Facts

A private limited company formed for the  purpose of  taking over the  business of the assessee-firm entered into an agreement with the  assessee whereunder the assessee sold the business as a whole as a going concern. The consideration    for the sale was Rs. 11,50,400 which was paid by allotment of fully paid-up shares to the assessee’s partners. The business stood transferred to the company accordingly in the accounting year relevant to the assessment year in question.    For the purpose of determination of purchase consideration the assets were shown at Rs. 41,73,973 out of which the machinery and dead-stock was revalued  by the valuer at Rs. 1,5,87,296. The liabilities were shown at Rs. 30,23,573 and    the balance amount of Rs. 11,50,400 was shown as the purchase consideration.  The assessee filed nil return for the year in question. Relying upon the decision     of the Supreme Court in  CIT v.  B.M. Kharwar [1969] 72 ITR 603 (SC), the ITO held that tax was payable under section 41(2) on the surplus amount, i.e., difference between the written down value of plant, machinery and deadstock as per the assessee’s books and the value of the same as revalued by the valuer. The ITO took the difference between the value of plant, machinery and dead-stock (Rs. 15,87,296) as revalued and the written down value of the plant, machinery   and dead-stock as per assessee’s book (Rs. 4,36,896) which came to Rs. 11,50,400  as taxable u/s. 41(2).

The AAC, on appeal, held that the surplus was assessable under the head ‘Capital gains’ and not under the head ‘Profits and gains of business or profession’. As regards the status of the assessee it was held that the assessee must be taxed in    the status of ‘association of persons’ and not in the status of a ‘registered firm’.    The assessee as well as the revenue filed appeals against the said decision of the AAC before the Tribunal.

The Tribunal while upholding the ITO’s view,  held that the surplus was taxable   as business profit under section 41(2) and that theassessee  was  assessable  in the status of a registered firm. The High Court held that on the facts of the case section 41(2) was notattracted and that the transfer of a going concern was liable

to tax under section 45. The High Court has held that the decision of this Court     in B. M. Kharwar’s case [l969] 72 ITR 603 (SC) is not applicable and that the present case is governed by the decision of this Court in CIT v. Mugneeram Bangur & Co. [1965] 57 ITR 299 (SC) The High Court  further  held  that  the status of the assessee was that of BOI and not registered firm.

On appeal to the Supreme Court.

Issue

Whether the surplus as a result of difference between the written down value and the sale consideration for the plant, machinery and dead-stock transferred by the assessee is taxable u/s. 41(2) of the 1961 Act

View

It was held in CIT v. Mugneeram Bangur & Co. [1963] 47 ITR 565 (Cal)(HC) that where there is a slump transaction and the business is sold as a going concern  what is to be seen is whether any portion of the slump price is attributable to       the stock-in-trade and if on the basis of the facts it can be found that a particular price is attributable to a particular item, then the excess amount would be chargeable to tax under section 10(2)(vii), proviso (ii) of the Indian Income-tax   Act, 1922 corresponding to section 41(2)of the 1961 Act.

In the instant case, it was the admitted case of the assessee before the ITO   that the plant, machinery and dead-stock had been revalued at the time of the agreement for sale and the amount of Rs. 11,50,400 was fixed after taking into account the value of the plant, machinery and dead-stock at  Rs.  15,87,296 as per valuation by the valuer. This showed that at the time of execution of the agreement the value of the plant, machinery and dead-stock that were transferred was Rs. 15,87,296.

It was no doubt true that in the agreement there was no reference to the value        of the plant, machinery and dead-stock. But on the basis of the information that was furnished by the assessee before the ITO it became evident that the amount    of Rs. 11,50,400 had been arrived at by taking into consideration the value of the plant, machinery and dead-stock as assessed by the valuer at Rs. 15,87,296. This was not a case in which it could not be said that the price attributed to the items transferred was not indicated and, hence, section 41(2)could not be applied.

Held

Therefore, the High Court was not correct in holding that section 41(2) was not applicable.

The income was chargeable to income-tax under section 41(2). The decision of the High Court that it was chargeable to tax as capital gain could not be upheld. But

the liability under section 41(2)  is limited to the amount of surplus to the extent   of difference between the written down value and the actual cost. If the amount     of surplus exceeds the difference between the written down value and the actual cost, then the surplus amount to the extent of such excess  will have to be treated  as capital gain for the purpose of taxation. The Tribunal had not considered the matter in this light. It will be open to the Tribunal to rehear the parties and record clear findings in the light of the observations made in this judgment. The High Court was correct in its view that the assessee could not be assessed as a ‘registered firm’, and had to be assessed in the status of a ‘body of individuals’.   (AY. 1967-68) (CAO. 2276 (NT) of 1981 dt. 8-7-1897)

Editorial: Subsequent decisions on the issue may be referred East India Electric Supply & Traction Co. Ltd. v. CIT (2003) 263 ITR 243 (Cal.)(HC); CIT v. Carew Phipson Ltd. (2003) 260 ITR 668 (Cal.)(HC)

“When you are right, you have no need to be angry. When you are wrong, you have no  right to be angry.”

– Mahatma Gandhi