COMMISSIONER OF INCOME TAX Vs. MOHANBHAI PAMABHAI

JUDGEMENT

(1.) THESE references raise an interesting question of law relating to the scope and ambit of the charging provision in relation to capital gains tax. The question arises out of assessments to income tax made on the assessees for the asst. yr. 1963 64. Prior to 18th February, 1961, the assessees and seven other persons carried on business in partnership in the firm name of Prajapati Tiles Company. The business of the firm was the manufacture of Mangalore tiles and this business was being carried on by the firm ever since its inception on 13th January, 1953. There were disputes between the partners of the firm and as a result of these disputes, the assessees retired from the firm w.e.f. 18th February, 1962, leaving the other seven as continuing partners of the firm. The terms and conditions of retirement were recorded in a document dated 18th February, 1962, executed by and between the partners. This document was in the form of minutes of the proceedings of the meeting held on 18th February, 1962, at which the decision was taken by the partners that the assessees should retire from the firm. Since one of the main controversies between the parties turns on the true interpretation of this document, it would be desirable to set out its material provisions in extenso. These provisions, according to their English translation, read :

(2.) ON retirement, each assessee received a certain amount in respect of his share in the partnership as contemplated in cls. (3) and (4) and this amount was worked out by taking the proportionate value of his share in the net partnership assets after deduction of liabilities and prior charges. The amount received by each assessee included in its break up an amount representing his proportionate share in the value of the goodwill, since goodwill constituted an asset of the partnership and it was liable to be taken into account in determining the share of each assessee in the partnership at the date of retirement. The ITO assessing each of the assessees for the asst. yr. 1963 64, for which the relevant previous year was Samvat year 2016, took the view that the amount received by each assessee to the extent it included his proportionate share in the value of the goodwill represented capital gains chargeable to tax under S. 45 of the IT Act, 1961, and he accordingly brought it to tax in the assessment of each assessee. There is no dispute before us as to what was the amount representing the proportionate share of each assessee in the value of the goodwill which was included in the amount received by him on retirement and it is, therefore, not necessary to refer to the figures in the case of each assessee ; it would be sufficient to state that in the case of the assessee in the first reference, namely, IT Ref. No. 22 of 1970, this amount was taken to be Rs. 28,598. Each of the assessees preferred an appeal to the AAC but the appeals were unsuccessful and the assessments were confirmed. This led to the filing of a further appeal to the Tribunal by each of the assessees. Two contentions in the main were advanced on behalf of the assessees in these appeals. The first contention was that the retirement of the assessees from the partnership amounted to dissolution of the firm within the meaning of S. 47, cl. (ii), and, therefore, no transfer of capital asset chargeable to tax under S. 45 was involved in the process by which the goodwill of the firm was taken over by the remaining seven partners and the proportionate share in the value of the goodwill was paid to each of the assessees. This contention was negatived by the Tribunal which took the view that the present case was a case of retirement of four partners from the firm and not a case of dissolution which would attract the applicability of S. 47, cl. (ii). The second contention, however, found favour with the Tribunal and that contention was that goodwill was a self created asset which had cost nothing to the firm and its partners in terms of money and a "transfer" of it was, therefore, not within the ambit of the charging provision contained in S. 45 and the proportionate share in the value of the goodwill received by each assessee for transfer of his interest in the goodwill was not taxable as capital gain. The Tribunal in this view of the matter directed that in the case of each assessee, no amount received in respect of his proportionate share in the value of the goodwill should be assessed to tax. The Commissioner was, obviously, dissatisfied with this decision of the Tribunal, in so far as it went against him and he, therefore, moved the Tribunal and, on his application, the following two questions of law were referred for the opinion of this Court in the case of each assessee :

(3.) SO far as the second question is concerned, there were two contentions urged on behalf of the assessees in support of the decision of the Tribunal that the amount representing the proportionate share of each assessee in the value of the goodwill of the firm was not liable to be assessed to tax as capital gain. One contention was that the proportionate share in the value of the goodwill was received by each assessee as part of the amount representing his share in the net partnership assets after deduction of liabilities and prior charges and this last amount having been received by him in satisfaction of his share in the partnership and not by way of consideration for transfer of his interest in the goodwill or other assets of the firm, there was no transfer of capital asset which would attract liability to capital gains tax. This contention was at no time urged before the Revenue authorities or even before the Tribunal and it was raised for the first time at the hearing of the references before us, but since it does not involve a new question and represented merely a different aspect of the same quesion, we allowed the assessees to raise it and it must be said in fairness to the counsel for the Revenue that he rightly did not contend that it should not be allowed to be raised. The other contention urged on behalf of the assessees was that having regard to the scheme of the provisions relating to capital gains tax and particularly S. 48, cl. (ii), the capital asset contemplated by S. 45 is a capital asset, acquisition of which has cost something to the assessee in terms of money, and since goodwill of the firm in the present case admittedly cost nothing to the firm and its partners in terms of money, transfer of his interest in the goodwill by each of the assessees did not attract the charge of capital gains tax. Of these two contentions, the first is, in our opinion, well founded while the second must be rejected. Our reasons for saying so are as follows : Turning to the first contention, it is clear from the provisions or the document dated 18th February, 1962, that the assessee retired from the partnership and each of them received a certain amount representing his share in the net partnership assets after deducting debts and liabilities of the partnership. This amount was made up by adding two components : one component represented the proportionate share in the partnership assets other than goodwill after deducting debts and liabilities [vide cl. (3)], and the other represented the proportionate share in the goodwill of the firm [vide cl. (4)]. The argument of the Revenue was that when the assessees retired from the partnership, the interest of each of the assessees in the partnership assets including the goodwill was extinguished and there was accordingly "transfer" of his interest in the goodwill by each of the assessees within the meaning of S. 2(47) and the amount representing the proportionate share in the value of the goodwill having been received by each assessee as consideration for transfer of his interest in the goodwill and there being no cost of acquisition of the goodwill to the firm and, consequently, to any partner the whole of such amount is liable to be taxed as capital gain in the hands of each assessee. This argument, plausible though it may seem, is fallacious in that it ignores the true nature of the interest of a partner in a partnership and the legal consequences which flow when a partner retires from the firm.