Full Judgment Text
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PETITIONER:
SHRI SUNIL SIDDHARTHBHAI ETC.
Vs.
RESPONDENT:
COMMISSIONER OF INCOME TAX, AHMEDABAD ETC.
DATE OF JUDGMENT27/09/1985
BENCH:
PATHAK, R.S.
BENCH:
PATHAK, R.S.
BHAGWATI, P.N. (CJ)
SEN, AMARENDRA NATH (J)
CITATION:
1986 AIR 368 1985 SCR Supl. (3) 102
1985 SCC (4) 519 1985 SCALE (2)755
ACT:
Transfer of a capital asset - When the assessee brings
the shares of the limited companies into the partnership
firm as his contribution to its capital, whether there was a
transfer within the definition of section 2 (47) of capital
asset within the terms of section 45 of the Income Tax Act,
1961.
Capital gains, scheme of - Sections 45 and 48 of the
Income Tax, 1961, scope of - When the assessee transferred
his shares to the partnership firm, whether he can be said
to have received a consideration within the meaning of
section 48 of the Income Tax Act, 1961 and that a profit of
gain accrued to him for the purpose of section 45 ibid.
HEADNOTE:
In Civil Appeal No. 1841 of 1981, the appellant-
assessee was a partner in Messrs Suvas Trading Company, a
partnership firm constituted under a deed of partnership
dated September 27, 1973. As his contribution to the capital
of the partnership firm, the assessee made over certain
shares of limited companies which were held by him as his
capital assets. The book value of the said shares in his
account books was shown as Rs. 1,60,279 but on the date when
he contributed those shares to the partnership firm he
revalued the shares at the market value of Rs. 1,49,819, and
debited the resulting difference of Rs. 10,460 to his
capital account. Since the Income Tax Officer, when drawing
up the assessment order for the assessment year 1974-75 in
respect of the assessee did not include the difference in
the assessable income, the Commissioner of Income Tax, being
of the opinion that the difference between the market value
of the shares and the cost of acquisition of the shares to
the assessee is liable to tax as capital gains under section
45 of the Income Tax Act, 1961 exercised his revisional
jurisdiction and reopening the assessment, remanded the case
to the Income Tax Officer directing him to revise the
assessment after computing the capital gains arising out of
the transfer. The assessee appealed to the Income Tax
Appellate Tribunal, which held that while the transaction
did amount to a transfer within the meaning of sub-section
(47) of
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103
section 2 of the Income Tax Act, 1961, it did not result in
capital gains liable to tax. Subsequently the Appellate
Tribunal referred the case to the High Court of Gujarat for
its opinion on the said two issues.
In Civil Appeal No. 1777/1981, the appellant was a
partner in a registered partnership firm, M/s. Rajka,
constituted under an agreement dated February 24, 1973 of
which the other partner was his wife. The assessee had in
his possession 580 ordinary shares of the Ahmedabad
Manufacturing and Calico Printing Co. Ltd. and 82 ordinary
shares of Karamchand Premchand Private Ltd., the total cost
of purchase being Rs. 1,81,106. On March 22, 1973, the
assessee introduced the two share holdings in the
partnership firm as his capital contribution ant the firm
credited his account with the market value of the shares,
namely Rs. 475,136. In the assessment proceedings for the
assessment year 1973-74, the Income Tax Officer took the
view that the contribution by the assessee of the shares to
the assets of the partnership constituted a transfer within
the meaning of sub-section (47) of D section 2 of the Income
Tax Act, 1961 and that the assessee was liable to income tax
on a capital gain of Rs. 2,94,030, being the difference
between the market price at which the shares were entered in
the books of the partnership firm and the cost of the shares
to the assessee. The appeal before the Appellate Assistant
Commissioner failed, but in second appeal, the Appellate
Tribunal took the view that there was no transfer of a
capital asset within the meaning of section 45 read with
sub-section (47) of section 2 of the Income Tax Act and
consequently deleted the item from the assessment. In the
circumstances the Tribunal did not go into the question
whether the transfer was without consideration. At the
instance of the Commissioner of Income Tax a reference was
made to the High Court on the correctness of the Tribunal’s
views. By a common judgment dated April 30/May 1 and 4, 1981
the High Court answered the questions referred in favour of
the Revenue ant against the assessee. Hence the appeals by
special leave of the Court,
Allowing the appeals in part, the Court
^
HELD: 1.1 When the assessee brought the shares of the
limited companies into the partnership firm as his
contribution to its capital, there was a transfer within the
meaning of sub-section (47) of section 2 of the Income Tax
Act, 1961, of a capital asset within the terms of section 45
of the Act.
104
1.2 It is well settled that a partnership firm is not a
separate legal entity ant that the assets owned by the
partner ship are collectively owned by the partners and that
when a partner hands over a business asset to the
partnership firm as his contribution to its capital, he
cannot be said to have effected a sale. [113 A-B; G-H]
Malabar Fisheries Co. v. Commissioner of Income Tax,
Kerala, (1979) 120 ITR 49; Commissioner of Income Tax, West
Bengal v. Hind Construction Ltd. (1972) 83 ITR 211 (SC)
referred to.
Commissioner of Income Tax, Madras v. Janab N. Hyath
Batcha Sahiv, (1969) 72 ITR 528 (Madras); Commissioner of
Income Tax (Madras) - I v. Abdul Khader Motor and Lorry
Service (1978) 112 ITR 360 (Madras); Dr. M.C. Kackkar v.
Commissioner of Income Tax, Kanpur and Ors. (1973) 92 ITR 87
(Allahabad); Commissioner of Income Tax, Kerala v. C.M.
Khunhameed (1974) 94 ITR 179 (Kerala) approved.
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1.3 But while the transaction may not amount to a sale,
it can be described as a transfer of some other kind. m e
definition of the expression transfer in sub-section (47) of
section 2 of the Income Tax Act, 1961 is inclusive merely
and does not exhaust other kinds of transfer. [114 A-B]
1.4 In its general sense, the expression transfer of
property" connotes the passing of rights in the 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 may 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 it would seem that there is a transfer of
interest. Therefore when a partner brings in his personal
asset into the capital of the partnership firm as his
contribution to its capital he reduces his exclusive rights
in the asset to shared rights in it with the other partners
of the firm. While he does not lose his rights in the asset
altogether what he enjoys now is an abridged right which
cannot be identified with the fulness of the right which he
enjoyed in the asset
105
before it entered the partnership capital. When a partner
brings in his personal asset into a partnership firm as his
contribution to its capital, an asset which originally was
subject to the entire ownership of the partner becomes w
subject to the rights of other partners in it. It is not an
interest which can be evaluated immediately. It is an
interest which is subject to the operation of future
transactions of the partnership, and it may diminish in
value depending on accumulating liabilities and losses with
a fall in the prosperity of the partnership firm. The
evaluation of a partner’s interest takes place only when
there is a dissolution of the firm or upon his retirement
from it. Upon the dissolution of the firm or upon the
partner retiring from the firm, the partner’s right to
realise the interest and receive its value arises. What is
realized is the interest which the partner enjoys in the
assets during the subsistence of the partnership firm by
virtue of his status as a partner and in accordance with the
terms of the partnership agreement. It is because that
interest exists already before dissolution that the
distribution of the assets on dissolution does not amount to
a transfer to the erstwhile partners. What the partner gets
upon dissolution or upon retirement is the realisation of a
pre-existing 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 in the partnership capital transformed into a
shared interest 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. But the position is different when a partner
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retires or the partnership is dissolved. What the partner
receives then is his share in the partnership. What is
contemplated here is a share of the partner qua the net
assets of the partnership firm. On evaluation, that share in
a particular case may be realised by the receipt of only one
of all the assets. What happens here is that a shared
interest in all the assets of the firm is replaced by an
exclusive interest in an asset of equal value. That is why
it has been held that there is no transfer. It is the
realisation of a pre-existing right. The position is
different, when a partner brings his personal asset into the
partnership firm as
106
his contribution to its capital. An individual asset is the
sole subject of consideration. An exclusive interest in it
before it enters the partnership is reduced on such entry
into a shared interest. [114 D-G; 116 A-F; 117 B-D]
Addanki Narayanappa & Anr. v. Bhaskara Krishtappa and
13 Ors. [1966] 3 SCR 400; Malabar Fisheries Co. v.
Commissioner of Income Tax, Kerala (1979) 120 ITR 49 (SC)
referred to.
Commissioner of Income-Tax, Madras-I v. Abdul Khader
Motor and Lorry Service (1978) 112 ITR 360 (Madras); and
Commissioner of Income Tax, Tamil Nadu IV, Madras v. H.
Kannan (1984) 149 ITR 545 (Madras) partly overruled.
Commissioner of Income Tax, Madhya Pradesh, Nagpur and
Bhandara v. Dewas Cine Corporation (1968) 68 ITR 240 (SC);
Commissioner of Income Tax, Kerala v. Nataraj Motor Service
(1972) ITR 109 (Kerala) Commissioner of Income Tax, Gujarat
v. Mohanbhai Pamabhai (1973) 91 ITR 393 (Gujarat)
distinguished.
A. Abdul Rahim, Travancore Confectionery Works v.
Commissioner of Income Tax, Kerala (1977) 110 ITR 595
(Kerala); Addl. Commissioner of Income Tax, Mysore v. M.A.J.
Vasanaik (1979) 116 ITR 110 (Kerala) approved.
Firm Ram Sahay Mall Rameshwar Dayal & Ors. v.
Bishwanath Prasad, AIR 1963 Patna 221; Sudhansu Kanta v.
Manindra Nath, AIR 1965 Patna 144 explained.
2.1 When the Assessee transferred his shares to the
partnership firm he received no consideration within the
meaning of section 48 of the Income Tax Act, 1961 nor did
any profit or gain accrue to him for the purpose of section
45 of the Income Tax Act, 1961- [118 A-B]
2.2 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 a share in the net
partnership assets as on the date of the dissolution or
retirement after a reduction of liabilities ant prior
charges. The credit entry mate in the partner’s capital
account in the books of the partnership firm does not
represent the true value of the consideration. It is a
notional value only,
107
intended to be taken into account at the time of determining
the A value of the partner’s share in the net partnership
assets on the date of dissolution or on his retirement, a
share which will depend upon a deduction of the liabilities
and prior charges existing on the date of dissolution or
retirement. It is not possible to predicate before hand what
will be the position in terms of monetary value of a
partner’s share on that date. At the time when the partner
transfers his personal asset to the partnership firm, there
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can be no reckoning of the liabilities ant losses which the
firm may suffer in the years to come. All that lies within
the womb of the future. It is impossible to conceive of
evaluating the consideration acquired by the partner when he
brings his personal asset into the partnership firm when
neither the date of dissolution or retirement can be
envisaged nor can there by any ascertainment of liabilities
and prior charges which may not have even arisen yet.
Therefore, the consideration which a partner acquires on
making over his personal asset to the partnership firm as
his contribution to its capital cannot fall within the terms
of section 48. And as that provision is fundamental to the
computation machinery incorporated in the scheme relating to
the determination of the charge provided in section 45, such
a case must be regarded as falling outside the scope of
capital gains taxation altogether. [118 E-H; 119 A-C]
Commissioner of Income Tax, Bangalore v. B.C. Srinivasa
Setty (1981) 128 ITR 294 referred to.
2.3 Applying the principle that profits or gains under
the Income Tax Act must be understood in the sense of real
profits or gains, that is to say, on the basis of ordinary
commercial principles on which actual profits are computed,
a sense in which no commercial man would misunderstand, and
having regard to the nature and quality of the consideration
which the partner may be said to acquire on introducing his
personal asset into the partnership firm as his contribution
to its capital, it cannot be said that any income or gain
arises or accrues to the assessee in the true commercial
sense which a businessman would understand as real income or
gain. Of course, the partnership firm in question mu t be a
genuine firm and not the result of a sham or unreal
transaction, and the transfer by the partner of his personal
asset to tee partnership firm must represent a genuine
intention to contribute to the share capital of the firm for
the purpose of carrying on the partnership business. [120 A-
B; 119 C-D]
Miss Dhun Dadabhoy Kapadia v. Commissioner of Income-
Tax, Bombay (1967) 63 ITR 651 (SC); Calcutta Co. Ltd. v.
Commissioner of Income-Tax, West Bengal, (1959) 37 ITR 1 SC;
Commissioner of
108
Income Tax v. Bai Shirinbai K. Kooka, (1962) 46 ITR 86 SC;
Poona Electric Supply Co. Ltd. v. Commissioner of Income-
Tax, Bombay City I, (1965) 57 ITR 521 SC; Commissioner of
Income-Tax, West Bengal II v. Birla Gwalior (P) Ltd. (1973)
89 ITR 266 SC; Bafna Textiles v. Income Tax Officer,
Assessment-4, Circle II, Bangalore (1975) 98 ITR 209 SC
referred to.
2.4 If the transfer of a personal asset by the assessee
to a partnership in which he is or becomes a partner is
merely a device or ruse for converting the asset into money
which would substantially remain available for his benefit
without liability to income tax on a capital gain, it will
be open to the income tax authorities to go behind the
transaction and examine whether the transaction of creating
the partnership is a genuine or a sham transaction and, even
where the partnership is genuine, the transaction of
transferring the personal asset to the partnership firm
represents a real attempt to contribute to the share capital
of the partnership firm for the purpose of carrying on the
partnership business or is nothing but a device or ruse to
convert the personal asset into money substantially for the
benefit of the assessee while evading tax on a capital gain
121 E-G]
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JUDGMENT:
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1841 of
1981.
From the Judgment and Order dated 30.4.1981, 1/4.5.1981
of the Gujarat High Court in Income Tax Reference No. 235 of
1980.
AND
Civil Appeal No. 1777 of 1981.
From the Judgment and Order dated 30.4.1981, 4.5.1981
of the Gujarat High Court in Income Tax Reference No. 34 of
1980.
V.S. Desai, J.P. Shah, P.H. Parekh and Gautam Phliph
for the Appellant in C.A. No. 1841 of 1981.
M.K. Vanerjee, Additional Solicitor General, S.T.
Desai, P.A. Francis, and Miss A. Subhashini for the
Respondent in C.A. No. 1841 of 1981.
J.P. Shah and P.H. Parekh for the Intervener in C.A.
No. u 1841 of 1981.
109
V.S. Desai, S.P. Mehta and Mrs. A.K. Verma for the
Appellant in C.A. No. 1777 of 1981.
S.T. Desai, and Miss A. Subhashini for the Respondent
in C.A. No. 1777 of 1981.
T.A. Ramachandran, Mrs. J. Ramachandran, H.K. Kaji and
S.C. Patel for the Intervener in C.A. No. 1777 of 1981.
The Judgment of the Court was delivered by
PATHAK, J. This and the connected appeal, filed by
certificate granted by the High Court, raise the interesting
question whether the capital contribution by a partner to
the assets of a partnership firm at an appreciated value can
be said to give rise to a capital gain in his hands liable
to income-tax.
In Civil Appeal No. 1841 of 1981, the facts are as
follows. The appellant, who is the assessee, was a partner
in Messrs. Suvas Trading Company, a partnership firm
constituted under a deed of partnership dated September 27,
1973. As his contribution to the capital of the partnership
firm the assessee made over certain shares of limited
companies which were held by him as his capital assets. The
book value of those shares in his account books was shown as
Rs. 1,60,279, but on the date when he contributed those
shares to the partnership firm he revalued the shares at the
market value of Rs. 1,49,819 and debited the resulting
difference of Rs. 10,460 to his capital account.
The Income Tax Officer, when drawing up the assessment
order for the assessment year 1974-75 in respect of the
assessee, did not include the difference in the assessable
income. The Commissioner of Income-Tax, however, being of
opinion that the difference between the market value of the
shares and the cost of acquisition of the shares to the
assessee should have been brought to tax as capital gains in
view of s. 45 of the Income Tax Act, 1961, exercised his
revisional jurisdiction, and reopening the assessment he
remanded the case to the Income Tax Officer directing him to
revise the assessment after computing the capital gains
arising out of the transfer. The assessee appealed to the
Income Tax Appellate Tribunal, and the Appellate Tribunal
held that while the transaction did amount to a transfer
within the meaning of sub-s.(47) of s.2 of the Income Tax
Act it did not result in capital gains liable to tax. The
Appellate Tribunal allowed the appeal and set aside the
order of the Income
110
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Tax Officer. Subsequently the Appellate Tribunal referred
the case to the High Court of Gujarat for its opinion on the
following questions of law:
1 Whether, on the facts and in the circumstances
of the case, the Income Tax Appellate Tribunal was
right in law in holding that no capital gains
resulted from the transfer of the shares held by
the assessee to the partnership firm as his
capital contribution, the cost of acquisition of
the shares to the assessee being Rs. 1,49,819 and
the market value of the shares being Rs. 1,60,279?
2. Whether, on the facts and in the Circumstances
of the case, the Tribunal was right in law in
holding that there was a transfer within the
meaning of sub-s.(47) of s.2 of the Income Tax
Act, 1961 of the shares contributed by the
assessee as capital to the partnership firm in
which he was a partner?
In Civil Appeal No. 1777 of 1981, the appellant was a
partner in a registered partnership firm, Messrs. Rajka, or
which the other partner was his wife. m e partnership was
constituted under an agreement dated February 25, 1973. The
partnership deed recited that the partnership business had
commenced on January 1, 1973, that it was a partnership at
will and further provided that the assessee would initially
contribute Rs. 9,000 in cash to the share capital of the
firm and his wife would contribute Rs. 1,000 in cash. It was
provided that when any addition to the capital was required
for the purposes of the partnership, the partners would
contribute such additional capital from time to time. It was
further provided that if any asset was brought in by a
partner as capital contribution the account of such partner
would be credited with the fair market value on the date the
asset was brought in. The assessee had in his possession 80
ordinary shares of the Ahmedabad Manufacturing and Calico
Printing Company Limited which had been purchased at Rs.
1,55,440. He had-also 82 ordinary shares of Karamchand
Premchand Private Limited purchased at Rs. 25,666. The total
cost was Rs. 1,81,106
on March 22, 1973 the market value of a share of the
Ahmedabad Manufacturing and Calico Printing Company Limited
was Rs. 442 and that of a share of Karamchand Premchand
Private Limited was Rs. 2,668. On that day, the assessee
introduced the
111
two shareholdings in the partnership firm as his capital
contribution, and the firm credited his account with the
market value of the shares, namely Rs. 4,75,136.
In the assessment proceedings for the assessment year
1973-74, the Income Tax Officer took the view that the
contribution by the assessee of the shares to the asset of
the partnership firm constituted a transfer within the
meaning of sub-s.(47) of s. 2 of the Income Tax Act, 1961
and that the assessee was liable to income tax on a capital
gain of Rs. 2,94,030 being the difference between the market
price at which the shares were entered in the books of the
partnership firm and the cost of the shares to the assessee.
The assessee appealed to the Appellate Assistant
Commissioner of Income Tax, but the appeal was dismissed. In
second appeal, however, the Income Tax Appellate Tribunal
took the view that there was no transfer of a capital asset
within the meaning of s.45 read with sub-s.(47) of s.2 of
the Income Tax Act and consequently he deleted the item from
the assessment. In the circumstances, the Appellate Tribunal
did not go into the question whether the transfer was
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without consideration. The Commissioner of Income Tax
obtained a reference to the High Court of Gujarat on the
following questions of law:
1. Whether, on the facts and in the circumstances
of E the case, the Appellate Tribunal was right in
law in holding that the contribution in the form
of shares of the value of Rs. 4,75,136 by the
assessee in the partnership firm of Messrs. Rajka
did not amount to a transfer within the meaning of
sub-s.(47) of s. 2 of the Act resulting in capital
gains chargeable to tax?
2. If the reply to question No. 1 is in favour of
the Revenue, whether the Tribunal erred in not
considering whether the transfer is with or
without consideration?
By a common judgment dated April 30/May 1 and 4, 1981 the
High Court answered the questions in favour of the Revenue
and against the assessee.
Section 45 of the Income Tax Act, 1961 provides:
"45. (1) Any profits or gains arising from the
transfer of a capital asset effected in the
previous year shall, save as otherwise provided in
sections 53,
112
54 and 54B and 54D, be chargeable to income-tax
under the head Capital gains , and shall be deemed
to be the income of the previous year in which the
transfer took place".
Section 48 of the Act provides:-
"48. The income chargeable under the head Capital
gains shall be computed by deducting from the full
value of the consideration received or accruing as
a result of the transfer of the capital asset the
following amounts, namely:-
(i) expenditure incurred wholly and exclusively in
connection with such transfer;
(ii) the cost of the acquisition of the capital
asset and the cost of any improvement thereto.
Learned counsel for the assessee contends that in order
to attract tax under the head Capital gains , s. 45 must be
read with s.48 and therefore three cumulative conditions
must be fulfilled:-
1. There must be a transfer of a capital asset,
either under the general law or within the
definition in sub-s.(47) of s.2 of the Income Tax
Act.
2. Consideration must be received or must accrue
as a result of the transfer, and the consideration
must be capable of being determined in monetary
terms in order that the computation of capital
gains may be as required by s. 48.
3. Profits or gains must arise from the transfer
and must be embedded in the consideration.
It is urged that if any of the three conditions remains
unfulfilled no charge can be levied under the head "Capital
gains .
In support of the submission that there is no
"transfer" in the general sense of that term when a partner
brings his personal assets into-the firm as his contribution
towards its capital,
113
learned counsel points out that a partnership firm is not a
separate legal entity and that the assets owned by the
partnership are collectively owned by the partners. We have
no hesitation in accepting that proposition for in Malabar
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Fisheries Co. v. Commissioner of Income-Tax, Kerala (1979)
120 I.T.R. 49 SC, this Court observed:-
.......... It seems to us clear that a partnership
firm under the Indian Partnership Act, 1932, is
not a distinct legal entity apart from the
partners constituting it and equally in law the
firm as such has no separate right of its own in
the partnership assets and when one talks of the
firm’s property or firm’s assets all that is meant
is property or assets in which all the partners
have a Joint or common interest.
Our attention has been invited to Commissioner of
Income Tax, West Bengal v. Hind Construction Ltd., (1972) 83
I.T.R. 211. In that case the assessee entered into a
partnership and as its share of the capital it transferred
the stock of machinery to the partnership firm. This Court
held that when the assessee made over its machinery to the
partnership firm there was no sale and the assessee did not
derive any income. In Commissioner of Income-Tax, Madras v.
Janab N. Hyath Batcha Sahib, (1969) I.T.R. 528, the Madras
High Court held that when a partner introduces his property
into a partnership firm as his contribution to its capital
the transaction does not involve a sale of the property. The
High Court referred to B. 14 of the Indian Partnership act
and observed:-
When a partnership is formed for the first time
and one of the members of the partnership brings
into the firm assets, they become the property of
the firm, not by any transfer, but by the very
intention of the parties evinced in the agreement
between them to treat such property belonging to
one or more of the members of the partnership as
that of the firm-
The view that when a partner hands over a business asset to
the partnership firm as his contribution to its capital he
cannot be said to have effected a sale was also taken by the
Allahabad High Court in Dr. M.C. Kackkar v. Commissioner of
Income-Tax, Kanpur and Others, (1973) 92 I.T.R. 87, the
Kerala High Court in Commissioner of Income-Tax, Kerala v.
C.M. Kunhammed (1974) 94 I.T.R. 179 and by the Madras High
Court in Commissioner of Income-Tax, Madras-l v. Abdul
Khader Motor ant Lorry Service,
114
(1978) 112 I.T.R. 360. We find no difficulty in accepting
that proposition. But while the transaction may not amount
to a sale, can it be described as a transfer of some other
kind? Illustrations of other kinds of transfer are provided
by sub-s.(47) of s.2 of the Income Tax Act which defines the
expression transfer in relation to a capital asset as
including the sale exchange or relinquishment of the asset
or the extinguishment of any rights therein or the
compulsory acquisition thereof under any law. The definition
is inclusive merely, and does not exhaust other kinds of
transfer. Its inclusive character was overlooked by the
Madras High Court in Commissioner of Income-Tax, Madras-I
(supra) and in Commissioner of Income-Tax, Tamil Nadu-IV,
Madras v. H. Rajan and H. Kannan, (1984) 149 I.T.R. 545. In
both cases the High Court confined itself to considering
whether the transaction before it was covered by any of the
express terms used in the definition, that is to say, sale,
exchange relinquishment or extinguishment, and taking the
view that it did not fall under any of them it held that
there was no transfer.
In its general sense, the expression transfer of
property connotes the passing of rights in the property from
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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
may 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 it would seem that there is a transfer of
interest. Therefore when a partner brings in his personal
asset into the capital of the partnership firm as his
contribution to its capital he reduces his exclusive rights
in the asset to shared rights in it with the other partners
of the firm. While he does not lose his rights in the asset
altogether what he enjoys now is an abridged right which
cannot be identified with the fullness of the right which he
enjoyed in the asset before it entered the partnership
capital. In Addanki Narayanappa & Anr. v. Bhaskara
Krishtappa and 13 Ors. [1966] 3 S.C.R. 400., this Court
explained:-
........ whatever may be the character of the
property which is brought in by the partners when
the partnership is formed or which may be acquired
in the
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course of the business of the partnership it
becomes the property of the firm and what a
partner is entitled to is his share of profits, if
any, accruing, to the partnership from the
realisation of this property, and upon dissolution
of the partnership to a share in the money
representing the value of the property. No doubt,
since a firm has no legal existence, the
partnership property will vest in all the partners
and in that sense every partner has an interest in
the property of the partnership. during the
subsistence of the partnership, however, no
partner can deal with any portion of the property
as his own. Nor can he assign his interest in a
specific item of the partnership property to
anyone. His right is to obtain such profits, if
any, as fall to his share from time to time and
upon the dissolution of the firm to a share in the
assets of the firm which remain after satisfying
the liabilities set out in cl.(a) and sub-
cls.(i),(ii) of cl.(b) of s. 48.
The position was elaborated later in the same judgment
as follows:
The whole concept of partnership is to embark upon
a joint venture and for that purpose to bring in
as capital money or even property including
immovable property. Once that is done whatever is
brought in would cease to be the exclusive
property of the person who brought it in. It would
be the trading asset of the partnership in which
all the partners would have interest in proportion
to their share in the joint venture of the
business of partnership. The person who brought it
in would, therefore, not be able to claim or
exercise any exclusive right over any property
which he has brought in, much less over any other
partnership property. He would not be able to
exercise his right even to the extent of his share
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in the business of the partnership. As already
stated, his right during the subsistence of the
partnership is to get his share of profits from
time to time as may be agreed upon among the
partners and after the dissolution of the
partnership or with his retirement from
partnership of the value of his share in the net
partnership assets as on the date of dissolution
of retirement after a deduction of liabilities and
prior charges.
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It is apparent, therefore, that when a partner brings in his
personal asset into a partnership firm as his contribution
to its capital, an asset which originally was subject to the
entire ownership of the partner becomes now subject to the
rights of other partners in it. It is not an interest which
can be evaluated immediately, it is an interest which is
subject to the operation of future transactions of the
partnership, and it may diminish in value depending on
accumulating liabilities and losses with a fall in the
prosperity of the partnership firm. The evaluation of a
partner’s interest takes place only when there is a
dissolution of the firm or upon his retirement from it. It
has some times been said, and we think erroneously, that the
right of a partner to a share in the assets of the
partnership firm arises upon dissolution of the firm or upon
the partner retiring from the firm. We think it necessary to
state that what is envisaged here is merely the right to
realise the interest and receive its value. What is realised
is the interest which the partner enjoys in the assets
during the subsistence of the partnership firm by virtue of
his status as a partner and in accordance with the terms of
the partnership agreement. It is because that interest
exists already before dissolution, as was held by this Court
in Malabar Fisheries Co. (supra), that the distribution of
the assets on dissolution does not amount to a transfer to
the erstwhile partners. What the partner gets upon
dissolution or upon retirement is the realisation of a pre-
existing 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 a
shared interest 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.
Learned counsel for the assessee has attempted to draw
an analogy between the position arising when a personal
asset is brought by a partner into a partnership as his
contribution to the partnership capital and that which
arises when on dissolution of the firm or on retirement a
share in the partnership assets
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passes to the erstwhile partner. It has been held by this
Court in Commissioner of Income-Tax, Madhya Pradesh, Nagpur
and Bhandra v. Dewas Cine Corporation, (1968) 68 I.T.R. 240,
Commissioner of Income-Tax, U.P. v. Bankey Lal Vaidya,
(1971) 79 I.T.R. 594 and recently in Malabar Fisheries Co.
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(supra) as well as by the Punjab and Haryana High Court in
Kay Engineering Co. v. Commissioner of Income-Tax, Patiala,
(1971) 82 I.T.R. 950 the Kerala High Court in Commissioner
of Income Tax, Kerala v. Nataraj Motor Service (1972) 86
I.T.R. 109, and the Gujarat High Court in Commissioner of
Income-Tax Gujarat v. Mohanbhai Pamabhai (1973) 91 I.T.R.
393 that when a partner retires or the partnership is
dissolved what the partner receives is his share in the
partnership. What is contemplated here is a share of the
partner qua the net assets of the partnership firm. On
evaluation, that share in a particular case may be realised
by the receipt of only one of all the assets. What happens
here is that a shared interest in all the assets of the firm
is replaced by an exclusive interest in an asset of equal
value. That is why it has been held that there is no
transfer. It is the realisation of a pre-existing right. The
position is different, it seems to us, when a partner brings
his personal asset into the partnership firm as his
contribution to its capital. An individual asset is the sole
subject of consideration. An exclusive interest in it before
it enters the partnership is reduced on such entry into a
shared interest.
Our attention has also been invited to clause (b) of
sub-s.(l) of s. 17 of the Registration Act which requires
the registration of non-testamentary instruments which
purport or operate to create declare assign limit or
extinguish whether in present or in future, any right, title
or interest whether vested or contingent, of the value of
one hundred rupees and upwards, to or in immovable property,
and to the view taken by the courts in this country that
when a person brings in even his immovable property as his
contribution to the capital of the firm no written document
or registration is required under that clause. That view,
was expressed in Firm Ram Sahay Mall Rameshwar Dayal and
Others v. Bishwanath Prasad, A.I.R. 1963 Patna 221. The
learned Judges relied on the English law that the personal
assets introduced by a partner into the firm as his
contribution to its capital becomes the property of the firm
by reason of the intention and agreement of the parties. The
view does not spring from the consideration that there is no
transfer. The view is that no document of transfer is
required and that, therefore, registration is unnecessary.
The Patna High Court reiterated that view in Sudhansu Kanta
v. Manindra Nath A.I.R. 1965 Patna 144.
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Accordingly we hold that when the assessee brought the
shares of the limited companies into the partnership firm as
his contribution to its capital there was a transfer of a
capital asset within the terms of s.45 of the Income Tax
Act. In this view of the matter we agree with the conclusion
reached by the Kerala High Court in A. Abdul Rahim,
Travancore Confectionery Works v. Commissioner of Income-
Tax, Kerala, (1977) 110 I.T.R. 595 the Karnataka High Court
in Addl. Commissioner of Income-Tax, Mysore v. M.A.J.
Vasanaik, (1979) 116 I.T.R. 110 and by the Gujarat High
Court in the judgment under appeal.
The second question is whether the assessee can be said
to have received any consideration as that expression is
understood in the scheme of capital gains under the Income-
Tax Act. In Commissioner of Income-Tax, Bangalore v. B.C.
Srinivasa Setty, (1981) 128 I.T.R. 294, this Court observed
that the charging section and the computation provisions
under each head of income constitute an integrated code, and
when there is a case to which the computation provisions
cannot apply at all it is evident that such a case was not
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intended to fall within the charging section. On the basis
of that proposition learned counsel for the assessee has
urged that s.45 is not attracted in the present case because
to compute the profits or gains under s.48 the value of the
consideration received by the assessee or accruing to him as
a result of the transfer of the capital asset must be
capable of ascertainment in monetary terms. 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 a share in the net partnership assets as on
the date of the dissolution or retirement after a 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. It is notional value only, intended to be
taken into account at the time of determining the value of
the partner’s share in the net partnership assets on the
date of dissolution or on his retirement, a share which will
depend upon a deduction of the liabilities and prior charges
existing on the date of dissolution or retirement. It is not
possible to predicate before hand what will be the position
in terms of monetary value of a partner’s share on that
date. At the time when the partner transfers his personal
asset to the partnership firm, there can be no reckoning of
the liabilities and losses which the firm may suffer in the
years to
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come. All that lies within the womb of the future. It is
impossible to conceive of evaluating the consideration
acquired by the partner when he brings his personal asset
into the partnership firm when neither the date of
dissolution or retirement can be envisaged nor can there be
any ascertainment of liabilities and prior charges which may
not have even arisen yet. In the circumstances, we are
unable to hold that the consideration which a partner
acquires on making over his personal asset to the
partnership firm as his contribution to its capital can fall
within the terms of s.48. And as that provision is
fundamental to the computation machinery incorporated in the
scheme relating to the determination of the charge provided
in s.45, such a case must be regarded as falling outside the
scope of capital gains taxation altogether.
The third contention of learned counsel for the
assessee is that no profit or gain car. be said to arise to
a partner when he brings his personal asset into a
partnership firm as his contribution to its capital. It is
urged that the capital gains chargeable under s.45 are real
capital gains computed on the ordinary principles of
commercial accounting and that the capital gains must be
embedded in the capital asset. In Miss Dhun Dadabhoy Kapadia
v. Commissioner of Income-Tax, Bombay, (1967) 63 I.T.R..
651, the appellant held by way of investment some ordinary
shares in a limited company. An offer was made by the
company to her by which she was entitled to apply for an
equal number of new ordinary shares at a premium with an
option of either taking the shares or renouncing them in
favour of others. The appellant renounced her rights to all
the shares and realised Rs. 45,262.50. When this amount was
sought to be wholly taxed as a capital gain the appellant
claimed that on the issue of the new shares the value of her
old shares depreciated and that as a result of the
depreciation she suffered a capital loss in the old shares
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which she was entitled to set off against the capital gain
of Rs. 45,262.50. In the alternative she claimed that the
right to receive the new shares was a right which was
embedded in her old shares and consequently when she
realised the sum of Rs. 45,262.50 by selling her right, the
capital gain should be computed after deducting from that
amount the value of the embedded right which became
liquidated. This Court upheld the claim of the appellant
that she was entitled to deduct from the sum of Rs.
45,262.50 the loss suffered by way of depreciation in the
old shares. The Court proceeded on the basis that in working
out capital gain or loss, the principles which had to be
applied are those which are a part of commercial practice or
which an
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ordinary man of business would resort to when making
computation for his business purposes. It will be noticed
that this principle was applied by the Court in a case where
a capital gain was sought to be taxed under the Income Tax
Act. That profits or gains under the Income Tax Act must be
understood in the sense of real profits or gains, that is to
say, on the basis of ordinary commercial principles on which
actual profits are computed, a sense in which no commercial
man would misunderstand, has been regarded as a principle of
general application, and there is a catena of cases of this
Court which affirms that principle. Reference may be made to
Calcutta Co. Ltd. v. Commissioner of Income-Tax, West
Bengal, (1959) 37 I.T.R. 1, Commissioner of Income-Tax v.Bai
Shirinbai K. Kooka, (1962) 46 I.T.R. 86, Poona Electric
Supply Co. Ltd. v. Commissioner of Income-Tax, Bombay City
I, (1965) 57 I.T.R. 521, Commissioner of Income-Tax, West
Bengal II v. Birla Gwalior (P) Ltd. (1973) 89 I.T.R. 266 and
Bafna Textiles v. Income-Tax officer, Assessment-4, Circle
II, Bangalore, (1975) 98 I.T.R. 209.
What is the profit or gain which can be said to accrue
or arise to the assessee when he makes over his personal
asset to the partnership firm as his contribution to its
capital? The consideration, as we have observed, is the
right of a partner during the subsistence of the partnership
to get his share of profits from time to time and after the
dissolution of the partnership or with his retirement from
the partnership to receive the value of the share in the net
partnership assets as on the date of dissolution or
retirement after a deduction of liabilities and prior
charges. When his personal asset merges into the capital of
the partnership firm a corresponding credit entry is made in
the partner’s capital account in the books of the
partnership firm, but that entry is made merely for the
purpose of adjusting the rights of the partners inter-se
when the partnership is dissolved or the partner retires. It
evidences no debt due by the firm to the partner. Indeed,
the capital represented by the notional entry to the credit
of the partner’s account may be completely wiped out by
losses which may be subsequently incurred by the firm, even
in the very accounting year in which the capital account is
credited. Having regard to the nature and quality of the
consideration which the partner may be said to acquire on
introducing his personal asset into the partnership firm as
his contribution to its capital it cannot be said that any
income or gain arises or accrues to the assessee in the true
commercial sense which a business man would understand as
real income or gain.
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An objection has been taken by learned counsel for the
respondent to this submission being raised before us
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because, it is said, the question has neither been referred
to his Court nor was it ever argued at any earlier stage. We
are not impressed by the objection because we think that it
constitutes one aspect of the questions which have been
referred in these cases. The point rests on considerations
purely of law and is fundamental to the question whether
capital gain arises to an assessee upon the transfer of his
shares to the partnership firm as his capital contribution.
The objection is, therefore, over-ruled.
Inasmuch as we are of opinion that the consideration
received by the assessee on the transfer of his shares to
the partnership firm dies not fall within the contemplation
of s.48 of the Income-Tax Act, and further that no profit or
gain can be said to arise for the purposes of the Income-Tax
Act, we hold that these cases fall outside the scope of s.45
of the Act altogether.
We have decided these appeals on the assumption that
the partnership firm in question is a genuine firm and not
the result of a sham or unreal transaction, and that the
transfer by the partner of his personal asset to the
partnership firm represents a genuine intention to
contribute to the share capital of the firm for the purpose
of carrying on the partnership business. If the transfer of
the personal asset by the assessee to a partnership in which
he is or becomes a partner is merely a device or ruse for
converting the asset into money which would substantially
remain available-for his benefit without liability to income
tax on a capital gain, it will be open to the income tax
authorities to go behind the transaction and examine whether
the transaction of creating the partnership is a genuine or
a sham transaction and, even where the partnership is
genuine the transaction of transferring the personal asset
to the partnership firm represents a real attempt to
contribute to the share capital of the partnership firm for
the purpose of carrying on the partnership business or is
nothing but a device or ruse to convert the personal asset
into money substantially for the benefit of the assessee
while evading tax on a capital gain. The income Tax Officer
will be entitled to consider all the relevant indicia in
this regard, whether the partnership is formed between the
assessee and his wife and children or substantially limited
to them, whether the personal asset is sold by the
partnership firm soon after it is transferred by the
assessee to it, whether the partnership firm has no
substantial or real business or the
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record shows that there was no real need of the partnership
firm for such capital contribution from the assessee. ALL
these and other pertinent considerations may be taken into
regard when the Income Tax Officer enters upon a scrutiny of
the transaction, for in the task of determining whether a
transaction is a sham or illusory transaction or a device or
ruse he is entitled to penetrate the veil covering it and
ascertain the truth.
In the result, the questions which arise in these
appeals are answered as follows:-
1. There was a transfer of the shares when the
assessee made them over to the partnership firm as
his capital contribution.
2. When the assessee transferred his shares to the
partnership firm he received no consideration
within the meaning of s.48 of the Income-Tax Act
1961 nor did any profit or gain accrue to him for
the purpose of s.45 of the Income-Tax Act, 1961.
These answers are given by us subject to the reservations
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made by us in the preceding paragraph.
The appeals are partly allowed and there is no order as
to costs.
S.R. Appeals partly allowed.
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