₹50-crore Nirma trademark sale not taxable as capital gains because acquisition cost was unascertainable, Gujarat High Court rules

The assessee claimed ownership of intangible assets associated with the Nirma business, including trademarks and trade names. A 1980 dissolution deed provided for payment to her of 2.5% of the firm’s net profits or Rs. 10,000, whichever was higher, and stated that ownership of the assets would belong to the SK Patel Family Trust.

The assessee received and returned the annual payments as income, which the Revenue taxed as income from other sources.

In 2001, following an arbitral award recognising the assessee’s ownership and the firm’s user rights, the trademarks and related assets were sold to Nirma Limited for Rs. 500 crore; Rs. 50 crore was allocated to the assessee.

The Assessing Officer taxed that amount as income from other sources, alternatively as long-term capital gains; the Tribunal held it was capital consideration but not taxable because the cost of acquisition was unascertainable.

The Revenue appealed against the Tribunal’s decision and against the deletion of a penalty under section 271(1)(c).

1. Whether the Rs. 50 crore received by the assessee was taxable as income from other sources or as long-term capital gains, and whether it was non-taxable because the cost of acquisition was unascertainable.

2. Whether the 1980 dissolution deed transferred ownership of the intangible assets to the Trust or assigned only their user rights, leaving ownership with the assessee.

3. Whether the Rs. 50 crore represented a commuted royalty or perpetual payment, rather than consideration for the sale of the assets.

4. Whether the arbitral award was binding between its parties and could be relied on in determining the character of the 2001 transaction.

5. Whether deletion of the addition required deletion of the penalty under section 271(1)(c).

Sections 45 and 48 of the Income-tax Act govern the charge and computation of capital gains; sections 49 and 55(2)(a) address the cost of acquisition in specified cases, including certain self-generated intangible assets.

Under CIT v. B.C. Srinivasa Setty, where the cost of acquisition of an asset cannot be determined under the applicable statutory scheme, the capital-gains computation machinery may fail, preventing a capital-gains charge.

Applying Devidas Vithaldas & Co. v. CIT and Travancore Sugars and Chemicals Ltd. v. CIT, the true character of a transaction is determined by construing its terms and surrounding circumstances; a payment linked to profits, for an indefinite period, and not tied to a fixed purchase price may indicate a licence or user-right arrangement rather than a sale.

The Court also applied the principle that an annuity ordinarily involves a fixed or predetermined payment, not an amount varying with profits.

Section 35 of the Arbitration and Conciliation Act, 1996 provides that an arbitral award is final and binding on the parties, while the Revenue, as a non-party, was not bound by it but could not displace it without a basis to challenge its genuineness.

Section 271(1)(c) provides for penalty in the circumstances specified by that provision.

The Court agreed with the Tribunal that the 1980 deed’s profit-linked, indefinite payments, with no fixed sale price or specified duration of use, supported the conclusion that the assessee had assigned user rights rather than transferred ownership.

The annual payments were not a fixed annuity, and the Rs. 50 crore received in 2001 was consideration for the sale of the assessee’s ownership interest, not a commuted perpetual royalty taxable as income from other sources.

The Court found no evidence establishing that the arbitral award was a colourable device; it therefore accepted the award’s role in the transaction between the parties.

For capital-gains purposes, the assets sold were trademarks and trade names, not goodwill; the later amendments deeming the cost of certain intangible assets to be nil did not apply retrospectively to this transaction. The Tribunal was therefore entitled to conclude that the cost of acquisition was unascertainable and that the receipt was not chargeable to capital gains tax.

As the quantum addition was deleted, the basis for the penalty did not survive.

It held that the Rs. 50 crore was sale consideration falling, in character, under capital gains rather than income from other sources, but was not taxable because the cost of acquisition was unascertainable.

Tax Appeal No. 1439 of 2006 was dismissed; the penalty under section 271(1)(c) was also held not leviable, and Tax Appeal No. 1054 of 2007 was dismissed.