- Supreme Court Bench comprising Justices M.R. Shah and M.M Sundreshheld that Section 45 (4) of the Income Tax Act applies to dissolution cases and cases of subsisting partners of a partnership, transferring assets in favor of a retiring partner.
- The assessee was the respondent and a partnership firm that initially consisted of brothers who were partners engaged in a clothing business.
- As per the family settlement, one of the brother’s shares was reduced and three other new partners were accepted.
- In the new partnership, two of the partners withdrew their capital.
- The partnership firm filed a return of income for relevant assessment years and it was later reopened under Section 147 of the Income Tax Act post the issue of notice under Section 148.
- The Assessing Officer said that the assessee revalued the land and building to enhance its value thereby increasing the value of assets.
- Revaluation of assets and crediting it to the respective partner’s capital account amount to transfer and is therefore liable to capital tax gains under Section 45 (4).
- The Commissioner of Income Tax (Appeals) [CIT (A)] affirmed the addition to short-term capital gains and observed the cleardistribution of assets to partners who had withdrawn from the capital account.
- It further noted that the assets value of the firm is common to all partners ofa partnership and is irrevocably transferred in each partner's profit-sharing ratio.
- The extent to which value has been allotted to each partner had relinquished its interest in the assets and was hence transferred by relinquishment.
- The CIT (A) approved that Section 45(4) conditions were satisfied and assets to the extent of value distributed are to be deemed as income from capital gains of the assessee’s firm.
- In an appeal to ITAT by the assessee, ITAT set aside the addition made by the assessing officer against the short-term capital gains remarking revaluation of assets and crediting to the partner’s account did not involve any transfer.
- The appeals were dismissed by the High Court and the revenue department approached the Supreme Court.
- The preliminary issue was regarding the applicability of Section 45(4).
- Omission of Section 2(47) (ii) and Section 47 (ii)exempts transform by the distribution of capital assets from the definition of the term “transfer”. This was used by the assessee in avoiding the levy of capital tax gains by revaluing assets, and transferring and distributing them at the time of dissolution.
- The loophole came into existence by the insertion of Section 45(4) and the omission of Section 2(47) (ii).
- The court stated that submission of the assesseewould amount to the dissolution of the partnership firm and transfer of the amount on revaluation to capital accounts to respective partners if Section 45(4) of the act is not applicable.
- The bench further noted that the partners can avail the amount for withdrawal and thus the assets revalued and credited into capital accounts of respective partners were transferred and these fall under “otherwise”. Hence, ITAT and High Court judgments were quashed and the order passed by Assessing Officer was restored. 45 (4) was applicable.
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