2024 (4) TMI 605 - HC - Income Tax

Partner's retirement from firm doesn't constitute capital asset transfer, amounts received not taxable as capital gains

Smt. Girija Reddy P. Versus Income Tax Officer

The Telangana HC ruled that amounts received by a partner upon retirement from a partnership firm cannot be taxed as capital gains. The court held that ... Characterization of receipt - amount received by the appellant upon retirement from the partnership - taxability as capital gains under the Income Tax or not? - department, was of the firm stand that the right of the appellant in the partnership firm is a capital asset and the extinguishment of the right in the said firm is in fact a transfer of the receipt against capital asset - Appellant as contended that receipt of the share value of goodwill cannot be subjected to capital gains tax as there was no transfer of goodwill to the firm by the appellant - Whether the Income Tax Appellate Tribunal was correct in law in holding that the receipt of the share in value of goodwill by the appellant is taxable as capital gains under the Act ? HELD THAT:- Coming to the impugned order passed by the Tribunal in SMT. GIRIJA REDDY, P HYDERABAD [2012 (7) TMI 652 - ITAT HYDERABAD] would give a clear indication that the principles laid down by the Division Bench of this High Court in Chalasani Venkateswara Rao [2012 (9) TMI 12 - ANDHRA PRADESH HIGH COURT] has been accepted by the Tribunal while making the aforesaid observations. However, while concluding, the Tribunal took a different view altogether which, therefore, would not be in the opinion of this Bench, proper, legal and justified. Therefore, the respondent-Department cannot tax the amount received by the appellant upon retirement from the partnership as capital gains as there is no specific transfer of a capital asset affected when the appellant had retired from the partnership firm. So also, the finding of the Tribunal holding that the receipt of share in value of goodwill by the appellant is taxable as capital gains is not proper. Therefore, the impugned order passed by the Tribunal is unsustainable and the same deserves to be and is accordingly dismissed. Assessee appeal stands allowed. Issues Involved:1. Taxability of payment of credit balance in capital account as capital gains.2. Taxability of receipt of share in value of goodwill as capital gains.3. Determination of transfer of capital asset upon retirement from partnership.Summary:Issue 1: Taxability of Payment of Credit Balance in Capital Account as Capital GainsThe appellant, a retired partner from M/s. Montage Manufacturers, received Rs. 8,22,17,952/- as her share of capital gain. The respondent-Department held that the right of the appellant in the firm is a capital asset, and its extinguishment stands transferred, making the receipt taxable u/s 45 of the Income Tax Act, 1961. The Tribunal partly allowed the appeal but dismissed the stay application. The High Court, referencing the Division Bench decision in Chalasani Venkateswara Rao vs. Income-Tax Officer, held that the payment of the credit balance in her capital account upon retirement does not constitute a transfer of capital asset and is not taxable as capital gains.Issue 2: Taxability of Receipt of Share in Value of Goodwill as Capital GainsThe appellant argued that the receipt of the share value of goodwill cannot be subjected to capital gains tax as there was no transfer of goodwill to the firm. The respondent-Department contended that the extinguishment of the appellant's right in the firm is a transfer of the receipt against the capital asset, taxable u/s 45 of the Act. The High Court, relying on the precedent set in Chalasani Venkateswara Rao, concluded that the receipt of share in value of goodwill by the appellant is not taxable as capital gains.Issue 3: Determination of Transfer of Capital Asset Upon Retirement from PartnershipThe Tribunal's observation in paragraph 44 of the impugned order acknowledged that if a partner is paid the amount standing to the credit of their capital account, there would be no transfer. However, the Tribunal concluded differently, which the High Court found improper and unjustified. The High Court emphasized that there was no specific transfer of a capital asset when the appellant retired from the partnership firm, making the Tribunal's finding unsustainable.Conclusion:The High Court dismissed the impugned order of the Tribunal, holding that the amount received by the appellant upon retirement from the partnership is not taxable as capital gains. The appeal was allowed with no costs, and any pending miscellaneous applications were closed.