G.D Agarwal, V.P:— This is assessee's appeal against the order of the Commissioner of Income-tax (Appeals), Gandhinagar dated 25-11-2008 arising out of the order of the Assessing Officer passed under Section 143(3) of the Income Tax Act, 1961.
2. At the time of hearing before us, it is stated by the learned counsel that Ground No. 1.1 of the assessee's appeal is general in nature needs no adjudication. Ground No. 1.2 reads as under:
“1.2 The ld. CIT(A) has grievously erred in upholding the addition of Rs. 18,38,180/- made by AO u/s. 47A(iii) of the Act without considering fully and properly the explanation offered and evidence produced by the appellant.”
3. Other grounds i.e Groun. 2.1 to 4.1 are only arguments in support of Ground No. 1.2 above. Thus, the only dispute in this appeal is with regard to taxing a sum of Rs. 18,38,180/- as long term capital gain. The facts of the case are that during the accounting year relevant to the assessment year under consideration, the partnership firm, Vishal Containers was converted into Vishal Containers Pvt. Ltd. Before such conversion, the name of erstwhile firm Vishal Industries was changed to Vishal Containers. During the assessment proceedings, the AO raised query with regard to applicability of Section 47A(3) r.w.s proviso-(c) of section 47(xiii). In response to which the assessee furnished the following explanation:
“Regarding your question No. 1, we have to inform you that on 01/04/2004 the name of Vishal Industries was changed to Vishal Containers and the profit/loss sharing Ratio and capital Balance of Rs. 1,00,00,000/- is clearly mentioned in the partnership deed. As such, all the partners had decided to covert this partnership firm into Joint Stock-Company arm-to—register under the Companies Act, 1956 and the paid up share capital of the partnership firm as Joint Stock Company shall be 10,00,000 Equity shares of Rs. 10/- i.e Rs. 1,00,00,000/- and shares shall be held by the parties hereto by way of share capital also clearly mentioned in the partnership deed. The partners of this partnership firm shall be the members of the Joint Stock Company as per the Partnership deed. Accordingly, Balance Sheet of Vishal Containers on 01/04/2004 had prepared and the Assets and Liabilities were transferred to Vishal Containers Pvt. Ltd. In the Balance sheet of Vishal Industries as on 31/03/2004 the capital balance of partner's was Rs. 1.184 crores but in the Balance sheet of Vishal Containers on 1-04-2004 the Capital balance a Rs. 1.00 Crore only and Rs. 18.4 lakhs transferred to Unsecured loans of partners. The partners and members of Vishal Containers as Joint Sock Company is the subscribers of Memorandum & Articles of Association of Vishal Containers Pvt. Ltd., in the same proportion of capital balance as share holders of the Company as per Chapter DC of Companies Act, 1956. Further, as per Clause 23(B) SCHEDULE-J of the Form 3 CD of Vishal Containers Pvt. Ltd. though the previous partners have been repaid by cheque or otherwise it is from the unsecured loan/deposit only and not from the capital balance. Thus, Proviso (C) of section 47(xiii) of the Income Tax Act is not violated and hence the question of gain arising out of transfer of the capital assets of the firm to be deemed as Profit and gains u/s. 47A(3) of the Income Tax Act does not arise. We are enclosing herewith copy of Partnership Deed of Vishal Containers, Balance sheet of Vishal Containers as on 01/04/2004 and Memorandum & Articles of Association of Vishal Containers Pvt. Ltd., for your ready reference. Against your Q. No. 1(B) we are enclosing herewith the details of Share holders of our Company as on 31/03/2005 in the manner as you required.
4. The AO was not satisfied with the above explanation of the assessee and held that there was violation of Section 47A(3). Accordingly, he taxed the sum of Rs. 18,38,180/- as long term capital gain in the hands of the assessee. The relevant finding of the AO reads as under:
“The Capital Balance in the Balance Sheet of “Vishal Industries” was Rs. 1.184 Crore as on 31/03/2004. This firm was renamed as “Vishal Containers” on 01/04/2004 and at the time of re-naming it, its Capital of Rs. 1.184 Crore was reduced to Rs. 1 Crore and the balance amount of Rs. 18.4 lakhs became payable to the partners. Exactly on the same day “Vishal Container was converted into the company “Vishal Containers Pvt. Ltd.”. The existence of the firm “Vishal Containers” started on 01/04/2004 and ended on 01/04/2004 itself. The only reason of creation of this firm on 01/04/2004 was to hide the fact that the firm “Vishal Industries” had not transferred all the assets and liabilities to the company “Vishal Containers Pvt. Ltd.” (assessee) exactly in the same manner as prescribed in section 47(xiii) read with proviso (a) and (c) of that section. The Memorandum & Article of Association of Vishal Containers Pvt. Ltd. also mentioned in page 2 that the partners' of Vishal Industries decided to covert into Private Limited Company. The partners of the firm “Vishal Industries” have received net consideration of Rs. 18.4 lakhs in contravention to the proviso (c) of Section 47(xiii) of the I.T Act. The Capital of the assessee-company at the time of conversion was Rs. 1 crores whereas the capital of the firm was Rs. 1.184 Crore in contravention of the proviso (a) of section 47(xiii) of the Act. The partners have collectively gained Rs. 18.4 lakhs in the process as they are holding the same “Assets” of the company by employing only Rs. 1 crore of Capital which they were earlier holding in the firm by employing Rs. 1.184 crore of Capital. However, as per the deeming provision of section 47A(3) of the I.T Act, such Capital Gain has to be charged in the hands of the successor Company, i.e assessee. The default has occurred on 01/04/2004. Therefore, the Capital Gain is deemed to have arisen in the assessment year 2005-2006. Therefore, Rs. 18.4 lakhs is taxed in the hands of the assessee as Capital Gain u/s. 47A(3) of I.T Act. As the partners are holding the assets of the firm for more than 3 years as the firm Vishal Industries was incorporated on 01/04/1994. The nature of such Capital Gain will be Long Term Capital Gain.
From the above, it is evident that as on 31-3-2004, there was a partnership firm in the name of “Vishal Industries”. The closing balance in the accounts of the partners taken together was Rs. 1,18,38,180/-. As on 1-4-2004, the name of the Vishal Industry was changed to Vishal Containers and out of the opening balance of the capital lying in the partners' account a sum of Rs. 1 crore retained as partners' capital and Rs. 18,38,180/- was treated as loan from partners. The firm Vishal Containers with the capital balance of Rs. 1 crore was converted into company named as Vishal Containers Pvt. Ltd. with the share capital of Rs. 1 crore dividend into 10 lakhs equity shares of Rs. 10/- each. All the assets of the partnership firm became the assets of the company. However, as per the AO, there is violation of proviso-(c) of clause (xiii) of Section 47, The clause-‘c’ of section 47(xiii) reads as under:
“(c) the partners of the firm do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of allotment of shares in the company; and”
5. After considering the arguments of both the sides and the facts of the case, we do not agree with the findings of the AO that on the facts of the assessee's case there was violation of proviso-(c) to section 47(xiii). As per the AO, by way of repayment of Rs. 18,38,180/- to the partners, there was benefit to them other than by way of allotment of shares in the company. As we have mentioned earlier, the partners' capital was Rs. 1,18,38,180/-. The partners have withdrawn Rs. 18,38,180/- out of their credit balance and remaining Rs. 1 crore was converted into as share capital of the company. Therefore, merely because the partners credit balance lying as their capital was converted into their loan and which was repaid to them, it cannot be said that there was any undue benefit directly or indirectly to the partners. No violation of any other sections or clause-(c) of section 47(xii) was pointed out. On the other hand, the learned counsel of the assessee has stated that all the requirement of Section 47A r.w.s section 47(xiii) were duly complied with. In our opinion, the withdrawal by the partners out of their credit balance cannot be treated as long term capital in the hands of the assessee-company. In view of the above, we delete the addition of Rs. 18,38,180/- made by the AO as long term capital gains.
6. In the result, assessee's appeal is allowed.