Income‑tax‑‑‑

‑‑‑‑Stock-in‑trade‑‑‑Firm‑‑‑Conversion of proprietary business into firm‑‑ Proprietor transferring his stock‑in‑trade to firm at cost price ‑‑‑Permissible‑‑‑

It is open to proprietor to value stock‑in‑trade transferred to firm at market rate if it was tower than cost price.

When stock‑in‑trade of a proprietary concern is taken over as part of the capital contribution of a partner who has earlier held the stock as proprietor and the firm continues the same business that the proprietary concern was carrying on, such stock‑in‑trade taken over by the firm, should be valued only at cost price unless the market price was lower in which case it would be open to the proprietor to adopt the lower of the two.

A.L.A. Firm ‑v. CIT" (1991) 189 ITR 285 (SC); Chainrup Sampatram v. CIT (1953) 24 ITR 481 (SC); CIT v. Ahmedabad New Cotton Mills Co. Ltd. AIR 1930 PC 56; (1929) 4 ITC 245 (PC); Kikabhai Premchand v., CIT (1953) 24 ITR 506 (SC) and Whimster & Co. v. CIR (1925) 12 TC 813 (C. Sess) ref.

Mrs. Chitra Venkataraman for the Commissioner Nemo for the Assessee.

JUDGMENT

R. JAYASIMHA BABU, J.‑‑‑It is the contention of the Revenue that when stock‑in‑trade of a proprietary concern is taken over as part of the capital contribution of a partner who has earlier held the stock as proprietor and the firm continues the same business that the proprietary concern was carrying on, such stock‑in‑trade taken over by the firm, should be valued at market rate and not at cost price. No statutory rule requiring valuation on that basis has been relied, upon to support that contention.

Counsel for the Revenue sought to infer such a requirement from the law laid down by the Supreme Court in the case of A.L.A. Firm v. CIT (1991) 189 ITR 285. That was a case where the partners, had valued the stock‑in‑trade at the time of dissolution at the market rate, but had disputed the liability for tax on the amount by which the value of stock‑in‑trade exceeded the cost price, on the ground that the income was only notional.

The Supreme Court while considering the plea elaborately considered the manner in which the stock‑in‑trade is to be valued and after referring to the decisions of the Supreme Court in the cases of Chainrup Sampatram v. CIT (1953)24 ITR 481; Kikabhai Premchand v. CIT (1953) 24 ITR 506, the decisionof the Privy Council in the case of CIT v. Ahmedabad New Cotton Mills Co. LLd., AIR 1930 PC 56, and the decision of the Court in the case of Whimster & Co. v, CIR (1925) 12 TC 813 (C. Sess) held that (page 304):"the proper practice is to value the closing stock at cost. That will eliminate entries relating to the same stock from both sides of the account. To this rule, custom recognises only one exception and that is to value the stock at market value if that is lower. But on no principle can one justify the valuation of the closing stock at a market value higher than the cost as that will result in the taxation of notional profits the assessee has not realised".

To that general rule, the Court recognised an exception in the case of dissolution of firms brought about by the death of a partner or by agreement or otherwise. In such cases, it was held that the adjustment of mutual rights of the persons entitled to the assets of the firm would require the valuation of the closing stock at the market rate as on thedate of dissolution as unless all the assets of the firm arevalued at that rate, the mutual adjust of the rights of theparties cannot be correctly effectuated. The Court observed that (page 307): "the real rights of the partners cannot be mutually adjusted on any other basis".

The exception so recognised by the Court was not meant to be the mother of several more exceptions to be inferred from that exception. What was said in the context of a dissolution of a firm for the, purpose of ensuring the proper adjustment of the rights of the parties entitled to share in the assets of the firm cannot be extended to a case where a proprietary concern is transformed into a partnership firm and the closing stock of the proprietary business is treated as part of the capital contribution of the erstwhile proprietor by valuing the stock in the manner in which it had been valued in the books of the proprietary concern, viz., the cost price. There is no rule as already observed which provides that the stock‑in‑trade of a proprietary Concern when brought into a partnership firm as part of the capital contribution, should be valued at the market rate even when the partners have agreed that the value as shown in the books of the proprietary concern, viz., the cost price should be the basis of valuation of such stock‑in‑trade. No question of adjustment of mutual rights arises when the proprietary concern is transformed into partnership by the proprietor agreeing to take another as his partner. It is for the partners to agree as to the extent of the capital to be contributed by each of the partners and if the capital is brought in the form of stock or goods, as to the value to be assigned, to such stock or goods, so long as the value so assigned is real when the value of the stock‑in‑trade had been recorded in the books of the proprietary concern at the cost price and that stock‑in‑trade had been with the proprietary concern at the time when the partnership firm was constituted; in the books of the proprietary concern, the stock‑in‑trade was necessarily to be valued only at the cost price unless the market price was lower in which case it would have been open to the proprietor to adopt the lower of the two. If the partners, who agreed to enter into the partnership, agreed to adopt that value of the stock‑in‑trade, viz., the cost price for the purpose of ascertaining the value of the capital contribution made by the erstwhile proprietor, there is nothing in law, which would compel them to adopt a method of valuation different from the one that they had chosen to adopt, viz., the cost price.

The Tribunal has rightly held that there was no warrant for the Commissioner to adopt the market price, which admittedly was much higher for u a cost price and to treat the difference as the income of the assessee purposes of taxation. The questions referred to us, viz.:

"(1)Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is correct in law in holding that there is no valid reason for invoking the provisions of section 263 and accordingly in cancelling the order so made for the assessment year 1978‑79?

(2)Whether the Appellate Tribunal's further finding that notwithstanding the fact that the sold proprietary business ceased to exist with effect from April 1, 1978, the closing stock has to be valued only at the cost price is sustainable in law?"

are, therefore, answered in favour of the assessee and against the Revenue As theassessee is unrepresented, there will be no order as to costs.

M.BA./640/FC Reference answered