Section 45(4) Of Income Tax Act Applicable To Cases Of Subsisting Partners Of A Partnership Transferring The Assets In Favor Of A Retiring Partner: Supreme Court

CAUSE TITLE:
The Commissioner of Income Tax Vs. M/s. Mansukh Dyeing and Printing Mills

DATE OF ORDER:
24 November 2022.

JUDGE(S):
Hon’ble Justice M.R. Shah, M.M. Sundresh.

PARTIES:
Petitioner: The Commissioner of Income Tax.
Respondent: M/s. Mansukh Dyeing and Printing Mills.

SUBJECT

This appeal was filed by the Commissioner of Income Tax as they were dissatisfied with the impugned judgement passed by the High Court of Bombay in relation with confirming the ordered passed by the Income Tax Appellate Tribunal (ITAT) and deleting the short term capital gains addition made by the Assessing Officer (A.O.).

IMPORTANT PROVISIONS

The Income Tax Act

• Section 45(4)- Power to charge tax.

BRIEF FACTS

• The respondent assesse was a partnership firm which originally consisted of four partners engaged in the business of Dyeing and Printing, Processing, Manufacturing and Trading in Clothing. All four partners were brothers.
• There was a family settlement on 2 May 1991. One of the existing partners (Shri M.H. Doshi) having 25% profit share in the firm was reduced to 12%. Three new partners were admitted namely, Smt. Ranjan Doshi (11%), Shri Prakash Doshi (1%) and Shri Rajeev Doshi (1%) by his remaining balance of 13%.
• Thereafter, Shri M.H. Doshi, Shri Manohar Doshi and Shri V.H. Doshi retired from the partnership and the partnership firm was reconstituted by Shri Hasmukhlal H. Doshi, Smt. Rajan H. Doshi, Shri Prakash H. Doshi and Shri Rajiv H. Doshi.
• On 1 November 1992, the firm was reconstituted and three more partners were added namely, Smt. Vaishali Shah (18%), Smt. Bhavna Doshi (9%), Smt. Rupal Doshi (9%) and M/s. Ranjana Textile Pvt. Ltd. (10%). The contributions of these three new partners are mentioned below-

1. Smt. Vaishali Shah- Rs. 4.50 lakhs.
2. M/s. Ranjana Textiles Pvt. Ltd.- Rs. 2.50 lakhs.
3. Smt. Bhavna Doshi- Rs. 2.25 lakhs.
4. Smt. Rupal Doshi- Rs. 2.25 lakhs.

• Shri Hasmukh H. Doshi and Smt. Ranjan Doshi decided to withdraw part of their capital after the reconstitution of the partnership firm.
• The assets of the firm was revalued on 1 December 1993. Following this, an amount of Rs. 17.34 crores were credited to the accounts of the existing partners in the firm in accordance to their profit-sharing ratio.
• Again Shri Hasmukhlal H. Doshi and Smt. Ranjan Doshi withdrew part of their capital which was around Rs. 20 to 25 lakhs.
• All of the new partners i.e. Smt. Vaishali Shah, Smt. Bhavna Doshi, Smt. Rupal Doshi and M/s Ranjana Textiles,were benefited by the credit to the revaluation done to their capital accounts. This was noted down by the Revenue.
• The respondent filed Return of Income for A.Y. 1993-1994 and the same was accepted under Section 143(1) of the Income Tax Act, 1961. However a notice was issued under Section 148 and the assessment was reopened under Section 147.
• Under Section 143(3) read with Section 147, the above mentioned assessment was reassessed. Also under Section 45(4) of the Income Tax Act, an addition was made to the short term capital gain and also to the A.Y. 1994-1995.
• The Assessment Officer (A.O.) said that the assesse revalued the land and building and enhanced it’s valuation for A.Y. 1993-1994. Thereafter the value of the assets was also increased and then revalued. Subsequently, under Section 45(4) it was credited to the respective partners’ capital accounts which was capable to capital gains tax.Due to the involvement of land and building, the assesse claimed depreciation on that.
• The amount of short term capital gain was then assessed by the Assessing Officer under Section 50.
• The Commissioner of Income Tax (Appeals) [CIT (A)] confirmed the addition on the account of Short-Term Capital Gains and even held that there was a clear distribution of assets as partners have also withdrawn amounts from the capital account by order dated 30 July 2004.
• CIT (A) also stated that the value of assets have been irrevocably transferred in the profit sharing ratio of all the partners individually in the partnership firm. This transfer maybe termed as “transfer by relinquishment” as this transfer has effectively relinquished its interest on the assets of the partnership firm.
• The CIT(A) noted down that the value of the assets which were distributed would be treated as “income by capital gains” in the hands of the assesse firm thereby, satisfying the conditions of Section 45(4).
• The High Court dismissed the appeals submitted by the Revenue by relying upon the decision of Hind Construction Ltd.
• Therefore, the present appeal has been filed by the petitioner before the Supreme Court of India.

QUESTIONS RAISED

• What is the applicability of Section 45(4) of the Income Tax Act?

ARGUMENTS ADVANCED BY THE APPELLANT

• The learned counsel appearing on behalf of the petitioner criticised the Income Tax Appellate Tribunal (ITAT) as well as the High Court for making a mistake in deleting the additions made towards the short term capital gain by the A.O.
• The petitioner submitted that Hon’ble High Court has not clearly showed the object and purpose of the introduction of Section 45(4). It said that it was introduced by omitting clause (ii) of Section 2(47).
• The omission of Section 47(ii) exempted transform by way of distribution of capital assets from the definition of “transfer”.
• Henceforth, the above omissions helped the assesse to avoid the levy of capital gains tax by revaluing the assets, transferring then distributing the same on dissolution. The petitioner urged to sort this loophole by inserting of Section 45(4) and omission of Section 2(47) (ii).
• The petitioner also brought forward that the A.O. rightly made the addition towards the short-term capital gains by including Section 45(4) of the Income Tax Act which was not required by the ITAT. Therefore the distribution of capital assets to the partners’ account was deemed to be transfer of capital assets and assessable as capital gains of the firm after the inclusion of Section 45(4).
• The reliance placed by the assesse in the case of Hind Construction Ltd. was also not applicable as the said decision was given considering the provisions prior to the inclusion of Section 45(4) of the Income Tax Act.
• The petitioner on contrary to the above point persuaded the Court to rely upon the case of A.N. Naik Associates and Ors.as it was dealing with Section 45(4).

ARGUMENTS ADVANCED BY THE RESPONDENT

• The respondent counsel opposed the appeals of the petitioner and stated that there was neither any dissolution of the partnership firm nor revaluation on dissolution of the partnership firm.
• It was clearly seen that there was a reconstitution of the partnership firm and on revaluation, the surplus amount was credited to the partners’ capital account. Hence that surplus cannot be said to be “transfer” as per the provisions of Section 45(4) of the Income Tax Act.
• The respondent submitted that neither there was any distribution of assets of the partnership firm nor any dissolution took place. Only the surplus of the revaluation was credited to the capital account of all the partners.
• Therefore enforcing the above point, the respondent said that the deduction of the addition made towards the short-term capital gains was correctly observed by ITAT and confirmed by the Hon’ble High Court as it was not a case of transfer/deemed transfer under Section 45(4).
• The counsel for the respondent relied upon the following decisions-

1. Hind Construction Ltd.
2. Texspin Engg. And Mfg. Works, Mumbai.

• It is submitted that the credited amounts were just notional or book entry whi was not represented by any additional tangible asset or income. Hence just due to revaluation of capital asset, there can be no income in the firm unless the capital asset is also transferred.
• The respondent counsel discussed the inapplicability of the case of A.N. Naik Associates and Ors.in the present case because in that case, the assets of the partnership firm was transferred to a retiring partner by a deed of retirement.

ANALYSIS BY THE COURT

• The Court held that the revalued amount of the assets which was transferred to the capital accounts of the partners’ in the partnership firm cannot be treated as “transfer” and it falls in the category of “OTHERWISE”. Therefore the provision of Section 45(4) inserted by the Finance Act, 1987 was applicable.
• The Court concluded to quash the decision taken by the High Court and the ITAT as it was unsustainable. It restored the order passed by the A.O. thereby allowing the present appeals given by the petitioner.

CONCLUSION

The Income Tax Act is very exhaustive and escaping from its provision is not an easy task. It is closely connected with the Finance Act. Therefore, the provisions which are coinciding with each other and creating such loopholes for escaping tax must be checked and suitable steps must be taken by the judiciary to amend those sections.

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