Latetribunal v. Texspin Engineering And Manufacturing

*THE HON’BLE SRI JUSTICE L.NARASIMHA REDDYAND *THE HON’BLE SRI JUSTICE T.SUNIL CHOWDARY+I..T.T.A.No.100 of 2002 % Dated 12.08.2014 Commissioner of Income Tax. … Appellant $ M/s. United Fish Nets. ….Respondent ! Counsel for the appellant : Sri S.R.Ashok ^ Counsel for respondent : Sri Ch.Dhanamjaya < GIST: > HEAD NOTE: ? Cases referred:1. (2003) 263 ITR 3452. (1953) 24 ITR 4053. 23 ITR 321 THE HON’BLE SRI JUSTICE L.NARASIMHA REDDYANDTHE HON’BLE SRI JUSTICE T.SUNIL CHOWDARYI..T.T.A.No.100 of 2002 JUDGMENT: (Per LNR,J) The respondent is a firm constituted under the PartnershipAct and was assessed to tax. In the assessment year 1993-94,it got itself transformed into a private limited company. The entireassets and liabilities of the respondent were made over to thecompany. The respective partners were issued shares by thecompany corresponding to the value of their share in the firm. The Assessing Officer took the view that there was transferof assets from the respondent to the private limited company andthereby the capital gains tax under Section 45 of the Income TaxAct, 1961 (for short ‘the Act’) became payable. An order ofassessment was passed to that effect on 29.03.1996. Aggrievedby that, the respondent filed an appeal before the Commissioner(Appeals). Through order, dated 12.04.1996, the Commissionerallowed the appeal. He took the view that Section 45(4) of theAct does not get attracted to the facts of the case. TheDepartment filed further appeal being I.T.A.No.61/HYD/93 beforethe Visakhapatnam Bench of the Income Tax AppellateTribunal. Through its order, dated 31.01.2002, the Tribunaldismissed the appeal. Hence, this appeal under Section 260-Aof the Act. Sri S.R.Ashok, learned counsel for the appellant submitsthat the respondent is an independent legal entity from the pointof view of the Act and once it has transferred its assets to adifferent legal entity viz., a private limited company, the transfer ofassets took place and thereby, the capital gains tax becamepayable. He submits that all the ingredients of Sub-section (4) ofSection 45 of the Act are present in the instant case and thatthere was no basis for the Commissioner of Appeals and theTribunal to reverse the order of assessment. He submits that thejudgments relied upon by the Tribunal are distinguishable onfacts and were rendered under a totally different legal regime. Heplaces reliance upon certain precedents. Sri Ch.Dhanamjaya, learned counsel for the respondent,on the other hand, submits that this is a typical case, in whichthere was no dissolution of the respondent-firm in its strict senseand has simply been transformed from a firm into a private limitedcompany. He submits that even if it is possible to assume thatthere is dissolution of the respondent-firm, there is no distributionof assets, since no partner of the respondent was passed on theassets corresponding to their share, much less there wasdistribution as contemplated under law. He places reliance uponthe Judgment of the Bombay High Court in Commissioner ofIncome Tax vs. Texspin Engineering and Manufacturing Works[[1]]. The facts are not in dispute, but the difference is only as tothe legal consequences that have flown from them. Therespondent is a firm registered under the Partnership Act. However, in the assessment year 1993-94, it got itselftransformed into a private limited company, as provided for underPart IX of the Indian Companies Act. Except that the assets andliabilities of the respondent were en bloc transferred and madeover to the newly formed company, no transaction of transfer inthe ordinary parlance has taken place, much less anyconsideration was paid to the respondent. Works[[1]]. The facts are not in dispute, but the difference is only as tothe legal consequences that have flown from them. Therespondent is a firm registered under the Partnership Act. However, in the assessment year 1993-94, it got itselftransformed into a private limited company, as provided for underPart IX of the Indian Companies Act. Except that the assets andliabilities of the respondent were en bloc transferred and madeover to the newly formed company, no transaction of transfer inthe ordinary parlance has taken place, much less anyconsideration was paid to the respondent. The Assessing Officer took the view that the respondentstood dissolved, once a new company has come into existencein its place. As regards assets, he took the view that onallotment of shares by the company to the shareholders, whowere none other than the partners of the respondent-firm,consideration stood paid for the respective extents of the assets. On this premise, the Assessing Officer levied the capital gainstax. In the appeal preferred by it before the Commissioner, thecontention of the respondent was that no distribution of assetshas taken place and the transfer of assets was not to anyindividual company whatever. The Commissioner accepted thecontention, and has allowed the appeal and set aside the orderof assessment. Insofar as levy of capital gains tax, the sameview taken by the Commissioner. It is true that a partnership firm, which does not have anyindependent legal existence in the common law, is conferredwith a semblance of status under the Act from the point of view ofmaking it obligatory for a firm to file returns, to pay income tax. The legal position on this aspect was explained by the Hon’bleSupreme Court, as it stood then, in Commissioner of Income Tax vs. A.W.Figgies and Company and others[[2]]. Theirlordships held: It is true that under the law of partnership, a firm has nolegal existence apart from its partners and it is merely acompendious name to describe its partners but it is also equally true that under that law there is no dissolution of thefirm by the mere incoming or outgoing of partners. A partnercan retire with the consent of the other partners and a personcan be introduced in the partnership by the consent of theother partners. The reconstituted firm can carry on its businessin the same firm’s name till dissolution. The law with respectto retiring partners as enacted in the Partnership Act is to acertain extent a compromise between the strict doctrine ofEnglish Common Law which refuses to see anything in thefirm but a collective name for individuals carrying on businessin partnership and the mercantile usage which recognizes thefirm as a distinct person or quasi corporation. But under theIncome Tax Act the position is somewhat different. A firm canbe charged as a distinct assessable entity as distinct from itspartners who can also be assessed individually. On the same lines is the judgment of the Patna High Court i n Kaniram Ganpatrai vs. Commissioner of Income Tax[[3]],wherein it was observed that: On the same lines is the judgment of the Patna High Court i n Kaniram Ganpatrai vs. Commissioner of Income Tax[[3]],wherein it was observed that: “It is true enough to state that a partnership is not inEnglish law or in India law a single juristic person and a firmas such has no legal personality or existence. But for thepurpose of the Income-tax Act a firm is regarded as having aseparate existence apart from the partners who carry on thebusiness. The question has recently been discussed by aDivision Bench of this Court in Jittanram Nirmalram vs.Commissioner of Income Tax ((1953) 23 ITR 288), where theauthorities on the point have been reviewed. It was held inthat case that a new partnership of three persons was adifferent legal entity from an old partnership of four persons,though three of the partners were common. The same principleis laid down in Income Tax Commissioners vs. Gibbs((1942) A.C. 402), in which the question arose whether apartnership of four stock brokers who took in a fifth partnerceased to carry on business and was succeeded by thepartnership of five within the meaning of sub-rule I of Rule 9. Schedule D to the Income Tax Act, 1918, which provided that ifa person charged under Schedule D ceased within the year ofassessment to carry on the trade in respect of which theassessment was made and was succeeded by anotherperson, the Commissioner shall adjust the assessment asdirected. It was held by the House of Lords reversing thedecision of the Court of Appeal that though in the English lawa partnership was not a single juristic person, the scheme ofthe income-tax legislation treated the partnership as a legalentity for the purpose of assessing revenue and there wassuccession to the business within the meaning of Rule 9, sub- rules 1 and 2. Applying the principle of these authorities it isclear that in the present case there has been a succession tothe partnership within the meaning of Section 25(4) of theIndian Income Tax Act and that the finding of the AppellateTribunal on this point is erroneous and should be overruled.” Therefore, whatever be the status of a firm, under thegeneral law of the land, it can certainly be treated as a legalentity from the point of view of the Act. This is also evident fromthe definition of “person” under Section 2(31) of the Act, whichincludes not only an individual but also Hindu undivided family,company, firm, association of persons, local authority and everyartificial juridical person, not falling within any of the precedingsub-clauses. What however becomes essential is whether the steps thatare contemplated under Sub-section (4) of Section 45 of the Acthave taken place in the instant case. Section 45(4) of the Actreads: “The profits or gains arising from the transfer of a capitalasset by way of distribution of capital assets on the dissolutionof a firm or other association of persons or body of individuals(not being a company or a co-operative society) or otherwise,shall be chargeable to tax as the income of the firm,association or body, of the previous year in which the saidtransfer takes place and, for the purposes of Section 48, thefair market value of the asset on the date of such transfer shallbe deemed to be the full value of the consideration received oraccruing as a result of the transfer.” From a perusal of this, it becomes clear that two aspectsbecome important viz., the dissolution of the firm and distributionof assets as a consequence thereof. Assuming that on its beingtransformed into a private limited company, the respondentceased to exist and thereby, it stood dissolved, the liability to paytax would arise, if only there is distribution of assets, as a resultof such dissolution. Even according to the Department, theerstwhile partners of the respondent-firm did not receive theassets corresponding to their shares. What all had taken placeis that they have been allotted shares in the companycorresponding to their share of assets in the firm. What constitutes distribution of assets under Section 45(4) From a perusal of this, it becomes clear that two aspectsbecome important viz., the dissolution of the firm and distributionof assets as a consequence thereof. Assuming that on its beingtransformed into a private limited company, the respondentceased to exist and thereby, it stood dissolved, the liability to paytax would arise, if only there is distribution of assets, as a resultof such dissolution. Even according to the Department, theerstwhile partners of the respondent-firm did not receive theassets corresponding to their shares. What all had taken placeis that they have been allotted shares in the companycorresponding to their share of assets in the firm. What constitutes distribution of assets under Section 45(4) of the Act was explained by the Bombay High Court in TexspinEngineering and Manufacturing Works’s case (1 supra). Incidentally, the facts of that case are identical with those in thepresent case. There also an existing firm was transformed into acompany under Part IX of the Indian Companies Act. Whendealing with the identical situation, wherein the Assessing Officerproposed to levy capital gains tax, the Bombay High Court held: In this case, the erstwhile firm has been treated as a LimitedCompany by virtue of Section 575 of the Companies Act. It is not indispute that in this case, the erstwhile firm became a Limited Companyunder Part IX of the Companies Act. Now, Section 45(4) clearly stipulatesthat there should be transfer by way of distribution of capital assets. UnderPart IX of the Companies Act, when a Partnership Firm is treated as aLimited Company, the properties of the erstwhile firm vests in the LimitedCompany. The question is whether such vesting stands covered by theexpression "transfer by way of distribution" in Section 45(4) of the Act.There is a difference between vesting of the property, in this case, in theLimited Company and distribution of the property. On vesting in theLimited Company under Part IX of the Companies Act, the properties vestin the company as they exist. On the other hand, distribution ondissolution presupposes division, realisation, encashment of assets andappropriation of the realised amount as per the priority like payment oftaxes to the Government, BMC etc., payment to unsecured creditors etc.This difference is very important. This difference is amply brought outconceptually in the judgment of the Supreme Court in the case of MalabarFisheries Co. v. CIT [1979] 120 ITR 49. In the present case, therefore, weare of the view that Section 45(4) is not attracted as the very firstcondition of transfer by way of distribution of capital assets is notsatisfied. In the circumstances, the latter part of Section 45(4), whichrefers to computation of capital gains under Section 48 by treating fairmarket value of the asset on the date of transfer, does not arise. The underlined portion, in a way, signifies the basic tenetsof transfer of assets. The distribution must result in sometangible act of the physical transfer of properties or the intangibleact of conferring exclusive rights vis-à-vis an item of property onthe erstwhile shareholder. Unless these or other legalcorrelatives take place, it cannot be inferred that there was anydistribution of assets. In the instant case, the shares of therespective shareholders in the respondent-company weredefined under the partnership deed. The only change that hastaken place on the respondent being transformed into acompany was that the shares of the partners were reflected inthe form of share certificates. Beyond that, there was nophysical distribution of assets in the form of dividing them intoparts, or allocation of the same to the respective partners or evendistributing the monetary value thereof. In our view, the judgment of the Bombay High Court squarely covers the facts ofthe case and the orders passed by the Appellate Commissionerand the Tribunal accords with the same. The appeal isaccordingly dismissed. The miscellaneous petition filed in this appeal shall alsostand disposed of. There shall be no order as to costs. judgment of the Bombay High Court squarely covers the facts ofthe case and the orders passed by the Appellate Commissionerand the Tribunal accords with the same. The appeal isaccordingly dismissed. The miscellaneous petition filed in this appeal shall alsostand disposed of. There shall be no order as to costs. ____________________ L.NARASIMHA REDDY, J ____________________ T.SUNIL CHOWDARY, J Date: 12.08.2014Note: L.R.Copy to be marked.JSU THE HON’BLE SRI JUSTICE L.NARASIMHA REDDYAND THE HON’BLE SRI JUSTICE T.SUNIL CHOWDARY I..T.T.A.No.100 of 2002 Date: 12.08.2014 JSU [1](2003) 263 ITR 345(2003) 263 ITR 345 [2](1953) 24 ITR 405 [3]23 ITR 321