1988 (8) TMI 120 - AT - Income Tax

Summary

Issues Involved:
1. Addition of Rs. 10 lacs under section 28(iv) of the I.T. Act, 1961.
2. Disallowance of rent under section 40A(2) of the I.T. Act, 1961.

Issue-Wise Detailed Analysis:

1. Addition of Rs. 10 lacs under section 28(iv) of the I.T. Act, 1961

Facts and Background:
The appellant is a firm of advocates with six partners. On the last day of the previous year, three partners retired, and the remaining three continued the business. The firm's assets were revalued, and the appreciated value of Rs. 10 lacs was distributed among the partners. The ITO issued a show-cause notice proposing to tax this sum under section 28(iv), arguing that the revaluation was a colorable device to avoid tax, citing the Supreme Court's decisions in McDowell & Co. and Associated Rubber Industry Ltd.

Arguments and Findings:
- The assessee argued that the revaluation did not result in taxable income, relying on the Gujarat High Court decision in Jayantilal Laxmichand.
- The ITO opined that there was no dissolution but merely a change in the constitution of the firm.
- The ITO and CIT(A) both held that the revaluation was a colorable device to distribute the firm's unadjusted income to the partners, thus taxable under section 28(iv).

Tribunal's Analysis:
- The Tribunal noted that revaluation of assets does not give rise to taxable income under section 28(iv). The benefit, if any, accrued to the partners, not the firm.
- The Tribunal found the CIT(A)'s reasoning far-fetched, emphasizing that the revaluation of assets is a standard practice during changes in partnership.
- The Tribunal rejected the application of the McDowell & Co. case, as there was no device to evade tax by the firm.
- The Tribunal concluded that the addition of Rs. 10 lacs was not taxable and directed its deletion.

2. Disallowance of rent under section 40A(2) of the I.T. Act, 1961

Facts and Background:
The ITO disallowed Rs. 12,500 out of Rs. 17,500 rent paid to M/s. Gandhi Chambers, owned by relatives of the partners, considering it excessive and unreasonable. The CIT(A) confirmed this disallowance.

Arguments and Findings:
- The assessee argued that the rent was reasonable and comparable to prevailing market rates for commercial properties in Baroda.
- The ITO's disallowance was based on the relationship between the partners and the property owners, the purchase price of the flat, and the absence of interest on loans given to the owners.

Tribunal's Analysis:
- The Tribunal found that the ITO's disallowance was based on surmises and conjectures without any supporting evidence.
- The Tribunal noted that the ITO did not make any inquiries about the market rates for commercial properties in the area.
- The Tribunal concluded that the disallowance under section 40A(2) was not justified and directed its deletion.

Conclusion:
The Tribunal allowed the appeal, deleting both the addition of Rs. 10 lacs under section 28(iv) and the disallowance of rent under section 40A(2).