Summary
A family partnership firm brought in new partners with small capital contributions of Rs 2.25 to 4.5 lakh. It then revalued its land and buildings upward by Rs 17.34 crore and credited the surplus to the partners' capital accounts, giving the new partners credits of over Rs 1.5 to 3 crore each, which were available for withdrawal. Some partners did withdraw capital. The Assessing Officer taxed the surplus as short-term capital gains under Section 45(4) of the Income Tax Act. The ITAT and the Bombay High Court deleted it, relying on Hind Construction. The Supreme Court restored the assessment. Section 45(4), inserted in 1987 to close a tax-avoidance loophole, applies to distribution of capital assets on dissolution 'or otherwise'. That wording reaches a subsisting firm. Hind Construction predates the provision, and A.N. Naik Associates was affirmed.
Issues
- Whether revaluation of a partnership firm's assets and credit of the surplus to the partners' capital accounts on reconstitution, without dissolution, is a transfer chargeable under Section 45(4) of the Income Tax Act, 1961.
Provisions considered
- Section 45(4) (inserted by Finance Act, 1987), Income Tax Act, 1961Profits on transfer of a capital asset by way of distribution on dissolution 'or otherwise' are taxable as the firm's income; 'otherwise' is not read ejusdem generis with dissolution and covers transfers by a subsisting firm. (¶¶ 7, 7.1, 7.2, 7.4)
- Sections 2(47)(ii) and 47(ii) (omitted), Income Tax Act, 1961Their omission alongside the insertion of Section 45(4) shows the intent to bring distribution of firm assets within 'transfer' and plug the revaluation-and-distribution loophole. (¶ 7.2)
Held
- The word 'otherwise' in Section 45(4) takes in not only dissolution but also cases of subsisting partners transferring assets, and the view of the Bombay High Court in A.N. Naik Associates is affirmed. (¶¶ 7.2, 7.4)
- Revaluing the assets by Rs 17.34 crore and crediting the surplus to the partners' capital accounts, where newly inducted partners received large credits for small contributions that were available for withdrawal and were partly withdrawn, amounts in effect to distribution and a transfer falling within 'otherwise'. (¶ 7.5)
- Hind Construction, decided before the insertion of Section 45(4) and the words 'or otherwise', does not assist the assessee in interpreting the new provision. (¶ 7.6)
Result
Civil Appeal Nos. 8258 and 8259 of 2022 allowed; the Bombay High Court judgments dated 24.06.2013 in Income Tax Appeal Nos. 1074 and 1174 of 2009 and the ITAT orders set aside, and the Assessing Officer's orders for A.Y. 1993-94 and 1994-95 restored; no costs.