1989 (8) TMI 136 - AT - Income Tax

Summary

Issues Involved:
1. Valuation of closing stock at market value on dissolution of a firm.
2. Applicability of section 263 of the Income-tax Act, 1961.
3. Continuation of business by successor firm and its impact on stock valuation.
4. Distinction between discontinuance of business and succession of business.

Issue-wise Detailed Analysis:

1. Valuation of Closing Stock at Market Value on Dissolution of a Firm:
The Commissioner of Income-tax noticed that the assessee-firm had been dissolved on 6-2-1984 due to the death of a partner and the firm was reconstituted the next day with the remaining partners. The Commissioner held that the stock-in-trade as on 6-2-1984 should be valued at market rate, following the decision of the Madras High Court in A.L.A. Firm v. CIT [1976] 102 ITR 622. The assessee argued that the business was not discontinued but succeeded by another firm, hence the closing stock was not required to be revalued. The Tribunal agreed with the assessee, stating that the value of the closing stock as shown in the books of the dissolved firm would be taken as the value of the opening stock in the hands of the successor firm, thus there was no necessity for revaluing the closing stock.

2. Applicability of Section 263 of the Income-tax Act, 1961:
The Commissioner invoked section 263, considering the failure to take the market value of the closing stock as an error prejudicial to the Revenue. The Tribunal held that the order of the Income-tax Officer accepting the profit shown by the assessee based on the method of accounting regularly followed was not erroneous and did not require revision under section 263. The Tribunal emphasized that since the business was continued by the successor firm, the closing stock valuation principle of cost or market value, whichever is less, should be maintained.

3. Continuation of Business by Successor Firm and its Impact on Stock Valuation:
The Tribunal pointed out that the business was continued by the successor firm and assessments were made separately on the dissolved firm and the successor firm under section 188. The Act recognizes that succession of business by one firm on the dissolution of another is not a case of business discontinuance. The Tribunal noted that the Supreme Court in Chainrup Sampatram v. CIT [1953] 24 ITR 481 explained that the valuation of closing stock at market rate is to balance the cost of goods and not to bring any appreciation in value into charge. The Tribunal concluded that since the business was not discontinued, revaluing the stock at market value was unnecessary.

4. Distinction Between Discontinuance of Business and Succession of Business:
The Tribunal highlighted that discontinuance of business involves complete cessation, whereas succession involves continuation by another entity. In the present case, the business was not discontinued, hence the question of revaluing the stock did not arise. The Tribunal differentiated this case from others where business discontinuance warranted revaluation. The Tribunal cited Malabar Fisheries Co. v. CIT [1979] 120 ITR 49, where the Supreme Court held that no transfer of assets occurs even upon dissolution, and the agreed value of stock cannot be substituted by market value.

Conclusion:
The Tribunal concluded that the valuation of the closing stock of a continuing business on the principle of cost or market value, whichever is less, cannot be substituted with the market value solely because the firm is dissolved and the business is taken over by another firm. The Tribunal allowed the appeal, canceling the order of the Commissioner of Income-tax.