1981 (8) TMI 42 - HC - Income Tax

Court rules no capital gain on goodwill transfer to public company; assessee wins case

The court ruled in favor of the assessee, holding that no capital gain was incurred on the transfer of goodwill to a public company. It determined that ... Capital gains - transfer of goodwill - cost of acquisition - computation provisions - charging section - transfer-effective date - voluntary winding up commencement - transfer requires transferee in existenceCapital gains - transfer of goodwill - cost of acquisition - computation provisions - charging section - Whether transfer of the business together with goodwill resulted in any capital gain chargeable under section 12B - HELD THAT: - The court held that goodwill is a capital asset but that the charging provision must be read with the computation provisions as an integrated code. Where the computation provisions cannot be applied-because it is impossible to ascertain in money either the cost of acquisition of goodwill or the cost of any improvement thereto-such transfers fall outside the charge. The court followed the approach in B. C. Srinivasa Setty and related High Court decisions, reasoning that goodwill is an inherently fluctuating, intangible asset whose moment of acquisition and cost of addition or improvement often cannot be determined in monetary terms. That incapacity to fix acquisition or improvement cost means the charging section cannot operate in respect of goodwill in the present case. Consequently the department erred in including the reported value of goodwill in computing capital gains on the sale of the undertaking.No capital gain arose on the transfer of goodwill; goodwill could not be subjected to tax under s. 12B in the circumstances of this case.Transfer-effective date - transfer requires transferee in existence - voluntary winding up commencement - Whether the sale/transfer of the undertaking (including goodwill and other assets) took place on April 1, 1947 or April 23, 1947 (and thus within the operation of s. 12B) or only upon later execution of the agreement - HELD THAT: - The court rejected the notion that a sale can legally take place to a non-existent company or that an executory agreement expressed to operate from an anterior date effects a transfer in law on that earlier date. Resolution to wind up the vendor company on April 23, 1947 commenced voluntary winding up, and the public company was incorporated later that day, but the comprehensive transfer of assets and rights listed in the eventual agreement required formal acts (writing, transfers, vesting of premises, endorsements) and implementation which had not occurred on those earlier dates. Possession or accounting arrangements and an agreement stating an antecedent operative date do not alter the legal incidence of transfer. As the material acts completing the transfer occurred only with the formal agreement executed on April 5, 1948 (and subsequent implementation), the transaction did not effect a taxable transfer within the period governed by s. 12B.The transfer did not occur for the purposes of s. 12B on April 1, 1947 or April 23, 1947; it was not a completed transfer within the chargeable period.Capital gains - transfer of goodwill - Whether the Tribunal was justified in refusing to allow the assessee to raise the legal question that goodwill is not assessable to capital gains - HELD THAT: - The court held that the reference framed by the Tribunal was wide enough to embrace the legal contention whether goodwill was chargeable under s. 12B, and that it was permissible for the High Court to entertain aspects of that question even if not argued before the Tribunal. Prior authorities were examined and the court rejected the department's objection that the point was not open to be argued at this stage. Given that the assessee had consistently maintained non-liability under s. 12B from the outset, the court permitted consideration of the legal contention and addressed it on the merits.Tribunal's refusal to permit the contention was not a bar to the High Court entertaining and deciding the legal question; the assessee was entitled to have the point considered.Final Conclusion: All three reference questions answered in the negative: no capital gain arose on transfer of the business (including goodwill) within the chargeable period under s. 12B; the purported earlier operative dates did not effect a legal transfer; and the assessee was entitled to raise and have considered the contention that goodwill was not assessable. Costs awarded to the applicants. Issues Involved:1. Whether the transfer of the business along with its assets and liabilities resulted in any capital gain liable to tax under section 12B of the Indian Income-tax Act, 1922.2. Whether the sale and transfer of the goodwill of the assessee-company can in law be said to have taken place on April 23, 1947, and thus be assessable to capital gains under section 12B of the Indian Income-tax Act, 1922.3. Whether the Tribunal was justified in not allowing the assessee to raise the question as to whether goodwill was property assessable to capital gains under section 12B of the Indian Income-tax Act, 1922.Issue-wise Detailed Analysis:1. Capital Gain on Transfer of Business:The primary issue was whether the transfer of the business along with its assets and liabilities by the assessee-company to Evans Fraser and Company (India) Ltd. resulted in any capital gain liable to tax under section 12B of the Indian Income-tax Act, 1922. The court considered the statutory provisions of capital gains tax, which was introduced in the Indian fiscal legislation by the Income-tax and Excess Profits Tax (Amendment) Act, 1947. The court emphasized that the charging section and the computation provisions together constitute an integrated code. It held that unless it is possible to determine in terms of money the cost of acquisition of goodwill as also the cost of additions or alterations thereto, the charging section is not attracted. The court concluded that there was no capital gain made on the transfer of goodwill of its business by the assessee-company to the said public company, and the department was in error in taking into account the value of the goodwill while computing the capital gain.2. Date of Transfer of Goodwill:The second issue was whether the sale and transfer of the goodwill of the assessee-company can in law be said to have taken place on April 23, 1947, and thus be assessable to capital gains under section 12B of the Indian Income-tax Act, 1922. The court analyzed the facts and the agreement dated April 5, 1948, which provided that the business was sold and purchased as from April 1, 1947. The court held that a sale or transfer postulates two persons, namely, a vendor or transferor and a vendee or transferee. It is not legally possible for a transfer to take place to a non-existent entity. The court concluded that the transfer could not have taken place on April 1, 1947, as the public company was not incorporated until April 23, 1947. Further, the court found that the actual transfer did not occur on April 23, 1947, either, as the agreement was an executory agreement and the various things required to be done for the transfer were not completed by that date.3. Tribunal's Justification on Goodwill Assessment:The third issue was whether the Tribunal was justified in not allowing the assessee to raise the question as to whether goodwill was property assessable to capital gains under section 12B of the Indian Income-tax Act, 1922. The court held that the assessee-company had consistently contended that they were not liable to pay any capital gains tax on the sale or transfer of goodwill. The court found that the question referred to it was in very wide terms and embraced within its scope the question whether some of the assets which were transferred were such as could be the subject-matter of the charge under section 12B. The court concluded that the Tribunal should have allowed the assessee to argue the point that goodwill is not liable to capital gains tax under section 12B.Conclusion:The court answered all the referred questions in the negative, in favor of the assessees and against the department. It held that there was no capital gain on the transfer of goodwill, the transfer did not legally occur on April 23, 1947, and the Tribunal was not justified in disallowing the assessee to raise the question regarding the assessability of goodwill to capital gains tax. The respondent was ordered to pay the costs of the references quantified at Rs. 1,500.