1990 (10) TMI 65 - HC - Income Tax

Valuation of closing stock in partnership dissolution must be at market value for accurate profit calculation.

Commissioner Of Income-Tax Versus Bharath Auto Stores

The court held that upon the dissolution of a partnership firm, the valuation of closing stock should be at market value, not book value as per the ... Developement Rebate, Reserve Issues Involved:1. Valuation of closing stock on the dissolution of a partnership firm.2. Applicability of the partnership deed provision on asset valuation upon dissolution.3. Binding nature of partnership agreements on Revenue.Detailed Analysis:1. Valuation of Closing Stock on the Dissolution of a Partnership Firm:The primary issue was whether the closing stock should be valued at book value or market value upon the dissolution of the partnership firm. The assessee, a partnership firm, had consistently valued its closing stock at book value as per clause 19 of its partnership deed. However, upon dissolution on March 31, 1974, the Income-tax Officer revalued the closing stock at market value, resulting in an addition of Rs. 90,468 to the income returned by the assessee.The court observed that during the continuance of the business, the valuation of stock at book value might be justified for ascertaining annual profits or losses. However, upon dissolution, there is a 'total disruption of the firm and its business activities,' necessitating the conversion of every asset into money for settling accounts. The court referred to Lindley on the Law of Partnership, emphasizing that an agreement on stock valuation during the partnership's continuance may not apply upon dissolution.2. Applicability of the Partnership Deed Provision on Asset Valuation Upon Dissolution:Clause 19 of the partnership deed stipulated that assets, including stock on hand, should be valued at book value upon dissolution. The Tribunal had upheld this clause, but the court disagreed, stating that such a provision might hold good between partners but not for the Revenue. The court highlighted that the Revenue has a right to a certain percentage of the firm's profits by way of income-tax, which cannot be compromised by internal agreements among partners.The court cited several precedents, including G. R. Ramachari and Co. v. CIT [1961] 41 ITR 142 (Mad) and A. L. A. Firm v. CIT [1976] 102 ITR 622 (Mad), which established that upon dissolution, the stock must be valued at market value to determine the true state of profits or losses. These cases reinforced the principle that the method of valuation during the business's continuance does not apply at the point of dissolution.3. Binding Nature of Partnership Agreements on Revenue:The court emphasized that while partners might agree on certain valuation methods, these agreements are not binding on the Revenue. The court referred to the decision in Spanish Prospecting Co. Ltd., In re [1911] 1 Ch 92 (CA), which stated that profits, especially when third-party rights like those of the Revenue are involved, must be calculated based on actual money value.The court also addressed the decisions cited by the assessee, such as CIT/CEPT v. Chari and Ram [1949] 17 ITR 1 (Mad) and CIT v. K. Sankarapandia Asari and Sons [1981] 130 ITR 541 (Mad), noting that these cases did not involve the dissolution of a firm and were therefore not applicable.Conclusion:The court concluded that the valuation of stock upon the dissolution of a partnership firm should be at market value and not book value, irrespective of any internal agreements among partners. The question referred to the court was answered in the affirmative, in favor of the Revenue, with the Revenue being entitled to costs.