Full Judgment Text
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PETITIONER:
COMMISSIONER OF INCOME TAX, BANGALORE ETC. ETC.
Vs.
RESPONDENT:
B. C. SRINIVASA SETTY, ETC. ETC.
DATE OF JUDGMENT19/02/1981
BENCH:
PATHAK, R.S.
BENCH:
PATHAK, R.S.
BHAGWATI, P.N.
TULZAPURKAR, V.D.
CITATION:
1981 AIR 972 1981 SCR (2) 938
1981 SCC (2) 460 1981 SCALE (1)384
CITATOR INFO :
R 1985 SC 146 (10)
RF 1986 SC 368 (15)
RF 1988 SC1305 (6)
D 1989 SC1055 (9,10)
RF 1992 SC 147 (6,8)
ACT:
Goodwill of a newly commenced business-Whether, (i) a
capital asset and (ii) if so, an asset falling within the
contemplation of section 45 of Income Tax: Act, 1961 giving
rise to a capital gain.
HEADNOTE:
The assesses, a registered firm, manufactured and sold
agarbattis. Clause (13) of the Instrument of Partnership
executed on 28th of July, 1954 and subsequently extended by
another instrument dated 31st March, 1964 showed that the
goodwill of the firm had not been valued, and the valuation
would be made on dissolution of the partnership. The
assesses firm was dissolved by a deed dated 31st December,
1965. At the time of dissolution the goodwill of the firm
was valued at Rs. 1,50,000/-. A new partnership by the same
name was constituted under an instrument subsequently and it
took over all the assets including the goodwill and
liabilities of the dissolved firm. The Income Tax Officer
made an assessment on the dissolved firm for the assessment
year 1966 67 but did not include any amount on account of
the gains arising on transfer of the goodwill. The
Commissioner, being of the view that the assessment order
was prejudicial to the Revenue, decided to invoke his
revisional jurisdiction and setting aside the assessment
order directed the Income Tax Officer to make a fresh
assessment after taking into account the capital gain
arising on the sale of the goodwill. The Income Tax
Appellate Tribunal in appeal accepted the contention of the
assesses that the sale did not attract tax on capital gains
under section 45 of the Income Tax Act, 1961. The High Court
of Karnataka on a reference, at the instance of the
Commissioner of Income Tax affirmed the Tribunal’s view and
held that the value of the consideration receive ed by the
assesses for the transfer of its goodwill was not liable to
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capital gains tax under section 45 of the Income Tax Act.
Hence the three appeals as to the taxability of the transfer
of the goodwill to capital gain tax.
Dismissing the appeals, the Court
^
HELD: 1. The goodwill generated in a newly commenced
business cannot be described as an asset within the terms of
section 45 of the Income Tax Act, 1961 and therefore its
transfer is not subject to Income Tax under the head
"capital gains". [946 B-C]
2.1. Goodwill denotes the benefit arising from
connection and reputation. The benefit to the business
varies with the nature of the business and also from one
business to another. No business commenced for the first
time possesses goodwill from the start. It is generated as
the business is carried on and may be augmented with the
passage of time. A variety of elements goes into its making,
and its composition varies in different trades and in
different businesses in the same trade, and while one
element may preponderate in one business, another may
dominate in another business. And yet because of its
intangible
939
nature, it remains insubstantial in form and nebulous in
character. In a progressing business goodwill tends to show
progressive increase. And in a failing business it may begin
to wane. Its value may fluctuate from one moment to another
depending on changes in the reputation of the business. It
is affected by everything relating to the business, the
personality and business rectitude of the owners, the nature
and character of the business, its name and reputation, its
location, its impact on the contemporary market, the
prevailing socioeconomic ecology, introduction to old
customers and agreed absence of competition. There can be no
account in value of the factors producing it. It is also
Impossible to predicate the moment of its birth. It comes
silently into the world, unheralded and unproclaimed and its
impact may not be visibly felt for an undefined period.
Imperceptible at birth it exists enwrapped in a concept,
growing or fluctuating with the numerous imponderables
pouring into, and affecting the business. [942 F, H, 943 A,
E-H, 944 A]
Cruttwell v. Lye, 1810, 17 Ves 335; Churton v. Douglas,
1859 John 174; Trego v. Hunt, 1896 A.C. 7; Commissioner of
Inland Revenue v. Muller & Co’s Margarine Limited, [1901]
A.C. 217. quoted with approval.
3.1. Section 45 of the Income Tax Act operates if there
is a transfer of a capital asset giving rise to & profit or
gain. The expression "capital asset" defined in section
2(14) to mean "property of any kind held by an assessee" is
of the widest amplitude and covers all kinds of property
except the property expressly excluded by clauses (i) to
(iv) of the sub-section which do nor include good-will. [942
D-E]
3.2. Section 45 is a charging section, charging the
profits or gains arising from the transfer of a capital
asset to income-tax, according to the detailed provisions
for computing the profits or gains under that head. The
charging section and the computation provisions together
constitute an integrated code. When there is a case to which
the computation provisions cannot apply at all, it is
evident that such a case was not intended to fall within the
charging section. [944 C, D-E]
3.3. The mode of computation and deductions set forth
in section 48 provides the principal basis for quantifying
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the income chargeable under the head "capital gains".
Section 48 contemplates an asset in the acquisition of which
it is possible to envisage a cost. The intent goes to the
nature and character of the asset, that it is an asset which
possesses the inherent quality of being available on the
expenditure of money to a person seeking to acquire it. None
of the provisions pertaining to the head "capital gains"
suggests that they include an asset in the acquisition of
which no cost at all can be conceived. [945 A, C-E]
3.4. The date of acquisition of the asset is a material
factor in applying the computation provisions pertaining to
capital gains. The "cost of acquisition mentioned in section
48 implies a date of acquisition, an inference as
strengthened by the provision of sections 49, 50 and sub-
section (2) of section 55. If the goodwill generated in a
new business is regarded as acquired at a cost and
subsequently passes to an assessee in any of the modes
specified in sub-section (1) of section 49, it will become
necessary to determine the cost of acquisition to the
previous owner. Having regard to the nature of the asset, it
will be impossible to determine such cost of acquisition.
Nor can sub-section (3) of section 55 be invoked, because
the date of acquisition by the previous owner will remain
unknown. [945 F-G, H, 946 A]
940
Commissioner of Income-tax v. K. Rathnam Nadar, (1969)
71 I.T.R. 433 (Mad.); Commissioner of Income-tax v. Chunilal
Prabhudas & Co., (1970) 76 I.T.R. 566 (Cal.); Jagdev Singh
Mumick v. Commissioner of Income-tax, (1971) 81 I.T.R. 500
(Delhi); commissioner of Income-tax v. E. C. Jacob, (1973)
89 I.T.R. 88 (Kerala): Commissioner of Income-tax v. Home
Industries & Co., (1977) 107 I.T.R. 609 (Bom.); commissioner
of Income-tax v. Michel Postal, (1978) 112 I.T.R. 315 (Bom.)
commissioner of Income-tax v. Jaswant Lal Dayabhai, (1978)
114 I.T.R. 798 (M.P.) approved.
Commissioner of Income-tax v. Mohanbhai Pamabhai,
(1978) 91 I.T.R. 393 (Guj.); K. N. Daftary v. Commissioner
of Income-tax (1977) 106 I.T.R. 998, overruled.
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1146 of
1975.
Appeal by Special Leave from the Judgment and order
dated 4-7-1974 of the Karnataka High Court in I.T.R. No.
38/72.
CONNECTED WITH
Civil Appeal No. 1378 of 1976.
Appeal by Special Leave from the Judgment and Order
dated 1-12-1975 of the Karnataka High Court in I.T.R.C. No.
32/74.
AND
Civil Appeal No. 926 of 1973.
From the Judgment and Order dated 2-11-1972 of the
Kerala High Court in Income Tax Reference No. 120/70.
C.A . No. 1146/75.
Soli J. Sorabjee, Addl. Sol. General, B. B. Ahuja and
Miss A. Subhashini for the Appellant.
T. A. Ramachandran, B. Partha Sarathi and Miss R.
Vaigai for the Respondent.
K. K. Goswami, S. P. Mehta, Dinesh Vyas, P. H. Parekh,
C. B. Singh, Miss Vineeta Caprihan and B. L. Verma for the
intervener.
C.A. No. 1378/76.
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Soli J. Sorabjee, Addl. Sol. General, B. B. Ahuja and
Miss A. Subhashini for the Appellant.
Vineet Kumar and A. K. Srivastava for the Respondent.
C.A. No. 926/73.
V. S. Desai, K. C. Dua and Miss A. Subhashini for the
Appellant
A. S. Nambiar and P. P. Namboodiri for the Respondent.
941
The Judgment of the Court was delivered by
PATHAK, J.-The question in these appeals is whether the
transfer of the goodwill of a newly commenced business can
give rise to a capital gain taxable under s. 45, Income Tax
Act, 1961.
The assessee, a registered firm, manufactured and sold
agarbattis. Clause (13) of the Instrument of Partnership
executed on 28th July, 1954 showed that the goodwill of the
firm had not been valued, and the valuation would be made on
dissolution of the partnership. The period of the
partnership was extended by an instrument dated 31st March,
1964, and it contained a similar clause (13). Subsequently,
the assessee firm was dissolved by a deed dated 1st
December, 1965. At the time of dissolution, it seems, the
goodwill of the firm was valued at Rs. 1,50,000/-. A new
partnership by the same name was constituted under an
instrument dated 2nd December, 1965 and it took overall the
assets, including the goodwill, and liabilities of the
dissolved firm.
The Income-Tax Officer made an assessment on the
dissolved firm for the assessment year 1966-67 but did not
include any amount on account of the gain arising on
transfer of the goodwill. The Commissioner, being of the
view that the assessment order was prejudicial to the
Revenue, decided to invoke his revisional jurisdiction and
setting aside the assessment order directed the Income-Tax
Officer to make a fresh assessment after taking into account
the capital gain arising on the sale of the goodwill.
In appeal before the Income Tax Appellate Tribunal, the
assessee maintained that the sale did not attract tax on
capital gains under s. 45 of the Income-Tax Act, 1961.
Accepting the contention, the Tribunal allowed the appeal.
At the instance of the Commissioner of Income-Tax it
referred a question of law to the High Court of Karnataka
which, as reformed by the High Court, leads as follows:
"Whether, on the facts and in the circumstances of
the case, the Tribunal was right in holding that no
capital gains can arise under s. 45 of the Income Tax
Act, 1961 on the transfer by the assessee firm of its
goodwill to the newly constituted firm?"
By its judgment dated 4th July, 1974 the High Court
answered the question in the affirmative, holding that the
value of the consideration received by the assessee for the
transfer of its goodwill was not liable to capital gains tax
under s. 45 of the Act. Civil Appeal No. 1146 of 1975 is
directed against that judgment.
942
Civil Appeal No. 1378 of 1976 arises out of a judgment
by the same High Court in which it has followed its earlier
view.
Civil Appeal No. 926 of 1973 has been preferred against
the judgment of the Kerala High Court where a similar
opinion has been expressed, but in respect of the provisions
of s. 12-B, Indian Income Tax Act. 1922.
At the relevant time s. 45, Income Tax Act, 1961
provided:
"45. (1) Any profits or gains arising from the
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transfer of a capital asset effected in the previous
year shall, save as otherwise provided in sections 53
and 54, be chargeable to income-tax under the head
"Capital gains", and shall be deemed to be the income
of the previous year in which the transfer took place."
The section operates if there is a transfer of a
capital asset giving rise to a profit or gain. The
expression "capital asset" is defined in s. 2(14) to mean
"property of any kind held by an assessee" It is of the
widest amplitude, and apparently covers all kinds of
property except the property expressly excluded by clauses
(i) to (iv) of the sub-section which, it will be seen, do
not include goodwill. But the definitions in s. 2 are
subject to an overall restrictive clause. That is expressed
in the opening words of the section: "unless the context
otherwise requires". We must therefore enquire whether
contextually s. 45, in which the expression "capital asset"
is used, excludes goodwill.
Goodwill denotes the benefit arising from connection
and reputation. The original definition by Lord Eldon in
Cruttwell v. Lye that goodwill was nothing more than "the
probability that the old customers would resort to the old
places" was expanded by Wood V.C. in Churton v. Douglas to
encompass every positive advantage "that has been acquired
by the old firm in carrying on its business, whether
connected with the premises in which the business was
previously carried on or with the name of the old firm, or
with any other matter carrying with it the benefit of the
business". In Trego v. Hunt Lord Herschell described
goodwill as a connection which tended to become permanent
because of habit or otherwise. The benefit to the business
varies with the nature of the business and also from one
business to another. No business commenced for the first
time possesses
943
goodwill from the start. It is generated as the business is
carried on and may be augmented with the passage of time.
Lawson in his "Introduction to the Law of Property"
describes it as property of a highly peculiar kind. In
Commissioner of Income-tax, West Bengal III v. Chunilal
Prabhudas & Co., the Calcutta High Court reviewed the
different approaches to the concept:
"It has been horticulturally and botanically
viewed as "a seed sprouting" or an "acorn growing into
the mighty oak of goodwill". It has been geographically
described by locality. It has been historically
described by locality. It has been historically
explained as growing and crystalising traditions in the
business. It has been described in terms of a magnet as
the "attracting force". In terms of comparative
dynamics, goodwill has been described as the
"differential return of profit". Philosophically it has
been held to be intangible. Though immaterial, it is
materially valued. Physically and psychologically, it
is a "habit" and sociologically it is a "custom".
Biologically, it has been described as Lord Macnaghten
in Trego v. Hunt as the "sap and life" of the business.
Architecturally, it has been described as the "cement"
binding together the business and its assets as a whole
and a going and developing concern."
A variety of elements goes into its making, and its
composition varies in different trades and in different
businesses in the same trade, and while one element may
preponderate in one business, another may dominate in
another business. And yet because of its intangible nature,
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it remains insubstantial in form and nebulous in character.
Those features prompted Lord Macnaghten to remark in
Commissioner of Inland Revenue v. Muller & Co.’s Margarine
Limited that although goodwill was easy to describe, it was
nonetheless difficult to define. In a progressing business
goodwill tends to show progressive increase. And in a
failing business it may begin to wane. Its value may
fluctuate from one moment to another depending on changes in
the reputation of the business. It is affected by everything
relating to the business, the personality and business
rectitude of the owners, the nature and character of the
business, its name and reputation, its location, its impact
on the contemporary market, the prevailing socio economic
ecology, introduction to old customers and agreed absence of
competition. There can be no account in value of the factors
producing it. It u also impossible to predicate the moment
of its birth. It comes silently
944
into the world, unheralded and unproclaimed and its impact
may not be visibly felt for an undefined period.
Imperceptible at birth it exists enwrapped in a concept,
growing or fluctuating with the numerous imponderables
pouring into, and affecting, the business. Undoubtedly, it
is an asset of the business, but is it an asset contemplated
by s. 45 ?
Section 45 charges the profits or gains arising from
the transfer of a capital asset to income-tax. The asset
must be one which falls within the contemplation of the
section. It must bear that quality which brings s. 45 into
play. To determine whether the goodwill of a new business is
such an asset, it is permissible, as we shall presently
show, to refer to certain other sections of the head,
"Capital gains". Section 45 is a charging section. For the
purpose of imposing the charge, Parliament has enacted
detailed provisions in order to compute the profits or gains
under that head. No existing principle or provision at
variance with them can be applied for determining the
chargeable profits and gains. All transactions encompassed
by s. 45 must fall under the governance of its computation
provisions. A transaction to which those provisions cannot
be applied must be regarded as never intended by s. 45 to be
the subject of the charge. This inference flows from the
general arrangement of the provisions in the Income-tax Act,
where under each head of income the charging provision is
accompanied by a set of provisions for computing the income
subject to that charge. The character of the computation
provisions in each case bears a relationship to the nature
of the charge. Thus the charging section and the computation
provisions together constitute an integrated code. When
there is a case to which the computation provisions cannot
apply at all, it is evident that such a case was not
intended to fall within the charging section. Otherwise one
would be driven to conclude that while a certain income
seems to fall within the charging section there is no scheme
of computation for quantifying it. The legislative pattern
discernible in the Act is against such a conclusion. It must
be borne in mind that the legislative intent is presumed to
run uniformly through the entire conspectus of provisions
pertaining to each head of income. No doubt there is a
qualitative difference between the charging provision and a
computation provision. And ordinarily the operation of the
charging provision cannot be affected by the construction of
a particular computation provision. But the question here is
whether it is possible to apply the computation provision at
all if a certain interpretation is pressed on the charging
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provision. That pertains to the fundamental integrality of
the statutory scheme provided for each head.
The point to consider then is whether if the expression
"asset" in s. 45 is construed as including the goodwill of a
new business, it is
945
possible to apply the computation sections for quantifying
the profits and gains on its transfer.
The mode of computation and deductions set forth in s.
48 provide the principal basis for quantifying the income
chargeable under the head "Capital gains". The section
provides that the income chargeable under that had shall be
computed by deducting from the full value of the
consideration received or accruing as a result of the
transfer of the capital asset:
"(ii) the cost of acquisition of the capital
asset..."
What is contemplated is an asset in the acquisition of
which it is possible to envisage a cost. The intent goes to
the nature and character of the asset, that it is an asset
which possesses the inherent quality of being available on
the expenditure of money to a person seeking to acquire it.
It is immaterial that although the asset belongs to such a
class it may, on the facts of a certain case, be acquired
without the payment of money. That kind of case is covered
by s. 49 and its cost, for the purpose of s. 48 is
determined in accordance with those provisions. There are
other provisions which indicate that s. 48 is concerned with
an asset capable of acquisition at the cost. s. 50 is one
such provision. So also is sub-section (2) of s. 55. None of
the provisions pertaining to the head "Capital gains"
suggests that they include an asset in the acquisition of
which no cost at an can be conceived. Yet there are assets
which are acquired by way of production in which no cost
element can be identified or envisaged. From what has gone
before, it is apparent that the goodwill generated in a new
business has been so regarded. The elements which create it
have already been detailed. In such a case, when the asset
is sold and the consideration is brought to tax, what is
charged is the capital value of the asset and not any profit
or gain.
In the case of goodwill generated in a new business
there is the further circumstance that it is not possible to
determine the date when it comes into existence. The date of
acquisition of the asset is a material factor in applying
the computation provisions pertaining to capital gains. It
is possible to say that the "cost of acquisition" mentioned
in s. 48 implies a date of acquisition, and that inference
is strengthened by the provisions of ss. 49 and 50 as well
as sub-section (2) of s. 55.
It may also be noted that if the goodwill generated in
a new business is regarded as acquired at a cost and
subsequently posses to an assessee in any of the modes
specified in sub-section (1) of s. 49, it will become
necessary to determine the cost of acquisition to the
previous owner. Having regard to the nature of the asset, it
will be impossible
946
to determine such cost of acquisition Nor call sub-section
(3) of s. 55 be invoked, because the date of acquisition by
the previous owner will remain unknown.
We are of opinion that the goodwill generated in a
newly commenced business cannot be described as an "asset"
within the terms of s. 45 and therefore its transfer is not
subject to income-tax under the head "Capital gain".
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The question which has been raised before us, has been
considered by some High Courts, and it appears that there is
a conflict of opinion. The Madras High Court in Commissioner
of Income-tax v. K. Rathnam Nadar, the Calcutta High Court
in Commissioner of Income-Tax v. Chunilal Prabhudas & Co.,
(supra) the Delhi High Court in Jagdev Singh Mumick v.
Commissioner of Income-tax, the Kerala High Court in
Commissioner of Income-tax v. E.C. Jacob, the Bombay High
Court in the Commissioner of Income-tax v, Home Industries &
Co. and Commissioner of Income-tax v. Michel Postal and the
Madhya Pradesh High Court in Commissioner of Income-tax v.
Jaswant Lal Dayabhai have taken the view that the receipt on
the transfer of goodwill generated in a business is not
subject to income-tax as a capital gain. On the other side
lies the view taken by the Gujarat High Court in
Commissioner of Income-tax v. Mohanbhai Pamabhai, and the
Calcutta High Court in R.N. Daftary v. Commissioner of
Income-tax that even if no cost is incurred in building up
the goodwill of the business, it is nevertheless a capital
asset for the purpose of capital gains, and the cost of
acquisition being nil the entire amount of sale proceeds
relating to the goodwill must be brought to tax under the
head "Capital gains". It is apparent that the preponderance
of judicial opinion favours the view that the transfer of
goodwill initially generated in a business does not give
rise to a capital gain for the purposes of income-tax.
Upon the aforesaid considerations, Civil Appeal No.
1146(T) of 1975 and Civil Appeal No. 1378 of 1976 must be
dismissed.
947
Civil Appeal No. 926 of 1973 raises the same question
with reference to s. 12B, Indian Income Tax Act, 1922. As
the relevant statutory provisions of the Indian Income Tax
Act, 1922 are substantially similar to the corresponding
provisions of the Income Tax Act, 1961, that appeal is also
liable to be dismissed.
Accordingly, the appeals are dismissed with costs.
S.R. Appeals dismissed.
948