COMMISSIONER OF INCOME-TAX VS R. RANGASWAMY NAIDU, 1998 PTD-MADRAS-HIGH-COURT-INDIA 1358 (1996)

Income-tax---

----Capital gains---Firm---Partner---Transfer---Sale of immovable property by partner to firm---Sale consideration credited to capital account of partner---Difference between sale consideration and fair market value of property assessable as capital gains---Indian Income Tax Act, 1961, Ss.45 & 48.

The abstract proposition that a partnership is not a legal entity is not correct. It is true that, under the law of partnership, a firm has no legal existence apart from its partners, and it is merely a compendious name to describe its partners. But under the income-tax law the position is different. The firm and the partners are distinct assessable entities. The law has for some specific purposes relaxed its general rigid notions, and extended a limited personality to a firm. There is nothing in the partnership law to suggest that the firm cannot

be treated as an entity for the purpose of dealing with property. During the subsistence of the partnership, the partnership acting through any particular partner authorized for the purpose or through all the partners will be in a position to deal with the asset.

On May 1, 1969, the assessee converted his proprietary business into a partnership consisting of himself and his three sons. On April 30, 1975, the assessee sold his property in favour of the firm for a sum of Rs.1,20,000. The net capital gains was computed at Rs.26,098. The property was sold under a registered sale-deed. Thereafter, the entire sale consideration was credited in the partnership capital account. The assessee claimed that inasmuch as the entire sale consideration was credited in the capital account of the firm there was no transfer and consequently no capital gains arose. The Income-tax Officer did not accept this claim but the Tribunal accepted it. On a reference:

Held, that normally, when a partner brings his asset into partnership, out of 100 per cent. ownership of the property, he would get only a fraction of the ownership according to his profit-sharing ratio in the firm. Therefore, in such a case, there cannot be any capital gain under the transfer. Hence, even though there is a transfer, section 48 of the Income Tax Act, 1961, cannot be made applicable since, it is not workable But, in the present case, the assessee after selling the property for Rs.1,20,000 credited the entire sale consideration in his capital account in the firm Therefore, the assessee in fact did not forgo anything in the transaction. There was a difference between the sale consideration and the fair market value to the extent of Rs.26,098. Under such circumstances, inasmuch as there was actual capital gain in the transaction, section 48 was applicable and the capital gain was assessable.

Chief Controlling Revenue Authority v. Chidambaram AIR 1970 Mad. 5; CIT v. Bharani Pictures (1981) 129 ITR 244 (Mad.); CIT v. W.L. Dahanukar (1959) 36 ITR 459 (Bom.); Kanniah Pillai (D.) v. CIT (1976) 104 ITR 520 (Mad.) and Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC) ref.

C.V. Rajan for the Commissioner.

P.P.S. Janarthana Raja for the Assessee.

JUDGMENT

THANIKKACHALAM, J.---At the instance of the Department, the Tribunal referred the following question for the opinion of this Court under section 256(1) of the Income Tax Act, 1961:

"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sale of the property by a partner to a firm in which he is a partner would not amount to a 'transfer' for purpose of capital gains under section 45 of the Income Tax Act, 1961, and accordingly no capital gains could be brought to tax on the sale of lands and building by the assessee to the partnership concern?"

The assessee is an individual. On May 1, 1969, he conversed his proprietary business into a partnership consisting of himself and his three sons. On April 30, 1975, he transferred his immovable property consisting of land and building to the firm. He returned the capital gains of Rs.26,098 as arising from the transfer. Later, by his letter dated November 12, 1976, he claimed that no chargeable capital gains arises for assessment in view of the decision of the Madras High Court in D. Kanniah Pillai v. CIT (1976) 104 ITR 520. The Income-tax Officer computed the capital gains arising out of the transfer at Rs.26,098 as returned. He noted that the transfer by such sale was by one of the partners to the firm by a registered sale-deed for consideration and, therefore, capital gains was eligible to tax. On appeal, the Appellate Assistant Commissioner found that the assessee had been collecting rent for the property from the firm prior to the conveyance. The assessee pleaded that by the conveyance he was only throwing his individual property into the stock of the firm in which he was a partner and, therefore,' applying the decision of the Madras High Court in the case of D. Kanniah Pillai (1976) 104 ITR 520, the conveyance did not amount to a transfer within the meaning of section 2(47) of the Income Tax Act and, therefore, there can be no capital gains eligible to tax. The Appellate Assistant Commissioner did not accept the contention in view of the fact that the decision of the Madras High Court has not considered the effect of the definition in section 2(47) of the Act which included the extinguishment of rights and he, therefore, confirmed the assessment. On further appeal, the Appellate Tribunal found that the facts in this case were on all fours with the decision of the Madras High Court in D. Kanniah Pillai's case (1976) 104 ITR 520. The Appellate Tribunal accordingly allowed the claim of the assessee and excluded the capital gains from the total income assessable to tax.

Learned standing counsel appearing for the Department submitted that in the present case the partnership was constituted on May 1, 1969, but the immovable property was sold on April 30, 1975, for consideration. The assessee himself admitted the capital gains of Rs.26,098. Even if the said entire sale consideration of Rs.1,20,000 was said to be entered in the capital account of the assessee which is a partnership, inasmuch as there is capital gains, the Department is entitled to levy capital gains tax under section 45 of the Act. According to learned standing counsel, the decision in the case of D. Kanniah Pillai (1976) 104 ITR 520 (Mad.) will not be applicable to the facts arising in the present case. In order to support his contention that there is transfer by executing the sale-deed by the assessee in favour of the partnership firm, after receiving the consideration, learned standing counsel relied on a decision of this Court in Chief Controlling Revenue Authority v Chidambaram, AIR 1970 Mad 5 (1713). Learned standing counsel further, relying upon the decision of the Supreme Court in Sunil Siddharthbhai v. CIT (1985) 156 ITR 509, contended that normally when the partner brings the assets into the partnership firm, there is transfer. Further, learned standing counsel, placing reliance on the decision of the Bombay High Court in CIT v. W.L. Dahanukar (1959) 36 ITR 459, submitted that it is competent to a person in law to sell his property to a partnership consisting of himself and another; such a transaction could be valid and binding and would have all the incidents of a legal and binding transaction of sale, and the difference between the purchase price of the land and the selling price would be the profit that would accrue to the person who purchased and sold the land. It was, therefore, submitted that the Tribunal was not correct in coming to the conclusion that there is no transfer in the present case and, hence, no capital gains tax is leviable.

On the other hand, learned counsel appearing for the assessee submitted that when a partner of a firm sold the property to a partnership firm and crediting the value of the sale consideration to the capital account, there is no transfer. According to learned counsel for the assessee, assets can he introduced by a partner of the firm either at the inception of the partnership or at a later stage. In both these stages when the partner brings his property to the partnership, it cannot be said that there is a transfer. In the present case, inasmuch as the entire sale consideration was credited in the capital account of the firm, the Department was not correct in stating that there is transfer and the difference between the sale consideration and the fair market value is exigible to capital gains tax. Learned counsel also placed reliance upon the decision in D. Kanniah Pillai's case (1976) 104 ITR 520 (Mad.) in order to support his aforesaid contentions.

We have heard learned standing counsel and learned counsel appearing for the assessee.

We have already set out the facts in detail. The assessee claimed exemption from tax of the capital gains arising to him in transferring a land with building in a sum of Rs.1,20,000 on April 30, 1975, to a partnership consisting of himself and his sons. In the return filed on July 31, 1976, although the capital gains of Rs.26,098 was offered for assessment by a separate letter dated November 12, 1976, before the assessment was taken up, the assessee claimed exemption based on the decision of the Madras High Court in D. Kanniah Pillai's case (1976) 104 ITR 520. On May 1, 1969, the assessee converted his proprietary business into a partnership consisting of himself and his three sons sharing the profits in the ratio of 2:1:1. On April 30, 1975, the assessee sold his property in favour of the partnership firm for a sum of Rs.1,20,000. The net capital gains was computed at Rs.26,098. The property was sold under a registered sale-deed. Thereafter, the entire sale consideration was credited in the partnership capital account. According to the assessee, inasmuch as the entire sale consideration was credited in the capital account of the partnership firm, there is no transfer and consequently no capital gains arises in the transaction.

In W.L. Dahanukar's case (1959) 36 ITR 459, the Bombay High court held that it is competent to a person in law to sell his property to a partnership consisting of himself and another. Such a transaction would be valid and binding and would have all the incidents of a legal and binding transaction of sale, and the difference between the purchase price of the land and the selling price would be the profit that would accrue to the person who purchased and sold the land.

In Sunil Siddharthbhai v. CIT (1985) 156 ITR 509, the Supreme Court while considering sections 45 and 48 of the Income Tax Act, 1961, held that (headnote) "where a partner of a firm makes over capital assets which are held by him to a firm as his contribution towards capital, there is a transfer of a capital asset within the terms of section 45 of the Income Tax Act, 1961, because the exclusive interest of the partner in personal assets is reduced, on their entry into the firm, into a shared interest";

It was further held that: "The consideration for the transfer of the personal assets is the right which arises or accrues to the partner during the subsistence of the partnership to get his share of the profits from time to time and, after the dissolution of the partnership or with his retirement from the partnership, to get the value of his share in the net partnership assets as on the date of the dissolution or retirement after deduction of liabilities and prior charges. The credit entry made in the partner's capital account in the books of the partnership-firm does not represent the true value of the consideration. Therefore, the consideration, which a partner acquires on making over his personal asset to the firm as his contribution to its capital cannot fall within the terms of section 48 of the Act. And as that provision is fundamental to the computation machinery incorporatedin the scheme relating to the determination of the charge provided in section 45 of the Act, such a case must be regarded as falling outside the scope of capital gains taxation altogether".

In D. Kanniah Pillai's case (1976) 104 ITR 520, this Court while considering the provisions of sections 41(2) and 45 of the Income Tax Act, 1961, held that (headnote): "though in commercial parlance a partner may be treated as any third party and very often they enter into transactions of sale and purchase with the firm in which they are partners and the Code of Civil Procedure also enables such a partner to enforce his claim against the partnership, it does not mean that even for a limited purpose, the firm is treated as a legal entity. In cases where a partner is treated as a creditor while enforcing the claim, unless the partners agree, he would not be entitled to a decree against the partnership firm as such and it would be open to the defending partners to ask for a dissolution of the partnership instead of paying the credits of the partner Even in such cases, it could not be stated that there was a legal sale within the meaning of the Sale of Goods Act. If there is no possibility of a transaction of sale when a proprietary concern is converted into a partnership, the mere fact that the parties choose to adopt a form which is in the nature of a sale will not convert that transaction into a sale".

It may be true that a partnership firm cannot be treated as a legal entity so as to enter into a contract of sale. The abstract proposition that the partnership is not a legal entity is not correct. It is true that, under the law of partnership, a firm has no legal existence apart from its partners, and it is merely a compendious name to describe its partners. But under the Income tax law the position is different. The firm and the partners are distinct assessable entities. The law has thus for some specific purposes relaxed its general rigid notions, and extended a limited personality to a firm. There is nothing in the partnership law to suggest that the firm cannot be treated as an entity for the purpose of dealing with the property. During the subsistence of the partnership, the partnership acting through any particular partner authorized for the purpose or through all the partners will be in a position to deal with the asset. The question as to who can deal with the partnership property is a matter of agreement. Under section 19 of the Partnership Act, the implied authority of a partner does not empower him to acquire immovable property for the firm or transfer immovable property belonging to the firm. In the absence of any agreement between the partners, if any occasion arises for dealing with the immovable property of the firm, then it would be necessary for all the partners to joint the instrument. (See CIT v. Bharani Pictures (1.981) 129 ITR 244 (Mad).).

In the general sense the expression "transfer of property" connotes the passing of rights in property from one person to another. In one case, there may be a passing of the entire bundle of rights from the transferor to the transferee. In another case, the transfer may consist of one of the estates only out of all the estates comprising the totality of rights in the property. In a third case, there will be a reduction of the exclusive interest in the totality of rights of the original owner into a joint or shared interest with other persons. An exclusive interest in property is a larger interest than a share in that property. To the extent to which the exclusive interest is reduced to a shared interest, there is a transfer of interest. (See Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC).

According to the facts of the present case, the assessee sold his property for a sum of Rs.1,20,000 and credited the entire sale consideration in his name in the capital account of the partnership. Normally, when a partner brings his asset into partnership, out of 100 per cent. ownership of the property, he would get only a fraction of the ownership according to his profit-sharing ratio in the firm. Therefore, in such a case, there cannot be any capital gain under the transfer. Hence, even though, there is transfer, section 48 of the Act cannot be made applicable since it is not workable. But, in the present case, the facts are different. The assessee after selling the property for Rs.1,20,000 credited the entire sale consideration in his capital account in the firm. Therefore, the assessee is forgoing nothing in that transaction. In fact, there is a difference between the sale consideration factual consideration) and the fair market value to the extent of Rs.26,098. Under such circumstances, inasmuch as there was actual capital gain in the transaction, section 48 of the Act is made applicable by, the Income-tax Officer in levying capital gains tax. In this process, we see that there is no reason for the Tribunal to conclude that there is no transfer at all and the assessee is not liable to capital gains tax. In that view of the matter, we answer the question referred to us in the negative and in favour of the Department. No. costs.

M.B.A./1398/FCOrder accordingly.