Section 45(4) read with section 2(14) – Receipt of money equivalent to share in enhanced portion of the assets re-valued by the Retiring Partners do not give rise to capital gain u/s. 45(4) read with section 2(14)

4. D.S. Corporation vs. Income Tax Officer (Mum) Members: P.M. Jagtap (V.P.) – Third Member I.T.A. Nos.: 3526 & 3527/MUM/2012 A.Y.s: 2006-2007 and 2007-2008 Dated: 10^th January, 2019 Counsel for Assessee / Revenue: Dr. K. Shivaram and Rahul Hakani / Ajay Kumar

Section 45(4) read with section 2(14) – Receipt of money equivalent to share in enhanced portion of the assets re-valued by the Retiring Partners do not give rise to capital gain u/s. 45(4) read with section 2(14)

FACTS

The assessee, a partnership firm, was originally constituted vide the deed of partnership entered into on 01.08.2005 with the object to carry on the business of real estate development and construction. The firm was reconstituted from time to time. On 23.09.2005, the assessee firm purchased a property at a suburb in Mumbai for a consideration of Rs. 6.5 crore. After arriving at a settlement with most of the tenants occupying the said property and obtaining permission of the competent authority concerned for construction of a five-star hotel, the said property was revalued at Rs. 193.91 crore as per the valuation report of the registered valuer. The resultant revaluation surplus was credited to the capital accounts of the partners in their profit sharing ratio. Two of the five partners retired from the partnership firm, on 27.03.2006 and on 22.05.2006. On their retirement, both these partners were paid the amounts standing to the credit of their capital accounts in the partnership firm including the amount of Rs. 30.88 crore credited on account of revaluation surplus.

According to the AO, there was transfer of capital asset by way of distribution by the assessee firm to the retiring partners in terms of section 45(4) of the Act and the assessee firm was liable to tax on the capital gain arising from such transfer. According to the CIT(A) there was no dissolution of partnership firm at the time of retirement, there was only reconstitution of the partnership firm with change of partners. Therefore, he held that the provisions of section 45 (4) were not attracted.

On appeal before the Tribunal, there was a difference of opinion between the Accountant Member and the Judicial Member. The Accountant Member relied on the decision of the Supreme Court in the case of Tribhuvan G. Patel vs. CIT (236 ITR 515), wherein it was held that even where a partner retires and some amount is paid to him towards his share in the assets, it should be treated as falling under clause (ii) of section 47 of the Act. Accordingly, the Accountant Member held that payment of amount to the retiring partner towards his share in the assets of the partnership firm amounted to distribution of capital asset on retirement and the same falls within the ambit of section 45(4). He held that use of the word “otherwise” in section 45(4) takes within its ambit not only the case of transfer of capital asset by way of distribution of capital asset on dissolution of the firm, but also on retirement.

Further relying on the decision of the Supreme Court in the case of CIT vs. Bankey Lal Vaidya (79 ITR 594) and the decision of the Bombay High Court in the case of CIT vs. A.N. Naik Associates (265 ITR 346), he upheld the addition made by the AO on account of capital gain to the total income of the assessee firm by application of section 45(4), but only to the extent of surplus arising out of revaluation of property which stood distributed by way of money equivalent to the retiring partners. According to him, the balance addition made by the AO on account of capital gain in the hands of the assessee firm on account of revaluation surplus credited to the capital of the other partners, who continued and did not retire during the years under consideration, could not be sustained as there was no transfer or distribution of capital asset to those non-retiring partners.

According to the Judicial Member, however, the cases relied upon by the Accountant Member were rendered on altogether different facts and the ratio of the same, therefore, was not applicable to the facts of the assessee. In the case of the assessee, except payment of money standing to the credit of the partners’ capital account in the partnership, there was no physical transfer of any asset by the partnership firm so as to attract the provisions of section 45(4). He also relied on the decisions of the Karnataka High Court in the case of CIT vs. Dynamic Enterprises [359 ITR 83] and the Mumbai Tribunal in the cases of Keshav & Co. vs. ITO [161 lTD 798] and Mahul Construction Corporation vs. ITO (ITA No. 2784/MUM/2017 dated 24.11.2017).

On account of the difference in opinion between the members, the matter was referred to the Third Member, i.e., in these facts and circumstances of the case, whether the money equivalent to enhanced portion of the assets revalued constitutes capital asset and whether there was any transfer of such capital asset on dissolution of the firm or otherwise within the meaning of section 45(4) read with section 2(14).

Before the Third Member, the Revenue contended that the assessee’s case was a clear case of transfer of right in the land by the retiring partners to the continuing / incoming partners giving rise to the capital gain. According to it, the decision of the Bombay High Court in the case of A.N. Naik Associates and the decision of the Supreme Court in the case of Bankey Lal Vaidya relied upon by the Accountant Member are relevant and the same squarely cover the issue in favour of the Revenue.

HELD

According to the Third Member, the partnership firm in the present case continued to exist even after the retirement of two partners from the partnership. There was only a reconstitution of partnership firm on their retirement without there being any dissolution and the land property acquired by the partnership firm continued to be owned by the said firm even after reconstitution without any extinguishment of rights in favour of the retiring partners. The retiring partners did not acquire any right in the said property and what they got on retirement was only the money equivalent to their share of revaluation surplus (enhanced portion of the asset revalued) which was credited to their capital accounts. There was thus no transfer of capital asset by way of distribution of capital asset either on dissolution or otherwise within the meaning of section 45(4) read with section 2(14) of the Act.

According to him, the money equivalent to enhanced portion of the assets re-valued does not constitute capital asset within the meaning of section 2(14) and the payment of the said money by the assessee firm to the retiring partners cannot give rise to capital gain u/s. 45(4) read with section 2(14). Accordingly, the Third Member agreed with the view of the Judicial Member and answered both the questions referred to him in favour of the assessee.