1. The assessee-firm is in appeal for the assessment year 1976-77 and the single contention raised is that both the ITO and the AAC had erred in taxing the goodwill amount of Rs. 55,800, which amount has further been wrongly confirmed by the AAC as Rs. 65,800. We may straightaway say that there is some smudging of the figure in the order of the AAC and it can be read as Rs. 55,800 also. However, the correct figure which the AAC could confirm is Rs. 55,800 only on the facts and circumstances of this case and the AAC's order would be read to be confirming only that amount.
2. The assessee-firm consisted of four adult partners and three minors were admitted to the benefits of partnership. The accounting year followed by the firm was samvat year 2031. In the course of this accounting period on 9-6-1975, the assessee-firm was dissolved and a dissolution deed dated 12-6-1975 was drawn up in Gujarati. A rough English translation of the dissolution deed was filed on behalf of the assessee and relied upon in these proceedings. The relevant clauses, being Clauses (7), (2) and (7A) are reproduced below : 1. The said partnership business is being closed from 9-6-1975 as from that date no business of the firm shall be said to be continued and no contract will be undertaken in the name of the firm of this partnership.
2. The said, 'Hind Motor Winding Works and Electrical Stores' assets and liabilities have been mutually settled and signed upon by us.
And it is decided that the party of the 1st part shall settle the liabilities of the firm. The list of such liabilities have been given to each of the party of this agreement. A separate list of the debtors of the firm No. 1 and 2 of which when the amount is received, the amount collected from List No. 1 is to be given to the party of the 1st part and the collections of List No. 2 when received are to be given to the remaining three parties of the agreement. Accordingly these accounts have been settled. However, whatever the excess amount is to be paid by party of the 1st part to the firm, a separate writing has been made to that effect and a lien of the remaining three parties have been agreed upon on the sole proprietary concern which is being started by the party of the 1st part from 23-6-1975. It is also agreed that as from 9-6-1975 the party of the 1st part may continue the business in the name of 'Hind Motor Winding Works and Electrical Stores' as his own independent business in partnership or as sole proprietary business in whatever manner he pleases. But the parties of second to fourth parts will have a lien charge on the shop premises and the goods which the first party will have until the amount due to the parties of second to fourth parts have been paid off their dues.
7A. The business of the said partnership business was being carried on in the premises of Municipal Census No. 1518-1 and 1518-16 in the rented premises, situated at Gaffurbhai's Chawl, opposite Govt.
C-Colony on Naroda Road. The tenancy rights of both these rooms have been given to the party of the 1st part by separate agreement. The rent of these two rooms as well as of the additional premises, bearing Municipal Census Nos. 1517-A, 1518-17, 1518-18, 1518-15 and 1518-2, totalling five rooms plus original two rooms, totalling seven rooms, belonged to the partnership firm as tenants. Out of these 7 rooms, in three rooms Nos. 1517-A, 1518-17 and 1518-18, the party' of the 1st part shall carry on business after 9-6-1975 and in the two room, Nos. 1518-1 and 1518-16, 'Bharat Stores' or any one who is authorised by Bharat Store's partners may carry on the business and it may be transferred at the instance of the partners of Bharat Stores. No goodwill remains of the said partnership firm as the retiring partners are to utilise the remaining rooms or used for any other future business of theirs. The party of the 1st part will not have any right as the original landlord in the said four rooms.
3. We are concerned in this appeal with the taxability of an amount of Rs 55,800 as capital gains in respect of the goodwill account as held by the AAC. A copy of that account is reproduced in the assessment order. The account opened with a debit balance of Rs. 12,200 and there were two credits made of Rs. 28,000 and Rs. 40,000 on account of receipts from partner Shri Premshankar C. Mehta and Bharat Stores, respectively. On account of these credits, there was a surplus of Rs. 55,800 in this account which has been held to be taxable as capital gains. After some discussion, it was not disputed by the assessee's authorised representative that the goodwill account in fact related to tenancy rights. It was explained on behalf of the assessee that the assessee-firm carried on its business in seven rooms out of which two rooms were taken on rent by the partner Shri Premshankar C. Mehta when he carried on this business as a sole proprietor and these were made over for the purposes of partnership business by the aforementioned person by charging an amount of goodwill of Rs. 12,200. It was further stated that five more rooms were taken on rent later on and tenancy rights of these seven rooms have been distributed as per Clause 7A to the partnership deed and attention was invited to the recitals in Clause 7A. According to this clause, three rooms were to go to Premshankar C. Mehta who paid a sum of Rs. 28,000, two rooms were to go to Bharat Jtores, another firm in which some partners were common, on payment of Rs. 40,000 and the remaining two rooms as per same clause were to be utilised by the retiring partners for any other future business of theirs. We may point out that neither the ITO has recorded the facts for the AAC has stated them correctly in his order. In fact, at one stage, it was argued on behalf of the assessee that partner Shri Premshankar C. Mehta paid the amount of Rs. 28,000 not only for tenancy rights but also for using the business name and contractor's licence, but when asked by the Bench to produce the evidence, this plea was given up and the case proceeded on the footing that the payment of Rs. 28,000 was made for tenancy rights only.
4. The assessee's authorised representative contended firstly that no capital gains would arise in view of Section 17(ii) of the Income-tax Act, 1961 ("the Act"), as it was a case of complete dissolution of partnership on 9-6-1975 and attention was invited to Clauses (1) and (2) reproduced above. Alternatively, it was contended that taking over of the tenancy rights by partner Shri P. C. Mehta would not give rise to any transfer for the purposes of Section 45 as this was a case of distribution of assets to a partner on dissolution of the firm. On behalf of the revenue, it was contended that tenancy rights in fact were sold by the firm and this was not a case of distribution of assets amongst the partners and the AAC has correctly held that the amount of Rs. 55,800 represented taxable capital gains.
5. We have carefully considered the submission made on behalf of the assessee and the papers included in the paper-book filed. It is clear from the reading of clause 7A that goodwill account in the assessee's books refers to the acquiring and disposal of tenancy rights. The account opened with a debit of Rs. 12,200 paid to the proprietor of the business taken over by the firm for the two rooms in his tenancy which came to be used for the purpose of assessee-firm's business. Similarly, at the time of dissolution, tenancy of five rooms has been given on payments of Rs. 28,000 and Rs. 40,000. These payments have given rise to the surplus of Rs. 55,800 in the goodwill account and such a surplus will be in the nature of capital gains as tenancy rights are a capital asset, it could not be disputed by the assessee's authorised representative that provisions of Section 47(ii) could not be available in the case of payment received on Rs. 40,000 from Bharat Stores.
Bharat Stores was a different partnership firm which only had some partners in common with the assessee-firm. Taking over of the use of two rooms by that firm cannot be treated as any distribution of capital assets amongst the partners on the dissolution of the firm. This leaves for consideration the payment of Rs. 28,000 made by partner Shri Premshankar Mehta. It was the alternative contention on behalf of the assessee that benefit of Section 47(ii) would be available in respect of this amount. Here also on facts we find that the assessee's claim is not well founded. It is clear from the perusal of entries that this is not a case of distribution of assets of the firm to partner Shri Premshankar C. Mehta. Firstly, this is not a case of taking over of assets at the book value. The price paid of Rs. 28,000 is much higher than the book value and would represent the sale consideration in fact.
Further, in the profit and loss account prepared, the assessee had taken credit of Rs. 55,800 under the head "Goodwill Account" prior to working out of the share of loss which was transferred to the accounts of four adult partners. This transfer also indicates that, prior to distribution of assets amongst the partners, the market value of the tenancy rights was determined and partner Shri Premshankar C. Mehta paid the amount and it was that amount which was taken into account for working out of share of loss of the partners. Lastly, it is clear from the tenor of goodwill account that first the value of tenancy rights was determined and realised and then only the profit and loss account of the year was worked out. This is not a case of preparation of any realisation account on dissolution of a partnership firm. In view of this, the amount paid of Rs. 28,000 will have to be treated as the sale price paid for tenancy rights by partner Shri Premshankar C. Mehta and it is not a case of a partner taking over the assets of the firm on its dissolution. From this, it follows that the assessee-firm realised capital gains of Rs. 55,800 on the sale of tenancy rights and it is correctly held by the AAC that the amount is liable to tax as such in the hands of the firm.