2012 (6) TMI 658 - HC - Income Tax

Evaluation of closing stock - at Cost price or market price - conversion of partnership firm into a private limited company - Held that - Considering the case of Commissioner Of Income-Tax Versus S. Koder 1996 (9) TMI 21 (HC) the assets and liabilities of the erstwhile firm were taken over by the company with the same persons as shareholders, therefore, it was a case of succession of business in its entirety by another entity the question whether the assessee-firm, upon the transfer of its business to a limited company, was obliged to value the stocks as per the market value was answered in the negative. The assets of the erstwhile firm vested in the company and as such there was no transfer of assets by way of distribution - provisions of section 45(1) and 45(4) of the Act were not attracted even though there was a transfer of assets from the firm to a newly constituted com- pany on conversion of the firm to a company under Chapter IX of the Companies Act. The shareholding of the erstwhile partnership firm remained the same upon conversion of the firm into a company as there was no transfer of assets of the firm to the company it is only that the business was taken over by the company, thus the closing stock of the erstwhile firm cannot be valued at the market price - in favour of assessee.

Summary

Issues:
Evaluation of closing stock of a partnership firm after its conversion into a private limited company.

Analysis:
The case involved a partnership firm converting into a private limited company under Chapter IX of the Companies Act, 1956. The key issue was the valuation of the closing stock of the partnership firm after its assets were taken over by the company. The Assessing Officer initially valued the closing stock at market value, leading to a dispute that proceeded to the Commissioner of Income-tax (Appeals) and eventually to the Income-tax Appellate Tribunal. The Tribunal ruled in favor of the assessee, emphasizing that there was no transfer of assets, and hence, the provisions of section 170 of the Income-tax Act, 1961 were not applicable. The Tribunal's decision was based on the interpretation of the succession to business under section 170(1) of the Act, which deals with the assessment of income before and after a business succession.

The judgment referred to legal precedents to support the Tribunal's decision. It cited the Supreme Court's interpretation of the Indian Income-tax Act, 1922, emphasizing the importance of change of ownership, integrity, identity, and continuity of a business in cases of succession. The Kerala High Court and the Bombay High Court decisions were also referenced, highlighting the criteria for determining capital gains under section 45 of the Act. The Bombay High Court particularly discussed the distinction between the vesting and distribution of assets when a partnership firm converts into a company, emphasizing that no transfer of assets occurred in such cases.

Furthermore, the judgment mentioned a Punjab and Haryana High Court decision that aligned with the Bombay High Court's interpretation, emphasizing that the conversion of a firm into a company does not result in a conveyance of property but rather a vesting of property in the company. In the present case, the conversion of the partnership firm into a private limited company did not involve a transfer of assets, as the shareholding remained the same. Therefore, the Tribunal's decision to value the closing stock of the erstwhile firm at cost price rather than market value was upheld by the High Court of Andhra Pradesh.

In conclusion, the High Court ruled in favor of the assessee, affirming the Tribunal's decision that the closing stock of the partnership firm should be evaluated at cost price following its conversion into a private limited company. The substantial question of law was answered in favor of the assessee, emphasizing the absence of a transfer of assets and the continuity of business ownership despite the change in the firm's legal structure.