ORDER
M. Ramakrishna, J. M.
1. In this appeal by the assessee directed against the order of the CIT(A)-II, Hyderabad, dt. 18th July, 1990, for the asst. yr. 1984-85, the only issue involved relates to valuation of closing stock as on the date of dissolution of the firm. During of course of hearing of this appeal by the Division Bench, comprising of two of us, the Tribunal came across conflicting and diametrically opposite views taken by the Tribunal on this issue in the cases cited before it. In paras 3 and 4 of the docket note, recorded by the Members constituting the Division Bench, extracted below, the conflicting views taken by the Tribunal in those cases were discussed, and constitution of a Special Bench was felt necessary for considering the question relating to valuation of closing stock on the date of dissolution of the firm, noted in para 4 of the said docket note dt. 10th March, 1995, noted below :
“3. After hearing the parties, we came across two Tribunal diametrically opposite views taken by the Tribunal. The Madras Benches of the Tribunal in the case of Preetham Pipe Syndicate 44 ITD 665, and in the case of J. A. Venkoba Rao 44 ITD 264, held that while it is possible for the ITO to substitute the cost by withdrawing the privilege to value the closing stock at market value which is less than cost as on the date of dissolution, there is no authority for the proposition that the cost as agreed to by the partners in the dissolution account should be substituted by market value which was higher. Hyderabad Bench ‘B’, in the case of M/s Deccan Engineers ITA Nos. 1978 and 1779/Hyd/1989, order dt. 14th Sept., 1994, followed the aforesaid two decisions. Both the Madras Benches and the Hyderabad Bench ‘B’ have taken into consideration the decision of the Supreme Court in the case of ALA Firm vs. CIT (1991) 189 ITR 285 (SC). The matter came up before Hyderabad Bench ‘A’ of the Tribunal again in the case of M/s Sri Krishna Crucible Works ITA No. 1330/Hyd/1991, order dt. 9th Nov., 1994, wherein the Tribunal, after noticing the aforesaid two decisions of the Madras Benches and also the decision of the Supreme Court held that the assessee has an option to value the stock-in-trade at cost or market value whichever was lower during the subsistence of a business, that such option is not available to it at the point of termination of business, when the closing stock has to be valued at market price, and that this view of the Madras High Court has been reaffirmed by the Supreme Court in the case of ALA Firm (supra), and, therefore, the Tribunal found itself unable to subscribe to the view canvassed by the assessee’s counsel that such an option was available to it even at the time of termination of business as this issue was squarely covered against the assessee by the decision of the Supreme Court in the case of ALA Firm (supra).
4. In view of the conflict in decision, we are of the opinion that this is a fit case which should be heard by a Special Bench on the following question :
“Whether in determining the income of the firm for the year in which it is dissolved, the book value of the closing stock as adopted by the partners is to be taken into consideration or the market value of such stock on the date of dissolution………………………”.”
Thus, during the course of a judicial proceeding, the formation of a Special Bench was considered necessary, and accordingly this Special Bench was constituted to answer the question noted in para 4 of the docket note extracted above.
2. Facts of the case in brief are that the assessee-firm consisted of four partners, including Mohd. Sahib, who died on 14th March, 1983. Consequent on his death, the firm was dissolved and reconstituted with the remaining partners which continued its business till 13th April, 1983. The assessee filed return for the entire period from 1st July, 1982, to 13th April, 1983, and a single assessment was originally made by the ITO under s. 143(3). Finding the action of the AO to be erroneous and prejudicial to the interests of Revenue, the CIT, exercising jurisdiction under s. 263, set aside the said assessment, with a direction to redo the assessments, in the light of his observations in the said order. In accordance with the order of the CIT under s. 263, two separate assessments were made one for the period from 1st July, 1982, to 14th March, 1983, and the other for the period from 15th March, 1983, to 13th April, 1983, and in making the assessment for the first period, the AO made an addition of Rs. 51,820 to the income of the assessee, by taking the value of the closing stock at market price.
3. Aggrieved by the said addition, assessee preferred appeal before the CIT(A) contending inter alia that revaluation of closing stock is not relevant as the business continued even after the death of Mohd. Sahib and with the same stock, etc. and as such the valuation of closing stock by increasing the same by gross profit should not have been done; and that the closing stock consisted of several items of lenses, frames, glasses, etc. some of them represent old and outdated stock, the value of which should not be as much as the value of the frames or glasses sold in the market, as there would be changes in fashion and requirements of customers, and as such there should not be any presumption that the entire stock would fetch a gross profit of 23% as shown by the assessee. Calling for bifurcation of the stock in shop and in godown of the assessee, and adding 23% gross profit to the value of stock in shop of Rs. 94,447 and 14% gross profit to the value of stock in godown of Rs. 1,31,074, the CIT(A) sustained a round sum addition of Rs. 40,000, thus giving a relief of Rs. 11,820 to the assessee. Still aggrieved, assessee preferred the present appeal before this Tribunal, and in the circumstances narrated in para 1 above, the matter came up for consideration before this Special Bench.
4. Reiterating the contentions urged before the lower authorities, the learned counsel for the assessee contended that when the partners had adopted the value of the closing stock at book value, it is not permissible for the ITO to adopt the value of the closing stock at market value, and to compute the profit of the dissolved firm on that basis. He also submitted that when the remaining partners of the assessee-firm continued to do the business even after death of Mohd. Sahib with the same stock, etc., there was no warrant for the revaluation of the closing stock, since there was only a technical dissolution of the assessee-firm on the death of Mohd. Sahib, as the remaining partners taking the same stock at book value continued to do the business.
5. On the other hand, the learned Departmental Representative strongly supported the order of the CIT(A), and also relied upon the decision of the Supreme Court in the case of ALA Firm vs. CIT (1991) 189 ITR 285 (SC) and the decision of the Division Bench of the Andhra Pradesh High Court in the case of Sha Raichand Chagganraj & Co. vs. CIT (1996) (1) ALT (Tax) 259 (DB) (AP) : (1996) 219 ITR 321 (AP).
6. We have considered the rival submissions, and perused the material on record and the caselaw on the point. The observations of the Madras Bench of the Tribunal in the case of ITO vs. Preetham Pipe Syndicate (1983) 44 ITD 665 (Mad) are to the following effect :
“The partners here had accepted the dissolution on book values. But the ITO wanted to substitute the book value with the market value only in respect of closing stock. Obviously, this would result in a distortion of the results of the business and brought to tax income which had not been actually realised. What was more, since the business had been taken over as a going concern by the other partner, the same profit will be taxed again when actually realised. Sec. 48 of the Indian Partnership Act, 1932, gives the rules for settling the accounts of the firm after dissolution and is subject to the agreement by partners. When the partners had accepted the dissolution account on the value appearing in the books, it implied that they had agreed that the book value represented the real value to them. Such an acceptance had to be taken in the context of the valuation of all the assets and liabilities of the firm. Such an acceptance was also evidenced by the fact that in the hands of the successor, the cost of the stock taken over was given only at the book value agreed to and not at any other value. Unless the agreement of the partners was shown to be mala fide or unreal, any revaluation of the assets would be unjustified particularly if it was only of one asset, viz., closing stock. Moreover, the exercise made by the ITO taxed the same income twice – once on the notional basis in the hands of the firm and again on realisation in the hands of the successor to the business as long as the Revenue refused to substitute the market value for the opening stock of the successor in the next year.”
Similarly, the Madras Bench of the Tribunal in the case of J. A. Venkoba Rao vs. ITO (1993) 44 ITD 264 (Mad) held as follows :
“The normal method of accounting with reference to the valuation of the closing stock is to take it at cost. However, custom has recognised the privilege of the assessee to value the stock at cost or market value, whichever is less, so that the assessee can have the benefit of anticipated loss in a falling market. This privilege is continued to a continuing business and can be withdrawn while determining the profit at the time of dissolution. This is because while the valuation of the assets during the subsistence of the partnership will be immaterial and could even be notional, the settlement of account at the time of dissolution has to be on a real basis as every asset should be converted into money and account of every partner settled on that basis. However, the Revenue’s contention that the cost should be replaced by market value could not be accepted for more than one reason. Firstly, no principle could justify the valuation of the closing stock at a market value higher than cost, as that would result in the taxation of notional profits which the assessee had not realised. Secondly, in the instant case, the closing stock was valued at cost and the accounts of the assessee as closed on the date of dissolution by reason of a death of a partner, were reflecting the market value. Thirdly, the adoption of the real basis could not by itself justify the substitution of the market value for the cost, where the market value was higher, particularly in the case of death of partner where the assets of the firm had not been converted into money. It was not necessary that the partners should sell all the goods and realise the price. They might agree among themselves that it would be more expedient to dispose of the assets amongst themselves rather than to outsiders and that they should do so at a book value which might be less than the market rate. Fourthly, in such a case, if the Revenue were to substitute the market value, then that would amount to bringing to tax the surplus which was not there but a notional and unreal surplus. Not only that, it would also mean that the actual surplus when subsequently realised by the successor firm would be taxed leading to double taxation of the same income. The proviso to 145 empowers the ITO to deduce only the true profits and that power cannot be exercised for taxing a notional and unrealised profit. In other words, while it is possible for the ITO to substitute the cost by withdrawing the privilege to value the closing stock at a market value which is less than cost as on the date of the dissolution, there is no authority for the proposition that the cost as agreed to by the partners in the dissolution accounts could be substituted by market value which was higher.”
Relying on the aforesaid observations, the Tribunal decided the matter in favour of the assessee in the case of M/s Deccan Engineers vs. ITO, ITA Nos. 1778 &1779/Hyd/1989, dt. 14th Sept., 1894, by observing as under :
“Respectfully following the above decisions of the Tribunal, which squarely apply to the facts of the case on hand, we set aside the order of the CIT(A) on this point, and direct the AO to reframe the assessment, valuing the closing stock at cost price. The impugned addition is accordingly deleted, and assessee’s ground of appeal is allowed.”
The matter came up before the Tribunal again in the case of M/s Sri Krishna Crucible Works in ITA No. 1330/Hyd/1991, wherein the Tribunal, after noticing the aforesaid two decisions of the Madras Bench of the Tribunal, has taken a contrary view, vide order dt. 9th Nov., 1994, with the following observations in para 8 thereof :
“With regard to the valuation of stock-in-trade, on the dissolution of the firm, as held by the Madras High Court in the case of ALA Firm (supra), though an assessee has an option to value the stock-in-trade at cost or market value, whichever was lower, during the subsistence of a business, that option is not available to it at the time of termination of business when the stock-in-trade has to be valued at market value. That view of the Madras High Court has been reaffirmed by the Supreme Court (supra). We are unable to subscribe to the view canvassed by the learned counsel for the assessee that such an option is available to it even at the time of termination of business, as this issue is squarely covered against the assessee by the decision of the Supreme Court in ALA Firm (supra).”
In the case of ALA Firm (supra), the Supreme Court affirmed the decision of the Madras High Court in the case of G. R. Ramachari & Co. vs. CIT (1961) 41 ITR 142 (Mad), wherein it was held that the principle of valuing the closing stock of a business at cost or market price at the option of the assessee is a principle that would hold good only so long as there is a continuing business and that where a business is discontinued, whether on account of dissolution or closure or otherwise by the assessee, then the profits cannot be ascertained except by taking the closing stock at market value. That decision was subsequently followed by the Kerala High Court in the case of Popular Workships vs. CIT (1987) 166 ITR 348 (Ker) and in the case of Popular Automobile vs. CIT (1989) 179 ITR 632 (Ker). In the case of ALA Firm (supra) at page 302 of the (ITR) reports (1991) 189 ITR 285 (SC) their Lordships of the Supreme Court held as follows :
“….. the High Court was right in pointing out that the several decisions relied upon for the assessee as to the nature of the transaction by which a firm, on dissolution, distributes its assets among its partners, have no relevance in the present case. As the High Court rightly observed, those cases relate to what happens after or in consequence of the dissolution of a firm whereas we are here concerned with a question that arises before or at the time of dissolution. What we have to decide is the basis on which, in making up the accounts of a firm up to the date of dissolution, the closing stock with the firm as at a point of time immediately prior to the dissolution is to be valued. …..”
At page 306 of the reports (1991) 189 ITR 285 (SC) (supra), their Lordships of the Supreme Court held that the decision in the case of Muhammad Ussain Sahib vs. S. N. Abdul Gaffoor Sahib AIR 1950 Mad 758 correctly sets out the mode of taking accounts regarding the assets of a firm. While the valuation of assets during the subsistence of the partnership would be immaterial and could even be notional, the position at the point of dissolution is totally different. The following passage from the said decision, at page 759 of the reports (AIR 1950) was quoted :
“But the situation is totally different when the firm is dissolved or when a partner retires. The settlement of his account must be not on a notional basis but on a real basis, that is, every asset of the partnership should be converted into money and the account of each partner settled on that basis….. The assets have to be valued, of course, on the basis of the market value on the date of the dissolution. ….”
This, their Lordships of the Supreme Court held, applies equally well to assets which constitute stock-in-trade. There can be no manner of doubt that, in taking accounts for the purposes of dissolution, the firm and the partners, being commercial men, would value the assets only on a real basis and not at cost or at their other value appearing in the books. At page 307 of the reports (189 ITR), their Lordships made it clear that the real rights of the partners cannot be mutually adjusted on any other basis and this has what happened in the case of G. R. Ramachari & Co. (supra).
7. In the case of G. R. Ramachari & Co. (supra), the facts are that in the course of the accounting year from 13th April, 1944, to 12th April, 1945, disputes arose between the partners which led to the dissolution of the partnership and it resulted in the accounts being taken in respect of the Madurai shop from 13th April, 1944, to 7th July, 1944, and the accounts of the Bombay and Nagpur shops upto 11th Sept., 1944. Ramachari took over the entire stock. In the suit between the two parties in this connection, it was decided by the High Court that in order to settle the claims inter se the parties, the stock as on the final dates of accounting should be valued at the market price. In that connection, it was held that the privilege of valuing the opening and closing stocks in a consistent manner is available only to a continuing business and it cannot be adopted where a business has to come to an end and the stock on hand has to be disposed of in order to determine the exact position of the business on the date of the closure. Where a partnership, which has been valuing its opening and closing stocks at cost price when its business was continuing, dissolves and one of the partners takes over the stock on hand, in order to arrive at the correct picture of the trading results of the partnership on the date when it ceases to function, the valuation of the stock on hand should made on the basis of the prevailing market price. Therefore, that the partner who takes over the stock on hand values them at cost price is of no effect.
8. In both the cases before the Kerala High Court (supra), for purposes of settlement of accounts the closing stock of spare parts was distributed among the partners at a price at which the firm had purchased them and the Court, by following the decision in the case of G. R. Ramachari & Co. (supra), held that it is the market price which is to be taken for the purpose of arriving at true profits earned by the firm. The earlier decision in the case of Popular Workshops (supra) was sought to be reconsidered in the subsequent case of Popular Automobiles (supra) on the basis of some agreement express or implied for taking the stock at a particular figure. Their Lordships held that an agreement express or implied with reference to taking of accounts has been held to be applicable only to the case of a continuing partnership and not when the firm is finally dissolved or when one of the partners has retired. Therefore, on the dissolution of a firm, the stock-in-trade has to be valued with reference to the market value and not with reference to the book value in order to arrive at the true profit earned by the firm during the relevant previous year.
9. Similarly, the Andhra Pradesh High Court in its recent decision in the case of M/s Sha Raichand Chagganraj & Co. (supra), following the decisions of the Supreme Court and the Kerala High Court discussed above, held that the closing stock should be valued at the market rate and the principle of book value would apply in the case of a running concern and would have no application on the dissolution of the firm. The decisions of the Madras Bench of the Tribunal have also been cited by the learned counsel for the assessee before the Andhra Pradesh High Court in that case. However, the High Court considering the position of law laid down by the Supreme Court, declined to take a different view.
10. In these circumstances, we are of the opinion that the view expressed by the Tribunal in the case of Sri Krishna Crucible Works (supra) is in accordance with the decisions of the Madras High Court, the Kerala High Court and the Supreme Court aforesaid, besides the recent decision of the Andhra Pradesh High Court in the case of M/s Sha Raichand Chagganraj & Co. (supra). We, therefore, respectfully following the aforesaid decisions, answer the question referred to us, and hold that it is the market value of the closing stock which has to be taken into consideration for arriving at the profit and no option is valuable to the assessee at the point of termination of business to value the stock at a price other than the market price.
11. Before parting, we may note that on the exact valuation of closing stock on the basis of market price by the CIT(A), though a specific ground is taken in this appeal, no convincing arguments were canvassed by the learned counsel for the assessee. We, therefore, hold that the CIT(A) was justified in arriving at the market value of the closing stock in the shop by adopting a gross profit rate of 23%; and the stock in the godown which was representing old and outdated stock, by adopting a gross profit rate of 14%, and thus sustaining a roundsum addition of Rs. 40,000. We accordingly uphold the order of the CIT(A).
12. In the result, assessee’s appeal is dismissed.