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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