TMI Blog1977 (2) TMI 24X X X X Extracts X X X X X X X X Extracts X X X X ..... ners on December 9, 1949. From 9th April, 1959, this business was taken over by a private limited company (M/s. Hico Products Private Ltd.) with all assets and liabilities and goodwill. The assets and liabilities of the firm were transferred to the limited company at book value while the goodwill was valued at Rs. 4,89,000. Initially there was no goodwill account in the books of the firm but, at the time of the transfer, goodwill account was debited in the books with Rs. 4,89,000 and each of the partners' account was credited with Rs. 1,63,000 representing each one's share in the goodwill. In other words, the consideration for the goodwill was divided equally between the three partners. The capital of the private limited company (M/s. Hico Products Pvt. Ltd.) was Rs. 5 lakhs divided into 5,000 ordinary shares of Rs. 100 each; 4,998 shares were distributed among the three partners, each one being allotted 1,666 shares while the remaining 2 shares were allotted to and held by two persons (one each) as the nominees for all the three partners. A declaration was also filed before the Registrar of Companies showing the two persons as the nominees. On the aforesaid facts in the assessme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... refore, directed that the sum of Rs. 3,64,830 should be deleted from the assessment. At the instance of the Commissioner of Income-tax the question set out at the commencement of this judgment has been referred to us by the Tribunal for our opinion. Mr. Joshi appearing for the revenue has pointed out that the view taken by this court in the case of Sir Homi Mehta's Executors [1955] 28 ITR 928 (Bom) and in the case of Rogers and Co. v. Commissioner of Income-tax [1958] 34 ITR 336 (Bom) has been expressly disapproved by the Supreme Court in Commissioner of Income-tax v. B. M. Kharwar [1969] 72 ITR 603 (SC) and as such the view taken by the Tribunal in the instant case which is based upon the aforesaid two decisions of this court would not be sustainable. He pointed out that in Kharwar's case [1969] 72 ITR 603 (SC) the Supreme Court has taken the view that where machinery of a factory belonging to a firm is transferred to a private limited company, assuming that thereby readjustment of the business relationship was intended, the liability to be taxed under the second provisio to section 10(2)(vii) of the Indian Income-tax Act, 1922, in respect of the readjustment has to be determine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ibunal that there was no transfer or sale of goodwill to Hico Products Pvt. Ltd. in the commercial sense and that there was no question of capital gain arising to the assesssee-firm will have to be regarded as unsustainable. But, according to him, that would not be the end of the matter, for he urged that the ultimate order of the Tribunal that the sum of Rs. 3,64,830 representing the so-called capital gain is not liable to be included in the assessment is sustainable on another ground. He urged that a self-generated or self-created goodwill is not a capital asset, the transfer of which will give rise to chargeable capital gain, having regard to the scheme of section 12B of the Indian Income-tax Act, 1922, which implies that there should be acquisition of an asset at the given point of time and for some monetary cost and he urged that since in the instant case no goodwill as such had been purchased by the assessee-firm nor had any goodwill been gifted to it but it was generated or earned and came into existence as a result of efforts and trading activities of the assessee-firm, there was no actual cost of that asset to the assessee that could be deducted from the consideration rece ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acts which are already on record, we do not see any reason why the assessee should not be allowed to raise this new ground. The only additional material that was taken on record by us was a true copy of the deed of partnership dated 9th December, 1949, recording the terms and conditions on which the three partners of the assessee-firm had agreed to and did carry on their business and that was merely for the purpose of confirming the position that the partnership business had been commenced by the three partners in January, 1947, a fact clearly mentioned in the statement of case. We must mention here that Mr. Joshi for the revenue in all fairness consented to such copy of deed of partnership going on record, which we have marked, by consent of parties, as exhibit D-1 in the reference. It is well-settled position that when the main question is under issue before the Tribunal there is no further limitation imposed by section 66(1) of the Act that the reference should be limited to those aspects of the question which had been argued before the Tribunal and if a different aspect of the same question is sought to be raised for the first time before the High Court, it would be permissib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (a) it is not a case where the assessee-firm had purchased for consideration any goodwill or had obtained it under any gift but the assessee-firm after commencing its business from January 2, 1947, onwards had built it up by its own exertion and trading activities, and (b) there was initially no goodwill account in the books of the firm but only on conversion the goodwill was valued at Rs. 4,89,000 and the goodwill account was debited in the books, with the partners' accounts being credited with Rs. 1,63,000 each, representing each one's share in goodwill and, according to him, the question at issue will have to be considered having regard to these aforesaid admitted facts which appear clear on record. He contended that though the goodwill of the firm would fall within the definition of "capital asset" as given in section 2(4A) of the 1922 Act, a self-created or self-generated goodwill (which it is in the instant case) would not be capital asset the transfer of which will give rise to the chargeable capital gain because, according to him, to attract capital gains the asset must be capable of being held by the assessee independently, must be capable of independent transfer and must ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... revenue pointed out that the definition of the, expression "capital asset" as given in section 2(4A) of the 1922 Act and the definition of that expression as given in section 2(14) of the 1961 Act is of the widest amplitude since according to these two definitions the expression "capital asset" has been defined to mean "property of any kind held by an assessee whether or not connected with his business or profession" and then follow three types of specified properties which are excluded from that definition with which the court is not concerned in this case and according to him though goodwill is an intangible asset and may not be capable of being held independently by an assessee in the sense that it always goes with the business of the assessee, it none the less falls within the definition of the expression "capital asset". He further pointed out that under section 6 of the 1922 Act as well as section 14 of the 1961 Act "capital gains" has been enumerated as one of the heads of income and both under section 12B(1) of the 1922 Act as well as under section 45 of the 1961 Act any profits or gains arising from transfer of capital asset effected in the previous year have been rendere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the 1922 Act as well as the 1961 Act, it would be desirable to set out a few undisputed facts which emerge very clearly on record. It was not disputed before us that the assessee-firm (M/s. Home Industries Co.) commenced its partnership business of manufacturing and selling textile auxiliaries, industrial and allied chemicals and process work of bleaching and printing at Lady Hardinge Road, with effect from January 2, 1947. In other words, the three partners constituting the assessee-firm had not taken over from any existing concern its business for being carried on in partnership by them but the three partners themselves started their fresh business in partnership in January, 1947. This aspect becomes clear from the recital as well as clause 2 of the deed of partnership dated December 9, 1949, which has been produced at exhibit D-1 in this reference. There is also a statement to that effect in the statement of case submitted by the Tribunal to this court. It was also not disputed before us that the books of account of the assessee-firm initially did not contain any goodwill account but that such goodwill account came to be opened only at the time of transfer of the said busi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asset" thus : " 'capital asset' means property of any kind held by an assessee, whether or not connected with his business, profession or vocation, but does not include-- (i) any stock-in-trade, consumable stores or raw materials held for the purposes of his business, profession or vocation ; (ii) personal effects, that is to say, movable property (including wearing apparel, jewellery and furniture) held for personal use by the assessee or any member of his family dependent on him ; (iii) any land from which the income derived is agricultural income." Section 6, which occurs in Chapter III of the Act, deals with taxable income and it enumerates six different heads of income chargeable to income-tax and clause (vi) refers to "capital gains" as one of the heads of income chargeable to income-tax. Then comes the material provision, viz., section 12B, under which "capital gains" have been rendered exigible to income-tax. Section 12B has for its marginal note the expression "capital gains". It may be stated that capital gains were brought under taxation, for the first time, by the Income-tax and Excess Profits Tax (Amendment) Act, 1947, which introduced section 12B into the I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... date and increased or diminished, as the case may be, by any adjustment made under clause (vii) of sub-section (2) of section 10 : Provided ...... (3) Where any capital asset became the property of the assessee by succession, inheritance or devolution or on any distribution of capital assets on the total or partial partition of a Hindu undivided family or on the dissolution of a firm or other association of persons or on the liquidation of a company or under a deed of gift, or transfer on irrevocable trust, its actual cost allowable to him for the purposes of this section shall be its actual cost to the previous owner thereof, and the provisions of sub-section (2) shall apply accordingly; and where the actual cost to the previous owner cannot be ascertained, the fair market value at the date on which the capital asset became the property of the previous owner shall be deemed to be the actual cost thereof : Provided that where the capital asset became the property of the assessee-- (i) before the 1st day of April, 1956, under a deed of gift or on the partition of a Hindu undivided family, the actual cost allowable to him shall be the fair market value of the capital asset on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l be computed by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely :-- (i) expenditure incurred wholly and exclusively in connection with such transfer ; (ii) the cost of acquisition of the capital asset and the cost of any improvement thereto." Section 49 deals with the aspect as to how the cost of acquisition of an asset to an assessee will have to be valued in certain modes of acquisition of that asset and the provisions thereof are similar or equivalent to some of the provisions contained in section 12B(3) of the 1922 Act. Now, there are five or six aspects of goodwill which have been pressed into service by Mr. Dastur in support of his contention that self-created or self-generated goodwill would not be a capital asset the transfer of which will give rise to chargeable capital gains under the scheme of section 12B of the 1922 Act. According to him, the position arising from sale or transfer of such type of goodwill will be the same even under the 1961 Act. In the first place, having regard to the definition of "capital asset" given in section 2(4A) of the 1922 Act, he u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... time nor it had cost anything to the firm in terms of money and that it had been sold by the firm along with its business as a going concern to the private limited company and, therefore, the transaction in question would not give rise to chargeable capital gain. In support of his aforesaid contentions reliance was placed by him upon the decisions of five different High Courts mentioned above. He pointed out that in K. Rathnam Nadar's case [1969] 71 ITR 433 (Mad) the Madras High Court has taken the view that goodwill is created by the trading activities of the assessee and probably by the name he has earned and the goodwill he has created among his customers ; that goodwill of a firm is an intangible asset and can be compared to a seed which is planted on the date the firm begins its business and sprouts and grows as the firm grows in its dealings, in its stature and in its reputation; it is difficult to say that it costs anything in terms of money for its coming into existence; that though goodwill is a capital asset, in the case of a goodwill of a business it cannot be said that it became the capital asset of the firm at any particular point of time ; that it is something whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Strong reliance was placed by Mr. Dastur upon the Full Bench decision of the Kerala High Court in E. C. Jacob's case [1973] 89 ITR 88 (Ker) [FB]. In that case the assessee had been practising as a chartered accountant under the firm name, J. W., from 1951. During the relevant accounting year, the assessee took in as partner one V, on July 15, 1965. The assessee's share in the business was 75% and V's share was 25%. The goodwill of the business was valued at Rs. 32,000 and V paid to the assessee Rs. 8,000 for his share of the goodwill. The firm was dissolved on October 19, 1965, when the assessee retired from the firm and the assessee received Rs. 24,000 towards his share of the goodwill of the firm. The Income-tax Officer held that the entire amount of Rs. 32,000 received by the assessee was taxable as "capital gains". On second appeal, the Appellate Tribunal held that the amount was not taxable. On a reference, the Full Bench of the High Court held that the Appellate Tribunal was correct in holding that the amount could not be subjected to tax as capital gains. The court took the view that what is charged under section 45 of the 1961 Act is the "profit or gain arising from the t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ells it for a higher price and thereby secures a determinate profit or gain. In such a case, goodwill is hardly distinguishable from any other capital asset and there is nothing in section 45 or other relevant provisions of the Income-tax Act that excludes such profits or gains from liability to assessment." Lastly, he relied upon the decision of the Karnataka High Court in B. C. Srinivasa Setty's case [1974] 96 ITR 667 (Kar). In that case the question that was referred to the High Court ran thus : " Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that no capital gains could arise under section 45 of the Income-tax Act, 1961, on the transfer by the assessee-firm of its goodwill to the newly constituted firm ? " It is true that as against the decisions rendered by the High Courts of Madras, Calcutta, Delhi and Kerala, the contrary view taken by the Gujarat High Court in Mohanbhai Pamabhai's case [1973] 91 ITR 393 (Guj) was also brought to the notice of the Karnataka High Court but the Karnataka High Court answered the question referred to it in the affirmative and held that the value of the consideration received by the assessee-f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ains tax. Such a levy will not be a tax on profits or gains but, in substance, a tax on the capital value of the asset. The capital value of goodwill is charged to tax under the Wealth-tax Act, 1957. Wealth-tax is an annual recurring tax. When there is an annual recurring tax on the capital value of goodwill, it will be unfair to levy another tax calling it as capital gains on the same value of the goodwill in the same assessment year, merely because the goodwill has been transferred for consideration". Relying on the aforesaid authorities Mr. Dastur urged that in the instant case the goodwill being a self-created asset should be regarded as not capital asset the transfer of which will give rise to chargeable capital gains and as such the question referred to us should be answered in the negative, in favour of the assessee. Mr. Joshi, on the other hand, contended that all the conditions requisite for levying capital gains tax under section 12B of the 1922 Act were satisfied in the instant case and, therefore, there was no reason why the capital gain made by the assessee-firm while transfering the goodwill of its business to the private limited company should not be brought to tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... intended by the legislature. According to him, if in a given case no expenditure of any kind is incurred in connection with such sale or transfer of capital asset, it could be urged that taxability of profit or gain made by transfer of a capital asset under section 12B(1) shall not arise, which could never have been intended by the legislature. According to him, therefore, the mere fact that the goodwill has not cost anything to the assessee-firm in terms of money in the instant case could not be a ground for not attracting the provisions of section 12B(1) to the transaction in question. He pointed out that under the 1922 Act the entire provision relating to capital gains tax his been enacted in section 12B of the Act, but even so, it is clear that the charging provision is to be found in sub-section (1) of section 12B while what is contained in sub-section (2) and the other sub-sections of section 12B will have to be regarded as machinery provisions. This aspect of the matter will become clear if the provisions of the 1961 Act are borne in mind. Under the 1961 Act, the charging provision is to be found in a separate section, viz., section 45, while the machinery provision is to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cisions that were cited at the Bar, we are inclined to agree with the view taken by the Madras High Court in Rathnam Nadar's case [1969] 71 ITR 433 (Mad) and by the Full Bench of the Kerala High Court in E. C. Jacob's case [1973] 89 ITR 88 (Ker) [FB]. Looking at the issue purely from the point of view of proper construction of the relevant provisions of the 1922 Act (being section 12B) and of the 1961 Act (being group of sections--sections 45 to 55 of the Act) it appears to us clear that there is sufficient warrant in the charging provision itself (in both the Acts) to exclude the self-created or self-generated goodwill (of the type with which we are concerned in this case) from the charge and for that purpose recourse to the machinery provision would be unnecessary, though what is contained in the machinery provision could strengthen the inference clearly arising from the charging provision. But, before we discuss the charging provision as well as the machinery provision (contained in both the Acts), we would at the outset indicate which out of the five or six aspects of goodwill which have been pressed into the service of Mr. Dastur will, according to us, have no bearing on the d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cost in terms of money would be equally important. As has been pointed out by the Madras High Court in Rathnam Nadar's case [1969] 71 ITR 433 (Mad), such goodwill is created by trading activities by the assessee and probably by the name he has earned and the goodwill he has created among his customers and comparing it to a seed, it is observed that goodwill is planted on the date the firm begins its business and sprouts and grows as the firm grows in its dealings, in its stature and in its reputation and, therefore, it is not possible to say that it becomes capital asset of the firm at any particular point of time and that it is something which goes on slowly growing. and perhaps waxing and waning also. It is also clear that it is very difficult to say that it costs anything in terms of money for coming into existence. Further, as has been pointed out by the Kerala High Court in E. C.Jacob's case [1973] 89 ITR 88 (Ker) [FB], normally, goodwill is an asset that gains in value by lapse of time and in the case of the goodwill of a profession, such augmentation is essentially attributable to the personal efforts, skill or sacrifice of the owner and it is not possible in such cases to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l appear clear on a reading of both the charging provisions that the incidence of tax is on "profits on gains" arising from the transfer or sale of a capital asset. In other words, the charging provision in both the Acts makes it very clear that there must be profit or gain which must arise from the transfer or sale of capital asset and it is such "profit or gain" that is chargeable to tax. The concept of "profit or gain" arising from transfer or sale necessarily implies that there is something received in excess of the cost of the capital asset which is transferred or sold. Profit or gain arising from sale has a necessary reference to the difference between the cost price of the asset and the sale price of the asset. In other words, it is not necessary to have any recourse to the machinery provision contained in sub-section (2) of section 12B of the 1922 Act, or section 48 of the 1961 Act, in order to come to the conclusion that the incidence of tax contemplated by the charging provision necessarily refers to the difference between the cost price and the selling price of a particular capital asset, the profit or gain arising from transfer of which is the subject-matter of the char ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act or section 45 of the 1961 Act. As regards the Gujarat High Court decision in Mohanbhai Pamabhai's case [1973] 91 ITR 393 (Guj), on which strong reliance was placed by Mr. Joshi, two or three aspects may be mentioned. In the first place, the decision on the concerned point is clearly obiter. It may be stated that two contentions were raised on behalf of the assessee who had retired from the partnership firm of Prajapati Tiles Company; the first was that the retirement of the assessee from the partnership amounted to dissolution of the firm within the meaning of section 47(ii) and, therefore, no transfer of capital asset chargeable to tax under section 45 was involved in the process by which the goodwill of the firm was taken over by the remaining seven partners and the proportionate share in the value of the goodwill was paid to each of the assessees and the second was that goodwill being a self-created asset which had cost nothing to the firm and its partners in terms of money its transfer was, therefore, not within the ambit of the charging provision contained in section 45 and the proportionate share in the value of the goodwill received by each assessee for transfer of hi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is implied in the charging provision itself or not and if it is implicit therein, then, the charge or the incidence of capital gains tax cannot fall upon such types of capital asset as would cost nothing to the assessee for acquiring the same. Such capital asset which cost nothing to the assessee in terms of money will have to be regarded as being outside the purview of the charging provision itself. Reliance by Mr. Joshi upon the decision of this court in Daulatran Nayar's case [1976] 105 ITR 843 (Bom) is misconceived. The question that arose for consideration in that case was whether the assessee was entitled to substitution of the market value of the asset as on January 1, 1954, for the "actual cost" as envisaged in the third proviso to section 12B(2) and the question was answered in favour of the assessee on certain assumptions and concessions made in the case. The facts of the case shortly stated have been these: The assessee was a partner in a partnership of eight partners, in which each of the partners had an equal share in the profits and losses; the business of the firm was taken over by a limited company of the same name as from July 1, 1959 ; the firm received the sum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as a transfer of this capital asset when the business of the firm was taken over by a limited company. This will become clear from the following observations which appear at page 845 of the report--See [1976] 105 ITR 843 (Bom) : "At the outset we would like to observe that we shall proceed to deal with and answer the question referred to us for opinion on the assumption that the goodwill though a self-generating asset is a capital asset and on further assumption that there was a transfer of this capital asset when the business of the firm was taken over by the limited company." In other words, this court proceeded to determine the question referred to it in that case on two assumptions indicated above and, therefore, it cannot be said that this court really decided the question whether a self-created or self-generated goodwill is a capital asset, the transfer of which would give rise to chargeable capital gains--a question which has been specifically raised before us in the instant case. The decision and all the observations made in Daulatran Nayar's case [1976] 105 ITR 843 (Bom) cannot, therefore, be taken to have decided the issue that has arisen in the instant case before u ..... X X X X Extracts X X X X X X X X Extracts X X X X
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