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TMI Blog2011 (3) TMI 655X X X X Extracts X X X X X X X X Extracts X X X X ..... HAN KAUL RAJIV SHAKDHER, JJ. JUDGMENT Rajiv Shakdher, J 1. The Income Tax Appellate Tribunal (hereinafter referred to as the Tribunal ) by its order dated 16.7.1992 has referred the following questions, which pertain to assessment year 1980-81 for adjudication of this court. 1. Whether on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in taking the value of the opening stock as on 11.11.1979 at Rs. 35,16,785/- which stock was received by the assessee on dissolution of the firm M/s Mehrae-Di-Hatti on 10.11.1979, at which point of the dissolution the said stock was valued at market price of Rs. 49,19,491. 2. Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in valuing the opening stock at cost though the said stock was received on the dissolution of the firm as capital by the assessee, which was converted by her into stock-in-trade? 2. The aforementioned questions of law arise for our consideration based on the following relevant facts which are culled out from the orders of the authorities below. 3. The assessee, who is a petitioner before us, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oprietorship concern where Smt. Madhu Rani Mehra was assessed in her individual capacity, the matter, as in the case of the firm also reached the Tribunal, having lost before the authorities below. The appeal of the proprietorship concern/Smt. Madhu Rani Mehra was registered as ITA No.2373 (Delhi) of 1985. 5.1 It is pertinent to note that the grievance, raised in ITA 2373 (Delhi) of 1985 before the Tribunal was, that the authorities below had accepted the stand of the revenue that the opening stock of the proprietorship concern should be valued at Rs. 35,16,785/- and not at the market value amounting to Rs. 49,19,491/- because there was a continuity of business inasmuch as the stock of gold and jewellery which had been shown as opening stock had been received from the dissolved firm at book value amounting to Rs 35,16,785. 6. The Tribunal by a common judgment dated 16.12.1991 disposed of the aforementioned appeals i.e., ITA No.2373 (Delhi) of 1985 and ITA No.2374 (Delhi) of 1985. 6.1 As regards the addition towards income of the firm was concerned, the counsel appearing for the firm before Tribunal conceded the position that the addition made by the Assessing Officer in the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce. He sought support, insofar as this contention was concerned, in the judgment of Supreme Court in the case of CIT v. Groz-Beckert Saboo Ltd. 116 ITR 125. Based on this judgment it was submitted that when a capital asset is converted into stock-in-trade then the taxable profits on its sales must be determined by deducting from the sale proceeds the market value of stock on the date of its conversion into stock-in-trade and not the original cost to the assessee, since this would be cost to the business. 9.2 The revenue by upholding the addition in the hands of the firm and not giving consequential deduction to the proprietor/Smt. Madhu Rani Mehra had brought about a situation where, in effect, a person would be taxed twice, in the first instance, in its capacity as the partner of the firm and, the second time over as an individual. 9.3 He further contended that the revenue having adopted the market value, in respect of the closing stock of the dissolved firm, for making an addition could not resort to the book value while, assessing the proprietor/Smt. Madhu Rani Mehra. In support of this submissions, Mr.Agarwal placed reliance on the judgment of the Madras High Court in the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or the year 1960-61 which commenced on 13.4.1960 would, in the ordinary course, have come to a close on or about 13.4.1961; since the firm was dissolved on 13.3.1961 it chose to close its accounts on the said date. In the return filed for the assessment year 1961-62 it showed in its profit and loss account a sum of $101,248/-, being the difference on revaluation of estates, gardens and house properties , arrived at on dissolution of the firm w.e.f 13.3.1961. However, this sum was deducted by the assessee for the purposes of calculation of income tax payable, on the ground that revaluation of estates, gardens and house properties, resulted in neither revenue nor capital gain and hence, was not assessable to tax. 12.2 It is pertinent to note that, in that case, on the dissolution of the firm the partners carried on their respective businesses with the help of assets which had fallen to their share on the dissolution of the firm. 12.3 It appears that at the stage of assessment, the Assessing Officer took an objection in respect of that part of the return whereby, the assessee had excluded the revaluation difference in the sum of $ 101,248/- from the profit and loss account. In ot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing as well as at the close of the financial year are taken into account; (ii) entries pertaining to both, opening stock and closing stock, in effect, cancel each other out so that only those transactions are left, in respect of which, actual sales have taken place; (iii) the steps indicated in clauses (i) and (ii) above, assist in determination of actual trading profit realized during the course of the year; (iv) therefore, ordinarily stocks should be valued at cost. On the other hand if, closing stock is shown at market value, which is, higher than the cost, it would result in the books recording notional profit which, the person concerned would not have earned. Inversely, if the market value of the stock is less than its cost; the closing stock shown at such a market value, will result in the books reflecting a notional loss which again the concerned person would not have incurred. However, having said so, the last method has received acceptability due customary practice, and perhaps adherence to the principle of conservatism, by the accountants, in drawing up accounts. Thus, the well accepted accounting principle which is applicable in most jurisdictions, is that, clos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... order of the CIT had carried the matter in appeal to the Tribunal. The Tribunal returned a finding of the fact that the assessee-firm stood reconstituted with the remaining partners of the erstwhile firm, under the partnership deed dated 6.3.1984 w.e.f 7.2.1984. The finding of the Tribunal was pivoted on the following clause contained in the partnership deed: Whereas the abovesaid parties were carrying on business in Erode in the name Sakthi Trading Company along with one Shri P.Chenniappan S/o late Sri Palanippa Gounder, Erode and whereas the abovesaid P.Chenniappan died on February 6, 1984, the parties hereto having decided to continue the business with all assets and liabilities in partnership from February 7, 1984, as orally agreed, this deed is drawn up reducing the oral agreement between the parties hereto taking effect from February 7, 1984, to carry on business in partnership upon the following terms and conditions. 14.1 Based on the above, the Tribunal came to the conclusion that, if the business itself is discontinued and the stocks are realized, then the value realized, would have to be substituted for the value given in the accounts, but where the business was n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... costing Rs. 9,45,545/- from the West German collaborator. Along with the said consignment, the West German collaborator dispatched to the assessee certain goods free of cost. These goods consisted partly raw-materials and partly semi-finished needles at various stages of manufacturing. In the invoice raised on the assessee, the West German collaborator made no reference to the goods which had been sent free of cost. On an objection being raised by the customs, a separate invoice was sent by the West German collaborator showing a sum of Rs. 44,448.20/- towards value of raw materials, namely wire and strip, and Rs. 30,000/- as the value of semi-finished needles supplied to the assessee. The assessee did not enter these invoices immediately in its books of account. The said invoice was entered in the books of account for the first time on 30.9.1961. At the stage of recording the transaction, the following entries were made, Rs 44,448.20 was debited to the account of wire and strip and credited to Wire and Strip Gift Account; while Rs 30,000/- was debited to the account of semi-processed needles and credited to Semi-Processed Needles Gift Account. 16.2 The said goods, which were rece ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... value which was Rs 44,448.20/- and Rs 30,000/-. The court elucidated the principle by saying that the position would have been no different than, if instead of goods the West German collaborator had gifted money equivalent to Rs 44,448.20 and Rs 30,000/- to the assessee who in turn were to introduce the said amount in the business and with that money the assessee had bought the goods in issue. The value of the goods thus purchased would have been deductable from the sale proceeds while determining the profits of the business as that would be cost to the business. The court also made an observation that merely because the initial entries had been made by the assessee i.e., on 30.9.1961 in the wire and strips gift account and semi processed gift account and the gains has been transferred to the credit of the capital account only on the last date of financial year, it would not make any difference to their conclusion since the court was obliged to draw the correct legal conclusion from a given set of the facts. The nomenclature of the account or accounts in which credit entries were made was not material. What was decisive is that amounts were debited to the respective accounts concer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... retirement after a deduction of liabilities and prior charges. The credit entry made in the partner s capital account in the books of the partnership firm does not represent the true value of the consideration. It is a notional value only, intended to be taken into account at the time of determining the value of the partner s share in the net partnership assets on the date of dissolution or on his retirement, a share which will depend upon a deduction of the liabilities and prior charges existing on the date of dissolution or retirement. It is not possible to predicate before hand what will be the position in terms of monetary value of a partner s share on that date. At the time when the partner transfers his personal asset to the partnership firm, there can be no reckoning of the liabilities and losses which the firm may suffer in the years to come. All that lies within the womb of the future. It is impossible to conceive of evaluating the consideration acquired by the partner when he brings his personal asset into the partnership firm when neither the date of dissolution or retirement can be envisaged nor can there be any ascertainment of liabilities and prior charges which may n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reconstituted firm should be the same as that which obtained when the same stock was held as closing stock of the dissolved firm. This observation was made by the court in the background of the following facts : A partnership firm was dissolved on the death of one of its two partners. The Assessing Officer apparently, while concluding the dissolved firm s assessment made an addition of Rs.40,800/- to the closing stock. The dissolved firm was reconstituted; with the wife of the deceased partner joining the other remaining partner of the dissolved firm. The issue arose as to whether the opening stock of the newly constituted firm would be valued inclusive of the addition made to the closing stock of the dissolved firm or without it. Both Tribunal and the Madras High Court held that since the operative principle is that, the opening stock is carried at the same value as the closing stock, the addition made to the closing stock would remain included while arriving at the value of the opening stock of the reconstituted firm. 18. Before we proceed further, it may be pertinent to briefly refer also to the relevant accounting standard ( in short, AS ) issued by the Institute of Chartere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he proprietorship concern would without doubt be valued at market value. Therefore, would the principle be any different if, as in the present case, the proprietor Ms. Madhu Rani Mehra wishes to use her share of the stock obtained from the dissolved firm in the new business. To our minds, the situation is no different and hence, the same principle ought to apply. A business has attributes of physicality as well as form. For continuation of business both have to remain intact, at least in large measure. In the instant case, the erstwhile firm disappeared on its dissolution. The proprietorship business gave birth to new business, in a different form. A somewhat similar situation obtained in ALA Firm s (supra) case, where the court was called upon to determine the value of the closing stock though of the dissolved firm. A converse situation arose in Sakthi Trading Co. Ltd. (supra) case where substantially both in terms of its physicality and form the business remained the same. We are thus of the opinion that the Tribunal s decision to value the stock at cost rather than the market value cannot be sustained. 21. For the aforementioned reasons, the impugned judgment is set aside. Bot ..... X X X X Extracts X X X X X X X X Extracts X X X X
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