T. SATYANARAYANA MURTY v. INCOME TAX OFFICER
[Citation -1985-LL-1231-1]

Citation 1985-LL-1231-1
Appellant Name T. SATYANARAYANA MURTY
Respondent Name INCOME TAX OFFICER
Court ITAT
Relevant Act Income-tax
Date of Order 31/12/1985
Assessment Year 1980-81
Judgment View Judgment
Keyword Tags relinquishment of rights • full-fledged partner • transfer of property • leasehold property • fair market value • long-term capital • mutual agreement • capital account • credit balance • share capital • book value • karta
Bot Summary: Each of the partners was having equal shares in the said firm and the said firm had run the cinema business with equal shares for 16 years, i. e., from 1-3-1962 t o 25-7-1978. Before the date of reconstitution, the firm owed Rs. 35,000 to Shri K. Narayanaraju son of Nagaiah Garu Rs. 33,000 to Shri G. Haranadh son of l a t e Butchi Venkateswarlu, minor, and Rs. 33,000 to Shri G. Venkata Madhavaraju son of late Ramalakshmamma Garu on three separate promotes date 27-7-1978, though the firm undertook to pay the said amounts to the above- said parties' creditors of the firm before 4-3-1979 they were not able to do so and the said creditors were pressing for repayment of those loans or alternatively they sought admission as partners of the firm for which all the existing partners agreed. According to the terms of reconstituted firm under the deed dated 28-4- 1979, the assessee-HUF had to contribute only the share capital of Rs. 1,05,000 whereas in fact the assessee-company was having a credit balance of Rs. 2,10,000 in its capital account of the firm. Simply because, the new partners brought in their capital before becoming the partners of the firm and simply because the total of the capital brought in by them is either the same or merely the same amount which the partner restricting his share withdraws from out of his capital account on account of its being in excess of the prescribed capital amount, if there was to be a transfer, then the question is, who is the transferee The newly introduced partners certainly cannot be stated to be the transfers as they did not pay anything to the assessee or a sum of Rs. 1,05,000 withdrawn by the assessee is not their money. At the time o formation of the partnership, the assessee was found to be having more capital than what it was under an obligation to contribute to carry on the business of the firm and the assessee withdrew the excess capital found in its capital account. The Hon'ble Supreme Court held that though a transfer is involved in the act of investing shares held by the assessee towards his capital in the firm consideration received by the assessee on the transfer of his shares to the partnership firm does not fall within the contemplation of section 48 of the Act and further no profit or gain can be said to arise for the purposes of the Act. Over and above everything, the Hon'ble Supreme Court categorically held that even in the case of relinquishment of rights of the assessee in favour of the firm, no transfer is involved and no capital gains tax can be exigible in such cases.


This is assessee's appeal directed against order of AAC dated 2-12-1983 and it relates to assessment year 1980-81. assessee is HUF. facts leading to this present appeal are stated as under. 2. assessee-HUF and one Tatavarthi Raja were originally partners in firm called Brundawan Talkies, Machilipatnam. said firm had possessed besides cinema house called Brundawan Talkies along with projectors, furniture, electrical fittings, motors and sound and stage equipments, etc., land on which cinema hall was standing as well as appurtenant land. Each of partners was having equal shares in said firm and said firm had run cinema business with equal shares for 16 years, i. e., from 1-3-1962 t o 25-7-1978. Subsequently, assessee-HUF incurred certain losses and liabilities in its individual account and offered to give up part of his share in Brundavan Talkies and requested to pay proportionate capital in form of cash. However, as firm had already borrowed certain loans and together with interest, amount of Rs. 88,000 is to be repaid by firm to third parties, Brundavan Talkies, firm was not able to accept offer made by assessee-HUF. However, Mr. G. Narasimharaju and Mr. G. Ramaraju offered to contribute in cash sum of Rs. 1,40,000 to firm and requested that they may be allotted some share in Burndavan Talkies and they agreed to abide by all terms and conditions under which firm was hitherto governed and also by terms which may be mutually agreed upon between all partners thereafter. said firm admitted both of them as its partners. Thus, for first time, firm was reconstituted under deed of partnership deed dated 26-7-1978. Under terms of partnership deed, assessee-HUF restricted its share in firm to 30 paise instead of 50 paise. newly admitted partners were each given 10 paises share. It was clearly agreed that reconstituted firm should come into effect from 26-7-1978. Under deed of reconstitution dated 26-7-1978, assessee-HUF had to contribute only 2,10,000 as its capital. As per day book entries of firm, Brundavan Talkies dated 26-7-1978, amount of Rs. 1,40,000 was paid in cash to karta of HUF, as it was found to be in excess of amount of capital required to be kept by him. said reconstituted firm did business till 31-3-1979 relevant to assessment year 1979-80. While completing assessment of assessee-HUF, ITO considered that assessee-HUF derived Rs. 1,40,000 towards relinquishing its share in Brundavan Talkies, in favour of two newly admitted partners referred to above and, hence, he computed capital gains arising out of transaction. matter was ultimately brought to this Tribunal in second appeal. While disposing of second appeal, this Tribunal, Bench 'A' in IT Appeal No. 1099 (Hyd.) of 1981, following Gujarat High Court's decision in CIT v. Kartikey V. Sarabhai (1981) 131 ITR 42 in which it is held that once there is extinguishment of rights of partner introducing asset into firm, transaction of transfer would be complete within meaning of section 2(47) , read with section 45 , of Income-tax Act, 1961 ('the Act'). It is unnecessary to look for party to whom it is transferred and identify his personality from perspective of bilateral transaction. Tribunal aslo considered earlier Bench decision of same Tribunal in case of Ramaratan Soni (IT Appeal No. 117 (Hyd.) of 1979, dated 24-2-1981) was passed for assessment year 1975-76, wherein it was held that when leasehold property was brought to t h e partnership, there was transfer within meaning of section 2(47). Therefore, keeping in view above-said two decisions, Tribunal held that they are of view that reduction of said right to extent of 20 per cent share and subsequent investment or introduction of capital to extent of Rs. 1,40,000 with narration referred to earlier was clearly covered under definition of transfer referred to in section 2(47) in view of observation of Gujarat High Court in Kartikey V. Sarabhai's case (supra) at p. 53 which is applicable on all fours to facts of present case. Thus, holding, Tribunal dismissed appeal filed by assessee. 3. There was another reconstitution of same firm with effect from 1-4- 1979 as per terms of deed dated 28-4-1979. In said deed, there is clear stipulation that four partners were carried on business till 31-3-1979 and ascertained and divided profiteers up to said date between themselves. Before date of reconstitution, firm owed Rs. 35,000 to Shri K. Narayanaraju son of Nagaiah Garu Rs. 33,000 to Shri G. Haranadh son of l t e Butchi Venkateswarlu, minor, and Rs. 33,000 to Shri G. Venkata Madhavaraju son of late Ramalakshmamma Garu on three separate promotes date 27-7-1978, though firm undertook to pay said amounts to above- said parties' creditors of firm before 4-3-1979 they were not able to do so and said creditors were pressing for repayment of those loans or alternatively they sought admission as partners of firm for which all existing partners agreed. Therefore, they have admitted Shri K. Narayanaraju as full-fledged partner and Shri G. Haranadh and Shri G. Venkata Madhavaraju being minors were admitted to benefits of partnership. Each of three new admitted partners were given 5 paise share each and their capital was stated to be Rs. 35,000 each. share of assessee-HUF was reduced from 30 paise to 15 paise. According to terms of reconstituted firm under deed dated 28-4- 1979, assessee-HUF had to contribute only share capital of Rs. 1,05,000 whereas in fact assessee-company was having credit balance of Rs. 2,10,000 in its capital account of firm. Therefore, according to clause 3(a) (ii), it was agreed between partners that partner No. 2 that is, T. Satyanarayana Murty's capital will have to be reduced from Rs. 2,10,000 to Rs. 1,05,000 by debiting his account with Rs. 1,05,000 and contra-crediting same to his loan account. While considering assessment of assessee-HUF for assessment year 1980-81, ITO felt that assessee-HUF derived long-term capital gains by restricting its shareholding to 15 paise and by withdrawing Rs. 1,05,000 from its share capital account. ITO had taken Rs. 1,05,000 as value of share foregone by assessee-HUF. Ultimately, as per his assessment order dated 28-2-1983, ITO computed long-term capital gains on this transaction at Rs. 41,250 and brought it to tax. AAC following Tribunal's order in assessee's own case for assessment year 1979- 80 passed in IT Appeal No. 1099 (Hyd.) of 1981 by their orders dated 31-3-1982 confirmed decision of ITO. Now in this second appeal, we have heard S h r i A. Satyanarayana, learned advocate for assessee and Shri Padmanabhan, learned departmental representative. It is contended that as per Madras High Court's decision in CIT v. N. Palaniappa Gounder (1983) 143 ITR 343 and Andhra Pradesh High Court's decision in case of CIT v. L. Raghu Kumar (1983) 141 ITR 674 where it was held that in cases where partner foregoes part or whole profits share in firm and to that extent withdraws his capital, there was no element of transfer of property nor any capital in this deal to be subjected to tax. It is further contended that reference is pending in Andhra Pradesh High Court against decision of this Tribunal dated 31-3-1982 passed in IT Appeals No. 1099 (Hyd.) of 1981 assessment year 1979-80. Tribunal would not have come to same conclusion which it did not for assessment year 1979-80, neither Madras nor Andhra Pradesh High Courts decisions were brought to its notice. In view of binding decisions of Madras and Andhra Pradesh High Courts, decision of Tribunal for assessment year 1979-80 should not be followed by this Tribunal while disposing of this appeal. On other hand, learned departmental representative argued that decision of lower authorities was supported by earlier decision in this very assessee's case but also by decision of Gujarat High Court's decision in Kartikey V. Sarabhai's case (supra) and, therefore, it is neither just nor necessary to interfere with impugned order already passed by AAC. We have considered rival contentions. We are inclined to agree with learned advocate for assessee. Our reasons are as follows. Firstly, we have to hold that restricting shareholding by partner in firm especially when such restricted share was not sold to new partner does not amount to effecting transfer within meaning of section 2(47). Now on facts before us by 31-3-1979, existing partners, by that time, settled their accounts and also closed and finalised their accounts. This is partnership at will, it can be terminated at any time by mutual agreement among partners. There was agreement to close old firm by 31-3-1979 and reconstituted firm is altogether new firm. While constituting new firm, it is will and pleasure of any of old partners either to keep shareholding as it is or to revise it to extent they desire. So also, it is mutual will and agreement that new partners can be admitted into firm. Simply because, new partners brought in their capital before becoming partners of firm and simply because total of capital brought in by them is either same or merely same amount which partner restricting his share withdraws from out of his capital account on account of its being in excess of prescribed capital amount, if there was to be transfer, then question is, who is transferee? newly introduced partners certainly cannot be stated to be transfers as they did not pay anything to assessee or sum of Rs. 1,05,000 withdrawn by assessee is not their money. If we consider that interest foregone or surrendered in favour of remaining partners or it amounts to relinquishment or retirement by partner then Andhra Pradesh High Court's decision is categorical in its assertion that merely because section 47(ii) of Act excludes application of section 45 in cases of dissolution of firms on ground that no transfer is involved, it cannot be implied that transfer is involved in case of retirement. Andhra Pradesh High Court further stated that for purposes of section 45 , no distinction can be drawn between amount received by partner on dissolution of firm and that received on retirement, since both of them stand on same footing. Therefore, amount received by partner from partnership in excess of capital and profits standing to his credit in partnership at time of retirement cannot be construed as capital gains under section 45 in as much as there is no 'transfer' within meaning of section 2(47) and such excess is not exigible to tax on capital gains. Now in this case, no excess over capital standing to credit of assessee is involved. case dealt with by Andhra Pradesh High Court is extreme case than one now considered by us. Even in such case, no transfer was held involved giving rise to levy of capital gains. Further, Madras High Court in N. Palaniappa Gounder's case (supra) held as per head-note as follows: "... That there was no element of capital gains arising merely because valuation of this share on retirement of assessee from firm resulted in excess over book value of net assets of firm referable to his share." (p. 343) We have already stated that there is complete settlement of accounts and assets and liabilities of firm were ascertained and profits and losses were also ascertained by 31-3-1979. We are considering situation as on 1-4-1979 immediately after settlement of accounts took place on previous day. Therefore, in our opinion, Madras High Court's decision fully applies to facts of our case and we are constrained to observe that while giving decision previous Bench did not take into consideration effect of either of decisions as perhaps none of parties brought them to their notice. Further, Tribunal while deciding issue for assessment year 1978-79 appeared to have been greatly influenced by Gujarat High Court's decision in Kartikey V. Sarabhai's case (supra). In that case, shares held by assessee in Ahmedabad Mfg. & Calico Printing Co. Ltd. as well as assessee in Ahmedabad Mfg. & Calico Printing Co. Ltd. as well as Karamchand Premchand (P.) Ltd. were brought in as capital of assessee i n firm Rajka. difference between book value and fair market value of share contributed by assessee as capital in firm of Rajka was adjusted in capital account of assessee. ITO took view that thought it was not amount to sell or exchange, it would amount to relinquishment of assets or extinguishment of rights of assessee for shares and would, therefore, amount to transfer within meaning of section 2(47). However, facts before us are quite different. At time o formation of partnership, assessee was found to be having more capital than what it was under obligation to contribute to carry on business of firm and, therefore, assessee withdrew excess capital found in its capital account. Now in this case before us, excess capital was not taken away but was only credited in name of assessee's interest account. Therefore, we are of opinion as far as facts are concerned, there is great divergence between set of facts available in Kartikey V. Sarabhai's case (supra) considered by Gujarat High Court and present cases before us. Further, case of Kartikey V. Sarabhai (supra) was reversed by Hon'ble Supreme Court in recent judgment in Sunil Siddharthbhai v. CIT (1985) 156 ITR 509. Hon'ble Supreme Court held that though transfer is involved in act of investing shares held by assessee towards his capital in firm consideration received by assessee on transfer of his shares to partnership firm does not fall within contemplation of section 48 of Act and further no profit or gain can be said to arise for purposes of Act. Therefore, they held that cases which Hon'ble Supreme Court was considering fall outside scope of section 48 altogether. Tribunal in its previous orders observed in penultimate paragraph that Kartikey V. Sarabhai's case (supra) at p. 53 is applicable on all fours to facts of present case. When said judgement of Gujrat High Court was reversed b y Supreme Court, decision of Karti key V. Sarabhai's case (supra) should be held to be no longer holding filed or should not be considered good law. Therefore, this is one of main reasons why we hold that previous orders of Tribunal should not be followed. Further, Andhra Pradesh High Court's decisions well as Madras High Court's decision were not considered by Tribunal while delivering previous orders. According to us, both of them directly cover issue and according to those decisions, no transfer is involved. Over and above everything, Hon'ble Supreme Court categorically held that even in case of relinquishment of rights of assessee in favour of firm, no transfer is involved and no capital gains tax can be exigible in such cases. Following all above, we hold that impugned order should be set aside and we direct ITO to delete lone- term capital gains from out of computation of assessee's income for assessment year 1981-82. 4. appeal is, therefore, allowed. *** T. SATYANARAYANA MURTY v. INCOME TAX OFFICER
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