Smt Girija Reddy v ITO [IT Appeal No. 297 (Hyd.) of 2012] (Hyderabad ITAT)

Background:

During the year under consideration, the assessee, a partner in the firm M/s. Montage Manufacturers, retired and her account had been credited by the firm with Rs. 7,95,88,639 being her share of goodwill. The Assessing Officer held that the crediting of the amount of Rs. 7,95,88,639 in lieu of the assessee’s share of goodwill on her retirement also amounting to transfer, and therefore, such receipt is liable for capital gains tax, as her right in the firm is a capital asset and extinguishment thereof amounts to transfer.

Assessee’s contentions

• Referring to sec. 14 of the Partnership Act, it was submitted that the goodwill belongs to the partnership firm and not to the partners. What the assessee got was only her share in such goodwill at the time of retirement, which had been valued and her share was credited to her capital account as per the provisions of Partnership Act, which she withdrew at the time of retirement.
• If the amount so credited is considered as received on transfer of goodwill and how the same would be taxed in the hands of the partners retiring in any subsequent year. It would therefore, not be correct to tax the amounts as capital gains only in the hands of the retiring partners.

Tax Authority’s arguments

• Amount received by the retiring partner represents the market value of the assets of the firm, her right and interest including her share in the goodwill of the firm. By retiring from the firm the retiring partner surrendered all her rights therein which were later to be enjoyed by the continuing partners. Her rights over the assets of the firm are not transferred free of cost but for the consideration received from the firm.
• Hon’ble Bombay High Court in the case of CIT v. A.N. Naik Associates [2004] 265 ITR 346 deliberated upon the purpose of introduction of sub sec. (3) of sec. 45 of the Act by the Finance Act, 1987 and observed that the effect thereof was that the profits and gains arising from the transfer of a capital asset by a partner to a firm would be chargeable as the partners income for the previous year in which the transfer takes place.
• Hon’ble Delhi High Court in the case of Bishan Lal Kanodia v. CIT [2002] 257 ITR 449, held that where “parties agree to pay a lump sum in consideration of the retiring partner assigning or relinquishing his share or right in the partnership and its assets in favour of the continuing partners, the transaction would amount to a transfer within the meaning of sec. 2(47) of the Act.

HELD:

• The share or interest of a partner in the partnership and its assets would be property and, therefore, a capital asset within the meaning of the definition u/s 2(14).
• Reliance is placed on the following rulings of Hon’ble Bombay High Court:
  (a)  Tribuvandas G. Patel’s case [1999] 236 ITR 515 ;
  (b)  CIT v. H.R. Aslot [1978] 115 ITR 255 (Bom);
  (c)  N.A. Modi’s case [1986] 162 ITR 420;
  wherein it was held that if instead of quantifying his share by taking accounts on the footing of notional sale, parties agree to pay a lump sum in consideration of the retiring partner assigning or relinquishing his share or right in the partnership and its assets in favour of the continuing partners, the transaction would amount to a transfer within the meaning of s. 2(47) of the Act
• Clause No. 17 and 18 partnership deed (retirement) dated 26.12.2007 read as follows:
  “17. On and with effect from the Effective Date, the Retiring Partners shall have no right, title or interest in the firm or its assets. ”
  18. All payments to the Retiring Partners by the Firm shall be on account of settlement of their capital accounts as set forth above. The Retiring Partners agree and confirm that they have no current claims of whatsoever nature against the Firm.”
• Lump sum payment is made in consideration of the retiring partner assigning or relinquishing her share or right in the partnership and its assets in favour of the continuing partners. The assessee satisfies the parameters laid down by the Bombay High Court in the cases referred to above and, therefore, there was a transfer of interest of the retiring partner over the assets of the partnership firm on her retirement and, therefore, there was a liability to tax on account of capital gain.