sale of property distributed on dissolution of partnership firm amounts to capital gain not business income

ITAT, Ahmedabad has held that sale of shops by the assessee which were distributed on dissolution of partnership firm amounts to capital gain not business income.

Case Details:
ITA.No.1239/Ahd/2012 Asstt. Year: 2008-2009 
DCIT vs. Mafatlal Nathalal Patel
Date of Order: 01/04/2016

Brief Facts of the Case:
The assessee was partner in M/s. Shri Rang Developers (partnership firm). The said firm was engaged in the business of development of projects in  Surat. The firm was dissolved on and from 1st April, 2006. At the time of dissolution, there were certain assets and liabilities including the unrealized stock, i.e. office/shops. In order to close the books of accounts of the firm on its dissolution, it was decided by the partners to debit unrealized amount of stock to the capital account of various partners with an understanding that as and when the amount will be realized in future, for this stock, the same will be paid to the partners Accordingly, a sum of Rs.25,83,750/- was debited by the firm to the assessee’s capital account.. Subsequently, when the shops were sold, the entry was reverse and the assessee treated it as sale consideration received. However, According to the AO, the shops were situated in the heart of Surat City, and the prices shown by the assessee were nominal. The AO was not satisfied with the explanation of the assessee and adopting the rate of Rs.2,500 per sq.feet., he calculated the values of the shops and made an addition of Rs.1,63,16,250/- treating it as business income.

On appeal, the CIT(A) deleted the addition by observing that the assets in the hands of the assessee were capital assets and can be subjected to tax as capital gain. CIT(A) was of the opinion that once the firm was disallowed, then, assets will be distributed to the partners, and at that very moment, the stock ceased to be business asset. CIT(A) also stated that once the shops were termed as business asset, the valuation of shops could not be made on the basis of Jantri rates as it becomes out of the purview of section 50C of the Income Tax Act, 1961.

Excerpts from ITAT Judgment:

The finding recorded by the ld.CIT(A) is worth to note. It read as under:

“5. I have considered the facts of the case, basis given by AO for making addition and arguments of the appellant. The AO has made addition on the ground that the appellant has made the sale transactions at very low value below the market price prevalent in that area. Therefore he estimated the market price of the shops at Rs.2,500/- per sq. ft. on the basis that the rate of Rs.2,500/- is most conservative price as the complex is situated in the heart of Surat city. Further, Jantri price of this area based on scientific study on 01.04.2008 is near to Rs.3,200/- per sq. ft. and sale price in Mllennium Textile Market during the year under assessment is near to Rs.3,500/- per sq. ft. and the building of appellant is located at very advantageous place on the same road on which Mllennium Textile Market is situated. However, to ascertain the market value, property was referred by AO to valuation authority u/s.55A of I.T. Act, but the report could not be received in the office of AO before the completion of assessment. On the basis of these facts, AO estimated market price of shops at Rs.2,500/- per sq. ft. and made addition of Rs.1,63,16,250/- as undisclosed profit under the head business income.

5.1 From the finding given by AO, it is clear that he has computed business income out of sale of shops by treating them as business assets. Though in the concluding para of assessment order it is not mentioned that income is being assessed as business income but the show cause notice issued as well as the heading in the assessment order reflect that income on account of sale of shops have been assessed as business income. Now the question arises whether any business asset can be valued on market price opposed to what the assessee has shown in the computation of income or profit and loss account. In my opinion, there is no provision in the statute to determine the market value of any business asset other than shown in books of account, in absence of any cogent material in possession of AO. In some exceptional circumstances, such as dissolution of firm, discontinuation of business etc. market value of the business assets can be determined but that also on the basis of material available with the AO or in the books of account of the assessee. In the statute, market value or full value of consideration is determined mostly for the purpose of valuation of capital asset

In the case of appellant, once the shops have been termed as business asset, the valuation of shops cannot be made on the basis of Jantri rates as it becomes out of the purview of section 50C of I.T. Act. Being business asset, it cannot be referred to valuation authority also u/s. 55A of I.T. Act. Had the AO treated these shops as capital asset, the provisions of section 50C and 55A of I.T. Act could have been applied. As it was held in the case CIT vs. Thiruvengadam Investments (P) Ltd (320 ITR 345) by Hon’ble Madras High Court that since the property was treated as business asset and not as capital asset in the hands of assessee, provision of section 50C could not be invoked and AO was not justified in taking the sale consideration as determined by sub registrar against actual sale consideration shown by assessee. Similarly, Hon’ble Delhi High Court in the case of CIT vs. Smt. Nilofer I. Singh (309 ITR 233), following the judgments of Hon’ble Supreme Court in the cases CIT vs. Gillenders Arbuthnot and Co. (87 ITR 407) and CIT vs. George Henderson and Co. Ltd (66 ITR 622) has held that in the case of sale price of asset, there would be no question of any market value and all that one has to see that what is the consideration bargained for. In view of these legal provisions, if a property has been held as business asset not the capital asset, it can’t be assessed as per the provisions of section 50C or 45 of I.T. Act and profit and gains has to be computed on the basis of actual sale consideration received or accruing to the seller as per sale document.

5.2 So far as reference to valuation authority u/s. 55A of IT. Act is concerned, AO has mentioned in the assessment order that after reference, valuation report from Valuation Officer could not be received till the completion of assessment proceedings. In this regard, appellant has mentioned that he had objected the reference on the ground that the reference to Valuation Officer was made by AO much after the completion of assessment proceedings. As pointed out by appellant in the appellate proceedings, reference to Valuation Officer was made on 27.07.2011 by AO whereas the assessment order was34 passed on 29.12.2010 for-the year under consideration. It has also been pointed out by appellant that he had written a letter to Commissioner of Income Tax-1, Surat on 07.11.2011 objecting the reference on the ground that reference had been made much after the completion of assessment proceedings and passing of order and as such there was no proceeding pending in his case. It has further been informed by appellant that there after no valuation of the said property has been done. However, these facts have been verified by me from the assessment records and found correct. In view of these facts, it is clear that AO was not having the valuation from competent authority to estimate the market value of assets in consideration.

5.3 One more basis given by AO for estimating the market price of shops is that the complex wherein these shops are situated is on the Ring Road from where flyover starts and near to Millennium Textile Market, therefore situated at very advantageous place. However, the AO has not given any comparable rates prevalent in adjoining shops or market. He has just described the location of the shops without giving specific instance. The appellant has submitted that comparison of shops with the Millennium Market is wrong and misplaced as the Millennium Market is very well known and one of the costliest textile markets of the country. Moreover, the shops are sold there on per shop basis not on per sq. ft. basis. It is further submitted by appellant that his shops are half kilometer away from the Millennium Market. Therefore, there is no comparability between the two. Moreover, the structure and design of shops of both the markets are totally different. However, these arguments given by appellant during the assessment proceedings, have not been controverted by AO. Since the location of complexes, structure and business viability of shops being business- assets are different and no comparison can be made, the rates applied to the shops of Millennium Market cannot be applied to the shops of appellant.

5.4 In view of the above discussion, it is held that the market rate i.e. @ Rs.2,500/- per sq. ft. applied by AO is presumptive, without any basis and misplaced. He is not having any credible evidence to ascertain the rates of shops at such high rate in absence of valuation report of the Departmental Valuation Officer or Stamp Valuation Officer or any other statutory authority for that matter. He is not even having the comparable rates of adjoining shops or any credible evidence in his possession to show that the appellant has received any amount over and above the sums disclosed in the return of income. In such situation, estimating the rates of shops at Rs. 2,500/- per sq. ft. is presumptive, unreasonable and without any basis. In my opinion, shops of appellant, being building, are capital assets which attract the provisions of section 50C of I.T. Act. Since, the reference to Valuation Officer to value the market price of the property could not reach to the conclusion and proceedings were dropped without making valuation of property, the rates determined by Stamp Valuation Authority of those very shops are to be taken in to consideration for computing the capital gains. There are court decisions which say that in absence of valuation by departmental valuation authority, value adopted by Stamp Valuation Officer has to be taken as full value of consideration received or accruing as result of transfer of property. In the case Ambattur Clothing Co. Ltd vs. ACIT (326 ITR 245), Hon’ble Madras High Court has held that AO was justified in treating the value adopted by Stamp Valuation Authority as the deemed sale consideration received / accruing as a result of transfer. Hon’ble Bombay High Court in the case Bhatia Nagar Premises Co-operative Society Ltd vs. Union of India and others (334 ITR 145), held that section 50C is measure provided to bridge the gap as it was found that assessees were not correctly declaring the full value of consideration or resorting to the practice of under valuation and value adopted or assessed by the Stamp Valuation Authority is only a measure of tax u/s.50C of IT. Act.

5.5 In view of above, it is held that the shops in consideration are actually capital assets and govern by provision of section 50C of IT. Act and computation of capital gain on transfer of these assets would be made accordingly.”

On due considerations of the facts and circumstances, we find that the ld.CIT(A) has examined the issue lucidly and that too of all possible angles. The firm was disallowed w.e.f. 1-4-2006. On dissolution of the firm, assets must have been distributed. Unsold stocks represented shops/offices space fallen to the assessee. The moment the firm was dissolved, this stock was converted into capital assets of the partners. The AO could have taken action as per section 45(4) of the Income Tax Act against the firm on its dissolution in that assessment year. The ld.First Appellate Authority has examined this aspect in the finding extracted (supra). Once it is held as capital asset, then, the capital gain would accrue to the assessee and it can be enhanced with the help of section 50C only. The ld.CIT(A) has also done that. This action of the ld.CIT(A) has not been challenged by the Revenue in its grounds of appeal. Therefore, we do not find any error in the order of the ld.CIT(A) on this issue. The ground no.1 is rejected.

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