Dr. Vithal V. Kamat v. Jt. CIT [ITA No. 3909/M/2018, ITA No. 3870/M/2018, dt. 6-11-2020] : 2020 TaxPub(DT) 5003 (Mum-Trib)

Amount received from partnership firm on retirement whether subject to capital gains under section 45(1)

Facts:

Assessee was a partner in a firm which was formed to construct and run a club vide partnership deed dated 6-5-1992

The capital contribution in the above firm by the first 4 partners (i), (ii), (iii) and (iv) was done by way of a land measuring 15,260 sq. yard. The said land was valued at Rs. 5 crores and treated as capital of the 4 partners and the rest of the two partners (v), (vi) one being the assessee brought in Rs. 1.5 crore each as capital. Subsequently the first 4 partners retired with effect from 4-4-2008 and following 4 new partners were admitted as partners of the said firm --

(1) M/s. Runwal Developers Pvt. Ltd.;

(2) Subhash S. Runwal;

(3) Sandeep S. Runwal; and

(4) Suboth S. Runwal

The retiring partners sold their parcels of the land to the company Runwal Developers Pvt. Ltd. which was the new partner for Rs. 11 crores and accordingly the proceeds were offered to capital gains on their respective shares.

Subsequently the assessee retired from the partnership on 4-4-2008 and thus received Rs. 48.15 crores as his share of assets in the firm which was returned by the assessee as exempt receipt. He was having a debit balance in his capital account is to be noted.

The assessing officer made additions of the Rs. 47.13 crores (48.15 less certain legitimate club obligations 1.01) amount received as capital gains under section 45(1). His argument was that the said amount was received towards the share of the land which was sold by the rest of the 4 partners. Assessee's counter was that he did not have any share of the land right from the inception of the firm and it was the rest of the 4 partners who retired who had sold and thus the said capital contribution was simply repayment of his capital and accumulations over the tenure of the firm thus a capital receipt exempt from tax. Commissioner (Appeals) negated the views of the assessing officer. On higher appeal by the revenue --

Held against the revenue (in favour of the assessee) that the receipt on retirement by way of share of assets of the firm was not taxable as capital gains.

The basic ingredient of section 45 which is ownership in the capital asset and the charging section were found missing here. If a reading of section 45(4) was to be done it is the firm which is subject to capital gains was also put across by the assessee besides the fact that the cost of acquisition as confirmed by revenue is NIL as the partner has a debit balance so CIT v. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC) : 1981 TaxPub(DT) 0902 (SC) would also apply where the computation section would fail if the cost of acquisition for capital gains was to be read NIL.

"4.4.17 It is the rule that a capital receipt is not to be subjected to tax and the provisions of section 45 are exception to the rule. Therefore, a capital receipt would ordinarily be not subjected to tax unless the same is shown to be falling under the domain of section 45. The provisions of section 45 prescribe the criterion of ownership of the capital asset and the transfer of the same. It is already the legal and factual position that the capital asset considered by the assessing officer, i.e., land was never owned by the appellant. Further the amount received by the appellant was not on account of transfer of any asset but because of the retirement from the partnership firm and thereby the liquidation of the status of the appellant as a partner of the partnership firm. This does not require separate mentioning that while the status of being a partner in a partnership firm is a right but the same is a capital right and cannot be construed as a right leading to revenue implications".

Assessing officer's argument was vide CIT v. A.N. Naik Associates (2004) 136 Taxman 107 (Bom) : 2004 TaxPub(DT) 0785 (Bom-HC) it is held: "The purpose and object of the Act of 1987 was to charge tax arising on distribution on capital assets of firms which otherwise was not subject to taxation. If the language of sub-section (4) is construed to mean that the expression "otherwise" has to partake of the nature of dissolution or deemed dissolution, then the very object of the amendment could be defeated by the partners, by distributing the assets to some partners who may retire. The firm then would not be liable to be taxed thus defeating the very purpose of the Amending Act. The Court noticed that the position prior to the amendment by introduction of section 45(4) by the Finance Act, 1987, was that there was no transfer of assets by the firm to the partners on dissolution or transfer of assets to the retiring partner on retirement".

The term otherwise means even retirement of a partner will come under purview of section 45(4). In view of section 45(4) if there is any capital gain tax has to be levied in the assessment of the firm and not in the assessment of the partner. This view is even upheld by Chalasani Venkateshwara Rao v. ITO (2012) 349 ITR 423 (AP-HC) : 2013 TaxPub(DT) 0131 (AP-HC).

"4.4.19 The assessing officer has himself negated the taxability of receipt in the hands of appellant under section 45(4). From the conclusion of the assessing officer it is seen that the sole basis for his conclusion depends on his understanding that certain rights in the nature of capital assets were transferred in lieu of consideration received on the date of retirement and the same is taxable as long term capital gains under section 45(1) of the Act. Detailed discussion in the preceding para clearly establishes that argument of the assessing officer is factually incorrect and legally untenable".

The Hon'ble Supreme Court and the Hon'ble High Courts including the jurisdictional High Court had occasions to review the taxability of receipt in the hands of retiring partners under the identical facts and circumstances of the case to that of the appellant's case, and on each occasion it has been held that such receipt is neither in lieu of capital asset, nor a transfer as defined under section 2(47) of the Act, nor it can be chargeable to tax under section 45(1) of the Act. Some of the landmark judgments are discussed below :--

CIT v. Mohanbhai Pamabhai (1987) 165 ITR 166 (SC) : 1987 TaxPub(DT) 1259 (SC) held -- "the extended definition of the term 'transfer' under section 2(47) of the Act, by which relinquishment and extinguishment of any right in a capital asset is considered as transfer would not apply when a partner retires from the partnership and there would be no transfer of interest in the partnership assets".

CIT v. Lingamallu Raghu Kumar (2001) 247 ITR 801 (SC) : 2001 TaxPub(DT) 0035 (SC): "The Supreme Court held, while affirming the principle laid down in Mohanbhai Pamabhai (supra) that when a partner retires from a partnership and the amount of his share in the net partnership assets after deduction of liabilities and prior charges is determined on taking accounts, there is no element of transfer of interest in the partnership assets by the retired partner to the continuing partners and the amount received by the retiring partner is not "capital gain" under section 45 of the Act".

Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC) : 1985 TaxPub(DT) 1358 (SC): "What the partner gets upon dissolution or upon retirement is the realisation of a preexisting right or interest. It is nothing strange in the law that a right or interest should exist in praesenti but its realisation or exercise should be postponed. Therefore, what was the exclusive interest of a partner in his personal asset is, upon its introduction into the partnership firm as his share to the partnership capital, transformed into an interest shared with the other partners in that asset. Qua that asset, there is a shared interest. During the subsistence of the partnership, the value of the interest of each partner qua that asset cannot be isolated or carved out from the value of the partner's interest in the totality of the partnership assets. And in regard to the latter, the value will be represented, by his share in the net assets on the dissolution of the firm or upon the partner's retirement".

Prashant S. Joshi (2010) 324 ITR 154 (Bom) : 2010 TaxPub(DT) 1561 (Bom-HC): "During the subsistence of a partnership, a partner does not possess an interest in specie in any particular asset of the partnership. During the subsistence of a partnership, a partner has a right to obtain a share in profits. On a dissolution of a partnership or upon retirement, a partner is entitled to a valuation of his share in the net assets of the partnership which remains after meeting the debts and liabilities. An amount paid to a partner upon retirement, after taking accounts and upon deduction of liabilities does not involve an element of transfer within the meaning of section 2(47)".

CIT v. Dynamic Enterprises (2013) 40 taxmann.com 318 (Karnataka) (Full Bench) : 2014 TaxPub(DT) 2363 (Karn-HC): "In the instant case, after the retirement of three partners, the partnership continued to exist and the business was carried on by the remaining five partners. There was no dissolution of the firm or at any rate there was no distribution of capital asset when three partners retired from the partnership firm. What was given to the retiring partners is cash representing the value of their share in the partnership. No capital asset was transferred on the date of retirement under the deed of retirement deed dated 1-4-1994. In the absence of distribution of capital asset and in the absence of transfer of capital asset in favour of the retiring partners, no profit or gain arose in the hands of the partnership firm".