2002 (3) TMI 603 - AT - Income Tax

Summary

Issues Involved:
1. Applicability of Section 45(4) of the Income Tax Act on the dissolution of the firm.
2. Deletion of addition made by the Assessing Officer on account of capital gains arising from capital assets distributed at the time of dissolution.
3. Deletion of addition made by the Assessing Officer on account of valuation of closing stock at the time of dissolution of the firm.

Issue-Wise Detailed Analysis:

1. Applicability of Section 45(4) of the Income Tax Act:
The core issue was whether the provisions of Section 45(4) were applicable to the case of the assessee firm. The CIT(A) held that the provisions of Section 45(4) were not applicable as there was no distribution of assets upon the dissolution of the firm. The CIT(A) noted that the retiring partners were only allowed to take the credit balance in their capital accounts and no other assets were distributed. The Tribunal confirmed this view, emphasizing that for Section 45(4) to apply, there must be a transfer of capital assets by way of distribution on the dissolution of the firm. The Tribunal cited the Supreme Court's decision in CIT v. Bankey Vaidya Lal, which held that the distribution of assets on dissolution does not result in any extinguishment of rights and thus does not constitute a transfer.

2. Deletion of Addition on Account of Capital Gains:
The Assessing Officer had made additions on account of capital gains arising from the distribution of capital assets at the time of dissolution. The CIT(A) deleted these additions, concluding that there was no distribution of capital assets. The Tribunal upheld this deletion, referencing the case of G. Seshagiri Rao, where it was held that when a retiring partner receives the amount standing to their capital account, it does not constitute a transfer of a capital asset for the purposes of Section 45. The Tribunal further noted that the definition of 'transfer' under Section 2(47) had not been amended to include the distribution of assets on dissolution, reinforcing that no capital gains tax was applicable.

3. Deletion of Addition on Account of Valuation of Closing Stock:
The Assessing Officer had also made additions based on the valuation of closing stock at market value at the time of dissolution. The CIT(A) deleted these additions, asserting that the firm was not dissolved but merely reconstituted, and thus the provisions of Section 45(4) did not apply. The Tribunal agreed with this assessment, confirming that no distribution of assets occurred and the business continued with the remaining partners, negating the need for such additions.

Conclusion:
The Tribunal upheld the CIT(A)'s decision, confirming that the provisions of Section 45(4) were not applicable as there was no transfer of capital assets by way of distribution upon the dissolution of the firm. Consequently, the additions made by the Assessing Officer on account of capital gains and valuation of closing stock were rightly deleted. The appeal of the revenue was dismissed, and the cross-objection filed by the assessee was allowed for statistical purposes.