COMMISSIONER OF INCOME-TAX Vs. J GOWRIKANTHAN

JUDGEMENT

(1.) The assessee is a chartered accountant and a partner in a firm of auditors constituted under a deed of partnership dated August 3, 1964. At the inception, the assessee and another were partners in the firm, the assessee having contributed a capital of Rs. 7,500 and the other partner Rs. 2,500 and the profit and loss sharing ratio was fixed as 75 : 25. On June 1, 1969, another chartered accountant was also taken in as a partner and a fresh deed of partnership was entered into among them on June 30, 1969. Therein, besides a provision for the payment of monthly remuneration to the newly taken partner at the rates and for the periods specified, it was also further provided that the profit or loss was to be shared between the assessee and the other two partners in the ratio of 69 : 25 : 6. Again, on June 1, 1972, a fresh arrangement was made among the partners and yet another deed of partnership was executed on April 2, 1973, under which the assessee and the other two partners were to contribute capital of Rs. 5,000, Rs. 3,000 and Rs. 2,000, respectively, and share the profits and losses in the ratio of 50 : 30 : 20. The result of this was that the share of profits of the assessee, which was 75% to begin with and later reduced to 69%, ultimately got fixed at 50%, while the share of profits of the other two partners increased from 25% to 30% and from 6% to 20%, respectively. According to the assessee, it was agreed then among the partners of the firm that he should be paid Rs. 25,000 by the other two partners, in consideration of his giving up a portion of his shares in the goodwill of the firm. Entries were made in the accounts of the assessee and the other two partners in the books of the firm on May 31, 1973, according to which the assessee's account was credited with Rs. 25,000 representing the amount payable to him by the other two partners in consideration of the assessee giving up a portion of his shares in the goodwill of the firm and the accounts of the other two partners were debited with Rs. 5,000 and Rs. 20,000 respectively. In the course of the assessment proceedings of the assessee, as an individual, for the assessment year 1974-75, the assessee took up the stand that, as the amount of Rs. 25,000 was received by him from the other partners in consideration of his giving up a portion of his share in the goodwill of the firm, there was no question of subjecting to tax any capital gains arising therefrom. However, the Income-tax Officer took the view that the assessee had transferred a portion of his share in the firm on receipt of consideration in a sum of Rs. 25,000 and the asset so transferred by the assessee could not be regarded as a self-generating asset and since it was a long-term asset and had no cost of acquisition, the entirety of Rs. 25,000 was liable to tax under section 45 of the Income-tax Act, 1961 (hereinafter referred to as "the Act"). In so holding the Income-tax Officer placed reliance upon the decision in CGT v. V. A. M. Ayya Nadar [1969] 73 ITR 761 (Mad). On appeal by the assessee reiterating the plea that Rs. 25,000 was received by the assessee from the other two partners only as consideration for giving up a portion of his share in the goodwill of the firm and there was no question of any gains arising from the transfer of goodwill, the Appellate Assistant Commissioner viewed the receipt of Rs. 25,000 by the assessee as consideration for his giving up a portion of his share in the goodwill of the firm and so doing, it was further held that as goodwill was a self-generating asset, there was no question of any capital gains arising therefrom as per the decision in CIT v. Rathnam Nadar [1969] 71 ITR 433 (Mad). On further appeal by the Revenue before the Tribunal, it took into account the entries dated May 31, 1973, in the accounts of the assessee and the other two partners in the books of the firm and held that the sum of Rs. 25,000 was agreed to be paid to the assessee by the other two partners as consideration for the giving up of a portion of his share in the goodwill of the firm by the assessee and them was no capital gain arising out of such transfer which could be subjected to tax treatment. In view, the Tribunal dismissed the appeal. Under section 256(2) of the Act, at the instance of the Revenue, the following question of law has been referred to this court for its opinion :

(2.) Learned counsel for the Revenue contended that, in a firm in existence and carrying on its business, it is not open to any partner of the firm say that he owned any asset and to deal with it on that footing and that the goodwill of the firm could be taken into account only in the event of the dissolution of the firm and not while the firm continued to exist and carry on its business. Reliance was also placed by learned counsel on some decisions which we shall refer to later in the course of this judgment. On the other hand, learned counsel for the assessee submitted that goodwill would constitute an asset of the firm and that there is no bar in law to effecting a redistribution of the total interest in the goodwill of a firm, as between the different partners and the resulting transfer of the interest in the goodwill of the firm by one of the partners in favour of others, having regard to the peculiar nature of the asset, would not attract tax as capital gains. Our attention was also drawn in this connection to certain decisions to which we shall advert a little later.

(3.) From the account entries of the firm relating to the receipt of Rs. 25,000 by the assessee, it is seen that on May 31, 1973, the account of the assessee had been credited with two sums of Rs. 5,000 and Rs. 20,000, respectively, and the accounts of the other two partners correspondingly debited with the same amounts. The narration found in the entries refers to the adjustment of the firm's goodwill account as mutually agreed upon among the partner. Obviously, therefore, the amount of Rs. 25,000 credited to the assessee is referable to adjustment of the right of the partners inter se in the goodwill of the firm. Our attention has not been drawn to any material to doubt the correctness of the narration or genuineness of the entries and we find from the order of the Tribunal that its conclusion was based upon the aforesaid entries in the accounts coupled with the fact that the income of the firm, which had no fixed assets whose value was likely to appreciate, had increased for the accounting periods ending May 31, 1971, and May 31, 1972, and the valuation of the goodwill of the firm at one lakh of rupees, as on June 1, 1972, was not excessive. It is thus seen from the facts found that the amount of Rs. 25,000, as per the entries was, the consideration received by the assessee from the other two partners for transferring or relinquishing a part of his interest in the goodwill of the firm in favour of the other two partners. There had thus been a redistribution of the totality of the interest in the goodwill of the firm, to the different partners, as a result of the transaction reflected in the accounts referred to earlier. Essentially, goodwill connotes benefits arising from connection and reputation and a variety of component elements go into its making, and its composition in different trade and in different businesses in the same trade varies and its value, affected by every aspect relating to the business, like the personality and business rectitude of owners, the nature and character of the business, its name, reputation, location, customer service, etc., fluctuates. Further, it has also been accepted that it is impossible to predicate the moment of the birth of goodwill, as it comes silently into the world unheralded and unproclaimed and though imperceptible at birth, it exists, grows or fluctuates, with numerous imponderables affecting the business. Goodwill being of such a nature would undoubtedly form part of the property of the firm. Under section 14 of the Indian Partnership Act, the property of the firm. Includes also the goodwill. All that is meant by the expression property of the firm or assets of the firm, is that all partners have a joint or common interest in the property or assets. It, therefore, follows that, on the facts of this case, the assessee had relinquished or transferred a part of his interest in the goodwill which, under section 2(14) of the Act is a capital asset of the firm. Under section 2(47) of the Act, the expression "transfer", in relation to a capital asset, would include the sale or relinquishment of the asset or even the extinguishment of any rights therein and that definition is wide enough to include the transaction entered into by the assessee extinguishing his rights in a part of the goodwill of the firm within the meaning of "transfer". Under those circumstances, the assessee, in this case, had transferred part of his interest in a capital asset. Whether he can do so or not had not been debated before the Tribunal. We may, in passing, notice the contention urged by learned counsel for the Revenue that it is not open to a partner to deal with any part of the property of the firm as his own nor can he assign his interest in a specific item of partnership property to anyone. What had happened in this case is that the assessee had brought about a redistribution of the interest of the partners in the goodwill of the firm and it is not as if the assessee had dealt with any particular asset of the firm as his own or assigned his interest in any specific item, for, the assessee still continues to hold an interest in the goodwill of the firm, which was one of its assets, in spite of his parting with a portion of his interest in the goodwill, and the firm consisting of three partners continued as before, to hold its goodwill, as an asset We are, therefore, of the view that the argument of learned counsel for the Revenue cannot be accepted and as a partner, could not have dealt with a portion of his interest in the goodwill of the firm, had not been made before the Tribunal. Considering the nature of the asset, viz, the goodwill of the firm, which had been generated in the course of the carrying on of the business of the firm, there could be no cost of acquisition, but that would not justify the tax treatment of the entire sale proceeds relating to goodwill under the head " Capital gains". We are, therefore, of the view that the goodwill of the firm in this case is in the nature of a self-generated capital asset with no cost of acquisition and that, on the amount realised by the assessee from the other two partners, for the extinguishment of a part of his interest in the goodwill of the firm, no tax could be levied on the footing that capital gains arose.