Income Tax Appellate Tribunal - Madras
Sakthi Trading Co. vs Income-Tax Officer on 3 August, 1989
Equivalent citations: [1989]31ITD259(MAD)
ORDER
T.N.C. Rangarajan, Judicial Member
1. This appeal is directed against the order of the Commissioner of Income-tax, made under Section 263 of the Income-tax Act, 1961.
2. The assessee is a registered firm. For the assessment year 1984-85, corresponding to the accounting period ended on 6-2-1984, the assessee filed a return showing income of Rs. 1,37,810, from its business in turmeric. The Income-tax Officer made the assessment under Section 143(3) on 30-5-1984 accepting the income as returned. The Commissioner of Income-tax, on a review of that assessment order, noticed that the assessee-firm had been dissolved on 6-2-1984 on the death of one of the partners and the firm had been reconstituted on the next day with the remaining five partners and that the assessment of the income for the period 7-2-1984 to 31-3-1984 had been made separately. He was of the view that in making the present assessment the stock-in-trade as on 6-2-1984 had to be valued at market rate, following the decision of the Madras High Court in the case of A.L.A. Firm v. CIT [1976] 102 ITR 622. He held, after hearing the assessee, that the failure to take the market value of the closing stock was an error prejudicial to the Revenue and he, therefore, set aside the assessment and directed the Income-tax Officer to make a fresh assessment accordingly.
3. In the appeal before us it was contended on behalf of the assessee that the question of valuing the closing stock at market value could arise only on discontinuance of the business as such and as in the present case the business of the firm was never terminated but had been taken over on succession by another firm, the closing stock was not required to be revalued. It was submitted that the decision of the Madras High Court in the case of A.L.A. Firm (supra) did not apply to a case such as this and reliance was placed on the decision of the Tribunal in the case of ITO v. Krishna Traders [IT Appeal No. 1416 (Mad.) of 1982, dated 30-6-1983]. On the other hand it was contended on behalf of the Revenue that on the dissolution of a firm the closing stock had to be revalued and, therefore, the order of the Commissioner was justified, as it was based on the decision of the Madras High Court in the case of A.L.A. Finn (supra). Reliance was also placed on the decisions of the Tribunal in K.P. Yeriswamy & Sons v. ITO [1984] 9 ITD 372 (Hyd.), Sha Raichand Chagganraj & Co. v. ITO [1986] 18 ITD 167 (Hyd.) and Madura Aluminium Co. v. ITO [IT Appeal No. 647 (Mad.) of 1986, dated 30-5-1989] which have followed the above judgment of the Madras High Court.
4. On a consideration of the rival submissions we are of the opinion that the assessee is entitled to succeed. The facts in brief are that there was a firm constituted by a deed dated 1-4-1983 with six partners, which was terminable at will. One of the partners P. Chenniappan died on 6-2-1984 and consequently that firm stood dissolved on that date. On 6-3-1984 another partnership deed was executed by the remaining five partners. That deed recites: -
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 Shri Palaniappa Gounder, Erode and whereas the abovesaid P. Chenniappan died on 6-2-84, the parties hereto having decided to continue the business with all assets and liabilities in partnership from 7-2-84 as orally agreed, this deed is drawn up reducing the oral agreement between the parties hereto taking effect from 7-2-84, to carry on business in partnership upon the following terms and conditions.
The new partnership was thus constituted on 7-2-1984 to continue that business. The question is whether in computing the income of the dissolved firm the value of the closing stock should be revised according to market rates ignoring the fact that the closing stock have been valued at cost or market value whichever is less in the accounts regularly maintained by the dissolved firm.
5. It may be kept in mind that in this case because of the dissolution of the firm the business is continued by the successor firm and the assessments are made under Section 188 separately on the dissolved firm for the period up to the date of dissolution and on the successor firm after that date. That section refers to the provisions of Section 170 for making the assessment, which is a provision for assessment in a case where a person carrying on business has been succeeded by another person. This provision is quite distinct from Section 176, which applies to a case where a business is discontinued. Thus the Act itself recognizes that a case of a succession of the business by one firm on the dissolution of another firm is not a case of a business being discontinued. This recognition is presumably based on the long line of decisions, which have uniformly held that discontinuance did not cover mere change of ownership but referred only to complete cessation of the business - See CIT v. P.E. Polson [1945] 13 ITR 384 at 388 (PC). The provisions of Section 189 make no difference to this situation for it only enables proceedings to be initiated against the dissolved firm or in respect of a discontinued business as if such discontinuance or dissolution had not taken place.
6. The income chargeable under the head "Profits and gains of business" is to be computed in accordance with the method of accounting regularly employed by the assessee as provided by Section 145(1) of the Act. One of the principles adopted generally is to value the closing stock at cost or market value, whichever is less. The Supreme Court has explained this practice in the case of Chainrup Sampatram v. CIT [1953] 24 ITR 481, as under: -
It is wrong to assume that valuation of the closing stock at market rate has for its object, the bringing into charge any appreciation in the value of such stock. 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 at the time of their purchase, 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 have been actual sales in the course of the year showing the profit or loss actually realised on the year's trading.
The Supreme Court further pointed out that there was only one exception to the rule of valuation of market value, namely, to allow the anticipated loss to be taken into account if the market value was less than the cost. The Supreme Court observed further: -
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 prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that closing stock is 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. As profits for income-tax purposes are to be computed in conformity with the ordinary principles of commercial accounting, unless of course, such principles have been superseded or modified by legislative enactments, unrealised profits in the shape of appreciated value of goods remaining unsold at the end of an accounting year and carried over to the following year's account in a business that is continuing are not brought into charge as a matter of practice, though as already stated, loss due to a fall in price below cost is allowed even if such loss has not been actually realised. As truly observed by one of the learned Judges in Whimster & Co. v. CIT [1926] 12 TC 813, 827. Under this law (Revenue law) the profits are the profits realised in the course of the year. What seems an exception is recognized where a trader purchased and still holds goods or stocks which have fallen in value. No loss has been realised. Loss may not occur. Nevertheless at the end of the year he is permitted to treat these goods or stocks as of their market value'.
7. Based on the above premise if the business itself is discontinued and the stocks are realised then the value realised would have to be substituted for the value given in the accounts. Such a realisation becomes necessary where the business is discontinued with or without dissolution of the firm. However, where the business is not discontinued, though the firm is dissolved, the question of realising the value of the goods does not arise and there is no necessity for revaluing the closing stock. This is because the value of the closing stock as shown in the books of the dissolved firm will be taken as the value of the opening stock in the hands of the successor in interest, the business continuing without any disruption. However, if the partners of the dissolved firm have in their dissolution accounts revalued the stock, then that value would have to be substituted. That was exactly the position in the case of A.LA. Firm (supra). The judgment notes that the firm in that case closed its accounts on 13-3-1981, the date of dissolution, and the profit was arrived at by crediting to the profit and loss account the difference on revaluation of the stock as on that date. However, for income-tax purposes the firm claimed that the difference should be written back and the profit adjusted. The High Court did not countenance such a claim. The earlier decision in G.R. Ramachari & Co. v. CIT [1961] 41 ITR 142 (Mad.) was followed to hold that when there is a dissolution the stock-in-trade should be valued at market value. But the question whether it is necessary to value the stock at market value inispite of any agreement among the partners as to the valuation of the stock was not considered by the High Court. At the same time the High Court referred to the decision of the Gujarat High Court in CIT v. Keshavlal Chandulal [1966] 59 ITR 120, and reproduced with approval the following passage:
There can, therefore, be no doubt that distribution of assets is part of the transaction of dissolution and is a business transaction entered into by the partners who, until then, were jointly carrying on the business. In our view, what applies to dissolution of a partnership must equally apply to a transaction entered into by businessmen when they decide to discontinue the business and make up accounts and distribute its assets and liabilities amongst themselves.
Then the Madras High Court observed: -
We would apply the above passage with reference to stock-in-trade. We are, however, not to be understood as holding that the above passage applied with reference to assets other than the stock-in-trade.
It follows that the question posed by us has already been answered to the effect that where the value of the stock is accepted by the partners upon dissolution it cannot be varied by the Income-tax Officer.
8. There is another reason why the stock of a continuing business does not require to be varied. It is that there is no realisation of stock and the accounting practice normally followed has to be maintained because the business itself has not been discontinued. The Supreme Court has held in Malabar Fisheries Co. v. CIT [1979] 120 ITR 49, that there is no transfer of assets involved even in the sense of any extinguishment of the firm's rights in the partnership assets when distribution takes place upon dissolution. Thus the value put for the stock taken by any partner on dissolution is an agreed value and cannot be substituted by the market value because it is not a realisation sale.
9. A dissolution of a firm may or may not coincide with the discontinuance of a business. If on dissolution of a firm the business is also discontinued and the value of the stock realised it may be possible for the Income-tax Officer to insist that the value realised should be taken as the value of the closing stock instead of any notional valuation on the regular principle of cost or market value whichever is less. But where the business is not discontinued the question of revaluing the stock cannot arise at all. In fact by requiring the revaluation of the stock at market value when the stocks have not been sold not only the anticipated loss which the assessee is entitled to take into account as an exceptional rule of accountancy practice is denied but the profit which has not actually been realised is brought to tax, which is against the principle of assessment of real income as adumbrated by the Supreme Court in the case of Slate Bank of Travancore v. CIT [1986] 158 ITR 102/24 Taxman 337. Hence for all these reasons we are of the considered opinion that the valuation of the closing stock of a continuing business on the principle of cost or market value whichever is less cannot be substituted with the market value only because the firm carrying on that business is dissolved and the business is taken over by another firm consisting of the remaining partners. The same view has been taken by the Tribunal (Madras Bench-D) in the case of ITO v. Krishna Traders [IT Appeal No. 1416 (Mad.) of 1982, dated 30-6-1983.].
10. We may now consider the decisions relied upon by the Revenue. As we have already noticed, the decision of the Madras High Court in the case of A.L.A, Finn (supra), was a case where the partners have agreed to substitute the market value and wanted to retract from it. Therefore that case does not support the contention of the Revenue that the value agreed by the partners could yet be substituted by the market value. The case of G.R. Ramachari & Co. (supra), was a case in which there was a decree of court taking the value, which was, therefore, to be substituted. Moreover in both of those cases there was a discontinuance of the business itself which is not the case in the present case. The Kerala High Court decision in Popular Workshops v. CIT [1987] 166 ITR 348 was also a case of discontinuance of the business and the distribution of the stock to the various partners. The decisions of the Tribunal in K.P. Yeriswamy & Co.'s case (supra) and Sha Raichand Chagganraj & Co's case (supra) have followed the decision in A.L.A. Firm's case (supra) without noticing these distinguishing features. The decision of the Tribunal in Madras Aluminium Co. [IT Appeal No. 647 (Mad.) of 1986, dated 30-5-1989] specifically stated that the facts of the case did not disclose any agreed valuation among the partners so as to apply the decision of the Tribunal in Krishna Traders' case (supra). Thus none of the decisions relied on by the Revenue supports the contention that where the business is not discontinued the closing stock could be revalued by substituting the market value. Since there is no warrant for such revaluation, the order of the Income-tax Officer accepting the profit shown by the assessee on the basis of the method of accounting regularly followed was not in any way erroneous and did not require to be revised under Section 263. We, therefore, cancel the order of the Commissioner of Income-tax.
11. The appeal is allowed.