Stock in a new business to be taken on market value basis rather than cost basis: Delhi High Court

Madhu Rani Mehra v. CIT, decided on 21^st March, 2011

ITR No. 541/1992

Assessment Year: 1980-81

Relevant Facts:

1. The assessee was one of the 2 partners in a firm being run under the name and style of M/s. Mehrae-Di-Hatti holding 50% share in the firm. Consequently, the firm was dissolved.

3.2 It is not in dispute that the Petitioner took over the assets and liabilities of the dissolved firm and carried on the same sort of business which related to gold and diamond jewellery.

3.3 On the date of dissolution of the firm i.e., 10.11.1979, the firm had in its possession stock, comprising of gold and diamond jewellery of a substantial value. The said stock was evidently valued at average cost price by the firm. As per the books the closing stock was valued by the firm as on 10.11.1979 at Rs 35,16,785/-. It is not in dispute that the market price of the firms closing stock, as on 10.11.1979 was Rs 49,19,491/-

Questions of law:

1. Whether on the facts and in the circumstances of the case, the ITAT was correct in law in taking the value of the opening stock in law in taking the value of the opening stock as on 11.11.1979 at Rs. 35,16,785/- which stock was received by the assessee on dissolution of the firm M/s Mehrae-Di-Hatti on 10.11.1979, at which point of the dissolution the said stock was valued at market price of Rs.49,19,491/-?

2. Whether, on the facts and in the circumstances of the case, the Income-Tax Appellate Tribunal was correct in law in valuing the opening stock at cost though the said stock was received on the dissolution of the firm as capital by the assessee, which was converted by her into stock-in-trade?

Upholding the appeal of the assessee, the Hon’ble Court held that:

Para 19: “The partnership firm was dissolved. One individual of the erstwhile firm continued to make a living out of a business, which by sheer coincidence happened to be again jewellery business, in which, distributed capital was introduced in the form of stock. The stock on introduction in the business, stood converted into stock-in-trade. The value of this stock will have to be the market value on the date of introduction. In the facts of this case, the undisputed market value of the stock is Rs.49,19,491.”

Para 20: “A business has attributes of physicality as well as form. For continuation of business both have to remain intact, at least in large measure. In the instant case, the erstwhile firm disappeared on its dissolution. The proprietorship business gave birth to new business, in a different form. A somewhat similar situation obtained in ALA Firm's (supra) case, where the court was called upon to determine the value of the closing stock though of the dissolved firm. A converse situation arose in Sakthi Trading Co. Ltd. (supra) case where substantially both in terms of its physicality and form the business remained the same. We are thus of the opinion that the Tribunals decision to value the stock at cost rather than the market value cannot be sustained.”

The decision is available here.

Amounts received under non-compete agreements are capital receipts and not taxable till amendment by Finance Act, 2002 :Supreme Court

Guffic Chem P.Ltd. vs C.I.T,Belgaum and anr., decided on 16^th March, 2011

CIVIL APPEAL NO.2522 OF 2011 (arising out of S.L.P. (C) No. 6081 of 2010)

Assessment Year: 1997-98

Relevant facts:

1. The assessee received Rs. 50,00,000/- from Ranbaxy as non-competition fee under an agreement dated 31.3.1997.

2. Assessee agreed to transfer its trademarks to Ranbaxy and in consideration of such transfer assessee agreed that it shall not carry on directly or indirectly the business hitherto carried on by it on the terms and conditions appearing in the agreement.

3. The agreement defined the period, i.e., a period of 20 years commencing from the date of the agreement. The agreement defined the territory as territory of India and rest of the world.

4. In short, the agreement contained prohibitive/restrictive covenant in consideration of which a non-competition fee of ` 50 lakhs was received by the assessee from Ranbaxy. The agreement further showed that the payment made to the assessee was in consideration of the restrictive covenant undertaken by the assessee for a loss of source of income.

Question/s before the Hon’ble Court:

1. Whether a payment under an agreement not to compete (negative covenant agreement) is a capital receipt or a revenue receipt is the question which arises for determination in this case?

Upholding the appeal of the assessee, the Hon’ble Court held that:

Para 7: “Two questions arose for determination, namely, whether the amounts received by the appellant for loss of agency was in normal course of business and therefore whether they constituted revenue receipt? The second question which arose before this Court was whether the amount received by the assessee (compensation) on the condition not to carry on a competitive business was in the nature of capital receipt? It was held that the compensation received by the assessee for loss of agency was a revenue receipt whereas compensation received for refraining from carrying on competitive business was a capital receipt. This dichotomy has not been appreciated by the High Court in its impugned judgment. The High Court has misinterpreted the judgment of this Court in Gillanders' case (supra). In the present case, the Department has not impugned the genuineness of the transaction. In the present case, we are of the view that the High Court has erred in interfering with the concurrent findings of fact recorded by the CIT(A) and the Tribunal. One more aspect needs to be highlighted. Payment received as non-competition fee under a negative covenant was always treated as a capital receipt till the assessment year 2003-04.”

The decision is available here.

ITAT, Mumbai: Book Profit u/s 115JB includes amount of loan waived off

Duke Offshore Ltd. v. Dy. CIT decided on 5^th January, 2011

Question before the Tribunal: Whether in the course of settlement under OTS with a bank, the reduction of liability to Bank credited to the P&L account should be taken into account in computing Book Profits u/s 115JB, particularly when part of the same represents waiver of principal portion of loan?

Relevant facts: “The Assessee had an OTS with GTBank as a result of which there was a waiver/ reduction of the liability to bank to the extent of Rs. 44,513,406. This was shown as an extraordinary item, `below the Line’. The Assessee took the P&L figure of Rs. 1,08,48,955/- appearing before the extraordinary items and offered it as book profits and contended that the extraordinary item of Rs. 44,513,406/- cannot be added in computing the Book profits. The AO on the other hand took P&L as Rs. 54,168,537/- appearing after the extraordinary items and appropriations as the starting point for computation of Book Profits u/s 115JB and held that the extraordinary item of Rs. 44,513,406/- cannot be reduced in computing the Book profits.”

Dismissing the appeal of the assessee, it was held, inter-alia that:

1. (Para 8): “From the above, it is very clear that the net profit figure to be taken is only after the appropriation ie, below the line. Otherwise, adding to / reducing from the book profits the appropriations like amount carried to reserve, amount withdrawn form the reserve, the provisions made for diminution in value of assets, provisions for meeting liability etc. as per the explanations become unworkable. Therefore the language of Section 115JB is very clear to indicate that starting point of the profit and loss should be the figure after the appropriation as well as any extraordinary item made or prior year expenses which the company may for the purpose presentation show `below the line’. Therefore amounts credited or debited to the P&L account below line cannot be ignored.”

2. (Para 13): “Computation of book profit is a separate code itself and determination has to be made on the basis of profit computed in the Companies Act and in accordance with the various Accounting Standard and guideline issued in this regard. What is capital or revenue for the purpose of computation of taxable income under the normal provisions may not be the capital or revenue while computing book profit… As pointed out earlier, any receipt even if it is a capital receipt, which may or may not be taxable under the normal provisions of the Income tax Act, if it is credited to the profit and loss account cannot be excluded in computing the book profit, unless it is specifically excluded under any of the Explanations found in that section.”

The judgment is available here.