1988 (8) TMI 121 - AT - Income Tax

Summary

Issues Involved:
1. Addition of Rs. 10 lakhs under Section 28(iv) of the IT Act, 1961.
2. Disallowance of rent under Section 40A(2) of the IT Act, 1961.

Issue-wise Detailed Analysis:

1. Addition of Rs. 10 lakhs under Section 28(iv) of the IT Act, 1961:

Facts and Arguments:
- The appellant, a firm of advocates, had six partners. On the dissolution date (4th November 1983), three partners retired, and the remaining three continued the business.
- Assets were revalued, resulting in an appreciation of Rs. 10 lakhs, which was distributed among the partners.
- The ITO issued a show-cause notice to tax the Rs. 10 lakhs arising from the revaluation of assets, contending that it was taxable under Section 28(iv) as it provided a benefit arising from business transactions.
- The ITO and CIT(A) both opined that the firm did not dissolve but underwent a change in constitution, interpreting the dissolution deed accordingly.
- The CIT(A) upheld the ITO's view, stating that the revaluation was unjustified and fictitious, and deemed it a colourable device to avoid tax, referencing the Supreme Court's decisions in McDowell & Co. and Workmen of Associated Rubber Industry Ltd.

Tribunal's Analysis:
- The Tribunal noted that revaluation of assets does not give rise to taxable income for the firm under Section 28(iv). The benefit, if any, accrued to the partners, not the firm.
- The Tribunal highlighted that the firm ended up with an enhanced value of assets but also a corresponding liability to pay Rs. 10 lakhs to the partners, resulting in no net benefit.
- It was observed that revaluation of assets is a standard practice during changes in partnership, whether due to dissolution or otherwise, to settle accounts based on market value.
- The Tribunal rejected the CIT(A)'s view that the revaluation was a device to distribute unadjusted income, emphasizing that the firm's accounting method (cash basis) was consistent and accepted.
- The Tribunal concluded that the Supreme Court's decision in McDowell & Co. was not applicable as there was no device to evade tax by the firm.

Conclusion:
- The addition of Rs. 10 lakhs was deleted as it was not taxable under Section 28(iv).

2. Disallowance of rent under Section 40A(2) of the IT Act, 1961:

Facts and Arguments:
- The ITO disallowed Rs. 12,500 out of the Rs. 17,500 rent paid to M/s Gandhi Chambers, citing that the rent was excessive and unreasonable given the flat's purchase price and area.
- The CIT(A) confirmed the ITO's disallowance without independent reasoning.
- The assessee argued that the rent was reasonable compared to prevailing rates for office premises in Baroda and that the disallowance was made without supporting evidence.

Tribunal's Analysis:
- The Tribunal noted that the ITO was influenced by the relationship between the flat owners and the partners and the debit balance in the firm's books.
- The Tribunal found that the ITO did not provide evidence of comparable property rents to substantiate the claim that the rent was excessive.
- The Tribunal emphasized that the ITO's disallowance was based on surmises and conjectures without any contrary evidence.

Conclusion:
- The disallowance of rent under Section 40A(2) was deleted as the ITO failed to provide a factual basis for the addition.

Final Judgment:
- The appeal was allowed, deleting both the addition of Rs. 10 lakhs under Section 28(iv) and the disallowance of rent under Section 40A(2).