Aniruddha JainSnapshot:
In a landmark decision, Hon’ble Supreme Court gave clarity on “Otherwise” word in Section 45(4) which shall include revaluation of capital asset of firm by credit to partners’ capital account in their PSR. Though section 45(4) witnessed sea changes vide Finance Act, 2021, the decision will impact ongoing litigation pertaining to the same.
Facts of the Case
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- Assessee, a partnership firm originally consisted of four partners (all brothers) engaged in the business of Dyeing and Printing, Processing, Manufacturing and Trading in Clothing. Under the Family Settlement dated 02.05.1991, the share of one of the existing partners – Shri M.H. Doshi having 25% profit share in the firm was reduced to 12% and, for his balance 13% share, three new partners were admitted namely, viz., Smt. Ranjan Doshi (11%), Shri Prakash Doshi (1%) and Shri Rajeev Doshi (1%).
- Thereafter, Shri M.H. Doshi, Shri Manohar Doshi and Shri V.H. Doshi retired from the partnership and reconstituted the partnership firm consisted of the partners namely, viz., Shri Hasmukhlal H. Doshi, Smt. Rajan H. Doshi, Shri Prakash H. Doshi & Shri Rajiv H. Doshi.
- On 01.11.1992, the firm was again reconstituted and three more partners, namely, viz., Smt. Vaishali Shah (18%), Smt. Bhavna Doshi (9%), Smt. Rupal Doshi (9%) and M/s. Ranjana Textile Pvt. Ltd. (10%) were admitted as partners.
- 01.01.1993, the assets of the firm were revalued and an amount of Rs. 17.34 crores were credited to the accounts of the partners in their profit-sharing ratio.
- Addition of Rs. 17,34,86,772/- was made by AO towards short term capital gain under Section 45(4) of the Income Tax Act. According to the Revenue, the new partners were immediately benefited by the credit to their capital accounts of the revaluation amount.
| New Partners admitted | Capital Contribution | Balance after immediate revaluation |
| Vaishali Shah | 4.50 lakhs | 3.12 crore |
| Bhavna Doshi | 2.25 lakhs | 1.56 crore |
| Rupal Doshi | 2.25 lakhs | 1.56 crore |
| M/s Ranjana Textiles | 2.50 lakhs | 1.73 crore |
- The Commissioner of Income Tax (Appeals) [CIT(A)] by order dated 30.07.2004 confirmed the addition.
- In an appeal preferred by the assessee, the ITAT by judgment and order dated 26.10.2006 and relying upon the decision of this Court in the case of Commissioner of Income Tax, West Bengal Vs. Hind Construction Ltd., (1972) 4 SCC 460 allowed the appeal and has set aside the addition made by the AO towards Short Term Capital Gains by observing that as observed and held by this Court in the aforesaid decision, revaluation of the assets and crediting to partners’ account did not involve any transfer.
- Relying upon the decision of this Court in the case of Hind Construction Ltd. (supra), by the impugned judgment and order the High Court has dismissed the appeals preferred by the Revenue.
Supreme Court
- The object and purpose of introduction of Section 45(4) was to pluck the loophole by insertion of Section 45(4) and omission of Section 2(47)(ii). While introduction to Section 45(4), clause (ii) of Section 2(47) came to be omitted. Earlier, omission of Clause (ii) of Section 2(47) and Section 47(ii) exempted the transform by way of distribution of capital assets from the ambit of the definition of “transfer”. The same helped the assessee in avoiding the levy of capital gains tax by revaluing the assets and then transferring and distributing the same at the time of dissolution.
- Assessee’s stand of unless there is a dissolution of the partnership firm, and there is only transfer of the amount on revaluation to the capital accounts of the respective partners, Section 45(4) of the Income Tax Act shall not be applicable has no substance in view of the amended Section 45(4) of the Income Tax Act inserted vide Finance Act, 1987, by which, “OR OTHERWISE” is specifically added.
- The expression “otherwise” in our opinion, has not to be read ejusdem generis with the expression, dissolution of a firm or body or assets of persons. The expression “otherwise” has to be read with the words ‘transfer of capital assets” by way of distribution of capital assets. it becomes clear that even when a firm is in existence and there is a transfer of capital assets it comes within the expression “otherwise” as the object of the amending Act was to remove the loophole which existed whereby capital gain tax was not chargeable.
- It is clear that when the asset is transferred to a partner, that falls within the expression otherwise and the rights of the other partners in that asset of the partnership is extinguished. That was also the position earlier but considering that on retirement the partners only got his share, it was held that there was no extinguishment of right. Considering the amendment, there is clearly a transfer and if, there be a transfer, it would be subject to capital gains tax
- In the present case, some new partners came to be inducted by introduction of small amounts of capital ranging between Rs. 2.5 to 4.5 lakhs and the said newly inducted partners had huge credits to their capital accounts (on account of revaluation) immediately after joining the partnership, which amount was available to the partners for withdrawal and in fact some of the partners withdrew the amount credited in their capital accounts. Therefore, the assets so revalued and the credit into the capital accounts of the respective partners can be said to be “transfer” and which fall in the category of “OTHERWISE” and therefore, the provision of Section 45(4) inserted by Finance Act, 1987 w.e.f. 01.04.1988 shall be applicable.
