Goodwill from Partnership Revaluation Not Taxable Under Section 28(iv) Without Monetary Benefit

The ITAT Chennai held that the amount credited to the assessee's current account on account of goodwill arising from revaluation of the partnership firm is taxable under section 28(iv) only if it constitutes a non-monetary perquisite. Since the assessee did not withdraw any money and the reconstitution was based on a family arrangement among partners, the AO erred in treating the amount as taxable income under section 28(iv). Further, the reopening of assessment under section 147 was quashed as the AO failed to record valid reasons or provide them to the assessee, violating settled judicial principles. The reassessment orders were held invalid for lack of jurisdiction. The appeal by the assessee was allowed, dismissing the revenue's grounds.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether amounts credited to the assessee’s current account and/or withdrawn as a consequence of revaluation of partnership firms and subsequent reconstitution and family arrangement constitute taxable "the value of any benefit or perquisite" arising from business within the meaning of section 28(iv) of the Income-tax Act.

1.2 Whether the transaction effected by the Memorandum of Family Arrangement and amended partnership deeds — entailing drastic reduction of profit‑sharing ratios to 0.01% while credits for revaluation (goodwill) were reflected in partners’ accounts and partial payments made to trusts — amounts to a "transfer" or alienation attracting capital gains provisions (section 45(4) read with section 2(47) / section 47) or is non‑taxable as a family arrangement.

1.3 Whether the reassessment proceedings under sections 147/148 were validly initiated and conducted, having regard to mandatory procedural safeguards — specifically the obligation to furnish recorded reasons for reopening, to allow filing of objections and to dispose of those objections by a speaking order before completing reassessment (judicial guidance in GKN Driveshafts and subsequent authorities) — and whether failure to comply vitiates jurisdiction and renders the reassessment orders non‑est.

2. ISSUE‑WISE DETAILED ANALYSIS

2.1 Issue 1 — Applicability of section 28(iv) to amounts credited/withdrawn on revaluation and reconstitution

2.1.1 Relevant legal framework and precedents: Section 28(iv) taxes "the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession." The Tribunal considered Supreme Court and High Court rulings including Mahindra & Mahindra (holding that section 28(iv) does not apply to receipts in the form of money), Mafatlal Gangabhai & Co. (interpretation of "whether convertible into money or not"), Chetanaben B. Sheth (Gujarat HC) and ITAT decisions (Manish M. Chheda) that revaluation‑linked increase in partner's capital lacks nexus with business so as to attract section 28(iv). Recent Bombay High Court authority (Ramona Pinto v. DCIT) reinforcing that monetary settlements on relinquishment/retirement are not taxable under section 28(iv) was also considered by the Tribunal.

2.1.2 Court’s interpretation and reasoning: The Tribunal accepted the principle that section 28(iv) is principally directed at non‑monetary benefits or perquisites arising in the course of business. A monetary receipt standing as settlement or withdrawal consequent to revaluation and alteration of profit‑sharing was not a perquisite in kind within section 28(iv). The Tribunal held that a necessary condition — nexus with the business as a non‑monetary benefit arising in the course of business — was not satisfied here.

2.1.3 Key evidence and findings: The material showed revaluation of one firm producing goodwill of approx. Rs. 712.27 crores, credit of goodwill amounts to partners’ current accounts in 2013‑14, amended profit‑sharing reducing the assessee’s share from 50%/30% to 0.01%, and subsequent withdrawals/credits alleged by the AO (part amounts routed to trusts). The assessee contended that credits were capital realignments under a family arrangement and that no non‑monetary perquisite was received.

2.1.4 Application of law to facts: Applying the precedents, the Tribunal found the credits/withdrawals to be akin to settlement/realignment resulting from revaluation or retirement/reconstitution and not a non‑monetary perquisite arising from business activity. The Tribunal distinguished the Revenue’s submission that the revaluation was a business arrangement producing taxable perquisites, on the ground that all partners were family members and the reconstitution was effected by a family arrangement; increase in partner’s capital following revaluation lacked requisite nexus with business under cited authorities.

2.1.5 Treatment of competing arguments: Revenue argued the revaluation and deliberate maintenance of 0.01% share were colorable devices to avoid section 45(4) and that credits were convertible benefits taxable under section 28(iv), relying on decisions treating waiver/settlement as taxable perquisites. The Tribunal examined RAMANIYAM HOMES (loan waiver as perquisite) and McDowell (restrictions on colourable devices) contentions but distinguished Mahindra & Mahindra and related precedents to hold that receipt in cash or equivalent on relinquishment/retirement does not fall within section 28(iv). The Tribunal accepted authorities that revaluation‑credited amounts to partner’s capital/current account are not perquisites taxable under section 28(iv).

2.1.6 Conclusion on Issue 1: The Tribunal concluded that section 28(iv) did not apply to the amounts in issue; therefore, the AO erred in treating the sums as income under the head "profits and gains of business or profession". The CIT(A)’s deletion of additions under section 28(iv) was upheld.

2.2 Issue 2 — Whether the transaction is a "transfer" attracting capital gains (section 45(4)/2(47)) or a non‑taxable family arrangement

2.2.1 Relevant legal framework and precedents: Section 45(4) (as applicable prior to later amendments) and section 2(47) deal with "transfer" of capital assets on dissolution/partnership reconstitution. Jurisprudence (Mafatlal; Additional CIT v. Mohanbhai Pambhal; National Company and others) delineates when allotment/realignment on retirement/reconstitution constitutes transfer/realization of capital asset versus being merely the retiring partner’s share in partnership assets not attracting capital gains. The Tribunal also noted decisions where family arrangements effecting realignment among family members were held not to be transfers for capital gains purposes.

2.2.2 Court’s interpretation and reasoning: The Tribunal examined substance over form — whether the arrangement effected real alienation of partnership assets or was an intra‑family reallocation (family arrangement) that did not constitute a taxable transfer. It found the arrangement to be in substance a family arrangement among family members (all partners related), leading to realignment of interests rather than an alienation to outsiders.

2.2.3 Key evidence and findings: The Memorandum of Family Arrangement dated 05.05.2013, amended partnership deeds (06.05.2013), family nexus of partners, and timing of revaluation and credits were scrutinized. The goodwill was reflected in firm’s balance sheet then credited to current accounts. The assessee continued nominally as 0.01% partner and subsequently ceased to be HUF in 2015; capital and current account entries indicated distribution/realignment among family members.

2.2.4 Application of law to facts: On application of authorities, the Tribunal held that the increase in partner’s account due to revaluation and subsequent reallocation under a family arrangement did not amount to transfer within section 2(47) or taxable capital gains under section 45(4). The Tribunal relied on precedent that amounts received on retirement/allotment of partner’s share in partnership assets represent share in partnership and not consideration for transfer, and that family arrangements effecting redistribution among family members are not transfers attracting capital gains.

2.2.5 Treatment of competing arguments: Revenue's contention that retention of nominal 0.01% stake was a device to avoid section 45(4) and that amounts were consideration for relinquishment of exclusive profit rights was considered but rejected because of family context and legal precedents establishing that intra‑family realignments and retirement‑type settlements do not necessarily constitute "transfer" for capital gains.

2.2.6 Conclusion on Issue 2: The Tribunal concluded that the transaction was a family arrangement effecting reallocation of partnership interests among family members and did not attract capital gains provisions; thus deletions on this ground were affirmed.

2.3 Issue 3 — Validity of reassessment proceedings under sections 147/148: compliance with procedural safeguards

2.3.1 Relevant legal framework and precedents: The Tribunal applied the procedural jurisprudence flowing from GKN Driveshafts (Supreme Court) mandating furnishing of reasons for reopening, right to object, and requirement that the Assessing Officer dispose of objections by a speaking order before proceeding to reassessment; subsequent High Court and Tribunal decisions (including Janak Shantilal Mehta, Home Finders, IDFC First Bank) interpreting the scope of that duty were considered.

2.3.2 Court’s interpretation and reasoning: The Tribunal found that the Assessing Officer issued notice under section 148, the assessee sought reasons and filed objections, but no proper speaking order disposing of objections was provided prior to completion of reassessment. The AO purported to dispose of objections only within the draft/final assessment order and passed the final order within a few days — conduct inconsistent with procedural mandate. The Tribunal held that such omission strikes at the root of jurisdiction to reopen and assess, rendering reassessment orders non‑est.

2.3.3 Key evidence and findings: Chronology: survey (22.05.2019), notice under section 148 (05.11.2019), return filed (03.12.2019), notice under section 143(2) (29.09.2020) seeking details, objections filed (15.10.2020), show‑cause/draft order (10/13.09.2021) wherein objections were disposed within the draft, hearing notices and VC slots (16–17.09.2021), and final reassessment order (18.09.2021). The Tribunal noted absence of timely furnishing of recorded reasons and absence of a prior speaking order disposing objections as mandated by GKN.

2.3.4 Application of law to facts: Applying the GKN principle and its progeny, the Tribunal held that the AO’s manner of disposing objections by embedding the disposal in the draft/final order without furnishing reasons and a prior speaking order violated procedural safeguards. The Tribunal relied on case law holding such procedural non‑compliance to vitiate the reassessment, and distinguished authorities where remedial curative action was available in different factual matrices.

2.3.5 Treatment of competing arguments: Revenue argued that reasons were supplied (notice under section 143(2)) and objections were disposed of (show‑cause notice/draft order) and that procedural safeguards under Madras High Court decisions were satisfied. The Tribunal rejected that submission on record‑based chronology, noting that disposing objections in the body of the assessment/draft did not meet the requirement of a speaking order prior to reassessment completion as envisaged by GKN and subsequent jurisprudence.

2.3.6 Conclusion on Issue 3: The Tribunal held that omission to furnish recorded reasons in time and to pass a speaking order disposing objections before framing the reassessment order vitiated jurisdiction; the reassessment orders for both assessment years were quashed as non‑est. Cross‑objections by the assessee on procedural grounds were allowed.

3. FINAL OUTCOME (as concluded in the Reasons above): The Tribunal dismissed Revenue’s appeals on merits and procedure: (a) section 28(iv) not attracted; (b) reconstitution under family arrangement not a taxable transfer under capital gains provisions; and (c) reassessment proceedings were vitiated for failure to comply with GKN procedural safeguards — reassessment orders quashed. Cross‑objections on procedural validity were allowed accordingly. (See cross‑references in paras 2.1.4–2.1.6 and 2.3.1–2.3.6 above.)

 

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