2014 (7) TMI 998 - HC - Income Tax

Existence of partnership firm - Nature of the firm and legal consequences flowing from it - Intention to carry on business - Whether the firm was only a nominal entity - Held that - The firm is brought into existence through a registered document and separate returns are field on behalf of the firm, posting profits and furnishing other ingredients of a typical return, one cannot expect the ITO to ignore the existence of the firm - as a result of dissolution of the firm, redistribution of the properties took place in a manner, different from the one, in which they were held before the constitution of the firm - the existence of firm is acknowledged, thus, the applicant cannot plead to the contrary Decided against Assessee. Nature of property - Whether the immovable properties are capital asset or stock in trade of partnership Held that - The manner, in which the value of an asset, which forms part of stock in trade of a firm must be arrived at as explained in ALA Firm Versus Commissioner of Income-Tax 1991 (2) TMI 1 - SUPREME Court the principle is that the value can be determined on the basis of cost or market value and the assessee will have option to choose between lesser of them, provided the business or trade is being continued; in case the firm is dissolved or the business activity is discontinued, the market value alone becomes relevant - whatever may have been the liberty of an assessee to choose between the cost and market value of an asset, whichever is beneficial to him; that liberty stands taken away when the firm is dissolved, or the business activity is discontinued - For the purpose of determining the value of property, which is allotted to the respective partners on dissolution, it is only the market value that becomes relevant; and that exactly was taken into account Decided against Assessee.

Summary

Issues:
1. Intention of the parties in forming a partnership for business.
2. Existence and nature of the firm for carrying on business.
3. Classification of immovable properties as capital assets or stock in trade.

Analysis:
Issue 1: The primary issue was whether the partnership formed by the parties was genuinely intended to carry on business or if it served an extraneous purpose. The court considered the dissolution of the firm within a year and the lack of significant business activities as factors indicating a nominal entity. However, the court noted that the firm was constituted through a registered document with profits posted in the profit and loss account, which indicated a genuine partnership for legal purposes.

Issue 2: The court deliberated on whether the firm's existence, both in form and substance, was valid regardless of its specific business objectives. The applicant argued that the firm was merely a device to readjust property shares within the family and should not be considered a legitimate business entity. Conversely, the respondent contended that once a firm is established through a registered document with profits recorded, it cannot be disregarded as a nominal entity. The court ultimately ruled against the applicant on this issue.

Issue 3: The controversy revolved around the classification of immovable properties as either capital assets or stock in trade of the partnership. The Income Tax Officer (ITO) determined the value of a property based on annual lease value, leading to tax implications. The court analyzed the partnership deed, which specified the property as a capital contribution, indicating the intent to conduct real estate business. The court agreed with the Tribunal's observation that the property could be considered stock in trade for real estate business purposes.

Additional Considerations: The court highlighted the significance of market value determination for assets when a firm is dissolved or business activities cease. It referenced legal precedents emphasizing the relevance of market value over cost in such scenarios. The court also addressed the issue of interest levied under Section 217 of the Income Tax Act, leaving the possibility of waiver open if the applicant files a relevant application.

In conclusion, the court ruled against the applicant on all three issues, affirming the legitimacy of the partnership for business purposes and the classification of immovable properties as stock in trade. The judgment emphasized the legal principles governing the valuation of assets in the context of firm dissolution and the importance of market value considerations in such scenarios.