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Petitioner: DAS & Co. VS Respondent: COMMISSIONER OF INCOME TAX, PATNAHonorable Justice UNTWALIAS. N. Dutta,R. J. Bahadur
1963 P T D 908
1963 P T D 908
[Patna, India]
Before Ramaswami C. J. and Untwalia, J
DAS & Co.
versus
COMMISSIONER OF INCOME TAX, PATNA
Miscellaneous Judicial Case No. 472 of 1958, decided on 4th July 1961.
Income-----
---- Sale of entire stock at cost price when business was making good profits Price fixed for good will also Income tax Authorities charging difference between market price and cost price as profits Legality Price fixed by vendor is binding if bona fide Good will Method of valuation.
The assessee sold the entire stock of his goods to an incorporated company at cost price amounting to Rs. 1,19,138. The assessee also sold to the company the good will of the business for a sum of Rs. 50,000. The Income tax Officer held that as the assessee was earning a gross profit on an average of 35 per cent. per year the sale value of the stock in trade should be over Rs. 1,50,000 and a profit of Rs. 50,000 should have accrued to the assessee in respect of the stock in trade sold to the company and that the Rs. 50,000 paid for good will did not represent the price of good will but represented profits of the assessee on the sale of stock in trade. Accordingly, he added a sum of Rs. 50,000 to the gross profits of the assessee. The Appellate Assistant Commissioner and the Tribunal took the view that the value of the good will was not so high as Rs. 50,000 but should be placed at Rs. 25,000 and accordingly the profits of the assessee should be increased by Rs. 25,000. On a reference of the question whether the sum of Rs. 50,000 mentioned as the price of good will or any portion thereof was liable to be taxed by the Income tax Department :
Held, in the absence of a finding that the transaction of the sale of good will was a sham transaction it was not open to the Income tax Authorities to hold that the price paid for the stock-in-trade by the company to the assessee was not the amount mentioned in the contract, but something more than that amount, and that the difference between the market price and the cost price should be taxed as the profits of the assessee. Accordingly, no portion of the sum of Rs. 50,000 mentioned as the price of good will was liable to be taxed by the Income tax Department :
Held also, that in the matter of valuation of the good will of a business the proper approach is to ascertain the net annual earning of the business after a careful investigation of the books of accounts and calculating the average net annual earning on the basis of the past three to five years. From the average net profits thus arrived at it is usual to deduct as a matter of accountancy practice at least 6 per cent. on the capital outlay involved and a sum as would cover the proprietor's services to the business. The good will is then calculated at five to ten years' purchase of the net annual profits. Calculated in this manner the amount of Rs. 50,000 fixed for the goodwill was not too high and the finding of the Appellate Assistant Commissioner that the good will was worth about Rs. 25,000 was based on no materials and was arbitrary.
Commissioners of Inland Revenue v. Duke of Westminster 1936 A C 1 ; Craddock v. Zevo Finance Co. Ltd. (1946) 27 T C 267 and Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income tax (1955) 28 I T R 952 ref.
STATEMENT OF CASE
Iu compliance with the direction of the Patna High Court passed in M. J. C. No. 472 of 1958, under section 66 (2) of the Income tax Act, requiring this Tribunal to state the case and to refer the question mentioned therein, we hereby draw up a statement of the case and refer it to the High Court of Judicature at Patna the following question as directed :
"1. Whether, in the facts and circumstances of the case, the entire sum of Rs. 50,000 mentioned as the price of goodwill of Das & Company in the deed dated 22nd August 1951, or any portion thereof, is liable to be taxed by the income-tax department ?"
2. The statement of the case relates to the assessment year 1951 52 for which the relevant account year was B. S. 1357.
3. The applicant is a Hindu undivided family carrying on business in radios and musical instruments at Muradpur, Patna, under the name and style of Das & Co. having its head office at Muradpur and branch offices at Muzaffarpur and at New Market in Patna. On April 2, 1951, i.e., about two weeks before the close of the "previous year" the assessee's head office, including their branch at New Market in Patna, sold certain goods and assets worth Rs. 1,00,470 to a company named Electricity and Sound Limited, hereinafter referred to as "the company". The assessee's branch at Muzaffarpur also sold goods to the company of the value of Rs. 18,668. These goods were alleged by the applicant to have been sold to the company at cost. The aggregate value of the goods thus sold to the company at cost amounted to Rs. 1,19,138. Besides this, the assessee also transferred to the company the goodwill of the business at Rs. 50,000. In the absence of any compelling circumstances to sell such huge stocks to a stranger at cost when the applicants were making the huge profits at an average gross profit rate of 35 per cent., the Income tax Officer doubted the factum of sale of such huge stock of goods to the company at cost price and the applicants were, therefore, called upon to explain the reasons for the sale of the goods to the company. The applicant filed written reply dated February 6, 1952, stating that the company acquired the entire stock and other movable assets at cost along with the goodwill but did not take over the book debts and liabilities of the assessee firm and contended that entire stock having been taken over by the company it was sold at cost. On further requirement by the Income tax Officer the applicant also filed a list dated March 14, 1952, of the assets transferred to the said company. The written reply dated February 6, 1952, and the list of the assets dated March 14, 1952, furnished by the applicants to the Income tax Officer are made parts of the case and are Annexures "A" and "B". On a perusal of the list dated March 14, 1952, the Income tax Officer found that the amounts of outstanding dues from the company at the close of the year, did not include the sum of Rs. 50,000 as the goodwill of the applicant's firm. From the gross profit disclosed by the applicants the Income tax Officer found that it was earning gross profit at an average rate of 35 per cent. On this basis if the stock of the value of Rs. 1,19,138 transferred to company was sold to outsiders in open market in the ordinary course of business the applicants would have made a profit of Rs. 41,698. The further fact that the company got saleable stock of the value of Rs. 1,19,138 without any incidental charges, according to the Income tax Officer, indicated that the company must have offered a higher margin of profit on the transfer of goods in question. Under these circumstances the Income tax Officer held that the profit of Rs. 50,000 accrued to the applicants in respect of the goods sold to the company and that the assessee did not sacrifice any profit by selling them to the company but the amount of Rs. 50,000 was received by the applicant in the guise of the sale price of goodwill. Hence the Income tax Officer added Rs. 50,000 to the gross profit of the assessee. The order of the Income tax Officer is made part of the case and is Annexure "C".
4. The matter was taken up in appeal before the Appellate Assistant Commissioner. The Appellate Assistant Commissioner found that the applicant's family held the controlling shares of the company, and that on August 22, 1951, 100 shares of the company were allotted to the applicant's Hindu undivided family by adjustment against the sale of the goods sold by the applicant's firm to the said company. Similarly 500 shares were also allotted to the members of the applicant's family by adjustment against the sale price of the goods. In this manner: the applicant's family had acquired 600 shares out of 1,150 shares of the said company, and consequently, the controlling interest of the said company. The audited copy of the profit and loss account of the vendee company disclosed a gross profit of Rs. 29,482 for the period ending June 30, 1951, and Rs. 77,936 for the year . ending June 30, 1952, and that they "watered down" to a net profit of Rs. 4,552 in this first year and to a net loss of Rs. 4,382 in the next year, respectively. From these facts the Appellate Assistant Commissioner concluded that while the profits of the applicant's family had been understated it had been so arranged that the vendee company in which the members of the applicant's family held the controlling shares had nominal profit in the first year and a loss in the next year, so that the tax liability was greatly minimized. The Appellate Assistant Commissioner was also of the opinion that the value of the goodwill placed at Rs. 50,000 was not genuine and that at least a part of this sum represented the diversion of the sale price of the stock. As the business concern of the appellant was being carried on for the last thirty years, the Appellate Assistant Commissioner had observed that it should be expected to have some goodwill but that its value could not be placed at such a high figure as Rs. 50,000 as indicated by the above facts and also the fact that the business had for the last few years been running at a loss. Taking all these facts into consideration, and the fact that the sale of the entire stock to one purchaser would not fetch the same rate of profits as it would fetch if sold in the normal course of the business to different purchasers, the Appellate Assistant Commissioner estimated the value of the goodwill at Rs. 25,000 and the balance of Rs. 25,000 was considered as, the diversion of the sale price of the stock. In the result, the Appellate Assistant Commissioner! reduced the profits of the assessee by Rs. 25,000. The order of the Appellate Assistant Commissioner is made part of the case and is Annexure "D".
5. The assessee then took up the matter in appeal to the Tribunal. The Tribunal observed that (1) the applicant's firm did not transfer their business name to the company, (2) that the appellants were merely , dealers in, and distributors of, well known products and that they were not of any special production of their own, and (3) that the contacts that they established during all the years of business were not made available to the company, and that (4) shorn of all these facilities there was no significance whatsoever, for the goodwill of the applicant's firm. Holding that way, the Tribunal was of the opinion that any amount paid for goodwill over and above the price of the stock in fact represented extra purchase consideration under a different name. In this view of the matter, the Tribunal considered that the Appellate Assistant Commissioner had been very considerate in assessing some value for the goodwill of the applicant's firm and, therefore, they declined to interfere in this matter. The order of the Tribunal is made part of the case and is Annexure "E".
6. On the above facts, we refer the question formulated in paragraph 1 of the statement for the opinion of their Lordships.
S. N. Dutta, V. D. Narayan and Shiveshwar Prasad Sinha for the Assessee.
R. J. Bahadur for the Commissioner.
JUDGMENT
UNTWALIA, J. In this case the assessee is a Hindu undivided family carrying on business in radios and musical instruments at Moradpur, Patna, in the name of Das & Company. We are concerned in this case with the assessment year 1951 52, for which the relevant accounting year is Bengali Sambat year 1357. On 2nd April 1951, the assessee sold certain goods and assets worth Rs. 1,00,470 to an incorporated company, named Electricity and Sound Limited, which is hereinafter referred to as "the company" The Muzaffarpur branch of the assessee also sold goods to the :company to the extent of Rs. 18,669. The aggregate value of the goods sold to the company, therefore, amounted to Rs. 1,19,138. It appears that the assessee also sold to the company the goodwill of the business for a sum of Rs. 50,000. The Income tax Officer held that the stock in trade should not have been sold by the assessee to the company at cost price, and on the statement of gross profits disclosed by the assessee the Income tax Officer found that the assessee was earning a gross profit on an average of 35 per cent. per year, and the finding of the Income tax Officer was that on this basis the sale value of the stock in trade should be over Rs. 1,50,000 and profit of Rs. 50,000 should have accrued to the assessee in respect of the stock in trade sold to the company. The view taken by the Income tax Officer apparently was that the sum of Rs. 50,000 paid to the assessee for the sale of goodwill did not really represent the price of the goodwill but represented the profits made by the assessee on the transaction of the sale of the stock in trade. Accordingly, the Income tax Officer added a sum of Rs. 50, 000 to the gross profit of the assessee for the accounting year in question. The assessee took the matter in appeal to the Appellate Assistant Commissioner, who took the view that the value of the goodwill should be placed at Rs. 25,000 and the profits made by the assessee on the sale of the stock in trade should be Rs. 25,000 and accordingly the profits of the assessee should be increased by a sum of Rs. 25,000. The assessee preferred an appeal to the Income tax Appellate Tribunal, but the appeal was dismissed.
As ordered by the High Court, the Income tax Appellate Tribunal has stated a case on the following question of law under section 66 (2) of the, Income tax Act :
"Whether, in the facts and circumstances of the case, the entire sum of Rs. 50,000 mentioned as the price of goodwill of Das & Company in the deed, dated 22nd August 1951, or any portion thereof is liable to be taxed by the income tax department ?"
On behalf of the assessee learned counsel put forward a two fold argument. In the first place, it was submitted that there is no reason for the Income tax Authorities to hold that the assessee should have sold the stock in trade to the company not for the cost price but for the market price. It was contended that there was no material to suggest that the transaction was not a bona fide transaction and that the price received by the assessee and paid for by the company far the stock in trade was other than the amount of Rs. 1,19,138. It was also submitted on behalf of the assessee that the Appellate Tribunal has given five reasons for taking the view that the consideration for the sale of the stock in trade was really more than the amount mentioned in the contract, but none of these reasons is supported by any material. The first two reasons given by the Appellate Tribunal are : (1) that the name of the assessee doing the business was not transferred to the company, and (2) that the company started its business under an entirely different name.
The original sale deed dated 22nd August, 1951, was produced iii the course of hearing by learned counsel for the assessee. This document is referred to by the assessee in its letter to the Income tax Officer dated 14th March 1950, which is printed at pages 1 2 of the paper book. It is clear from this document that the right to use the name of Das & Company was transferred by the assessee to the company, and the first two reasons given by the Tribunal are erroneous. The other reasons given by the Tribunal are : (1) the assessee was only a dealer in, and distributor of, some well known products and it was not dealing in special products of its own ; (2) the book debts bad not been transferred to the company ; and (3) the contacts which the assessee might have established over a period of years were not made available to the company. There is no relevancy in the third and fourth reasons given by the Appellate Tribunal, and as regards the fifth reason the registered sale deed dated 22nd August 1951, clearly indicates that the right of representation was transferred by the assessee along with the goodwill and the contacts of the assessee were made available to the new company. In any event, there is no
finding by the Appellate Tribunal that the transaction of the sale of good will is a sham transaction, and in the absence of such a finding it was not open to the Appellate Tribunal to say that the price paid for the stock in trade by the company to the assessee was not the amount mentioned in the contract, but something more than that amount, namely, the difference between the market price and the cost price (sic) and that this difference in amount should be taxed as the profits of the assessee.
The view we have expressed is supported by the decision of the Madras High Court in Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income tax ((1955) 28 I T R 952). In that case the account books of the assessee, a limited Company, showed that some of its goods were sold to its managing agency firm, to one of its directors and to a firm in which one of its directors was a partner, at prices much lower than the market rates, and the Income tax Authorities finding that the sales to these persons at lower prices were not bona fide sales and were effected to benefit the purchasers at the expense of the company, included the difference between the price for which these goods were sold and their market price as profits of the company in its assessment. It was held by the Madras High Court in these circumstances that the sales could not be regarded as mere sham transactions unless there was sufficient evidence to prove that. It was also held that in the absence of evidence to show that the sales were sham transactions or that the market prices were in fact paid by the purchasers, the mere fact that the goods were sold at a concessional rate to benefit the purchasers at the expense of the company would not entitle the income tax department to assess the difference between the market price and the price paid by the purchasers as profits of the company. The same principle has been expressed in an English case, Craddock v. Zevo Finance Company Ltd. ((1946) 27 T C 267). In that case the respondent company, an investment dealing company, was formed in May 1932, to take over the more speculative investments of another investment dealing company. The investments were purchased by the respondent company on 15th June 1932, at the prices at which they stood in the books of the old company, being their cost price to that company in 1927. The consideration was satisfied by the respondent company undertaking to discharge the liability in respect of the old company's debentures and interest thereon and by the allotment of its authorised capital, with the shares credited as fully paid, to the shareholders of the old company. As a result of debiting the investments at the purchase price, the respondent company's accounts showed a loss for the first accounting period, but an assessment to income tax was made on the company for the year 1933 34 on the basis that the correct debit in respect of the purchase of the investments in stock in trade was their market value on the day of purchase according to stock exchange prices, on which basis the trading results of the company showed a profit. On appeal to the General Commissioners against the assessment the respondent company contended, inter alia, (i) that in computing the profits the amount to be debited in respect of the opening figure of stock was the purchase price, which was the price it had agreed to pay, and that the amount paid in shares should be taken at the par value of the shares ; and (ii) that, in any event, the stock exchange prices did not, in the circumstances of the case, represent the true market value of the investments and there was no evidence what such true market value was. The Commissioners found as a fact that, in the circumstances of the case, if the respondent company had set out to buy the investments at the stock exchange prices, those prices would have risen against it, though it was impossible to say by how much, and they discharged the assessment. In the High Court the Crown abandoned the contention that the investments should be valued at the stock exchange prices on 15th June 1932, but claimed that the disparity between the purchase price and the stock exchange prices was so great that the real value of the investments must have been very much less than the price at which they were taken over, and that the case should be remitted to the Commissioner to ascertain their real value when they were taken over. Upon these facts it was held by the Court of Appeal that the assessment should be discharged because the Crown had failed to establish that the value of the investments was less than the nominal value of the consideration for which the respondent company had acquired them, namely, the liability to discharge the debentures and interest thereon and the allotment of its share capital as fully paid. The matter had been very clearly put by Lord Greene M. R. at page 279 of the report as follows :
"I am not concerned to dispute the correctness of the principle advanced by Mr. Stamp in connection with his analogous case. But I am bound to say, with all respect to the ingenuity of its inventor, that this analogy that is as misleading as any analogy that I have heard. It seems to me quite impossible to say that there is any analogy to be found between the case where a trader acquires a piece of stock in trade for nothing and the case where a company acquires its stock in trade upon the terms of a contract under which it provides consideration. The argument, so far as it deals with the facts of the present case, is, as it appears to me nothing but an attempt to revive the `supposed doctrine' of substance and form. That argument, one had hoped, had been recently inferred by the decision in Commissioners of Inland Revenue v. Duke of Westminster (1936) A C 1. But its ghost still walks on occasions, and this, it appears to me, is one of them. As Lord Tomlin said in the Duke of Westminster's case, the substance is that which results from the legal rights and obligations of the parties ascertained upon ordinary legal principles'. What then was the substance of the transaction under which the respondents acquired these investments ? First of all they acquired them by virtue of a contract of sale and purchase the validity of which, as importing legal rights and obligations between the parties to it cannot be impugned, and (until Mr. Stamp's argument was presented in, this Court) had always been accepted by the Crown. If the contract had been broken by either of the parties, it could have been enforced in the usual way by the other. There can be no possible question as to this. The contract is described in clause (1) as a contract of sale and purchase. It is a contract under which the respondents acquired the investments in consideration of their undertaking to the syndicate and its liquidator to assume the liability on the debentures and to issue the fully paid shares. These were the rights and obligations imported by the contract. Their legal effect is beyond dispute. By what process of reasoning they are to be disregarded and treated as non existent I am at a loss to understand. The respondents did in fact, as they were bound to do, take over the liability and issue the shares. It was on these terms, and these terms alone, that they acquired the investments. The carrying out of these terms was in law the price which they paid for the investments, and it seems to me quite impossible to accept the view upon which Mr. Stamp's whole argument was based that they must be taken as having acquired the investments in a manner which was not in law contractual and for no consideration at all. Mr. Stamp went so far as to say that not even the liability undertaken in respect of the debentures ought to be regarded as an item of cost, contrary to the position accepted by the Solicitor General. This is the `supposed doctrine' of substance with a vengeance."
Applying the principle of these authorities to the present case we hold that there was no material before the Income tax Authorities to suggest that the transaction between the company and the assessee was not bona fide and that the price actually paid for the stock in trade was in any way different from the amount of Rs. 1,19,138 which was the contractual price agreed upon between the parties for the transfer of the stock in trade.
With regard to the transfer of the goodwill of the business, the Appellate Assistant Commissioner has stated that it was an overvaluation and the proper amount for the sale of the goodwill should be Rs. 25,000 and not Rs. 50,000. The Appellate Assistant Commissioner has not given any reason for holding why the sale price…
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