Whether when partners in a firm make capital contribution in a company by relinquishing rights and such a company is succeeded by another company, which finally sells entire share-holding at book value, such transactions can be construed as colourable device - NO: ITAT

THE issue before the Bench is - Whether when partners in a firm make capital contribution in a company by relinquishing their rights and such a company is succeeded by another company, which finally sells entire share-holding at book value, such a series of transactions can be construed as colourable device to avoid capital gains tax. And the answer favours the assessee.

Facts of the case
Assessees are members of Reddy family of Bangalore. They all were partners in a firm. All these partners brought their shareholding in one company as their capital contribution in the firm and the capital accounts of the partners in the firm were also credited respectively. Thereafter this firm was succeeded in 2006-07 by another company namely NSCPL and while transferring the shareholding pattern the firm had revalued the shares at enhanced value and credited the accounts of the respective partners with the enhanced value. Thereafter this company namely NSCPL had sold out the entire shares to some other company in 2007-08 at the book value and could not pay any capital gain.

In this background of the case the AO was of the view that the series of transactions entered into by the assessee was a colorable device to avoid capital gain and accordingly the AO lifted the veil of the company and taxed the gains in the hands of the partners on the ground that it was a sale of shares directly from the partners to the buyer. The CIT(A) went a step further and held that the partnership firm was per se illegal and hence the AO was correct in assessing the partners. The CIT(A) while holding so also overlooked that the partners had already paid the capital gain tax in the previous year when the shares were taken over by NCSPL. On appeal before the Tribunal, both the sides argued their viewpoints.

Held that,

++ it is clear from the documents available before us that the firm BVRE has been accepted to be genuine by the Revenue in the orders passed u/s. 185 of the Act for the AYs 1980-81 & 1984-85. In fact, for AY 2006-07, the firm BVRE has filed return of income before the ACIT-I(1), Tirupathi on 30.10.2006. The said return has been accepted by the Revenue. Thus, prima facie, the Revenue has accepted the genuineness and existence of the firm BVRE. The Revenue cannot now say that the firm BVRE is not genuine or that it was defunct firm. In any event, the AO while assessing the assessees for AY 2007-08 has no jurisdiction to render a finding that the firm BVRE was not in existence or that the same was defunct, without putting the firm BVRE on notice on the grounds on which the AO wants to come to such conclusions. In the light of the evidence available on the record, we hold that the firm BVRE was genuine, legal and valid, was not defunct and was legally an existing partnership firm;

++ the CIT(A) has not properly appreciated the true effect of the description in the partnership deed. As far as V.Madhusudan Reddy, V.Vikram Reddy and V.Dinesh Reddy are concerned, they were shown as partners in their individual capacity in all the partnership deeds prior to 24.3.2006. The fact that their names appearing in individual capacity in all the deeds prior to 24.3.2006 was in fact in their capacity viz., representing the HUF has been brought out in the partnership deed dated 24.3.2006. This became necessary because, these 3 persons also became partners of the firm BVRE in their individual capacity under the deed of partnership dated 24.3.2006. As far as Dwarkanath Reddy is concerned, he became partner in two capacities under the deed of partnership dated 24.3.2006 viz., in his capacity on behalf of the HUF and in his individual capacity. Here again to distinguish the two capacities in which he was a partner, the description “in his HUF capacity” and “in his individual capacity” had been used in the partnership deed dated 24.3.2006. As rightly contended on behalf of the assessee, the fact that the name of an individual is written in the partnership deed followed by the description “partner in his HUF capacity” cannot constitute the HUF as a partner. The intention of the parties is very clear that the individual is a partner of the firm as far as the firm is concerned. As far as the members of the HUF are concerned, he is acting on their behalf in a representative capacity;

++ the above observations of the Hon’ble Supreme Court in the case of Vodafone it is clear that all tax planning is not illegal/illegitimate/impermissible. It is only when colourable or dubious devices are employed or transactions are sham or when arrangements are a mere subterfuge, as part of tax planning can it be said that they are illegal, illegitimate, and impermissible. For ascertaining what the real intention of the parties was, it is permissible to “go behind” the documents. Generally one must proceed on the basis of the intention as expressed in the transaction or document. If that is challenged as not true on good grounds then the real intention can be looked into. If it is found that the arrangement is a make-believe affair, or a dubious device and the real intention was tax evasion then the arrangement need not be given effect to. In cases where transactions or arrangement are evidenced by written agreement/arrangement it is not possible to rewrite the agreement/arrangement. The right of the parties to enter into transactions according to their free will and choice has always been protected, the only rider being that both the professed intention and the real intention should be the same;

++ the facts of the present case to see if the proposed intention and the intention gathered from the documentation are the same. For this purpose, we need to confine ourselves only to the first set of transactions by which the shares of NCCPL held by the 13 partners of the firm BVRE in their names were transferred to the firm BVRE. On this aspect we have already narrated the facts in paragraphs 16 to 23 of this order and are not being repeated again. Suffice it to say that there was a valid transfer of shares of NCCPL by the 13 individuals to the firm BVRE. The law is well settled whatever is brought in by the partners as capital contribution or treated as property of the firm becomes the property of the firm. The evidence on record clearly indicate that there was a transfer of ownership in shares from the 13 individuals in favour of the firm BVRE as on 24.3.2006 when the firm made the necessary book entries and when the partners made their intentions clear that the shares were to be treated as the property of the Firm in the form of resolution, declaration u/s.187-C of the Companies Act, 1956. Thus the Assessees could no longer be considered as owners of shares of NCCPL brought in as capital of the firm, on and from 24.3.2006. There is nothing on record to suggest real intention of the parties was to treat the Assessee as owner of the shares even after the transfer of shares to the firm;

++ it is not possible to lift the corporate veil just for the asking. A case of defrauding the revenue has to be made out. The question is as to whether the course of action adopted by the Assessee was permissible or not. The answer to the question would be that there were two ways in which the shares of NCCPL held by the 13 partners of BVRE could have been transferred to GBFL. One way was that the 13 partners in their individual capacity could have transferred the shares of NCCPL held by them to GBFL at a price at which they were ultimately sold to GBFL through NCSPL. The other way was the manner in which the Assessees have transferred the shares through the medium of the firm BVRE. The latter course would certainly result in lesser tax burden to the Assessees but that is a course which the law permits. The Assessees have altered their legal rights under the various documents. It is not possible to ignore the legal effects of all the actions carried out by the Assessees and proceed on the basis that it is the Assessees who sold their share-holding in NCCPL to GBFL during the previous year relevant to AY 07-08;

++ the course adopted by the Assessees was within the framework of law and was permissible. In fact there was a lacuna in the law which has now been filled up by a retrospective statutory amendment to the provisions of law. That only shows that the course adopted by the Assessees was legally valid. Even the Assessee in the written submissions dated 2.1.2013 has accepted the position that in view of the retrospective statutory amendment there is no tax advantage at all. In that view of the matter, we are of the view that on issue No.6, we have to hold that the entire series of transactions by which the shares of NCCPL were ultimately transferred to GBFL were all valid. Even if it were to be considered that they were arranged in such a manner so as to avoid payment of tax on the correct quantum of capital gain that would result on transfer of shares of NCCPL to GBFL, such a course was permitted and within the framework of law. On issue No.7, we have to hold that the series of transactions by which the shares of NCCPL were ultimately transferred to GBFL were not colourable or dubious device or subterfuge and were legal and valid. The consequence of the same, even if it results in reduction of tax burden, is that they cannot be ignored and the Revenue cannot bring to tax the quantum of capital gain which would have resulted, had the transactions of sale of shares of NCCPL to GBFL being carried out by the assessees directly to GBFL instead of through NCSPL/BVREPL. We hold accordingly on issue No.6 and 7. The other decisions referred to by the learned Senior Advocate for the revenue are not being adverted to as the decision of the Hon’ble Supreme Court in the case of Vodafone.