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Commissioner of Income Tax-23 vs. M/s. Mansukh Dyeing and Printing Mills

Civil Appeal · 2022 INSC 1225Decided 24 Nov 2022
Civil Appeal Nos. 8258-8259 of 2022
M.R. Shah · M.M. Sundresh

Background

A partnership firm revalued its land and building, increasing their book value by about Rs. 17.34 crore, and credited this increase to the partners' capital accounts in their profit-sharing ratio, including new partners who had contributed only small amounts of capital but suddenly had large credit balances they could withdraw. The tax department treated this revaluation-and-crediting as a "transfer" attracting short-term capital gains tax under Section 45(4) of the Income Tax Act, but the Income Tax Appellate Tribunal and the Bombay High Court both ruled in the firm's favour, relying on an older Supreme Court decision (Hind Construction) that predated a key 1987 amendment to the law.

Decision Breakdown

The Supreme Court held that the 1987 amendment to Section 45(4) added the words "or otherwise" specifically to close the loophole the firm was relying on, meaning the provision applies not only when a firm dissolves, but also when a subsisting firm distributes/credits revalued assets to its partners' capital accounts, effectively transferring value to them. Since the Hind Construction decision predated this amendment, it could not be used to escape the tax. Crediting Rs. 17.34 crore in revaluation gains to partners' capital accounts (from which they could and did withdraw funds) amounted to a "transfer" under the amended law, so it was correctly taxed as short-term capital gains. The Court set aside the ITAT and High Court rulings and restored the Assessing Officer's tax demand.

Lesson Learnt

Revaluing a partnership firm's assets and crediting the gain to partners' capital accounts is not a tax-free bookkeeping exercise, since 1988, Indian tax law treats such distributions as a "transfer" liable to capital gains tax, even without a formal dissolution of the firm.

Official source (sci.gov.in)View Judgment (PDF)

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