Taxability of capital gains on sale of partnership property: Revision u/s 263 upheld; AO directed to make further enquiries

Revision under section 263 challenged an assessment completed u/s 143(3) r.w.s. 147 r.w.s. 144B concerning taxability of capital gains on sale of partnership property after dissolution. The tribunal analysed the scope of the provision equivalent to section 45(4) and the limited purpose of the provision corresponding to section 189, finding those provisions apply where a firm has carried on business and is assessed for the period of its business; they do not apply where the firm ceased to exist and no business was carried on in the relevant year. Consequently, the revisional power was found properly invoked to direct further enquiries by the AO; the appeal was dismissed.

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Issues: (i) Whether the Principal Commissioner of Income Tax was justified in invoking the revisional jurisdiction under section 263 of the Income-tax Act, 1961 and setting aside the reassessment order dated 30.03.2022 passed under section 143(3) r.w.s.147 r.w.s.144B for AY 2017-18 on the ground that the assessment was erroneous and prejudicial to the interest of revenue for not taxing the capital gains in the correct hands.

Analysis: The question required examination of (a) whether the partnership M/s. Baliga Lighting Company stood dissolved on the death of one of two partners such that the firm was non-existent for AY 2017-18; (b) the scope of section 189 and section 45(4) of the Income-tax Act regarding assessment of capital gains on dissolution; and (c) whether failure to make enquiries (including applicability of section 50C) rendered the assessment erroneous and prejudicial to revenue within section 263. Authorities and Partnership Act provisions establish that a partnership consisting of only two partners is dissolved on the death of one partner unless a contrary contractual provision involving more than two partners exists; on dissolution the legal representatives have rights to surplus under section 46 but do not automatically become partners. Section 189 creates a limited deeming fiction for assessment of the previous year in which dissolution occurred and does not permit invoking that provision to assess the firm in perpetuity where the firm did not exist or carry on business in the relevant year. Section 45(4) creates a deeming rule as to distribution on dissolution for the relevant previous year but does not convert a subsequent transfer by non-existing firm into an assessment in the hands of that firm for a later year. Where identical shares of capital gains were assessed in the hands of other legal heirs for AY 2017-18 and the sale occurred after the date of death, the reassessment accepting taxation in the hands of the legal heirs and directing enquiries into taxability and valuation (including section 50C) concerned taxation in the correct hands and remedial steps to protect revenue. The Tribunal found that the Assessing Officer had failed to make requisite enquiries and that section 189 and section 45(4) could not be used to perpetuate assessability of a non-existing firm in AY 2017-18; thus the revisional jurisdiction was properly exercised to direct fresh enquiries and correction.

Conclusion: In favour of Revenue.

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