Capital gain chargeable only on transferor and not on transferee: No Tax on firm on crediting Revaluation Surplus to Retiring Partners A/c

Mahul Construction Corporation Vs. ITO (ITAT Mumbai)

In this case The AO wants to tax the amount credited in capital a/c of retiring as well as continuing partners within the realm of 45(4) of the Act. So far as amount credited to capital a/c of retiring partners is concerned, notwithstanding the fact that there is no distribution by firm to retiring partners, the transferor and transferee are like two sides of the same coin. The capital gain is chargeable only on the transferor and not on the transferee. In this case, the transferor is the partners who on their retirement assign their rights in the assets of the firm and in lieu the firm pays the retiring partners the money lying in their capital a/c, meaning thereby that the firm becomes the transferee in this transaction. Hence, it is the firm and its continuing partners who have acquired the rights of the retiring partners in the assets of the firm by paying them lump sum amount on their retirement. So it cannot be said that the firm is transferring any right in capital asset to the retiring partner, rather it is the retiring partner who is transferring the rights ill capital assets in favour of continuing partners. The ITAT Mumbai in case of Sudhakar Shetty (2011) 130 lTD 197 (Mum) has held that such transaction amounted to transfer within the meaning of section 2(47) of the Act, inasmuch as the partner i.e. Sudhakar Shetty could be said to have assigned, released and relinquished his interest and share in partnership and its assets in favour of the continuing partners to assignment and accordingly confirmed the capital gains assessed in hands of the retiring partner Shri Sudhakar Shetty in respect of the amount received by him from the firm over and above his capital contribution. The ITAT held that the transaction was taxable in hands of retiring partner for assignment of his rights in favour of firm and its continuing partners. Since the same event cannot result into transfer by retiring partners as well as by firm, the ITAT by holding the transaction to be transfer from retiring partner to firm impliedly held that the transactions not to be taxable in hands of firm. The purpose of 45(4) of the Act is to bring such transactions which have an effect of transfer of capital asset without the asset being actually transferred. The purpose is to tax the actual beneficiary of such transactions. In the present case, the firm or the continuing partners are not the beneficiaries as no new tangible income or asset has arisen to them, rather the firm and continuing partners have purchased the share of retiring partner by paying cash. It is the retiring partners who have been benefitted by receiving much more than actual capital contributed by them on account of revaluation. Thus there can be no case of tax avoidance by colorable device by the firm on the facts and circumstances of the assessee firm’s case. Accordingly, we are of the view that the assessee firm is not liable to capital gains on the above transaction. This issue of assessee’s appeal is allowed.

Full Text of the ITAT Order is as follows:-

This appeal by the Assessee is arising out of the order of Commissioner of Income Tax (Appeals)-42, Mumbai, [in short CIT(A)] in appeal No. CIT(A)-42/IT-339/1 3-13 dated 28-12-2016. The Assessment was framed by the Income Tax Officer, Ward-24(1)(1), Mumbai (in short ITO) for the assessment year 2009-10 vide order dated 28-03-2013 under section 143(3) of the Income Tax Act, 1961 (hereinafter ‘the Act’).

2. There are two inter-connected issues in this appeal of assessee and these are the following:-

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