1971 (9) TMI 56 - HC - Income Tax

Goodwill not subject to capital gains tax when considered part of partnership assets.

The court held that the goodwill of the firm is a self-acquired asset and not subject to capital gains tax. The amount received by the assessee for their ... Chargeability to capital gains under section 45 - mode of computation of capital gains under section 48 - transfer (extended meaning) and extinguishment or relinquishment of rights - interest of a partner in partnership assets upon retirement or dissolution - goodwill as a capital asset - consideration received or accruing as a condition for capital gainsGoodwill as a capital asset - interest of a partner in partnership assets upon retirement or dissolution - The Tribunal was right in holding that the goodwill of the firm is a self-acquired asset of the firm. - HELD THAT: - The court accepted that goodwill is an intangible 'property' and hence a capital asset within the wide definition of 'capital asset'. However, the legal character of a partner's interest was examined: a partner's right is to a share in the net partnership assets (profits during subsistence and value of net assets on dissolution or retirement) and not an interest in any specific partnership item. Reliance was placed on authoritative decisions (Narayanappa v. Bhaskara Krishnappa; Commissioner of Income-tax v. Dewas Cine Corporation) and a Full Bench decision of this court to show that on retirement or dissolution what is received is the partner's share in net assets determined (often) on a notional sale basis and that such adjustment does not operate as a transfer of specific partnership property. On that basis the court agreed that goodwill is self-created and is a capital asset of the firm.Affirmative - the Tribunal was right that the goodwill of the firm is a self-acquired asset.Chargeability to capital gains under section 45 - mode of computation of capital gains under section 48 - consideration received or accruing as a condition for capital gains - transfer (extended meaning) and extinguishment or relinquishment of rights - The amount received by each retiring partner as his share (including the proportionate share attributed to goodwill) is not liable to be assessed as capital gain under section 45. - HELD THAT: - Two alternative contentions were considered. First, the court held that amounts paid on retirement represented the retiring partner's share in the net partnership assets after deduction of liabilities and prior charges and were received in satisfaction of his partnership share; such receipt is an adjustment of rights and not a transfer of interest in a particular partnership asset. Thus no 'transfer' of the partner's interest in goodwill arose within the statutory meaning as applied to capital gains. Second, addressing the contention that self-created assets which cost nothing are nevertheless taxable if transferred, the court analysed sections 45 and 48: section 45 charges profits arising from transfer of a capital asset where consideration is received or accrues; section 48 prescribes computation by deducting expenditure and cost of acquisition (if any). The court rejected the argument that absence of monetary cost to acquire a self-created asset excludes it from section 45; rather, if there is a transfer with consideration the full value would form the gross receipt and any applicable cost (if existent) would be deductible under section 48. Applying these principles, even if (contrary to the primary view) a transfer occurred on retirement, no consideration received or accruing for extinguishment of a partner's interest in a particular asset could be identified; the retiring partner received his share in the net assets as such. Therefore no part of the amount attributable to goodwill was assessable as capital gains under section 45.Affirmative - the Tribunal was right that the amounts received in respect of the retiring partners' shares in goodwill are not assessable as capital gains.Final Conclusion: For assessment year 1963-64 the Court held (1) goodwill is a self-acquired capital asset of the firm, and (2) amounts paid to retiring partners as their shares (including the portion attributed to goodwill) represented realization of their share in the net partnership assets and were not taxable as capital gains under section 45; costs awarded to the assessees. Issues Involved:1. Whether the goodwill of the firm is a self-acquired asset of the firm.2. Whether the amount received by the assessee by way of his share in the goodwill of the firm is liable to be assessed to tax.3. Whether the retirement of the assesses as partner from the firm amounted to dissolution of the firm, and therefore, the capital gain, if any, is chargeable to tax in view of the provisions of section 47(ii) of the Act.Detailed Analysis:Issue 1: Goodwill as a Self-Acquired AssetThe Tribunal held that the goodwill of the firm is a self-acquired asset, which had cost nothing to the firm and its partners in terms of money. This view was supported by the argument that goodwill is a self-created asset and its transfer does not fall within the ambit of the charging provision contained in section 45 of the Income-tax Act, 1961. The court agreed with the Tribunal's view, stating that the goodwill of the firm is indeed a self-acquired asset.Issue 2: Taxability of Amount Received for GoodwillThe court examined whether the amount received by each assessee for their share in the goodwill of the firm is liable to be assessed to tax as capital gains. The court considered two main contentions:1. The amount received was part of the assessee's share in the net partnership assets and not consideration for the transfer of interest in the goodwill.2. Goodwill, being a self-created asset that cost nothing to the firm and its partners, does not attract capital gains tax.The court concluded that the first contention was well-founded. It was held that when a partner retires from a partnership, the amount received represents their share in the net partnership assets after deducting liabilities and prior charges, and not consideration for the transfer of interest in the goodwill. The court referenced the Supreme Court decisions in Narayanappa v. Bhaskara Krishnappa and Commissioner of Income-tax v. Dewas Cine Corporation, which clarified that a partner's interest in a partnership is not in any specific item of the partnership property, but in the net partnership assets after liabilities. Therefore, the amount received by the retiring partner is not taxable as capital gains.Issue 3: Retirement vs. Dissolution of FirmThe Tribunal included a third question regarding whether the retirement of the assessees amounted to the dissolution of the firm, which would invoke section 47(ii) of the Act, making the capital gain, if any, non-taxable. However, the court decided that it was unnecessary to address this question due to the conclusions reached on the first two issues.Conclusion:The court answered the questions as follows:- Question No. (1): Affirmative. The goodwill of the firm is a self-acquired asset.- Question No. (2): Affirmative. The amount received by the assessee by way of his share in the goodwill of the firm is not liable to be assessed to tax.- Question No. (3): Does not arise.The Commissioner was directed to pay the costs of each reference to the assessee.