2019 (7) TMI 593 - AT - Income Tax

Computation of Capital gains - sum above credit standing in partner account was received on his retirement from a partnership firm - certain amount credited on revaluation of assets - whether it can be said that there was a transfer of capital asset by the retiring partner in favour of the firm and its continuing partners so as to attract a charge u/s 45 ? - HELD THAT - The decision in the case of Tribhuvandas G.Patel 1996 (2) TMI 16 - SUPREME COURT is a case where the deed of reconstitution specifically referred to release of rights of the outgoing partners in the assets of the partnership and further the fact that a specified sum over and above the sum standing to the credit of the partner s capital account was paid to the retiring partner, which excess sum was attributed to the retiring partner giving up his rights over the properties of the firm. It is only because of the provisions of Sec.47(ii) of the Act that the Hon ble Court held that there was no incidence of tax on capital gain on the transaction. The decision will therefore have to be viewed as not applicable to cases after the amendment to the law w.e.f. 1-4-1989 whereby Sec.47(ii) of the Act was deleted and simultaneously Sec.45(3) 45(4) were introduced. Therefore the question whether there will be incidence of tax on capital gain on retirement of a partner from the partnership firm would depend on the upon mode in which retirement is effected as laid down by the Hon'ble Bombay High Court in the cases of Tribhuvandas G. Patel 1977 (9) TMI 13 - BOMBAY HIGH COURT and N.A. Modi's case 1985 (10) TMI 52 - BOMBAY HIGH COURT . Therefore the decision of the ITAT Mumbai in the case of Sudhakar M.Shetty Vs. ACIT 2010 (9) TMI 746 - ITAT, MUMBAI following the decision of the Pune Bench of the ITAT in the case of Shevantibhai C. Mehta v. ITO 2003 (8) TMI 208 - ITAT PUNE holding that question of taxability of an amount received by a partner on retirement from firm would depend upon mode in which retirement is effected, holds good. Therefore taxability in such situation would depend on several factors like the intention as is evidenced by the various clauses of the instrument evincing retirement or dissolution, the manner in which the accounts have been settled and whether the same includes any amount in excess of the share of the partner on the revaluation of assets and other relevant factors which will throw light on the entire scheme of retirement/reconstitution. After reducing the Partner s drawing and other payments made the balance to the credit of Assessee s capital account as on 31.3.2007 was ₹ 2,77,88,200/-. On 9.6.2007 the Assessee s was paid ₹ 38,38,200 towards Goodwill and another sum of ₹ 2,39,00,000/- being part of the consideration of ₹ 339.50 lacs payable on retirement. The difference between the sum of ₹ 3,39,50,000 and the sum of ₹ 2,77,88,200 viz., a sum of ₹ 61,61,800 was taxed as capital gain by the AO. Out of the above, ₹ 38,38,200 was Goodwill. Therefore to the extent of ₹ 2,77,88,200 being closing balance as on 31.3.2007 in the capital account and ₹ 38,38,200/- being Goodwill, was the sum payable as per the capital account of the Assessee. The claim of the Assessee that the entire sum of ₹ 61,61,800 is Goodwill is not substantitated by entries in the books of accounts of the Assessee and the book entries are only for ₹ 38,38,200/- recorded in the Assessee s capital account as well as Goodwill Account. The capital gain therefore would be ₹ 339.50 lacs minus ₹ 2,77,88,200 38,38,200 ₹ 23,23,600/-. The Assessee had invested a sum of ₹ 50 lacs in specified bonds and therefore the AO allowed deduction upto ₹ 50 lacs. Therefore there would no capital gain which is chargeable to tax. We uphold the action of the revenue authorities in taxing the excess paid over and above the sum standing to the credit of the capital account of the Assessee as capital gain. The computation of the capital gain has been modified by us by treating value of goodwill also as part of the credit in the partners capital account. Consequently, the capital gain in question was less than ₹ 50 lacs and since the Assessee has been allowed exemption u/s.54EC to the extent of ₹ 50 lacs, no capital gain is exigible to tax in the present case - Appeal of the assessee is allowed

Summary

Issues Involved:

1. Whether the sum of ?11,61,800 received by the assessee on retirement from a partnership firm is chargeable to tax as capital gains.

Issue-wise Detailed Analysis:

1. Taxability of the Amount Received on Retirement as Capital Gains:

The primary issue in this appeal is whether the sum of ?11,61,800 received by the assessee upon retirement from a partnership firm should be taxed as capital gains. The assessee and D. Venkatesh formed a partnership firm on 1.4.2004, and Miss Suvidha Venkatesh was inducted as a partner on 1.4.2007. An MOU dated 8.6.2007 and a retirement deed dated 9.6.2007 indicated that the assessee would retire from the firm effective 1.4.2007 and receive ?339.50 lakhs. The capital account of the assessee showed a balance of ?2,77,88,200 as of 31.3.2007. The difference between the retirement sum and the capital account balance, ?61,61,800, was taxed as capital gains by the AO, who allowed a deduction of ?50 lacs for investment in specified bonds and brought ?11,61,800 to tax as long-term capital gains.

The AO's rationale was that the amount received represented goodwill and was thus liable to capital gains tax under Section 45, as the assessee extinguished her rights in the firm's assets and liabilities. The CIT(A) upheld this view, relying on the Bombay High Court's decision in CIT Vs. A.N Naik Associates, which held that capital gains tax applies when assets are transferred to a retiring partner, even if the firm continues.

2. Legal Provisions and Judicial Precedents:

The Tribunal referred to several legal provisions and judicial precedents to analyze the issue. Section 45(1) of the Income-tax Act, 1961, taxes capital gains arising from the transfer of a capital asset. Section 2(47) defines "transfer" to include relinquishment or extinguishment of rights in an asset. The Tribunal noted that the share or interest of a partner in the partnership and its assets constitutes a capital asset.

The Tribunal discussed the evolution of partnership law and tax avoidance strategies, such as converting individual assets into partnership assets and distributing assets on dissolution. It highlighted that Section 45(3) and 45(4) were introduced to address these loopholes. The Tribunal also examined the distinction between retirement and dissolution of a partnership, as elucidated in Tribhuvandas G. Patel Vs. CIT and other cases.

3. Analysis of the Present Case:

The Tribunal compared the facts of the present case with the case of Sudhakar M. Shetty, where revaluation of assets and subsequent retirement led to capital gains tax. The Tribunal concluded that the facts in the present case were similar, as the assessee received a sum over and above the capital account balance, indicating a transfer of rights in the partnership assets.

The Tribunal noted that the assessee's claim that the entire sum of ?61,61,800 was goodwill was not substantiated by the books of accounts, which only recorded ?38,38,200 as goodwill. Therefore, the capital gain was recalculated as ?23,23,600 (?339.50 lakhs minus ?2,77,88,200 + ?38,38,200). Since the assessee had invested ?50 lacs in specified bonds, no capital gain was exigible to tax.

Conclusion:

The Tribunal upheld the action of the revenue authorities in taxing the excess amount over the capital account balance as capital gain. However, after recalculating the capital gain and considering the exemption under Section 54EC, no capital gain was exigible to tax in this case. The appeal of the assessee was allowed to the extent indicated above. The order was pronounced on 3rd May 2019.