Bombay High Court
R.V. Lathia vs Commissioner Of Income-Tax on 5 December, 1994
Equivalent citations: [1995]214ITR691(BOM)
JUDGMENT S.M. Jhunjhunuwala, J.
1. By this reference made under section 256(2) of the Income-tax Act, 1961, the following questions have been referred to this court for opinion at the instance of the assessee :
"1. Whether the assessment of Rs. 2,55,000 as capital gain in the hands of the applicant on account of the goodwill in relation to the sale of the entire business by the firm to the limited company is valid in law ?
2. Whether, on the facts and in the circumstances of the case, the inference that the goodwill of the firm was not the property of the firm merely because the goodwill belonged exclusively to the applicant and, hence, the capital gain is taxable in the hands of the applicant is valid in law, even though prior to the sale, the partnership had given due credit to the applicant in respect of the goodwill ?"
2. The relevant assessment year is 1970-71 and the corresponding previous year ended on March 31, 1970.
3. The assessee, an individual, was a partner in the firm of Industrial Supplies Corporation along with one P. J. Kumbhani as per deed of partnership dated October 26, 1953. The said Kumbhani retired from the said partnership and, as such, the said partnership was dissolved on the terms and conditions mentioned in the deed of dissolution dated November 24, 1956. The assessee took over the assets and liabilities of the said erstwhile partnership and the said Kumbhani, the retiring partner, was paid by the assessee the sum of Rs. 20,000 representing the cost of the said Kumbhani's share in the goodwill of the business carried in the partnership. The assessee, thereafter, took one C. P. Lathia with him as a partner to carry on the business in partnership in the said firm name and style of "Industrial Supplies Corporation" on the terms and conditions mentioned in the deed of partnership dated November 24, 1956. Subsequently, one D. P. Lathia was also admitted into the partnership along with the assessee and the said C. P. Lathia on the terms and conditions mentioned in the deed of partnership executed in the month of April, 1966, to carry on the business in the said firm name and style of "Industrial Supplies Corporation". Accordingly, in the month of April, 1966, there were three partners in the said firm of "Industrial Supplies Corporation", namely, the assessee, the said C. P. Lathia and the said D. P. Lathia, having sharing ratio as 70 : 15 : 15, respectively, and as per clause 22 of the said deed of partnership executed in the month of April, 1966, the assessee was solely entitled to the goodwill and neither the said C. P. Lathia nor the said D. P. Lathi was entitled to any share or interest in the goodwill in respect of the business carried in the partnership.
4. On April 30, 1969, the said reconstituted partnership firm entered into an agreement with a limited company incorporated under the provisions of the Companies Act, 1956, whereunder the reconstituted partnership firm agreed to sell its entire business along with all assets and liabilities to the company on the terms and conditions mentioned therein. Pursuant to the said agreement, a sale deed was executed on March 31, 1971, and the goodwill was valued at Rs. 2,75,000. According to the Income-tax Officer, the assessee became liable to pay the capital gains tax on the sum of Rs. 2,55,000 since the goodwill was valued at Rs. 2,75,000 and the cost of acquisition was taken at Rs. 20,000. The contention of the assessee that no capital gains tax was leviable on the value of the goodwill was rejected by the Income-tax Officer. Being dissatisfied with the order of the Income-tax Officer, the assessee preferred an appeal to the Appellate Assistant Commissioner who held that the Income-tax Officer was not justified in assessing the capital gains at Rs. 2,55,000. In the Departmental appeal to the Income-tax Appellate Tribunal, the Tribunal held that the Appellate Assistant Commissioner was not justified in reversing the Income-tax Officer and further held that the assessee was liable to capital gains tax on the sum of Rs. 2,55,000. It is in these circumstances, the present reference has been made at the instance of the assessee for the opinion of this court on the questions referred above.
5. Under section 45 of the Income-tax Act, 1961, any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 53, 54, 54B and 54D, be chargeable to income-tax under the head "Capital gains", and shall be deemed to be the income of the previous year in which the transfer took place. Section 2(14) of the Act defines "capital asset". Section 48 of the Act lays down the mode of computing capital gains. As per section 48, income chargeable under the head "Capital gains" shall 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 expenditure incurred wholly and exclusively in connection with such transfer and the cost of acquisition of the capital asset and the cost of any improvement thereto. Goodwill is property or an asset of a business. It is a capital asset. Acquisition of the goodwill of a business is, without doubt, acquisition of a capital asset. But merely because it is a capital asset, gains arising on its transfer would not automatically be liable to tax. Charging section 45 and the computation provision contained in section 48 are but one integral whole and unless and until it is possible to determine in terms of money the cost of acquisition of the goodwill as also the cost of additions or improvements thereto, the charging section is not attracted.
6. In the present case, it is an admitted position that the assessee had paid the sum of Rs. 20,000 to the said Kumbhani, the then partner in the erstwhile partnership for acquiring the share of the said Kumbhani in the goodwill of the business. Hence, the cost of acquisition so far as the share of the said Kumbhani in the goodwill is concerned was available. So also, the date of acquisition of the share of the said Kumbhani in the goodwill was available and could be pin-pointed. However, the cost of acquisition of the share of the assessee in the goodwill on retirement of the said Kumbhani from the erstwhile partnership was neither ascertained nor available as the assessee did not incur any cost since it had been self-generated. The self-generated share of the assessee in the goodwill could not be subjected to capital gains tax.
7. Though under the said sale deed executed on March 31, 1971, the value of the goodwill was taken at Rs. 2,75,000, in view of the fact that for the share of the assessee in the goodwill no cost of acquisition was incurred, it was not possible to attribute the entire balance of Rs. 2,55,000 arrived at by deducting Rs. 20,000 from Rs. 2,75,000 as capital gains to levy tax thereon. It is correct that under clause 22 of the deed of partnership executed in the month of April, 1966, the goodwill belonged solely to the assessee. However, that goodwill did contain such portion in acquisition of which it was not possible to envisage a cost as no cost of such acquisition was incurred by the assessee. In view of the fact that cost of acquisition of the share of the said Kumbhani in the goodwill was available and no cost of acquisition in the self-generated share of the assessee therein was available, it was not right for the Tribunal to hold that the assessee was liable to pay capital gains tax on the said entire sum of Rs. 2,55,000 . In view of the judgment of the Supreme Court in CIT v. B. C. Srinivasa Setty [1981] 128 ITR 294 and to synchronise conflict of opinion of the various High Courts on the aspect as to whether capital gains tax is leviable on transfer of goodwill, in our opinion, since the cost of acquisition of half share of the said Kumbhani in the goodwill was ascertained and available, half of the consideration for transfer of goodwill, namely, Rs. 2,75,000 ought to have been attributed towards transfer of that share in the goodwill which was acquired by the assessee on payment of Rs. 20,000 on retirement of the said Kumbhani. The cost of acquisition of the share of the said Kumbhani in the goodwill being Rs. 20,000, the said amount was required to be deducted from the sum of Rs. 1,37,500 being half of Rs. 2,75,000 and capital gains tax ought to have been levied on the balance amount of Rs. 1,17,500.
8. In this view of the matter, we hold that the Tribunal was not right in holding that the assessee was liable to capital gains tax on Rs. 2,55,000. In our opinion, the assessee was liable for capital gains tax on Rs. 1,17,500. Both the questions are answered accordingly.
9. There shall be no order as to costs.