2023 (2) TMI 444 - AT - Income Tax

Capital gains - Gains arising from transfer of proprietory concern to assessee company - Violation of the conditions of section 47(xiv) - Goodwill acquired by incurring cost - Whether the gains which were exempt should be brought to tax in the hands of the successor company which is the assessee company? - HELD THAT - As per the details filed by the assessee, goodwill considered by the AO is not self-generated but created by the erstwhile proprietary concern before assets and liabilities have been transferred to Pvt. Ltd. Co., which is evident from the fact that the assessee has filed necessary details of expenditure incurred for generation/creation of goodwill in the books of accounts of proprietary concern. This fact is strengthened by the findings of the order of the Ld.CIT(A) in the case of Mr.D.Sathish Babu 2016 (2) TMI 348 - ITAT CHENNAI for the AY 2006-07, where the Ld.CIT(A) had categorically find that the assessee has spent a sum of Rs.3.47 Crs. towards goodwill and on account of transfer of proprietary concern to a Pvt. Ltd. Co., there will not be any capital gains. The ITAT Chennai in 2016 (2) TMI 348 - ITAT CHENNAI had upheld the findings of the Ld.CIT(A) in the case of Mr.Satish Babu and held that since the assessee has generated goodwill by paying consideration, on transfer of said goodwill, capital gains become nil . From the above, it is very clear that even if you invoke the provisions of Sec.47A(3) of the Act, to withdraw exemption granted u/s.47(xiv)(b) of the Act, but, in principle there cannot be any capital gains on transfer of goodwill, because, said goodwill is not self-generated or created on account of conversion of proprietary concern into a Pvt. Ltd. Co., but acquired by incurring cost. If you consider cost incurred by the assessee for acquiring goodwill, then, capital gains on transfer of said goodwill would come to nil amount. CIT(A) after considering the relevant facts has rightly deleted the additions made by the AO. Hence, we are inclined to uphold the findings of the Ld.CIT(A) and dismissed the appeal filed by the Revenue.

Summary

Issues Involved:
1. Assessment of capital gains on transfer of goodwill at book value.
2. Violation of conditions under Sec.47(xiv) and applicability of Sec.47A(3) of the IT Act.
3. Interpretation of provisions regarding exemption and taxation in case of conversion of proprietary concern into a Pvt. Ltd. Co.

Analysis:

Issue 1: Assessment of capital gains on transfer of goodwill at book value:
The appeal filed by the Revenue challenged the deletion of an addition of Rs.3.47 crores by the Commissioner of Income Tax (Appeals) regarding the assessment of capital gains on the transfer of goodwill at book value. The Revenue contended that the AO had subjected the gains arising from the transfer of the proprietary concern to the assessee company for assessment. However, the CIT(A) held that the capital gains would be nil as the goodwill was not self-generated but acquired through expenses incurred by the assessee. The ITAT Chennai had previously upheld a similar decision in another case. The Tribunal agreed that there was no capital gain on the transfer of goodwill, and thus, upheld the CIT(A)'s decision to delete the addition.

Issue 2: Violation of conditions under Sec.47(xiv) and applicability of Sec.47A(3) of the IT Act:
The assessee had converted the proprietary concern into a Pvt. Ltd. Co. under Sec.47(xiv)(b) of the Act. However, a violation occurred when the erstwhile proprietor transferred 16.67% of his shareholding within five years from the date of the transfer, breaching the conditions of Sec.47(xiv)(b). This triggered the application of Sec.47A(3) of the Act, leading to the withdrawal of the exemption granted under Sec.47(xiv)(b). While the AO correctly invoked Sec.47A(3), the Tribunal noted that even with the withdrawal of the exemption, there was no liability for capital gains on the conversion as all assets and liabilities were transferred at book value, including the goodwill. The Tribunal upheld the CIT(A)'s decision to delete the additions made by the AO.

Issue 3: Interpretation of provisions regarding exemption and taxation in case of conversion of proprietary concern into a Pvt. Ltd. Co.:
The Tribunal emphasized that despite the violation of conditions under Sec.47(xiv)(b) and the subsequent application of Sec.47A(3) to withdraw the exemption, there was no capital gains liability on the conversion due to the nature of the goodwill and its acquisition. The Tribunal reiterated that the goodwill was not self-generated but acquired through expenses, leading to a capital gains amount of nil. Therefore, the Tribunal upheld the CIT(A)'s decision and dismissed the appeal filed by the Revenue.

Overall, the Tribunal's decision focused on the technical aspects of capital gains assessment, compliance with statutory provisions, and the interpretation of relevant sections of the IT Act to determine the tax liability in the case of the conversion of a proprietary concern into a private limited company.