1. In this appeal directed against the order of the Commissioner (Appeals) for the assessment year 1979-80 in his case, the assessee has drawn up as many as six grounds. However, the controversy raised, can be effectively summed up as under : Whether the Commissioner (Appeals) was right in upholding the estimate made by 'the ITO of the value of the 'Goodwill' received by the assessee on the sale of his business at Rs. 4,32,000 as against Rs. 5,20,000 declared by the assessee and in confirming the addition of the difference, i.e., Rs. 88,000 as 'short-term' capital gains.
2. The facts of the case may be summarised as follows: The assessee, Shri G.N. Kamath, a qualified mechanical engineer, carried on the business of manufacturing mechanical drivers and couplings under the style and name Handling and Processing Equipment. This business, which was his proprietary concern till 30-11-1976, was, with effect from 1-12-1976, taken over by a partnership firm (constituted under a deed of partnership dated 14-2-1977) consisting of Shri G.N. Kamath, the assessee (holding 30 per cent share) and four other partners. The firm inits turn, by a deed of assignment dated 31-7-1977, transferred this business as a going concern to a limited company, viz., Concord Steel Works (P.) Ltd. for a total consideration of Rs. 23,21,315. This amount was shown to comprise Rs. 18,01,315 being the value of the firms' assets as per books and Rs. 5,20,000 as the value of the goodwill. It may be mentioned here that though there was no provision regarding goodwill in the original partnership deed (dated 14-2-1977), in an amendment to it, effected by an agreement dated 28-3-1977, it was provided that goodwill of the business shall belong to Shri G.N. Kamath (the assessee) exclusively. It was in pursuance of this provision in the amended partnership deed that the assessee was paid the amount of Rs. 5,20,000 by the purchaser company. This fact was duly recorded in the books of the firm which, for the accounting period starting on 1-5-1977 were closed on 31-7-1977, i.e., the date on which the assignment of the firm's business came into effect.
3. The assessee, who follows the financial year ending 31st March as his accounting year, showed the aforesaid receipt in his return for the assessment year 1979-80 but claimed it to be exempt being consideration for the transfer of a self-generated asset. The ITO, however, called upon the assessee to furnish the basis for computing the value of the goodwill at Rs. 5,20,000 and as there was no response from the assessee, he proceeded to ascertain the value of the goodwill by applying 'the capitalisation of super profits' method. The ITO found this method to be most suitable in the context of the nature of the business and the fact that it was carried on for six years (prior to its transfer to the company) and had shown increase in profits from year to year. He computed the average profits taking into account depreciation as per the Income-tax Rules, 1962, reasonable remuneration to Shri G.N.K. Kamath and interest on the capital of the proprietor and of the partners. On this basis, the super profits for the period from 1-4-1974 to 31-3-1977 worked out to Rs. 4,91,683 and the average annual profit came to Rs. 1,43,880. At three years purchase price the value of goodwill amounted to Rs. 4,31,640 or say Rs. 4,32,000. Having arrived at this value of the goodwill, the ITO observed, that the value of the goodwill at Rs. 5,20,000 as per the deed of assignment was clearly overstated. The obvious inference, according to the ITO, was that the excess (of Rs. 88,000) represented compensation for the transfer of Shri G.N. Kamath's valuable leasehold right rights in land in the MIDC plot in Thane (on which the factory premises of the business stood).
The ITO noted that the assessee, Shri G.N. Kamath, who had paid a premium of Rs. 2,15,400 to obtain such leasehold rights had shown to have transferred them at cost whereas it should have been at the market value as on the date of transfer. He, therefore, added the aforesaid 'excess' value of goodwill to the amount of Rs. 2,15,400 at which the assessee's rights in the MIDC plot were stated to have been transferred and arrived at the gross value of transfer of Rs. 3,03,400 (Rs. 2,15,400+ Rs. 88,000). As the difference between the two values exceeded 15 per cent, the ITO invoked the provisions of Section 52(2) of the Income-tax Act, 1961 ('the Act'). Then finding that the assessee who had obtained the leasehold rights in question under a lease agreement dated 26-9-1975 and had transferred them (to the company) by an agreement dated 8-9-1978, i.e., in less than three years, the ITO treated the amount of Rs. 88,000 as 'short-term' capital gain and assessed it as such in the assessee's hands for the assessment year 1979-80.
4. The assessee challenged this addition in appeal before the Commissioner (Appeals) mainly on the plea that the ITO had incorrectly linked the value of goodwill with the transfer of immovable property on surmises and conjectures. A statement giving the basis for computing the goodwill in question at Rs. 5,20,000 was also submitted before the Commissioner (Appeals). The latter found the said working of the value of goodwill to be 'thoroughly unsatisfactory'. He observed that the assessee had taken the profit for the assessment year 1979-80 at Rs. 2,61,648 and capitalised it at two years purchase amounting to Rs. 5,23,296 which was rounded off to Rs. 5,20,000. He pointed out that the period relevant for the assessment year 1979-80 was taken from 1-5-1977 to 31-7-1977, which was incorrect. That besides, it was not clear how the profit was determined at Rs. 2,61,648. He further observed that in the same working sheet the assessee had cited an estate duty case where the goodwill was calculated at three years purchase price on the basis of average maintainable profit of four years. He added that, on the other hand, the ITO had elaborately given the basis of working the super profits and considered all the relevant aspects, e.g., remuneration of the working partner, i.e., the assessee, the interest on capital, etc., for these reasons, the Commissioner (Appeals) upheld the valuation of goodwill made by the ITO. He also confirmed the ITO's decision to treat the excess of Rs. 88,000 as consideration for the increased market value of the assessee's leasehold rights which he pointed out could not have remained the same as on 26-9-1975 (i.e., the date on which the assessee had acquired them from MIDC) and that there was bound to be a rise. On this reasoning he confirmed the assessment and dismissed the assessee's appeal. Hence, the present appeal by the assessee to the Tribunal.
5. On behalf of the assessee, Shri M.J. Lalchandani, the learned counsel, submitted that the working of the value of the goodwill done by the ITO was erroneous inasmuch as he had mixed up the income assessed in the hands of the assessee 'Individual' and that assessed in the hands of the firm, Handling and Processing Equipment; that since the latter, i.e., the firm, was the 'assignor' of the business, it was the firm's income that was relevant for the valuation of the goodwill.
He pointed out that the firm was assessed to income-tax for the assessment years 1978-79 and 1979-80 on profits as under:(i) 1-12-1976 to 30-4-1977-5 months Rs. 2,25,498 That after providing for partners' salary and interest on partners' capital, the ITO had come to aggregate profits for the said nine months of Rs. 4,04,863 and in that context, the profit for twelve months would work out to 4,04863/9 x 12=5,39,817 which when capitalised at three years purchase would yield the value of goodwill of Rs. 16,19,451. Shri Lalchandani urged that, in these circumstances, the value of goodwill received by the assessee was quite reasonable and realistic and ought not to have been disturbed by the ITO. He added that, at any rate, the ITO's inference that the value of goodwill received by the assessee included an element of compensation for the value of leasehold rights of the assessee in the MIDC plot had no basis and deserves to be discarded as a pure surmise or conjecture. He urged that, consequently, the question of any capital gains under Section 52(2) did not arise.
Shri Viswanathan, the learned departmental representative, on his part, strongly relied on the reasoning given in the order of the Commissioner (Appeals) as well as in that of the ITO.6. We have carefully considered the submissions made and arguments advanced on behalf of the assessee vis-a-vis the facts of the case as they emerge from the records.
It is needless to emphasise that the first question to be considered in this case is whether the value of 'Goodwill' has been overstated in the assignment deed dated 31-3-1977 and secondly, if so, whether there was justification to infer that the excess value represented the compensation for the transfer of the leasehold rights whose value had gone above the cost.
On the first point it is pertinent to note that no basis for valuing the 'Goodwill' at Rs. 5,32,000 is given either in the deed of assignment or in the course of the assessment proceedings. Even the basis furnished at the time of appeal proceedings before the Commissioner (Appeals), was obviously tentative. At any rate it was, to say the least, naive on the part of the assessee's counsel to suggest that only the profit of the accounting year relevant for the assessment year 1979-80 should be taken into consideration for valuing the goodwill; for, it is a well accepted principle that 'goodwill' builds up over years of performance of a business and in the present case especially the business which was founded by Shri G.N. Kamath in 1971 had progressed from year to year by dint of his efforts. It was in this context significant that by an amendment deed dated 28-3-1977 the goodwill of the business was declared to belong to Shri G.N. Kamath exclusively. In these circumstances, the argument that the partnership firm being the assignor of the business to the company, only the firm's profits should be taken into account for valuing the goodwill is untenable. The assessee's counsel himself has indicated the absurd results to which such an approach would lead by calculating the 'goodwill' at Rs. 16,19,451. On the other hand, we find the ITO's valuation of the goodwill to be on sound, well settled principles of valuation as already explained above. We, therefore, hold that the Commissioner (Appeals) has rightly upheld the said valuation, i.e., Rs. 4,32,000. This naturally raises the question as to what represents the balance amount of Rs. 88,000 received by the assessee. You must remember that the only other asset which Shri G.N. Kamath as 'Individual' parted with in favour of the company [Concord Steel Works (P.) Ltd.], was his leasehold rights obtained in perpetuity from MIDC.On this point Shri Lalchandani argued that the assessee could not transfer the lease freely to the company ; that there were several restrictions to which the lease was subject. However, these aspects of the lease do not detract from the fact that the transfer to the company was effected and that the assessee was the only confirming party to such transfer having been the original lessee of the MIDC plot in question. It does not stand to reason that the assessee would agree to the transfer of the lease without adequate compensation commensurate with the rise in the market value of the lease rights relating to such a scarce asset as a plot in an industrial estate. Since the assessee could not overtly charge a premium, he has thought it fit to include it in the value of the 'goodwill' which has the added advantage of being exempt from tax in view of the principles laid down by the Supreme Court regarding self-generated assets. We, therefore, hold that there was good reason for the ITO to treat the excess amount of Rs. 88,000 as compensation for the rise in the value of the leasehold rights shown to have been transferred at cost. Since the transfer of the said leasehold rights was effected within three years of their acquisition, the 'capital gains' were rightly assessed as 'short-term' capital gains.
Accordingly, we confirm the decision of the Commissioner (Appeals) whereby he has upheld the decision of the ITO on both the points at issue.