ORDER
N.L. Kalra, Accountant Member
1. The assessee has filed an appeal against order of learned CGT(A) dated 30.8.2002. Before discussing various grounds of appeal, it will be useful to give facts in brief as mentioned by learned C.G.T.(A) in paras 2.1 to 2.5 of his order.
2.1 The appellant is a partner of M/s Mysore Hotel Complex, a firm, which came into existence vide partnership deed dated 24.8.1983 with three partners namely Mr. A K Ahmed, Mr. Machingal Mohammed and Mr. P K Usman. The business of the partnership was construction of shopping complex, hotels, lodgings, including commercial complex and running hotels and lodging. Sri A K Ahmed and Sri Machingal Mohammed had bought two pieces of adjacent land measuring 2017 sq mts and 2021.68 sq mts respectively, and the same were brought into the partnership as their capital contribution in kind. The total capital of the firm including the land brought in was decided to be at Rs. 23,30.015/- and the third party being Shri P K Usman was expected to bring his contribution in cash. The partners enjoyed profit sharing ratio of 50% : 25% : 25% respectively.
2.2 The firm was reconstituted with effect from 10.4.1984 vide partnership deed of even date. By this reconstitution the company M/s Bhuvaneshwari Hotels (P) Ltd., represented by Shri A K Ahmed, one of the directors and Smt. Khamarunnixa Ahmed, w/o Sri A K Ahmed were included as partners and the partnership continued along with the earlier partners Sri A K Ahmed, Sri Machingal Mohammed and Sri P K Usman. Smt. Khamarunnisa Ahmed had purchased property at No. 2729 measuring 7002 sq ft and this was brought in as capital by her with a valuation of Rs. 2 lakhs. It was decided that M/s Bhuvaneshwari Hotels (P) Ltd. was required to bring in capital of Rs. 10 lakhs and was also decided that in the event of dissolution or appreciation in value of the property, the same will go to the company M/s Bhuwaneshwari Hotels, (P) Ltd. only. Further, other partners will have no right or title or interest in the future or further appreciation of the sites which have been brought as capital contribution by partners. The company was given a profit sharing ratio of 50% and the other partners Shri A K Ahmed, Sri Machingal Mohammed, Sri P K Usman and Smt. Khamarunnisa Ahmed enjoyed profit sharing ratio of 15% : 12.5% : 12.5% : 10% respectively.
2.3 A further reconstitution was made by way of partnership deed dated 12.10.1988 and Smt. Khanmrunnisa Ahmed retired from the partnership. The other four partners continued to any on the business of the firm M/s Mysore Hotel Complex. This partnership came into effect from 1.4.1988 and in this deed it was decided that Smt. Khamarunnisa Ahmed will be paid Rs. 2 lakhs compensating her capital contribution. Further, it was decided that Shri A K Ahmed, Sri Machingal Mohammed and Sri P K Usman will bring in capital Rs. 4 lakhs, Rs. 2 lakhs and Rs. 2 lakhs respectively.
M/s Bhuvaneshwari Hotels (P) Ltd., was however, required to contribute Rs. 10 lakhs. The profit sharing ratio was decided as under:
A K Ahmed 25% Machingal Mohammed 12.5% PK Usman 12.5% M/s Bhuvaneshwari Hotels (P) Ltd. 50% The clause that appreciation in the value of the properties belonging to the firm would go to the company M/s Bhuvaneshvari Hotels (P) Ltd., continued in this deed also.
2.4 The next reconstitution of the partnership is vide a deed dated 01.10.1992. In this deed it was decided to change the profit sharing ratio amongst the partners Sri A K Ahmed. Sri P K Usman, Sri Machingal Mohammed and M/s Bhuvaneshwari Hotels (P) Ltd. from 25% : 12.5% : 12.5% : 50% to 45% : 22.5% : 22.5% : 10% respectively. M/s Bhuvaneshwari Hotels (P) Ltd. relinquished its rights in the partnership to the extent of 40% in favour of the other three existing partners. The reason given in the deed for reconstitution is that the partner M/s ‘Bhuvaneshwari Holds (P) Ltd. was not able to contribute sufficient capital as agreed upon for the expansion of business and hence reconstitution.
2.5 The relinquishment of rights to the extent of 40% by M/s Bhuvaneshwari Hotels (P) Ltd., in favour of the other three partners Sri A K Ahmed, Sri P K Usman and Sri Machingal Mohammed by way of reconstituted deed dated 1.10.92 was the reason for initiation of gift tax proceedings in the case of the appellant. The following events documented in the returns of income filed by M/s Mysore Hotel Complex substantiated initiation of gift tax proceedings for the A Y 1993-94.
i) Along with the return of income for the AY 1992-93 there is a schedule of fixed assets wherein on 30.1.1993 the land and building which had book value of Rs. 20,90,305/- and Rs. 18,78,964/- respectively were revalued to Rs. 1,40,90,305/- and Rs. 62,22,856/-. As such on that day the asset value was increased by Rs. 1,63,43,892/-. This appreciation was allocated amongst the partners in the profit sharing ratio of 45% : 22.5% : 22.5% : 10%. But for the reconstitution on 1.10.92 the assessee would have had complete right over this appreciation of Rs. 1,63,43,892/-.
ii) On 1.2.1993 another reconstitution was effected to the firm wherein four more partners being Sri M K Potharaja Smt. G. Kamala, Sri P Sundar and Smt. Gowramma Sundar were inducted to the partnership and the profit sharing ratio was decided as under:
1) A K Ahmed 38%
2) Machingal Mohammed 19%
3) P K Usman 19%
4) M/s Bhuvaneshwari Hotels (P) Ltd. 9%
5) M K Potharaju 5%
6) Mrs. G Kamala 2.5%
7) P. Sundar 5%
8) Mrs. Gowramma 2.5%
The reason for reconstitution was that the existing partners being Sri A K Ahmed, Sri Machingal Mohammed, Sri P K Usman Khan and M/s Bhuvaneshwari Hotels (P) Ltd. were not in a position to bring sufficient capital for expansion of business.
iii) The four new partners brought in additional capital of Rs. 25 lakhs by 31.3.1993.
iv) During the previous year relevant to the A Y 1994-95 the partners A K Ahmed, Sri Machingal Mohammed, and Sri P K Usman withdrew from the firm an amount to the extent of Rs. I.08,24,500/’. During the previous year relevant to the AY 1995-96 the three partners herein retired from the partnership.
Recording the facts discussed above as reason, notice Under Section 16 was issued to M/s Bhuvaneshwari Hotels (P) Ltd. for the AY 1993-94. The notice was issued with prior approval of JCIT, Mysore Range, Mysore.
3. The AO took into account the reduction in share of profit from 50% to 10% in the case of the appellant vide partnership deed 1.10.92 and omission of exclusive right in appreciation available to appellant vide deeds dt. 10.4.84 and 12.10.88 in the deed dated 1.10.92. After exclusion of such exclusive rights in appreciation in the deed dated 1.10.92, the assets of the firm i.e. land and building were revalued as on 31.01.93 i.e. before three new partners were introduced. Due to revaluation, value of land and building was increased to Rs. 203.08 lakhs from 39.68 lakhs. Due to revaluation, the value of land and building has been increased to 500% of the book value. Capital of the existing partners was increased due to revaluation as per the profit sharing mentioned in deed dated 1.10.92. During the previous year relevant to AY 94-95, the three partners, who got the increase in their capital due to revolution withdrew an amount to the extent of Rs. 108.24 lakhs. Appreciation on account of revaluation resulting in increase in capital was transformed into liquid assets by the three partners. Those three partners were continuing in the firm since August, 1983. After withdrawing substantial sum in AY 94-95, these three partners retired from the firm in AY 95-96.
4. The AO initiated gift tax proceedings against the appellant and reasons for initiation of such proceedings are mentioned in para 13 and 14 of the AO’s order. These are reproduced as under:
13. In view of above facts, but for the reconstitution of rights on 1.10.92 the company M/s Bhuvaneshwari Hotels (P) Ltd. would have enjoyed 100% of rights in the appreciation of value of assets in the event of dissolution or appreciation. This would be in addition to 50% of rights in the book value of the assets. For that matter if the assessee’s wealth in common parlance is to be determined as on 31.3.1992 the whole of the appreciation in value of the assets would be considered as assessee’s wealth. Consequent to reconstitution on 1.10.92 the assesses would enjoy only 10% in the appreciation of the value of assets and therefore, there is a reduction of wealth consequent to the reconstitution.
14. In the reconstituted deed no new partners have been admitted, no additional capital brought in and no additional responsibilities have been taken over by the beneficiary partners being Sri A.K. Ahmed, Sri Machingal Mohammed and Sri P K Usman warranting the assesses to relinquish the rights to the extent of 40% in the assets and appreciation in the value of the assets of the firm in their favour. such act of the assessee which resulted in reduction of wealth was not compensated. The other three partners Sri A K Ahmed, Sri Machingal Mohammed and Sri P K Usman have been benefited to that extent without compensatory payment responsibility.
5. Before the AO, the appellant contended that there is no case of deemed gift on account of the following reasons:
A The Company A/A Bhuvaneshwari Hotels (P) Ltd. was required to bring in capital of Rs. 10 lakhs and therefore 50% profit sharing ratio, right over the appreciation in value of the assets were given. Since the company did not bring the capital as agreed, its rights were reduced in favour of the other partners. Such reduction is for the failure in meeting with a contractual obligation and therefore no gift tax arises.
B. The company M/s Bhuvaneshwari Hotels (P) Ltd. was required to bring in additional funds for expansion of the business and since such funds were not brought in, profit sharing ratio was reduced, right over appreciation in the value of the assets taken away.
C. As per partnership Act right of a partner in the assets of a firm crystallizes only on dissolution and during the subsistence of the partnership there is no way of any partner assigning either wholly or partly his interest in any individual asset to others. In view of this there cannot be any gift.
D. If the rationale behind the decisions in the cases of D.C. Shah v. Commissioner of Gift Tax 169 ITR 93, C.S. Patil v. Commissioner of Gift Tax 188 ITR 97, cases of Ghevergheese 83 ITR 403 and Commissioner of Gift Tax v. Ali Hussain Jervaji 123 ITR 425 are considered in the present situation there cannot be any gift.
6. The AO in his order has rejected the above contention by observing as under:
(i) The capital account of company in the firm shows balance as NIL but the company has maintained substantial amount in the current account. The position is as under:
31.3.88 Rs. 3,32,433/- 31.3.89 Rs. 18,81,148/- 31.3.90 Rs. 19,34,158/- 31.3.91 Rs. 16,29,157/-
Balance maintained in current account exceeded Rs. 10 lakhs and therefore the company has fulfilled its contractual obligation of contributing Rs. 10 lakhs as capital for purpose of business. Closing current balance as on 31.3.92 has been transferred to capital account and hence it is clear that balance in current account is transferable to capital account.
(ii) As per partnership deed dated 10.4.84, it was mentioned that all the partners will contribute capital to the extent of Rs. 31 lakhs and all farther finance was to be arranged by the appellant. However, such requirement of arrangement of further capital by the appellant was omitted in the deed dated 12,10.88, The appellant was to contribute only Rs. 10 lakhs as capital.
The AO relied on the following decisions in support of the finding that appellant is liable to gift tax:
BT Patil & Sons v. CGT 247 ITR 589
Assets of firm transferred to partners at book value. If transfer is without inadequate consideration than there is gift chargeable to tax.
CGT v. Ayyandar 73 ITR 761
Redistribution of shares of partners without any introduction
Of instruction of any fresh capital or partner means transfer of a right which has the effect of diminishing a partner’s interest.
7. Before the learned CIT(A), the appellant raised the same factual contention that share of appellant was reduced as it failed to bring the capital as required under partnership deed. The learned CIT(A) agreed with AO that appellant company maintained current account in which balance exceeded Rs. 10 lakhs. The learned CIT(A) further pointed out that major shareholder of the company were other partners and their family members. The appellant company itself wanted its share to be reduced. The reason of not contributing sufficient capital cannot be ground for reducing share as there was no such event of non-contribution of sufficient capital.
8. It was submitted before the learned CIT(A) that there was no surplus as on 1.10.92. Hence there is no relinquishment of right in surplus as on 1.10.92. The subsequent event of revaluation as on 31.01.93 does not create a right on 01.10.92. The learned CIT(A) observed that revaluation was done on 31.1.93 and appreciated value has been apportioned as on 31.1.93. Benefit of gift made on 1.10.92 has actually been passed on to the beneficiaries consequent to revaluation on 31.1.93.
9. The learned CIT(A) considered the following judgements quoted by the learned AR.
CS Patil v. CGT 180 ITR 197 (Karnataka)
CGT v. P Ghevergheese 83 ITR 403 (SC)
D C Shah v. CGT 169 ITR 93 (SC)
10. The learned CIT(A) was of the opinion that in all the cases referred to above, there has been a transfer due to change in share of ratio of profits of partners but such change is for adequate consideration. However, in the instant case, the relinquishment is without any consideration. The learned CIT(A) quoted the following para from the judgement of the jurisdictional High court in the case of D C Shah v. CGT 134 ITR 192:
——If the ratio of the decision in Ayyandar ‘s case (73 ITR 761 (Mad.) is that a mere reallocation of shares on a reconstitution of a firm results in a gift to the extent of the difference in the shares compared to the period earlier to the reconstitution, we are unable to subscribe to that enunciation. As we have mentioned earlier there must be some material from which it could legitimately inferred that there was a gift.
11. The learned CIT(A) held that in the instant case, there is material and hence, it is to be held that it is a case of gift.
12. The learned CIT(A) relied on the following case laws in support of the proposition that transfer of property or right for inadequate consideration will give rise to deemed gift:
(a) Khoday Eswarsa and Sons v. CGT 186 ITR 388 (Kar.)
(b) CGT v. B Sathiar Singh 98 ITR 316 (Mad.)
(c) Addl. CGT v. S V R Cycle Mart 110 ITR 429 (Mad.)
(d) CIT v. Bhavani Pictures 129 ITR 244 (Mad.)
(e) CGT v. Surender Paul 156 ITR 173 (Cal.)
13. Thus, it was held that appellant is liable to gift tax as it has made a deemed gift. Against the finding of learned CGT(A), the appellant has filed an appeal. The effective grounds of appeal are as under:
1) The order of reassessment is bad in Iaw and void-ab-initio for want of requisite jurisdiction especially, the mandatory requirements to assume jurisdiction Under Section 16 of the Act did not exist and have not been complied with and consequently, the ‘”reassessment requires to be cancelled. without prejudice to the above.
2) The authorities below erred in holding that alteration in a partnership agreement which was avoidable on account of not performing reciprocal promise and therefore, was altered amounts to relinquishment of rights without appreciating in the absence of performing the reciprocal promise, no such legally enforceable right got vested in the appellant and the agreement altering the clause does not amount to any relinquishment to attract the provisions of deemed gift.
3) The authorities below failed to appreciate that there was no relinquishment of any vested right and no surplus was ascertained on the date of the alteration of the partnership deed and therefore, there is no warrant to assume that the appellant was entitled to any surplus in the value of assets on the date of the alteration to infer that the appellant relinquished any right in the ascertained surplus liable as deemed gift.
4) The authorities below failed to appreciate that there was neither a dissolution nor determination of surplus on the revaluation of the assets on the date of alteration of the terms in the partnership deed to hold that, certain amount was due to the appellant which the appellant relinquished by reducing its share to warrant initiation and assessment of deemed gift.
5) Without prejudice to the above, the evaluation of the taxable gift is excessive and liable to be reduced substantially.
6) The appellant denies itself liable to be charged to interest Under Section 16B of the Income-tax Act, 1961 which requires to be cancelled under the facts and in the circumstances of the appellant’s case.
14. During the course of proceedings before us, the learned AR has filed a paper book containing 59 pages. The learned AR submitted that AO has given the facts in his order. The learned AR drew our attention to partnership deed dated 10,4.84 available at pages 9 to 26 of the paper book.
(i) As per Clause 7 of the partnership deed, all the partners were required to contribute capital of Rs. 31 lakhs and further finances were required to be arranged by the appellant. The appellant was required to contribute Rs. 10 lakhs as capital. Any surplus amount contributed by partner was to kept in current account with an option to the partner to withdraw the same as and when required.
(ii) The learned AR drew our attention to page 48 of the paper book and submitted that appellant did not contribute any amount in the capital account from 84 to March, 92.
(iii) The amounts were advanced in current account by the appellant to the firm from the year I ending 31.3.88 to 31.3.92.
(iv) The learned AR drew our attention to the balance sheet of the appellant for the years ending 31.3.87 and 31.3.92. In the balance sheet the appellant has shown the amounts given to the firm under the head ‘loan and advances and not under the head investment’.
(v) The learned AR drew our attention to the fact that appellant company had only subscribed capital of Rs. 200 only.
15. On the basis of the above, facts, it was argued that since the appellant has not contributed capital as required under the partnership deed hence it did not have any vested right. As per Section 55 and 62 of Contract Act, the agreement was voidable.
16. During the subsistence of partnership, no partner has a specific right in any asset of the firm as held by the Supreme Court in the case of A Naryanappa AIR (1966) 1300 (SC). The learned AR relied on the following judgments to explain the right of partner in the partnership firm.
i) CIT v. Devvas Cine Corporation 68 ITR 240 (SC)
ii) Malabar Fisheries v. CIT 120 ITR 49 (SC)
iii) Sunil Sidharth Bai v. CIT 156 ITR 509 (SC)
iv) S V Chandra Pandian and Ors. v. S Sivalinga Nadar & Sons 212 ITR 592 (SC)
v) N Khadervali Sahed and Anr. v. N Guddu Sahib 261 ITR 1 (SC)
vi) CGT v. T M Luiz 245 ITR 831 (SC) vii) K Govindan v. CGT 140 Taxman 101 (Ker.)
17. The learned AR drew our attention towards para 22 and 27 of the assessment order. It was argued that till the dissolution or distribution of assets, none of the partners can assign the rights in the asset. It was argued that decision of Karnataka High Court in the case of D C Shah v. CGT 134 ITR 492 was approved by Supreme Court reported at 249 ITR 518 and hence, that is binding. Mere change in profit sharing ratio will not result in deemed gift.
18. The learned DR drew our attention to Clause 9 of the partnership deed dated 12.10.88. As per this clause, the appreciation in the property owned by the firm shall belong to appellant firm. No other partner was having any right, title or interest in the future and further appreciation of the property. When fresh partnership deed was executed on 1.10.92, no such clause giving the appellant an absolute right in appreciation of property was executed. It was argued that appellant has relinquished the right in appreciation in favour of other partners without any consideration and this has resulted into a gift. It is not a simple case of change in the profit sharing ratio.
19. Identical applications were also filed by the following persons before the Bench:
1. Shri D Machingal Mohammed.
2. Shri P.K Usman
3. Shri A.K Ahmed
20. All the three above named persons were of the firm M/s Mysore Hotels and retied from the firm in the previous year relating to the asst. year 95-96 after withdrawing the sum of Rs. 1.08 crore from the firm. I? will be relevant to mention that Shri A.K Ahmed was a Director of the company at the time when he became partner in the M/s Mysore Hotels. He was also a Director when the share of the company was reduced and right in future appreciation available to the company was net mentioned in the deed dated Oct, 92. In the identical applications all the 3 persons have submitted as under:
The applicant is alleged donee as contemplated by the revenue which has invoked the proceedings under Gift Tax Act to levy the tax on the alleged donor who is applicant in the appeal. As the alleged donee, the applicant is also served with a demand as gift, as made by the assessing authority. The donee is seeking an opportunity to be heard when the appeal is fixed for hearing. The applicant may kindly be allowed to intervene as an intervener in the above appeal.
21. All the 3 above persons filed power of attorney in favour of Shri S. Parthasarthy and others. Accordingly notices were issued to Shri S Partha Sarathy. Keeping in view the fact that notice was earlier issued to Shri S Parthasarathy, opportunity was offered to Shri S Parthasarathy to file his written submissions. Accordingly written submissions vide letter dated 26.5.2005 has been filed. Following submissions have been made in the letter filed before us:
a. The interveners supports (he argument of the assesses
b. The Supreme Court in the case of Shri Narayana Trust v. CIT 261 ITR 279 has held that there is no gift, when the share of profit is reduced on reconstitution. The Assessing Officer has not held that there was consideration, which was inadequate for reducing the share of the assessee company in the firm.
c. When the firm M/s Mysore Hotel was reconstituted w.e.f 10.4.84, there was condition precedent that the assessee should contribute capital of Rs. 10 lakhs. Since the assessee company did not contribute capital of Rs. 10 lakhs, therefore, it was agreed amongst partners that profit sharing ratio of the assesses company should be reduced.
d. The reduction in profit sharing ratio is only to readjust their right on sharing future profits of the firm which is yet to occur.
e. The decision of the Madras High Court reported in 73 ITR 761 has been distinguished by the jurisdictional High Court and therefore cannot be relied for levying gift tax.
f. The case of D.B Patel Sons 247 ITR 589 is not applicable as in that case assets were specifically transferred to the partner.
22. We have heard both the parties and have gone through the paper books submitted. Partnership firm was formed vide deed dated 24.8,83 between the following partners.
1. Mr. A K Ahmed First Party 2. Mr. Machingal Mohammed, NRI Second Party. 3. Mr. P K Usman Third Party
23. The firm was named as Mysore Hotel Complex and business stated in the deed was of construction of shopping complex, Hotels and lodging including commercial complex and also running the business of Hotels. First and second parties contributed land as capita, contribution and appreciation beyond Rs. 27,30,015 in case of revaluation, was to be adjusted in the accounts of first and second party. Vide deed dated 10.4.84, Mrs. K Ahmed wife of Mr. A K Ahmed and the appellant company were introduced as partners, Smt. K Ahmed contributed a site as her capital contribution. The site was worth Rs. 2 lakhs. Vide this deed, it has been mentioned that all the future appreciation will belong to the appellant. The partnership deed dated 12.10.88 is important as it also contained the same clause regarding the right in appreciation in the value of assets owned by the firm. Relevant clause 9 of the deed is reproduced as under:
If on any future date, the valuation of the property in ‘as on’ or ‘in relating to’ the date of the bringing in the said property as capital contribution in kind is made by the Government Valuer for any purpose, then such increase/decrease over the amount of Rs. 2 lakhs treated and agreed upon as capital contribution in kind of the party of the continuing partners, shall be adjusted in the books of the firm to such account treated as and agreed upon as capital contribution in kind. In the event of dissolution of the firm or the appreciation in value of the property as above said – contributed as capital, shall belong to Messers Sri Bhuvaneshwari Hotels Pvt. Ltd. only and the other parties of the continuing partners shall not have any right or title or interest in the future and further appreciation of the asset after the date on which it is so contributed as capital, asset in kind. All the future appreciation in the property owned by the firm shall belong to M/s Bhuvaneshwari Hotels Pvt. Ltd. from the date of this agreement and the other ‘continuing partners’ shall not have any right, title, interest in the future and further appreciation of the property owned by the firm after this date.
24. Smt. K Ahmed retired from the firm vide deed dated 12.10.88. Accumulated losses in her name to the extent of Rs. 1,51,988/- were waived. This waiver is in consideration of her retiring from the firm. Thus, the firm consisting of the appellant company as partner gave consideration to the retiring partner and it can be said that firm treated that retirement of the partner was for a consideration.
25. Section 4(1)(a) & (c) of the gift tax Act are:
4(1)(c) Where there is a release, discharge, surrender, forfeiture or abandonment of any debt, contract or other actionable claim or of interest in property by any person, the value of the release, discharge, surrender, forfeiture or abandonment to the extent to which it has not been found to the satisfaction of the Assessing Officer to have been bonafide shall be deemed to be a gift made by the person responsible for the release, discharge, surrender, forfeiture or abandonment.
4(1) (a) Where property is transferred otherwise than for adequate consideration, the amount by which the value of property as on the date of transfer and determined in the manner laid down in Schedule II exceeds the value of consideration shall he deemed to be a gift made by the transferor.
Rule 16 of Schedule III of Wealth Tax Act gives the basis for computation of net wealth of the firm amongst the partners. It recognizes that net wealth can be more than the capital of the partners. It may happen an account of appreciation in the value of assets or including the value of goodwill.
26. Clause 22 and 23 of the partnership deed dated 12.10.88 are –
22. The death or retirement, insolvency, winding up, liquidation or ceasing to be a partner for any reason whatsoever of any of the partners shall not cause the dissolution of the firm but the surviving partners shall carry on the business including the operations of the bank accounts of the firm.
23. The goodwill of the firm shall belong to M/s Bhuvaneshwari Hotels Pvt. Ltd. only.
27. While executing partnership deed dated 1.10.92, Clause 22 was retained and mentioned as Clause 19, However, Clause 23 relating to goodwill was changed. Clause 20 relating to goodwill is as under:
The goodwill of the firm shall belong to the firm and shall be ascertained only when the business is sold.
28. From the above, it is clear that substantial changes were effected vide deed dated 1.10.92. Due to this, the appellant company lost its exclusive right in appreciation of property and goodwill of the firm. The learned Rajasthan High Court in the case of CGT v. Lal Chand Deomal 208 ITR 1030 observed –
A running concern has goodwill and goodwill is an asset. If (here is an express or implied agreement that the remaining partners (other than the retiring one) are entitled to carry on the business and the right to a share in the asset of the retiring partner shall devolve upon them, the normal rule is that a retiring partner has a right to a share in the assets of the firm which will include goodwill at the time of retirement.
29. In the instant case, the right is available to continuing partners to carry on the business. Thus appellant company having absolute rights in appreciation and goodwill vide deed of 1988 relinquished such rights in deed executed in October, 1992.
30. Now let us consider the case laws quoted by learned AR:
Sunil Siddharth Bhai v. CIT 156 ITR 509
During the subsistence of the partnership, no partner can deal with any portion of the property as own. The value at which asset is introduced is a national value and is 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 deduction of the liabilities and prior charges existing on the date of dissolution or retirement.
Malabar Fisheries Co. v. CIT 120 ITR 49 (SC)
Distribution of assets between partners at the time of dissolution is not transfer as the partners own jointly or in common the assets of the partnership.
CIT v. Dewas Cine Corporation 68 ITR 240 (SC)
Adjustment of rights of the partners in a dissolved firm by allotment of its assets is not a transfer nor is it for a price. In this case, theatres were given to the original owner on dissolution on book value and learned Supreme Court held that theatres are deemed to be returned to the original owner in satisfaction partially or wholly of claim to a share in residue of the assets after discharging debts and other obligations.
CIT v. T M Louiz 245 ITR 831 (SC)
In this case, the assesses retired from the two firms. What was argued before the Supreme Court was that the assessee has received less than the market value of his shares since the goodwill of the firms had not been taken into account, The learned Supreme Court held that the retiring partner got the value of his share in the partnership assets less than its liabilities. It cannot, in such circumstances, be held, assuming that the retiring partner received less than what was his due, that the difference was something that he had transferred to the continuing partners within the meaning of transfer of property for the purposes of Gift Tax Act or that there was a gift liable to gift tax.
N Khadervali Saheb and Anr. v. N Gudu Sahib (Deed.) and Ors. 261 ITR 169 (SC)
Disputes arose between the partners on dissolution of firm and such differences were referred to arbitrators. Arbitrators made an award by which the residue was distributed amongst partners by allocating the assets. The learned Supreme Court held that award did not require registration Under Section 17 of the Indian Registration Act, 1908, since the document did not transfer or assign any interest in any asset.
K Govindan v. CGT 140 Taxman 101 (Ker.)
There was re-allocation of profits and not a reconstitution of firm. The learned High Court held that revenue has not proved any fact to show that there is a gift.
31. The above judgments do hold that during the subsistence of partnership, no partner can have any specific right in a particular asset. The partner is having a right in the residue representing the excess of assets over liabilities. Retirement of a partner from the firm does not mean any transfer in favour of existing partner when goodwill remains with the firm and business is continued. Each case is to be judge on the basis of facts in each case.
32. The learned AR has heavily relied on the judgment of jurisdictional High Court in the case of Shah DC v. CGT 134 ITR 492 in support of the proposition that change in profit sharing ratio does not result in gift. The above referred judgement was approved by Supreme Court and reported at 249 ITR 518. The above referred judgement of the Karnataka High Court was referred before the Supreme Court by the counsel of the tax payer in the case of Sree Narayana Chandrika Trust v. CIT 261 ITR 279. The learned Supreme Court observed at page 285.
The judgement in D C Shah’s case 134 ITR 492 came to be appealed to this Court at the instance of revenue. The appeal came to be disposed off by this Court by a judgement in Civil Appeals No. 4551-56 of 1984 on September 25, 1996, wherein it was held: That the share of one partner is decreased and that of another partner correspondingly increased does not lead to the inference (hat the former had gifted the difference to the latter, The profit sharing ratio in a firm can vary for a number of reasons, among them, the ability of the partners to devote time to the business of the firm. The gift of a part of a partner’s share to another partner has to be established by relevant evidence. The onus of doing so is on the revenue. It has not been discharged in the present case.
32. In the case before the Supreme Court at 261 ITR 279, the matter was chargeability of gift due to reduction in share at the time of reconstitution of firm due to introduction of new partner. The worthy Supreme Court at page 285 observed:
Although it may be possible to say in the appellant’s case that relinquishment of the share of profit/loss by a partner in favour of the inducted partner may amount to transfer, we are unable to accept the contention that it was for inadequate consideration so as to amount to a taxable gift within the meaning of Section 4(1) (a) of the Gift Tax Act.
33. The learned Supreme Court in the case of CGT v. Chhotalal Mohanlal 166 ITR 124 held that relinquishment of share of an existing partner in favour of the minors, admitted to the benefit of partnership without any consideration amounted to gift by the said partner in favour of minors. The reason was that the goodwill of the firm is the property of the firm and upon admission of the two minors to the benefits of the partnership, the right to the money value of the capital stands transferred. Since this transfer is without consideration, in so far as the minors are concerned, the transaction would amount to a taxable gift under the Gift Tax Act.
34. Another decision of Supreme Court in the case of B T Patil and Sons v. CGT 247 ITR 588 is worth mentioning. In this case, the firm transferred certain machinery to each of five partners at the book value which was written down value. Within a short time, the partners floated another partnership and those machineries were brought as capital contribution at value which was three times the written down value. The newly floated firm sold those machineries to another concern for a still higher value. The Gift Tax Officer held that firm had made a gift of the machinery to each of its five partners for inadequate consideration and, therefore, the transaction was assessable to gift tax. The learned Supreme Court held that when an asset of the firm becomes an asset of the partner during the subsistence of the partnership firm than it is a case of transfer of that asset by the partnership to the individual partner. If such transfer is for less than the value of the asset, there is a deemed gift to the extent of the difference under the provision of Section 4(1)(a) of the G.T. Act.
35. Keeping in view the above discussion, it cannot be held that reallocation of shares amongst partners will not result into transfer. In case such reallocation is with adequate consideration then there is no case of deemed gift. The onus is on the revenue to establish that such reallocation is without inadequate consideration after the assessee gives its explanation about the consideration which necessitated such reallocation.
36. It will be relevant to quote the following Head Note from the judgment of the Supreme Court in the case of Sunil Siddharthbahai v. CIT 156 ITR 509.
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 transect ion of creating the partnership is a genuine or sham transaction and even where the partnership is genuine, whether 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 capital gain. The ITO will be entitled to consider all the relevant indicia in this regard viz. 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 for the partnership firm for such capital contribution from the assessee. All these and other pertinent considerations may he 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 an illusory transaction or a device or ruse, he is entitled to penetrate the veil covering it and ascertain the truth.
37. Now one has to consider the facts in the instant case in the light of above observation. New partnership deed is executed on 1.10.92 vide which the appellant surrenders his right on appreciation on the value of assets and goodwill and reduces its share of profit from 50% to 10%. The firm in which appellant was a partner was having substantial real estates and business included the development of commercial estates also, Appreciation in the value was in-built. Fixed assets were revalued on 30.1.93 to the extent of Rs. 1.63 crores and partner’s accounts were credited. On 1,2.93, some new partners are introduced. The three partners whose accounts were credited on account of revaluation, withdraw the amounts in AY 94-95 including the amount credited due to revaluation. These three partners retire in AY 95-96. The fourth partner is the appellant company. The appellant company also changes hands as Director, who has filed the appeal is a different director. Originally, the managing partner of the firm, in which appellant is a partner, was Director of the company. Addresses of all the four partners as per deed dated 1.10.92, are the same. The decision to reduce the share of appellant company and to relinquish the right over appreciation and goodwill is taken by the Director, who is also managing partner and got substantial benefit due to revaluation. His share increased to 45% from 25%. Thus, partners got converted the assets originally contributed and subsequently acquired into money and withdrew the same. They did not pay any tax on capital gain. One should appreciate that fresh partnership executed on 1.2.93 may not be the result of one day negotiation. Revaluation of assets on 31,1.93, execution of new deed dated 1.10.92 and reconstitute of firm by admitting new partners is clearly a device or ruse to evade payment of due tax. The AO was rightly justified in penetrating the veil.
38. Now let us consider the argument of the assessee mat due to non-contribution of the capital, the share of the appellant was reduced. This was adequate consideration for effecting changes in various clauses of the partnership deed. As per partnership deed dated 10.4.84, the appellant company was required to contribute Rs. 10 lakhs as capital. Further finances were required to be contributed by the appellant company. It is the submission of the learned AR that no capital was introduced by the appellant. Amount was contributed under the head ‘current account’ The appellant company was having subscribed capital of Rs. 200 and was unable to contribute the desired capital.
The learned AR has filed paper book containing –
1) Balance sheet and P&L account of the appellant company for F.Y. 86-87 to 94-95.
2) Balance sheet and P&L account of the firm M/s Mysore Hotel Complex for F.Y.84-85 to 94-95.
Perusal of the above show that the appellant company is showing on asset side as on 31.3.87 as under:
Advance to Mysore Hotel Complex, a partnership firm as a partner (exceeding 6 months 8,00,000 less than 6 months 3,00,000) - Rs. 11,00,000/-
39. Previous year figure shown is Rs. 6,50,000/-. Hence it is clear that appellant company has invested substantial amount from F.Y. 85-86. In absence of figures of earlier years, it cannot be said as to how much amount was invested. The appellant has not shown any amount in the name of appellant company as on 31.3.86 and 31.3.87 in the chart furnished at page 48 of paper book while balance sheet of assesse company shows such investment.
40. On credit side, the sum of Rs. 11,00,000/- is shown as advance for share capital. Hence, share capital is not Rs. 200 as on 31.3.86 or 31.3.87.
Year Advance to firm Advance reed.
ending As partner. towards subs-
cription of share
capital by company
------------------------------------------------------------------------
Note: As on
31.3.88 loss
31.3.88 11,00,000 11,00,000 from firm is
31.3.89 18,81,148 30,15,505 shown on
31.3.90 19,34,158 30,15,505 credit side of the
31.3.91 16,29,157 26,15,505 balance sheet
31.3.92 16,00,648 24,65,505 by the assessee
31.393 27,49,438 21,15,505 company.
41. Balance sheet for F.Y.94-95 has been signed by Shri G Komala, who is a partner, admitted vide deed dated 1.2.93. It means company has changed hands in the F.Y. 94-95 and the retiring partners i.e. Shri A K Ahmed, Shri M Mohammed and Shri P K Usman realized the enhanced value of assets and also transferred the ownership of the company. Perusal of Schedule attached with balance sheet showed that advance for share capital contribution were received from the persons, who were partners in the firm as per deed dated April, 84. This shows that appellant company was being controlled by the same persons, who were partners in the firm.
42. Book profit of the firm after debit of depreciation for various years is as under (upto 31.3.87, expenses have been capitalized as construction work was in progress from F.Y. 84-85):
Year Profit/loss Depreciation Profit/Loss
Ending after dep- before dep-
reciation, reciation.
F.Y.87-88 (-) 15,19,889 15,56,999 (+) 37,110
F.Y.88-89 (-) 5,62,010 13,51,748 (+) 17,89,738
F.Y.89-90 (+) 1,28,219 11,06,410 12,34,629
F.Y.90-91 (+) 1,90,000 9,15,883 11,05,883
FY.91-92 (+) 2,62,982 6,57,873 9,20,855
F.Y.92-93 (+) 8,62,367 5,21,159 13,83,726
From the above chart, it is clear that firm was in profit from the beginning in case depreciation is not considered. In F.Y.92-93, it was earning handsome profit.
43. No interest was being credited in capital account or current account of the partners. Hence, for all practical purposes, both the accounts were similar. The appellant company was having more than required capital in current account as on 31.3.87. The company is nothing but a closely held company controlled by the partners of the firm in which company was also a partner. From the above facts, it appears that the existing partners wanted to sell the business including immovable assets and a device was adopted for this purpose. As a result of this device, the appellant company surrendered its right in appreciation of the value of properties and goodwill by deed, dated 12.10.92.
44. The above discussions are summarized as under;
a. Firm M/s Mysore Hotels, came into existence vide deed dated 24.8.83 and the company became a partner in this firm vide deed dated 10.4.84
b. Vide dead dated 10.4.84, the assesse company was required to bring capital of Rs. 10 lakhs. Vide clause No. 8 at pg. 7 of the partnership deed, appreciations in the property owned by the firm belonged to the appellant company. The other partners were not given any right in future and further appreciation of the property owned by the firm. As per Clause – 19 of the deed good will of the firm and was to be ascertained only when the business was to be sold.
c. The firm was later reconstituted vide deed dated 12.10.88. As per dame ~ 9 of this deed, all the future appreciation in the property owned by the firm belonged to the assessee company and the new partners were not given any right in future and further appreciation of the property. Shri A.K Ahmed was a Managing Partner of the firm. Clause – 22 of the partnership deed gave right to continuing partners to carry on business of the firm in case any of the partners loses his right in the profit sharing on account of death, retirement, insolvency etc. As per clause – 23 of the deed, the good-will of the firm belonged to the assessee company
d. The firm was re-constituted in Oct, 92, In the deed it has been written that share of the assessee company is reduced as the assessee company was not able to contribute sufficient capital as agreed upon for the expansion of the business. The share of the assessee company was reduced The clause relating to the right of the assessee company in future appreciation was omitted clause – 20 of the partnership deed provides that goodwill of the firm belong to the firm while in earlier deed goodwill of the firm belonged to the assessee. As per clause 19 of the partnership deed continuing partners were given a right to continue the business incase any of the partners leave the firm on account of death, retirement, insolvency etc.
(e) Assets were revalued on 30th Jan, 93 and accordingly capital accounts of the partners were credited in the profit sharing ratio. The assessee company got only 10% of appreciation though as per deed dated Oct, 88, the assessee company was entitled to the entire appreciation.
(f) Fresh partnership deed was executed vide deed dated 1.2.93 and 4 new partners were introduced. The new partners were father, his two sons and his daughter in law. In the financial year 93-94, the 3 partnrs i.e. Shri A.K Ahmed, M.M Shri P.K Usman withdrew a sum of Rs. 1.08 crore from the firm. In the financial year 94-95 all these 3 partners retired. Vide deed dated Oct, 92 there were four partners i.e. Shri A.K Ahmed, Shri Mohammed Shri P.K Usman and the assessee company. In the financial year 94-95, the management of the assesse company was taken over by the persons who became partners vide deed dated 1.2.93 and after retirement of the 3 partners, the firm was controlled by one group as the control over the company vested with them.
(g) It is true that vide deed dated Oct, 84, the assessee company was required to contribute capital of Rs. 10 lakhs. The firm was re-constituted in Oct, 88. Before that, assessee company has advanced funds to the partnership firm. As per the details available, a sum of Rs. 6.5 lakhs was given by the assessee company to the firm before 31/3/86, The details of investments made by the assessee company in the firm have been mentioned in earlier paras. Vide deed dated Oct. 92, the firm was re-constituted and the terms and conditions of deed dated Oct, 88 were changed. Before the reconstitution of the firm vide deed dated Oct, 8, the assesses company contributed sufficient amounts as in the form of land and advances to firm.
(h) During the financial year 84-85 to 93-94, Shri A.K Ahmed was Director of the assesse company and he was also the Managing partner of the firm. As and when the funds were required to be contributed to the firm by the assessee company, the assessee company received advances towards share capital from Shri A.K Ahmed, Shri M Mohammed and Shri . P.K Usman. It is, therefore, clear that the firm was controlled by one group before another group was introduced vide deed dated 1st Feb, 93. First group retired from the firm and also gave away the management of the company to the other group so (hat other group became the owner of the company and was thus able to control (he affairs of the firm.
45. There has been not only the reduction in the profit sharing ratio by the assessee company vide deed dated Oct, 92 but also the assessee company surrendered its rights in appreciation and goodwill of the firm. The consideration as stated by the assessee was neither genuine nor adequate. The modus operandi has been adopted to evade payment of tax and the Assessing Officer has every right to penetrate the veil to uncover at and ascertain the truth.
46. Our findings are as under:
The Assessing Officer in his order has initiated the gift tax proceedings on the basis of facts mentioned in para 1 – 4 of the. asst. order. It includes the reduction in profit sharing ratio by the assessee company and surrender of the appreciation in the value of the property belonging to the firm. Considering the fact as mentioned by the Assessing Officer in his order the finding of the CIT(A) in confirming the issue on validity of issue of notice under Section 16 of the gift tax Act is upheld and second ground of appeal is dismissed.
47. Keeping in view, the discussion contained in this order, it is held that learned CIT(A) was justified in confirming that the assessee company was liable to gift tax as there has been a case of deemed gift. Hence ground of appeal No. 3 to 6 are dismissed.
48. The Assessing Officer has mentioned charging of interest under Section 16B in the body of the order and therefore no interference is required to be made in the finding of the learned CIT(A) in confirming the charging of interest under Section 16B.
In the result, the appeal of the assessee is dismissed.