By TIOL News Service

CHENNAI, MAY 02, 2019: THE ISSUE BEFORE THE DIVISION BENCH IS - Whether properties obtained by retiring partners through family arrangement will not amount to "transfer" for purposes of capital gain, and hence, reconstitution of partnership firm will not attract provisions of Section 45(4). YES IS THE VERDICT.

Facts of the case:

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 into 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 allottment of assets among the retiring and continuing partners took place.

For the A.Y 2004-2005, the partnership Firm declared an income of Rs.1,23,93,699/-. The AO however, passed the assessment order at a total income of Rs.9,77,05,330/- by making an addition of Rs.8,53,11,630/- alleging long term capital gains arising out of transfer of immovable properties by the partnership firm to the retiring partners. On appeal, the CIT(A) held that the properties obtained by the retiring partners through a family arrangement was 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 however held that Section 45(4) applied to the Assessee and that there was "transfer" of assets within the meaning of Section 2(47)(vi).

High Court held:

++ the substantial questions of law revolve around the issue whether Section 45(4) applies on retirement of a partner from the partnership business and whether the word "otherwise", it would take into its sweep not only cases of dissolution of partnership firm but also cases of reconstitution of a partnership firm on retirement of a partner. However, 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 his interests in the firm. The interest of a partner in a partnership firm is a right to obtain share of profits from time to time during the subsistance of the partnership and further, on dissolution of the partnership, or on his retirement from the partnership, to get the value of his share in the net partnership assets which remain after deducting the debts and liabilities of the partnership. This could be in the form of immovable assets or in the form of cash in lieu of the immovable assets. Therefore, when a partner retires from a partnership and his share in the net partnership assets is determined and allotted to him, what he receives is his share in the partnership and not any consideration for transfer of his interest in the partnership to the continuing partners. There is in this transaction no element of transfer of interest in the partnership assets by the retiring partner to the continuing partners;

++ the transfer of a capital assets in order to attract capital gains tax must be one as a result of which consideration is received by the assessee or accrues to the assessee. When a partner retires from a partnership he receives his share in the partnership and this does not represent consideration received by him in lieu of relinquishment of his interest in the partnership asset. It is seen that the Supreme Court in Commissioner of Income Tax Vs. R.Lingmallu Raghukumar reported in 2001 247 ITR 801 SC, had held that on retirement, the settlement to a partner of his share in the assets of the partnership after deduction of liabilities is not assessable to capital gains. In the present case, very significantly, there was only a reconstitution of the partnership firm by retirement of two partners and admission of another partner. 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. Hence, the provisions of Section 45(4) would not be attracted on the retirement of the two partners and consequential allotment of their share in the assets in the Assessee Firm.

(See 2019-TIOL-954-HC-MAD-IT)