GOKULAKRISHNA,CHENNAI vs. DEPUTY COMMISSIONER OF INCOME TAX, NON CORPORATE CIRCLE 8(1), CHENNAI

Gokulakrishna, The Deputy Commissioner of D 401, Purva Jade, Arcot Road, Vs. Income Tax, Valasaravakkam, Chennai 600 087. Non Corporate Circle 8(1), Chennai. [PAN: AOKPG-1579-A] (अपीलाथ�/Appellant) (��यथ�/Respondent) अपीलाथ� क� ओर से/Appellant by : Shri R. Sivaraman, Advocate ��यथ� क� ओर से/Respondent by : Ms. R. Anita, Addl. CIT सुनवाई क� तारीख/Date of Hearing : 13.06.2025 घोषणा क� तारीख/Date of Pronouncement : 17.06.2025 आदेश/ O R D E R

PER GEORGE GEORGE K, VICE PRESIDENT:

S.A. No. 48/Chny/25 2. The solitary issue argued on merits is with regard to confirmation of addition made under short term capital gain on the amounts credited to the partners’ current account as a consideration against the sacrificing ratio on admission of new partner.

f. as per clause 11.3 of the Investment Agreement dt. 17.11.2016 which is reproduced here under: “The designated Partners and Working Partners will enter into fixed term employment agreements with the LLP in substantially the form attached herewith as Annexure 2 at Closing.......”, the partner has to enter into an Executive Employment Agreement wherein the partner who is an Executive has to agree to comply with the Non-compete and Non Solicitation clause and the same is reproduced hereunder: “..... The Executive agrees to comply with the obligations set forth in Clause 19 of the Investment Agreement and Schedule H of the LLP Agreement during the period the Executive is in the employment of the LLP and during the Restricted period.....”

6. On perusal of the Amended and Restated Agreement of LLP dt.02.02.2017, the Assessing Officer gathered information and narrated under para 3.5.2 are reproduced herein under: a. M/s. Elior India Catering LLP has been inducted into the existing LLP i.e. M/s. CRCL LLP in consideration of M/s. Elior India Catering LLP contributing Rs.31,76,03,000/- towards the capital of M/s. CRCL LLP. b. that the capital ratio of the assessee was 12% and the contribution to capital account of M/s. CRCL LLP was Rs. 12,000/-. c. subsequent to the induction of new partner, M/s. Elior India Catering LLP, the capital ratio of the assessee has been reduced to 5.88% and the contribution to capital account of M/s .CRCL LLP was Rs. 12,000/-. d. that capital contribution from M/s. Elior India Catering LLP to the extent of Rs.13,86,72,100/- was to be credited to the current account of the existing partners of M/s. CRCL LLP. e. that capital contribution from M/s Elior India Catering LLP to the extent of Rs.5,94,30,900/- shall be credited to the current account of the existing partners of M/s. CRCL LLP after fulfilment of the "Conditions Subsequent" as per clause 7 of the Investment Agreement dt.17.11.2016 to the satisfaction of M/s. Elior India Catering LLP. f. that the assessee has undertaken with M/s. Elior India Catering LLP that he and his affiliates shall not for two years from being ceased to be the partner of M/s. CRCL LLP either directly or indirectly or through any other person participate, carry on or be engaged or interested in, whether financially or otherwise, in Non-compete Business in any form or invest in, hold direct or S.A. No. 48/Chny/25 indirect interest in or otherwise benefit economically from, facilitate or enter into any arrangement or agreements with any person that competes directly or indirectly with the Non-compete business.

7. In view of the above observations, the Assessing Officer did not accept the contention of the assessee that the amount of ₹.2,38,63,452/- is not taxable for the following reasons:  The assessee has stated in his response dt.07.09.2021 that on admission of a new partner, profit sharing ratio changed and the goodwill was calculated and distributed amongst the existing partners including the assessee and the assessee received an amount of Rs. 2,38,63,452/- in his current account held in M/s.CRCL LLP.  The assessee vide his response dt.07.09.2021 has stated that on the basis of mutual agreement between the partners it was decided that M/s. Elior India Catering LLP would have 51% stake in M/s. CRCL LLP.  That there was no valuation report to support the basis for contribution of Rs.31,76,03,000/- against taking over 51% share in the firm, M/s. CRCL LLP. Hence no basis for arriving at the amount of Rs.31,76,03,000/- to be paid by M/s. Elior India Catering LLP.  That the assessee's profit sharing ratio has changed from 12% to 5.88% on induction of new partner, M/s. Elinor India Catering LLP and thus the assessee relinquished 6.12% of the profit sharing ratio as well as the share in the goodwill of the firm.  The contention of the assessee that the profit sharing ratio has remained in the same proportion to the capital infused into the firm is nothing but camouflaging his reduction in the profit sharing ratio and the share in the goodwill of the firm.  The assessee has not justified as to why he received Rs.2,38,63,452/- when his contention is that his profit sharing ratio has remained in the same proportion to the capital infused and there is no change in his capital in the firm M/s. CRCL LLP.  In this case of the assessee, there is admission of a new partner and the share of the assessee in profit of firm got reduced from, 12% to 5.88% and in lieu of this reduction of his right to receive profit and goodwill, he had received payments from the new incoming partner which has been subsequently withdrawn from the current account by the assessee.  That the amount of Rs.2,38,63,452/- received by the assessee is nothing but a payment in lieu of reduction of assessee's right to receive profit and share in the goodwill. There is no references / relation shown of the payment with the assets of the firm.  That on perusal of Investment Agreement dt.17.11.2016 as well as the Amended and Restated Agreement of LLP dt.02.02.2017, it can be concluded that the assessee has released his partnership interest in the firm, M/s. CRCL LLP in favour of M/s. Elior India Caterers LLP acquiring the partnership interest in the firm, M/s. CRCL LLP.

S.A. No. 48/Chny/25  Further, perusal of the Investment Agreement dt.17.11.2016 as well as the Amended and Restated Agreement of LLP dt.02.02.2017, it can be seen that it is a composite agreement where the partners are foregoing their rights as a partner in the firm and the liabilities of non-compete undertaking as per clause 19 of the Investment Agreement dt.17.11.2016 and as per para 7 to 11 given in Schedule F- "Duties of Partners" in the Amended and Restated Agreement of LLP dt.02.02.2017 were tied to each of the partner. The payment credited to the assessee is against forgoing of the interest by the assessee.  As per sec 2(14) "capital asset" means property of any kind held by the assessee whether or not connected with his business or profession. Further, property has vide connotation and it signifies every possible interest which a person can acquire, hold and enjoy. Therefore, business can be considered as property. Thus, the right to receive profit in a partnership firm is a capital asset under section 2(14) of the Act and relinquishment of the right to receive profit is a transfer within the definition of section 2(47) of the Act.  That reduction clearly indicated that there was diminishment in the assessee's capital asset to the extent of 6.12%. In lieu thereof, the assessee has been paid compensation of Rs.2,38,63,452/-. Thus, the share in the partnership firm which was an income-yielding asset got reduced to that extent. The compensation for the same would, therefore, partake of the character of a capital receipt in the hands of the assessee.  It is now well-settled that when the shareholding of an assessee gets reduced in any partnership business, that reduction without special features as were noted by the Supreme Court in Gangadhar's case [1972] 86 ITR 19, would reflect impairment in assessee's capital asset, meaning an income-yielding apparatus which the assessee had with him prior to such reduction.  It cannot be doubted that, because of reduction of the share of the assessee in the reconstituted firm from 12% to 5.88% the trading structure of the assessee was impaired and such cancellation would result in proportionate loss of an income-yielding asset. Consequently, the payment made to him as compensation for such impairment has to be treated as a capital receipt.

8. In view of the above observations, the Assessing Officer was of the opinion that the right to receive profit in a partnership firm is a capital asset under section 2(14) of the Act and relinquishment of the right to receive profit is a transfer within the definition of section 2(47) of the Act. Accordingly, the Assessing Officer treated the amount of ₹.2,38,63,452/- received from Elior India as income from short term capital gains and

9. On being aggrieved, the assessee is in appeal before the Tribunal.

10. The ld. Counsel for the assessee Shri R. Sivaraman, Advocate has submitted that the assessee is one of the partners in CRCL with a 12% profit sharing ratio. Consequent upon induction of Elior India as a partner with 51% stake by contributing ₹.31.75 crores into CRCL of which ₹.19.88 crores has been credited to the existing partners’ current account in their respective sacrificing ratio. The assessee got 12% profit-sharing ratio before admission of Elior India as a partner in CRCL and the same has been reduced to 5.88% after induction of Elior India and ₹.2,38,63,452/- has been credited to the assessee’s current account held in CRCL towards sacrificing profit share. However, the Assessing Officer erroneously held that the amount credited to the current account of the assessee is in the nature of goodwill on admission of new partner and treated the same as income chargeable to tax. The ld. Counsel for the assessee vehemently argued that the assets belonging to CRCL are not transferred from the assessee on account of admission of a new partner as the assets continue to be held by the CRCL and no partner has got any independent or specific interest in respect of the assets of the firm. He further argued that the assessee’s share in the partnership firm’s assets of CRCL, inter alia, S.A. No. 48/Chny/25 goodwill would be crystallized only on dissolution of the LLP of retirement of the assessee and in the event of admission of Eliar India, the goodwill did not exist. Thus, the assumption of the Assessing Officer that the credited amount represents goodwill does not hold good.

11. The ld. Counsel for the assessee has further submitted that the reconstitution agreement indicates that none of the existing partners retired or there was any distribution of assets, thereby, the credit amount represents goodwill is not correct. He further submitted that the relationship between partners is governed by section 23 of the LLP Act, 2008, which allows parties to agree on mutual rights and duties without requiring the determination of goodwill upon reconstitution. By referring to the Investment Agreement dated 17.11.2016 as well as the Amended and Restated Agreement of LLP dated 02.02.2017, the ld. Counsel for the assessee has submitted that the said agreement does not specify that the income of partner’s contribution is towards goodwill and moreover there was no revaluation. To support his arguments, the ld. Counsel relied on the following case law: 1. CIT v. Kunnamkulam Mill Board 257 ITR 544 (Kerala) 2. CIT v. P.N. Panjawani 356 ITR 676 (Kar.) 3. ITO v. Smt. Paru D. Dave [2008] 110 ITD 410 (Mum.) 4. ITO v. Fine Developers [2013[] 55 SOT 122 5. Radhu Palace v. Addl. CIT 148 ITD 424 (Delhi) 12. He further argued that there is no legal requirement to obtain a valuation report between two unrelated parties when there is an agreement S.A. No. 48/Chny/25 for the price. He argued that there is no element of transfer so as to attract the provision of section 2(47) of the Act and hence there cannot be any levy of tax on capital gain under section 45 of the Act on the event of introduction of a new partner. He has further submitted that even if the amount of ₹.2,38,63,452/- is considered as goodwill, the same cannot be treated as income in the hand of the assessee as a partner does not have any right over the assets of the firm when the firm is still in existence and at best, the said transaction could be envisaged under section 45(4) of the Act to tax in the hands of the firm and not in the hands of the partners of the firm.

12. Per contra, the ld. DR Ms. R. Anita, Addl. CIT has submitted that the contention of the ld. Counsel for the assessee that there was no legal requirement to obtain a valuation report in case of transaction between related parties is correct, then how it can be ascertained what are the assets of the firm and how the said assets have been valued whether on a slump sale basis or on individual asset wise values have been arrived at. To support her contention, the ld. DR relied on the judgement of the Hon’ble Supreme Court in the case of JCIT v. Vatsala Sheny [2016] 74 taxmann.com 143 (SC), wherein, it was upheld the principle that extinguishment/transfer of interest in partnership firm’s assets for a consideration that results in transfer of capital asset liable to tax. The ld. DR has further submitted that the case on hand is not a distribution of S.A. No. 48/Chny/25 assets/value of the assets by the firm for section 45(4) of the Act to be made applicable, but a sale/transfer of partnership interest being the ownership interest held by the old partner in the partnership firm to the new partner for a consideration. The ownership interest represents as stated above the right to receive profits and the right to receive net assets. As in the case of a corporate set up, wherein, a shareholder sell his/her stake in the company to a third party, the same is liable to capital gain, even though the shareholder does not own the assets of the company as the same belong to the company and the shareholder is entitled to the dividend and share of assets on winding up of the company net liabilities. Similar is the case in hand, wherein, the assessee being a partner of an LLP has transferred part of his ownership to the new partner. The LLP is a new form of organization and as per section 42 (1) of the LLP Act, what is transferred in this case is the economic rights of the assessee partner and the same is an asset under section 2(47) of the Act and the transfer is liable to capital gains under section 45(1) of the Act and relied on the following case law:

1. 1. Sudhakar M Shetty v. ACIT [2011] 130 ITD 197 (Mumbai) 2. Samir Suryakant Seth v. ACIT in & 3092/Ahd/2002 dt. 25.01.2012.

3. B. Raghurama Prabhu Estate v. JCIT [2012] 20 taxmann.com 390 (Karnataka).

13. We have heard both the sides, perused the material available on record and gone through the orders of authorities below as well as case law relied by both the parties. The assessee is one of the partners in M/s.

S.A. No. 48/Chny/25 CRCL LLP with a 12% profit- sharing ratio. M/s. Elior India Catering LLP has been inducted into assessee’s partnership firm as a partner with 51% stake by contributing ₹.31.75 crores into CRCL of which ₹.19.88 crores has been credited to the existing partners’ current account in their respective sacrificing ratio. The assessee got 12% profit-sharing ratio before admission of Elior India as a partner in CRCL and the same has been reduced to 5.88% after induction of Elior India and ₹.2,38,63,452/- has been credited to the assessee’s current account held in CRCL towards sacrificing profit share. The Assessing Officer erroneously held that the amount credited to the current account of the assessee is in the nature of goodwill on admission of new partner and treated the same as income chargeable to tax, which was confirmed by the CIT(A) on further appeal.

14. In this case, the contention of the ld. Counsel for the assessee is that no goodwill existed at the time of Elior India’s investment in CRCL, making it impossible for the assessee to receive a share of non-existent goodwill. In fact, CRCL was a nascent organisation when Elior India was admitted and if at all the Department treat it as goodwill, the same cannot be treated as income in the hands of the assessee as one of the partners in the partnership firm, the assessee does not have any right over the assets of the firm when the firm is still in existence. Admittedly, consequent upon the induction of Elior India into CRCL, there is reduction in the shares of existing partners, in assessee’s case, the profit-sharing ratio has been S.A. No. 48/Chny/25 reduced from 12% to 5.88%, thereby, the Assessing Officer held that it amounts to transfer within the meaning of section 2(47) of the Act. It is also an admitted fact that the erstwhile partners have not retired and they continued to be the partners along with the income partners. The assessee has relied on the decision of the Hon’ble High Court of Karnataka in the case of CIT v. P.N. Panjawani (supra), wherein, the Hon’ble High Court examined whether the admission of new partners and the consequent reduction in the share of existing partners constituted a taxable event under section 2(47) of the Act. By considering various judgements of the Apex Court and the Hon’ble High Court, held that the reduction in the share of the existing partners due to the admission of new partners did not amount to a transfer of capital assets and hence was not taxable. The observations of the Hon’ble High Court of Karnataka and the ruling are reproduced below: 5. These appeals were admitted to consider the following substantial question of law: “Whether the appellate authorities were right in holding that the admission of the new partners and assignment of right in the firm to the new partners out of the rights of the assessee for consideration does not amount to transfer in the hands of assessee under Sec. 2(47) of the Act and consequently not liable to tax under S4ec. 45 of the Act?”

S.A. No. 48/Chny/25 [(1A) Notwithstanding anything contained in sub-section (1), where any person receives at any time during any previous year any money or other assets under an insurance from an insurer on account of damage to, or destruction of, any capital asset, as a result of- (i) flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or (ii) riot or civil disturbance; or (iii) accidental fire or explosion; or (iv) action by an enemy or action taken in combating an enemy (whether with or without a declaration of war), then, any profits or gains arising from receipt of such money or other assets shall be chargeable to income-tax under the head "Capital gains" and shall be deemed to be the income of such person of the previous year in which such money or other asset was received and for the purposes of section 48, value of any money or the fair market value of other assets on the date of such receipt shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital asset. Explanation, For the purposes of this sub-section, the expression "insurer" shall have the meaning assigned to it in clause (9) of section 2 of the Insurance Act, 1938 (4 of 1938)] (2) ***** [(3) The profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a co-operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48, the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset. (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 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 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 result of the transfer]”

S.A. No. 48/Chny/25 13. Section 2(31) of the Income Tax Act defines 'person' as follows:- “person” includes- (i) an individual, (ii) a Hindu undivided family, (iii) a company, (iv) a firm, (v) an association of persons or a body of individuals, whether incorporated or not, (vi) a local authority, and (vii) every artificial juridical person, not falling within any of the preceding sub- clauses; [Explanation - For the purposes of this clause, an association of persons or a body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits or gains;]"

16. It is in this background if we look at the background of this case, the landed property was not owned by the erstwhile partners. It was owned by the partnership firm. May be the erstwhile partners had 1/3rd share each in all the partnership assets including this assets. On reconstitution of the firm, four more partners were inducted, who contributed Rs.2.50 crores as their capital contribution. Thus, the inducted partners also became partners in the firm and the firm continue to assets own, including .this, landed property. The erstwhile partners withdrew the money brought in by the incoming partners as drawings, They did not retire from the partnership firm. They continued to be the partners of the firm. However, their share got reduced. In other words, 50% of their S.A. No. 48/Chny/25 share held before reconstitution became the share of the incoming partners. As the property was not owned by this erstwhile partners, it cannot be said they transferred 50% in favour of incoming partners and any amount represents the consideration received for such transfer and as such it is liable for payment of capital gains under Section 45 (1) of the Act. It is because they did not transfer the capital assets. Insofar as arguments with regard to the reconstitution, their share got reduced and the amount which was withdrawn and partnership represents inducted partners along with erstwhile partners. As rightly pointed by the appellate authorities in the scheme of the Income Tax Act, there is no provision for levying capital gains on such consideration received for reduction of the share in the partnership firm. The provisions of Section 45(3) or 45(4) is not applicable to the facts of the case. Insofar as the contention that this is a colourable device adopted by the firm as well as the assessees to avoid payment of tax is concerned, it has no substance because tax planning is legitimate. However, it has to be done within the frame work of law.

17. The partnership firm came into existence in the year 1962. It acquired property in the year 1967. It carried on business up to 1992-93 and returns were filed from time to time. It is only in the year 1995, revaluation was done, four new new partners inducted who brought in cash and the firm was not dissolved, the incoming partners did not retire from the firm and it only reduced their share in the partnership firm. The erstwhile partners only reduced their share in the partnership firm and continued to be the partners of the reconstituted firm also. Therefore, it cannot be said that either the firm is a dubious one or the entire transaction is a colourable device and the only object is to avoid payment of tax. Therefore, the law laid down by the Apex Court in the case of McDowell Co. Ltd.'s case (supra) has no application to the facts of this case.

18. The learned Counsel for the revenue relied on the judgment of the Apex Court in the case of Kartikeya V. Sarsbhai v. CIT [1997] 228 ITR 163 / 94 Taxman 164 where it was held as follows: “Section 2(47) of the Income-tax Act, 1961, defines "transfer" in relation to a capital asset. It is an inclusive definition which, inter alia, provides that relinquishment of an asset or extinguishment of any right therein amounts to a transfer of a capital asset. It is not necessary for a capital gain to arise, that there must be a sale of a capital asset, Sale is only one of the modes of transfer envisaged by Section 2(47) of the Act. Relinquishment of the asset or extinguishment of any right in it, which may not amount to sale, can also be considered as a transfer and any profit or gain which arises from the transfer of a capital asset is liable to be taxed under section 45 of the Act."

22. In the instant case, the firm is not taxed. It is the individual partners who are taxed. Moreover, in the instant case, the erstwhile partners have not retired, they also continued to be the partners along with the incoming partners. All that has happened is that the shares of the erstwhile partners are reduced. Therefore, the said judgment also has no application to the facts of this case.

15. The ld. DR could not controvert the above judgement of the Hon’ble High Court of Karnataka in the case of CIT v. P.N. Panjawani (supra). The judgement of the Hon’ble Karnataka High court has not been reversed by the Hon’ble Apex Court. The judgement of Hon’ble Karnataka High Court in

S.A. No. 48/Chny/25 19. However, we find that in order to bring the profit or gains from receipt of money or capital asset or both by the specified person from a specified entity on reconstitution of the specified entity shall be chargeable to income-tax as income of such specified entity under the head “Capital Gains”, the legislation amended the provisions of section 45(4)] vide Finance Act, 2021, shall come into force on the 1st day of April, 2021, which is prospective in nature. Similarly, the provisions of section 9B of the Income Tax Act has been inserted w.e.f. A.Y. 2021-22 vide Finance Act, 2021 to bring under the tax net the income on receipt of a capital asset or stock in trade by a specified person from the specified entity in connection with the dissolution or reconstitution of such specified entity, shall come into force on the 1st day of April, 2021, which is prospective in nature. In fact, transfer of capital asset is common in both section 9B and section 45(4) of the Act. In the present case, the assessment year under consideration is 2017-18 and accordingly, the amendments vide Finance Act, 2021 have no application in the present case.

20. Under the above facts and circumstances of the case as well as judicial precedents, the addition made by the Assessing Officer towards levy of short term capital gains tax at ₹.2,38,63,452/- and confirmed by the CIT(A) stands deleted. Thus, the grounds raised by the assessee are allowed.

S.A. No. 48/Chny/25 21. The Stay Application filed by the assessee in S.A. No. 48/Chny/2025, was also heard along with the main appeal. Since we have adjudicated the main appeal by setting aside the CIT(A)’s order and deleting the addition made by the Assessing Officer, the stay application filed by the assessee become infructuous and accordingly, the same stands dismissed.

Order pronounced in the open court on 17th June, 2025 at Chennai.