IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE No 243 of 1985 and INCOME TAX REFERENCE No 243-A of 1985 For Approval and Signature: Hon'ble CHIEF JUSTICE MR DM DHARMADHIKARI and Hon'ble MR.JUSTICE M.S.SHAH ============================================================ 1. Whether Reporters of Local Papers may be allowed : NO to see the judgements? 2. To be referred to the Reporter or not? : NO 3. Whether Their Lordships wish to see the fair copy : NO of the judgement? 4. Whether this case involves a substantial question : NO of law as to the interpretation of the Constitution of India, 1950 of any Order made thereunder? 5. Whether it is to be circulated to the Civil Judge? : NO -------------------------------------------------------------- COMMISSIONER OF INCOME-TAX Versus SHAHIBAUG ENTERPRENUERS PVT. LTD. -------------------------------------------------------------- Appearance: MR BB NAIK with MR MANISH R BHATT for Petitioner MR RK PATEL for Respondent No. 1 -------------------------------------------------------------- CORAM : CHIEF JUSTICE MR DM DHARMADHIKARI and MR.JUSTICE M.S.SHAH Date of decision: 08/03/2001 COMMON CAV JUDGEMENT (Per : MR.JUSTICE M.S.SHAH) In these references at the instance of the revenue, the following common questions have been referred to us under Section 256(2) of the Income-tax Act, 1961 (hereinafter referred to as "the Act") in respect of assessment years 1970-71 and 1974-75 :- 1. Whether on the facts and in the circumstances of the case, no question of assessing profits under sec. 41(2) of the Income-tax Act, 1961 in the hands of a holding company arises in case of sale by a holding company as a going concern to its 100% subsidiary company ? 2. Whether on the facts and in the circumstances of the cases, the AAC was right in setting aside the assessment and requiring the Income-tax Officer to reframe the assessment ? 2. The facts leading to Income-tax Reference No. 243-A, briefly stated, are as under :- 2.1 Karamchand Premchand Pvt. Ltd. (hereinafter referred to as "KPP") was a Private Limited Company which maintained its accounts on the basis of the financial year ending 31st March and on that basis its assessments were completed upto A.Y. 1973-74. KPP was amalgamated with Shahibaug Entrepreneurs Pvt. Ltd. (hereinafter referred to as "SEP" or "the assessee") with effect from 1.1.1974. 2.2 On 30.3.1970 the assessee sold the Wadala unit of one of its divisions called Swastik Oil Mills to Vegoll Pvt. Ltd., a wholly owned subsidiary of the assessee for a consideration of Rs. 1 Crore. This was made up of Rs.7.55 lacs for land and building, Rs.6.45 lacs for plant and machinery at book value and Rs.10 lacs for technical knowledge etc. and Rs.76 lacs for goodwill. The assessee did not declare any income chargeable to tax but the ITO included a sum of Rs.86 lacs relating to sale of technical knowledge and goodwill as profits from an adventure in the nature of goodwill. He further held that as the fixed assets were sold at WDV there was no profit under section 41(2). 2.3 In appeal, the AAC held that all the relevant facts for the purpose of determining the profits from an adventure in the nature of trade and the balancing charge under section 41(2), if any, not having been determined by the ITO, the matter was required to be remitted to him for giving an opportunity to the assessee to place on record relevant material and contentions having regard to the various aspects of the controversy. The AAC accordingly set aside the assessment. 2.4 In appeal before the Income-tax Appellate Tribunal (hereinafter referred to as "the Tribunal") by majority of 2:1 the Tribunal held by its decision dated 4.1.1982 that as there was a slump sale, there was no question of assessing the profits under Section 41(2) of the Act and secondly that since there was no scope for including the total income in the income by way of balancing charge under Section 41(2), the AAC was not justified in setting aside the assessment. Hence, at the instance of the revenue, Reference No. 243-A of 1985 arises from the aforesaid decision of the Tribunal in respect of A.Y. 1970-71. 3. As far as Income-tax Reference No. 243 of 1985 is concerned, the same relates to assessment of SEP-assessee in respect of KPP for the previous year corresponding to the period from 1.4.1973 to 31.3.1974 in background of the following facts :- 3.1 The assessee was carrying on business as a proprietor of a number of industrial undertakings which were described as divisions. With effect from 30.6.1973 the assessee sold, by separate transactions, six of its divisions to four different Companies, all of which were wholly owned subsidiaries of the assessee, the particulars of which are given hereinafter. In all these four cas.....T.............T..........J the assets including the goodwill of the respective businesses alongwith the liabilities of the respective divisions with effect from 30.6.1973. The value of the goodwill was not shown in the accounts and the balance-sheets of any of the undertakings, but a firm of the Chartered Accountants of the assessee determined the goodwill of each division as per the particulars given hereinafter. Adding the value of the goodwill to the value of the assets shown in the balance-sheet and deducting from the total amount, the liabilities as shown in the balance-sheet as at 30.6.1973, the consideration was determined for sale of each division. 3.2 The particulars of the sale of the aforesaid divisions to four different wholly owned subsidiary Companies of the assessee are as under :- .....T.............T....----------------------------- ------------------------------------------------------------------------ -------------------------- Sr. Division Transferee Conside- Value of Value f Balancing No. (undertaking) Company (wholly ration goodwill good ill charge transferred owned subsidiary Rs.(approx.) determined as per by assessee Company of by assessee assess ent assessee) order Rs. Rs. Rs. ------------------------------------------------------------------------ -------------------------- (a) (b) (c) (d) (e) (f) (g) ------------------------------------------------------------------------ --------------------------------------------------------- & Ind. Products Pvt. Ltd. 2 Sarabhai Chemicals Sarabhai Chemicals 6.95 Crores 7.50 Crores 4.34Cr res 3.40 Crores Sarabhai Common P. Ltd. Service Dvn. Sarabhai Mktg. Dvn. 3 Sarabhai Machinery Fabriquip Pvt.Ltd. 1.36 Crores 40 lacs Nil 4 Sarabhai Glass Dvn Packart Pvt. Ltd. 54 lacs 10 lacs 03.60 lacs ------------------------------------------------------------------------ ---------------------------- 3.3 All the above transactions were with effect from 30.6.1973. The assessee did not offer any income as chargeable in its assessment for A.Y. 1974-75 in relation to the aforesaid transactions. The ITO, however, held that in respect of each transaction there was a chargeable income which was includible in the assessment. The ITO firstly held that on sale of Swastik Oil Mills there was an adventure in the nature of trade and that the business did not have any goodwill and, therefore, the amount of Rs.2 crores (determined as goodwill of the business) was charged under the head "business income" being income from an adventure in the nature of trade. He further held that the value of the goodwill of the business of the other undertakings was not as much as adopted by the assessee and to that extent the consideration had passed on the fixed assets, stocks, spare parts etc. Thus, as against the value of goodwill of all the divisions (other than Swastik Oil Mills) as adopted by the assessee at Rs.8 Crores (Rs.7.5 crores + Rs.40 lacs + Rs.10 lacs), the ITO estimated the total value of goodwill at Rs.4,37,60,000/- (Rs.4.34 crores + Nil + Rs. 3.60 lacs respectively). Thus, according to the ITO, the balance amount of Rs.3,62,40,000/- (i.e. Rs. 8 crores - Rs.4,37,60,000/-) was paid for transfer of assets for which depreciation had been allowed in the assessments for earlier years and for transfer of stocks, spare partes etc. As a result, the ITO included in the assessment certain incomes by way of balancing charge under section 41(2) and certain other income as realized from sale of stocks, spare parts etc. Thus, the income by way of balancing charge was determined at Rs.3,60,48,375/- and the income from business chargeable an on sale of stocks, spare parts, etc. were determined at Rs.1,91,625/-. 3.4 The assessee filed an appeal before the AAC disputing the additions made by the ITO. As regards the transaction of transfer of Swastik Oil Mills, the AAC held that there was no justification for holding that there was income from from an adventure in the nature of trade. As regards the sale of other divisions, the AAC tested the correctness of the estimate of the value of goodwill of the business in each case and marketing value of the other assets which were transferred to the purchasers. The AAC was of the view that income by way of balancing charge taxable under section 41(2) and relating to profit arising from sale of stock was includible in the assessment, but for this purpose inquiry as to the valuation of goodwill and the other aspects was necessary. The AAC observed that it was necessary to hold this inquiry because a part of the total amount of consideration had not passed for transfer of goodwill but had passed for transfer of capital assets and the stocks. The AAC accordingly set aside the assessment and restored the matter on the file of the ITO for making a fresh assessment order after carrying out the inquiries in light of the order of the AAC. 3.5 The assessee file a second appeal before the Tribunal. In this appeal also, the Tribunal by a majority of 2:1 held in favour of the assessee on both the points i.e. the Tribunal held that since the transaction in question was a case of slump sale of each of the divisions as a going concern, there was no question of assessing the profits under Section 41(2) in the hands of the assessee (a holding Company) to its 100% subsidiary Company. In this view of the matter, the Tribunal, by a majority of 2:1, held that the AAC was not right in setting aside the assessment and in requesting the ITO to reframe the assessment after holding inquiries regarding the value of the goodwill and the other assets. From the aforesaid decision dated 4.1.1982 of the Tribunal based on the majority view, Income-tax Reference No. 243 of 1985 has been made under Section 256(2) of the Act at the instance of the revenue in respect of A.Y. 1974-75. 4. Since both the references pertain to the same assessee and raise common questions of law, with the consent of the learned counsel for the parties, the two references were heard together and are being disposed of by this common judgment. 5. We have heard Mr BB Naik, learned counsel for the revenue, instructed by M/s M.R. Bhatt & Co. We have also heard Mr RK Patel, learned counsel for the assessee. Both the learned counsel have taken us through the assessment order, the order of the Appellate Assistant Commissioner and the judgments of all the three learned Members of the Tribunal. The learned counsel have also invited our attention to the copies of the agreements regarding the aforesaid transactions of sale of the respective divisions. 6. Mr BB Naik, learned counsel for the revenue has made the following submissions :- (i) As far as the sale of Swastik Oil Mills division is concerned, the assessing officer was justified in holding that it was an adventure in the nature of trade and, therefore, it did not have any goodwill. In any view of the matter, the division could not have any goodwill as it was incurring losses for the last five years and, therefore, it could not have had any goodwill. It is apparent that when such an undertaking with land and building, plant and machinery,stocks and raw material was sold at Rs.2.45 Crores, the value of the goodwill could not have been Rs.2 Crores. The ITO was justified in assessing the value of the goodwill at Nil. (ii) In respect of the other undertakings also the ITO was justified in holding that the goodwill was grossly overvalued at Rs. 8 Crores (Rs.7.5 crores + Rs.40 lacs + Rs.10 lacs) and that the ITO was justified in valuing the goodwill at Rs.4,37 Crores (to be precise Rs.4,37,60,000/-i.e. Rs.4,34,00,000 + Rs. 3,60,000). Hence, the ITO had rightly added the remaining amount of Rs.3,62,40,000/- as the price paid for transfer of assets on which depreciation had been allowed in assessments for the earlier years and for transfer of stocks, spare-parts etc. together. (iii) The Tribunal erred in not appreciating that the assessee had valued the goodwill on the basis of the valuation report which applied the method of capitalization of future maintainable profits. Detailed submissions have been made for pointing out the errors in the valuation made by the valuer relied upon by the assessee. (iv) The controversy raised in these references is squarely covered by the decision of the Apex Court in CIT vs. Artex Manufacturing Co., (1997) 227 ITR 260. 7. On the other hand, MR RK Patel, learned counsel for the respondent-assessee has made the following submissions :- I The provisions of Section 41(2) of the Act are not applicable to the transactions in question for the following reasons :- (a) Aggregate value of any asset is not equivalent to itemwise value of that particular asset. (b) Deeds of Assignment relating to all the transfers indicate only aggregate values of assets and in the corresponding schedules no itemwise value by way of break-up value of aggregate value is available. (c) All transfers are as going concerns by assessee, as a holding Company to 100% wholly owned Indian subsidiary companies and all assets are transferred at book value. (d) The Tribunal's order, particularly the order of the third learned Member of the Tribunal, gives an undisputed finding of fact that the transactions are transactions of slump sales and each undertaking is sold as a whole. On this limited aspect, there is no difference of opinion between the Members of the Division Bench. The Tribunal further states that the appellant has not entered into sales of different items of the undertakings in question, but has sold the entire undertaking in each case. The parties have not put the valuation on the different assets and liabilities involved before coming to the net price in computing the slump price. Strong reliance has been placed on the decision of the Apex Court in CIT vs. Electrical Control Gear Mfg. Co., (1997) 227 ITR 278. II The decision of the Apex Court in Artex Manufacturing Company (Supra) is not applicable for the following reasons :- (a) The Apex Court has expressed the view that the provisions of section 41(2) are applicable in a case where a going concern is transferred and separate consideration for each item of properties sold is available, though there is no separate sale of different items. This is contrary to the factual situation existing in the assessee's case as stated above. (b) In Artex case, it is an admitted position on facts that the assets had been the subject matter of revaluation by an authorized valuer at the time of agreement for sale whereas in the present case all assets are transferred at book value and no such exercise of revaluation of each item of all the assets was undertaken. (c) In Artex case, though itemwise value attributable to each item of the total assets was not available at initial stage, the same was available from the record before the Assessing Officer on the basis of information furnished by the assessee during the course of assessment and hence in the ultimate analysis price attributable to the items transferred was available on record. Therefore, the Hon'ble Supreme Court concluded that provisions of section 41(2) were applicable on the facts of that case, with particular reference to this aspect. On the other hand in the instant case, no such information of itemwise value attributable to the aggregate value of asset was available at any stage right from inception and the same is not capable of being ascertained even as on today in absence of the same having been actually worked out at any time in the relevant Schedules appended to the corresponding Deed of Assignments read alongwith the relevant Minute Books of the concerned companies. (d) Alternatively and without prejudice to the aforesaid contention, even assuming that the charge is fastened or the charge fructifies on principle, the actual machinery for computation fails in arithmetical terms. This is because of absence of any itemwise value of actual cost as well as written down value of the items of each asset in the Schedules to the Deed of Assignments. Practical difficulty will arise in arriving at arithmetical value being difference between actual cost and written down value of each item of assets for charging the same as income u/s. 41(2) because of several important factors like varying rates of depreciation for different assets. Strong reliance is placed on the decision of the Apex Court in Sunil Siddharthbhai vs. CIT, (1985) 156 ITR 509. III Lastly, in any case, the taxable event is applicable only to the building, machinery, plant and furniture and, therefore, no other assets can be included within the scope of section 41(2) for taxability of difference between written down value and the actual cost. 8. Before dealing with the rival contentions, it will be necessary to make a brief reference to the findings given by the Income-tax Officer in the assessment order, by the Assistant Appellate Commissioner in appeal and by the Members of the Tribunal regarding valuation of the goodwill as the said findings would assume considerable importance while deciding the rival contentions. 9.0 FINDINGS GIVEN BY THE ITO 9.1 Swastik Oil Mills Ltd. was a separate Company from 1930 onwards and it was under the managing agency of Sarabhai Sons (P) Ltd., a sister concern of the assessee. Earlier the shares of Swastik Oil Mills Ltd. were held by three groups including Sarabhai group and as per the agreement of the shareholders, all the shares of Swastik Oil Mills Ltd. came to be purchased by Sarabhai group i.e. by Sarabhai Sons (P) Ltd. The shares were purchased for a price which was higher than the value obtained on break up value method. The assessee company agreed to take over the entire share capital of Swastik Oil Mills Ltd. Sarabhai Sons (P) Ltd. which was holding all the shares of Swastik Oil Mills Ltd. agreed to sell its entire shareholding to the assessee Company on 15.4.1968. Upon purchase of Swastik Oil Mills Ltd., the same was amalgamated with the assessee Company and became one of the divisions of the assessee Company. Swastik Oil Mills Ltd. had two units, one at Wadala manufacturing vegetable oils and the other at Ambernath manufacturing detergents and cosmetics. Simultaneously, the assessee Company also floated a new wholly owned subsidiary Vegoils (Pvt.) Ltd. in July, 1968 itself with an authorized share capital of Rs. 1 Crore and subscribed whole of the share capital. At the end of the accounting year 1969-70, the assessee Company sold Wadala unit of its Swastik Oil Mills division to its newly floated wholly owned subsidiary Vegoil (Pvt) Ltd. for a consideration of Rs. 1 Crore which had the following break up :- Particulars Amount (Rs.) Land, building, plant & 14,00,000/- machinery Technical know-how 10,00,000/- Goodwill 76,00,000/- The Ambernath unit of Swastik Oil Mills manufacturing detergents and cosmetics etc. was sold by the assessee to its newly floated wholly owned subsidiary Swastik Household & Industrial Products (P) Ltd. on 30.6.1973 for a sale consideration of Rs.2.45 Crores (which included goodwill of Rs. 2 Crores). 9.2 In support of its claim for goodwill of Rs. 2 Crores, the assessee filed a valuation report dated 25.6.1973 of Sorab S. Engineers & Co. The report valued the goodwill on capitalization of future maintainable profits. The ITO did not accept the said valuation report on the following grounds :- (a) The profit and loss account of Swastik Oil Mills division shows a huge loss of Rs.54.97 lakhs during the past 5 years while the valuation officer tries to imagine future profits of Rs. 607 lakhs. (b) The Swastik Oil Mills Division had previously been owned by Swastik Oil Mills Ltd. since 1930 and it had never shown any prosperity as imagined by the valuer prior to its amalgamation with the assessee Company. (c) When the Swastik Oil Mills Ltd. was incurring losses it was sold to the assessee by its shareholders. (d) Even after the assessee assumed its control it could not make any profits and it incurred losses to the tune of Rs.54.92 lakhs as stated above. (e) As discussed above, the Swastik Oil Mills had two divisions - one of its divisions i.e. Wadala Unit has already been sold by the assessee in the accounting year 1969-70 to Vegoils (P) Ltd. and a goodwill of Rs.76,00,000/- had already been charged. When a goodwill of Rs.76,00,000/- had already been charged then where is the possibility of any further goodwill and that too to the extent of Rs. 2 Crores ? (f) Goodwill in its present form means the business is better than normal return of profitability. But here the case is reverse. So there is no goodwill. The business is also not of a monopolistic nature. (g) It is pertinent to mention here that the Swastik Oil Mills division was sold to Swastik Household and Industrial Products (P) Ltd. on 30.3.1973 whereas the above valuation report is dated 25.6.1975. It means whole of the story of goodwill is an after thought cooked up story to show the real profits in the garb of so-called goodwill so that it can be claimed as a capital receipt from the subsidiary of the assessee Company. Thus, there is no goodwill at all attached to the business of the Swastik Oil Mills division as claimed by the assessee. 9.3 The ITO gave notice dated 9.3.1977 to the assessee to show cause why the so called goodwill of Rs. 2 Crores charged in the sale consideration of the Ambernath unit of Swastik Oil Mills division to Swastik Household and Industrial Products (P) Ltd. on 30.6.1973 should not be taxed as business income from an adventure in the nature of trade on the aforesaid grounds. The assessee submitted its objections dated 14.3.1977. After considering the objections, the ITO held that there was no justification for valuing the goodwill at Rs. 2 Crores. After charging the so called goodwill of Rs. 2 Crores, it was credited to the capital reserve in the balance sheet and then the assessee manipulated losses on the sale of shares of newly floated companies to its floated subsidiaries at less than 50% of their face value and squared up the amount credited in the capital reserve in the balance sheet drawn on 30.6.1973 but thereafter in the months of July and December, 1973, the assessee Company sold a large number of shares to other group Companies (most of them were purchased in the recent past) to its large number of newly floated wholly owned subsidiaries and manipulated the capital loss amounting to Rs. 10.51 Crores to square up the credit of Rs.10 crores by selling such shares to its floated subsidiaries at 50% of their face value. In this process, the assessee received a benefit to the extent of the above amount of so called goodwill but without causing any loss either to itself or to the subsidiary. Since the assessee contended that (without prejudice to its other contentions) that the Ambernath unit had become its stock-in-trade on 30.6.1973 but no resultant surplus arose in the form of gains or profits, the ITO held that the profit of Rs.2 Crores realized by the assessee on sale of Ambernath unit of Swastik Oil Mills to Swastik Household & Industrial Products (P) Ltd. on 30.6.1973 was assessable in the income of the assessee in a transaction which was in the nature of a trade. Valuing the land and building, machinery and equipments, loans and advances, current assets (including sundry debtors) and cash and bank balance, raw material, stock-in-process, strock-in-trade, spares, stores and other articles and current liabilities available in the books of