Individuals transferring capital assets to partnership firm - levy of capital gains. - Income Tax - 1471/CBDT

INSTRUCTION NO. 1471/CBDT Dated: June 7, 1982 Cases have come to the notice of the board where individuals transfer their capital assets to the partnership firms in the books of which their capital accounts are credited with the market value of these assets which is mostly far in excess of the cost of acquisition of the assets in the hands of the individuals. The question whether capital gains tax could be levied on the individual partner in such cases was under consideration of the board for quite sometime. The Ministry of law have also been consulted in the matter. 2. Section 45 of the I.T.Act, 1961 provides inter-alia that any profits or gains arising from the transfer of a capital asset will be chargeable to income-tax under the head capital gains. The expression transfer in relation to a capital asset is defined in sec.2(47) of the I.T.Act 1961 and includes sale, exchange or relinquishment of the asset or extinguishment of any right therein or the compulsory acquisition thereof under any law. 3. In the light of the aforesaid provision it has to be seen(i) whether in the type of cases under consideration, the transaction in question is a transfer and (ii) if it is a transfer, the further question will be whether such a transaction is one for a consideration as a result of which capital gains have been received or have accrued to the partner. 4. On a combined reading of sec.45 along with sec.2(47) of the I.T.Act, it would appear that any profits or gains arising from the transfer of a capital asset shall be chargeable to tax under the head capital gains such transfer would also include the extinguishment of any rights in such assets. 5.In the case of CIT Vs.sarabhai which dealt with a similar question relating to the contribution in the form of shares towards capital of a partnership firm the following tests were posed in order to ascertain the rights of a person concerned, vis-a-vis the assets in question:- 1) Can he sell gift away or alienate or transfer the said property or any part of it or any interest there-in any manner. 2) can he dispose of the said property or any interest therein by will. 3) Will it be includible in the net wealth for the purpose of wealth tax. The Honourable Gujarat High court opined that the erstwhile title in respect of the said property would stand extinguished from the point of time when it is introduced as a capital asset in the firm of which he is a partner. This would constitute transfer within the meaning of sec.2(47) of the I.T.Act. This view also finds support in the case of Abdul Rahim Vs. CIT (ITO ITR 595). In this case the full bench of the Kerala High court examined the definition of the term transfer as appearing in sec.2(47) and held that when a partner brings his own asset into the firm there is an extinguishment of his exclusive right over the property and therefore there is transfer within the meaning of sec.2(47). 6. As to the second question referred to in para 3 above namely whether there is consideration for such a transfer it may be pointed out that consideration in the sense of actual payment in cash has not flowed from the partnership to the person who has introduced his capital asset in the firm but as pointed out in C.I.T. Vs. Kartikey Vs. Sarabhai (131 ITR 42 ) a sum equivalent to its market value has been credited in the capital account of the person concerned in the books of the partnership firm. Whether payment is made in cash or by making a credit entry in the books of account of the partnership is irrelevant and immaterial. 7. Keeping in view the observations made above, the board have decided that capital gain tax should be levied in the type of cases discussed above. 8. These instructions should be brought to the notice of all the officers working under your charge for their guidance. They must be directed that where a partner brings his capital asset in the partnership and his capital account is credited with the market value of the asset the capital gains arising as a result of this transaction may be included in the income while completing the assessment of the partner.