1963 PLP 908 (PTD)

UNTWALIA, J. In this case the assessee is a Hindu undivided family carrying on business in radios and musical instruments at Moradpur, Patna, in the name of Das & Company. We are concerned in this case with the assessment year 1951 52, for which the relevant accounting year is Bengali Sambat year 1357. On 2nd April 1951, the assessee sold certain goods and assets worth Rs. 1,00,470 to an incorporated company, named Electricity and Sound Limited, which is hereinafter referred to as "the company" The Muzaffarpur branch of the assessee also sold goods to the :company to the extent of Rs. 18,

669. The aggregate value of the goods sold to the company, therefore, amounted to Rs. 1,19,

138. It appears that the assessee also sold to the company the goodwill of the business for a sum of Rs. 50,

000. The Income tax Officer held that the stock in trade should not have been sold by the assessee to the company at cost price, and on the statement of gross profits disclosed by the assessee the Income tax Officer found that the assessee was earning a gross profit on an average of 35 per cent. per year, and the finding of the Income tax Officer was that on this basis the sale value of the stock in trade should be over Rs. 1,50,000 and profit of Rs. 50,000 should have accrued to the assessee in respect of the stock in trade sold to the company. The view taken by the Income tax Officer apparently was that the sum of Rs. 50,000 paid to the assessee for the sale of goodwill did not really represent the price of the goodwill but represented the profits made by the assessee on the transaction of the sale of the stock in trade. Accordingly, the Income tax Officer added a sum of Rs. 50, 000 to the gross profit of the assessee for the accounting year in question. The assessee took the matter in appeal to the Appellate Assistant Commissioner, who took the view that the value of the goodwill should be placed at Rs. 25,000 and the profits made by the assessee on the sale of the stock in trade should be Rs. 25,000 and accordingly the profits of the assessee should be increased by a sum of Rs. 25,

000. The assessee preferred an appeal to the Income tax Appellate Tribunal, but the appeal was dismissed. As ordered by the High Court, the Income tax Appellate Tribunal has stated a case on the following question of law under section 66 (2) of the, Income tax Act : "Whether, in the facts and circumstances of the case, the entire sum of Rs. 50,000 mentioned as the price of goodwill of Das & Company in the deed, dated 22nd August 1951, or any portion thereof is liable to be taxed by the income tax department ?" On behalf of the assessee learned counsel put forward a two fold argument. In the first place, it was submitted that there is no reason for the Income tax Authorities to hold that the assessee should have sold the stock in trade to the company not for the cost price but for the market price. It was contended that there was no material to suggest that the transaction was not a bona fide transaction and that the price received by the assessee and paid for by the company far the stock in trade was other than the amount of Rs. 1,19,

138. It was also submitted on behalf of the assessee that the Appellate Tribunal has given five reasons for taking the view that the consideration for the sale of the stock in trade was really more than the amount mentioned in the contract, but none of these reasons is supported by any material. The first two reasons given by the Appellate Tribunal are : (1) that the name of the assessee doing the business was not transferred to the company, and (2) that the company started its business under an entirely different name. The original sale deed dated 22nd August, 1951, was produced iii the course of hearing by learned counsel for the assessee. This document is referred to by the assessee in its letter to the Income tax Officer dated 14th March 1950, which is printed at pages 1 2 of the paper book. It is clear from this document that the right to use the name of Das & Company was transferred by the assessee to the company, and the first two reasons given by the Tribunal are erroneous. The other reasons given by the Tribunal are : (1) the assessee was only a dealer in, and distributor of, some well known products and it was not dealing in special products of its own ; (2) the book debts bad not been transferred to the company ; and (3) the contacts which the assessee might have established over a period of years were not made available to the company. There is no relevancy in the third and fourth reasons given by the Appellate Tribunal, and as regards the fifth reason the registered sale deed dated 22nd August 1951, clearly indicates that the right of representation was transferred by the assessee along with the goodwill and the contacts of the assessee were made available to the new company. In any event, there is no finding by the Appellate Tribunal that the transaction of the sale of good will is a sham transaction, and in the absence of such a finding it was not open to the Appellate Tribunal to say that the price paid for the stock in trade by the company to the assessee was not the amount mentioned in the contract, but something more than that amount, namely, the difference between the market price and the cost price (sic) and that this difference in amount should be taxed as the profits of the assessee. The view we have expressed is supported by the decision of the Madras High Court in Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income tax ((1955) 28 I T R 952). In that case the account books of the assessee, a limited Company, showed that some of its goods were sold to its managing agency firm, to one of its directors and to a firm in which one of its directors was a partner, at prices much lower than the market rates, and the Income tax Authorities finding that the sales to these persons at lower prices were not bona fide sales and were effected to benefit the purchasers at the expense of the company, included the difference between the price for which these goods were sold and their market price as profits of the company in its assessment. It was held by the Madras High Court in these circumstances that the sales could not be regarded as mere sham transactions unless there was sufficient evidence to prove that. It was also held that in the absence of evidence to show that the sales were sham transactions or that the market prices were in fact paid by the purchasers, the mere fact that the goods were sold at a concessional rate to benefit the purchasers at the expense of the company would not entitle the income tax department to assess the difference between the market price and the price paid by the purchasers as profits of the company. The same principle has been expressed in an English case, Craddock v. Zevo Finance Company Ltd. ((1946) 27 T C 267). In that case the respondent company, an investment dealing company, was formed in May 1932, to take over the more speculative investments of another investment dealing company. The investments were purchased by the respondent company on 15th June 1932, at the prices at which they stood in the books of the old company, being their cost price to that company in 1927. The consideration was satisfied by the respondent company undertaking to discharge the liability in respect of the old company's debentures and interest thereon and by the allotment of its authorised capital, with the shares credited as fully paid, to the shareholders of the old company. As a result of debiting the investments at the purchase price, the respondent company's accounts showed a loss for the first accounting period, but an assessment to income tax was made on the company for the year 1933 34 on the basis that the correct debit in respect of the purchase of the investments in stock in trade was their market value on the day of purchase according to stock exchange prices, on which basis the trading results of the company showed a profit. On appeal to the General Commissioners against the assessment the respondent company contended, inter alia, (i) that in computing the profits the amount to be debited in respect of the opening figure of stock was the purchase price, which was the price it had agreed to pay, and that the amount paid in shares should be taken at the par value of the shares ; and (ii) that, in any event, the stock exchange prices did not, in the circumstances of the case, represent the true market value of the investments and there was no evidence what such true market value was. The Commissioners found as a fact that, in the circumstances of the case, if the respondent company had set out to buy the investments at the stock exchange prices, those prices would have risen against it, though it was impossible to say by how much, and they discharged the assessment. In the High Court the Crown abandoned the contention that the investments should be valued at the stock exchange prices on 15th June 1932, but claimed that the disparity between the purchase price and the stock exchange prices was so great that the real value of the investments must have been very much less than the price at which they were taken over, and that the case should be remitted to the Commissioner to ascertain their real value when they were taken over. Upon these facts it was held by the Court of Appeal that the assessment should be discharged because the Crown had failed to establish that the value of the investments was less than the nominal value of the consideration for which the respondent company had acquired them, namely, the liability to discharge the debentures and interest thereon and the allotment of its share capital as fully paid. The matter had been very clearly put by Lord Greene M. R. at page 279 of the report as follows : "I am not concerned to dispute the correctness of the principle advanced by Mr. Stamp in connection with his analogous case. But I am bound to say, with all respect to the ingenuity of its inventor, that this analogy that is as misleading as any analogy that I have heard. It seems to me quite impossible to say that there is any analogy to be found between the case where a trader acquires a piece of stock in trade for nothing and the case where a company acquires its stock in trade upon the terms of a contract under which it provides consideration. The argument, so far as it deals with the facts of the present case, is, as it appears to me nothing but an attempt to revive the `supposed doctrine' of substance and form. That argument, one had hoped, had been recently inferred by the decision in Commissioners of Inland Revenue v. Duke of Westminster (1936) A C

1. But its ghost still walks on occasions, and this, it appears to me, is one of them. As Lord Tomlin said in the Duke of Westminster's case, the substance is that which results from the legal rights and obligations of the parties ascertained upon ordinary legal principles'. What then was the substance of the transaction under which the respondents acquired these investments ? First of all they acquired them by virtue of a contract of sale and purchase the validity of which, as importing legal rights and obligations between the parties to it cannot be impugned, and (until Mr. Stamp's argument was presented in, this Court) had always been accepted by the Crown. If the contract had been broken by either of the parties, it could have been enforced in the usual way by the other. There can be no possible question as to this. The contract is described in clause (1) as a contract of sale and purchase. It is a contract under which the respondents acquired the investments in consideration of their undertaking to the syndicate and its liquidator to assume the liability on the debentures and to issue the fully paid shares. These were the rights and obligations imported by the contract. Their legal effect is beyond dispute. By what process of reasoning they are to be disregarded and treated as non existent I am at a loss to understand. The respondents did in fact, as they were bound to do, take over the liability and issue the shares. It was on these terms, and these terms alone, that they acquired the investments. The carrying out of these terms was in law the price which they paid for the investments, and it seems to me quite impossible to accept the view upon which Mr. Stamp's whole argument was based that they must be taken as having acquired the investments in a manner which was not in law contractual and for no consideration at all. Mr. Stamp went so far as to say that not even the liability undertaken in respect of the debentures ought to be regarded as an item of cost, contrary to the position accepted by the Solicitor General. This is the `supposed doctrine' of substance with a vengeance." Applying the principle of these authorities to the present case we hold that there was no material before the Income tax Authorities to suggest that the transaction between the company and the assessee was not bona fide and that the price actually paid for the stock in trade was in any way different from the amount of Rs. 1,19,138 which was the contractual price agreed upon between the parties for the transfer of the stock in trade. With regard to the transfer of the goodwill of the business, the Appellate Assistant Commissioner has stated that it was an overvaluation and the proper amount for the sale of the goodwill should be Rs. 25,000 and not Rs. 50,

000. The Appellate Assistant Commissioner has not given any reason for holding why the sale price of the goodwill should be reduced to Rs. 25,

000. The approach of the Appellate Assistant Commissioner to this question has been arbitrary. The finding of the Appellate Assistant Commissioner on this point has been affirmed by the Income tax Appellate Tribunal. The reasons given by the Appellate Tribunal are also either factually incorrect or irrelevant, as we have already shown. In the matter of valuation of the goodwill of the business the proper approach is to ascertain the net annual earnings of the business after a careful investigation of the books of accounts and calculating the average net annual earning on the basis of the past three to five years. From the average net profits thus arrived at, it is usual to deduct as a matter of accountancy practice, at least 6 per cent. on the capital outlay involved and a sum as would cover the proprietor's services to the business. The goodwill is then calculated at five to ten years' purchase of the net annual profits. The usual method of calculation of the valuation of goodwill is set out at pages 807 and 808 of Advanced Accounting by Batliboi, 16th edition. The matter is summarised at pages 807 and 808 of that treatise as follows : "Before, therefore, it can be said that a particular business has an exchangeable value of goodwill attached to it, it must be seen that the annual profits which that business is expected to earn in the future will exceed the normal return on the capital invested, with due regard to the nature of the risk involved. In other words, while determining the value of goodwill, the purchaser has mainly to ascertain as to what future annual super profit he can reasonably accept 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 earnings of any one normal year, but to find out after a careful and exhaustive investigation of the books of accounts, the average net annual earning on the basis of the past three to five years. From the average net profits 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 proprietor's 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 deemed 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 by 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." In the present case neither the Appellate Tribunal nor the Appellate Assistant Commissioner has paid any attention to the net profits of the business sold by the assessee to the company for the previous years in calculating the value of the goodwill. It is the admitted case that for the assessment year 1948 49 the assessee was taxed on a total income of Rs. 55,821, for the assessment year 1949 50, on a total income of Rs. 50,704, and for the assessment year 1950 51 on a total income of Rs. 53,

542. Applying, therefore, any of the usual methods of calculating goodwill to the present case, it would appear that the valuation of the goodwill at a sum of Rs. 50,000 which was the contractual price fixed between the parties, was not unreasonable. As we have already stated, the Appellate Assistant Commissioner has applied an arbitrary procedure for fixing the valuation of the goodwill, and the Appellate Tribunal has also committed an error of law in upholding the finding of the Appellate Assistant Commissioner. We have already shown that the Appellate Tribunal has addressed itself on this point to irrelevant considerations and has not applied its mind to relevant considerations. It is manifest that the Appellate Tribunal has committed an error of law. For these reasons we hold that, in the facts and circumstances of this case, no portion of the sum of Rs. 50,000 mentioned as the price of the goodwill of Das & Company in the deed dated 22nd August 1951, is liable to be taxed by the Income tax Department. We accordingly answer the question of law referred by the Income-tax Department in favour of the assessee and against the Income-tax Department. The assessee is entitled to costs of this reference. Hearing fee Rs.

250. Question answered accordingly.