By TIOL News Service

MUMBAI, SEPT 18, 2014: THE issue before the Bench is - Whether character of any stock-in-trade acquired by partners of a firm changes into a capital asset upon dissolution of the firm, without presence of any agreement regarding such conversion by the partners. And the answer is NO.

Facts of the case

The assessee is an individual. It had entered into an agreement of partnership at will with one Amruthben K Chedda on 1st Mar, 1982. The partnership deed was silent as to its assets or stock-in-trade. The said partners purchased two plots of land at Thane Dist. under a conveyance deed in their favor dated 2nd Apr, 1982 for purpose of its development. However, later they decided to dissolve the partnership and a dissolution deed dated 1st Apr, 1985 came to be executed whereunder the partners decided to treat the partnership assets as their co-owned plots of land and as their personal capital assets. Both the parties agreed that they will repay the loan that they had borrowed for the purchase of land out of their own resources. During the A.Y, then assessee filed its return showing the income of Rs. 15,49,110/- and claimed long term capital gains at Rs. 8,22,754/. The AO noticed that the said two plots were sold by the alleged co-owners to M/s Abhishek Construction Co. for a consideration of Rs. 37,50,000/- and profit on the sale of these plots were claimed by the assesses as well as Amrutben Chedda as long term capital gains. The AO however, treated the same as business income after providing for deduction of amounts of stamp duty, costs and registration fees and capitalization interest and arrived at a figure of Rs. 24,15,540/- which was subjected to tax.

On appeal before the Income Tax Appellate Tribunal, the assessee pursued his case that the plot in question constituted a capital asset in the hands of the partners by virtue of the partnership and its dissolution but held there was no conveyance of the land unto individual members of the partners, although they had been treating the land as personal capital assets and reflected them in their wealth tax returns. The lands were sold after two and a half years of dissolution of the partnership.

The counsel appearing for the Revenue submitted that the land having been sold before three years, therefore, no deduction could be shown even assuming that it was a long term capital gain. It was contended before the Income Tax Appellate Tribunal that whatever the nature of the assets in the hands of the firm after dissolution of the firm, the assets in the hands of the partners were always capital asset and also contended that the other co-owner had already been assessed and her share in the land was treated as long term capital gains as a result, the same treatment was claimed by the assesses in the present case. The Tribunal found that there was nothing to show that the former partner Smt. Amrutben Chedda had been assessed on the basis of profits as long term capital. The submission that the view taken in the case of co-owner should be adopted in the case of the assesses was rejected. The Tribunal held that in the absence of conveyance of the land in the individual names of the partners, they could not be treated as co-owners and the consequent gains could not be assessed as long term capital gains but as stock-in-trade. The Tribunal was of the view that the lands were brought with the intention to develop and carry out construction as builder and contractor. The character and nature of the land continues to be in the hands of the co-owners as such and constituted stock-in-trade of the partnership firm and the same was the gain from the business income.

On appeal, the High Court held that,

++ we note that the question which arises for consideration is, whether the property acquired by the two partners were stock-in-trade; and if the same were stock-in-trade, is their character changed upon the dissolution and they become capital assets. The provisions of the deed of dissolution shows that the erstwhile partners agreed to take over the two plots of land as co-owners and claim possession of the plots as their personal assets. The recital of the deed also clearly shows that the parties treated the plots of land as stock-in-trade and it is only at the time of dissolution, they agreed to convert the partnership assets into a personal capital asset. The property in the hands of the partners, therefore, did undergo change in nature by way of conversion of property into capital assets from its earlier nature of partnership property. Thus, in terms of the judgment of Khatau Vallabhadas vs. CIT, Central, Bombay, the property did undergo a change in its nature and, therefore, became eligible for being treated as capital asset subject to all other applicable provisions of law. In this respect, the fact of non registration need not engage our attention in view of the judgment of the Apex Court in Addanki Narayanappa & Anr. vs. Bhaskara Krishnappa;

++ however, there is nothing to show that the assessee and the other partner had dissolved the firm with the intention to carry on the said business of the firm in their individual capacities. However, it is not the case of the revenue that the business of the firm was that of buying and selling land and that being the case, it would have been possible to contend that the sale of the land by erstwhile partners constituted business of the partnership in their individual capacity and for that reason could be brought within the fold of stock-in-trade. The deed itself provides that the partners have agreed to take over the plots of land as co-owners and as capital assets and they shall have co-ownership and as a test of conversion if applied, the assessee has indeed provided for conversion. Hence we have no difficulty in concluding that the property does not seem to be stock-in-trade by the execution of the dissolution deed. In our view, there is no mode which provides for conversion of stock-in-trade into capital assets except by agreement of parties.

(See 2014-TIOL-1603-HC-MUM-IT)