1985 (9) TMI 7 - SC - Income Tax

Contribution of appreciated shares to a genuine partnership is a transfer under s.45 but not consideration under s.48

Sunil Siddharthbhai and Kartikeya V. Sarabhai Versus Commissioner of Income-Tax, Ahmedabad

SC held that when a partner contributes appreciated shares as partnership capital there is a transfer within the meaning of s.45, but no consideration as ... Capital of the partnership firm - transaction constituted a 'transfer' within the meaning of Section 2(47) - Consideration Received - whether the capital contribution by a partner to the assets of a partnership firm at an appreciated value can be said to give rise to a capital gain in his hands liable to income-tax. - shares revalued at market value, and the difference was credited to his capital account - HELD THAT:- What the partner gets upon dissolution or upon retirement is the realisation of a pre-existing right or interest. It is nothing strange in the law that a right or interest should exist in praesenti but its realisation or exercise should be postponed. Therefore, what was the exclusive interest of a partner in his personal asset is, upon its introduction into the partnership firm as his share to the partnership capital, transformed into an interest shared with the, other partners in that asset. Qua that asset, there is a shared interest. During the subsistence of the partnership, the of the interest of each partner qua that asset cannot be isolated or carved out from the value of the partner's interest in the totality of the partnership assets. And in regard to the latter, the value will be represented by his share in the not assets on the dissolution of the firm or upon the partner's retirement. We hold that when the assessee brought the shares of the limited companies into the partnership firm as his contribution to its capital, there was a transfer of a capital asset within the meaning of the terms of section 45 of the Income-tax Act. In this view of the matter, we agree with the conclusion reached by the Kerala High Court in A. Abdul Rahim, Travancore Confectionery Works v. CIT [1974 (7) TMI 8 - KERALA HIGH COURT], the Karnataka High Court in Addl. CIT v. M. A. J. Vasanaik [1978 (9) TMI 46 - KARNATAKA HIGH COURT] and by the Gujarat High Court in the judgment under appeal. Whether the assessee can be said to have received any consideration as that expression is understood in the scheme of capital gains under the Income-tax Act - HELD THAT:- At the time when a partner transfers his personal asset to the partnership firm, there can be no reckoning of the liabilities and losses which the firm may suffer in the years to come. All that lies within the womb of the future. It is impossible to conceive of evaluating the consideration acquired by the partner when he brings his personal asset into the partnership firm when neither the date of dissolution or retirement can be envisaged nor can there be any ascertainment of liabilities and prior charges which may not have even arisen yet. In the circumstances, we are unable to hold that the consideration which a partner acquires on making over his personal asset to the partnership firm as his contribution to its capital can fall within the terms of section 48. And as that provision is fundamental to the computation machinery incorporated in the scheme relating to the determination of the charge provided in section 45, such a case must be regarded as falling outside the scope of capital gains taxation altogether. What is the profit or gains which can be said to accrue or arise to the assessee when lie makes over his personal asset to the partnership firm as his contribution to its capital ? - We have decided these appeals on the assumption that the partnership firm in question is a genuine firm and not the result of a sham or unreal transaction and that the transfer by the partner of his personal asset to partnership firm represents a genuine intention to contribute to the share capital of the firm for the purpose of carrying on the partnership business. If the transfer of the personal asset by the, assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income-tax on a capital gain, it will be open to the income-tax authorities to go behind the transaction and examine whether the transaction of creating the partnership is a genuine or a sham transaction and, even where the partnership is genuine, the transaction of transferring the personal asset to the partnership firm represents a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business or is nothing but a device or ruse to convert the personal asset into money substantially for the benefit of the assessee while evading tax on a capital gain. The, Income-tax Officer will be entitled to consider all the relevant indicia in this regard, whether the partnership is formed between the assessee and his wife and children or substantially limited to them, whether the personal asset is sold by the partnership firm soon after it is transferred by the assessee to it, whether the partnership firm has no substantial or real business or the record shows that there was no real need for the partnership firm for such capital contribution from the assessee. All these and other pertinent considerations may be taken into regard when the Income-tax Officer enters upon a scrutiny of the transaction, for, in the task of determining whether a transaction is a sham or illusory transaction or a device or ruse, he is entitled to penetrate the veil covering it and ascertain the truth. In the result, the questions which arise in these appeals are answered as follows : There was a transfer of the shares when the made them over to the partnership firm as his capital contribution. When the assessee transferred his shares to the partnership firm, he received no consideration within the meaning of section 48 of the Income-tax Act, 1961, nor did any profit or gain accrue to him for the purpose of section 45 of the Income-tax Act, 1961. Issues Involved:1. Whether the capital contribution by a partner to the assets of a partnership firm at an appreciated value gives rise to a capital gain liable to income-tax.2. Whether the transaction of contributing shares to a partnership firm constitutes a 'transfer' under Section 2(47) of the Income-tax Act, 1961.3. Whether the assessee received any consideration as understood in the context of capital gains under the Income-tax Act.4. Whether any profit or gain arises to a partner when he brings his personal asset into a partnership firm as his contribution to its capital.Issue-wise Detailed Analysis:1. Capital Contribution and Capital Gain:The primary issue in these appeals was whether the capital contribution by a partner to the assets of a partnership firm at an appreciated value results in a capital gain liable to income-tax. The court examined the facts where the assessee, a partner in a firm, contributed shares as his capital contribution. The shares were revalued at market value, and the difference was credited to his capital account. The Income-tax Officer initially did not include the difference in the assessable income, but the Commissioner of Income-tax later directed the inclusion of the difference as capital gains. The Tribunal, however, held that no capital gains resulted from the transfer, a view that was contested by the Revenue.2. Definition of 'Transfer':The court analyzed whether the transaction constituted a 'transfer' within the meaning of Section 2(47) of the Income-tax Act, 1961. It was argued that a partnership firm is not a separate legal entity, and the assets are collectively owned by the partners. The court referred to previous judgments, including Malabar Fisheries Co. v. CIT, which stated that a partnership firm has no separate rights in the partnership assets. The court also considered CIT v. Hind Construction Ltd., where it was held that the transfer of machinery to a partnership firm did not constitute a sale. The court concluded that while the transaction might not amount to a sale, it could still be considered a transfer under the inclusive definition provided in Section 2(47).3. Consideration Received:The court examined whether the assessee received any consideration as required under Section 48 of the Income-tax Act. It was argued that the consideration for the transfer of personal assets to the partnership firm is the right to share in the profits and, upon dissolution or retirement, to receive the value of the net partnership assets. The court noted that the credit entry in the partner's capital account does not represent the true value of the consideration, as it is a notional value subject to future liabilities and losses. The court held that the consideration received by the assessee could not be ascertained in monetary terms at the time of the transfer, and therefore, the case fell outside the scope of capital gains taxation.4. Profit or Gain Arising:The court addressed whether any profit or gain arises to a partner when he brings his personal asset into a partnership firm. It was argued that real capital gains must be computed on ordinary commercial principles, and the capital gains must be embedded in the capital asset. The court referred to previous judgments, including Miss Dhun Dadabhoy Kapadia v. CIT, which upheld the principle that profits or gains must be understood in the sense of real profits or gains. The court concluded that no income or gain arises to the assessee in the true commercial sense when he contributes his personal asset to the partnership firm.Conclusion:The court held that when the assessee brought the shares into the partnership firm as his capital contribution, there was a transfer of a capital asset within the meaning of Section 45 of the Income-tax Act. However, the consideration received by the assessee did not fall within the terms of Section 48, and no profit or gain accrued to him for the purpose of Section 45. The court emphasized that the partnership firm in question must be genuine and not a sham transaction. The appeals were partly allowed, with no order as to costs.Judgment:1. There was a transfer of the shares when the assessee made them over to the partnership firm as his capital contribution.2. When the assessee transferred his shares to the partnership firm, he received no consideration within the meaning of Section 48 of the Income-tax Act, 1961, nor did any profit or gain accrue to him for the purpose of Section 45 of the Income-tax Act, 1961.Appeals allowed in part.