Amount received by partner above capital account liable to tax as capital gains : ITAT

By | July 9, 2019
(Last Updated On: July 9, 2019)

IN THE ITAT BANGALORE BENCH ‘C’

Savitri Kadur

v.

Deputy Commissioner of Income-tax, Circle-9 (1), Bengaluru

N.V. VASUDEVAN, VICE-PRESIDENT
AND JASON P. BOAZ, ACCOUNTANT MEMBER

IT APPEAL NO. 1700 (BANG.) OF 2016
[ASSESSMENT YEAR 2008-09]

MAY  3, 2019

Padamchand Khincha, CA for the Appellant. Dr. Pradeep Kumar, Addl. CIT (DR) for the Respondent.

ORDER

N.V. Vasudevan, Vice President. – This is an appeal by the by the assessee against order dated 4/8/2016 of CIT, Bengaluru-2, Bengaluru relating to asst. year 2008-09.

2. The only issue that arises for consideration in this appeal is as to whether the Revenue authorities were justified in treating sum of Rs.11,61,800/- as capital gains chargeable to tax which sum was received by the assessee on his retirement from a partnership firm by name M/s PSI Hydraulics.

3. The facts and circumstances under which aforesaid issue arises for consideration are that the Assessee and one D. Venkatesh formed a Partnershi by a deed of partnership dated 1.4.2004. Miss. Suvidha Venkatesh, D/O. D. Venkatesh was inducted as partner in the firm w.e.f. 1.4.2007. On 8.6.2007 an MOU was signed by the three partners and it was agreed that the Assessee would retire from the firm w.e.f. 1.4.2007 and a sum of Rs.339.50 lakhs would be paid to the Assessee. On 9.6.2007 deed of retirement was signed. The Assessee gave up all her rights as partner of the firm and its assets nor was the Assessee liable to pay any of its liabilities. The capital account of the Assessee as on 1.4.2006 showed an opening balance of Rs.1,64,14,044. Profit for the year of Rs.46,20,591 was credited to his account. Similarly on revaluation of the land and building on 15.1.2007, a sum of Rs.53,26,462 and Rs.9,24,650 respectively was credited to her account. Another sum of Rs.18,12,528 was also credited as interest on capital in her capital account. After reducing the Partner’s drawing and other payments made the balance to the credit of Assessee’s capital account was Rs.2,77,88,200/-. The difference between the sum of Rs.3,39,50,000 and the sum of Rs.2,77,88,200 viz., a sum of Rs.61,61,800 was taxed as capital gain by the AO. The Assessee had invested a sum of Rs.50 lacs in specified bonds and therefore the AO allowed deduction upto Rs.50 lacs and brought to tax Rs.11,61,800/- as Long term capital gain. The AO was of the view that sum of Rs.61,61,800/- was liable to be taxed as capital gain for the following Reasons:—

“The amount received from the erstwhile firm is nothing but Goodwill which attracts liability of Capital Gains u/s 45.Amount paid to the retiring partner towards goodwill would represent amount paid for her giving up of her right in existing goodwill of the firm and the existing goodwill is, by and large self generated. Further, the assessee has also extinguished her right to claim any share in the fixed assets of the partnership firm. The overall effect of the consent terms(MOU) is that, they provide for the retirement of the assessee from the partnership by way of compensation. There is, in the consent terms (MOU) a clause providing for the assignment of the assessees’ share in the partnership to the continuing partners. Thus, there was a transfer by the assessee within the meaning of Section 2(47) and the liability to Capital Gains exists. When the partnership firm paid lump-sum amount to the retiring partner, it is paid in consideration of her retirement in the partnership and assignment of her interest to other partners, the transaction would amount to transfer u/s 2(47) of the IT Act. Referring to the MOU, it was held that there was a transfer and hence liable to tax under the provisions of Sec 45 of the IT Act. The judicial pronouncements stated above would support the taxability of Goodwill under the provisions of Sec 45 of the IT Act.

However, the assessee had also invested Rs.50,00,000/- in Rural Electrification Corporation Ltd under the provisions of Sec 54 EC as an abundant caution for claiming exemption u/s 54EC. After considering the investment of Rs. 50,00,000/- the Capital Gains is worked out as under. (61,61,800/- (-) 5000000/- = 11,61,800/-)”

4. Accordingly the AO brought to tax a sum of Rs.11,61,800/- as chargeable capital gains.

5. Aggrieved by the aforesaid order of the AO, assessee preferred an appeal before the CIT(A). Before the CIT(A), the assessee relied on the decision of the Hon’ble Supreme Court in the case of Addl. CIT v. Mohanbhai Pamabhai [1987] 165 ITR 166 for the proposition that the amount received by a partner on his retirement from a firm is his share in the partnership firm and not for consideration in transfer of his inters in the partnership to the other partners. There was no transfer of interest in assets of the partnership firm in terms of the definition of the term transfer u/s 2(47) of the Act. Therefore there was no capital gain that could be brought to tax in the hands of the assessee. Before CIT(A) assessee also gave a breakup of his payments made to the assessee which was as follows:—

(i) Amount outstanding in her capital account as on 31.3.2007Rs.2,77,88,200/-
(ii) Good will paid during AY 2008-09Rs. 21,64,800/-
Good will paid during AY 2009-10Rs. 39,97,000/–
Rs. 61,61,800/-
Rs.3,39,50,000/-

5.1 It can be seen from the aforesaid submission of the Assessee that the difference between the sum payable to the Assessee on retirement and the sum shown as credit in the capital account of the Assessee viz. a sum of Rs.61,61,800/-is being claimed by the Assessee to be Goodwill. Neither in the MOU or in the Deed of reconstitution there is a reference to Goodwill. Only a sum of Rs.38,38,200/- has been shown as Goodwill in the books of the Assessee and also in the capital account of the Assessee. The assessee also placed reliance on the decision of the Hon’ble Karnataka High Court in the case of CIT v. Dynamic Enterprises [2013] 359 ITR 83/[2014] 223 Taxman 331/40 taxmann.com 318 (Kar). The CIT(A) however placed reliance on the decision of the Hon’ble Bombay High Court in the case of CIT v. A.N Naik Associates , [2014] 265 ITR 346 wherein the Hon’ble Bombay High Court took the view that u/s 45(4) of the Act there would be charge to the capital gains tax when the assets of the partnership is transferred on a retiring partner and it is not necessary that there should be distribution of assets of the firm only on dissolution of the firm. Following the ratio laid down, the aforesaid decision the ld CIT(A) took the view that the action of the AO in bringing to tax capital gains on retirement of the assessee from the partnership firm was correct.

6. Aggrieved by the aforesaid order of the CIT(A), the assessee has preferred the present appeal before the Tribunal.

7. We have heard the rival submission. The learned DR as well as the learned Counsel for the Assessee primarily placed reliance on several decided cases. We shall deal with those cases at the appropriate juncture.

8. To appreciate the rival contentions we have to refer to certain provisions of the Income-tax Act, 1961. Section 45(1) of the Act brings to tax any capital gain that accrues or arises on transfer of a capital asset. The capital gain is charged to tax in the previous year in which the transfer takes place. Section 2(47) defines what is transfer and it reads as follows :

(47) “transfer”, in relation to a capital asset, includes,—

(i)the sale, exchange or relinquishment of the asset; or
(ii)the extinguishment of any rights therein; or
(iii)the compulsory acquisition thereof under any law; or
(iv)in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment;
(v)any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882); or
(vi)any transaction (whether by way of becoming a member of or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.

Explanation. – For the purposes of sub-clauses (v) and (vi), “immovable property” shall have the same meaning as in clause (d) of section 269UA;

9. Capital asset has been defined in section 2(14) of the Act, as meaning “Property” of any kind held by the assessee, whether or not connected with his business or profession. The above exhaustive definition is subject to the following exclusions like stock-in-trade, consumable stores or raw material held for the purpose of business or profession, personal effects agricultural land in India, certain Gold bonds, special bearer bonds and Gold deposit bonds.

10. The share or interest of a partner in the partnership and its assets would be property and, therefore, a capital asset within the meaning of the aforesaid definition. To this extent, there can be no doubt.

11. The question is as to whether it can be said that there was a transfer of capital asset by the retiring partner in favour of the firm and its continuing partners so as to attract a charge under section 45 of the Act.

12. A look at how formation and dissolution of partnership was used as a device to evade tax on capital gains to convert an asset held individually into an asset of the firm in which the individual is a partner and conversion of capital assets into individual assets on dissolution or otherwise, is necessary. Partnership as a form of carrying on business evolved so that two or more persons can to join together by pooling resources in the form of capital and expertise.

1. Conversion of individual Assets into Asset of Partnership:

13. One of the devices used by assessee to evade tax on capital gain was to convert an asset held individually into asset of the firm in which the individual as a partner. A partner can bring asset owned by him as his capital contribution. The intention to treat own property as property of the firm can be inferred even by book entries in the firm. No document registered or otherwise is required for doing so. Such introduction of capital asset as capital contribution by a partner up to 1-4-1988 did not result in incidence of capital gain. It was so held by the Hon’ble Supreme Court in the case of Sunil Sidharthbhai v. CIT [1985] 56 ITR 509 The Hon’ble Supreme Court held that under the Income-tax Act, 1961, where a partner of a firm makes over capital assets which are held by him to a firm as his contribution towards capital, there is a transfer of a capital asset within the terms of section 45 of the Act, because an exclusive interest of the partner in personal assets is reduced, on their entry into the firm, into a share interest. On such introduction of capital the partner’s capital account is credited with the market value of the property. Such entry does not represent the true value of 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 date of dissolution or retirement. It is not possible to predicate before hand what will be the position in terms of monetary value of a partner’s share on that date. At that time when the partner transfers his personal asset to the partnership firm, there can be no reckoning of the liabilities and losses which the firm may suffer in the years to come. All that lies within the womb of the future. It is impossible to conceive of evaluating the consideration acquired by the partner when he brings his personal asset into the partnership firm when neither can the date of dissolution or retirement be envisaged nor can there be any ascertainment of liabilities and prior charges which may not have even arisen yet. Therefore, the consideration which a partner acquires on making over his personal asset to the firm as his contribution to its capital cannot fall within the terms of section 48 of the Act. And as that provision is fundamental to the computation machinery incorporated in the scheme relating to the determination of the charge provided in section 45, such a case must be regarded as falling outside the scope of capital gains taxation altogether. Parliament with the avowed object of blocking this escape route for avoiding capital gains tax by the Finance Act, 1987, introduced sub-section (3) to section 45 with effect from 1-4-1988. The effect of this was that the profits and gains arising from the transfer of a capital asset by a partner to a firm are chargeable as the partner’s income of the previous year in which the transfer took place and the amount recorded in the books of account of the firm, shall be deemed to be the full value of consideration received or accruing as a result of transfer of the capital asset.

14. It is important to note that the incidence of tax is on the Partner brining in capital because he converts or transfers his individual asset into asset of the firm or to the firm.

2. Distribution of Assets on Dissolution

15. In the case of dissolution where partners are allotted capital assets of the firm, it was held that there was no transfer. In Malabar Fisheries v. CIT [1979] 120 ITR 49 (SC), the Hon’ble Supreme Court has explained the nature of distribution of assets of a partnership on dissolution amongst its partners and as to whether such distribution of assets would constitute transfer within the meaning of section 2(47) of the Income-tax Act as follows :

“A partnership firm under the Indian Partnership Act, 1932 is not a distinct legal entity apart from the partners constituting it and equally in law the firm as such has no separate rights of its own in the partnership assets and when one talks of the firm’s property or firm’s assets all that is meant is property or assets in which all partners have a joint or common interest. If that be the position it is difficult to accept the contention that upon dissolution the firm’s rights in the partnership assets are extinguished. The firm as such has no separate rights of its own in the partnership assets but it is the partners who own jointly by or in common the assets of the partnership and, therefore, the consequence of the distribution, division or allotment of assets to the partners which flows upon dissolution after discharge of liabilities is nothing but a mutual adjustment of rights between the partners and there is no question of any extinguishment of the firm’s rights in the partnership assets amounting to a transfer of assets within the meaning of section 2(47) of the Act. Further, it is necessary that the sale or transfer of assets must be by the assessee to a person. Now every dissolution must in point of time be anterior to the actual distribution, division or allotment of the assets that takes place after making up accounts and discharging the debts and liabilities due by the firm. Upon dissolution the firm ceases to exist, then follows the making up of accounts, then the discharge of debts and liabilities and thereupon distribution, division or allotment of assets takes place inter se between the erstwhile partners by way of mutual adjustment of rights between them. The distribution, division or allotment of assets to the erstwhile partners, is not done by the dissolved firm. In this sense there is no transfer of assets by the assessee (dissolved firm) to any person.”

16. To plug this loophole the Finance Act, 1987, brought on the statute book a new sub-section (4) in section 45 of the Act, with effect from 1-4-1988, which reads as follows:

“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 purposes 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.”

17. Before the introduction of sub-section (4) to section 45, there was clause (ii) of section 47 which read as under:

‘Transactions not regarded as transfer.

47. Nothing contained in section 45 shall apply to the following transfers:—

“(ii) any distribution of capital assets on the dissolution of a firm, body of individuals or other association of persons;”‘

18. Clause (ii) omitted by the Finance Act, 1987, w.e.f. 1-4-1988. Prior to omission of Sec.47(ii) of the Act, distribution of capital assets on dissolution of a firm, body of individuals or other Association of persons, would be regarded as transfer of a capital asset but by virtue of provisions of Sec.47(ii) of the Act, there was no charge to tax of the capital gain on such transfer.

19. It is important to note that here the incidence of tax is on the Partnership firm because it is the firms asset which is getting converted into asset of the transferee.

3. The firm continues and there is reconstitution whereby a partner retires and the retiring partner is allotted capital asset of the firm for relinquishing all his rights, interest in the partnership firm as partner.

20. The above two circumstances cover only bringing in individual assets as asset of the firm and the firm distributing its capital assets on distribution. The third case would be where the firm continues and there is reconstitution whereby a partner retires and the retiring partner is allotted capital asset of the firm for relinquishing all his rights, interest in the partnership firm as partner. In such a scenario also there is a distribution of capital asset by the firm to the partner otherwise than on dissolution and such cases are covered by the ruling of the Hon’ble Bombay High Court in the case of A.N. Naik Associates (supra) The facts of the case before the Hon’ble Bombay High Court was that by the memorandum of family settlement, dated 30-1-1997, it was agreed between the parties thereto, that the business of six firms as set out therein would be distributed in terms of the family settlement as the parties desired that various matters concerning the business and assets thereto be divided separately and partitioned. Under the terms and conditions of the settlement, it was set out that the assets which were proposed to be divided in partition under the settlement were held by the aforesaid firms and individual partners. With reference to the firms, the manner in which the firms were to be reconstituted by retirement and admission of new partners was also set out. It also provided that such of those assets or liabilities belonging to or due from any of the firms allotted to parties thereto in the schedule, would be transferred or assigned irrevocably and possession made over and all such documents, deeds, declarations, affidavits, petitions, letters and alike as were reasonably required by the party entitled to such transfer would be effected. Pursuant to the said family settlement, there was a deed of reconstitution of various partnerships as set out under the family settlement. For the relevant assessment year 1997-98, the Assessing Officer taxed the partnerships for capital gains under section 45(4). On appeal, the appellate authority upheld the impugned order. On second appeal, the Tribunal held that there was no dissolution but only reconstitution. It also held that the expression ‘otherwise’ in section 45(4) has to be read ejusdem generis and would contemplate situations like a deemed dissolution. It, accordingly, held that the business continued to be run and there was no dissolution of the firm and, consequently, section 45(4) was not attracted. On further appeal by the Revenue, the Hon’ble Bombay High Court held that the expression ‘otherwise’ used in Sec.45(4) of the Act, 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 the 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 under section 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. Even in this situation it is only the firm that is liable to tax and not the transferee.

4. The firm continues and there is reconstitution whereby a partner retires and the retiring partner is paid ;

(a)on the basis of amount lying in his/her capital account
(b)on the basis of amount lying in his/her capital account + amount over and above the sum lying in his/her capital account.
(c)or a lump sum consideration with no reference to the amount lying in his/her capital account.

in consideration for relinquishing all his rights, interest in the partnership firm as partner.

21. The situation involved in the present appeal, is a case where the Assessee was paid sums over and above the sum standing to the credit of his capital account i.e., situation (b) referred to above. As far as situation (a) is concerned, there cannot be any dispute that there can be no incidence of tax and the principle laid down by the Hon’ble Supreme Court in the case of Mohanabai Pamabai (supra) would continue to apply.

22. As far as situation (b) & (c) are concerned, this situation has been subject matter of consideration in several cases and there is conflict of opinion amongst Courts on whether there would be incidence of tax or not. We also make it clear that the fact that there was revaluation of the assets of the firm and resultantly the capital account of the firm stood enhanced is also not relevant. What is the credit in the capital account of the partner alone has to be seen. So long as there is no prohibition on revaluation of assets of the firm and there are no tax incidence on revaluation of assets of the firm, the credit to the partners capital account on revaluation cannot be looked at adversely.

23. Capital asset has been defined in section 2(14) of the Act, as meaning “Property” of any kind held by the assessee, whether or not connected with his business or profession. The above exhaustive definition is subject to the following exclusions like stock-in-trade, consumable stores or raw material held for the purpose of business or profession, personal effects agricultural land in India, certain Gold bonds, special bearer bonds and Gold deposit bonds. The share or interest of a partner in the partnership and its assets would be property and, therefore, a capital asset within the meaning of the aforesaid definition. The next question is as to whether it can be said that there was a transfer of capital asset by the retiring partner in favour of the firm and its continuing partners so as to attract a charge under section 45 of the Act.

24. The Hon’ble Bombay High Court had an occasion to deal with identical case as that of the Assessee in the present case which was a case of situation (b) referred to earlier in Tribhuvandas G.Patel v. CIT [1978] 115 ITR 95 (Bom.) In the case of Tribhuvandas G. Patel (supra), the assessee was a partner in the firm of KEW. The assessee had served on the other two partners a notice of dissolution of the firm with effect from 31-12-1960, which was not accepted by the other partners. The assessee, therefore, filed a suit for dissolution and accounts, but, ultimately, the disputes between the parties were amicably settled out of court and under a deed dated January 19, 1962, the assessee retired from the firm with effect from 31-8-1961, and the remaining partners continued to carry on the business of the firm. On the occasion of such retirement, the assessee was paid: (1) 1 lakh as his share of profits of the firm for the broken period ended 31-8-1961, (2) Rs. 50,000 as his share of the value of the goodwill, and (3) Rs. 4,77,941 as his share in the remaining assets of the firm. The issue with regard to taxability of the sum of Rs. 4,77,941 or any part thereof to capital gains tax arose for consideration before the Hon’ble Court. The Hon’ble Court took up for consideration as to what is the real nature of the transaction when a partner retires from the partnership. Does the transaction amount to any relinquishment of his share or interest in the partnership in favour of the continuing partners, or does it stand on the same footing as an adjustment of his rights that results upon dissolution of the partnership. On behalf of the assessee it was contended that retirement of a partner and quantification of his share and payment thereof to him stands on the same footing as adjustment of rights that results upon dissolution of a firm and, therefore, since there was no transfer of any capital asset in the instant case, the sum of Rs. 4,77,941 or any part thereof was not liable to be charged under the head “Capital gains”. This was not accepted by Hon’ble Bombay High Court and they held that a clear distinction exists between retirement of a partner from a firm and dissolution of the firm. In the case of retirement of a partner from the firm it is only that partner who goes out of the firm and the remaining partners continue to carry on the business of the partnership as a firm, while in the case of dissolution of the firm as such no more exists and the dissolution is between all the partners of the firm. Thereafter the Hon’ble Court held that where accounts are taken and the partner is paid the amount standing to the credit of his capital account there would be not transfer. If, on the other hand, the partner is paid a lump sum consideration for transferring or releasing his interest in the partnership assets to the continuing partners then there would be an element of transfer. The Hon’ble Court held that what one has to see is whether the terms of the deed of retirement constitutes release of any assets of the firm in favour of the continuing partners. Having regard to the particular mode employed by the assessee and the continuing partners to effect and bring about retirement of the assessee from the partnership, the Court held that the transaction will have to be regarded as amounting to “transfer” within the meaning of section 2(47) of the Income-tax Act, inasmuch as the assessee could be said to have assigned, released and relinquished his interest and share in partnership and its assets in favour of the continuing partners and the transaction cannot be regarded as amounting to any distribution of capital assets upon dissolution of a firm. The above decision was followed by the Hon’ble Bombay High Court in the other two cases of N.A. Modi v. CIT [1986] 162 ITR 420 and CIT v. H.R. Aslot [1978] 115 ITR 255 (Bom.).

25. As against the decision of the Hon’ble Bombay High Court in the case of Tribhuvandas G. Patel (supra) the Assessee preferred appeal before the Hon’ble Supreme Court and the Hon’ble Supreme Court in the case of Thirubhuvandas G. Patelv. CIT [1999] 236 ITR 515 framed three questions of law for consideration and the following two questions (Question No.2 & 3) which are relevant for the present case were decided as follows:

“2. Whether, on the facts and in the circumstances of the case, the sum of Rs. 50,000 received by the assessee as his share of the value of the goodwill or any part thereof was liable to tax as capital gain?

3. Whether, on the facts and in the circumstances of the case, the sum of Rs. 4,77,941 or any part thereof was liable to tax as capital gain by reason of section 47(ii) of the Act?”

So far as question No. 2 is concerned, it has already been answered in favour of the assessee. In view of the decision of this court in CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294 the said question must be held to have been rightly answered in favour of the assessee.

So far as question No. 3 is concerned the assessee invoked clause (ii) of section 47 to contend that the said sum of Rs. 4,47,941 does not represent a capital gain. Mr. Sharma, learned counsel for the appellant-assessee, has brought to our notice the decision of this court in Addl.CIT v. Mohanbai Pamabhai [1987] 165 ITR 166 where it has been held, following the decision in Sunil Siddharthbhai v. CIT [1985] 156 ITR 509 (SC), that even where a partner retires and some amount is paid to him towards his share in the assets, it should be treated as falling under clause (ii) of section 47. Therefore, following this decision, this question has to be and is answered in favour of the assessee and against the Revenue.”

26. The decision in the case of Tribhuvandas G. Patel (supra) is a case where the deed of reconstitution specifically referred to release of rights of the outgoing partners in the assets of the partnership and further the fact that a specified sum over and above the sum standing to the credit of the partner’s capital account was paid to the retiring partner, which excess sum was attributed to the retiring partner giving up his rights over the properties of the firm. It is only because of the provisions of Sec.47(ii) of the Act that the Hon’ble Court held that there was no incidence of tax on capital gain on the transaction.

27. The decision will therefore have to be viewed as not applicable to cases after the amendment to the law w.e.f. 1-4-1989 whereby Sec.47(ii) of the Act was deleted and simultaneously Sec.45(3) & 45(4) were introduced.

28. Therefore the question whether there will be incidence of tax on capital gain on retirement of a partner from the partnership firm would depend on the upon mode in which retirement is effected as laid down by the Hon’ble Bombay High Court in the cases of Tribhuvandas G. Patel (supra) and N.A. Modi’s case (supra). Therefore the decision of the ITAT Mumbai in the case of Sudhakar M. Shetty v. Asstt. CIT [2011] 130 ITD 197 (Mum.) following the decision of the Pune Bench of the ITAT in the case of Shevantibhai C. Mehta v. ITO [2004] 4 SOT 94 holding that question of taxability of an amount received by a partner on retirement from firm would depend upon mode in which retirement is effected, holds good. Therefore taxability in such situation would depend on several factors like the intention as is evidenced by the various clauses of the instrument evincing retirement or dissolution, the manner in which the accounts have been settled and whether the same includes any amount in excess of the share of the partner on the revaluation of assets and other relevant factors which will throw light on the entire scheme of retirement/reconstitution.

29. In the case of Sudhakar M.Shetty (supra), the ITAT came to the conclusion after taking into consideration the sequence of events in that case (Paragraph-40 of the said order) which lead to ultimately the partner retiring from the firm. A Partnership firm in that case came into existence on 1.8.2005 between the Assessee and another as partners. On 16.9.2005 another partner joined the partnership. On 23.9.2005 the firm purchased a property for a consideration of Rs.6.5 Crores with 81 tenants therein to be vacated by the firm. On 26.9.2005 two more partners were inducted into the Partnership firm. On 8.3.2006 a sanction was obtained for setting up a 5 Star hotel over the property purchased by the firm. Thereafter On 26.3.2006 one partner retired from the firm. Prior to such retirement a revaluation of the assets of the firm which was the land that was purchased by the firm took place. There was surplus of Rs.154,39,90,000/- on revaluation. This was credited in the profit-sharing ratio of the partners in their respective capital account. Thereafter on 22.5.2006, the Assessee retired from the partnership firm. The amount standing to the credit of the Assessee’s capital account was Rs.4.45 Crores on which interest of Rs.26,85,963 was paid and profit on revaluation of land at Rs.30,87,98,087/-was also credited. Thus a sum of Rs.35,59,84,050 was standing to the credit of the Assessee’s capital account as on 31.3.2006. As per the deed of retirement the Assessee was paid the sum standing to the credit of his capital account and he gave up all his rights as partners and also over the property that the firm had purchased. All these factors were cumulatively considered as nothing but an act by which the Assessee gave up his rights over the property of the firm and therefore the sum of Rs.30,87,98,087/- (gain on valuation of the property of the firm) was construed as a capital gain for giving up rights over the property of the firm liable to tax on capital gain. In such a scenario one has to construe the act of giving up or relinquishing rights as partner as transfer of capital asset and the capital gain will be the sum paid over and above the sum standing to the credit in the capital account.

30. It can be seen from the facts of the case of Sudhakar M. Shetty (supra), the revaluation of the assets took place in AY 2006-07. The Assessee Sudhakar M.Shetty retired in AY 2007-08 and what was taxed was virtually the sum credit to his capital account consequent to revaluation of assets that took place in AY 2006-07. As we have already observed it should not be taken that the revenue has taxed the gain on revaluation of assets. All cumulative factors will have to be seen to come to a conclusion regarding the real nature of gain before concluding that there was in fact capital gain on relinquishment of right as partner in the firm.

31. Keeping in mind the legal position as set out in the earlier paragraphs, let us examine the facts of the present case. The facts of the case are almost identical to the facts in the case of Sudhakar M.Shetty (supra). The Assessee and D.Venkatesh formed a Partnershi by a deed of partnership dated 1.4.2004. Miss.Suvidha Venkatesh, D/O.D.Venkatesh was inducted as partner in the firm w.e.f. 1.4.2007. On 8.6.2007 an MOU was signed by the three partners and it was agreed that the Assessee would retire from the firm w.e.f. 1.4.2007 and a sum of Rs.339.50 lakhs would be paid to the Assessee. On 9.6.2007 deed of retirement was signed. The Assessee gave up all her rights as partner of the firm and its assets nor was the Assessee liable to pay any of its liabilities. The capital account of the Assessee as on 1.4.2006 showed an opening balance of Rs.1,64,14,044. Profit for the year of Rs.46,20,591 was credited to his account. Similarly on revaluation of the land and building on 15.1.2007, a sum of Rs.53,26,462 and Rs.9,24,650 respectively was credited to her account. Another sum of Rs.18,12,528 was also credited as interest on capital in her capital account. After reducing the Partner’s drawing and other payments made the balance to the credit of Assessee’s capital account as on 31.3.2007 was Rs.2,77,88,200/-. On 9.6.2007 the Assessee’s was paid Rs.38,38,200 towards Goodwill and another sum of Rs.2,39,00,000/- being part of the consideration of Rs.339.50 lacs payable on retirement. The difference between the sum of Rs.3,39,50,000 and the sum of Rs.2,77,88,200 viz., a sum of Rs.61,61,800 was taxed as capital gain by the AO. Out of the above, Rs.38,38,200 was Goodwill. Therefore to the extent of Rs.2,77,88,200 being closing balance as on 31.3.2007 in the capital account and Rs.38,38,200/- being Goodwill, was the sum payable as per the capital account of the Assessee. The claim of the Assessee that the entire sum of Rs.61,61,800 is Goodwill is not substantitated by entries in the books of accounts of the Assessee and the book entries are only for Rs.38,38,200/- recorded in the Assessee’s capital account as well as Goodwill Account. The capital gain therefore would be Rs.339.50 lacs minus Rs.2,77,88,200 + 38,38,200 = Rs.23,23,600/-. The Assessee had invested a sum of Rs.50 lacs in specified bonds and therefore the AO allowed deduction upto Rs.50 lacs. Therefore there would no capital gain which is chargeable to tax.

32. With regard to case laws cited on behalf of the Assessee, they are as follows:

1Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 (SC)93-101
2Mohanbhai Pamabhai (supra)102
3CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393 (Guj)103-111
4CIT v. Legal Representatives of N Paliniappa Gounder [1983] 143 ITR 343 (Mad.)112-115
5CIT v. P.H Patel [1988] 171 ITR 128 (A.P)116-121
6CIT v. Madan Lal Bhargava [1980] 122 ITR 545 (All.)122-125
7Addl. CIT v. Sri Mahinderpal Bhasin [1979] 117 ITR 26 (All.)126-129
8CIT v. Krishnamoorthy [1998] 229 ITR 559 (Mad.)130-132
9CIT v. L Raghu Kumar [1983] 141 ITR 674 (A.P)133-136
10CIT v. Lingmallu Raghukumar [2001] 247 ITR 801 (SC)137-138
11Tribhuvandas G Patel (supra)139-141
12CIT v. P.N Panjawani [2012] 356 ITR 676 (Karn.)142-152
13CIT v. G Seshagiri Rao [[1995] 213 ITR 304 (A.P)153-155
14Asstt. CIT v. Unity Care & Health Services [2006] 103 ITD 53 (Bang.)156-162
15ITO v. Prabhuraj B Appa [2006] 6 SOT 415 (Bang.)163-165
16CIT v. Dynamic Enterprises[2013] 359 ITR 83 (Kar.)166-176
17Asstt. CIT v. P Sivakumar [2014] (Chennai – Trib.)177-181
18Prashant S Joshi and Dattaram Shridhar Bhosale v. ITO [2010] 324 ITR 154 (Bom.)182-188
19CIT v. J.P Devadhar and M.S Sanklecha [2014] (Bom.)189-190
20Sharadha Terry Products Ltd. v. Asstt. CIT [2016] 68 taxmann.com 282 (Chennai – Trib.)191-220
21CIT v. A.N Naik Associates [2004]265 ITR 346 (Bom.)221-229
22Smt. Girija Reddy v. ITO [2012]52 SOT 113 (Hyd.) (URO)230-245

In addition to the above cases the learned counsel for the Assessee also placed reliance on the decision of the Third Member case of ITAT Mumbai Bench in the case of D.S. Construction v. ITO [IT Appeal No.3526 & 2527/Mum/2018 dated 10.1.2019], and the decision of ITAT Mumbai in the case of JamesP.D’ Silva v. Dy. CIT [2019] 197 ITD 533 (Mum.).

33. Cases at Sl.No.1 to 11 & 13 are cases prior to the amendment of the law w.e.f. 1-4-1989 and some of these cases have already been discussed and we have held that cases after 1.4.1989 have to be decided on different parameters. As far as case law at Sl.No.12 in the case of P.N. Panjawani (supra) is concerned it was a case of induction of partners and therefore not relevant to the present case. Case at Sl.No.14 in the case of Unity Care & Health Services (supra) is a case of conversion of firm into a company which are governed by specific provisions and therefore not relevant to the present case. Case at Sl.No.15 in the case of Prabhuraj B. Appa (supra) is a case of receipt of consideration on account of goodwill and therefore to that extent this aspect has been discussed and held in favour of the Assessee in the earlier paragraphs. Case law at Sl.No.16 & 21 in the case of Dhinaic Enterprises (supra) and A.N. Naik Associates (supra) are cases in which the firm was the Assessee. The present appeal is from the perspective of the retiring partner. Hence, these decisions do not held the plea of the Assessee. Decision at Sl.No.18 in the case of Prashant S. Joshi (supra) is a case of notice u/s.148 of the Act and it was held that there was no reason to believe to initiate proceedings u/s.147 of the Act. Incidentally the belief of chargeable capital gain escaping assessment was held to be unsustainable. Decision at S.No.19 in the case of Riyaz A. Sheikh (supra) follows the decision in the case of Tribbhuvandas G. Patel (supra) which relates to the law prior to Amendment w.e.f. 1.4.1989. The decision at Sl.No.20 in the case of Sharadh Terry Products Ltd. (supra) is a case of settlement of accounts as per the credit balance in the capital account and hence there was no gain. The decision at Sl.No.22 in the case of Smt. Girija Reddy (supra) is a case of lump sum consideration paid on retirement and it was held that there was an incidence of capital gain liable to tax. As far as Sl.No.17 in the case of P.Sivakumar (supra) is concerned, the finding of fact is the payment which was sought to be taxed u/s.28(va) was amount paid to retiring partner as his share in the worth and value of the business akin to goodwill. Therefore this case is also distinguishable. The decision in the case of M/S.D.S. Corporation is again a case where the tax incidence was examined from the angle of the firm and not the retiring partner, which is the position in the present case. Lastly, the decision in the case of James P.D’ Silva (supra) is a case where the Assessee received share of capital along with accrued profit, goodwill and brokerage/commission. This is not the fact situation in the present case.

34. For the reasons given above, we uphold the action of the revenue authorities in taxing the excess paid over and above the sum standing to the credit of the capital account of the Assessee as capital gain. However, the computation of the capital gain has been modified by us by treating value of goodwill also as part of the credit in the partners capital account. Consequently, the capital gain in question was less than Rs.50 lacs and since the Assessee has been allowed exemption u/s.54EC to the extent of Rs.50 lacs, no capital gain is exigible to tax in the present case.

35. In the result, the appeal of the assessee is allowed to the extent indicated above.

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