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TMI Blog1988 (6) TMI 62X X X X Extracts X X X X X X X X Extracts X X X X ..... e was a transfer within the meaning of sections 2(47) and 45 and that the real purpose of the transfer was to convert the personal asset of the partner into money for its own benefit while avoiding the liability to tax on the capital gains. He, therefore, held that there was a transfer for consideration making the surplus liable to tax. In other words, the appellant was liable to tax on the capital gains arising out of the transfer of capital assets to the firm in the accounting year. The CIT(A) directed the IAC to give the appellant an opportunity to establish its claim for substitution of the value of the capital asset as on 1-1-1964. It is against this finding of the CIT (Appeals) that the present appeal has been filed. 2. Before dealing with the arguments advanced in this regard, certain facts, which are relevant for understanding the issues raised in the appeal, may first be stated. The appellant is a limited company which was incorporated in 1937 and carried on investment business. On 9-4-1979, at the company's Bombay office at Bajaj Bhavan, 226 Nariman Point, Bombay-21, the directors of the company decided to commence a new business activity and as required by section 149( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... other individuals/companies to carry on business, inter alia, of dealing in shares, securities and properties. Such a firm would be styled as "Bajaj Trading Co.". It was decided to contribute the stock-in-trade in the form of land and shares and an amount of Rs. 2 lakhs as company's contribution as capital in the firm. A partnership was entered into on 8-5-1979 between Jamnalal Sons Ltd., the appellant herein, and Shri Rahulkumar Kamalnayan Bajaj, Shri Shishirkumar Kamalnayan Bajaj, Shri Ramkrishna Jamnalal Bajaj, Shri Nirajkumar Ramkrishna Bajaj, Shekhar Ramkrishna Bajaj as karta of Shekhar Bajaj (HUF) and Madhur Ramkrishna Bajaj as karta of Madhur Bajaj (HUF). The partnership deed provided that each of the parties had agreed to bring into the said partnership assets in specie as and by way of capital and the appellant was expected to contribute a capital of Rs. 1,23,16,750. Such capital contribution on the part of the appellant-company was described in clause (5) of the partnership deed as under : " Rs. 1,20,03,000 in the form of value of plots of lands situated at Juhu. Rs. 1,13,750 in the form of shares in limited companies and Rs. 2,00,000 in the form of cash to be broug ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2(47) read with section 45. However, by virtue of the same decision, the transfer was not for any consideration within the meaning of sec. 48 and therefore no capital gains arose out of these transactions. Therefore, at the conclusion of para 5 of his order, CIT(A) gave a finding that the appellant is not liable to tax on the transfer of the assets to the firm as no capital gain arose. Thereafter, the CIT(A) proceeded to consider whether the judgment of the Supreme Court in McDowell Co. Ltd. v. CTO [1985] 154 ITR 148 would apply. He held that only deliberate and complex tax planning schemes would be affected by that judgment. The decision in IRC v. Duke of Westminster [1936] 19 TC 490 would apply in the case of a single-step tax saving plan. The CIT(A) further held that the contribution of the assets to the firm did not give rise to any capital gains in the light of the decision in Sunil Siddharthbhai v. CIT [1985] 156 ITR 509 (SC). The CIT(A) thereafter proceeded to go through the records of the appellant as well as that of the firm called 'Bajaj Trading Co.' and he held that the appellant had drawn from the firm a sum of Rs. 1 crore in Sept. 1982 and had used it to partly fina ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tock-in-trade could be done by the partner either by himself or through the firm. Shri Palkhivala then argued that what was brought in by way of capital was stock-in-trade, the value of which was a capital asset. There was nothing to prevent a partner from bringing his stock-in-trade and crediting its value to the capital account. There was difference between capital asset and capital account which was not appreciated, according to Shri Palkhivala, by the departmental authorities. There was no question of any capital gains tax at all because what was credited as capital was only a value of stock-in-trade and if at all there was any transfer, what was transferred was stock-in-trade and not a capital asset. Alternatively and without prejudice, Shri Palkhivala argued that there was no transfer within the meaning of sec. 2(47) as there is no sale or exchange when a partner brings in capital. Definition of "transfer" within the meaning of sec. 2(47) in relation to capital asset does not apply when a partner contributes capital to the firm. Section 2(47) contemplates sale, exchange or relinquishment of a capital asset or extinguishment of any rights therein. Shri Palkhivala thereafter ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case, the transaction is genuine. The firm is genuine. The CIT(A) has held both the transactions as well as the partnership firm as genuine. The firm is assessed to tax till date. These are the findings of the CIT(A) and these very findings, according to Shri Palkhivala, preclude him from coming to the conclusion that he finally did. 6.1 Commenting on the final conclusions of the CIT(A) at para 12(d) of his order, Shri Palkhivala argued that there was no harm in the firm taking advances. The conveyance was not executed only to avoid stamp duty which is a normal practice when promoters and builders who deal in real estate. Shri Palkhivala pointed out that [vide para 12(c)] the CIT(A) had at one stage stated that the advances were received for the sale of plots and at a later stage stated that the drawal of Rs. 1 crore could only emanate from the capital of the firm itself which capital had been contributed by the appellant-company by revaluing its investments at the market price. This was clearly a contradiction in terms. It would have had to pay no tax if the firm was not formed at all and the company was avoiding no tax which it was otherwise required to pay. Shri Palkhivala fur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ame section was amended in 1987 with a view to overcome the situation created by Sunil Siddharthbhai's case. These amendments of 1984 and 1987 have no retrospective effect. Referring to some of the salient facts, Shri Palkhivala pointed out that the withdrawal by the assessee-company from the partnership of amounts was only in the fourth year. Total sale proceeds by that year exceeded Rs. 11 crores. Since the partnership did not require money for the day-to-day activities, it was natural that the partnership withdraws moneys from the firm and invests in other profitable avenues of investment. He clarified that no director of the assessee-company is a relative of any partner or any shareholder of the assessee-firm and no single partner is a substantial shareholder of the assessee-company. Finally, Shri Palkhivala argued that McDowell Co. Ltd.'s case applied only where a sham or unreal transaction is put up by the assessee when in fact and in law the transaction was never intended to take effect commercially. 8. Shri Jetley, on the other hand, argued that the assessee had adopted a device to avoid payment of tax. It was not a case of simple avoidance but a case of evasion of tax. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... equirements of sec. 149A of the Companies Act to enable it to start business in real estate. All these resolutions and declarations were self-created self-serving documents and could not be taken at their face value without due scrutiny. For this proposition, Shri Jetley relied on the decision of the Supreme Court in the case of CIT v. Durga Prasad More [1971] 82 ITR 540 at p. 541. He also relied on the Supreme Court decision in McDowell Co. Ltd.'s case and drew our attention to the observations of the Supreme Court at pages 152 and 159. Shri Jetley then argued that if the assessee resorted to tax planning and justified it with reference to judge-made law, then the question whether it is tax planning or a device to avoid tax should also be decided with reference to judge-made law. If the appellant relied on the rationale of the decision of the Supreme Court in Bai Shirinbai K. Kooka's case in support of its case, the department was entitled to draw support from McDowell Co. Ltd.'s case as well as from the relevant observations at page 523 in Sunil Siddharthbhai's case. Shri Jetley then relied on a decision of the Supreme Court in Workmen of Associated Rubber Industries Ltd. v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e para 5-a) that the conversion of the land into stock-in-trade cannot be called sham or bogus act; that such conversion was valid and genuine. He has also held that the firm is genuine, Shri Jetley has attacked these findings of the CIT(A) by invoking Rule 27 of the IT Rules. What we have to consider is whether land and shares held by the limited company since 1938 as capital asset became the stock-in-trade of the limited company by a mere declaration and whether it is necessary that there should be some further evidence that they should have been treated as stock-in-trade by the limited company prior to its contribution as capital to the partnership firm, of which the appellant became a partner. In this context, we feel that the argument of Shri Palkhivala that a person can do business with the stock-in-trade either singly or as a partner of a firm is only an argument of convenience or, alternatively, an argument that begs the question. When it is the case of the appellant that what was transferred as capital was stock-in-trade of the appellant-company, it must be proved to be so before it became stock-in-trade of the firm. The facts before us lead us to an exactly contrary decis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alue of the 15 plots of land which was contributed as capital was Rs. 1,20,03,000 against their book cost of Rs. 90,573. It was argued that the assessee may act as a dealer jointly with others. The assessee has not itself, as a limited company, treated in land or shares. Therefore, prior to becoming a partner in the firm of Bajaj Trading Co., the assessee's status as a trader in land had not been established as indeed it could not be because there was hardly a day between the conversion of the land into stock-in-trade and the decision to start trading activity in real estate by forming a partnership so that the conversion took place on 2-5-1979. The decision to commence business in land by entering into partnership was taken on 3-5-1979 and the partnership itself was started on 8-5-1979. In the hands of the limited company, the land remained as a stock-in-trade, if at all, only for a day or two before its contribution as capital to the partnership firm of Bajaj Trading Co. In fact, no specific declaration converting the land from capital asset into stock-in-trade has been brought to our notice. Even the description in the partnership deed indicating the appellant's contribution whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntion 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 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 the partnership is a genuine or a sham transaction, even where the partnership is genuine, the transaction of transferring the personal asset 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. " [Emphasis provided] Shri Palkhivala was at pains to point out that the firm was genuine. It was still in existence and, therefore, the reservation mentioned by the Supreme Court would not apply in the appellant's case a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the appellant-company has been substantially recovered out of the advances of the firm within a matter of three years after the year in which capital in kind was contributed by the assessee to the partnership firm. The amount of Rs. 1,16,60,000 is certainly not the share of profits of the appellant. In fact, the appellant-company was incurring losses and its share of loss was being separately debited to its current accounts. Thus, in S.Y. 2038, its share of loss was Rs. 1,63,800. In S.Y. 2039, its share of loss was Rs. 11,27,706 and S.Y. 2040 its share of loss was Rs. 1,62,504. The current account showed consistently a debit balance on the one hand and on the other hand the amount was refunded from the capital account in S.Y. 2039 from out of the advances received from sale of land. Shri Palkhivala took the argument that the company found it prudent to utilise the funds elsewhere more profitably and therefore there was nothing wrong in withdrawing the amounts from out of the advances. We are not here doubting the intention of the company or questioning its purpose in withdrawing the amounts from its capital account. We are only concerned with the effect of such withdrawals in the l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ds in specified investments to avoid capital gains tax. 15. It is necessary to deal with some of the important cases to which very frequent reference was made by counsels on either side. Shri Palkhivala firstly relied on Bai Shirinbai K. Kooka's case. In that case, the question posed by the Supreme Court was how should the profit made by the assessee by sale of her shares as a trading activity be computed, it being not in dispute that there was in this case a real sale resulting in actual profits. In that case, the High Court emphasized that in order to arrive at real profit one must consider the accounts on commercial principles and construe profits in the normal and natural sense and it then pointed out that what the shares cost originally to the assessee when she had no business or trading activity could not in a commercial sense be said to be the cost of shares to the business which started on 1-4-1945. The High Court held that the market value when the trading activity started should be treated as the cost of the shares in which trading took place and this view was confirmed by the Supreme Court. At page 95 of the report, the Hon'ble Supreme Court observed as under : " We ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... George Dawson, together with his wife and two sons, held shares in two companies and transferred them to another company called Wood Bastow Holdings Ltd. The transaction of transfer of shares was carried out through an intermediary company which was formed in the Isle of Man in which a new company was created for a short while called Greenjacket Investments Ltd. All this scheme was entered into for the purpose of tax deferment. After discussing all the facts and the relevant cases on the issue, Lord Brightman observed as under : " My Lords, in my opinion the rationale of the new approach is this. In a preplanned tax saving scheme, no distinction is to be drawn for fiscal purposes, because none exists in reality, between (i) a series of steps which are followed through by virtue of an arrangement which falls short of a binding contract, and (ii) a like series of steps which are followed through because the participants are contractually bound to take each step seriatim. In a contractual case the fiscal consequences will naturally fall to be assessee in the light of the contractually agreed results. For examples, equitable interests may pass when the contract for sale is signed. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the House of Lords, in essence, held that where there is a pre-ordained series of transactions or one single composite transaction, whether or not it includes the achievement of a legitimate commercial, and steps are inserted which have no commercial purpose apart from the avoidance of a liability to tax, the inserted steps are to be disregarded and the end result considered in the light of the relevant taxing statute. This would only mean that the mere fact that an arrangement is legal or genuine is not enough if such arrangement is embarked upon with a pre-determined object of circumventing the provisions of fiscal statute. The decision in Dawson's case as well as in W. T. Ramsay Ltd.'s case was followed by the Chancery Division in Ingram v. IRC [1985] Simon's TC 835. The facts in this case were briefly these. The taxpayer negotiated a price of pound 145,500 for the purchase of an unencumbered freehold property with vacant possession. With a view to reducing the stamp duty payable on the transfer of the property the following transactions were entered into : (1) The vendor and the taxpayer made an agreement for the lease of the property for a term of 999 years at a premium of po ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ri Palkhivala was that the decision of the CIT(A), if confirmed, would mean giving retrospective effect to the amendments of sec. 45 brought about in 1984 and 1987. In our opinion, there is a fallacy in the argument of Shri Palkhivala. Shri Palkhivala's argument is based on the assumption that Bai Shirinbai K. Kooka's case in any case, applicable. But for the amendment brought about to sec. 45 by the Taxation Laws Amendment Act, 1984, with effect from 1-4-1985, the appellant would be entitled to the benefit of this decision. We have already pointed out that the decision in the case of Shirinbai K. Kooka was given on a different set of facts and circumstances where trading in shares had taken place and the question was how to work out profit on such trading. The facts there were not in dispute. We have also held that this decision on facts is not applicable to the present case because there is no trading in land as stock-in-trade by the appellant-company per se and therefore the question of treating the market value of the trading asset as the cost of trading asset which was the rationale of the Supreme Court's decision, does not apply to the present case. In view of this finding, t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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