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TMI Blog2004 (8) TMI 82X X X X Extracts X X X X X X X X Extracts X X X X ..... tal income at Rs. 16,41,760 for the assessment year 1993-94. The relevant previous year is the financial year 1992-93. The assessment was finalised on a total income of Rs. 20,52,210 on February 24, 1995, under section 143(3) of the Income-tax Act, 1961 (hereinafter referred to as "the Act"). On February 27, 1997, the respondent issued a notice under section 263 of the Act, as according to him the Assessing Officer had erred while passing the assessment order for the assessment year 1993-94. According to the respondent, during the accounting year, the firm was dissolved and therefore, the closing stock should have been valued at market rate in view of the decision of the hon'ble Supreme Court in the case of A.L.A. Firm v. CIT [1991] 189 ITR 285. Applying the gross profit rate at around 15 per cent, on closing stock of Rs. 12 crores approximate an addition of Rs. 1.82 crores for undervaluation of closing stock was proposed. The appellant submitted its written reply but the respondent passed an order under section 263 of the Act on March 20, 1997, setting aside the assessment order with a direction that fresh order be made in accordance with the direction given in his order after gi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arried on by the proprietor in the light of the fact that all the assets and liabilities were willed away by the deceased partner to the surviving partner. In support of the proposition that the respondent could not have exercised jurisdiction under section 263 of the Act reliance was placed on the decision of the apex court in the case of Malabar Industrial Co. Ltd. v. CIT [2000] 243 ITR 83, and it was contended that where two views were possible and the Assessing Officer had taken one view with which the Commissioner did not agree, the assessment order could not be treated as an order erroneous and prejudicial to the interests of the Revenue. In relation to the second question as to whether the closing stock had to be valued at cost or market price, reliance was placed on the apex court decision in the case of Sakthi Trading Co. v. CIT [2001] 250 ITR 871 to submit that the earlier decision in the case of A.L.A. Firm [1991] 189 ITR 285 (SC) had been referred to and in the subsequent decision the apex court had categorically held that for the purpose of valuing the closing stock at market value in a case of dissolution of a firm, discontinuance of the business was a necessary con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ought to be revised is erroneous; and (ii) it is prejudicial to the interests of the Revenue. If one of them is absent-if the order of the Income-tax Officer is erroneous but is not prejudicial to the Revenue or if it is not erroneous but is prejudicial to the Revenue-recourse cannot be had to section 263(1) of the Act. There can be no doubt that the provision cannot be invoked to correct each and every type of mistake or error committed by the Assessing Officer, it is only when an order is erroneous that the section will be attracted. An incorrect assumption of facts or an incorrect application of law will satisfy the requirement of the order being erroneous. In the same category fall orders passed without applying the principles of natural justice or without application of mind. The phrase "prejudicial to the interests of the Revenue" is not an expression of art and is not defined in the Act. Understood in its ordinary meaning it is of wide import and is not confined to loss of tax. . . . The scheme of the Act is to levy and collect tax in accordance with the provisions of the Act and this task is entrusted to the Revenue. If due to an erroneous order of the Income-tax Office ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t prevailed with the High Court. The decision in N. Muhammad Ussain Sahib v. S.N. Abdul Gaffoor Sahib, AIR 1950 Mad 758; [1950] 1 MLJ 81 correctly sets out the mode of taking accounts regarding the assets of a firm. While the valuation of assets during the subsistence of the partnership would be immaterial and could even be notional, the position at the point of dissolution is totally different: 'But the situation is totally different when the firm is dissolved or when a partner retires. The settlement of his account must be not on a notional basis but on a real basis, that is every asset of the partnership should be converted into money and the account of each partner settled on that basis. . . The assets have to be valued, of course, on the basis of the market value on the date of the dissolution. . . .' This applies equally well to assets which constitute stock-in-trade. There can be no manner of doubt that, in taking accounts for purposes of dissolution, the firm and the partners, being commercial men, would value the assets only on a real basis and not at cost or at their other value appearing in the books." Thus, the position that emerges is that valuation of all the asset ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ock which appears in a trading account is merely intended to cancel the charge for the goods purchased which have not been sold, it should necessarily represent the cost of the goods. If it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure .... From this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom, viz., the adoption of market value at the date of making up accounts, if that value is less than cost. It is of course an anticipation of the loss that may be made on those goods in the following year, and may even have the effect, if prices rise again, of attributing to the following year's results a greater amount of profit than the difference between the actual sale price and the actual cost price of the goods in question' (extracted in paragraph 281 of the Report of the Committee on the Taxation of Trading Profits presented to British Parliament in April, 1951). While anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness and, therefore, the closing stock could not be directed to be valued at the market rate." Therefore, it is evident that for the purpose of valuation of closing stock in a case where there is a dissolution, market value has to be adopted where the dissolution is accompanied by discontinuance of the business and not otherwise. The established rule of commercial practice and accountancy that closing stock has to be valued at cost or market price, whichever is lower, is accepted and approved both in the case of A.L.A. Firm [1991] 189 ITR 285 (SC) and Sakthi Trading Co. [2001] 250 ITR 871 (SC), when the business is continuing. The facts of the present case show that the erstwhile partnership firm was constituted of two partners; the mother and son. The mother expired on February 11,1993, leaving behind her share of assets and liabilities of the partnership firm by will to her son who incidentally happened to be the other partner. The result was that the entire business, viz., all assets and liabilities came to be held by the surviving partner. It is well settled in law that on death the will of the testator takes effect and there is no hiatus between the point of death and vest ..... X X X X Extracts X X X X X X X X Extracts X X X X
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