Section 45(4) Inapplicable to Capital Contribution by Incoming Partner.

I. Section 45(4) Inapplicable to Capital Contribution by Incoming Partner.

Issue:

Whether Section 45(4) of the Income-tax Act, 1961, which deals with capital gains on distribution of assets by a firm, is applicable when a new partner introduces capital into the firm, and no assets are transferred from the firm to the individual partners.

Facts:

For Assessment Years 2017-18 and 2018-19, the assessee-firm introduced a new partner who contributed a certain amount of capital to the firm. The funds introduced by the incoming partner were deployed in the business. The Assessing Officer (AO) likely attempted to invoke Section 45(4) to make an addition, perhaps misunderstanding the nature of the transaction as a deemed distribution of assets.

Decision:

In favor of the assessee: The court held that the provisions of Section 45(4) are applicable only when there is a conversion of partnership firm assets into individual assets on dissolution or otherwise. Therefore, for invoking Section 45(4), partnership assets must be transferred to individual partners either on dissolution or otherwise. Since, in the instant case, there was no transfer of any asset to the partners’ account from the firm, and the funds introduced by the incoming partner were merely deployed in the business, the addition made under the provisions of Section 45(4) was to be deleted.

Key Takeaways:

Scope of Section 45(4): Section 45(4) of the Income-tax Act deals with capital gains arising from the transfer of capital assets by way of distribution of assets on the dissolution of a firm or otherwise. The crucial element is a transfer of firm’s assets to partners.
Capital Contribution is Not Asset Distribution: When a new partner introduces capital into a firm, it is a contribution of assets to the firm, not a distribution of assets from the firm to the partners. This transaction is entirely outside the ambit of Section 45(4).
“Otherwise” in Section 45(4): The term “otherwise” in Section 45(4) (e.g., distribution other than on dissolution) refers to situations where assets are transferred from the firm to a partner, even without a formal dissolution, such as retirement or reconstitution where firm’s assets are distributed. It does not encompass capital contributions.
CBDT Circular No. 495 (1987): While the context of this circular isn’t fully detailed here, it generally provides clarification on the interpretation of certain provisions related to firms. It might have been cited by the assessee to support the understanding of how capital contributions are treated.

II. Business Expenditure – Allowability of “Other Discount” Fully Supported by Records.

Issue:

Whether “other discount” offered by a diagnostic center to customers and corporate clients, which was not explicitly reflected in bills/invoices but debited in the profit and loss account, can be disallowed under Section 37(1) of the Income-tax Act, 1961, when the assessee provides comprehensive documentation to substantiate the same.

Facts:

For Assessment Years 2017-18 and 2018-19, the assessee, a partnership firm engaged in the business of a diagnostic center, was subject to a search. During the search, it was found that “other discount” was being offered to customers and corporate clients. The Assessing Officer (AO) noted that this “other discount” was not reflected in the bills and invoices but was debited directly in the profit and loss account. Consequently, the AO disallowed the amount claimed as “other discount.”

However, the assessee substantiated the discount by producing a complete ledger account, detailed information of “other discount” with respect to bills and parties, and extracts from the computer system where the discount was mentioned for each customer. The amount of discount tallied with the amount mentioned in the books of account and each of the invoices.

Decision:

In favor of the assessee: The court held that the expenditure incurred by the assessee under the head “other discount” was wholly and exclusively incurred by the assessee for the purposes of its business. Since it was fully supported by the name of the party, invoice number, and rate of discount, it could not be disallowed.

Key Takeaways:

Commercial Expediency (Section 37(1)): For an expenditure to be allowed as a deduction under Section 37(1), it must be incurred wholly and exclusively for the purpose of business. Offering discounts is a common commercial practice to attract and retain customers.
Substantiation is Key: Even if a discount is not explicitly printed on the face of every invoice (e.g., it’s a post-billing adjustment or an overall scheme), it can still be allowed if the assessee maintains proper records and can substantiate the genuineness of the discount. Providing ledger accounts, party-wise details, bill-wise references, and computer system extracts (showing the discount linked to specific customers/invoices) is crucial.
No Disallowance for Accounting Methodology: The mere fact that a discount is debited to the profit and loss account rather than being reflected on every bill or invoice is an accounting methodology and, by itself, is not a ground for disallowance if the underlying transaction and its commercial nature are verifiable. The AO cannot disallow a genuine business expenditure based on how it’s recorded if its reality is proven.
Burden of Proof (AO’s Failure): The AO’s disallowance based on the discount “not being reflected in bills and invoices” was not sustained because the assessee provided overwhelming evidence from their internal records that the discount was genuine and related to business operations.

IN THE ITAT BANGALORE BENCH ‘A’

Anand Diagnostic Laboratory

Deputy Commissioner of Income-tax

SOUNDARARAJAN K., Judicial member
and Prashant Maharishi, Vice president

IT Appeal Nos.968 and 969 (Bang) of 2024
[Assessment Years 2017-18 and 2018-19]

APRIL 29, 2025

Arjunraj, Adv. for the Appellant. Netrapal M.S., Addl. CIT (DR) (ITAT), Bengaluru for the Respondent.

ORDER

Prashant Maharishi, Vice President.- These are two appeals in ITA No.968/Bang/2024 for AY 2017-18 & ITA No.969/Bang/2024 for AY 2018-19 filed by M/s Anand Diagnostic Laboratory (the assessee/appellant) against the appellate order passed by the CIT(Appeals)-15, Bangalore dated 29.3.2024 and 25.3.2024 respectively wherein the appeals filed by the assessee against the assessment orders passed u/s 143 (3) of the Act for both the years were dismissed.

AY 2017-18

2. In ITA No.968/Bang/2024 the assessee is aggrieved by the appellate order and has raised the following grounds of appeal :-

“1. The order of the learned Commissioner of Income Tax (Appeal)-15, Bengaluru in ITBA/APL/M/250/2023-24/1063626871(1), dated 25.03.2024 for the A.Y.2017-18 confirming the order of the Assistant Commissioner of Income Tax, Circle-2(4), Bengaluru under the provisions of section 143(3) r.w.s 153A of the act is opposed to the facts of the case and law applicable to it.

2. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.17,40,515/- ignoring the fact that, the said discount was allowed to the customer at the time of realization of dues and settling the accounts and under law there is no prohibition for allowing such discounts.

3. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.17,40,515/- with a finding that, such discount was not allowed in the bills raised and hence not allowable.

4. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.17,40,515/- with a finding that, no credit notes/debit notes or fresh bills were found at the time of search indicating allowing such difference and hence the said expenditure is not allowable.

5. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.17,40,515/- with a finding that, the other party would have claimed expenses on the entire bill without discount and hence allegedly not allowable as expenditure.

6. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.17,40,515/- giving a finding that, such amount is not allowable as bad debt also, allegedly for the reason that, the gross receipts have not been entered in the books and hence not allowable ignoring the fact that, the gross receipts in fact were entered in the books and hence the claim of “other discount” which is allowed as at the time of settlement of account with the customer.

7. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred ignoring the fact that the claim related to A.Y.2017-18 and as on the date of search i.e., 29.11.2017, the return of income for the A.Y.2017-18 was already filed on the basis of audited books of accounts and the claim of “other discount” was on the basis of discount allowed to customers at the time of settlement and reflected in their ledger accounts of such audited cooks of accounts and there was no material seized during the course of search to draw an inference that, such “other discount” was in fact not allowed.

8. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in giving a finding that, the whole arrangement of claim of “other discount” appears to be to reduce the taxable income by entering an amount as discount at the end of the year ignoring the factual position that, the entry “other discount” appeared in the individual customer ledger as and when the realization was finalized and this was not a single entry in the Profit & Loss account as alleged by CIT(A), but consolidation of various entries on dates spanning over the year in the individual customer’s accounts.

9. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of claim of “other discount” merely on the basis of alleged statements recorded which were not corroborated with any factual evidence.

10. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of claim of “other discount” ignoring the fact that, there was no material seized during the course of search to justify the inference drawn but was only on the basis of certain statements recorded which was not corroborated also and hence such disallowance could not have been made in an order U/s.153A of the act.

11. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in not following the ratio laid down by Hon’ble Supreme Court in the case of Pr.Commissioner of Income Tax, Central -3 V. Abhisar Buildwell (P) Ltd ITR 212 (SC), wherein it is held that, no income can be quantified or disallowance made invoking provisions of section 153A of the act unless justified on the basis of material seized during the course of search.

PRAYER

The appellant prays that the Hon’ble Tribunal may kindly hold that, the order U/s.143(3) r.w.s 53A of the act passed by Deputy Commissioner of Income Tax, Central Circle-2(4), Bangalore is cad in law in as much as there was no material seized during the course of search to invoke the provisions of section 153A of the act and direct that, the disallowance of Rs.17,40,515/- made in 7-e assessment is not warranted and deleted.”

3. First we take up appeal for AY 2017-18 and the facts show that assessee is a partnership firm engaged in the business of diagnostic center, filed its return of income on 14.10.2017 at Rs. Nil.

4. A search & seizure action u/s. 132 of the Act was carried out on 29.11.2017 and consequently notice u/s. 153A of the Act was issued on 08.10.2018. In response to the above notice, the assessee reiterated its original return filed vide letter dated 12.11.2018. The ld. AO issued notice u/s. 143(2) of the Act on 29.4.2019 and notice u/s. 142(1) was also issued on 29.8.2019 and 4.11.2019.

5. During the course of search conducted on the business premises of the assessee as well as at the residence of A.V. Ramaprasad, one of the partners, it was observed that “other discount” is being offered to the customers and corporate clients by the assessee at the time of payment which is not reflected in the invoices of the assessee firm. This ‘other discount’ is debited to the Profit & Loss account, but same was not reflected in the invoices and therefore, Mrs. Sangamitra, Accounts Manager of the firm was confronted which could not be explained by her. The ld. AO noted that other discount is Rs.79,46,250 for the accounting period 2011-12 to 2017-18. The partner of the firm, Sujay Rama Prasad was also confronted with the above facts and he submitted to offer for disallowance, if it remains unsubstantiated. Accordingly in FY 2016-17 relevant to AY 2017-18 other discount of Rs.17,40,515 debited to the Profit & Loss account was proposed to be disallowed. The assessee submitted that the claim of other discount made by the assessee is an expenditure allowable to the assessee as it is wholly incurred for the purposes of the business. The assessee substantiated that the LIS system of the assessee clearly shows claim of other discount paid to the parties to whom bills are raised at the time of payment. Therefore naturally this sum cannot be mentioned in the bills as it is decided at the time of payment, as payment happens at later point of time. The assessee further stated accountant Mrs. Sanghamitra has stated that she needs time to substantiate. The assessee referred to the answer to Q.12 of her statement wherein it was clearly stated that this discount is given at the time of payment and therefore not reflected in the bills raised for which prompt payment is made and discount is given for that bill. The assessee also referred to answer to Q.11 of her statement wherein the same was confirmed. Therefore the contention of the assessee is that there is no confession at all either in the statement of Mrs. Sanghamitra or of Sujay Rama Prasad. The assessee also submitted the details of discount by submitting the extract from LIS system maintained by the assessee and also submitted the complete detail of such discount in Compact Disc to the ld. AO. The assessee also reiterated the same facts by letter dated 6.12.2019 which is extracted at pages 23 to 29 of the assessment order.

6. The ld. AO after considering the explanation of the assessee was of the view that discount allowed by the assessee is not reflected in the bills & invoices, but the same is debited in the Profit & Loss account which is not the proper accounting by the assessee. He further held that the statement of the partner of the assessee to Q.6 wherein he agreed that the other discount figure may be disallowed for want of substantiation. The ld. AO thereafter relying on several judicial precedents disallowed Rs.17,40,515 claimed as other discount, passed assessment order u/s. 153A r.w.s. 143(3) of the Act determining total income of assessee at Rs.66,48,252.

7. The assessee preferred appeal before the ld. CIT(Appeals), who also confirmed the disallowance. The reason for confirmation of such disallowance is that there is no proof for discount given and further it was not mentioned in the bill or bills are not revised. According to him, even same is not allowed as bad debt because of the reason that the gross receipt has first to be entered in the books of account and subsequently if the debtor fails, then only same is allowable.

8. Assessee is aggrieved with the appellate order. Though the assessee has raised in all 11 grounds of appeal on the issue, but the ld. AR summarizing all the grounds submitted that discount claimed by the assessee is debited to the Profit & Loss account, the amount of discount with respect to each of the party is identified with respect to each of the bill. He further submitted that in subsequent bill, discount is shown and therefore the reason for confirmation of the disallowance that discount was not shown in that particular bill is not correct. He submits that this discount is given to the parties on account of timely payment of earlier invoices by the parties and such discount is shown in the subsequent bills. In the subsequent bills, invoice no., date of payment and discount appliable rate is disclosed. Naturally when the original bill was raised, there was no payment by the parties and payment happened subsequently, therefore the amount of discount of that bill naturally could not have been incorporated in that particular bill for which discount is provided. He further referred to the statement of Mrs. Sanghamitra and submitted that there is no disclosure of any undisclosed income or inflation of expenditure.

In the statement of the partner, reference was made by the ld. AO about the disclosure is also incorrect for the reason that in answer to Q.6, he agreed for disallowance for want of substantiation. However, when it is substantiated later on in assessment proceedings, there is no reason for making the disallowance. In fact, the partner specifically asked for time for reconciliation. In view of this, the disallowance of other discount is not proper. It was submitted that ‘other discount’ is an expenditure incurred by the assessee wholly & exclusively for the purposes of business and hence allowable.

9. The ld. DR submitted that when the disclosure is made u/s. 132(4) of the Act by making a statement, it has evidentiary value and therefore same is correctly made. He supported the orders of ld. lower authorities.

10. The ld. AR, in the rejoinder, submitted that each of the other discount is identified with respect to the party, particular bill and rate of discount. The books of account are audited and it is not the case of the revenue that any of the parties who have been paid discount have not received such discount. The books of account of the assessee are audited and also verified by the AO. The ld. AO has also not shown that the discount mentioned in the account of any of the parties, have denied receiving such discount.

11. We have carefully considered the rival contentions and perused the orders of the ld. lower authorities. As the assessee is carrying on business of diagnostic center, on prompt payment of the bill, it gives discount to various parties. During the course of search, on verification of books of account, the accountant of the assessee Mrs. Sanghamitra was asked that in the books of account from FY 2011-12 to 2017-18, there is a total debit of Rs.79,46,250 under the head ‘other discount’. The accountant was asked who submitted that to substantiate the above sum, she needs time. This was as per Q.6 of her statement recorded u/s. 132 of the Act. Further in answer to Q.10 where also the same question arose, the accountant stated that it needs to be reconciled. The partner of the assessee firm when confronted with the statement of the accountant with respect to other discount, he offered the above sum in answer to Q.no.6, agreed for disallowance for want of substantiation. However, when the show cause notice was issued to the assessee during the course of assessment proceedings, assessee substantiated the same by producing the complete ledger account, the details of other discount with respect to the bills and the partis, extract of the computer system where the discount is mentioned with respect to each of the customer. The amount of discount tallied with the amount of discount that is mentioned in the books of account and each of the invoices. Therefore it is apparent that the assessee has produced the proof of discount given to each of the customer with respect to each of the bill and rate of discount. The subsequent invoices produced before the lower authorities also clearly show that discount was with respect to the earlier invoices. As the discount involved is a cash discount which is called a prompt payment discount, which was finalized at the time of receipt of payment, which happened post raising of the original invoices, therefore naturally in the original invoices there could not have been any reference to discount. As the details of discount is with respect to each of the parties and same is also mentioned in the subsequent invoices raised to those parties mentioning the invoice no., clearly shows that there is proof of payment of discount. This is so because in the subsequent invoices the amount payable by the customers are reduced. Therefore it is not the case of revenue that by debiting other discount, the assessee has inflated the expenditure which is bogus. The complete detail of such discount qua party and qua the invoices are made available to the lower authorities. Even the statement of the partner of the assessee firm during the course of search states that ‘other discount’ is required to be substantiated. In the absence of such substantiation, he agreed for disallowance. However, when later on during the course of assessment proceedings, neither the AO nor the CIT(Appeals) could find any infirmity, therefore, it is apparent that the expenditure incurred by the assessee under the head ‘other discount’ is wholly and exclusively incurred by the assessee for the purposes of its business and is fully supported by name and party, invoice no., and rate of discount, could not be disallowed. Accordingly, the orders of ld. Lower authorities are reversed and the AO is directed to the delete the disallowance. Ground Nos. 1 to 11 of the appeal of the assessee are allowed.

12. In the result, ITA No.968/Bang/2024 filed by the assessee is allowed.

AY 2018-19

13. Coming to the facts of the case for AY 2018-19 in ITA No.969/Bang/2024, the following grounds are raised:-

“1. The order of the learned Commissioner of Income Tax (Appeal)-15, Bengaluru in ITBA/APL/M/250/2023-24/1063340210(1), dated 25.03.2024 for the A.Y.2018-19 confirming the order of the Assistant Commissioner of Income Tax, Circle-2(4), Bengaluru under the provisions of section 143(3) of the act, dated 31.12.2019 is opposed to the facts of the case and law applicable to it.

2. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.31,51,444/- ignoring the fact that, the said discount was allowed to the customer at the time of realization of dues and settling the accounts and under law there is no prohibition for allowing such discounts.

3. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.31,51,444/- with a finding that, such discount was not allowed in the bills raised and hence not allowable.

4. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.31,51,444/- with a finding that, no credit notes/debit notes or fresh bills were found at the time of search indicating allowing such difference and hence the said expenditure is not allowable.

5. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.31,51,444/- with a finding that, the other party would have claimed expenses on the entire bill without discount and hence allegedly not allowable as expenditure.

6. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the disallowance of the claim of “Other Discounts” amounting to Rs.31,51,444/- giving a finding that, such amount is not allowable as bad debt also, allegedly for the reason that, the gross receipts have not been entered in the books and hence not allowable ignoring the fact that, the gross receipts in fact were entered in the books and hence the claim of “other discount” which is allowed as at the time of settlement of account with the customer.

7. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred ignoring the fact that the claim related to A.Y.2018-19 and as on the date of search i.e., 29.11.2017, the previous year was not complete and the claim of “other discount” was on the basis of discount allowed to customers at the time of settlement and reflected in their ledger accounts of regular books of accounts and there was no material seized during the course of search to draw an inference that, such “other discount” was in fact not allowed.

11. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in confirming the addition of Rs.49,00,12,501/- under the provisions of section 45(4) of the act ignoring the factual position that there were no transfer of assets consequent to alleged distribution and in the absence of any such distribution there was capital gains chargeable to tax.

12. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in not following the ratios laid down in the following decisions which were in favour of the appellant and squarely on similar facts and circumstances.

(i)

Commissioner of Income Tax-IV, Bangalore V. Karnataka Agro Chemicals

(ii)

Commissioner of Income Tax V. Dynamic Enterprises

(iii)

Commissioner of Income Tax V. P.N.Panjavan

(iv)

Girish Textile Industries V. Assistant Commissioner of Income Tax, Circle-23(1) [2006] 10 SOT 474 (Mumbai)

13. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in relying on the ratio laid down by the Hon’ble Supreme Court in the case of Commissioner of Income Tax V. Mansukh Dyeing and Printing MillS 354/[2022] 449 ITR 439 (SC), as justification for confirming the addition of Rs.49,00,12,501/- U/s.45(4) of the act ignoring the fact that, the ratio laid down by the Hon’ble Supreme Court was for a different set of facts and do not match the facts of the appellant and hence the ratio was not applicable.

14. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in not appreciating the fact that, the Hon’ble Supreme Court in the case of Commissioner of Income Tax V. Mansukh Dyeing and Printing Mills354/[2022] 449 ITR 439 (SC), was dealing with a situation wherein consequent to a family arrangement there was reconstitution of a partnership firm with some of the partners foregoing a portion of their share of profit in favour of other partners admitted with very marginal capital and later, on revaluation of assets of the firm being land & building credited huge amounts to such new partners and hence there was undue benefit conferred on them and in this context it was held that, such benefit is taxable under the provisions of section 45(4) of the act, on the contrary in the appellant case there was business valuation before admitting new partners. The Good Will arose on account of business valuation. The Good Will value was allocated to existing partners in proportion to their fixed capital. Subsequently new partners are admitted and no portion of the Good Will valuation was credited to them as such there was no undue benefit conferred on the new partners, hence the decision of Supreme Court would not apply on facts and law.

15. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in ignoring the fact that, in the appellant’s case what was recognized was an intangible asset being good will and the value was allocated to the existing partners and such allocation was within their right and the new partner admitted later on had brought in sufficient capital to justify the share of profit allocated to them and hence the decision of Hon’ble Supreme Court in the case of Commissioner of Income Tax V. Mansukh Dyeing and Printin was not applicable at all, all the more so for the reason that, the existing partners did not withdraw any portion of the credit to the capital account on account of revaluation of business.

16. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in following the ratio laid down by the Hon’ble Supreme Court in the case of Commissioner of Income Tax V. Mansukh Dyeing and Printing MillS ITR 439 (SC) while confirming the taxation of the amount of Rs. 49,00,12,501/- under the provisions of section 45(4) of the act, ignoring the fact that, the ratio laid down is not a finding on a position of law in regard to interpretation but in the context of application of law for a particular set of facts and such interpretation can vary with reference to the variance in facts.

17. The learned Commissioner of Income Tax (Appeals)-15, Bengaluru erred in

PRAYER

The appellant prays that the Hon’ble Tribunal may kindly direct that,

(i)

The addition consequent to disallowance of other discount of Rs.31,51,444/- be deleted.

(ii)

The addition of Rs. 49,00,12,501/- under the provisions of section 45(4) of the act be deleted.”

14. On looking at the grounds of appeal, we find that ground no.1 of appeal is general in nature and therefore same is dismissed.

15. Ground Nos. 2 to 10 are with respect to disallowance of ‘other discount’ amounting to Rs.31,51,444 which is identical to grounds of appeal raised by the assessee for AY 2017-18. As we have already allowed the appeal of the assessee for AY 2017-18 directing the ld. AO to delete the disallowance of other discount, in absence of any change in facts and circumstances of the case, therefore for similar reasons, we direct the ld. AO to delete the disallowance of Rs.31,51,444 of other discount for this year also and thus allow ground nos. 2 to 10 of the appeal.

16. Ground No.11 of the appeal is with respect to addition of Rs.49,00,12,501 under the provisions of section 45(4) of the Act. Ground Nos. 12 to 16 are supporting the above ground.

17. The brief facts of the case show that during the course of search, it was found that assessee has introduction of a new partner, viz., Neuberg Diagnostic Pvt. Ltd. on 7.6.2017, who invested Rs.32.69 crores for 40% share in the assessee. The AO observed that before introduction of new partner, goodwill of the firm was valued at Rs. 49,00,12,501. When the goodwill was created, capital account of the existing partners was credited identically in the ratio of their share of profit. Thus the goodwill created in the books of account was shared between the existing partners of the firm in their profit sharing ratio. The new partner brought in money equivalent to share of his profit on the basis of the enterprise value of the goodwill. On looking at the facts, the AO was of the view that the provisions of section 45(4) are to be invoked and therefore assessee was directed to furnish an explanation.

18. The assessee vide letter dated 27.11.2019 submitted that there is no distribution of assets, goodwill has continued in the books of assessee firm, none of the asset is transferred and therefore there is no scope for applicability of section 45(4) of the Act. It was submitted that none of the partners have withdrawn any sum from the firm.

19. The ld. AO rejected the contention of the assessee. He noted that assessee just before reconstitution of the firm revalued its assets and created goodwill. Amount equivalent to goodwill was distributed to existing partners by crediting their account in their profit sharing ratio. Therefore, provisions of section 45(4) applies to the facts of the case. Accordingly he brought to tax a sum of Rs. 49,00,12,501 by invoking provisions of section 45(4) of the Act. Assessment order u/s. 143(3) of the Act was passed on 13.12.2019.

20. The assessee approached the ld. CIT(Appeals), who dismissed the appeal of the assessee holding that the issue is squarely covered against the assessee by the decision of Hon’ble Supreme Court in the case of CIT v. Mansukh Dyeing and Printing Mills[2022] 449 ITR 439 (SC). The ld. CIT(A) noted that there was a reconstitution of the firm with introduction of new partner and just before the reconstitution, assets of the firm were revalued by which the goodwill was created and same was credited to the account of the existing partners as per their profit sharing ratio. According to him, this amount was available for withdrawal by the partners without any restriction and therefore the assets so revalued have been otherwise transferred to the partners. Thus he confirmed the addition. The assessee, aggrieved with that, is in appeal before us.

21. The ld. AR submitted that the decision of the Hon’ble Supreme Court does not apply to the facts of the case. He submitted that the goodwill was capitalised in the books of account and credited to the account of the partners existing prior to the reconstitution. The new partner did not have any right in the goodwill or no sum is credited to their account. Further the new partner has brought in substantial capital. He submitted that the new partner, Neuberg Diagnostic Pvt. Ltd. has brought in capital of Rs.32.69 crores in the firm. None of the assets or the capital account has been withdrawn by the existing partners. He specifically referred to para 7.5 of the decision of the Hon’ble Supreme Court cited supra and submitted that the facts of that case and the facts of the case of the assessee are quite different and therefore the provisions of section 45(4) does not apply. He further submitted that the incremental capital brought in by the new partner were also utilised by the assessee firm for the purposes of business of the asse. Thus, in a nutshell, it was the argument that as there is no transfer of assets, no distribution, the provisions of section 45(4) does not apply and the decision of the Hon’ble Supreme Court is not applicable to the facts of the present case.

22. The ld. DR vehemently supported the orders of ld. lower authorities and submitted that prior to the introduction of new partner there is goodwill created in the books of account and credited the same to the account of the existing partners and therefore clearly the provisions of section 45(4) apply and there is no infirmity in the orders of ld. lower authorities. The ld. DR further referred to the decision of the coordinate Bench of Hyderabad Tribunal in the case of Shree Estates(Hyderabad – Trib.) stating that it does apply to the facts of the case.

23. The Ld AR submits that:-

(i)

The decision of the Hon’ble Supreme Court in the case of Mansukh Dyeing & Printing Mills,/[2022] 449 ITR 439 (SC) does not apply to the facts of the present case. In fact he referred to the decisions of the Hon’ble Telangana High Court and Hon’ble Calcutta High Court to state that both these Courts have considered the above decision of the Hon’ble Supreme Court and stated that it was decided on peculiar facts of the case and therefore does not apply to the case of the assessee.

(ii)

Circular No.495 dated 22.9.1987 clearly provides that the provisions of section 45(4) applies only when there is a transfer of capital asset by a firm on dissolution or otherwise. He submits that there is no transfer of any of the capital asset from the partnership firm to the partners. He further stated that the Circular binds the revenue authorities and therefore according to the Circular, the impugned transaction is not covered by the provisions of section 45(4) of the Act.

(iii)

The decision of the Hon’ble Supreme Court in interpreting the word “or otherwise” occurring in section 45(4) covers in case of dissolution of the firm including retirement after transferring the assets in favour of the partners. In the present case, there is no transfer of any assets in favour of the partnership firm and there is neither dissolution and nor retirement.

(iv)

The provisions of section 45(4) applies only when there is an actual distribution of capital assets of the firm to its partners. Therefore, despite the assets remaining with the firm and not transferred to the partners, the provisions of section 45(4) do not apply.

(v)

He further referred to the decision of Hon’ble Supreme Court in 439 (SC) and referred to para 7.5 of the judgment. He stated that because of the peculiar facts of that case, the Hon’ble Supreme Court held that the assets so revalued and credited into the capital account of the partners were held to be a transfer and hit by the provisions of section 45(4) of the Act. He stated that the partners introduced newly despite contributing very small sum have taken credit for huge sums on account of revaluation resulted into applicability of section 45(4) of the Act. In the present case, there is no credit to the new incoming partner.

(vi)

The ld. AR further referred to the decision of Hon’ble Telangana High Court in (Telangana) wherein she is a partner in a firm received payment of credit balance in her capital account upon her retirement from partnership was held to be not hit by the provisions of section 45(2) of the Act. eld to be not hit by the provisions of section 45(2) of the Act, since there is no specific transfer of a capital asset when assessee retired from the partnership firm. The Hon’ble Telangana High Court considered the decision of the Hon’ble Supreme Court in Mansukh Dyeing & Printing Mills (supra) at para 12 and the Hon’ble High Court considered that decision in para 6 wherein it was held that the said decisions do not lay down any law as it has been decided in entirely different contextual backdrop. He further referred to the decision of Hon’ble Calcutta High Court in 106 wherein the above decision of the Hon’ble Supreme Court was considered in para 16 and it was decided. Thus, the case of Mansukh Dyeing & Printing Mills (supra) was decided on its own facts. It was further stated that the facts of the assessee are also quite different.

24. We have carefully considered the rival contentions and perused the orders of ld. lower authorities. The brief facts of the case show that assessee, a partnership firm, was having the partners viz., Dr. A.V. Ramaprasad (40% share), Dr. Sujoy Prasad (20% share), Mrs. Sheela Ashok (20% share) & Mrs. Smitha Jayaram (20% share). These existing partners were carrying on the business of Pathology pertaining to routine tests. By deed of Partnership dated 07.06.2017, Ms/. Syllam Enterprises Pvt. Ltd. became a partner in the firm and made an investment of Rs.32,68,00,075 acquiring 40% of the share in the capital as well as in the profit. Prior to the introduction of the above company as partner, the assets of the partnership were revalued and share of goodwill was credited to the account of Dr. A.V. Ramaprasad (Rs.19.60 crores), Dr. Sujoy Prasad (9.80 crores), Mrs. Sheela Ashok (9.80 crores) & Mrs. Smitha Jayaram (9.80 crores). There was no credit of the goodwill to the account of the incoming partners. Thus, the sum of Rs.49 crores were debited as a goodwill account in the assets of the partnership firm and consequent credit was given to the existing partners. The ld. AO invoked the provisions of section 45(4) of the Act and held that there is a transfer of capital assts on dissolution of the firm or otherwise is taxable in the hands of the assessee company to the extent of Rs.49 crores. The assessee objected to this. The contention of the assessee that there is no transfer of capital asset was rejected. It was further held that no restriction was placed on withdrawal of account credited to the account of the partners is also not shown. Accordingly the above sum was brought to tax u/s. 45(4) of the Act.

25. When the matter reached the ld. CIT(Appeals), the ld. CIT(A) dismissed the appeal of the assessee following the decision of the Hon’ble Supreme Court in the case of Mansukh Dyeing & Printing Mills (supra) holding that there is a reconstitution of the firm with the introduction of new partner and just before the reconstitution the firm’s assets are revalued and goodwill created to the existing partners capital account which is available for their withdrawal and therefore the assets so revalued have been transferred to the partners.

26. The assessee challenged the above decision of the ld. CIT(Appeals) before us. We find that in the present case there is no transfer of any asset to the partners account from the firm. On revaluation the goodwill is credited in the ratio of the profit sharing of the existing partners. Provisions of section 45(4) is applicable only when there is a conversion of partnership firm assets into individual assets on dissolution or otherwise. Circular No.495 dated 22.9.1997 specifically states that to invoke section 45 (4) of the Act there must be a transfer of capital asset. Therefore for invoking the provisions of section 45(4), the partnership assets must be transferred to the individual partners either on dissolution or otherwise. Even the decision of Hon’ble Supreme Court (supra) does not say to include in ‘or otherwise’ introduction of fresh partner who contributed the capital afresh. Even the existing partners have not withdrawn any funds of the partnership firm. The funds introduced by the incoming partner were also deployed in the business.

27. The Hon’ble Supreme Court in para 7.5 has categorically held that provisions of section 45(4) were invoked for the reason that on dissolution of the assets of the partnership firm, some new partners were inducted and on introduction of small amounts of capital, had used credits to their capital account immediately after joining the partnership which was available to the partners for withdrawal and in fact some of the partners withdrew the amount so credited. Therefore it was held that provisions of section 45(4) were applicable to the facts of that case. It was held as under :-

“7.5 In the present case, the assets of the partnership firm were revalued to increase the value by an amount of Rs. 17.34 crores on 1-1-1993 (relevant to A.Y. 1993-1994) and the revalued amount was credited to the accounts of the partners in their profit-sharing ratio and the credit of the assets’ revaluation amount to the capital accounts of the partners can be said to be in effect distribution of the assets valued at Rs. 17.34 crores to the partners and that during the years, some new partners came to be inducted by introduction of small amounts of capital ranging between Rs. 2.5 to 4.5 lakhs and the said newly inducted partners had huge credits to their capital accounts immediately after joining the partnership, which amount was available to the partners for withdrawal and in fact some of the partners withdrew the amount credited in their capital accounts. Therefore, the assets so revalued and the credit into the capital accounts of the respective partners can be said to be “transfer” and which fall in the category of “OTHERWISE” and therefore, the provision of Section 45(4) inserted by Finance Act, 1987 w.e.f. 1-4-1988 shall be applicable.”

28. The decision of the Hon’ble Supreme Court was considered by the Hon’ble Telangana High Court in (Telangana) at para no. 12 of that order. Further at para 6 the Hon’ble Telangana High Court held that the said decision does not lay down any law, as the said decision was decided in an entirely different contextual backdrop and is distinguishable on facts alone. In the case before the Telangana High Court, the assessee retired from a partnership firm and received a sum of Rs.8.22 crores and the revenue invoked the provisions of section 45(4) of the Act. In that case also the assessee received a share of goodwill. The Hon’ble High Court held that receipt of share value of goodwill cannot be subjected to capital gains tax as there was no transfer of goodwill to the firm. The Hon’ble High Court dealt the whole issue as under:-

12. Learned Senior Standing Counsel however relied on the decisions of the Hon’ble Apex Court in the case of CIT v. Mansukh Dyeing and Printing Mills wherein this Court, under similar circumstances, held at paragraph Nos.19 to 22 as under :

“19. In CIT v. Bankey Lal Vaidya [1971] 79 ITR 594 (SC), the Supreme Court held that a partner in a firm (carrying on business of manufacturing and selling pharmaceutical products and literature relating thereto) whose assets (which included goodwill, machinery, furniture, medicines, library and copyright) were valued at Rs.2,50,000, was paid towards his half share, on the dissolution of the firm, a sum of Rs. 1,25,000 in lieu of his share, the arrangement between the partners of the firm amounted to a distribution of the assets of the firm on dissolution. It held that there was no sale or exchange of the respondent’s share in the capital assets to the other partner. The Supreme Court of India further held as follows :

“In the course of dissolution the assets of a firm may be valued and the assets divided between the partners according to their respective shares by allotting the individual assets or paying the money value equivalent thereof. This is a recognized method of making up the accounts of a dissolved firm. In that case the receipt of money by a partner is nothing but a receipt of his share in the distributed assets of the firm. The respondent received the money value of his share in the assets of the firm ; he did not agree to sell, exchange or transfer his share in the assets of the firm. Payment of the amount agreed to be paid to the respondent under the arrangement of his share was therefore not in consequence of any sale, exchange or transfer of assets.”

20. The Supreme Court upheld the contention of the assessee that no part of the amount of Rs.1,25,000 received by the assessee represented capital gains and relied on CIT v. Dewas Cine Corporation [1968] 68 ITR 240 (SC) referred to above. It held that adjustment of the rights of the partners in a dissolved firm by allotment of its assets is not a transfer for a price. The facts of the instant case are identical with the facts of the case in CIT v. Bankey Lal Vaidya [1971] 79 ITR 594 (SC).

21. In CIT v. L. Raghu Kumar(Andhra Pradesh), a Division Bench of the Andhra Pradesh High Court followed the judgment of the Gujarat High Court in CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393 (Gujarat) and held that no transfer is involved when a retiring partner receives at the time of retirement from the firm, his share in the partnership assets either in cash or any other asset. It further held that for the purpose of section 45 of the Income-tax Act, no distinction can be drawn between an amount received by the partner on the dissolution of the firm and that received on his retirement, since both of them stand on the same footing.

22. In CIT v. P. H. Patel (Andhra Pradesh) held that when a partner retires from a partnership firm taking his share of partnership interest, no element of transfer of interest in the partnership asset by the retiring partner to the continuing partner was involved.”

14. Similarly, the Division Bench, while dealing with Sections 47(2) and 45(4) of the Act, at paragraph No.23, held as under, viz., :

“23. In the light of the above decisions, which are binding on us, we hold that the Income-tax Appellate Tribunal was not correct in confirming the orders passed by the Commissioner of Income-tax (Appeals) and the respondent. When the appellant was paid Rs. 15 lakhs by Y. Kalyana Sundaram in full and final settlement towards his 50 per cent. share on the dissolution of the firm, there was no “transfer” as understood in law and, consequently, there cannot be tax on alleged capital gain. The appellant was correct in law in contending that the amount he received from Y. Kalyana Sundaram is towards the full and final settlement of his share and such adjustment of his right is not a “transfer” in the eye of law. It is a recognized method of making up the accounts of the dissolved firm and the receipt of money by him is nothing but a receipt of his share in the distributed asset of the firm. The appellant received the money value of his share in the assets of the firm. He did not agree to sell, exchange or transfer his share in the assets of the firm. Payment of the amount agreed to be paid to the appellant under the compromise was not in consequence of any sale, exchange or transfer of assets to Y. Kalyana Sundaram. Moreover, as rightly contended by the assessee, up to the assessment year 1987-88, section 47(ii) of the Income- tax Act, 1961, excluded these transactions. From assessment year 1988-89, in the case of dissolution of a firm, only the firm is taxable on capital gains on dissolution under section 45(4) of the Income-tax Act, 1961, and not the partner. Section 45(4) states as follows:

“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.”

Thus, it is clear that the Legislature, even though it was aware of the above decisions, did not choose to amend the law by making the partner liable when it amended the Income-tax Act, 1961, by introducing clause (4) to section 45 by the Finance Act, 1987, with effect from April 1, 1988, and made only the firm liable. Therefore, the contention of the assessee has to be accepted and that of the Revenue is liable to be rejected.”

15. Learned Senior Standing Counsel for the respondent Department further contended that the Commissioner of Appeals in yet another case of a partner in the same firm has allowed the appeal setting aside the order passed by the Assessing Officer while allowing the appeal by relying on the aforementioned decision of the Division Bench of this Court in Chalasani Venkateswara Rao (3 supra), wherein it observed at paragraph Nos.4 and 5 as under, viz.,

“4.4. The same was remanded to the A.O. to verify the additional grounds filed by the appellant but no reply from the A.O. Since, they are additional grounds admitted and decided by me. The appellant during the course of appeal hearings submitted that the goodwill created by the firm M/s.Montage Manufacturer through entries without incurring any cost and payment of share of the goodwill to the assessee, a retired partner, cannot be taxed for capital gains in the hands of the appellant. The appellant specifically relied on the case law of Chalasani Venkateswara Rao v. I.T.O. wherein it was categorically held that in the fact and circumstances of the case capital gains cannot be taxed in the hands of the appellant. The appellant also submitted the provisions of Section 14 of the Indian Partnership Act, 1932 which reads “subject to contract between the partners, the property of the firm includes all property and rights and interests in property originally brought into the stock of the firm, or acquired, by purchase or otherwise by or for the firm or for the purpose and in the course of the business of the firm, and includes also the goodwill of the business. Unless the contrary intention appears, property and rights and interest in property acquired with money belonging to the firm are deemed to have been acquired for the firm.

5. I have gone through the submissions of the appellant and also the observations made by the A.O. in the assessment order. After going through the above, it is noticed as per M/s.Montage Manufacturers, the goodwill was of Rs.7,95,88,699/- and not Rs.8,22,17,952/-. As per the appellants submissions and case laws relied in the case of Chalasani Venkateswara Rao v. I.T.O., the goodwill cannot be taxed in the hands of the appellant. Therefore, I am in agreement with the submissions of the appellant and the long-term capital gains are deleted.”

16. The above order, according to learned Senior Standing Counsel for the respondent-Department, has not been subjected to further challenge in any forum. So far as the decisions relied upon by the learned Senior Standing Counsel for the respondent-Department in R.F. Nangrani (2 supra) (also relied upon by the learned counsel for the appellant) and the decision in Mansukh Dyeing and Printing Mills (1 supra) are concerned, the said decisions do not lay down any law as the said decisions have been decided in an entirely different contextual backdrop unlike in the present. Therefore, the said decisions are distinguishable on facts alone.”

29. Similarly in the decision of Hon’ble Calcutta High Court in ITR 345 (Calcutta), the decision of Hon’ble Supreme Court was cited before the High Court in para 16 of that order. The Hon’ble Calcutta High Court dealt the same as under:-

“16. The decision in the K.T.C. Automobiles case (supra) relied on by the revenue will be wholly inapplicable as the facts noted in paragraphs 9 and 12 of the judgment, ultimately it was held that the liability to pay tax on the profit and gains of such transfer of capital assets does not fall on the erstwhile firm. This decision is wholly against the revenue. The revenue placed on the decision of the CIT v. Mansukh Dyeing & Printing Mills/[2022] 449 ITR 439 (SC)/2022 SCC Online SC 1618 The facts of the case have been noted in paragraphs 4 to 6 in the said judgment which clearly shows that the contribution of all four partners put together was Rs. 11.50 lakhs whereas each of them had got Rs. 7.97 crores upon the revaluation and two of the existing partners had withdrawn part of their capital and the revenue’s case was new partners were immediately benefited by the credit to their capital accounts of the revaluation amount and in such factual position, it was held that the asset so revalued and the credit into capital accounts after respective partners can be said to be transfer “which falls in the category of otherwise” and therefore the provisions of section 45(4) inserted by Finance Act, 1987 with effect from 1-4-1988 shall be applicable. The facts being entirely different, the said decision does not in any manner assist the case of the revenue.

30. Therefore in both the above cases, the decision of Supreme Court was held to be applicable on different facts. The same is the case before us. In this case also, there was no benefit to the new partner and thus there is no transfer.

31. The decision of the Hyderabad Bench in in the case of Shree Estates was also cited by the ld. DR. A careful perusal of the decision and on considering the above decision of the Hon’ble Telangana High Court and Hon’ble Calcutta High Court, we find that the facts of that decision does not apply.

32. Therefore respectfully following the above judgments of the Hon’ble Telangana High Court and Hon’ble Calcutta High Court, we direct the ld. AO to delete the addition of Rs.49,00,12,501 made under the provisions of section 45(4) of the Act. Accordingly, grounds 11 to 16 of the appeal are allowed.

33. In the result, the appeal by the assessee is partly allowed.