|QUERY:||We are carrying on real estate business and hold land at stock-in-trade. The land cost us Rs. 50 lakhs. It is worth Rs. 2 crores today. We propose to revalue the land at its market value in the books of account and credit Rs. 1.50 crores to the P & L A/c. We shall introduce the land as our capital contribution in a firm in which we will become partners. The firm will credit our capital account by Rs. 2 crores. Are we taxable on the difference between Rs. 50 lakhs and Rs. 2 crores?|
|ANSWER:||In Hind Construction 83 ITR 211, the Supreme Court held that when a partner introduces his asset into a firm as capital contribution such introduction did not constitute a "sale". In Sunil Siddharthbhai 156 ITR 509 (SC), it was held that when a partner introduces his asset into a firm as capital contribution, there is a “transfer” though the gains are not chargeable to tax as the consideration is not determinable. It was clarified that this principle did not apply if the partnership was non-genuine or sham or where the transaction of transferring the personal asset to the partnership firm was a device or ruse to convert personal assets into money while evading tax on capital gains.
Provisions of the Income-tax Act:
To supercede the law laid down in the aforesaid judgements, section 45(3) was added w.e.f 01.04.1988. It reads as follows:
"(3) The profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a co-operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48, the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset."
As is evident, section 45 (3) applies when there is a "transfer of a capital asset". There is no law with respect to introduction of 'stock-in-trade' into a partnership.
Judgements on the issue:
However, the Special Bench, Delhi, has held in a majority judgement in DLF Universal vs. DCIT that though S. 45 (3) applies when a capital asset is introduced into a firm as capital contribution, it will also apply when stock-in-trade is introduced into a firm because the transaction is on the capital account and stock-in-trade does not retain its character as stock-in-trade at the point of time of introduction.
In that case, the assessee was engaged in the business of real estate development. It held land as stock in trade with a book value of Rs. 4.4 crs. The said land was introduced at its market value of Rs. 11.50 crs as capital contribution into a new firm. The surplus of Rs. 6.01 crore was credited to the profit and loss account. The assessee relied on Hind Construction 83 ITR 211 (SC) and claimed that the surplus of Rs. 6.01 crs was not liable to tax as the introduction of an asset into a partnership was not a sale. It was also claimed that s. 45 (3) was applicable only to capital assets and not to stock-in-trade. However, the majority of the Special Bench held that section 45(3) did apply and that the said surplus was chargeable to tax. The fact that the assessee had revalued the stock-in-trade to its market value prior to the introduction into the firm was cited as a factor to show that the stock-in-trade (which is valued at cost) had been converted into a capital asset.
On that facts of that case, the majority also held that though the partnership was genuine, the assessee had adopted a calculated device of converting land into money by withdrawing substantial sums from the firm and debiting the same to its current account. It was held that the contribution by the assessee of its personal land to the share capital of the firm was a device or ruse for converting land into money for its benefit. It was opined that the entry of Rs. 11.50 crs being the value of land credited in assessee’s capital account was not imaginary or notional and that it was chargeable to tax.
However, the issue cannot be treated as settled because the dissenting Member has opined that as section 45 (3) applies only to a “capital asset” which is defined in s. 2 (14) to exclude ‘stock-in-trade’, the same cannot appply to stock-in-trade. The dissenting member held that the finding of the majority that the stock-in-trade was converted into a capital asset on introduction was not correct. He opined that stock-in-trade could also be dealt with by the assessee in partnership given that partnership is not a distinct legal entity. He held that the introduced asset continues to be stock-in-trade and its character did not change as a result of introduction into partnership; He also differed from the view of the majority that the transaction was a sham or non-genuine.
The result of this conflict in law is that there is no clarity in the legal position. However, the better view appears to be that of the dissenting Member who correctly held that it is not right to hold that stock-in-trade gets converted into a capital asset at the point of introduction into the firm so as to attract section 45 (3).
|CATCH WORDS:||capital contribution, capital gains, partnership firm|
Opinion Of Eminent Legal Luminaries On Controversial Issues
If we introduce stock-in-trade as capital contribution into a firm, are we taxable?
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