1. This appeal by the assessee directed against the order of the AAC dated 17-11-1980 arises for the assessment year 1974-75. The grounds of appeal relate to the computation of capital gains and relief under Section 80E of the Income tax Act, 1961 ('the Act').
2. The assessee is a partner of Varma & Varma, a registered firm of chartered accountants. During the accounting period relevant for the assessment year 1974-75 the firm was reconstituted and the share of the assessee in the profits was reduced from 17 per cent to 15.25 per cent.
The ITO, in completing the assessment on 31-3-1978, subjected to charge an amount of Rs. 3,242 computed as capital gains on surrender of 1.75 per cent share in the firm by the assessee for consideration.
3. The assessee preferred appeal against such addition before the A AC contending that after the assessee joined as partner in 1956 there had been an improvement in the profession of the firm; the cost of improvement for each percentage of the shares after its acquisition cannot be evaluated and, therefore, no capital gains can be computed or subjected to charge. The assessee relied on the decision of the Kerala High Court in CIT v. E.C. Jacob  89 ITR 88 (FB).
4. The AAC stated detailed facts in paragraph (?) of his order which are extracted below : ...During the accounting year concerned, there was a re-constitution of the firm of Chartered Accountants Varma & Varma in which the appellant is the senior partner ; some new partners have also been admitted and there has been re-allocation of shares. Share of increase in the value of goodwill in the firm has been computed on the basis of the value of the goodwill at the beginning of this year and at the time of last re-allocation of shares. Thus the total capital gains on account of the increase in value of the goodwill was computed and the increase in goodwill has been credited to the already existing partners who had surrendered certain percentage out of their share of profit. The appellant had surrendered 1.75 per cent of his share of profits and the increase in the value of the goodwill proportionate to the appellant's share amounting to Rs. 14,882 has been credited in his favour.
During the earlier years, the appellant had made payments towards the goodwill on his admission as a partner as well as in respect of increase in his share effected in the subsequent years. The proportionate cost attributed to his 1.75 per cent share surrendered has been worked out at Rs. 3,398. The difference of Rs. 11,484 has been treated by the Income-tax Officer as capital gains in respect of the consideration of Rs. 14,882 received by him for surrender of 1.75 per cent of the profits from his share of profits. This has been treated as capital gain by the Income-tax Officer. This action of the Income-tax Officer is questioned in the appeal before me....
The AAC distinguished the decision in E.C. Jacob's case (supra) and rejected the assessee's contention stating that this is a case where the assessee has incurred cost of acquisition for his share of goodwill and where a portion of his share of goodwill is transferred for consideration, the difference is liable to tax as capital gains. The AAC also held the view that there is no tangible investment for improvement of the profession and there is no cost of improvement to be adjusted. In this view he dismissed the appeal.
5. In further appeal the assessee has urged before us that capital gains cannot be assessed in respect of share of a professional firm since the cost of improvement effected to the goodwill by the partners is not capable of being evaluated and, therefore, there can be no charge of capital gains tax in respect of goodwill acquired by the partner and transferred subsequently for consideration, as per the ratio of the decision in the case of E.C. Jacob (supra). According to the assessee, goodwill gains by lapse of time and in the case of a professional firm such augmentation is especially attributable to the personal efforts, skill or sacrifice of the owners and it is not possible to evaluate the increase in value in terms of money. It is stated that the above decision squarely applies to the facts of the assessee's case. Shri Venugopal C. Govind, on behalf of the assessee, referred to the decision of the Supreme Court in the case of CIT v.B.C. Srinivasa Setty  128 ITR 294 where it is held that the charging section and the computation section constitute an integrated code and where the computation provision cannot be applied, the charging section will not also apply. It was maintained that goodwill is a fluctuating thing. It changes constantly and as goodwill changes from time to time its value also changes and even though it is possible to evaluate the value of a goodwill at a particular point of time, just as in the case of a newly constituted business it is not possible to ascertain in terms of money the cost of acquisition of goodwill, it is equally impossible to ascertain in terms of money the cost of addition or alteration to the quality of goodwill which led to the increase in its value. The assessee's representative argued that for chargeability to capital gains tax, capital asset in question must be such that it is capable of improvement at an ascertainable cost in terms of money and the goodwill in the profession having been augmented by further self-generation, it is not possible to evaluate in terms of money the cost of such improvement and, therefore, it does not fall under the computation provision of Section 48(ii) of the Act and no capital gains tax can be charged. The decision of the Bombay High Court in the case of Evans Fraser & Co. Ltd. v. CIT  137 ITR 493 was referred to.
The identical question has been specifically considered in that case and it has been held that since the cost of improvement of goodwill cannot be ascertained gains arising on its transfer would not be liable to tax.
6. The departmental representative relied on the orders of the AAC. It was particularly pointed out that the assessee in this case had made payment for the acquisition of the goodwill earlier at the time of his admission to the partnership and also at the time of increase in his profit sharing ratio at every subsequent stage and during this year he has surrendered 1.75 per cent from 17 per cent of his share on receiving Rs. 14,882 as consideration. It is said that no special cost has to be incurred in the process of improvement to be adjusted (sic).
It was then said that the decision of the Supreme Court in the case of B.C. Srinivasa Setty (supra) applied only where there is no cost of acquisition and to a case of self-generated asset initially acquired and the principle cannot be extended to a case of transfer of goodwill which had already been acquired on payment of cost. It was also submitted that the decision of the Kerala High Court in E.C. Jacob's case (supra) was approved by the Supreme Court only in relation to capital gains arising out of the transfer of goodwill as originally acquired.
7. The main point thus arising for decision is whether the gains that arose to the assessee on transfer of goodwill as a result of the reconstitu-tion of the firm and the re-allocation of shares is subject to the charge of capital gains tax under Section 45 of the Act.
8. There is no controversy on the fact that the goodwill of the profession is a capital asset. It is also not now disputed that on re-allocation of the shares there had been a diminution in the profit sharing ratio of the assessee which resulted in extinguishment of a portion of the right in the goodwill. Transfer in relation to a capital asset, as defined in Section 2(47) of the Act, includes relinquishment of the asset or the extinguishment of any right therein. It cannot, therefore, be disputed that there had been transfer of a capital asset on re-allocation of the shares when the firm was reconstituted. Such transfer was for consideration and had also resulted in gains. In order that such gains are to be subjected to charge of capital gains tax, it is not enough that the transfer is in respect of a capital asset or that it has resulted in gains. The Supreme Court in the case of B.C.Srinivana Setty (supra) held that all transactions encompassed by Section 45 must fall under the governance of its computation provision and a transaction to which those provisions cannot be applied must be regarded as never intended by Section 45 to be the subject of the charge for what is contemplated by Clause ((ii) of Section 48 is an asset in the acquisition of which it is possible to envisage a cost, i.e., it must be an asset which possesses the inherent quality of being available on the expenditure of money to a person seeking to acquire it. It is not correct to say that the ratio of the Supreme Court decision applies only to a case of transfer of goodwill in the first instance and has no application in the case of subsequent transfers after acquisition of the goodwill at a cost.
8A. The question whether such subsequent transfers attract charge under Section 45 arose for consideration before the Kerala High Court in the case of E.C. Jacob (supra). In that case the assessee had been practising as a chartered accountant under the firm name, J & W from 1951. During the relevant accounting year, the assessee took in as partner, one V on 15-7-1965. The assessee's share in the business was valued at Rs. 32,000 and V paid to the assessee Rs. 8,000 for his share of the goodwill. The firm was dissolved on 19-10-1965 and the assessee received Rs. 24,000 towards his share of goodwill of the firm. The ITO held that the entire amount of Rs. 32,000 received by the assessee was taxable as capital gains. On second appeal, the Tribunal held that the amount was not taxable. On a reference, the High Court held that the Tribunal was correct in holding that the amount could not be subjected to capital gains tax. The High Court observed thus : ...What is charged under Section 45 of the Income-tax Act, 1961, is the 'profits or gains arising from the transfer of a capital asset'.
In computing the 'profit and gain' in accordance with the provisions of Section 48 of the Act, the cost of the acquisition of the capital asset and the cost of any improvement thereto have to be deducted from the full value of the consideration for the transfer of the capital asset. In the context of the Income-tax Act, the expression 'cost of acquisition' signifies some expenditure or outlay in terms of money by the assessee in the creation or acquisition of the concerned capital asset....(p. 88) Under Section 48(ii) the assessee is also entitled to claim deduction for cost of improvement, if any, effected by him in respect of his capital asset. 'Cost of any improvement' in Section 55(1)(b) of the Act means all expenditure of a capital nature incurred by making any addition or alteration to the capital asset. After referring to these provisions the Court observed : ...Here again, just as in the case of 'cost of acquisition', the expenditure contemplated is expenditure in terms of money. It cannot be disputed that, normally, 'goodwill' also is an asset that gains in value by lapse of time ; and in the case of the goodwill of a profession, such augmentation is essentially attributable to the personal efforts, skill or sacrifice of the owner. It is not possible in such cases to evaluate the increase in value in terms of money. Thus, in the case of certain categories of transfer of 'goodwill', it is not possible to determine the 'cost of acquisition' and the 'cost of improvement' referred to in Section 48(a) for the purposes of computation of 'capital gain's' under Section 48. Without computation of 'profits or gains', no tax can be levied under Section 45 of the Act of 1961. That precisely is the situation obtained in relation to the goodwill in dispute.(p. 95) It was accordingly held that the amount of Rs. 32,000 received by the assessee towards value of goodwill is not assessable to tax under Section 48 in so far as the profits or gains arising from the transaction in relation to the goodwill cannot be and has not been computed in accordance with the provisions of Section 48. It is the above view of the High Court that is approved in the case of B.C.Srinivasa Setty (supra).
9. The ratio of the decision applies to the facts of the present case.
The assessee herein has acquired the goodwill of the profession for a definite amount and had later on transferred the goodwill for a higher price and had secured determinate profits or gains. But it is not a case where the addition to the value was without his efforts. The value of the goodwill has changed only because the goodwill has changed qualitatively. The market value fluctuated because of the fluid nature of the goodwill. Therefore, the cost of improvement as defined in Section 55(1)(b) is not ascertainable. Unless and until it is possible to determine in terms of money, the cost of acquisition of the goodwill as also the cost of additions or alterations thereto, the charging section is not attracted, as held in E.C. Jacob's case (supra). The Bombay High Court in the case of Evans Eraser Co. Ltd. (supra) also upheld the same view. It was a case of a subsequent transfer of the goodwill originally acquired. The Court held that the income chargeable to capital gains tax has to be computed by deducting from the full value of the consideration, the cost of acquisition of the capital asset and the cost of any improvement thereto and where the cost of improvement of goodwill cannot be ascertained gains arising on its transfer would not be liable to tax. Applying the ratio of these decisions here, we would hold that the gain that arose to the assessee on the transfer of the goodwill is not subject to the charge of capital gains tax. We, therefore, delete the addition of Rs. 3,242 from the computation of the total income.