An Analysis
Capital gains, as a chargeable head of income under the Income Tax Act, 1961 (IT Act), has gone through many legislative, departmental and judicial “surgeries”. The Parliament has, time and again, modified the provisions of taxation of capital gains, apart from the other income tax provisions. The executive, through the Central Board of Direct Taxation (CBDT), has brought in various amendments and modifications to the manner of implementation of the law, through umpteen notifications and circulars. And finally, the judiciary, as the ultimate interpreter of the numerous tinkering by the parliament and the executive, has taken its own view on the taxation of capital gains through a plethora of judgements.
Capital gains arising out of transfer of an asset by a firm or an Association of Persons or a Body of Individuals or OTHERWISE is dealt with in sub-section (4) of Section 45 of the IT Act. “Transfer” for purpose of Section 45(4) is a transfer by reason of distribution of assets.
When it comes to modifications, sub-section (4) of Section 45 of the IT Act has a history of its own insofar as it being subject to periodic improvisation by the Parliament followed by the natural corollary of periodic judgements on the subject. It was first introduced in the direct tax statute by the Finance Act, 1964 only to be later omitted by the Finance Act, 1966, and then again re-introduced by the Finance Act, 1987.
When it was first introduced, the said sub-section merely spoke about the inclusion of profit or gain arising from transfer of “any share” with reference to a “company”. However, upon re-introduction in 1987, it brought into the tax ambit, transfer, by way of distribution of asset(s), by an entity not being a company or a co-operative society, to its partner(s)/member(s). The scheme of sub-section (4) was to tax, in the hands of the transferor entity, the capital gains, deemed or otherwise, that arises to it on transfer of its asset to its own member. The sub-section was made very broad-based by the word “otherwise”, which would even bring within its scope a Hindu Undivided Family.
On the judicial front, the courts have given various interpretations of Section 45(4) of the IT Act. This article briefly discusses a recent judgement of the Hon’ble Supreme Court on the issue (CIT v Mansukh Dyeing and Printing Mills). In this case, the issue before the Apex Court was whether revaluation of assets of a partnership and subsequent credit of the revalued amount to the partners’ capital account in their Profit-Sharing Ratio (PSR) attracted the provisions of Section 45(4). Holding in the affirmative, the Supreme Court held that subsequent to the omission of sub-section (11) from Section 47, the distribution of capital asset on dissolution of a firm would be regarded as “transfer”. While discussing the word “otherwise”, the Court said that the expression has not to be read ejusdem generis with the expressions “dissolution of a firm or body of individual or assets of persons” but has to be read with the words “transfer of capital assets”. Applying this to the issue on hand, the Hon’ble Court stated:
“If so read, it becomes clear that even when a firm is in existence and there is a transfer of capital assets it comes within the expression ‘otherwise’ as the object of the amending Act was to remove the loophole which existed whereby capital gain tax was not chargeable.”
The Mansukh Dyeing judgement has held that the word “otherwise” takes into its sweep not only the cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of a retiring partner. Revaluation of assets and credit of the value to the partners’ capital account was therefore held to be a “transfer”, falling within the category of “OTHERWISE” and thus, taxable under the provisions of Section 45(4), as inserted by the Finance Act, 1987. Here, it would be pertinent to mention that the judgement in Mansukh Dyeing supra relates to A. Y. 1993-94 and A. Y. 1994-95 and the amendment introduced by Finance Act, 1987 were applicable to it.
The term “transfer” defined in Section 2(47), as noted by the Supreme Court in Malabar Fisheries Co. v. CIT, Kerala case “gives an artificial meaning to the expression to the expression transfer for it not merely includes transaction of sale and exchange in ordinary parlance but would also mean relinquishment or extinguishment of rights which are ordinarily not included in that concept”.
Coming to the present times, the Finance Act, 2021 brought in a substituted sub-section (4) of Section 45. The substitution while maintaining the characteristic and essence of the original 1987 sub-section introduced the terms “specified person” and “specified entity”. Finance Act, 2021 also introduced a new section 9B in Chapter II of the Income Tax Act, 1961. Both, the fully substituted sub-section (4) of Section 45 and Section 9B target the same income, albeit in a different manner. Sub-section (4) of Section 9B enables the Board to issue guidelines for the purpose of removal of difficulties in the application of both Section 9B and Section 45(4). In exercise of this power, the CBDT has issued Circular No. 14 of 2021, which is crucial to understand the operation of both these different provisions, which subject similar income to tax.
Circular 14 referred to above “clarifies”, having regard to the non-obstante clause in Section 45(4), that in case of receipt by a specified person on reconstitution of a specified entity, in addition to the specified entity being taxed under Section 9B, it would be further subject to tax under Section 45(4). The non-obstante clause in Section 45(4) reads as “…notwithstanding anything to the contrary contained in this Act such profits or gains shall be determined in accordance with the following formula…”.
The question here is that in comparison to the now-deleted sub-section (4) of Section 45 of the IT Act, whether the substituting clause along with Section 9B of the IT Act would amount to double taxation or enhanced taxation on account of the increased taxable parameters? The answer, perhaps, will have to wait as the issue lives through some years of hierarchical litigation until it gets finally resolved by the Hon’ble Supreme Court.
During the intervening time, however, tax experts would be left to apply their minds to arrive at various interpretations on the applicability of the two provisions. Needless to say, with progress in time, and with the power to issue guidelines, the Board may well exercise its liberty to tweak the application of the law, or the law itself might undergo the routine and infamous parliamentary surgeries that tax enactments have been historically subjected to.
The last word on the issue of taxing a “specified entity” on receipt of its assets etc. by “specified person(s)” remains, yet to be thought of and written.
