Capital gains – Section 45(4) – A. Y. 1993-94: Conversion of firm into company – Transfer of assets means a physical transfer or intangible transfer of rights to property – Conversion of shares of partners to shares in company – No transfer within meaning of section 45(4) – No capital gain:

In the A. Y. 1993-94, the assessee firm was converted into a private limited company. The entire assets and liabilities of the firm were made over to the company. The respective partners were issued shares by the company corresponding to the value of their share in the firm. The Assessing Officer took the view that there was transfer of assets from the firm to the private limited company and thereby the capital gains tax u/s. 45 became payable. The Tribunal held that section 45 was not applicable and deleted the addition.

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

“i) From a perusal of section 45(4) of the Incometax Act, 1961, it becomes clear that two aspects become important, viz., the dissolution of the firm and the distribution of the assets as a consequence thereof. The distribution must result in some tangible act of physical transfer of properties or tangible act of conferring exclusive rights vis-à-vis an item of property on the erstwhile shareholder. Unless these other legal correlatives take place, it cannot be inferred that there was any distribution of assets.

ii) The shares of the respective shareholders in the assessee company were defined under the partnership deed. The only change that had taken place on the assessee being transformed into the company was that the shares of the partners were reflected in the form of share certificates. Beyond that, there was no physical distribution of the assets in the form of dividing them into parts, or allocation of the assets to the respective partners or even distribution the monetary value thereof. Section 45 was not applicable.”