Rajesh Brothers v. Commissioner Of Income Tax

Arijit Pasayat, C.J:— Pursuant to the directions given by this court, the following questions have been referred at the instance of the assessee under section 256(2) of the Income-tax Act, 1961 (in short “the Act”), by the Income-tax Appellate Tribunal (in short “the Tribunal”), for the opinion of this court:

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that there was no goodwill attached to the assessee's cinema theatre known as Apsara?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the assessee's method of evaluation of goodwill was not the correct method, according to the recognised principles of evaluation of goodwill?”

2. The assessment year involved is 1972-73. The factual position in a nutshell is as follows:

The assessee, a registered firm, started film exhibition business with effect from October 9, 1969. The land was acquired in the year 1967 and later a building was constructed thereon and the cinema theatre was being run under the name and style of Apsara cinema at Delhi-U.P border, since October 9, 1969. After running the cinema hall for some years, the assessee sold the same to Star Exhibitors and Agencies (P.) Ltd. for a total consideration of Rs. 9 lakhs. On the date of sale, the book value of various assets including cinema building, machinery, etc., was Rs. 6,78,974. The assessee claimed goodwill of Rs. 2,09,268 and, brokerage to the extent of Rs. 31,500 paid with the result that according to it, there was a loss of Rs. 19,742 in this transaction. The Income-tax Officer (in short “the ITO”), did not accept the assessee's contention. He found that there was no goodwill attached to the cinema business run by the assessee. He found that during the assessment years prior to the sale, the profits of the business for previous three years were as under:

Assessment year Profit 1969-70 23,577 1970-71 98,519 1971-72 1,23,317

3. The Income-tax Officer further found that the gross receipts from the sale of tickets during the previous four assessment years was as under:

Assessment year Gross receipts 1969-71 1,87,761 for 4½ months 1970-72 6,24,100 for full year 1971-72 5,70,170 for full year 1972-73 49,49,490 for about 11 months

4. The Income-tax Officer worked out the average yearly profit of the assessee for the three years immediately preceding the date of sale which came to Rs. 67,000. The capital investment of the partners in the firm was Rs. 7 lakhs and if interest at 12 per cent, was allowed on the capital, it would come to Rs. 84,000 and the reasonable remuneration payable to two partners who were actively engaged in the business at Rs. 1,000 per month would work out of Rs. 24,000. Therefore, the Income-tax Officer was of the view that if those two amounts were considered, the net result would be a loss and hence there was no super profit earned by the firm. On the aforesaid basis, the Income-tax. Officer negatived the claim of the assessee and subjected the difference between the book value of the assets and the sale price realised to capital gains. The matter was carried in appeal before the Commissioner of Income-tax (Appeals) (in short, “the CIT(A)”). The said authority did not accept the stand of the assessee and upheld the decision of the Income-tax Officer. The matter was carried in further appeal before the Tribunal. After considering the relevant submissions, the Tribunal came to hold that there was no goodwill generated and no fault was found in the action of the Income-tax Officer and the Commissioner of Income-tax (Appeals) in holding that there was no goodwill. The appeal of the assessee was dismissed. A prayer for reference under section 256(1) was also rejected. However, as noted above, pursuant to the directions of this court, the questions as set out above have been referred.

5. We have heard learned counsel for the Revenue. There has been no appearance on behalf of the assessee despite service of notice. Learned counsel for the Revenue submitted that the Income-tax Officer, the Commissioner of Income-tax (Appeals) and the Tribunal have analyzed the factual position to hold that there was no goodwill. The conclusions are factual giving rise to no question of law. The Tribunal has referred to the method of valuation of goodwill which is normally adopted in such cases.

6. Goodwill is a thing very easy to describe, but very difficult to define. It is the benefit and advantage of the good name, reputation and connection of a business. It is the attractive force which brings in customers. It is the magnetic quality of a particular trade or business which attracts customers to it as a matter of course. This quality springs from and is developed by various contributing factors that earn a reputation for honest dealing, quality and standard. It is an intangible asset being the whole advantage of the reputation and connections formed with the customers together with the circumstances which make connections durable. It is the component of total value of the undertaking which is attributable to the ability of the concern to earn profits over a course of years because of its reputation, location and other features (see Khushal Khemgar Shah v. Mrs. Khorshed Banu Dadiba Boatwaua, (1970) 1 SCC 415 : AIR 1970 SC 1147). Goodwill is one thing which distinguishes an old established business from a new business at its first start. If there is one attribute common to all cases of goodwill it is the attribute of locality, for goodwill has no independent existence. It cannot subsist itself. It must be attached to a business. Destroy the business and the goodwill perishes with it, though elements remain which may perhaps be gathered up and be revived again, (see IRC v. Muller and Co.'s Margarine Ltd., [1901] AC 217 (HL)). A some what similar view was expressed by the apex court in Rustom Cavasjee Cooper v. Union Of India, [1970] 40 Comp Cas 325; (1970) 1 SCC 248 : AIR 1970 SC 564.

7. Goodwill is sometimes valued on the basis of a certain number of years' purchase of the average profits of the past three or four or five years. For example, goodwill may have to be valued on the basis of three years in one of the cases which is commonly known as “three years purchase of five years' profits”. There is another method which is also referred to as the “super profit method”. There is yet another method which is called the annuity method which is another name for the super profit method. So far as the super profit method is concerned, the maintainable profits of the firm of which goodwill is for sale, are compared with the normal profits of the firm, i.e, profits which would have been earned with the same capital by an average firm. If the estimated future profits are more than the normal profits the difference is known as super profit. This is the measure of the extra profits obtained by the firm. Goodwill is found by multiplying the super profits by a certain number, i.e, the number of years' purchase. Normal profits are ascertained by multiplying the average capital employed by the rate of general expectation and dividing by 100. To take a simplified example, suppose a firm employs Rs. 6 lakhs as capital, the investors are not satisfied with an income of less than 8 per cent, and the profits likely to be continued are Rs. 75,000. The super profit of the firm would work out as under:

Rs. Actual profit 75,000 Less: Normal profit = 48,000 Superprofit 27,000

8. If goodwill is to be valued at three years purchase the value of goodwill will be Rs. 81,000, i.e, 27,000 × 3. If, on the other hand, if the profit is Rs. 45,000, there is no super profit because the actual profit is less than the normal profits and hence no goodwill. In the case of the super profits method, the number of years of purchase of goodwill will also differ from industry to industry, and from business to business. A business where the retiring proprietor was the main reason for success will have goodwill based on one or two years' purchase of goodwill. Three to five years' purchase is commonly adopted. If super profits are large, a large number of years' purchase is allowed. If the profits are declining the number of years for purchase of goodwill will probably be only one or two. Theoretically the number of years is to be determined with reference to the probability of a new business catching up with the old established business. Goodwill is generated as the business is carried on and may be augmented with passage of time. Because of its intangible nature, goodwill remains insubstantial in form and nebulous in character. In a progressing business goodwill tends to show progressive increase; and in a failing business it may begin to wane, (see CIT v. B.C Srinivasa Setty, [1981] 128 ITR 294 (SC)).

9. Considered on the above basis, the factual conclusions of the Tribunal cannot be held to be irrational. Therefore, the questions referred are answered in the affirmative, in favour of the Revenue and against the assessee.