Self-created goodwill and capital gains: High Court ruled it was not taxable under the 1922 income-tax law

Section 66(2) of the Indian Income-tax Act, 1922 could not be invoked unless the party had first made a section 66(1) application and the Tribunal had refused to state the case; procedural rules could not enlarge that statutory right, so the assessee's reference on that footing failed. On the substantive tax issue, the transfer of rights on dissolution included goodwill, but self-created goodwill was treated as an intangible asset not intended to be taxed as capital gains under section 12B. The question of capital gains liability was also within the scope of the reference because it was implicit in the issue framed. Capital gains on the transfer of self-created goodwill were therefore not taxable.

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Issues: (i) Whether a party could seek a reference under section 66(2) of the Indian Income-tax Act, 1922 without first making an application under section 66(1) and without refusal by the Tribunal. (ii) Whether capital gains tax was chargeable under section 12B of the Indian Income-tax Act, 1922 on the transfer of goodwill and, if so, whether the question was within the scope of the reference.

Issue (i): Whether a party could seek a reference under section 66(2) of the Indian Income-tax Act, 1922 without first making an application under section 66(1) and without refusal by the Tribunal.

Analysis: The statutory scheme made an application under section 66(1) a condition precedent to invoking section 66(2). The High Court's power under section 66(2) arose only where the Tribunal had refused to state the case on an application duly made under section 66(1). Procedural rules framed by the Tribunal could not enlarge that statutory right. A party replying to the opposite party's reference application could not, by way of answer, introduce an entirely different question not founded on its own section 66(1) application.

Conclusion: The preliminary objection was rightly sustained, and the assessee could not maintain the reference under section 66(2) in the absence of a prior section 66(1) application by him.

Issue (ii): Whether capital gains tax was chargeable under section 12B of the Indian Income-tax Act, 1922 on the transfer of goodwill and, if so, whether the question was within the scope of the reference.

Analysis: The transfer of the assessee's rights in the firm on dissolution included the transfer of goodwill. However, the Court held that goodwill in this context was a self-created intangible asset and that the wording and scheme of section 12B did not evince a legislative intent to tax capital gains arising from the transfer of such self-created goodwill. The Court also held that the question whether the amount was taxable as capital gains was implicit in the reference as framed and could be considered.

Conclusion: Capital gains on the transfer of goodwill were not liable to be taxed under section 12B, and the question was within the scope of the reference.

Final Conclusion: The assessee succeeded on the substantive tax issue, and the reference was answered in the assessee's favour.

Ratio Decidendi: Under section 12B of the Indian Income-tax Act, 1922, self-created goodwill was not taxable as capital gains, and a question framed on assessability in capital gains could encompass that underlying issue where it was implicit in the reference.

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