PRINCIPAL COMMISSIONER OF INCOME TAX-30 vs. ELECTROPLAST ENGINEERS

ORAL JUDGMENT: (PER AKIL KURESHI, J.) This appeal is filed by the Revenue to challenge the Judgment of   Income   Tax   Appellate   Tribunal   (“ITAT”   for   short).   Following question was presented for our consideration: “Whether in law and on the facts of the instant case, was the Tribunal correct in holding that there was no transfer of capital asset by way of CNR No : HCBM020131432016 Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28

2                                                         14.137.17 itxa.doc distribution at the time of making payment to the retiring partners”. 2 Brief facts are as under. (I) Respondent assessee a partnership firm, had filed return of income   for   the   assessment   year   2010­2011. The   assessee   was engaged in manufacturing of tubelight fittings and other lighting accessories   for   over   13   years.   The   firm   was   constituted   under Partnership Deed dated 16/11/1996, originally  consisting of two partners.   On   15/01/2010,   constitution   of   the   firm   underwent   a change under a Deed of Reconstitution of partnership. Three new partners   were   admitted.   On   16/01/2010,   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                                                         14.137.17 itxa.doc of their shares in the partnership business. (II) The   Assessing   Officer   was   of   the   opinion   that   in   terms   of section 45(4) of the Income Tax Act, 1961, (“the Act” for short) 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 distribution of the capital asset by way of “dissolution of the firm or otherwise”. (III) The   assessee   carried   the   matter   in   appeal   in   which   heavy reliance was placed on Full Bench Judgment of Karnataka High Court in the case of Commissioner of Income­Tax and Another v. Dynamic   Enterprises1. The   Commissioner   agreed   with   the contention of the assessee that there was neither dissolution of the firm nor the firm was discontinued. He, however, held that the rights and   interests   in   assets   of   the   firm   were   transferred   to   the   new members and in this manner there was transfer of capital asset. He was further of the opinion that Section 45(4) of the Act would apply 1 [2013] 359 ITR 83 (Karn) [FB] Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28

4                                                         14.137.17 itxa.doc in the present case which would cover even a case of transfer of capital asset otherwise than by dissolution of the firm. (IV) The assessee carried the matter in further appeal before the Tribunal.   The   Tribunal   by   the   impugned   Judgment   allowed   the assessee's   appeal.   The   Tribunal   was   of   the   opinion   that   the conditions required for applying section 45(4) of the Act were not satisfied in the present case. The Tribunal placed reliance on the decision   of   the   Karnataka   High   Court   in   the   case   of   Dynamic Enterprises (Supra). The Revenue has filed this appeal against the said Judgment of the Tribunal. 3 The counsel for the appellant submitted that decision of this Court in the case of  Commissioner of Income­Tax  v.  A. N. Naik Associates and Another2 would be applicable in the present case. The Tribunal has committed an error in proceeding on the basis that Section 45(4) of the Act would apply only in a case where there has been dissolution of the firm. 2 [2004] 265 ITR 346 (Bom) Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28

5                                                         14.137.17 itxa.doc 4 On   the   other   hand,   the   learned   counsel   for   the   assessee opposed the appeal contending that decision of this Court in the case of A. N. Naik Associates (Supra) concerned a question whether Section 45(4) of the Act would apply only in a case of dissolution of the firm and not in case of retirement of a partner. The Court was not concerned with the question of applicability of Section 45(4) of the   Act   without   there   being   any   transfer   of   capital   asset.   The Karnataka High Court in the case of Dynamic Enterprises (Supra) has noticed the decision of this Court in the case of  A. N. Naik Associates (Supra) and held that when there is no transfer of capital asset, Section 45(4) will not apply. 5 Having thus heard the learned counsel for the parties, we may summarise the undisputed facts: (I) Assessee   firm   was   registered   partnership   firm,   initially comprising of two partners. After carrying on the business for about 13   years,   partnership   was   reconstituted   to   bring   in   three   new partners. Almost immediately thereafter, a new Deed was executed Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28

6                                                         14.137.17 itxa.doc under which the original two partners retired. Newly inducted three partners of the firm continued the business of the firm and the assets were redistributed. While doing so, the partnership evaluated its   goodwill.   The   retiring   partners   were   paid   their   share   in   the goodwill in proportion of their existing shares in the partnership business. (II) Section 45 of the Act pertains to computation of the capital gains. Sub Section 4 of Section 45 reads as under: “45 (4)  The 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 persons or body of individuals (not being a company or a co­operative 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 purposes of section 48, 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”.

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7                                                         14.137.17 itxa.doc 6 As per this provision, profits or gains arising from transfer of capital asset by way of distribution of capital asset on dissolution of firm or otherwise shall be chargeable to tax as income of the firm. For application of this provision, thus, transfer of capital asset is necessary.   Provisions   of   Section   45(4)   of   the   Act   came   up   for consideration before this Court in the case of A. N. Naik Associates (Supra). It was a case in which there was re­organization of the partnership   in   quick   succession.   The   Court   held   that   such   re­ organization   would   not   amount   to   dissolution   of   the   firm.   The question in such background was whether Section 45(4) of the Act would apply in case there has been transfer of capital asset. The Court referred to legislative changes and observed that when the asset is transferred to the partner, that falls within the expression “otherwise” and the rights of the other partners in that asset of the partnership are extinguished. It was held that transfer of assets of the partnerhsip of the retiring partners would amount to transfer of capital assets. 7 This decision of the Court in the case of A. N. Naik Associates Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28

8                                                         14.137.17 itxa.doc (Supra) was considered by the Karnataka High Court in the Full Bench Judgment in the case of Dynamic Enterprises (Supra). The question considered by the court was when retiring partner takes only money towards value of his share, whether the firm should be made liable to pay capital gains even when there is no distribution of capital asset among the partners under section 45(4) of the Act. In the said case of Dynamic Enterprises (Supra), the partnership firm was engaged in the business of buying land and properties and construction   of   buildings   thereon.   The   firm   underwent reconstitution. Before such reconstitution the assets of the firm were revalued as per the report of the registered valuer. Three erstwhile partners retired. Retiring partners received enhanced value of the property upon retirement. In this context, the Court considered the above   noted   question.   The   Court   held   that   after   retirement   of partners,   the   partnership   continued   and   the   business   was   also carried on by the remaining partners. There was thus no dissolution of the firm and there was no distribution of capital asset. What is given to the retiring partners was money representing the value of their share in the partnership. No capital asset was transferred on Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28

9                                                         14.137.17 itxa.doc the date of retirement. In absence of distribution of capital asset and in absence of transfer of capital asset in favour of retiring partners, no profit of gain arose in the hands of partnership firm. Following observations of the court may be noted:

“25. In the instant case, the partnership firm had purchased the property under a registered sale deed in the name of the firm.   The   property   did   not   stand   in   the   name   of   any individual   partners.   No   individual   partners   brought   that capital   asset   as   capital   contribution   into   the   firm.   Five partners brought in cash by way of capital when the firm was reconstituted on April 28,1993. Nearly a year thereafter on April 1,1994, by way of retirement, the erstwhile three partners took their share in the partnership asset and went out of the partnership. After the retirement of three partners, the partnership continued to exist and the business was carried on by the remaining five partners. There was no dissolution   of   the   firm   or   at   any   rate   there   was   no distribution of capital asset on April 1,1994, when the three partners retired from the partnership firm. What was given to the retiring partners is cash representing the value of their share in the partnership. No capital asset was transferred on the date of retirement under the deed of retirement deed dated April 1,1994. In the absence of distribution of capital Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28

10                                                         14.137.17 itxa.doc asset   and  in  the  absence  of   transfer  of   capital  asset   in favour of the retiring partners, no profit or gain arose in the hands of the partnership firm. Therefore, the question of the firm being assessed under Section 45(4) and charging them tax for the profits or gains which did not accrue to them would not arise.

11                                                         14.137.17 itxa.doc their   interest   in   the   immovable   property.   What   they relinquished   is   their   share   in   the   partnership.   Therefore, there is no transfer of a capital asset, as such, no capital gains or profit arises in the facts of this case. In that view of the matter, Section 45(4) has no application to the facts of this case.

12                                                         14.137.17 itxa.doc Central question was, would Section 45(4) apply even if there was no dissolution of the firm. Issue of transfer of capital asset was not the focal point. 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. 9 In the result, we do not find any error in the view of Tribunal. 10 Income Tax Appeal is dismissed. [SARANG V. KOTWAL, J.]                  [AKIL KURESHI, J.] Uploaded on - 21/08/2020 Downloaded on - 28/10/2026 03:34:28 Powered by TCPDF (www.tcpdf.org)