Case Law Details
ITO Vs Shri Mahendrabhai D. Zalavadia (ITAT Rajkot)
The issue under consideration is whether section 45(2) will be applicable in situation where Land transferred by partner as capital contribution recorded as stock-in-trade in the books of firm?
In the given case, ITAT state that the impugned land was transferred by the partners to the firm as capital contribution which was recorded as stock-in-trade in the books of the firm. As such there was no transfer of capital assessee as stock-in-trade in the books of the assessee. Therefore in their considered view, there cannot be any application of the provisions of section 45(2) of the Act in the hands of the assessee.
Further, ITAT also note that the provisions of section 45(3) of the Act requires to take the sale consideration in the case of transfer of any capital asset by the partner to the firm as capital contribution which was recorded in the books of accounts of the firm. In the case on hand, there is no dispute that the value of such assets transferred by the partner to the firm was recorded at the book value which can be verified from the financial statements of the assessee. Accordingly, there cannot be any income in the hands of the assessee on account of transfer of such assets as capital contribution.
Hence the appeal of the Revenue is dismissed.
FULL TEXT OF THE ITAT JUDGEMENT
The captioned appeal has been filed at the instance of the Revenue against the order of the Learned Commissioner of Income Tax (Appeals)-1, Rajkot dated 18/09/2015 ( in short “Ld.CIT(A)”) arising in the matter of assessment order passed under s. 143(3) r.w.s 147 of the Income Tax Act, 1961 (here-in-after referred to as “the Act”) dt. 25/03/2015 relevant to the Assessment Year 2007-2008.
The Revenue has raised the following grounds of appeal:
1) The Learned C.I.T.(A)-1, Rajkot has erred in law and on facts in deleting the addition of Rs.27,36,800/- on the ground that the issue in question is not governed by provisions of section 45(2). The Ld.CIT(A)-1 ought to have appreciated that this is a technical error and he being a fact finding authority, ought to have directed the AO to recomputed capital gain u/s.45(3) r.w.s 50C of the I.T Act.
2) The Learned C.I.T. (A)-1, Rajkot has erred in deleting remuneration from the firm amounting to Rs.1,58,79,299/- in which the appellant had claimed deduction u/s.80IB(10)..
3) The Learned C.I.T.(A)-1, Rajkot has erred in deleting the interest on capital amounting to Rs.1,02,557/-
2. The 1st issue raised by the Revenue is that the learned CIT(A) erred in deleting the addition made by the AO for Rs. 27,36,800/- on account of transfer of land by the partners to the partnership firm.
3. The assessee in the present case is an individual and drawing his income from the source of salary and share of profit from the partnership firm namely M/s Swapnalok Developers comprising of 10 partners in total. All the partners of the firm are having equal profit sharing ratio. The assessee along with other partners held a piece of land which was purchased by all of them (partners) for Rs.63 Lacs. All the partners brought such land to the partnership firm as capital contribution dated 5 July 2004 which was recorded by the firm as stock-in-trade at the book value.
4. However, the AO was of the view that such transfer of land as stock in trade to the firm is a transfer within the meaning of section 45(2) of the Act further noticed the fair market value (Jantri value) as on the date of transfer i.e. Rs. 3,36,68,000/-. Accordingly, the AO computed the capital gain of Rs. 2,73,68,000/- on the transfer of land by the partners as capital contribution in the partnership firm and attributed a sum of Rs.27,36,800/- being 10% share of the assessee in such capital gain. Hence the AO made the addition of Rs. 27,36,800/- to the total income of the assessee.
Aggrieved assessee preferred an appeal to the learned CIT (A).
5. The assessee before the learned CIT (A) submitted that he has never converted the land into stock-in-trade. Therefore the provisions of section 45(2) of the Act cannot be invoked in the hands of the assessee.
6. The learned CIT (A) after considering the submission of the assessee deleted the addition made by the AO by observing as under:
6.3 The contentions of the appellant and material on record are caredully considered. There is nothing on record that the appellant converted the land to stock in trade. On the contrary, as one of the joint owners, the appellant contributed agricultural land itself as his share of capital of the firm M/s.Swapnalok Developers. When a person contributes an asset as capital of the firm, provision of Sec. 45(3) get attracted which is a specific charging section for this purpose under which it is the amount recorded by the firm to the credit of the partner for such land that becomes the deemed sale consideration for the purpose of computing capital gains u/s.48 in the hands of the partner. I find that in the present case, the firm has recorded an amount according to which no capital gain arises in the hands of the partner. In view of the deeming provision of Sec. 45(3), the action of the A.O. in considering fair market value and that too by adopting the stamp duty valuation directly cannot be upheld as valid in law. In the result, the impugned addition is directed to be deleted and the fourth ground of appeal on merits is allowed.
7. Being aggrieved by the order of the learned CIT (A) Revenue is in appeal before us.
8. The learned DR before us submitted that the Ld. CIT (A) in the order vide Para 6.3 made a statement that “I find that in the present case, the firm has recorded an amount according to which no capital gain arises in the hands of the partner. The consideration of the CIT (A) is needed to be discarded that the law and the act are made on the very ground of the facts, logic and to establish the natural law of justice. As per the statement, the phrase “recorded an amount according to which no capital gain arises” is the sole and fine basis to invoke the sec. 147 of the Act, the believe to reopen the case, and the assessee adopted a convenient and comfortable way to record a transaction which guaranteed for the escapement of the income. The recording of the amount in the transaction involved is not justified by the assessee whereas the AO under the circumference and discussion of the section 50C found a sound ground to add the evaded tax judiciously. In addition to the discussion it pertinent here to state that the assessee made no compliance regarding the following queries via notice u/s 142(1) dated 11.03.2015 :-
a) Details of project completed viz. shop/flat along with area of them on the land introduced as capital
b) The plan layout of the project
c) The ratio/proportion of the sale of flat/shop of the total project with that of proportionate portion of land.
8.1 The Ld.D.R further stated that the assessee has neglected the queries only to disguise the correct income earned or to be determined. The firm M/s. Swapnalok Developers has constructed residential units on the said land which has been sold during the period A.Y. 2007-08 and 2008-09. The assessee was a partner in M/s. Swapnalok Developers, Rajkot consisting of 10 partners each having equal share @ 10%. It was also noticed that the partners of the firm M/s.Swapnalok Developers, including the assessee have brought the land purchased by them at Rs. 63,00,000/- on 05/07/2004 into partnership firm. Since all the 10 partners of the firm had brought in land into the partnership firm, the capital gain was required to be calculated on the said transfer of the land as stock in trade to the firm as per the provisions of section 45(2) of the I.T. Act which says that the transfer by way of conversion by the owner of capital asset into stock in trade of a business carried on by him is chargeable to tax as his income in the year in which such stock in trade is sold or otherwise transferred. For the purpose of section 48 of the I.T. Act, the fair market value of the asset as on the date of such conversion shall be deemed to be the full value of the consideration received or accrued as a result of the transfer of capital asset. On perusal of records, it was noticed that the land transferred by the partners was 16834 sq.mtr, jantri rate of which was Rs.2000/- per sq.mtr. At the said rate the total value of the land transferred by the partners comes to Rs. 3,36,68,000/- which was purchased by the partners for Rs.63,00,000/-. Therefore, there was a capital gain of Rs. 2,73,68,000/- on introduction of this land into firm and 10% share of the-assessee on the said capital gain at Rs.27,36,800/- was added judiciously to the total income of the assessee.
The definition of “Transfer” as per Act states u/s 2(47)(iv) in a case where the asset is converted by the owner thereof into, or is treated by him as, stock in trade of a business carried on by him, such conversion or treatment”
The word ” or treatment” is inserted in the Act for the purpose to the effectiveness arises due to the non conversion of capital asset into stock in trade but the nature of the activity carried out with the capital asset. The capital asset so introduced by the assessee (one of the partner as per his share) is changed or transformed with the development work and construction activity which were later sold on as residential units and it was so done under the name of Swapnalok Developers. So the argument here to treat it as stock in trade without having gone through any conversion is valid , sound and judicious as the capital assets must be considered under the phrase ”
conversion or treatment”.
8.2 The Ld.D.R also relied upon the judgment of Hon’ble Supreme Court in the case of Sunil Siddharthbhai vs. CIT (1985)156 ITR 509 SC was dealing with the situation where an individual makes over his capital asset to a partnership as a contribution towards capital and the asset was valued for the purpose at the market value, and in that event it was held by the Hon’ble Supreme Court that there was asset within the meaning of section 45 of the Income Tax Act, 1961.
8.3 Even, such a transaction now takes care of by section 45(3) of the Income-tax Act, 1961, inserted from the assessment year 1988-89. SubSection (3) of section 45 of the Act, effective from assessment year 1988-89, enacts that the profits and gains arising from the transfer of a capital asset by a person to a firm, in which he is or becomes a partner, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purpose of section 48, the amount recorded in the books of account of the firm as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as result of the transfer of the capital asset.
8.4 In the case of Sunil Siddharthbhai V. Commissioner of Income-tax, the Hon’ble Supreme Court issued a word of caution by stating that the principles laid down by them in that case will hold good if the firm or the transaction is a genuine one, and thus observed as follows:-
“If the partner of the personal asset by the assessee to a partnership in which he is 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 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,. Te ITO 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 record shows that there was no real need of the partnership firm for such capital contribution from the assessee. All these and other ITA Nos. 3622/D/95, 2546D/01, 3233/D/01, 267/D/03, 1986/D/03 .pertinent considerations may taken into regard when the ITO enters upon a security 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 a sham to
penetrate the veil covering it and ascertain the truth.”
In the light of aforesaid word of caution emphasized by the Hon’ble Supreme Court, whether the transfer of land in question as capital contribution by the assessee to a partnership firm in which the assessee became a partner was merely a device or ruse for converting the land into money which would substantially remain available for assessee’ s benefit without liability to income-tax.
9. On the other hand, the learned AR before us filed a paper book running from pages 1 to 10 and submitted as under:
a. A.O. has treated the difference between value of contribution of land by partners and stamp duty as capital gain of partner u/s.45(2) for A.Y. 2007-08.
b. In fact, partner contributed his personal land to the firm on dated 02-12-2014(A.Y. 2005-06) and not this year, hence there can’t be question of gain to him in A.Y. 2007-08 (PB page 1,4,5 and 10).
c. Amount recorded by the firm u/s 45(3) can’t be disturbed by the A.O u/s.50C or otherwise.
d. Land given by partner became stock-in-trade in business of the firm and not of the partner; sec. 45(2) not attracted in partner’s case; he did not sell any land in A.Y. 2007-08 at all.
e. Besides in A.Y. 2005-06 contribution by partner of land as capital of firm was neither a registrable not a stampable document, hence there is no question of sec.50C.
10. Both the learned DR and the AR before us relied on the order of the authorities below as favourable to them.
11. We have heard the rival contentions of both the parties and perused the materials available on record. At the outset, we note that the land was transferred by the assessee to the partnership firm in the year ending as on 31st March 2005 corresponding to the assessment year 2005-06. This fact can be verified from the partner’s capital account in the partnership firm which is placed on page 6 of the paper book. Admittedly, the impugned land was transferred by the partners to the firm as capital contribution which was recorded as stock-in-trade in the books of the firm. As such there was no transfer of capital assessee as stock-in-trade in the books of the assessee. Therefore in our considered view, there cannot be any application of the provisions of section 45(2) of the Act in the hands of the assessee.
11.1 We also note that the provisions of section 45(3) of the Act requires to take the sale consideration in the case of transfer of any capital asset by the partner to the firm as capital contribution which was recorded in the books of accounts of the firm. In the case on hand, there is no dispute that the value of such assets transferred by the partner to the firm was recorded at the book value which can be verified from the financial statements of the assessee placed on pages 2 to 7 of the paper book. Accordingly, there cannot be any income in the hands of the assessee on account of transfer of such assets as capital contribution.
In view of the above, we do not find any infirmity in the order of the learned CIT-A. Hence the ground of appeal of the Revenue is dismissed.
12. The next issue raised by the revenue in ground No. 2 and 3 is that the learned CIT(A) erred in deleting the remuneration and interest on capital from the firm for Rs.1 ,58,79,299/- and Rs.1,02,557/- respectively.
13. The AO during the assessment proceedings found that the assessee was entitled for the remuneration and interest on capital from the partnership firm. But the assessee has not claimed the same in order to claim the higher deduction under section 80(IB)(10) of the Act in the hands of the firm. The AO also observed that the assessee was authorized by the deed of partnership firm for such remuneration and interest on capital as per the provisions of section 40(b) of the Act. Accordingly the AO added the amount of remuneration and interest amounting to Rs. 1,58,79,299/- and Rs.1,02,557/- respectively to the total income of the assessee.
14. Aggrieved assessee preferred an appeal to the learned CIT (A) who deleted the addition made by the AO by observing as under:
7.1 In the separate appeal no.228/14-15 filed in case of the said firm, I have by my separate order held that the said remuneration does not become a deduction in the hands of the firm and hence the claim of deduction u/s.80IB(10) could not have been reduced to that extent. Moreover, I also find that the A.O. never allowed the remuneration or interest to partners as deductible expenditure in assessment of the firm, in view specific provisions of Sec. 28(v), the said amount cannot be treated as income of the partner, being the appellant before me. In view of the same, as a corollary thereof, the addition in the hands of the appellant being a partner of the firm cannot be sustained. Hence, the fifth ground of appeal is allowed.
8. The sixth ground of appeal pertains to addition of Rs.1,02,557/- added in the hands of the appellant – partner on the ground that interest on capital was receivable from the firm M/s.Swapnalok Developers in which the appellant was a partner.
Decision
8.1 In view of the same reasons as stated in ground no.5 supra, the addition in the hand of the appellant being a partner of the firm cannot be sustained. Hence, the sixth ground of appeal is allowed.
Being aggrieved by the order of the learned CIT (A), the Revenue is in appeal before us.
15. The learned DR before us submitted that the remuneration being deleted by the Ld. CIT(A) was not taken care of the fact that the assessee was the sole active partner(as per Partnership Deed) who was eligible for the remuneration as the residential units were thoroughly completed within the time and sold. It is pertinent here to say that without having handsome interest and active assistance such sort of the business/profession is hard to carry on and to complete. Thus the view of the AO the reason and intention behind not to allow remuneration is nothing but to claim higher deduction u/s 80IB(10) of the IT Act. It is required to bring in notice that this is a prevailing tax evasion pattern carried out by the assessee involved in the same business/concerns
15.1 Hence, the instance of Interest being deleted by the Ld. CIT(A), was not due taken care of the fact that the reason and intention behind not to allow the same is nothing but to claim higher deduction u/s 80IB(10) of the IT Act. It is required to bring in notice that this is a prevailing tax evasion pattern carried out by the assessee involved in the same business/concerns.
16. On the other hand, the learned AR submitted that the assessee has not received any remuneration and interest from the partnership firm. Similarly, the firm has not claimed any deduction on account of such remuneration and interest from partnership firm. Therefore there cannot be any addition to the total income of the assessee.
17. Both the learned DR and the AR before us relied on the order of the authorities below as favourable to them.
18. We have heard the rival contentions and perused the materials available on record. The controversy in the case before us relates whether the assessee is bound to draw the amount of remuneration and interest from the partnership firm in pursuance to the date of partnership firm.
18.1 The partnership firm comes into existence with mutual understanding between the persons. These understanding can be reduced in writing or otherwise. Thus, it is clear that it is not necessary to execute the deed of partnership in writing. However, in the current scenario, it is not possible to work under the module of the partnership without executing the partnership deed in black and white. It is because to run the business one needs to have a bank account, PAN, etc. which is not possible to obtain without having the deed of partnership. Thus, the deed of the partnership will reveal the understanding on the basis of which partners agreed to work together.
18.2 Thus it can be inferred that the clauses mentioned in the partnership deed are not mandatory but made to avoid any ambiguity and misunderstanding between the partners. As such, there is no dispute among the partners for not claiming the remuneration/ interest on capital in the profit and loss account of the firm. Therefore, in our considered view the conduct of the partners of the firm suggests that it was agreed not to claim any remuneration/interest on the capital account. In holding so, we find support and guidance from the order of Amritsar Tribunal in the case of ITO vs. Mala Tondon in ITA No.319/ASR/2010 vide order dated 14.06.2011 wherein it was held as under:
“6. We have heard both the parties and given our thoughtful consideration to the rival submissions, examined the facts of the case, evidence and material placed on record and also gone through the orders of the authorities below. A careful perusal of the impugned appellate order clearly reveals that the Ld. CIT(A), has considered and adjudicated the issue, in question, in greater detail, after appreciation of the evidences and material on record, as also the legal and factual position of the case. Needless to say that the impugned appellate order is well reasoned and based on the cogent and credible material and facts of the case. However, it would pertinent to reproduce the relevant part of the decision of the CIT(A), for the purpose of proper appreciation of the same:
“3.4. I have considered the rival submissions carefully. An identical issue has been decided in the case of Rohit Tandon, husband of the appellant, the other partner in M/s. Dynamech holding 50% share in the partnership firm for the assessment year 2006-07. In that case also, the AO had added the interest payable on the capital of Sh. Rohit Tandon and remuneration payable to Sh. Rohit Tandon to the total income of the assessee, I have adjudicated that appeal vide order dated 14.7.2009 in appeal No.591/08-09/CIT(A)/Jal and have deleted similar additions as under:
“9.5 I have considered the rival submissions carefully. Clause 4 and 5 of the partnership deed providing for interest on capital and salary are as under:
“4. The capital of the partners is as per their respective accounts in the books of the partnership. The partners shall be entitled to interest on their capital @ 18% per annum or at such other rate or rates as the partners may at the end of each financial year mutually settled subject to the maximum amount admissible under the Income-tax Act, 1961.
5. Both the partners shall diligently attend to the business of the partnership and carry on the same for their greatest common advantage. Both the working partners shall be entitled to a remuneration of Rs.48,000/- per annum each or at such other rate or rates as the partners may at the end of each financial year, mutually settle subject to the maximum amount admissible under the Income-tax Act, 1961.”
9.6. The aforesaid clauses of the partnership deed are clearly enabling clauses since the word used in both the clauses are “the partners shall be entitled…”. This shows that the partners were entitled to get interest on the capital and to draw remuneration for their services without binding them to do so. This, in my opinion, is not a mandatory provision in the partnership deed which would be worded like ” the partners shall be provided/given….”. Further, it is also mentioned in both these clauses, that the rate or rates of interest and the remuneration would be mutually settled by the partners at the end of each financial year. Now, a partnership, by its very name and as per the provisions of Partnership Act is by will of the partners. There are only two partners in this firm, both having equal shares. The accounts drawn up at the end of the year reveal that no interest on the capital or remuneration to the partners has been provided in the accounts of the firmM/s.Dynamech. This act by itself signifies that the partners have agreed not to provide interest on their capital or to charge remuneration for their services. In my opinion, the terms of the partnership deed do not signify that interest on capital and remuneration to partners had necessarily to be provided in the account of M/s. Dynamech..
9.7. The AO has drawn support from the provisions of section 80IA(10). This sub-section provides that where the affairs between the eligible business and any other person is so arranged that more than ordinary profits arise to the assessee, the AO shall, in computing the profit and gains of such an eligible profits for the purposes of deduction under this section, take the amount of profits as may be reasonably taken to have been derived therefrom. Thus sub-section has been made applicable to section 80IB by virtue of sub-section (13) of section 80IB. However, this sub-section only enables, the AO to effect the profit of the undertaking claiming deduction u/s 80IB, which is M/s. Dynamech in this case. This does not enable the AO to alter the profits or the income of the other person referred to in this subsection. It is a fact that the assessee has not received interest and
remuneration from M/s. Dynamech. As noted earlier, the terms of partnership deed are not so worded so as to make payment of interest on capital and remuneration to partners as mandatory. It is also not rebutted by the AO that no interest or remuneration has been received by the appellant in earlier years also. This income has not accrued or arisen to the assessee. I, therefore, hold that the AO was not justified in making the addition on account of interest on capital in M/s. Dynamech and remuneration receivable from M/s. Dynamech. This ground of appeal is allowed.”
3.5. Following the decision in the case of Sh. Rohit Tandon (supra), ground No.3 of appeal is allowed.”
6.1. In view of the above, we do not find any infirmity in the findings of the CIT(A), as the same are based on proper appreciation of the legal and factual position of the case. Accordingly, this appeal of the revenue is dismissed.”
From the above order, we note that it is not compulsory to claim the remuneration/interest on partner’s capital account despite the fact there was a specific clause in the deed of partnership. Accordingly, we do not find any infirmity in the order of the learned CIT (A). Hence the ground of appeal of the Revenue is dismissed.
19. In the result, the appeal filed by the Revenue is dismissed
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