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TMI Blog2009 (6) TMI 645X X X X Extracts X X X X X X X X Extracts X X X X ..... he stock declared by the assessee in its books of account - Held that: GP rate of the assessee-firm and the AO has taken the same GP rate for computing profit element on taking over stock by M/s D.D. International (P) Ltd. from assessee - Decided in favor of the assessee - - - - - Dated:- 12-6-2009 - Member(s) : H. S. SINDHU., CHANDRA POOJARI. ORDER-CHANDRA POOJARI, A.M.: The appeal of the Revenue and cross-objection of the assessee are filed against the order dt. 29th Jan., 2008 of CIT(A), Bhatinda for the asst. yr. 2000-01. 2. The Revenue has raised the following grounds: "1. That on the facts and in the circumstances of the case, the order of the learned CIT(A) is bad in law. 2. That on the facts and in the circumstances of the case the learned CIT(A) is in error while holding that provisions of s. 45(4) are not applicable ignoring the applications of the provisions of s. 47(xiii) of the IT Act, 1961 to the facts of the case in as much as the partners have received consideration/benefit in the form of deposits after adjustment of shares in the new company to be allotted against part capital of the firm. 3. That on the facts and in the circumstances of the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g partner by comparing the fair market value with book value of stock. 6. Now, we will take up Revenue's appeal. The brief facts of the case are that the assessee filed a return declaring loss of Rs. 6,95,231 on 31st Oct., 2000. Later on, the return was processed under s. 143(1) on 30th March, 2002. Later on a notice under s. 148 of the Act was issued on 21st July, 2005 which was got served on the assessee on 29th July, 2005. There were valid reasons recorded for reopening. Originally, the assessee comprised of nine partners. The said partnership firm was reconstituted vide letter dt. 1st June, 1999 whereby two partners retired. Again on 16th Dec., 1999, the firm has admitted one more partner namely D.D. International (P) Ltd. Later on 31st Dec., 1999, the firm was dissolved and whole business including all of its assets and liabilities was taken over by M/s D.D. International (P) Ltd. The capital standing to the credit of the retiring partners was partly to be adjusted against the shares to be allotted and the balance was to be kept as deposit. The AO invoked the provisions of s. 45(4) of the Act and profits and gains arising from the transfer of capital assets by way of distrib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the firm. Further, the learned Departmental Representative submitted that in this case s. 45(4) of the Act is applicable and the AO is justified in invoking the same. 7.2 The learned Authorised Representative, on the other hand, submitted that the assessee's partnership firm was being run by 9 partners including D.D. International (P) Ltd. From the close of 31st Dec., 1999 all other partners retired and the entire running business of the firm along with all the assets and liabilities were taken over by the partner D.D. International (P) Ltd. on going concern basis. He further submitted that against the capital standing to the credit of retiring partners, partly shares were issued and balance was kept as deposit in the company D.D. International (P) Ltd. and the retiring partners were neither paid any money nor any asset of the firm was distributed amongst them on the retirement. He further submitted that the provisions of s. 45(4) of the Act came into operation only on the satisfaction of the following two conditions namely (i) if there is dissolution of firm; and (ii) if there is transfer of capital asset by way of distribution on such dissolution. It was further pleaded that b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he expression 'otherwise' has to be read with the words 'transfer of capital asset' by way of distribution of capital assets on the dissolution of a firm. Sec. 45 is a charging section. The purpose and object of the Finance Act, 1987 was to charge tax arising on distribution of capital assets of firms which otherwise was not subject to taxation. If the language of sub-s. (4) is construed to mean that the expression "otherwise" has to partake of the nature of dissolution or deemed dissolution, then the very object of the amendment could be defeated by the partners, by distributing the assets to some partners who may retire. The firm then would not be liable to be taxed thus defeating the very purpose of the amending Act. Prior to the Finance Act, 1987, in the case of a partnership it was held that the assets are of the partners and not of the partnership. Therefore, if on retirement a partner received his share of the assets, may be in the form of a single asset, it was held that there was no transfer and similarly on dissolution of the partnership. Another device resorted to by some assessees that to convert an asset held independently as an asset of the firm in which the individua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ereby capital gains tax was not chargeable. In our opinion, therefore, when the asset of the partnership is transferred to a retiring partner the partnership which is assessable to tax ceases to have a right or its right in the property stands extinguished in favour of the partner to whom it is transferred. If so read it will further the object and the purpose and intent of the amendment of s. 45. Once, that be the case, we will have to hold that the transfer of assets of the partnership to the retiring partners would amount to the transfer of the capital assets in the nature of capital gains and business profits which are chargeable to tax under s. 45(4) of the IT Act. The word 'otherwise' takes within its sweep not only cases of dissolution but also cases of subsisting partners of a partnership transfering assets to retiring partners. As such transfer of capital assets by existing firm could give rise to capital gain in view of sub-s. (4) of s. 45 w.e.f. 1st April, 1988. 8.1 Further, in the present case all the capital assets of the assessee-firm were taken by one of the partners of the firm, the firm was dissolved and the existing partners got the shares of M/s D.D. Internatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that Finance Act, 1987 w.e.f. 1st April, 1988 omitted this clause, the effect of which is that the distribution of capital assets on dissolution of firm would henceforth be regarded as 'transfer'. Therefore, instead of incorporating cl. 45(4) in s. 2(47), the suitable amendment was carried out by the same Finance Act in s. 47 the result of which is that the distribution of capital assets on the dissolution of firm would be regarded as 'transfer'. Therefore, the contention that since s. 2(47) did not contemplate the transfer as noted in s. 45(4) and hence no capital gain is chargeable, is devoid of any merit. 8.5 Further, the Hon'ble Supreme Court in the case of CIT vs. Bankey Lal Vaidya (1971) 79 ITR 594 (SC) and Hon'ble Punjab Haryana High Court in the case of Raman Lal Khanna vs. CIT (1972) 84 ITR 217 (P H) held that on dissolution of the firm, one of the partners took up the whole business and other partners were paid their shares in money for the credits held. Thus, there was a distribution of assets of the firm within the meaning of s. 47(ii). But now with the Finance Act, 1987 w.e.f. 1st April, 1987, the s. 47(ii) was deleted. As such the distribution of capital on disso ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he legal heirs of the deceased partner. On the other hand, what is found by the Tribunal is that even after the demise of one of the partners, the business continued and assessment continued to be made on the firm. There was a dissolution by operation of law by reason of s. 42(c) of the Partnership Act. That, however, was not followed by transfer of capital assets by way of distribution of capital assets on the dissolution of the firm. Sec. 45(4) is concerned with the capital gains arising from transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm. The section does not deem the date of dissolution as the date on which the transfer takes place. Dissolution by operation of law as in this case may take place on the demise of one of two partners. That however, does not imply that on that day there is a notional transfer of capital assets and that anyone or more of the capital assets owned by the erstwhile firm stands transferred to other partner or to other persons entitled to claim the share of the deceased partner. The relevant date for ascertaining the year in which the tax is to be levied is the year in which the transfer takes place. Tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng stock is not a "capital asset" under s. 2(14) of the IT Act. As such on invoking the provisions of s. 45(4), the difference in the value between closing stock as compared to fair market value and book value cannot be brought to tax. The learned CIT(A) has totally misunderstood the concept and was of the opinion that the AO treated the closing stock as capital asset. 11. The learned Departmental Representative relied on the order of the AO. 12. The learned counsel for the assessee submitted that stock does not fall within the provisions of s. 45(4) being not a capital asset. Sec. 45(4) applies only to the distribution of "capital assets" on the dissolution of firm. The word "capital asset" is defined in s. 2(14) which specifically excludes stock-in-trade. 12.1 The learned counsel further submitted that the Department has challenged the decision of CIT(A) where it was held that if at all stocks are to be considered for valuation it has to be valued as in the case of slump sale and straightway the GP rate could not be added to its value to arrive at its market value. 12.2 He further submitted that there can be no doubt that in a situation like the one the stocks can only be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... firm was discontinued. However, in the case of assessee there is neither any distribution of assets among the partners nor any discontinuation of business as the entire running business of the firm was taken over by one partner on going concern basis. Even the capital of retiring partners remained in the company in form of share capital and deposit and was not paid to the retiring partners. The above decision has been distinguished by the Hon'ble Supreme Court in the case of Sakthi Trading Co. vs. CIT (2001) 169 CTR (SC) 297 : (2001) 250 ITR 871 (SC); the case is almost similar to the facts of the assessee's case. In this case the firm got dissolved on death of one of the six partners and the entire running business was taken over by the remaining partners on going concern basis without there being any distribution of assets. The Hon'ble Supreme Court held that it is an established rule of practice and accountancy that where there is no discontinuance of business the closing stock is to be valued at lower of cost or market price. (ii) Naveen Hardware Electrical Stores vs. CIT; This case cited by AO is also a case where distribution of assets amongst the partners took place ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tock as capital asset. He has treated only plant and machinery as capital asset and on the other hand he has relied on the decision of Hon'ble Supreme Court in the case of A.L.A. Firm vs. CIT and valued the closing stock at market price and treated the difference between the fair market value of stock and book value of closing stock as profit of the assessee. In the case of A.L.A. Firm vs. CIT, it was held as under: "It is settled law that the true trading results of a business for an accounting period cannot be ascertained without taking into account the value of the stock-in-trade remaining at the end of the period. The proper practice is to value the closing stock at cost. That will eliminate entries relating to the same stock from both sides of the account. To this rule, custom recognises only one exception and that is to value the stock at market value if that is lower. On no principle can one justify the valuation of the closing stock at a market value higher than cost as that will result in the taxation of notional profits the assessee has not realised." In that case it was further held that where the erstwhile firm was dissolved and business of the firm was discontinu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d fact is that the firm consists of six partners. There was death of one partner on 6th Feb., 1984. The firm was dissolved which was reconstituted with effect from the next day i.e., 7th Feb., 1984, with the remaining five partners. As such, the closing stock as on 6th Feb., 1984 had to be valued at cost price or market price whichever is less since the firm is continued. However, in the present case the business of the assessee discontinued. Hence, the ratio laid down by the judgment in the case of Sakthi Trading Co. vs. CIT is not applicable to the present case and the judgment in the case of A.L.A. Firm vs. CIT is applicable to the facts of the present case. The assessee relied on various judgments. Accordingly, we have relied upon the judgment in the case of A.L.A. Firm vs. CIT; we are not considering the various other judgments cited by the learned counsel for the assessee. Further, the assessee relied on some judgments of the Tribunal and High Courts wherein partnership firm was converted into joint stock company by operation of law i.e. under Part IX of the Companies Act by virtue of s. 575 of the Companies Act i.e., vesting the title in the assets of the company. The facts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e are concerned with the profit is earned by the assessee firm which has transferred its stock to M/s D.D. International (P) Ltd. The net profit rate at which M/s D.D. International (P) Ltd. is earning is immaterial to us. We have to consider the GP rate at which the assessee-company is selling its goods. The GP rate of the assessee-firm is 10.16 per cent in the assessment year under consideration. There is no dispute regarding this GP rate as per return filed by them. Hence, we have to take the GP rate of the assessee-firm and the AO has taken the same GP rate for computing profit element on taking over stock by M/s D.D. International (P) Ltd. from assessee. Accordingly, we uphold the action of the AO. This cross-objection is dismissed. 15. The learned counsel for the assessee defended the order of learned CIT(A) by submitting as follows: (i) No addition in respect of value of closing stock could have been made since there is no mention of valuation of closing stock in the reasons recorded by the AO. There is nothing on record which came to the notice of AO during the course of reassessment proceedings to form his belief that other chargeable income has also escaped assessment ..... X X X X Extracts X X X X X X X X Extracts X X X X
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