Deemed gift on business conversion requires proof of inadequate consideration; continuing business does not mandate market-value stock revaluation.

Conversion of a proprietary concern into a partnership did not, on these facts, create a deemed gift under the Gift-tax Act because the incoming partners contributed capital and the Revenue had not shown inadequacy of consideration for the business as a whole. The business value could not be split by taxing only one asset. The closing stock also did not have to be revalued at market price, since the business continued without discontinuance and ordinary commercial valuation principles applied. The article therefore states that, in a continuing business, a mere change in business form does not by itself justify deemed-gift treatment or compulsory market-value stock revaluation.

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Issues: (i) Whether conversion of a proprietary concern into a partnership with capital contribution by the incoming partners amounted to a deemed gift under the Gift-tax Act, 1958. (ii) Whether, on conversion of the proprietary concern into a partnership, the closing stock had to be valued at market value for computing a taxable gift.

Issue (i): Whether conversion of a proprietary concern into a partnership with capital contribution by the incoming partners amounted to a deemed gift under the Gift-tax Act, 1958.

Analysis: The incoming partners contributed capital and were admitted to the firm with profit-sharing ratios linked to their contribution. The transfer could not be treated as one without consideration merely because the original proprietor gave up part of his interest in the business. For application of the deemed-gift provision, inadequacy of consideration must be established, and the value of the business cannot be fragmented by selecting only one asset for taxation.

Conclusion: The conversion did not amount to a taxable deemed gift, and the finding was in favour of the assessee.

Issue (ii): Whether, on conversion of the proprietary concern into a partnership, the closing stock had to be valued at market value for computing a taxable gift.

Analysis: The business continued without cessation after conversion, so the rule applicable to dissolution cases was inapplicable. In the absence of discontinuance, closing stock is valued according to ordinary commercial principles, namely at cost or market price, whichever is lower. The adoption of market value for the entire closing stock was therefore unsustainable on the facts.

Conclusion: The closing stock was not required to be valued at market value, and this issue was also in favour of the assessee.

Final Conclusion: The reference was answered in favour of the assessee, and the Revenue's stand on deemed gift and stock valuation was rejected.

Ratio Decidendi: For a deemed gift to arise on transfer of a business interest, the Revenue must establish inadequacy of consideration in respect of the business as a whole, and in a continuing business the closing stock is not to be compulsorily revalued at market price merely because the business form changes.

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