H.R. Khanna, C.J.
(1) Following question has been referred to this Court under section 66(1) of the Indian Income-tax Act, 1922 (hereinafter referred to as the Act) :-
'WHETHERthe sum of Rs. 83,624.00 was rightly assessed under section 12B of the Indian Income-tax Act, 1922?'
(2) The case relates to assessment year 1947-48, the previous year for which ended on March 1, 1947. The assessed is an individual who was carrying on business under the name and style of Mumick Opticians at Connaught Place, New Delhi. A private limited company called 'Mumick Limited' (hereinafter referred to as the Company) was incorporated with the assessed as its Managing Director to take over the said business. An agreement to that effect was entered into between the said Company and the assessed on September 16, 1946- The nominal capital of the Company was Rs. 5 lakhs divided into 5000 ordinary shares of Rs. 100.00 each. Clauses I and 2 of the agreement read as under :-
'1.The Vendor sells and the Company purchases :
FIRSTthe goodwill of the said business (with the exclusive right to carry on the business under the name and style of Mumik and represent the company as carrying on such business in continuation of the Vendor firm and in succession thereto, and right to use any word or words indicating that the business is carried on in continuation of or succession to the said firm) and all trade works connected therewith.
Secondly all the plant, machinery tools, licenses, stores, furniture to which the vendor is entitled in connection with the said business, as specified in the first schedule hereto.
Thirdly the full benefit of all pending contracts, engagement and orders in connection with the said business as well as the book debts amounting to Rs. 3,006/12- more fully described in the second schedule attached to this agreement.
Fourthly cash balances of the business as on 31.8.46 Rs. 1,164/12- and balance with Punjab National Bank Ltd., New Delhi as on 31.8.46 amounting to Rs. 3,707/15/9.
LASTLYall other property to which the vendor is entitled in connection with this business.
'2.The consideration of the said sale is Rs. 1,17,341/15/9 which is to be paid or satisfied as follows :-
(A)By payment of Rs. 1,959/11/6 out of the above amount to the creditors of the vendor, more fully described in the third schedule attached to this agreement.
(B)By allotment of 1150 shares of Rs.100.00 each fully . . . . up in the share capital of the Company.
(C)By payment of Rs. 341/15/9 in cash to the Vendor.'
(3) The assets of the business of the assessed, viz. machinery, furniture,. stock and goodwill, were valued at Rs- 1,26,000. The Company in that connection issued 1260 shares of Rs. 100.00 each to the assessed and his nominees as under :-
(a)Shri Jagdev Singh .. .. 1150 Shares of Rs.100.00each. assessed. (b)Smt. Ravindra Mumick .. .. 100 Shares of RS.100.00each. wife of the assessed. (c) Shri B. P. Mitra, who appears to be an em- . . 10 Shares of Rs. 100.00 each. ployee of the assessed. ------ 1260 Shares.
(4) The Income-tax Officer held that there was a capital gain of Rs. 83,624.00 in the hand of the assessed and taxed him as such. In this connection it was observed :
'THEassets were acquired by the Company, not at book value, but at an enhanced price. Machinery valued at Rs. 14,032.00 in the balance sheet on 31-8-46 was acquired at a value of Rs. 40,434.00. Similarly furniture valued at Rs. 2,353.00 was acquired at a value of Rs. 9,575.00. The Stocks were acquired at book value. The company also paid Rs. 50,000.00 as good-will which did not exist in the books previously.'
(5) On appeal the Appellate Assistant Commissioner held that 'the maximum amount of Capital Gains which could be included in the assessment would have to be limited to the proportionate burden of the profit which had fallen on the outsider, namely, B.P. Mitra, who had contributed 10 shares.' The department 'filed an appeal to the Income-tax Tribunal. The Tribunal was of the view that the following fundamental question was involved :
'WHENa person, who carried on a proprietary business, converts it into a limited company and receives shares in lieu of the business assets transferred for an enhanced valuation, can it be said that he has 'realised' any Capital Gains? If so, how to determine the quantum of such gains ?'
(6) It was felt that a specific enquiry be made to find out the market value of the assets shown at the time of the transaction and the actual quantum of gain. The case was, accordingly, remanded to the Appellate Assistant Commissioner for making the enquiry. The Appellate Assistant Commissioner thereafter submitted a report, the concluding part of which reads as under:-
'TOsum up, the market value of assets transferred by the appellant to M/s. Mumick (P) Limited as on the date of transaction was in my view the same as disclosed and there are no reasons to conclude that the sale value was national and excessive. This being the position, the market value of the shares as on the date of transaction would be the same as the face value, i.e., Rs. 100.00 per share.'
(7) After the receipt of the report of the Appellate Assistant Commissioner, the Tribunal discussed the matter and made the following observations :-
'5.Finally, we would look at this question from another point of view. Was there any gain in the transaction We felt the validity of this argument and it is for this reason that we obtained the remand report on the valuation of the shares on the date of the transaction. The Appellate Assistant Commissioner has done his best to arrive at a fair market value but he is of the opinion that there is no reason to disbelieve the valuation placed at the time of incorporation. In other words, he accepts the value put down by the vendor and the vendees as the fair market value. As the assessed has not been able to controvert this even in the remand proceedings, we agree that we must adopt the value of the incorporation to be the market value, particularly, because it was accepted by the parties concerned. Viewed this way, it must be said that the assessed 'sold' the assets of the business and the good-will received adequate compensation thereof in the form of shares.'
(8) It was, accordingly, held to be a case of Capital Gains and liable to tax under section 12B of the Act. On the application thereafter of the assessed. the question reproduced above was referred to this Court. The material parts of sub-sections (1) and (2) of section 12B of the Act at the relevant time read as under :
'(1)The tax shall be payable by an assessed under the head 'Capital gains' in respect of any profits or gains- arising from the sale, exchange or transfer of a capital asset effected after the 31st day of March, 1946; and such profits and gains shall be deemed to be income of the previous year in which the sale, exchange or transfer took place:..............'
'(2)The amount of a capital gain shall be computed after making the following deductions from the full value of the consideration for which the .sale, exchange or transfer of the capital asset is made, namely :-
(I)expenditure incurred solely in connection with such sale, exchange or transfer :
(II)the actual cost, to the assessed of the capital asset, including any- expenditure of a capital nature incurred and borne by him in making any additions or alterations thereto, but excluding any expenditure in respect of which any allowance is admissible under any provision of sections 8, 9, 10 and 12:............'
(9) We have heard Mr. Bhatt on behalf of the assessed and Mr. Kirpal on behalf of the Revenue. The first contention, which has been advanced on behalf of the assessed, is that as he and his nominees owned all the shares of the Company and as purported sale of the assets of the assessed in accordance with the agreement dated September 16, 1946 was in favor of the Company, it amounted to transfer by the assessed in his own favor. As, such, it should be held to be not a sale for the purpose of section 12B of the Act. There is, in our opinion, no force in the above contention. A company from a juristic point of view is a legal personality; it is wholly distinct from its members and is capable of enjoying rights and being subjected to duties which are not the same as those enjoyed or borne by its members. As observed by Lord Ressell of Killowen in the case of E. B. M. Co.. Ltd. v. Dominion Bank, (1937) 3 All E.R. 555
'THEYbelieve it to be of supreme importance that the distinction should be clearly marked, observed and maintained, between an incorporated company's legal entity and its actions, assets, rights and liabilities on the one hand, and the individual shareholders and their actions, assets, rights and liabilities on the other hand.'
(10) In the case of John Foster & Sons Limited v. The Commissioners of Inland Revenue, (1894) 1 Q.B. 516, Lindley LJ. while dealing with the question whether a deed was a conveyance on sale for the purpose of stamp duty, observed :
'NOW,the document in this case is an indenture made between eight gentlemen of the first eight parts, and 'John Foster & Sons, Limited (hereinafter called 'the company of the 9th part'. Pausing there for a moment : although the persons of the first eight parts may be, and were members, and the only members, of John Foster & Company, Limited. John Foster & Company Limited, is not those eight individuals; John Foster & Company Limited, is a corporation. We have, accordingly, two parties, one party consisting of several individuals, and the other party consisting of a corporation.
(11) Whether they are or not the members, or the only members of the corporation, is wholly immaterial. The corporation is a totally different person from them in any capacity you choose to assign to them except a corporation one.'
(12) The above observations, were relied upon by the Patna High Court in the case of Maharajadhiraj Sir Kameshwar Singh v. Commissioner of Income-tax, Bihar and Orissa, (1963) 48 Itr 483 (3). The assessed in that case was carrying on the publication of some newspapers. He floated a private limited company for the purpose of carrying on this business and sold to the company the said business as a going concern for the sum of Rs. 12,500.00- which was received by the assessed in the shape of 12,500.00 fully paid up shares of Rs. 100.00 each in the company. Out of the 25,000 shares in the company all but 50 shares were held by the assessed and the remaining by his nominees. The original cost of the building, plant and machinery which were transferred was Rs. 2,79,822.00 and their written down value at the time of transfer was Rs. 1,49,037.00. The income-tax authorities treated the excess, viz., l,30,785 as profits under the second proviso to section 10(2)(vii) of the Income-tax Act and assessed this amount to income-tax. It was contended on behalf of the assessed that since substance of the shares in the Company were owned by the assessed, there was no sale to a different person but only a different method of carrying on the same business, and that the excess of Rs. 1,30,785.00 could not be assessed under the second proviso to section 10(2)(vii). The above contention was repelled and it was held that the assessed, though he was the owner of all the shares in the Company, could not claim to be treated as if he were identical with the company. It may be stated that the Bombay High Court in two cases, namely, Commissioner of Income-tax v. Sir Homi Mehta's Executors : 28ITR928(Bom) , and Rogers & Co. v. Commissioner of Income-tax (1938) 35 Itr 336, Calcutta High Court in Commissioner of income-tax v. Mungneeram Bangur & Co. : 47ITR565(Cal) , the Kerala High Court in Commissioner of Income-tax v. Morning Star Bus Service, : 49ITR927(Ker) and the Madras High Court in M.C. Cherian v. Commissioner of Income-tax : 51ITR631(Mad) took a different view.
(13) Their Lordships of the Supreme Court in the case of Commissioner of Income-tax, Gujarat Ii v. B. M. Kharwar : 72ITR603(SC) , noted the above conflict of view and expressed their disapproval of the view expounded by the Bombay, Calcutta, Madras and Kerala High Courts. Shah J., speaking for the Court, observed:-
'THEtaxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the 'substance of the transaction'. This principle applies alike to cases in which the legal relation is recorded in a formal document, and to cases where it has to be gathered from evidence-oral and documentary-and conduct of the parties to the transaction.'
(14) The machinery of a factory belonging to a firm in the above case was transferred to a private limited company. Dealing with the above transfer, the Court observed:
'ASSUMINGthat thereby readjustment of the business relationship was intended the liability to be taxed in respect of the readjustment had to be determined according to the strict legal form of the transaction. The company was a legal entity distinct from the partnership under the general law. Transfer of the machinery was by the firm to the company; and the legal effect of the transaction was to convey for consideration the rights of the firm in the machinery to the company. The transaction resulted in excess realization over the written down value of the machinery to the firm, and the liability to tax, if any, arising under the Act could not be avoided merely because in consequence of the transfer the interest of the partners in the machinery was substituted by an interest in the shares of the company which owned the machinery.'
(15) Although the above observations were made in the context of section 10(2) (vii), proviso (ii), we are of the opinion that they hold equally good in a case arising under section 12-B of the Act. As the machinery and the furniture of the assessed were acquired by the Company at a price which exceeded their book value by Rs. 33,624.00, the excess price in our view, should be held to be a Capital Gain. As such, it was liable to tax under section 12B of the Act.
(16) As regards the amount of Rs. 50,000.00 which was paid on account of the good-will, we are of the opinion that it cannot be held to be a Capital Gain. Good-will, it is well-established, is the advantage which is acquired by a business, beyond the mere value of the capital, stock, fund or property employed therein, in consequence of the general public patronage and encouragement which it receives from constant or habitual customers. What good-will means must depend on the character and nature of the business to which it is attached. It is composed of a variety of elements and is bound to differ in its composition in different trades and in different businesses in the same trade. One element may preponderate in one business and another in another business. Generally speaking, it means much more than the mere probability that the old customers will resort to the old place. Often, good-will is the very sap and life of a business, without which the business will yield little or no fruit. It is the whole advantage, whatever it may be, of the reputation and connection of the firm, which may have been built up by years of honest work. (See in this connection the decision of the House of Lords In Anna Trego and William Wilson Smith v.George Stratfored Hunt, 1896 A. C. 7. Lawson in his introduction to the Law of Property has described 'good-will' in the following words:
'GOOD-WILLis property of a highly peculiar kind. It is the right to enjoy all the advantages of an established trade connexior. Customers who have been in the habit of dealing with a business will probably continue to do so, even if the business changes hands, and this probability is regarded as so valuable that large sums of money are commonly paid for it. So well established a head of property is it that its value must be taken into account for purposes of taxation. Yet it is an odd kind of property since only the person who has transferred the good-will can be placed under a duty to respect it. He indeed can be restrained from soliciting his former customers and he may also agree not to carry on a competing business. But no third party can be restrained from trading in such a way as to reduce the value of the good-will. Yet as a marketable object, good-will must be considered property.'
(17) It cannot be disputed that good-will is an asset. All the same it has to be borne in mind that it is an intangible asset. The question as to whether the transfer of a good-will of a firm would attract section 12B of the Act, was considered by the Madras High Court in the case of Commissioner of Income-tax, Madras v. K. Rathnam Nada : : 71ITR433(Mad) . It was held that the amount received on the transfer of a good-will was not liable to be taxed under section 12B of the Act. The learned Judges (Veeraswami and Alagiriswami JJ.) observed:
'SUB-SECTION(2) of section 12B provides that the amount of a capital gain shall be computed after making the following deductions from the full value of the consideration for which the sale, exchange, relinquishment or transfer of the capital asset is made, namely, (i) expenditure incurred solely in connection with such sale, exchange, relinquishment or transfer; (ii) the actual cost to the assessed of the capital asset including any expenditure of a capital nature incurred and borne by him in making any additions or alterations thereto, but excluding any expenditure in respect of which any allowance is admissible under any provision of sections 8, 9, 10 and 12. Sub-clause (ii) of sub-section (2) may suggest that the capital gain arises only on the transfer of a capital asset which has actually cost to the assessed something in money. The actual cost in the context of the Income-tax Act can only be cost in terms of money. It cannot, it would appear, apply to transfer of capital assets (assuming that the goodwill is a capital asset, about which there was not much dispute), which did not cost anything to the assessed in terms of money in its creation or acquisition. What is the cost in terms of money in this creation or acquisition of good-will It would appear that there is really no such cost. Good-will is created by the trading activities of the assessed, and probably by the name he has earned and the good-will he has created among his customers. Good-will of a firm is an intangible asset. It is difficult to say that it costs anything in terms of money for its coming into existence. Good-will of a firm can probably be compared to a seed which is planted on the day that the firm begins its business and sprout and grows as the firm grows in its dealings. Nothing to the contrary has been brought to our notice. We would, thereforee, hold that the amount of Rs. 50,000.00, which was received on account of the transfer of the good-will, could not be taxed as Capital Gain under section 12B.
(18) As a result of the above, we hold that a sum of Rs. 33,624.00 out of Rs. 83,624.00 was rightly assessed under section 12B of the Indian Income-tax Act. The remaining amount of Rs. 50,000.00 was not rightly assessed. The question referred to this Court is answered accordingly.
(19) In the circumstances of the case, we leave the parties to bear their own costs.