The Income Tax Appellate Tribunal of Mumbai bench, in a recent decision, held that u/s 45(4) of the Income Tax Act, 1961, the capital gain arising out of distribution of capital asset on the dissolution of a firm shall be chargeable to tax as income of the firm. The ITAT further observed that for the purpose of section 48 of the Act, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.
The assessee is a partnership firm deriving income from business and is engaged in the business of builder and developers of property. It was observed by the A.O. that one of the partners retired vide deed of retirement dated 19th April, 2006 and he was allotted shops, flats etc. on the basis of book value to the extent of Rs. 1,30,19,945/-. On perusal of the P&L account of the assessee, it was observed by the AO that the assessee had shown sale consideration out of transfer of above shops/flats to the retiring partner only at Rs. 1,14,49,805/- and thus there is a difference on sale cost and book value at Rs. 15,70,140/-. As per the sale summary, it was also observed by the AO that the assessee did not show sale consideration of unit no 02 and 09 in the project ‘Hermes Attrium’ and the same was also not appearing in the closing stock.
The assessee maintained that as per the terms of the said retirement deed, the retiring partner was given certain units in the ‘Hermes Attrium’ Project at the book value in terms of settlement of his account in the partnership firm i.e. the assessee on his retirement. Since the assessee had shown the sale consideration in the P&L account at Rs. 1,14,49,805/- which was excluding the value of unit at Sl No. 1 & 2 i.e. Unit No. 2 & 9, the A.O. considered the sale value which worked out at Rs. 45,21,956/- and the same was added to the total income of the assessee keeping in view the provisions of section 45(4) of the Act vide assessment orders dated 30.12.2009 passed by the AO u/s 143(3) of the Act.
Aggrieved by the said order the assessee approached the CIT(A) who has dismissed the claim of the assesseeby holding that under Section 45(4) of the Act, the profits or gains arising from the transfer of a capital asset by way of distribution of capital asset on the dissolution of a firm shall be chargeable to tax as income of the firm. In this case only one partner retired from the partnership and the remaining partners continued to be the partners of the firm with revised profit ratio. As per judicial decisions relied upon by the assessee, retirement of a single partner does not amounts to dissolution of firm and therefore, provisions of Section 45(4) of the Act were not applicable.
Being aggrieved, the assessee filed a second appeal before the Appellate Tribunal contending that the impugned orders were passed by adding Rs. 4,521,956/- u/s. 45(4) of the Income Tax Act, 1961 (the Act) without appreciating fact that the same is not applicable in the case of retirement of the partner.
Section 45 is the charging section. Under section 45, there must be a transfer of a capital asset by way of distribution of assets in the first instance. Capital asset under section 2(14) of the Income-tax Act, 1961, has been defined to mean property of any kind held by an assessee. In other words, the property transferred must fall within the ambit of capital asset. The next relevant section is the expression “transfer” as set out in section 2(47) which in relation to a capital asset includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein. Therefore, it was observed that the transfer will also include relinquishment of the asset or extinguishment of any rights therein.
In the instant case, the documents would clearly show that before the continuing partners retired there was an induction of a new partner in the morning of the said day and the outgoing partners retired at the closing of business hours on that day. In other words, the partnership subsisted but with two partners and the business also continued. That would, therefore, not amount to dissolution of the firm and clearly, therefore, the order of the Income-tax Appellate Tribunal
The Tribunal placed reliance on the decision of the Hon’ble Bombay High Court in CIT v. Shri Rajnish Maniklal Bhandari, IT Appeal No. 2058 of 2012, it which it was held that the amount received by partner on retirement from the partnership firm is not taxable in the hands of the partner.
It was observed the ITAT that section 45(4) of the Act profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of person 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 said transfer takes place and for the purpose of section 48 of the Act, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.
Read the full text of the order below.