Shri Sunil Siddharthbhai Vs.
Commissioner of Income Tax, Ahmadabad [1985] INSC 208 (27 September 1985)
PATHAK, R.S.
PATHAK, R.S.
BHAGWATI, P.N. (CJ) SEN, AMARENDRA NATH (J)
CITATION: 1986 AIR 368 1985 SCR Supl. (3) 102
1985 SCC (4) 519 1985 SCALE (2)755
ACT:
Transfer of a capital asset - When the
assessee brings the shares of the limited companies into the partnership firm
as his contribution to its capital, whether there was a transfer within the
definition of section 2 (47) of capital asset within the terms of section 45 of
the Income Tax Act, 1961.
Capital gains, scheme of - Sections 45 and 48
of the Income Tax, 1961, scope of - When the assessee transferred his shares to
the partnership firm, whether he can be said to have received a consideration within
the meaning of section 48 of the Income Tax Act, 1961 and that a profit of gain
accrued to him for the purpose of section 45 ibid.
HEADNOTE:
In Civil Appeal No. 1841 of 1981, the
appellant- assessee was a partner in Messrs Suvas Trading Company, a
partnership firm constituted under a deed of partnership dated September 27,
1973. As his contribution to the capital of the partnership firm, the assessee
made over certain shares of limited companies which were held by him as his
capital assets. The book value of the said shares in his account books was
shown as Rs. 1,60,279 but on the date when he contributed those shares to the
partnership firm he revalued the shares at the market value of Rs. 1,49,819,
and debited the resulting difference of Rs. 10,460 to his capital account.
Since the Income Tax Officer, when drawing up the assessment order for the
assessment year 1974-75 in respect of the assessee did not include the
difference in the assessable income, the Commissioner of Income Tax, being of
the opinion that the difference between the market value of the shares and the
cost of acquisition of the shares to the assessee is liable to tax as capital
gains under section 45 of the Income Tax Act, 1961 exercised his revisional
jurisdiction and reopening the assessment, remanded the case to the Income Tax
Officer directing him to revise the assessment after computing the capital
gains arising out of the transfer. The assessee appealed to the Income Tax
Appellate Tribunal, which held that while the transaction did amount to a
transfer within the meaning of sub-section (47) of 103 section 2 of the Income
Tax Act, 1961, it did not result in capital gains liable to tax. Subsequently
the Appellate Tribunal referred the case to the High Court of Gujarat for its opinion
on the said two issues.
In Civil Appeal No. 1777/1981, the appellant
was a partner in a registered partnership firm, M/s. Rajka, constituted under
an agreement dated February 24, 1973 of which the other partner was his wife.
The assessee had in his possession 580 ordinary shares of the Ahmedabad
Manufacturing and Calico Printing Co. Ltd. and 82 ordinary shares of Karamchand
Premchand Private Ltd., the total cost of purchase being Rs. 1,81,106. On March
22, 1973, the assessee introduced the two share holdings in the partnership
firm as his capital contribution ant the firm credited his account with the
market value of the shares, namely Rs. 475,136. In the assessment proceedings
for the assessment year 1973-74, the Income Tax Officer took the view that the
contribution by the assessee of the shares to the assets of the partnership
constituted a transfer within the meaning of sub-section (47) of D section 2 of
the Income Tax Act, 1961 and that the assessee was liable to income tax on a
capital gain of Rs. 2,94,030, being the difference between the market price at
which the shares were entered in the books of the partnership firm and the cost
of the shares to the assessee. The appeal before the Appellate Assistant
Commissioner failed, but in second appeal, the Appellate Tribunal took the view
that there was no transfer of a capital asset within the meaning of section 45
read with sub-section (47) of section 2 of the Income Tax Act and consequently
deleted the item from the assessment. In the circumstances the Tribunal did not
go into the question whether the transfer was without consideration. At the
instance of the Commissioner of Income Tax a reference was made to the High
Court on the correctness of the Tribunal's views. By a common judgment dated
April 30/May 1 and 4, 1981 the High Court answered the questions referred in
favour of the Revenue ant against the assessee. Hence the appeals by special
leave of the Court, Allowing the appeals in part, the Court ^
HELD: 1.1 When the assessee brought the
shares of the limited companies into the partnership firm as his contribution
to its capital, there was a transfer within the meaning of sub-section (47) of
section 2 of the Income Tax Act, 1961, of a capital asset within the terms of
section 45 of the Act.
104
1.2 It is well settled that a partnership
firm is not a separate legal entity ant that the assets owned by the partner
ship are collectively owned by the partners and that when a partner hands over
a business asset to the partnership firm as his contribution to its capital, he
cannot be said to have effected a sale. [113 A-B; G-H] Malabar Fisheries Co. v.
Commissioner of Income Tax, Kerala, (1979) 120 ITR 49; Commissioner of Income
Tax, West Bengal v. Hind Construction Ltd. (1972) 83 ITR 211 (SC) referred to.
Commissioner of Income Tax, Madras v. Janab
N. Hyath Batcha Sahiv, (1969) 72 ITR 528 (Madras); Commissioner of Income Tax
(Madras) - I v. Abdul Khader Motor and Lorry Service (1978) 112 ITR 360
(Madras); Dr. M.C. Kackkar v.
Commissioner of Income Tax, Kanpur and Ors.
(1973) 92 ITR 87 (Allahabad); Commissioner of Income Tax, Kerala v. C.M. Khunhameed
(1974) 94 ITR 179 (Kerala) approved.
1.3 But while the transaction may not amount
to a sale, it can be described as a transfer of some other kind. m e definition
of the expression transfer in sub-section (47) of section 2 of the Income Tax
Act, 1961 is inclusive merely and does not exhaust other kinds of transfer.
[114 A-B]
1.4 In its general sense, the expression
transfer of property" connotes the passing of rights in the property from
one person to another. In one case there may be a passing of the entire bundle
of rights from the transferor to the transferee. In another case, the transfer
may consist of one of the estates only out of all the estates comprising the
totality of rights in the property. In a third case, there may be a reduction
of the exclusive interest in the totality of rights of the original owner into
a joint or shared interest with other persons. An exclusive interest in
property is a larger interest than a share in that property.
To the extent to which the exclusive interest
is reduced to a shared interest it would seem that there is a transfer of
interest. Therefore when a partner brings in his personal asset into the
capital of the partnership firm as his contribution to its capital he reduces
his exclusive rights in the asset to shared rights in it with the other
partners of the firm. While he does not lose his rights in the asset altogether
what he enjoys now is an abridged right which cannot be identified with the
fulness of the right which he enjoyed in the asset 105 before it entered the
partnership capital. When a partner brings in his personal asset into a
partnership firm as his contribution to its capital, an asset which originally
was subject to the entire ownership of the partner becomes w subject to the
rights of other partners in it. It is not an interest which can be evaluated
immediately. It is an interest which is subject to the operation of future
transactions of the partnership, and it may diminish in value depending on
accumulating liabilities and losses with a fall in the prosperity of the
partnership firm. The evaluation of a partner's interest takes place only when
there is a dissolution of the firm or upon his retirement from it. Upon the
dissolution of the firm or upon the partner retiring from the firm, the
partner's right to realise the interest and receive its value arises. What is
realized is the interest which the partner enjoys in the assets during the subsistence
of the partnership firm by virtue of his status as a partner and in accordance
with the terms of the partnership agreement. It is because that interest exists
already before dissolution that the distribution of the assets on dissolution
does not amount to a transfer to the erstwhile partners. What the partner gets
upon dissolution or upon retirement is the realisation of a pre-existing right
or interest. It is nothing strange in the law that a right or interest should
exist in praesenti but its realisation or exercise should be postponed.
Therefore, what was the exclusive interest of a partner in his personal asset
is, upon its introduction into the partnership firm as his share in the
partnership capital transformed into a shared interest with the other partners
in that asset. Qua that asset, there is a shared interest. During the
subsistence of the partnership the value of the interest of each partner qua
that asset cannot be isolated or carved out from the value of the partner's
interest in the totality of the partnership assets. And in regard to the
latter, the value will be represented by his share in the net assets on the
dissolution of the firm or upon the partner's retirement. But the position is
different when a partner retires or the partnership is dissolved. What the
partner receives then is his share in the partnership. What is contemplated
here is a share of the partner qua the net assets of the partnership firm. On
evaluation, that share in a particular case may be realised by the receipt of
only one of all the assets. What happens here is that a shared interest in all
the assets of the firm is replaced by an exclusive interest in an asset of
equal value. That is why it has been held that there is no transfer. It is the
realisation of a pre-existing right. The position is different, when a partner
brings his personal asset into the partnership firm as 106 his contribution to
its capital. An individual asset is the sole subject of consideration. An
exclusive interest in it before it enters the partnership is reduced on such
entry into a shared interest. [114 D-G; 116 A-F; 117 B-D] Addanki Narayanappa
& Anr. v. Bhaskara Krishtappa and 13 Ors. [1966] 3 SCR 400; Malabar
Fisheries Co. v. Commissioner of Income Tax, Kerala (1979) 120 ITR 49 (SC) referred
to.
Commissioner of Income-Tax, Madras-I v. Abdul
Khader Motor and Lorry Service (1978) 112 ITR 360 (Madras); and Commissioner of
Income Tax, Tamil Nadu IV, Madras v. H. Kannan (1984) 149 ITR 545 (Madras)
partly overruled.
Commissioner of Income Tax, Madhya Pradesh,
Nagpur and Bhandara v. Dewas Cine Corporation (1968) 68 ITR 240 (SC);
Commissioner of Income Tax, Kerala v. Nataraj
Motor Service (1972) ITR 109 (Kerala) Commissioner of Income Tax, Gujarat v.
Mohanbhai Pamabhai (1973) 91 ITR 393 (Gujarat) distinguished.
A. Abdul Rahim, Travancore Confectionery
Works v.
Commissioner of Income Tax, Kerala (1977) 110
ITR 595 (Kerala); Addl. Commissioner of Income Tax, Mysore v. M.A.J. Vasanaik
(1979) 116 ITR 110 (Kerala) approved.
Firm Ram Sahay Mall Rameshwar Dayal &
Ors. v. Bishwanath Prasad, AIR 1963 Patna 221; Sudhansu Kanta v. Manindra Nath,
AIR 1965 Patna 144 explained.
2.1 When the Assessee transferred his shares
to the partnership firm he received no consideration within the meaning of section
48 of the Income Tax Act, 1961 nor did any profit or gain accrue to him for the
purpose of section 45 of the Income Tax Act, 1961- [118 A-B]
2.2 The consideration for the transfer of the
personal assets is the right which arises or accrues to the partner during the
subsistence of the partnership to get his share of the profits from time to
time and, after the dissolution of the partnership or with his retirement from
the partnership, to get the value of a share in the net partnership assets as
on the date of the dissolution or retirement after a reduction of liabilities
ant prior charges. The credit entry mate in the partner's capital account in
the books of the partnership firm does not represent the true value of the
consideration. It is a notional value only, 107 intended to be taken into
account at the time of determining the A value of the partner's share in the
net partnership assets on the date of dissolution or on his retirement, a share
which will depend upon a deduction of the liabilities and prior charges
existing on the date of dissolution or retirement. It is not possible to
predicate before hand what will be the position in terms of monetary value of a
partner's share on that date. At the time when the partner transfers his
personal asset to the partnership firm, there can be no reckoning of the
liabilities ant losses which the firm may suffer in the years to come. All that
lies within the womb of the future. It is impossible to conceive of evaluating
the consideration acquired by the partner when he brings his personal asset
into the partnership firm when neither the date of dissolution or retirement
can be envisaged nor can there by any ascertainment of liabilities and prior
charges which may not have even arisen yet.
Therefore, the consideration which a partner
acquires on making over his personal asset to the partnership firm as his
contribution to its capital cannot fall within the terms of section 48. And as
that provision is fundamental to the computation machinery incorporated in the
scheme relating to the determination of the charge provided in section 45, such
a case must be regarded as falling outside the scope of capital gains taxation
altogether. [118 E-H; 119 A-C] Commissioner of Income Tax, Bangalore v. B.C.
Srinivasa Setty (1981) 128 ITR 294 referred to.
2.3 Applying the principle that profits or
gains under the Income Tax Act must be understood in the sense of real profits
or gains, that is to say, on the basis of ordinary commercial principles on
which actual profits are computed, a sense in which no commercial man would
misunderstand, and having regard to the nature and quality of the consideration
which the partner may be said to acquire on introducing his personal asset into
the partnership firm as his contribution to its capital, it cannot be said that
any income or gain arises or accrues to the assessee in the true commercial
sense which a businessman would understand as real income or gain. Of course,
the partnership firm in question mu t be a genuine firm and not the result of a
sham or unreal transaction, and the transfer by the partner of his personal
asset to tee partnership firm must represent a genuine intention to contribute
to the share capital of the firm for the purpose of carrying on the partnership
business. [120 A- B; 119 C-D] Miss Dhun Dadabhoy Kapadia v. Commissioner of
Income- Tax, Bombay (1967) 63 ITR 651 (SC); Calcutta Co. Ltd. v. Commissioner
of Income-Tax, West Bengal, (1959) 37 ITR 1 SC; Commissioner of 108 Income Tax
v. Bai Shirinbai K. Kooka, (1962) 46 ITR 86 SC;
Poona Electric Supply Co. Ltd. v.
Commissioner of Income- Tax, Bombay City I, (1965) 57 ITR 521 SC; Commissioner
of Income-Tax, West Bengal II v. Birla Gwalior (P) Ltd. (1973) 89 ITR 266 SC;
Bafna Textiles v. Income Tax Officer, Assessment-4, Circle II, Bangalore (1975)
98 ITR 209 SC referred to.
2.4 If the transfer of a personal asset by
the assessee to a partnership in which he is or becomes a partner is merely a
device or ruse for converting the asset into money which would substantially remain
available for his benefit without liability to income tax on a capital gain, it
will be open to the income tax authorities to go behind the transaction and
examine whether the transaction of creating the partnership is a genuine or a
sham transaction and, even where the partnership is genuine, the transaction of
transferring the personal asset to the partnership firm represents a real
attempt to contribute to the share capital of the partnership firm for the
purpose of carrying on the partnership business or is nothing but a device or
ruse to convert the personal asset into money substantially for the benefit of
the assessee while evading tax on a capital gain 121 E-G]
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 1841 of 1981.
From the Judgment and Order dated 30.4.1981,
1/4.5.1981 of the Gujarat High Court in Income Tax Reference No. 235 of 1980.
AND Civil Appeal No. 1777 of 1981.
From the Judgment and Order dated 30.4.1981,
4.5.1981 of the Gujarat High Court in Income Tax Reference No. 34 of 1980.
V.S. Desai, J.P. Shah, P.H. Parekh and Gautam
Phliph for the Appellant in C.A. No. 1841 of 1981.
M.K. Vanerjee, Additional Solicitor General,
S.T.
Desai, P.A. Francis, and Miss A. Subhashini
for the Respondent in C.A. No. 1841 of 1981.
J.P. Shah and P.H. Parekh for the Intervener
in C.A. No. u 1841 of 1981.
109 V.S. Desai, S.P. Mehta and Mrs. A.K.
Verma for the Appellant in C.A. No. 1777 of 1981.
S.T. Desai, and Miss A. Subhashini for the
Respondent in C.A. No. 1777 of 1981.
T.A. Ramachandran, Mrs. J. Ramachandran, H.K.
Kaji and S.C. Patel for the Intervener in C.A. No. 1777 of 1981.
The Judgment of the Court was delivered by
PATHAK, J. This and the connected appeal, filed by certificate granted by the
High Court, raise the interesting question whether the capital contribution by
a partner to the assets of a partnership firm at an appreciated value can be
said to give rise to a capital gain in his hands liable to income-tax.
In Civil Appeal No. 1841 of 1981, the facts
are as follows. The appellant, who is the assessee, was a partner in Messrs.
Suvas Trading Company, a partnership firm constituted under a deed of
partnership dated September 27, 1973. As his contribution to the capital of the
partnership firm the assessee made over certain shares of limited companies
which were held by him as his capital assets. The book value of those shares in
his account books was shown as Rs. 1,60,279, but on the date when he
contributed those shares to the partnership firm he revalued the shares at the
market value of Rs. 1,49,819 and debited the resulting difference of Rs. 10,460
to his capital account.
The Income Tax Officer, when drawing up the
assessment order for the assessment year 1974-75 in respect of the assessee,
did not include the difference in the assessable income. The Commissioner of
Income-Tax, however, being of opinion that the difference between the market
value of the shares and the cost of acquisition of the shares to the assessee
should have been brought to tax as capital gains in view of s. 45 of the Income
Tax Act, 1961, exercised his revisional jurisdiction, and reopening the
assessment he remanded the case to the Income Tax Officer directing him to
revise the assessment after computing the capital gains arising out of the
transfer. The assessee appealed to the Income Tax Appellate Tribunal, and the
Appellate Tribunal held that while the transaction did amount to a transfer
within the meaning of sub-s.(47) of s.2 of the Income Tax Act it did not result
in capital gains liable to tax. The Appellate Tribunal allowed the appeal and
set aside the order of the Income 110 Tax Officer. Subsequently the Appellate
Tribunal referred the case to the High Court of Gujarat for its opinion on the
following questions of law:
1 Whether, on the facts and in the
circumstances of the case, the Income Tax Appellate Tribunal was right in law
in holding that no capital gains resulted from the transfer of the shares held
by the assessee to the partnership firm as his capital contribution, the cost
of acquisition of the shares to the assessee being Rs. 1,49,819 and the market
value of the shares being Rs. 1,60,279?
2. Whether, on the facts and in the
Circumstances of the case, the Tribunal was right in law in holding that there
was a transfer within the meaning of sub-s.(47) of s.2 of the Income Tax Act,
1961 of the shares contributed by the assessee as capital to the partnership
firm in which he was a partner? In Civil Appeal No. 1777 of 1981, the appellant
was a partner in a registered partnership firm, Messrs. Rajka, or which the
other partner was his wife. m e partnership was constituted under an agreement
dated February 25, 1973. The partnership deed recited that the partnership
business had commenced on January 1, 1973, that it was a partnership at will
and further provided that the assessee would initially contribute Rs. 9,000 in
cash to the share capital of the firm and his wife would contribute Rs. 1,000
in cash. It was provided that when any addition to the capital was required for
the purposes of the partnership, the partners would contribute such additional
capital from time to time. It was further provided that if any asset was
brought in by a partner as capital contribution the account of such partner
would be credited with the fair market value on the date the asset was brought
in. The assessee had in his possession 80 ordinary shares of the Ahmedabad
Manufacturing and Calico Printing Company Limited which had been purchased at
Rs.
1,55,440. He had-also 82 ordinary shares of
Karamchand Premchand Private Limited purchased at Rs. 25,666. The total cost
was Rs. 1,81,106 on March 22, 1973 the market value of a share of the Ahmedabad
Manufacturing and Calico Printing Company Limited was Rs. 442 and that of a
share of Karamchand Premchand Private Limited was Rs. 2,668. On that day, the
assessee introduced the 111 two shareholdings in the partnership firm as his
capital contribution, and the firm credited his account with the market value
of the shares, namely Rs. 4,75,136.
In the assessment proceedings for the
assessment year 1973-74, the Income Tax Officer took the view that the
contribution by the assessee of the shares to the asset of the partnership firm
constituted a transfer within the meaning of sub-s.(47) of s. 2 of the Income
Tax Act, 1961 and that the assessee was liable to income tax on a capital gain
of Rs. 2,94,030 being the difference between the market price at which the
shares were entered in the books of the partnership firm and the cost of the
shares to the assessee.
The assessee appealed to the Appellate
Assistant Commissioner of Income Tax, but the appeal was dismissed. In second
appeal, however, the Income Tax Appellate Tribunal took the view that there was
no transfer of a capital asset within the meaning of s.45 read with sub-s.(47)
of s.2 of the Income Tax Act and consequently he deleted the item from the
assessment. In the circumstances, the Appellate Tribunal did not go into the
question whether the transfer was without consideration. The Commissioner of
Income Tax obtained a reference to the High Court of Gujarat on the following
questions of law:
1. Whether, on the facts and in the
circumstances of E the case, the Appellate Tribunal was right in law in holding
that the contribution in the form of shares of the value of Rs. 4,75,136 by the
assessee in the partnership firm of Messrs. Rajka did not amount to a transfer
within the meaning of sub-s.(47) of s. 2 of the Act resulting in capital gains
chargeable to tax?
2. If the reply to question No. 1 is in
favour of the Revenue, whether the Tribunal erred in not considering whether
the transfer is with or without consideration? By a common judgment dated April
30/May 1 and 4, 1981 the High Court answered the questions in favour of the
Revenue and against the assessee.
Section 45 of the Income Tax Act, 1961
provides:
"45. (1) Any profits or gains arising
from the transfer of a capital asset effected in the previous year shall, save
as otherwise provided in sections 53, 112 54 and 54B and 54D, be chargeable to
income-tax under the head Capital gains , and shall be deemed to be the income
of the previous year in which the transfer took place".
Section 48 of the Act provides:- "48.
The income chargeable under the head Capital gains shall be computed by
deducting from the full value of the consideration received or accruing as a
result of the transfer of the capital asset the following amounts, namely:- (i)
expenditure incurred wholly and exclusively in connection with such transfer;
(ii) the cost of the acquisition of the
capital asset and the cost of any improvement thereto.
Learned counsel for the assessee contends
that in order to attract tax under the head Capital gains , s. 45 must be read
with s.48 and therefore three cumulative conditions must be fulfilled:-
1. There must be a transfer of a capital
asset, either under the general law or within the definition in sub-s.(47) of
s.2 of the Income Tax Act.
2. Consideration must be received or must
accrue as a result of the transfer, and the consideration must be capable of
being determined in monetary terms in order that the computation of capital
gains may be as required by s. 48.
3. Profits or gains must arise from the
transfer and must be embedded in the consideration.
It is urged that if any of the three
conditions remains unfulfilled no charge can be levied under the head
"Capital gains .
In support of the submission that there is no
"transfer" in the general sense of that term when a partner brings
his personal assets into-the firm as his contribution towards its capital, 113
learned counsel points out that a partnership firm is not a separate legal
entity and that the assets owned by the partnership are collectively owned by
the partners. We have no hesitation in accepting that proposition for in
Malabar Fisheries Co. v. Commissioner of Income-Tax, Kerala (1979) 120 I.T.R.
49 SC, this Court observed:- .......... It seems to us clear that a partnership
firm under the Indian Partnership Act, 1932, is not a distinct legal entity
apart from the partners constituting it and equally in law the firm as such has
no separate right of its own in the partnership assets and when one talks of
the firm's property or firm's assets all that is meant is property or assets in
which all the partners have a Joint or common interest.
Our attention has been invited to
Commissioner of Income Tax, West Bengal v. Hind Construction Ltd., (1972) 83
I.T.R. 211. In that case the assessee entered into a partnership and as its
share of the capital it transferred the stock of machinery to the partnership
firm. This Court held that when the assessee made over its machinery to the
partnership firm there was no sale and the assessee did not derive any income.
In Commissioner of Income-Tax, Madras v.
Janab N. Hyath Batcha Sahib, (1969) I.T.R.
528, the Madras High Court held that when a partner introduces his property
into a partnership firm as his contribution to its capital the transaction does
not involve a sale of the property. The High Court referred to B. 14 of the
Indian Partnership act and observed:- When a partnership is formed for the
first time and one of the members of the partnership brings into the firm
assets, they become the property of the firm, not by any transfer, but by the
very intention of the parties evinced in the agreement between them to treat
such property belonging to one or more of the members of the partnership as
that of the firm- The view that when a partner hands over a business asset to
the partnership firm as his contribution to its capital he cannot be said to
have effected a sale was also taken by the Allahabad High Court in Dr. M.C.
Kackkar v. Commissioner of Income-Tax, Kanpur and Others, (1973) 92 I.T.R. 87,
the Kerala High Court in Commissioner of Income-Tax, Kerala v.
C.M. Kunhammed (1974) 94 I.T.R. 179 and by
the Madras High Court in Commissioner of Income-Tax, Madras-l v. Abdul Khader
Motor ant Lorry Service, 114 (1978) 112 I.T.R. 360. We find no difficulty in
accepting that proposition. But while the transaction may not amount to a sale,
can it be described as a transfer of some other kind? Illustrations of other
kinds of transfer are provided by sub-s.(47) of s.2 of the Income Tax Act which
defines the expression transfer in relation to a capital asset as including the
sale exchange or relinquishment of the asset or the extinguishment of any
rights therein or the compulsory acquisition thereof under any law. The
definition is inclusive merely, and does not exhaust other kinds of transfer.
Its inclusive character was overlooked by the Madras High Court in Commissioner
of Income-Tax, Madras-I (supra) and in Commissioner of Income-Tax, Tamil
Nadu-IV, Madras v. H. Rajan and H. Kannan, (1984) 149 I.T.R. 545. In both cases
the High Court confined itself to considering whether the transaction before it
was covered by any of the express terms used in the definition, that is to say,
sale, exchange relinquishment or extinguishment, and taking the view that it
did not fall under any of them it held that there was no transfer.
In its general sense, the expression transfer
of property connotes the passing of rights in the property from one person to
another. In one case there may be a passing of the entire bundle of rights from
the transferor to the transferee. In another case, the transfer may consist of
one of the estates only out of all the estates comprising the totality of
rights in the property. In a third case, there may be a reduction of the
exclusive interest in the totality of rights of the original owner into a joint
or shared interest with other persons. An exclusive interest in property is a
larger interest than a share in that property.
To the extent to which the exclusive interest
is reduced to a shared interest it would seem that there is a transfer of
interest. Therefore when a partner brings in his personal asset into the
capital of the partnership firm as his contribution to its capital he reduces
his exclusive rights in the asset to shared rights in it with the other
partners of the firm. While he does not lose his rights in the asset altogether
what he enjoys now is an abridged right which cannot be identified with the
fullness of the right which he enjoyed in the asset before it entered the
partnership capital. In Addanki Narayanappa & Anr. v. Bhaskara Krishtappa
and 13 Ors. [1966] 3 S.C.R. 400., this Court explained:- ........ whatever may
be the character of the property which is brought in by the partners when the
partnership is formed or which may be acquired in the 115 course of the
business of the partnership it becomes the property of the firm and what a
partner is entitled to is his share of profits, if any, accruing, to the
partnership from the realisation of this property, and upon dissolution of the
partnership to a share in the money representing the value of the property. No
doubt, since a firm has no legal existence, the partnership property will vest
in all the partners and in that sense every partner has an interest in the
property of the partnership. during the subsistence of the partnership, however,
no partner can deal with any portion of the property as his own. Nor can he
assign his interest in a specific item of the partnership property to anyone.
His right is to obtain such profits, if any, as fall to his share from time to
time and upon the dissolution of the firm to a share in the assets of the firm
which remain after satisfying the liabilities set out in cl.(a) and sub-
cls.(i),(ii) of cl.(b) of s. 48.
The position was elaborated later in the same
judgment as follows:
The whole concept of partnership is to embark
upon a joint venture and for that purpose to bring in as capital money or even
property including immovable property. Once that is done whatever is brought in
would cease to be the exclusive property of the person who brought it in. It
would be the trading asset of the partnership in which all the partners would
have interest in proportion to their share in the joint venture of the business
of partnership. The person who brought it in would, therefore, not be able to
claim or exercise any exclusive right over any property which he has brought
in, much less over any other partnership property. He would not be able to
exercise his right even to the extent of his share in the business of the
partnership. As already stated, his right during the subsistence of the
partnership is to get his share of profits from time to time as may be agreed
upon among the partners and after the dissolution of the partnership or with
his retirement from partnership of the value of his share in the net partnership
assets as on the date of dissolution of retirement after a deduction of
liabilities and prior charges.
116 It is apparent, therefore, that when a
partner brings in his personal asset into a partnership firm as his
contribution to its capital, an asset which originally was subject to the
entire ownership of the partner becomes now subject to the rights of other
partners in it. It is not an interest which can be evaluated immediately, it is
an interest which is subject to the operation of future transactions of the
partnership, and it may diminish in value depending on accumulating liabilities
and losses with a fall in the prosperity of the partnership firm. The
evaluation of a partner's interest takes place only when there is a dissolution
of the firm or upon his retirement from it. It has some times been said, and we
think erroneously, that the right of a partner to a share in the assets of the
partnership firm arises upon dissolution of the firm or upon the partner
retiring from the firm. We think it necessary to state that what is envisaged
here is merely the right to realise the interest and receive its value. What is
realised is the interest which the partner enjoys in the assets during the
subsistence of the partnership firm by virtue of his status as a partner and in
accordance with the terms of the partnership agreement. It is because that
interest exists already before dissolution, as was held by this Court in
Malabar Fisheries Co. (supra), that the distribution of the assets on
dissolution does not amount to a transfer to the erstwhile partners. What the
partner gets upon dissolution or upon retirement is the realisation of a pre-
existing right or interest. It is nothing strange in the law that a right or
interest should exist in praesenti but its realisation or exercise should be
postponed. Therefore, what was the exclusive interest of a partner in his
personal asset is, upon its introduction into the partnership firm as his share
to the partnership capital, transformed into a shared interest with the other
partners in that asset. Qua that asset, there is a shared interest. During the
subsistence of the partnership the value of the interest of each partner qua
that asset cannot be isolated or carved out from the value of the partner's
interest in the totality of the partnership assets. And in regard to the
latter, the value will be represented by his share in the net assets on the
dissolution of the firm or upon the partner's retirement.
Learned counsel for the assessee has
attempted to draw an analogy between the position arising when a personal asset
is brought by a partner into a partnership as his contribution to the
partnership capital and that which arises when on dissolution of the firm or on
retirement a share in the partnership assets 117 passes to the erstwhile
partner. It has been held by this Court in Commissioner of Income-Tax, Madhya
Pradesh, Nagpur and Bhandra v. Dewas Cine Corporation, (1968) 68 I.T.R. 240,
Commissioner of Income-Tax, U.P. v. Bankey Lal Vaidya, (1971) 79 I.T.R. 594 and
recently in Malabar Fisheries Co. (supra) as well as by the Punjab and Haryana
High Court in Kay Engineering Co. v. Commissioner of Income-Tax, Patiala,
(1971) 82 I.T.R. 950 the Kerala High Court in Commissioner of Income Tax,
Kerala v. Nataraj Motor Service (1972) 86 I.T.R. 109, and the Gujarat High
Court in Commissioner of Income-Tax Gujarat v. Mohanbhai Pamabhai (1973) 91
I.T.R.
393 that when a partner retires or the
partnership is dissolved what the partner receives is his share in the
partnership. What is contemplated here is a share of the partner qua the net
assets of the partnership firm. On evaluation, that share in a particular case
may be realised by the receipt of only one of all the assets. What happens here
is that a shared interest in all the assets of the firm is replaced by an
exclusive interest in an asset of equal value. That is why it has been held
that there is no transfer. It is the realisation of a pre-existing right. The
position is different, it seems to us, when a partner brings his personal asset
into the partnership firm as his contribution to its capital. An individual
asset is the sole subject of consideration. An exclusive interest in it before
it enters the partnership is reduced on such entry into a shared interest.
Our attention has also been invited to clause
(b) of sub-s.(l) of s. 17 of the Registration Act which requires the
registration of non-testamentary instruments which purport or operate to create
declare assign limit or extinguish whether in present or in future, any right,
title or interest whether vested or contingent, of the value of one hundred
rupees and upwards, to or in immovable property, and to the view taken by the
courts in this country that when a person brings in even his immovable property
as his contribution to the capital of the firm no written document or
registration is required under that clause. That view, was expressed in Firm
Ram Sahay Mall Rameshwar Dayal and Others v. Bishwanath Prasad, A.I.R. 1963
Patna 221. The learned Judges relied on the English law that the personal
assets introduced by a partner into the firm as his contribution to its capital
becomes the property of the firm by reason of the intention and agreement of
the parties. The view does not spring from the consideration that there is no
transfer. The view is that no document of transfer is required and that,
therefore, registration is unnecessary.
The Patna High Court reiterated that view in
Sudhansu Kanta v. Manindra Nath A.I.R. 1965 Patna 144.
118 Accordingly we hold that when the
assessee brought the shares of the limited companies into the partnership firm
as his contribution to its capital there was a transfer of a capital asset
within the terms of s.45 of the Income Tax Act. In this view of the matter we
agree with the conclusion reached by the Kerala High Court in A. Abdul Rahim,
Travancore Confectionery Works v. Commissioner of Income- Tax, Kerala, (1977)
110 I.T.R. 595 the Karnataka High Court in Addl. Commissioner of Income-Tax,
Mysore v. M.A.J. Vasanaik, (1979) 116 I.T.R. 110 and by the Gujarat High Court
in the judgment under appeal.
The second question is whether the assessee
can be said to have received any consideration as that expression is understood
in the scheme of capital gains under the Income- Tax Act. In Commissioner of
Income-Tax, Bangalore v. B.C. Srinivasa Setty, (1981) 128 I.T.R. 294, this
Court observed that the charging section and the computation provisions under
each head of income constitute an integrated code, and when there is a case to
which the computation provisions cannot apply at all it is evident that such a
case was not intended to fall within the charging section. On the basis of that
proposition learned counsel for the assessee has urged that s.45 is not
attracted in the present case because to compute the profits or gains under
s.48 the value of the consideration received by the assessee or accruing to him
as a result of the transfer of the capital asset must be capable of
ascertainment in monetary terms. The consideration for the transfer of the
personal assets is the right which arises or accrues`to the partner during the
subsistence of the partnership to get his share of the profits from time to
time and, after the dissolution of the partnership or with his retirement from
the partnership, to get the value of a share in the net partnership assets as
on the date of the dissolution or retirement after a deduction of liabilities
and prior charges. The credit entry made in the partner's capital account in
the books of the partnership firm does not represent the true value of the
consideration. It is notional value only, intended to be taken into account at
the time of determining the value of the partner's share in the net partnership
assets on the date of dissolution or on his retirement, a share which will
depend upon a deduction of the liabilities and prior charges existing on the
date of dissolution or retirement. It is not possible to predicate before hand
what will be the position in terms of monetary value of a partner's share on that
date. At the time when the partner transfers his personal asset to the
partnership firm, there can be no reckoning of the liabilities and losses which
the firm may suffer in the years to 119 come. All that lies within the womb of
the future. It is impossible to conceive of evaluating the consideration
acquired by the partner when he brings his personal asset into the partnership
firm when neither the date of dissolution or retirement can be envisaged nor
can there be any ascertainment of liabilities and prior charges which may not
have even arisen yet. In the circumstances, we are unable to hold that the
consideration which a partner acquires on making over his personal asset to the
partnership firm as his contribution to its capital can fall within the terms
of s.48. And as that provision is fundamental to the computation machinery
incorporated in the scheme relating to the determination of the charge provided
in s.45, such a case must be regarded as falling outside the scope of capital
gains taxation altogether.
The third contention of learned counsel for
the assessee is that no profit or gain car. be said to arise to a partner when
he brings his personal asset into a partnership firm as his contribution to its
capital. It is urged that the capital gains chargeable under s.45 are real
capital gains computed on the ordinary principles of commercial accounting and
that the capital gains must be embedded in the capital asset. In Miss Dhun
Dadabhoy Kapadia v. Commissioner of Income-Tax, Bombay, (1967) 63 I.T.R.. 651,
the appellant held by way of investment some ordinary shares in a limited
company. An offer was made by the company to her by which she was entitled to
apply for an equal number of new ordinary shares at a premium with an option of
either taking the shares or renouncing them in favour of others. The appellant
renounced her rights to all the shares and realised Rs. 45,262.50. When this
amount was sought to be wholly taxed as a capital gain the appellant claimed
that on the issue of the new shares the value of her old shares depreciated and
that as a result of the depreciation she suffered a capital loss in the old
shares which she was entitled to set off against the capital gain of Rs.
45,262.50. In the alternative she claimed that the right to receive the new
shares was a right which was embedded in her old shares and consequently when
she realised the sum of Rs. 45,262.50 by selling her right, the capital gain
should be computed after deducting from that amount the value of the embedded
right which became liquidated. This Court upheld the claim of the appellant
that she was entitled to deduct from the sum of Rs.
45,262.50 the loss suffered by way of
depreciation in the old shares. The Court proceeded on the basis that in
working out capital gain or loss, the principles which had to be applied are
those which are a part of commercial practice or which an 120 ordinary man of
business would resort to when making computation for his business purposes. It
will be noticed that this principle was applied by the Court in a case where a
capital gain was sought to be taxed under the Income Tax Act. That profits or
gains under the Income Tax Act must be understood in the sense of real profits
or gains, that is to say, on the basis of ordinary commercial principles on
which actual profits are computed, a sense in which no commercial man would
misunderstand, has been regarded as a principle of general application, and
there is a catena of cases of this Court which affirms that principle.
Reference may be made to Calcutta Co. Ltd. v. Commissioner of Income-Tax, West
Bengal, (1959) 37 I.T.R. 1, Commissioner of Income-Tax v.Bai Shirinbai K.
Kooka, (1962) 46 I.T.R. 86, Poona Electric Supply Co. Ltd. v. Commissioner of
Income-Tax, Bombay City I, (1965) 57 I.T.R. 521, Commissioner of Income-Tax,
West Bengal II v. Birla Gwalior (P) Ltd. (1973) 89 I.T.R. 266 and Bafna
Textiles v. Income-Tax officer, Assessment-4, Circle II, Bangalore, (1975) 98
I.T.R. 209.
What is the profit or gain which can be said
to accrue or arise to the assessee when he makes over his personal asset to the
partnership firm as his contribution to its capital? The consideration, as we
have observed, is the right of a partner during the subsistence of the
partnership to get his share of profits from time to time and after the
dissolution of the partnership or with his retirement from the partnership to
receive the value of the share in the net partnership assets as on the date of
dissolution or retirement after a deduction of liabilities and prior charges.
When his personal asset merges into the capital of the partnership firm a
corresponding credit entry is made in the partner's capital account in the
books of the partnership firm, but that entry is made merely for the purpose of
adjusting the rights of the partners inter-se when the partnership is dissolved
or the partner retires. It evidences no debt due by the firm to the partner.
Indeed, the capital represented by the notional entry to the credit of the
partner's account may be completely wiped out by losses which may be
subsequently incurred by the firm, even in the very accounting year in which
the capital account is credited. Having regard to the nature and quality of the
consideration which the partner may be said to acquire on introducing his personal
asset into the partnership firm as his contribution to its capital it cannot be
said that any income or gain arises or accrues to the assessee in the true
commercial sense which a business man would understand as real income or gain.
121 An objection has been taken by learned
counsel for the respondent to this submission being raised before us because,
it is said, the question has neither been referred to his Court nor was it ever
argued at any earlier stage. We are not impressed by the objection because we
think that it constitutes one aspect of the questions which have been referred
in these cases. The point rests on considerations purely of law and is
fundamental to the question whether capital gain arises to an assessee upon the
transfer of his shares to the partnership firm as his capital contribution.
The objection is, therefore, over-ruled.
Inasmuch as we are of opinion that the
consideration received by the assessee on the transfer of his shares to the
partnership firm dies not fall within the contemplation of s.48 of the
Income-Tax Act, and further that no profit or gain can be said to arise for the
purposes of the Income-Tax Act, we hold that these cases fall outside the scope
of s.45 of the Act altogether.
We have decided these appeals on the
assumption that the partnership firm in question is a genuine firm and not the
result of a sham or unreal transaction, and that the transfer by the partner of
his personal asset to the partnership firm represents a genuine intention to
contribute to the share capital of the firm for the purpose of carrying on the
partnership business. If the transfer of the personal asset by the assessee to
a partnership in which he is or becomes a partner is merely a device or ruse
for converting the asset into money which would substantially remain
available-for his benefit without liability to income tax on a capital gain, it
will be open to the income tax authorities to go behind the transaction and
examine whether the transaction of creating the partnership is a genuine or a
sham transaction and, even where the partnership is genuine the transaction of
transferring the personal asset to the partnership firm represents a real
attempt to contribute to the share capital of the partnership firm for the
purpose of carrying on the partnership business or is nothing but a device or
ruse to convert the personal asset into money substantially for the benefit of
the assessee while evading tax on a capital gain. The income Tax Officer will
be entitled to consider all the relevant indicia in this regard, whether the
partnership is formed between the assessee and his wife and children or
substantially limited to them, whether the personal asset is sold by the
partnership firm soon after it is transferred by the assessee to it, whether
the partnership firm has no substantial or real business or the 122 record
shows that there was no real need of the partnership firm for such capital
contribution from the assessee. ALL these and other pertinent considerations
may be taken into regard when the Income Tax Officer enters upon a scrutiny of
the transaction, for in the task of determining whether a transaction is a sham
or illusory transaction or a device or ruse he is entitled to penetrate the
veil covering it and ascertain the truth.
In the result, the questions which arise in
these appeals are answered as follows:-
1. There was a transfer of the shares when
the assessee made them over to the partnership firm as his capital
contribution.
2. When the assessee transferred his shares
to the partnership firm he received no consideration within the meaning of s.48
of the Income-Tax Act 1961 nor did any profit or gain accrue to him for the
purpose of s.45 of the Income-Tax Act, 1961.
These answers are given by us subject to the
reservations made by us in the preceding paragraph.
The appeals are partly allowed and there is
no order as to costs.
S.R. Appeals partly allowed.
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