2018 (6) TMI 1323 - HC - Income Tax

Revision u/s 263 - dissolution of a partnership and the partners taking the assets of the firm in accordance with their individual shares - capital gain on dissolution of partnership - Held that - The share of the assessee which he received exclusively on dissolution being relatable to a pre-existing right he had, as one of the partners; to the extent of such share, the assessee s claim for exemption from long term capital gains for reason of the deposit made to UTI under Section 54EA has to be allowed. However, on the value of the shares in which the other partner had a pre-existing right; which was released in favour of the assessee, the right over it can be claimed only from the date of release and if subsequent sale falls within the 36 month period, necessarily the assets are to be assessed as short term capital gains to that extent. The Tribunal has not gone into the facts and has proceeded on the basis that the allotment of shares on dissolution would not result in a transfer, which, according to the Tribunal, is a legally permissible option available to the assessee. On the correct law applied to the peculiar facts, do not agree with the Tribunal on the acceptance of the claim raised by the assessee for long term capital gains to be a permissible view at least to the extent of the value of the assets released in his favour by the other partner on dissolution. To that extent, the finding of the Assessing Officer in the original order was an erroneous finding, which was also prejudicial to the interest of the revenue. Commissioner was perfectly justified in invoking the powers under Section 263. To the extent of the share the assessee had prior to dissolution and the valuation of that share, which was allotted to his share on dissolution; we concur with the order of the Tribunal insofar as allowing the exemption available from long term capital gains for reason of compliance with Section 54EA. There is no ground for a suo motu revision to that extent since the Assessing Officer s finding on that count is not erroneous. The provision only enables assessment at the hands of the firm and does not deem the allotment of capital assets in proportion to the share on dissolution or otherwise as a transfer. Herein, we are not concerned with whether the firm was assessed at the time of dissolution and are only concerned with the erstwhile partners assessment as an individual; that too of the consideration received from the sale of the assets he held exclusively after the dissolution of the firm, which sale was also subsequent to the dissolution. Answer the questions of law partly in favour of the Revenue and partly in favour of the assessee. As we noticed at the outset, the exact shares of the partners are not placed before us and the valuation is also a question to be decided on facts. We hence remand the matter to the Tribunal, before whom the assessee shall produce the deed of dissolution and release executed in the year 1997-98.

Summary

Issues Involved:
1. Invocation of Section 263 of the IT Act.
2. Validity of long-term capital gains claim under Section 54AE.
3. Classification of capital gains as short-term or long-term.

Detailed Analysis:

1. Invocation of Section 263 of the IT Act:
The primary issue is whether the Commissioner of Income Tax (CIT) could have initiated a suo motu revision under Section 263 of the Income Tax Act, 1961. The Tribunal had found that the Assessing Officer (AO) had considered the long-term capital gains and allowed it, and the mere lack of elaborate consideration was irrelevant. The Tribunal referred to precedents indicating that a firm is not an independent entity, and its partners are the real owners of the assets. The Tribunal concluded that the AO's view was permissible in law and that Section 263 could not be invoked merely because the AO's decision resulted in a revenue loss.

The High Court, however, noted that for Section 263 to be invoked, two conditions must be satisfied: the order must be erroneous and prejudicial to the interests of the Revenue. The Court found that the Tribunal did not correctly apply the law to the facts, particularly regarding the release of the share by the other partner, which constituted a transfer. Consequently, the CIT was justified in invoking Section 263 to the extent that the AO's original order was erroneous and prejudicial to the revenue.

2. Validity of Long-Term Capital Gains Claim under Section 54AE:
The assessee claimed exemption from long-term capital gains for land, goodwill, and trademark, arguing that there was no transfer on the dissolution of the firm. The Tribunal supported this view, relying on precedents that stated the allotment of assets on dissolution does not amount to a transfer.

The High Court, however, differentiated between the pre-existing rights of the assessee and the release of the share by the other partner. The Court held that the assessee's share received on dissolution was a pre-existing right and thus eligible for long-term capital gains exemption under Section 54EA. However, the share released by the other partner constituted a transfer, and any subsequent sale within 36 months should be considered short-term capital gains.

3. Classification of Capital Gains as Short-Term or Long-Term:
The High Court addressed whether the entire property should be classified as short-term capital gains from the date of dissolution. The learned Standing Counsel argued that since the assessee held the properties exclusively for less than 36 months, they should be considered short-term capital assets under Section 2(42A). The Court noted that while the assessee's pre-existing share could be claimed as long-term capital gains, the share released by the other partner constituted a transfer and should be classified as short-term capital gains if sold within 36 months.

The Court remanded the matter to the Tribunal to determine the exact shares and valuations based on the dissolution deed and the release of the share. The Tribunal was directed to decide the quantum of long-term and short-term capital gains accordingly, with the value of the assets to the extent the assessee obtained on allotment of his share on dissolution being available for long-term capital gains exemption under Section 54AE.

Conclusion:
The High Court partly allowed the appeal, upholding the CIT's invocation of Section 263 for the erroneous order prejudicial to the revenue but also recognizing the assessee's right to claim long-term capital gains exemption for his pre-existing share. The matter was remanded to the Tribunal for further determination of the exact valuations and classifications of the capital gains.