2014 (10) TMI 574 - HC - Income Tax

Capital gain u/s 45 - Transfer of assets from partnership firm to Private limited company Taxability u/s 45(4) - Held that - Under the Income Tax Act, a firm can be charged as a distinct assessable entity as distinct from its partners who can also be assessed individually - Following the decision in Commissioner of Income-Tax Versus Texspin Engineering And Manufacturing Works 2003 (3) TMI 56 - BOMBAY High Court - an existing firm was transformed into a company under Part IX of the Indian Companies Act - the erstwhile firm has been treated as a Limited Company by virtue of Section 575 of the Companies Act - Section 45(4) clearly stipulates that there should be transfer by way of distribution of capital assets - section 45(4) is not attracted as the very first condition of transfer by way of distribution of capital assets is not satisfied - the latter part of Section 45(4), which refers to computation of capital gains u/s 48 by treating fair market value of the asset on the date of transfer, does not arise. The shares of the respective shareholders in the respondent-company were defined under the partnership deed - The only change that has taken place on the respondent being transformed into a company was that the shares of the partners were reflected in the form of share certificates - beyond that, there was no physical distribution of assets in the form of dividing them into parts, or allocation of the same to the respective partners or even distributing the monetary value thus, the order of the Tribunal is upheld Decided against revenue.

Summary

Issues:
1. Whether the transformation of a firm into a private limited company constitutes a transfer of assets for the purpose of capital gains tax liability under Section 45 of the Income Tax Act, 1961?
2. Whether the distribution of assets, as required under Section 45(4) of the Act, occurred in the case of a firm transforming into a private limited company?

Analysis:
1. The case involved the transformation of a firm into a private limited company, leading to a dispute over the applicability of capital gains tax under Section 45 of the Income Tax Act, 1961. The Assessing Officer contended that the transfer of assets from the firm to the company triggered tax liability. However, the Commissioner and the Tribunal ruled in favor of the firm, stating that the provisions of Section 45(4) were not met. The appellant argued that the firm's transformation constituted a transfer of assets, thus attracting capital gains tax. The respondent countered, claiming that no dissolution or distribution of assets occurred, relying on relevant legal precedents.

2. The key issue revolved around whether the transformation of the firm into a company involved a distribution of assets as required by Section 45(4) of the Act. The Assessing Officer viewed the transformation as dissolution, leading to the distribution of assets in the form of share allotments to partners. However, the Commissioner and the Tribunal disagreed, emphasizing that no actual distribution of assets occurred, as partners only received shares in the new company. The respondent's argument centered on the lack of asset distribution and the absence of consideration paid to partners, citing the Bombay High Court's judgment in a similar case.

In conclusion, the High Court upheld the decisions of the Commissioner and the Tribunal, dismissing the appeal. It emphasized that the mere transformation of the firm into a company did not constitute a distribution of assets as required under Section 45(4) of the Act. The judgment highlighted the distinction between vesting of property in a company and actual distribution, emphasizing the necessity of tangible acts or legal transfers for asset distribution. The court's analysis aligned with the principles outlined in the Bombay High Court's judgment, emphasizing the lack of physical asset distribution in the case at hand.