1972 (7) TMI 3 - HC - Income Tax

Goodwill from personal professional practice treated as capital asset with indeterminable cost; sale proceeds not taxable capital gains

Whether sale proceeds attributable to goodwill of a profession constitute taxable capital gains under ss.45, 48 and 55 of the Income-tax Act: the court ... Capital gains - goodwill as a capital asset - self-created goodwill - computation of capital gains under section 48 of the Income-tax Act, 1961 - cost of acquisition and cost of improvement - taxability of proceeds from transfer of goodwillGoodwill as a capital asset - taxability of proceeds from transfer of goodwill - Whether the transferred goodwill is a capital asset and whether consideration received for its transfer is in principle liable to tax as capital gains - HELD THAT: - The Court accepted the settled position that acquisition of goodwill constitutes acquisition of a capital asset and that consideration paid for its transfer may, in principle, attract capital gains treatment. The decision in Devidas Vithaldas & Co. was relied upon to show that goodwill is a capital asset and that purchase price of goodwill is capital expenditure, distinguishing transactions for acquisition of goodwill from payments for mere right to use it. Thus goodwill is not excluded categorically from the charge to capital gains. [Paras 11]Goodwill is a capital asset and consideration for its transfer is, in principle, capable of being assessed as capital gains.Computation of capital gains under section 48 of the Income-tax Act, 1961 - cost of acquisition and cost of improvement - self-created goodwill - Whether the amount of Rs. 32,000 received by the assessee towards goodwill was assessable to tax as capital gains given the requirements of computation under section 48 - HELD THAT: - Section 45 charges 'profits or gains arising from the transfer of a capital asset' and such profits or gains must be computed under section 48 by deducting expenditure incurred in connection with the transfer, the cost of acquisition and the cost of improvement. For self-created professional goodwill built up by personal effort over years, the court held that the 'cost of acquisition' and 'cost of improvement' contemplated by section 48/55 denote expenditure in terms of money. Where such expenditure cannot be ascertained (the cost of creation or subsequent improvement being incapable of determination in monetary terms), the statutory formula for computing capital gains cannot be applied. In the present case the goodwill was self-created and its cost of acquisition and improvement could not be determined, and consequently the profits or gains arising from its transfer could not be computed under section 48. [Paras 13, 14, 15]The amount received (Rs. 32,000) in respect of the goodwill is not assessable to tax as capital gains insofar as the profits or gains cannot be computed under section 48 because cost of acquisition and improvement are incapable of determination.Final Conclusion: The reference is answered in the affirmative and against the revenue: although goodwill is a capital asset in principle, the Rs. 32,000 received by the assessee in this case is not assessable as capital gains because the statutory computation under section 48 could not be effected for lack of ascertainable cost of acquisition or improvement; the Appellate Tribunal's decision is sustained on that ground and the assessee is entitled to costs. Issues: Whether the amount of Rs. 32,000 received by the assessee in connection with formation and dissolution of a partnership, representing the value of goodwill, is assessable to tax as capital gains under the Income-tax Act, 1961.Analysis: The charging provision for capital gains is contained in section 45, and computation of gains is governed by section 48 which permits deduction of (i) expenditure incurred wholly and exclusively in connection with the transfer, (ii) cost of acquisition, and (iii) cost of any improvement. Sections 55(1)(b) and 55(2)(i) define 'cost of improvement' and 'cost of acquisition' respectively. For self-created goodwill built up by personal efforts over years, there is no ascertainable expenditure in money that can be reliably quantified as cost of acquisition or cost of improvement. Where such determinative elements required by section 48 cannot be computed, the 'profits or gains' arising from the transfer cannot be determined for the purpose of section 45. Precedents addressing goodwill and self-created assets were considered for their persuasive value but the decisive point is the inability to compute deductible items under section 48 for this category of goodwill.Conclusion: The amount of Rs. 32,000 received by the assessee in respect of goodwill is not assessable to tax as capital gains under the Income-tax Act, 1961; decision is in favour of the assessee.