Full Judgment
2. That alternatively, but without prejudice to other grounds, the additions as made by the learned Income Tax Officer and confirmed by the learned Commissioner (Appeals) are very excessive.
3. That the learned assessing officer and the learned Commissioner (Appeals) are not justified in not accepting and allowing assessee's claim for depreciation, which be kindly allowed.
4. That the several additions/ disallowances have been made on contradictory grounds and even over-lap each other. The assessee's contentions have not been properly appreciated by the learned authorities below and the inferences as drawn and observations as made by them are misconceived, erroneous, untenable, unwarranted and uncalled for.
5. That the Penal Interest of Rs. 49,678 under Section 234B has been wrongly charged, which be kindly held as not chargeable.
6. That the resulting demand is a disputed demand which be kindly stayed till decision in this appeal.
2. The ground Nos. 1 to 4 of the appeal are interconnected and are being disposed of together for the sake of convenience.
3. The brief facts of the case are that the assessee-firm carried on hotel business at Abu Lane, Meerut. It comprised of two partners namely, Shri Suresh Kumar and Shri Balraj Singh with equal shares in the profits. The firm came into existence by an instrument of partnership dated 29-1-1969. The hotel situated at Abu Lane was taken on lease at Rs. 300 per month from M/s. Ramji Lal Narayan Das, an HUF of partners of the assessee-firm. On 31-3-1992 the firm was dissolved by executing a deed of dissolution according to which the firm stood dissolved on 34 -3-1992 and all its assets and liabilities as on that date at book value were taken over by its partner Shri Suresh Kumar.
The other partner Shri Balraj Singh was allowed to take away the credit balance standing to his capital gain. After the dissolution the hotel business was carried on by Shri Suresh Kumar from the same premises as a proprietorship concern. The name of the hotel was also converted from M/s. Hotel Naveen to M/s. Naveen (Deluxe). The assessing officer was of the view that due to continuation of business for more than 23 years the firm had earned a goodwill which was an intangible asset of the assessee-firm. The assessing officer also found that on dissolution of the firm no revaluation of assets and goodwill of the firm was done.
The assets of the firm including depreciable assets as well as car, VCR, TV sets, generators, furniture and fixtures were taken by Shri Suresh Kumar at book value. He was of the opinion that the fair market value of the assets as on date of dissolution exceeded the book value hence according to the provisions of Section 45(4) the assessee was liable to capital gains tax on transfer of assets to Shri Suresh Kumar on dissolution of the firm.
4. The assessee submitted before the assessing officer that there was no transfer in view of provisions of Section 2(4 7) of the Income Tax Act, 1961. It was submitted that even after insertion of Section 45(4) in the Income Tax Act, 1961 with effect from 1-4-1988 there was no transfer of assets for purposes of chargeability of capital gains tax under Section 45 on dissolution of firm or on retirement of a partner.
Reliance was placed on the decision of Addl. CIT v. Mohanbhai Pamabhai , CIT v. Madan Lal Bhargava and 5. The assessee submitted that there was no distribution of assets on dissolution of firm. It was submitted that as the facts clearly reveal that on dissolution the retiring partner has not been given any assets at all from the firm, only his capital gain balance stood converted into a loan and the running business of the dissolved firm was taken over by the other partner Shri Suresh Kumar with all its assets and liabilities including the balance owned to the retired partners at the book value. Even his own amount was paid in cash without allotment of any, asset and that too not by the assessee-firm but by Shri Suresh Kumar out of the cash funds of the running business taken over by him in the following year. It was submitted that there was no distribution of assets of the firm and its dissolution which is a condition precedent for applicability of Section 45(4). It was also the argument of the assessee that distribution of assets on dissolution of firm pre-supposes /contemplates the winding of the business of the firm and by no stretch of imagination it covered a case of succession of a running business as is the case of the assessee. From this angle also there is no capital gains tax liability in the case of the assessee in terms of provisions of Section 45(4).
6. The assessee also submitted that the purpose of insertion of Section 45(3) and Section 45(4) has been explained in the CBDT explanatory circular No. 495, dated 22-9-1987 as to plug the escape route arising out of the decision of the Hon'ble Supreme Court in the case of Kartikeya V Sarabhai v. CIT wherein it was held that conversion of an individual asset of a firm in which the individual is a partner or vice versa fall outside the scope of capital gains tax which made the funds of capital gains tax possible in case of such conversion /transfer of assets at much higher than the cost value. The purposes of the enactment of this sub-sections was to check the avoidance of capital gains tax in such eventualities. It was submitted that for computing capital gains it as has been provided in Section 45(3) itself that value of asset recorded in the books of the firm shall be deemed to be full value of the consideration received or accrued as a result of the transfer of capital asset. Similarly, deeming provision is contained in Section 45(4) which also forms part of the same scheme as stated in the said circular itself. Therefore, the same interpretation about the full value of consideration viz-a-viz fair market value will hold good for purposes of Section 45(4) as well.
A different interpretation would forfeit the very purpose and intentment of the legislation.
7. Hence it was submitted that there cannot be any liability to capital gains tax under Section 45(4) in the facts and circumstances of the case of the assessee since provisions of Section 45(4) do not apply in the assessee's case or even otherwise the amount of capital gains even if any comes to nil since the running business has been taken over with all its assets and liabilities, including the balance amount due to the retiring partner at book value itself.
8. The assessing officer did not accept the arguments of the assessee that the definition contained for transfer in Section 2(47) has not undergone change after insertion of Section 45(4) in the Act. According to him the definition of transfer given in Section 2(47) is an inclusive one and not exhaustive. The other reason stated by him is that the charging Section 45(4) itself takes within its ambit a situation arising out of such transfer as is in the case of the assessee. It clearly mentions in the sub-section that "profits or gains arising from the transfer of capital assets by way of distribution of capital assets on dissolution of firm shall be chargeable to tax". Thus the intention of the Legislature is clear from the wordings of the sub-section and it is not required for amending definition of transfer contained in Section 2(47) of the Act. The assessing officer was also of the view that it was not necessary that all assets should be divided between the partners in order bring it within the meaning of distribution of capital assets. The Hon'ble Supreme Court had the occasion to interpret what amounted to distribution of assets of a firm on dissolution in the judgment in CIT v. Bankey Lal Vaidya . It was held that in the course of dissolution, the assets of the firm may be valued and divided between the partners according to their respective shares either by allotting individual assets or by paying the money value thereof. This is a recognized method of dividing the gains of a dissolved firm. In the instant case, the receipt of money by a partner is nothing but a receipt of his share in the distributed assets of the firm. The assessing officer was also of the view that in view of the clear provisions contained in Section 45(4) the fair market value of the assets shall be deemed to be the full value of consideration and the book value or even otherwise the value shown by the assessee for the purposes of transfer does not matter. The circular No. 495, dated 22-9-1997 issued by CBDT mentions in para 24.3 that conversion of partnership assets into individual assets on dissolution or otherwise also forms part of the same scheme of tax avoidance. Accordingly Finance Act, 1987 inserted Section 45(4) in the Act. The effect of it is that profits and gains arising from transfer of capital assets by a firm to a partner on dissolution or otherwise is chargeable as the firms income in the previous year in which the transfer took place and for the purposes of computation of capital gains. Fair market value of the assets on the date of transfer shall be deemed to be the full value of consideration received or accrued as a result of transfer. Hence he held that the provisions of Section 45(4) were applicable to the case of the assessee.
9. Further the assessing officer required the assessee to show why computation of capital gains be not made in accordance with the workings given in the notice dated 6-1-1995. For the purpose of valuation of the goodwill of firm, book profits for assessment years 1988-89 to 1992-93 were adjusted and the amount of interest payable or chargeable on accrued or debit balance of partners at the rate of 18 per cent per annum was taken into account. Further salary payable to working partners was also deducted from book profits to arrive at adjusted book profit. On query by the assessing officer as to who was looking after the business of the assessee-firm up to assessment year 1992-93, Shri Suresh Kumar stated that up to assessment year 1992-93 the business of the Hotel Naveen was look after by him only. Therefore, the assessing officer concluded that salary was payable to only one partner and deducted it for arriving at adjusted book profit and the claim of the assessee that the salary paid to both partners should be deducted was not admitted. The assessee claimed that salary to working partner should be allowed at the rate of Rs. 6,000 per month which was not accepted due to the fact that hotel was managed by two managers and salary of managers was Rs. 2,400 per month in the assessment year 1992-93, Rs. 2,000 per month in assessment year. 1991-92, Rs. 1,500 per month in assessment year 1990-91. Accordingly he allowed the salary to Shri Suresh Kumar as under: 10. The book profit of the assessee-firm was also adjusted by the amount of interest payable or chargeable on accrued or debit balances of partners. He noted that in the assessment years 1990-91 to 1992-93 capital balances of the two partners were in debit, therefore, during these years the interest was chargeable from them whereas in assessment years 1988-89 to 1989-90 sum total of the capital of the partners was not accrued, hence interest was payable to them. Accordingly amount of interest was adjusted as per details in Annexure A-3. As per this Annexure the converted adjusted book profit per year came to Rs. 61,035. Looking to the part of continuation of business and other facts value of goodwill was multiplied by four times of average adjusted book profit of Rs. 61,035. Accordingly, the value of the goodwill was determined at Rs. 2,44,140. He further observed that since the goodwill was acquired by the assessee-firm during continuation of business for 23 years it was a long-term capital asset and, therefore, deduction under Section 48(2) will be allowed on amounts resulting from transfer of goodwill. The cost of acquisition of the goodwill was taken as nil in view of the provisions of Section 45(2)(a) applicable with effect from assessment year 1988-89. Hence Rs. 2,44,140 was charged to tax as long-term capital gains.
11. The learned Commissioner (Appeals) observed that there has been a dissolution of the firm and the assets and liabilities were taken over by one of the partners and the other partner was allowed to take away the credit balance standing to his credit. Even in such a situation there is a distribution of assets. It is only for the sake of convenience that the partners decided to distribute the assets in such a way. It was just a matter of modality on which both the partners agreed in such a way that one gets only the assets and liabilities and the other partner takes away the credit balance. Accordingly, he held that the observation of the assessing officer that there was distribution of asset on the dissolution of the firm and Section 45(4) was applicable as the section specifically provides that taking the market value of the assets and charging of capital gains. Accordingly he held that the argument of the learned AR for the assessee was devoid of any merit regarding legality of charging of capital gains. He also held that the working of the capital gain was also in order and no interference was called for.'He upheld the working of value and consequentially the capital gain in respect of each and every asset and dismissed the ground of appeal.
12. As far as the value of goodwill at Rs. 1,14,570 is concerned, it was submitted by the assessee that it is an established and recognised method of determining value of goodwill by analyzing the super/excess profits over the normal profits at certain number of years purchase was at 1-3 times/years purchase price depending upon nature of business.
This necessitates the adjustment of book profits by normal outstanding and incomes which are not recorded in the books of account. Such valuation of goodwill added to the book value of the business representing the market value of the business as well which a prospective buyer would like to pay having regard to the extra super earnings over and above the normal earnings of the business is enjoying. The value shall determin represents and comprises the same value of net assets i.e., all assets less liabilities of the business whether shown in the balance sheet or not.
13. It was also submitted that in the course of the assessment it as argued that the business did not enjoy any goodwill having regard to deduction for salaries to two partners at the rate of Rs. 6,000 per month to each partner and other heads "nominal rent for building for which only nominal rent was paid", though such other heads were not deleted, added as even the amount of salaries to partners was more than enough to completely set off the book profits.
14. It was also submitted that the assessing officer determined value of goodwill by adopting taxable income instead of book income as base, and allowing deduction for salary of only one partner instead of two at reduced rate of Rs. 2,000 per month to Rs. 3,000 per month as against Rg. 6,000 per month for each of the two partners claimed by the assessee and adding besides deducting interest on credit balance in capital account, interest on debit balances in the capital account of the partners and further without allowing deduction for any other account (such as nominal rent of building taken on lease from the partners HUF on a very nominal rent for running the hotel), and capitalizing such super profit determined at Rs. 61,035 at four times i.e., 4 years purchase price.
15. It was also submitted that as will be apparent from the assessment order that during the last so many years the assessee-firm admitted paying handsome commission to rickshaw pullers and taxi drivers in order to attract customers. The hotel situated at Abu Lane was taken on lease at Rs. 300 per month from M/s. Ramji Lal Narayan Das, an HUF is concern of partners of the assessee-firm, there is no positive value and goodwill enjoyed by the assessee, and its value, even if any, as almost negligent, even if not Nil.
16. It was submitted that there was no super profit as determined by the assessing officer at Rs. 61,035.
17. The learned Departmental Representative relied on the order of the assessing officer and the Commissioner (Appeals) whereas the learned AR for the assessee reiterated the submissions made before the assessing officer and the Commissioner (Appeals) which has been discussed in the preceding paragraphs.
18. Having heard the rival submissions and perused the orders of both the 'lower authorities and the materials available on record, we are of the considered opinion that the assessing officer while determining the profits for the last five years had made adjustment to the profit shown in the profit & loss 'account of the assessee as much as taking salaries paid to the partners at Rs. 2,000 to Rs. 3,000 as against Rs. 6,000 per month shown by the assessee. Further the assessing officer had taken salary for only one partner as against salary paid to two partners at the rate of Rs. 6,000 per month shown by the assessee in the profit & loss account. Over and above this the assessing officer made adjustments by way of charging interest and the over and above capital gain of the partners as well as allowing interest on the credit balance in the capital gain of the partners. In doing so, the assessing officer has estimated the profit of the assessee at a higher figure.
The contention of the assessee is that during the last five years under consideration whatever profits was earned by the assessee has been wiped off after payment of salary to the partners. The contention of the assessee is that if the assessee would have earned super profits then it would not be housing a hotel in a leased building. The further submission of the assessee is that it is paying handsome commission to rickshaw wallahs and taxi drivers to bring customers to the hotel which fact is evident from the assessment order. Thus these facts go to show that the assessee was not having any goodwill. After considering the entire facts and circumstances of the case, we are of the considered on that the assessing officer has determined the value of goodwill the adjusting the profits for the last five years shown by the assessee in the profit & loss account. In doing so, he has ignored or disregarded the circumstantial evidence which would go to show that the assessee-firm was having any goodwill. The fact that the assessee was earning book profit which was not sufficient even to pay salary to the partners coupled with the fact that in order to procure business it had to make payment of handsome commission to rickshaw wallahs and taxi drivers goes to show that the assessee-firm was not enjoying any goodwill. In our considered opinion the firm enjoys goodwill where it has the capacity to earn super profit i.e., profit over and above the normal profits. Further a firm has goodwill where it has loyal customers who will come to the assessee for goods and services. Where the assessee has to give handsome commission to rickshaw wallahs and taxi drivers it cannot be said that the assessee is having an established market share in the business. Therefore, in the circumstances, it cannot be said that the assessee is having any goodwill. Therefore, the assessing officer was wrong in valuing the goodwill of the firm and thereby making addition of Rs. 1,44,570 as long-term capital gains arising out of the transfer of goodwill. Hence we set-aside the order of the lower authorities and deleted the addition made.
19. Further it is observed that the assessing officer has determined the market value of the various assets shown in the balance sheet of the firm. He has merely estimated the value of these assets without any basis. The revenue during the course of the hearing has not brought any material on record to show that the asset shown in the balance sheet had the market value over and above its book value shown by the assessee in the balance sheet. Without such an evidence it cannot be said that the transfer of assets made by the assessee had a fair market value over and above its value shown in the balance sheet. Therefore, in our considered opinion the determination of short-term capital gain at depreciable asset at Rs. 1,12,196 and other assets at Rs. 93,016 is not justified. Hence we set aside the orders of the authorities below and delete the addition made.
20. As the addition made by the lower authorities are found to be unsustainable the other issues raised by the assessee regarding applicability of Section 45(4) and non-distribution of assets during the year and hence no income is assessable under Section 45(4) during the year under appeal have become merely academic in nature. Hence we refrain from adjudicating the same.
21. The fifth ground of appeal relates to charging of interest under Section 234B of the Act.
22. It was submitted that charging of interest was consequential in nature and is accordingly disposed of.