2003 (3) TMI 56 - HC - Income Tax

Section 45(4) inapplicable when no distribution on dissolution; Sections 45(1) and 48 can't fix market value as consideration

Commissioner of Income-Tax Versus Texspin Engineering And Manufacturing Works.

HC held that section 45(4) did not apply because there was no transfer by distribution on dissolution, so the Assessing Officer could not treat market ... Applicability of Section 45(1) and Section 45(4), on the transfer of assets from a firm to a newly constituted company - Entitlement to depreciation under Section 32 read with Section 43(6)(c)(i)(B) - two conditions were required to be fulfilled, viz., (i) dissolution of the partnership firm, and (ii) distribution of the assets of the partnership firm - difference between the market value and the written down value of the assets transferred to the company - HELD THAT:- According to the Assessing Officer, both the conditions under section 45(4) stood satisfied and, therefore, he was entitled to take the fair market value of the asset on the date of the transfer to be the full value of the consideration received as a result of the transfer. It is for this reason that the Assessing Officer has computed the capital gains under section 48 by referring to the comparative figures of the book value and the market value. As stated above, in this connection, the Assessing Officer has computed the capital gains arising to the assessee-firm at Rs. 9 lakhs on the basis of the difference between the market value and the written down value. The Assessing Officer has taken the written down value as on April 1, 1995, and he has taken the market value as on November 8, 1995 (alleged date of transfer), and on that basis, he has computed the capital gains. However, as stated, computation under section 45(4) read with section 48 would arise only if the aforestated two conditions are satisfied to attract section 45(4). In our opinion, this clause has been introduced with effect from April 1, 1999, in order to encourage more and more firms becoming limited companies. It also indicates the difference between transfer and transmission. Basically, when a firm is treated as a company under Part IX, it is a case similar to transmission. This is amply made clear by clause (xiii) to section 47, which states that where a firm is succeeded by a company in the business, the transaction shall not be treated as a transfer. Now, this amendment has been made in section 47 in view of the controversy arising on section 45(1) read with section 2(47)(ii). Under section 45(4) in cases of transfer by way of distribution and where such transfer is as a result of dissolution, the Department is certainly entitled to take the full market value of the asset as full value of consideration provided there is transfer by distribution of assets. In this case, we have held that there is no such transfer by way of distribution and, therefore, section 45(4) is not applicable. This deeming provision, regarding full value of consideration, is not there in section 45(1) read with section 48. If one reads section 45(1) with section 48, it is clear that the former is a charging section and if that section is applicable, the computation has to be done under section 48, which only refers to deductions from the full value of consideration received or accruing. Section 48 does not empower the Assessing Officer to take the market value as the full value of consideration as in the case of section 45(4). In the circumstances, even if we were to hold that vesting amounts to transfer, the computation is not possible because it has been laid down in the above judgment of the Supreme Court that full consideration cannot be construed to mean the market value of the asset transferred. The Legislature, in its wisdom, has amended only section 45(4) by which the market value of the asset on the date of the transfer is deemed to be the full value of consideration. However, such amendment is not there in section 45(1). In the circumstances, neither section 45(1) nor section 45(4) stand attracted. Disallowance of claim for depreciation - The language of section 34(2)(ii) is similar to section 43(6)(c)(i)(B). It was held that section 34(2)(ii) provided that no depreciation was to be allowed in respect of the assets sold, discarded, demolished or destroyed, whereas the term 'transfer' in section 2(47) is only in relation to capital assets as defined under section 2(14). That the term 'transfer' was in relation to computation of capital gains under Chapter IV-E of the Act and, therefore, section 2(47) cannot be invoked for the purposes of section 32, particularly because the words used in section 34(2)(ii) were 'sold, discarded, demolished or destroyed' and not 'transfer'. This judgment of the Madras High Court applies to the facts of our case. Lastly, there is no requirement for the firm to remain owner for the entire year. Hence disallowance by the Assessing Officer on this count was erroneous. Both the aforestated questions are answered in the affirmative, i.e., in favour of the assessee and against the Department. Accordingly, the appeal is disposed of. Issues Involved:1. Applicability of Section 45(1) and Section 45(4) of the Income-tax Act, 1961, on the transfer of assets from a firm to a newly constituted company.2. Entitlement to depreciation under Section 32 read with Section 43(6)(c)(i)(B) of the Income-tax Act, 1961.Detailed Analysis:Issue 1: Applicability of Section 45(1) and Section 45(4)Section 45(4):- Facts and Arguments:- The firm converted into a limited company under Part IX of the Companies Act, 1956, did not show capital gains in its return.- The Assessing Officer (AO) argued that the conversion resulted in a transfer of assets, invoking Section 45(4), which concerns profits from the transfer of a capital asset by way of distribution on the dissolution of a firm.- The assessee contended that Section 45(4) requires both dissolution and distribution of assets, neither of which occurred as the firm was merely converted into a company.- Findings:- The court noted that under Part IX of the Companies Act, the firm's properties vest in the company statutorily, not by distribution.- Citing the Supreme Court's judgment in Malabar Fisheries Co. v. CIT, the court emphasized the difference between vesting and distribution of assets.- Since there was no distribution of assets, Section 45(4) was not applicable.Section 45(1):- Facts and Arguments:- The Department argued that the vesting of the firm's properties in the company constituted a transfer under Section 45(1) due to the extinguishment of the firm's rights in the capital assets.- The assessee argued that Section 45(1) requires the existence of two parties and consideration, which was not the case here as the firm was merely treated as a company.- Findings:- The court held that when a firm is treated as a company under Part IX, it is akin to a statutory transmission rather than a transfer.- Section 45(1) read with Section 48 requires consideration, which was not present as the assets vested statutorily without an actual transfer.- The court referenced Supreme Court judgments in CIT v. George Henderson and Co. Ltd. and CIT v. Gillanders Arbuthnot and Co., which stated that 'full value of consideration' means the price bargained for, not the market value of the asset.- Therefore, Section 45(1) was not applicable as the computation of capital gains was not possible under Section 48.Issue 2: Entitlement to Depreciation- Facts and Arguments:- The AO disallowed the depreciation claim of Rs. 27,67,000, arguing that the assets were sold during the year due to the conversion and hence, the firm did not own the assets at the end of the year.- The assessee argued that depreciation should be allowed as long as the assets were used for business purposes during the year, regardless of ownership at the year-end.- Findings:- The court cited the Madras High Court's judgment in A.M. Ponnurangam Mudaliar v. CIT, which distinguished the term 'transfer' for capital gains from the terms 'sold, discarded, demolished or destroyed' used in the context of depreciation.- The court concluded that the vesting of assets in the company did not constitute a sale, and the firm was entitled to depreciation as the assets were used during the year.- There is no requirement for the firm to remain the owner of the assets for the entire year to claim depreciation.Conclusion:Both issues were resolved in favor of the assessee. The court held that neither Section 45(1) nor Section 45(4) was applicable to the conversion of the firm into a company, and the assessee was entitled to claim depreciation for the year. The appeal was disposed of, with no order as to costs.