2006 (2) TMI 118 - HC - Income Tax

Valuation of closing stock in business conversion clarified by High Court decision

The High Court upheld the Income-tax Appellate Tribunal's decision that the closing stock in a case of converting a proprietary business into a ... Conversion of proprietary business into partnership firm – valuation of stock - 'Whether, Tribunal is correct in law in holding that in the case of conversion of proprietary business into partnership firm, the stock should not be valued at market price?' - Tribunal has rightly held that though the conversion of a proprietary business into partnership is undoubtedly a transfer, it could not be said that the nominal value credited to capital account in the hands of the firm is the consideration for the transfer. It is only when the business is closed forever, the question of valuing the stock at the market price might arise. In this case, it cannot be said that the assessee has ceased to remain in the same business, when he converted his proprietary business into a partnership. That apart the Revenue has also not placed any material before the Appellate Tribunal to sustain its claim that the stock should be valued at the market price. In the absence of any material placed before the Appellate Tribunal, we hold that the Appellate Tribunal was justified in coming to the conclusion that the closing stock should not be valued at the market price. Issues: Valuation of stock in case of conversion of proprietary business into a partnership firm.In the judgment delivered by the High Court, the court considered the question of law referred by the Income-tax Appellate Tribunal regarding the valuation of stock in the case of conversion of a proprietary business into a partnership firm for the assessment year 1983-84. The issue arose when the Revenue appealed against the acceptance of loss claimed by the assessee in the sole proprietary concern after its conversion into a partnership firm. The Commissioner of Income-tax (Appeals) set aside the assessment order, directing the Assessing Officer to revalue the stock according to market price based on previous court decisions. However, the Income-tax Appellate Tribunal overturned this decision, stating that the nominal value credited to the capital account in the hands of the firm was not the consideration for the transfer, as per the Supreme Court decision in Sunil Siddharthbhai v. CIT. The Tribunal referred the question of law to the High Court.During the hearing, the senior standing counsel for the Revenue acknowledged that the issue was against the Revenue based on previous court decisions, including the Supreme Court decision in Sakthi Trading Co. v. CIT and the High Court decision in K. Shanmuganathan v. CGT. The court emphasized the commercial practice and accountancy rule that in the absence of business discontinuance, the closing stock should be valued at cost or market price, whichever is lower, upon conversion. Referring to previous decisions, the court held that since there was no cessation of business in the conversion from proprietary to partnership, the closing stock should be valued at cost or market price, whichever is lower.The High Court agreed with the Income-tax Appellate Tribunal's decision that the nominal value credited to the capital account in the partnership firm was not the consideration for the transfer, emphasizing that valuation at market price would only be necessary if the business had permanently closed. The court noted the lack of material presented by the Revenue to support valuing the stock at market price. Consequently, the court upheld the Tribunal's decision, ruling that the closing stock should not be valued at the market price. The question of law was answered in the affirmative, favoring the assessee and against the Revenue.