1. This appeal is filed by the assessee against the order of the AAC.It is relevant for the assessment year 1980-81.
2. The assessee-firm was constituted vide partnership deed dated 2-4-1978. Application in Form No. 11 was filed on 30-3-1979 for registration of the firm. The ITO was satisfied with the genuineness of the firm and registration was allowed for the assessment year 1980-81.
3. In the course of the assessment proceeding the ITO noticed that the assessee claimed depreciation on enhanced value of some old machinery and building used previously by a firm of the same name Ashok Theatres, Shamli. Since the ITO was not convinced about the genuineness of the claim, he took recourse to Section 43(7) of the Income-tax Act, 1961 ('the Act'). After getting the approval of the IAC in this behalf the ITO revalued the assets as follows: The ITO, accordingly, allowed the claim of depreciation on the above basis.
4. Aggrieved by the said order the assessee went in appeal before the AAC, who, however, upheld the order of the ITO. According to the AAC, the case of the assessee was a case of change in the constitution of the firm and it was not a case where the old firm was succeeded by a new firm. There being no transfer of assets of the old firm to the new firm and the dissolution deed executed on 1-4-1978 being brought out for the purpose of avoidance of tax only, the AAC held that there was no occasion for enhancing the value of the said assets. Even, in any case, the AAC was of the view that the action taken by the ITO was justified in view of the provisions to Explanation 3 to Section 43(7), the revaluation being done with a view to reduce tax liability by claiming depreciation with reference to the enhanced cost of the assets.
5. The assessee is aggrieved and has come up in appeal before us. Shri O.P. Sapra, the learned counsel of the assessee, vehemently objected to the order of the AAC. According to him, the original partnership of 12 partners having been duly dissolved vide deed of dissolution dated 1-4-1978, there is no reasonable ground for the AAC to treat the case of the assessee as that of change. If the deed of dissolution has been disputed, then the question of acceptance of the new partnership deed dated 2-4-1978 along with the application for fresh registration does not arise. Since the claim of the assessee supported by various documents has been accepted by the ITO after careful consideration, it is not open to the AAC to upset the finding without any basis. The question whether there has been dissolution of the firm and upon such dissolution a new firm has succeeded to the old firm is a question which depends upon the intentions of the parties to be gathered from the document or documents, if any, executed by and between the partners and other facts and surrounding circumstances of the case as held the hon'ble Supreme Court in the case of CIT v. Pigot Chapman & Co.  135 ITR 620. Whether the old firm was dissolved and the new firm was rightly constituted was a subject-matter of claim before the ITO and the ITO satisfied himself about the genuineness of the claim and allowed registration. As such the AAC cannot upset the finding without any basis. With regard to the question of intention to reduce the liability of tax, the learned counsel of the assessee relied on the decision of the hon'ble Allahabad High Court in the case of Jaswant Sugar Mills Ltd. v. CIT 1973 Tax LR 1336 for the proposition that the objective satisfaction of the ITO cannot be inferred from the mere fact that the ITO had obtained approval of the IAC to have recourse to the proviso to Section 10(5)(a) of the Indian Income-tax Act, 1922. It is necessary for the ITO to come to a specific finding that the transfer, to attract the provisions of Section 43(1), was for the purpose of reduction of tax liability. Such finding was not recorded by the ITO except the suspicion that the transfer might be for the purpose of reduction of liability. Since the value of the assets has been taken by the assessee-firm on the basis of genuine dissolution document and on the basis of the shares allotted to the partner, such allocation has to be accepted for the purpose of considering actual cost for depreciation. In this regard reliance has been placed on the decision of the hon'ble Allahabad High Court in the case of Matrumal Dhanna Lal v. ITO  86 ITR 497. On the other hand, Shri R.N. Bara, the learned senior departmental representative, supported the order of the AAC. According to him, the case of Jaswant Sugar Mills Ltd. (supra), relied upon by the learned counsel of the assessee, is not exactly identical to the one before us. In this case the original partners of the dissolved firm decided to reconstitute a new firm by admitting another partner. In that process they revalued the assets of the old firm and introduced them in the new firm at its enhanced value just to get the benefit of higher depreciation allowance. In this view of the matter, it is not necessary any longer for the revenue to prove that the transfer was with the intention to reduce the tax liability. The purpose being evident, no further proof is necessary. With regard to the valuation also the learned senior departmental representative contended that the valuation being done by the partners on mutual agreement without taking the advice of an expert in this regard, the same cannot be accepted and has to be revalued to find out the actual cost. Even, in any case, the requirements of Explanation 3 to Section 43(7) are satisfied once the approval of the IAC has been obtained and in this regard the following case laws are cited-Pingle Venkatarama Reddy v. CWT  85 ITR 132 (AP) and Ginners & Pressers (P.) Ltd. v.CIT  113 ITR 616 (Bom.).
6. We have carefully considered the rival submissions in the light of the evidences on our record. The meaning of 'actual cost' will be different depending on the context in which such actual cost has to be considered. The definition of the term 'actual cost' given under Chapter IV-D of the Act is different from the one given under 'capital gains' in Chapter IV-E of the Act. We are now concerned with the definition of actual cost for the purpose of depreciation under Chapter IV-D under the head 'Profits and gains of business or profession'.
Section 43(7) defines actual cost as meaning the actual cost of the assets of the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. Explanations 7 to 7 give different circumstances under which the ITO can resort to the different considerations for determining the actual cost. The ITO in the instant case applied Explanation 3 to Section 43(1) on the reasoning that the old firm was dissolved and was succeeded by a new firm. In that case the actual cost of the assets allotted to the new partners on dissolution of partnership shall be the actual cost to the respective partners as held by the hon'ble Delhi High Court in the case of Raj Narain Agarwala v. CIT  75 ITR 1.
Similar view is held by the Allahabad High Court in the case of Matrumal Dhanna Lal (supra). When there was dissolution and the assessee as a partner in that dissolved firm received assets, then the valuation of that assets taken or given to it while making allocation of assets of partnership would be the actual cost to the assessee. In this case the dissolution deed of 1-4-1978 specifically allotted the share of each partner after valuing the entire capital assets consisting of building, shops, land under cinema and machinery, fans and cooling plant, furniture and fixtures at Rs. 5,20,000. As this document is accepted as genuine, the allotted shares of the partners shall have to be taken as shown in the document. It cannot be objected to when subsequent investment is made by the partner in another firm.
7. Assuming that this is not a case of dissolution, then we cannot see how the provisions of Explanation 3 to Section 43(1) can be applicable.
If the same firm is continuing, then the question of transfer to another person will not arise and the provisions of Explanation 3 to Section 43(1), in our view, cannot be attracted. In this view of the matter, the reasoning of the learned AAC appears to be contradictory.
If the case of the assessee was not a case of succession, then Explanation 3 to Section 43(1) cannot apply to the case.
8. With regard to the reasoning of the learned AAC regarding the correct application of the provisions in that it is enough for the ITO to get the approval of the IAC for sufficient compliance, such view cannot be accepted in view of the direct decision of the hon'ble Allahabad High Court in the case of Jaswant Sugar Mills Ltd. (supra) relied upon by the learned counsel of the assessee. If any transaction is to be treated as entered into for the purpose of reduction of tax liability, then the ITO has to give a specific finding after giving the assessee an opportunity to explain the genuineness of the transfer.
Such exercise not being done in the instant case, the mere fact of obtaining the approval of the IAC will not be sufficient compliance to the requirements of the section. Since the existing partners wanted to enter into a new partnership with another firm, they consider it necessary to increase their capital contribution by revaluing the assets. It is not the case of the revenue that the valuation made by the partners for the assets in question are not market value.
9. The next objection raised appears to be that the market value fixed in the instant case do not represent the written down value of the assets taken over from the other assets. This cannot be a valid reason for treating the transaction as for the purpose of reducing the tax liability. There is no such restriction in law and the partners can distribute their shares at the time of dissolution either according to the market value or on the basis of the written down value. In any case, it will not attract capital gains.
10. Having regard to the above and also keeping in view the fact that the genuineness of the document in regard to the dissolution of the original firm and the constitution of the new firm not being disputed, we are of the view that the value adopted by the assessee-firm on the basis of dissolution deed dated 1-4-1978 cannot be treated as for the purpose of reducing the tax liability in terms of Explanation 3 to Section 43(7). We hold accordingly. We, therefore, direct the ITO to allow depreciation on the basis of the actual allocation of the assets to partners in terms of the dissolution deed dated 1-4-1978. Since these assets were introduced to the new firm immediately from the next day, the question of depreciation or cost of improvement will not arise. That is not the claim of either of the parties also. The ITO is directed to recompute the allowable depreciation on the above basis.
11. The next ground is regarding disallowance on account of subscription and part of telephone expenses. This ground, however, is not pressed and is dismissed.
12. Similarly ground No. 3 regarding levy of interestunder Section 2(1)(vii) (sic) of the Act being consequential to ground No. 1 and the income determined thereon, the same has not been pressed. The ITO shall give consequential relief accordingly.