2020 (6) TMI 325 - HC - Income Tax

Reopening of assessment u/s 147 - stock-in-trade had to be valued at the present market value - HELD THAT - The true purpose of crediting the value of unsold stock is to balance the cost of those goods entered on the other side of the account so that the cancelling out of the entries relating to the same stock from both sides of the account would leave only the transactions on which there had been actual sales in the course of the year showing the profit or loss actually realised on the year s trading. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock has to be valued at cost or market price whichever is lower and it is now generally accepted as an established rule of commercial practice and accountancy. Taking the view that profits for income tax purposes are to be computed in conformity with the ordinary principles of commercial accounting unless such principles have been superseded or modified by legislative enactments, it would be a misconception to think that any profit arises out of valuation of the closing stock. Computation of capital gains - stand of the assessee is that it had rightly deducted the cost incurred in acquiring the property from the fair market value of the land converted into stock-in-trade - HELD THAT - For computing the income under the head capital gains , the full value of consideration received as a result of transfer of the capital asset shall be deducted by the expenditure incurred in connection with such transfer, cost of acquisition of the asset and the cost incurred in improvement of the asset. The expression the full value of the consideration would mean the fair market value of the asset on the date of such conversion. The meaning of the expressions cost of improvement and cost of acquisition are explained in Sections 55(1) and 55(2) of the Act respectively. In the case of Miss Piroja C. Patel 1999 (3) TMI 38 - BOMBAY HIGH COURT the question before this Court was whether the Tribunal was justified in holding that the amount in question being compensation paid by the assessee to the hutment dwellers for vacating the land was an allowable expenditure within the meaning of Section 48 read with Section 55 of the Act. This Court held that on eviction of the hutment dwellers from the land in question, the value of the land increases and therefore, the expenditure incurred for having the land vacated would certainly amount to cost of improvement. Third ground is concerned, we do not find any rationale in the view taken by the Assessing Officer. The cost incurred on stamp duty etc. together with the cost incurred in carrying out eviction of the hutment dwellers would certainly add to the value of the asset and thus amount to cost of improvement which is an allowable deduction from the full value of consideration received as a result of the transfer of the capital asset for computing the income under the head capital gains . AO has taken the view that long term capital gains arising out of sale or transfer of land would be assessed to tax only in the year in which the land is sold or otherwise transferred by the assessee ? - What the partner gets upon dissolution of the partnership or upon retirement from the partnership is the realisation of a pre-existing right or interest - There was nothing strange in the law that a right or interest should exist in praesenti but its realisation or exercise should be postponed. Applying the above principle, it can certainly be said that upon purchase of the flat, the purchaser certainly acquires a right or interest in the proportionate share of the land but its realisation is deferred till formation of the co-operative society by the flat owners and transfer of the entire property to the co-operative society. There was no basis or justification for respondent No.1 to form a belief that any income of the assesee chargeable to tax for the assessment years under consideration had escaped assessment within the meaning of Section 147 - reasons rendered could not have led to formation of any belief that income had escaped assessment within the meaning of the aforesaid provision. Therefore impugned notices issued under Section 148 of the Act cannot be sustained. - Decided in favour of assessee.

Summary

Issues Involved:

1. Legality and validity of notices issued under Section 148 of the Income Tax Act, 1961 for re-assessment.
2. Adequacy of reasons for re-opening assessments under Section 147 of the Act.
3. Compliance with Section 45(2) of the Act regarding capital gains.
4. Valuation of closing stock and computation of capital gains.

Issue-wise Detailed Analysis:

1. Legality and Validity of Notices Issued under Section 148:

The petitioner challenged the legality and validity of four notices dated 25.02.2000 issued under Section 148 of the Income Tax Act, 1961, proposing to re-assess the income for the assessment years 1992-93 to 1995-96. The petitioner contended that these notices were issued without jurisdiction and were based on erroneous grounds.

2. Adequacy of Reasons for Re-opening Assessments under Section 147:

The court examined whether the Assessing Officer had "reason to believe" that income chargeable to tax had escaped assessment. It was emphasized that such belief must be based on rational connection or live link between the material before the Assessing Officer and the belief formed. The court referred to the Supreme Court's decision in Income Tax Officer Vs. Lakhmani Mewal Das, which clarified that the reasons must have a material bearing on the question of escapement of income from assessment. The court found that the reasons recorded by the Assessing Officer did not justify the re-opening of assessments as they were based on erroneous assumptions and lacked a rational connection to the belief of income escapement.

3. Compliance with Section 45(2) of the Act Regarding Capital Gains:

The petitioner had converted a portion of the property into stock-in-trade and offered the capital gains to tax in the years when the flats were sold. The Assessing Officer contended that the capital gains should be assessed only in the year when the land is sold or transferred to the co-operative society formed by the flat purchasers. The court found that the petitioner had complied with Section 45(2) of the Act, which states that profits or gains arising from the transfer by way of conversion of a capital asset into stock-in-trade shall be chargeable to income tax in the year in which such stock-in-trade is sold or otherwise transferred. The court held that the methodology adopted by the petitioner was in accordance with law.

4. Valuation of Closing Stock and Computation of Capital Gains:

The Assessing Officer's reasons for re-opening the assessments included the following points:

- The closing stock should have been valued at the market price on the date of closing of accounts for each year, resulting in under-valuation of closing stock and reduction of profit.
- The ownership of the land continued to remain with the petitioner, and its value should have been considered in the closing stock.
- The cost of the land for computing capital gains should have been a fraction of the original cost, leading to inflation of cost.
- Capital gains should be assessed only in the year when the land is sold or transferred to the co-operative society, not in the year when individual flats are sold.

The court found merit in the petitioner's contention that the valuation of closing stock at market rate does not aim to bring any appreciation in the value of such stock into charge. The court referred to the Supreme Court's decision in Chainrup Sampatram Vs. CIT, which held that it is a misconception to think that any profit arises out of valuation of the closing stock. The court also referred to the decision of this Court in CIT Vs. Piroja C. Patel, which held that expenditure incurred for having the land vacated amounts to cost of improvement and is an allowable expenditure.

The court concluded that the reasons given by the Assessing Officer for re-opening the assessments did not justify the formation of belief that income had escaped assessment. Therefore, the impugned notices issued under Section 148 were set aside and quashed.

Conclusion:

The court allowed the writ petition, making the Rule absolute, and set aside the impugned notices dated 25.02.2000 issued under Section 148 of the Income Tax Act, 1961. There was no order as to costs.