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TMI Blog2002 (12) TMI 28X X X X Extracts X X X X X X X X Extracts X X X X ..... gment of the court was delivered by G.C. BHARUKA J.-On an application made by the Commissioner of Income-tax under section 256(1) of the Income-tax Act, 1961 (in short, "the Act"), the Tribunal has referred the following questions of law seeking opinion of this court: "(i) Whether, on the facts and circumstances of the case, the Tribunal was right in setting aside the order of the Commissioner under section 263? (ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that there was nothing wrong in the assessee valuing the closing stock at cost instead of at market price? (iii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that there was no transfer of capital assets of the firm to the partners even though the assessee-firm stood dissolved on December 18, 1987?" In order to answer the above questions of law, we need to narrate the relevant facts to the extent those are found necessary for the purpose. The present reference relates to the assessment year 1989-90. Some time in 1939, the late S. Raghuram Prabhu started the business of manufacturing beedies. Subsequently, his b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... abilities and rights as a partner of the firm shall come to an end." According to the above clause (3) of the partnership deed, the partnership was to dissolve on June 5, 1987. But, because of mutual agreement between the partners as provided in the above clause (3) itself, the duration was extended for a further period of six months, i.e., up to December 5, 1987. Therefore, in terms of section 39 read with sections 40 and 42(a) of the Partnership Act, 1932, the firm stood dissolved with effect from December 6, 1987. As a consequence of the dissolution of the firm, the affairs of the firm were required to be wound up in the manner provided in the partnership deed. Clause (16) of the partnership deed has made specific provisions for the manner in which the affairs of the firm were to be wound up after its dissolution. It reads as under: "(16). If the partnership is dissolved, the going concern carried on under the name of the firm, Mangalore Ganesh Beedi Works, and all the trade marks used in the course of the said business by the said firm and under which the business of the partnership is carried on shall vest in and belong to the partner who offers and pays or two or more p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ublic including the partners by giving publicity in three consecutive issues of two English daily national newspapers which have wide circulation in the country and one Kannada daily newspaper having wide circulation in Karnataka, the time allowed from making offers being at least 45 days between the last publication and the date fixed for receipt of the offers... (v) If the sale of the dissolved partnership firm as a going concern in favour of any partner or partners or an outsider is accepted by the court, such offerer shall, within 60 days from the date of the acceptance of the offer, deposit with the official liquidator the price or such part of the price together with interest on the total amount of the price at 15 per cent. per annum from December 6, 1987, till the date of deposit, which may become liable to be paid to the partner or partners towards their share of the price in the partnership firm together with interest on such amount." Some of the partners of the dissolved firm assailed the above order before the Supreme Court by preferring special leave petition in S.L.P. No. 10680 of 1991 but the same was ultimately dismissed as withdrawn on April 8, 1994. Pursuant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssets were handed over by the official liquidator attached to this court to the purchasing-AOP on January 7, 1995, vide his report 10 of 1995 and sale proceeds were distributed by the official liquidator under the order's of this court amongst the out-going partners on February 2, 1995. It is also a matter of record that despite dissolution of the firm, for one or the other reason, the business of the firm could not be wound up in terms of clause (16) of the partnership deed and as noticed above the same was continued even thereafter in the normal way under the supervision and direction of this court. This fact becomes evident from the order dated April 11, 1990, passed by the Division Bench in O.S.A. No.2 of 1989 wherein it was inter alia held that: "No doubt, according to the partnership dated June 13, 1982, the partnership was to continue for a period of five years. But, it is not disputed by either side that the partners agreed that the partnership should be continued on the same terms and conditions contained in the deed of partnership for a further period of six months and even after the expiry of the further period of six months, they have continued the business." None ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntentions of the assessee held that there was no transfer of capital assets of the firm to the partners so as to attract the provisions of section 45(4) of the Act and as such according to it, no capital gains tax is leviable on the firm. The Tribunal by relying on the case law on the subject also held that there was nothing wrong on the part of the firm in valuing its closing stock at cost instead of market price as on the date of the dissolution of the firm. In the backdrop of the foregoing facts, the Tribunal has referred the three questions of law reproduced in the first paragraph of this judgment. Before proceeding to answer the question of law relating to capital gains, i.e." question No. (iii), one has to bear in mind that "partnership" as defined in section 4 of the Indian Partnership Act, 1932, is the relation between persons who have agreed to share the profit of a business carried on by all or any of them acting for all. This relationship may have many other attributes as agreed between the parties and are recognised under the Partnership Act. So far as a relationship in association of persons is concerned, it has not been defined in any statutory provision. But the Su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise: Provided that the firm is in no case bound by the acts of a partner who has been adjudicated insolvent; but this proviso does not affect the liability of any person who has after the adjudication represented himself or knowingly permitted himself to be represented as a partner of the insolvent." In the case of Saligram RupIal Khanna v. Kanwar Rajnath, AIR 1974 SC 1094, keeping in view section 47 of the Indian Partnership Act, the Supreme Court has held that: "According to section 47 of the Indian Partnership Act, 1932, after the dissolution of a firm, the authority of each partner to bind the firm, and the other mutual rights and obligations of the partners, continue notwithstanding the dissolution, so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution but not otherwise. The word 'transaction' in section 47 refers not merely to commercial transaction of purchase and sale but would include also all other matters relating to the affairs of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed 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. 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. The real rights of the partners cannot be mutually adjusted on any other basis." Admittedly, at no point of time, the business which was being carried on by the firm despite its dissolution had been closed during the previous year pertaining to the assessment year in question and the same set of persons ..... X X X X Extracts X X X X X X X X Extracts X X X X
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