Sections 2(47) and 45(4) – Capital gains – Where retiring partners were paid sums on reconstitution of assessee-partnership firm in proportion to their share in partnership business / asset, no transfer of assets having taken place, no capital gains would arise

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Principal CIT vs. Electroplast
Engineers; [2019] 104 taxmann.com 444 (Bom)

Date of order: 26^th March,
2019

A.Y.: 2010-11

Sections
2(47) and 45(4) – Capital gains – Where retiring partners were paid sums on
reconstitution of assessee-partnership firm in proportion to their share in
partnership business / asset, no transfer of assets having taken place, no
capital gains would arise

Under a
Deed of Retirement cum Reconstitution of the Partnership, the original two
partners retired from the firm and three new partners redistributed their
share. Goodwill was evaluated and the retiring partners were paid a certain sum
for their share of goodwill in proportion to their share in the partnership.
The assessee-partnership firm filed return of income. The A.O. was of the
opinion that the goodwill credited by the assessee-partnership firm to its
retiring partners was capital gain arising on distribution of the capital asset
by way of dissolution of the firm or otherwise. Thus, the assessee-partnership
firm had to pay short-term capital gain tax in terms of section 45(4) of the
Income-tax Act, 1961.

The
Commissioner (Appeals) agreed with the contention of the assessee-partnership
firm that there was neither dissolution of the firm nor was the firm
discontinued. He held that the rights and interests in the assets of the firm
were transferred to the new members and in this manner amounted to transfer of
capital asset. Thus, section 45(4) would apply. The Tribunal held that section
45(4) would apply only in a case where there has been dissolution of the firm
and, thus, the conditions required for applying section 45(4) were not
satisfied.

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

“i)   As per the provision of section 45(4),
profits or gains arising from transfer of capital asset by way of distribution
of capital asset on dissolution of firm or otherwise shall be chargeable to tax
as income of the firm. For the application of this provision, thus, transfer of
capital asset is necessary.

ii)   In the
case of CIT vs. Dynamic Enterprises [2014] 223 Taxman 331/[2013] 40
taxmann.com 318/359 ITR 83, the full bench of the Karnataka High Court
has held that after the retirement of the partners, the partnership continued
and the business was also carried on by the remaining partners. There was,
thus, no dissolution of the firm and there was no distribution of capital
asset. What was given to the retiring partners was money representing the value
of their share in the partnership. No capital asset was transferred on the date
of retirement. In the absence of distribution of capital asset and in the
absence of transfer of capital asset in favour of the retiring partners, no
profit or gain arose in the hands of the partnership firm.

iii)   In the instant case, admittedly, there was no
transfer of capital asset upon reconstitution of the firm. All that happened
was that the firm’s assets were evaluated and the retiring partners were paid
their share of the partnership asset. There was clearly no transfer of capital
asset.”