Commissioner Of Income-Tax (Central), Ludhiana v. M/S. Rita Mechanical Works, Ludhiana

IN THE HIGH COURT OF PUNJAB AND HARYANA AT CHANDIGARH Income-tax Appeal No. 5 of 2001 Date of decision: 24.9.2010 Commissioner of Income-tax (Central), Ludhiana Versus M/s. Rita Mechanical Works, Ludhiana --- Appellant --- Respondent CORAM:HON’BLE MR. JUSTICE ADARSH KUMAR GOELHON’BLE MR. JUSTICE AJAY KUMAR MITTAL --- Present:Mr. Rajesh Katoch, Advocatefor the appellant. Mr. S.K. Mukhi, Advocate assisted by Ms. Jyoti, Advocate for the respondent. --- AJAY KUMAR MITTAL, J. 1.This appeal under section 260A of the Income Tax Act, 1961, (inshort “the Act”) against the order dated 28.4.2000, Annexure A-3, passed bythe Income-tax Appellate Tribunal, Chandigarh Bench, Chandigarh (in short“the Tribunal”) in Income-tax Appeal No. 2/Chandi/99 for the assessment year1995-96, has been filed by the Revenue-appellant. 2.Facts as narrated in the appeal are that M/s. Rita MechanicalWorks, Ludhiana, the respondent-firm, which during the relevant year wasengaged in the business of manufacturing sewing machines and its spareparts, filed its return for the assessment year 1995-96 declaring income of Rs.54,31,400/-, on 31.10.1995. The respondent re-evaluated its assets on31.3.1994 and on the basis of the report of Valuer enhanced the value of the assets to the tune of Rs. 3,27,38,045/-, i.e. Rs. 2,51,49,229/- in respect of landand building and Rs. 75,88,816/- in respect of plant and machinery. The profitaccruing on the above amount was credited to the capital account of thepartners as per their profit sharing ratios. The existence of the respondent,however, came to an end on 31.3.1995 and the co-partners of the firm made adeed of settlement dated 28.3.1995 whereby they mutually settled theirholdings of the subscribed capital amongst themselves as members of theJoint Stock Company and also agreed to take over certain number of sharesof the newly constituted Limited Company in the name and style of M/s. RitaMachines (India), Limited as per Agreement dated 29.3.1995. No separatedissolution deed was prepared or executed and the respondent stooddissolved w.e.f. 31.3.1995. The transfer of capital assets took place by way ofdistribution within the meaning of Section 45(4) of the Act, and the profit andgain arising there from, were liable to be charged as capital gains. 3.The assessing officer after examining the entire situation framedassessment under Section 143(3) of the Act, vide order dated 11.3.1998(Annexure A-1) at an income of Rs. 3,96,94,499/- and while doing so, theassessing officer observed that as the assets and liabilities of the old firm hadbeen taken over by the newly established Company, there wasrelinquishment/Extinguishment of Right by the firm which is to be treated asTransfer in terms of Section 2(47) of the Act. It was further observed thatunder the circumstances, the transaction of taking over the assets of firm bythe company and allotment of shares to the erstwhile partners does constitute“transfer” chargeable to tax under Section 45 of the Act. The assessingofficer, after invoking provisions of Section 45(4) read with Section 50 of theAct, charged short term capital gain on an amount of Rs. 3,27,32,628/- andmade disallowance on account of depreciation of Rs. 7,38,042/- on the groundthat the firm ceased to exist on 31.3.1995. 4.This led to filing of appeal before the Commissioner of IncomeTax (Appeals) (Central), Ludhiana [in short “the CIT (A)”] by the assessee. In 4.This led to filing of appeal before the Commissioner of IncomeTax (Appeals) (Central), Ludhiana [in short “the CIT (A)”] by the assessee. In the appeal, the assessee raised various points, inter alia, that there has beenno dissolution of the firm; distribution on dissolution is not transfer; unlessthere is a transfer, no capital gain arises in view of the decision of ITAT JaipurBench; for the purpose of Transfer, there has to be Transferor and aTransferee; in the case under consideration there is change in the status onlyfrom an unregistered company to a registered company; since an unregisteredcompany succeeded a registered company, there was vesting of assets infavour of successor company and since there was no transfer the provisions ofsection 45(4) are not applicable. The CIT(A) dismissed the appeal vide orderdated 13.11.1998, (Annexure A-2) as none of the above grounds found favourwith it. The CIT(A), however, differed with the assessing officer who had heldthat the capital gain was of short term nature. According to the appellateauthority the land was not depreciable asset and as such capital gainchargeable was not short term but it should be given a long term treatmentand this view of the appellate authority was accepted by the Department andlong term capital gain was charged instead of short term capital gain. 5.The assessee did not feel satisfied and took the matter in appealbefore the Tribunal. The Vice President and the Judicial Member constitutingthe Bench differed from each other on certain points and expressed theirindividual views. All that is essential needed to be noticed here is that the VicePresident of the Tribunal pronounced that no capital gain arose to theassessee within the meaning of Section 45(4) of the Act and deleted theaddition made on that account. As regards disallowance of depreciation, itwas held that as the firm was in continuation up to 3.4.1995, the assessee wasentitled to depreciation allowance. As per the opinion of the Judicial Memberof the Tribunal, capital gain under section 45(4) did arise and was chargeableto tax but the same was chargeable in the assessment year 1996-97 and notin the assessment year 1995-96. He, however, concurred with the VicePresident that depreciation was admissible. The Tribunal however,notwithstanding divergent views on certain issues, held vide order under appeal, dated 28.4.2000 (Annexure A-3) that during the assessment year1995-96, no capital gain chargeable to tax arose and deleted the additionsmade on account of profits chargeable to tax on capital gain in the assessmentyear 1995-96. Claim of depreciation was also allowed. 6.It is how the Revenue has preferred the present appeal proposingfollowing substantial questions of law for determination by this Court:following substantial questions of law for determination by this Court: 1-Whether on the facts and in the circumstances of the caseand on proper interpretation of the provisions of section 45(4) read with section 2(47) of the I.T. Act, the ITAT wasright in law in holding that taking over of the assets of thefirm by a Company and allotting Shares to the Partners ofthe firm as per their holding in the firm does not give rise toProfit chargeable to Capital Gain u/s 45(4) of the Act.and on proper interpretation of the provisions of section 45(4) read with section 2(47) of the I.T. Act, the ITAT wasright in law in holding that taking over of the assets of thefirm by a Company and allotting Shares to the Partners ofthe firm as per their holding in the firm does not give rise toProfit chargeable to Capital Gain u/s 45(4) of the Act. 1-Whether on the facts and in the circumstances of the caseand on proper interpretation of the provisions of section 45(4) read with section 2(47) of the I.T. Act, the ITAT wasright in law in holding that taking over of the assets of thefirm by a Company and allotting Shares to the Partners ofthe firm as per their holding in the firm does not give rise toProfit chargeable to Capital Gain u/s 45(4) of the Act.and on proper interpretation of the provisions of section 45(4) read with section 2(47) of the I.T. Act, the ITAT wasright in law in holding that taking over of the assets of thefirm by a Company and allotting Shares to the Partners ofthe firm as per their holding in the firm does not give rise toProfit chargeable to Capital Gain u/s 45(4) of the Act. 2-Whether on the facts and in the circumstances of the casethe ITAT was right in holding that capital gain arisen relatesto assessment year 1996-97 instead of assessment year1995-96 whereas Co-partner in the Company agreed toreceive share allotment in the erstwhile company as peragreement dated 29.3.1995, though the Company wasincorporated on 3.4.1995 in Papers only.the ITAT was right in holding that capital gain arisen relatesto assessment year 1996-97 instead of assessment year1995-96 whereas Co-partner in the Company agreed toreceive share allotment in the erstwhile company as peragreement dated 29.3.1995, though the Company wasincorporated on 3.4.1995 in Papers only. 3-Whether on the facts and in the circumstances of the casethe ITAT was right in allowing depreciation to the Firmwhich stood dissolved on 31.3.1995?.”the ITAT was right in allowing depreciation to the Firmwhich stood dissolved on 31.3.1995?.” 7. We have heard learned counsel for the parties and perused the record. 8.Questions No.1 and 2 are inter-related and are being taken uptogether. In the present case, the partnership firm has been converted intocompany under the provisions of Part IX of the Companies Act, 1956 (in short“1956 Act”). There is no dissolution of the erstwhile firm and the company hasbeen formed with the same partners as its shareholders. The question for adjudication would be, whether capital gain arises on taking over of businessof an erstwhile firm by formation of a limited Company in which the partners ofthe erstwhile firm are the shareholders. The reliance of the Revenue is on thejudgments, Artex Manufacturing Co. vs. Commissioner of Income Tax,(1981) 131 ITR 559; Suvardhan v. The Commissioner of Income Tax,ITRC No. 21 of 1999, decided on 4.8.2006 by Karnataka High Court;Commissioner of Income Tax v. A.N. Naik Associates, (2004) ITR 346(Bom)whereas the reliance by the assessee has been placed onCommissioner of Income-tax v. Texspin Engineering and ManufacturingWorks, (2003) 263 ITR 345 (Bombay); Commissioner of Income-tax v.Kunnamkulam Mill Board, (2002) 257 ITR 544 (Kerala); Commissioner ofIncome-tax v. Vijayalakshmi Metal Industries, (2002) 256 ITR 540(Madras). 9.We have given our thoughtful consideration to the submissionsmade by the counsel for the parties and find unable to accept the contentionof the revenue. 10.The primary thrust of the revenue has been on interpretation andscope of Section 45(4) of the Act. 11.Looking to the legislative history, sub-section (4) to Section 45 ofthe Act was inserted whereas Section 47(ii) had been omitted by FinanceAct, 1987 w.e.f. 1.4.88. Prior thereto, under Section 47(ii) of the Actdistribution of capital assets on dissolution of a firm, association etc. was notconsidered to be transfer and was, thus, exempt from being charged to capitalgain tax. 12.Section 45(4) of the Act which is relevant reads thus:- 9.We have given our thoughtful consideration to the submissionsmade by the counsel for the parties and find unable to accept the contentionof the revenue. 10.The primary thrust of the revenue has been on interpretation andscope of Section 45(4) of the Act. 11.Looking to the legislative history, sub-section (4) to Section 45 ofthe Act was inserted whereas Section 47(ii) had been omitted by FinanceAct, 1987 w.e.f. 1.4.88. Prior thereto, under Section 47(ii) of the Actdistribution of capital assets on dissolution of a firm, association etc. was notconsidered to be transfer and was, thus, exempt from being charged to capitalgain tax. 12.Section 45(4) of the Act which is relevant reads thus:- “The profits or gains arising from the transfer of a capitalasset by way of distribution of capital assets on thedissolution of a firm or other association of persons or bodyof individuals (not being a company or a cooperativesociety) or otherwise, shall be chargeable to tax as theasset by way of distribution of capital assets on thedissolution of a firm or other association of persons or bodyof individuals (not being a company or a cooperativesociety) or otherwise, shall be chargeable to tax as the income of the firm, association of persons or body ofindividuals, of the previous year in which the said transfertakes place and, for the purposes of Section 48, the fairmarket value of the asset on the date of such transfer shallbe deemed to be the full value of the consideration receivedor accruing as a result of the transfer.” 13.According to the aforesaid provision, the profits or gains arisingfrom transfer of capital assets by way of distribution of those assets ondissolution of a firm or other association of persons or body of individuals (notbeing a company or a cooperative society) or otherwise shall be liable to taxas income of the firm etc. of the previous year when such transfer takes place.Under Section 48, the fair market value of the asset on the date of transfershall be deemed to be the full value of the consideration received or accruingas a result of the transfer. 14.For applicability of Section 45(4) of the Act, the following twoconditions need to be fulfilled, namely,- (a)there must be a transfer of capital asset by way ofdistribution of capital assets, and distribution of capital assets, and (b)there must be a dissolution of a firm, Association ofpersons or Body of Individual etc. or otherwise.persons or Body of Individual etc. or otherwise. 15.The Bombay High Court in Texspin Engineering andManufacturing Works case (supra), under similar circumstances interpretingSection 45(4) of the Act recorded thus:- “Under Section 45(4), profits arising from the transfer of acapital asset by way of distribution of capital assets on thedissolution of a firm are chargeable to tax as the income ofthe firm in a previous year in which the transfer takes placeand for the purposes of section 48, the fair market value ofthe asset on the date of such transfer is deemed to be thefull value of the consideration received or accruing as a result of the transfer. Section 48 deals with mode ofcomputation. It, inter alia, lays down that the incomechargeable under the head “Capital gains” shall becomputed by deducting from the full value of theconsideration, the expenditure incurred in connection withthe transfer and the cost of acquisition of the asset.Therefore, under section 45(4), two conditions are requiredto be satisfied, viz., transfer by way of distribution of capitalassets, and, secondly, such transfer should be ondissolution of the firm or otherwise. Once these twoconditions are satisfied then, in that event, for the purposeof computation of capital gains under section 48, the marketvalue on the date of the transfer shall be deemed to be thefull value of consideration received or accruing as a result ofthe transfer.” 16.The Court had concluded that Section 45(4) of the Act was notattracted in a situation where the firm was converted into company underChapter IX of 1956 Act. The relevant observations are as follows:- “In this case, the erstwhile firm has been treated as alimited company by virtue of section 575 of the companiesAct. It is not in dispute that in this case, the erstwhile firmbecame a limited under Part IX of the Companies Act. Now,section 45(4) clearly stipulates that there should be atransfer by way of distribution of capital assets. Under PartIX of the Companies Act, when a partnership firm is treatedas a limited company, the properties of the erstwhile firmvests in the limited company. The question is whether suchvesting stands covered by the expression “transfer by wayof distribution” in section 45(4) of the Act. There is adifference between vesting of the property, in this case, in the limited company and distribution of the property. Onvesting in the limited company under Part IX of theCompanies Act, the properties vest in the company as theyexist. On the other hand, distribution on dissolution pre-supposes division, realisation, encashment of assets andappropriation of the realised amount as per the priority likepayment of taxes to the Government, BMC, etc., paymentto unsecured creditors, etc. This difference is veryimportant. This difference is amply brought out conceptuallyin the judgment of the Supreme Court in the case ofMalabar Fisheries Co. v. CIT [1979] 120 ITR 49. In thepresent case , therefore, we are of the view that section 45(4) is not attracted as the very first condition of transfer byway of distribution of capital assets is not satisfied. In thecircumstances, the latter part of section 45(4), which refersto computation of capital gains under section 48 by treatingthe fair market value of the asset on the date of transfer,does not arise.” 17.The plea of applicability of Section 45(1) read with Section 2(47)(ii) of the Act was also negated with the following conclusion:- “In the present case, we are concerned with a partnershipfirm being treated as a company under the statutoryprovisions of Part IX of the Companies Act. In such cases,the company succeeds the firm. Generally, in the case of atransfer of a capital asset, two important ingredients are:existence of a party and a counter-party and, secondly,incoming consideration qua the transferor. In our view,when a firm is treated as a company, the said twoconditions are not attracted. There is no conveyance of theproperty executable in favour of the limited company. It is 17.The plea of applicability of Section 45(1) read with Section 2(47)(ii) of the Act was also negated with the following conclusion:- “In the present case, we are concerned with a partnershipfirm being treated as a company under the statutoryprovisions of Part IX of the Companies Act. In such cases,the company succeeds the firm. Generally, in the case of atransfer of a capital asset, two important ingredients are:existence of a party and a counter-party and, secondly,incoming consideration qua the transferor. In our view,when a firm is treated as a company, the said twoconditions are not attracted. There is no conveyance of theproperty executable in favour of the limited company. It is no doubt true that all properties of the firm vest in thelimited company on the firm being treated as a companyunder Part IX of the Companies Act, but that vesting is notconsequent or incidental to a transfer. It is a statutoryvesting of properties in the company as the firm is treatedas a limited company. On the vesting of all the propertiesstatutorily in the company, the cloak given to the firm isreplaced by a different cloak and the same firm is nowtreated as a company, after a given date. In thecircumstances, in our view, there is no transfer of a capitalasset as contemplated by section 45(1) of the Act. Evenassuming for the sake of argument that there is a transferof a capital asset under section 45(1) because of thedefinition of the word “transfer” in section 2(47)(ii), eventhen we are of the view that the liability to pay capital gainstax would not arise because section 45(1) is required to beread with section 48, which provides for mode ofcomputation. These two sections are required to be readtogether as the charging section and the computationsection constitute one package. Now, under section 48 it islaid down, inter alia, that the income chargeable under thehead “Capital gains” shall be computed by deducting fromthe full value of the consideration received or accrued as aresult of the transfer, the cost of acquisition of the asset andthe expenditure incurred in connection with the transfer.Section 45(4) is mutually exclusive to section 45(1).Section 45(4) categorically states that where there is atransfer by way of distribution of capital assets and wheresuch transfer is due to dissolution or otherwise of the firm,the Assessing Officer was entitled to treat the market value of the asset on the date of the transfer as full value of theconsideration received. This latter part of section 45(4) isnot there in section 45(1). Therefore, one has to read theexpression “full value of the consideration received/accruing” under section 48 de hors section 45(4) and if onereads section 48 with section 45(1) de hors section 45(4)then the expression “full value of consideration” in section48 cannot be the market value of the capital asset on thedate of transfer.” 18.The aforesaid view has the acceptance of the legislative intent asFinance (No.2) Act, 1998 effective from 1.4.1999 has incorporated Clause (xiii)to Section 47 to the following effect:- “Nothing contained in Section 45 shall apply to the followingtransfers:- (xiii) where a firm is succeeded by a company in thebusiness carried on by it as a result of which the firmsells or otherwise transfers any capital asset orintangible asset to the company.” 19.Now stage is set to analyze the case law relied upon by thecounsel for the revenue. 18.The aforesaid view has the acceptance of the legislative intent asFinance (No.2) Act, 1998 effective from 1.4.1999 has incorporated Clause (xiii)to Section 47 to the following effect:- “Nothing contained in Section 45 shall apply to the followingtransfers:- (xiii) where a firm is succeeded by a company in thebusiness carried on by it as a result of which the firmsells or otherwise transfers any capital asset orintangible asset to the company.” 19.Now stage is set to analyze the case law relied upon by thecounsel for the revenue. 20.In Amartex Manufacturing Co's case, the Gujarat High Courtwas seized of the matter where the entire assets and liabilities of thepartnership were not transferred to the limited Company. The business of thefirm as a whole was not transferred for a lump sum price to the limitedcompany but only the machinery used in manufacturing of the business of thefirm was transferred to the newly formed limited company and theconsideration was received by the partners of the firm in the shape of sharesof the company and the shares were allotted to the partners on the same basis as their shares in the profits of the partnership firm. It was in those facts thatthe provisions of capital gains were held to be exigible. 21.Karnataka High Court in Suvardhan's case (supra) wasadjudicating the matter where the partners had derived share on thedissolution of the partnership firm. 22.The factual matrix in A.N. Naik Associates's case (supra)before the Bombay High Court was that a new partner was inducted beforeoutgoing partners had been relieved and the business also continued. Thegain in the hands of the retiring partners was held to be amenable to capitalgains tax. 23.These judgments are, thus, not applicable and are clearlydistinguishable. 24.In view of the above, the irresistible conclusion is that no capitalgain under Section 45(4) of the Act would be attracted in the present case.Accordingly, questions No.1 and 2 are answered against the revenue. 25.Adverting to question No.3 regarding depreciation, the authoritiesbelow had concurrently recorded that there was no dissolution which tookplace as urged by the learned counsel for the revenue on 31.3.1995, whereasthe firm continued upto 3.4.1995, i.e. the date of incorporation of the company.The aforesaid finding has not been shown to be perverse or erroneous in anymanner by the learned counsel. Once that is so, the assessee-respondentwas entitled to claim depreciation on the assets for the period upto 31.3.1995relating to the assessment year 1995-96. Accordingly, question No.3 is alsoanswered against the revenue. 26.As an upshot of the above discussion, finding no merit in theappeal, the same is hereby dismissed. (AJAY KUMAR MITTAL) JUDGE September 24, 2010rkmalik/gbs (ADARSH KUMAR GOEL) JUDGE