1964-VIL-31-AP-DT

Equivalent Citation: [1965] 57 ITR 540 (AP)

ANDHRA PRADESH HIGH COURT

Case Referred No 35 of 1962

Dated: 14.04.1964

KUNGUNDI INDUSTRIAL WORKS PRIVATE LTD

Vs

COMMISSIONER OF INCOME-TAX, ANDHRA PRADESH

K. Ranganadhachari, for the Appellant

C. Kondaiah, for the Respondent

Bench

P. CHANDRA REDDY and KUMARAYYA, JJ.

JUDGMENT

KUMARAYYA J.--The Income-tax Appellate Tribunal, Hyderabad Bench, has referred under section 66(1) of the Indian Income-tax Act the following question for decision:

"Whether, on the facts and in the circumstances of the case, the first proviso to section 10(5)(a) of the Act applied to the assessee?"

The facts of the case may be briefly stated. The assessee is a private limited company carrying on business in distillation and sale of sandal-wood oil. The assessment in question relates to the assessment for the eight years, the assessment years being 1950-51, 1951-52, 1952-53, 1953-54, 1954-55, 1955-56, 1956-57 and 1957-58, the corresponding accounting periods being the financial years ending with March 31, 1950, March 31, 1951, March 31, 1952, March 31, 1953, March 31, 1954, March 31, 1955, March 31, 1956, and March 31, 1957, respectively. The present assessee is a limited company which was formed from the then existing registered firm consisting of nine partners. There were in fact altogether fourteen shareholders by reason of the partition in the family of one G. Venkatesam Chetty and also due to transfer of some shares by Srinivasalu Chetty to his son. The shareholders of the new private limited company are no other than the old partners and their nominees. On the formation of the new private limited company, the shares also were allotted in the same proportion as the shares held by them in the partnership firm. Thus the present status of private limited company is only a change-over from that of the old partnership firm. At the time of the change-over as a private limited company the assessee valued the assets such as building and machinery received from the firm mentioned supra at Rs 63,000 and Rs 87,000 respectively, but the written down value as per the books of the firm then was only of Rs 3,994 and Rs 13,210 respectively. At the time of purchase, the valuation was placed also on goodwill and it was determined at Rs 64,000. The assessee had to incur the necessary expenses for due execution of agreement and sale deeds and for conversion of the firm into a private limited company after partition among the various partners. The enhancement in value of the assets in question became a matter of primary importance for purposes of taxation inasmuch as but for the change-over the assessee could not have claimed a higher depreciation on the assets in question on the basis that the enhanced value is the proper value. The assessee filed before the Income-tax Officer along with its returns the statement dated July 28, 1951, and also the certificate of an engineer as to the estimated value of the building and machinery besides the agreement and sale deeds. The assessee represented to the income-tax authorities that there were several reasons which necessitated the conversion into a private limited company. It was alleged that the partners of the erstwhile firm were making indiscriminate drawings regardless of the delicate financial position of the firm and that considerable difficulty was being experienced in controlling such drawings. Further the partners who were financially better placed naturally desired in these circumstances to protect their private properties by limiting their liability, which could be done only by way of conversion of the firm into a private limited company. Besides, on account of the partition the number of shareholders too was on the increase with the result that they thought that the conversion was a dire necessity. The Income-tax Officer was firmly of the view that whatever be the reasons necessitating the conversion of the firm into a private limited company, there was practically no necessity for over-valuing the assets and the main purpose of the conversion of the firm into a private limited company was only to reduce the income-tax liability by claiming depreciation on enhanced value. In this view he thought that the proviso to section 10(5)(a) of the Act did apply. He determined the value accordingly. The Appellate Assistant Commissioner of Income-tax agreed with the order of the Income-tax Officer in that, in the circumstances, the agreement of transfer was actuated principally by the idea of reducing the tax liability of the vendor-company and the second proviso to section 10(5)(a) did apply. On further appeal, the Appellate Tribunal held the view that the main reason for the transfer was to get reduction of tax liability by claiming depreciation with reference to enhanced costs and hence the first proviso to section 10(5)(a) applied. However, the Tribunal fixed the value of the assets transferred at Rs 25,000 in excess of the written down value of the two items as determined by the Income-tax Officer. On the requisition of the assessee the Tribunal has referred the question of law for decision to this court.

Learned counsel on behalf of the assessee contends that the assessee being a private limited company, as a distinct entity from the previous partnership firm, was entitled to depreciation allowance having regard to the actual cost of assets to him and not to the written down value of the assets in the hands of the previous partnership firm, that the proviso to section 10 (5)(a) had no application in that the conversion of the firm and the transfer of assets were motivated by considerations of efficient management of the business and due protection of the private properties of the partners, and that reduction of taxation liability is but an incident of change-over in status. It was also contended that the value of the assets shown in the sale deeds is the actual market value as on the date of sale which value has been even accepted by the income-tax authority for purposes of computing the profits under section 10(2)(vii) in the assessment of the vendor's firm.

We now proceed to consider how far these contentions are tenable. Indeed, it is always open to a subject to carry on his business in the way he thinks best. It is certainly not for the department to dictate to an assessee what methods he should adopt in conducting his business. If the shareholders thought that for the efficient and profitable working of the concern and the protection of their just interests, conversion of the partnership firm into a private limited company was an effective method the advisability of such a step cannot be open to question. All that the department is concerned with is the tax which is due under law. Even for purposes of taxation it is open to a subject to so regulate his business or adopt such methods as may be legitimate for him to adopt which would reduce his tax liability to the minimum. He may regulate his business in such a manner as to avoid paying income-tax if he could legally and legitimately do so. There is nothing illegal therein. The conversion of a partnership firm into a private limited company made in law the newly formed company entirely a distinct entity from the previous partnership firm or its partners. What were the assets which formerly belonged to the partnership firm have now become the assets belonging to the new company. The change-over certainly affected the position of tax liability as well. We are however concerned in this proceeding only with the depreciation allowances as provided by section 10(2)(vi) read with section 10(5). Section 10(2)(vi) and section 10(5)(a), so far as material, read thus:

"10. (2) Such profits or gains shall be computed after making the following allowances, namely:--...

(vi) in respect of depreciation of such buildings, machinery, plant or furniture being the property of the assessee, a sum equivalent (where the assets are ships other than ships ordinarily plying on inland waters) to such percentage on the original cost thereof to the assessee as may in any case or class of cases be prescribed and in any other case, to such percentage on the written down value thereof as may in any case or class of cases be prescribed....

10. (5)(a) In sub-section (2) 'paid' means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under this section; 'plant' includes vehicles, books, scientific apparatus and surgical equipment purchased for the purposes of the business, profession or vocation; and 'written down value' means--

(a) in the case of assets acquired in the previous year, the actual cost to the assessee:

Provided that where, before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of business and the Income-tax Officer is satisfied that the main purpose of the transfer of such assets, directly or indirectly, to the assessee was the reduction of a liability to income-tax (by claiming depreciation with reference to an enhanced cost), the actual cost to the assessee shall be such an amount as the Income-tax Officer may, with the previous approval of the Inspecting Assistant Commissioner, determine having regard to all the circumstances of the case."

It is clear from section 10(2)(vi) that allowance on depreciation of buildings and machinery has to be worked out having regard to their "written down value" which expression in relation to assets acquired in the previous year as per section 10(5)(a) must mean the actual cost of the assets to the assessee. This meaning however is controlled by the proviso which in matters like the present provides that if the Income-tax Officer is satisfied that the main purpose of the transfer of assets to the assessee was directly or indirectly reduction of liability of income-tax by claiming depreciation with reference to the enhanced cost, the actual cost of the assessee shall be the amount that may be determined by the Income-tax Officer with the previous approval of the Inspecting Assistant Commissioner. It is well settled that the word "assessee" in section 10(2)(vi) and 10(5)(a) refers to the person who owns the property in question and who is being assessed and not his predecessor and the depreciation allowance is to be based on the actual cost of such property to such person and not to the written down value to his predecessor. It is so ruled by the Privy Council in Commissioner of Income-tax v. Buckingham & Carnatic Co. Ltd. [1935] 3 I.T.R. 384 (P.C.) This view was also approved of by the Supreme Court in Jogta Coal Co. Ltd. v. Commissioner of Income-tax [1959] 36 I.T.R. 521 (S.C.). It is the actual cost of the assets to the assessee that should determine the statutory allowance for depreciation. Ordinarily the contractual price will be deemed to be the actual cost. But in certain cases it may be palpably fictitious. So then, 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. As observed in Commissioner of Income-tax v. Harveys Ltd. 1940] 8 I.T.R. 307, the original cost of any particular asset is entirely a question of fact, and like any other question of fact depends upon the evidence produced to prove it. The mere production of documentary evidence showing that a contract has been made for purchasing assets at a certain price does conclusively establish the correctness of a claim made by an assessee that for the purpose of section 10(2)(vi) of the Indian Income-tax Act the original cost is the amount shown in the document; and, if the circumstances show that an assessee has arranged to put an entirely fictitious price on his assets, it is open to the income-tax authorities to refuse to accept that price and to ascertain what the true value is. It is thus clear even in cases beyond the reach of the proviso to section 10(5)(a) the amount entered in the contract is not necessarily the last word and the Income-tax Officer in certain circumstances can go behind the contract. But when the above proviso applies, the statute says in terms explicit that the actual cost shall be the amount determined by the Income-tax Officer with the previous approval of the Inspecting Assistant Commissioner. This proviso was introduced by an amendment Act which came into force from April 1, 1959. No doubt it is alleged that conversion into a private limited company was in contemplation ever since 1943, but it was actually implemented in the year 1949, with the result that the matter will be governed by the proviso if it comes within its scope. Admittedly, the assets were used before the date of acquisition by a partnership firm for the purpose of its business and the newly formed company is a distinct entity in the eye of law. That being the case the Income-tax Officer had only to be satisfied that the main purposes of transfer of assets was directly or indirectly to reduce the liability by claiming depreciation with reference to enhanced cost. The only question to be considered is whether this condition is satisfied. This indeed is a question of fact and has to be inferred from the proved or admitted circumstances of the case. The shareholders of the new company are no other than the old partners and their nominees. Shares were allotted in the same proportion as the shares held by them in the partnership firm. In fact the identity and continuity of the business has been maintained. There has been only a change-over in the status. What was a partnership firm is now a private limited company. Of course both the entities are distinct and separate. But it is not a case where the price is actually paid by one person to another person for the assets have gone into the hands of the same old partners and their relations with this difference that, whereas the written down value of the assets was Rs 3,994 for building and Rs 13,210 for machinery, now it has been inflated to Rs 63,000 and Rs 87,000 respectively and has been entered in the sale deeds, etc. It is not known whether or not the written down value of the assets in the hands of the partnership firm had by that time reached even the rock-bottom value in the hands of the previous assessee. But this much is certain that the inflation has become possible on account of the change-over. The question then in these circumstances is, whether the main purpose for the change-over or transfer of assets to the assessee was directly or indirectly the reduction of a liability to income-tax by claiming depreciation with reference to an enhanced cost. If that be inferred from the circumstances the matter would be governed by the proviso to section 10(5)(a). It must be borne in mind that for the application of the proviso that need not be the only reason for the change-over or transfer of assets. There may be other reasons also but the main purpose should be the reduction of liability to income-tax directly or indirectly by claiming depreciation on enhanced value. Of course, several reasons have been shown for the change-over, namely, the efficient working of the concern, due control over its members and preservation of rights of some of its opulent members. If they were the only guiding motives, there is no reason why the same assets were given a higher value even when in fact though not in law they did not change hands. It is this consideration that weighed with the income-tax authorities. The increase in the value, it may be noted, is substantial and out of all proportion to the written down value in the hands of the previous assessees. The reduction of liability to income-tax, if that figure be taken into consideration, is indeed not inconsiderable. In these circumstances, it admits of little doubt that the main purpose of the transfer of assets directly or indirectly to the assessee was a reduction of liability to income-tax by claiming depreciation with reference to an enhanced cost. That being the case, the proviso to section 10(5)(a) is inevitably attracted. In these circumstances, the Income-tax Officer had power to go behind the agreement and sale deeds, etc., and make his own estimate having regard to all the circumstances of the case, subject of course to the previous approval of the Inspecting Assistant Commissioner. That is what has been done by him. That is how in further appeal the Tribunal has determined the actual cost. In our opinion the question referred must be answered in the affirmative. We answer it accordingly and direct the assessee to pay the costs which are fixed at Rs 100.

Question answered in the affirmative.