Facts

The assessee-firm’s instrument of partnership showed that its goodwill had not been valued and that the same would be made on its dissolution. Subsequently,     it was dissolved by a deed dated  31.12.1965 and  its  goodwill was  valued at Rs. 1,50,000. A new partnership by the same name was constituted under an instrument dated 2.12.1965 and it took over all the assets, including the goodwill, and liabilities of the dissolved firm. The Revenue sought to tax the sale of goodwill as capital gains in the hands of the dissolved firm. The Tribunal held   that the impugned sale of the goodwill did not attract tax on capital gain under section 45. The High Court, on reference under section 256(1), sustained the Tribunal’s order.

Issue

Whether the transfer of goodwill to the newly constituted firm gave rise to capital gains under section 45 in the hands of transferor firm?

View

Goodwill denotes the benefit arising from connection and reputation. 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 is also impossible to predicate the  moment of  its  birth.  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.

The asset must be one which falls within the contemplation of section 45. It must bear that quality which brings section 45 into play. All transactions encompassed by section 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 section 45 to be the subject of the charge. Thus, inference flows from the general arrangement of the provisions in the Act in which the

charging section and the computation provisions together constitute an integrated code. 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 provision.

Held

The Supreme Court held:

• 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
• All transactions encompassed by s. 45  must fall under the  governance  of its computation A transaction to which those provisions cannot be applied must be regarded as never intended by section 45 to      be the subject of the charge. What is contemplated by section 48(ii) is an asset in the acquisition of which it is possible to envisage a cost: it must    be 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. When goodwill generated in a new business is sold and the consideration brought to tax, what is charged is the capital value of the asset and not    any profit or gain. Further, the date of acquisition of the asset is a material factor in applying the computation provisions pertaining to capital gain;  but in the case of goodwill generated in a new business it is not possible    to determine the date when it  comes into  existence. Having regard to the nature of goodwill, it will be impossible to determine its cost of acquisition.
• Therefore, ‘goodwill’ generated in a newly commenced business cannot be described as an “asset” within the terms of section 45 and the transfer of goodwill initially generated in a business does not give rise to a capital gain for the purposes of income-tax. (AY. 1966-67) (dt. 18-2-1981)

• Editorial: Amendment in section 55(2) overturned this decision and the position now is that cost of acquisition of self generated goodwill of a business or profession is to be taken as nil. However, as per the ratio: once computation provisions cannot be applied, the charge must fail, is unaffected by the amendment.

   

  It is also well settled that in a case where the charge is certain, the machinery/ computational provisions have to be read in a manner so as to avoid defeating     the levy of tax. In the above case, the self generated goodwill was held to be not    an ‘asset’ and therefore, not envisaged to be taxed under section 45. Refer A. R. Krishnamurthy v. CIT (1989) 176 ITR 417 (SC), which distinguished the above case.

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