2017 (5) TMI 346 - HC - Income Tax

Capital gain - partnership firm - conversion from investment into stock in trade of shareholding - Firm transferred the shares as loss to partners and adjusted its profit - partners transferred the shares at profit and adjusted against their loss - tax avoidance or not - Held that - Tribunal correctly considered applicability of Section 45 (2) and has observed that it is a case of outright sale of share holding by Assesses Firm to its partner and that to for consideration, hence it can not be a case of distribution by dissolution of Firm or even under the word otherwise because sale is not covered under Section 45 (4) of Act, 1961. Further, all the partners have not purchased shares as only 16 partners out of 18 purchased and that too, not in their profit sharing ratio as explained by Assesses. More that 90% shares were purchased by M/s Siddharth Construction Co. Pvt. Ltd while it was having 41% share in the Assesses Firm. Hence, Section 45 (4) is not attracted. Revenue repeatedly referred to the findings of A.O to contend that the entire transaction was a device to avoid tax in the same transaction but could not dispute that CIT(A) and Tribunal have considered each and every aspect on which the matter has been examined by A.O. in detail and concurrent findings of fact have been recorded by both appellate authorities that there was no shame transaction as presumed/assumed by A.O. and his finding was clearly incorrect and conjectured. - Decided against revenue

Summary

Issues Involved:
1. Justification of the Income Tax Appellate Tribunal's finding on the conversion of investment into stock-in-trade.
2. Legitimacy of the conversion and subsequent sale of shares at a loss.
3. Applicability of Section 45(2) of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Justification of the Income Tax Appellate Tribunal's finding on the conversion of investment into stock-in-trade:
The appeal under Section 260-A of the Income Tax Act, 1961, arose from the judgment and order dated 28.02.05 by the Income Tax Appellate Tribunal (ITAT), Lucknow Bench. The core question was whether ITAT was justified in stating that the conversion of shares from investment to stock-in-trade was proven, despite the CIT (A) not making such a finding for A.Y 1990-91. The Tribunal found that the Assessee had the right to convert its investment into stock-in-trade, supported by valid reasons and amendments in the partnership deed. The Tribunal emphasized that the conversion was reflected in the balance sheet and other books of accounts, proving the factum of conversion.

2. Legitimacy of the conversion and subsequent sale of shares at a loss:
The Assessing Officer (A.O.) viewed the conversion as a colorable device to avoid taxes, noting that shares were sold at a lower price shortly after conversion. However, the CIT(A) and Tribunal found the Assessee's explanation credible, highlighting that the Assessee's business receipts had significantly decreased, prompting a change in business objectives. The Tribunal noted that the Assessee provided a detailed calculation showing that the conversion and subsequent sale resulted in higher tax payments, contrary to the A.O.'s assumption of tax evasion. The Tribunal dismissed the A.O.'s argument that the Assessee manipulated the transactions, noting that the shares were sold at prevailing market rates, and the future market trends were unpredictable.

3. Applicability of Section 45(2) of the Income Tax Act, 1961:
The Tribunal considered the applicability of Section 45(2), which deals with the tax implications of converting a capital asset into stock-in-trade. It was determined that the Assessee's actions constituted an outright sale of shares to its partners for consideration, not a distribution by dissolution of the firm. Therefore, Section 45(4) was not applicable. The Tribunal emphasized that only 16 out of 18 partners purchased shares, and not in their profit-sharing ratio, further supporting the non-applicability of Section 45(4).

Conclusion:
The Tribunal's findings were upheld, with the court noting that both appellate authorities had thoroughly examined the A.O.'s concerns and found no evidence of a sham transaction. The concurrent findings of fact by CIT(A) and the Tribunal were deemed correct, and the appeal was dismissed, answering all questions in favor of the Assessee and against the Revenue.