2025 (10) TMI 513 - AT - Income Tax

Addition under s.56(2)(vii)(b) unsustainable where property bought with firm funds and shown as firm asset, not partner's gift

ITAT held that the addition under s.56(2)(vii)(b) was not sustainable. The property was acquired by the partnership using firm funds and reflected as a ... Addition u/s 56(2)(vii)(b) - income from other sources - value of the property purchased in the name of the assessee through the alleged loan from the firm where she is the partner - HELD THAT:- Merely because the property was held in the name of the partner, the same could not be held to be gift considering the fact that the property was reflected as an asset in the Balance Sheet. In terms of Sec.14 of Indian Partnership Act, 1932, the partnership property includes all property and rights originally brought into the firm or acquired by or for the firm. The property has been acquired by the partnership-firm using its own funds. The firm’s treatment of the property as an asset reinforces that no personal gift or transfer without consideration has occurred. As in the case of Smt. Chandrasekaran Valarmathi [2023 (12) TMI 405 - ITAT CHENNAI] considering the provisions of Sec.14 of Indian Partnership Act, 1932, under similar circumstances, held that the property is deemed to have been acquired by the firm and not by individual partners. The same supports the adjudication of CIT(A). Even otherwise, the transaction, at the most be considered as loan by the firm to the partner but the same cannot be treated as gift in the hands of the assessee. The same is also supported by the fact that necessary rectification for classification of the property has been carried out by the firm in subsequent financial year 2017-18. Therefore, the provisions of Sec. 56(2)(vii)(b) could not be applied in this situation also. Lastly, it could also be ascertained that the partnership firm was constituted by the assessee and her relatives only. Applying the doctrine of substance over form, it could be concluded that even if there was a gift, the same has happened within the relatives and such transactions are excluded from the purview of Sec.56 (2)(vii)(b). This view is supported by decision of Ms. Anitha Kumaran [2022 (9) TMI 1682 - ITAT CHENNAI] ISSUES PRESENTED AND CONSIDERED 1. Whether section 56(2)(vii)(b) can be invoked to tax as income the benefit to a partner where a partnership firm purchases property using firm funds but the property is held in the name of the partner. 2. Whether absence of a debit to the partner's capital or current account in the firm's books necessarily establishes a gratuitous benefit (gift) to the partner attracting section 56(2)(vii)(b). 3. Whether subsequent reclassification/rectification in the firm's financial statements or characterization of the transaction as a loan prevents invocation of section 56(2)(vii)(b). 4. Whether transfers or benefits between a firm constituted by the partner and her relatives fall within the scope of section 56(2)(vii)(b) or are excluded by reason of the relative-relationship exception. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of section 56(2)(vii)(b) where firm-acquired property is held in partner's name Legal framework: Section 56(2)(vii)(b) taxes any property received without consideration or for inadequate consideration; partnership law (s.14, Indian Partnership Act, 1932) deems property acquired for the firm to be partnership property. Precedent Treatment: The Tribunal relied on a coordinate-bench decision addressing similar facts (reference to co-ordinate bench holding property acquired by firm is deemed firm property under s.14), treating partnership law as determinative of beneficial ownership for tax purposes. Interpretation and reasoning: The Court examined firm bank statements and the firm's balance sheet showing the property as an asset and the payment debited to a firm asset head. Those facts indicate acquisition by the firm for firm benefit, notwithstanding the property title being in the partner's name. Section 14 of the Partnership Act treats property acquired by or for the firm as partnership property irrespective of legal title; therefore, beneficial ownership rests with the firm. Mere registration in partner's name does not convert firm property into a gift to the partner where the firm treats the property as an asset in its books and funds are used by the firm. Ratio vs. Obiter: Ratio - where firm funds purchase property and the property is reflected as a firm asset, section 56(2)(vii)(b) does not apply to tax the partner on the ground of gift merely because legal title stands in partner's name. Obiter - factual observations as to evidentiary weight of specific ledger entries. Conclusion: Section 56(2)(vii)(b) cannot be invoked when firm funds are used and the property is accounted as a firm asset; the property is deemed partnership property under s.14, and no income arises in partner's hands as gratuitous receipt. Issue 2 - Significance of absence of debit to partner's capital/current account Legal framework: Accounting entries (capital/current account debits) typically reflect transfers to partners; absence of such entry may be relied upon by tax authorities to infer gratuitous benefit, but inference must be tested against overall evidence of firm treatment and documentary records. Precedent Treatment: The Tribunal noted the AO's reliance on absence of debit but treated that fact alongside the firm's balance sheet, bank records, and partnership composition; coordinate-bench authorities were treated as supportive where substance over form was applied. Interpretation and reasoning: The mere absence of a debit to the partner's capital account is not determinative if contemporaneous objective records (firm's bank payments, asset entry in balance sheet) demonstrate that the payment and beneficial ownership remained with the firm. The proper analysis is one of substance over form: whether the transaction, on the whole, reflects an appropriation by the firm or a transfer to the partner. Where the firm continues to account for the property as a firm asset, inability to locate a debit to partner account does not automatically establish a gift. Ratio vs. Obiter: Ratio - absence of capital/account debit does not, by itself, establish a gift where the firm's accounts and conduct show the property as firm-owned. Obiter - remarks on possible inferences in different factual matrices. Conclusion: The AO's reliance solely on non-debit to the partner's account is insufficient to bring the transaction within section 56(2)(vii)(b) when other records demonstrate firm ownership. Issue 3 - Effect of subsequent reclassification/characterization as loan on applicability of section 56(2)(vii)(b) Legal framework: Tax liability under section 56(2)(vii)(b) depends on the nature of transfer (gift/transfer without consideration); characterization as loan or internal accounting rectification may negate gratuitous receipt if supported by evidence. Precedent Treatment: The Tribunal referred to the firm's rectification in a subsequent year and accepted that such reclassification supported the view that the transaction was not a gift but either firm ownership or a loan; coordinate-bench authority on intra-family/partner transactions was invoked to support non-application of s.56(2)(vii)(b). Interpretation and reasoning: If firm books are later rectified to correctly classify the transaction (e.g., show property as firm asset or record loan), and bank records indicate firm funds, the substance indicates a business/firm transaction rather than gratuitous transfer. Consequently, section 56(2)(vii)(b) is not attracted. The Court emphasized substance over form and the totality of documentary evidence (bank statements, balance sheet entries, subsequent rectification) to conclude absence of gift. Ratio vs. Obiter: Ratio - subsequent rectification and consistent documentary evidence can confirm that the transaction is not a gift and therefore does not fall within section 56(2)(vii)(b). Obiter - treatment of rectifications in other factual permutations. Conclusion: Subsequent reclassification and corroborative evidence of firm funding support treating the transaction as non-gratuitous (loan or firm asset), precluding application of section 56(2)(vii)(b). Issue 4 - Application of relative-relationship exception to intra-firm/relative transactions Legal framework: Section 56(2)(vii)(b) excludes certain transactions between relatives from taxation as gratuitous receipt; partnership firms constituted by relatives may fall within this exclusion depending on relationship and facts. Precedent Treatment: The Tribunal relied on a coordinate-bench decision holding that transactions within relatives do not attract section 56(2)(vii)(b), applying the relative-relationship exception and the doctrine of substance over form. Interpretation and reasoning: The Court noted the firm was constituted by the partner and her relatives. Even if, arguendo, the transaction were a gift, transactions between relatives fall outside the scope of section 56(2)(vii)(b). The combination of family composition of the firm and documentary evidence negates the conclusion that a taxable gratuitous receipt occurred. Ratio vs. Obiter: Ratio - where the firm is constituted by the partner and relatives, and the transaction is intra-relative, section 56(2)(vii)(b) does not apply to tax such transfers as income. Obiter - observations on interplay between partnership substance and relative exceptions in differing fact patterns. Conclusion: Transactions involving a firm constituted by the partner and her relatives are excluded from section 56(2)(vii)(b); this supports the non-application of that provision on the facts. Overall Conclusion (Cross-references) Considering (i) firm funding evidenced by bank statements and balance-sheet asset classification, (ii) absence of requisite accounting entries being insufficient alone to infer gift (see Issue 2), (iii) subsequent rectification and possible loan characterization (Issue 3), and (iv) the firm's composition of relatives (Issue 4), the Court concluded that section 56(2)(vii)(b) was incorrectly invoked. The adjudication of the appellate authority deleting the addition under section 56(2)(vii)(b) is upheld as the ratio decidendi on these facts.