K.C. Srivastava, Accountant Member
1. This appeal by the assessee is directed against the order of the Commissioner of Income-tax Under Section 263 for the assessment year 1980-81. The facts are that there was a firm known as Mascot (India) Tools & Forgings which had three partners, namely, Shri Harbans Lal Goel, having 75% share, Smt. Kiran Goel, the wife having 5% share and a limited company M/s. Mascot (India) Tools & Forgings Pvt. Ltd. having 20% share. This company was also wholly owned by Shri Goel and his family. The partners decided to dissolve this firm on 4-1-1979. From that date the business of the firm was taken over by the limited company and one of the terms in the Memorandum of Dissolution of the firm was that while closing the accounts on 4th January, 1979 the plant and machinery belonging to the said partners was to be taken in accordance with a valuation report from a qualified person. The other assets and liabilities were agreed to be taken at their book value.
2. An approved valuer, Shri S.R. Jain, revalued the plant and machinery as on 4-1-1979 and the assessee-company claimed depreciation on the revised value. The amount of appreciation was credited to the account of the partners in the books of the firm on 4-1-1979. Before the Income-tax Officer the company relied on the decision of the Allahabad High Court in the case of Matrumal Dhanna Lal v. ITO  86 ITR 497 and reference was also made to the decision in the case of Kalooram Govindram v. CIT  57 ITR 335 (SC). While making the assessment of the company the Income-tax Officer allowed depreciation on the higher valuation of the plant and machinery.
3. The CIT was of the view that the revaluation of the machinery at Rs. 29,51,629 as against the written down value of Rs. 19,28,831 was not bonafide and in view of the provisions of Section 43(1) read with Explanation (3) to the Section the main purpose of the valuation was to obtain higher depreciation and thus to reduce the taxable income. Considering the order of the Income-tax Officer, to be erroneous insofar as it was prejudicial to the interests of the Revenue, he gave notice to the assessee Under Section 263 of the Income-tax Act. He found that the persons owning the business and the plant and machinery were the same and only the form had changed. It was contended by the assessee before the Commissioner that the partners were free to enter into an agreement of dissolution and also to value the assets for adjusting their shares. It was also contended that the distribution of assets between the partners at the time of dissolution could not be considered as a transaction resulting in profit to the partners. According to the Commissioner, the whole transaction was a make-believe and only a device for avoiding income-tax liability by claiming depreciation on higher figure. He noted that the limited company had only two shareholders, namely, Shri Harbans Lal Goel and his wife Smt. Kiran Goel. Thus, the interest of Shri and Smt. Goel was the same as the interest of the company and in these circumstances, revaluing the plant and machinery was only a make-believe affair and the only purpose of such dissolution and revaluation of plant and machinery was to claim a higher depreciation and to reduce the taxable income of the limited company. The Commissioner of Income-tax found that the reason given by the partners for dissolution was vague as it was stated that the dissolution was being made by “diverse reasons and good causes”. The Commissioner of Income-tax further held that the cases of Matrumal Dhanna Lal (supra) and other cases relied on by the assessee did not apply to the present case as those principles were applicable only to such cases where there was no collusion or inflation or deflation of the value for ulterior purposes. The CIT, therefore, proceeded to set aside the order passed by the Income-tax Officer and directed the Income-tax Officer to examine the claim of the assessee keeping in view the facts of the case and the provisions of Explanation (3) to Section 43(1) of the Income-tax Act.
4. The learned Counsel for the assessee submitted that this was not a case where the Income-tax Officer had accepted the plea of the assessee without ascertaining the facts. He pointed out that the Income-tax Officer had written to the assessee on 6th January, 1983 and had asked him to comment on this transaction with reference to the provisions of Explanation (3) to Section 43(1) of the Income-tax Act. He also drew our attention to the reply given by the assessee on 28th January, 1983 that the assessee had explained that the revaluation was done on the basis of replacement cost of the machinery on the basis of prices and rate structure prevalent on 4-1-1979. From this value the depreciation as accrued up to 4-1-1979 was deducted and the resultant figure was taken as the value of the plant and machinery. It was also pointed out that this transaction cannot result in any profit in the hands of the partners as the revaluation was neither a sale nor a discard or demolition or destruction Under Section 41(2) of the Income-tax Act. It was also pointed out that the company had agreed to allow 2,000 fully paid up equity shares of the face value of Rs. 100 in its capital to the other outgoing partners besides other payments of the accounts in full satisfaction of all their rights and claims against the company and also for relinquishing all the entire business and assets of the partners and the firm in favour of the company. It was contended that the value of the machinery had not been enhanced and fixed arbitrarily and notionally but on a scientific basis by an expert. The actual replacement cost was reduced by the depreciation accrued up to the date of dissolution. A copy of the valuation report was also furnished before the Income-tax Officer.
5. Before us the learned Counsel submitted that though most of the machineries which were revalued were Indian in origin, the important ones were foreign machineries. It was submitted that the replacement cost of these machineries was very high and that was particularly true of the foreign machinery. The valuer had adopted the value after ascertaining the replacement cost on the relevant date and from this the accrued depreciation had been deducted. He, therefore, contended that the determination of the actual cost was based on a rational basis and should have been accepted. It was further contended that there was no material before the Commissioner to hold that the purpose of this transfer or fixing of the actual cost was reduction of tax liability. It was argued that the motive or purpose could not be judged only by the ultimate result.
6. It was further submitted that as a result of the revaluation and the entries passed in the firm’s books the partners have become entitled to higher amounts which became a part of their wealth. These partners had been assessed for wealth-tax on this value. It was contended that the revaluation being bona fide the ratio of the judgment in the case of Matrumal Dhanna Lal (supra) is applicable. Reliance was placed on the decision of the Supreme Court in the case of Kalooram Govindram (supra). It was argued that the purpose having not been established by the Commissioner, his order should not be sustained.
7. The Departmental Representative, on the other hand, submitted that the interference by the Commissioner was due to the fact that the Income-tax Officer had not properly appreciated that the partners of the firm and the limited company itself was being controlled by the same persons. He submitted that there was no outsider involved and the machinery which belong to the firm of which the company was also a partner now belongs to the company and the only difference which has happened was that the company was in a position to claim a higher depreciation in view of the enhanced valuation. It was further submitted that the significance of the close connection or the identity of the two parties has not been appreciated by the Income-tax Officer and this has resulted in prejudice to the Revenue. It was also contended that in such circumstances it was open to the Revenue to ignore the corporate veil so as to bring out the real situation insofar as the motive of the assessee was concerned. Reliance was placed on the order of the Andhra Pradesh High Court in the case of Kungundi Industrial Works (P.) Ltd. v. CIT  57 ITR 540. In this case the partners of a firm decided to convert themselves into a private limited company and the shares were allotted to the erstwhile partners or their nominees. At the time of change over the assets were revalued appreciably and it was taken at a figure much higher than the written down value. The company had claimed the depreciation allowance on its assets on the basis of their enhanced value. This had not been allowed by the Revenue and the Tribunal. The High Court held that the increase in the value was out of proportion and the reasons advanced for the change over did not justify the increase in the value of the assets. It was held that the main purpose of the change over was reduction of liability to income-tax by claiming higher depreciation. While doing so the court observed that in cases where the assessee takes resort to some subterfuge or devise in order to avoid tax, which he is liable to pay or otherwise acts fraudulently or the transaction appears to be illusory or colourable, it is open to the Income-tax Officer to go behind the contract and ascertain the actual cost. The court had also held that the purpose can be gathered from all the surrounding circumstances, as the shareholders of the new company and the old partners were identical there was no change except that of status and it was not a case where the price is actually paid by one person to another person for the assets having gone into the hands of the same old partners with this difference that they would get a higher depreciation in the hands of the company. The court further observed that even if there are other reasons for the change over, the main purpose has to be gathered and if that is reduction of tax liabilities, the Income-tax Officer has the right to interfere. The Departmental Representative further relied on the observations of the Delhi High Court in the case of CIT v. Dalmia Dadri Cement Ltd.  125 ITR 510 where considering the definition of “actual cost” it was observed that he should exclude collusive, inflated or deflated or fictitious cost. It was further argued that in order to give opportunity to the assessee to explain his stand properly the Commissioner sent the matter back to the Income-tax Officer so that the contention of the assessee could be taken into consideration. In reply, the learned Counsel submitted that the facts obtaining in the case before the Andhra Pradesh High Court were different and that case was not applicable to the facts of the present case.
8. We have considered the rival submissions. The main question to be decided in the present case is whether from the facts brought out it has been established that the main purpose of the transfer at an enhanced value was the reduction of tax liability. In these circumstances, the Commissioner would be right to hold that the action of the Income-tax Officer was not correct in accepting the assessee’s contention. For this purpose, the main thing which has to be appreciated is the close connection, rather complete identity of the two parties involved in this transaction. Shri Harbans Lal Goel and his wife were the owners of the business and its assets and the only other partner, that is, the assessee-company was also a company only in form but having Shri Harbans Lal Goel and his wife as the main shareholders. This very company has taken over the business and it is open to Shri Harbans Lal Goel to decide that henceforth he would continue the business in the status of a limited company. Legally an individual and a limited company are separate entities and for purposes of law they have to be treated separately. However, in the present case what we have to see is not only the transfer of business but the purpose of such a transfer. The ostensible reason given in the deed of dissolution was a vague assertion that the dissolution was taking place for diverse reasons and good causes. These reasons and good causes have not been spelt either in the deed of dissolution or in any other document and the only assertion made before us was that it is beneficial to carry on business in the form of a company when the business expands. It makes it easier to have transactions with foreign companies and concerns and adds a respectability to the business name. Apart from this ostensible reason, one has to ascertain the purpose of revaluation of the plant and machinery when Shri Harbans Lal Goel and his family decided that henceforth he would carry on business in the name of a company instead of the firm. The partners of the firm were very much aware of the legal proposition that on dissolution there is no transfer and no tax becomes payable by the partners in spite of an entry of a higher amount in their accounts. It is very clear from the reply filed before the Income-tax Officer on 28th January, 1983. It shows that the whole legal position had been taken into consideration by the partners of the firm and whereas they were not to pay any tax as a result of this revaluation, the company was to obtain a larger benefit by way of depreciation. The whole scheme is very much clear from the manner in which the things have been arranged and executed. The submission of the learned Counsel for the assessee that the appreciation in value was real and not merely notional, does not lead to contradict the inference regarding the purpose of such revaluation at the time of transfer. Whereas there could be no objection in a suitable case at the time of an actual transfer for valuing the assets at market rate the position in this case is entirely different. We are in agreement with the Commissioner that the Income-tax Officer could not appreciate that the purpose of all the transactions of revaluation was to reduce the tax liability of the company as a result of this exercise.
9. We have looked into the report of the valuer as well. It is not necessary for us to go into the great details but it appears that he ascertained the market value by making inquiries on telephone and whatever was communicated to him on telephone he has adopted and has made adjustment about the depreciation actually allowed. In some cases he has found the value on the basis of the cost index and has fixed the value as a result of inflation in the market at the time of the determination of value. What the valuer has done is to adopt the estimated market value of the machineries and then deduct depreciation from this estimated value. We do not consider it necessary to go into each item of the machinery but the net effect is that there has been an increase of cost by about Rs. 10 lacs in the depreciated cost of machinery and to this extent the company was to get benefit over a number of years by way of depreciation. Having regard to the totality of circumstances, we are of the view that the Commissioner has rightly set aside the order of the Income-tax Officer as he found that the Income-tax Officer had not appreciated the nature and purpose of the revaluation. The fact that the Commissioner did not give a final direction to the Income-tax Officer to ignore the increase and has directed the Income-tax Officer to give an opportunity to the assessee and then come to a final conclusion, will not make the order of the Commissioner deficient in any manner. We uphold the order of the Commissioner of Income-tax and dismiss the appeal.
10. In the result, the appeal is dismissed.