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Commissioner Of Income-Tax v. S. Natarajan.
Summary of the Opinion — N.V. Balasubramanian, C.J.
Factual and Procedural Background
The Revenue referred a question of law under the Income-tax Act, 1961 concerning whether the Appellate Tribunal was correct in holding that the assessee was not liable to capital gains tax under section 45 when the assessee's proprietorship business, V.R. Sambasiva Aiyar and Company, was transferred to Mir Mohammed Ali.
The assessee, an individual, sold his proprietorship business as a going concern to Mir Mohammed Ali for an agreement value stated as Rs. 36,000 (agreement dated 16 August 1973). The assessee had earlier retired from two partnerships (Kamakshi Industries and Southern Engineering Company) and had received Rs. 10,000 and Rs. 8,000 respectively in connection with those retirements/reconstitutions.
For the assessment year 1974–75 the assessee filed a return claiming a loss and the right to carry forward business losses. The Income-tax Officer (ITO) adjusted the returned loss by treating a deemed profit under section 41(2) of Rs. 2,08,595 as having arisen by reason of the sale of the business as a going concern and determined business income at Rs. 1,43,219. The ITO also declined to allow carry forward of depreciation business loss on the ground that the business was relinquished.
The Appellate Assistant Commissioner confirmed the assessment. The assessee appealed to the Appellate Tribunal, which framed specific questions (see Legal Issues Presented). The Tribunal concluded that no section 41(2) profit arose when the business was transferred as a whole and, relying on the Supreme Court decision in CIT v. Mugneeram Bangur & Co., held that no part of the price of a sale of the whole concern could be attributed to land (and thus was not taxable as capital gain). The Tribunal therefore held the assessee not liable to capital gains and did not proceed further on carry forward issues.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case and having regard to the provisions of section 2(47) of the Income-tax Act, 1961, the Appellate Tribunal was right in holding that the assessee was not liable to capital gains tax under section 45 when the business of the assessee which runs in the name and style of V.R. Sambasiva Iyer and Sons was transferred by him to Mir Mohammed Ali?
- Whether the assessee is liable to section 41(2) profits to the extent of Rs. 2,08,959?
- Whether the assessee is liable to long-term capital gains of Rs. 1,58,800 arising from the transfer of the assessee's proprietary interest in V.R. Sambasiva Aiyar and Company?
- Whether the assessee is liable for short-term capital gains of Rs. 2,05,213 as regards Kamakshi Industries?
- Whether the assessee is liable for capital gains of Rs. 1,38,637 in the case of Southern Engineering Company?
Arguments of the Parties
Assessee's Arguments
- The assessee contended before the Tribunal that the sale consideration was only Rs. 36,000 as stated in the agreement and therefore the profit determined by the ITO (Rs. 2,08,959 under section 41(2)) could not be correct.
- The Tribunal's conclusions (as adopted by the assessee) included reliance on Mugneeram Bangur & Co.'s case to argue that where the whole concern is sold no portion of the price can be attributed to the cost of land (and thus is not taxable as capital gain).
Revenue / Income-tax Officer's Position
- The ITO treated the transaction as involving a transfer of the business as a going concern but computed a larger effective consideration by treating liabilities taken over by the buyer as forming part of consideration: assets per balance sheet were Rs. 1,11,746; total liabilities were Rs. 4,34,505; the difference was Rs. 3,31,759. The ITO added the stated Rs. 36,000 to that amount to arrive at the total consideration on which he computed profits under section 41(2) and capital gains.
- Implicitly, the Revenue’s approach treated the liabilities taken over by the buyer as real components of the transaction and part of the consideration for the transfer.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| CIT v. Mugneeram Bangur & Co., [1965] 57 ITR 299 (SC) | The principle that when the entire proprietary concern is transferred as a whole, it may be inappropriate to attribute part of the sale price to the cost of particular assets such as land; in that case a sum shown as liabilities not related to a particular asset did not attract section 41(2). | The Tribunal relied on this decision to hold that no part of the price could be attributed to the cost of land and thus not taxable as capital gains. The Court held that the Tribunal misapplied Mugneeram because it failed to examine whether any part of the consideration was attributable to particular assets and did not take into account liabilities taken over by the buyer which, where quantified and agreed, form part of the consideration. |
| Commissioner of Income Tax, Gujarat v. Artex Manufacturing Co., [1997] 227 ITR 260 | Explained Mugneeram: even in a realisation sale, if it is possible to attribute the sale price to specific assets (for example evaluated plant and machinery), the excess realised over written down value on the sale of such assets may be liable to tax. | The Court relied on Artex to emphasise that the Tribunal should have examined whether the parties evaluated and attributed values to plant, machinery or other assets under the agreement; because the Tribunal did not do this, it failed to apply the correct test. |
| Additional Commissioner of Income-Tax v. Govindoss Purushothamdoss, [1980] 124 ITR 319 | Where parties show a particular value for assets in their books or transaction documents, that value cannot automatically be treated as a notional figure and may be a real value for tax purposes. | The Court referred to this authority to support the proposition that the values and the liability figure agreed by the parties (e.g., Rs. 3,31,759) cannot be dismissed as ad hoc and should be examined as a real part of the transaction when determining tax liability. |
Court's Reasoning and Analysis
The Court reviewed the Tribunal's reasoning and identified several deficiencies:
- Failure to test attribution: The Tribunal relied on Mugneeram Bangur & Co. but did not examine whether any part of the consideration could, in fact, be attributed to particular assets transferred. The Court emphasized that Mugneeram was concerned with transfers of the entire proprietary concern where attribution is not appropriate, but each case requires an examination of the facts to see whether attribution is possible.
- Treatment of liabilities taken over: The ITO's computation included liabilities taken over by the buyer (difference between liabilities and assets as per books) and added the Rs. 36,000 stated consideration. The Tribunal did not give due weight to the agreed figure of liabilities taken over (Rs. 3,31,759). The Court observed that where the buyer expressly takes over liabilities and the parties have agreed a figure, that figure forms part of the consideration and cannot be ignored as an ad hoc number.
- Interaction between section 41(2) and section 45: The Court noted that the issues of deemed profit under section 41(2) and capital gains under section 45 are related. If an amount is not liable under section 41(2), that does not eliminate potential liability under section 45; the Tribunal failed to grapple with both possibilities in sequence.
- Relevant authorities and tests: The Court relied on later clarifications in Artex (which explains that in a realisation sale, where it is possible to attribute price to assets, excess over written down value is taxable) and on Govindoss (which treats parties’ agreed values as real) to state that the Tribunal should have investigated whether plant, machinery, stock or liabilities were specifically evaluated and assigned values in the transaction documents or accounts.
- Conclusion on Tribunal's approach: Because the Tribunal did not apply these tests — attribution of consideration, the significance of liabilities taken over, and whether assets were separately valued — the Court held that the Tribunal erred in its application of Mugneeram and failed to decide the tax liabilities correctly.
The Court therefore directed that the Appellate Tribunal should reconsider the matter de novo applying the correct tests: determine the true amount of sale consideration for the transfer; decide whether it is possible to attribute any part of the consideration to particular assets attracting section 41(2); and if section 41(2) is not attracted, determine whether any amount is chargeable as capital gains under section 45.
Holding and Implications
Holding: The referred question is answered in the affirmative in favour of the Department and against the assessee. The Court held that the Appellate Tribunal erred in its approach and directed it to reconsider the matter de novo.
Implications:
- The Appellate Tribunal must reopen its consideration and determine: (a) the correct amount of sale consideration for the transfer; (b) whether any portion of that consideration can be attributed to particular assets so as to attract section 41(2); and (c) if section 41(2) does not apply, whether any amount is chargeable under capital gains (section 45).
- The Court recognized that where parties explicitly agree values (including liabilities taken over), those figures cannot be summarily disregarded and should be examined as part of the transaction.
- No new broad precedent beyond the application of existing authorities was laid down; rather the Tribunal was required to apply the tests and authorities (Mugneeram as explained by Artex, and Govindoss) to the facts and attribute consideration where possible.
- Practical effect for the parties: the matter is remitted to the Appellate Tribunal for fresh determination of tax liability in accordance with the directions. As there was no representation for the assessee at the hearing, the Court made no order as to costs.
N.V Balasubramanian, C.J:— At the instance* of the Revenue, the following question of law has been referred under the Income-tax Act, 1961:
“Whether, on the facts and in the circumstances of the case and having regard to the provisions of section 2(47) of the Income-tax Act, 1961, the Appellate Tribunal was right in holding that the assessee was not liable to capital gains tax under section 45 when the business of the assessee which runs in the name and style of V.R Sambasiva Iyer and Sons was transferred by him to Mir Mohammed Ali?”
2. The assessee is an individual. He sold his proprietorship business styled as V.R Sambasiva Aiyar and Company as a going concern to one Shri Mir Mohammed Ali for a consideration of Rs. 36,000. The Tribunal referred to the retirement of the assessee from the two partnerships viz., Kamakshi Industries and Southern Engineering Company, due to dispute which arose among the partners. The assessee had received a sum of Rs. 10,000 for taking over his share in Shree Kamakshi Industries and Rs. 8,000 for taking over 5 per cent, of the share which the assessee held in the firm of Southern Engineering Company when both the firms were reconstituted on January 1, 1973. The assessee filed a return of income for the assessment year 1974–75 claiming a loss of Rs. 47,267. The assessee claimed that he was entitled to carry forward certain business losses. The Income-tax Officer, inter alia, determined the business income as against the loss returned at Rs. 1,43,219 by adjusting the loss claimed against a deemed profit under section 41(2) of Rs. 2,08,595 on the ground that it had arisen by reason of sale of the business of V.R Sambasiva Aiyar and Co., as a going concern. We are not concerned with the other items found in the order of assessment. The Income-tax Officer also declined to carry forward the depreciation business loss as the business was relinquished in the year of accounting. On appeal, the Appellate Assistant Commissioner confirmed the assessment. The assessee carried the matter in appeal to the Appellate Tribunal and raised several contentions regarding the assessment of profit under section 41(2) of the Act. The Tribunal raised the following points for consideration:
1. Whether the assessee is liable to section 41(2) profits to the extent of Rs. 2,08,959?
2. Whether the assessee is liable to long-term capital gains of Rs. 1,58,800 as arising from the transfer of the assessee's proprietary interest in the concern of V.R Sambasiva Aiyar and Company?
3. Whether the assessee is liable for short-term capital gains of Rs. 2,05,213 as regards Kamakshi Industries?
4. Whether the assessee is liable for capital gains of Rs. 1,38,637 in the case of Southern Engineering Company?
3. The Tribunal noticed that under the agreement dated August 16, 1973, wherein the business was sold as a going concern, the assessee transferred his rights in the industrial unit, viz., K.R Sundaram Industrial Estate (P.) Ltd., and the rights under the hire purchase agreement with National Small Scale Industries in favour of the buyer.
4. The Tribunal noticed how the Income-tax Officer arrived at the amounts of profits under section 41(2) and the capital gains. The Income-tax Officer had noticed the value of the assets as per the balance sheet was Rs. 1,11,746 and he granted deduction of the same from the total value of the liability amounting to Rs. 4,34,505 and determined the difference at Rs. 3,31,759. The sum of Rs. 36,000 was added to the said amount of Rs. 3,31,759 and the total consideration under the agreement was thus determined and on the total sum, the Income-tax Officer determined the profits chargeable under section 41(2) of the Act and the amounts chargeable under capital gains. The contention of the assessee before the Tribunal was that the sale consideration was only Rs. 36,000 and the profit could not be Rs. 2,08,959. The Tribunal came to the conclusion that when the business was transferred as a whole, there was no question of the assessee being liable to profits under section 41(2) of the Act. As regards the long-term capital gains arising on the transfer of the assessee's proprietorship business in V.R Sambasiva Aiyar and Company, the Tribunal relied upon the decision of the Supreme Court in the case of CIT v. Mugneeram Bangur and Company, [1965] 57 ITR. 299 and held that when the sale was of the whole concern, no part of the price can be attributed to the cost of the land, and no part of the same is taxable. The Tribunal referred to the cases arising from the retirement of partnership and held that there was no transfer of capital in the transfer in favour of the partnerships and came to the conclusion that the assessee was not liable to capital gains. In that view of the matter, it held that it was not necessary to consider the question relating to carry forward of the losses.
5. We have gone through the order of the Appellate Tribunal. The Tribunal was of the view that the decision of the Supreme Court in Mugneeram Bangur and Co.'s case, [1965] 57 ITR 299, was applicable to the facts of the case. The Tribunal, in the view it had taken should have examined the question further whether any part of the consideration was attributable to the assets sold by the assessee. The Tribunal unfortunately has not determined that question at all. Secondly, the Income-tax Officer found that even though under the agreement, it is stated that a sum of Rs. 36,000 was the consideration, the buyer took over the liability amounting to Rs. 3,31,759, as a part of consideration. The Tribunal did not give due attention to the fact that it was the figure arrived at by the parties and when the buyer took over the liability amounting to Rs. 3,31,759, the assessee to that extent was relieved of the liabilities and it formed part of the transaction. The amount of liability agreed to be taken over was an agreed sum and the figure of Rs. 3,31,759 cannot be regarded as an ad hoc figure. The Supreme Court in Mugneeram Bangur and Co.'s case, [1965] 57 ITR 299, held that a sum of rupees one lakh and odd shown as liabilities did not relate to any particular asset and there was no liability under section 41(2) of the Act. On the other hand, it is seen that when the parties arrived at a figure for transfer of a business as a whole, and when the buyer took over the business including the assessee's liabilities and where the liabilities taken over exceeded the value of the assets, the value of the liabilities arrived at by the parties would be a part of the consideration of the transfer. When considering the question whether the consideration for the transfer can be attributed to a particular asset transferred to the buyer, it has to be determined whether a portion of the consideration can be attributed to a particular asset. When the entire business is sold as a going concern, it is impermissible to ignore the liability taken over by the buyer and disregard the same as not forming a part of the consideration. The Tribunal also did not attach much importance to the fact that even if the assessee succeeds in its claim that the amount cannot be taxed under section 41(2) of the Act, the profit or gain arising on the transfer of the assets would be assessable under capital gains. The Tribunal, therefore, in our opinion, erred in applying the principles laid down in Mugneeram. Bangur and Co.'s case, [1965] 57 ITR 299 (SC), which was a case where the Supreme Court was dealing with the determination of profit arising under capital gains when the entire proprietary concern of the assessee was transferred.
6. The Supreme Court subsequently in Commissioner Of Income Tax, Gujarat v. Artex Manufacturing Co., [1997] 227 ITR. 260 explained the decision in Mugneeram Bangur and Co.'s case, [1965] 57 ITR 299 (SC), and held that even in the case of a realisation sale, the excess amount realised over the written down value on the sale of the asset, would be liable to tax, where it is possible to attribute the sale price to the assets sold and when the value of the plant and machinery was evaluated and transferred. Therefore, in each case, it has to be seen whether under the agreement, the value of the machinery was evaluated before it was sold. In this case, the Tribunal has not examined this aspect at all. Further, this court in Additional Commissioner Of Income-Tax v. Govindoss Purushothamdoss., [1980] 124 ITR 319 held that where the parties showed a particular value for the assets in the books, the value arrived at by the parties cannot be taken as a notional figure but a real one. As we have already pointed out, the Tribunal has not undertaken any such exercise to find out whether the parties have evaluated the value of the plant and machinery or stock or the liability taken over by the buyer and on what basis the sum of Rs. 36,000 was ultimately agreed to be paid by the buyer in favour of the assessee.
7. That apart, we are of the view, the case arises on the question regarding the assessability of profits under section 41(2) of the Act as well as the capital gains under section 45 of the Act. We have already indicated that if the case of the assessee succeeds under section 41(2) of the Act, it has to necessarily fail under section 45 of the Act. Admittedly, there was a transfer of business and the business was taken over by the purchaser.
8. In our opinion, the Tribunal should determine the question once again and find out what is the amount of sale consideration for the transfer and whether it is possible to attribute the sale consideration to any of the assets transferred attracting the provisions of section 41(2) of the Act and if section 41(2) is not attracted, whether there is any liability arising under capital gains. Since the Tribunal has not applied the proper tests in cancelling the assessment, we direct the Appellate Tribunal to consider the question de novo in the light of the observations made by us.
9. Accordingly, we answer the question of law referred to us in the affirmative, in favour of the Department and against the assessee, subject to the direction that the Tribunal should go into the question once again and determine the liability to tax. As there was no representation on behalf of the assessee, there will be no order as to costs.
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