Rc/112/2001 Of M/S Arjundas Rajkumar And Others v. Commissioner Of Income Tax

* THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM + R.C.No.112 of 2001 %Date: 09.07.2014 M/s.Arjundas Rajkumar and others. and …applicant. $.Commissioner of Income-tax, Hyderabad. …Respondent. ! Counsel for applicant: Sri Y.Ratnakar ^ Counsel for Respondent : Sri S.R.Ashok < GIST: > HEAD NOTE: ? Cases referred 1. 189 ITR 2852. 236 ITR 4123. 250 ITR 871 THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM R.C.No.112 of 2001 ORDER:(Per the Hon’ble Sri Justice L.Narasimha Reddy) This reference under Section 256(2) of the Income Tax Act,1961 (for short ‘the Act’) is made by the Hyderabad Bench ‘B’ of theIncome Tax Appellate Tribunal (for short ‘the Tribunal’), to this Court,with a request to express its opinion on the following questions: 1. “Whether on the facts and in thecircumstances of the case and on cumulativeconsideration of all relevant factors and inexistence it could be said that the parties neverintended to carry on any business and whetherthe nature of partnership by a deed dated07.04.1986 was for extraneous purpose otherthan carrying on business? 2.Whether on the facts and in circumstancesof the case, the Tribunal is correct in itsconclusion that there can be a firm in existenceboth in form and substance and it is immaterialwhether the object of the firm was to carry onbusiness in real estate or for any otherpurpose? 3. Whether on the facts and in thecircumstances of the case the immovableproperties bearing Municipal No.7-8-757/1/FGodown Road, Nizamabad and Plot No.3 and4, Yellamma Nizamabad are capital asset orstock in trade of partnership?” Briefly stated, the facts are that, the applicant-firm comprisedof three partners, namely Susheela Devi and her two sons, Arjundasand Rajkumar. The firm was constituted through a partnership deed,dated 07.04.1986. Before the constitution of the firm, the mother andtwo sons had equal shares, in an item of immovable property, beinga house at Nizamabad. Another item was an open land, in which two brothers had equal shares. Both the properties were pooled intoassets of the firm towards the respective shares of the partners. Thefirm, however, was dissolved on 02.04.1987. On dissolution, theentire house was allotted to the share of Susheela Devi, whereas theentire landed property was allotted to the share of Rajkumar. Arjundas appears to have been allotted either cash component, orother properties. In the returns filed by the firm, the value of various propertieswere shown. The Income Tax Officer (ITO), who processed thereturn, took the view that the value of the house would beRs.17,67,678/-. The basis was that he determined the annual lease value atRs.1,60,698/- and multiplied the same, 11 times. This lead to theincrease in the value of the property and treated the total income asRs.13,88,370/-. The difference of tax of Rs.6,49,969/-, together withinterest, of Rs.58,925/-, under Section 139B of the Act, and anadditional interest, of Rs.29,571/-, under Section 217 of the Act, werelevied. Aggrieved by the order of the Assessing Authority, theapplicant carried the matter in appeal before the Commissioner. Theorder of the ITO was affirmed, by the Commissioner, through hisorder, dated 01.02.1991. Thereafter, the applicant filedI.T.A.No.488/Hyd/1991 before the Tribunal. The appeal wasdismissed, through a detailed order, dated 26.06.1992. The applicant filed R.A.No.303 of 1992 with a request to referthe three questions, mentioned above, to this Court. When therequest was not acceded to, he approached this Court by filing R.C.,and on a direction issued therein, the questions were referred. Sri Y.Ratnakar, learned counsel for the applicant, submits thatthe very act of the I.T.O. in determining the value of the house atRs.17,67,678/-, as against the value shown in the return at The applicant filed R.A.No.303 of 1992 with a request to referthe three questions, mentioned above, to this Court. When therequest was not acceded to, he approached this Court by filing R.C.,and on a direction issued therein, the questions were referred. Sri Y.Ratnakar, learned counsel for the applicant, submits thatthe very act of the I.T.O. in determining the value of the house atRs.17,67,678/-, as against the value shown in the return at Rs.6,73,000/-, is contrary to law. He contends that it is a fairly settledpractice and principle not only in the accountancy, but also in thefield of taxation that an assessee, who undertakes trade, is entitled totake the cost, of an asset, or its market value, whichever is less. Hesubmits that the firm was brought into existence only as a device toreadjust the shares in the immovable properties held by the familymembers and it cannot be treated as a firm within the meaning of thePartnership Act. He contends that the very fact that it stooddissolved within one year and that hardly any activity wasundertaken, would demonstrate that it was a nominal entity and wasnot intended to be an agency to carry on business. He submits thatthe same principle applies, whether the firm is continuing or stooddissolved. Learned counsel further submits that the view taken by theITO, the Commissioner and the Tribunal cannot be supported in lawand that all the three questions deserve to be answered in favour ofthe applicant. Another facet of the argument of the learned counselis that the ITO ought not to have levied interest under Section 217 ofthe Act or at any rate, he ought to have waived it in the given factsand circumstances of the case. He has placed reliance upon someprecedents. Sri S.R.Ashok, learned Senior Standing Counsel for theIncome Tax Department, on other hand, submits that, once the firmwas brought into existence, through a registered document andcertain profits were also posted in the profit and loss account, itcannot be treated as a nominal entity, and that questions 1 and 2deserve to be answered against the applicant. He submits that inR.C.No.160 of 2000, referred to this Court, at the instance of this veryapplicant, the very existence of the partnership firm is not doubted, orchallenged by the applicant, and that it is not open to him to plead, to the contrary, in this reference. Learned Senior Counsel further submits that whatever may bethe value furnished by an assessee about an item, which is part ofstock in trade, the determination of market value becomes relevant,particularly when the firm is dissolved and the business activity isdiscontinued. Placing reliance upon the judgment of the Supreme Court in A.L.A. Firm v. Commissioner of Income Tax[[1]],learnedSenior Counsel submits that subtle distinction in this behalf wasclearly maintained by the Supreme Court and that the same hasbeen applied by the ITO, the Commissioner and Tribunal in theinstant case. Though the three questions are referred, questions 1 and 2covered one facet and question No.3, another. The purport ofquestions 1 and 2 is about the nature of the firm and the legalconsequences flowing from it. The effort of the applicant is toconvince this Court that the firm was only a nominal entity and it didnot have any difference, whether it was dissolved or not, and theentire controversy turned around it. There may be instances where the firms are brought intoexistence nominally and no activity is undertaken by them. In casesof that nature, the assessee may convince ITO, and if the pleadedfacts are proved, the ITO himself may ignore the existence of suchfirm. Where however, the firm is brought into existence through aregistered document and separate returns are field on behalf of thefirm, posting profits and furnishing other ingredients of a typicalreturn, one cannot expect the ITO to ignore the existence of the firm. Added to that, a peculiar situation exists in the instant case. There may be instances where the firms are brought intoexistence nominally and no activity is undertaken by them. In casesof that nature, the assessee may convince ITO, and if the pleadedfacts are proved, the ITO himself may ignore the existence of suchfirm. Where however, the firm is brought into existence through aregistered document and separate returns are field on behalf of thefirm, posting profits and furnishing other ingredients of a typicalreturn, one cannot expect the ITO to ignore the existence of the firm. Added to that, a peculiar situation exists in the instant case. As a result of dissolution of the firm, redistribution of theproperties took place in a manner, different from the one, in whichthey were held before the constitution of the firm. That, in turn,attracted imposition of gift tax. The matter landed before this Court inthe form of R.C.No.160 of 2000 at the instance of the applicantherein. The applicant did not dispute the existence of firm. Theplea, on the other hand, was that the dissolution of the firm does notbring about any transfer of property, and thereby, the occasion tolevy the gift tax, does not arise. Having acknowledged the existenceof firm in that case, the applicant cannot plead to the contrary, in thiscase. Therefore, questions 1 and 2 are answered against theapplicant. Coming to the third question, the controversy is as to whetherthe house, which was brought into the pool of assets of the firm, canbe treated as stock in trade, and if so, the value thereof. In theincome tax returns, the value thereof was shown as Rs.6,73,000/-. Itis a matter of record that the house was given on rent to aNationalised Bank and it was fetching a rent of about Rs.16,000/-,per month. In the order passed by him, the ITO determined the valueof the property at Rs.17,67,678/-. This figure was arrived at by theprocess of capitalisation i.e. firstly by determining the annual leasesvalued at Rs.1,60,698/- and then multiplying it 11 times. No seriousdoubt is expressed as to the formula adopted by the ITO. Theobjection is mostly about the very process of treating it as a ‘stock intrade’. The Tribunal has undertaken extensive discussion in its orderabout this aspect. It was observed that in the partnership deed itself,the partners made it clear that the property is being contributed as anitem of capital. It was also observed that the identified objective ofthe firm is to carry on the business in real estate and in the activity of that nature, an item of immovable property can certainly be a stock intrade. We are in agreement with the observation made by theTribunal. Learned counsel for the applicant is not able to convinceus to take a different view. Though the value thereof is a subsidiary question, it, in fact, isthe root cause of the entire controversy. It is on account of theescalation of the value that the incidence or imposition of taxtogether with interest has arisen. The contention of the learnedcounsel for the applicant is that, in the context of determining thevalue of an item of stock in trade the determination can be either bytaking its cost, or the prevailing market value into account and anassessee is always entitled to adopt a figure whichever is less oradvantageous to him. Another argument advanced in this behalf isthat in case the ITO was empowered to re-determine the value of anitem, which forms part of the stock in trade, at the stage ofdissolution, he is equally under obligation to determine the valuethereof, when it gained its entry into the assets of the firm byadopting the same parameters. Reliance is placed upon thejudgment of this Court in Commissioner of Income-Tax v. AgarwalEnterprises[[2]]. It is, no doubt, true that in the said judgment, this Court tookthe view that it is competent for the ITO to arrive at his ownconclusion about the value of an item furnished at the stage of entryinto the stock in trade of a firm. That, however, was in a totallydifferent context. At any rate, that question was neither raised beforethe Tribunal, nor it forms part of the questions, referred to us. The manner, in which the value of an asset, which forms partof stock in trade of a firm must be arrived at, is explained by theSupreme Court in A.L.A. Firm’s case (1 supra). Broadly stated, the principle is that (a) the value can be determined on the basis of costor market value and the assessee will have option to choosebetween lesser of them, provided the business or trade is beingcontinued; (b) in case the firm is dissolved or the business activity isdiscontinued, the market value alone becomes relevant. To beprecise, this is what the Hon’ble Supreme Court said: “…G.R.Ramachari and Co.{(1961) 41 ITR 142(Mad)} holds that the principle of valuing the closing stockof a business at cost or market price at the option of theassessee is a principle that would hold good only so longas there is a continuing business and that where abusiness is discontinued, whether on account ofdissolution or closure or otherwise by the assessee, thenthe profits cannot be ascertained except by taking theclosing stock at market value…” This was followed by the Supreme Court in the subsequentjudgments, including Shakthi Trading Co. v. C.I.T.[[3]]. With this, it becomes clear that whatever may have been theliberty of an assessee to choose between the cost and market valueof an asset, whichever is beneficial to him; that liberty stands takenaway when the firm is dissolved, or the business activity isdiscontinued. For the purpose of determining the value of property,which is allotted to the respective partners on dissolution, it is onlythe market value that becomes relevant; and that exactly was takeninto account, in the instant case. We, therefore, answer the third question also against theapplicant and in favour of the Department. The last of the submission made by the learned counsel forthe applicant is about the waiver of interest levied under Section 217of the Act. It is true that Rule 40 of the Income Tax Rules (for short ‘the Rules’), provides for the waiver of such interest levied underSection 217 of the Act, under various circumstances enumeratedunder Clauses 1 to 5, of the Rules, as stood then. It is also true that,no business in its true sense has taken place, in this case, and thesurvival of the firm itself was less than one year and it may be a casefalling under Clause (5) of Rule 40 of the Rules. This, however, canbe appreciated, if only the applicant files an application in thisbehalf. We leave that aspect open. ____________________ L.NARASIMHA REDDY, J. _____________________ CHALLA KODANDA RAM, J. Date:09.07.2014L.R. copy to be marked. GJ [1]189 ITR 285[2]236 ITR 412[3]250 ITR 871189 ITR 285[2]236 ITR 412[3]250 ITR 871