Commissioner of Income Tax vs Kartikey V. Sarabhai

Thakkar, J.—The four pillars on which the approach bridge to taxation matters is built are:

Not a rupee more than is legitimately due. But so also not a rupee less than is so due, least the burden of one who is really liable is not shifted on the shoulders of others.

No avoidable hardship or inconvenience to the small taxpayer and a sympathetic handling in respect of his unintentional faults and failings of an essentially technical character. But an unyielding unindulgent approach in accordance with the letter- cum -spirit of the law in dealing with the assessee with an inclination to avoid tax by means subtle or crude

A pragmatic interpretation of law and facts informed with the anxiety not to violate common sense or the spirit of the law which does not encourage circumvention by over smart manipulations designed to hoodwink the law in substance while showing excessive regard for the outer form.

A balanced rope-walker''s stance.

Commonsense as also the letter and the spirit of the law will have to be by and large sacrificed and the aforesaid pillars will have to be dismantled in order to uphold the startling proposition that (a) when A introduces his capital asset "X" acquired sometime earlier at a cost to him of, say, Rs. 10 lakhs in a partnership formed by him with B, and (b) his capital account in the newly formed partnership is credited with say, Rs. 90 lakhs, being the current market value of "X" at the time of its introduction, a capital gain of Rs. 80 lakhs (representing the difference between the amount credited to his capital account on the basis of its market value and the original cost of acquisition to him) does not accrue to A.

And yet the aforesaid proposition canvassed by the assessee has found favour with the Tribunal which has taken the view that-

" 1. There is no transfer of capital asset ''X'' even within the extended meaning and content of the expression ''transfer'' as defined by section 2(47) of the income tax Act, 1961 (hereinafter referred to as ''the Act'') which reads as under:

'' 2(47) ''transfer'' in relation to a capital asset, includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law;

[Emphasis supplied.]

That no capital gains exigible to tax u/s 45 of the Act reproduced herein below have arisen or accrued to A:

''45. Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 53, 54, 54B, 54D and 54E be chargeable to income tax under the head ''Capital gains'', and shall be deemed to be the income of the previous year in which the transfer took place.''

If this view were correct, all that one has to do to escape with impunity the liability to pay tax on capital gains is (i) to form a partnership with one''s wife (as was done by the assessee in Reference No. 34 of 1980); (ii) credit one''s capital account in the firm with the appreciated market value of the asset in question; (iii) sell it at the prevailing appreciated value on the third day (as was done by the assessee in Reference No. 34 of 1980, and (iv) dissolve the firm on the fourth day and get back one''s share in appreciated value thereby pocketing the capital gains without paying a single rupee as tax on capital gains. it is a device or a scheme (the expression is not used in any derogatory or condemnatory sense) which can easily be resorted to in order to defeat and thereby virtually repeal section 45 pertaining to capital gains tax, the repeal being effected not by the Parliament but by the resourceful assessee whose viewpoint is sustained by the Tribunal. And the scheme of device resorted to is a widespread epidemic as is evident from the fact that there are more than 125 matters raising this identical question which are being disposed of along with the matters at hand, apart from about 100 or more matters which are pending. And we come across dozen or so every week on the admission day. And counsel for the revenue states that the tax impact may well be in the neighbourhood of Rs. 1 crore in Gujarat State alone. The assessee cannot be prevented from making recourse to this device and having his pound of flesh (the expression is used to denote a success on super technical considerations), provided there is any compulsion of law or logic and the Court is obliged to be a helpless and a hapless spectator. But such compulsion there is none. In fact a Full Bench of the Kerala High Court and a Division Bench of the Karnataka High Court have taken the view that such a transaction falls within the four corners of the definition of "transfer" as defined by the section 2(47). We are, however, being persuaded to take a contrary view which we are unable to do for reasons which will become evident in the course of what follows.

Two hurdles will have to be overcome in the context of the facts of each particular case in order to uphold the contention of the revenue that such capital gains are exigible to tax u/s 45 of the Act. The first question which requires to be resolved is whether the transaction in question is "transfer" within the meaning of the aforesaid pro-visions. The next question which requires to be resolved is as to whether such a transaction is one for consideration as a result of which capital gains have been received or have accrued to the assessee concerned. The second question has arisen because, according to the assessee, even assuming that the introduction of a capital asset in a partnership formed by him with someone else constitutes "transfer" within the meaning of the aforesaid provisions, no question of capital gains can arise if the transfer is not for consideration resulting in any capital gains being received by him or any capital gains having accrued to him. It so transpires that the first question has been referred to us in Reference No. 34 of 1980. So far as the second question is concerned, though it was raised before the Tribunal, it declined to decide the said question on the ground that it was not necessary to do so having regard to the view formed by the Tribunal on the first question that it did not constitute "transfer" at all. The second question, however, requires to be answered in the context of Reference No. 235 of 1980 which has been heard along with the former reference inasmuch as in that case, the Tribunal upheld the contention of the revenue that the introduction of capital asset in a partnership firm by an assessee in a firm formed with someone else did constitute "transfer" within the meaning of section 2(47). However, the Tribunal was of the opinion that the transfer in question could not be said to be one for consideration as a result of which capital gains had come into the hands of the assessee or has accrued to him. In other words, in the former reference the first question has been decided against the revenue and the second question has not been answered, whereas in the latter reference the first question has been decided in favour of the revenue but the second question has been answered against it. The first question will have, therefore, to be resolved from the standpoint of both the references. Since, however, the second question has not been tackled at all. by the Tribunal in the former reference in the view taken by it in regard to the first question, the second question will have to be answered in the context of the latter reference. As both these questions arise in hundreds of matters, we have heard both the references along with each other and we propose to answer both the questions, by this common judgment. The first question we will answer in the context of Reference No. 34 of 1980 as well as Reference No. 235 of 1980. The second question we will answer in the context of Reference No. 235 of 1980.

We first propose to deal with the first question which has been answered against the revenue in Reference No. 34 of 1980. The question has been referred to us u/s 256(1) of the Act in the following terms:

"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the contribution in the form of shares of the value of Rs. 4,75,136 by the assessee in the partnership firm of M/s Rajka did not amount to transfer within the meaning of section 2 (47) of the Act resulting into capital gains chargeable to tax."

The relevant facts incorporated in paragraph 2 of the statement of case are as under:

"The assessee brought 580 ordinary shares of Ahmedabad Manufacturing & Calio Printing Co. Ltd., as capital contribution in the registered firm of M/s Rajka in which the assessee was a partner on 22-3-1973 and also brought 82 ordinary shares of Karamchand Premchand (P.) Ltd., as capital contribution in the said firm on the same day. The said firm credited the account of the assessee on 22-3-1973 with Rs. 4,75,136. The shares were valued at the market rate as on 22-3-1973. The market rate was stated to be Rs. 442 per share in respect of the shares of Calico Printing Co. Ltd. and Rs. 2,668 per share in respect of the shares of Karamchand Premchand (P.) Ltd. In the account books of the firm as well as of the assessee, these shares were stated to be the stock in trade of the firm. The assessee and his wife were the partners in the firm of M/s Rajka. The partnership agreement is dated 25-2-1973. The partnership deed provided that the business of partnership has commenced on 1-1-1973 and shall be at will and further provides that the assessee shall initially contribute in cash Rs. 9,000 and his wife shall initially contribute in cash Rs. 1,000. The partnership also provides that if any further capital is required for the purpose of partnership, the partners shall contribute such additional capital in such proportions and in such manner as the partners may from time to time determine and in respect of any asset brought in by any partner as capital contribution, the account of such partner shall be credited with the fair market value on the date the asset is so brought in. The accounts showed that the difference of Rs. 1,21,827 between the book value and the fair market value of the shares contributed by the assessee as the capital in the firm of M/s Rajka was adjusted in the capital account of the assessee. The income tax Officer took the view that the transaction, though it would not amount to sale or exchange, would amount to relinquishment of the assets or the extinguishment of the rights of the assessee therein and would amount to ''transfer'' within the meaning of section 2(47) of the Act. The income tax Officer held that the assessee was liable to pay capital gains tax of Rs. 2,94,030. This figure was arrived at by deducting Rs. 25,666, being the cost of 82 shares of Karamchand Premchand (P.) Ltd., from Rs. 2,18,776 and by deducting Rs. 1,55,440, being the cost of 580 shares of Ahmedabad Manufacturing & Calico Printing Co. Ltd., from Rs. 2,56,350."

It is not necessary to enter into detailed discussion of the facts for the purposes of answering the first question as it can be resolved on broad facts which are not in dispute. The broad facts in the background of which the question has arisen may now be outlined. The assessee introduced a capital asset in the form of shares soon after the formation of a partnership with his wife. The market value of the aforesaid capital asset (shares) was credited in the books of account of the partnership firm in the capital account of the assessee. The market value credited in the capital account of the assessee in the firm is far in excess of the cost of acquisition to the assessee. The difference between the larger amount credited in the capital account of the assessee in the partnership firm on the basis of the market value, and the cost of acquisition to the assessee, is sought to be taxed as capital gains u/s 45 as a profit or gain from the transfer of the capital asset in question.

The expression "transfer" employed by the Legislature in section 45 will have to be read in the light of the definition provided in section 2(47), which, in relation to a capital asset, includes the sale, exchange, relinquishment or extinguishment of any rights therein. On a combined reading of section 45 along with section 2(47) (which are complimentary and constitute a complete Code from the perspective of taxing capital gains) any profits or gains arising from the transfer of a capital asset (which expression shall include the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein) shall be chargeable to tax as capital gains to be computed in the manner prescribed by section 48 of the Act. Two preconditions are required to be satisfied, viz., (i) whether there is a transfer, say, by extinguishment, and (ii) whether as a result of such extinguishment capital gains have accrued or arisen to the person whose rights are extinguished only because that is the only element which can be invoked in the pre-sent fact-situation. The question has, therefore, arisen as to whether when a partner introduces a capital asset in a firm of which he is a partner, it results in a transfer within the meaning of section 2(47) read with section 45. Since the extinguishment of any right of the assessee in relation to any capital asset falls within the orbit of the expression "transfer", it will have to be first decided whether an extinguishment of an assessee''s rights in the capital asset introduced or brought in the partnership firm of which he is a partner would result on the asset being introduced in the newly formed partnership of which he himself is one of the partners. As soon as the capital asset in question is brought in or introduced in the firm in which the assessee is a partner, section 14 of the Indian Partnership Act, 1932 (Partnership Act) reading as under would come into operation:

"Subject to contract between the partners, the property of the firm includes all property and rights and interests in property originally brought into the stock of the firm, or acquired, by purchase or otherwise, by or for the firm, or for the purposes and in the course of the business of the firm, and includes also the goodwill of the business."

Thus, upon a property or capital asset belonging to the assessee being brought in or introduced by an assessee in the firm of which he is a partner, the property in question would belong to the partnership. That it would so belong to the partnership from the point of time when it is brought in or introduced in the firm of which the assessee is a partner, is not disputed. But what would happen to the title of the partner who introduced the asset in question into the firm? The following tests will have to be posed in order to ascertain the rights of the partner concerned, vis-a-vis, the asset in question:

Can he sell, gift away or alienate or transfer the said property or any part of it or any interest therein in any manner?

Can he dispose of the said property or any interest therein by will?

Will it be includible in his net wealth for the purposes of Wealth-tax Act?

If he can neither alienate it, nor gift it to anyone, nor dispose it of by a will, and if it does not require to be included in his net wealth for his wealth-tax return, does it remain his property?

The answer in each case is an emphatic "No". What would be includible in his wealth-tax return would be the valuation of his interest in the firm which question can arise only if the total assets exceed the total liabilities. In a given case, the liabilities may exceed the assets and there may not be any surplus. In case, however, there is a surplus, the interest in the firm will have to be valued. And the value of such interest in the firm (and not the value of the interest in the capital asset introduced by him) will have to be included in his net wealth. Of course, the valuation will have to be done in accordance with the mode of valuation prescribed by rule 2 of the Wealth-tax Rules which bears the caption "Valuation of interest in partnership or association of persons". The relevant part of the said rule insofar as material reads thus:

"2. (1) The value of the interest of a person in the firm of which he is a partner or an association of persons of which he is a member, shall be determined in the manner provided therein. The net wealth of the firm or the association on the valuation date shall first be determined. That portion of the net wealth of the firm or association as is equal to the amount of its capital shall be allocated among the partners or members in the proportion in which capital has been contributed by them. The residue of the net wealth of the firm or association shall be allocated among the partners or members in accordance with the agreement of partnership or association for the distribution of assets in the event of dissolution of the firm or association, or, in the absence of such, agreement, in the proportion in which the partners or members are entitled to share profits. The sum total of the amounts so allocated to a partner or member shall be treated as the value of the interest of that partner or member in the firm or association."

It is, therefore, not possible to contend that the assessee continues to be an owner in respect of the property introduced by him in the firm of which he is a partner. Not even in respect of a part of the said property. He no longer has any title to the said property or any part of it. He no, longer has any power to dispose of the whole or any part of it or any interest therein as his property. Neither the whole nor any part of it is includible in his net wealth in the context of his liability under the Wealth-tax Act. ft is, therefore, abundantly clear that his erstwhile title in respect of the said property would stand extinguished from the point of time when it is introduced as a capital asset in the firm of which he is a partner. This would constitute "transfer" within the meaning of section 2(47). Once it constitutes "transfer'''', any profits or gains arising in the wake of such transfer would be exigible to tax u/s 45 without anything more. Yet, it is urged on behalf of the assessee that it would not be so. The arguments urged in this behalf can be broadly divided into the following three categories:

Notwithstanding such extinguishment of rights, it is no transfer because all the rights (emphasis being on "all") are not extinguished. It is contended that his rights as a partner are retained or remain with the person introducing the capital asset.

There can be no transfer within the meaning of section 45 unless it is a bilateral transaction between two legal persons. There can be no transfer from oneself to oneself. And a partnership firm not being a legal entity, there cannot be any such bilateral transaction of transfer.

Since distribution of surplus assets available with the partnership upon dissolution does not constitute transfer as held by the courts in several cases, the converse must hold good and there can be no transfer so as to attract exigibility to tax.

These arguments are wholly fallacious. In the first place, it cannot be posited that a partner has any interest in the specific partnership properties. A partner having a one-half share in the partnership is not the one-half owner of the specific properties belonging to the firm. What he has is a one-half share in the residue of the partnership assets remaining after payment of debts and liabilities of the firm. A partnership firm can own immovable properties and have capital assets. These may be introduced by a partner or may be subsequently purchased by the firm. As soon as the property is acquired either by way of introduction by a partner or by way of subsequent purchase, it becomes a part of the assets of the partnership firm. But, in respect of the property in question, no partner can say that he has any specified interest in it. If the assessee were to contend that he has an interest in the property introduced by him, he must be in a position to say that his interest in the particular specified property introduced by him is capable of being transferred either by way of sale, gift or mortgage. It must be capable of being made a subject-matter of a Will. It must be includible as an item of his wealth for the purposes of his liability to pay wealth-tax. As discussed earlier, it is impossible to contend that the rights of the assessee in the property which was introduced in the firm of which he is a partner are not extinguished. After it becomes a part of the assets of the partnership firm, he himself would not have the power in his own right to alienate or transfer either the property or his alleged interest therein by any of the modes described earlier and he would not be obliged to value it for the purposes of his liability under the Wealth-tax Act. The position cannot be disputed on first principle that he has no specified interest in any specified property belonging to the partnership firm of which he becomes a partner. His right is restricted to claim a share in the profits during the subsistence of the firm and to claim a share in the residue or surplus remaining after payment of debts and discharge of liabilities at the time of the dissolution of the firm. The Supreme Court, in Addanki Narayanappa and Another Vs. Bhaskara Krishtappa and Others, , has declared such to be the law in no unclear terms in paragraphs 3 and 5 of the report. The following propositions emerge therefrom:

In theory all properties collectively vest unto the partners but no partner has any specific interest in any specified item of property, and theoretical vesting, notwithstanding the rights of partners, are no more than the rights enumerated in the propositions which follow.

During the subsistence of the partnership, no partner can deal with any portion of the property as his own. Nor can be assign his interest in a specific item of the property to anyone.

His right is merely the right to obtain such profits, if any, as fall to his share from time to time.

Upon the dissolution of the firm, he has the right to claim a share in the assets of the firm which remain surplus after satisfying the liabilities set out in clause (a) and sub-clauses (i), (ii) and (iii) of clause (b) of section 48 of the Partnership Act.

The resultant position in the eye of law is that the exclusive property of the person who brought it in would cease to be his exclusive property and would become the asset of the partnership in which all the partners would have interest in proportion to their share. The person who introduced the property in question would not be able to claim or exercise any exclusive right over any property which he has brought in or over any other partnership property. He would not be able to exercise his right even to the extent of his share in the business of the partnership. This is all that a person who introduces his property in a firm of which he is a partner acquires as per the law declared by the Supreme Court in Addanki Narayanappa''s case (supra) in unequivocal terms. The legal rights, vis-a-vis the property introduced by a partner "before" and "after" such introduction are, therefore, no more in doubt''. Previously the assessee was an exclusive owner in respect of the property or capital asset. Upon introducing the said property in the partnership firm of which he is a partner, all his rights stood extinguished and he had no defined interest in the said property which could be called his own and which he could have dealt with or in respect of which he could be made liable to pay tax as an item of his wealth. What he acquired thereupon was not any interest in the item of property introduced by him in the firm. No. That is not what he acquired. What he acquired was altogether a different right. Apart from the right to claim a share in the profits, he would have a right to claim (upon dissolution) a share in the surplus assets of the firm in case there is a surplus after satisfying the liabilities envisioned by section 48. In a given case there may be no surplus. In that event, the person who contributed the capital asset in the partnership, instead of getting a share of the surplus partnership asset, may have to make a contribution in order to make good the deficiency to the extent that he is liable in that behalf. This is the only right that he has acquired and no other right. In respect of the property introduced by him, all his rights stand extinguished and no specific right or interest in the said property is retained by him or remains with him. There is no substance in the next limb of the argument that it does not amount to transfer by reason of the fact, that there is no bilateral transaction and one cannot transfer the property to oneself. The definition of section 5 of the Transfer of Property Act provides a clear and unambiguous answer. Insofar as material, it reads thus:

"5. In the following sections ''transfer of property'' means an act by which a living person conveys property, in present or in future, to one or more other living persons, or to himself, or to himself and one or more other living persons, and ''to transfer property'' is to perform such act."

The Transfer of Property Act does very much contemplate a transfer from a person to himself or to himself and one or more other living persons. Therefore, the second limb of the submission is also devoid of any merit. It needs to be clarified that once there is extinguishment of rights of the partner introducing the asset into the firm, the transaction of transfer would be complete within the meaning of section 2(47) read with section 45. It is unnecessary to look for the party to whom it is transferred and identify his personality from the perspective of a bilateral transaction. Even so we are trying to test its validity irrelevant as it is in the view we take. And we see no substance in it for the reasons mentioned earlier. As regards the submission that it would constitute a transfer from oneself to oneself and another and that under the circumstances, it cannot be said that the interest of the partner who introduces his exclusive property in the firm can constitute transfer, we have already pointed out that there is no legal bar to the transfer of a property from oneself to oneself and someone else. In fact such a transfer is recognised, in law and section 5 in terms envisions such a transaction. In the second place, it appears to be well-settled that it is permissible to transfer one''s own property in favour of a partnership consisting of oneself and another as has been held by a Division Bench of the Bombay High Court in Commissioner of Income Tax, Bombay South Vs. W.L. Dahanukar, . Says the Division Bench speaking through S.T. Desai, J.:

"It will be seen that neither the judicial member nor the accountant member had ascertained the assessable profit at Rs. 19,400. It will also be seen that the third member has taken a view of his own which is not in argument with that of either of the two other members of the Tribunal. In our judgment, the reasoning by which this amount of Rs. 19,400 has been arrived at is unsound. It is competent to a person in law to sell his property to a partnership firm consisting of himself and another. Such a transaction would be valid and binding and would have all the incidents of a legal and binding transaction of sale, and the difference between the purchase price of the land and the selling price would be the profit that would accrue to the person who purchased and sold the land. That amount in the present case would be the difference between Rs. 90,000 and Rs. 41,500, i.e., Rs. 48,500." (p. 463)

We are, therefore, unable to comprehend how it can be contended that notwithstanding the aforesaid decision it does not constitute a transfer. On one hand, there is the extinguishment of the right of the person who introduces his exclusive property in the firm of which he is a partner. And, on the other hand all that he gets is the right to claim a share in the partnership assets if there be any surplus at the point of time of dissolution, with no right or interest in any specific property including the property introduced by him as per the law declared by the Supreme Court in Addanki Narayanappa''s case (supra). How can it then be contended that even so there is no "transfer" within the meaning of section 2(47) read with section 45?

The question, viz., whether the act of introducing the property or the capital asset in the partnership firm of which the person introducing the asset in question is an owner, constitute "transfer" within the meaning of section 2(47) came up for consideration before the Kerala High Court as well as the Karnataka High Court though not in the context of the charge-ability to capital gains u/s 45. The question came to be examined by a Full Bench of the Kerala High Court in A. Abdul Rahim, Travancore Confectionery Works Vs. Commissioner of Income Tax, in the context of development rebate claimable u/s 34(3)(b) of the Act. The Full Bench consisted of P. Govindan Nair, CJ., V. Balakrishna Eradi, J. (as he then was) and Kr. Baskaran, J. The Full Bench, speaking through P. Govindan Nair, CJ., has taken the view that it would constitute a transfer within the meaning of section 2(47). The Full Bench posed the question what happens when a person brings the property which belonged to him exclusively for the purpose of the business of the firm which was to be formed with him as the partner? Is there any extinguishment of any right that he had in the property by the above process? Relying upon Addanki Narayanappa''s case (supra), the Full Bench has answered the question in the following manner:

"It is thus clear that every partner has an interest in the property of the partnership. What is more, the person who brought in the property for the purpose of the business of the firm would not be able to claim or exercise any exclusive right over the property. Such a situation can arise only, if there was an extinguishment of some right of the partner in the property which was exclusively his and which was brought in for the purpose of the business of the firm. Without such extinguishment, it is inconceivable that the other partners would get an interest in that property. That interest which a partner gets in the property of the firm (property of the firm is used in the general sense), the Supreme Court held, in the very same case, is movable property. The interest, therefore, the partner gets is not something illusory. It is something substantial and tangible, termed by the Supreme Court as a right to property though of course it is only movable property. Such substantial rights can come into existence, as we have already indicated, only on a corresponding extinguishment of the exclusive right of the partner in the property that he brought in for the purpose of the business of the firm. This is sufficient for the purpose of attracting section 2(47) of the Act which speaks of ''extinguishment of any rights therein'', ''therein'' standing for ''capital asset'' which term is defined in section 2 (14) of the Act. It is not contended before us that the machinery brought in by Abdul Rahim for the formation of the partnership is not ''capital asset''. There was thus a transfer of a capital asset within the meaning of section 2(47) attracting sections 34(3)(b) and 155(5) of the Act. The transfer is clearly by the assessee in this case." (p. 601)

A similar question arose in the same context (of development rebate) before a Division Bench of the Karnataka High Court consisting of D.M. Chandrashekhar, CJ., and E.S. Venkataramaiah, J. (as he then was) in Addl. Commissioner of Income Tax, Mysore Vs. M.A.J. Vasanaik, . The Division Bench has placed reliance on Addanki Narayanappa''s case (supra) and has also sought support from the aforesaid decision rendered by the Full Bench of the Kerala High Court in A. Abdul Rahim''s case (supra). The view taken by the Karnataka High Court in substance is that the individual, who introduced the property in the firm of which he was a partner, would lose his exclusive title to it and would thereupon acquire only the right as a partner in the partnership assets in accordance with the provisions of the Partnership Act as is evident from the following passage quoted from the decision:

"It may be that no formal deed or conveyance is necessary to transfer the property of an individual to the firm of which he is a partner. But there must be an agreement amongst the partners to do so. If the partners agree to treat the property of any of them as partnership property, such property will become partnership property and section 14 of the Partnership Act becomes applicable. The said Act is not similar to the unilateral act on the part of a coparcener who throws his separate property into the family hotchpot. The legal results which flow from the individual''s property being converted into partnership property are that the partner to whom the property belonged before becoming partnership property loses his exclusive title to it and the right he thereupon acquires is only the right of a partner in the partnership assets, in accordance with the partnership agreement and the provisions of the Partnership Act. There is virtually a transfer of his right in the property to the partners of the firm including himself. Section 5 of the Transfer of Property Act recognises transfer from an owner to himself and others. But the Transfer of Property Act is not an exhaustive code dealing with all kinds of transfers. As its preamble suggests it deals with only certain kinds of transfers. It cannot, therefore, be said that any Act which transfers right in a property but which is not covered by the Transfer of Property Act is no transfer." (p. 121)

An argument was advanced before the Division Bench of the Karnataka High Court that the definition of the expression "transfer" embodied in section 2(47) was only for the purposes of section 45, viz., in the context of chargeability to capital gains tax and not in the context of the provisions relating to development rebate contained in section 34(3)(b). The Karnataka High Court has expressed the view that even without making recourse to section 2(47), the transaction of introducing the property in the partnership of which one is a partner would constitute transfer even as understood in the ordinary sense without calling into aid the extended definition of the expression and the wider sense in which it is defined by section 2(47) for the purposes of chargeability to tax on capital gains u/s 45. Says the Division Bench:

"A Full Bench of the Kerala High Court has held in the case of A. Abdul Rahim v. CIT [1977] 110 1TR 595 that on the conversion of an individual business into a partnership, a transfer of the assets of the individual to a firm attracting the provisions of section 34(3)(b) of the Act takes place. It is no doubt true that the Full Bench has relied upon section 2(47) of the Act which defines the expression ''transfer''. Section 2(47) provides that ''transfer'' in relation to a capital asset includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law. It is argued that the definition of ''transfer'' found in section 2(47) is introduced'' in the Act only for the purpose of section 45 of the Act which deals with capital gains and it cannot be relied upon for interpreting the words ''otherwise transferred'' in section 34(3)(b) of the Act. We are of opinion that in order to hold that on the individual business being converted into partnership business, there is a transfer of the assets of individual to the partnership, it is not necessary to rely on the definition in section 2(47) at all because the said transaction amounts to a transfer in the eye of law even when the word ''transfer'' is understood in the ordinary sense and not in the wider sense in which it is defined in section 2(47) of the Act." (p. 123)

The approach made by us is somewhat different from the approach made by the Kerala and the Karnataka High Courts as outlined in the discussion made a short while gap. Whilst the route is slightly different, the destination reached is the identical one. But we still have to settle score with some more submissions urged by counsel of the assessee based on a Calcutta High Court case. It arose in the context of the Indian income tax Act, 1922 (hereinafter referred to as "the 1922 Act") as it stood at the time of the assessment years in question. Reliance is placed on Commissioner of Income Tax, West Bengal Vs. Hind Construction Ltd., . It appears that one Patel Engineering Co. Ltd. and the assessee-company embarked upon a joint venture. The stock of the disposal machinery which formed a part of the assets belonging to the joint venture were divided between the assessee and Patel Engineering Co. Ltd. The assessee received machinery valued at Rs. 2 lakhs and odd as its share. In its own books of account for 1949-50 by recourse to the method of revaluation on paper the valuation of the said machinery was written up by Rs. 4 lakhs by inflating the valuation from Rs. 2 lakhs and odd to Rs. 6 lakhs and odd. The difference of Rs. 4 lakhs was credited to a capital reserve account. Thereafter a new firm was floated. Patel Engineering Co. Ltd. also transferred their share of the assets received on dissolution of the joint venture to the new firm by following the same modus operandi of revaluation on paper. Thus, both the parties made an upward revision in the valuation of the assets which came to their share by enhancing the same by Rs. 4 lakhs. The capital account of each of the partners including that of the assessee was credited with the sum of Rs. 6 lakhs and odd which included the sum of Rs. 4 lakhs representing the extent to which upward valuation was effected by way of writing up of the valuation in the books of account. In the context of these facts the question arose before the ITO whether the aforesaid amount of Rs. 4 lakhs could be treated as the assessee''s profits. The Tribunal and the High Court rendered a concurrent finding to the effect that (i) there was no sale of the machinery when the assessee resorted to revaluation and inflated the price of the machinery which fell to its share on paper, and (ii) there was no sale in favour of the partnership when the new partnership was created. The Supreme Court upheld the view that writing up the valuation of an asset would not constitute sale. So also the Supreme Court expressed the view that the transaction in question did not constitute a sale in favour of the partnership firm. The question before the Supreme Court, it is significant to realise, had arisen in the context of the 1922 Act as it stood at the material time in the context of the assessment year 1951-52. There was no provision, similar to section 2(47) of the Act with which we are concerned, investing the expression "transfer" with an extended meaning and context including the extinguishment of the rights of a person in an item of property at that point of time. The Supreme Court was not interpreting the fact-situation from the standpoint of the provisions as they now exist. Hind Construction''s case (supra) was cited before the Karnataka High Court in Vasanaik''s case (supra). The argument in the context of this decision has been dealt with in Addl. CIT v. M.A.J. Vasanaik (supra) in the following manner:

"In Commissioner of Income Tax, West Bengal Vs. Hind Construction Ltd., , the Supreme Court no doubt held that a person by handing over his goods to a partnership of which he was a partner as his share of the capital cannot be considered as having sold his goods to the firm. But the Supreme Court did not say that the goods had not been otherwise transferred thereby. That was not a case dealing with section 34(3)(b) of the Act. Cases in which proviso (e) to section 24(2)(ii) of the Indian income tax Act, 1922, and section 78 of the Act have been considered are not of much assistance to the assessees as the decisions rendered in those cases are based on express statutory provisions which have no bearing on the issues involved in these cases. Hence, we have not chosen to deal with them." (p. 125)

The Karnataka High Court has taken the view that the Supreme Court was dealing with the question as to whether or not there was a sale of goods in favour of the firm and the Supreme Court was not required to and in fact did not deal with the question as to whether it would constitute transfer in any other sense. The Supreme Court was not seized with the question whether or not a transaction of this nature would constitute "transfer" within the extended meaning with which the expression is invested by virtue of section 2(47). It may be stated that the aforesaid decision in Hind Construction Ltd.''s case (supra) decided by the Supreme Court was not cited before the Kerala High Court. It has, therefore, not been dealt with by the Kerala High Court. We concur with the reasoning of the Karnataka High Court. In Hind Construction Ltd.''s case (supra), the Supreme Court was considering the question as to whether or not it constituted a sale in the context of the 1922 Act as it stood at the material time, i.e., assessment year 1951-52. The Supreme Court was not faced with the question as regards the interpretation of the expression "transfer" as per the extended meaning assigned to it by the Legislature u/s 2(47). Nor are we concerned with the question as to whether or not it was "sale". In order to avoid repetition, we may say that the question arose in the context of writing up of the valuation of the machinery in the assessee''s own books of account by revaluation on paper. Obviously, no profit can arise by mere upward revaluation on paper. Besides, the question whether or not it was "sale" arose in the context of the 1922 Act as it stood then which did not contain any provision similar to the one with which we are concerned, viz., section 2(47). Under the circumstances, no useful purpose will be served by launching upon an investigation of the reasoning which found favour with the Supreme Court in rendering the aforesaid decision. Counsel for the assessee has also placed reliance on Commissioner of Income Tax Vs. Janab N. Hyath Batcha Sahib, . In that case a partner had handed over his lorries to the partnership consisting of himself and another. The question arose whether it would constitute a "sale" within the meaning of the Sale of Goods Act. The question arose in the context of the assessment year 1960-61 when the 1922 Act was in force. There was no provision similar to the provision contended in definition clause of "transfer" embodied in section 2(47). That is why, following the law laid down in Commissioner of Income Tax, Madhya Pradesh Vs. Dewas Cine Corporation, and a number of other decisions, the view was taken that it would not amount to "sale" within the meaning of the Sale of Goods Act. We are concerned with an altogether different question, viz., as to whether the transaction under scrutiny would constitute "transfer" within the meaning of section 2(47). The decision in Hyath Batcha Sahib''s case (supra) cannot, therefore, turn the scales in favour of the assessee.

Now at least we come to the last submission. It is contended that the transaction did not constitute a transfer by drawing inspiration from a number of decisions rendered in the context of the converse situation obtaining at the point of time of dissolution of a partnership firm. The legal rights of the partners at the point of time of dissolution of a firm, in our opinion, can have little bearing in regard to the question as to what is the legal effect of a transaction resulting from the introduction of a capital asset at the time of the formation of the partnership or subsequent thereto. The first decision on the point is the one rendered by the Supreme Court in CIT v. Dewas Cine Corporation (supra). The question arose in the context of the fact that upon a dissolution of a partnership firm a theatre introduced by the concerned partner during the subsistence of the partnership came to be returned to the original owner. The revenue advanced an argument to the effect that this would constitute a sale of the theatre by the partnership to the individual partners in consideration of their respective shares in the residue. The Supreme Court negatived this contention. The Supreme Court has taken stock of the legal position in the course of its judgment and referred to Addanki Narayanappa''s case (supra) with approval. The following propositions emerge from the aforesaid decision:

The right of a partner upon dissolution is to his share in the value of the residue after discharge of liabilities.

2.(a) A partner may insist on the realization of the value of the assets by sale; or

(b) he may accept allotment of a specific item of property in satisfaction of his share in the residue determined on the footing of actual or notional sale of the asset.

(c) if course in 2(b) is adopted, it does not constitute a sale by the erstwhile partnership to the erstwhile partner.

Two points must be grasped clearly. First, upon the firm being dissolved, there is no question of the dissolved firm effecting any sale in favour of a one time partner. The second point which requires to be understood is that the proposition of law has never been doubted or disputed that the right of a partner upon dissolution is no more than to have the assets of the partnership sold for the discharge of the debts or obligations of the partnership and to claim a share only in the residue. There can, therefore, be no question of any transfer by the partnership to a partner when, instead of selling the assets and distributing the residue, the assets are divided amongst themselves in specie on a notional or actual sale thereof.

The next decision on which reliance is placed in the context of this argument is the decision of the Supreme Court in Commissioner of Income Tax, U.P. Vs. Sh. Bankey Lal Vaidya (Dead) by Lawyers, . Again the question posed was whether the distribution of assets of a firm amongst the partners on dissolution would constitute sale in favour of partners receiving the assets. The facts culled out from the aforesaid decision go to show that the assets of the partnership firm including goodwill, machinery, furniture, etc., were taken over by one of the partners. In lieu thereof he paid the share of the other partner on the basis of the valuation of the said machinery. It was in this context that the question arose whether the sum of Rs. 65,000 being part of the amount received by the partner upon dissolution could be brought to tax as capital gains u/s 12B(1) of the 1922 Act. There again the question arose in the context of the law as it stood which did not contain a provision similar to section 2(47) which gives an extended meaning to the expression "transfer". Besides, there was no question of any sale on payment of price in that case. It was a case of adjustment of the rights of the partners in the surplus proportionate to the shares of the partners done in the course of dissolution of the partnership firm and consequent distribution of its assets. The Supreme Court has, therefore, taken the view that there was no sale in favour of the partner concerned and there was no question of capital gains. The same question raised its head before a Division Bench of this High Court in Commissioner of Income Tax, Gujarat Vs. Mohanbhai Pamabhai, . The question arose in the context of the retirement of a partner from the partnership firm. This Court has taken the view that when a partner retires from a partnership and the amount of his share in the net partnership assets after deduction of liabilities and prior charges is determined on taking accounts on the footing of notional sale of the partnership assets and given to him, it would not constitute a consideration paid to him for transfer of his interest in the partnership by the continuing partners. His share in the partnership is worked out by taking accounts in the manner prescribed in the relevant provisions of the Act and there can be no question of any transfer of interest in any partner-ship assets on the part or the retiring partner. No doubt section 2(47) was on the statute book at the material time. However, this did not make any difference for the very good reason that the question arose in the context of the retirement of a partner which was in a way akin to the position arising upon dissolution of the firm. When the partner retired, his share in surplus was valued and payment was made in respect of that share. But what was his right and what was his share? It is this aspect which we have been emphasizing throughout this judgment. His right was a right to get the value of his share in the net partnership assets after the satisfaction of debts and liabilities of the firm. We stress the expression "a share is the net partnership assets which remained after the payment of debts and liabilities". In other words, a share in the residue of the totality of the partnership assets which remained surplus after payment of debts. It is not a payment in respect of a particular interest in a specified property belonging to the partnership firm. The value of all the assets and liabilities would enter into the working out of the surplus. And it is a share in the surplus which is distributed in specie or paid to him by valuing his share in the surplus. There is, therefore, no question of any transfer involved at the stage of dissolution. The position is vastly different at the stage of introduction of an asset into the partnership. At the stage of dissolution, there is no question of extinguishment of the right of the partner in any particular property which can be said to belong to him exclusively. In fact, it cannot be said that he has any particular interest in any particular property, his right being no more the right to share in the surplus after the sale of the assets and payment of the debts and liabilities in case there is a surplus. Once again, at the cost of repetition, it may be stated that there may be no surplus. In fact, there may be a deficit. Where then is the question of transfer of any asset or interest in any property? But at the stage of introduction of the property, the right of the person who introduces the property into the partnership of which he is a partner, is extinguished. This position is incapable of being disputed. It is, therefore, not permissible to argue that because the payment at the time of dissolution of a partnership to a partner in respect of his share in the surplus worked out after payment of all debts and liabilities would not constitute transfer, the transaction of introducing the property at the stage of the formation of the partnership or at a subsequent stage which results in extinguishment of the right of the partner introducing the capital asset in question in the partnership would also not constitute a transfer, it being a situation converse to the case obtaining in the context of dissolution of a firm. In the case of dissolution, section 2(47) will not come into play for the very good reason that the partner who gets his share does not get any value of a particular property. He gets his share in the surplus, if any. But at the time of introduction of the property or the capital asset, his right in the property stands extinguished and, therefore, it is difficult to comprehend how the decisions rendered by the Supreme Court in Dewas Cine Corporations case (supra) and Bankely Lal Vaidya''s case (supra) and the decision rendered by this Court in Mohanbhai Pamabhai''s case (supra) can come to the rescue of the assessee. We find support for the proposition that in a converse case the same result would not follow by parity of reasoning in Malabar Fisheries Co. Vs. Commissioner of Income Tax, Kerala, . In the context of withdrawal of development rebate upon the dissolution of a firm and distribution of its assets between partners, the Supreme Court has taken the view that there is no "transfer" within the meaning of section 2(47), read with section 34(3)(b), read with section 155(5), of the Act. In the second but last paragraph of the report, the Supreme Court has observed as under:

"... In the first instance, that decision dealt with the converse case and it does not necessarily follow on a parity of reasoning that the distribution, division or allotment of partnership assets to the partners of a firm upon its dissolution would amount to a transfer of assets as was sought to be contended by the counsel for the revenue...." (p. 60)

In our opinion, the flash back or the backward frog leap method of reasoning cannot be logically invoked in order to ascertain the position at the entry point of the tunnel (of partnership) in the light of what happens at the exit point of the tunnel. It is, therefore, spacious to contend that because there is no transfer at the point of dissolution when the surplus is distributed, there can be no transfer at the point of an introduction of an asset by an individual in a partnership of which he is a partner.

Almost in desperation, a clutch-at-straw effort was made to seek support from Commissioner of Income Tax, Madras Vs. R.M. Chidambaram Pillai and Others, . The question arose there in the context of the 1922 Act and rule 24 of the income tax Rules, 1922 (hereinafter referred to as "the 1922 Rules"). The Supreme Court took the view that salary paid to a partner retained the same character of the income of the firm. The view was taken that one cannot be an employee of oneself and inasmuch as a partnership firm has no distinct personality, there cannot be a contract of employment. We fail to see how the observations made by the Supreme Court in the context of the aforesaid situation and rule 24 of 1922 Rules can turn the scales in favour of the assessee. So far as the present problem is concerned, we are confronted with the question as to whether introduction of a capital asset in a partnership firm of which the person concerned is a partner would constitute "transfer" within the meaning of section 2(47). And the question is posed in the context of the fact that section 5 of the Transfer of Property Act in terms recognises a transfer from oneself to oneself and to one or more other living persons. The argument advanced by the counsel for the assessee must, therefore, fail. As discussed above, we are of the opinion that there is an extinguishment of the rights of a person who introduces the property in the partnership firm of which he is a partner along with others and that the property ceases to belong to him. We have negatived the contention that since the partnership is not a legal person and since it amounts to a transfer in favour of oneself and others, it cannot constitute "transfer" u/s 2(47). Besides, in a way nothing turns on this dimension of the matter. The definition of "transfer" embodied in section 2(47) being an inclusive one, as soon as a nexus is established between the extinguishment of the right of the individual introducing the property in the partnership and the accrual of capital gains to him as a result of the extinguishment of the right, there is a "transfer" within the meaning of section 45 read with section 2(47). A link has to be established. Once this link is established and there is a clear nexus, section 45 would be attracted in view of the inclusive definition of section 2(47). A Division Bench of this Court, consisting of B.J. Divan; CJ., and P.D. Desai, J., has taken the view in Commissioner of Income Tax Vs. Vania Silk Mills (P.) Ltd., , that if a property belonging to a person is destroyed by fire and capital gains accrue to him as a result of the payment of the insurance amount to him, section 45 would be attracted having regard to the definition clause contained in section 2(47). The discussion made in the following passage lends support to the view that commends itself to us:

... The word ''transfer'', which is separately defined by an inclusive definition, has an enlarged meaning and it takes in not only that which is comprehended by the ordinary signification thereof but also that which the definition says is included therein. The net is thus cast very wide and not only any profit or gain arising from ''every act by which property may pass from one person to another'' (that being the natural meaning assigned to the word ''transfer'' in Vadilal Soda Ice Factory Vs. Commissioner of Income Tax, Gujarat II, but also that arising specially from the sale, exchange or relinquishment of a capital asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law is now subjected to tax u/s 45. (p. 306)

** ** **

On an analysis of the section recast as above, it would be apparent that the following conditions must be satisfied before bringing any transaction within its ambit; (i) there must be an extinguishment of any of the rights of the assessee in a capital asset; (ii) such extinguishment must have been effected in the previous year; (iii) profit or gain must have arisen to the assessee from such an extinguishment; and (iv) the exempting provisions of sections 53 and 54 must not be attracted to such a transaction" (p. 307)

After referring to Vadilal Soda Ice Factory Vs. Commissioner of Income Tax, Gujarat II, , wherein it has been held that the expression "transfer" would be attracted whether it is a transfer by an act of the parties or a transfer is brought about as a result of operation of law. The Division Bench has proceeded to observe as under:

"It is true that the decision was given in the context of section 12B(1) and that it deals specifically with the case of transfer by operation of law. However, since the material words reappear in section 45, the ratio of the decision will apply with full force and the ratio is that a ''transfer'' for the purposes of levy of capital gains would include not only transfer by virtue of an act done by the transferor with that intention, as in the case of a conveyance or assignment, but also transfer without any volitional act on his part. It is worthy of note that in the case of ''extinguishment'', that is destruction or annihilation, which is a stronger word as compared to ''transfer'' simpliciter, the concept of a voluntary act on the part of the owner of the asset is so inherently inconsistent that such a limitation, which so drastically curtails the natural meaning of the word, could never have been intended to be brought in having regard to the object and purpose and legislative history of the enactment." (p. 310)

The conclusion is expressed in the following words:

"The net effect of the transaction as a whole was that there was an extinguishment of the proprietary interest of the assessee in the capital asset, namely, the machinery, and that profit arose to it in consequence of the payment made for such extinguishment. On account of fire, the machinery was so extensively damaged that, for all practical purposes, it ceased to be useful as such. Since the entire machinery in the premises of the insured was covered by insurance, the insurer paid the value of the machinery to the insured and took away the damaged machinery. The insured, in its turn, paid proportionate amount out of the compensation received from the insurer to the assessee and in the course of this transaction the bundle of proprietary rights which the assessee had in the machinery, including the rights to claim its possession back from the hirer on the termination of the contract of hire and to hold, enjoy and dispose it of, came to an end. There was thus a clear extinguishment of the rights of the assessee in the capital asset and consideration was received by it as a result of such extinguishment. There is no material to show that the amount received by the assessee was relatable to some other transaction which extinguished an altogether different right and, therefore, no other conclusion than that there was a ''transfer'' of the capital asset within the meaning of section 45 read with section 2(47) and that profit arose out of such ''transfer'' is possible." (p. 314)

In the present case, on one hand there is extinguishment of the right of the person who had introduced property in the partnership and, on the other hand, there is a credit entry made in his capital account in the partnership of which he is the partner representing the market value of the property on the date of the introduction of the property. Admittedly, the amount credited to the account of the assessee in the capital account in the partnership firm is in excess of the cost of acquisition of the capital asset in question. It is, therefore, evident that capital gains have arisen or accrued to the assessee as a result of the extinguishment of his right. If the property had not been introduced in the firm and if the value thereof was not credited in the capital account of the person concerned in the firm in which he is a partner no such question would have arisen. The two acts, viz., the act of the introduction of the property and the resultant extinguishment of the right and the corresponding credit entry in the capital account are inextricably related with each other. There is a direct nexus and a direct link. It is, therefore, futile to contend that no capital gains have accrued as a result of the extinguishment of the rights or that no transfer has taken place. It may be mentioned that in a case where a credit in the capital account of the partner introducing his capital asset in the firm is for an amount smaller than the market value, either section 52 of the Act, which deals with the consideration for transfer in cases of understatement, may be attracted or the amount of difference between the market value and the sum credited in the capital account may be treated as a gift. For the present, we are not concerned with that aspect of the matter. We are dealing with a situation where the market value has been credited in the capital account of the partner introducing his property in the partnership firm and we are examining the question from the said angle. In any view of the matter, therefore, the transaction fulfils the criteria of "transfer" within the meaning of section 2(47) and section 45. And finally we may mention for the purposes of the record an involved argument to the effect that extinguishment of rights of the person introducing the capital being the consequence of the transaction and not the cause of it, it does not constitute transfer. We fail to see how the cause-effect argument can arise in view of the elaborate discussion made by us hereinbefore. We see no substance in the argument. For the weighty reasons discussed hereinbefore, there is no escape from the conclusion that the transaction constitute "transfer" within the meaning of section 45 read with section 2(47).

We must now deal with an argument advanced by counsel appearing for the assessee in Reference No. 235 of 1980 in the backdrop of the recommendations made by the Direct Tax Laws Committee in its Final Report of September 1978. It requires to be placed into focus that counsel for the assessee in Reference 34 of 1980 himself was a member of the said Committee particularly because as it appears to be the recommendation made by the Committee. The recommendation lend support to the view which has commenced itself to us though counsel for the assessee would have it otherwise. The Committee has proceeded to consider the question about the position in the context of introduction of a capital asset by a person in a firm in which he himself is a partner. In paragraph I.9.16 the Committee has expressed the same opinion as we have done earlier in the course of the discussion notwithstanding the law laid down by the Supreme Court in CIT v. Hind Construction Ltd. (supra). The Committee has referred to the Full Bench decision of the Kerala High Court in A. Abdul Rahim''s case (supra) to which we have adverted to in the course of the earlier discussion and the Committee had expressed the opinion that the decision of the Supreme Court in CIT v. Hind Construction Ltd. (supra) was rendered on its own facts from the stand point of the problem whether it constituted a "sale" at the point of time when a provision similar to section 2(47) was not in existence. This is what has been observed by the Committee:

"I.9.16. Apart from the specific exemption u/s 47(ii) in regard to distribution of assets on the dissolution of a firm, the Supreme Court has held that where a partner introduces capital assets belonging to him as his share of capital contribution in a firm, there is no sale - Commissioner of Income Tax, West Bengal Vs. Hind Construction Ltd., . The Kerala High Court in a Full Bench decision, A. Abdul Rahim, Travancore Confectionery Works Vs. Commissioner of Income Tax, , has applied the definition of ''transfer'' u/s 2(47) to the case where a partner introduced his own assets in a firm as his capital. The question in that case was whether this operation amounted to a sale or transfer of an asset on which development rebate was allowed, thereby entailing the loss of the development rebate. The Court held that there was an extinguishment of the rights of full ownership on the property becoming the asset of the firm and that there was a transfer within the meaning of section 2(47). It is, of course, true that the decision of the Supreme Court referred to earlier was not cited before the Kerala, High Court; but it may be stated that the Supreme Court held on the facts of that case that there was no sale. The Court had no occasion to construe the provisions of section 2(47) as examined by the Kerala High Court."

[Emphasis supplied.]

Having accorded due recognition to the proposition of law that once a property becomes a part of the assets of the firm no partner has an identifiable interest or right therein, and having considered all the decisions including the decision in Hind Construction Ltd.''s case (supra), the Committee has opined to the effect that where a partner introduces capital assets in the partnership firm, it should be deemed to be a "transfer" u/s 2(47) subject to the recommendation contained in Paragraph I.9.18, viz., that the fiction of transfer on introduction of capital assets into partnership by an assessee should apply in the year when the assessee concerned realises the consideration for such introduction in money or the equivalent of money, or when the firm transfers such assets, whichever is earlier. The passages from which the aforesaid statements have been extracted may be quoted in extenso for the sake of fairness:

"I.9.17. It should be pointed but that the general concept of relationship between a partner and the firm as applicable under the Indian Partnership Act, 1932, acquires a particular significance under the provisions of the income tax law. The line of division between a partner and the firm as obtaining under the partnership law need not necessarily be the same as under the income tax law. Under the income tax law a firm is deemed to be a person and a taxable entity in its own right apart from the partners constituting the firm. The expression ''transfer'' may, therefore, acquire a special connotation in the circumstances of such operations between a partner and the firm. Our attention has been drawn to several cases of partners introducing assets into partnership firms at enhanced valuations. In that context, therefore, it would be appropriate to deem such transactions of introduction of assets into the firm as a transfer within the meaning of section 2(47). When a partner''s account is credited at an enhanced valuation, it bears the characteristics of a transfer in a broad sense. Even under the partnership law once an asset becomes the property of the firm, the partner cannot claim to have any identifiable right or interest over that particular asset. There is, therefore, a change in the characteristics of ownership of the assets from the individual when such asset is introduced as the property of the firm. We, accordingly, recommend that where a partner introduces capital assets into the partnership firm, it should be deemed to be a transfer u/s 2(47) of the Act subject to the recommendation in the next paragraph."

"I.9.18. The recommendation made in the preceding paragraph would block an avenue of avoidance of tax on capital gains. However, whenever fictions are introduced into a taxing statute, it is absolutely essential to clearly demarcate and restrict the area of operation of the fiction. Failure to do so may lead to unintended hardships. It should in that context be recognised that introduction of assets into a firm need not always be motivated by considerations of capital gains. There may be several circumstances where for genuine business necessity such transactions may be effected. It would be wholly unfair, therefore, to apply a fiction suggested in the preceding paragraph generally to all cases. In the first place, it is appropriate to clarify that the provisions of section 52 would not be invoked in such cases. This is to ensure that what is brought to charge is only actual profit and not a notional profit. In the second place, difficulty would be created where business assets are introduced and the partner concerned does not really obtain money or money''s worth as consideration. The mere credit to his account by itself would not place him in the position of one who is effecting a real transfer of a capital asset. On the same parity of reasoning of the subsequent recommendation in the following paragraph, the fiction should only be applied at the point of time when the taxpayer in question realises the value in money or money''s worth. We, accordingly, recommend, that the fiction of transfer on introduction of capital assets into partnership by a taxpayer should apply in the year when the taxpayer concerned realises the consideration for such introduction, in money or the equivalent of money, or when the firm transfers such assets, whichever is earlier."

It was argued that by necessary implication the report of the Committee would go to show that in its opinion a transaction of this nature would not constitute "transfer" within the meaning of section 2(47) read with section 45 as it now stands unless a clarificatory provision is introduced by way of amendment of the Act pursuant to the recommendations of the Committee. We are unable to read the aforesaid passages in the light in which counsel view the same. That is one of the reasons why we have quoted the passages in extenso. We may also mention that assuming that by implication such a view was expressed, it cannot govern our decision which we have to render on our own. We cannot substitute the opinion of the committee for our opinion. To do so would be to abdicate our function to decide the question posed in the present reference. To do so would be to constitute the members of the Direct Tax Laws Committee as Judges in our stead. We cannot do so. We may, however, repeat and reiterate that we do not read the aforesaid passages in the manner in which counsel wants us to read. In fact, in our opinion, the view expressed by the Direct Tax Laws Committee fully accords with the view that we are taking, namely, that such a transaction would constitute "transfer". As we read the passages, the Direct Tax Laws Committee has made a recommendation in April 1978 in order to avoid some anticipated hardship in the context of the situation envisaged in paragraph I.9.18.

In the result, we have no hesitation in holding that a transaction of introduction of a capital asset by an individual in a firm of which he is a partner would constitute a "transfer" within the meaning of section 45 read with section 2(47) so as to render the capital gains, if any, exigible to tax.

The next question which has been raised is as to whether there is consideration for such a transfer. In Reference No. 34 of 1980 (between CIT v. Kartikeya V. Sarabhai), the Tribunal refused to express its opinion on this question on the ground that it was unnecessary to do so having regard to the view taken by it on the first question that it did not constitute transfer. We may mention that it would have been much better if the Tribunal had expressed its opinion on this question so as to make the judgment complete and so as to avoid a remand in case the High Court or the Supreme Court were to take a different view. It would have resulted in considerable saving of time and expense. When two questions arise one of which is inter-linked with another, it would always be desirable to answer both the questions. Be it realised that the problem has arisen in the context of the assessment year 1973-74 and for seven years the revenue has been deprived of a large amount of tax which it could have collected in case the view canvassed on its behalf was upheld. We are told that in the present group the tax impact may well be in the neighbourhood of Rs. 60 lakhs. The Tribunal ought to have realised that it would have been preferable to make the judgment complete and answer both the questions which had been raised before it instead of answering only one question and leaving the other to be answered only provided the decision of the Tribunal on the first question was found to be erroneous. Be that, as it may, having regard to what has transpired. Question No. 2 has been raised in the following manner:

"2. If reply to Question No. 1 is in favour of the revenue, whether the Tribunal erred in not considering whether the transfer is with or without consideration?"

Since we are of the opinion that Question No. 1 must be answered in favour of the revenue, we must answer Question No. 2 in this reference (No. 34 of 1980) in the affirmative and in favour of the revenue and remit it to the Tribunal. But since this very question arises in the allied matter which we are disposing of by this common judgment, viz., in Reference No. 235 of 1980 between CIT v. Sunil Siddarth bhai, the Tribunal will have to decide the question in accordance with the opinion expressed by us in regard to this question in the allied matter. And to this problem we will address ourselves presently.

Turning now to the questions referred to us in Reference No. 235 of 1980 it appears that the Tribunal in that case decided the question, as to whether or not there was a "transfer" within the meaning of section 2(47), in favour of the revenue and against the assessee. However, the second question as to whether it was for consideration and whether any capital gains had accrued, the question was decided in favour of the assessee. As a result thereof, both the assessee as well as the revenue prayed for-making a reference of the respective questions decided against them. Question No. 2 in this reference corresponds to Question No. 1 in Reference No. 34 of 1980 which we have dealt with a short while ago. It reads as under:

"2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that there was a transfer within the meaning of section 2(47) of the income tax Act, 1961 of the shares contributed by the assessee as capital to the partnership firm in which he was a partner?"

So far as this question is concerned, in view of the discussion made earlier, the question must be answered in the affirmative and against the assessee. What now remains to be considered is as to whether such a transaction can be considered a transfer for consideration and whether capital gains can be said to have arisen or accrued to the assessee. This problem is projected in Question No. 1 which is in the following terms:

" 1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that no capital gains resulted from the transfer of the shares held by him to the partnership firm as his capital contribution, the cost of acquisition of the shares to the assessee being Rs. 1,49,819 and the market value of the shares being Rs. 1,60,279."

The Tribunal in paragraph 3 of its judgment has referred to its earlier decision rendered in IT Appeal No. 271 (Ahd.) of 1976-77 decided on 24-6-1977. Instead of reproducing its own reasoning in this matter, the Tribunal has incorporated by reference the reasoning which found favour with it whilst rendering the aforesaid decision. Now the said decision has given rise to Reference No. 237 of 1980 which is also listed on the board though it is not being disposed of along with the present two matters for reasons which we need not advert to for the present purposes. It would be convenient to reproduce the reasoning which was injected into the decision of the Tribunal relying on the aforesaid decision as embodied in paragraph 7 of the order passed by the Tribunal in IT Appeal No. 271 (Ahd.) of 1976-77 with reference to the assessment year 1971-72. The decision was rendered on 24-6-1977. The reasoning in paragraph 7 is unfolded as under:

"The last contention of the assessee on the question relating to capital gains was that even if the agricultural land in question was held to be a capital asset and even if its investment as share of the capital in the partnership firm is held to be a transfer, no amount becomes assessable to tax as capital gains, inasmuch as no consideration flowed from the partnership firm to the assessee on 1-5-1970 or thereabout when the contribution of the share capital took place.

We see force in this submission. The department is not able to point out that on the basis of the material on record either that the firm was, as a result of the said contribution of the share of capital, out of pocket by any amount or that the said contribution was in any way to the detriment of the partnership firm in that the assessee became richer on,1-5-1970 as a result of the contribution in question. Thus, even if technically it could be said that a transfer did take place as it gave rise to no consideration, no profit assessable as capital gains can be said to accrue to the assessee. Thus, the provision of section 45 read with section 48 cannot be attracted."

We are, therefore, concerned with the validity of the view taken by the Tribunal and the reasoning unfolded in the aforesaid passage. The view taken is that no consideration has in fact flowed from the partnership to the person who has introduced the capital asset in question in the firm. It is no doubt true that the consideration in the sense of actual payment in cash has not flowed from the partnership to the person who has introduced his capital asset in the firm. But then a sum equivalent to its market value has been credited'' in the capital account of the person concerned in the accounts of the partnership firm. Whether payment is made in cash or by making a credit entry in the books of account of the partnership is altogether irrelevant and immaterial. Why was the capital account of the person concerned credited with the particular amount equivalent of the market value of the asset which was introduced? The answer is very simple. The amount in question was credited to his capital account because the right of the person who introduced the capital asset was extinguished and it became an asset of the partnership firm. If in this transaction the consideration for extinguishment of the absolute right of the person, who has introduced the capital asset in the partnership firm, is the amount credited to its capital account in the partnership firm, it is difficult to comprehend how it can be said that there is no consideration. The following facts are not in dispute:

The capital account of the partner concerned has been credited with a large sum of money.

The said amount is not paid in cash.

The said amount is equivalent to the market value of a capital asset belonging to him which was introduced in the firm by the said partner.

Why is it that, notwithstanding the fact that no such cash amount has been paid, a credit entry has been made? It has been made precisely because it represents the value of the capital asset introduced in the partnership. The partner concerned has introduced the capital asset in the partnership in consideration, of the obligation to make contribution of capital in order to run the partnership business. There is a direct nexus between the extinguishment of the right and the credit of the money, equivalent of the market value of the property in question as on the date of its introduction in the capital account of the partner. There is, therefore, consideration for the transfer. What belonged to the person who introduced the asset, no more belongs to him. What now belongs to him is the money equivalent of the amount which has been credited in the capital account of the partnership firm. There is an inseverable link between the two. Would it make any difference in the eye of law whether the shares are sold in open market and the sale proceeds thereof are credited in his capital account with the firm or whether the market value thereof is credited in the capital account straightaway and a corresponding debit entry is made in the share account to indicate the cost of the acquisition of the shares to the firm? None. Notionally speaking, the shares are sold in the open market by the partner introducing the asset and the shares are simultaneously purchased from the open market at the same price by the firm. Instead of paying in cash for the shares, the price of shares is credited in the capital account of the partner to whom the shares belonged prior to the transaction. In reality, as also in the eye of law, this is the result. Otherwise, how can the partners capital account be credited with, say, Rs. X lakhs without payment of a single rupee in cash? And of necessity there will be a corresponding debit entry showing the value of the shares as the cost of acquisition of the shares to the partnership firm (otherwise the accounts will not balance).

The operation is an omnibus multi-dimensional on which brings about four results, namely, (i) the extinguishment of the right of the partner who introduces a capital asset which hitherto belonged to him, (ii) a simultaneous credit to his account of a sum of money representing the money equivalent of the asset in question on the basis of its market value in lieu of the said asset which ceases to belong to him thereinafter, (iii) the asset becomes the property of the firm and belongs to it thereafter, and (iv) the books of account of the partnership would show that the cost of acquisition of the property to the firm as debited in the accounts corresponds to the amount credited to the capital account of the person introducing the asset in question. We are, therefore, unable to accept the submission that there is no consideration. So also there is no merit, not the slightest merit, in the other facet of the submission, namely, that the assessee has not become "richer" as a result of this operation. Surely, the amount credited to his capital account with the firm is not illusory. And the said amount is far in excess of the cost of acquisition to him of the asset which he introduced in the firm and wherein his rights were extinguished. A reverse flick to the illustration sketched in the opening paragraphs of the judgment will show that for introducing an asset which costs him, say, Rs. 10 lakhs, he obtained a credit entry in the capital account of the firm of, say, Rs. 90 lakhs. It is not merely a play with figures. Without he having to pay Rs. 90 lakhs in cash, his capital account with the firm credited with Rs. 90 lakhs., The operation has thus yielded Rs. 90 lakhs which he has chosen to have credited in his capital account. He lost an asset worth Rs. 10 lakhs and won an asset worth Rs. 90 lakhs. Thus, the operation has, in fact, resulted in a concrete (and not notional or illusory) gain of Rs. 80 lakhs representing the difference between the two figures. As we indicated earlier, it makes no difference whether the asset is sold in the open market for Rs. 90 lakhs and the sale proceeds in cash are credited in his capital account with the firm or whether the same result is brought about by recourse to this modus operandi. His erstwhile asset of exclusive ownership is now converted into a credit of Rs. 90 lakhs in his capital account in the firm. The difference of Rs. 80 lakhs being the difference between the original cost of acquisition to him and the amount credited in hi? capital account is evidently his gain in reality and not in imagination. The firm could be dissolved the next day without carrying on any other business and he would get back Rs. 90 lakhs. Or the firm could sell the asset the next day. Since there would not be any appreciable appreciation, it would not have to pay a single rupee as tax under the head "Capital gains". Resultantly, the assessee will say he has not; firm will, say no capital gains have accrued to it. In that event what has happened to the sum of Rs. 80 lakhs (Rs. 90 lakhs being the amount credited in the capital account of the assessee less Rs. 10 lakhs being original cost) ? Where has it evaporated? Can it even so be seriously contended that he has not become richer by Rs. 80 lakhs? His own accounts would not balance unless (i) Rs. 90 lakhs are credited to the account of the asset in question, and (ii) Rs. 90 lakhs are debited to the account of the partnership (as a capital contribution). So also the books of account of the firm will not balance unless Rs. 90 lakhs are debited to the account of the cost of the asset to the firm. His own books of account (if he does not maintain accounts and notional reconstruction or projection requires to be made) must, therefore, show a profit of Rs. 80 lakhs. It is not merely jugglery of figures. It is a concrete gain to the assessee. It is, therefore, evident that the argument has an inbuilt fallacy. Were it not so, all that an assessee, who wants to sell his capital asset which has appreciated in value, has to do is to form a partnership with his wife and sell the asset on the next day. And no one will have to pay any tax on the resultant capital gains. Whether or not the assessee has become richer, others need to be wiser. Be that as it may, we have no hesitation in rejecting this spacious plea, for we are convinced of its hollowness. But we do so with a feeling of distress at its having been advances at all.

An assessee cannot be allowed to defeat his liability so easily or so lightly lest he himself losses respect for the Courts, not to speak of the common man on whose shoulders the burden is bound to be shifted in order to fill the vacuum. Instead of the burden being shouldered by one who profits and can carry it, but is exonerated from liability, it will have to be carried by one who does not profit and is incapable of carrying any further load. Instead of the able-bodied man, the emaciated man will have to bear the burden. Instead of a man who can do so with a smile, one who cannot do so even with tears in his eyes will have to do so. Such a situation, however, need not arise, as no other view is possible from the platform of law, logic or common sense. This question must, therefore, be answered in Reference No. 235 of 1980 in the negative and against the assessee. We may, however, make it abundantly clear that this does not necessarily mean that in point of fact there was a capital gain to the assessee concerned. We make this clarification at the request of the learned counsel for the assessee as it appears that some confusion has been introduced in the statement of facts prepared by the Tribunal as to whether the amount credited is in excess of file cost of acquisition or falls short of it. The effect of our decision would be that in case factually the amount credited to the account of the person who introduces the capital asset in the partnership is in excess of the cost of acquisition of the asset in question as computed in accordance with the relevant rules, the transaction in question in the first place constitutes "transfer" within the meaning of section 45 read with section 2(47) and in the second place it is a transfer for consideration and capital gains have accrued or arisen to the assessee concerned. If factually there is any error and there is no excess, then the question will not arise. Be it realised that we are not considering, for the present purposes, a case where the account of the person concerned is credited with an amount which does not correspond with market value at the relevant time. If it is credited with a sum, which is less than the equivalent of its market value, section 52 may be attracted or the difference may be treated as a gift. We do not wish to express any opinion on this question since no such question has been referred to us. All that we say is that the transaction does constitute "transfer" within the meaning of section 45 read with section 2(47) and if it results in profits or gains, the same are exigible to tax as capital gains.

In the result, the questions referred to us are answered as under:

Questions

Answers

REFERENCE No. 34 of 1980

"1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the contribution in the form of shares of the value of Rs. 4,75,136 by the assessee in the partnership firm of M/s Rajka did not amount to ''transfer'' within the meaning of section 2(47) of the Act resulting into capital gains chargeable to tax?"

In the negative and in favour of the revenue

"2. If reply to Question No. 1 is in favour of the revenue, whether the Tribunal erred in not considering whether the transfer is with or without consideration?"

In the affirmative and in favour of the Revenue. The matter will have to be remitted to the Tribunal for deciding on merits in accordance with law in the light of the decision being rendered in the allied matter, viz., Reference No. 235 of 1980

REFERENCE No. 235 of 1980

"1. Whether, on the facts and in the circumstances of the case, the income tax Appellate Tribunal was right in law in holding that no capital gains resulted from the transfer of the shares held by him to the partnership firm as his capital contribution the cost of acquisition of the shares to the assessee being Rs. 1,49,819 and the market value of the shares being Rs. 1,60,279?"

In the negative and against the assessee. The transfer was for consideration and capital gains arising or accruing from the transaction are exigible to tax u/s 45

"2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that there was a ''transfer'' within the meaning of section 2(47) of the income tax Act, 1961 of the shares contributed by the assessee as capital to the partnership firm in which he was a partner?"

In the affirmative and in favour of the revenue. It is clarified that the factual position as to whether or not in fact capital gains had arisen or accrued having regard to the cost of acquisition computed in accordance with the relevant rules will have to be decided by the Tribunal in accordance with law in case the factual position is disputed.

An oral request is made by counsel for the assessee in each of the two matters for a certificate of fitness to appeal to the Supreme Court.

As envisioned by section 261 of the Act. We consider each of the two cases to be fit one for appeal to the Supreme Court. We certify accordingly.