Arjundas Rajkumar and others V. Commissioner of Income-tax, Hyderabad

RC/112/2001

AI Insights

The case involves a dispute over the valuation of properties and the tax implications following the dissolution of a partnership firm. The firm, consisting of Susheela Devi and her two sons, was formed to manage family properties but was dissolved within a year. The Income Tax Officer (ITO) revalued the properties significantly higher than declared in the tax returns, leading to increased tax liabilities. The firm contested these valuations and the consequent tax assessments, which were upheld by the Commissioner and the Tribunal. The matter was referred to the High Court to resolve specific legal questions regarding the nature of the partnership and the appropriate valuation of the properties.

• Counselvise Citation: [2014] 140 COUNSELVISE.COM (IT) 818764 (HC-HYDERABAD)
• Appeal Type: Others
• Pronouncement Date: 09-07-2014
• Assessment Year: misc
• Other Referred Cases: A.L.A. Firm v. Commissioner of Income Tax, Commissioner of Income-Tax v. Agarwal Enterprises, Shakthi Trading Co. v. C.I.T.
• Laws Referred To: Income Tax Act, 1961
• Result in Favour of: Revenue
• Court: HIGH COURT
• Department Lawyers: S R ASHOK
• Assessee Lawyers: Y RATNAKAR
• Keywords: Capital asset; Dissolution; Immovable Property; Income Tax; Partnership; Stock-in-Trade; Valuation
• Section: 256(2); 217; 139B

Judgement Text

"* 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. …applicant. and $.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 285 2. 236 ITR 412 3. 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 the Income 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 the circumstances of the case and on cumulative consideration of all relevant factors and in existence it could be said that the parties never intended to carry on any business and whether the nature of partnership by a deed dated 07.04.1986 was for extraneous purpose other than carrying on business? 2. Whether on the facts and in circumstances of the case, the Tribunal is correct in its conclusion that there can be a firm in existence both in form and substance and it is immaterial whether the object of the firm was to carry on business in real estate or for any other purpose? 3. Whether on the facts and in the circumstances of the case the immovable properties bearing Municipal No.7-8-757/1/F Godown Road, Nizamabad and Plot No.3 and 4, Yellamma Nizamabad are capital asset or stock in trade of partnership?” Briefly stated, the facts are that, the applicant-firm comprised of three partners, namely Susheela Devi and her two sons, Arjundas and Rajkumar. The firm was constituted through a partnership deed, dated 07.04.1986. Before the constitution of the firm, the mother and two sons had equal shares, in an item of immovable property, being a house at Nizamabad. Another item was an open land, in which two brothers had equal shares. Both the properties were pooled into assets of the firm towards the respective shares of the partners. The firm, however, was dissolved on 02.04.1987. On dissolution, the entire house was allotted to the share of Susheela Devi, whereas the entire landed property was allotted to the share of Rajkumar. Arjundas appears to have been allotted either cash component, or other properties. In the returns filed by the firm, the value of various properties were shown. The Income Tax Officer (ITO), who processed the return, took the view that the value of the house would be Rs.17,67,678/-. The basis was that he determined the annual lease value at Rs.1,60,698/- and multiplied the same, 11 times. This lead to the increase in the value of the property and treated the total income as Rs.13,88,370/-. The difference of tax of Rs.6,49,969/-, together with interest, of Rs.58,925/-, under Section 139B of the Act, and an additional interest, of Rs.29,571/-, under Section 217 of the Act, were levied. Aggrieved by the order of the Assessing Authority, the applicant carried the matter in appeal before the Commissioner. The order of the ITO was affirmed, by the Commissioner, through his order, dated 01.02.1991. Thereafter, the applicant filed I.T.A.No.488/Hyd/1991 before the Tribunal. The appeal was dismissed, through a detailed order, dated 26.06.1992. The applicant filed R.A.No.303 of 1992 with a request to refer the three questions, mentioned above, to this Court. When the request 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 that the very act of the I.T.O. in determining the value of the house at Rs.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 settled practice and principle not only in the accountancy, but also in the field of taxation that an assessee, who undertakes trade, is entitled to take the cost, of an asset, or its market value, whichever is less. He submits that the firm was brought into existence only as a device to readjust the shares in the immovable properties held by the family members and it cannot be treated as a firm within the meaning of the Partnership Act. He contends that the very fact that it stood dissolved within one year and that hardly any activity was undertaken, would demonstrate that it was a nominal entity and was not intended to be an agency to carry on business. He submits that the same principle applies, whether the firm is continuing or stood dissolved. Learned counsel further submits that the view taken by the ITO, the Commissioner and the Tribunal cannot be supported in law and that all the three questions deserve to be answered in favour of the applicant. Another facet of the argument of the learned counsel is that the ITO ought not to have levied interest under Section 217 of the Act or at any rate, he ought to have waived it in the given facts and circumstances of the case. He has placed reliance upon some precedents. Sri S.R.Ashok, learned Senior Standing Counsel for the Income Tax Department, on other hand, submits that, once the firm was brought into existence, through a registered document and certain profits were also posted in the profit and loss account, it cannot be treated as a nominal entity, and that questions 1 and 2 deserve to be answered against the applicant. He submits that in R.C.No.160 of 2000, referred to this Court, at the instance of this very applicant, the very existence of the partnership firm is not doubted, or challenged 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 be the value furnished by an assessee about an item, which is part of stock in trade, the determination of market value becomes relevant, particularly when the firm is dissolved and the business activity is discontinued. Placing reliance upon the judgment of the Supreme Court in A.L.A. Firm v. Commissioner of Income Tax[1], learned Senior Counsel submits that subtle distinction in this behalf was clearly maintained by the Supreme Court and that the same has been applied by the ITO, the Commissioner and Tribunal in the instant case. Though the three questions are referred, questions 1 and 2 covered one facet and question No.3, another. The purport of questions 1 and 2 is about the nature of the firm and the legal consequences flowing from it. The effort of the applicant is to convince this Court that the firm was only a nominal entity and it did not have any difference, whether it was dissolved or not, and the entire controversy turned around it. There may be instances where the firms are brought into existence nominally and no activity is undertaken by them. In cases of that nature, the assessee may convince ITO, and if the pleaded facts are proved, the ITO himself may ignore the existence of such firm. Where however, the firm is brought into existence through a registered document and separate returns are field on behalf of the firm, posting profits and furnishing other ingredients of a typical return, 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 the properties took place in a manner, different from the one, in which they were held before the constitution of the firm. That, in turn, attracted imposition of gift tax. The matter landed before this Court in the form of R.C.No.160 of 2000 at the instance of the applicant herein. The applicant did not dispute the existence of firm. The plea, on the other hand, was that the dissolution of the firm does not bring about any transfer of property, and thereby, the occasion to levy the gift tax, does not arise. Having acknowledged the existence of firm in that case, the applicant cannot plead to the contrary, in this case. Therefore, questions 1 and 2 are answered against the applicant. Coming to the third question, the controversy is as to whether the house, which was brought into the pool of assets of the firm, can be treated as stock in trade, and if so, the value thereof. In the income tax returns, the value thereof was shown as Rs.6,73,000/-. It is a matter of record that the house was given on rent to a Nationalised Bank and it was fetching a rent of about Rs.16,000/-, per month. In the order passed by him, the ITO determined the value of the property at Rs.17,67,678/-. This figure was arrived at by the process of capitalisation i.e. firstly by determining the annual leases valued at Rs.1,60,698/- and then multiplying it 11 times. No serious doubt is expressed as to the formula adopted by the ITO. The objection is mostly about the very process of treating it as a ‘stock in trade’. The Tribunal has undertaken extensive discussion in its order about this aspect. It was observed that in the partnership deed itself, the partners made it clear that the property is being contributed as an item of capital. It was also observed that the identified objective of the 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 in trade. We are in agreement with the observation made by the Tribunal. Learned counsel for the applicant is not able to convince us to take a different view. Though the value thereof is a subsidiary question, it, in fact, is the root cause of the entire controversy. It is on account of the escalation of the value that the incidence or imposition of tax together with interest has arisen. The contention of the learned counsel for the applicant is that, in the context of determining the value of an item of stock in trade the determination can be either by taking its cost, or the prevailing market value into account and an assessee is always entitled to adopt a figure whichever is less or advantageous to him. Another argument advanced in this behalf is that in case the ITO was empowered to re-determine the value of an item, which forms part of the stock in trade, at the stage of dissolution, he is equally under obligation to determine the value thereof, when it gained its entry into the assets of the firm by adopting the same parameters. Reliance is placed upon the judgment of this Court in Commissioner of Income-Tax v. Agarwal Enterprises[2]. It is, no doubt, true that in the said judgment, this Court took the view that it is competent for the ITO to arrive at his own conclusion about the value of an item furnished at the stage of entry into the stock in trade of a firm. That, however, was in a totally different context. At any rate, that question was neither raised before the Tribunal, nor it forms part of the questions, referred to us. The manner, in which the value of an asset, which forms part of stock in trade of a firm must be arrived at, is explained by the Supreme 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 cost or market value and the assessee will have option to choose between lesser of them, provided the business or trade is being continued; (b) in case the firm is dissolved or the business activity is discontinued, the market value alone becomes relevant. To be precise, 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 stock of a business at cost or market price at the option of the assessee is a principle that would hold good only so long as there is a continuing business and that where a business is discontinued, whether on account of dissolution or closure or otherwise by the assessee, then the profits cannot be ascertained except by taking the closing stock at market value…” This was followed by the Supreme Court in the subsequent judgments, including Shakthi Trading Co. v. C.I.T.[3]. With this, it becomes clear that whatever may have been the liberty of an assessee to choose between the cost and market value of an asset, whichever is beneficial to him; that liberty stands taken away when the firm is dissolved, or the business activity is discontinued. For the purpose of determining the value of property, which is allotted to the respective partners on dissolution, it is only the market value that becomes relevant; and that exactly was taken into account, in the instant case. We, therefore, answer the third question also against the applicant and in favour of the Department. The last of the submission made by the learned counsel for the applicant is about the waiver of interest levied under Section 217 of 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 under Section 217 of the Act, under various circumstances enumerated under 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 the survival of the firm itself was less than one year and it may be a case falling under Clause (5) of Rule 40 of the Rules. This, however, can be appreciated, if only the applicant files an application in this behalf. We leave that aspect open. ____________________ L.NARASIMHA REDDY, J. _____________________ CHALLA KODANDA RAM, J. Date:09.07.2014 L.R. copy to be marked. GJ [1] 189 ITR 285 [2] 236 ITR 412 [3] 250 ITR 871 "