2003 (8) TMI 172 - AT - Income Tax

Summary

Issues Involved:
1. Whether the reduction in the assessee's share in profit/losses in a partnership results in a taxable gift.
2. Calculation of the value of the taxable gift, including consideration of goodwill and market value.
3. Allowability of salary to partners while calculating goodwill.
4. Consideration of increased turnover of the partnership firm.
5. Inclusion of goodwill and appreciation of assets as part of capital for interest calculation.
6. Deduction of interest and salary at market rates while confirming the addition on account of goodwill.
7. Quantum of gift chargeable to tax being excessive.
8. Filing of the account copy of a partner.

Detailed Analysis:

1. Taxable Gift from Reduction in Profit/Loss Share:
The main issue raised in all appeals is whether the reduction in the assessees' profit-sharing ratio in favor of new partners constitutes a taxable gift. The tribunal upheld the view that the reduction in profit-sharing ratio resulted in a transfer of interest in the firm's assets and goodwill, thereby constituting a gift under the Gift-tax Act. The tribunal referred to the judgment of the Supreme Court in CGT v. Chhotalal Mohanlal, which held that goodwill is an asset of the firm, and any reduction in profit-sharing ratio amounts to a gift.

2. Calculation of Taxable Gift Value:
The tribunal confirmed that both goodwill and market value must be considered while calculating the value of the taxable gift. The Assessing Officer computed the difference between the fair market value of assets and the book value and included goodwill to determine the net taxable gift. The tribunal agreed with this approach, emphasizing that the fair market value of the assets far exceeded the book value, justifying the inclusion of goodwill in the taxable gift calculation.

3. Allowability of Salary to Partners:
The tribunal addressed the issue of salary allowance to partners while calculating goodwill. It was observed that the business was conducted by the partners, but no salary was allowed. The tribunal upheld the decision of the CGT(A) that no salary should be considered in the calculation of goodwill.

4. Increased Turnover Consideration:
The tribunal noted the increase in the turnover of the partnership firm from 5 crores to 7 crores. However, it was held that this factor alone does not negate the fact that the reduction in profit-sharing ratio resulted in a gift.

5. Goodwill and Appreciation of Assets as Capital:
The tribunal upheld the CGT(A)'s decision that the amount of goodwill and appreciation of assets should not be considered as part of the capital for allowing interest on that capital. The tribunal emphasized that the partners had a definite interest in the assets of the firm, and any reduction in profit-sharing ratio without adequate consideration constituted a gift.

6. Deduction of Interest and Salary at Market Rates:
The tribunal rejected the assessees' contention that interest on partners' capital and salary to partners at market rates should be deducted while confirming the addition on account of goodwill. It was held that the reduced share of profit in favor of new partners without adequate consideration amounted to a gift.

7. Quantum of Gift Chargeable to Tax:
The tribunal dismissed the argument that the quantum of the gift held to be chargeable to tax was excessive. The tribunal found that the computation of taxable gifts was based on average profits of the last five years and the fair market value of assets as per wealth tax returns, which was reasonable and justified.

8. Filing of Partner's Account Copy:
The tribunal noted that the CGT(A) wrongly held that the account copy of a partner was not filed. However, this issue was not considered significant enough to affect the overall decision regarding the taxable gift.

Conclusion:
The tribunal upheld the orders of the CGT(A) in all cases, confirming that the reduction in the assessees' profit-sharing ratio in favor of new partners constituted a taxable gift. The computation of the taxable gift, including the consideration of goodwill and market value, was found to be appropriate. All eight appeals filed by the assessees were dismissed.