2010 (11) TMI 661 - AT - Income Tax

Revenue appeal partly allowed, remanding issues for fresh consideration. Recomputation of capital gains and verification of labour charges required.

ITO Versus Om Namah Shivay Builders and Developers

The Tribunal partly allowed the Revenue's appeal, remanding both issues for fresh consideration. The first issue regarding the addition of Rs. 62,13,027 ... Addition - difference between the estimated fair market value and book value of the stock in trade and other assets of the firm - Assessing Officer issued a show-cause notice dated 20-12-2007 calling upon the assessee to show cause as to why the capital gain on transfer of the properties by the firm to one of its partners on dissolution of the firm be not brought to tax under the head 'capital gains - The law with regard to distribution of assets to partners on dissolution of a firm, as it originally prevailed and subsequent legislative amendments are as follows - It also observed that the position of law could not have been different for determination of the quantum of income even without specific reference to market value under section 45(4), because it is on the basis of the market value that the remaining assets of the firm are divided between the partners Regarding labour charges - In the year in the project is completed, it may not be possible for the Assessing Officer to embark upon an enquiry as to whether labour charges incurred for an earlier assessment year which has already been considered as part of WIP, is genuine or not - Appeal is allowed for statistical purpose Issues Involved:1. Deletion of addition of Rs. 62,13,027 by CIT(A) regarding the difference between the estimated fair market value and book value of stock in trade and other assets on dissolution of the partnership firm.2. Deletion of disallowance of Rs. 9,55,879 by CIT(A) regarding labour charges.Issue-wise Detailed Analysis:1. Deletion of Addition of Rs. 62,13,027:The Revenue challenged the deletion of the addition of Rs. 62,13,027 made by the Assessing Officer (AO) on account of the difference between the estimated fair market value (FMV) and the book value of stock in trade and other assets upon the dissolution of the partnership firm. The firm, initially constituted by a deed dated 1-4-2001, consisted of two partners and was involved in real estate development. Upon the death of one partner and subsequent retirement of the legal heirs, the firm was dissolved on 31-7-2004, and the surviving partner took over all assets and liabilities.The AO issued a show-cause notice to the assessee, arguing that the dissolution and transfer of assets to the surviving partner amounted to a taxable transfer under the head 'capital gains'. The AO added Rs. 62,13,027 to the assessee's income, representing the difference between the FMV of work-in-progress and its book value.The CIT(A) deleted the addition, relying on the Supreme Court's decision in Sakthi Trading Co. v. CIT, which held that in cases of dissolution without discontinuance of business, closing stock should be valued at cost or market price, whichever is lower. The CIT(A) concluded that since the business continued without disturbance, the stock should not be valued at market price.Upon appeal, the Tribunal observed that the AO's assessment should have been under 'capital gain' rather than 'business income'. The Tribunal referred to section 45(4) of the Income-tax Act, 1961, which considers the distribution of capital assets on dissolution as a transfer, taxable as capital gains. The Tribunal noted that the firm was dissolved, and the project was taken over by the surviving partner, constituting a transfer of capital assets. The Tribunal reversed the CIT(A)'s order, stating that the FMV of the assets on the date of dissolution should be deemed the full value of consideration for computing capital gains. The matter was remanded to the AO for fresh computation of capital gains.2. Deletion of Disallowance of Rs. 9,55,879:The Revenue also contested the deletion of Rs. 9,55,879 by the CIT(A), which was disallowed by the AO as labour charges. The AO had issued notices to verify the genuineness of the transactions, which were returned unserved. Consequently, the AO disallowed the amount.The CIT(A) accepted the assessee's submission that the project was ongoing and the costs, including labour charges, formed part of the work-in-progress. The CIT(A) opined that even if some labour charges were unverifiable, it would not affect the income for the year under consideration as the project was not completed, and the valuation of closing stock would adjust accordingly.The Tribunal, however, held that the CIT(A) should have determined the genuineness of the labour charges. It noted that verifying such expenses in the year of project completion might not be feasible. Therefore, the Tribunal remanded the issue back to the CIT(A) for a fresh determination of the genuineness of the labour charges.Conclusion:The Tribunal partly allowed the Revenue's appeal, remanding both issues for fresh consideration. The first issue regarding the addition of Rs. 62,13,027 was remanded to the AO for recomputation of capital gains, while the second issue concerning the disallowance of Rs. 9,55,879 was remanded to the CIT(A) to verify the genuineness of the labour charges.