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ITAT rules on revaluation profit case
In a recent decision in the case of KTC Automobiles Private Limited (KTC), the Cochin Income Tax Appellate Tribunal (ITAT), has denied capital gain exemption upon the conversion of a partnership firm into a private limited company under section 47of the Income tax Act. Taxand India discusses the key aspects of the case.
KTC was a partnership firm and had an automobile dealership. The firm owned a land parcel having a book value of Rs 18.1 million which was revalued to Rs 77.2 million and the revaluation profits were credited to the partners’ current accounts as per their profit sharing ratio. The firm was converted into a private limited company during the Assessment Year (AY) 2005- 06. The credit balance in the partners’ current accounts after revaluation was treated as loan in the hands of the company and not as share capital.
The taxpayer contended that it had complied with the provisions of section 47(xiii) of the Act and therefore there was no liability for capital gain tax on the transfer of assets to the company on its conversion from the partnership firm. However, during the course of assessment, the Revenue Authorities (RA) held that the profit accrued on revaluation of the assets was indirectly transferred to the partners and therefore the taxpayer had not fulfilled the conditions laid down in section 47(xiii) of the Act. The AO treated the conversion as ‘transfer’ under section 45 of the Act and taxed the revaluation profit as capital gains in the hands of the taxpayer.
The Tribunal ruled against the taxpayer mainly on the basis that the conditions as laid down in the section 47(xiii) of the Act were not fulfilled. The Tribunal observed that all the assets and liabilities of the firm did not become the assets and liabilities of the company in the given case since the land was shown as asset of the company, while its revaluation amount was shown as loan in the balance-sheet of the company. Further, the Tribunal held that by converting the partnership firm into a private limited company, the taxpayer made an attempt to create a liability in the hands of the private limited company. As a consequence, the first condition under section 47(xiii) of the Act for exemption of the capital gain is not complied with.
Conversion of partnership firms into companies is a commonly adopted practice by taxpayers for corporatisation of assets / businesses. In delivering the judgment, the Cochin Tribunal has mainly relied on the fact that all conditions provided in section 47(xiii) of the Act to avail of the exemption from transfer were not met and consequently held that the transfer of assets on succession of the firm was taxable.
The Tribunal’s noting that the scheme of transactions was nothing but an accounting technique to avoid capital gains tax is another case where a ‘substance over form’ approach has been adopted by the Tribunal.