No Capital Gain when new Partner bring Cash by way of Capital Contribution and Retiring Partners take Cash and Retire: Bombay HC [Read Judgment]

The Bombay High Court on March 26^th earlier this year ruled that when new Partner brings Cash by way of Capital Contribution and Retiring Partners take Cash and Retire, No Capital Gain happens.

The assessee Electroplast Engineers, a partnership firm, had filed the return of income for the assessment year 2010-­2011. The assessee was engaged in manufacturing of tube light fittings and other lighting accessories for over 13 years. The firm was constituted in 1996 under Partnership Deed, originally consisting of two partners. In 2010, the constitution of the firm underwent a change under a Deed of Reconstitution of partnership. Three new partners were admitted. Later, another Deed of Retirement cum Reconstitution of the partnership was executed by which the original two partners retired from the firm and the remaining three partners re­distributed their share in a partnership firm. The partnership created a goodwill account and a sum of Rs. 3.75 Crores was credited in the books of the firm in the said account. The retiring partners were paid sums of Rs. 2.97 Crores and 77.27 Lakhs respectively in the proportion of their shares in the partnership business.

The Assessing Officer was of the opinion that in terms of section 45(4) of the Income Tax Act, 1961, the firm had to pay short term capital gain tax on such amounts. The Assessing Officer was of the opinion that the goodwill credited by the firm of Rs. 3.75 Crores was nothing but the capital gain arising on the distribution of the capital asset by way of “dissolution of the firm or otherwise”. The assessee carried the matter in further appeal before the Tribunal. The Tribunal allowed the assessee’s appeal and was of the opinion that the conditions required for applying section 45(4) of the Act were not satisfied in the present case.

Justice Sarang V. Kotwal and Justice Akil Kureshi while dismissing the appeal in favour of the assessee held, “ In the present case, admittedly there was no transfer of capital asset upon reconstitution of the firm. All that happened was the firm’s assets were evaluated and the retiring partners were paid their share of the partnership asset. There was clearly no transfer of capital asset. Revenue has not argued that the reconstitution of the firm was a colourable device to avail tax liability. In the result, we do not find any error in the view of Tribunal.”