BANERJEE J. - This is a reference under section 64 (1) of the Estate Duty Act, 1953. The question referred to this court is :
'Whether, on the facts and in the circumstances of the case, in computing the break-up value of the shares held by the deceased in Messrs. Minerals and Metal Private Ltd. on the basis of the balance-sheet of that company as on June 18, 1958, the Tribunal was justified in,
(a) valuing the goodwill of that company at Rs. 50,000;
(b) allowing, as a deduction from the assets, the proposed dividend of Rs. 74,740 as provided for in the balance-sheet ?'
The circumstances under which the above question comes up for consideration are hereinafter related in brief. One Shrimati Shanti Devi Rungta died on September 26, 1958. The deceased held 440 ordinary shares of the face value of Rs. 100 each in Messrs. Minerals & Metals Private Ltd. It is not disputed that the total of ordinary shares issued by Messrs. Minerals & Metals Private Ltd. was 2,020 shares of Rs. 100 each fully paid up. It is not also disputed that the shares were not quoted in the stock exchange. In determining the value of the shares held by the deceased, the Assistant Controller of Estate Duty proceeded to determine the break-up value of the shares on the basis of the net assets of the company as disclosed in the balance-sheet as on June 18, 1958. He computed the net assets of the company, firstly, at Rs. 4,05,034. In arriving at the figure, he did not allow any deduction for proposed dividend, which was shown as liability in the balance-sheet. As the balance-sheet did not include any value for the good-will of the company, he estimated the value of the goodwill at Rs. 1,10,000 and added back the same to the value of the net assets as computed by him. The methods employed by the Assistant Controller in valuing the goodwill is hereinafter set out :
'The value of each share in the company on the book-value of the assets as on June 18, 1958, comes to nearly Rs. 200. The average annual profits of the company for the 3 years ended June 18, 1958, amount to Rs. 1,09,300. Allowing 20 per cent. margin for any future fall in the profits, the future annual profits are estimated at Rs. 87,500. The capital employed other than goodwill is about Rs. 4 lakhs. Estimating the normal yield at 15 per cent., the annual profits amounted to Rs. 60,000. Thus the annual super-profits worked out to Rs. 27,500. Taking goodwill at the 4 years purchase of super-profits the same works out to Rs. 1,10,000.'
Having added back the value of the goodwill to the value of the other assets of the company, the Assistant Controller arrive at the figure Rs. 5,15,034 for 2,020 issued shares and found that the break-up value of each share may be taken at the round figure of Rs. 250. The value of the shareholdings of the deceased, namely 440 shares at Rs. 250 per share, was thus taken at Rs. 1,10,000.
Dissatisfied with the valuation made by the Assistant Controller, the accountable person appealed before the Appellate Controller. The Appellate Controller party allowed the appeal on the valuation of shares of Minerals and Metals Private Limited on the following ground :
'On going through the calculation of the goodwill of the business made by the Assistant Controller, I find that he took the normal yield at the rate of 15 per cent. of the capital employed other than goodwill and took four years purchase of the annual super-profits of Rs. 27,500. In my opinion, the value of the goodwill was fair and reasonable. Here also, the Assistant Controller had not taken into account the contingent liability. After deducting 30 per cent. of the claim for contingent liability, namely, Rs. 1,60,000, net assets would come to Rs. 4,50,000 (roundly). On this basis, the value of each share would come to Rs. 223. I, however, take the value of each share of this company at Rs. 220 per share. This means a reduction of Rs. 30 per share of 440 shares, that is, Rs. 13,200.'
Not satisfied with the small success before the Appellate Controller, the accountable person preferred an appeal before the Appellate Tribunal. It was argued before the Tribunal that goodwill was no doubt an asset but because such an asset was not shown in the balance-sheet, the same should not be included for the purpose of estate duty. Alternatively, it was contended that the valuation of the goodwill taken at 4 years purchase of the annual superprofits was in any event too high. The Tribunal partly accepted the contention of the accountable person with the following observation :
'There can be no doubt that goodwill, if there is one, can be computed and taken into consideration in placing the valuation on the shares of the company. In this case, Minerals and Metals Private Ltd. Have been consistently earning considerable profits. In computing the goodwill, the Assistant Controller had allowed 20 per cent. margin for any future fall in the profits and it is after this deduction that the annual profits were estimated at Rs. 87,500. But to value the goodwill at four years purchase of the annual super-profits of Rs. 27,500 was, in our opinion, very high. Taking into consideration the fact that the deceased was holding a minority interest in this private limited company and could exercise no control over the dividend policy of the company, in our opinion, a round figure of Rs. 50,000 for the value of the goodwill on the basis of two years purchase of the super-profits would be a more correct estimate of the value of goodwill. The net assets of the company will thus be reduced by a sum of Rs. 60,000 on this score.'
There was another objection taken by the accountable person before the Appellate tribunal, namely, that the proposed dividend of Rs. 74,740 should have been deducted in arriving at the break-up value of the private company. The Tribunal allowed this claim with the following observations :
'As regards the proposed dividend, relying on the decision of the Calcutta High Court, in the Gift-tax case of Kasturchand Jain v. Gift-tax Officer, we must hold that this is also an allowable deduction in computing the break-up value of the shares. On this basis, the net assets of the company work out to Rs. 3,15,260 and the break-up value per share works out to Rs. 155. The 440 shares in Minerals and Metals Private Ltd. should be valued accordingly.'
Against the order made by the Tribunal, the Controller of Estate Duty obtained a reference to this court on the point of law quoted at the beginning of this judgment.
Now, in this case, there is no dispute with regard to the computation of the annual super-profit of Messrs. Minerals and Metals Private Limited at the figure of Rs. 27,500. This is a fact which we need bear in mind. There is also no dispute that goodwill is an asset. The dispute is, firstly, whether the value of the goodwill, which was not shown in the balance-sheet, should be added or taken into consideration in arriving at the break-up value of the assets of the company and, second, how the valuation of goodwill is to be made, namely, whether at four years purchase of the annual super-profit.
Now, the contention of the accountable person that the value of the goodwill need not be taken into consideration at all because the same was not borne on the balance-sheet did not succeed even before the Tribunal. The assessee did not obtain any reference to this court against the order of the Tribunal. We are, therefore, not concerned, in this reference, with the dispute whether the valuation of the goodwill of the company should have at all been taken into consideration. Goodwill, as is well-known, is the value attaching to a successful business beyond the intrinsic worth to the net assets therein employed, because of its good reputation, established connections, common celebrity, continued prosperity and the hope that the business will maintain the same profit earning capacity in future. Were we called upon to consider such a question, we would have been inclined to hold that goodwill has a marketable value and forms part of the assets of a company and that there is no reason to exclude that value when valuing the assets of the company.
Then the question is how the goodwill is to be valued. There are several methods of valuation of goodwill to be found in standard books of accountancy. In Batlibois book on 'Advanced Accounting', 22nd edition, at pages 887-88, the following passage appears :
'... while determining the value of goodwill, the purchaser has mainly to ascertain as to what future annual super-profits he can reasonable expect from the business he wishes to acquire, and for this purpose, super-profit may be defined as the amount by which the future profits of any undertaking are likely to exceed a normal rate of interest as would ordinarily be earned in a like business.
The first step towards arriving at a fair exchangeable value of goodwill is to ascertain the net annual earnings of the business. For this purpose, it would not be safe to take the net earning of any one normal year, but to find out, after a careful and exhaustive investigation of the books of accounts, the average net annual earnings on the basis of the past three to five years. From the average net profits thus arrived at, there should be deducted interest at least 6 per cent. on the capital outlay involved in the carrying on of the business, and a sum as would cover the proprietors services to the business, if the same has not been charged against the profits, in the past...
The prospective purchaser having thus ascertained the probable net annual income to be derived from the business he is out to take over, must next determine how much of such income represents an excess over what would be deeded to be a fair return on the capital outlay involved on the acquisition of such business with due regard to the risks involved. The purchase price of goodwill thus resolves itself into the value of expected super-profits over a certain number of years, that is, profits in excess of a reasonable return on the amount invested in the acquisition of the net tangible assets (i.e., assets minus liabilities) of the business. The only question that then remains to be settled is for the purchaser to come to an agreement with the vendor as to the number of years for which such excess shall be paid for. The number of years purchase also varies considerably, but this will mostly depend on the expectation of the business likely to yield similar results in the future to what it did in the past. Thus, the price to be paid for goodwill is at best a matter of negotiation between the buyer and the seller and also dependent on the form of purchase consideration, that is, whether it is to be paid for in cash or kind.
There are instances where the amount agreed upon for goodwill ranges from the payment of five to ten years of the excess profits...'
The learned author also visualises a second methods of valuation of goodwill in the following language :
'A rough and ready method that is largely employed for ascertaining the value of goodwill is to take it as being worth one to three years purchase of the annual profits of the two to five years immediately preceding the date of such valuation, without any deduction in respect of interest on capital and owners services.'
The learned author expresses the above view possible on his own experience. He, however, does not forget to mention that there have been extreme cases where the amount of goodwill has been ascertained by capitalising super-profits of five to ten years.
In Dymonds Death Duties (14th edition), at pages 613-14, the learned author observes :
'With business of substantial size, there are two common ways of computing the goodwill value, viz. the super-profits method and the total capitalisation method, The two method, which are complementary and may often be used as a check upon each other, and which may theoretically give the same results, may conveniently be illustrated by an example (the figures given are purely illustrative and not to be regarded as any indication of the appropriate yields in any particular case). In each case it is necessary to estimate the probable amount of the future profits (after making a reasonable allowance for management remuneration) - suppose these are taken at Pounds 20,000 pounds per annum. Then -
'Super-profits' method :
Estimated value of tangible assets employed, say....
Interest on capital, at, say, 8 per cent. on 1,00,000 = 8,000 pounds per annum
'Super-profit 20,0008000 = 12,000 pounds per annum
Goodwill at, say, five years purchase of super-profit 12,000 pounds (equivalent to a 20 per cent yield).
Total value of business....
'Total capitalisation' method : Value of whole business estimated on basis of 121/2 per cent. yield - eight years purchase of full profits 20,000 ...
Less estimated value of tangible assets employed.....
Value of goodwill....
In method (b), the value of the tangible assets is taken into account in estimating the yields (12 1/2 per cent.) on the basis of which the capitalisation is to be made, because a purchaser will require a higher yield from a business where the tangible assets are small in relation to the purchase price that from one where the purchase price is largely covered by tangible assets. An accurate valuation of the tangible assets may not be necessary unless they include assets (industrial hereditrial hereditaments, plant and machinery and agricultural property) attracting duty at a reduced rate. The essential difference between the two methods is that in (b) a single yield is adopted for the whole concern, whereas in (a) this is broken down into two separate yields, a lower one in respect of tangible assets and a higher one in respect of goodwill.'
The learned author, however, warns that either method may tend to become unrealistic where the profits are either abnormally low or abnormally high and in such cases more ad hoc methods of valuation may have to be applied.
The super-profit method of valuation was adopted by the Patna High Court in Das & Co. v. Commissioner of Income-tax, and part of the quotation, that we have extracted from Batlibois book, was also quoted with approval. The rough and ready method of valuation of goodwill appears to have been adopted by the Madras High Court in K. A. Subramaniam v. Controller of Estate Duty.
Thus, for valuation of goodwill, capitalisation of super-profit method appears to be an accepted method of valuation. The Tribunal did not condemn the valuation of the goodwil by the method employed by the Assistant Controller of Estate Duty (as was affirmed by the Appellate Controller, subject to certain reliers for contingent liabilities) but differed on the ground that the deceased was holding a minority interest in this privatelimited company and could exercise no control over the dividend policy of the company and, therefore, the number of years by which the super-profits should be multiplied should be reduced from four years to two years. In so doing, the Tribunal went wrong. The Tribunal was called upon to consider the value of the goodwill of the goodwill of Messrs. Minerals and Metals Private Limited so as to value the shares in the said company held by the deceased. The value of the goodwill by the company was not dependent upon the number of shares held by the deceased. The Tribunal was not considering the value to the deceased of the goodwill of Messrs. Minerals and Metals Private Limited. This was the error which the Tribunal committed. In the facts and circumstances of the instant case, we are of the opinion that the Assistant Controller adopted the correct principle when he wanted to value the goodwil by finding out the super profit and multiplying the same by 4 years in the manner done by him. Wer are also of the opinion that the Appellate Controller was right in giving further relief to the accountable person, as done by him. In the result, the valuation of the shares by the Tribunal at the round figure of Rs. 50,000 was wrong and the valuation as made by the Appellate Controller was right.
We are also of the opinion that in determining the break-up value of the shares, the proposed divident of Rs. 74,740 as provided for in the balance-sheet was n0ot an allowable deduction. This point is now covered by the decision of the Supreme Court in Kesoram Industries & Cotton Mills Ltd. v. Commissioner of Wealth-tax, and also by a decision of this court in Gift-tax Officer, Calcutta v. Kastur Chand Jain.
In the view that we take, we hold that the Tribunal was not justified in valuing the goodwill of the company at Rs. 50,000 and in allowing, as a deduction from the assets, the proposed divident of Rs. 74,740 as provided for in the balance-sheet. The question must be answered in the negative and against the accountable person.
Since there was no appearance on behalf of the accountable person, we make no order as to costs.
K. L. ROY J. - I agree.
Question answered in the negative.