2017 (11) TMI 1418 - AT - Income Tax

Distribution of capital assets u/s 45(4)- partnership firm - whether the provision of section 45(4) is applicable to the firm on crediting revaluation surplus to partners account settling their accounts on their retirement or not? - Held that - In this case, the transferor is the partners who on their retirement assign their rights in the assets of the firm and in lieu the firm pays the retiring partners the money lying in their capital a/c, meaning thereby that the firm becomes the transferee in this transaction. Hence, it is the firm and its continuing partners who have acquired the rights of the retiring partners in the assets of the firm by paying them lump sum amount on their retirement. So it cannot be said that the firm is transferring any right in capital asset to the retiring partner, rather it is the retiring partner who is transferring the rights ill capital assets in favour of continuing partners. The ITAT Mumbai in case of Sudhakar Shetty 2011 (3) TMI 1644 - ITAT MUMBAI held that the transaction was taxable in hands of retiring partner for assignment of his rights in favour of firm and its continuing partners. Since the same event cannot result into transfer by retiring partners as well as by firm, the ITAT by holding the transaction to be transfer from retiring partner to firm impliedly held that the transactions not to be taxable in hands of firm. The purpose of 45(4) of the Act is to bring such transactions which have an effect of transfer of capital asset without the asset being actually transferred. The purpose is to tax the actual beneficiary of such transactions. In the present case, the firm or the continuing partners are not the beneficiaries as no new tangible income or asset has arisen to them, rather the firm and continuing partners have purchased the share of retiring partner by paying cash. It is the retiring partners who have been benefitted by receiving much more than actual capital contributed by them on account of revaluation. Thus there can be no case of tax avoidance by colorable device by the firm on the facts and circumstances of the assessee firm s case. Accordingly, we are of the view that the assessee firm is not liable to capital gains on the above transaction. This issue of assessee s appeal is allowed.

Issues Involved:
1. Classification of the land at Mahul, Mumbai as stock-in-trade or capital asset under section 2(14) of the Income Tax Act, 1961.
2. Applicability of section 45(4) of the Income Tax Act, 1961 in the context of revaluation surplus credited to partners' accounts upon their retirement.

Detailed Analysis:

Issue 1: Classification of Land as Stock-in-Trade or Capital Asset

The primary issue was whether the land at Mahul, Mumbai, purchased by the assessee from Bharat Containers Private Limited, should be classified as stock-in-trade or a capital asset under section 2(14) of the Income Tax Act, 1961. The CIT(A) held that the land was a capital asset and not stock-in-trade. The assessee argued that the land was intended for development, thus should be classified as stock-in-trade. However, the CIT(A) noted that the agreement with the seller indicated a clear title free from encumbrances and no development work was carried out on the land from 23-11-2005 onwards, supporting the classification of the land as a capital asset.

Issue 2: Applicability of Section 45(4) on Revaluation Surplus

The second issue was whether section 45(4) of the Income Tax Act, 1961, applied to the firm when the revaluation surplus of the land was credited to the partners' accounts upon their retirement. The AO considered the transaction as a transfer of capital assets under section 45(4) because the retiring partners took their share of the valuation gain, and HDIL gained a larger share in the firm without paying any tax. The CIT(A) upheld this view, stating that the revaluation and payment to retiring partners amounted to the distribution of capital assets, thus taxable under section 45(4).

The assessee argued that the land was always treated as work-in-progress and not a capital asset, and that the revaluation did not result in a transfer as defined under section 2(47) of the Act. They contended that the firm continued with three original partners and one new partner, with no dissolution occurring, thus section 45(4) should not apply.

Tribunal's Findings:

The Tribunal found that the assessee firm and the continuing partners were not the beneficiaries, as no new tangible income or asset came to them. It was the retiring partners who benefited by receiving more than their actual capital contribution due to revaluation. The Tribunal noted that the mode of retirement revealed an extinguishment and assignment of the retiring partners' rights over the partnership and its properties in favor of the continuing partners/firm, making the retiring partners liable to capital gains tax.

The Tribunal emphasized that during the continuation of the partnership, partners have separate rights over the assets of the firm, and only upon dissolution can a partner claim a share in the assets. Since there was no distribution of capital assets at the time of retirement, section 45(4) was not applicable. The Tribunal relied on precedents, including the Karnataka High Court's decision in CIT vs. Dynamic Enterprises and the Bombay High Court's decision in CIT vs. Ravishankar R. Singh, which supported the view that revaluation alone does not trigger capital gains tax.

Conclusion:

The Tribunal concluded that the revaluation of the Mahul land and the credit of the revalued amount to the capital accounts of the partners did not entail any transfer as defined under section 2(47) of the Act. The transaction did not result in the distribution of capital assets, and thus section 45(4) was not applicable. The appeal of the assessee was allowed, and the addition made by the AO was restricted to ?63,12,50,000 instead of ?63,12,80,810, providing a relief of ?30,810 to the assessee.

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