2003-VIL-186-ITAT-DEL

Equivalent Citation: TTJ 082, 575, [2004] 4 SOT 143 (DELHI)

Income Tax Appellate Tribunal DELHI

IT APPEAL NOS. 5805 AND 6461 (DELHI) OF 1996

Date: 20.05.2003

KRISHNA ELECTRICAL INDUSTRIES.

Vs

DEPUTY COMMISSIONER OF INCOME TAX.

BENCH

Member(s)  : R. K. GUPTA., T. N. CHOPRA.

JUDGMENT

These are two appeals by assessee and Department against the order of CIT(A) relating to asst. yr. 1993-94.

ITA No. 5805/Del/1996

2. The only ground in appeal of the assessee is in not allowing the depreciation of Rs. 8,58,226.

2.1 At the time of hearing, the counsel of the assessee stated that originally the CIT(A) has not decided this issue, therefore, the appeal was filed before the Tribunal. However, in the meantime the assessee moved application under s. 154 before the CIT(A), who by accepting the application under s. 154, directed the AO to allow the depreciation as per law. Therefore, the appeal of the assessee has become infructuous.

2.2 In view of these facts and circumstances, we treat this appeal of the assessee as infructuous. Therefore, the same is dismissed.

ITA No. 6461/Del/96 (Department’s appeal)

3. The Department is objecting in holding that there is no transfer of capital asset and deleting the addition of Rs. 80 lakhs being capital gain computed by the AO.

3.1 The brief facts of the case are that the assessee filed its return on 31st Oct., 1993, declaring an income of Rs. 11.52 lakhs. The assessee was carrying on the business of manufacturing and trading of power cable. The firm was originally constituted in 1968-69. The constitution of the firm was changed from time to time, as some of the partners were retired and joined. During the year under consideration, the firm got itself converted into a company under the name and style of KEI. Industries Ltd. This conversion was made as limited company under Chapter IX of the Companies Act. As a result of the formula of the aforesaid company, the business of the firm with all its assets and liabilities got automatically vested in the company. Before conversion into company, the firm revalued its land and factory building, which was adopted at Rs. 80 lakhs and Rs. 10 lakhs, respectively, based upon the valuation report of the registered valuer. However, the assessee-firm did not charge depreciation on the enhanced value of land and factory building, resulting on account of revaluation. The AO, in view of the fact that assessee-firm got converted into a limited company, was of the view that there was a transfer within the meaning of s. 2(47) of the IT Act and accordingly directed the assessee to explain as to why short-term capital gain be not assessed to tax, as provided under s. 50 of the Act. In reply, it was stated that as conversion of partnership firm into a limited company, does not involve any transfer and as such no capital gain is liable to be assessed. It was further submitted that there was no transfer, but only a conversion of the firm into a limited company, as all the assets and liabilities were merged with the company. In support of this contention, a detailed note was filed. The provisions of s. 575 of the Companies Act were also relied upon. The reliance was also placed on various case law. It was also submitted that all the partners in the erstwhile firm were owning the entire equity share capital of the company. Therefore, the company was formulated from the firm as a going concern. Accordingly, it was submitted that when an undertaking as a whole is transferred as a going concern together with its goodwill and all other assets and liabilities, therefore, it cannot be said that there was any transfer. Accordingly, no capital gain arises. However, the AO was not satisfied. In his view, the firm has transferred its assets and liabilities to the company, therefore, provisions of s. 45(4) of the Act were applicable. While holding so, the AO placed reliance on various decisions, reported in (1989) 177 ITR 98 (sic); CIT vs. R.R. Ramakrishna Pillai (1967) 66 ITR 725 (SC) and Orissa Cement Ltd. vs. CIT (1971) 80 ITR 901 (Del), and thereafter the AO brought the amount of Rs. 80 lakhs to taxation under s. 112 of the IT Act.

3.2 Same arguments were reiterated before the CIT(A) as were made before the AO. The reliance was also placed on various case law. After considering the reply of the assessee and perusing other material on record, the CIT(A) was of the view that provisions of s. 45(4) are not applicable on the facts of the present case, as this is not a case of transfer because the firm as a whole was converted into a company. The issue was discussed by the CIT(A) at great length. Each and every objection raised by the AO was considered and then the conclusion was arrived at that this is not a case of transfer. The CIT(A) has considered that whether the firm can be registered as a limited company under Chapter IX of the Companies Act, and what is the scope of meaning of s. 575 of the Companies Act and what is the meaning of the word "transfer" under the provisions of ss. 2(47) and 54(5) (sic) of the Act, and what is the legal position before insertion of s. 45(4) of the IT Act and whether automatic vesting of the assets and liabilities in the new company will amount to transfer of asset, and what is the scope of s. 45(4) of the Act that whether distribution of assets is a must. After discussing all these provisions of law in detail and placing reliance on various case law, reported in E.I.D. Parry Ltd. vs. CIT (1988) 98 CTR (Mad) 49 : (1988) 174 ITR 11 (Mad) and in the case of Maharajadhiraj Sir Kameshwar Singh vs. CIT (1963) 48 ITR 483 (Pat), the CIT(A) held that there is no transfer of capital asset from the firm to the company and, therefore, the provisions of s. 112 of the IT Act r/w s. 45(4) cannot be applied, and accordingly it was held that the AO wrongly brought the amount to capital gain. Thus, the addition made by the AO was deleted. Now the Department is in appeal here before the Tribunal.

3.3 The learned Departmental Representative strongly supported the order of the AO. On the other hand, the learned counsel of the assessee firstly strongly supported the order of the CIT(A) and then it was submitted that the identical issue has been decided by the Hon’ble Bombay High Court in the case of CIT vs. Texspin Engineering & Manufacturing Works (2003) 180 CTR (Bom) 497. It was further stated that the provisions of s. 45(4), along with s. 47, cl. (xiii), which was amended w.e.f. 1st April, 1999, were considered and then the decision of the Bombay Bench of the Tribunal reported in Texspin Engineering & Manufacturing Works vs. Jt. CIT (2001) 70 TTJ (Mumbai) 789 was confirmed by the Hon’ble Bombay High Court. The attention of the Bench was drawn on the copy of the orders placed on record.

3.4 We have heard the rival submissions and considered them carefully. After perusing the relevant material, along with various case law relied upon by both the parties, we find that the CIT(A) was justified in holding that there was no transfer, hence no capital gain arises. We noted that the company was registered under Chapter IX of the Companies Act, 1956, which was converted from a partnership firm. We further noted that the company was registered under Chapter IX of the Companies Act, in view of the provisions of s. 575, means thereby that there was no physical transfer of assets, but there was an automatic vesting of all the assets and liabilities of the erstwhile firm to the company. There is no transfer from one hand to another hand, as all the partners in the firm became shareholders in equal proportion of their capital with the firm. Neither any consideration was received by the firm or their partners, nor there was a receivable by the firm or the partners from the company, therefore, atleast firm cannot be brought to tax under s. 112 of the IT Act. It is stated in the order of the AO and CIT(A) himself that there was no transfer of asset but it was a conversion into company by the firm as a whole. Therefore, it cannot be said that it was a case of exchange of property or transfer of property from one person to another person.

3.5 In the case of Sunil Siddarthbhai vs. CIT (1985) 49 CTR (SC) 172 : (1985) 156 ITR 509 (SC), the Hon’ble Supreme Court has discussed the issue in regard to transfer of property and one of the findings of the Hon’ble apex Court is that if there was a transfer of shares but the person has got no consideration within the meaning of s. 48, then in that case no profit or gain accrued to him for the purpose of s. 45 of the Act. It was further observed by the Hon’ble Court that where the entire bundle of rights from the transferor has been made and rights of the transferor have not reduced, then in that case also provisions of s. 45 are not applicable. However, it has been observed by the apex Court that if the rights of the person are reduced in transferring the assets to another person, then of course it tantamounts to transfer of interest.

3.6 In the present case, undisputedly the assets and liabilities of the erstwhile firm were converted into company as a whole and all the partners of the firm were allotted shares of the company in equal proportion which was in the firm. Therefore, the interest of the partners was not reduced in any way, neither any amount was paid separately to the firm or the partners on account of goodwill or on account of revaluation of assets. Therefore, the provisions of s. 45(4) of the IT Act r/w s. 112 of the Act are not applicable on the facts of the present case.

3.7 On similar facts, the Hon’ble Bombay High Court in the case of CIT vs. Texspin Engineering & Manufacturing Works held that the provisions of s. 45(4) are not applicable where the firm as a whole was converted into a company. While holding so, the Hon’ble Bombay High Court has discussed the issue in detail. Some of the observations and findings of the Hon’ble High Court are as under:

"Held: Under s. 45(4) two conditions are required to be satisfied viz., transfer by way of distribution of capital assets, and secondly, such transfer should be on dissolution of the firm or otherwise. Once these two conditions are satisfied then, in that event, for the purposes of computation of capital gains under s. 48, the market value on the date of the transfer shall be deemed to be the full value of consideration received or accruing as a result of the transfer. In this case, the erstwhile firm has been treated as a limited company by virtue of s. 575 of the Companies Act. Under Part IX of the Companies Act, when a partnership firm is treated as a limited company, the properties of the erstwhile firm vest in the limited company. 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 pre-supposes division, realization, encashment of assets and appropriation of the realized amount as per the priority like payment of taxes to the Government, BMC, etc., payment to unsecured creditors, etc. This difference is very important. In the present case, therefore, s. 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 later part of s. 45(4), which refers to computation of capital gains under s. 48 by treating fair market value of the asset on the date of transfer, does not arise—Malabar Fisheries Co. vs. CIT (1979) 12 CTR (SC) 415 : (1979) 120 ITR 49 (SC) applied.

Clause (xiii) of s. 47 though not applicable here, it provides a clue to the legislative intent. It has been introduced w.e.f. 1st April, 1999, in order to encourage more and more firms becoming limited companies. It also indicates the difference between transfer and transmission. Basically, when a firm is treated as a company under Part IX, it is a case similar to transmission. This is amply made clear by cl. (xiii) to s. 47, which states that where a firm is succeeded by a company in the business, the transaction shall not be treated as a transfer. The expression "transfer of a capital asset" in s. 45(1) is required to be r/w s. 2(47)(ii) which states that transfer in relation to a capital asset shall include extinguishment of any rights therein. In certain cases of reconstitution of firms and introduction of new partners, there is a resultant extinguishment of the rights in the capital assets proportionately. In order to get over this controversy and keeping in mind the object of encouraging firms being treated as companies, the controversy is resolved by the legislature by introducing cl. (xiii) in s. 47 w.e.f. 1st April, 1999.

When a partnership firm is treated as a company under the statutory provisions of Part IX of the Companies Act, the company succeeds the firm. Generally, in the case of a transfer of a capital asset, two important ingredients are : existence of a party and a counter-party and, secondly, incoming considering qua the transferor. When a firm is treated as a company, the said two considerations are not attracted. There is no conveyance of the property executable in favour of the limited company. It is no doubt true that all properties of the firm vest in the limited company on the firm being treated as a company under Part IX of the Companies Act, but that vesting is not consequent or incidental to a transfer. It is a statutory vesting of properties in the company as the firm is treated as a limited company. On vesting of all the properties statutorily in the company, the cloak given to the firm is replaced by a different cloak and the same firm is now treated as a company, after a given date. In the circumstances, there is no transfer of a capital asset as contemplated by s. 45(1). Even assuming for the sake of argument that there is a transfer of a capital asset under s. 45(1) because of the definition of the word "transfer" in s. 2(47)(iii), even then liability to pay capital gains would not arise because s. 45(1) is required to be read with s. 48, which provides for mode of computation. These two sections are required to be read together as the charging section and the computation section constitute one package. Now, under s. 48 it is laid down, inter alia, that the income chargeable under the head "capital gains" shall be computed by deducting from the full value of the consideration received or accrued as a result of the transfer, the cost of acquisition of the asset and the expenditure incurred in connection with the transfer. Sec. 45(4) is mutually exclusive to s. 45(1). On has to read the expression "full value of the consideration received/accruing" under s. 48 de hors s. 45(4) and if one reads s. 48 with s. 45(1) de hors s. 45(4) then the expression "full value of consideration" in s. 48 cannot be the market value of the capital asset on the date of transfer. In the circumstances, even if one were to proceed on the basis that vesting in the company under Part IX constituted transfer under s. 45(1), still the assessee ought to succeed because the firm can be assessed only if the full value of the consideration is received by the firm or if it accrues to the firm. In the present case, the company had allotted shares to the partners of the erstwhile firm, but that was in proportion to the capital of the partners in the erstwhile firm. That allotment of shares had no correlation with the vesting of the properties in the limited company under Part IX of the Act. If one reads s. 45(1) with s. 48, it is clear that the former is a charging section and if that section is applicable, the computation has to be done under s. 48, which only refers to deductions from full value of consideration received or accruing. Sec. 48 does not empower the AO to take market value as full value of consideration as in the case of s. 45(4). In the circumstances, even if one were to hold that vesting amounts to transfer, the computation is not possible because full consideration cannot be construed to mean market value of the asset transferred. The legislature, in its wisdom, has amended only s. 45(4) by which the market value of the asset on the date of the transfer is deemed to be the full value of consideration. However, such amendment is not there in s. 45(1). In the circumstances, neither s. 45(1) nor s. 45(4) stands attracted. CIT & Anr. vs. George Henderson & Co. Ltd. (1967) 66 ITR 622 (SC) and CIT vs. Gillanders Arbuthnot & Co. 1973 CTR (SC) 136 : (1973) 87 ITR 407 (SC) relied on.

Conclusion: Conversion of partnership firm into company under Part IX of the Companies Act did not attract the provisions of s. 45(4) as there was no distribution of capital assets on dissolution; provisions of s. 45(1) also could not be applied as the vesting of the properties of the firm in the company was not consequent or incidental to a transfer as contemplated by s. 45(1)."

3.8 The fact of the case before the Bombay High Court and the facts involved in the present case, as stated above, are similar. Therefore, in view of the reasoning given by the CIT(A) and the reasoning of ours and in view of the decision of the Bombay High Court, we confirm the order of the CIT(A) on this issue.

4. In the result, the appeal of the Department is dismissed.

 

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