A two-judge bench of the Madras High Court has held that the properties obtained by the retiring partners of a Firm through family arrangement do not amount to ‘transfer’ for the purpose of imposing capital gain, and therefore, the reconstitution of the firm will not attract Section 45(4) of the Income Tax Act, 1961.
The assessee company is engaged in the business of construction and it also owns, manages and maintains a commercial complex, two theatres and two Kalyana mandapams. N. Munuswamy Mudaliar originally started a sole proprietorship concern under the name of “National Company” in the year 1950. He then converted it as a partnership firm in the year 1974 and admitted his son, two daughters and one son-in-law, into the partnership. Since the son passed away in the year 1994, the partnership firm was reconstituted and the other son-in-law was also admitted as a partner. Later on, N. Munuswamy Mudaliar passed away and thereafter, the partnership firm was again reconstituted, which further resulted in serious disputes among the partners. Accordingly, an Arbitrator was appointed to settle the disputes. Dr. Shanthi Shanmugasundaram and Dr.V. Shanmugasundaram agreed to retire from the partnership business and the Firm continued with the remaining partners Dr Chandra Ananthasayanam and Dr.C.V Ananthasayanam, who also admitted their son Arjun A. Raja as another partner. At the time of retirement of the two partners, valuation of the assets & liabilities of the firm and allotment of assets among the retiring and continuing partners took place.
The department held that the transfer of immovable properties by the partnership firm to the retiring partners would amount to ‘transfer’ and long-term capital gain is payable on such persons.
On appeal, the CIT(A) held that the properties obtained by the retiring partners through a family arrangement were not “transfer” for the purpose of capital gain. It was held that reconstitution of the partnership firm would not attract the provisions of Section 45(4) and therefore, the addition of Rs.8,53,11,630/- was set aside.
On further appeal, the Tribunal restored the original order.
The bench comprising Justice Vineeth Kothari and Justice C V Karthikeyan observed that two primary requirements are essential for the application of Section 45(4), namely, (i) there should be a transfer of a capital assets; and (ii) there should be distribution of capital assets on the dissolution of a firm or otherwise. It is to be noted that on the retirement of a partner from the firm, there will be allotment of
“In the present case, very significantly, there was only a reconstitution of the partnership firm by the retirement of two partners and admission of another partner. The partnership firm continued. It must also be further noted that the assets of the firm originally belonged to the father of the retiring / continuing partners and there was only a division of the assets on retirement in accordance with their entitlement on the shares in the partnership. As pointed out earlier, the National Company was originally a sole proprietorship concern started by N. Munuswamy Mudaliar. It was in the business of construction and assets had been acquired even at that particular point of time. The two daughters and two sons-in-law of N.Munuswamy Mudaliar were subsequently admitted as partners and on the division of the assets, it can also be arguably pointed out that one daughter and one son-in-law were allotted a share which they were otherwise legally entitled to out of the holdings N.Munuswamy Mudaliar.”
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