2008 (2) TMI 487 - AT - Income Tax

Firm's Dissolution: Valuation of Work-in-Progress & Tax Liability under Income Tax Act

Assistant Commissioner Of Income-Tax. Versus GH. Reddy And Associates.

The Tribunal allowed the Revenue's appeal, determining that the firm was dissolved on 31st March 2002, requiring the valuation of work-in-progress at ... Valuation Of Closing Stock Issues Involved:1. Whether the assessee firm could be treated as dissolved for valuing the work-in-progress.2. Whether capital gain is exigible to tax under Section 45(4) of the Income Tax Act, 1961.Issue 1: Dissolution of Firm for Valuing Work-in-ProgressThe primary issue is whether the assessee firm was dissolved on 31st March 2002, necessitating the valuation of work-in-progress at market value. The assessee firm, existing for 24 years, engaged in civil contracts, real estate projects, and computer education centers, demerged its business into an independent unit managed by a group of existing partners as per an MoU dated 1st August 2002. The AO concluded that the firm was dissolved on 31st March 2002, leading to the formation of two new firms and valued the closing work-in-progress at market value, adding Rs. 6,43,43,000 to the income returned. Additionally, invoking Section 45(4) of the IT Act, the AO computed long-term capital gains at Rs. 26,98,020.The CIT(A) held that there was no dissolution of the firm as of 31st March 2002, and thus, the assets need not be valued at market value, and Section 45(4) provisions were not attracted. The Revenue appealed this decision.The Tribunal referred to the A.L.A. Firm vs. CIT case, where the Supreme Court held that upon dissolution, assets should be valued at market value, not at cost or book value. The Tribunal noted that in the present case, there was no overt revaluation of assets, but a covert revaluation was evident through the transfer of assets among partners.The Tribunal concluded that the business was discontinued in relation to the real estate project and computer education centers, and the ratio of the ALA Firm case was applicable. Thus, the AO was correct in adopting the market value of assets as of 31st March 2002. The order of the CIT(A) was reversed, restoring the AO's order.Issue 2: Capital Gain under Section 45(4)The second issue pertains to whether capital gain is exigible to tax under Section 45(4) of the IT Act. The CIT(A) held that there was no dissolution, and thus, Section 45(4) was not applicable. However, the Tribunal referred to the CIT vs. A.N. Naik Associates case, where it was held that capital gain arises in the event of distribution of assets on dissolution of partnership or otherwise. In the present case, capital gains arose on 31st March 2002 when assets were divided among the partners, making it exigible to tax in the year under consideration.ConclusionThe Tribunal allowed the Revenue's appeal, concluding that the firm was dissolved for valuing work-in-progress at market value and that capital gain was exigible to tax under Section 45(4) of the IT Act.