Holding

Reassessment under s.147(b) is valid as the officer obtained new information post‑assessment, and the surplus from market valuation of closing stock on dissolution is assessable as profit.

Summary

The appellant, A.L.A. Firm, a partnership engaged in money‑lending and property transactions, was dissolved on 13 March 1961 and reported a revaluation surplus of $1,01,248 (Rs.1,58,057) in its 1961‑62 return, treating it as neither revenue nor capital. The Income‑Tax Officer initially accepted this view but later, after becoming aware of the Madras High Court decision in Ramachari & Co. v. CIT, reopened the assessment under section 147(b) and added the surplus to taxable income. The firm challenged the validity of the reassessment and argued that the surplus, arising from market valuation of closing stock at dissolution, was not assessable income. The Supreme Court held that the reassessment was valid because the officer had obtained new "information" (the Ramachari decision) after the original assessment, fitting the scope of section 147(b), and that the surplus must be taxed as profit since closing stock on dissolution is valued at market price. Consequently, the appeal was dismissed and the reassessment upheld.

Issues considered

Whether the reassessment of the firm for AY 1961‑62 under section 147(b) of the Income Tax Act, 1961 is legally valid.
Whether the revaluation surplus arising on dissolution of the partnership constitutes assessable income.
Whether the appellate tribunal was correct in sustaining the assessment based on the Central Board of Revenue circular (the Court did not answer this question).

Legislation cited

Income Tax Act, 1922s. 34(1)(b)
Income Tax Act, 1961s. 147(b), s. 148, s. 23(2)

Subjects

Income TaxSection 147(b)ReassessmentClosing stock valuationDissolution of partnershipCapital vs revenueInformation doctrineChange of opinion

Judgment

A.L.A. FIRM
A ·v.
COMMISSIONER OF INCOME TAX, MADRAS

FEBRUARY 21, 1991

B [S. RANGANATHAN, N.M. KASLIWAL AND
S.C. AGRAWAL, JJ.]

Income Tax Act, 1961: Section 147(b)-Scope of-Assessment
year 1961-62-Reassessment-Interpretation and meaning of the word
"information"-Material coming to the notice of the Income Tax
Officer subsequent to original assessment-Meaning of the word.
c "Escape".

Dissolution of Firm-Valuation of closing stock-Principles-In
continuing business closing stock to be valued at cost or market price
which ever is lower-Where business is discontinued, the closing stock
D to be valued at market price.

The Appellant-Assessee, a partnership firm was engaged mainly,
in Malaya, in money lending business since 1949 and incidental to this
business was also doing the business of sale and purchase of house
properties, gardens and estates. It was reconstituted under a deed dated
E 26.3.1960. The firm was dissolved on 13.3.1961 and closed its accounts
with effect from that date. ID its income-tax return filed on 10.4.1962
for the assessment year 1961-62 it had filed a profit and loss account
wherein an amount of $.1,01,248 equivalent of Rs.1,58,057 was shown
as "difference on revaluation of the estates, gardens and house proper-
ties" on the dissolution of the firm. In the memo of adjustment for
p income-tax purposes this amount was deducted as being not assessable
either as revenue or capital. The Income Tax Officer issued notice
under section 23(2) of the Act on that very day and completed the ..:;.+
assessment also on the same day after making a petty addition of
Rs.2088 paid as property tax in Malaya.

G When for the subsequent year 1962-63, the a~ssee filed its return
showing nil income stating in the forwarding letter that the Firm had
been dissolved on 13.3.1961, the I.T.O. wrote to the assessee that the
revaluation difference of Rs.1,58,057 should have been brought to tax '--y'-
in the previous year. The assessee replied that no profit or less could be
assessed on a revaluation of assets, that the assessee was gradually
H winding up its business in Malaya, the surplus would be only capital

624
A.LA. FlRM v. C.l.T.. MADRAS 625

gains and that revaluation had been at the market price prevalent since
A
1954 and thus no capital gains were chargeable to tax. Not satisfied, the
I.T.O. issued a notice under section 148 read with section 147(b) of the
Income Tax Act, 1961. The assessee filed objections. Overruling all the
objections, the Income Tax Officer completed reassessment of the
assessee Firm adding back the sum of Rs.1.58,057 to the previously
assessed income. Having failed right upto the High Court, the assessee B
came in appeal before this Court.

Dismissing the appeal, affirming the decision of the High Court,
this Court,

HELD: (1) The proceedings u/s 147(b) were validly initiated. The
facts of this case squarely fall within the scope of propositions (2) and c
(4) enunciated in Kalyanji Mavji's case. Proposition (2) may be briefly
summarised as permitting action even on a "mere change of opinion".
This is what has been doubted in the IENS case. But, even leaving this
out of consideration, there can be no doubt that the present case is
squarely covered by proposition (4) set out in Kalyanji's case. This D
proposition clearly envisages a formation of opinion by the Income-Tax
Officer on the basis of material already on record provided the forma-
tion of such opinion is consequent on "information" in the shape of
some light thrown on aspects of facts or law which the Income Tax
Officer bad not earlier been conscious of. [636G-637B]
E
The difference between the situations envisaged in propositions
(2) and (4) of Kalyanji Mavji is this, that proposition (4) refers to a case
where the Income Tax Officer initiates reassessment proceedings in the
light of "information" obtained by him by an investigation into mate-
rial already on record or by research into the law applicable thereto
which has brought out an angle or aspect that had been missed earlier. F
Proposition (2) no doubt covers this situation also but it is so widely
expressed as to include also cases in which the Income Tax Officer,
having considered all the facts and law, · arrives at a particular
conclusion, but reinitiates proceedings because, on a reappraisal of the
same material which had been considered earlier and in the light of
the same legal aspects to which his attention had been drawn earlier, he G
comes to a conclusion that an item of income which he had earlier
~y consciously left out from the earlier assessment should have been
brought to tax. (637F-H]

It is true that the return was filed and the assessment was comp-
leted on the same date. Nevertheless, it is opposed to normal human H
626 SUPREME COURT REPORTS [1991] 1 S.C.R.

conduct that an officer would complete the assessment without looking
A
at the"Dlaterial placed before him. It is not as if the assessment record
contained a large number of documents or the case raised complicated
issues rendering it probable that the Income Tax Officer had missed
these facts. It is a case where there is only one contention raised before
the Income Tax Officer -and it is, we think, impossible to hold that the
8 Income-Tax Officer did not at all look at the return-filed by the assessee
or the statements accompanying i,t. The more reasonable view to take
,would~ in our '!Pinion, be that the Income-Tax Officer looked at the facts
and accepted the assessee's contention that the surplus was not taxable.
But, in doing so. he obviously missed to take note of the law laid down in
Ramachari - which there ls nothing to show, had been brought to his
notice. When he subsequently became aware of the decision, he initia-
C ted proceedings under section 147(b). The material which constituted
information and on the basis of which the assessment was reopened was
the. decision in Ramachari. This material was not considered at the time
of the original assessment. Though it was a decision of 1961 and the
Income Tax Ofticer could ~ve known Or it had he been diligent, the obvious
D fact is that he was not aware of the existence of that_ decision then and,
when he came to know aJ>out i~, he rightly initiated proceedings for
reassessment. [639E-640B]

The material on which the Income Tax Officer has taken action is
a judicial decision. This had been pronounced just a few months earlier ~-
E to the original assessment and it is not difficult to see that the Income '
Tax Officer must have missed it or else he could not have completed
the assessment as he did. Indeed it has not been suggested that he was
_aware of it and yet chose not to apply it. It is therefore, much easier
to see that the initiation of reassessment proceedings here is based
on definite material not considered at the time of the original
F assessment. [640D-E]

(2) The stock-in-tra_de !>fa firm !}t the time of its disolution, has to
be assessed at a fair volue. There can be no manner Of doubt that, in
taking accounts for purposes of dissolution, the firm and the partners,
being commercial inen, would value the,;lssets_only on a real basis and
G not at cost or at their other value appearing in- the books. The real
rights of the partners cannot be mutually adjusted on any other..basis.
This is what happened in Ramachari. Indeed, this is exactly what the
par,tners in this. case have done and, having done so, it is untenable for
them to contend that the vaiuation should be on some other basis. Once
this principle is applied and the stock-in-trade is valued at -market
H price, the surplus, if any, has to get reflected as the profits of the firm
A.LA. FIRM v. C.l.T., MADRAS 627

and has to be charged to tax. The view taken by the High Court has held
A
the field for about thirty years now and we see no reason to disagree
even if a different view was possible. [642B-D, 647E, 648A-C]

Popular Automobiles v. Commissioner of Income-Tax, [1989]
179 I.T.R. 632; Sunil Siddharthbhai v. Commissioner of Income Tax,
[1985] 156 I.T.R. 509; Pupular Workshops v. Commissioner of B
Income-Tax, [1987] 166 I.T.R. 348; Malabar Fisheries Co. v. Commis-
sioner of Income Tax, [1979] 120 I.T.R. 49; Indian & Eastern News-
paper Society v. Commissioner of Income Tax, [1979].119 I.T.R. 996;
Kafyanji Mavji & Co. v. Commissioner of Income Tax, [1976] 102
I.T.R. 287; M/s. A.L.A. Firm v. The Commissioner of Incpme Tax,
Madras, [1976] I.T.R. 622; Commissioner of Income Tax v. Hind
Construction Ltd., [1972] 83 I. T .R. 211; Commissioner of Income Tax c
v. Birla Gwalior (P.) Ltd., [1973] 89 I.T.R. 266; Anandji Haridas &
Co. (P.) Ltd. v. S.P. Kushare, Sales Tax Officer, [1968] 21S.T.C.326;
Commissioner of Income Tax v. Dewas Cine Corporation, [1968] 68
I. T ;R. 240; Ramachari & Co. v. Commissioner of Income Tax, [1961]
41 I.T.R. 142; Maharaj Kumar Kamal Singh v. Income Tax Officer, D
[1954] 35 I.T.R. l S.C.; Commissioner of Income Tax v. A. Raman &
Co., [1968] 67 I.T.R. 11 S.C.; Salem Provident Fund Society Ltd. v.
Commissioner of Income Tax, [1961] 42 I.T.R. 547; Commissioner of
Income Tax v. Rathinasabapathy Mudaliar, [1964] 51 I.T.R. 204;
Addanki Narayanappa v. Bhaskara Krishnappa, [1966] 3 S.C.R. 400;
Commissioner of Income Tax v. Bankey Lal Vaidya, [1971] 79 I.T.R. E
594; Kikabhai Premchand v. Commissioner of Income Tax, [1953] 24
I.T.R. 506 (S.C.); Commissioner of Income Tax v. K.A.R.K. Firm,
[1934] 2 I. T .R. 183; Chainrup Sampathram v. Commissioner of Income
Tax, [1953] 24 I.T.R. 481; Commissioner of Income Tax v. M/s.
Shoorji Vallabhdas & Co., [1962] 46 I.T.R. 144; Commissioner of
Income Tax v. Krishnaswamy Mudaliar, ]1964] 53 I.T.R. 122; Com-
missioner of Income Tax v. Ahmedabad New Cotton Mills Co. Ltd.,
]1930] L.R. 57 I.A. 21; Muhammad Hussain Sahib v. Abdul Gaffoor
Sahib, ]1950] 1M.L.J.81. referred to.

CIVIL APPEELLATE JURISDICTION: Civil Appeal No. 570
of 1976. G

-y- Appeal by Certificate from the Judgment and Order dated
9 .2.1976 of the Madras High Court in Tax Case No. 104 of 1969.

T.A. Ramachandran, P.N. Ramalingam and A.T.M. Sampath
for the Appellant. H!
628 SUPREME COURT REPORTS [1991] 1 S.C.R.

V. Gauri Shanker, Manoj Arora, S. Rajappa and Ms. A. Sub-
A hashini for the Respondent.
~-

The Judgment of the Court was delivered by

RANGANATHAN, J. This is the assessee's appeal from a judg-
B ment of the Madras High Court dated 10.1.1975 answering three ques-.
tions referred to it by the Income-tax Appellate Tribunal in favour of
the Revenue and against the assessee. The reference related to .the
assessment year 1961-62, the previous year in respect of which com-
menced on 13.4.1960. The judgment of the High Court is reported as
(1976) 102 I.T.R. 622.
c The appellant-assessee is a partnership firm. Since 1949, it was
carrying on, in Malaya, a money lending business and, as part of and
incidental to the said business, a business in the purchase and sale of
house properties, gardens and estates. It had been reconstituted under ·'--
a deed dated 26.3.1960. The firm's accounts for the year 1960-61,
o which commenced on 13.4.60, would normally have come to a close on
or about the 13th April, 1961. However, the firm closed its accounts as
on 13.3.1%1 with effect from which date it was dissolved. Along with
its income-tax return for the assessment year 1961-62 filed on 10th
· April 1962, the assessee filed a profit and loss account and certain
other statements. In the profit and loss account, a sum of$ 1,01,248
E was shown as "difference on revaluation of estates, gardens and house
properties" on the dissolution of the firm on 13.3.61, such difference
being$ 70,500 in respect of "house properties" and$ 30,748 in respect
of estates and gardens. In the memo of adjustment for income-tax
purposes, however, the above sum was deducted on the ground that it
was not assessable either as revenue or capital. A statement was also
F made before the officer that partner Ramanathan Chettiar, forming
one group and the other partners forming another group, were carry-
ing on business separately with the assets and liabilities that fell to ~·-
their shares on the dissolution of the firm.

The Income-tax Officer (LT.O.) issued a notice under section
G 23(2) on the same day (10.4.1962) posting the hearing for the same day
and completed the assessment also on the same day, after making a
petty addition of Rs.2083 paid as property tax in Malaya, and record-
ing the following note:
\

"Audit assessment-Lakshmanan appears-'-return filed-
H 1.T. 86 acknowledged in list of books-scrutinised-order
dictated" ..
A.LA. FIRM v. C.l.T., MADRAS [RANGANATHAN, J.] 629

~ For the subsequent assessment year 1962-63, the assessee filed a
return showing nil income along with a letter pointing out that the firm .Ai\ I

had been dissolved on 13.3.1961. Thereafter, on 3.9.63, the I.T.O.
wrote a letter to the assessee to the effect that the revaluation dif-
ference of $ 1,01,248 should have been brought to tax in the assess-
ment year 1961-62 in view of the decision of the Madras High Court,in
Ramachari & Co. v. C.I. T., [1961] 41 I.T.R. 142. He called for the :B
basis for the valuation and also for the assessee's objections. The
~- assessee sent a reply stating that no profit or loss could be assessed on
a revaluation of assets. Relying on a circular of the Central Board of
Revenue dated 21.6.1956, it was urged that the assessee was gradually

...
-~
winding up its business in Malaya and that, therefore, the surplus
would only be capital gains. It was urged that the revaluation had been
at a market price prevalent since ~.1.1954 and that, therefore, no c
capital gains were chargeable to tax. The l.T.O. followed up his letter
'

by a notice under S. 148 read with S. 147(b). The assessee objected to
~-
the reassessment on two grounds: (1) that the circumstances did not
justify the initiation of proceedings under S. 147(b); and (2) that no
assessable profits arose to the firm on the revaluation of assets on the D
eve of the dissolution of the firm. Overruling these objections, the
I. T. 0. completed a reassessment on the firm after adding back the ,
sum of Rs.1,58,057 (the equivalent of $ 1,01,248) to the previously
assessed income. The assessee's successive appeals to the Appellate
-)"""" A~sistant Commissioner and the Appellate Tribunal and reference, at
its instance, to the High Court having failed, the assessee is before us. E

- Three questions of law were referred to the High Court by the
Tribunal. These were:

.. "l. Whether, on the facts and circumstances of the case,
the reassessment made on the assessee firm for the assess-
ment year 1961-62 under section 147 of the Income-tax Act
is valid in Law?
2. Whether, on the facts and circumstances of the case, the
F

assessment of the sum of$ 1,01,248 as revenue profit of the
assessee firm chargeable to tax for the assessment year
1961-62 is justified in law? G

--y' 3. Whether, on the facts and circumstances of the case, the
Appellate Tribunal is right in law in sustaining the assess- .
ment of the sum of $ 1,01,348 after having found that the
Department Officers are bound by the Circular of the
Central Board of Revenue?" H.
630 SUPREME COURT REPORTS [1991] 1 S.C.R.

We may deal at the outset with the third question. Though the
A
High Court has dealt with this question at some length, we do not
think any answer to this question can or need be furnished by us for the
following reasons. First, the assessee has not been able to place before
us the circular of the Board on which reliance is placed. It is not clear
whether it is a circular or a communication of some other nature.
B Second, the circular, to judge from its purport set out in the High
Court's judgment, seems to have _been to the effect that the surplus
arising from the sale of properties acquired by a money-lender in the
course of his business would be in the nature of capital gains and not of
income. Obviously such a proposition could not have been intended as
a broad or general proposition of law, for the nature of the surplus on
c sale Qf assets would depend on the nature of the asset sold and this, in r

turn, would depend on the facts and circumstances of each case. In this
case, no material was placed at any stage to show that the assets in
question constituted the capital assets of the firm and not its stock-in-
trade. Third, the plea of the assessee which was in issue all through
was that there was no sale of assets by the firm when its assets are
D distributed among its partners and that no profits-whether capital or
revenue--could be said to arise to the firm merely because, at the time
of the dissolution, the firm revalued its assets on the basis of market
value or any other basis, for adjusting the mutual rights and liabilities
of the partners on the dissolution of the firm. The terms of the circular,
as set out in the order of the High Court, cannot therefore be of any
E assistance to the assessee in answering the issues in this case. We,
therefore, do not answer the third question posed by the Tribunal.

Turning now to the first question, the relevant facts have already
been noticed. The following relevant and material facts viz. (i) the ·
dissolution of the firm, (ii) the revaluation of its assets, (iii) the
F distribution thereof among two groups of its partners, and (iv) the
,division and crediting of the surplus on revaluation to the partner's
accounts were not only reflected in the balance sheet, the profit and
loss aCCOUJ!t and the proflt and loss a~justment account but- were also
mentioned in the statement filed before the I.T.O. along with the
return. Clearly, action u/s 148 read with clause (a) of s. 147 could not
G be initiated in these circumstances but is action under clause (b) of that
section also impermissible? That is the question.

We may now set out the provisions of clause (b) of section 147
for purposes of easy reference .. This clause-which corresponds to
s. 34{1)(b) -of the fndian- Incom~~tax Act. 1922 ('the _1922 Act')
H permits-initiation of reassessment of proceedings, "notwithstanding'
A.LA. FIRM v. C.l.T., MADRAS (RANGANATHAN, J.] 631

that there has been no omission or failure as mentioned in clause (a)
on the part of the assessee" provided "the Income-tax Officer has, in A
consequence of information in his possession, reason to believe that
income chargeable to tax has escaped assessment".

In the present case, on the information already on record and in
view of the decision in Ramachari & Co. v. C.I.T., [1961] 411.T.R. B
142, there can be no doubt that the l.T.O. could reasonably come to .._,
the conclusion that income, profits and gains assessable for the assess-
ment year 1961-62 had escaped assessment. But is that belief reached
"in consequence of 1nformation in his possession"? The assessee's
counsel says "no", for, says he, it is settled law that the "information"
referred to in clause (b) above, should be "information". received by
the l.T.O. after he had completed the original assessment. Here it is C
pointed out that all the relevant facts as well as the decision in
Ramachari (supra) had been available when the original assessment
was completed on 10.4.1962. Action cannot be taken under this clause
merely because the l.T.O., who originally considered the surplus to be 1

not assessable, has on the same facts and the same case law which had D
been available to him when he completed the assessment original\y,
changed his opinion and now thinks that the surplus should have been
charged to tax.
~
J
The validity of the assessee's argument has to be tested in the
light of the decisions of this Court which have interpreted S. 147(b) of E
the 1961 Act or its predecessor S. 34(l)(b) of the 1922 Act and ex-
pounded its parameters. We may start with the decision in Maharaj
Kumar Kama1 Singh v. LT.O., [1954135 i.T.R. 1 S.C. In thi~ case it
was held that the word "information" would include infon;nation as to
the true and correct state of the law and would also cover information
as to relevant judicial decisions. In that case, the l.T.O. had re-opened F
the assessment on the basis of a subsequent decision of the Privy
Council and this was upheld. Referring to the use of the word
"escape" in the section, the Court observed:

"In our opinion, even in a case where a return has been
submitted, if the income-tax Officer erroneously fails to tax G
a part of assessable income, it is a case where the said part of
the-income has escaped assessment. The appellant's attempt
to put a very narrow and. artificial ilinitation on the mean-
ing of the word "escape" in section 34(1)(b) cannot, there-
fore, succeed."
(underlining ours) H
632 SUPREME COURT REPORTS [1991] 1 S.C.R.

A The meaning of the word "information" was again explained
thus in C.l.!. v.A. Raman & Co., ['1968] 67 l.T.R. 11 SC:

"The expression 'information' in the context in which it
occurs must, in our judgment, mean instruction or know-
ledge derived from an external source concerning facts or
particulars, or as to law relating to a m_atter bearing on the
assessment . ...... .

Jurisdiction of the Income-tax Officer to reassess income
arises if he has in consequence of information in his posses-
sion reason to believe that income chargeable to tax has
c escaped assessment. That informatioin, must, it is true,
have come into the possession of the Income-tax Officer
after the previous assessment, but even if the information be
such that it could have been obtained during the previous
assessment from an investigation of the materials on the
record, or the facts disclosed thereby or from other enquiry
D or research into facts or law, but was not in fact obtained,
the jurisdiction of the Income-tax Officer is not affected."
(underlining ours)

We may next refer to Kalyanji Mavji & Co. v. C./. T., [1976-102]
l.T.R. 287. It is unnecessary to set out the facts of this case. It is
E sufficient to refer to the enunciation of the law regarding the scope of
section 34(1)(b) as culled out from the earlier decision~ of this Court
on the subject. At page 296 the Court observed:

"On a combined review of the decisions of this Court the
-
following tests and principles would apply to determine the
F applicability of section 34(1)(b) to the following categories
of cases:

(1) where the information is as to the true and correct state
of the law derived from relevant judicial decisions;
G (2) where in the original assessment the income liable to
tax has escaped assessment due to oversight, inadvertence
or a mistake committed by the Income-tax Officer. This
is obviously based on the principle that the taxpayer would
not be allowed to take advantage of an oversight or mistake
committed by the taxing authority;
H
A.L.A. FIRM v. C.I.T., MADRAS [RANGANATHAN, J.] 633

(3) where the information is derived from an external
A
source of any kind. Such external source would include
discovery of new and important matters or knowledge of
fresh facts which were not present at the time of the origi-
nal assessment;

( 4) where the information may be obtained even from the B
record of the original assessment from an investigation of
the materials on the record, or the facts disclosed thereby
or from othei; enquiry onesearch into facts or law."

--
-~,- Before applying the above principles to the facts of the present
case, we may refer to two earlier decisions of the Madras High Court
which have been followed in the judgment under appeal. In Salem
Provident Fund Society ltd. v. C.I. T., [1961] 42 ITR 547, the Income-
tax Officer, in calculating the annual profits of an insurance company,
c

had, under the statute, to work out the difference between the
!" deficiencies as shown in the actuarial valuation of the company in
respect of two successive valuation periods .. At the time of original D
assessment, the Income-tax Officer, by mistake, added the two de-
ficiencies instead of subtracting one from the another. This mistake he
committed not in one assessment year but in two assessment years.
Subsequently, he discovered his mistake and initiated proceedings un-
der section 34(1)(b). The contention urged on behalf of the assessee
was that all the statements, on the basis of which the re-assessment E
proceedings were taken, were already on record and that; in such a
case, there was no 'information' which would justify the reassessment.
An argument was also raised that the rectification, if any, could have
been carried out only under section 35 and not under section 34.'These
contentions were repelled. In regard to the former objection, the High
Court pointed out: F
--~ "We are unable to accept the extreme proposition that
nothing that can be found in the record of the assessment,
which itself would show escape of assessment or under-
assessment, can be viewed as information which led to the
belief that there has been escape from assessment or under- · G
assessment. Suppose a mistake in the original order of
assessment is not discovered by the Income-tax Officer
himself on further scrutiny but it is brought to this notice by
another assessee or even by a subordinate or a superior
officer, that would appear to be information disclosed to
the Income-tax Officer. If the mistake itself is not extrane- H
634 SUPREME COURT REPORTS [1991] 1 S.C.R.

ous to the record and the informant gathered the informa-
A tion from the record, the immediate source of information
to the Income-tax Officer in such circumstances is in one
sense extraneous to the record. It is difficult to accept the
position that while what is seen by another in the record is
'information' what is seen by the Income-tax Officer him-
B self is not information to him. In the latter case he just
informs himself. It will be information in his possession
within the meaning of section 34. In such cases of obvious
mistakes apparent on the face of the record of assessment
that record itself can be a source of information, if that
information leads to a discovery or belief that there has
been an escape of assessment or under-assessment.
c
A Similar question arose in CIT v. Rathinasabapathy Mudaliar,
[1964] 51 I..T.R. 204. In that case the assessee; who was· a partner ina
firm, did not include in his return the income of his minor son admitted
to the benefits of the partnership as required by section 16(3) of the .....
I

D 1922 Act. The minor son submitted a separate return and was assessed
on this income. Subsequently, the Income-tax Officer "discovered"
his error in not assessin_g the father thereon and started re-!lssessment ·
proceedings. The re-assessment was upheld by the Madras High Court
on the same logic as had been applied in Salem Provident Fund Society
Ltd. case (supra). The above line of thinking has not only held the
E field for about thirty years now but has also received approval in
Anandji Haridas and Co. (P) Ltd. v. S.P. Kushare, Sales Tax Officer,
[1968] 21 S.T.C. 326.

This issue has further been considered in the decision of this
Court in the case of Indian and Eastern Newspaper Society v. C.I. T.
F (the IENS case, for short) [1979] 119 I:T.R. 996: In this case the income
of the assessee derived by letting out certain portions of the building
owned by it to its members as well as to outsiders was being assessed as
business income. In the course of audit, an internal audit party expres-
sed the view that the money realised by the assessee on account of the
occupation of its conference hall and rooms should have been assessed
G under the head "income from property" and not as business income.
The Income-tax Officer thereupon initiated re-assessment proceedings
and this was upheld by the Tribunal. On a direct reference under s. 257
of the Act, this Court held that the opinion of the audit party on a
point of h1w could not be regarded as "information" and that the
initiation of the reassessment proceedings was not justified. It was
H contended for the Revenue, that the reassessment proceedings would
A.LA. FIRM v, C:I.T., MAD~S [RANOANATHAN, J.] 635
. ,·
·~ be valid even on this premise. Dealing with this argu~ent, the Court ~
observed: 1

"Now, in the case before.us, 'the IT9 had, when he made
the original assessment, COQSidered the provisions, of
sections 9 and 10. Any different ,view taken by him after-
wards on the applica~iOn of th9se-provisions would amount B
to a change. of opinion on material already .. con_sisJered by
him. The revenue contends that.it is open to him. to do so,
and on that basis to reopen the assessment under s. 147(b).
Reliance is placed on Kalyanji Mavji & Co. v. CIT, [1976]
102 l.T.R. 287, where a Bench of two learn'ed,,Judges of
this Coutt observed that a case where income had escaped
assessment due to the "oversight, inadvertence or mistake" c
of the ITO must fall withins. 34( l)(b) of the Indiaii.'focome
Tax Act, 1922. It appears to us, with respect,' that .the
proposition is stated (oo widely and travels farther than the
statute warrants in so far as it can be said to Jay down that if,,
on re-appraising the material considered by him during the b.
original assessment, the ITO discovers that he has commit-
ted an error in consequence of which income has escaped
assessment, it is open to him to reopen the assessment. In
our. opinion, an error discovered on a reconsideration of
the same material (and no more) does not give him that
power. That was the view taken by this Court in Maharaj E,
Kumar Kamal Singh v. CIT, [1959] 35 I.T.R. 1; CITv. A.
Raman & Co., [1968] 67 ITR 11 and Bankipur Club Ltd. v. ·
CIT [ 1971] 82 ITR 831 and we do not 1'elieve that the law
has since taken a different course. Any observation in
Kalyanji Mavji & Co. v. CIT, [1976] 102 I.T.R. 287
suggesting the contrary do not, we say with respect, lay F
down the correct law."
(underlining ours)

The Court proceeded further to observe:

"A further submission raised by the revenue on G
.s. 147(b) of the Act may be considered at this stage. It is
urged that the expression "information" ins. 147(bfrefers
to the realisation by the ITO that he has committed an
error when making the original assessment. It is said that,
when upon receipt of the audit note the ITO discovers or
realizes that a mistake has been committed in the original H
I
636 SUPREME COURT REPORTS (1991] 1 S.C.R.

assessment, the discovery of the mistake would be "infor-
A mation" within the meaning of s. 147(b ). The submission
appears to us inconsistent with the terms of s. 147(b).
Plainly, the statutory provision envisages that the ITO
must first have information in his possession, and then in
consequence of such information he must have reason to
B believe that income has escaped assessment. The realisa-
tion that income has escaped assessment is covered by the
words "reason to believe", and it follows from the "infor-
mation" received by the ITO. The information is not the
realisation, the information gives birth to the realisation."

Sri Ramachandran submits that these decisions support his con-
c tention that reassessment proceedings can be validly initiated only if
there is some information received by the l.T.O. from an external
source after the completion of the original assessment but not in a case
like the present where there is nothing more before the l.T.O. than
what was available to him when the original assessment was comp-
D leted. He also submits that the observations in the JENS case have cast
doubts on the propositions enunciated in Kalyanji Mavji's case (supra)
and reiterates the proposition that reassessment proceedings cannot be
availed of to revise, on the same material, the opinion formed or
conclusion arrived at earlier in favour of the assessee.

E On the other hand, Dr. Gaurisankar, appearing for the
Revenue, mentioned that the decision in the JENS case holding that
the opinion of an audit party would not constitute 'information' and
qualifying the principles enunciated in Kalyanji Mavji is pending con-
sideration by a larger Bench of this Court. He, however, submitted
-
that the reassessment in this case would be valid even on the strength
F of the observations in the JENS case. We shall proceed to consider the
correctness of this submission.

We have pointed out earlier that Kalyanji Mavji (supra) outlines
four situations in which action under S. 34(1)(b) can be validly
initiated. The JENS case has only indicated that proposition (2) out-
G lined in this case and extracted earlier may have been somewhat widely
stated; it has not cast any doubt on the other three propositipns set out
in Kalyanji Mavji's case. The facts of the present case squarely fall
within the scope of propositions 2 and 4 enunciated in Kalyanji Mavji's
case. Proposition (2) may be briefly summarised as permitting action
even on a "mere change of opinion". This is what has been doubted in
H the JENS case (supra) and we shall discuss its application t~ this case a
A.L.A. FIRM v. C.l.T., MADRAS [RANGANATHAN; J.] 637

~1ittle later. But, even leaving this out of consideration, there can be no
A
doubt that the present case is squarely covered by proposition (4) set
out in Kalyanji Mavji & Co. (supra). This proposition clearly envisages
a formation of opinion by the Income-tax Officer on the basis of
material already on record provided the formation of such opinion is
consequent on "information" in the shape of some light thrown on
aspects of facts or law which the I.T.O. had not earlier been conscious B
~of. To give a couple of illustrations, suppose an I. T. 0., in the original
· assessment, which is a voluminous one involving several contentions,
accepts a plea of the assessee in regard to one of the items that the
profits realised on the sale of a house is a capital realisation not charge-
~- able to tax. Subsequently he finds, in the forest of papers filed in
connection with the assessment, several instances of earlier sales of
house property by the assessee. That would be a case where the I.T.0. c
derives information from the record on an investigation or enquiry
./into facts not originally undertaken. Again, suppose in l.T.O. accepts
the plea of an assessee that a particular receipt is not income liable to
tax. But, on further research into law he finds that there was a direct
decision holding that category of receipt to be an income receipt. He D
would be entitled to reopen the assessment under s. 147(b) by virtue of
proposition (4) of Kalyanji Mavji. The fact that the details of sales of
house properties were ~lready in the file or that the decision subse-
--,).- quently come across by him was already there would not affect the .
position because the information that such facts or decision existed
comes to him only much later. E

... What then, is the difference between the situations envisaged in
propositions (2) and (4) of Kalyanji Mavji (supra)? The difference, if
one keeps in mind the trend of the judicial decisions, is this. Propo-
sition (4) refers to a case where the I.T.O. initiates reassessment
~proceedings in the light of "information" obtained by him by an F
investigation into material already on record or by research into the
law applicable thereto which has brought out an angle or aspect that
had been missed earlier, for e.g., as in the two Madras decisons
referred to earlier. Proposition (2) no doubt covers this situati9n also
but it is so widely expressed as to include also cases in which the
I. T. 0., having considered all the facts and law, arrives at a particular G•
_-._ conclusion, but reinitiates proceedings because, on a reappraisal of the
'--( same material which had been considered earlier and in the light of the
same legal aspects to which his attention had been drawn earlier, he
comes to a conclusion that an item of income which he had earlier
consciously left out from the earlier assessment should have been
brought to tax. In other words, as pointed out in JENS case, it also H
638 SUPREME COURT REPORTS [1991] 1 S.C.R.

ropes in cases of a "bare or mere change of opinion" where the I.T.O.
A
{very often a successor officer) attempts to ·reopen the assessment
because the opinion formed earlier by himself (or, more often, by a
predecessor I.T.O.) was, in his opinion, incorrect. Judicial decisions
had consistently held that this could not be done and the JENS case
(supra) has warned that this line of cases cannot be taken to have been
B overruled by Kalyanji Mavji (supra). The second paragraph from the
judgment in the JENS case earlier extracted has also reference only to
this situation and insists upon the necessity of some information which
make the ITO realise th.at he has committed an error in the earlier
assessment. This paragraph does not in any way affect the principle
enumerated in the two Madras cases cited with approval in Anandji ~ ·
Haridas, [1986] 21 S.T.C. 326. Even making allowances for this limita-
c tion placed on the observations in Kalyanji Mavji, the position as
summarised by the High Court in the following words represents, in
'..
our view, the correct position in law:

"The result of these decisions is that the statute does
D not require that the information must be extraneous to the
record. It is enough if the material, on the basis of which
the reassessment proceedings are sought to be initiated,
came to the notice of the Income-tax Officer subsequent to
the original assessment. If the Income-tax Officer had ,...~
considered and formed an opinion on the said material in
E the original assessment itself, then he would be powerless
to start the proceedings for the reassessment. Where,
however, the Income-tax Officer had not considered the -
material and subsequently come by the material from the
. record itself, then such a case would fall within the scope of
section 147(b) of the Act."
F .~
Let us now examine the position in the present case keeping in v
mind the narrow but real distinction pointed out above. On behalf of
the assessee, it is emphasised (a) that the amount of surplus is a very
substantial amount, (b) that full details of the manner in which it had
resulted had been disclosed, (c) that the profit and loss account, the
G profit and loss adjustment account and statement made before the
I. T.O. had brought into focus the question of taxability of the surplus '-y,.._
and (d) that the decision in Ramachari's case had been reported by
10.4.1962. No Income-tax Officer can be presumed to have completed
the assessment without looking at all this material and the said deci-
sion. No doubt, some doubt had been thrown as to whether a state-
H ment had been given at the time of original assessment that the amount
A.L.A. FIRM v. C.I.T., MADRAS [RANGANATHAN, J.] 639

~of surplus was not taxable as an income or a capital gain but the case
has proceeded on the footing that such a statement was there before A
the officer. This, therefore, is nothing but a case of "change of
opinion'.'. On the other hand, the authorities and the Tribunal have
drawn attention to the fact that the return, the S. 143(2) notice and
assessment were all on the same day and counsel for the Revenue
urged that, obviously, in his haste, the I.T.O. had not looked into the B
facts at all. It is urged that no Income-tax Officer who had looked into
~the facts and the law could have failed to bring the surplus to tax in
view of the then recent pronouncement in Ramachari's case. Dr.
Gaurishankar submitted that the Tribunal has found that the I.T.O.
"had acted mechanically in accepting the return without bringing his
mind to play upon the entry in the statement with reference to the
distribution of the assets". He pointed out that there is no evidence of c
any enquiry with reference to this aspect and that, the amount
_ involved being sufficiently large, the I.T.O., if he had been aware of
the existence of the entry would certainly have discussed it. He urged
that the question whether the I.T.O. had considered this matter at the
time of the original assessment or not is purely a question of fact and D
the Tribunal's conclusion thereon having been endorsed by the High
Court, there is no justification to interfere with it at this stage.

We think there is force in the argument on behalf of the assessee
·-~ that, in the face of all the· details and statement placed before the
I. T. 0. at the time of the original assessment, it is difficult to take the
view that the Income-tax Officer had not at all applied his mind to the

- question whether the surplus is taxable or not. It is true that the return
was filed and the assessment was completed on the same date.
Nevertheless, it is opposed to normal human conduct that an officer
would complete the assessment without looking at the material placed
before him. It is not as if the assessment record contained a large F
. . number of documents or the case raised complicated issues rendering
it probable that the l.T.O. had missed these facts. It is a case where
there is only one contention raised before the I.T.O. and it is, we
think, impossible to hold that the Income-tax Officer did not at all
look at the return filed by the assessee or the statements accompanying
it. The more reasonable view to take would, in our opinion, be that the G
Income-tax Officer looked at the facts and accepted the assessee's
-.'""'( contention that the surplus was not taxable. But, in doing so, the
' obviously missed to take note of the law laid down in Ramacfiari which
there is nothing to show, had been brought to his notice. When he
subsequently became aware of the decision, he initiated proceedings
under S. 147(b). The material which constituted information and on H
640 SUPREME COURT REPORTS [1991] 1 S.C.R.

A ·the basis of which the assessment was reopened was the decision in~
Ramachari. This material was not considered at the time of the
original assessment. Though it was a decision of 1961 and the 1.T.O.
could have known of it had he been diligent, the obvious fact is that he
was not aware of the existence of the decision then and, when he came
to know about it, he rightly initiated proceedings for assessment.
B
We may point out that the position here is more. favourable to
the Revenue than that which prevailed in the Madras cases referred to~
earlier. There, what the l.T.O. had missed earlier was the true purport
of the relevent statutory provisions. It seems somewhat difficult to
believe that the l.T.O. could have failed to read properly the statutory
provisions applicable directly to facts before him (though that is what -~ -
c seems to have happened). Perhaps an equally plausible view, on the
facts, could have been taken that he had considered them and decided,
in one case, not to apply them and, in the other, on a wrong construe-·~
tion thereof. In the present case, on the other hand, the material on
which the l.T.O. has taken action is a judicial decision. This had been
D pronounced just a few months earlier to the original assessment and it
is not difficult to see that the l.T.O. must have missed it or else he
could not have completed the assessment as he did. Indeed it has not
been suggested that he was aware of it and yet chose not to apply it. It
is therefore much easier to see that the initiation of reassessment pro- \
ceedings here is based on definite· material not considered at the time~-
E of the original assessment. ·

In the above view of th_e matter, we uphold the High Court's
view on the first question.

The second question raises a more difficult problem. There can
-
F be no doubt that the decision of the Madras High Court in Ramachari
squarely covers the situation. Ramachari holds that the principle of~
valuing the closing stock of a business at cost or market at the opti9n of .
the assessee is a principle that would hold good only sc long as there is
a continuing business and that where a business is discontinued,
whether on account of dissolution or closure or otherwise, by the
G assessee, then the profits cannot be ascertained except by taking the
closing stock at market value. Ramachari has subsequently been
followed by the kerala High Court in Popular Workshops v. CommiS---,.....,--
sioner of Income-Tax, [1987] 166 ITR 348 and in Popular Automobiles '.
v. Commissioner of Income-Tax, [1989] 179 ITR 632.

H Shri Ramachandran contends that the decision in Ramachari
A.L.A. FIRM v. C.I.T., MADRAS [RANGANATHAN, J.] 641

,..-...,.,_.. does not lay down the correct law. He submits tham, while it is no
doubt true that the closing stock has to be valued, the well settled A
principle is that it should be valued at cost or market whichever is
lower and there is no justification for laying down a different principle
for valuation of the closing stock at the point of discontinuance of
business unless the goods are actually sold by the assessee at the time
of discontinuance. Further, it has been held by a series of decisions of B
this Court that when a firm is dissloved and the assets are distributed
._,.._,-l-~ among the partners, there is no sale or transfer of the assets of the firm
to the various partners: vide, Addanki Narayanappa v. Bhaskara
Krishnappa, [966] 3 SCR 400; CIT v. Dewas Cine Corporation, [1968]
~· 68 ITR 240; CIT v. 2Bankey Lal Vaidya, [1971] 79 ITR 594; Malabar
- Fisheries Co. v. C. /. T., [1979] 120 ITR 49 and in Sunil Siddharthbhai
v. C.I. T., [1985] 156 ITR 509. He submits that, in logical sequence, c
dissolution comes first and distribution of assets comes later. There-
fore, revaluation of the assets of a firm, which is only for the division
of the assets among the partners on a real and not a notional basis, is
part of the division of the assets and therefore logically, in point of
time, subsequent to the dissolution of the firm. Since the revaluation D
takes place after the dissolution no profits can be said to have accrued
to the firm by the process of revaluation. The revaluation of the assets
is not in the course of business and is not an activity which can partake
of the nature of trade. Assuming but not conceding that it is possible to
have a revaluation of the assets, for example, stock in trade before
dissolution,. any excess which arises on the revaluation in only an E

... imaginary or notional profit and cannot be brought to tax for the
following reasons:

(i) As a result of such revaluation, there can be no profit,
because the firm cannot make a profit out of itself: Vide
Kikabhai Premchand v. C./. T., [1953] 24 LT.R. 506 (S.C.). F

(ii) The process of revaluation of stock by itself cannot
bring in any real profits: vide C./. T. v. K.A.R.K. Firm, [1934] 2
I.T.R. 183; Chainrup Sampatram v. C.J.T., [1953) 24 LT.R. 481
and C.J. T. v. Hind Construction Ltd., [ 1972] 83 I.T.R. 211; and
G
(iii) It is well settled that what is taxable under the income
tax law is only real income vide C./. T. v. Mis Shoorji Vallabhdas
and Co., [1962] 46 I.T.R. 144 and C.I.T. v. Birla Gwalior (P)
Ltd., [1973] 89 I. T.R. 266. There is, therefore, no principle by
which the stock-in-trade can be valued at market price so as to
bring to tax the notional profits which might in future be realised H
as a result of the sale of the stock in trade.
642 SUPREME COURT REPORTS [1991] 1 S.C.R.

The question posed before us is a difficult ope. We think, how-____.,.....,
A
ever, that the High Court was right in pointing 6ut that the several r
decisions relied upon for the assessee as to the nature of the transac-
tion by which a firm, on dissolution, distributes its assets among its
partners, have no relevance in the present case. As the High Court
rightly obseved, those cases relate to what happens after or in conse-
B quence of the dissolution of a firm whereas we are here concerned with
a question that arises before or at the time of dissolution. What we
have to decide is the basis on which, in making up the accounts of a -~
firm upto the :date of dissolution. the closing stock with the firm as at a
point of time immediately prior to the dissolution is to be valued. It is
this principle that has been decided in Ramachari and the High Court
decisions following it (including the one under appeal) and the ques- ....,r.__
c tion is whether they lay down the correct law.

In the first place, it is settled law that the true trading results of a ~
business for an accounting period cannot be ascertained without taking
into account the value of the stock-in-trade remaining at the end of the
D period. Though, as pointed out by this Court in Chainrup Sempatram
v. C./. T., [1953] 24 I.T.R. 481 it is a misconception to think that any
profit arises out of the valuation of closing stock, it is equally true that
such valuation is a necessary element in the process of determining the
trading results of the period. This is true in respect of any method of
accounting and in C./. T. v. Krishnaswamy Mudaliar, [1964] 53 I.T.R. ~-
E 122 this Court pointed out that,· even where the assessee is following
the cash system of accounting, the valuation of closing stock cannot be
dispensed with. In this decision, this Court quoted with approval the
following observations in C./.R. v. Cock, Russel & Co. Ltd. [1949] 29
T.C. 387:
-
F "There is no word in the statutes or rules which deals with
this question of valuing stock-in-trade. There is nothing in-~
the relevant legislation which indicates that in computing "-
the profits and gains of a commercial concern the stock-in-
trade at the start of the accounting period should be taken
in and that the smount of the stock-in-trade at the end of
G the period should also be taken in. It would be fantastic not
to do it: it would be utterly impossible accurately to assess
profits and gains merely on a statement of receipts and , --,,,.---
payments or on the basis of turnover. It has long been
recognised that the right method of assessing profits and
gains is to take into account the value of he stock-in-trade
H at the beginning and the value of the stock-in trade at the
A.L.A. FIRM v. C.I.T., MADRAS [RANGANATHAN, J.] 643

end as two of the items in the computation. I need not cite
A
authority for the general proposition, which is admitted at
the Bar, that for the purposes of asceratining profits and
gains the ordinary principles of commercial accounting
should be applied, so long as they do not conflict with any
express provision of the relevant statutes."
B
Next the principles as to the method of valuation of the dosing
--·----~'< stock are equally well setted. Lord President Clyde set these out in
Whimster & Co. v. C.l.R., (1925] 12 T.C. 813 in the following words:

"In computing the balance of profits and gains for the
purposes of income-tax, ... two general and fundamental
commonplaces have always to be kept in mind. In the first C
place, the profits of any particular year or accounting
- period must be taken to consist of the difference between
the receipts from the trade or business during such year or
accounting period and the expenditure laid out to earn
those receipts. In the second place, the account of profit D
and loss to be made up for the purpose of ascertaining that
difference must be framed consistently with the ordinary
principles of commercial accounting, so far as applicable,
and in conformity with the rules of the Income-tax Act, or
of that Act as modified by the provisions and schedules of
the Acts regulating excess profits 'duty, as the case may be. E
For example, the ordinary principles of commercial

- accounting rquire that in the profit and loss account of a
merchant's manufacturer's business the values of the stock-
in-trade at the beginning and at the end of the period
covered by the account should be entered at cost or market
price, whichever is the lower; although there is nothing F
about this in the taxing statutes."

The principle behind permitting the assessee to value the stock at
cost is very simple. In the words of Bose, J. In Kikabhai Premchand v.-
C.l. T., [1953] 24 I.T.R. 506 S.C. it is this:
G
"The appellant's method of book-keeping reflects the true
position. As he makes his purchases he enters his stock at
the cost price on one side of the accounts. At the close of
the year he enters the value of any unsold stock at cost on
the other side of the accounts thus cancelling out the
entries relating to the same unsold stock earlier in the H
644 SUPREME COURT REPORTS [1991] 1 S.C.R.

accounts; and then that is carried forward as the opening ~·
A balance in the next year's account. This cancelling out of
the unsold stock from both sides of the accounts leaves only
the transactions on which there have been actual sales and
gives the true and actual profit or loss on his year's
dealings."
B
. .As aga~nst this, the valuation of.the closing stock at.ma~ket value ---~-
mvanably wdl create a problem. For If the market value IS higher than r

cost, the accounts will reflect notional profits not actually realised. On
the other hand,· if the market value is less, the assessee will get the
benefit of a notional loss he has not incurred. Nevertheless, as
mentioned earlier, the ordinary principles of commercial accounting
c permit valu.ation "at cost or market, whichever is the lower". The
rationale behind this has been explained by Patanjali Sastri, C.J. in
Chinrup Sampatram v. C.l.T., [1953] 24 I.T.R. 481, S.C. where an t..._ .--
attempt was made to value the closing stock at a market value higher
than cost. The learned Chief Justice observed:
D
"It is wrong to assume that the valuation of the closing
stock at market rate has, for its object, the bringing into
charge any appreciation in the value of such stock. The true
purpose of crediting the value of unsold stock is to balance
the cost of those goods entered on the other side of the
E account at the time of their purchase, so that the cancelling
out of the entries relating to the same st'9ck from both sides
of the account would leave only the transactions on which
there have been actual sales in the course of the year show-
ing the profit or loss actually realised on the year's trading.
As pointed out in paragraph 8 of the Report of the
F Committee on Financial Risks attaching to tl.e holding of
Trading Stocks, 1919, "As the entry for stock which
appears in a trading account is merely intended to cancel
the charge for the goods purchased which have not been
sold, it should necessarily represent the cost of the goods.
If it is more or less than the cost, then the effect is to state
G the pofit on the goods which actually have been sold at the
incorrect figure . . . . . . . . . . From this rigid doctrine one
exception is very generally recognised on prudential
grounds and is now fully sanctioned by custom, viz., the
adoption of market value at the date of making up
accounts, if that value is less, than cost. It-is of course an
H anticipation of the loss that may be made on those goods in

•
A.L.A. FIRM v. C.i:T., MADRAS [RANGANATHAN, J.] 645

the following year, and may even have the effect, if prices
A
rise again, of attributing to the following year's results a
greater amount of profit than the differnce between the
actual sale price and the actual cost price of the goods in
question" (extracted in paragraph 281 of the Report of the
Committee on the Taxation of Trading Profits presented to
British Parliament in April 1951). Whlle anticipated loss is B
thus taken into account, anticipated profit in the shape of
appreciated value of the closing stock is not brought into
the account, as no prudent trader would care to show in-
creased profit before its actual realisation. This is the
theory underlying the rule that the closing stock is to be
valued at cost or market price whichever is the lower, and it
is now generally accepted as an established rule of commer-
cial practice and accountancy."

From the above passage, it will be seen that the proper practice is
to value the closing stock at cost. That will eliminate entries relating to
the same stock from both sides of the account. To this rule custom D
recognises only one exception and that is to value the stock at market
value if that is lower. But on no principle can one justify the valuation
of the closing stock at a market value higher than cost as that will result
~ ~·in the taxation of notional profits the assessee has not realised. The
High Court in Ramachari has, however, outlined another exception
and seems to have rested this on two considerations. The first is the E
observation of Lord Buckmaster in C.J. T. v. Ahmedabad New Cotton
- Mills Co. Ltd., [1930] L.R. 57 I.A. 21 to the following effect:

"The method of introducing stock into each side of a profit
and loss acco.unt for the purpose of determining the annual
profits is a method well understood in commercial circles F
and does not necessarily depend upon exact trade valua-
tions being given to each article of stock that is so intro-
duced. The one thing that is essential is that there should
be a definite method of valuation adopted which should be
carried through from year to year. so that in case of any
deviation from strict market values in the entry of the stock G
at the close of one year it will be rectified by the accounts in
the next year."

From these observations, the High Court inferred:

"It is obvious from the above that the privilege of valuing H
646 SUPREME COURT REPORTS [1991] 1 S.C.R.

the opening and closing st~cks in a consistent manner is~
A available only to continuing businesses and that it cannot
be adopted where the business comes to an end and the
stock-in-trade has to be the disposed of in order to deter-
mine the exact position of the ·business on the date of
closure."

The second consideration which prevailed with the High Court is ~
reflected in the following passage froin the judgment: '

"It seems to us that none of these cases has any application
to the facts of the present case. There is no authority -_,,,r -
directly in point dealing with this question, where a part- .._
nership concern dissolves its business in the course of the
accounting year, what is the basis on which the stock-in-
trade-has to be valued as on the date of dissolution. We have ' (
_accordingly to deal with the matter on first principles.

D The case of a firm which goes into liquidation forms a close·
parallel to the present case. In such a case all the stock-in-
trade and other assets of the business will have to be sold
and their value realised. It cannot be controverted that it is
only by doing so that the true state of the profits or losses of J..__ __
the business can be arrived at. The position is not very
different when the partnership ceases to exist in the course
of the accounting year. The fact that Ramachari, one of the
ex-partners, took over the entire stock and continued to .,.
run the business on his own, is not relevant at all, when we
consider the profits or losses of the, partnership' which has
come to an end. It should, therefore, follow that in order to
F arrive at the correct picture of the trading results of the A-
partnership on the date when it ceases to function, the · ·
valuation of the stock in hand should be made on the basis
of the prevailing market price."

We are not quite sure that the first of the considerations that
G prevailed with the High Court is relevant in the present case. Even in a
continuing business, the valuation at market value is permissible only
when it is less than cost; it is not quite certain whether the rules permit
an assessee if he so desires to value closing stock at market value
where it is higher than cost. But, in either event, it is allowed to be
done because its effect can be offset over a period of time. But here,
H where the business comes to a close, no future adjustment of an over
A.LA. FIRM v. C.l.T., MADRAS [RANGANA1HAN, J.] 647

-~r under valuation is-possible, In this context, it is difficult to see how
valuation, at other than cost, can be justified on the principle of
Ahmedabad Advance Mills case (supra).

We, however, find substance in the second consideration that
prevailed with the High Court. The decision in Muhammad Hussain
B
Sahib v. Abdul Gaffoor Sahib, [1950] 1 M.L.J. 81 correctly sets out the
, mode of taking accounts regarding the assets of a firm. While the
_,_,~. valuation of assets during the subsistence of the partnership would be
immaterial and could even be notional, the position at the point of
dissolution is totally different:

"But the situation is totally different when the fim1 is dis- c
solved or when a partner retires. The settlement of his
account must be not on a notional basis but on a real basis,
that is every asset of the partnership should be converted
into money and the account of each partner settled on that
basis ...... The assets have to be valued, of course, on the
D
basis of the market value on the date of the dissolution
"

This applies equally well to assets which constitute stock-in-
trade. There can be no manner of doubt that, in taking accounts for
~~~purposes of dissolution, the firm and the partners, being commercial
man, would value the assets only on a real basis and not at cost or ;;it E
their other value appearing in the books. A short passage from Pickles
on Accountancy (Third Edn), p. 650 will make this clear:

"In the event of the accounts being drawn up to the date of
death or retirement, no departure from the normal proce-
F
dure arises, but it will be necessary to see that every revalu-
ation required by the terms of the partnership agreement is
· made. it has been laid down judi~ially that, in the absence
of contrary agreement, all assets and liabilities must be
taken at a "fair value," not merely a "book value" basis,
thus involving recording entries for both appreciation and
G
depreciation of assets and liabilities. This rule is ap.plicabl~,
notwithstanding the omission of a particular item from the
books, e.g. investments, goodwill (Cruikshank v. Suther-
land), Obviously, the net effect of the revaluation will be a
profit or loss divisible in the agreed profit-or loss-sharing
ratios."
H
648 SUPREME COURT REPORTS [1991) 1 S.C.R.

A The real rights of the partners cannot be mutually adjusted o~~
any other basis. This is what happened in· Ramachari. Indeed, this is f
exactly what the partners in this case have done and, having done so, it
is untenable for them to contend that the valuation should be on some
other basis. Once this principle is applied and the stock-in-trade is
valued at market price, the surplus, if any, has to get reflected as the
B profits of the firtn and has to be charged to tax. The view taken by the
High Court has held the field for about thirty years now and we see no
reason to disagree even if a different view were possible. For these-..l._
reasons, we agree with the answer given by the High Court to the
second question as well.

,C The appeal fails and is dismissed. But we would make no order
regarding costs.
..
'__,,__

R.N.J. Appeal dismissed,
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