2016 (10) TMI 59 - HC - Income Tax

Partnership Firm's Capital Contribution Not Taxable as Capital Gains

Jamnalal Sons Ltd. Versus The Commissioner of Income Tax

The court determined that the capital contribution to the partnership firm constituted a transfer of a capital asset under the Income Tax Act. However, it ... Transfer of capital assets - contribution of capital asset into the firm - capital gain computation - selection of assessment year - Held that:- So far as the character of immovable property, shares and securities invested by the applicant company into the partnership firm M/s. Bajaj Trading Company as a stock in trade as contended by the applicant or capital asset as held by the Tribunal is concerned, the same need not be examined. This for the reason that applicant company has contended that even if it is assumed that what was transferred was a capital asset, yet the transaction is not exigible to capital gain tax. However, it does reserve its right to contend otherwise, in case the Court does not accept its contention that no capital gain tax is payable on its contribution of capital asset i.e. immovable property, share and securities invested in M/s. Bajaj Trading Company. Therefore, for the present, we proceed on the basis that what has been invested in the partnership firm by the applicant assessee was a capital asset in the hands of the applicant assessee. There is a transfer of a capital asset when the applicant company introduced its immovable property, shares and securities as its contribution to the capital of the partnership firm M/s. Bajaj Trading Company. See Sunil Siddharthbhai [1985 (9) TMI 7 - SUPREME Court]. No capital gain chargeable to tax arises on the amount contributed as capital into the partnership firm. This on the basis that at the relevant time, it did not give rise to receipt of any determinable consideration to the transferor as contemplated in Section 48 of the Act.In the above view, we have proceeded on the basis that the immovable property, stock and security were capital assets in the hands of the Applicant Company when introduced into the partnership firm – M/s. Bajaj Trading Company. Moreover, the Authorities have held that the partnership firm was genuine and not a colourable device. Therefore, the investment made in it, cannot be a device when seen in the light of the subsequent conduct of the partnership firm of dealing in immovable properties, stocks and securities as its stockintrade for the subsequent years. In fact, we are informed the firm continues to do so till date and is being assessed to tax as a dealer in immovable property, stocks and securities. In the circumstances, when the transaction is looked at in its entirety, the investment made cannot be said to be ruse to evade tax (see Vodafone International v/s. Union of India [2012 (1) TMI 52 - SUPREME COURT OF INDIA ]). Accordingly, we answer the question partly in the affirmative to the extent the Tribunal held that there was a transfer of capital asset when the applicant assessee made its capital contribution in the form of land, shares and securities to the partnership firm M/s. Bajaj Trading Company. However, other parts of the question namely that the transfer of capital assets resulted in capital gains, which can be subjected to capital gain tax in the subject assessment year, is answered in the negative, i.e. in favour the of the applicant assessee and against the Revenue. Issues Involved:1. Characterization of the capital contribution: capital asset or stock in trade.2. Whether the contribution to the partnership firm constitutes a transfer of capital asset under Section 2(47) and 45 of the Income Tax Act.3. Determination of capital gains arising from the transfer.4. Taxability of the capital gains in Assessment Year (A.Y.) 1980-81.Detailed Analysis:Issue 1: Characterization of the Capital ContributionThe court did not delve into whether the capital contribution in the form of immovable property, stocks, and shares was a capital asset or stock in trade. The applicant reserved the right to argue this point if the court did not accept the contention that no capital gains tax was payable. Thus, the court proceeded on the basis that the contribution was a capital asset.Issue 2: Transfer of Capital AssetThe court held that the contribution of capital assets to the partnership firm constituted a transfer of capital asset under Section 2(47) read with Section 45 of the Income Tax Act. This conclusion was based on the precedent set by the Supreme Court in Sunil Siddharthbhai v. Commissioner of Income Tax, which established that such contributions are transfers of capital assets.Issue 3: Determination of Capital GainsThe court found substance in the applicant's argument that no capital gain chargeable to tax arose from the contribution of capital assets to the partnership firm. This was because, at the relevant time, the transfer did not result in any determinable consideration to the transferor as required by Section 48 of the Act. The Supreme Court's decision in Sunil Siddharthbhai, relying on Commissioner of Income Tax v. B.C. Srinivasa Setty, held that if the computation provisions fail, the charge itself fails. The consideration received was only a right to share in the profits and net assets upon dissolution or retirement, which was not a determinable value. This interpretation was valid for the period before the introduction of Section 45(3) in A.Y. 1988-89, which deemed the recorded value in the firm's books as full consideration.Issue 4: Taxability in A.Y. 1980-81The court noted that the authorities had proceeded on the assumption that the partnership firm was genuine and not a sham. The partnership firm continued to trade in land, shares, and securities, indicating that the contribution was not a device to evade tax. The withdrawal of capital by the applicant three years later was from advances received by the firm, not a device to evade tax. Thus, the transfer did not result in taxable capital gains in A.Y. 1980-81. The court emphasized that the transaction, viewed in its entirety, did not fall within the mischief indicated by the Supreme Court in Sunil Siddharthbhai.Conclusion:The court answered the question partly in the affirmative, acknowledging that there was a transfer of capital asset when the applicant made its capital contribution to the partnership firm. However, it held that the transfer did not result in capital gains subject to tax in A.Y. 1980-81. The reference was disposed of with no order as to costs.