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TMI BlogIntricacies in application of Section 45(3) in the light of Section 50C and Section 56X X X X Extracts X X X X X X X X Extracts X X X X ..... Intricacies in application of Section 45(3) in the light of Section 50C and Section 56 - By: - Ramesh Patodia - Income Tax - Dated:- 20-11-2018 - - issue regarding taxability on transfer of a capital asset upon introduction as capital contribution in a Partnership firm by a Partner has been subject matter of controversy even prior to the introduction of Section 45(3) in the Statute book and the same has been further aggravated upon introduction of Section 50C, Section 50CA and Section 56(2)(x) in the Income-tax Act,1961 . These three provisions when applied to the same transaction leads tax payers to diverse situations and it is becoming difficult to make an assessment as to how to deal with the transaction. The present article seeks to highlight some of the issues arising from the said provisions Initially , there were no specific provisions under the Income Tax Act, 1961 (hereinafter referred to as Act) in respect of taxability of the transaction viz. transfer of any capital asset by a partner to a partnership firm representing his capital contribution and the transaction could not be brought to tax under the Income tax Act and it was found to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a tax escaping route by transferring the capital asset into the partnership firm as capital contribution by accelerating the value of the asset being transferred at a higher rate in the books of the partnership firm. Therefore, with a view to plug the said loophole in the statute book , sub section (3) was inserted in Section 45 of the Act which specifically provided to tax the transaction in question under the head capital gains by way of a deeming fiction. Later-on , Section 50C (introduced by Finance Act 2002 w.e.f. 1/4/2003) and Section 50CA (introduced by Finance Act 2017 w.e.f. 1/4/2018) dealing with capital gains on transfer specifically in respect of transfer of immovable property being land or building and shares other than the quoted shares respectively were introduced by way of deeming fictions wherein deeming provisions were made to deem the amount of full value of consideration in cases dealt with therein. . Also the Finance Act, 2017 inserted a new clause (x) in 56(2) of the Act to provide for the taxation under the head Other Sources in respect of nature of transfers stated therein in the hands of the recipient of property as defined ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ein. Therefore, in the light of the above stated provisions , a question arises as to how the transaction when a partner transfers any capital asset in a partnership firm as his capital contribution has to be dealt with? The present article deals with the issues arising out of the analysis of the said sections i.e. section 45(3) , Section 50C , section 50CA and section 56(2)(x) of the Income Tax Act, 1961 when applied to a transaction in question i.e. transfer of a capital asset by a partner in the partnership firm as capital contribution. Issues: Section 45(3 ) was inserted in the Statute book w.e.f. 1/4/1988 by the Finance Act, 1987 to provide that when any partner contributes any capital asset as his capital contribution in a partnership firm then capital gain would be taxable in the year of such transfer and for this purpose ,full value of consideration shall be the value recorded in the books of the partnership firm. At the same time Section 50C and Section 50CA states that the full value consideration in case of immovable property being land or building or shares other than quoted shares respectively, shall not be less than the v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alue adopted by stamp valuation authority in case of land and building and fair market value calculated in the prescribed manner in case of unquoted shares. In such a situation, a question arises whether in a transaction of the type dealt with by Section 45(3) for the purpose of calculating capital gains in the hands of the partner, the full value of consideration will be deemed to be the amount at which the capital asset is recorded in the books of the firm or the stamp duty value in case of immovable property as provided in Section 50C or the fair market value calculated in the prescribed manner in case of shares other than those shares which are listed on stock exchanges as provided in Section 50CA . All these three provisions are deeming fictions to determine capital gains on transferability of capital asset. At the same time, Section 56(2)(x) inserted vide Finance Act, 2017 deals with taxability in the hands of recipient of the asset arising upon transfers which are done at a value which is lower than the stamp duty value in case of immovable property and fair market value in case of other properties by deeming the difference as income u/s 56(2)(x) in the h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ands of the recipient Therefore in a transaction of introduction of capital asset by a Partner in the Partnership firm as his capital contribution, while the provisions of Section 45(3) deems the full value of consideration in the hands of the Partner as the value at which the said capital asset is recorded in the books of the firm , the provisions of Section 56(2)(x) seeks to deem the stamp duty value or the fair market value in the hands of the recipient i.e., the Partnership firm as the full value of the consideration. In order to deal with the issues mentioned herein above, it is pertinent to understand the relevant provisions in the Income Tax Act, 1961 in relation to transaction of a partner contributing any asset as a capital contribution in the partnership firm. Relevant provisions under the Income Tax Act, 1961 (hereafter referred to as Act) in relation to taxability for transfer of capital asset by any partner in the partnership firm as a capital contribution: Section 45(3) states thatthe profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpany or a co- operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48 , the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset. Section 50C of the Act states that where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being land or building or both, is less than the value adopted or assessed or assessable by any authority of a State Government (hereafter in this section referred to as the stamp valuation authority ) for the purpose of payment of stamp duty in respect of such transfer, the value so adopted or assessed shall, for the purposes of section 48, be deemed to be the full value of the consideration received or accruing as a result of such transfer. Also, section 50CA has been inserted vide the Finance Act, 2017 which states that Where the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... consideration received or accruing as a result of the transfer by an assessee of a capital asset, being share of a company other than a quoted share, is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined shall, for the purposes of section 48, be deemed to be the full value of consideration received or accruing as a result of such transfer. Also, clause (x) has been inserted under section 56(2) of the Act which states about the taxability of the differential amount under the head Other Sources where any person receives any sum of money or immovable property or any other property without consideration or with consideration which is less than the stamp duty value or fair market value by an amount exceeding rupees fifty thousand. Analysis: Position before insertion of Section 45(3) As already stated hereinabove, the transaction of the type covered in Section 45(3) were not earlier taxable and the issue was dealt with by the Apex Court decision as follows:- In the case of Sunil Siddharthbhai vs. CIT, 1985 (9) TMI 7 - SUPREME COURT it was held as follows: Where a partner of a f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... irm makes over a capital assets which are held by him to a firm as his contribution towards capital, there is transfer of capital asset within the terms of section 45 of the Income Tax Act, 1961 , because an exclusive interest of partner in personal assets is reduced, on their entry into the firm, into a share interest but it was also held that when a partner transfers capital asset in partnership firm, no consideration is received by the partner within the meaning of section 48 since in such a case no income or gain arises to the partner in the true commercial sense and therefore no capital gain can be made chargeable under section 45 of the Act . However, it was also held that if the transfer of the personal asset by the assessee to a partnership firm in which he becomes the partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income tax on a capital gain, it will be open to the income tax authorities to go behind the transaction and examine whether the transaction of creating a partnership is genuine or a sham transaction and, even where the partnership is genuine, the tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansaction of transferring the personal asset by the assessee to the partnership firm represents a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business or is nothing but a device or ruse to convert the personal asset into money substantially for the benefit of the assessee while evading tax on a capital gain. For the purpose of determining the motive of such tax evasion it was held to consider all the relevant indicia in this regard, whether the partnership is formed between the assessee and his wife and children or substantially limited to them, whether the personal asset is sold by the partnership firm soon after it is transferred by the assessee to it, whether the partnership firm has no substantial or real business or the record shows there was no real need of the partnership firm for such capital contribution from the assessee. Although the Apex Court had held that there cannot be any consideration in case any person transfers the capital asset in a partnership firm and therefore there cannot be any capital gain for such transfers, it was also held to take pertinent consideration to determine wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ether the transaction is sham or illusory transaction or a device or ruse to evade tax. Insertion of Section 45(3) in the Act : Thereafter, since after the pronouncement of the judgement in the case of Sunil Sidharthbhai many tax evaders with the motive of evading tax on capital gain started taking benefit of the ruling i.e. there cannot be any capital gain in case of transferring the capital asset by a partner in a partnership firm and made it a route of evading capital gain tax. Therefore, in order to block this route of tax evasion, the above stated sub section (3) was inserted in section 45 vide the Finance Act, 1987 w.e.f. 01-04-1988 and the circular (FINANCE ACT, 1987 - CIRCULAR NO. 495, DATED 22-9-1987 ) explaining the said introduction reads as follows: 24.1 One of the devices used by assessees to evade tax on capital gains is to convert an asset held individually into an asset of the firm in which the individual is a partner. The decision of the Supreme Court in Kartikeya V. Sarabhai v. CIT [1985] 156 ITR 509 = 1985 (9) TMI 7 - SUPREME COURT has set at rest the controversy as to whether such a conversion amounts to transfer. The Court held ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that such conversion fell outside the scope of capital gain taxation. The rationale advanced by the Court is, that the consideration for the transfer of the personal asset is indeterminate, being 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 on dissolution of the partnership to get the value of his share from the net partnership assets. 24.2 With a view to blocking this escape route for avoiding capital gains tax, the Finance Act, 1987 has inserted new sub-section (3) in section 45. The effect of this amendment is that profits and gains arising from the transfer of a capital asset by a partner to a firm shall be chargeable as the partner s income of the previous year in which the transfer took place. For purposes of computing the capital gains, the value of the asset recorded in the books of the firm on the date of the transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer of the capital asset. Effect of introduction of section 45(3) : Thus vide the introduction of section 45(3) in the Act, the capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al gain is to be taxed in the hand of the partner in the year of such transfer via considering the full value of consideration, for the purpose of section 48 of the Act, to be the value at which such capital asset is recorded in the books of the partnership firm. Therefore, insertion of the above said provision did not create any hardship for the assessee who transfers the capital asset into the partnership firm representing a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business without any motive to evade tax on capital gain. However, for the transfers with the motive to evade tax via making of partnership firm for this sole motive, introduction of section 45(3) blocked such route of escaping capital gain tax. Therefore, the views pronounced by the Apex Court in the case of Sunil Siddarthbhai were only confirmed by the introduction of section 45(3) in the Act i.e. capital gain will only be charged in the hand of the partner transferring the capital asset in partnership firm with a motive to escape tax on capital via transferring the capital asset at a higher value to the partnership fir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m . In genuine cases of such transfer, taxation of capital gain would not effect since the full value of consideration would the value recorded in the books of the partnership firm. Effect of section 50C and 50CA : While s ection 50C and section 50CA of the Act states that in case of land and building and shares other than the quoted shares, for the purpose of computing capital gain the full value of consideration cannot be lower than the value as determined by the stamp valuation authority in case of land and building and the fair market value in case of shares other than the quoted shares. Thus, the issue which arises is that in the cases of a partner contributing land or building or unquoted shares in partnership firm. In such a situation, what would be considered in determining the full value of consideration- (i). the value recorded in books of the firm or (ii). the value adopted by stamp valuation authority for land and building and the fair market value for unquoted shares? A recent judgement pronounced by the Mumbai ITAT in the case of Amartara Pvt. Ltd, dated 29-12-2017, it was held that though the provisions of section 45(3) is not a specific p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rovision, it overrides the other provisions of the Act, importing a deeming fiction provided in section 50C of the Act cannot be extended to another deeming fiction created by the statute by way of section 45(3) to deal with the special cases of transfer the purpose of which is to deal with the cases of transfer between partnership firm and partners and in such cases, the Act provides for computation mechanism of capital gain and also provides for consideration to be adopted for the purpose of determination of full value of consideration. The above said legal proposition was supported by the decision by the Apex Court in the case of CIT vs. Moon Mills Ltd wherein it was observed that the one deeming fiction cannot be extended by importing another deeming fiction. However, the Hon ble Allahabad High Court in the case of Carlton Hotel Pvt. Ltd, 2017 (1) TMI 1471 - ALLAHABAD HIGH COURT , dated 31-01-2017 considering the facts of the case which prima facie showed that the entire transaction of contribution to partnership was a sham and fictitious transaction and an attempt to avoid tax which could also be fortified by the terms and conditions of the partnership it was hel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that the provision s of section 45(3) will not applicable in this case and for the purpose of determining the full value of consideration for transfer of capital asset in question, section 50C of the Act would be applicable being the transaction in the nature of fictitious transaction to avoid tax. The important question which arises is how two deeming fictions created by two different sections have to be dealt with when they deal with the same subject matter. In this regard, The Apex Court in the case of Bhuwalka Steel Industries Ltd Another Vs Union of India decided on 24 th March,2017 deal with a case where there were deeming provisions dealing with the same transaction at two different places and the hon ble Court observed as under:- The words shall be deemed to be occurring in both Section 3A(2) and Rule 5 appear to create a fiction. But in our opinion, on a true and proper construction (as rightly argued by the respondent) they do not create a legal fiction. In Consolidated Coffee Ltd. Another v. Coffee Board, Bangalore, (1980) 3 SCC 358 = 1980 (4) TMI 278 - SUPREME COURT OF INDIA , it was held: (page 371, para 11) the word deemed is use ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d a great deal in modern legislation in different senses and it is not that a deeming provision is every time made for the purpose of creating a fiction. A deeming provision might be made to include what is obvious or what is uncertain or to impose for the purpose of a statute an artificial construction of a word or phrase that would not otherwise prevail, but in each case it would be a question as to with what object the legislature has made such a deeming provision. In St. Aubyn v. Attorney-General, 1952 AC 15, 53 : (1951) 2 All ER 473, 498, Lord Radcliffe observed thus: The word deemed is used a great deal in modern legislation. Sometimes it is used to impose for the purposes of a statute an artificial construction of a word or phrase that would not otherwise prevail. Sometimes it is used to put beyond doubt a particular construction that might otherwise be uncertain. Sometimes it is used to give a comprehensive description that includes what is obvious, what is uncertain and what is, in the ordinary sense, impossible. Thereafter, The Apex Court also observed that a fiction always conflicts with reality. It should also be seen that the deeming fiction cr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eated by Section 45(3) is based upon a particular type of transaction whereas the deeming fiction created by Section 50C or Section 50CA is based upon the nature of the asset. Thus, these two deeming fictions deal with different things. In the instant case, it can be seen that the fiction created by Section 45(3) conflicts with the deeming provision of Section 50C and Section 50CA of the Income-tax Act, 1961. In such a situation, the objective behind the introduction of the deeming fiction has to be seen. Conclusion regarding applicability of section 45(3) or section 50C and section 50CA : Therefore, in the light of the above discussion and analysis, it can be construed that in such cases of transfer of capital asset by a partner in the partnership firm, the genuineness of the transaction has to be evaluated to determine whether such transfer is a real attempt to contribute in the partnership firm for the purpose of carrying on the partnership business or is nothing but a device or ruse to convert personal asset into money while evading tax on capital gain by considering the factors like partnership is formed between the assessee and his wif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e and children or substantially limited to them, whether the personal asset is sold by the partnership firm soon after it is transferred by the assessee to it , whether the partnership firm has no substantial or real business or the record shows there was no real need of the partnership firm for such capital contribution from the assessee, etc. Hence, , if the transaction is genuine with an intention for the purpose of business of partnership firm then the provisions of section 45(3) would be applicable in determining the full value of consideration for any capital asset whether it be land or building or unquoted shares or any other capital asset. However, if the said transfer has been determined to be not genuine or is sham or fictitious transaction with a view to evade capital gain, section 45(3) would not be said to be applicable and in respect of capital asset being a land or building or unquoted shares, for the purpose of determining full value of consideration section 50C and section 50CA of the act would be applicable respectively as has been held in Carlton case(supra) as well as many other decisions. Effect of introduction s ection 56(2)(x) in the Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... : As far as the implementation of deeming fiction created by Section 56(2)(x) is concerned, it is important to note that the provisions of Section 56(2)(x) deals with the taxability in the hands of the transferee as opposed to the provisions of Section 45(3) read with Section 50C and Section 50CA which deals with the capital gains in the hands of the transferor. Therefore, the applicability of Section 56(2)(x) has to be dealt with accordingly. It is also to be noted that the Section 56(2)(x) deals with those cases where there is a transfer without consideration or at a consideration which is less than the fair market value as computed as per the provisions of that Section. A question arises whether in a case of introduction of capital asset in a partnership firm by a Partner, what is the consideration that is parted with by the Partnership firm. The consideration in reality is the share of profit to which a Partner is entitled to in the partnership firm or the asset which he is entitled to in case of dissolution of the firm. Therefore, Can it be said that such a transaction is covered within the ambit and scope of Section 56(2)(x) . It is to be noted that in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case of a company which issues shares in consideration is specifically dealt with in Section 56(2)(viib) and therefore it is clear that such transactions are outside the scope of Section 56(2)(x) when a company issues shares in cash or in kind. As a corollary it appears that a partnership firm when receives any capital asset in consideration of share in its partnership firm, it cannot be said that the transaction is covered by Section 56(2)(x) in a absence of any specific provision of the type covered in Section 56(2)(viib) . There is no mechanism in the Income-tax Act or the Income-tax Rules to be provide for valuation of interest in the Partnership firm. Though Rule 11UB of the Income-tax Rules provides for valuation of the interest in the Partnership firm, but it is for the limited purpose of Section 9 dealing with foreign company or foreign entity and cannot be applied to an ordinary transaction of capital contribution. Therefore, without any specific provision of the type of Section 56(2)(viib ), the applicability of Section 56(2)(x) to the type of transactions covered by Section 45(3) is a questionable proposition. Therefore, the provisions of Section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 56(2)(x) is not applicable in case of transaction of the type covered by Section 45(3) though the reasoning in the decision of Siddharth bhai(supra) is equally applicable that the transaction should be a genuine transaction and not a sham transaction with no real intention of capital introduction. Though none of the cases have specifically so far dealt with this issue and only time will tell and until then of course the tax payers are left guessing the applicability of all these provisions. - Reply By DEV KUMAR KOTHARI as = Transfer is a deemed transfer and not actual transfer. The amount recorded in books of firm is deemed consideration in hands of partner. Amount so recorded will be 'actual cost' and '''the cost of acquisition,' in hands of the firm, for computing income - business or capital gains as the case may be. Therefore other deeming provisions are not applicable in case of transaction covered by S.45.3 . Dated: 23-11-2018 - Scholarly articles for knowledge sharing authors experts professionals Tax Management India - taxmanagementindia - taxmanagement - taxmanagementindia.com - TMI - TaxTMI - TMITax ..... X X X X Extracts X X X X X X X X Extracts X X X X
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