Introduction
In the case of Shree Estates v. Income Tax Officer[i], the Income Tax Appellate Tribunal, Hyderabad (‘ITAT’), decided a significant question about the interpretation and application of s. 45(4) of the Income-tax Act, 1961 (‘ITA’), relating to capital gains arising from the revaluation of assets by a partnership firm. The issue before the ITAT was whether the revaluation of assets and the subsequent crediting of the amount into the partners' capital accounts amounts to a transfer of capital assets and, therefore, should be treated as capital gain under s. 45(4) of the ITA. Additionally, ITAT also considered a question regarding the Commissioner Appeals (‘CIT(A)’) authority to introduce a new source of income that was not previously considered by the assessing officer (‘AO’).
Facts
M/s Shree Estates (‘Assessee’), a partnership firm, was initially constituted with three partners in May 2017 and subsequently reconstituted in November 2017 to have a total number of 6 partners. The Assessee filed its return of income for the financial year (F.Y.) 2017-18, declaring a total income of Rs. 1.
The Assessee’s case was selected for scrutiny due to the substantial increase in partners' capital accounts in a year. The AO called upon the firm to (i) explain such a substantial increase in partners’ capital accounts and (ii) furnish the partners’ capital account details.
In its reply, the Assessee explained that two partners contributed land parcels and another partner contributed Rs. 1 lakh. The land assets were then revalued, and the credit was credited to the partners’ capital accounts.
It was further explained that the firm availed of secured loans amounting to Rs. 14,14,38,779, later converted into the capital of three partners. The firm revalued its land, and the revaluation amount of Rs. 12,56,24,460 was credited to the partners' capital accounts.
Unsatisfied by the Assessee's response, the AO treated the entire capital account as unexplained credit and, thus, taxed the same under s. 68 of the ITA.
Aggrieved by the assessment order passed by the AO, the Assessee filed an appeal before the CIT (A), in which the Assessee duly evidenced and explained the nature and source of the increase in the capital account. The submissions made by the Assessee were subsequently accepted, and the additions made under s. 68 of the ITA were deemed incorrect and hence deleted.
However, the CIT (A), while directing the AO to recompute the income of the Assessee under the head of capital gains, observed that the revaluation of assets and the subsequent credit to the capital accounts of the respective partners should be treated as a ‘transfer’ under the category of ‘otherwise’. Consequently, it held that the provisions of s. 45(4) of the ITA would apply.
Aggrieved by the order passed by the CIT (A), the Assessee filed an appeal before ITAT.
Held
The ITAT upheld the CIT (A)’s application of s. 45(4) of the ITA, ruling that the revaluation of assets and crediting of the revaluation reserve to the partners’ capital account constituted a ‘transfer’ within the meaning of ‘otherwise’ as specified in the provision. This revaluation reserve, thus subject to capital gains taxation, was interpreted in accordance with the Hon’ble Supreme Court’s decision in CIT v. Mansukh Dyeing & Printing Mills[ii].
On the issue of CIT(A)’s authority to introduce a new source of income, the ITAT found that CIT (A) holds wide powers under s. 251(1)(a) of the ITA to decide an appeal. The CIT (A) could consider the issues appealed against and any other issues arising from the assessment proceedings. The CIT (A) has co-terminus powers with the AO and can assess any income that emerges during the assessment process.
Our Analysis
S. 45 of the ITA is the charging section for capital gains, and the taxation of capital gains arising from the distribution of assets by any person or company to its partners or shareholders is specifically dealt with under s. 45(4) of the Act. The insertion of sub-section (4) was aimed at plugging the loopholes where the assessee was evading tax by revaluing assets and subsequently distributing the same during dissolution.
In lieu of the above statutory background, the order passed by the Ld. CIT (A), which the ITAT subsequently upheld, directed the re-computation of income while taking into consideration the provisions of s. 45(4) of the IT Act was correct and justified under law. This might particularly be the case if the assessee undertook such revaluation with the potential motive of evading tax.
Lastly, the observation that the CIT (A) is authorised to address any issue arising during assessment proceedings, even if it involves re-characterizing or taxing a new source of income that the AO did not identify, clarifies the expansive powers of the CIT (A) under s. 251 of the ITA.
End Notes
[i] [2024] 165 taxmann.com 261 (Hyderabad – Trib.).
[ii] [2022] 145 taxmann.com 151/290 Taxman 354/449 ITR 439 (SC).
Authored by Anshi Bhatia, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.
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