By TIOL News Service

NEW DELHI, JULY 17, 2017: THE ISSUE BEFORE THE APEX COURT IS - Whether where a partnership firm stood dissolved by the operation of law in view of death of one of the partners, but the business did not come to an end as the other partner continued with the business, there is no question of selling the assets of the firm and therefore it is not necessary to value stock-in-trade at market price. YES is the verdict.

Facts of the case:

The assessee was a registered firm engaged in the business of sale of scrap of ship materials. The firm was constituted with two partners, i.e., mother and son. During the period under consideration, the firm was dissolved on account of the death of one of the partners. At the time of dissolution, the firm had valued the closing stock at cost price. The assessee thereafter filed return of income showing total income of Rs.16,41,760/- for A.Y 1993-1994. On this return, the assessment order was passed by the AO u/s 143(3) accepting the method of valuation adopted by the assessee. Subsequently, the CIT in exercise of his revisional jurisdiction u/s 263 issued show cause notice and directed the AO to value the closing stock at the time of dissolution at the market price. He therefore added the average gross profit of 15 per cent to the disclosed value of the closing of Rs.12 crores and the same resulted in addition of Rs.1,82 crores. The assessee questioned the validity of the order passed u/s 263 of the Act taking the plea that revisional jurisdiction could not be exercised in this manner. When the matter reached the High Court, the assessee's contention was accepted and the revisional order passed by CIT was set aside.

On appeal, the SC held that,

++ this Court is concerned with the validity of exercise of jurisdiction by CIT u/s 263 of the Act. Whereas the CIT, while exercising this power, relied upon the judgment of this Court in A.L.A. Firms , wherein the High Court while upsetting the said order referred to the judgment of this Court in Sakthi Trading Co. v. Commissioner of Income Tax - 2002-TIOL-569-SC-IT, wherein it was held that such a power given to the Commissioner to revise the order of AO is constitutionally valid having regard to the fact that the Department has no right of appeal to the CIT (A) against any order passed by the AO. It is for this reason, Section 263 is enacted to empower the Commissioner with the authority of revising the order of Assessing Officer, where the order is erroneous and the error has resulted in prejudice to the interests of the Revenue. As is clear from the language of the provision, there has to be a proper application of mind by the Commissioner to come to a firm conclusion that the order of the Assessing Officer is erroneous and prejudicial to the interests of the Revenue. At the same time, this Court has also laid down that this provision cannot be invoked to correct each and every type of mistake or error committed by the AO. While interpreting the expression 'prejudicial to the interests of the Revenue', it is also held that order of AO cannot be termed as prejudicial simply because AO has adopted one of the courses permissible in law and it has resulted in loss of revenue, or where two views are possible and the AO has taken one view with which the Commissioner did not agree. It is clear from the above that where two view are possible and the Assessing Officer has taken one view and the the CIT again revised the said order on the ground that he does not agree with the view taken by the AO, in such circumstances the assessment order cannot be treated as an order erroneous or prejudical to the interest of the Revenue. Reason is simple. While exercising the revisionary jurisdiction, the CIT is not sitting in appeal;

++ in the instant case, the assessee-firm was constituted with two partners viz., mother and son and it came to be dissolved during assessment year because of the demise of one of the partners. The assessee in the return had valued the closing stock at cost price. This method of valuation was accepted by the AO. According to CIT, the aforesaid method could not be adopted in the case of a dissolved firm as in such a situation closing stock is to be valued at market rate. If the approach of the AO in accepting the cost based valuation of closing stock was totally impermissible, then CIT was perhaps right inasmuch as in such a situation, order of the AO becomes erroneous and also prejudicial to the interest of the Revenue. The moot question therefore is as to whether the view taken by the AO in accepting the valuation of the closing stock at cost price was a plausible view in the circumstances of this case. If it was so, then CIT could not exercise his revisionary jurisdiction u/s 263 of the Act. For this purpose, we may first discuss the judgment in the case of A.L.A. Firm, wherein the High Court had held that privilege of valuing the opening and closing stocks in a consistency manner is available only to continuing business and that it cannot be adopted where the business comes to an end and the stock-in-trade has to be disposed of in order to determine the exact position of the business on the date of closure. The Madras High Court has also held that the partnership concern which dissolves its business in the course of the accounting year forms a close parallel to the case of a firm which goes into liquidation. In both the cases all the assets and stock-in-trade of business will have to be sold and their value realised for the purposes of ascertaining the true state of the profits to losses of the business. It is clear from the above that the judgment in ALA Firm's case proceeds on the basis that with the dissolution of the firm, the business of the firm comes to an end and in that situation, the cost method of valuing the stock was not permissible. The question is as to whether this situation would apply in the instant case where the partnership firm stood dissolved by the operation of law in view of the death of one of the partners, i.e., the mother, but the business did not come to an end as the other partner, viz., son, who inherited the share of the mother, continued with the business. In a situation like this, there was no question of selling the assets of the firm including stock-in-trade and, therefore, it was not necessary to value stock-in-trade at market price;

++ the purpose of adopting a particular valuation of the closing stock is succinctly explained by this Court in the case of Sampatram v. Commissioner of Income Tax, West Bengal, wherein it was observed that when a business continues, it may not be necessary to follow the market rate to value the closing stock as the reasons because of which the same is to be done are not available. When this position becomes clear, it follows that in the instant case the view taken by the AO in accepting the book value of the stock-in-trade was a plausible and permissible view. In this scenario, the CIT could not exercise his powers u/s 263 of the Act.

(See 2017-TIOL-254-SC-IT)