COMMISSIONER OF INCOME TAX Vs. P.N. PANJAWANI

JUDGEMENT

(1.) As a common question of law is involved in all these three appeals, they are taken up for consideration together and disposed off by this common order. The firm M/s. Kamal Industries was dealing in manufacturing and marketing of audio and video cassettes. The partnership was constituted on 05.04.1961. The firm owned property in the form of land situated at 6/2 and 6/3, Doddanakundi Industrial Road, Tubbarahalli village, Marathahaili measuring 1,67,765 sq.ft. The firm filed its return of income for the assessment year 1992-93. Afterwards, no returns were filed on the ground that the firm had stopped its activities and there was no income. In the books of account, the value of the land shown is at Rs. 25,747/-, the value at which it was purchased in the year 1967. The value of the borewell, dining room and factory building along with the value of the land were shown at Rs. 1,93,510/-. The firm revalued the assets as on 01.04.1995 and the opening value was at Rs. 7/- crores. As on 31.03.1995, the firm consisted three partners each having equal share. The said partnership was reconstituted by a partnership deed dated 12.10.1995 admitting four more new partners. The four new partners contributed Rs. 3.50 crores towards their share of capital. As a result of reconstitution of the firm, the assets hitherto owned by the firm of three partners were made over to the reconstituted firm, of seven partners. The result was that the interest of the three partners of the erstwhile firm which in the immovable property was reduced from 1/3rd to 1/6th or 16.67%. Therefore, the Assessing Authority held that there was a relinquishment of right and interest insofar as 50% of the interest of each of the partners in the erstwhile firm by means of assets made over to the reconstituted firm which amounted to transfer within the terms of Section 2(47) of the Income Tax Act, 1961 (for short hereinafter referred to as 'the Act'). The erstwhile three partners after reconstitution of the firm have withdrawn a sum of Rs. 1,16,66,666/- each on 14.10.1995. According to the Assessing Authority, this amount represented the capital gain for relinquishment of their 50% of the right in the erstwhile partnership firm and its assets. Therefore, he framed an assessment order and accordingly held that Rs. 3,46,84,942/- is the capital gain and accordingly, apportioned the same from each of the partners at Rs. 1,16,66,666/- and called upon them to pay income tax on long term capital gain of Rs. 23,04,329/- with interest under Section 234(A) and 234(B), in all in a sum of Rs. 59,56,689/-. Aggrieved by the said order, the assessee preferred an appeal to the Commissioner of Income Tax (Appeals). The Appellate Authority after referring to Sections 45(1), 45(3) and 45(4) of the Act held that the facts of the case clearly suggest that the property in the form of the land or the landed property was certainly not held by the assessee partners in their own personal capacity. This landed property was actually an asset of the firm in its capacity as legal owner. This landed property belonged to the firm and stood in its name in the relevant legal documents of ownership and was reflected as such in its books of account also. Therefore, if at all there was a transfer of these assets or landed property from the firm to the incoming partners in which event it is the firm, which is to be taxed, and not the individual partners. It also held that reduction in the share of profit and loss of the firm on account of induction of new partners qualifies to be categorized as "capital gains" in the hands of the old and continuing partners, is not correct. None of the provisions of the Income Tax Act specifically envisages a situation where capital gains would be chargeable on account of reduction in the share of a partner in the firm following the reconstitution of the firm by way of induction of new partners. Therefore, a reduction in the share in a partnership firm on account of reconstitution of the firm by way of induction of new partners cannot be said to have effected a transfer of any kind even by an act of extinguishment. In view of the judgment of the Apex Court in the case of Malabar Fisheries Co. v. CIT, 1979 120 ITR 49 , where it has been held that there is no transfer of assets even when distribution takes place upon dissolution of the firm. Therefore how can it be justified that there is a transfer of asset merely on reconstitution of the firm through induction of new partners and therefore, the Appellate Authority set aside the order passed by the Assessing Authority taxing the assessee for the capital gain. Aggrieved by the said order, the revenue preferred an appeal to the Tribunal. The Tribunal after taking note of the relevant provisions of the Income Tax Act as well as the Indian Partnership Act, 1932 and the judgments of the Apex Court held that the judgments relied on by the revenue would apply to a case where the firm, the assessee is not genuine and the action taken by the firm should lead to a situation of tax evasion. In the instant case, it is nobody's case that the firm is not genuine. The firm even after the induction of new partners, continues to exist. Merely because, they did not carry on any business after induction of new partners is no ground to hold that it is not a genuine firm. Further held that the admission of a partner to the firm results in the reduction of the share of interest from the profit of the firm by virtue of reduction in the share of profit, but it is not the same as in transfer of property for valuable consideration in favour of the newly admitted partners. Therefore, in the instant case, it is not a case of transfer of property by the three partners because the firm is still subsisting and has not been dissolved. Therefore, it declined to interfere with the well-considered order passed by the Appellate Authority. Aggrieved by the said order, the revenue is in appeal.

(2.) The learned Counsel for the revenue assailing the impugned order contended that it is not disputed that the partnership firm was reconstituted by induction of four partners on 12.10.1985 who brought in Rs. 3.50 crores towards share of capital. Prior to their induction, the three partners had 1/3rd share in the partnership firm and consequently, the property was owned by the partnership firm. After reconstitution, within two days i.e., on 14.10.1985 all the three assessees who are erstwhile partners of the old firm have withdrawn a sum of Rs. 1,16,66,666/- each, as their drawings i.e., the entire Rs. 3.5 crores brought in by the incoming partners. After such reconstitution, the firm is not carrying on any business. Under these circumstances, the amount withdrawn by the partners represents the consideration for the reduction of their share capital percentage in the partnership and therefore, it falls within Section 45 (1) of the Act and they are liable to pay capital gains. In support of their contention, they relied on two judgments, one is of the Apex Court and another of this Court and contended that the impugned orders are liable to be set aside.

(3.) Per contra, the learned Counsel appearing for the assessee submitted that the aforesaid facts are not in dispute but it does not constitute transfer as defined under Section 2(47) read with Section 45(1) of the Act. Assuming it is to be treated as a transfer, then, the tax is to be levied at the hands of the firm and hot on individual partners. Admittedly, the partnership continues and the erstwhile partners continue to have interest in the partnership assets. Merely because, they have withdrawn money from the partnership firm, it does not constitute consideration for proportionate reduction in their share in the firm. Both the appellate authorities on a careful consideration of the facts and the law on the point have rightly upheld the contention of the assessee and it does not call for any interference and therefore, he submits that there is no merit in these appeals and are liable to be dismissed.