B. Nagi Reddy vs Commissioner of Income Tax

Ratnam, J.—The assessee is an individual and he submitted a return for the assessment year 1973-1974, admitting an income of Rs.

13,940. On an examination of the return, the Income Tax Officer felt that a variation in the income returned in excess of Rs. 1,00,000 was called

for and, in accordance with the procedure laid down u/s 144B of the Income Tax Act, 1961 (hereinafter referred to as ""the Act""), the Income Tax

Officer forwarded on March 23, 1976, a draft of the proposed order of assessment to the assessee inviting his attention to section 144B(1), (2)

and (3) of the Act and calling for his objections, if any, to the proposed variation within seven days of the receipt of the draft order. In that

communication, the assessee was also informed that, if no objections were received within the period of seven days or the extended period u/s

144B(2) of the Act or if the assessee intimated his acceptance to the proposed variation, the assessment will be completed on the basis of the draft

order. The draft order and the notice were served on the assessee on March 24, 1976. Subsequently, on March 25, 1976, the Income Tax

Officer forwarded to the assessee a supplement to the draft assessment order already sent and called upon the assessee to prefer his objections, if

any, within seven days and the attention of the assessee was also invited to the provisions of section 144B(1), (2) and (3) of the Act as in the

earlier notice. This supplement to the draft order was served on the assessee on March 26, 1976. The draft orders and the notices so forwarded

to the assessee did not evoke any response at all from the assessee within the period of seven days from the date of receipt of the draft order and

the notice. However, by a letter dated April 6/10, 1976, received by the Department on April 14, 1976, the assessee purported to raise some

objections to the proposal for variation as indicated in the draft order. The Income Tax Officer took the view that, as the assessee had not filed

objections within seven days and had also not sought an extension of time for preferring objections, the belated objections received beyond the

time stipulated could not be countenanced and proceeded to complete the assessment. In the course of the assessment proceedings, the assessee

maintained that the income received by the assessee from Vijaya and Vauhini Studios and the income received from letting out the studios should

be assessed under the head ""Business income"". This, however, was negatived by the Income Tax Officer by assessing that income as ""income from

property"". In computing the income from Vijaya and Vauhini Studios, the Income Tax Officer did not also allow depreciation on the building, plant,

machinery or furniture on the ground that depreciation cannot be allowed on those items as they were transferred by the assessee to a firm called

Vijaya Productions of which the assessee was a partner during the previous year relevant to the assessment year and that would attract section

41(2) of the Act. Regarding the income of the assessee from Sarada Binding Works the assessee maintained that it should be considered as

income from ""other sources"". But the Income Tax Officer assessed as income as ""income from property"". In regard to the claim of the assessee

that a sum of Rs. 14,000 being the amount incurred in the production of two pictures which were given up should be allowed as a revenue

expenditure, the Income Tax Officer negatived the same. Ultimately, on April 29, 1976, the Income Tax Officer completed the assessment

including certain amounts by way of capital gains. On appeal by the assessee to the Appellate Assistant Commissioner questioning the legality of

the assessment on the ground that the provisions of section 144B of the Act had not been complied with and that assessment was also barred by

limitation, by his order dated February 4, 1977, he took the view that there was nothing illegal in the assessment order and that it was also not

barred by time. Regarding the assessment of income from Vijaya and Vauhini Studios, the Appellate Assistant Commissioner, following the

decision of the Tribunal for the earlier assessment year in respect of the same assessee, held that that income was assessable under the head

Business income"" and the Income Tax Officer was directed to work it out in terms of the provisions of sections 28 to 43A of the Act and adopt

the correct figures under the head ""Business"". With reference to the rental income from Sarada Binding Works, the Appellate Assistant

Commissioner, purporting to follow the decision of the Tribunal for the earlier assessment years, directed the Income Tax Officer to assess the

rental income under the head ""Other sources"". The claim made by the assessee in a sum of Rs. 14,000 as allowable deduction in respect of the

amounts spent by the assessee for the production of two pictures which were subsequently given up was upheld. In the result, the appeal was

partly allowed. The Income Tax Officer, while giving effect to the order of the Appellate Assistant Commissioner dated February 4, 1977, and

working out the income of the assessee from Vijaya and Vauhini Studios, did not allow depreciation on the building, plant, machinery or furniture

on the ground that, u/s 34(2)(ii) of the Act, depreciation cannot be allowed as they were transferred by the assessee to the firm, Vijaya

Productions. That formed the subject-matter of an appeal to the Appellate Assistant Commissioner who, by his order dated September 26, 1977,

found that section 34(2)(ii) of the Act could not be invoked at all, as the assessee did not sell, discard, demolish or destroy any building,

machinery, plant or furniture, but had become a partner in Vijaya Productions with effect from April 1, 1972, by which process, the property of

the assessee became converted into the assets of the partnership of which the assessee was also a partner and, therefore, the assessee cannot be

denied the benefit of depreciation on these items in the previous year relevant to the assessment year. Accordingly, the Income Tax Officer was

directed to recompute the correct amount of depreciation allowable and give relief to the assessee and the appeal was allowed. Against the orders

of the Appellate Assistant Commissioner, the Revenue preferred appeals before the Tribunal while the assessee also preferred a cross-objection

questioning the conclusion of the Appellate Assistant Commissioner regarding the legality and validity of the assessment and other matters decided

against. The Tribunal, on a consideration of the facts and circumstances of the case, found that the failure on the part of the assessee to submit his

objections within the time granted by the Income Tax Officer or even pray for an extension of time for submission of objections led to the passing

of the order of assessment and no exception could be taken to the order so passed. Adverting to section 153 of the Act and the Explanation

thereunder, the Tribunal found that the completion of the assessment by the Income Tax Officer on April 29, 1976, was well within the time

allowed. The assessment of the income of the assessee from Vijaya and Vauhini Studios and Sarada Binding Works, in the manner directed to be

done by the Appellate Assistant Commissioner, was upheld. Likewise, the allowability of the sum of Rs. 14,000 incurred by the assessee as a

deduction, as directed by the Appellate Assistant Commissioner, was also upheld. Dealing with the question of the applicability of section 34(2)(ii)

of the Act, the Tribunal held that the assessee cannot be stated to have sold, discarded, demolished or destroyed any of his assets by converting

these assets into partnership assets and upheld the conclusion of the Appellate Assistant Commissioner in that regard. That is how, at the instance

of the assessee and the Revenue, u/s 256(1) of the Act, the following questions of law have been referred to this court, for its opinion :

Whether, on the facts and circumstances of the case, the Income Tax Officer''s order u/s 144B is illegal and barred by limitation ?

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the income received by the

assessee from Vijaya and Vauhini Studios should be assessed in the hands of the assessee as ''business income'' ?

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the income derived from letting the

studios is assessable under the head ''Business'' ?

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the income from the lease rent from

Messrs. Sarada Binding Works should be assessed under the head ''Other sources'' ?

Whether, on the facts and in the circumstances of the case, the sum of Rs. 14,000 is a revenue expenditure and not a capital expenditure ?

Whether, on the facts and in the circumstances of the case, section 34(2)(ii) is not applicable, when the assets of a proprietary concern were

converted into the assets of a partnership concern ?

We proceed to consider the questions referred seriatim. With reference to the first question, learned counsel for the assessee contended that the

Income Tax Officer, after forwarding the first draft order on March 23, 1976, became functus officio and he had no jurisdiction whatever to

forward a second draft order on March 25, 1976. Reliance was placed by learned counsel in this connection upon the decision in Sudhir Sareen

Vs. Income Tax Officer, Central Circle XVII, New Delhi and another, . Learned counsel for the Revenue controverted this contention stating that,

in the course of the proceedings before the authorities below, no objection was raised by the assessee to the draft assessment order and that this

question cannot also be said to arise out of the order of the Tribunal, as it had not been dealt with by the Tribunal or even raised before it, though

not decided by it. Learned counsel further submitted that this question not having been raised before the Tribunal and not dealt with by it in its

order, cannot be said to arise out of the order of the Tribunal even if, on the facts, the question may be stated to fairly arise.

A careful perusal of the proceedings before the authorities shows that, at no point of time, the assessee raised any objection that the Income Tax

Officer had no jurisdiction to forward a supplement to the draft assessment order. Even in the so-called objections put in belatedly by the assessee

before the Income Tax Officer on April 14, 1976, such an objection had not been raised. In the course of the proceedings before the Appellate

Assistant Commissioner and the Tribunal, the assessee did not put forth any such objection at all. The Tribunal, naturally, did not, therefore, go into

that aspect which was never put forward before it. The question sought to be raised is thus one which had not been put forward by the assessee at

any stage of the proceedings before the authorities below and cannot also be said to arise out of the order of the Tribunal. We are, therefore, of

the view that the assessee cannot be permitted to raise this question at this stage. Even on the assumption that the assessee could be permitted to

put forward such a plea, we are of the view that there is no substance in it. It is seen that, in the first instance, on March 23, 1976, the Income Tax

Officer had forwarded to the assessee a draft assessment order along with the notice and that had been served on the assessee on March 24,

1976. On March 25, 1976, the Income Tax Officer had sent to the assessee a notice in the following terms :

In addition to the variations proposed in the draft of the assessment order enclosed to my letter cited above, a further addition is also proposed to

be made as indicated in the supplement to the draft of the assessment order herewith enclosed. .....

From the aforesaid, it is clearly seen that the draft order sent along with the notice on March 25, 1976, was not in the nature of a second draft

order as such, but was in addition to or a supplement to the earlier draft assessment order sent to the assessee on March 23, 1976, along with the

notice. In other words, the draft (supplement) sent on March 25, 1976, has to be regarded as forming an integral part and parcel of the earlier

draft order sent to the assessee by the Income Tax Officer on March 23, 1976, and they have to be read together and considered as one single

order and not as two distinct and separate orders. In that view, the very basis of the argument that there was a second order and the Income Tax

Officer did not have jurisdiction to forward such an order does not exist. The decision in Sudhir Sareen Vs. Income Tax Officer, Central Circle

XVII, New Delhi and another, , dealt with a case in which the first draft order was forwarded to the assessee by the Income Tax Officer on

March 30, 1979, to which the assessee had filed his objections and the Inspecting Assistant Commissioner heard the matter and at this stage, a

second draft order for further enhancement, prejudicial to the assessee, was issued on September 10, 1979, on the directions of the Inspecting

Assistant Commissioner. It is, thus, seen that, in that case, thereafter a second draft order had been forwarded to the assessee nearly six months

thereafter and that too on the directions of the Inspecting Assistant Commissioner thus violating the proviso to section 144B(4) of the Act. It was

under these circumstances that the court pointed out that, before directions prejudicial to the assessed are given by the Inspecting Assistant

Commissioner, an opportunity should have been given to the assessee, which had not been given and that that would vitiate the second order. On

the facts of this case and in the view taken regarding the nature of the order forwarded by the Income Tax Officer to the assessee on March 25,

1976, that decision cannot have any application at all.

Learned counsel for the assessee next faintly contended that there had been an extension of time by fourteen days granted to the assessee

automatically, as it were, and, therefore, the assessment order passed without following the procedure u/s 144B(4) of the Act is not valid. Learned

counsel for the Revenue submitted that, in this case, the assessee, after the receipt of the draft order along with notice on March 24, 1976, and

March 26, 1976, did not forward any objections within seven days of the receipt of the draft order and no extension of time for forwarding

objections had also been sought for and, under these circumstances, the first part of section 144B(3) of the Act would stand attracted, enabling the

Income Tax Officer to complete the assessment on the basis of the draft order and no invalidity could attach to such an order. It is not in dispute

that the notices dated March 23, 1976 and March 25, 1976, along with the draft orders enclosed therewith were received by the assessee on

March 24, 1976 and March 26, 1976. In accordance with the contents of the notices and the terms of section 144B(2) of the Act to which the

attention of the assessee had also been drawn in the notices, the assessee should have forwarded his objections to the proposed variation within

seven days of the receipt by him of the draft order. If, for some reason, the assessee was unable to do so, then, he should have made an

application to the Income Tax Officer praying for extension of time to forward his objections to the draft order. It is not in dispute that the assessee

did not make any application for extension of time. All that had been done by the assessee in this case was to forward the so-called objections to

the draft order on April 14, 1976. Clearly, that was not within seven days from the date of receipt of the draft order by the assessee. As the time

for forwarding the objections to the draft order had not been extended by the Income Tax Officer in the manner contemplated u/s 144B(2) of the

Act, the assessee cannot take advantage of his inaction till April 14, 1976, and claim that there has been an automatic extension of time for

forwarding objections. In the absence of extension of time by the Income Tax Officer, the forwarding of objections by the assessee on April 14,

1976, beyond the period of seven days as provided u/s 144B(2) of the Act, would not enable the assessee to contend that objections to the draft

order were forwarded as provided u/s 144B(2) of the Act. In other words, in the absence of forwarding of the objections within the time-limit

prescribed u/s 144B(2) of the Act or within such time as could be extended thereunder, it has to be taken that the assessee had no objections and

the completion of the assessment by the Income Tax Officer on the basis of the draft order cannot be objected to. We have, therefore, no

hesitation in rejecting this contention of learned counsel for the assessee.

Learned counsel for the assessee next contended that the assessment should have been completed within thirty days from March 23, 1976, and

not having been so done, the assessment proceedings were barred by limitation. In controverting this contention, learned counsel for the Revenue

pointed out that, u/s 153(1)(a)(iii) of the Act, the assessment for the assessment year 1973-74 on the assessee should have been completed on or

before March 31, 1976, but that the period stood extended by reason of the latter part of clause (iv) of Explanation 1 to section 153 of the Act

and the period of thirty days from March 31, 1976, would be available for the completion of the assessment, i.e., till April 30, 1976, and the

assessment, having been completed on April 29, 1976, was in time.

The assessment year in question is 1973-74 and the end of the assessment year in which the income was first assessable was on March 31,

1974. u/s 153(1)(a)(iii) of the Act, the period of two years from March 31, 1974, would be available. In other words, the assessment on the

assessee ought to have been completed on or before March 31, 1976. However, in Explanation 1, exclusion in the computation of the period of

limitation, for the purpose of section 153 of the Act, has been provided in certain cases. Under clause (iv) of Explanation 1, provision is made for

exclusion of the period of limitation, with reference to cases falling u/s 144B of the Act. The second part of clause (iv) of Explanation 1 to section

153 of the Act refers to exclusion of a period of thirty days in cases where no objections to the draft order were received from the assessee. It has

earlier been seen that, in this case, the assessee did not forward any objection to the draft order as contemplated u/s 144B(2) of the Act and that,

in turn, attracted the first part of section 144B(2) of the Act enabling the Income Tax Officer to complete the assessment on the basis of the draft

order, being a case where no objections were received either within the period of seven days or the extended period, as there was no extension.

The period of thirty days has necessarily to be excluded from the period of two years provided u/s 153(1)(a)(iii) of the Act and, if so done, the

assessment in this case should have been completed by April 30, 1976, without attracting the bar of limitation. Actually, the assessment was

completed on April 29, 1976. We are, therefore, of the view that the argument of learned counsel for the assessee that the assessment should have

been completed within thirty days from March 23, 1976, deserves rejection. Thus, on a due consideration of the facts and circumstances and the

relevant provisions of the Act, we answer the first question referred to us in the negative and in favour of the Revenue.

We now proceed to consider the second and the third questions referred to us. Those questions relate to the head of tax treatment to be

accorded to the income received by the assessee from Vijaya and Vauhini Studios and also by letting out the studios. The Tribunal took the view

that the income from these sources should be assessed under the head ""Business"". In so holding, the Tribunal was quite right. In respect of the

same assessee, though for the assessment years 1963-64 to 1969-70, an identical question came to be considered by a Division Bench of this

court in Commissioner of Income Tax, Tamil Nadu-I Vs. B. Nagi Reddy, , to which one of us (Ratnam J.), was a party. Therein it was pointed out

that whether a particular letting is business or not has to be decided in the circumstances of each case and in the setting and background of facts

and there is no such thing as a naturally born commercial asset, as an asset becomes a commercial one in view of the use to which it is put in a

business and not owing to its inherent qualities. Considering the activities of the assessee in film business, as a producer, distributor, exhibitor,

studio owner and the like, it was held that, on an overall consideration of the facts, the tax treatment to be accorded to the rental income had to be

determined and the utilisation of the studios by the assessee in making his own films and the letting out of the buildings to others as well as realising

rental income constituted the business activities of the assessee in relation to the studios and, therefore, the rental income should be brought to tax

under the head ""Business income"". Again, the same question with reference to the same assessee arose for consideration before this court in

Commissioner of Income Tax Vs. B. Nagi Reddy, in respect of the assessment year 1971-72, and under the head ""Business income"". With

reference to the assessment year in question, the same considerations would apply and the facts are also not any different and, under those

circumstances, in view of the decisions in Commissioner of Income Tax, Tamil Nadu-I Vs. B. Nagi Reddy, and Commissioner of Income Tax Vs.

B. Nagi Reddy, , we hold that the Tribunal was right in its conclusion that the income received by the assessee from Vijaya and Vauhini Studios

and from letting out the studios should be assessed in the hands of the assessee as ""Business income"". We, therefore, answer the second and the

third question referred to us in the affirmative and against the Revenue.

In regard to the fourth question, relating to the head under which the income from Sarada Binding Works should be assessed in the hands of the

assessee, the Income Tax Officer took the view that the assessment should be made under the head ""Income from property"". However, before the

Appellate Assistant Commissioner, it was represented on behalf of the assessee that that issue had been settled by an order of the Tribunal for

earlier years, wherein it had been held that the income should be assessed under the head ""Other sources"". Accordingly, the Appellate Assistant

Commissioner directed the assessment of the income from Sarada Binding Works under the head ""Other sources"". The Tribunal also stated that it

found that the matter is covered by an earlier decision of the Tribunal. With a view to ascertain the precise head under which the income from

Sarada Binding Works has to be assessed as per the earlier order stated to have been passed by the Tribunal in the case of the assessee, we

called upon learned counsel for the assessee to produce before us a copy of the order of the Tribunal. Though we had granted more than adequate

time to learned counsel for the assessee to produce the order, we find that no such order is forthcoming. In the absence of any order of the

Tribunal for the earlier years to the effect that the income from Sarada Binding Works should be assessed under the head ""Other sources"", we are

unable to uphold the conclusion of the Tribunal in this regard, for there is no material on which such a conclusion could be sustained. We,

therefore, answer the fourth question referred to us in the negative and in favour of the Revenue.

That takes us on to a consideration of the fifth question relating to the allowability of a sum of Rs. 14,000 incurred by the assessee in the

production of two films, subsequently abandoned, as revenue expenditure. The assessee had incurred an expenditure of Rs. 14,000 on the

production of two pictures, which were given up. The Income Tax Officer disallowed the claim of the assessee stating that, in the line of business of

production of feature films, there is no question of loss arising if abandoned or given up, and its value would subsist and can be exploited at any

time. On the other hand, the Appellate Assistant Commissioner, considering the line of business of the assessee, held that the loss arising on

account of giving up of the production of films has to be allowed as business expenditure based on commercial expediency. The Tribunal accepted

the view taken by the Appellate Assistant Commissioner. It is seen that the assessee had just started a venture in the production of the two films

and thereafter thought it prudent not to proceed further. The giving up by the assessee of the production of two films was only on the grounds of

commercial expediency after expenses had been incurred by the assessee for payment to writers, for the choice of a story and for its adaptation as

film. When the assessee found that the project was not likely to be profitable, it was given up in order that, freed from his efforts in the production

of these two films, the assessee could concentrate on the making of better and more profitable ventures in film-making in order to facilitate the

carrying on of the business of the assessee. We, therefore, agree with the Tribunal that the claim of the assessee for deduction of Rs. 14,000 as

revenue expenditure was an allowable one. We answer the fifth question in the affirmative and against the Revenue.

That leaves for consideration the last question referred to us. The Income Tax Officer did not allow depreciation on building, machinery, plant

or furniture on the ground that section 34(2)(ii) of the Act would apply, as they were transferred to the firm, Vijaya Productions, during the

previous year relevant to the assessment year. However, on appeal, the Appellate Assistant Commissioner found that section 34(2)(ii) of the Act

cannot be applied, as the assets were neither sold, discarded, demolished or destroyed, but were merely converted into the assets of a partnership

firm. The Tribunal upheld the view of the Appellate Assistant Commissioner and, in so holding, the Tribunal was right. It is seen that the assets of

the assessee, on the assessee becoming a partner in a firm, because converted as assets of the firm. There was no element of sale involved in that

process. In order to deny the benefit of depreciation u/s 34(2)(ii) of the Act, the building, machinery, plant or furniture should have been sold,

discarded, demolished or destroyed in the previous year relevant to the assessment year. All that the assessee had done in this case is to enter into

a partnership by making available his assets as his contribution to the partnership of which he was also a partner. In other words, the assets which

were exclusively held by the assessee got transformed into assets of a partnership, of which the assessee was a partner. With reference to such a

transaction, the Supreme Court in Commissioner of Income Tax, West Bengal Vs. Hind Construction Ltd., , pointed out that it is difficult to

appreciate that there was a sale when the machinery was used by the assessee as the capital of the new firm of which he was a partner. To similar

effect are the decisions in D. Kanniah Pillai Vs. Commissioner of Income Tax, and A. Subbiah Nadar Vs. Commissioner of Income Tax, . In the

first of the aforesaid decisions, it was held that when an individual converts his sole proprietary concern into a partnership of which he is himself a

partner, no question of sale would arise and there was no possibility of a transaction of sale when the proprietary concern was converted into a

partnership. Finally, the court pointed out that the Tribunal was wrong in holding that there was a sale of the assets by the assessee to the

partnership firm. This was reiterated in the later decision where the members of a Hindu undivided family which owned lorries transferred them to a

partnership consisting of the members of the family and others and a question arose as to whether section 41(2) of the Act stood attracted. It was

laid down that when an individual converts his individual property into that of a partnership, the individual ceases to hold the property as his

individual property and when a Hindu undivided family does that, the Hindu undivided family ceases to hold the property as such family property

but the members of the Hindu undivided family hold the property as partners and that the principle applicable to the conversion of a proprietary

concern into a partnership would apply even to a Hindu undivided family. In the light of the aforesaid decisions, the conversion of the exclusive

proeprty of the assessee by making it available to a partnership of which he is a partner would not constitute a sale, nor can the process of

conversion be regarded as one amounting to discarding, demolishing or destroying the building, machinery, plant or furniture. Such conversion

cannot, by any stretch of imagination, be regarded as either demolishing or destroying the assets. Nor would it be governed by the expression

discarded"", which means, to throw away or give up as useless. The assessee, by becoming a partner in the firm by making his exclusive properties

the assets of the firm, cannot be stated to have discarded the building, machinery, plant or furniture. Thus, none of the requirements of section

34(2)(ii) of the Act is satisfied and that provision cannot apply at all. The Tribunal was, therefore, right in concluding that the assessee would be

entitled to the benefit of depreciation as found by the Appellate Assistant Commissioner. We, therefore, answer the last question referred to us in

the affirmative and against the Revenue. In view of the partial success of the Revenue and the assessee on the questions referred, we do not make

any order as to costs.