2012 (6) TMI 647 - HC - Income Tax

Court rules no capital gains in firm-to-company transfer under Income-tax Act, allowing depreciation claims.

Commissioner of Income-tax Versus Rita Mechanical Works

The High Court ruled against the Revenue in a tax case involving the interpretation of the Income-tax Act. It held that no capital gain arose from the ... Whether Tribunal was right in law in holding that taking over of the assets of the firm by a company and allotting shares to the partners of the firm as per their holding in the firm does not give rise to profit chargeable to capital gain under section 45(4) of the Act - partnership firm has been converted into company - no dissolution of the erstwhile firm and the company has been formed with the same partners as its shareholders – Held that:- section 45(4) is not attracted as the very first condition of transfer by way of distribution of capital assets is not satisfied - no capital gain under section 45(4) of the Act would be attracted in the present case – In favor of assessee Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was right in allowing depreciation to the firm which stood dissolved on March 31, 1995 – Held that:- Assessee-respondent was entitled to claim depreciation on the assets for the period up to March 31, 1995, relating to the assessment year 1995-96- In favor of assessee Issues Involved:1. Interpretation and applicability of Section 45(4) read with Section 2(47) of the Income-tax Act.2. Determination of the correct assessment year for capital gains.3. Eligibility for depreciation claim by the dissolved firm.Detailed Analysis:Issue 1: Interpretation and Applicability of Section 45(4) Read with Section 2(47) of the Income-tax ActThe primary issue was whether the taking over of the assets of a firm by a company and allotting shares to the partners constitutes a 'transfer' chargeable to capital gains under Section 45(4) of the Income-tax Act. The Tribunal held that no capital gain arose within the meaning of Section 45(4) and deleted the addition made on that account. The Revenue argued that the transaction should be treated as a transfer under Section 2(47) and chargeable to tax under Section 45. However, the High Court concluded that Section 45(4) was not attracted in this case, as the firm was converted into a company under Part IX of the Companies Act, and there was no dissolution of the firm. The court relied on the Bombay High Court's decision in Texspin Engineering and Manufacturing Works, which stated that vesting of property in the limited company under Part IX does not amount to a 'transfer by way of distribution' as required under Section 45(4).Issue 2: Determination of the Correct Assessment Year for Capital GainsThe Tribunal held that even if capital gain under Section 45(4) were to arise, it would be chargeable in the assessment year 1996-97 and not in 1995-96. The High Court upheld this view, noting that the company was incorporated on April 3, 1995, and therefore, any capital gain would relate to the subsequent assessment year. The Revenue's contention that the capital gain should be assessed in 1995-96 was rejected.Issue 3: Eligibility for Depreciation Claim by the Dissolved FirmThe Tribunal allowed the claim of depreciation, stating that the firm continued up to April 3, 1995, and thus was entitled to depreciation allowance for the period up to March 31, 1995. The High Court affirmed this decision, noting that the finding that there was no dissolution on March 31, 1995, was not shown to be perverse or erroneous by the Revenue. Therefore, the firm was entitled to claim depreciation for the assessment year 1995-96.ConclusionThe High Court answered all three questions against the Revenue:1. No capital gain under Section 45(4) of the Act would be attracted.2. Capital gain, if any, would relate to the assessment year 1996-97.3. The firm was entitled to claim depreciation for the assessment year 1995-96.The appeal was dismissed, finding no merit in the Revenue's arguments.