Tax on Capital Gain on transfer of Asset to Retiring partner

By | September 3, 2015

Tax on Capital Gain on transfer of Asset to Retiring partner

Q :whether the transfer of land belonging to the firm to the retiring partner is liable to be taxed under the head “capital gains ” and if so in whose hands ? in the hands of the firm or retiring partner ?

The transfer of the asset is by the firm which is a ‘legal entity’ to the retiring partner another distinct legal entity being an ‘individual’. Therefore, it is crystal clear that capital gain will arise in the hands of the transferor, viz., the assessee-firm and not the transferee viz., the retiring partner. [Para 9]

IN THE ITAT CHENNAI BENCH ‘D’

Vikas Academy

v.

Income-tax Officer, Ward- II (4), Madurai*

N.R.S. GANESAN AND A.MOHAN ALANKAMONY, JJ.

IT APPEAL NO. 2323 (MDS.) OF 2014
[ASSESSMENT YEAR 2009-10]

JUNE  12, 2015

ORDER

A. Mohan Alankamony, Accountant Member – This appeal is filed by the Assessee, aggrieved by the order of the Learned Commissioner of Income Tax(A)-l, Madurai dated 20.08.2014 in ITA No.0053/2013-14 passed under Sec.143(3) read with section 147 & Sec. 250 of the Act.

2. The Assessee has raised 24 elaborate & argumentative grounds in its appeal, however the crux of the issue is that:—

(1) The Commissioner of Income Tax (Appeals) had erred in sustaining the validity of the re-assessment proceedings u/s.147 of the Act as it is beyond the scope of the powers conferred by Sec. 148 of the Act.
(2) The Commissioner of Income Tax (Appeals) had erred in sustaining the order of the Assessing Officer who had made addition by invoking the provisions of section 45(4) of the Act and treating the settlement of an asset in favour of the retiring partner as capital gain amounting to Rs. 6,16,67,531/-.
(3) The Commissioner of Income Tax (Appeals) had erred in sustaining the addition on levy of interest u/s.234B & 234C of the Act.

3. The brief facts of the case are that the assessee is a partnership firm, engaged in the business of running educational institutions, and real estate, filed its return of income on 31.03.2010 admitting its income as Nil. Initially, the return was processed u/s.143(1) on 25.01.2011, subsequently the assessment was reopened by issuance of notice U/s.148 of the Act on 04.04.2011 and finally assessment was completed U/s. 143(3) of the Act on 28.3.2013 wherein the Ld. Assessing Officer determined the long term capital gain of the assessee at Rs. 6,16,67,531/- for transferring the immovable property of assessee to the outgoing partner Mrs. Aruna Rs. 9,04,10,000/- invoking the provisions of section 45(4) of the Act.

4. On the issue of reopening, the Ld. A.R. did not advance any argument to substantiate the claim of the assessee that reopening was bad in the case of the assessee. Hence, the same is dismissed as not pressed. Similarly, on the issue of levy of interest U/s. 234 B & 234C of the Act was also not argued, therefore the same is dismissed as a consequential. Therefore the only ground to be adjudicated in the case of the assessee is in regard to the addition made by the Ld. Assessing Officer by invoking Section 45(4) of the Act for transfer of immovable property of the assessee to the outgoing partner of the firm.

4.1 During the year under consideration, it was observed by the Ld. Assessing Officer that the assessee had transferred its immovable property to the outgoing partner, the value of which was stated as Rs. 9,04,10,000/- in the partition deed entered between the firm and the outgoing partner. The Ld. Assessing Officer opined that in the case of the assessee section 45(4) of the Act would be applicable and by invoking the aforesaid provisions of the Act computed the capital gain at Rs. 6,16,67,531/- being the difference between the value of the asset transferred as stated in the partition deed at Rs. 9,04,10,000/- and the indexed cost of acquisition of Rs. 2,87,42,469/-. The Ld. A.R. had objected to the addition before the Ld. Assessing Officer for the following reasons:—

‘• The term “or otherwise” as interpreted in the case of CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bom.)cannot be made applicable unless there is a transfer of capital asset by way of distribution happens in the partnership.
Only when there is a transfer of capital asset by way of distribution on the dissolution of a firm or otherwise, can the provisions of section 45(4) be invoked.
In the present case there is no distribution as envisaged by the section 45(4), since there has been no cessation of business as the other partners continue the business as a going concern after the retirement of one of them.
There can be no distribution where a running business as a going concern is taken over as pointed by the Supreme Court in Sakthi Trading Co. v. CIT in (2001) 250 ITR 871.
Reliance was also placed on the following case laws:
Puranyannur Industries v. ACIT (2010) 188 Taxman 34(Mag.)(Cochin)(Trib.) wherein it was held that on allocation of properties and goodwill to the account of the retiring partner, and constitution by remaining partners, by a new deed on next day, would not amount to dissolution of existing firm, and constitution of new firm so as to invoke provisions of section 45(4). Where some partners exist from the firm with other partners continuing the business as a going concern with accounts indicating settlement of account by credit to partners for goodwill, there can be no interference of any transfer by the firm or the exiting partners to the continuing partners there can be no liability.
Dy. Ld. CIT v. G.K. Enterprises (2001) 79 TTJ (Mad.) 82, wherein it was held by the Tribunal that the transactions as evidenced by the documents filed did not show any dissolution of firm as much has to apply the provisions of section 45(4) of the Act. It cited the decision of Gujarat H.C in CIT v. Mohanbhai Pamabhai (1973) 91 ITR 393 affirmed by the apex court reported in 165 ITR 166(SC).
It is held in the above case by the ITAT that ‘Allocation of assets of the firm to the retiring partners is the basis for invocation of provisions of section 45(4). In the case under consideration, neither there was any dissolution nor did other event take place that had an effect of allocation of exclusive interest in any capital asset to the retiring partners. In these circumstances, FAA was justified in holding that conditions of Section 45(4) were not fulfilled. In our opinion the firm or the continuing partners were not liable to be taxed under the head ‘capital gain’, as held by the FAA. Retiring partners had relinquished their rights in the assets of the firm and in lieu of that firm had paid the retiring partners money lying in their capital account. Obviously, assessee-firm had not transferred any right in capital asset to the retiring partners rather it is the retiring partners who have transferred the rights in capital assets in favour of the continuing partners. So, even if capital gain has to be taxed it has to be in the hands of the retiring partners not in the case of the assessee firm.”
The basis of arrival of the fair market value of the asset which shall be deemed to be the consideration adopted for Rs. 9,04,10,000/- has not been stated.’

5. However the Ld. Assessing Officer rejected arguments of the Ld. A.R. for the following reasons:—

“■ The case laws quoted are not at all relevant and therefore not acceptable as under :
Case law quoted Held/Discussed Reasons for rejection
Sakthi trading Co. v.CIT in (2001) 250 ITR 871 The ruling of the apex court is relating to reconstitution of firm on the death of one of the partners and relating valuation of closing stock. There is no transfer of capital asset and the case law irrelevant to this case.
Puranyannur Industriesv. ACIT (2010) 188 Taxman 34 (Mag.) (Cochin) (Trib.) There was no dissolution and no de-facto distribution of assets. The Tribunal has considered the question of dissolution and not dealt with the meaning of “otherwise”. Further there is de-facto transfer of asset.
Puranyannur Industriesv. ACIT (2010) 188 Taxman 34 (Mag.) (Cochin) (Trib.) Here again the Tribunal has considered the question of dissolution and not the meaning of “otherwise”.
Gujarat H.C in CIT v.Mohanbhai Pamabai(1973) 91 ITR 393 Case law relates to retirement of partners and with regard to share of goodwill. Both the points in question are not relevant in the instant case.
ITO v. Fine Developersin ITA No.4630 (Mum.) Discussion is relating to question of whether there is any transfer due to introduction of a new partner in a firm. Totally irrelevant to the instant case and totally misquoted.
On going through the case laws quoted by the assessee, it is found that either they are irrelevant or misquoted.
Further it has been observed by the Hon’ble ITAT, Mumbai in the case of ITO v. Fine Developers in IT A No.4630 (Mum) of 2011 that obviously assessee firm had not transferred any right in capital asset to the retiring partners rather it is the retiring partners who have transferred the rights in capital assets in favour of the continuing partners. So even if capital gain has to be taxed it has to be in the hands of the retiring partners not in the case of the assessee -firm.
In the instant case, there is a clear transfer of Schedule ‘A’ property as per the partition deed by the continuing two partners of the firm and relinquishment of Schedule ‘B’ property by the outgoing partner. Therefore, as far as the transfer of the Schedule ‘A’ property, the firm has to be taxed U/s.45(4) of the IT Act.
During the course of the above discussed written submission on 20.02.2013 it was explained to the assessee’s representative about the basis for the arrival of the deemed value of the consideration of Rs. 9,04,10,000/- being the one quoted in the partition deed entered into between the outgoing partner and the other partners of the firm. There was absolutely no dispute raised.
A letter has been issued to the Joint sub-registrar-4, Madurai to correctly ascertain about the fair market value as on the date of transfer and the reply is awaited. Necessary remedial action will be initiated in case of any difference in the value of adopted and the actual fair market value.

8. In the instant case, there is distribution of capital asset, namely, the land and building as visible from the partition deed. Further, it is held by the Hon’ble Bombay High Court in the case of CIT v. A.N. Naik Associates (2004) 265 ITR 346 as under:—

Word ‘otherwise’ used in section 45(4) takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner.
The expression ‘otherwise’ has not to be read ejusdem generis with the expression’ dissolution of a firm or body of individuals or association of persons. The expression ‘otherwise’ has to be read with the words ‘transfer of capital assets’ by way of distribution of capital assets. If so read, it becomes clear that even when a firm is in existence and there is a transfer of capital assets, it comes within expression ‘otherwise’ as the object of the amending Act was to remove the loophole which existed whereby capital gain tax was not chargeable. Therefore, when the asset of the partnership is transferred to a retiring partner, the partnership which is assessable to tax ceases to have a right or its right in the property stands extinguished in favour of the partner to whom it is transferred. If so read, it will further the object and purpose and intent of the amendment of section 45. Once that be the case, the transfer of assets of the partnership to the retiring partners would amount to the transfer of the capital assets in the nature of capital gains and business profits which are chargeable to tax U/s. 45(4). Therefore, the word ‘otherwise’ takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner.”

The Ld. A.R. had further made the following representations before the Ld. A.O:—

“The property was purchased with loan from Federal Bank, Madurai. The loan outstanding as on 31.03.2009 is Rs. 3,86,20,848/-(as per balance sheet submitted along with return of income for the assessment year 2009-10). This needs to be considered at the time of capital gain calculation if the Assessing Officer intends to tax the partition done between Mr. Biju Sundarshan and Mr. Beboy John on the one side and Mrs. Aruna Visveswar on the other side.
The loan has been agreed to be settled by the continuing partners and hence the sacrifice by the continuing partners need to be factored to the extent of loan outstanding, since the loan has been taken for the purchase of asset from Madura Coats Ltd as per the deed enclosed.”

The Ld. Assessing Officer rejected the argument of the Ld. A.R. by observing as under:—

“10. It is to be pointed out here that had there been no liability, the share of the outgoing partner on the property would be more by the proportionate value of liability which should have been brought to tax. Further, there is no provision in the Act to provide for such liability in the capital gain tax. It is only the cost of acquisition and cost of improvement which should be taken into account after the indexation, if any. Any such liability would become deductible in cases of inheritance/will, with a specific condition in it, only. But in the case of assessee firm, it is only partition of firm’s assets. As discussed supra , the share of the outgoing partner would have been more had there been no liability. Therefore, the claim of the assessee is not acceptable and rejected.

11. Therefore, in view of the foregoing discussion and applying the ratio of the judgment in the case CIT v. A.N. Naik Associates (2004) 265 ITR 346 (Bom.), I hold that the facts of this case clearly falls within the meaning of section 45(4) of the I.T. Act, 1961 and the deemed value of transfer is taken as Rs.9,04,10,000/-. ”

6. Further on appeal, the Ld. CIT (A) sustained the order of the Ld. Assessing Officer by observing as under:—

“5.26 The above decisions are on identical issue and have considered the matter holistically in a very detailed manner discussing and considering the statement of objects of Finance Act 1987 for introducing the section 45(4) taking into consideration whether partnership assets are converted to individual assets holding that provisions of section 45(4) are applicable.

The case laws cited by the Appellant, discussed earlier, are not on identical facts and also they ignored the statement of objects of Finance Act 1987 for introducing the section 45(4). In my view the decision of High Court off Bombay, Goa Bench in CIT v. A.N. Naik Associated (2004) 265 ITR 346 and ITAT Mumbai Bench ‘I’ Sudhar M. Shetty v. ACIT, Mumbai [2011] 130 ITD 197(Mum.) are directly applicable to the present case. Following above two decisions it is held that provisions of section 45(4) are applicable as there is conversion of partnership assets into the individual assets.

5.27 It is held that the decision of the Assessing Officer on this issue is in order. Objects of the appellant on this issue are rejected.

6. What is the consideration to be adopted : The next objection relates adopting Rs. 9,04,10,000/- as the consideration while computing capital gains. As discussed by the A.O a partition deed was entered in which the value of land and building allotted to M. Aruna Vishweshwar was recorded as Rs. 9,04,10,000. The Assessing Officer has also written to the sub-registrar about the value which was not received. He chose to adopt this value.

6.1. Appellant objected as under:

Merely based on the number mentioned in the partition deed, which is the value of the property as per the provisions of the Income Tax Act 1961. Since the Assessing Officer has written a letter had to the Joint Sub-Registrar Madurai to ascertain he fair market value as on the date of transfer. He however proceeded with the value as partition deed.

In case the value adopted by the appellant was on the lower side the Assessing Officer would have raised the value of the computation based on the fair market value. Hence the Ld. Assessing Officer failed to compute the capital gain as envisaged in section 48 of the Income tax and since the computation fails the assessment order needs be quashed.

The prop consists of land and building and the same was depreciated in the books of account and hence the computation of land and building needs to be separate and cannot be taken as a consolidated figure. Hence in the instant case the computation of the capital gain is incorrect and is liable to be recomputed on actual basis.

6.2 As per the provisions of section 45(4), the fair market value of the prop should be adopted as the deemed consideration. It is pertinent here to note that the figure of Rs.9,04,10,000/- was adopted by the Assessing Officer as the Fair Market Value since this is mentioned in the partition deed dated 02.06.2008 entered into between the outgoing partner and the other partners of the firm as the value of property agreed by all the partners. What else can be relied more than this? Of course the only other option is that Assessing Officer has written to the Joint Sub-registrar-4, Madurai about the value of the property the reply to make sure that this is not less than the market value as per the sub registrar. The value was not received at the time of conclusion of assessment and hence A.O adopted the value which is scientific and backed by evidence filed by the appellant. There is no merit in appellant’s arguments and are rejected.”

7. Moreover on the issue with respect to loan taken from Federal Bank, which was to be settled by the continuing partners that need to be factored while computing capital gain of the assessee was also decided against the assessee by the Ld. CIT (A) thereby sustaining the order of the Ld. Assessing Officer.

8. Before us, the Ld. A.R. reiterated the submissions made before the Revenue on either occasions and also heavily relied in the decision of the Chennai Bench of the Tribunal in the case Asstt. CIT v. Goyal Dresses [2010] 126 ITD 131 which was confirmed by the Hon’ble Jurisdictional Madras High Court vide order dated 20.8.2013 in Tax Appeal No.222 of 2013, 84 of 2009 & 88 of 2010. However, we find the decision of the Goyal Dresses case (supra ) not applicable to the case of the assessee because that case relates to family arrangement which is not the case of the assessee before us. Ld. D.R on the other hand relied on the orders of the Revenue.

9. We have heard both the parties and carefully perused the materials available on record. The case of the assessee is very simple. During the year under consideration the assessee firm was reconstituted wherein one of the partners Mrs. Aruna Visvewar had retired and therefore reconstituted partnership deed was drawn on 30.5.2008 whereby the assessee firm has transferred one of its immovable asset being land to the retiring partner Mrs. Aruna Visvewar valued at Rs. 9,04,10,000/- as mentioned in the partition deed entered between the firm and the outgoing partner. The question that arises before us is whether the transfer of land belonging to the firm to the retiring partner is liable to be taxed under the head “capital gains ” and if so in whose hands. It is pertinent to mention here that the transfer of the asset is by the firm which is a “legal entity” to the retiring partner another distinct legal entity being an “individual”. Therefore, it is crystal clear that capital gain will arise in the hands of the transferor viz. the assessee firm and not the transferee viz. the retiring partner Mrs. Aruna Visvewar. Provisions of section 45(4) of the Act are reproduced herein below for reference:—

“Section 45(4):- The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place, and for the purpose of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.”

The words “or otherwise” have been elaborately explained in the following decisions:—

(i ) Asstt. CIT v. D.D. International (Global) [2009] 125 TTJ 112 (Asr.)

The word ‘otherwise’, used in section 45(4) is not to be read ejusdem generis with dissolution of firm or AOP. The expression ‘otherwise’ has to be read with the words ‘transfer of capital asset’ by way of distribution of capital assets on the dissolution of a firm. The word ‘otherwise’ in section 45(4) takes within its sweep not only cases of dissolution but also cases of subsisting partners of a partnership transferring assets to retiring partners.

(ii ) New Gujarat Tin Printing Works v. ITO [2010] 8 taxmann.com 24/[2011] 128 ITD 182 (Ahd.)

The word ‘otherwise’ as occurring in section 45(4) covers a situation, where the capital asset of the firm is distributed to its partners otherwise than on dissolution of the firm.

(iii ) CIT v. A.N. Naik Associates [2004] 136 Taxman 107/265 ITR 346 (Bom.)

The expression ‘otherwise’ has not to be read ejusdem generis with the expression’ dissolution of a firm or body of individuals or association of persons. The expression ‘otherwise’ has to be read with the words ‘transfer of capital assets’ by way of distribution of capital assets. If so read, it becomes clear that even when a firm is in existence and there is a transfer of capital assets, it comes within expression ‘otherwise’ as the object of the amending Act was to remove the loophole which existed whereby capital gain tax was not chargeable. Therefore, when the asset of the partnership is transferred to a retiring partner, the partnership which is assessable to tax ceases to have a right or its right in the property stands extinguished in favour of the partner to whom it is transferred. If so read, it will further the object and purpose and intent of the amendment of section 45. Once that be the case, the transfer of assets of the partnership to the retiring partners would amount to the transfer of the capital assets in the nature of capital gains and business profits which are chargeable to tax U/s. 45(4). Therefore, the word ‘otherwise’ takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner.

(iv ) Burlingtons Exports v. Asstt. CIT [1993] 45 ITD 424 (Bom.)

The words ‘or otherwise’ are used as an alternate to the words ‘on dissolution’ and therefore in both the situations, i.e., on dissolution or otherwise, the distribution of a capital asset is a must.

From the above it is crystal clear that Section 45(4) of the Act mandates the assessee firm to be liable for capital gain tax arising out of the transfer of its asset to the retiring partner even in the circumstance when the partnership is reconstituted on retirement of a partner. Further, the loan taken by the assessee firm for purchase of the asset which is transferred cannot be factored because the loan does not alter the cost of the assets purchased or the value of the asset transferred to the transferee. Therefore we do not have any hesitation to confirm the order of the Ld. CIT (A) as well as the order of the Ld. Assessing Officer.

10. In the result, the appeal of assessee is dismissed.

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