Holding

The contribution of shares to a partnership firm is a transfer of a capital asset, but no consideration under section 48 is received and no profit or gain accrues, so the transaction is outside the ambit of section 45.

Summary

The appellant, a partner in two different partnership firms, contributed shares of limited companies to the firms as capital. The Revenue argued that the contribution constituted a transfer of a capital asset under section 45 of the Income Tax Act, 1961 and that a capital gain arose because the market value of the shares exceeded their cost. The Supreme Court held that while the contribution is indeed a transfer within the meaning of section 2(47) and therefore falls under section 45, no consideration as defined in section 48 is received and no profit or gain accrues to the partner. Consequently, the transaction lies outside the scope of capital‑gains tax. The appeals were allowed in part, affirming the revenue’s view on the existence of a transfer but rejecting the claim of taxable capital gain.

Issues considered

Whether the contribution of shares to a partnership firm amounts to a transfer of a capital asset within the meaning of section 2(47) and section 45 of the Income Tax Act, 1961.
Whether the partner receives any consideration within the meaning of section 48 of the Act on such a transfer.
Whether a profit or gain accrues to the partner for the purpose of section 45.
Whether the transaction is a genuine partnership contribution or a sham device to avoid tax.

Legislation cited

Income Tax Act, 1961s. 2(47), s. 45, s. 48
Registration Acts. 17(b)

Subjects

capital gainspartnershiptransfer of capital assetconsiderationsection 45section 48income taxsham transaction

Judgment

102

SHRl SUNIL SlDDllARTllBHAl ETC.
A V•
COMMISSIONER OF INCOME TAX, AllMEDABAD ETC.

SEPTEMBER 27, 1985

[P.N. llHAGWATI, CJ., R.S. PATHAK AND A(1ARENDRA NATH SEN, JJ.]
B
Transfer of a capital asset - When the assessee brings the
shareS' of the limited companies into the partn~rship firm as
his contribUtion to its capital, whether there was a transfer
within the definition of section 2 (47) of capital asset within
the terms of section 45 of the Income Tax Act, 1961.

c Capital gains, scheme of - Sections 45 and 48 of the Income
Tax, 1961, scope of - When the assessee transferred his shares to
the partnership firm, whether he can be said to have received a
consideration within the meaning of section 48 of the Income Tax
Act, 1961 and that a profit of gain accrued to him for the
purpose of section 45 ibid.

D In Civil Appeal No. 1841 of 1981, the appellant-assessee
was a partner in Messrs Suvas Trading Company, a partnership
firm constituted under a deed of partnership dated September 27,
1973. As his contribution to the capital of the partnership firm,
the assessee made over certain shares of limited companies which
were held by him as his capital assets. The book value of the
E said shares in his account books was shown as Rs. 1,60,279 but on
the date when he contributed those shares to the partnership firm
he revalued the shares at the market value of Rs. 1,49,819, and
debited the resulting difference of Rs. 10,460 to his capital
account. Since the Income Tax Officer, when drawing up the
assessment order for the assessment year 1974-75 in respect of
F the assessee did not include the difference in the assessable
income, the Commissioner of Income Tax, being of the opinion that
the difference between the market value of the shares and the
cost of acquisition of the shares to the assessee is liable to
tax as capital gains under section 45 of the Income Tax Act, 1961
exercised his revisions! jurisdiction and reopening the
. G assessment, remanded the case to the Income Tax Officer directing
him to revise the assessment after computing the capital gains
arising out of the trall$fer. The assessee appealed to the Income
Tax· Appellate Tribunal, which held that while the transaction did
amount to a transfer within the meaning of sub-section (47) of

H
s; SIDDHARTHBHAI v. c.I.T •. 103

section 2 of the Income Tax Act, 1961, it did not result in·
A
capital gains liable to tax. Subsequently the Appellate Tribunal
ref erred the case to the High Court of Gujarat for its opinion on
the said two issues.

In Civil Appeal No. 1777/1981, the appellant was a partner
in a registered partnership firm, M/s. Rajka, constituted under
B
an agreement dated February 24, 1973 of which the other partner
was his wife. The assessee had in his possession 580 ordinary
shares of the Alunedabad Manufacturing and Calico Printing Co.
Ltd. and 82 ordinary shares of Karamchand Premchand Private Ltd.,
the total cost of purchase being Rs. 1,81,106. On March 22, 1973,
the assessee introduced the two share holdings in the partnership
firm as his capital contribution and the firm credited his
c
account with the market value of the shares, namely Rs. 475,136.
In the assessment proceedings for the assessment year 1973-74,
the Income Tax Officer took the view that the contribution by the
assessee of the shares to the assets of the partnership
constituted a transfer within the meaning of sub"'.section (47) of
D
section 2 of the Income Tax Act, 1961 and that the assessee was
liable to income tax on a capital gain of Rs. 2,94,030, being the
difference between the market price at which the shares were
entered in the booka of the partnership firm and the cost of the
shares to the assessee. The appeal before the Appellate Assistant
Commissioner failed, but in second appeal, the Appellate Tribunal
E
took the view that there was no transfer of a capital asset
within the meaning of section 45 read with sub-section ( 47) of
section 2 of the Income Tax Act and consequently deleted the item
from the assessment. In the circumstances the Tribunal did not go
into the question whether the transfer was without consideration.
At the instance of the Commissioner of Income Tax a reference was
made to the High Court on the correctness of the Tribunal's
F
views. By a cOUDDOn judgment .dated April 30/May l and 4, 1981 the
High Court answered the questions referred in favour of the
Revenue and against the assessee. Hence the appeals by special
leave of the Court,

Allowing the appeals in part, the Court
G
HELD: l. l When the assessee brought the shares of the
l.1mited companies into the partnership firm as his contribution
to its capital, there was a "transfer"' within the meaning of
sub-section (47) of section 2 of the Income Tax Act, 1961, of a
capital asset within the terms of section 45 of the Act.
104 SUPl<EME COURT REPORTS [1985] SUPP.3 S.C.R.

A
1.2 It is well settled that a partnership firm is not a
separate legal entity and that the assets owned by the partner-
ship are collectively owned by the partners and that when a
partner hands over a business asset to the partnership firm as
his contribution to its capital, he cannot be said to have
B
effected a sale. (113 A-B; ~]

Malabar Fisheries Co. v. C<wUsstooer of Income Tax,
Kerala, (1979) 120 ITR 49; Ccunissiooer of lnome Tax, West
Bengal v. lliDd Construction Ltd. (1972) 83 ITR 211 (SC) referred
to.

Coaaissioner of Income Tax, Madras v. Jaoab N. llyath Batcba
c Sabiv, ( 1969) 72 ITR 528 (Madras); c.-issioner of l:ocome Tax
(Madras)-! v. Abdul Kbader Motor and Lorry Service (1978) 112 ITR
360 (Madras); Dr. 11.c. Kackkar v. Ccunissioner of Income Tax,
iaopur and Ors. (1973) 92 ITR 87 (Allahabad); C<llll•ifssioner of
IDcome Tax, Kerala v. C.11. ""'mlyrmpcl (1974) 94 ITR 179 (Kerala)
approved •.
D
1.3 But while the transaction may not amount to a sale, it
can be described as a transfer of some other kind. The definition
of the expression "transfer" in sub-section (47) of section 2 of
the Income Tax Act, 1961 is inclusive merely and does not exhaust
other kinds of transfer. (114 A-BJ
E
1.4 In its general sense, the expression "transfer of
property" connotes the passing of rights in the property from one
person to another. In one case there may be a passing of the
entire bundle of rights from the transferor to the transferee. In
another case, the transfer may consist of one of the estates only
out of all the estates comprising the totality of rights in the
F
property. In a third case, there may be a reduction of the
exclusive . interest in the totality of rights of the origins!
owner into a joint or shared interest with other persons. An
exclusive interest in property is a larger interest than a share
in that property. To the extent to which the exclusive interest
is reduced to a shared interest it would seem that there is a
G
transfer of interest. Therefore when a partner brings in his
persons! asset into the capital of the partnership firm as his
contribution to its capital he reduces his exclusive rights in
the asset to shared rights in it with the other partners of the
firm. While he does not lose his rights in the asset altogether
what he enjoys now is an abridged right which cannot be identi-
H
fied with the fulness of the right which he enjoyed in the asset
s. SIDDHARTHBHAI V• c.1.r. 105

before it entered the partnership capital. When a partner brings
A
in his pe~sonsl asset into a partnership firm as his contribution
to its capital, an asset which originally ·was subject to the
entire ownership of the partner becomes now subject to the rights
of other partners in it. lt is not an interest which can be
evaluated illlllediately. lt is an intere8t which is subject to· the
operation of future transactions of the partnership, and it may B
diminish in value depending on accumulating liabilities and
losses with a fall in the prosperity of the partnership firm. The
evaluation of a partner's interest takes place only when there is
a dissolution of the firm or upon his retirement from it. Upon
the dissolution of the firm or upon the partner retiring from the
firm, the partner's right to realise the interest and receive its
value arises. What is realised is the interest which the partner
c
enjoys in the assets during the subsistence of the partnership
firm by virtue of his status as a partner and in accordance with
the terms of the partnership agreement. It is because that
interest exists already before dissolution that the distribution
of the assets on dissolution does not amount to a transfer to the
D
erstwhile partners. What the partner gets upon dissolution or
upon retirement is the realisation of a pre-existing right or
interest. lt is nothing strange in the law that a right or
interest should exist in praesenti but its realisation or
exercise should be postponed. Therefore, what was the exclusive
interest of a partner in his personal asset is, upon its intro-
E
duction into the partnership firm as his share in the partnership
capital transformed into a shared interest with the other
partners in that asset. Qua that asset, there is a shared
interest. During the subsistence of the partnership the value of
the interest of each partner qua that asset cannot be isolated or
carved out from the value of the partner's interest in the
totality of the partnership assets. And in regard to the latter,
F
the value will be represented by his share in the net assets on
the dissolution of the firm or upon the partner's retirement. But
the position is different when a partner retires or the partner-
ship is dissolved. What the partner receives then is his share in
the partnership. What is contemplated here is a share of the
partner qua the net assets of the partnership firm. On
G
evaluation, that share in s particular case may be realised by
the receipt of only one of all the assets. What happens here is
that a shared interest in all the assets of the firm is replaced
by an exclusive interest in an asset of equal value. That is why
it has been held that there is no transfer. lt is the realisation
of a pre-existing right. The position is different, when a
partner brings his personal asset into the partnership firm as
H
106 SUPREME COURT REPORTS (1985] SUPP.3 s.c.R.

A b.ia contribution to its capital. An individual asset is the sole
subject of consideration. An ezi:lusive interest in it . before it
eutera the partnership is reduced on such entry into a shared
interest.· 1114 D-G; 116 A-F; 117 B-il] ·

Mdankf llarayanappa & J.iir. v. Bhutan Xriahtappa and 13 ·
B Ora. (1966] 3 SCR 400; Malabar Fisberles Co. v. C<wofaaf.oner of
lDcam!! Tax, l:erala.(1979).120 ITR 49 (SC) referred to.

C<wo<saioaer of ~. Madras-IV• Abdul lhader Motor.
·and Lorry Serr1ce (1978) 112 ITR 360 (l'.adraa); and ,.,,_,ssioau
of lDcam!! Tax, . Ta:all Madu IV, l!adras v. H. Rajan and H. l:mmaD
· (1984) 149 ITR 545 (Madras) partly overruled. · ·
c
Cqwfss1.ooer of lDcolle Tax, l!adllya Pradeah, Dagpur and
Bbanclars V• Dewaa Cine Corporatioo (1~68) 68 ITR 240 (SC);
Cmmfsailxler of Iacme Tax, l:erala v. Hataraj Motor Service
(1972) ITR 109 (Kerala) ra..1 . .f.oner of ~. Gujaiat V•
IW;anNµif Pmaabbai (1973) 91 ITR 393 (Gujarat) distinguished.
_I • / •

D
,.,,...1 ..A.tooerAbdnl llahiJa, Tranncore Confectiollery Works· v.
of lDcaiie-'Iu:, l:erala (1977) 110 ITR 595 (Kerala);
Add.l. r......r•sioner_ Of ~~ My8ore Y• M.A.J. V•samtk·.
'(1979) 116 ITR 110 (Kerala) approved •
. 1' .
Fina Ema Sahay Hall Kaaeallllar Dayal & Ora. v. Bislsanath
· E . Prasad, AIR 1963 .Patna 221; Sodh•nm l:anta V• llanfnclrs Hath, AIR
.1965 Patna '144 explained.

·2.1 'When the -Asaessee. transferred his · shilres to the
partnership firm he received no consideration within the· meaning
, .of section 48 of the Income Tax Act, 1961 nor did any ,profit or
F ~ gain accrue . to him for the purpose of section 45 of the . Income
Tax Act, 1961 •• (118 A-BJ

2.2 The consideration '.for the transfer· of the personal
assets is the right which arises or accrues to the partner during
the subsistence of the partnership to get his share of . the
G profits from time to time and, after the dissolution of the
partnership or with his retirement from the partnership, to get
the value of a share in the net partnership assets as on the date
I
1· ·-~- of the dissolution or retirement after a deduction of liabilities
I
and prior charges. The credit entry made in the partner's capital
I . account in the books of the partru.rship . firm does not reifresent<
H ·· the true v8l.ue ·of the ccinsideration. It is a notional value only,
S. SlDDHARTHBHAI v •. C.I.T. 107

intended to be taken \nto account at the time of determining the A
value of the partner's share in the net partnership assets on the
date of dissolution or on his retirement, a share 1'ilich will
depend upon a deduction of the liabilities and prior charges
existing on the date of dissolution or retirement. It is not
possible to predicate before hand what will be the position in
terms of monetary value of a partner's share on that date. At the B
time when the partner transfers his personal asset to the
partnership firm, there can be no reckoning of the liabilities
and losses which the firm may s;,ffer in the years to come. All
that lies within the womb of the future. It is impossible to
conceive of evaluating the· consideration acquired by the partner
when he brings his personal asset into the partnership firm when c
neither the date of dissolution or retirement can be envisaged
nor can there by any ascertainment of liabilities and prior
charges which may not have even arisen yet. Therefore, the
consideration which a partner acquires on making over his
personal asset to the partnership firm as his contribution to its
capital cannot fall within the terms of section 48. And as that D
provision is fundamental to.the computation machinery incorpora-
ted in the scheme relating to the determination of the charge
provideil in section 45, such a case must be regarded as falling
outside the scope of capital gains taxation altogether. [118 E-H;
119 A-CJ

Cgzpissicmer of Iocame Tax, Bangalore V• B.C. SriDivasa
Setty (1981) 128 ITR 294 referred to.

2.3 Applying the principle that profits or gains under the
Income Tax Act must be understood in the sense of real profits
or gains, that is to say, on the basis of ordinary comnercial
principles on which actual profits are computed, a sense in which F
no comnercial man would misunderstand, and having regard to the
nature and quality of the consideration·which the partner may be
said to acquire on introducing his personal asset into the
partnership firm as his contribution to its capital, it cannot be
said that any income or gain arises or accrues to the assessee in
the true commercial sense which a businessman would understand as G
real income or gain. Of course, the partnership firm in question
must be a genuine firm and not the result of a sham or unreal
transaction, and the transfer by the partner of his personal
asset to tre partnership firm must represent a genuine intention
to contribute to the share capital of the firm for the purpose of
carrying on the partnership business. [ 120 A-B; 119 C-D]
H
ll1Bs lbm Dadabboy lapadia v. ec-tsaioner of Income-Tax,
~ (1967) 63 ITR 651 (SC); Calcutta Co. Ltd. v. C<mf•stoner
of :cnco--Tax, West Bengal, (1959) 37 ITR l SC; Cgng!e.f.oner of
108 SUPREME COURT REPORTS [1985] SUPP.3 s.c.R.

A
Inc.- Tax V• Bai Sb1r1nhai L looka, (1962) 46 ITR 86 SC; Poona
·Klectric Supply Co. Ltd. v. r,.,isatcmer of Incme-Tax, Bombay
City I, (1965) 57 ITR 521 SC; ec.w.ai.oner of ~ West
Bengal ll v. BirlaGwal.ior (P) Ltd. (1973) 89 ITR 266 SC; llafDa
Textfles v. lDCC8! Tax Officer, Asses ••,....\, Cixcle ll,
Bangalore (1975) 98 ITR 209 SC referred to.
B
2.4 If the transfer of a personal asset by. the assessee to
a partnership in which he is or becomes a partner is merely a
device or ruse for converting the assset into money which liOUld
substantially remain available for his benefit without liability
to income tax on a capital gain, it will be open to the income
tax authorities to go behind the transaction and examine whether
the transac'tion of creating the partnership is a genuine or a
c sham transaction and, even where the partnership is genuine, the
transaction of transferring the personal asset to the partnership
firm represents a real attempt to contribute to the share capital
of the partnership firm for the purpose of carrying on the
partnership business or is nothing but a device or ruse to
convert the personal asset into 1110ney substantislly for the
benefit of the assessee while evading tax on a capital gain.
D
[121 E-G)

CIVIL APPELLATE JURISDICTION Civil Appeal No. 1841 of
1981.

From the Judgment and Order dated 30.4.1981, 1/4.5.1981 of
E the Gujarat High Court in Income Tax Reference No. 235 of 1980.

AND

Civil Appeal No. 1777 of 1981.
F. From the Juiigment and Order dated 30.4.1981, 4.~.1981 of
the Gujarat High Court in Income Tax Reference No. 34 of 1980.

v.s. Desai, J.P. Shah, P.H. Parekh and Gautam Phliph for
the Appellant in C.A. No. 1841 of 1981.
G M.K. Vanerjee, Additional Solicitor General, S.T. Desai,
P.A. Francis, and Miss A. Subhashini for the Respondent in C.A.
No. 1841 of 1981.

J.P. Shah and P.H. Parekh for the Intervener in C.A. No.
1841 of 1981.
H
S. SIDDllARTHBHAI v. ·c.I.T. [PATHAK, J.J 109

v.s. Desai, S.P. Mehta and Mrs. A.K.· Verma for the A
Appellant in C.A. No. 1777 of 1981.

S.T, Desai, and Miss A. Subhashini for the Respondent in
c.A. No. 1777 of 1981.

T.A. Ramachandran, Mrs. J. Ramachandran, H.K. Kaji and s.c. B
Patel for the Intervener in C.A. No. 1777 of 1981.

The Judgment of the Court was delivered by

PATHAK, J, This and the connected . appeal, fil~d by
certificate granted by the High Court, raise the interesting C
questi<;>n whether the capital contribution by a partner to the
assets of a partnership firm at an appreciated value can be said
.to give rise to a capital gain in his hands liable to income-tax.

In Civil Appeal No. 1841 of 1981, the facts are as follows.
The appellant, who is the assessee; was a partner in Messrs. D
Suvas Trading Company, a partnership' firm constituted under a
deed of partnership dated September 27, 1973. As his ccmt.ribution
to the capital of the partnership firm the assessee made over
certain shares of limited companies which were held by him as his
capital assets. The book value of those shares .in his account
books was shown as Rs. 1,60,279, but on the date when he E
contributed those shares to the partnership firm he revalued the
shares at the market value of Rs. 1,49,819 and debited the
resulting difference of Rs. 10,460 to his capital account.

The Income Tax Officer, when drawing up the assessment
order for the assessment year 1974-75 in respect of the assessee,
did not include the difference in the assessable income. The F
Connnissioner of Income-Tax, however, being of opinion that the
difference between the market value of the shares and the cost of
acquisition of the shares to the assessee should have been
brought to tax as capital gains in view of s, 45 of the Income
Tax Act, 1961, exercised his revisions! jurisdiction, and
reopening the assessment he remanded the case to the Income Tax G
Officer directing him to revise the assessment after computing
the capital gains arising out of the transfer. The asses see
appealed to the Income Tax Appellate Tribunal, and the Appellate
Tribunal held that while the transaction did amount to a transfer
within the meaning of sub-s.(47) of s.2 of the Income Tax Act it
did not result in capital gains liable to tax. The Appellate
Triburial allowed the appeal and set aside the order of the Income H
110 SUPREME COURT REPORTS [1985] SUPP.3 S.C.R.

A
Tax Officer. Subsequently the Appellate Trl.bunal referrsd the
case to the High Court of Gujarat for its opinion on the
following questions of law:

1. Whether, on the facts and in the cirClDDStances of
B the case, the Income Tax Appellate Tribunal was right
in law in holding that no capital gains resulted from
the transfer of the shares held by the assessee to the
partnership firm as his capital contribution, the cost
of acquisition of the shares to the assessee being Rs.
1, 49, 819 and the market value of the shares being Rs.
1,60,279?
c
2. Whether, on the facts and in the Circumstances of
the case, the Tribunal was right in law in holding
that there was a transfer within the meaning of
sub-s.(47) of s.2 of the Income Tax Act, 1961 of the
shares contributed by the assessee as eapital to the
partnership firm in which he was a partner?

In Civil Appeal No. 1777 of 1981, the appellant was a
partner in a registered partnership firm, Messrs. Rsjka, oi which
the other partner was his wife. The partnership was constituted
under an agreement dated February 25, 1973. The partnership desd
recited that the partnership business had comnenced on January l,
E 1973, that it was a partnership at will and further provided that
the assessee would initially contribute Rs. 9,000 in cash to the
share capital of the firm and his wife would contribute Rs. 1,000
in cash. It was provided that when any addition to the capital
was required for the purposes of the partnership, the partners
would contribute such additional capital from time to time. It
F was further provided that if any asset was brought in by a
partner as capital contribution the account of such partner would
be credited with the fair market value on the date the asset was
brought in. The assessee had in his possession 80 ordinary shares
of the Ahmedabad Manufacturing and Calico Printing Company
Limited which had been purchased at Rs. 1,55,440. He had also 82
G ordinary shares of Karamchand Premchand Private Limited purchased
at Rs. 25,666. The total cost was Rs. 1,81,106'.

On March 22, 1973 the market value of a share of the
Ahmedabad Manufacturing and Calico Printing Company Limited was
Rs. 442 and that of a share of Karamchand Premchand Private
H Limited was Rs. 2,668. On that day, the assessee intoruduced the
s. SIDDHARTHBHAI v. c.r.T. [PATHAK, J.] 111

two shareholdings in the partnership firm as his capital A
contribution, and the firm credited his account with the market
value of the shares, namely Rs. 4,75,136.

In the assessment proceedings for the assessment· year
1973-74, the Income Tax Officer took the view that the
contribution by the assessee of the shares to the asset of the B
partnership firm constituted a transfer within the meaning of
sub-s.(47) of s. 2 of the Income Tax Act, 1961 and that the
assessee was liable to income tax on a capital gain of Rs.
2,94,030 being the difference between the market price at which
the shares were entered in the books of the partnership firm and
the cost of the shares to the assessee. The assessee appealed to c
the Appellate Assistant Commissioner of Income Tax, but the
appeal was dismissed. In second appeal, however, the.Income Tax
Appellate Tribunal took the view that there was no transfer of a
capital asset within the meaning of s.45 read with sub-s.(47) of
s.2 of the. Income Tax Act and consequently he deleted the item
from the assessment. In the circumstances, the Appellate Tribunal D
did not go into the question whether the transfer was without
consideration. The Commissioner of Income Tax obtained a
reference to the High Court of Gujarat on the following questions
of law:

1. Whether, on the facts and in the circumstances of E
the case, the Appellate Tribunal was right in law in.
holding that the contribution in the form of shares of
the value of Rs. 4, 75, 136 by the asse.ssee in the
partnership firm of Messrs. Rajka did not amount to a
transfer within the meaning of sub-s.(47) of s. 2 of
the Act resulting in capital gains chargeable to tax?
F
2. If the reply to· question No. 1 is in favour of the
Revenue, whether the Tribunal erred in not considering
whether the transfer is with or without consideration?

By a common judgment dated April 30/May 1 and 4, 1981 the High
Court answered the questions in favour of the Revenue and against G
the assessee.

Section 45 of the Income Tax Act, 1961 provides:-

"45. (1). Any profits or gains arising from the
transfer of a capital asset effected in the previous
year shall, save as otherwise provided in sections 53, H
112 SUPREME COURT REPORTS [1985) SUPP.3 S.C.R.

A
54 and 54B and 54D, be chargeable to income-tax under
the head "Capital· gains", and shall be deemed to be
the income of the previous year in which the transfer
took place".
B Section 48 of the Act provides:-

"48. The income chargeable under the head "Capital
gains" shall be computed by deducting from the full
value of the consideration received or accruing as a

c
result of the transfer of the capital asset the
fol1'>wing amounts, namely:- I
(i) expenditure incurred wholly and exclusively in
connection with such transfer;

(ii) the cost of the acquisition of the capital asset
and the cost of any improvement thereto."
D Learned counsel for the assessee contends that in order to
attract tax _under the head "Capital gains", s. 45 must be read
with s .48 and therefore three cumulative conditions llllSt be
fulfilled:-

l. There must be a "transfer of a capital asset,
E either under the general law or within the definition
in sub-s.(47) of s.2 of the Income Tax Act.

2. Consideration must be received or must accrue as a
result of the transfer, and the consideration llllSt be
capable of being determined in monetary terms in order
F that the computation of capital gains may be as
required by s. 48.

3. Profits or gains must arise from the transfer and
must be embedded in the consideration.
G It is urged that if any of the three conditiO!lS remains
unfulfilled no charge can be levied under the head "Capital
gains".

In support of the subuL.ssion that there is no "transfer" in
the general sense of that term when a partner brings his personal
H assets into-the firm as his contribution towards its capital,
s. SIDDHARTHBHAI v. C.I.T. [PATHAK) J.] 113

A
learned counsel points out that a partnership firm is not a
separate legal entity and that the assets owned by the
partnership are collectively owned by the partners. We have no
hesitation in accepting that proposition for in Malabar Fisheries
Co. v. Commissioner of Income-Tax; Kerala (1979) 120 I.T.R.
49 SC, this Court observed:- B

" •••..••••• It seems to us clear that a partnership firm
under the Indian Partnership Act, 1932, is not a
distinct legal entity apart from the partners
constituting it and equally in law the firm as such has
no separate right of its own in the partnership assets C
and when one talks of the firm's property or firm's
assets all that is ·meant is property or assets in which
all the partners have a joint or common interest."

Our attention has been invited to Commissioner of lncome-
Tax, West Bengal v. Hind Construction Ltd., (1972) 83 I.T.R. 211. D
In that case the assessee entered into a partnership and as its
share of the capital it transferred its stock of machinery to the
partnership firm. This Court held that when the assessee made
over its machinery to the partnership firm there was no sale and
the assessee did not derive any income. In Commissioner of
Income-Tax, Madras V• Janab N. Hyath Batcha Sahib, (1969) I.T.R. E
528, the Madras High Court held that when a partner introduces
his property into a partnership firm as his contribution to its
capital the transaction does not involve a sale of the property.
The High Court referred to s • 14 of the Indian Partnership act
and observed:-

"When a partnership is formed for the first time and F
one of the members of the partnership brings into the
firm assets, they become the property of the firm, not
by any transfer. but by the very intention of the
parties evinced in the agreement between them to treat
such property belonging to one or more of the members
of the partnership as that of the firm." G

The view that when a partner hands over a business asset to the
partnership firm as his contribution to its capital he cannot be
said to have effected a sale was also taken by the Allahabad High
Court in Dr· M.c. Kackkar v. Comnissioner of Income-Tax, Kanpur
and Others, (1973) 92 I.T.R. 87, the Kerala High Court in
Commissioner of Income-Tax, Kerala v. C.M. Kunhammed (1974) 94 H
r.r.R. 179 and by the Madras High Court in Commissioner of
Income-Tax, Madras-1 v. Abdul Khader Motor and Lorry Service,
114 SUPREME COURT REPORTS [1985] SL'PP.3 s.c.R.

A (1978) 112 I.T.R. 360. We find no difficulty in accepting that
proposition. But while the transaction may not amount to a sale,
can it be described as a transf" r of some other kind? Illustra-
tions of other kinds of transfer are provided by sub-s.(47) of
s.2 of the Income Tax Act which defines the expression "transfer"
in relation to a capital asset as including "the sale exchange or
B relinquishment of the asset or the extinguishment of any rights
therein or the compulsory acquisition thereof under any law." The
definition is inclusive merely, and does not exhaust other kinds
of transfer. Its inclusive character was overlooked by the Madras
High Court in Comnissioner of Income-Tax, Madras-I (supra) and in
Comnissioner of Income-Tax, Tamil Nadu-IV, Madras v. H. Rajan and
H. Kannan, (1984) 149 I.T.R. 545. In both cases the High Court
c confined itself to considering whether the transaction before it
was covered by any of the express terms used in the definition,
that is to say, sale, exchange relinquislunent or extinguishm.ent,
and taking the view that it did not fall under any of them it
held that there was no transfer.

In its general sense, the expression "transfer of
D property" connotes the passing of rights in the property from one
person to another. In one case there may be a passing of the
entire bundle of rights from the transferor to the transferee. In
another case, the transfer may consist of one of the estates only
out of all the estates comprising the totality of rights in the
property. In a third case, there may be a reduction of the
E exclusive interest in the totality of rights of the original
owner into a joint or shared interest with other persons. An
exclusive interest" in property is a larger interest than a share
in that property. To the extent to which the exclusive interest
is reduced to a shared interest it would seem that there is a
transfer of interest. Therefore when a partner brings in his
F
personal asset into the capital of the partnership firm as his
contribution to its capital he reduces his exclusive rights in
the asset to shared rights in it with the other partners of the
firm. While he does not lose his rights in the asset altogether
what he enjoys now is an abridged right which cannot be
identified with the fullness of the right which he enjoyed in the
G asset before it entered the partnership capital. In Addanki
Narayanappa & Anr. v. Bhaskara Krishtappa and 13 Ors. [ l 966] 3
S.C.R. 400., this Court explained:-

" •••••••• whatever may be the character of the property
which is brought in by the partners when the
H partnership is formed or which may be acquired in the
S. SIDDHARTKBHAI v. C.I.T. [PATHAK, J.J 115

course of the business of the partnership it becomes A
the property of the firm and what a partner is
entitled to is his share of profits, if any, accruing,
to the partnership from the realisation of this
property, and upon dissolution of the partnership to a
share in the money representing the value of the
property. No doubt, since a firm has no legal B
existence, the partnership property will vest in all
the partners and in that sense every partner has an
interest in the property of the partnership. During
the subsistence of the partnership, however, no
partner can deal with any portion of the property as
his own. Nor can he assign his interest in a specific C
item of the partnership property to anyone. His right
is to obtain such profits, if any, as fall to his
share from time to time and upon the dissolution of
the fl.rm to a share in the assets of the firm which
remain after satisfying the liabilities set out in
cl.(a) and sub-cls.(i),(ii) of cl.(b) of s. 48." D

The position was elaborated later in the same judgment as
follows:

"The whole concept of partnership is to emb1.rk upon a
joint venture and for that purpose to bring in as E
capital money or even property including immovable
property. Once that is done whatever is. brought in
would cease to be the exclusive property of the person
who brought it in. It would be the trading asset of the
partnership in which all the partners would have
interest in proportion to their share in the joint
venture of the business of partne~ship. The person who F
brought it in would, therefore, not be able to claim or
exercise any exclusive right over any property which he
has_ brought in, much less over any other partnership
property. He would not be able to exercise his right
even to the extent of his share in the business of the
partnership. As already stated, his right during the G
subsistence of the partnership is to get his share of
profits from time to time as may be agreed upon among
the partners and after the dissolution of the
partnership or with his retirement crom partnership of
the value of his share in the net partnership assets as
on the date of dissolution of retirement after a
deduction of liabilities and prior charges." H
116 SUPKEME COURT REPORTS (1985] SUPP.3 s.c.a.

It is apparent, therefore, that when a partner brings in his
A personal asset into a partnership firm as his contribution to its
capital, an asset which originally was subject to the entire
ownership of the partner becomes now subject to the rights of
other partners in it. It is not an interest which can be
evaluated imnediately, it is an interest which is subject to the
operation of future transactions of the partnership, and it may
B diminish in value depending on acclllllUlating liabilities and
losses with a fall in the prosperity of the partnership firm. The
ev~luation of a partner's interest takes place only when there is
a dissolution of the firm or upon his retirement from it. It has
some times been said, and we think erroneously, that the right of
a partner to a share in the assets of the partnership firm arises
upon dissolution of the firm or upon the partner retiring from
c the firm. We think it necessary to state that what is envisaged
here is merely the right to realise the interest and receive its
value. What is realised is the interest which the partner enjoys
in the assets during the subsistence of the partnership firm by
virtue of his status as a partner and in accordance with the
terms of the partnership agreement. It is because that interest
exists already before dissolution, as was held by this Court in
D
Malabar Fisheries Co. (supra), that the distribution of the
assets on dissolution does not amount to a transfer to the erst-
while partners. What the partner gets upon dissolution or upon
retirement is the realisation of a pre-existing right or
interest. It is nothing strange in the law that a right or
interest should exist in praesenti but its realisation or
E
exercise should be postponed. Therefore, what was the exclusive
interest of a partner in his personal asset is, upon its intro-
duction into the partnership firm as his share to the partnership
capital, tranaformed into a shared interest with the other
partners in that asset. Qua that asset, there is a shared
interest. During the subsistence of the partnership the value of
F the interest of.each partner qua that asset cannot be isolated or
carved out from the value of the partner's interest in the
totality of the partnership assets. And in regard to the latter,
the value will be represented by his share in the net assets on
the dissolution of the firm or upon the partner's retirement.

Learned counsel for the assessee has attempted to draw an
anology between the position arising when a personal asset is
brought by a partner into a partnership as his contribution to
the partnership capital and that which arises when on dissolution
of the 'firm or on retirement a share in the partnership assets
H
s. SIDDHARTHBHAI v. C.I.T. [PATHAK, J.J 117

A
passes to the erstwhile partner. It has been held by this Court
in Colllllissioner of Income-Tax, Madhya Pradesh, Nagpur and Bhandra
v. Dewas Cine Corporation, (1968) 68 I.T.R. 240, Colllllissioner of
Income-Tax, U.P. Vo Bankey Lal Vaidya, (1971) 79 I.T.R. 594 and
recently in Malabar Fisheries Co. (supra) as well as by the
Punjab and Haryana High Court in Kay Engineering Co. v. B
Commissioner of Income-Tax, Patiala, (1971) 82 I.T.R. 950 the
I<erala High Court in Comnissioner of Income-Tax, Kerala v •
Nataraj Motor Service (1972) 86 I.T.R. 109,and the ·Gujarat High
Court in Comnissioner of Income-Tax Gujarat v. Mohanbhai Pamabhai
(1973) 91 I.T.R. 393 that when a partner retires or the
partnership is dissolved what the partner receives is his share c
in the partnership. What is contemplated here is a share of the
partner qua the net assets of the partnership firm. On
evaluation, that share in a particular case may be realised by
the receipt of only one of all the assets. What happens here is
that a shared interest ~n all the assets of the firm is replaced
by an exclusive interest. in an asset of equal value. That is why D
it has been held that there is no transfer. It is the realisation
of a pre-existing right. ·The position is ·different, it seems to
us, when a partner brings his personal asset into the partnership
firm as his contribution to its capital. An individual asset is
the sole subject of consideration. An exclusive interest in it
before it enters the partnership is reduced on such entry into a E
shared interest.

Our attention has also been invited to clause (b) of
sub-s.(1) of s. 17 of the Registration .Act which requires the
registration of non-testamentary instruments which purport or
operate "to create declare assign limit or extinguish whether in
present or in future, any right, title or interest whether vested F
or contingent, of the value of one hundred rupees and upwards, to
or in irnmOvable property," and to the view taken by the courts in
this country that when a person brings in even his iamovable
property as his contribution to the capital of the firm no
written document or registration ts required under that clause.
That view was expressed in Firm Rem Sahay Mall Rameshwar Dayal G
and Others v. Bishwanath Prasad, A.I.R. 1963 Patna 221. The
learned Judges relied on the English law that the personal assets
introduced by a partner into the firm as his contribution to its
capital becomes th_e property of the firm by reason of the
intention and agreement of the parties. The vi"ew does not spring
from the consideration that there is no transfer. The view is
that no document of transfer is required and that, therefore, H
registration is unnecessary. The Patna High Court reiterated that
view in SudhaDBu Kanta v. Manindra Nath, A.I.R. 1965 Patna 144.
118 SUPREME COURT REPORTS [1985] SUPP.3 s.c.R.

A Accordingly we hold that when the assessee brought the
shares of the limited companies into the partnership firm as his
contribution to its capital there was a transfer of a capital
asset within the terms of s.45 of the Income Tax Act. In this
view of the matter we agree with the conclusion reached by the
Kerala High Court in A•. Abdul Rahim, Travancore Confectionery
B Works v. Colllllissioner of Income-Tax, Kerala, (1977) 110 I.T.R.
595 the Karnataka High Court in Addl. Colllllissioner of Income-Tax,
Mysore v. M.A.J. Vasansik, (1979) 116 I.T.R. 110 and by the
Gujarat High Court in the judgment under appeal.

The second question is whether the assessee can be said to
have received any consideration as that expression is understood
c in the scheme of capital gains under the Income-Tax Act. In
Commissioner of Income-Tax, Bangalore v. B.C. Srinivasa Setty,
(1981) 128 I.T.R. 294, this Court observed that the charging
section and the computation provisions under each head of income
constitute an integrated code, and when there is a case to which
.the computation provisions cannot apply at all it is evident that
such a case was not intended to fall within the charging section.
u On the basis of that proposition learned counsel for the assessee
has urged that s.45 is not attracted in the present case because
to compute the profits or gains under s.48 the value of the
consideration received by the assessee or accruing to him as a
result of the transfer of the capital asset must be capable of
ascertpimnent in monetary terms. The consideration for the
E transfer of the personal assets is the right which arises or
accrues 'to the partner during the subsistence of the partnership
to get his share of the profits from time to time and, after the
dissolution of the partnership or with his retirement from the
partnership, to get the value of a share in the net partnership
assets as on the date of the dissolution or retirement after a
F deduction of liabilities and prior charges. The credit entry made
in the partner's capital account in the books of the partnership
firm does not represent the true value of the consideration. It
is notinal value only, intended to be taken into account at the
time of determining the value of the partner's share in the net
partnership assets on the date of dissolution or on his retire-
G ment, a share which will depend upon a deduction of the liabili-
ties and prior charges existing on the date of dissolution or
retirement. It is not possible to predicate before hand what will
be the position in terms of monetary value of a partner's share
on that date. At the time when the partner transfers his personal
asset to the partnership firm, there can be no reckoning of the
H liabilities and losses which the firm may suffer in the years to
S. SIDDHARTHBllAI v. C.I.T. [PATHAK, .J.] 119

come. All that lies within the womb of the future. "It is impossi- A
ble to conceive of evaluating the consideration acquired by the
partner when he brings his personal asset into the partnership
fim when neither the date of dissolution or retirement can be
envisaged nor can there be any ascertainment of liabilities and
prior ~barges which may not have even arisen yet. In the circum-
stances, we are unable to hold that the consideration which a B
partner acquires on making over his personal asset to the
partnership fim as his contribution to its capital can fall
within the· terms of s.48. And as that provision is fundamental to
the computation machinery incorporated in the scheme relating to
the determination of the charge provided in s.45, such a case
must be regarded as falling outside the scope of capital gains C
taxation altogether·.

The third contention of learned counsel for the assessee is
that no profit or gain can be said to arise to a partner when he
brings his personal asset into a partnership fim as his contri-
bution to its capital. It is urged that the capital gains D
chargeable under s .45 are real capital gains computed on the
ordinary principles of commercial accvunting and that the capital
gains must be embedded in the capital asset. In Miss Dhun
Dadabhoy Kapadia v. Commissioner of Income-Tax, Bombay, (1967) 63
I.T.R. 651, the appellant held by way of investment some ordinary
shares in a limited company. An offer was made by the company to E
her by which she was entitled to apply for an equal number of new
ordinary shares at a premium with an option of either taking the
shares or reno_uncing them in favour of others. The appellant
renounced her rights to all the shares and realised Rs.
45, 262. 50. When ·this amount was sought to be wholly taxed as a
capital gain the appellant claimed that on the issue of the new
shares the value of her old shares depreciated and that as a F
result of the depreciation she suffered a capital loss in the old
shares which she was entitled to set off against the capital gain
of Rs. 45,262.50. In the alternative she claimed that the right
to receive the new shares was a right which was embedded in her
old shares and consequently when she ·realised the sum of Rs.
45,262.50 by selling her right, the capital gain should be G
computed after deducting from that amount the value of the
embedded right which became liquidated. This Court upheld the
claim of the appellant that she was entitled to deduct from the
sum of Rs. 45,262.50 the loss suffered by way of depreciation in
the old shares. The Court proceeded on the basis that in working
out capital gain or loss, the principles which had to be applied
are those which are a part of connnercial practice or which an H
120 SUPREME COURT REPORTS [1985] SUPP.3 s.c.R.

A ordinary man of business would resort to when making computation
for his business purposes. It will be noticed that this principle
was applied by the Court in a case where a capital gain was
sought to be taxed under the Income Tax Act. That profits or
gains under the Income Tax Act must be understood in the sense of
real profits or gains, that is to say, on the basis of ordinary
ll commercial principles on which actual profits are computed, a
sense in which no corrmercial man would misunderstand, has been
regarded as a principle of general application, and there is a
catena of cases of this Court which affirms that principle.
Keference may be made to Calcutta Co. Ltd. v. Comnissioner of
Income-Tax, West Bengal, (1959) 37 I.T.R. l, Comnissioner of
Income-Tax v.Bai Shirinbai K. Kooka, (1962) 46 I.T.R. 86, Poona
c Electric Supply Co· Ltd. v. Comnissioner of Income-Tax, Bombay
City l, (1%5) 57 I.T.R. 521, Commissioner of Income-Tax, West
Bengal ll v. Birla Gwalior (P) Ltd• (1973) 89 I.T.R. 266 and
Bafna Textiles V• Income-Tax officer, Assessment-4,Circle ll,
Bangalore, (1975) 98 I.T.R. 209.

What is the profit or gain which can be said to accrue or
D arise to the assessee when he makes over his personal asset to
the partnership firm as his contribution to its capital? The
consideration, as we have observed, is the right of a partner
during the subsistence of the partnership to get his share of
prof its from time to time and after the dissolution of the
partnership or with his retirement from the partnership to
g receive the value of the share in the net partnership assets as
on the date of dissolution or retirement after a deduction of
liabilities and prior charges. When his personal asset merges
into the capital of the partnership firm a corresponding credit
entry is made in the partner's capital account in the books of
the partnersh.ip firm, but that entry is made merely for the
F purpose of adjusting the rights of the partners inter-se when the
partnership is dissolved or the partner retires. It evidences no
debt due by the firm to the partner. Indeed, the capital
represented by the notional entry to the credit of the partner's
account may be completely wiped out by losses which may be subse-
quently incurred by the firm, even in the very accounting year in
u which the capital account is credited. Having regard to the
nature and quality of the consideration which the partner may be
sa. i.a to acquire on introducing his personal asset into the
partnership firm as his contribution to its capital it cannot be
said that any income or gain arises or accrues to the assessee tn
the true commerci;.il sense which a business man would underst'ind
H as real income or 5ain.
S. SIDDHARTHBllAI v. C.I.T. [PATHAK, J.] 121

· An objection has been taken by learned counsel for the
A
respondent to this submission being raised before us because, it
is said, the question has neither been referred to his Court nor
was it ever argued at any earlier stage. We are not impressed by
the objection because we think that it constitutes one aspect of
the questions which have been referred in these cases. The point
rests on considerations purely of law and is fundamental to the B
question whether capital gain arises to an assessee upon the
transfer of his shares to the partnership firm as his capital
contribution. The objection is, therefore, over-ruled.

Inasmuch as we are of opinion that the consideration
received by the asses see on the transfer of his shares to the
partnership firm dies not fall within the contemplation of s.48
c
of the Income-Tax Act, and further that no profit or gain can be
said to arise for the purposes of the Income-Tax Act, we hold
that these cases fall outside the scope of s. 45 of the Act
altogether.
D
We have decided these appeals on the asswnption that the
partnership firm in question is a genuine firm and not the result
of a sham or unreal transaction, and that the transfer by the
partner of his personal asset to the partnership finn represents
a genuine intention to contribute to the share capital of the
firm for the purpose of carrying on the partnership business.
E
If the transfer of the personal asset by the assessee to a
partnership in which he is or becomes a partner is merely a
device or ruse for converting the asset into money which would
substantially remain available for his benefit without liability
to income tax on a capital gain, it will be open to the income
tax authorities to go behind the transaction and examine whether
the transaction of creating the partnership is a genuine or a
F
sham transaction and, even where the partnership iS genuine the
transaction of transferring the personal asset to the partnership
firm represents a real attempt to contribute to the share capital
of the partnership firm for the purpose of carrying on the
partnership business or is nothing .but a device or ruse to
convert the personal asset into money substantially for the
G
benefit of the assessee while evading tax·on a capital gain. The
income Tax Officer will be entitled to consider all the relevant
indicia in this regard,, whether the partnership is formed between
the assessee and his wife and children or substantially limited
to them, whether the personal asset is sold by the partnership
firm soon after it is transferred by the assessee to it, whether
the partnershtp firm has no substantial or real business or the
H
122 SUPREME COURT REPORTS [1985] SUPP.3 s.c.R.

A
record shows that there was no real need of the partnership firm
for such capital contribution from the assessee. All these and
other pertinent considerations may be taken into regard when the
Income Tax Officer enters upon a scrutiny of the transaction, for
in the task of determining whether a transaction is a sham or
illusory transaction or a device or ruse he is entitled to
penetrate the veil covering it and ascertain the truth.
B
In the result, the questions whicn arise in these appeals,
are answered as follows:-

1. There ,was a transfer of the shares when the
assessee made them over to the partnership firm as his
capital contribution.
c
2. When the assessee transferred his shares to the
partnership firm he received no consideration within
the meaning of s.48 of the Income-Tax Act 1961 nor did
any profit or gain accrue to him for the purpose of
s.45 of the Income-Tax Act, 1961.
D
These answers are given by us subject to the reservations made by
us in the preceding paragraph.

The appeals are partly allowed and there is no order as to
costs.
E

S.R. Appeals partly allowed.