Transfer of capital from proprietorship to partnership was not reconstruction u/s 10AA – High Court

Transfer of capital from proprietorship to partnership was not reconstruction u/s 10AA, dis entitling the assessee firm the benefit of exemption-High Court 

 Transfer of capital

ABCAUS Case Law Citation:
ABCAUS 2136 (2017) (11) HC

The Revenue has filed two appeals assailing the judgment and order of the Tribunal whereby tribunal had dismissed the appeal of the department and confirmed the order of the CIT(A).

Section 10AA of the Income Tax Act, 1961 (the Act) provides for exemptions to newly established units in Special Economic Zones (SEZs) in respect of income from exports.

The respondent assessee was a partnership firm with two partners having partnership ratio of 80 & 20% respectively. The assessee firm started its business from A.Y. 2007- 08 and was claiming 100% deduction u/s 10AA of the Act being a SEZ unit.

One of the partners with 80% stake in the firm also had a proprietorship concern which was also having business of same nature which was closed down in the subsequent year.

The Assessing Officer noted that out of the capital received by the partnership firm during the AY 2007-08, 73% thereof had been received from the said proprietorship concern of one of the partner. From the perusal of last year’s capital account it was noted that there had been a direct intake of capital from proprietorship firm to the partnership firm.

Thus the AO concluded that the new unit namely the partnership firm had not been formed out of new funds, but it merely reflected shift of money from the original business to the new one. Accordingly he disallowed the deduction claimed u/s 10AA holding that the assessee did not fulfill the conditions of Section 10AA(4)(ii) of the Act namely that the undertaking should not be formed by the reconstruction of business already in existence.

However CIT(A) allowed the appeal of the assessee and deleted the addition. The order of the CIT(A) was confirmed by the ITAT.

The Hon’ble High Court observed that the issue was squarely covered by the decision of the court in case of same assessee.

The major observation of the said decisions were as under:

(i) So long as the assets appearing in the balance sheet of old concern are not shofted to new unit but lying as it is, it cannot be a case of reconstruction of business. The purchasing or selling may be common but it cannot amount to reconstruction of old business.

(ii) As held by the Hon’ble Supreme Court, reconstruction of business involves substantially the same person carrying on substantially the same business but at the same time has also held that where the new industrial undertaking is separate and independent production unit and the undertakings can be carried out separately without complete absorption of identity of the old business they are not to be treated as business formed by reconstruction of the old business.

(iii) As observed by the Hon’ble Supreme Court by establishing new undertakings if the assessee expands his existing business then also the assessee cannot be deprived of the benefit. That every new creation in business is some kind of expansion and advancement but as long as a new and identifiable undertaking separate and distinct from the existing business is set up, it cannot be tantamount to reconstruction.

(iv) The very purpose of bringing the provisions of section 10AA and a-like provision is to encourage new units with new plant and machinery to be set up for manufacturing or production of articles to be exported. The beneficial provisions brought in statute book to encourage the export and to encourage setting up new business units should be interpreted liberally.

(v) The Hon’ble Bombay High court has held that reconstruction of business or industrial undertaking must necessarily involve the concept that the original business or undertaking do not cease functioning and its identity is not to be lost or abandoned. The underlying idea of a reconstruction is of a “business already in existence” – there must be a continuation of the activities and business of the same industrial undertaking. The undertaking must continue to do same business though in some altered or varied form. In the instant case the earlier industrial undertaking was owned by Smt. Kamlesh Dangayach while the present undertaking is owned by the firm. The firm is separate entity under the income tax Act and the earlier industrial undertaking of the assessee must cease to the function. The deduction u/s 10 AA is undertaking specific.

(vi) The Hon’ble Allahabad High Court observed that every new creation in business is some kind of expansion and advancement. If the undertaking is new and identitiable undertaking, separate and distinct, foom the existing business then it will not be reconstruction of business already in existence.

(vii) The Hon’ble Delhi High Court held that the fact that the new Unit manufactured some of the items which were manufactured by the old unit will not make it an integral part of old unit, Even if new undertaking manufactures a product which is feeded to the old business even then it will not amount reconstruction of the old business. Establishment of the new unit with new separate plant and machinery by investing substantial funds is essential. If the new unit has not derived any thing foom the old unit by way of equipment or by way of factory building and no assets of the old unit have been transferred to the new unit, the new unit had not been formed by reconstruction.

(viii) Even if for the argument sake, it is considered that substantial persons have started the unit even then it can not be considered as reconstruction of the existing business. There is substantial investment in new plant and machinery…. Hence the unit even if relate to person having substantial interest in old unit, even then the new unit can not be considered a reconstruction of old business as new unit if independent is not to be considered as reconstruction of business.

In view of the above observations, the Hon’ble High Court dismissed the appeal.

Transfer of capital

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