1. The following two questions have been referred to us at the instance of the Commissioner by the Income-tax Appellate Tribunal, Poona Bench :
'1. Whether, on the facts and in the circumstances of the case, where the assessee-firm sold its real estate business as a going concern having a net value of Rs. 27,238 to the company, M/s. Chandan and Bharat Pvt. Ltd., of which the partners of the assessee-firm were the sold shareholders, for a consideration of Rs. 1 lakh in the form of shares of said company, the excess value of Rs. 72,760 which accrued to or was received by the assessee-firm under the said transaction was capital gains and taxable as such ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the said excess value of Rs. 72,760 which accrued to, or was received by, the assessee-firm under the said transaction was only fictional income or fictional gain and, therefore, was not chargeable to tax ?'
2. As we shall presently show, the Tribunal has, in our opinion, decided in favour of the assessee on a wrong footing. However, a number of points had been canvassed before the ITO and the AAC which have not been gone into by the Tribunal. Accordingly, we will have to answer the question in favour of the Revenue, but, when the matter goes back to the Tribunal before deciding the question of taxability and quantum.
3. There was a firm by name Messrs. Chandan and Bharat Enterprises of Poona with six partners which carried on real estate business in the purchase and sale of land and construction and sale of flats. By an agreement dated March 26, 1965, the business carried on by the said firm, which is the assessee before us was sold to a limited company under the name and style of Chandan and Bharat Pvt. Ltd. The said company had as its object, inter alia, the acquisition and working of the business carried on by the assessee-firm. Under the agreement between the two, viz., the firm and the vendor, namely, the assessee, was to sell and company was to buy the goodwill of the business with the exclusive rights to use the name of Chandan and Bharat Pvt. Ltd. and all the trade-marks, permits, licence, etc., connected therewith and all the machinery, office furniture, all the book debts and other debts and actionable claims as also the full benefit of pending contacts and engagements of the vendors and all other property transferred to the limited company. The consideration of the sale was fixed in the sum of Rs. 1,00,000 which was to be paid up through the allotment to the vendors of their nominees of 1,000 fully paid up shares of Rs. 100 each in the capital of the company. In other words, the business of the firm was taken over as a going concern by the said limited company.
4. The ITO found during the course of assessment of the said firm for the assessment year 1966-67 that the book value of the assets of the firm at the time taking over came to Rs. 6,14,238. Against this, its liability stood at Rs. 5,87,000. According to the ITO, the net value of the assets thus came to Rs. 27,238 against which the firm had received Rs. 1,00,000 being the value of shares. Thus, according to the ITO, the firm had made a profit of Rs. 72,760. According to the ITO, the assets of the firm had been sold and as the sale price was in excess of the value of the assets, it was required to be treated as income liable to tax. He rejected the argument advanced on behalf of the assessee that the difference, if any, would represent the payment for the good will enjoyed by the firm. According to the ITO, there was no transfer of goodwill but the transfer was of the entire business assets.
5. The assessee carried the matter in appeal and the AAC took a slightly different view of the submissions advanced on behalf of the assessee. He held that the ITO was wrong in coming to the conclusion that Rs. 72,760 represented the business income of the appellant. In his view what resulted was an appreciation of capital. He rejected the contention advanced on behalf of the assessee that the differential paid by the company was only in lieu of the goodwill. Accordingly, he directed modifications of the assessment by substituting capital gains of Rs. 72,760 in place of business income as determined by the ITO.
6. Before the Income-tax Appellate Tribunal, it was contended on behalf of the assessee, inter alia, that there was no sale in reality as the share holders of the limited company were the very same persons who were the erstwhile partners of the dissolved firm. It was, accordingly, urged that in view of the complete identity between the buyer and the seller, the substance of the transaction should be considered ignoring its form. A number of other arguments were also advanced before the Tribunal. These are indicated in para. 3 of the statement of the case.
7. The Tribunal, however, after noting certain decisions of the Supreme Court, held that the excess appeared to be only fictional income or fictional gain.
8. This observation to be found in paragraph 3 of the appellate decision was obviously a result of acceptance of the assessee's first argument that it regard be had to the substance of the transaction, there were no two separate entities and, therefore, no real income or real gain. This argument found favour with the Tribunal which chose not to apply its mind to the other contentions.
9. Mr. Joshi has drawn our attention to the decision of the Supreme Court in CIT v. Kharwar : 72ITR603(SC) and submitted that the theory that the substance of the transaction must be looked into has to been found favour with the Supreme Court. Indeed, this was one of the decisions referred to by the Tribunal in its order, but, according to the Tribunal, as against the decision, there were two or three decisions which lent support to the view canvassed for by the assessee. The headnote in CIT v. Kharwar : 72ITR603(SC) reads :
'Where machinery of a factory belonging to a firm is transferred to a private limited company, assuming that thereby readjustment of the business relationship was intended, the liability to be taxed under the second proviso to section 10(2)(vii) of the Indian Income-tax Act, 1922, in respect of the readjustment has to be determined according to the strict legal form of the transaction. The company is a legal entity distinct from a partnership under the general law, the transfer of the machinery is by the firm to the company, and the legal effect of the transaction is to convey for consideration the rights of the firm in the machinery to the company. If the transaction results in excess realisation over the written down value of the machinery to the firm, the liability to tax, if any, arising under the Act, cannot be avoided merely because, in consequence of the transfer, the interest of the partners in the machinery is substituted by the interest in the shares of the company which owned the machinery.'
10. In our opinion, in view of these clear observations, the Tribunal was in error in allowing the appeal of the assessee on the footing that there was no real income or real gain but only fictional income or fictional gain.
11. The other decisions cited are not directly in point and cannot be availed of for the purpose of granting relief to the assessee.
12. The above discussion is sufficient, in our opinion, to dispose of question No. 2 referred to us which will have to be answered in favour of the Revenue. On question No. 1, however, we find that the Tribunal has not gone into several aspects, both pertinent and relevant, which are germane to the question. In our opinion, it will not be proper for us to attempt to answer this question without having the benefit of the Tribunal's view in connection with these arguments. We are, accordingly, inclined in the circumstances to refrain from answering question No. 1 resting content with the observations that these several aspects will be required to be gone into by the Tribunal at which states the assessees will be entitled to urge all the arguments which have been noted by the Tribunal and such other arguments as to the taxability of the amount and the proper quantification of the same, if it is held to be taxable.
13. In the result, we answer question Non. 2 as under :
No. 2 : In the negative and in favour of the Revenue.
14. We have refrained from answering question No. 1 in the light of our discussion set out earlier. Parties to bear their own costs of the reference.