When a partnership firm is formed for carrying on real estate business and a partner contributes land or building therein then the tax consequence of contribution of such land or building becomes a tricky issue. The computation of the capital gain on this transaction is a challenge because of two Sections that are apparently applicable but conflicting in their approach. This article seeks to analyse the issue and attempts to provide some thoughts towards the solution thereto.
As per Section 45(3) of the Income tax Act, 1961 ('the Act') when any capital asset is contributed to the firm by a partner then the 'value' of that asset as 'recorded in the books of account' of recipient firm is taken as full value of consideration of the transfer of that asset for levy of capital gains tax. On the other hand, if a land or building is transferred by any person to any other person, then as per Section 50C, value adopted for levying stamp duty is to be considered as full value of consideration, for computing capital gains, provided such value is higher than declared transaction value.
When a partner contributes land or building to the firm then whether the amount recorded in books of account of the firm is to be adopted [as required under Section 45(3)] or value adopted for stamp value [as per Section 50C] is a question that requires careful consideration.
Section 45(3) creates a deeming fiction and was introduced by the Finance Act, 1987 with the objective [see end note 1] to overrule the Supreme Court decision in Sunil Sidharthbhai v. CIT [see end note 2]. Supreme Court in that case had held that when the assets are transferred from partner to a firm, no determinable consideration is received by that partner within the meaning of Section 48, nor does any profit or gain accrue to him in commercial sense, and therefore, chargeability under Section 45 doesn’t arises. To get over the conundrum of determinability, the law provided that value recorded in books of account be adopted. On the other hand, the provisions of Section 50C of the Act is a special provision intended to deal with unaccounted money generated by under-reporting of the sale price.
The issue before hand came up for consideration in the case of Carlton Hotel (P) Ltd. v. ACIT [see end note 3]. However, the controversy was resolved by stating that Section 50C is not applicable on a standalone basis. Following Navneet Kumar Thakkar v. ITO [see end note 4] it was held that despite contribution of land to the firm it continues to be legally owned by the partner since registration of the property has not been carried out. The ITAT was of the view that for want of registration, stamp duty has not actually been assessed as a result Section 50C does not apply. Resultantly only Section 45(3) was held as applicable. Now the provisions of Section 50C stand amended [see end note 5] and if the stamp value is not actually assessed then the value at which it would have been assessable [see end note 6] is required to be adopted under Section 50C. This amendment, in effect, impliedly overruled the aforesaid decision pronounced by Lucknow and Jodhpur benches of Tribunal. Hence the problem of resolving conflict between Section 45(3) and 50C has become acute.
Similar conflict was resolved denying the applicability of Section 45(3) when contrasted with applicability of transfer pricing provisions. AAR held that the value of consideration shall not be the value as recorded in the books of the firm, but the same shall be determined on the basis of arm’s length price in accordance with transfer pricing provisions [see end note 7].
We have hereunder independently interpreted the provisions in dispute and provided our preliminary conclusion.
Harmonious interpretation: It is a settled principle that a statute must be read as a whole and one provision of the Act should be construed with reference to other provisions in the same Act so as to make a consistent enactment of the whole statute [see end note 8]. The rule of construction is well settled that when there are, in an enactment, two provisions which cannot be reconciled with each other, they should be so interpreted that, if possible, effect should be given to both [see end note 9]. Looking from this perspective one would feel that objective of Section 45(3) was to bring the transaction within tax net by providing computation mechanism and objective of Section 50C is to ensure that the tax is levied on the proper sum of money. Therefore the value adopted for Section 50C should be adopted so that the objectives of both the sections are met.
General v. special provision: Another well known rule is to classify two apparently conflicting provisions as general and special. The rule requires that specific provision should be read as overruling the general one, and the general enactment must be taken to affect only the other parts of the statute to which it may properly apply [see end note 10].
Examined from this perspective, we find that the provisions of Section 50C are specific with respect to class of assets (being land or building), whereas the provisions of Section 45(3) are general as far as the class of assets is concerned, but specific to a category of transaction (between partner and firm). It appears difficult to arrive at a conclusion based on this rule.
Scope of a legal fiction: Legal fictions are created only for a definite purpose and they are limited to the purpose for which they are created and should not be extended beyond their legitimate field [see end note 11]. Even from this perspective one would say that objective of Section 45(3) was to bring the transaction within tax net while objective of Section 50C is to ensure that the tax is levied on the proper sum of money and therefore value adopted for Section 50C should be adopted so that both the objectives are met.
Literal rule is the 'Golden Rule': The opening part of Section 50C reads as "where the consideration received or accruing as a result of the transfer.......is less than the [stamp] value". Therefore, for invoking the provisions of Section 50C, there must be a 'consideration' received or accruing. It needs to be carefully examined whether any consideration is received or accruing as a result of transfer, in real sense, when an incoming partner contributes land and building as his capital in the firm. The Supreme Court in Sunil Sidharthbhai v. CIT [see end note 12] made an important observation in this regard, “It is impossible to conceive of evaluating the consideration acquired by the partner when he brings his personal asset into the partnership firm.....In the circumstances, we are unable to hold that the consideration which a partner acquires on making over his personal asset to the partnership firm as his contribution to its capital can fall within the terms of Section 48.”
The proposition that the consideration received or accruing cannot be determined when a land and building is transferred by a partner to a firm was thus affirmed in Supreme Court judgment (supra) and in real sense, no determinable consideration is received or accrued as a result of transfer in such a case where an incoming partner introduces capital asset as his contribution to the firm. It is for this reason Section 45(3) was introduced to provide for deeming an amount as 'full value of consideration' an expression different from 'consideration' appearing in Section 50C. The former is a deemed one which can neither be received nor accrued.
Based on a detailed analysis of the relevant provisions of the Act as well as the relevant decisions of various Courts and Tribunals in this context, followed by the amendment that was introduced by Finance (No.2) Act, 2009; it can be contended that Section 50C could not be invoked in such a case, which as a matter of fact can be invoked in cases where an actual sum of consideration is received or accrued as a result of transfer in real sense and not a fictitious amount. The adverse ruling of Canoro Resources (supra) can be independently supported by a different legal reasoning and in view of the authors should not affect the conclusion herein above.
[The authors are, respectively, Senior Associate and Director, Direct Tax Practice, Lakshmikumaran & Sridharan, New Delhi]
- Circular No. 495 dated 22/09/1987
- (1981) 156 ITR 509
- (2009) 122 TTJ 515 (Luck)
- (2007) 110 ITD 525 (Jodhpur SMC)
- Finance (No. 2) Act, 2009
- Clause 25 of the Memorandum explaining the Finance Bill, 2009
- In Re: Canoro Resources Ltd. 313 ITR 2 (AAR)
- M. Pentiah v. Veeramallappa Muddala, (1961) 2 SCR 295
- Sultana Begum v. Prem Chand Jain, 1997 AIR 1006, p. 1009,1010
- Narain Das Paramanand Das v. ITO, (1979) 117 ITR 174 (Cal)
- CIT v. T.S. Rajam, (1980) 125 ITR 207 (Mad), Cambay Electric Supply Ind. Co. Ltd. v. CIT (1978) 113 ITR 84(SC)
- (1981) 156 ITR 509