1972 (3) TMI 13 - HC - Income Tax

Gift Tax Act 1958 - Whether Tribunal was right in law in holding that the redistribution of the profit sharing ratio on the admission of the two partners did not amount to a gift by the assessee of a portion of his share in the goodwill of the firm - Whether Tribunal was right in law in holding that the surrender or abandonment by the assessee of a share in the goodwill of the business in favour of his two children was bona fide and therefore did not amount to a gift within the meaning of section 4(c) of the Gift-tax Act

Issues Involved:
1. Whether the redistribution of the profit-sharing ratio on the admission of two partners amounted to a gift by the assessee of a portion of his share in the goodwill of the firm.
2. Whether the surrender or abandonment by the assessee of a share in the goodwill of the business in favor of his two children was bona fide and did not amount to a gift within the meaning of section 4(c) of the Gift-tax Act.

Detailed Analysis:

Issue 1: Redistribution of Profit-Sharing Ratio as a Gift
The court examined whether the redistribution of the profit-sharing ratio upon admitting two new partners constituted a gift of a portion of the assessee's share in the firm's goodwill. The assessee had converted his sole proprietorship into a partnership with his daughters, holding a 60% share, and later included his son and another daughter, redistributing the shares equally among all partners.

The Gift-tax Officer determined that the assessee had gifted a portion of his share, including 40% of the goodwill, valuing the gift at Rs. 1,10,000. The Appellate Assistant Commissioner confirmed this, though he directed a recomputation of the goodwill's value.

The Tribunal, however, held that the redistribution was an act of the firm and not the assessee, and any benefit to the new partners was due to their capital contribution, not a gift. They also opined that even if there was a surrender of goodwill, it was bona fide and not a gift under section 4(c) of the Act.

The High Court disagreed, stating that the redistribution of profit-sharing ratio did involve a transfer of property amounting to a gift. The court referenced the definition of "gift" under section 2(xii) of the Gift-tax Act and "transfer of property" under section 2(xxiv), which includes the grant of partnership interest. The court cited the case of Commissioner of Gift-tax v. V. A. M. Ayya Nadar, where a similar redistribution was considered a transfer of property and thus a gift.

The court concluded that the redistribution of the profit-sharing ratio on the admission of new partners did amount to a gift by the assessee of a portion of his share in the goodwill of the firm.

Issue 2: Bona Fide Surrender or Abandonment
The second issue was whether the surrender or abandonment of a share in the goodwill by the assessee to his children was bona fide and thus not a gift under section 4(c) of the Gift-tax Act.

The Tribunal had held that the surrender was bona fide and did not amount to a gift. However, the High Court found this argument untenable, stating that the entire transaction, including the gift of share capital and the transfer of assets and liabilities, was one integrated transaction. The court emphasized that the redistribution of shares and the profit-sharing ratio did involve a transfer of property amounting to a gift, chargeable to tax.

The court referenced the Supreme Court decision in Commissioner of Gift-tax v. P. Gheevarghese, which held that it was not permissible to isolate one asset (goodwill) as the subject of a gift when the entire business was transferred. However, the High Court distinguished the present case, noting that the value of the net assets excluding goodwill was determined separately, unlike in the Supreme Court case where goodwill was included in the total capital valuation.

The court also noted that under section 48 of the Partnership Act, the residue of the assets, including goodwill, would be divided among partners in proportion to their profit-sharing ratio upon dissolution, reinforcing that the donees were entitled to a share in the goodwill.

Conclusion:
The High Court answered the first question in favor of the revenue, holding that the redistribution of the profit-sharing ratio on the admission of new partners did amount to a gift of a portion of the assessee's share in the firm's goodwill. Consequently, the second question regarding the applicability of section 4(c) as a "deemed gift" was rendered moot and not addressed. The assessee was liable to pay gift-tax on the transferred share of the goodwill.

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