Capital gains- Transfer- S/s. 45(1), (4) – A. Y. 1992- 93- Conversion of firm to company- Takeover of business of firm with assets by private limited company with same partners as shareholders in same proportion: Subsequent revaluation of assets- No dissolution of partnership- No consideration accrued or received on transfer of assets: Transaction not transfer giving rise to capital gains-

The assessee was a firm with two partners having equal shares. A private limited company was formed on 21/11/1991 and took over the business of the firm and its assets. The assets were revalued on 30/11/1991. The partners immediately before succession became the shareholders in the same proportion as in the capital account of the firm on the date of succession. For the A. Y. 1992-93, the Assessing Officer concluded that the transfer of the business assets of the firm to the company constituted distribution of assets which gave rise to capital gains taxable u/s. 45(4) of the Income-tax Act, 1961. The Tribunal upheld the decision of the Assessing Officer. On appeal by the assessee, the Madras High Court upheld the decision of the Tribunal and held as under:

“i) When firm is transformed into a company, there is no distribution of assets and no transfer of capital assets as contemplated by section 45(1) of the Income-tax Act, 1961.

ii) There is no authority for the proposition that even in cases where the subsisting partners of a firm transfer assets to a company, there would be a transfer, covered under the expression “or otherwise in section 45(4). When a firm is transformed into a 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.

iii) There was no transfer of assets because
(a) no consideration was received or accrued on transfer of assets from the firm to the company,
(b) the firm had only revalued its assets which did not amount to transfer,
(c) the provision of section 45(4) of the Act, was applicable only when the firm was dissolved. The vesting of the property in the company was not consequent or incidental to a transfer.”