The Issue Appears To Have Come Up For The First Time Under Theprovisions Of The Indian Income Tax Act, 1922 When The Supremecourt Dealt With The Succession Of A v. M/S.hansa Footwear

*HONOURABLE THE CHIEF JUSTICE SHRI MADAN B.LOKURANDHONOURABLE SHRI JUSTICE SANJAY KUMAR +I.T.T.A. NO.36 OF 1999% 26-12-2011# The Commissioner of Income Tax,A.P.-I, Hyderabad. … AppellantVs.$ M/s.Hansa Footwear,12-2-709/1, Berbun,Hyderabad. … Respondent<GIST:>HEAD NOTE:! Counsel for appellant : Sri S.R.Ashok^ Counsel for respondent : Sri A.V.Krishna Koundinya ? CASES REFERRED: 1)(1965) 55 I.T.R. 674 (SC)2)(1998) 233 I.T.R. 6203)(2003) 263 I.T.R. 3452)(1998) 233 I.T.R. 6203)(2003) 263 I.T.R. 345 HONOURABLE THE CHIEF JUSTICE SHRI MADAN B.LOKURANDHONOURABLE SHRI JUSTICE SANJAY KUMAR I.T.T.A. NO.36 OF 1999 JUDGMENT: (PER HON’BLE THE CHIEF JUSTICE SHRI MADAN B.LOKUR) The substantial question of law framed for our consideration is asfollows: “Whether on the facts and circumstances of the case, the appellateTribunal was correct in holding that the closing stock of the firmshould be evaluated at cost price for the purpose of determination ofincome notwithstanding the closure of business by the partnershipfirm and take over of the business by an independent legal entity viz.,the company?”Tribunal was correct in holding that the closing stock of the firmshould be evaluated at cost price for the purpose of determination ofincome notwithstanding the closure of business by the partnershipfirm and take over of the business by an independent legal entity viz.,the company?” 2. The assessee was in the business of manufacturing footwear. Itwas initially a partnership firm but subsequently it got converted into aprivate limited company in accordance with Chapter IX of theCompanies Act, 1956. All the partners became shareholders in thecompany and their respective shareholding was in the sameproportion as in the partnership firm. 3. The assets of the partnership firm, i.e. footwear, was taken overby the company and the question that arose before the AssessingOfficer was whether the closing stock of the partnership firm should betaken at market value or not. According to the assessee, the closingstock should be taken at the cost price and not at the market value. 4. The Assessing Office came to the conclusion that the closingstock should be taken at the market value and passed an assessmentorder accordingly. 5. Before the Commissioner of Income Tax (Appeals), the assessee was not able to succeed and accordingly the assessmentorder was confirmed by the Commissioner of Income Tax (Appeals). 6. In a further appeal, the Income Tax Appellate Tribunal (for short,‘the Tribunal’) decided in favour of the assessee and came to theconclusion that there was no transfer of assets and therefore theprovisions of Section 170 of the Income Tax Act, 1961 (for short, ‘theAct’) were not applicable in as much as there was no capital gain in sofar as the assessee is concerned. 7. Section 170(1) of the Act deals with succession to businessotherwise than on death and reads as follows: “170. (1) Where a person carrying on any business orprofession (such person hereinafter in this section being referred toas the predecessor) has been succeeded therein by any otherperson (hereinafter in this section referred to as the successor) whocontinues to carry on that business or profession,- (a)the predecessor shall be assessed in respect of theincome of the previous year in which the successiontook place up to the date of succession;income of the previous year in which the successiontook place up to the date of succession; (b)the successor shall be assessed in respect of theincome of the previous year after the date ofsuccession.”income of the previous year after the date ofsuccession.” 8. The question of determining capital gains would be referable toSection 45 of the Act read with Section 47 of the Act. (a)the predecessor shall be assessed in respect of theincome of the previous year in which the successiontook place up to the date of succession;income of the previous year in which the successiontook place up to the date of succession; (b)the successor shall be assessed in respect of theincome of the previous year after the date ofsuccession.”income of the previous year after the date ofsuccession.” 8. The question of determining capital gains would be referable toSection 45 of the Act read with Section 47 of the Act. 9. The issue appears to have come up for the first time under theprovisions of the Indian Income Tax Act, 1922 when the SupremeCourt dealt with the succession of a business from the ‘transferor’ tothe ‘transferee’. In COMMISSIONER OF INCOME-TAX, MADRAS v. K.H.CHAMBERS[[1]]the export business of the father was taken overby the son. The entire business was transferred and the identity of thebusiness was preserved in as much as the same business continued.The Supreme Court recognised that succession involves change ofownership, that is, the transferor goes out and transferee comes in; itconnotes that the whole business is transferred, and that substantiallythe identity and continuity of the business is preserved. In a transfer ofbusiness, an arrangement between the transferor and transferee in respect of some of the assets and liability, not with a view to enable thetransferor to run a part of the business transferred but to enable thetransferee to run the business unhampered by the load of debts or forany other appropriate collateral purpose, cannot detract from thetotality of the succession. 10. In this backdrop, the Supreme Court interpreted Section 25(4) ofthe Indian Income Tax Act, 1922 and held that the tests of change ofownership, integrity, identity and continuity of a business have to besatisfied before it can be said that a partner has succeeded to thebusiness of another. 11. Following the decision of the Supreme Court, the Kerala High Court in COMMISSIONER OF INCOME-TAX v. KODER[[2]]came tothe conclusion, based on the facts of that case, that the assets andliabilities of the erstwhile firm were taken over by the company with thesame persons as shareholders. Therefore, it was a case of successionof business in its entirety by another entity. Consequently, the questionwhether the assessee firm, upon the transfer of its business to a limitedcompany, was obliged to value the stocks as per the market value wasanswered in the negative. 12. We find from a perusal of COMMISSIONER OF INCOME-TAX v. TEXSPIN ENGINEERING AND MANUFACTURING WORKS[[3]]thatthere is a far more elaborate discussion on the subject taking intoconsideration the provisions of Section 45 of the Act as well as theprovisions of Chapter IX of the Companies Act. In this decision, theBombay High Court noted that Section 45(4) of the Act provides for twoconditions to be satisfied, namely, that there must be a transfer ofassets by way of distribution and secondly, such transfer should be ondissolution of the firm or otherwise. If these two conditions aresatisfied, then for the purposes of computation of capital gains underSection 48 of the Act, the market value on the date of transfer shall bedeemed to be the full value of the consideration received or accruing as a result of the transfer. TEXSPIN ENGINEERING AND MANUFACTURING WORKS[[3]]thatthere is a far more elaborate discussion on the subject taking intoconsideration the provisions of Section 45 of the Act as well as theprovisions of Chapter IX of the Companies Act. In this decision, theBombay High Court noted that Section 45(4) of the Act provides for twoconditions to be satisfied, namely, that there must be a transfer ofassets by way of distribution and secondly, such transfer should be ondissolution of the firm or otherwise. If these two conditions aresatisfied, then for the purposes of computation of capital gains underSection 48 of the Act, the market value on the date of transfer shall bedeemed to be the full value of the consideration received or accruing as a result of the transfer. 13. On the facts of that case, it was noted that there was no disputethat the erstwhile firm became a limited company under Chapter IX ofthe Companies Act. The assets of the erstwhile firm vested in thecompany and as such there was no transfer of assets by way ofdistribution. The Bomaby High Court noted the difference betweenvesting of property and distribution of property. On conversion of apartnership firm into a company under Chapter IX of the CompaniesAct, the assets and property of the erstwhile firm vest in the company.On the other hand, distribution or appropriation takes place when theprovisions of Chapter IX of the Companies Act are not applicable, suchas in a case of dissolution of the firm which presupposes division,realisation, encashment of assets and appropriation of the realisedamount. The Supreme Court also made a note of the insertion ofclause (xiii) in Section 47 of the Act. This sub-section was inserted byFinance (No.2) Act, 1998 and although the Court was not concernedwith the amendment (nor are we concerned with the amendment), itwas noted that the amendment provides a clue to the legislative intentwith the purpose of encouraging firms to become limited companies. 14. In view of the elaborate discussion undertaken by the HighCourt, it was held that the Tribunal in that case was justified in holdingthat the provisions of Sections 45(1) and 45(4) of the Act were notattracted even though there was a ‘transfer’ of assets from the firm to anewly constituted company on conversion of the firm to a companyunder Chapter IX of the Companies Act. 15. The view expressed by the Bombay High Court was followed inCOMMISSIONER OF INCOME-TAX v. RITA MECHANICALWORKS, which is an unreported decision but is available as‘MANU/PH/3828/2010’ decided on 24.09.2010 by the Punjab andHaryana High Court. The High Court took the view that in a casewhere a firm is converted into a company under Chapter IX of theCompanies Act, there is no conveyance of property in favour of the limited company and there is only vesting of property in that company.Accordingly, the Punjab and Haryana High Court took the view that theTribunal was right in holding that taking over of assets of the firm bythe company and allotting shares to the erstwhile partners of the firmas per their holdings in the firm did not give rise to profit chargeable tocapital gains under Section 45(4) of the Act. 16. In so far as the present appeal is concerned, the facts of the caseindicate that the firm was converted into a private limited companyunder Chapter IX of the Companies Act. The shareholding of theerstwhile partnership firm remained the same upon conversion of thefirm into a company. Effectively, there was no transfer of assets of thefirm to the company. It is only that the business was taken over by thecompany. That being the position and on the basis of the case law thatwe have already referred to above, it is quite clear that the closingstock of the erstwhile firm cannot be valued at the market price. 16. In so far as the present appeal is concerned, the facts of the caseindicate that the firm was converted into a private limited companyunder Chapter IX of the Companies Act. The shareholding of theerstwhile partnership firm remained the same upon conversion of thefirm into a company. Effectively, there was no transfer of assets of thefirm to the company. It is only that the business was taken over by thecompany. That being the position and on the basis of the case law thatwe have already referred to above, it is quite clear that the closingstock of the erstwhile firm cannot be valued at the market price. 17. Under the circumstances, the Tribunal was correct in coming tothe conclusion that both the Assessing Officer as well as theCommissioner of Income Tax (Appeals) had erroneously decided thatthe closing stock of the erstwhile firm should be valued at the marketprice. 18. Under the circumstances, the substantial question of law isanswered in the affirmative, in favour of the assessee and against theRevenue. 19. The Appeal stands disposed of on the above terms. ( MADAN B.LOKUR, CJ ) ( SANJAY KUMAR, J ) VGSR/TNB HONOURABLE THE CHIEF JUSTICE SHRI MADAN B.LOKURANDHONOURABLE SHRI JUSTICE SANJAY KUMAR I.T.T.A. NO.36 OF 1999 Dt: 26.12.2011 Between The Commissioner of Income Tax,A.P.-I, Hyderabad. …Appellant AND M/s.Hansa Footwear,12-2-709/1, Berbun,Hyderabad. …Respondent [1] (1965) 55 I.T.R. 674 (SC) (1965) 55 I.T.R. 674 (SC) [2] (1998) 233 I.T.R. 620 [3] (2003) 263 I.T.R. 345 (2003) 263 I.T.R. 345