IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE No 69 of 1993 For Approval and Signature: HON'BLE MR.JUSTICE D.A.MEHTA and HON'BLE MS.JUSTICE H.N.DEVANI ============================================================ 1. Whether Reporters of Local Papers may be allowed : NO to see the judgements? 2. To be referred to the Reporter or not? : YES 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 concerned : NO Magistrate/Magistrates,Judge/Judges,Tribunal/Tribunals? -------------------------------------------------------------- ACCURATE TURST Versus COMMISSIONER OF INCOME TAX -------------------------------------------------------------- Appearance: 1. INCOME TAX REFERENCE No. 69 of 1993 MR SN SOPARKAR, SR. ADVOCATE WITH MRS SWATI SOPARKAR for Applicant - Assessee MR TANVISH U. BHATT for Respondent - Revenue -------------------------------------------------------------- CORAM : HON'BLE MR.JUSTICE D.A.MEHTA and HON'BLE MS.JUSTICE H.N.DEVANI Date of decision: 29/04/2005 ORAL JUDGEMENT (Per : HON'BLE MR.JUSTICE D.A.MEHTA) 1. By this reference, Income Tax Appellate Tribunal, Ahmedabad Bench "C" has raised various questions under Section 256(1) of the Income Tax Act, 1961 (the Act), both at the instance of the assessee and the revenue. 2. It appears that both the assessee and the revenue have filed separate reference applications arising from independent appeals before the Tribunal preferred by the assessee and the revenue - against the order of CIT (Appeals), and hence, following identical questions have been raised and referred by Tribunal pertaining to different reference applications : Questions at the instance of assessee : "(1) Whether on the facts and in the circumstances of the case the Tribunal has been right in law in holding that the right or actionable claim was retained by the assessee Trust and that it was never the property of the firm? (2) Whether on the facts and in the circumstances of the case the Tribunal has been right in law in holding that "right of cause of action was never subject of distribution on dissolution of the firm M/s Accurate Engineering Company? (3) Whether on the facts and in the circumstances of the case the Tribunal has been right in law in holding that receipt of Rs.31,99,077/- was due to extinguishment of the right or actionable claim resulting into transfer as enshrined in Section 47(2) of the Income Tax Act, 1961? (4) Whether on the facts and in the circumstances of the case the Tribunal has been right in law in holding that amount realised by the assessee on "transfer" of goodwill was exigible to capital gains tax? (6) Whether on the facts and in the circumstances of the case the Tribunal has been right in law in holding that amount of Rs.31,99,077/- was taxable capital gains in the hands of the assessee - Trust? (7) Whether on the facts and in the circumstances of the case the Tribunal has been right in directing the revenue to find out whether the said capital gain is to be taxed as long term capital gains or short term capital gains?" Questions at the instance of revenue : "(1) Whether the Appellate Tribunal is right in law and on facts in holding that the assessee trust does not seem to have adopted a colourable device and therefore, the decision of the Hon'ble Supreme Court in the case of Mcdowell & Company (154 ITR 148) is not applicable? (2) Whether the Appellate Tribunal is right in law and on facts in holding that the amount of Rs.31,99,077/- is not taxable under Section 28(iv) of the Act? (3) Whether the Appellate Tribunal is right in law and on facts in holding that the provisions of Section 41(2) could not come into operation in respect of an amount of Rs.2,64,338/-?" 3. The Tribunal has also referred supplementary question at the instance of the assessee, which reads as under : "Whether in the facts and circumstances of the case the Tribunal was right in law in confirming rejection of the claim of the assessee for deduction in respect of bonus payment?" 4. The assessment year is 1985-86 and the relevant accounting period is year ended on 31st March 1985. The assessee is a private trust assessed in the status of association of persons. 5. The facts relatable to the supplementary independent question regarding bonus liability are that the assessee paid a sum of Rs.1,18,869/- as bonus to employees of erstwhile firm of M/s Accurate Engineering Co., which was dissolved. The assessee's claim for deduction of the amount was rejected by the assessing officer on the ground that the bonus was paid to employees of erstwhile firm and as the employees were not in the service of the assessee trust, there was no liability to pay such bonus. 6. Assessee went in appeal before the CIT (Appeals) and in relation to claim of bonus, succeeded because the CIT (Appeals) held that the firm was floated as a colourable device, and as such, the liability to pay bonus was that of the assessee trust. 7. Revenue carried the matter in appeal before the Tribunal and the Tribunal, for the reasons stated in its order dated 17th January 1992, held that the partnership firm was a genuine firm and hence, the liability to pay bonus could not be fastened on the assessee trust. The Tribunal further held that the assessee had not carried on any business as it had transferred entire business including all assets and liabilities to the partnership firm on 1st April 1984. 8. The Tribunal has set aside the order of CIT (Appeals) after recording the aforesaid findings without appreciating that the assessee trust had made a claim for deduction before the assessing officer and the same had been denied. 9. Having heard the learned advocate appearing for the assessee and the revenue, it is apparent that the question referred cannot be answered in absence of proper recording of facts and appreciation of evidence by the Tribunal, upon which the Tribunal is expected to give its findings. In the circumstances, the question is left unanswered and the Tribunal shall adjust its decision after undertaking necessary exercise in this regard. 10. In so far as the questions raised by the assessee and the revenue are concerned, as the facts are common, they are being dealt with together. 11. The assessee trust came into existence under a deed of trust executed on 21st August 1980 with effect from 7th August 1980. The trust along with various individuals formed a partnership firm with effect from 16th August 1980 in the name and style of M/s Accurate Engineering Co. (the firm). The trust had 50% share in the profit and loss as per the terms of the partnership deed. The partnership was dissolved under a deed of dissolution dated 30th October 1980 with effect from 30th September 1980. Under the said deed of dissolution, the business of the firm was taken over by the trust; and the trust as proprietor of the business, continued to carry on the business upto 31st March 1984. 12. With effect from 1st April 1984, another partnership firm having the same name M/s Accurate Engineering Co. (new firm) was constituted and the new firm comprised of the trust, five individuals and one limited company, namely M/s Austin Engineering Pvt. Ltd. (the company). At the time of formation of the new firm, the trust brought in all the assets and liabilities as per balancesheet as on 31st March 1984 of the proprietary business by way of its capital contribution, but retained the goodwill, the tradename, trademark and right to appreciation in the value of the assets of the proprietary business. 13. The new firm was dissolved on 1st July 1984 by dissolution deed, and under the deed, the company was permitted to take over entire running business with all the assets and liabilities of the dissolved firm in lieu of and towards settlement of right, title and interest in the partnership. The remaining partners, including the trust were to receive money value of their respective rights in the partnership business and accordingly, by mutual agreement, a statement of affairs as on 30th June 1984 was prepared showing settlement of accounts of the partner inter-se. The total networth was worked out at a sum of Rs.1,74,35,358/- which was taken to the books of account. Out of this, an amount of Rs.25,00,000/- was worked out as value of goodwill; an amount of Rs.1,54,331/- was worked out as appreciation in value of the assets i.e. land and building; and an amount of Rs.5,44,746/- was worked out as appreciation in value of the plant and machinery. In light of the fact that, as per terms of deed of partnership executed on 1st April 1984, the assessee trust was entitled to the goodwill and the appreciation in value of the assets of the proprietary business, total amount of Rs.31,99,077/- was credited to the account of the trust in the books of the company apart from other entry denoting settlement of other assets of the partnership business. 14. In the aforesaid backdrop of the facts, trust filed return of income on 26th June 1985 declaring total loss of Rs.4,34,427/-. The assessing officer assessed the trust at a total income of Rs.30,70,890/-, which inter alia included addition of the sum of Rs.31,99,077/-. According to the assessing officer, the total sum of Rs.31,99,077/- amounted to a benefit or perquisite within the meaning of section 28(iv) of the Act and was taxable under the head "profits and gains of business or profession". The assessing officer, placing reliance on the Supreme Court decision in case of McDowell & Co. Ltd. v. Commercial Tax Officer, (1985) 154 ITR 148 also held that the entire exercise of contributing proprietary business in the new firm, dissolution of the new firm, and taking over of the entire business by the company, was a colourable exercise, instead of transferring the business of the trust to the company directly. According to the assessing officer, this mode was adopted by the trust to get over the provision of section 164 of the Act, with special reference to the proviso thereunder which had been inserted with effect from assessment year 1984-85 by the Finance Act, 1984. 15. The assessee trust carried the matter in appeal before the CIT (Appeals). The CIT (Appeals) held that the action of the assessing officer in bringing to tax a sum of Rs.31,99,077/- under Section 28(iv) of the Act was incorrect. However, he upheld the applicability of ratio of decision in case of McDowell & Co. Ltd. (supra), but according to him, the floating of the new firm was a colourable device and hence, the transaction had to be viewed at from the angle of bringing to tax the transfer of the assets from the trust to the company directly. 15.1 The Commissioner (Appeals) held that the total sum of Rs.31,99,077/- was exigible to tax under the head "capital gains" under Section 45 of the Act as well as under the head "profits and gains of business or profession" under Section 41(2) of the Act. That goodwill was a separate asset; it had actual cost where the business of the old firm was taken over by the trust on 1st October 1980 and accordingly, the assessing officer was directed to compute the same by adopting the same basis, as was adopted by the parties while working out the goodwill as on 30th June 1984. 16. The assessee and the revenue carried the matter in second appeal before the Tribunal on being aggrieved by the aforesaid order of the CIT (Appeals). The grievance made by the trust before the Tribunal was against confirmation of applicability of the Supreme Court case in case of McDowell & Co. Ltd. (supra); bringing to tax the sum of Rs.31,99,077/- under Sections 45 and 41(2) of the Act and other additions which are not relevant for the present. 17. On the other hand, the revenue challenged the order of CIT (Appeals) to the extent it was held that the provisions of section 28(iv) of the Act were not applicable as well as direction to tax a sum of Rs.2,64,338/- under Section 41(2) of the Act and Rs.29,34,739/- as capital gains under Section 45 of the Act. 18. The Tribunal, taking up the issue of device in the first instance, did not concur with the views expressed by the assessing officer and the CIT (Appeals). The Tribunal has found that the new firm was genuine and on that basis, the new firm was granted registration under the provisions of the Act. That during the short period of its existence i.e. three months, the new firm had carried on substantial business and for this, the Tribunal referred to the balancesheet and profit & loss account of the new firm. The Tribunal further found that there was no material to show that the new firm had been granted registration under the Act under a misconception of law, or due to a mistake; and even if there was a mistake, no remedial action had been initiated by revenue to rectify such a mistake. In other words, the registration granted to the new firm had become final and remained undisturbed. It has further been found by the Tribunal that the revenue has not been able to place on record any fact or circumstance or the evidence on the basis of which it could be held that the trust had taken recourse to a colourable device. The Tribunal has further found that, in the process of transferring the proprietary business, by the Trust to the new firm, and on dissolution, by the new firm to the company, the assessee trust had been subjected to a greater tax liability. In light of these findings, the Tribunal held that no case was made out by revenue to show that the assessee trust had adopted a colourable device and the ratio of the Apex Court decision in case of McDowell & Co. Ltd. (supra) was not applicable. 18.1 The learned counsel for revenue has neither been able to dispute the aforesaid findings of fact, nor point out how such findings are incorrect in any manner. Hence, in absence of any infirmity in the impugned order of the Tribunal on this count no interference is called for. 18.2 Question No.1, therefore, referred at the instance of revenue, stands answered accordingly in the affirmative i.e. in favour of the assessee and against the revenue. 19. The Tribunal thereafter took up for consideration applicability of provisions of section 28(iv) of the Act. It has upheld the order of CIT (Appeals) on the basis of decision rendered by this Court in the case of Commissioner of Income Tax, Gujarat-I v. Alchemic Pvt. Ltd., (1981) 130 ITR 168. It has concurrently been found by both the CIT (Appeals) and the Tribunal that the assessee trust had received the amount in cash and had not been given any benefit or perquisite which arose from conducting of business or exercise of profession. In the circumstances, in light of the ratio of the aforesaid decision rendered by this Court as well as the findings recorded on appreciation of evidence by the CIT (Appeals) and the Tribunal, it is not possible to state that any error has been committed by the Tribunal when it came to the conclusion that the amount of Rs.31,99,077/- is not taxable under Section 28(iv) of the Act. 19.1 Question No.2 at the instance of revenue, therefore, is answered in the affirmative i.e. in favour of the assessee and against the revenue. 20. The Tribunal thereafter has dealt with the applicability or otherwise of provisions of Section 41(2) of the Act. It has been found by the Tribunal that the new firm was dissolved and there was no sale or transfer of the assets from the new firm to the company. That what had taken place was settlement of accounts amongst the partners inter-se. That assets of the new firm had neither been sold nor discarded nor demolished nor destroyed in any manner. The Tribunal, therefore, held that the sum of Rs.2,64,338/- could not be brought to tax as balancing charge under Section 41(2) of the Act. Nothing has been pointed out to show that the aforesaid findings recorded by the Tribunal are erroneous in any manner. It is apparent that, on a plain reading, provisions of section 41(2) of the Act cannot be invoked. 20.1 Therefore, question No.3 at the instance of revenue is answered in the affirmative i.e. in favour of the assessee and against the revenue. 21. That brings up for consideration as to whether the sum of Rs.31,99,077/- or any part thereof is exigible to tax under Section 45 of the Act. In this connection, the Tribunal has held that, as per clause (5) of the partnership deed dated 1st April 1984, assessee trust had retained with it goodwill and the right to appreciation in the value of the assets of the proprietary business. The latter, according to the Tribunal, was akin to an actionable claim. The Tribunal, therefore, held that even if the settled legal position, namely there would be no exigibility to capital gains tax when assets / moneys are received at the time of dissolution, is accepted, the assessee cannot get the benefit of the said legal position considering the fact that goodwill and the right to appreciation in the value of the assets was never put in the common corpus or hotchpotch of the new firm. The Tribunal further recorded a finding to the effect that the company paid these moneys exclusively to the assessee trust to the exclusion of other partners of the new firm which was dissolved. That payment of of Rs.31,99,077/was not made on the dissolution of the new firm; in other words, the receipt was not because there was dissolution of the new firm, but by virtue of the agreement, emanating from various clauses of the partnership deed dated 1st April 1984 and the dissolution deed dated 1st July 1984. That accordingly, assessee parted with goodwill and the right to appreciation in value of the assets of the proprietary business in favour of the company and on transfer, consideration of Rs.31,99,077/- was received which constituted capital gains chargeable under Section 45 of the Act. 22. In relation to the cost of goodwill, after referring to the decision rendered by the Supreme Court in case of Commissioner of Income Tax, Bangalore v. B.C.Srinivasa Setty, (1981) 128 ITR 294, the Tribunal held that, on principle, there could be no dispute that goodwill, which is self-generating asset, would normally not have any cost of acquisition. However, the Tribunal has found that, as recorded by CIT (Appeals), goodwill was taken over along with all assets, liabilities, quota rights etc. when the trust took over the entire business of the firm at the time of dissolution on 30th September 1980. That while taking over the business at that time, trust paid for goodwill also, and though the same was not quantified or disclosed in the books of account, the same could be determined as on 30th September 1980 adopting the same basis which was adopted for determination of goodwill as on 1st July 1984. 23. Mr.S.N.Soparkar, the learned Senior Advocate appearing on behalf of the trust submitted that, (a) a fair reading of the partnership deed of the new firm could lead to only one conclusion, namely that the assessee had transferred ownership rights in the assets of the proprietary business and the agreement amongst partners was to realise incremental value in the event of sale of such assets; an owner of an asset has only one right in an asset - to realise its value; (b) such a right cannot be split into two rights, namely to realise original value and also to realise incremental value; (c) as per provisions of sections 14, 13(b), 37, 48 and 49 of the Indian Partnership Act, 1932, all the assets would vest in the firm and assessee was entitled to only the surplus at the time of dissolution. The same was, therefore, exempted under Section 47(ii) of the Act. In support of the aforesaid proposition, he submitted various illustrations for consideration like the right of creditors of a partnership may have, as to what the partners can agree to while entering into a partnership etc. He placed reliance on the following decisions : [a] Addanki Narayanappa v. Bhaskara Krishnappa, AIR 1966 SC 1300 [b] Commissioner of Income Tax v. Dewas Cine Corporation, [1968] 68 ITR 240 [c] Commissioner of Income Tax v. Shreyas Chinubhai, (1999) 237 ITR 358 (Gujarat) [d] Commissioner of Income Tax v. Anant Narhar Nimkar (HUF), (1997) 224 ITR 221 (Gujarat) [e] Commissioner of Income Tax v. R.Lingmallu Raghukumar, (2001) 247 ITR 801 (SC) An alternative contention was raised that even if the view adopted by the Tribunal that the assessee had an independent right was correct, such a right had no cost and hence, the computation machinery would fail and therefore, no capital gains tax could be levied. 24. In relation to goodwill, it was fairly submitted that he was not contending that the same had been transferred to the new firm, but was assailing the order of the Tribunal to the extent of cost. That reference to dissolution deed of 30th September 1980 would show that the said document only recorded acquisition of goodwill at the time of dissolution, but there was no statement that the assessee had actually paid any cost at the time of dissolution. That in fact the Tribunal itself had found that books of account of the firm as well as assessee reflected that there was no goodwill and the same was created for the first time at the time of dissolution of the new firm on 30th June 1984. That, therefore, in absence of any cost of goodwill, the same was not taxable. He placed reliance on an unreported decision of this Court rendered on 9th/10th December 2004 in Income Tax Reference No.225 of 1991 in case of Commissioner of Income Tax v. Manoharsinhji P. Jadeja. It was submitted that ratio of this decision would apply to the alternative contention relatable to the right of accretion in the value of the assets of the proprietary business also. 25. Mr.Tanvish U.Bhatt, the learned standing counsel appearing on behalf of revenue submitted that the Tribunal had recorded that, as per Clause (10) of dissolution deed dated 30th September 1980, entire balance standing to the credit of the outgoing partners was to be paid by the trust and this would include value of all assets of the partnership, including goodwill. That therefore the CIT (Appeals) and the Tribunal were justified in stating that it was possible to work out the cost of goodwill as on the said day, the assessee having actually paid for the same. He supported the order of the Tribunal and submitted that the Tribunal had found, as a matter of fact, that goodwill and the right to appreciation had never gone to the new firm and therefore, the contention that the amount had been received at the time of settlement of accounts cannot be accepted. He, therefore, urged that no interference was called for in the order of the Tribunal in relation to the aforesaid items. 26. Partnership deed executed on 1st day of April 1984 between assessee trust, five individuals and the company assumes importance and the relevant extracts of the same as are necessary read as under : "WHEREAS it is agreed by and between the parties to this Deed, that the entire business of the party of the first part along with all the assets, whether movable or immovable, right, interest, claims, benefits and liabilities of any nature whatsoever shall be brought by the party of the first part as its capital contribution in the partnership business as depicted by an audited Balance Sheet of the business as on 31-3-84 which shall, when it