Capital gains – Transfer – Sections 45(4) and 47 of ITA, 1961 – Conversion of firm to private limited company – Transaction not transfer giving rise to capital gains

Capital gains – Transfer – Sections 45(4)
and 47 of ITA, 1961 – Conversion of firm to private limited company –
Transaction not transfer giving rise to capital gains

The assessee was a
private limited company. Originally, the assessee was a partnership firm and it
was converted into a private limited company. The firm revalued its assets and
in the revaluation, the value of the assets was increased to Rs. 117,24,04,974,
but the book value of the assets on the date of revaluation was Rs. 52,16,526.
The AO held that the total value of the capital account of all the four
partners after being revalued stood at Rs. 117,32,87,069, that the shares were
allotted to the partners of the firm for a total amount of Rs. 10 lakhs and
that the balance of Rs. 117,22,87,070 was given as credit of loan to the
partners of the erstwhile firm in the same proportion as their share capital of
the firm, that this was a deviation stipulated u/s 47(xiii) of the Income-tax
Act, 1961 for exemption from the capital gains and made an addition of Rs.
117,22,87,070 towards short-term capital gains and brought the amount to tax.

The Tribunal held
that the capital gains tax could not be levied in the hands of the
assessee-company, which succeeded to the assets and the liabilities of the firm
and allowed the appeal of the assessee.

On appeal by the
Revenue, the Madras High Court upheld the decision of the Tribunal and held as
under:

‘(i)   The legal position having been well settled
that when vesting takes place, it vested in the company as it existed.
Therefore, unless and until the first condition of transfer by way of
distribution of assets is satisfied, section 45(4) of the Act would not be
attracted. In the facts and circumstances, there was no transfer by way of
distribution of assets.

(ii)   The Commissioner (Appeals) did not take into
consideration the legal issue involved, i.e., when a firm was succeeded by a
company with no change either in the number of members or in the value of
assets with no dissolution of the firm and no distribution of assets with
change in the legal status alone, whether there was a “transfer” as
contemplated u/s 2(47) and 45(4) of the Act. The Tribunal rightly decided the
issue.’