Income Tax Appellate Tribunal - Cochin
Poulose And Matthen (P.) Ltd. vs Deputy Commissioner Of Income-Tax on 15 July, 1992
Equivalent citations: [1992]43ITD141(COCH)
ORDER
G. Santhanam, Accountant Member
1. These two appeals are by the assessee. The appellant is a company in which public are not substantially interested. It is engaged in the business of purchasing raw carbondioxide and bottle in cylinders after purification. The assessment year 1986-87 is the first year of its income-tax assessment. The appellant was a partner in a partnership firm consisting of nine partners, including the appellant. The shareholders of the appellant company are the eight others of the firm. The firm was dissolved on 25-2-1985 and the assets and liabilities of this firm lock stock and barrel were taken over by the appellant company. On the eve of the dissolution of the partnership firm its assets were revalued at a figure of Rs. 22,30,795 as against the written down value of Rs. 3,16,110. It was at the revalued figure that the company took over the assets. The dissolution deed bears testimony to these facts, apart from entries in the accounts. It should be stated in this context that the revaluation was done by an approved valuer. The value fixed by the approved valuer was at any rate, less than the market value. These facts are not disputed before us.
2. The dispute is whether the appellant company is entitled to claim depreciation on the assets taken over from the partnership firm at the revalued figure or at the written down value as they stood in the books of the partnership firm.
3. The revenue's contention is that the appellant was admitted as a partner on 1-9-1984 and remained as a partner for hardly about 5 months, as the firm itself was dissolved on 25-2-1985. Thus, the admission of the appellant company as a partner in the partnership firm and the subsequent dissolution of the partnership and the revaluation of the assets on the eve of the dissolution, constituted a design or device or a ruse to reduce the tax liability by setting up the claim for higher amount of depreciation on the enhanced value of assets and, therefore, the decision of the Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 22 Taxman 11. was clearly attracted to the facts of the case. Further he invoked the Explanation 3 to Section 43(1) of the Act. Thus, the Income-tax Officer ignored the value of the assets at which they were brought into the books of the appellant company and took only the written down value of such assets for purposes of depreciation.
4. Aggrieved, the assessee carried the matter in appeal before the CIT (Appeals) and the first appellate authority for reasons stated by the assessing officer, upheld the order of assessment. The assessee is on second appeal.
5. Shri C.K. Nair, the learned counsel for the assessee submitted that the authorities have not appreciated the facts of the case in the proper perspective the appellant company was a partner along with eight others. It is settled law that in the event of dissolution of the firm a true account of assets and liabilities must be taken at their proper values in settlement of the claims inter se among the partners. This principle has been laid down on more than one occasion by the Supreme Court, as for instance, in Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 2 Taxman 409. and A.L.A. Firmv. CIT [1991] 189 ITR 285 55 Taxman 497.. Therefore, there was nothing wrong for the partners in having resorted to the revaluation of the assets on the eve of the dissolution of the firm. The revaluation was done by an approved valuer. There is nothing on record to suggest that the value placed by the approved valuer was unsupported, imaginary, arbitrary or otherwise excessive. As a matter of fact, there are quotations suggesting that the market value of the assets are a little above the values given by the approved valuer. Therefore, the revaluation of the assets was done bonafidely by the partnership. By way of settlement of claim, the appellant company which was a partner in the firm took over the assets and liabilities of the business at the revalued figures. Further all the shareholders of the appellant company were the partners of the erstwhile firm. In other words this is a case of conversion of the partnership into a limited company, a process known to law. Further such conversion is yet another step in the evolution of business. Moreover, the tax authorities have accepted the company and assessed the same to tax. Hence, it cannot be said that it is a sham transaction. In such circumstances the ratio laid down in McDowell & Co. Ltd. 's case (supra) was not attracted to the facts of the case and authorities erred in invoking the same. As for the Explanation 3 to Section 43(1), it is only when the assets are taken over at a figure higher than the market value of such assets motive can be attributed to the company that it was done with a view to reduce the tax liability by way of higher claim of depreciation. In this case, the market value of the assets have been shown to be higher than the value placed on the assets on revaluation by an approved valuer. Therefore, the Explanation cited supra cannot also be applied.
6. Shri Nair submitted that it is not as if no consideration was paid to the previous owners of the assets. In fact, the amounts due to the erstwhile partners were also brought into the accounts of the company and the same was settled firstly by allotment of shares and secondly in a span of two years by account payee cheques or by cash through running accounts. Thus consideration was also paid for the revalued figure. In such circumstances, the assessing authority was not justified in adopting the written down value of the assets in preference to the revalued figures at which they were brought in the books of the company.
7. Shri Abraham, learned departmental representative submitted that since all the shareholders were partners of the assessee firm and effected only a conversion of the firm into a limited company, there was no need for them to resort to revaluation of assets. After all the owners are one and the same. The revaluation was done only with a view to claim higher amount of depreciation than that to which they are entitled. Hence, Explanation 3 to Section 43(1) was rightly invoked. Payment to the erstwhile partners was not done immediately. It was done in a course of two years. Naturally it may be inferred that the amount required for the payment must have come from the higher amount of depreciation on which no tax was paid by the company. Therefore, it can be said that there was a ruse or device with a view to reduce the tax liability and hence the ratio laid down in the McDowell & Co. Ltd.'s case (supra) was rightly invoked.
8. We have thus heard rival submissions and perused the records. The partnership firm known as Poulose and Matthen came into existence with effect from 25-11-1959 and was engaged in the manufacture of carbondioxide. The partnership firm has seen several re-constitutions and the last one was on 1-9-1985 evidenced by an instrument in writing of even date in which the appellant, namely M/s. Poulose & Matthen (P.) Ltd., a company registered under the Companies Act, 1956, having registration No. 4015 of 1984 with the Registrar of Companies, Kerala, was admitted into the partnership as a Partner with a share in the profit and loss at 10%. The main objects to which the appellant company was formed are as under :
1. To manufacture, sell, export and import industrial gases including Carbondioxide.
2. To manufacture, sell, export, import and generally to deal in gas cylinders, parts and accessories thereof.
3. To manufacture and sell and generally to deal in aerated waters and aerated beverages and the ingredients thereof including essences and colours.
4. To manufacture, sell, export, import and generally to deal in bottles, cans, barrels and all types of containers for beverages, crown, corks, caps and other parts and accessories thereof.
Some of the objects incidental or ancillary to the attainment of the Main objects, are as follows:
1. To acquire and undertake the whole or any part of the goodwill, business, concern, undertaking, property, rights, assets and liabilities of any person, firm, association, society, company or corporation carrying on any business which this company is authorised to carry on or possessed of property suitable for the purpose of this Company and to pay for the same by shares or debentures of this Company, or by cash or otherwise, or partly in one way and partly in another or others, and to conduct, expand and develop or wind up and liquidate such business and to purchase and take steps for the acquisition of existing and new licences in connection with any such business.
2. To form, establish, promote, subsidise, aid, acquire, organise or be interested in any other company or companies, or partnerships for the purpose of acquiring all or any of the undertaking, property and liabilities of this company or shares therein by way of exchange for its shares or otherwise or for any purpose which may seem calculated directly or indirectly to benefit the company.
3. To enter into partnership with concerns or firms carrying on business similar to or allied to the objects for which this Company is formed and to enter into such arrangements with the said partnership Firm(s) to take over the assets and liabilities including goodwill of the said firm or Firms in the event of the dissolution of the said firm or Firms and do all matters necessary for the purpose.
Thus, the appellant company was empowered to become a partner and was empowered to take over the assets and liabilities of any business. On 25-2-1985, the assets of the firm were revalued by one Shri N.H. Rajkumar, Trivandrum, an Approved Valuer and his report is to be found at pages 52 to 56 of the first paper book. The report contains the item of asset and Description (with identification number, if any), Supplier's name and address. Year of purchase/installation, Location, Original cost, Book value of written down value, condition of the machinery at the time of revaluation and the assessed value of the approved valuer for most of the items. Reference to invoice numbers also have been given in case where it is available. As for the lands, a brief description of the lands and the improvements made thereon have been taken into account in arriving at the assessed value. The building which was constructed in 1976 was revalued at the rate of Rs. 100 per sq. ft., less 2% depreciation per year for nine years in arriving at the assessed value of Rs. 2,50,403 as against the written down value of Rs. 73,689. This valuation was supported by another detailed schedule found at pages 60 & 61 of the paper book No. 1. For example, in the case of land which was revalued at Rs. 80,000, adjoining property, sold at Rs. 2,200 per cent, was the basis. For the building, with an assessed value of Rs. 2,50,403 as against the written down value of Rs. 73,689, the basis was on an estimate for a similar CO2 factory building from Mr. George Abraham Engineering Contractors for Cochin Carbonic (P.) Ltd. for Rs. 3,01,455/24 for a 300M2 floor area building at Rs. 1005 per sq. meter. The Approved Valuer has adopted Rs. 880 per sq. meter. In the case of plant and machinery either quotations for same type of machines and the purchase value of the accessories for similar type of machines or on the basis of fabrication done by others in the same field was taken to be the basis and after giving proper discount the assessed value was ascertained. In the case of a gas drying plant which was valued at Rs. 63,000 an invoice for the similar machine from Lamda Industries, Bombay, in the month of August 1984 for a sum of Rs. 70,928 was referred to and then the value was fixed at Rs. 63,000. Thus, we find that the Approved Valuer had not gone about the assessment of the values of the machines, land and building, in an ad hoc manner. There was basis for his computation and the details of such basis have been furnished to the revenue authorities. Therefore, it cannot be said that the revaluation was done in an arbitrary manner or on an ad hoc basis. The assessing officer has not disputed the basis of valuation nor has he found that the revaluation was on an ad hoc basis. In other words, he has no grievance against the manner in which the revaluation of the asset was done by the Approved Valuer and adopted by the assessee. His only grievance is that this was done with a view to reduce the tax liability and this view was confirmed by the appellate authority substantially for the same reason adduced by the assessing officer. We do not uphold the view of the authorities. It is no doubt true that revaluation was resorted to on the eve of the dissolution of the partnership firm in which the appellant is a partner. It is settled law that in the event of dissolution of the firm, a true account should be taken of all assets and liabilities in order to adjust the mutual rights of the partners in the partnership property. In the case of A.L.A. Firm (supra] the Apex Court approvingly quoted a short passage from Pickles on Accountancy (Third Edn.), p. 650, as follows :
In the event of the accounts being drawn up to the date of death or retirement, no departure from the normal procedure arises, but it will be necessary to see that every revaluation required by the terms of the partnership agreement is made. It has been laid down judicially that, in the absence of contrary agreement, all assets and liabilities must be taken at a 'fair value' not merely a 'book value' basis, thus involving recording entries for both appreciation and depreciation of assets and liabilities. This rule is applicable, notwithstanding the omission of a particular item from the books, e.g., investments, goodwill [Cruikshank v. Sutherland 11922] 92 LJ Ch 136 (HL)]. Obviously, the net effect of the revaluation will be a profit or loss divisible in the agreed profit or loss-sharing ratios.
The Supreme Court further held that the real rights of the partners cannot be mutually adjusted on any other basis.
9. In the course of the judgment, the Supreme Court approvingly quoted the decision in N. Muhammad Ussain Sahib v. S.N. Abdul Gqffoor Sahib AIR 1950 Mad. 758 as correctly setting 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 (at p. 759) :
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. ...
Therefore, we hold that the revaluation of the assets on the eve of the dissolution of the firm was with a view bonafidely done for the adjustment of the mutual rights of the partners in the partnership firm and such a course of action has been sanctified by the decision of the Supreme Court cited supra.
10. When a firm is dissolved several options are open in the settlement of accounts:
(a) all the assets are sold, money realised, the liabilities are paid off and the balance shared among the partners in settlement of their mutual interest or right in the partnership;
(b) each one of the partners taking some asset or other at agreed values along with some liability or other also at their agreed value and thus the claim is settled;
(c) one of the partners taking over all the assets and liabilities at agreed value and paying off the other partners in respect of their share of interest in the partnership either by way of money or monies worth; and
(d) a combination of any one of these modes.
In this case one of the partners had taken over the assets and liabilities at agreed value and the other partners had been given either cash or shares in the new company and the payment of the outstanding due to them was made subsequently. This is a method known to law and is a normal incident of dissolution of a partnership firm. Therefore, the method adopted by the assessee cannot be considered as repugnant to any of the provisions of the Partnership Act or the provisions of the Companies Act, as the appellant is a company. The appellant company had taken over the assets at the revalued figure and the liabilities at their face value upon a mutual understanding among the partners and the other partners were allotted shares in the appellant company at the face value of Rs. 2 lakhs as is evident from the ledger folio No. 1 of the appellant company. The amounts due to the other partners have been carried over as liabilities of the company acknowledged by it in its ledger folio Nos. 19 to 26. After setting off the value of the shares allotted, the balance standing in the accounts of the erstwhile partners as on 30-4-1985 was carried over to the succeeding year. Their accounts in the succeeding years have witnessed payments by the appellant company and thus in a course of two years, the amounts due to the erstwhile partners have all been cleared. Therefore, it cannot be held that no payment was made to the erstwhile partners in respect of their interest in the partnership firm which interest was ascertained after revaluation of the assets by the approved valuer. Thus, we hold that the appellant company has paid in money or monies worth for the assets taken at their revalued figure. The cost of such assets should take its colour from the revalued figure. We would reiterate that the assets were not taken over at their written down value nor the difference between the written down value in the hands of the partnership and the revalued figure of the assets in the hands of the appellant company remained unpaid or existed merely as book entry. Therefore, we hold that the Explanation 3 to Section 43(1) cannot be invoked in the case of the assessee nor the ratio laid down in McDowell and Co. Ltd. 's case (supra) can be said to be attracted.
11 . If the transaction is sham or if the appellant company had not paid for the assets taken over at the revalued figure, or in other words if the transaction remained as a make belief transaction, then and then only the ratio laid down in McDowell & Co. Ltd. 's case (supra) would be attracted. On facts, we hold that such is not the case before us. Further, the company has been assessed to tax and, therefore, its entity, as a real entity, has the approval of the revenue.
12. Shri Abraham, the learned senior departmental representative contended that the appellant company was inducted into the firm as a partner in September 1984 and within a few months firm was dissolved with the appellant taking over the assets and liabilities and therefore this could be construed as a ruse or device. We have carefully considered this submission. No doubt, the interval between the entry of the appellant company as a partner and the dissolution of the firm is short. If the shareholders of the assessee-company were totally different persons, motives can be imputed in view of the brevity of the interval. In the case of the appellant company, all its shareholders were the partners of the erstwhile firm. In fact, the assessee company itself was formed to do similar business and the obvious intention in the transaction was to convert the partnership into a limited company. Conversion of partnership into a limited company with all the shareholders having been the partners of the erstwhile firm is a process known to law and has the statutory recognition in Section 32A(7), which is as follows:
32A(7). Where a firm is succeeded to by a company in the business carried on by it as a result of which the firm sells or otherwise transfers to the company any ship, aircraft, machinery or plant, the provisions of Clauses (a) and (b) of Sub-section (6) shall, so far as may be, apply to the firm and the company.
Explanation: The provisions of this sub-section shall apply only where
(i) all the property of the firm relating to the business immediately before the succession becomes the property of the company;
(ii) all the liabilities of the firm relating to the business immediately before the succession become the liabilities of the company; and
(iii) all the shareholders of the company were partners of the firm immediately before the succession.
A particular mode of transfer of business recognised by the statute cannot by any stretch of imagination be considered as ruse or device to out-wit or hood-wink the tax gatherer. Further, the company form of business is yet another mile stone in the evolution of business from partnership.
13. Shri Abraham vehemently contended that since all the shareholders were the partners of the erstwhile firm, one should not be taken in by the form of the business but rather look at the substance of the matter and therefore the assets should have been taken only at the written down value as they stood in the books of the partnership firm prior to the dissolution. This is certainly a very attractive argument but on analysis it should fail. A company is a different and distinct entity from that of its shareholders. It: is an artificial juridical person capable of acting on its own unlike a partnership firm. When only malafides are attributed or when the transactions are not genuine or if the transactions are held to be sham, one can certainly lift the corporate veil and look at the substance of the transaction. That is not the case before us. The transactions are bona fide and real, the revaluation was done by an approved valuer and for the bona fide purpose of ascertaining the mutual rights of the partners in the partnership and such ascertainment of value on the dissolution of the firm has the sanction of the Apex Court in the cases cited supra and, therefore, we hold that this is not a fit case to invoke the doctrine of lifting the veil.
14. Shri Abraham further contended that the erstwhile partners were paid off only from out of the funds availed of on the higher amount of depreciation claimed by the appellant company in the subsequent years. No material was placed before us in support of this proposition. In a sense it cannot be held that the depreciation does not represent cash outlay. In fact, it is a recognition of consumption of a pre-paid expense. The Supreme Court in the case of P.K . Badianiv. CIT[1976] 105 ITR 642 approved as reasonable and plausible the view expressed by the Gujarat High Court in CITv. Viramgam Mills Co. Ltd. [1961] 43 ITR 270 that the normal depreciation reserve of a company could not form the accumulations of past profits as in the words of Wixon, it was 'the estimated expiration of asset value' or as observed by Paton in his Account's Hand Book, it is an out-of-pocket cost as any other costs. It further observed : There is still widespread misapprehension as to the precise significance of the depreciation charge. It is often deemed a more or less imaginary and hypothetical element, and is sharply contrasted with the regular 'out-of-pocket' cost as any other. The depreciation charge is merely the periodic operating aspect of fixed asset costs, and there is no doubt as to the reality of such costs. Far from being a non-out-of-pocket charge depreciation represents the extreme example of pre-payments.
Therefore we hold that the argument that the payments were made from out of the depreciation is not available to the revenue.
15. The other contention of Shri Abraham is that a sum of Rs. 1,91,468.41 which stood to the credit of the account of the appellant company, in the books of the partnership, upon the revaluation of the assets and liabilities on the dissolution of the firm, represented its own funds and no cost was incurred for the same and therefore at least from the revalued figure of the assets the sum of Rs. 1,91,468 should be deducted. In other words, from out of the total amount of Rs. 22,30,795 being the value of the revalued assets, a sum of Rs. 1,91,468 must be deducted and the balance alone should be treated as cost.
16. Shri C.K. Nair, the learned counsel for the assessee, vehemently contended that the impugned amount should not be deducted.
17. Having regard to the rival submissions, we reject the revenue's contention. When the appellant company became a partner it acquired an interest in the partnership properties. It had invested Rs. 10,000 initially which has grown into a sum of Rs. 2,11,588 on dissolution. It has to get back its investments as it stood on dissolution. The share of the appellant company in the assets (that were taken over) was accepted in quit of or in view of the amount due to it from the dissolved firm. Thus, the appellant company had in effect paid for such assets through such a settlement. Hence, the amount of Rs. 1,91,468, to be exact, the sum of Rs. 2,11,588 cannot be deducted from the value of the assets acquired.
18. Lastly Shri Abraham contended that the case of the revenue is supported by the decision of the Bombay High Court in the case of Ginners & Pressers (P.) Ltd. v. CIT [ 1978] 113 ITR 616. The assessee also relied on the very same case in support of its contention.
19. We have gone carefully through the decision of the Bombay High Court. It was a case where there was transfer of assets by a parent company to a subsidiary company and the assets were transferred, at a value higher than the written down value in the books of the parent company. In that case the assessee had withheld the basis of valuation. There was non-production of material on the basis of which the assets were revalued and these factors led to an adverse inference against the assessee. It was on appreciation of these facts, the High Court decided the issue against the assessee. The facts of the case before us are different. The assessee has furnished the revaluation report of the approved valuer and had also given the basis for the valuation, copies of which have been furnished before us also in the paper book. Thus, there is a material difference in this case. There is also an important observation in the course of the judgment at page 623 to the effect that What would be the normal market value of the assets as on the date of transfer is a different matter, but for the purpose of attracting the proviso to Section 10(5)(a) [corresponding to Section 43(1)] all that is required to be proved is that the market value of the assets transferred as on the date of their transfer was lower than the consideration for which the transfer had taken place and if the circumstances led to that adverse inference then the proviso to Section 10(5)(a) [corresponding to Section 43(1)] of the Act could be clearly attracted.
We have examined the transaction in the light of this test laid down by the Bombay High Court and hold that the assessee by its letter dated 25-10-1988 addressed to the Dy. Commissioner of Income-tax (Assessment), Special Range 2, Ernakulam, has clearly explained the basis of valuation. On a perusal of the same it is abundantly clear that the market value of the different assets are stated at a figure higher than the values placed by the approved valuer. Therefore, no adverse inference can be drawn against the assessee.
20. In the light of our discussion we set aside the order of the CIT (Appeals) on this issue and direct the Income-tax Officer to adopt the cost of the assets at the values at which the company has acquired the same as reflected in its books.
21. The other issue in the appeal for the assessment year 1986-87 is about the disallowance of Rs. 12,950, which is not pressed before us and as such dismissed.
22. For the assessment year 1987-88, the issue is only about the value of assets to be taken for purpose of depreciation on normal and additional shifts. This is consequential to the issue for the assessment year 1986-87. In the view we have taken for the assessment year 1986-87, we hold that the + should succeed in its claim.
We order accordingly.
23. In the result, the appeal for the assessment year 1986-87 is partly allowed and the appeal for the assessment year 1987-88 is allowed in full.