1969 (9) TMI 17 - HC - Income Tax

Whether the Tribunal was right in holding that no capital gains could arise under section 12B of the Indian Income-tax Act, 1922, out of the transfer by the firm of its assets and goodwill to the two private limited companies - question is answered in affirmative and in favour of the assessee

Issues Involved:
1. Whether goodwill is considered a capital asset under section 12B of the Indian Income-tax Act, 1922.
2. Whether the transfer of goodwill by a firm to two private limited companies results in capital gains under section 12B of the Indian Income-tax Act, 1922.

Issue-wise Detailed Analysis:

Issue 1: Whether goodwill is considered a capital asset under section 12B of the Indian Income-tax Act, 1922.
The court examined the definition of "capital asset" under section 2(4A) of the Indian Income-tax Act, 1922, which includes "property of any kind held by an assessee whether or not connected with his business, profession or vocation," but excludes certain properties like stock-in-trade, personal effects, and agricultural land. The court emphasized that goodwill is not explicitly mentioned in the Income-tax Act and must be inferred by necessary implication if it is to be taxed. The court noted that goodwill is an intangible asset and fundamentally represents reputation, which cannot be divided, sold, or transferred in fragments like tangible capital assets. The court concluded that goodwill does not fit within the definition of a capital asset for the purposes of section 12B, as it is not a tangible asset that can be independently valued or transferred without the associated business.

Issue 2: Whether the transfer of goodwill by a firm to two private limited companies results in capital gains under section 12B of the Indian Income-tax Act, 1922.
The court reviewed the facts of the case, noting that the firm transferred its goodwill to two private limited companies composed of the same partners and their families. The consideration for the transfer was paid by allotment of shares in the companies, not in cash. The Income-tax Officer initially treated the entire amount of Rs. 1,20,000 as capital gains, but the Appellate Assistant Commissioner reduced it to Rs. 46,114 based on the valuation of goodwill as on January 1, 1954. The Tribunal, however, held that the transfer did not amount to a commercial transaction and thus did not result in assessable profits or gains.

The court analyzed section 12B, which imposes tax on "profits or gains arising from the sale, exchange, relinquishment or transfer of a capital asset." It emphasized that for capital gains to be taxable, there must be a profit or gain arising from the transaction. The court found that the transfer of goodwill in this case did not produce any profit or gain, as it was merely a conversion of partners' shares into company shares without any actual monetary transaction. The court also highlighted that the statutory provisions and deductions under section 12B did not contemplate the inclusion of goodwill as a taxable capital gain.

The court cited various authorities and previous judgments to support its conclusion, including the Madras High Court's decision in Commissioner of Income-tax v. K. Rathnam Nadar, which held that self-created assets like goodwill are not subject to capital gains tax under section 12B. The court also referred to the Supreme Court's observations in Jogta Coal Co. Ltd. v. Commissioner of Income-tax and S. C. Cambatta & Co. Ltd. v. Commissioner of Excess Profits Tax, which emphasized that goodwill has no independent existence apart from the business it represents.

Conclusion:
The court held that goodwill is not a capital asset within the meaning of section 12B of the Indian Income-tax Act, 1922, and no capital gains arose from the transfer of goodwill by the firm to the two private limited companies. The answer to the reframed question was in the affirmative and in favor of the assessee, with each party bearing its own costs.

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