2013 (11) TMI 731 - HC - Income Tax

Transfer of property from old firm to the new firm - Whether the firm should be made liable to pay capital gains even when there is no distribution of capital asset/assets among the partners under Section 45(4) of the I.T. Act Retiring partner taking out money towards his share - In the instant case, the partnership firm did not transfer any right in the capital asset in favour of the retiring partner. The partnership firm did not cease to hold the property and consequently, its right to the property is not extinguished. Conversely, the retiring partner did not acquire any right in the property as no property was transferred in their favour The instant case is distinguished from the following case namely, Commissioner of Income Tax And Another Vs. Gurunath Talkies 2009 (7) TMI 738 - KARNATAKA HIGH COURT and Commissioner of Income Tax Vs. A.N.Naik Associate - 2003 (7) TMI 46 - BOMBAY High Court , wherein it was held that assessee in that case is also liable to pay capital gains tax under Section 45(4). As in the present case there is no distribution of assets and hence, one of the condition precedent for invoking Section 45(4) does not exist and hence Section 45(4) is not attracted to the facts of this case - When a retiring partner takes only money towards the value of his share and when there is no distribution of capital asset/assets among the partners there is no transfer of a capital asset and consequently no profits or gains is payable under Section 45(4) of the Income Tax Act Decided against the Revenue.

Issues Involved:
1. Liability of the firm to pay capital gains tax under Section 45(4) of the Income Tax Act.
2. Liability of the retiring partner to pay capital gains tax.

Detailed Analysis:

1. Conflict Between Judgments:
A Division Bench of the Karnataka High Court identified a conflict between the judgments in Commissioner of Income Tax Vs. Mangalore Ganesh Beedi Works and Commissioner of Income Tax And Another Vs. Gurunath Talkies. The matter was referred to the Full Bench to resolve this conflict.

2. Substantial Questions of Law:
The primary questions were:
- Whether a firm should be liable to pay capital gains tax when a retiring partner takes only money towards the value of their share without distribution of capital assets.
- Whether the retiring partner would be liable to pay for the capital gains.

3. Factual Matrix:
The case involved a partnership firm, M/s. Dynamic Enterprises, which underwent multiple reconstitutions and retirements of partners. The firm purchased land and revalued its assets before the retirement of some partners, who received the enhanced value of the property.

4. Assessing Officer's Findings:
The Assessing Officer contended that the firm transferred property within the meaning of Section 2(47) of the Income Tax Act and issued a notice under Section 148. The firm argued there was no transfer of assets and thus no capital gains tax liability.

5. Tribunal's Findings:
The Tribunal held that there was no transfer of assets as the firm continued business and ownership of the land. It concluded that the firm was not liable to pay capital gains tax.

6. Rival Contentions:
The revenue argued that the incoming partners brought capital, and the retiring partners relinquished their interest, amounting to a transfer of capital assets under Section 45(4). The assessee contended that Section 45(4) requires dissolution and distribution of capital assets, which did not occur.

7. Conflicting Judgments:
- In Gurunath Talkies, the court held that reconstitution and transfer of assets to new partners amounted to a transfer of capital assets.
- In Mangalore Ganesh Beedi Works, the court held that there was no distribution of capital assets despite dissolution, and thus no capital gains tax liability.

8. Statutory Provisions:
Section 45(4) of the Income Tax Act concerns the distribution of capital assets on the dissolution of a firm or otherwise, resulting in profits or gains chargeable to tax. The definition of 'transfer' under Section 2(47) includes sale, exchange, or relinquishment of assets.

9. Supreme Court Precedents:
The Supreme Court in Narayanappa vs. Bhaskara Krishnappa and Malbar Fisheries Co. vs. CIT clarified that partnership property is jointly owned by partners and distribution upon dissolution is a mutual adjustment of rights, not a transfer.

10. Analysis of Section 45(4):
For Section 45(4) to apply, there must be:
- Distribution of capital assets.
- Transfer of capital assets by the firm to a partner.
- Resulting profits or gains.
- Distribution upon dissolution or otherwise.

11. Application to the Instant Case:
The firm did not transfer any capital assets to retiring partners; they received cash equivalent to their share. The firm continued to own the property, and thus no transfer occurred, and no capital gains tax liability arose under Section 45(4).

12. Conclusion and Answer:
The court concluded that when a retiring partner takes only money towards the value of their share without distribution of capital assets, there is no transfer of a capital asset, and no capital gains tax is payable under Section 45(4). The question of the retiring partner's liability to pay capital gains tax was not addressed as it was not relevant to the case.

Order:
- The substantial question of law was answered in favor of the assessee.
- The appeal was dismissed.
- No costs were awarded.

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