2014 (8) TMI 203 - HC - Income Tax

Transfer of goodwill to partners - reconstruction of firm - transfer - extinguishment of right - AO noticed that assessee firm had created and self-generated assets in the form of goodwill and transferred it to the current accounts of the four partners proportionately consequent to reconstitution of assessee firm - Whether there was transfer or not and in view of the circular of CBDT notional transfer cannot be subject to taxation Held that - The assets of the partnership was revalued and for the first time they valued the goodwill at ₹ 7,59,28,000 - No portion of the goodwill is transferred to the retiring partners, there is no transfer of the capital asset Tribunal rightly was of the view that if there is no transfer of capital asset, Section 45(4) is not attracted - the partnership firm did not cease to hold the property - its right to the property is not extinguished - the retiring partners did not acquire any right in the property as no property was transferred in their favour thus, the order of the Tribunal is upheld Decided against Revenue.

Summary

Issues:
1. Taxation of self-generated goodwill.
2. Treatment of unexplained cash credit under Section 68 of the Income Tax Act.
3. Interpretation of Section 45(4) in the context of distribution of capital assets on the dissolution of a firm.

Analysis:
1. The appeal by the revenue challenged the order upholding that there was no transfer of self-generated goodwill, hence not subject to taxation. The assessing officer treated the goodwill as "long term capital gains," but the appellate authority found no transfer of assets to retiring partners, concluding that no transfer occurred within the terms of relevant sections of the Income Tax Act. The Tribunal, after reevaluation, concurred that no transfer of goodwill took place, thus not attracting Section 45(4) for taxation. The revenue's argument that the distribution of goodwill constituted a transfer was dismissed, emphasizing the absence of asset transfer to retiring partners.

2. Regarding the unexplained cash credit under Section 68, the assessing authority added the amount to the income returned by the assessee. However, the remand report revealed that the sum was properly accounted for, sourced from loans taken by cheque, leading the appellate authority and Tribunal to delete the addition. The Senior Counsel for revenue acknowledged the proper explanation for the cash credit, conceding that no grievance could be raised on this matter.

3. The interpretation of Section 45(4) in the context of capital asset distribution on firm dissolution was crucial. The Full Bench of the Court clarified that for Section 45(4) to apply, there must be a transfer of capital asset resulting in profits or gains to the firm. It outlined conditions necessitating a transfer, profit derivation, and dissolution of the firm. In this case, as no transfer of capital asset occurred to retiring partners, the right to property was not extinguished, and absolute title was not acquired by them. Consequently, the appeal was dismissed as no transfer of capital asset from the firm to retiring partners was established, precluding the application of Section 45(4) for taxation purposes.

In conclusion, the judgment addressed the issues of self-generated goodwill taxation, treatment of unexplained cash credit, and the interpretation of Section 45(4) in the context of capital asset distribution on firm dissolution, ultimately dismissing the appeal by the revenue.