COMMISSIONER OF INCOME-TAX VS BISON KNITTING CO, 2000 PTD-MADRAS-HIGH-COURT-INDIA 2259 (1996)

Income-tax---

----Depreciation---Firm---If there is a change in constitution of firm depreciation allowable only on written down value of assets of firm---If there is no change in constitution depreciation allowable on book value or market value of machinery of firm---S, managing partner in firm---Firm coming to an end and S looking after business as proprietary concern---Proprietary concern becoming partnership concern (assessee-firm)---No connection between assessee-firm and erstwhile firm in which S was managing partner-- No change in constitution of assessee-firm-- Assessee-firm entitled to depreciation on book value of assets of firm---Indian Income Tax Act, 1961, S.32.

There was a firm in existence in which S was the managing partner. That partnership came to an end. Thereafter, S was looking after the concern as her proprietary concern between April 1, 1975 and April 30, 1975. With effect from May 1, 1975, the proprietary concern became a partnership concern (the assessee-firm). For the assessment year 1976-77, the assessee- firm claimed depreciation on a sum of Rs.2,71,138. The Income-tax Officer allowed the claim of the assessee. The Commissioner of Income-tax acting under section 263 of the Income Tax Act, 1961, found that the sum of Rs.2,71,138 represented the book value of the machinery as taken over by the assessee-firm from the predecessor-owner and was not its written down value which should have been adopted as cost for purpose of depreciation The Commissioner of Income-tax set aside the assessment order of the Income-tax Officer and directed him to make a fresh assessment keeping in view the change in the constitution of the firm, the addition alleged to have been made to the machinery account, the profits under section 41(2) in the hands of the earlier firm, etc. On appeal by the assessee-firm, the Tribunal held that when the earlier partnership came to an end and the business was taken over as a proprietary concern by S, it amounted to a sale and, hence the capital gains arising out of that transfer was liable to tax, that when the proprietary business once again became a partnership concern, there was also scope for chargeability to capital against tax, and, therefore, the tax on capital gains on either of these transactions or on both, would be much more than the increase in revenue, that might arise by the adoption of the written down value in the hands of the old firm even if that be permitted as the basis of the cost in the hands of the assessee-firm and that, therefore, there was no prejudice to the Revenue from the order of the Income-tax Officer and cancelled the order of the Commissioner of Income-tax. On a reference:

Held, that if there is a change in the constitution of the firm, depreciation can be claimed only on the written down value of the assets of the firm. If there is no change in the firm, depreciation can be claimed either on the book value or on the market value of the machinery of the firm. In the instant case, after the original firm came to an end, the concern was looked after by S as a proprietary concern between April 1, 1975. and April 30, 1975. The new partnership firm, which was the assessee-firm came into existence from May 1, 1975. There was no connection between the assessee and the erstwhile firm in which S was the managing partner. Therefore, there 'was no change in the constitution of the assessee-firm. Therefore, the assessee-firm was entitled to depreciation on the book value of the assets of the firm and the Tribunal rightly. cancelled the order of the Commissioner under section 263 of the Act.

C.V. Rajan for the Commissioner.

P. P. S. Janarthana Raja for the Assessee.

JUDGMENT

K. A. THANIKKACHALAM, J.---At the instance of the Department, the Tribunal referred the following two questions for the opinion of this Court under section 256(1) of the Income Tax Act, 1961:

"(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in cancelling the order section 263 of the Commissioner of Income-tax on the ground that no prejudice had been caused to the interest of the Revenue by the order of the Income-lax Officer, even though the Income-tax Officer had allowed depreciation on the entire plant and machinery at a uniform rate of 15 per cent.?

(2) Whether, on the facts and in the circumstances of the case, the views taken by the Tribunal that the capital gains that would arise on the transfer of the business by the old firm to the individual, Smt. P. S. Seethalakshmi, and again on the transfer of the proprietary business to the assessee-firm would be more than the increase in the revenue that might arise by the adoption of the written down value of the machinery as the cost of the same in the hands of the assessee-firm, would be relevant to decide the issue as to whether any prejudice has been caused to the interest of the Revenue by the order of the Income-tax Officer?"

The assessee is a firm engaged in the manufacture and sale of hosiery articles. It filed a return for the assessment year 1976-77 on July 23, 1976, admitting an income of Rs:88,169. In arriving at the above income, the assessee had claimed depreciation of Rs.40,671, i.e., at 15 per cent. on Rs.2,71,138. The -Income-tax Officer while completing the assessment, allowed the assessee's. claim as above. Later on, the Commissioner of Income-tax, while scrutinising the said order, found that the sum of Rs.2,71,138 represented the book value of the machinery as taken over by the assessee from the predecessor-owner arid was not its written down value, which alone should have been adopted as cost for depreciation purpose.

Acting under section 263 of the Income-tax Act, the Commissioner gave an opportunity to the assessee asking it to show cause why he should not set aside the Income-tax Officer's order and direct the latter to make a fresh assessment. The assessee stated that there was a firm which was in existence up to March 31, 1975, which owned these machineries originally, that on April 1, 1975, the partnership concern came to an end and the business was taken over by one Smt. P. S. Seethalakshmi as proprietary concern, and with effect from May 1, 1975, the said proprietary concern became a partnership concern. It was further stated that depreciation in respect of machinery was claimed on the sum of Rs.2,71,138 which was the cost of machineries of the firm. It was, therefore, argued that the depreciation as claimed by the assessee and allowed by the Income-tax Officer was correct and hence the assessment order need not be set aside.

The Commissioner after considering all the facts of the case, set aside the assessment order made by the Income-tax Officer and directed him to make a fresh assessment having in view the change in the constitution of the firm, the addition alleged to have been made to the machinery account, the profits under, section 41(2) in the hands of the earlier firm, etc Thereupon, the assessee preferred an appeal to the Appellate Tribunal.

The Tribunal held that when the earlier partnership concern came to an end and the business was taken over as a proprietary concern by Smt, Seethalakshmi, it amounted to sale and hence the capital gains arising out of that transfer was liable to tax. Similarly, when the proprietary business once again became a partnership concern, there also was scope for chargeability to capital gains tax and, therefore, the tax on capital gains on either of these transactions or on both would be much more than the increase in Revenue that might arise by the adoption of the written down value in the hands of the old firm even if that be permitted as the basis of the cost in the hands of the assessee-firm. The Tribunal, therefore, held that there was no prejudice to the Revenue from the order of the Income-tax Officer and the order of the Commissioner of Income-tax deserved to be cancelled.

We have heard learned junior standing counsel appearing for the Department, who contended that the Tribunal was not correct in setting aside the order passed by the Commissioner under section 263 of the Act. According to learned standing counsel, the depreciation ought to have been given in the present case on the written down value of the machineries, since there was change in the constitution of the firm. Learned standing counsel also drew our attention to section 187(2) of the Act in order to elucidate the meaning of the words "change in the constitution of the firm". Ultimately. learned standing counsel contended that the Tribunal was not correct in setting aside the order passed by the Commissioner under section 263 of the Act.

We have also heard learned counsel appearing for the assessee, who supported .the order passed by the Tribunal. According to learned counsel appearing on behalf of the assessee, inasmuch as there is no continuity of the old firm, it cannot be said that there is change to the constitution of the new firm. It was, therefore, submitted that the Tribunal was correct in setting aside the order passed by the Commissioner under section 263 of the Act.

The fact remains that there was a partnership firm in existence in which ` P. S. Seethalakshmi, wife of the late P. Subramaniam, was the managing partner. That partnership firm came to an end Smt. P. S. Seethalakshrni was looking, after the concern as a proprietary concern between April 1, 1975, and April 30, 1975. Thereafter, a partnership firm was constituted, which is the assessee herein. The assessee-firm came into existence on May 1, 1975. The sum of Rs.2,71,138 on which depreciation is claimed by the firm represented the book value of these assets in the hands of the assessee-firm. If there is a change in the constitution of the firm, the depreciation can be claimed only on the written down value of the assets of the firm. If there is no change in the firm; depreciation can be claimed either on the book value or on the market value of the machineries of the firm. In the present case, admittedly, after the original firm came to an end, the concern-was looked after by Smt. Seethalakshmi as a proprietary concern between April 1, 1375, and April 30, 1975. The new partnership firm, which is. an assessee herein, came into existence from May 1, 1975. There is no connection between the assessee-firm and the erstwhile firm in which Smt. Seethalakshmi was the managing partner. Therefore, there is no change in the constitution of the assessee-firm. In such a case, the assessee, is entitled to claim depreciation on the book value. in the present case. The. authorities below were not correct on the facts arising in this case to say that there is a change in the. constitution of the assessee-firm. Since this is the fact, which we have ascertained, we consider that the order passed by the Tribunal in setting aside the order passed by the Commissioner under section 263 of the Act is in order.

The question as framed and referred to us by the Department, does not reflect the two issues arising in this case. Therefore, we reframe the question as under:

"Whether, on the fact and in the circumstances of the case, the Appellate Tribunal was right in cancelling the order under section 263. of the Income Tax Act, 1961, passed by the Commissioner of Income-tax?"

In view of the foregoing reasons, we answer the question in the affirmative and against the Department. There will be no order as to costs.

M.B.A./4104/FC Reference answered.