High Court Of Madras
S.V. Kumaragurupasamy vs. CIT
Sections 2(47), 45(1)
Asst. Year 1982-83
R. Jayasimha Babu & K. Raviraja Pandian, JJ.
Tax Case No. 177 of 1993
2nd September, 2002
Counsel Appeared
P.P.S. Janardhanaraja, for the Applicant : T. Ravikumar, for the Respondent
JUDGMENT
R. JAYASIMHA BABU, J. :
Two questions have been referred to us at the instance of the assessee. The assessment year is 1982-83. The questions referred are : “1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in confirming that the entire transaction by the petitioner is a sham or devise ?
2. Whether, on facts and in the circumstances of the case the Tribunal was right in holding that the devise encompasses the goodwill amounting to Rs. 2,72,500 also ?” 2. The assessee is an individual. He was one of the partners in a firm, styled as “Sakthi Velu Poly Pack”, which firm had come into existence under a deed, dt. 12th Oct., 1970. That firm was dissolved on 1st April, 1980, the assessee taking over all the assets and liabilities of the firm and taking over its business as a going concern. The firm which was so dissolved had made profits during the three years, preceding the date of dissolution. The goodwill was not taken into account while drawing up the accounts as on 1st April, 1980.
3. The assessee ran the business as a proprietary concern for about a year thereafter. On 21st April, 1981, he got certain assets of the firm revalued and as a result of such revaluation, which was in respect of building, machinery and generator, the book value of those items went up by Rs. 4,57,500. The very next day, on 22nd April, 1981, he entered into a partnership with six others. That partnership deed provided that the value of the assets and liabilities of the assessee in that business as on 21st April, 1981, shall be treated as his capital contribution. The document does not spell out what the capital contribution of the other six partners is to be. There was, however, provision for partners advancing monies to the firm. The firm so constituted was granted registration.
4. The share of the profits/loss of the assessee in that firm was fixed at ten per cent and the other ninety per cent was made over to the other six partners, who had not brought in any capital contribution. The deed also provided that the goodwill of the business of the assessee was to be separately valued at the sum of Rs. 2,72,500. The justification for that valuation was stated to be that it represented approximately the average of three years’ profits. After so valuing that goodwill, that amount was also credited to the capital account of the assessee.
5. That deed contained a very unusual clause in cl. (9) which stipulated thus : “It is mutually agreed that except an amount of rupees two lakh fifty thousand only (Rs. 2,50,000) all other amounts standing to the credit of the first partner after crediting the goodwill and the capital as determined as per cl. 3 shall be transferred to the current account of the party of the first part and shall be withdrawn by the party of the first part as and when he likes.”
6. The assessee withdrew a sum of rupees seven lakhs from his capital account on the 16th May, 1981 and a further sum of Rs. 2,15,000 on the 29th Aug., 1981. After such withdrawal, the amount left in the capital account of the assessee was only Rs. 2,50,000. It was a portion of the value assigned to the goodwill and which goodwill had not been valued at any time prior to the formation of this firm.
7. The AO having taken note of the unusual features in the manner in which this firm was formed, the amount credited to the capital account of the assessee, the speed with which substantial amounts were drawn from the capital accounts by the assessee, concluded that the whole arrangement was premeditated and was aimed at avoiding payment of capital gains tax on the transfer of the assessee’s business to the six persons who were inducted into the firm under the partnership deed of 22nd April, 1981, and who took over the entire business of the firm on its dissolution under the deed, dt. 30th May, 1983. At that dissolution, the assessee was only assigned certain items of sundry debtors and no cash payment was made to the assessee. The AO, however, did not levy any tax on the amount of the goodwill as the statute, as it prevailed during the relevant year did not provide for levy of capital gains tax on self-generated assets.
8. The assessee’s appeal to the CIT(A) and thereafter to the Tribunal proved unsuccessful, those two authorities having upheld the view of the AO that the series of transactions was devised solely with a view to avoid capital gains tax by the assessee on the transfer of the proprietary business to six others, who had taken over that business, by adopting the device of becoming partners, bringing in monies of their own to pay the amounts representing the value of the business, which was effectively transferred to them by the device of forming the firm and providing for the withdrawal of those amounts from the capital account of the assessee.
9. The apex Court, in the case of Sunil Siddharthbhai vs. CIT (1985) 49 CTR (SC) 172 : (1985) 156 ITR 509 (SC), a decision rendered by a Bench of three Judges, held that when a person brings his personal assets into a firm, there is a transfer within the terms of s. 45 of the IT Act, as the exclusive interest of the partner is reduced into a share interest. While also holding that that transfer would, however, not be assessable to capital gains tax as 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, made the following observations which are of relevance for the purpose of this case : “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 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 IT 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 devise or ruse to convert the personal asset into money substantially for the benefit of the assessee while evading tax on a capital gain.”
10. The facts of this case clearly fit into the last of those observations. In this case, though the partnership formed on 22nd April, 1981, had been granted registration, and that registration was at no time cancelled, nevertheless the transaction of transferring the personal asset of the assessee viz., the running business which was his proprietary concern to the partnership firm was in substance and reality a device or a ruse to convert that personal asset into money and was not aimed at contributing to the share capital of the partnership firm. When the firm was constituted on 22nd April, 1981, the value of the business of the assessee who was prior to the formation of the firm carrying on that business as a proprietary concern had been revalued by him on his own and that higher valuation was credited to his capital account in the firm. But that amount was not to be his capital contribution. The whole of that amount was available to the assessee for being withdrawn at any time of his choosing and was in fact withdrawn by him within two months of the formation of the firm. The further amount that was credited to his capital account was the value which was assigned to the goodwill of the business and which had not been valued at all earlier. The business simply could not have been run merely by treating that value of the goodwill in the capital account as working capital as that figure merely represented an entry in the account books and did not represent any cash balance or the value of any tangible asset.
11. The whole device, it is evident, was meant to enable the assessee to receive the value of his business immediately after the formation of the firm and avoid payment of capital gains tax by claiming that the drawal of the capital contribution would not amount to the receipt of the proceeds of sale of the proprietary business of the assessee. The amount required for enabling the assessee to draw the value of his proprietary business which had been credited to his capital account was obviously provided by the other six partners who had in terms of the deed brought in no capital at all but who apparently had given advances to the firm in order to provide to the assessee the value of the business which was taken over by the other six persons by the device of forming the firm. The first question referred to us is, therefore, required to be and is answered against the assessee, by holding that the entire transaction was a device adopted by the assessee to avoid the payment of capital gains tax and that the assessee is liable for the payment of that tax on the value of the proprietary business made over to the firm.
12. So far as the second question is concerned the AO had not brought the goodwill to tax as it was a selfgenerated asset and during this assessment year the statute did not provide for the levy of capital gains tax on that goodwill.That question is answered in favour of the assessee and against the Revenue.
[Citation : 260 ITR 127]
