2023 (8) TMI 1221 - AT - Income Tax

Conversion of the Partnership Firms into Companies - Capital gain on revaluation of land made in the hands of the Partners - Difference between the costs of lands and revalued amounts credited to the Appellant's capital account in the partnership firm - HELD THAT - In the instant case, the shares of the respective shareholders in the respondent-company were defined under the erstwhile 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 thereof. The Hon ble Gujarat High Court in the case of DCIT Vs. R.L. Kalathia Co. 2016 (1) TMI 581 - GUJARAT HIGH COURT held that Sale of business of assessee-firm as a going concern to company for consideration of paid up share capital does not amount to transfer liable to tax as capital gains. Thus addition made on account of capital gain on revaluation of land made in the hands of the Partners are not sustainable in law and the Grounds raised by the Revenue are devoid of merits. Therefore the appeals filed by the Revenue are hereby dismissed.

Summary

Issues Involved:

1. Whether the revaluation of land and the subsequent crediting of the revaluation amount to the partners' capital accounts constitutes taxable income.
2. Whether the conversion of the partnership firm into a private limited company and the subsequent allocation of shares and unsecured loans to partners constitutes a transfer liable to capital gains tax.
3. The applicability of Section 47(xiii)(b) of the Income Tax Act, 1961, regarding the conversion of a partnership firm into a company.
4. Whether the income arising from the revaluation of land should be assessed in the hands of the firm or the partners.

Summary of the Judgment:

Issue 1: Taxability of Revaluation Amount
The Assessing Officer (AO) held that the revaluation amount credited to the partners' capital accounts is taxable as casual and non-recurring income under Section 2(24) read with Section 28 of the Income Tax Act, 1961. However, the Commissioner of Income Tax (Appeals) [CIT(A)] disagreed, stating that the revaluation is merely a book entry and does not constitute real income. The CIT(A) noted that income should be assessed in the hands of the firm, not the partners, as per Section 10(2A) of the Act, which exempts partners' share of profit from a firm.

Issue 2: Conversion and Allocation of Shares
The AO argued that the conversion of the partnership firm into a private limited company and the subsequent allocation of shares and unsecured loans to partners constituted a transfer liable to capital gains tax. The CIT(A) disagreed, stating that the revaluation reserve was converted into unsecured loans, not equity, and thus did not constitute a transfer. The CIT(A) also noted that the applicability of Section 47(xiii)(b) should be considered in the hands of the firm, not the partners.

Issue 3: Applicability of Section 47(xiii)(b)
The CIT(A) held that Section 47(xiii)(b), which deals with transactions not regarded as transfer, should be applied to the firm during its conversion into a company. The CIT(A) emphasized that the section's applicability should be considered in the hands of the firm, not the partners, and thus the revaluation amount should not be assessed as capital gains in the hands of the partners.

Issue 4: Assessment in Hands of Firm vs. Partners
The CIT(A) concluded that the revaluation amount should be assessed in the hands of the firm, not the partners. The CIT(A) relied on various judicial precedents, including decisions from the Gujarat High Court and the Supreme Court, which held that revaluation of assets and subsequent conversion into a company does not constitute a taxable transfer liable to capital gains tax.

Conclusion:
The Income Tax Appellate Tribunal (ITAT) upheld the CIT(A)'s decision, dismissing the Revenue's appeals. The ITAT concluded that the addition made on account of capital gains on revaluation of land in the hands of the partners is not sustainable in law. The appeals filed by the Revenue were dismissed, and the order was pronounced in open court on 23-08-2023.