1. These are three appeals -two by the assessee and one by the department- relating to the assessment year 1980-81. These were heard together and are disposed of by a consolidated order.
2. The accounting year of the assessee is 31-3-1980. During this accounting year, the assessee became a partner in a firm of MIs.
Premchand Roychand & Sons with effect from 22-10-1979 which was the beginning of S.Y. 2036. This fact was incorporated in the partnership deed dated 21-6-1979. By way of capital for being admitted as a partner, he brought in the property in the form of land and building known as Madhukunj situated at Narayan Dabolkar Road and costing Rs. 6,53,881 which included the cost of tubewell, electric lift and furniture. In the first assessment completed on 12-9-1983, the ITO held that the introduction of an asset in the form of a property as capital contribution in a firm amounted to a transfer within the meaning of Section 2(47) of the IT Act. The ITO, therefore, brought to tax capital gains by working out the difference between the fair market value of the property transferred which the ITO took at Rs. 8,39,100 and the cost of acquisition of property as on 1-1-1964 which the ITO took as per the wealth-tax records at Rs. 4,68,460. The ITO made an addition on account of capital gains at Rs. 3,70,640. The ITO in making such assessment invoked the provisions of Section 52(1) of the IT Act as, in his opinion, the fair market value of the property was more than the consideration recorded in the accounts. The ITO further observed that the assessee had also received consideration by way of share to profit in the firm. This was a valuable consideration and there was therefore understatement of consideration shown by the assessee in the statement of income. After obtaining statutory approval of the IAC Under Section 52(1), he made the aforementioned computation of capital gains. The matter went in appeal to the CIT (Appeals) who referred to the decision of the Gujarat High Court in the case of CIT v. Kartikey V. Sarabhai  131 ITR 42 and held in para 7 as under : 7. Hence, on the basis of the decision of the Gujarat High Court referred to above, it is abundantly clear that when the appellant introduced the immovable property owned by him as a capital contribution to the firm, there was a transfer of such property within the meaning of Section 2(47) of the Income-tax Act and that the excess of the fair market value over the substituted cost of acquisition as on 1-1-1964 would represent capital gains chargeable to tax.
Thereafter. the CIT(A) proceeded to deal with the applicability of Section 52(1) and in para 10 he gave a clear and unequivocal finding that the application of Section 52(1) has not been established by the ITO. The relevant portion of para 10 of CIT(A)'s order, wherein he gave his finding on the applicability of Section 52(1), reads as under: (i) For the application of Section 52(1) of the Income-tax Act, the Income-tax Officer should have reason to believe that the transfer was effected with the object of avoidance or reduction of the liability of the assessee Under Section 45 of the Income-tax Act.
Unfortunately, in the entire assessment order, tte Income-tax Officer has not established that the basic intention in making the transfer of the immovable property to the partnership firm was to reduce or avoid the liability for capital gains tax. There is a mention in the directions of the Inspecting Assistant Commissioner, D-I Range that the intention of transfer to the firm is obviously to avoid capital gains tax either by claiming that such a transfer does not attract capital gains tax or by showing less consideration. On this ground to hold that the provisions of Section 52(1) are clearly applicable would not be sufficient. It may be mentioned that the Supreme Court in number of cases, such as CIT v. ICI (P.) Ltd.  83 ITR 710 have held that one of the ingredients and basic requirement before Sub-section (1) of Section 52 can be applied is that the Income-tax Officer should have reason to believe that the transfer was effected with the object of avoidance or reduction of the liability of the assessee to capital gains. Further, the Madras High Court in the case of Sivakami Co. (P.) Ltd. v. CIT Madras  83 ITR 311 had held that where shares were sold to a person connected at a price considerably less than the break-up value, the burden of proof that certain sales were effected with the object of avoidance or reduction of tax liability for capital gains was on the Department and it would not be enough that the explanation offered by the assessee was not acceptable and there was strong suspicion.
Similarly, the ITAT, Jaipur Bench in ITA No. 869/JP/ 1982, dated 20-8-1983 have also held that the Income-tax Officer must prove the understatement of consideration even if the transfer is to a closely related person. In the present case, the Income-tax Officer has nowhere given a specific finding that the object of transferring the immovable property was the avoidance or reduction of the liability of the appellant Under Section 45 of the Income-tax Act. The basic prerequisite for the establishment of jurisdiction Under Section 52(1) has not been satisfied in this case.
Thus, having held firstly that there was a transfer of property within the meaning of Section 2(47) and that the excess of fair market value over substituted cost of acquisition as on 1-1-1964 would represent capital gains chargeable to tax, the CIT(A) held that the basic pre-requisite for the appplication of Section 52(1) had not been established. Finally, the CIT(A) held that there was an inherent infirmity in the assessment order with regard to the taxation of capital gains amounting to Us. 3,70,640 and therefore set aside that part of the order relating to the computation of capital gains with a direction to the ITO to redetermine capital gains in accordance with the statutory provisions bearing in mind the defects pointed out by him. The ITO was directed to make statutory reference to the Valuation Officer and also given suffiicient opportunity to the appellant to prove his case.
3. The first appeal (ITA No. 3493/Bom./84) is directed against this order of the CIT(A). The revised assessment order was passed on 27-3-1986. In the order so passed, the ITO obtained the valuation from the Valuation Officer, Unit-II, Under Section 55A. The Valuation Officer concerned had determined the fair market value of the property, namely, Madhukunj, at Rs. 17,56,000. The ITO took the value as on 1-1-1964 as per original order at Rs. 4,68,460 and made an addition of Rs. 12,87,540. The assessee again went in appeal and the CIT(A) by another order dated 8-8-1986 held that the appellant was liable to be assessed to capital gains in respect of this transaction. However, for the purpose of working out the capital gains, the provisions of Section 52(1) could not be applied, according to the CIT(A), in view of the Supreme Court decision in the case of K.P. Varghese and a number of decisions of the Bombay High Court. He ultimately directed the ITO to compute capital gains by adopting figure of the credit given to the assessee in the books of the firm as the sale consideration. Against this order of the CIT(A), both the assessee and the department have come in appeal. The assessee's appeal is ITA No. 5106(Bom.)/86 and the appeal by the department is ITA No. 5752(Bom.)/86. All these appeals were heard together and a consolidated order is passed as a common issue is involved.
4. Prefacing his arguments, Shri Inamdar pointed out that the assessee owned shares of limited companies and the property, one of which he could have contributed as capital. He could become a partner in the firm which was a family concern only by means of contribution of capital and he could contribute capital only in kind, either by contributing the shares or the house properties owned by him. The property was built prior to 1960. Its cost including that of the land appurtenant thereto was Rs. 6,19,076. After including the cost of tubewell (Rs. 4,439), electric fittings (Rs. 10,825) and furniture (Rs. 19,541), total amount of Rs. 6,53,881 was credited to the capital account of the assessee when he was introduced as a partner on 22-10-1979 i.e., at the beginning of S.Y. 2036 when a change in the constitution of the firm took place. The firm decided to accept the capital contribution in kind having regard to the potential value of the property since it consisted of land admeasuring 3520 sq. yds. and was situated in prime area of Malabar Hill at Narayan Dabholkar Road.
Shri Inamdar further pointed out that no benefit was obtained by the assessee by transfer of this amount to the firm inasmuch as no part of the amount credited to the capital account being the cost of Madhukunj property was withdrawn or utilised by the assessee for his personal purpose. In support of this argument, Shri Inamdar has filed copies of the capital and current accounts of the assessee with the firm of Premchand Roychand & Sons for S.Y. 2036 to S.Y. 2041. The assessee did not intend to derive any benefit by contributing capital in kind and such contribution did not result in capital gains. The assessee had not received anything over and above the consideration by contributing this capital and therefore the first CIT(A)'s finding that such a contribution of capital was a transfer within the meaning of Section 2(47) resulting in capital gains was incorrect. The firms started developing the property only from 1984. The transaction involving contribution of capital in kind was a genuine transaction. The firm had been accepted as a genuine firm. The value of the asset had not been inflated inasmuch as the asset was transferred at cost. The assessee had made no attempt to make use of this money. The plot obtained by the firm as contribution from the assessee was developed by the firm as late as in 1984 or 1985. Therefore, argued Shri Inamdar, there was no transfer within the meaning of Section 2(47) resulting in capital gains as found by the first CIT(A) in his order dated 23-3-1985.
5. The second limb of Shri Inamdar's argument was that the first CIT(A) had clearly given a finding that the application of Section 52(1) had not been established. He had given detailed reasons for reaching that finding. The effective result of this finding was that the assessee was entitled to total and complete relief. Since Section 52(1) was found to be not applicable, there was no way by which capital gains could be calculated as it was not established that the transaction was entered into with the intention of avoidance of tax liability. Shri Inamdar also argued that the department had not challenged this finding of the first CIT(A) although it went in appeal on the other finding concerning the taxability of capital gains. Therefore, he was entitled to relief as a consequence of the first CIT(A)'s finding on Section 52(1) itself.
6. As regards the second order of the CIT(A) dated 8-8-1986, Shri Inamdar reiterated that even this CIT(A) had given the same finding as the first CIT(A) regarding the applicability of Section 52(1) but he had said that the transaction amounted to transfer resulting in capital gains. In this context, Shri Inamdar relied on the decision in the case of Sunil Siddharthbhai v. CIT  156 ITR 509 (SC) and, in particular, the observations of the Supreme Court at page 523. Shri Inamdar also relied on the Bombay High Court decision in the case of Babubhai M. Sanghvi v. CIT  97 ITR 213 and the two decisions of the Madras High Court in the case of Sundaram Industries (P.) Ltd. v.CIT  74 ITR 243 and Sivakami Co. (P.) Ltd. v. CIT  88 ITR 311 apart from relying on the decision of the Supreme Court in the case of K.P. Varghese v. ITO  131 ITR 597.
7. Shri Keshav Prasad, the learned Sr. Departmental Representative, relied on the orders of the authorities below, particularly that of the first CIT(A) and the two orders of the ITO dated 12-9-1983 and 27-3-1986. He argued that the first CIT(A) in his order dated 23-3-1984 had given an unequivocal finding to the effect that when the assessee introduced immovable property owned by him as capital contribution to the firm, there was a transfer of such property within the meaning of Section 2(47) of the IT Act and the excess over the substituted cost of acquisition as on 1-1-1964 would represent the capital gains chargeable to tax. He pointed out that in wealth-tax assessment the value of the same property for the assessment year 1979-80 was shown at Rs. 9,45,000. This was the value disclosed by the assessee in the wealth-tax return itself. On this basis, the ITO was justified in coming to the conclusion that the property was transferred to the firm at a consideration which was less than the fair market value. He was also equally justified in invoking the provisions of Section 52(1) because the major motive of such transfer was to avoid tax. That is also the grievance of the department which is ventilated in the departmental appeal against the second CIT(A)'s order in ITA No. 5752 (Bom.) of 1986. He argued that the facts in the decision of the Supreme Court in the case of K.P. Varghese (supra), were different from the facts of this case and the Supreme Court was considering mainly the provisions of Section 52(2) and not Section 52(1) in that case. Shri Keshav Prasad finally referred to the decision in the case of Sunil Siddharthbhai (supra) and argued that the tests laid down by the Supreme Court at page 523 of the report were not strictly fulfilled.
The whole transaction was a device or ruse for converting the asset into money which would substantially remain available for the assessee'a benefit without liability to income-tax or capital gains. He therefore argued that inasmuch as these conditions were not fulfilled, capital gains representing difference between the market value of the property and the value at which it was shown in the books was exigible to capital gains tax.
8. In reply, Shri Inamdar clarified firstly that both the ITOs had taken the value as on 1-1-1964 as per the wealth-tax records only in order to inflate the quantum of capital gains. The option of taking the value as on 1-1-1964 was available to the assessee and not to the department apart from the fact that the figure taken as on 1-1-1964 was not correctly taken. This option was intended to confer some kind of a benefit on the assessee particularly in those cases of old properties which were sold after long period of time and the cost of which was very much less than the cost as on 1-1-1964. The substitution of cost as on 1-1-1964 was done by the ITO not for the benefit of the assessee but for the benefit of the department. Secondly, Shri Inamdar pointed out that the Supreme Court in K.P. Varghese's case (supra) also referred to Section 52(1) and did not confine itself to Section 52(2).
Thirdly and finally, Shri Inamdar reiterated that the observations of the Supreme Court at page 523 squarely covered the case of the assessee in his favour. The partnership firm was genuine and not the result of a sham or unreal transaction. In any case, no such finding had been given in the firm's case by the departmental authorities. The transfer by the partner of his personal asset to the partnership represented a genuine intention to contribute to the share capital of the firm for the purpose of carrying on the partnership business. This was evident from the fact that the capital asset was transferred at cost and was not inflated. Thirdly, this was not a device or ruse for converting an asset into money as could be seen from the fact that firstly the property was transferred at cost and no benefit was sought to be obtained by the partner from the credit available to him to his capital account as a result of contribution of capital for this and subsequent year. The whole transaction represented a real attempt to contribute share capital for running the business of the firm and not to convert an asset into money for the benefit of the assessee. The subsequent event proved that the latter was not the intention. Finally, without prejudice and alternatively, Shri Inamdar pointed out that in the whole transaction the assessee did not receive any consideration whatsoever.
The right to share profits was also combined with the right to share losses. Benefits, if any, were also combined with responsibilities.
Therefore, it was not established that a consideration more than what was transferred to the firm was available or receivable or in fact received at a subsequent date by the assessee as a result of this transaction.
9. We have considered the submissions made by Shri Inamdar and Shri Keshav Prasad carefully. We have gone through the relevant records. We are firstly of the opinion that it is necessary for us to deal with both the orders of the CIT (A) independently. The first order of the CIT (A) is very clear in its finding that the contribution of capital resulted in a transfer and such transfer led to capital gains. This finding was based on the then prevailing decision of the Gujarat High Court in Kartikey V. Sarabhai's case (supra), to which a reference has been made in para 6 of his order. Consistent with this finding, the CIT (A) set aside the order of the ITO, directed to refer the matter to the valuer Under Section 55A and re-do the assessment. We are, therefore, of the opinion that the fact that the first CIT (A) gave his finding on Section 52(1) against the department does not render the ITO functus offlcio, particularly when he had given specific direction to the ITO to re-do the assessment. We would, therefore, firstly not accept Shri Inamdar's argument that once we reverse the finding of the first CIT (A), nothing further survives. As regards the finding of the CIT (A) in para 7 of his order which has been reproduced in the preceding paragraphs, we are inclined to accept Shri Inamdar's argument that the transaction did not involve a transfer of a character which would lead to capital gains. Firstly, this was not a sham or a colourable transaction. No evidence had been produced before us to come to the conclusion that this transaction (contribution of capital in kind) was entered into with the intention of avoidance of tax. The firm has been accepted as a genuine firm, registration has been granted and assessment completed in that case. Secondly, it is not disputed by any of the lower authorities that the property was transferred at cost at the time of assessee's admission to the partnership. Thirdly, it would appear from the copy of the capital accounts and current accounts of the aesessee with the firm produced before us that no effort has been made to derive any benefit from the transfer of this asset by way of withdrawals from the capital account. We are, therefore, satisfied that the conditions laid down by the Supreme Court in Sunil Siddharthbhai's case (supra) at page 523 have been fulfilled and their observations would appear to support the assessee in the case made out on his behalf. It has not been established before us that the contribution of capital was merely a device or ruse for converting the asset into money which would substantially remain available for the assessee's benefit.
This device is normally resorted to when the value of the asset so transferred is artificially inflated. In the present case, this has not been done. Further, we find that the assessee has not derived any benefit out of such transfer and no consideration has been received within the meaning of Section 48 of the IT Act. Therefore, on the merits of the case, in our opinion, the assessee is entitled to succeed. As regards the finding of the GIT (A) regarding the applicability of Section 52(1) in the second order of the CIT (A), which has been challenged by the department, the issue in question is covered by the Supreme Court decision in K.P. Varghese's case (supra) which has, in fact, considered the effect of Section 52(1) also. Apart from this, the Bombay High Court in the case of Babubhai M. Sanghvi (supra), held that in order that a transfer must be one with the object of avoiding or reducing the liability of the assessee Under Section 12B (of the Indian Income-tax Act, 1922), it must be a case where the consideration mentioned in the deed has been understated and actually the assessee has received more than what is stated in the document. In that case, the Bombay High Court held that the first proviso to Section 12B(2) would not apply and tax could not be levied on the deemed capital gains based on the market value of the shares. In the present case, an effort is made by the ITO to calculate the difference between the market value of the property and its cost on the assumption that when the property was contributed as capital such contribution constituted a transfer within the meaning of Section 2(47) and such transfer was made for a price which was deliberately understated. No such understatement has been proved in the present case as it has not been established that any consideration has been received by the assessee which would secure any benefit in the nature of capital gains as a result of such capital contribution. Similar decision has been given by the Madras High Court in Sivakami Co. (P.) Ltd.'s case (supra). Here also, the High Court was interpreting the first proviso to Section 12B of the old Act and observed that what is intended to be taxed is the real gain and not a fictional gain and Section 12B(2) deals with cases of avoidance of the tax liability on the gain actually received by understatement of consideration payable or paid. Another decision of the Madras High Court in the case of Sundaram Industries (P.) Ltd. (supra) laid down that proviso to Section 12B(2) (of the old Act) does not discourage or avoid honest transactions and is not intended to tiring about a fictional gain. It also held that this section does not treat what is not an actual capital gain as a deemed capital gain. In view of these judicial pronouncements, we would hold that there is not much substance in the appeal of the department. It may incidentally be stated that when the first CIT (A) gave the same finding, namely, that the application of provisions of Section 52(1) had not been established, such finding was not challenged by the department nor were any cross-objections filed even when the assessee filed an appeal against that order. Further, it is not correct, as argued by the Departmental Representative, that the Supreme Court in K.P, Varghese's case (supra) was only dealing with Section 52(2) of the IT Act. It specifically dealt with Section 52(1) and the difference between subSection (1) and Sub-section (2) of Section 52 at pages 606 and 607 of the report. It also observed at pages 606 and 607 as under: Now, it is necessary to bear in mind that when capital gains are computed by invoking Sub-section (1) it is not any fictional accrual or receipt of income which is brought to tax. Sub-section (1) does not deem income to accrue or to be received which in fact never accrued or was never received. It seeks to bring within the net of taxation only that income which has accrued or is received by the assessee as a result of the transfer of the capital asset.
These observations clearly indicate that the Supreme Court did deal with Section 52(1) of the IT Act. Therefore, there is not much substance in the argument of the department that the CIT (A)'s reliance on the Supreme Court decision was misplaced. This contention is hence rejected. In sum, the assessee's appeal against the first CIT (A)'s order is allowed in part and that against the second CIT (A)'s order is fully allowed in view of the findings given by us which are summed up as under : (1) Introduction of an asset by a person by way of capital contribution to a partnership firm on the occasion of his induction as a partner of that firm, though amounting to a transfer, is not such a transfer as to give rise to capital gains exigible to capital gains tax since no consideration is received. This finding is based on the decision of the Supreme Court in Sunil Siddharthbhai's case (supra). Assessee's first ground of appeal in ITA No. 3493 (Bom.)/ 84 is allowed.
(2) We do not agree that CIT (A) erred in setting aside the assessment made by the ITO merely because he held that Section 52(1) was not properly established. Since he had given a finding that capital gains were exigible to tax and had given directions for reference to the Valuation Officer, he was justified in setting aside the assessment order. We do not accept the assessee's claim that having given the finding in respect of Section 52(1) in favour of the assessee, CIT (A) should have ipso facto allowed the assessee's appeal. Therefore, assessee's first appeal, being ITA No. 3493 (Bom.)/84, is allowed in part.
(3) Assessee's second appeal, being ITA No. 5106 (Bom.)/86, is allowed in full since, as stated earlier, we have already given a finding on merits in favour of the assessee following a Supreme Court decision in Sunil Siddharthbhai's case (supra).
(4) The departmental appeal, being ITA No. 5752 (Bom.)/86, is dismissed.