The Principal Commissioner Of vs M/S.Ram Krishnan Kulwant Rai

In the High Court of Judicature at Madras

Dated : 16.7.2019

Coram :

The Honourable Mr.Justice T.S.SIVAGNANAM

and

The Honourable Mrs.Justice V.BHAVANI SUBBAROYAN

Tax Case Appeal No.391 of 2019

The Principal Commissioner of Income Tax, Central-2, Chennai-34 ...Appellant

Vs M/s.Ram Krishnan Kulwant Rai Holdings Pvt. Ltd., Chennai-28. ...Respondent

APPEAL under Section 260A of the Income Tax Act, 1961 against the

order dated 29.10.2018 made in ITA.No.1047/Chny/2018 on the file of the

Income Tax Appellate Tribunal, Chennai 'A' Bench for the assessment year

2009-10.

For Appellant : Mr.T.R.Senthilkumar, SSC For Respondent: Mr.R.Sivaraman

Judgment was delivered by T.S.SIVAGNANAM,J

We have heard Mr.T.R.Senthilkumar, learned Senior Standing Counsel

for the appellant – Revenue and Mr.R.Sivaraman, learned counsel appearing

for the respondent – assessee.

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2. This appeal filed by the Revenue under Section 260A of the Income

Tax Act, 1961 (for short, the Act) is directed against the order dated

29.10.2018 made in ITA.No.1047/Chny/2018 on the file of the Income Tax

Appellate Tribunal, Chennai 'A' Bench (hereinafter called the Tribunal) for the

assessment year 2009-10.

3. The Revenue has filed this appeal by raising the following substantial

questions of law :

“i. Whether the Appellate Tribunal is correct in law in holding that there is no violation of the conditions stipulated in Section 47(xiii) of the Income Tax Act without taking cognizance of the fact that the partners of the erstwhile firm derived benefit other than allotment of shares by way of loan credits in their favour on conversion of the partnership firm into a private limited company ?

ii. Whether the Tribunal was correct in placing reliance on the Madras High Court's decision in the case of CADD Centre Vs. ACIT [reported in 383 ITR 258], when the vital distinguishing factor viz benefit derived by partners of erstwhile firm other than allotment of shares in the succeeding company is not available in the relied upon case ? And iii. Whether the Tribunal was legally justified in holding that capital gains tax cannot be levied in the hands of the assessee company, which succeeded to the assets and liabilities of the

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partnership firm ?”

4. The issue, which falls for consideration, is as to whether there has

been any violation of the conditions stipulated under Section 47(xiii) of the

Act.

5. The assessee is a private limited company, which filed its return of

income on 30.9.2009 admitting an income of Rs.12,44,401/-. Originally, the

assessee was a partnership firm and it was converted into a private limited

company under the Companies Act. The partnership firm revalued its assets

on 30.11.2008 and in the revaluation, the value of the assets was increased

to the extent of Rs.1,17,24,04,974/-, but the book value of the assets on

date of revaluation was Rs.52,16,526/-.

6. Subsequently, the assessment was reopened and completed on

30.6.2016 under Sections 143(3) read with 147 of the Act. The Assessing

Officer held that the total revalued value of the capital accounts of all the four

partners stood at Rs.1,17,32,87,069.51 Ps, that the shares were alloted to

the partners of the firm for a total amount of Rs.10,00,000/- and that the

balance of Rs.1,17,22,87,070/- was given as credit of loan to the partners of

the erstwhile firm in the same proportion as their share capital of the firm.

Thus, the Assessing officer held that this was a deviation stipulated under

Section 47(xiii) of the Act for exemption from capital gains and therefore,

made an addition of Rs.1,17,22,87,070/- towards short term capital gains

and demanded tax thereon.

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7. Aggrieved by the order passed by the Assessing Officer, the assessee

preferred an appeal before the Commissioner of Income Tax (Appeals)-18,

Chennai [for brevity, the CIT(A)], who, by order dated 11.1.2018, dismissed

the appeal. On further appeal, the Tribunal, by the impugned order, allowed

the assessee's appeal and the Revenue is before us challenging the order

passed by the Tribunal by raising the aforementioned substantial questions of

law.

8. After hearing the parties, in our considered view, the CIT(A) did not

take into consideration the specific ground raised by the assessee contending

that the Assessing Officer erred in treating the registration of the partnership

firm to a company under Part IX of the Companies Act, 1956 does not

amount to a conversion of a partnership firm into a company as

contemplated under Section 47(xiii) of the Act. The CIT(A) also did not take

note of the fact that post conversion of the partnership firm into a company,

the total balance in capital account of all the partners stood at

Rs.1,17,32,87,070/-, that consequently, shares were allotted to the partners

of the firm for a total amount of Rs.10 lakhs and that the balance of

Rs.1,17,22,87,070/- was given as to the credit to the partners of the

erstwhile firm in the same proportion as in the firm.

9. The assessee specifically stated that upon conversion of a firm into a

joint stock company under the provisions of Part IX of the Companies Act,

1956, the assets and liabilities were vested into the company by virtue of law

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and that there was no transfer of assets. It was further contended that there

was no dissolution of the firm or distribution of assets among partners, which

is a condition precedent to tax the transaction under Section 45(4) of the

Act. In support of their contention, the assessee referred to various decisions

of the Tribunal and the High Courts.

10. However, the CIT(A) opined that the shares worth of Rs.10 lakhs

were given as credit of loan to the partners of the erstwhile firm in the same

proportion and that this has to be treated to fall foul of the condition

stipulated in Section 47(xiii) of the Act.

11. We find that the CIT(A) did not take into consideration the legal

issue involved i.e. when a firm is succeeded by a company with no change

either in the number of members or in the value of assets with no dissolution

of the firm and no distribution of assets with change in legal status alone,

whether there is a 'transfer' as contemplated under Sections 2(47) and 45(4)

of the Act. This issue was rightly decided by the Tribunal by taking into

consideration the decision of a Division Bench of this Court in the case of

CADD Centre Vs. ACIT [reported in (2016) 383 ITR 258], in which, the

decision of a Division Bench of the Bombay High Court in the case of CIT Vs.

Texspin Engineering and Manufacturing Works [reported in (2003)

263 ITR 345], was taken into consideration.

12. At this juncture, it will be worthwhile to extract the relevant portion

in the decision in the case of CADD Centre, which reads as hereunder :

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“The question is whether such vesting stands covered by the expression transfer by way of distribution in Section 45(4) of the Act. There is a difference between vesting of the property, in this case, in the Limited Company and distribution of the property. On vesting in the Limited Company under Part IX of the Companies Act, the properties vest in the company as they exist. On the other hand, distribution on dissolution presupposes division, realisation, encashment of assets and appropriation of the realised amount as per the priority like payment of taxes to the Government, BMC etc., payment to unsecured creditors etc. This difference is very important. This difference is amply brought out conceptually in the judgment of the Supreme Court in the case of Malabar Fisheries Co. Vs. CIT [1979] 120 ITR 49. In the present case, therefore, we are of the view that Section 45(4) is not attracted as the very first condition of transfer by way of distribution of capital assets is not satisfied. In the circumstances, the latter part of Section 45(4), which refers to computation of capital gains under Section 48 by treating fair market value of the asset on the date of transfer, does not arise.”

13. The endeavor of Mr.T.R.Senthilkumar, learned Senior Standing

Counsel before us is by laying emphasis on the fact that the shares worth of

Rs.10 lakhs were given to the partners, that the remaining was given as

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credit of loan to the partners of the erstwhile firm in the same proportion as

their share capital of the firm and that this is a deviation from the conditions

stipulated under Section 47(xiii) of the Act.

14. In our considered view, the legal position having been well settled

that when vesting takes place, it vests in the company as they exist.

Therefore, unless and until the first condition of transfer by way of

distribution of assets is satisfied, Section 45(4) of the Act will not be

attracted. Therefore, in the facts and circumstances of the case, we find that

there is no transfer by way of distribution of assets.

15. Mr.T.R.Senthilkumar, learned Senior Standing Counsel for the

Revenue would contend that the decision in the case of CADD Centre is

distinguishable on facts, as the Court held that there was no distribution of

assets, but only taking over of assets of the firm to the company.

16. However, the vital difference is that shares worth of Rs.10 lakhs

alone were allotted and that the remaining was given as credit of loan to the

partners of the erstwhile firm in the same proportion as their share capital of

the firm. In our considered view, what is required to be considered is the

effect of vesting as held in the case of Texspin Engineering and

Manufacturing Works, which followed the decision of the Hon'ble Supreme

Court in the case of Malabar Fisheries Co. Vs. CIT [reported in (1979)

120 ITR 49] and there can be no distribution of assets when a partnership

firm vests in a company under Part IX of the Companies Act, 1956. Thus, we

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T.S.SIVAGNANAM,J AND V.BHAVANI SUBBAROYAN,J

RS

are of the view that the Tribunal rightly followed the decision in the case of

CADD Centre.

17. For the above reasons, the above tax appeal filed by the Revenue is

dismissed and the substantial questions of law are answered against the

Revenue. No costs.

16.7.2019 Internet: Yes

To The Income Tax Appellate Tribunal, Chennai 'A' Bench.

TCA.No.391 of 2019

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