Income-tax---

----Succession of business---Valuation of stock---Conversion of firm to private limited company with erstwhile partners being the only shareholders- Business of firm continued by company---Section 170 applied---Stock of firm could not be valued at market price---Indian Income Tax Act, 1961, S.170.

The assessee-firm was converted into a private limited company, on and from June 1, 1980. The entire business of the firm continued to be carried on by the company, with the partners of the firm as the only share holders and with all the existing assets and liabilities of the firm. The Income-tax Officer held that in computing the income of the dissolved firm for the period ending on April 30, 1980, the closing stock of the firm had to be valued 'at market price. However, the Appellate Assistant Commissioner and the Tribunal found that the business which was run by the firm prior to June 1, 1980, was continued to be run by the successor limited company, its identity had not changed nor was the continuity of the business affected. The Tribunal observed that the intention of the partners in transferring the business to a private limited company was to change the form of" organization. The Tribunal recorded a finding that the dissolution was consequential to the transfer of business to the company. It held that section 170 of the Income Tax Act, 1961, was applicable. On a reference:

Held, that considering the facts and circumstances of the case it was clear that this was not a case where dissolution preceded the transfer. The consistent fact-finding of the three authorities rules out ,the question- of valuation of closing stock at market rate.

CIT v. K. H. Chambers (1965) 55 ITR 674 (SC) ref.

P. K. R. Menon and N. R. K. Nair for the Commissioner.

P. G. K. Wariyar for the Assessee.

JUDGMENT

V. V. KAMAT, J.---The question awaiting our answer is as follows:

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that on the dissolution of the assessee-firm consequent upon the transfer of the business to a limited company it was (sic) necessary to value the stocks as per their market value?"

Reading the question it would be seen that the question has certain factual postulates that there is a dissolution of the assessee-firm and it was consequent upon the transfer of the business to a limited company and it is upon these factual postulates the question poses a problem as to whether or not it was not necessary to value the stock as per their market value.

We have been taken through all the three orders, to reveal that these are not the factual postulates which are the basis of the question posed before us.

However, the factual postulates are quite contrary.

The assessee gets concerned for the assessment year 1981-82 for a very limited period, from April 1, 1980, up to May 31, 1980. The assessment was completed on September 13, 1980, with reference to a total income of Rs.43,630 on acceptance of the income shown in the return.

The factual situation emerging directly from the order of the Income-tax Officer specifies that this partnership firm got converted into a private limited company on and from June 1, 1980. It is thereafter specifically pinpointed that the entire business in the firm was continued to be carried on by the company with the partners of the firm as the only shareholders, and with all the existing assets and liabilities of the firm as a result thereof. .

However, the Income-tax Officer proceeded on the basis to compute the income of the dissolved firm for the period ending on April 30, 198(3, valuing the closing stock as of the above date at cost price of Rs.15,80,349. It was felt that this was wrong because the proper method of valuation, was to value at the market price. This resulted in the issue of notice under section 148 for reopening the assessment under section 147(b) of the Income tax Act.

In the said proceedings the assessment was completed computing a -minimum of 10% profit based on the valuation of stock at price--10% of Rs.15,80,349 and accordingly the Income-tax Officer has furnished the following calculation in his order:

It would be seen that, thus, resorting .to the process of valuation at the market price an amount of Rs.46,467 is shown as the balance amount of due tax.

Further travel of the proceedings before the first appellate authority Commissioner of income-tax (Appeals), Trivandrum, gave success, to the assessee. The first appellate authority has observed that the Income-tax Officer carefully overlooked the position in relation to the activities that are undisputed. The first appellate authority observed that this was not a situation of transfer of assets by one firm to a limited company but what had happened was that the same business was continued to be carried on by a limited company as a successor to the firm making the provisions of section 170 of the Income Tax Act, 1961, really relevant to the situation. .

The first appellate authority pinpointed the real peculiarity of the factual situation and concluded that in such a situation valuation at market rate had no application because in the absence of the situation it was an activity showing features of continuance or rather a process of succession wherein the same partners of the partnership firm changed over as a process of continuation to be under the garb of a private limited company. The appellate authority observed that with regard to such a situation in the process of valuation adoption of the market price value would not control the process of valuation.

The first appellate authorities also o served that there is no doubt in the mind of the Income-tax Officer that in the present case the firm gave up its business and a limited company assumes in of business and as such there was a succession.

The first appellate authority referring to the statutory provisions of section 170(1) of the Income Tax Act, 1961, has correctly observed that in a case where the business is succeeded by another person who continued to carry on that business or profession, the assessment on the predecessor shall be in respect of the income of the previous year in which. the succession took place up to the date of succession. As a logical consequence, the first appellate authority has observed that the successor or the new person-in charge of the business will have to be assessed in respect of the income of the previous year with reference to the date of succession,

In -reaching the above conclusion reliance is placed on the decision of the apex Court in CIT v. K.H. Chambers (1965) 55 ITR 674 laying down some of the well-accepted tests to infer continuation and/or succession, such as continuance of integrity, identity and continuity of business apart therefrom being a change, so-called in ownership.

Again, in the context of the factual position the first appellate authority has observed that the business which was run by the firm prior to June 1, 1980, was continued to be run by the successor limited company, its identity has not been changed nor was the continuity of the business affected. In the light of the above factual position clearly spread over as a factual fact finding, the first appellate authority has distinctly observed that the process :of, valuation at the market price would apply to a case of discontinued business where the stock-in-trade had to be-valued at market price to arrive a1 a settlement of interest of the partners inter, se. It has also emphasised that this will not be the case where the partners of the firm have continued to carry on the business in the new capacity as shareholders in the limited company. This position remains fully settled and undisputed in regard thereto. The first appellate authority, therefore, has deleted the addition made by the Income-tax Officer, allowing the appeal.

This correct and proper view on the basis of factual findings, no wonder, has received endorsement from the Income-tax Appellate Tribunal binding the Revenue before us.

The Tribunal has also fortified the factual position. In this connection, the Tribunal has clearly and specifically recorded as follows:

"There can be no dispute that in the case of dissolution of the firm, the assets are to be valued at their fair market value to the firm. In respect of stock-in-trade, though the assessee has got the option to value it at lower of cost or market price, in the event of dissolution it should be only at the market price. There can be no quarrel over this proposition. But in the case before us what has happened was that all the assets and liabilities of the firm were taken over by the company with the same persons as shareholders. Thus, this is a case of succession of business in entirety by another entity."

The Tribunal has also clarified even a possible confusion by tersely observing that the intention of the partners in transferring the business to a private limited company was to change the form of organisation. In this context, the Tribunal has also referred to clause (3A) of the memorandum of association of the company. The said clause (3A) is as follows:

"3-A. The main objects to be pursued by the company on its in corporation are:

(i) to take over and run the existing firm under the name and style S. Koder having its head office at Trivandrum and branches at Quilon and Kottayam for the purpose of carrying on the objects mentioned in clauses (ii) and (iii) below.

(ii) To deal in provisions and

stores, liquors, medicines, textiles and all such other consumable products.

(iii) To act as merchants and commission agents, manufacturers, manufacturers' representatives and sole selling agents of all products in which they deal."

The Tribunal on the basis thereof has recorded a finding that the dissolution is consequential to the transfer of business to the company and it will have to be held, considering the facts and circumstances of the case that it is nova case where dissolution preceded the transfer.

The consistent fact findings of the three authorities rule out the question of valuation at market rate. We have already observed; at the outset that the framing of the question is contrary to the factual situations referred to above.

For all the, above reasons, we answer the question in the affirmative---against the Revenue and in favour of the assessee.

A copy of the judgment under the seal of this Court and the signature of the Registrar shall be forwarded to the Income-tax Appellate Tribunal, Cochin Bench, as required by law.

M.B.A./3367/FC Reference answered.