ITO, DAVANGERE vs. M/S MAGANAHALLI STEEL CORPORATION, DAVANGERE

Per N.V. Vasudevan, Judicial Member

The appeal by the Revenue and Cross Objection by the assessee is against the order dated 8.4.2009 of the CIT(Appeals), Hubli relating to assessment year 1989-90.

(1) Whether on the facts and in the circumstances of the case, the Revenue authorities were right in coming to the conclusion that the firm M/s. Maganahalli Steel Corporation was not dissolved on 30.09.1983 as per the deed of dissolution and that the new firm M/s.Maganahalli Associates did not come into actual existence with effect from 02.10.1983 by the partnership deed executed on the same date? (2) Whether on the facts and in the circumstances of the case, the revenue authorities were right in holding that the firm M/s. Maganahalli Steel Corporation was liable to be taxed on capital gains on sale of the immovable property at Binny Company road, Davangere? (3) Whether the order passed by the AO is bad in law for the reason that the AO has passed the order after the expiry of period of six months from the date of the Hon’ble High Court’s order and contrary to the directions given by the Hon’ble High Court in the said order to dispose of the case within six months?

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 3 of 20 “2. The learned CIT(A) erred in directing to calculate Capital gains on land and building separately as per the principle laid down in the Hon’ble High court of Karnataka in the case of CIT Vs. C. R. Subramanian (242 ITR 342). 3. The learned CIT(A) erred in appreciating that the asset in this case was held for business purpose and depreciation had been claimed and Capital Gains is to be worked out as per Sec.50(2). “

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as follows. M/s. Maganahalli Steel Corporation (hereinafter referred to as “the Assessee” or “MSC”) was formed as a partnership firm on 1.4.1976 for

the purpose of carrying on business of dealing in iron and steel items. On

26.08.1977, a property at B.C.Road, Davangere bearing D.No.120/1 (hereinafter referred to as “the property”) was purchased out of the firm’s

funds in the name of the then partners Shri M.H. Nijananda for a consideration of Rs.52,344. Subsequently, by means of a registered sale

deed dated 27.11.1978, executed by the two partners viz. Shri M.H.

Nijananda and Shri M.H. Rameshanand (who thereafter retired from the firm) the property was transferred in favour of Shri M. V. Narendranatha,

one of the continuing partners of the assessee. A building was also constructed on the said plot of land during the period from 1978 to 1981 at

a cost of Rs.3,17,947, admitted to have been incurred by the assessee. The assessee also claimed depreciation on the said building as a result of

which the WDV of the building as on 01.07.1983 came down to

Rs.3,02,249. It was claimed by the assessee/MSC, that the firm at that time consisting of the four partners viz., Shri M. V. Mahendraswamy, M.V.

Narendranath, M.V.Rajendranath and Smt.M.R. Jayashree was dissolved with effect from 30.09.1983. A copy of the said deed of dissolution dated

01.10.1983 was filed on the record of the AO. According to the said

dissolution deed, whereas the property was allotted to the three retiring partners viz., Shri M.V. Mahendraswamy, M.V. Narendranath and M.V.

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 5 of 20

Rajendranath. The business in iron and steel items as a going concern,

was however, taken over by the other partner Smt. M.R.Jayashree. It is claimed that Smt. Jayashree ran the business of MSC as a proprietress till

finally it was closed some time in January- February 1988.

Rajendranath formed another partnership firm under the name and style

‘Maganahalli Associates’ (hereinafter referred as “MA”) by a partnership deed executed on 2.10.1983. A copy of the said partnership deed was also

placed on the records of the AO. According to the above partnership deed, the above mentioned property belonging jointly to the three partners was

made the property of the firm and the capital of the partners was constituted mostly by way of impressing the said property with the

partnership character. This partnership firm also carried on business in the

same line viz., iron and steel items with the additional provision that the partnership under its object clause was entitled to act as commission

agent, manufacturer’s representative and agents and developers and exploitation of properties. At the time of dissolution of the earlier firm MSC,

the value of the property for the purpose of ascertainment of assets and

liabilities of the different partners, is stated to have been revalued at Rs.25 lakhs. ln the new partnership firm MA also, the property was shown at this

new value of Rs.25 lakhs and the capital shown to have been contributed by the three partners was also fixed accordingly.

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 6 of 20

mentioned property was sold by the three partners viz. Shri M.V. Mahendraswamy, M.V. Narendranath and M.V. Rajendranath on behalf of

the partnership firm MA to M/s. Bapuji Co-operative Bank Ltd., for

Rs.24,01,101. The dispute in the instant case is at the time of sale of the property, who was its actual owner. The departmental contention is that the

above mentioned dissolution deed in respect of MSC and the partnership deed in respect of MA were bogus ones and in fact, MSC continued its

existence till the sale of the property was concluded. The Department

furthermore contends that MA never really came into existence as a partnership firm and that the family of the partners of the assessee firm

manipulated different documents and records to project the picture of dissolution of the earlier firm and formation of a new firm viz., MA.

Accordingly, the AO assessed the capital gains arising on the sale of the above mentioned property as short term capital gains in the hands of the

assessee firm, MSC. Some business income disclosed by MA during this

year was also assessed in the hands of MSC.

mentioned. Return of income of MSC for the assessment year 1985-86 for

the truncated period up to the date of dissolution viz., 30.09.1983 is stated to have been filed on 29.06.1985. A copy of the acknowledgment issued by

the IT office in this connection was placed on the record of the Tribunal. There is some dispute as to whether this return of income was actually filed

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in due course or at a much later date by making some manipulation. The

assessee also claimed that a letter dated 02.10.1983 indicating the dissolution of MSC was also flied on the record of the AO on 03.10.1983 in

respect of which also an acknowledgment was stated to have been issued

on the body of the copy retained by the assessee. The Department contested the genuineness of filing of this paper also. Form No.11 in

respect of the new firm i.e., MA for assessment year 1985-86 is also stated to have been filed on the records of the assessee on 02.10.1983 about

which also the Department raised a challenge. It is, however, a fact that an

assessment was made on 26.10.1987 under section 143(1) in respect of the above mentioned return of income for the period up to 30.09.1983. The

assessment order acknowledged the receipt of the return under consideration. The return filed by the new firm MA belatedly for assessment

years 1985-86, 1986-87 and 1987-88 were all assessed to tax under section 143(1) in substantial capacity but by considering the status of the

firm to be in unregistered firm, on different dates like 12.10.88, 5.3.1989

and 30.3.1989 respectively. The ITO, however, passed an order u/s. 185 for assessment year 1985-86 on 12.10.1988 in respect of MA in which this

partnership was considered as sham and a device to defeat the provisions of the Income Tax Act. Registration was accordingly refused to MA. Again,

when the proposal regarding sale of the property was under consideration,

MA applied for a clearance certificate under section 230A, which was duly granted by the ITO.

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is required to be resolved by the Tribunal was, whether MSC had actually been dissolved with effect from 30.9.1983 and the new firm had come into

existence from 1.10.1983. The AO had collected evidence from various

authorities and discussed them in detail in the assessment order to show that by circumstantial evidence it could be considered that the dissolution of

the earlier firm and formation of the new firm were not genuine. At the first appellate stage also, the CIT (Appeals) made detailed discussions of the

said arguments. The Department wanted to establish its point about the

return in case of MA for assessment year 1985-86 and also the other letter intimating dissolution of the firm having been planted at a later date by

referring to the regular receipt register maintained with the Department in which there were no entries relating to receipts of such papers. The

assessee, on the other hand, argued that when the assessee was having in its possession duly acknowledged receipts in support of filing of the

respective documents, the Department cannot now deny the said facts.

The other point raised by the assessee was that the Department having even made thorough investigation into the matter by referring it to the

Government Examiner of questioned documents, could not come to any proper finding and furthermore that the Department did not even make

proper inquiry as to whether the acknowledgments had been issued by the

duly authorized official remaining in-charge of the receipt of papers and documents of the relevant dates and hence, could not now claim that the

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return and the other documents in question had not been filed with the

Department in a regular manner.

aspects of the case and considering the theory of preponderances of probability, the Tribunal ultimately came to the conclusion that the

Departmental contention about non-dissolution of MSC and subsequent

non-inception of MA in October 1983 was required to be accepted.

had not actually come into existence, the Tribunal however, finally found that the property in question had not actually been transferred by MSC, but

by the three male partners of the said firm viz., Shri Mahendraswamy,

Narendranath and Rajendranath acting as partners of new firm, MA. The Tribunal found that the other partner of MSC viz., Smt. M.R. Jayashree was

in no way associated with the sale of the property. The Tribunal also found that not only did the purchaser accept these three male persons to be the

owner of the property as vendor thereof, but even the sale consideration

also was deposited in the bank account of MA constituted by the three male persons only. The Tribunal thus came to the conclusion that on the

face of such facts, it could not be concluded that the firm itself has sold away the property. On the other hand, the Tribunal held that it was the

three male persons, as stated above, who had sold away the property and

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 10 of 20 appropriated the entire sale proceeds amongst themselves. Accordingly, the Tribunal deleted the levy of capital gains tax in the hands of the assessee firm viz., MSC.

“ The reference is accepted. The order of the Assessing Officer and the appellate orders are set aside. The matter is remitted to the Assessing Officer for re-decision. Both parties are to appear before the Assessing Officer, without waiting for any notice on 27.12.2006. Liberty is reserved to both parties to place entire material in terms of this order. The Assessing Officer is to accept the additional material plus the material already available on record and in the light of the Judgment reported in 242 ITR 342, if available and thereafter proceed to pass a reasoned order on merits, without in any way being influenced by his earlier order or this order. The Assessing Officer is to complete the proceedings within six months thereafter. In the light of the remand order, we are not inclined to answer questions of law. Ordered accordingly. No costs.”

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 11 of 20 “The followings are the undisputed facts: (1) The assessee firm was not really dissolved on 30/09/1983 and it continued to exist till the date of sale which was evidenced by (a) The bank account and loan facility availed with Corporation bank which was closed only on 01/01/1988. (b) The sales tax assessment was made for the period subsequent to the said dissolution. (c) The insurance policies dated: 03/03/1983 were taken in the name of the assessee firm and not in the name of the proprietary. (d) Valuation of the properties for the purpose of sale was made in the name of the assessee. (e) Lease deed was entered in to with united India Insurance Company for the premises. (f) Form No.6, Form No.12 and Form No.28A were filed before the A.O. Up to 11/05/1987. (g) The second firm did not develop the said property for which it was constituted. The above facts clearly proves that the dissolution of the assessee firm and formation of a new firm were clearly a device to avoid incidence of capital gain tax on sale of the said property. Thus, I hold that the whole transaction was Shun transaction. I, therefore, hold that the assessee firm is liable to tax on Capital Gains arriving out of sale of immovable property by rejecting and assessee’s claim that the firm was dissolved and did not exist as on the date of sale and also the claim that property and the capital gain would be at a figure of Rs.24,01,101/- as deducted by Rs.25,00,000/-. Which was the cost to the new firm. As regards the applicability of the decision reported in 242 ITR 342. The assessee did not support any evidence.”

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 12 of 20 14. Aggrieved by the order of the AO, the assessee preferred appeal before the CIT(Appeals). The CIT(Appeals) was of the view that the reasons given by the AO for his conclusions are valid and did not call for any interference. The CIT(A) was, however of the view that capital gains, if any, have to be computed by bifurcating the sale consideration received by attributing a portion of it towards the value of land and another portion towards value of the building. The following were the relevant observations of the CIT(Appeals):-

“It is seen that AO has not bifurcated capital gains working separately for land & building and now he is directed in view of direction by Hon’ble High Court to follow principles of Hon’ble Karnataka High Court decision in case of CIT vs. C.R. Subramaniyan to compute capital gain separately for Land & building. It is stated in remand report that since depreciation was allowed in block of assets for A.Y.1989-90 further, depreciation is not allowed since sold during previous year. However, AO is directed to compute capital gain on Income received on transfer of such assets as per section 52(2) of the Act. 6.7 As discussed in above paras, I have gone through facts submitted by appellant and AO and it is seen that as claimed by appellant there cannot be a dissolution on 30.09.1983 by taking away jointly held property by firm by only male partners and allowing Lady partner to continue firm’s business, same will not amount to dissolution at most it can be change in constitution. Even same cannot be called as change of constitution in true term because said property has not been apportioned in profit/Loss sharing ratio but when property has been sold to Bapuji Bank on 23.12.1987 it can be treated as dissolution of firm to redistribute sale proceeds as per profit sharing ratio which will amount to capital gain and rightly so, AO has computed long term capital gain by applying provisions of section 50C of the Act. Action of AO to hold that capital gain arises in case is confirmed but as per directions of Hon’ble Karnataka High Court AO has to follow principles laid down by Hon’ble Karnataka High Court In case of

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 13 of 20 C.R. Subramaniyan referred above. Under the circumstances, action of computing capital gain is held as correct with a further directions to follow in computation computing capital gain separately for land & building as per above discussion. 7. Thus, AO has followed direction of Hon’ble High Court of Karnataka directions in the spirit directed by the Court. 8. Under the circumstances, principally action of AO is confirmed but technically for computation of capital gain tax as per directions of Hon’ble Karnataka High court, appeal is treated as partially allowed. In result appeal is allowed in part.”

“6. I have gone through materials on file and appeal is decided as under: 6.1 Date of passing order: It is crucial to know that when HONORABLE High Court mentions about specific date of performance of passing an order, if for laid down procedures of IT department of giving effect to such order only after receipt of such order by CIT/CCIT six month time as per IT Act will commence, Is the main Issue of content. (a) As per AO after receiving order from counsel order is given effect to within six months. Thus, in first instance AO has acted as per provisions of IT Act.

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 14 of 20 (b) In second place AO has no option but to follow procedure laid down by department. (c) Further, AO has acted in bonafide belief that order is to be passed after receiving from proper channel. (d) Delay has to be attached to time order traveled from Registry of the Honorable High Court to Department as meant by remand report of AO dated:13.10.2008. (e) In the order of the High Court at para 7, page 12 it is held that “In the order of Tribunal, we have seen that the Tribunal has not chosen to consider the material in terms of findings of AO or in terms of Commissioner in the light of available to either parties.... ” Therefore, AO has stated that fresh order is passed on 28.10.2007 after considering directions of Honorable High Court of Karnataka, it is also stated that certain facts whichever brought in during the course of original assessment are not disputed that the firm was not dissolved on 30.09.1983 but continue to exist till the date of sale of the said property to Bapuji co-operative Bank on 23.12.1987. The AO has given seven instances for treating the dissolution dated 30.09.83 as a change in the constitution.”

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made before the lower authorities and in the proceedings before the Tribunal in the first round of litigation. He drew our attention to the various

circumstances which are listed in para 6 of the order of the Tribunal dated

20.7.1995 in ITA No.2096/Bang/1992. He laid emphasis on the fact that the Tribunal, despite filing of intimation by the assessee before the

Registrar of Firms intimating the dissolution of MSC, chose to ignore the same apparently for no valid reasons. The Tribunal has merely observed

that these documents were not filed before the lower authorities and are

therefore not taken cognizance of. According to him, under Rule 29 of the I.T. Rules, these documents were necessary for proper adjudication of the

dispute in appeal and ought to have been considered by the Tribunal. He submitted before us that the same should be taken cognizance of.

According to him, the fact of intimation of MSC was duly intimated to the AO by the assessee and the fact that under Sales Tax Act, returns were

filed after the period of dissolution and bank accounts were operated by

MSC cannot be the basis to come to the conclusion that MSC was not dissolved on 30.9.1983.

Tribunal in the first round of litigation and the order of AO wherein he has listed out the circumstances for justifying the conclusions that the firm,

MSC, was not dissolved as on 30.9.1983.

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 16 of 20 20. The ld. DR also submitted that the order of the Hon’ble High Court fixing time limit for conclusion of the assessment by the AO was only directory and mandatory. According to him, the time limit as computed by the AO and approved by the CIT(Appeals) should be upheld.

“7. It would be evident from the narrations made above that the claim of the assessee about dissolution of MSC and formation of MA, although evidenced by duly executed deeds in those regards, are subject to considerable doubt and suspicion on account of omissions on the part of the assessee and the new firm to intimate these matters to other parties like the Sales Tax Department, bank, insurance company etc. We are not paying much attention to the claim of the assessee about intimation having been given at the relevant time to the Registrar of firms, for obvious reasons discussed above. However, the assessee has come up with some reasons, which have been described by us above. The justification of these reasonings is required to be weighed in the light of the theory of preponderance of probabilities. 8. For the purposes of establishing that MSC had not been dissolved and MA had not actually come into existence, the Department mainly relies on the circumstantial evidence of non- intimation to the authorities other than the income-tax department and also certain other factors. So far as the income-tax department itself is, however, concerned the facts sand that as per the assessee’s own version, the assessee had intimated the dissolution of MSC to the ITO and furthermore that a return of income for MSC in respect of assessment year 1985-86 (in which dissolution of the firm had been shown) was also duly filed with the income-tax department. The departmental contention in this regard is that these papers were not properly filed in the regular way but must have been planted in the office of the ITO. The

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 17 of 20 Department wants to establish this fact by arguing that in the Receipt Register of the Department there are no entries relating to filing of the abovementioned intimation letter and also of the return of income pertaining to MSC. The assessee argues hat when the assessee is having duly acknowledged receipts in support of filing of the respective documents, the Department cannot now deny the said facts. The other point raised by the assessee that the Department, having even made thorough investigations into the matter by referring it to the Government Examiner of Questioned Documents, could not come to any proper finding and furthermore that the Department did not even make proper enquiry as to whether the acknowledgement had been issued by the duly authorised officer remaining in-charge of the receipt of papers and documents on the relevant dates, also requires examination. However, at the same time, we are required to look into the totality of the circumstances prevailing at the relevant time. Although according to the assessee, MSC had already been dissolved and the new firm MA had been started, yet some of the erstwhile partners of MSC like S/Shri M.V. Mahendraswamy and M.V. Narendranath continued to sign the declaration forms in respect of turnover submitted before the Sales-tax authorities, as partners of MSC. The argument of the learned counsel for the assessee that the composition of the trading organization is not of much importance before the sales tax authorities may have some force. We are, however, confronted in this matter with the conduct of S/Shri M.V. Mahendraswamy and M.V. Narendranath. Had the dissolution of MSC really taken place, they would have been conscious enough not to sign the sales-tax turn-over declaration forms still as partners of MSC. They could have, at best, signed them for the proprietress Smt. M.A. Jayashree. It is a fact that by acting upon the return of income filed by MSC for assessment year 1985-86 showing the dissolution of the firm, the IT Department has indirectly accepted the said fact of dissolution. The same may be again the case about making assessments on the returns filed by MA for different years. However, it is required to be noted that all these assessments were made u/s. 143(1) without the conscious application of mind on the part of the assessing authority. On the other hand, similar strange circumstances like non-recording of the receipt of papers filed by the assessee with the Income-tax Department are claimed to have happened in respect of more than one such papers viz., the return of income of

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 18 of 20 MSC for assessment year 1985-86 and also the letter of the assessee dated 3-10-1983 intimating the dissolution of MSC. The co-incidence of such strange circumstances on more than one occasions has got to be considered as really improbable. Hence, taking into consideration all the different aspects of the case and considering the theory of preponderance of probability, we are led to hold that the departmental contention about non-dissolution of MSC and subsequent non-inception of MA in October 1983 itself has got to be accepted.”

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property of the Assessee firm, though it stood in the name of partners.

Therefore the conclusion that the property belongs to the Assessee has to be upheld. The grievances projected by the assessee in its CO are

therefore rejected.

computation of time limit as done by the Revenue is proper and calls for no

interference.

view that the bifurcation of land and building was rightly done by the CIT(Appeals), keeping in mind the directions of the Hon’ble High Court and

also following the decision rendered by the Hon’ble High Court of Karnataka in the case of C.R. Subramaniyan (supra). We find no grounds

to interfere with the order of the CIT(Appeals) on this issue also. Land is

not a depreciable asset and therefore to the extent consideration received on sale of the property is attributable to land, provisions of section 50(2) are

not attracted. The grievance projected by the Revenue in this regard is therefore rejected. The appeal of the Revenue is therefore dismissed.

ITA No.750/Bang/2009 & CO No.7/Bang/2009 Page 20 of 20 26. In the result, the appeal by the Revenue and CO by the assessee is dismissed.

Pronounced in the open court on this 10th day of April, 2015.

Sd/- Sd/-

( ABRAHAM P. GEORGE ) ( N.V. VASUDEVAN ) Accountant Member Judicial Member

Bangalore, Dated, the 10th April, 2015.

/D S/

Copy to:

By order

Assistant Registrar / Senior Private Secretary ITAT, Bangalore.