RAM KRISHAN KULWANT RAI,CHENNAI vs. ACIT CENTRAL CIRCLE 2(3), CHENNAI

आदेश /O R D E R

PER N.R.S. GANESAN, JUDICIAL MEMBER:

This appeal of the assessee is directed against the order of

the Commissioner of Income Tax (Appeals) -18, Chennai, dated

11.01.2018 and pertains to assessment year 2009-10.

that the assessee is a company engaged in the business of

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hospitality services, more particularly, promotion of hotels and service apartments. During the year under consideration, according to the Ld. counsel, there was a search under Section 132 of the Income-tax Act, 1961 (in short 'the Act') in RKKR SBQ group of companies on 26.09.2012. During the course of search operation, according to the Ld. counsel, the documents relating to registration of assessee-company was said to be found. Accordingly, a notice under Section 153C of the Act was issued by the Assessing Officer to the erstwhile partnership firm on 26.09.2014. According to the Ld. counsel, before the assessee-company was incorporated as a company under the Companies Act, it was a partnership firm. The partnership firm had revalued its assets on 03.11.2008. On account of revaluation, the value of the asset was increased to the extent of ₹117,24,04,974/- and the book value of the asset on the date of revaluation was ₹52,16,526/-. According to the Ld. counsel, the difference between the book value of the asset and the revaluation was given credit as loan from the partners’ capital account in the same proportion as their respective capital in the partnership firm. On conversion of partnership firm into a private limited company, the present assessee before this Tribunal, the balance in the capital account of all the shareholders / partners was ₹117,32,87,070/-.

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Consequently, according to the Ld. counsel, shares were allotted to the partners of the firm for a total amount of ₹10 lakhs each and the balance amount of ₹117,22,87,070/- was given credit to the partners of erstwhile firm in the same proportion as their capital in the firm. Therefore, according to the Ld. counsel, after the partnership firm was converted into private limited company, the shares and the value of the revaluation of asset was given credit on the same proportion as their capital in the partnership firm.

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153C of the Act since the assessee being a person other than the

searched person. According to the Ld. counsel, in fact, the Assessing Officer initiated proceeding by issuing notice under Section 153C of the Act. However, he dropped the proceeding for

the reason well known to him. According to the Ld. counsel, Section 153A and 153C of the Act commence with non obstante clause “notwithstanding anything”, therefore, notwithstanding

anything contained in Section 147, 148 and 139 of the Act, the Assessing Officer is bound to initiate proceeding under Section 153C of the Act. Having dropped the proceeding under Section 153C of the Act, according to the Ld. counsel, the Assessing Officer

cannot initiate any proceeding for reopening of assessment under Section 147 of the Act. The Ld.counsel placed his reliance on the decision of Amritsar Bench of this Tribunal in ITO v. Arun Kumar

Kapoor in I.T.A. No.147(ASR)/2010 dated 21.06.2011 and submitted that the Tribunal found that wherever there was search operation, the provisions of Section 153C of the Act come into

operation and Sections 147 and 148 of the Act stand ousted. The proceeding initiated under Section 153C of the Act was dropped, according to the Ld. counsel, the assessment framed under Section

143(3) read with Section 147 of the Act is invalid. For the same

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proposition, the Ld.counsel also placed his reliance on the judgment

of Delhi High Court in CIT v. Anil Kumar Bhatia (2012) 82 CCH 113.

by the Assessing Officer to the erstwhile partnership firm, the

Ld.counsel for the assessee submitted that the Assessing Officer

admitted that there was search operation in the case of SBQ Steels

Ltd. On examination of seized material, the Assessing Officer found

that part of the seized material belongs to erstwhile partnership firm.

Therefore, he initiated proceeding under Section 153C of the Act.

Having initiated the proceeding under Section 153C of the Act,

according to the Ld. counsel, the Assessing Officer is expected to

take the same to the logical conclusion. However, the Assessing

Officer dropped the proceeding initiated under Section 153C of the

Act, therefore, according to the Ld. counsel, the assessment framed

by the Assessing Officer under Section 143(3) read with Section

147 of the Act cannot stand in the eye of law. According to the Ld.

counsel for the assessee, admittedly there was a search and

proceedings were initiated under Section 153C of the Act, therefore,

the provisions of Section 143(3) and 147 are ousted, in view of

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express language employed by Parliament in Section 153A and

153C of the Act.

a transfer of property on conversion of partnership firm into a private limited company. According to the Ld. counsel, the assessee private limited company was a successor to the erstwhile

partnership firm. The shares of the assessee-company were allotted to the partners in the same proportion as their respective capital in the partnership firm. According to the Ld. counsel, the

private limited company succeeded to all the assets and liabilities of the firm, therefore, it cannot be construed as transfer of capital asset. Referring to Section 47(xiii) of the Act, the Ld.counsel

submitted that any transfer of capital asset or intangible asset by a firm to a company as a result of succession of firm by a company in the business carried on by the firm, cannot be construed as transfer.

Hence, no tax could be levied.

ground that the condition stipulated in Section 47(xiii) (c) of the Act

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was violated. According to the Ld. counsel, there was no violation

of Section 47(xiii) (c) of the Act at all. Referring to the conditions referred in Section 47(xiii) of the Act, the Ld.counsel submitted that the first condition is that all the assets and liabilities of the firm

relating to the business immediately before the succession shall become the assets and liabilities of the company. In this case, according to the Ld. counsel, all the assets and liabilities of the

erstwhile partnership firm became assets and liabilities of the assessee-company. Therefore, the first condition is fulfilled. The second condition under Section 47(xiii) of the Act is that all the partners of the firm immediately before the succession become the

shareholders of the company in the same proportion in which their capital accounts stood in the books of the firm on the date of succession. Here also, the partners of erstwhile partnership firm

became shareholders of the assessee-company in the same proportion in which their capital accounts stood in the books of the firm on the date of succession. Hence, the second condition is also

fulfilled. Referring to the third condition, the Ld.counsel submitted that the partners of the firm do not receive any consideration or benefit directly or indirectly in any manner other than by way of

allotment of shares in the company. According to the Ld. counsel,

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this condition was said to be violated since after revaluation, the

revalued amount was credited in the capital accounts of the partners as a loan in the same proportion as their capital accounts stood on the date of revaluation. According to the Ld. counsel, the

same credit on the date of revaluation continued even after the succession to the assessee-company in the same proportion. Therefore, according to the Ld. counsel for the assessee, the third

condition of Section 47(xiii) of the Act are not violated. In other words, according to the Ld. counsel, Section 47(xiii) is not violated. According to the Ld. counsel, there was no benefit received by the shareholders or the erstwhile partners either directly or indirectly.

submitted that in the case before the Madras High Court as in the case before us, the private limited company succeeded to the assets and liabilities of the partnership firm. All the partners of the

firm immediately before the succession became the shareholders of the company in the same proportion in which their capital stood in the books of the firm on the date of succession. As in the case before us, according to the Ld. counsel, the assets of the

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partnership firm were revalued and the partnership firm business

along with assets and liabilities was taken over by the private limited company as a going concern. In those facts and circumstances of the case, the Madras High Court, after considering various

judgments of the other High Courts and Supreme Court on the subject, came to a conclusion that there was no transfer of assets since no consideration was received or accrued on transfer of

assets from partnership firm to the company. The partnership firm has only revalued its assets which will not amount to transfer. According to the Ld. counsel, the High Court has also found that provisions of Section 45(4) of the Act is applicable only when the

partnership firm was dissolved. Since the property of the partnership firm vested in the private limited company not consequent to transfer, as contemplated under Section 45(4) of the

Act, the High Court found that there cannot be any capital gain arising out of conversion of partnership firm into a private limited company. This judgment of Madras High Court, according to the

Ld. counsel, is squarely applicable to the facts of the case.

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(1979) 120 ITR 49. The Ld.counsel has also invited our attention to

Section 45(4) of the Act and submitted that in case of dissolution and distribution of capital asset, the gain arising may be chargeable to capital gain. In this case, according to the Ld. counsel, it is a

case of succession and not a case of dissolution and distribution. Therefore, in view of judgment of Madras High Court in CADD Centre (supra) and judgment of Apex Court in Malabar Fisheries

Co. (supra), according to the Ld. counsel, it cannot be construed as transfer of capital asset by way of distribution on dissolution, hence, no capital gain tax is chargeable in the case of succession of the capital asset by a company from the erstwhile partnership firm. The

Ld.counsel has also invited our attention to sub-section (3) of Section 45 of the Act and submitted that even in worst case, if the succession of the company to the partnership firm is construed as

transfer of capital asset, then the capital gain may, at the best, be levied either in the hands of erstwhile partnership firm or in the hands of erstwhile partners. In the case before us, according to the

Ld. counsel, the private limited company, which succeeded to the assets and liabilities of the partnership firm is the assessee. Therefore, according to the Ld. counsel, the assessee-company is

not liable to capital gain tax even if it is construed as transfer of

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capital asset. Therefore, according to the Ld. counsel, the

CIT(Appeals) is not justified in confirming the order of the Assessing Officer.

Representative, submitted that admittedly there was a search operation in the case of SBQ Steels Ltd. on 26.09.2012 and document relating to formation of assessee-company converting the

partnership firm was found and the Assessing Officer issued notice on 26.09.2014 under Section 153C of the Act calling upon the assessee to file return of income within fifteen days. On verification

of the return filed by the assessee before the date of search, according to the Ld. D.R., it was found that the assessee has disclosed the revaluation of asset and formation of the company in

the return of income. Therefore, according to the Ld. D.R., all the information were available before the Assessing Officer before the date of search. Hence, the Assessing Officer had to initiate

proceeding only under Section 148 and 147 of the Act and not under Section 153C of the Act. Even though initially a notice under Section 153C of the Act was issued to the assessee, according to the Ld. D.R., the Assessing Officer subsequently found that the

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proceeding has to be initiated only under Section 148 of the Act for reassessment of escaped income. Therefore, according to the Ld. D.R., the Assessing Officer has rightly dropped the proceeding initiated under Section 153C of the Act and passed the order under Section 143(3) read with Section 147 of the Act.

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of right is also considered to be a transfer. On a query from the

Bench, when the company succeeded to the assets and liabilities of the partnership firm, even for argument sake, it was construed as transfer, whether the assessee-company is liable to pay capital gain

tax or the partners of the erstwhile partnership firm is liable to pay the tax? the Ld. D.R. could not clarify who is liable to pay tax on the capital gain in case it was construed as transfer.

into a private limited company. The assessee-company succeeded to all the assets, liabilities and business as a going concern of the erstwhile partnership firm. This is not in dispute. Moreover, the

erstwhile partners of the partnership firm were also allotted shares in the same proportion in which their capital accounts stood on the date of succession. The only dispute is with regard to credit of

difference between the revaluation value and book value of the asset as loan in the capital account of the partners. This credit of difference in the revaluation of asset in the capital account of the partners is claimed by the Revenue as indirect form of getting

14 I.T.A. No.1047/Chny/18

benefit by the partners other than by way of allotment of shares in

the company. It is not in dispute that asset of the partnership firm was revalued and the difference in revaluation and the book value was credited in the books of the partnership firm as loan in the

capital account of the partners in the same proportion in which their capital account stood on the date of revaluation. The question arises for consideration is whether there was any transfer of asset

within the meaning of Section 2(47) and 45(4) of the Act?

Court, a partnership firm engaged in the business of training and trading of software was converted into a private limited company. After incorporation of private limited company, the assets and

liabilities and business as going concern were succeeded by the private limited company, namely, CADD Centre India Pvt. Ltd. All the partners of the firm immediately before succession became

shareholders of the company in the same proportion as their capital accounts stood in the books of the firm on the date of succession. The erstwhile partnership firm revalued the assets and the partnership business was converted into business of private limited

15 I.T.A. No.1047/Chny/18

company as going concern. The Assessing Officer found that

transfer of business asset of the partnership firm to the private

limited company would constitute distribution of assets and attract

capital gain as contemplated under Section 45(4) of the Act. The

Madras High Court after considering the provisions of Section

47(xiii) and 45(4) of the Act, examined various judgments of the

other High Courts and Apex Court including the judgment in

Malabar Fisheries Co. (supra) and found that when the partnership

firm is transformed into a private limited company, there is no

distribution of assets as such and hence, there is no transfer.

Therefore, the erstwhile partnership firm is not liable to pay tax on

capital gain. In fact, the Madras High Court has observed as

follows:-

“16. It is not in dispute that the partnership firm transformed into a private limited company. The partnership firm and a private limited company are two different legal entities, with different legal liability. In other words, the liability of a partner is different from that of the liability of a director of a company. The company has an independent legal entity, de hors its share- holders, whereas the partnership firm has no such independent existence, de hors the partners. Therefore, when a partnership firm is transformed into a limited company with no change in the number of partners and the extent of property, there is no transfer of assets involved and hence, there is no liability to pay tax on capital gains. 17. It is strenuously contended that earlier, distribution of capital assets on dissolution of firm was not considered as transfer, but, on the Finance

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Act, 1987 (w.e.f. April 1, 1988), amending the said clause, the distribution of capital assets on the dissolution of firm will be a transfer. This proposition is not in dispute. The question here is, when there is no dissolution at all of the partnership firm, whether there is transfer of capital assets and consequently, whether there is a liability to pay tax on capital gains. On facts, the finding is that there is no dissolution of partnership firm. It is not in doubt that, in case of dissolution of partnership firm, there is transfer of assets and consequently, the assessee is liable to pay tax on capital gains. 18. It would be appropriate to quote the decision in Asst. CIT v. Unity Care and Health Services [2006] 286 ITR (AT) 121 (Bang) ; [2006] 106 TTJ 1086 (Bang.), whereunder, in a similar fact situation, it has been held that when a partnership firm is transformed into a company, there is no transfer of capital asset, as the transfer is by operation of law and the relevant observation reads as under (page 130 of 286 ITR (AT)) : "When a conversion of a firm into company takes place under the provisions of the company law, such conversion can be construed only as occasioned by operation of law. Hence, no controversy can arise on the application of this principle even for purposes of capital gains under section 45(4) of the Act. By insertion of section 47(xiii) in the Act, it cannot be said that the conversion of a firm into a company under Part IX is to be first treated as dissolution of firm within the meaning of section 45(4) and only if condition as contained in section 47(xiii) are complied, the exemption will be available. Section 47(xiii) applies only to a case of transfer by sale, but there is no authority for capital gain at all in the absence of a transfer under Part IX of the Companies Act in as much as such conversions do not fall within the definition of transfer Under section 2(47) of the Act. Section 45(4) would have application only when there is distribution of assets to the partners so that its application cannot be justified, firstly because it can apply only, when there is transfer and secondly only when there is distribution of assets to the partners. This is neither in the conversion of a firm into a company. It is seen that section 47(xiii) is also complied with if it is held that there is transfer of capital asset to a company, the clauses of section 47(xiii) are fulfilled and thus even if it is held that there is a transfer of capital asset by a firm to a company as a result of succession, the same is not chargeable, as the condition prescribed therein are complied with. Thus, looking at either angle, the capital gain is not chargeable to tax."

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is binding on this Tribunal, when the assets and liabilities and

business of the partnership firm as a going concern were taken over

by a private limited company incorporated and the partners of the

erstwhile partnership firm were allotted shares in the same

proportion of the capital as it stood in the books of the firm on the

date of succession, there was no transfer at all. Hence, there is no

question of levy of tax on capital gain would arise for consideration

at all.

the asset of the erstwhile partnership firm, the difference between

revaluation and book value was credited in the capital account of

the respective partners in the same proportion of their capital as

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loan, therefore, there was indirect benefit to the shareholders and

erstwhile partners. The question arises for consideration is whether there was any transfer on revaluation? Revaluation of existing asset of the partnership firm by itself does not amount to any

transfer as held by the Madras High Court in CADD Centre (supra). The Madras High Court, after considering the provisions of Section 47(xiii) of the Act, held that Section 47(xiii) applies only to a case of

transfer by sale. Moreover, Section 45(4) would apply only when there is distribution of asset to the partners. In view of this judgment of Madras High Court, there is no violations of the conditions stipulated in Section 47(xiii) of the Act.

erstwhile partners in the same proportion as their capital as a loan amounts to indirect benefit to the erstwhile partners, under the scheme of Income-tax Act, capital gain tax cannot be levied on the

assessee-company. Under the scheme of Income-tax Act, only transferor is liable to pay tax on capital gain. In the case before us, the assessee-company succeeded to assets and liabilities of the partnership firm. Therefore, the assessee-company may at the best

19 I.T.A. No.1047/Chny/18

be considered as transferee and certainly not transferor. Therefore,

considering the facts of the case in all respects, this Tribunal is of

the considered opinion that capital gain tax cannot be levied in the

hands of the assessee-company which succeeded to the assets

and liabilities of the partnership firm. Hence, we are unable to

uphold the orders of the lower authorities.

Tribunal to go into the contention of the assessee regarding validity

of assessment order passed under Section 143(3) read with Section

147 of the Act, when there was search operation and proceedings

were initiated under Section 153C of the Act.

orders of the lower authorities. Accordingly, orders of both the

authorities below are set aside and the addition made by the

Assessing Officer as capital gain is deleted.

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Order pronounced in the court on 29th October, 2018 at Chennai.

sd/- sd/- (एस जयरामन) (एन.आर.एस. गणेशन) (S. Jayaraman) (N.R.S. Ganesan) लेखा सद�य/Accountant Member �या�यक सद�य/Judicial Member

चे�नई/Chennai, �दनांक/Dated, the 29th October, 2018.

Kri. आदेश क� ��त�ल�प अ�े�षत/Copy to: 1. अपीलाथ�/Appellant 2. ��यथ�/Respondent 3. आयकर आयु�त (अपील)/CIT(A)-18, Chennai-34 4. Principal CIT, Central-2, Chennai 5. �वभागीय ��त�न�ध/DR 6. गाड� फाईल/GF.