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TMI Blog1969 (9) TMI 17X X X X Extracts X X X X X X X X Extracts X X X X ..... The controversy is confined in this case only to goodwill and nothing else. In fact, no question arises with regard to other assets from the order of the Tribunal. The question reframed, therefore, for the answer by this court is as follows : " Whether, on the facts and in the circumstances of the case, 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 goodwill to the two private limited companies ? " The facts giving rise to this question are as follows : The assessment year is 1957-58 with the corresponding accounting year ending on November 3, 1956. During this accounting year the assessee was a registered firm of six partners deriving income from import and export business. Its head office was in Calcutta and two branches in Bombay. On the very last day of this accounting year the assessee transferred its assets and liabilities and also the goodwill of its Calcutta business to a private limited company under the name, Messrs. Chunilal Prabhudas Co., Calcutta, Private Ltd. and the assets and liabilities and also the goodwill of its Bombay business to another com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal gains. The assessee thereafter appealed to the Tribunal. The contention raised before the Tribunal was that the shareholders of the company and the partners of the firm being more or less identical, the transfer of the firm to the company could not be regarded as a commercial transaction and no profits or gains could be said to arise out of such transfer. The Tribunal followed the case of Commissioner of Income-tax v. Mugneeram Bangur Co. and certain decisions of other High Courts relied on by the assessee before the Tribunal and held that the transfer by the firm of its goodwill to the two private limited companies did not amount to a commercial transaction and no assessable profits or gains could be said to arise out of such transfer. The result followed and the Tribunal directed the deletion of the amount of Rs. 46,114 assessed as capital gains of the assessee-firm for the assessment year 1957-58. The Commissioner thereupon asked for this reference finally resulting in the statement of the case raising the question quoted above. The argument for the revenue in this case is briefly this : Section 2(4A) of the Income-tax Act, 1922, defines capital asset as meaning " proper ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see under the head 'Capital gains ' in respect of any profits or gains arising from the sale, exchange, relinquishment or transfer of a capital asset effected after the 31st day of March, 1956, and such profits and gains shall be deemed to be income of the previous year in which the sale, exchange, relinquishment or transfer took place." It is followed by certain provisos to which I shall come later. The expression " capital asset " in section 12B, according to the definition of section 2(4A), as already noticed, means property of any kind; but it expressly does not include (i) any stock-in-trade, consumable stores or raw materials held for the purposes of business, profession or vocation; (i) personal effects, that is to say, movable property (including wearing apparel, jewellery and furniture), held for personal use by the assessee or any member of his family dependent on him ; (iii) any land from which the income derived is agricultural income." In this kind of definition of capital asset in section 2(4A), if the exclusion of the different types of properties mentioned under the three heads is any index or indication of the intention of the legislature, then the type ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business usually associated with capital asset. Unlike capital assets goodwill as an asset is indivisible and cannot be sold, transferred or dealt within fragments or fractions. One the interpretation of section 2(4A), section 2(4C) and section 12B and on their express words and tenor, goodwill does not come within the obvious meaning of capital assets. To bring goodwill within the meaning of capital asset and make it taxable would be to tax by implication or by analogy or by a forced and artificial construction. There is neither any express provision nor any necessary implication which brings goodwill within the meaning of " taxable capital gains " under section 12B of the income-tax Act. On the second test about profit or gains arising in connection with a sale or exchange or relinquishment or transfer many questions arise. In the first place, there may be a sale or exchange or relinquishment or transfer but if it does not produce any profit or gain then there would be no taxable capital gains within the meaning of section 12B of the Income-tax Act. It is not a question of whether the particular transaction is a trading transaction or not a trading transaction. There can certain ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... value of Rs. 60,000 only in the share capital of the purchaser-company to the said, six above-named parties collectively composing the vendor or to their individual respective nominees and said fully paid-up shares shall be accepted by the vendor as reasonable and adequate consideration and in full settlement of its/their joint and/or several rights, title or interests in the goodwill of the said vendor and its/their business and firm styled as Chunilal Prabhudas Co. " Finally clause 7 of the agreement provides : " The purchaser company shall have the sole and exclusive right of use and own the name Chunilal Prabhudas Co. in connection with the said business or any other business or businesses and/or for any other purposes whatsoever as the purchaser-company from time to time initiate, run or develop, or may decide upon. " On these facts the question is, is this transfer producing any profit or gain for practical purposes or even for legal notion ? There is no obvious profit or gain in money or material. The shares of the partners are converted into shares of the company. No money in cash or in kind passes according to ordinary or even remote acceptation of these terms. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not goodwill transferred in the case of a partnership(sic). That could not have been the intention of Parliament. Proceeding further with the interpretation of section 12B, a glance at sub-section (2) of section 12B indicates the principles of deduction. Sub-section (2) of section 12B provides how the amount of a capital gain shall be computed after making certain deductions from the value of the consideration for which the sale or exchange or relinquishment or transfer of the capital asset is made. Looking at the list of deductions, as for instance in section 12B(2)(i), there is, " expenditure incurred solely in connection with such sale, exchange, relinquishment or transfer ". It means that only that deduction is allowable which is in respect of an expenditure incurred solely for this purpose. Can there be an expenditure in this connection for transfer of goodwill which can be separate from other expenditure to say that this is an expenditure incurred solely for the transfer of goodwill ? The answer can only be in the negative. Again in sub-clause (ii) of section 12B(2) there is the mention of the actual cost to the assessee of the capital asset including any expenditure of a c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax, quoting Lord Macnaghten in Inland Revenue Commissioners v. Muller Co.'s Margarine Ltd., to which reference will presently be made, and where Lord Macnaghten emphasised that " goodwill has no independent existence. It cannot subsist by itself. It must be attached to business. " In addition to the principles of construction, there is the authority of a Division Bench of the Madras High Court in Commissioner of Income-tax v. K. Rathnam Nadar, which supports the conclusion to which we have arrived. It is an authority for holding that section 12B(2)(ii) of the Income-tax Act, 1922, suggests that capital gain arises only on the transfer of a capital asset which has actually cost to the assessee something, and that such actual cost in the context of the Income-tax Act is cost in terms of money, and it cannot apply to transfer of capital assets which did not cost anything to the assessee in terms of money in its creation or acquisition. The present reference stands on a stronger footing than that. In that case there was cash consideration for the goodwill but here there is only substitution of the partner's share in the company's share without any cash or without any money from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see's favour ". There are the direct authorities on section 12B of the Income-tax Act. But the question of has come up incidentally or collaterally when courts have considered other sections of the Income-tax Act such as section 10(2)(xv) of the Income-tax Act, 1922, dealing with profits and gains of business and allowances for expenditure of a residuary nature, but not being in the nature of capital expenditure or personal expenses laid out or expended wholly or exclusively for the purpose of the said business. Lord Bowen in City of London Contract Corporation Ltd. v. Styles expressed the view that money expended not for the purpose of carrying on a concern, but to acquire the concern is a capital expense. It is significant that in that case money was paid by a limited company to buy the business of a firm and that was held to be a capital gain. The Privy Counsel in Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax came to the conclusion that payment made in consideration of the acquisition of the right to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits, could not be allowed as a deduction in such cases. All ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mson, quoted at pages 39-40 of the 4th edition of The Valutation of Company Shares and Business by Adamson and Coorey in these terms : " In Whiteman Smith Motor Company v. Chaplin the types were zoologically classified into cats, dogs, rats and rabbits. The cat prefers the old home to the person who keeps it, and stays in the old home although the person who has kept the home leaves, and so it represents the customer who goes to the old shop whoever keeps it and provides the local goodwill The faithful dog is attached to the person rather than the place, he will follow the outgoing owner if he does not go too far. The rat has no attachments, and is purely casual. The rabbit is attracted by mere propinquity. He comes because he happens to live close by and it would be more trouble to go elsewhere. These categories serve as a reminder that the goodwill of a business is a composite thing referable in part to its locality, in part to the way in which it is conducted and the personality of those who conduct it and in part to the likelihood of competition, many customers being no doubt actuated by mixed motives in conferring their custom." In the Division Bench decision of this cour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Court in dealing with the question whether the vendor and the vendee were legal entities and whether it was permissible to tear the corporate veil to see whether the partners of the vendor were the same persons as the shareholders of the vendee, the Supreme Court observed that it was not necessary to deal with those questions. That they are different legal entities or different juristic personalities when a partnership becomes a limited company, has been copiously supported by many references cited from the Bar as Salomon v. Salomon. Again in Doughty v. Commissioner of Taxes the question was, two partners carrying on business in New Zealand sold their partnership business to a limited company in which they became the only shareholders. The sale was also of the entire assets including goodwill and the consideration was fully paidup shares in the company. The Privy Council came to the conclusion that if the transaction was to be treated as a sale, there was no separate sale of the stock and no valuation of it as an item forming part of the aggregate sold and that the transaction was a mere readjustment of the business position of the partners resulting in no profits and a mere book- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Doughty's case, dealing with slump sale, (3) as well as the Supreme Court decision in Mugneeram Bangur's case, and (4) the previous Supreme Court decision in Morning Star case. Mr. Banerjee has also contended that the observations in Kharway case, to the effect that it was not necessary for the purpose of the case and was apparently recorded without any debate on the question in Kikabhai's case, was in fact not casual but the ratio itself for the decision of the Supreme Court in Kikabhai's case, and he drew our attention to the principle and ratio in Kikabhai's case, at page 509 of the report. In fact Mr. Banerjee drew our attention to a larger Bench decision of the Supreme Court of seven judges in Bai Shirinbai K. Kooka at page 91, where the Full Bench affirmed the principle and the ratio in Kikabhai's case. In the view that we are taking it will no longer be ecessary to discuss the characteristics of the four different types of transactions, namely, (1) sale, (2) exchange, (3) relinquishment, and (4) transfer in section 12B of the Income-tax Act. Here the sale or transfer or exchange or relinquishment was to lead to the complete extinction of the partnership or, the firm. The e ..... X X X X Extracts X X X X X X X X Extracts X X X X
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