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Issues:
1. Validity of assessing capital gain on goodwill in relation to the sale of the entire business by the firm to a limited company. 2. Validity of taxing capital gain in the hands of the individual due to exclusive ownership of goodwill. Analysis: The High Court of Bombay addressed a reference under section 256(2) of the Income-tax Act, 1961, regarding the assessment of capital gain on goodwill. The case involved the dissolution of a partnership, subsequent formation of a new partnership, and the eventual sale of the business to a limited company. The main contention was the tax liability on the goodwill value of Rs. 2,75,000, with a cost of acquisition at Rs. 20,000. The Income-tax Officer assessed the capital gains tax at Rs. 2,55,000, leading to an appeal by the assessee. The Appellate Assistant Commissioner disagreed with the Income-tax Officer's assessment, but the Income-tax Appellate Tribunal upheld the tax liability on the goodwill value, prompting the reference to the High Court. The court delved into the provisions of the Income-tax Act, emphasizing that goodwill is a capital asset, and gains from its transfer are taxable under section 45. However, the court highlighted that the computation of capital gains under section 48 necessitates determining the cost of acquisition. In this case, it was established that the assessee had paid Rs. 20,000 to acquire a partner's share in the goodwill, allowing for the cost of acquisition to be ascertained. Yet, the self-generated share of the assessee in the goodwill, acquired upon the retirement of the partner, did not involve any cost, making it exempt from capital gains tax. The court scrutinized the sale deed's valuation of goodwill at Rs. 2,75,000, but due to the absence of a cost of acquisition for the assessee's self-generated share, it was deemed improper to tax the entire balance of Rs. 2,55,000 as capital gains. Referring to relevant case law, the court determined that only half of the consideration for the transfer of goodwill should be attributed to the share acquired on payment of Rs. 20,000. Consequently, the capital gains tax was levied on the balance amount of Rs. 1,17,500, rather than the full goodwill value of Rs. 2,55,000. In conclusion, the High Court held that the Tribunal erred in assessing the assessee's capital gains tax liability at Rs. 2,55,000. The correct tax liability was determined to be Rs. 1,17,500, considering the cost of acquisition of the partner's share in the goodwill. The court answered both questions accordingly and ruled that there would be no order as to costs.
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