Income Tax Appellate Tribunal - Madras
J.A. Venkoba Rao vs Income-Tax Officer on 30 October, 1992
Equivalent citations: [1993]44ITD264(MAD)
ORDER
T.N.C. Rangarajan, Vice President
1. This appeal relates to the valuation of the closing stock on the dissolution of a firm.
2. The assessee is a firm constituted by a deed dated 3-4-1980. There were only two partners in that firm viz., J.M.Venkoba and his wife Smt. Jeeri Bai who had 1/3 share each, the balance being given to their minor children admitted to the benefits of partnership. The firm was carrying on business in Calcutta Buckets and cast iron goods and it was at will. Shri Venkoba Rao died on 7-1-1982. Therefore for the accounting period ending 7-1-1982 corresponding to the assessment year 1982-83 a return was filed showing an income of Rs. 1,05,672. The trading account of the assessee for this period showed closing stock of Rs. 2,48,630. This value admittedly was the cost. The ITO was of the view that on the dissolution of the firm by death, the assessee lost the option to value the stock at cost or market value, whichever is less. He noted that the Madras High Court has held in A.L.A. Firm v. CIT [1976] 102 ITR 622 that stock had to be valued at market value. He estimated it by applying gross profit rate of 15.5 per cent to make an addition of Rs. 38,538. On appeal the Commissioner (Appeals) confirmed the addition.
3. In further appeal before us, it was contended on behalf of the assessee that even if the assessee had lost the privilege of valuing the closing stock at stock or market value, whichever is less, the ITO did not have the authority to value the stock at market value higher than the cost as it led to an assessment of unrealised profits. In the alternative, it was submitted that the value taken itself represented the market value since it was accepted as such in the estate duty proceedings of the deceased partner.
4. On the other hand, it was contended on behalf of the revenue that since the decision of the Madras High Court had been confirmed on appeal by the Supreme Court the addition made by the ITO had to be sustained.
5. We have considered the submissions of both sides. We are concerned with the determination of the profit of the firm for the accounting period ending with the date on which the firm was dissolved by the death of a partner. Under Section 145 the income chargeable under the head 'profit and gains of business' should be computed in accordance with the method of accounting regularly employed by the assessee. According to that method regularly employed by the assessee the profit has been derived at Rs. 5,78,696 in the trading account in which the closing stock has been valued at Rs. 2,48,630 at cost. The proviso to Section 145(1) states that if the method employed is such that in the opinion of the ITO the income cannot be properly deduced therefrom, the computation shall be made upon such basis and such manner as the ITO may determine. No doubt, this proviso enables the ITO to recast the trading account. But it has to be first shown that the trading account cast in accordance with the regular method of accounting did not give the true profit.
6. The normal method of accounting with reference to the valuation of the closing stock is to take it at cost. However, custom recognised the privilege of the assessee to value the stock at cost or market value, whichever is less so that the assessee can have the benefit of anticipated loss in a falling market. This privilege is confined to a continuing business and can be withdrawn while determining the profit at the time of dissolution. This is because while the valuation of assets during the subsistence of the partnership will be immaterial and could even be notional, the settlement of account at the time of dissolution has to be on a real basis as every asset should be converted into money and account of every partner settled on that basis. The ITO would therefore be justified in recasting the trading account by taking the cost instead of the lower market value at the time of dissolution of a firm.
7. But the revenue does not stop with that. It is claimed that the cost should be replaced by market value which is higher than cost. We are unable to accept this contention for more than one reason. Firstly, no principle can justify that the valuation of the closing stock at a market value higher than cost, as that will result in the taxation of notional profits which the assessee has not realised. Secondly, in the present case the closing stock was valued at cost and the accounts of the assessee as closed on the date of the dissolution by reason of a death of a partner was accepted in the estate duty proceedings also, as reflecting the market value. Thirdly, the adoption of the real basis cannot by itself justify the substitution of the market value for the cost, where the market value is higher, particularly in the case of a death of a partner where the assets of the firm have not been converted into money. As pointed out by the Gujarat High Court in CIT v. Keshavlal Chandulal [1966] 59 ITR 120 (Guj.) at pg. 133 it is not necessary that the partners should sell all the goods and realised the price. They may agree among themselves that it would be more expedient to dispose of the assets amongst themselves rather than to outsiders and that they should do so at a book value which may be less than market rate. Fourthly, in such a case if the revenue were to substitute the market value then that would amount to bringing to tax the surplus which was not there but a notional and unreal surplus. Not only that, it will also mean that the actual surplus when subsequently realised by the successor-firm would be taxed leading to double taxation of the same income. The Supreme Court has held in the case of Laxmipai Singhaniav. CIT[ 1969] 72 ITR 291 that it is a fundamental rule of the law of taxation and unless otherwise expressly provided income cannot be taxed twice.
8. The revenue relied on the decision of the Supreme Court in the case of A.L.A. Firm (supra) to contend that the substitution of market value had been upheld by the Supreme Court. We find that on the facts of that case, the partners had agreed to value the closing stock at market value in the dissolution account but wanted the ITO to take the book value for income-tax purpose. The Supreme Court upheld the action of the ITO substituting the market value which was agreed by the partners for dissolution in respect of income-tax assessment also. That was not a case where the market value was substituted as against cost or book value accepted by the partners in the dissolution accounts, to bring to tax notional and unrealised profit. We find that the decision of the Supreme Court is not an authority for bringing to tax a notional and unrealised profit. As we have seen before, the proviso to Section 145 empowers the ITO to deduce only the true profits and that power cannot be exercised for taxing a notional and unrealised profit. In other words, while it is possible for the ITO to substitute the cost by withdrawing the privilege to value the closing stock at a market value which is less than cost as on the date of the dissolution, we find no authority for the proposition that the cost as agreed to by the partners in the dissolution accounts could be substituted by market value which is higher. Hence we have no hesitation in deleting the addition. The ITO is directed to recompute the total income and also authorise him to amend the assessments of the partners as a consequence.
9. The appeal is allowed.