tribunal found that the revaluation of the assets by itself could not give rise to any profit as long as the owners of the assets remained the same. The Tribunal emphasized that the legal position is such that the revaluation of the assets in the hands of the owner by the owner himself cannot involve a realization of any capital gains. The Tribunal concluded that even if the firm had adopted a device to convert its assets to the company through dissolution, it does not attract capital gains tax because, under the provisions of Section 2(47) read with Section 47(ii) as it then stood, such a transaction would not amount to a transfer.

Conclusion:
The Tribunal confirmed the order of the CIT(A), holding that there was no transfer of assets upon dissolution which could give rise to taxable capital gains, nor was there any transfer by the firm to Mr. Ballal and his nominees of the business so as to tax the capital gains arising therefrom. The appeal by the Revenue was dismissed.