ORDER
B.S. Ahuja, Judicial Member
1. These three appeals by three brothers representing their respective HUFs raise common question of law and fact and are, therefore, disposed of by this common order, for the sake of convenience.
2. The three assessees received the property situated at Ghatkopar, Sl. No. 82, Hissa No. (1) Part of Ghatkopar, 140/42, Mahatma Gandhi Road as a gift from their mother, Smt. Madhubala Maganlal Ajmera, by a gift deed dated 27-9-1979. The gift was of the one-third share to each of these three brothers intended for their respective joint families. The gift was valued at Rs. 99,000.
3. On 26-10-1979, the assessees became partners in the firm of Dadhia Mehta Ajmera Associates, and contributed as their capital their shares in this immovable property and their capital accounts were credited by Rs. 33,000 each. On 31-3-1980, the assessees retired from this firm and they were paid Rs. 2,17,000 each, being their share on retirement, in respect of one-third property contributed by each of them to the firm. According to the ITO, the said firm had not done any business or any construction activity during the year ending 1980-81. Part 4 of the agreement consequent to dissolution deed reads as follows:
In consideration of the party on the second part agreeing and leaving the partnership business with all its assets and liabilities, it was agreed that the party on the first part shall pay to the party of the second part, a sum of Rs. 6,51,000 (rupees six lakhs fifty-one thousand only), equally divided amongst the three persons comprised and collectively called ‘party’ on the second part, in full and final settlement and as and by way of and in satisfaction of the interest, rights and titles of the party on the second part as partners in the erstwhile dissolved partnership firm and its business referred to above.
4. The ITO held that when the three assessees contributed one-third share of this property towards capital in the firm, there was a transfer involved in relation to this capital asset as defined in Section 2(47) of the Income-tax Act, 1961 (‘the Act’). He further held, following the Gujarat High Court decision in the case of CIT v. Kartikey V. Sarabhai [1981] 131 1TR 42 that on such transfer, capital gains arose to the assessees. He held that what each assessee received on 31-3-1980, in lieu of the one-third share in the land contributed as capital in the firm was the market value of the property as on that date and he reduced it by 10 per cent to arrive at its market price on the date of entering into the partnership, i.e., 26-10-1979. On that basis, he computed the capital gains and held that they were short-term capital gains. This order was challenged before the Commissioner (Appeals) who has upheld the order of the ITO on all the issues. The assessees are aggrieved and are in appeal.
5. We have heard the learned counsel for the assessees, Shri Gulanikar, and also the learned departmental representative, Shri Roongta. By the time this appeal came up for hearing, the decision of the Supreme Court in the case of Kartikey V. Sarabhai v. CIT had become available though it is still not reported in the ITR. A copy of the decision dated 27-9-1985 and reported in [1985] SVLR(T) 160/[1985] 23 Taxman 14W was made available to the learned counsel and the learned departmental representative to enable them to properly argue the issue arising out of these appeals. Accordingly, the appeals were fully argued on all the issues that arise in these appeals, in the light of the decision of the Supreme Court.
The Supreme Court has held in the case of Kartikey V. Sarabhai (supra) that when a capital asset is contributed by a partner towards his share of capital in the firm, it involves a transfer of that asset within the meaning of Section 2(47). The Supreme Court has, however, held that 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 of the Act and as that provision is fundamental to the computation machinery in regard to the claim relating to the determination of the charge, provided in Section 45 of the Act, such a case must be regarded as falling outside the scope of capital gains taxation altogether.
6. The Supreme Court further held that no profit or gain could be said to have arisen to the partner when he brought his personal assets into partnership firm as his contribution to its capital. After holding so, their Lordships observed in para 20 of the o rder as follows:
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 ITO 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 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 ITO 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. (p. 14ZE)
7. In the light of this judgment of the Supreme Court, the first point that arises, and which has been argued, is whether the case of the assessees falls within the ratio of what the Supreme Court has stated in Kartikey V. Sarabhai’s case (supra). The learned counsel for the assessees contended that the firm was a genuine one ; the partnership was formed to carry on the real estate business, but since the differences arose between the parties, the partnership was dissolved and the assessees, who had contributed their lands as their share of the capital, received the cash and the land was given on dissolution to the remaining partners to carry on the business. Evidence was produced to show that the firm did carry on the business in the sense that it obtained clearance under the Urban Land Ceiling Act and also made efforts to get the construction plans passed. Therefore, it was urged, it was not a sham transaction and the lands were transferred by the assessees to the firm with the genuine intention to contribute to the share capital of the firm for carrying on the business. Therefore, the learned counsel contended that it was not a device or a ruse for converting the asset into money without its being liable to capital gains tax.
8. On the other hand, the contention of the learned departmental representative was that there really was no business carried on by the firm and the conduct of the assessees showed that they contributed the land only to convert it into cash without going through the formality of the sale, so that no capital gains tax would be leviable. In short, his contention was that the case falls fairly and squarely within the ratio of para 20 of the judgment of the Supreme Court in Kartikey V. Sarabha’s case (supra).
9. We have heard the rival contentions. We have perused the voluminous paper books placed before us on behalf of the assessee. The firm came into existence on 26-10-1979. On 11-12-1979, a letter was addressed to the Additional Collector and Competent Authority, Urban Land Ceiling, Greater Bombay, vide page 51 of the paper book, and on 28-12-1979, vide page 52 of the paper book, the said clearance from the Urban Land Ceiling was granted for redevelopment of the said property as commercial and residential one. The application for passing the plans was also made to the Bombay Municipal Corporation and on 18-12-1980, the municipal corporation required certain particulars to be supplied, vide pages 54-55 of the paper book, and vide pages 56-57, by letter dated 19-5-1980, the plans were disapproved with certain observations. The contention of the assessee was that this was really an approval and not disapproval because what this letter meant was that the permission to develop the property according to the plans submitted would be granted when those requirements were satisfied. Be that as it may, all that it means is that during the period the partnership firm was in existence (it has been dissolved on 31-3-1980 and, therefore, the letter dated 19-5-1980 was received after the dissolution of the firm), efforts were being made to get the plan approved and the clearance from the Urban Land Ceilings. In the latter, the firm succeeded before dissolution, but not in respect of the former.
10. The question arises whether this evidence justifies a conclusion that the firm was a genuine one formed to carry on the business as detailed in the deed of partnership or whether it was a make-believe firm formed only to enable the assessees to transfer their property without being required to pay capital gains tax.
We may point out that the deed of dissolution (a copy of which is on pages 100 to 104 of the paper book) records on page 101 as follows:
Whereas certain differences arose in working out the partnership business… and whereas, on the advice of mutual friends and well-wishers, the parties of the first and second parts agree that the partnership should by mutual consent be dissolved with effect from 21st March, 1980….
11. We asked the learned counsel whether there was any evidence of differences having arisen between the partners in carrying on the business of the partnership and whether there was any evidence of any friends intervening to enable them to part by mutual consent. The learned counsel answered in the negative. He only stated that Mr. Seth, the valuer, enabled the parties to settle their differences.
12. When a firm comes into existence on 26-10-1979, and is dissolved on 31-3-1980, i.e., more or less after five months and four days, during which no positive work of construction is carried on nor anything positive regarding development of the land or other property and the firm is dissolved and the land changes hands from the party who contributed it as its share capital to the other party who is a developer of land and estates and a known builder, the question arises whether it was a genuine transaction of a firm being formed to carry on the business of development of lands and estates, as it is made out to be, or whether it was only a device or a ruse to transfer the land from the owners of the land to the other party who intends to develop it and make money thereby. In a normal case, when business is carried on for some years or so, differences may arise which may require one party or the other to take over the business, but in a case like this, when very little work has been done and the firm is dissolved, the obvious conclusion would be that the whole exercise of forming a firm and then dissolving it was nothing but a device or a ruse and, in fact, there was no genuine firm in existence. The assessees who owned the lands had no experience of developing lands or the properties, while the other group, who joined the firm, were well known builders and land developers. Obviously, the other group was interested in getting hold of this land in order to develop it, while the conduct of the assessees shows that they were interested in disposing of the lands and making money thereby. It appears, therefore, that this partnership firm was nothing but a camouflage, for the real intention was to transfer the lands by the assessees and to escape payment of capital gains tax the firm was formed. It is immaterial that the firm was granted registration because the firm really did no business and there was no income and since all the formalities had been completed by filing the forms along with partnership deed within the time, the ITO had to grant registration. But the Supreme Court was alive to such a case, because their Lordships observed that even where the partnership is genuine, the transaction of transferring personal assets to the partnership firm should represent the real attempt to contribute to the share capital of the firm for carrying on the business. That is not so here at all.
13. On the material on record, therefore, our conclusion is that the firm was not a genuine one in the sense it was not intended to carry on the business of developing lands or properties as the partnership firm formed by the two groups of people, but it was only a device or a ruse to enable the assessees to transfer the lands to the other group without having to pay capital gains tax thereon. Therefore, the assessees would not get the benefit of the decision of the Supreme Court in the case referred to above to the effect that no capital gains arose because that would be the case where the firm was genuine and had come into existence to carry on the business and the capital had been contributed by one group in the form or capital asset which, though transferred to the firm within the meaning of Section 2(47), would not result in capital gains tax being levied.
14. The next question that arises is as to whether the capital gains can be computed on the basis of the amount received by the assessees on the dissolution of the firm. Since the firm never did any business and though they did obtain the clearance under the Urban Land Ceiling Act, there was no occasion for any friction between the partners nor was there any income or loss suffered by the firm. Therefore, what the assessees had received from the firm on its dissolution was nothing but the price of the land, as per the market value prevailing on the date of dissolution. In fact, really speaking, the firm having been formed only as a device, it would be really the market value as on the date on which the firm came into existence, but the authorities below have taken it as the market value as on the date of dissolution and have given reduction of 10 per cent thereof on account of the fact that there was during the subsistence of the partnership clearance from the Urban Land Development Authority and this has increased the market value of the land. The valuation as on the date of the formation of the partnership was Rs. 2,17,000 less 10 per cent and, in our opinion, it is eminently reasonable and, on that basis, the capital gains may be computed. We uphold the orders of the authorities below in this regard.
15. The next ground pertains to the capital gains being taxed as short-term capital gains. In- this regard, the authorities below were clearly in error because they have ignored Section 2(42A)(b) and it was incumbent upon the ITO to take into account the period for which the asset was held by the previous owner because the assessees got the land under a gift deed within the meaning of Section 49(1)(ii) of the Act. The land was held by the donor and her predecessors for nearly 30 years or more and, therefore, the capital gains would be long-term capital gains and not short-term capital gains. We reverse the finding in this regard.
16. The appeals are partly allowed.