Alerts:

Tax Alert: No FMV substitution for land contributed as capital

10 September 2019

Background

It is general practice for partner in a Partnership Firm or Limited Liability Partnership (LLP) to introduce his personal capital asset as his capital contribution. Section 45(3) of the Income-tax Act, 1961 (the IT Act) deals with taxation of gains / loss arising from such transfer. As per this section, the amount recorded in the books of account of the partnership firm / LLP is deemed to be treated as the full value of the consideration received or accruing.

Another deeming provision, Section 50C of the IT Act is attracted when an immovable property being land or building is transferred for a consideration less than fair market value.

Hence, when an immovable property is introduced as capital contribution by one of the partners, a question arises as to which section (i.e. section 45(3) of the IT Act and section 50C of the IT Act) shall apply.

Whether section 45(3) of the IT Act would override section 50C of the IT Act or vice versa is litigative. Recently, Chennai Bench of Income-tax Appellate Tribunal[1] had an occasion to analyse the application of section 50C of the IT Act when provisions of section 45(3) of the IT Act are attracted.

We, at BDO, have summarized this ruling and provided our comments on the impact of this decision.

Fact of the Case

Sarrangan Ashok, a taxpayer, transferred his land admeasuring 55.62 cents to the partnership firm M/s K G P Builders as capital contribution. The value of land recorded in the books of the Firm was INR 2.98 mn. Subsequently, the land was revalued at the market value. The share of the taxpayer was determined at INR 239.44 mn. For the purpose of computing capital gains, while the taxpayer considered INR 2.98 mn (i.e. value at which the property was recorded in the books of Partnership Firm), the Tax Officer considered INR 239.44 mn (i.e. revalued amount). Thus, while taxpayer applied the provisions of section 45(3) of the IT Act, the Tax Officer applied the provision of section 45(3) of the IT Act as well as section 50C of the IT Act.

The taxpayer filed an appeal before the Appellate Authority. Hon’ble Commissioner of Income-tax (Appeals) (‘CIT(A)’) while upholding the applicability of both the sections – section 45(3) and section 50C – directed the Tax Officer to adopt the revalued value proportionate to the share of land contributed by the taxpayer.

Tribunal Ruling

On further appeal, the Income tax Appellate Tribunal, Chennai (the Tribunal), ruled in favour of the taxpayer (i.e. section 45(3) of the IT Act would prevail over section 50C of the IT Act). In its ruling, the Tribunal noted as under:

  • The provisions of Section 45(3) of the IT Act are exhaustive and does not confer any power on the Tax Officer to adopt consideration different from what is recorded in the books of accounts of the Firm.
  • The value of land recorded in the books of the firm should be considered as consideration. Reliance was placed on Hon’ble Madras High Court’s Ruling in case of Pr. CIT vs Dr. D. Ramamurthy[2] wherein Madras High Court has held that the value recorded in the book of the Firm is conclusive as to the consideration received on transfer of asset by a partner to the Firm.
  • The provision of section 50C of the IT Act are applicable in cases where there is actual receipt of consideration. The term ‘actual receipt’ implies that there should be physical flow of money.
  • Therefore, the provisions of section 50C of the IT Act cannot be applied to the case of deeming value of consideration like cases covered by provisions of section 45(3) of the IT Act.
  • If section 50C of the IT Act is treated to override section 45(3) of the IT Act, section 45(3) of the Act would become otiose.
  • The provisions of section 45(3) of the IT Act are special provisions as it deems value of consideration which otherwise is not computable under general law and it is applicable to the specific situations of introduction of capital by partner to the firm and whereas the provision of section 50C of the IT Act are general in nature applicable where consideration is known and determinate. It is rule of construction that the special provision prevail over general provisions.

BDO Comments

  • Post the introduction of section 50C of the IT Act, the applicability of section 45(3) of the IT Act to immovable property introduced as capital contribution has been a subject of discussion. Before this Ruling, Hon’ble Allahbad High Court and Mumbai Tribunal in the case of Carlton Hotel Private Limited[3] and Amartara Private Limited[4] respectively had an occasion to analyse this issue.
  • Hon’ble Allahabad High Court has, in light of its peculiar facts, held that the provisions of section 50C of the IT Act would override section 45(3) of the IT Act.
  • Hon’ble Mumbai Tribunal held that the Tax Officer cannot import another deeming fiction created for the purpose of determination of full value of consideration as a result of transfer of a capital asset by importing the provisions of section 50C of the IT Act.
  • While Chennai Tribunal’s Ruling and Mumbai Tribunal’s Ruling are on same lines, Chennai Tribunal has neither referred nor relied on the Ruling given in the case of Carlton Hotel Private Limited and Amartara Private Limited.
  • The Chennai Tribunal’s Ruling is a welcome Ruling as it fortifies the stand that section 45(3) of the IT Act shall prevail over section 50C of the IT Act. This Ruling will benefit to all the LLPs / Firms / Association of Person / Body of Individuals where the partner introduces his capital in the form of immovable property.
  • The decision is silent on applicability or otherwise of section 56(2)(x) of the IT Act in the hands of partnership firm / LLP.

[1] Shri Sarrangan Ashok vs ITO (ITA No. 544/Chny/2019 dated 19 August 2019)

[2] 410 ITR 2366 (Madras HC)

[3] ACIT vs Carlton Hotel Private Limited (88 taxmann.com 257) (Allahabad High Court)

[4] Amartara Private Limited vs. DCIT (ITA No. 6114/Mum/2016 dated 29 December 2017. Department has filed an appeal before Hon’ble Bombay High Court.