DLF Universal: Capital Contribution and Section 45(3) - Part II

In an earlier post, I had discussed the majority judgment of the Special Bench of the Income Tax Appellate Tribunal in the case of DLF Universal v. DCIT, [2010] 123 ITD 1 (Delhi - SB). The question in that case was in relation to the taxability of certain land held by assessee as its stock-in-trade, and introduced in the partnership firm as its capital contribution when the assessee became partner of the firm. The majority held, as summarised in the earlier post, that there is no transfer of land held by the assessee as stock-in-trade when the same was merely revalued at a market value in its books. No profit or gain accrues or arises merely on revaluation at a higher value in the books or on mere conversion from stock-in-trade to a capital asset. However, the position is different in cases where on or after conversion of stock-in-trade into a capital asset (either by implication of law or by act or conduct of the assessee), the asset is contributed to a firm as capital contribution. In such a case, there is a transfer of the assets. In such cases, the value of the asset recorded in the books of the firm shall be deemed to be the full value of consideration received or accruing as a result of the transfer of the asset.

It is submitted that the view of the dissenting member is more persuasive. The learned dissenting member held, “Under the Income-tax Act what is chargeable to tax is the income accruing to the assessee. The income can be said to have accrued provided the assessee either receives the sum or any legally enforceable right is acquired. Such right should be accruing immediately and should not be inchoate or contingent…” Support for this proposition is available in several cases – for instance, see CWT v Girija Ammal,  282 ITR 614; National Handloom Development Corporation v DCIT 266 ITR 647; CIT v Orissa State Financial Corporation 262 ITR 350.

Following from this proposition, the dissenting judgment held that when an asset is brought into the partnership as a capital contribution, “The amount credited to the account of the partner is not a debt due by the firm to the partner. The partner cannot legally enforce the claim to receive the amount standing to the credit to his account in the books of the firm. Thus, the amount due by the firm to the partner standing to the credit of partner's account whether by way of capital or by way of loan will not be a legally enforceable right in favour of partner against the firm or the other partners constituting such firm…” The only right which the partner has is of sharing in the profits of the partnership. Only on the dissolution of the partnership will the partner have any enforceable rights in the partnership assets as such. Accordingly, when an asset is brought into the partnership and an entry is passed in the books of account, in reality, no income has accrued to the partner. Furthermore, Section 45(3) of the Act which was relied on in the majority judgment is specifically limited to cases where a capital asset has been brought into the partnership. In the case of a stock-in-trade being brought in as capital contribution, there does not appear to be any warrant for applying the section. The majority decision effectively means that in every case where a stock-in-trade is brought into a partnership by a partner, the stock-in-trade is deemed to be a capital asset. There does not appear to be any warrant for such a fiction.

Consequently, it is submitted with respect that the dissenting judgment appears to be based on sounder reasoning; and the majority view may require some reconsideration.