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1998 Supreme(Mad) 938
High Court of Judicature at Madras
THE HONOURABLE MRS. JUSTICE A. SUBBULAKSHMY & THE HONOURABLE MR. JUSTICE R. JAYASIMHA BABU
Commissioner of Income Tax - Appellant
Versus
R. Venkatachari - Respondents
Tax Case No. 1464 of 1985
Decided On : 16 July 1998
The valuation of stock-in-trade of a proprietary concern when brought into partnership firm as part of the capital contribution is to be done at cost price unless the market price is lower, in which case it would be open to the proprietor to adopt the lower of the two.
Headnote:
INCOME TAX - Valuation of stock-in-trade - Proprietary concern transformed into partnership firm - Stock-in-trade treated as part of capital contribution - Valuation at cost price - No statutory rule requiring valuation at market rate - Exception recognised in case of dissolution of firm for adjustment of mutual rights - Not applicable to transformation of proprietary concern into partnership firm - Partners free to agree on valuation of stock-in-trade - Tribunal's finding that there was no valid reason for invoking the provisions of s. 263 and accordingly in cancelling the order so made for the asst. yr. 1978-79 and that the closing stock has to be valued only at the cost price is sustainable in law.
Fact of the Case:
The assessee, a proprietary concern, was transformed into a partnership firm. The closing stock of the proprietary business was treated as part of the capital contribution of the erstwhile proprietor. The CIT valued the stock-in-trade at market rate, which was much higher than the cost price, and treated the difference as the income of the assessee for purpose of taxation.
Finding of the Court:
The Tribunal held that there was no valid reason for the CIT to adopt the market price and to treat the difference as the income of the assessee for purpose of taxation. The Tribunal further held that notwithstanding the fact that the sole proprietary business ceased to exist w.e.f. 1st April, 1978, the closing stock has to be valued only at the cost price.
Issues: 1. Whether, on the facts and in the circumstances of the case, the Tribunal is correct in law in holding that there is no valid reason for invoking the provisions of s. 263 and accordingly in cancelling the order so made for the asst. yr. 1978-79? 2. Whether, the Tribunal's further finding that notwithstanding the fact that the sole proprietary business ceased to exist w.e.f. 1st April, 1978, the closing stock has to be valued only at the cost price is sustainable in law?
Ratio Decidendi: There is no statutory rule requiring valuation of stock-in-trade at market rate when it is taken over as part of the capital contribution of a partner who had earlier held the stock as proprietor and the firm continues the same business that the proprietary concern was carrying on. The exception recognised by the Supreme Court in the case of A.L.A. Firm vs. CIT, where the closing stock is to be valued at market rate, is applicable only in the case of dissolution of firm for the purpose of ensuring the proper adjustment of the rights of the parties entitled to the share in the assets of the firm. This exception cannot be extended to a case where a proprietary concern is transformed into partnership firm, and the closing stock of the proprietary business is treated as part of the capital contribution of the erstwhile proprietor by valuing the stock in the manner in which it had been valued in the books of the proprietary concern, viz., the cost price.
Final Decision: The questions referred to the court are answered in favour of the assessee and against the Revenue.
R. JAYASIMHA BABU, J.
It is the contention of the Revenue that when stock-in-trade of a proprietary concern is taken over as part of the capital contribution of a partner who had earlier held the stock as proprietor and the firm continues the same business that the proprietary concern was carrying on, stock-in-trade taken over by the firm should be valued at market rate and not at cost price.
No statutory rule requiring valuation on that basis has been relied upon to support that contention.
2. Counsel for the Revenue sought to infer such a requirement from the law laid down by Supreme Court in the case of A.L.A. Firm vs. CIT. That was a case where the partners had valued the stock-in-trade at time of dissolution at the market rate, but had disputed the liability for tax on the amount by which the value of stock-in-trade exceeded the cost price on the ground that the income was only notional. The Supreme Court while considering that plea elaborately considered the manner in which the stock-in-trade is to be valued and after referring to the decisions of the Supreme Court in the case of Chainrup Sampatram vs. CIT, Kikabhai Premchand vs. CIT, the decision of the Privy Council in the case of Ahmedabad New Cotton Mills Co. Ltd. vs. CIT 1930 AIR(PC) 56 and the decision of the Court in the case of Whimster & Co. vs. CIT 1925 (12) Tax(Cases) 813 (C Sess) held that,
"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 the cost as that will result in the taxation of notional profits the assessee has not realised".
. To that general rule, the Court recognised an exception in the case of dissolution of firm brought about by the death of a partner or by agreement or otherwise. In such cases, it was held that the adjustment of mutual rights of the persons entitled to the assets of the firm would require the valuation of the closing stock at the market rate as on the date of dissolution as unless all the assets of the firm are valued at that rate, the mutual adjustment of the rights of the parties cannot be correctly effectuated. The Court observed that
"the real rights of the partners cannot be mutually adjusted on any other basis."
3. The exception so recognised by the Court was not meant to be the mother of several more exceptions to be inferred from that exception. What was said in the context of a dissolution of a firm for the purpose of ensuring the proper adjustment of the rights of the parties entitled to the share in the assets of the firm cannot be extended to a case where a proprietary concern is transformed into a partnership firm, and the closing stock of the proprietary business is treated as part of the capital contribution of the erstwhile proprietor by valuing the stock in the manner in which it had been valued in the books of the proprietary concern, viz., the cost price. There is no rule, as already observed which provides that the stock-in-trade of a proprietary concern when brought into partnership firm as part of the capital contribution, should be valued at a market rate even when the partners have agreed that the value as shown in the books of the proprietary concern, viz., the cost price should be the basis of valuation of such stock-in-trade. No question of adjustment of mutual rights arises when the proprietary concern is transformed into partnership by the proprietor agreeing to take another, as his partner. It is for the partners to agree as to the extent of the capital to be contributed by each of the partners and if the capital is brought in the form of stock or goods, as to the value to be assigned to such stock or goods, so long as the value so assigned is real. When the value of the stock-in-trade
