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TMI Blog1985 (9) TMI 7X X X X Extracts X X X X X X X X Extracts X X X X ..... her the capital contribution by a partner to the assets of a partnership firm at an appreciated value can be said to give rise to a capital gain in his hands liable to income-tax. In Civil Appeal No. 1841 of 1981, the facts are as follows. The appellant, who is the assessee, was a partner in Messrs. Suvas Trading Company, a partnership firm constituted under a deed of partnership dated September 27, 1973. As his contribution to the capital of the partnership firm, the assessee made over certain shares of limited companies which were held by him as his capital assets. The book value of those shares in his account books was shown as Rs. 1,49,819, but on the date when he contributed those shares to the partnership firm, he revalued the shares at the market value of Rs. 1,60,279 and credited the resulting difference of Rs. 10,460 to his capital account. The Income-tax Officer, when drawing up the assessment order for the assessment year 1974-75 in respect of the assessee did not include the difference in the assessable income. The Commissioner of Income-tax, however, being of opinion that the difference between the market value of the shares and the cost of acquisition of the share ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ue on the date the asset was brought in. The assessee had in his possession 580 ordinary shares of the Ahmedabad Manufacturing and Calico Printing Co. Ltd. which had been purchased at Rs. 1,55,440. He had also 82 ordinary shares of Karamchand Premchand P. Ltd. purchased at Rs. 25,666. The total cost was Rs. 1,81,106. On March 22, 1973, the market value of a share of the Ahmedabad Manufacturing and Calico Printing Co. Ltd. was Rs. 442 and that of share of Karamchand Premchand P. Ltd. was Rs. 2,668. On that day, the assessee introduced the two shareholdings in the partnership firm as his capital contribution and the firm credited his account with the market value of the shares, namely, Rs. 4,75,136. In the assessment proceedings for the assessment year 1973-74, the, Income-tax Officer took the view that the contribution by the assessee of the shares to the asset of the partnership firm constituted a transfer within the meaning of clause (47) of section 2 of the Income-tax Act, 1961, and that the assessee was liable to income-tax on a capital gain of Rs. 2,94,030, being the difference between the market price at which the shares were entered in the books of the partnership firm an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns must be fulfilled 1. There must be a " transfer " Of a capital asset either under the general law or within the definition in clause (47) of section 2 of the Income-tax Act. 2. Consideration must be received or must accrue as a result of the transfer and the consideration must be capable of being determined in monetary terms in order that the computation of capital gains may be made as required by section 48. 3. Profits or gains must arise from the transfer and must be embedded in the consideration. It is urged that if any of the three conditions remains unfulfilled, no charge can be levied under the head " Capital gains ". In support of the submission that there is no " transfer " in the general sense of that term when a partner brings his personal assets into the firm as his contribution towards its capital, learned counsel points out that a partnership firm is not a separate legal entity and that the assets owned by the partnership are collectively owned by the partners. We have no hesitation in accepting that proposition, for, in Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 (SC), this court observed (p. 59): "....... it seems to us clear that a partnership firm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ely and does not exhaust other kinds of transfer. Its inclusive character was overlooked by the Madras High Court in CIT v. Abdul Khader Motor and Lorry Service [1978] 112 ITR 360 and in CIT v. Rajan and Kanan, [1984] 149 ITR 545 (Mad). In both cases, the High Court confined itself to considering whether the transaction before it was covered by any of the express terms used in the definition, that is to say, sale, exchange, relinquishment or extinguishment and taking the view that it did not fall under any of them, it held that there was no transfer. In its general sense, the expression " transfer of property " connotes, the passing of rights in property from one person to another. In one case, there may be a passing of the entire bundle of rights from the transferor to the transferee. In another case, the transfer may consist of one of the estates only out of all the estates comprising the totality of rights in the property. In a third case, there may be a reduction of the exclusive interest in the totality of rights of the original owner into a joint or shared interest with other persons. An exclusive interest in property is a larger interest than a share in that property. To t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ship. The person who brought it in would, therefore, not be able to claim or exercise any exclusive right over any property which he has brought in, much less over any other partnership property. He would not be able to exercise his right even to the extent of his share in the business of the partnership. As already stated, his right during the subsistence of the partnership is to get his share of profits from time to time as may be agreed upon among the partners and after the dissolution of the partnership or with his retirement from partnership of the, of his share in the net partnership assets as on the date of dissolution or retirement after a deduction of liabilities and prior charges." It is apparent, therefore, that when a partner brings in his personal asset into a partnership firm as his contribution to its capital, an asset which originally was subject to the entire ownership of the partner becomes now subject to the rights of other partners in it. It is not an interest which can be evaluated immediately, it is an interest which is subject to the operation of future transactions of the partnership, and it may diminish in value depending on accumulating liabilities and l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 (SC) as well as by the Punjab and Haryana High Court in Kay Engineering Co. v. CIT [1971] 82 ITR 950, the Kerala High Court in CIT v. Nataraj Motor Service [1972] 86 ITR 109 and the Gujarat High Court in CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393, that when a partner retires or the partnership is dissolved, what the partner receives is his share in the partnership. What is contemplated here is a share of the partner qua the net assets of the partnership firm. On evaluation, that share in a particular case may be realised by the receipt of only one of all the assets. What happens here is that a shared interest in all the assets of the firm is replaced by an exclusive interest in an asset of equal value. That is why it has been held that there is no transfer. It is the realisation of a pre-existing right. The position is different, it seems to us, when a partner brings his personal asset into the partnership firm as his contribution to its capital. An individual asset is the sole subject of consideration. An exclusive interest in it before it enters the partnership is reduced on such entry into a shared interest. Our attention has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee has urged that section 45 is not attracted in the present case because to compute the profits or gains under section 48, the value of the consideration received by the assessee or accruing to him as a result of the transfer of the capital asset must be capable of ascertainment in monetary terms. The consideration for the transfer of the personal assets is the right which arises or accrues to the partner during the subsistence of the partnership to get his share of the profits from time to time and, after the dissolution of the partnership or with his retirement from the partnership, to get the value of a share in the net partnership assets as on the date of the dissolution or retirement after deduction of liabilities and prior charges. The credit entry made in the partner's capital account in the books of the partnership firm does not represent the true value of the consideration. It is a notional value only, intended to be taken into account at the time of determining the value of the partner's share in the net partnership assets on the date of dissolution or on his retirement, a share which will depend upon deduction of the liabilities and prior charges existing on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alternative, she claimed that the right to receive the new shares was a right which was embedded in her old shares and, consequently, when she realised the sum of Rs. 45,262.50 by selling her right, the capital gain should be computed after deducting from that amount, the value of the embedded right which became liquidated. This court upheld the claim of the appellant that she was entitled to deduct from the sum of Rs. 45,262.50, the loss suffered by way of depreciation in the old shares. The court proceeded on the basis that in working out capital gain or loss, the principles which had to be applied are those which are a part of commercial practice or which an ordinary man of business would resort to when making computation for his business purposes. It will be noticed that this principle was applied by the court in a case where a capital gain was sought to be taxed under the Income-tax Act. That profits or gains under the Income-tax Act must be understood in the sense of real profits or gains, that is to say, on the of ordinary commercial principles on which actual profits are computed, a sense in which no commercial man would misunderstand, had been regarded as a principle of g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and is fundamental to the question whether capital gain arises to an upon the transfer of his shares to the partnership firm as his capital contribution. The objection is, therefore, overruled. Inasmuch as we are of opinion that the consideration received by the assessee on the transfer of his shares to the partnership firm does not fall within the contemplation of section 48 of the Income-tax Act and further that no profit or gain can be aid to arise for the purpose of the Income-tax Act, we hold that these cases fall outside the scope of section 45 of the Act altogether. We have decided these appeals on the assumption that the partnership firm in question is a genuine firm and not the result of a sham or unreal transaction and that the transfer by the partner of his personal asset to partnership firm represents a genuine intention to contribute to the share capital of the firm for the purpose of carrying on the partnership business. If the transfer of the personal asset by the, assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability ..... X X X X Extracts X X X X X X X X Extracts X X X X
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