1978 (5) TMI 55 - AT - Income Tax

Goodwill transfer not a capital gain: Assessees win appeal

The court held that the creation and transfer of the goodwill account did not result in a capital gain for the assessees. The firm did not receive ... Transfer of goodwill versus distribution of partnership asset - nature of partner's interest in partnership property - self-generated goodwill as a capital asset - point of acquisition and cost of acquisition for capital gains - construction of charging provision in favour of the assesseeTransfer of goodwill versus distribution of partnership asset - nature of partner's interest in partnership property - Whether any transfer by the partners of goodwill occurred so as to give rise to capital gains - HELD THAT: - The Tribunal held that no transfer by the partners of any specific partnership asset took place. Applying the principle that during the subsistence of a partnership a partner has no proprietary right in specific items of partnership property but only a right to share in profits and, on dissolution, to share in the net assets (as explained in Narayanappa v. Bhaskara Krishnapa), the creation of a goodwill account in the firm's books on the eve of takeover did not convert a partner's unspecified interest into a transferable asset. The partners' credited shares represented distribution of the firm's interest and not consideration received by partners for alienation of a distinct capital asset. The Tribunal therefore concluded that the ITO/AAC were not justified in treating the amounts credited to partners as proceeds of a transfer by the partners giving rise to capital gain. [Paras 9, 17]No transfer by the partners of goodwill was established; the amounts credited were distributional and did not give rise to capital gains in the hands of the partners.Self-generated goodwill as a capital asset - point of acquisition and cost of acquisition for capital gains - construction of charging provision in favour of the assessee - Whether the firm's creation and transfer of self-generated goodwill could be treated as transfer of a capital asset attracting capital gains tax - HELD THAT: - The Tribunal considered the alternative that, if the firm (and not the partners) had transferred goodwill to the company, the goodwill was a self-generated asset created in the books on 23rd Aug., 1972. Relying on the weight of authority from Madras, Calcutta, Delhi, Karnataka and Bombay High Courts, the Tribunal held that a self-generated goodwill, which has no ascertainable point or cost of acquisition in monetary terms, is not a capital asset within the charging provision and cannot give rise to taxable capital gain on transfer. The Tribunal rejected the contrary solitary view of the Gujarat High Court and relied on the principle that where two interpretations of a fiscal provision are possible the one beneficial to the assessee should be adopted. Further, even on the hypothesis of transfer by the firm at book value, no excess over book value (i.e., no realisation above written down value) was shown which could produce capital gain. [Paras 13, 14, 15, 16, 17]Self-generated goodwill created in the books on the eve of transfer was not a capital asset for purposes of charging capital gains; no taxable capital gain arose on its transfer.Final Conclusion: The Tribunal allowed the appeals: the amounts credited as goodwill did not attract capital gains tax-there was no transferable interest of the partners in the goodwill, and in any event self-generated goodwill does not constitute a chargeable capital asset giving rise to capital gains in the circumstances before the Tribunal. Issues Involved:1. Whether there is any capital gain arising to the assessee on the supposed transfer of goodwill.2. Whether the goodwill was an asset that could be transferred and thus liable to capital gains tax.3. Whether the creation of the goodwill account in the books of the firm and its subsequent transfer to a limited company constituted a taxable event.4. Whether the judicial precedents support the taxation of self-generated goodwill as a capital asset.Issue-wise Detailed Analysis:1. Capital Gain on Supposed Transfer of Goodwill:The primary issue is whether the transfer of goodwill by the firm to a limited company results in a capital gain for the assessees. The Income Tax Officer (ITO) treated the credited value of goodwill as capital gain and taxed it accordingly. The assessees argued that the goodwill was not sold but merely distributed among the partners, thus not constituting a transfer. The AAC disagreed, holding that the firm was not dissolved, and the goodwill was created specifically for the sale, making it taxable as capital gains.2. Goodwill as a Transferable Asset:The Departmental Representative argued that goodwill is a property capable of being transferred and thus a capital asset. The Gujarat High Court's decision in 91 ITR 393 supported this view, stating that even if the goodwill had no acquisition cost, the entire sale consideration should be treated as capital gain. However, the assessees contended that goodwill, being an intangible asset with no acquisition cost, should not result in capital gain upon transfer. They relied on various High Court decisions that held goodwill as a non-taxable asset due to the absence of acquisition cost.3. Creation and Transfer of Goodwill Account:The firm created the goodwill account for the first time on 23rd Aug., 1972, just before its assets were taken over by the limited company. The assessees argued that this creation and subsequent transfer did not involve a sale or transfer of an asset but was merely a distribution of an asset among partners. The Supreme Court's decision in Narayanappa vs. Bhaskara Krishnapa was cited, which held that during the subsistence of a partnership, no partner can deal with any specific item of partnership property as their own. Therefore, the transfer of goodwill to the limited company did not constitute a taxable event.4. Judicial Precedents on Self-Generated Goodwill:The Bombay High Court in CIT vs. Home Industries and Co. and other High Courts, including Madras, Calcutta, Delhi, Karnataka, and Kerala, held that self-generated goodwill, having no acquisition cost, could not be regarded as a capital asset for the purpose of capital gains tax. The Gujarat High Court's contrary view was not accepted as the correct law. The consensus of judicial opinion is that self-generated goodwill, costing nothing to the assessee, cannot be taxed as capital gains. The principle that fiscal statutes should be interpreted in favor of the assessee when two interpretations are possible was also highlighted.Conclusion:The judgment concluded that the creation and transfer of the goodwill account did not result in a capital gain for the assessees. The firm did not receive anything in excess of the book value, and the goodwill being a self-generated asset with no acquisition cost, could not be considered a capital asset for the purpose of capital gains tax. The majority judicial opinion supports this view, and the assessees' appeals were allowed, nullifying the capital gains tax assessments made by the Department.