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Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • S.C Deb
  • Dipak Kumar Sen, JJ.
Acts
  • section 21(1) of the Tanganyika Income-tax (Consolidation) Ordinance
  • section 23A(1) of the Indian Income-tax Act, 1922, as the section
  • 2(iv)(a) to section 23A of the Indian Income-tax Act, 1922.24.
  • section 66(1) of the Indian Income-tax Act, 1922,
  • section 12B of the Indian Income-tax Act, 1922,
  • section 23A of the Indian Income-tax Act, 1922.
  • English Companies Act of 1948. Clause 27(1)(b)
  • section 211 of the Indian Companies Act,
  • section 2(6A) of the Income-tax Act.
  • INCOME TAX ACT
  • Act (Companies Act, 1948, Sch. VIII)
  • COMPANIES AMENDMENT ACT
  • COMPANIES ACT 1956
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Cites
Cited by
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • S.C Deb
  • Dipak Kumar Sen, JJ.
Acts
  • section 21(1) of the Tanganyika Income-tax (Consolidation) Ordinance
  • section 23A(1) of the Indian Income-tax Act, 1922, as the section
  • 2(iv)(a) to section 23A of the Indian Income-tax Act, 1922.24.
  • section 66(1) of the Indian Income-tax Act, 1922,
  • section 12B of the Indian Income-tax Act, 1922,
  • section 23A of the Indian Income-tax Act, 1922.
  • English Companies Act of 1948. Clause 27(1)(b)
  • section 211 of the Indian Companies Act,
  • section 2(6A) of the Income-tax Act.
  • INCOME TAX ACT
  • Act (Companies Act, 1948, Sch. VIII)
  • COMPANIES AMENDMENT ACT
  • COMPANIES ACT 1956
See more information ...
Smart Summary

Comprehensive Summary of the Court's Opinion (Reference under section 66(1) of the Indian Income-tax Act, 1922)

Factual and Procedural Background

This reference arose under section 66(1) of the Indian Income-tax Act, 1922, concerning Bird & Co. (Private) Ltd. for the assessment years 1955-56, 1958-59, 1959-60 and 1960-61. The company was a private limited company that acted as managing agents for several companies.

In each assessment year the assessee declared dividends at percentages not less than those normally required under section 23A, but the declared dividends fell short of an enhanced statutory percentage which would apply if accumulated profits and reserves (including amounts capitalised from earlier reserves) exceeded either paid-up capital plus loan capital or the actual cost of fixed assets (whichever was greater). For computation the assessee treated goodwill as a fixed asset and valued it at original cost.

The Income-tax Officer (ITO) disallowed that approach: (a) holding goodwill to be an intangible (not a fixed) asset for this purpose and (b) holding that write-offs from goodwill (and associated reductions) depleted reserves/accumulated profits, thereby triggering the enhanced statutory dividend percentage and additional surtax. The Appellate Assistant Commissioner reversed on some points (holding goodwill a fixed asset and treating certain write-offs differently). The assessee appealed to the Tribunal which (a) held reductions in goodwill were justified on the facts and therefore the write-offs did not form part of accumulated profits and reserves; (b) held goodwill to be a fixed asset; and (c) dealt with whether write-offs were legitimate business expenditure and whether larger dividends could reasonably have been distributed. The Department and the assessee each advanced arguments further in the present reference to this court.

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case, the goodwill of the assessee-company constituted a "fixed asset" within the meaning of proviso (b) to section 23A(1) of the Indian Income-tax Act, 1922 (assessment year 1955-56) and within the meaning of Explanation 2(iv)(a) to section 23A (assessment years 1958-59, 1959-60 and 1960-61)?
  2. Whether, on the facts and in the circumstances of the case, the amounts written off from goodwill account by debiting capital reserve account and profit and loss account constituted "reserves representing accumulations of past profits" (proviso (b) to section 23A(1)) or "accumulated profits and reserves" (Explanation 2(iv)(a) to section 23A) for the respective assessment years?
  3. Whether the write-off of goodwill made in each of the relevant accounting periods was a legitimate business expenditure for the purpose of determining commercial profits (assessment years 1958-59, 1959-60 and 1960-61)?
  4. If the answer to question 3 is affirmative, whether the Tribunal was right in holding that having regard to the commercial profits a larger dividend than that declared by the company could reasonably have been distributed?

Arguments of the Parties

Revenue's Arguments (as presented by Mr. B.L. Pal)

  • Relied on the decision in Commissioner of Income-tax v. Chunilal Prabhudas & Co. [1970] 76 ITR 566 (Cal) to argue that goodwill should not be held to be a "capital asset" (in consequence, suggesting no question of it being a "fixed asset" arose for section 23A purposes).
  • Contended that amounts written off from goodwill (debited to capital reserve and profit & loss accounts) depleted accumulated profits and created secret reserves, so that enhanced statutory dividend percentages applied.
  • Sought to challenge the factual finding that the goodwill had in fact depreciated at the rates shown in the balance-sheet, and argued that the annual deduction of Rs. 5 lakhs for writing off goodwill was ad hoc and not established as actual depreciation.

Assessee's Arguments (as presented by Mr. Kalyan Roy and Mr. Ray)

  • Asserted that goodwill was properly treated as a fixed asset and valued at original cost for the relevant computations; reductions in book value were motivated by commercial reasons (Companies Amendment Bill and anticipated cessation of managing agencies) rather than tax avoidance.
  • Placed valuation reports (including valuers' reports tendered in wealth-tax proceedings) before the authorities to show market values consistent with the reduced book values; submitted that book value did not fall below certain valuer-determined figures in the years under appeal.
  • Contended that the write-offs were justified on factual evidence of depreciation and, even if the Rs. 5 lakhs charged yearly could not be treated as legitimate business expenditure, they should be regarded as capital loss which must be considered when deciding whether a larger dividend could reasonably have been distributed.
  • Invoked the Supreme Court decision in Commissioner of Income-tax v. Gangadhar Banerjee and Co. (P.) Ltd. [1965] 57 ITR 176 (SC) (and the earlier Williamson Diamonds authority) to argue that capital losses must be taken into account in assessing the reasonableness of dividends.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Bombay Cycle & Motor Agency Ltd. v. Commissioner of Income-tax [1964] 54 ITR 358 (Bom) Held that where a company writes off goodwill and does not add back the amount to accumulated profits/reserves, those profits applied in writing off goodwill cannot be treated as still forming part of accumulated profits or reserves for sec. 23A(1), proviso (b). The Tribunal followed this Bombay High Court principle and the court accepted that principle; it supported the view that amounts written off from goodwill did not form part of accumulated profits and reserves when the write-offs were justified.
Commissioner of Income-tax v. Chunilal Prabhudas & Co. [1970] 76 ITR 566 (Cal) Held, in the context of section 12B (capital gains), that goodwill failed the test of a "capital asset" for that section's purposes and should not be treated as a capital asset under that context. Relied on by the revenue to argue goodwill was not a capital/fixed asset. The court distinguished this decision: it observed Chunilal's ruling was in the limited context of section 12B and did not lay down that goodwill could never be a capital asset in the context of other provisions (such as section 23A).
K.N. Daftary v. Commissioner Of Income-Tax, West Bengal [1977] 106 ITR 998 (Cal) The Bench of this court had occasion to consider Chunilal's decision. Cited to note that Chunilal was considered previously by this Bench and to support the conclusion that Chunilal does not preclude treating goodwill as a capital/fixed asset under other sections.
R.C. Cooper v. Union of India [1970] 40 Comp Cas 325, 385 (SC) Described goodwill as an intangible asset: "the whole advantage of the reputation and connections formed with the customers together with the circumstances making the connection durable." Cited to support the proposition that goodwill is an intangible asset of business and to support the court's conclusion that goodwill can be a fixed asset for the purposes of section 23A.
Devidas Vithaldas & Co. v. Commissioner of Income-tax [1972] 84 ITR 277, 286 (SC) Stated that acquisition of goodwill is acquisition of a capital asset and purchase price is capital expenditure. Cited by the court to support the view that goodwill may properly be regarded as a capital asset (and, by implication, as capable of being a fixed asset for the statutory scheme under consideration).
Commissioner Of Income-Tax v. Lothian Jute Mills Co. Ltd. [1967] 66 ITR 630 (Cal) Considered whether depreciation (or similar provisions) constituted a reserve; held that amounts written off or retained for depreciation are not to be included in reserves as per the balance-sheet form and Schedule provisions. Cited by this court to support the proposition that amounts written off (for depreciation of goodwill) are not necessarily reserves; used in concluding that write-offs debited to profit & loss and capital reserve did not constitute accumulated profits and reserves for sec. 23A purposes.
Commissioner Of Income-Tax, Calcutta v. Sri Bibhuti Bhusan Dutt [1963] 48 ITR 233 (Cal) Held in that case that a depreciation fund shown as a reserve formed part of accumulated profits under section 2(6A) because the company had created such a reserve and was bound by its act. Cited as a contrasting authority; the court noted that where a company itself shows a fund as a reserve it may be bound thereby, but relied on Lothian Jute Mills and the statutory form to hold depreciation/write-offs cannot generally be treated as reserves.
Commissioner of Income-tax v. Gangadhar Banerjee and Co. (P.) Ltd. [1965] 57 ITR 176 (SC) Approved the principle (from Williamson Diamonds) that capital gains or losses are relevant and should be taken into account when considering the reasonableness of dividends declared. The Tribunal applied this principle in relation to assessment year 1957-58 (allowing the assessee's appeal for that year). The court accepted the principle and used it to hold that the Tribunal erred when it considered only commercial profits (ignoring capital loss) in concluding a larger dividend could reasonably have been distributed.
Commissioner of Income-tax v. Williamson Diamonds Ltd. [1959] 35 ITR 290 (PC) Concluded that, in construing a statute analogous to sec. 23A, one must consider all matters relevant to "unreasonableness" of dividend distribution; capital losses are among relevant matters. Cited by the court (via Gangadhar Banerjee) to support the position that capital losses must be considered in assessing whether distribution of a larger dividend would be reasonable.

Court's Reasoning and Analysis

The court proceeded by addressing each question in light of statute, precedent and the factual findings of the Tribunal.

  1. On whether goodwill is a "fixed asset" under section 23A (and Explanation 2(iv)(a)): the court surveyed authorities and statutory practice. It observed that Chunilal Prabhudas & Co. had held goodwill was not a capital asset for purposes of section 12B, but the court constrained that holding to the context of section 12B and refused to generalise it to other provisions. The court relied on and cited: (a) R.C. Cooper's description of goodwill as an intangible asset; (b) Devidas Vithaldas which treated acquisition of goodwill as acquisition of a capital asset; (c) treatises (Buckley on Companies Acts and Halsbury) and the Companies Act schedule and balance-sheet form treating goodwill under "fixed assets." On this composite basis the court concluded that goodwill in this case constituted a fixed asset within the meaning of Explanation 2(iv)(a) to section 23A.
  2. On whether write-offs from goodwill (debited to capital reserve and profit & loss) constituted accumulated profits/reserves for the purpose of raising the enhanced statutory dividend percentage: the court examined the legal meaning of "reserves" under companies law and prior authorities. It relied on Bombay Cycle & Motor Agency (Bom) and Lothian Jute Mills (Cal) which held that amounts applied in writing off goodwill or held for depreciation, if not left in accumulated profits/reserves by the company, cannot be treated by the tax authorities as still forming part of accumulated profits/reserves. The court noted the Tribunal had found, as a fact, that reductions in goodwill were justified and that the finding had not been challenged as perverse or unsupported by evidence. Given that factual finding and the cited principles, the court held the write-offs did not constitute accumulated profits or reserves.
  3. On whether the write-offs were legitimate business expenditure and whether the Tribunal was right to conclude a larger dividend could reasonably have been distributed: the Tribunal had found that the assessee had debited Rs. 5 lakhs each year as write-off of goodwill and had held that this was not legitimate business expenditure, thereby increasing commercial profit for dividend-reasonableness computations. The court noted that the Tribunal itself had accepted on facts that goodwill had depreciated at the rates claimed and had accepted the assessee's audited accounts. More importantly, the court emphasised the binding principle from Gangadhar Banerjee (and the Williamson Diamonds reasoning) that capital gains or losses are relevant to the assessment of whether distribution of a larger dividend would be unreasonable. The court found substance in the assessee's contention that capital loss (the write-off/depreciation) had to be taken into account; consequently the Tribunal erred in considering commercial profits alone and ignoring capital loss when concluding that a larger dividend could reasonably have been distributed.
  4. The court therefore combined legal principle and unchallenged factual findings: (a) goodwill is a fixed asset for section 23A purposes on the authorities and statutory practice cited; (b) properly justified write-offs do not remain part of accumulated profits/reserves for sec. 23A computations; and (c) capital losses must be considered when assessing the reasonableness of dividend distributions, so ignoring them rendered the Tribunal's conclusion on reasonable distributable dividend incorrect.

Holding and Implications

Holding (core rulings):

  • Question No. 1 for the assessment year 1955-56: answered in the affirmative — the goodwill of the assessee constituted a fixed asset within the meaning of proviso (b) to section 23A(1) as it stood.
  • Question No. 2 for the assessment year 1955-56: answered in the negative — amounts written off from goodwill by debiting capital reserve account and profit and loss account did not constitute "reserves representing accumulations of past profits" within proviso (b) to section 23A(1).
  • Questions Nos. 1 and 2 for assessment years 1958-59, 1959-60 and 1960-61: the court answered these questions identically to the above (i.e., goodwill is a fixed asset; the write-offs did not constitute accumulated profits/reserves).
  • The court declined to answer Question No. 3 for the assessment years 1958-59, 1959-60 and 1960-61.
  • The court reframed Question No. 4 for those assessment years (asking whether, having regard to commercial profits, a larger dividend could reasonably have been distributed) and answered it in the negative — in favour of the assessee — because the Tribunal erred in ignoring capital loss when reaching its conclusion on distributable dividend.
  • There will be no order as to costs.

Implications (direct effects and scope):

  • Direct effect on the parties: the answers favour the assessee on the principal contested points — goodwill is to be treated as a fixed asset for the purposes of section 23A calculations in these years, and the amounts written off from goodwill (where the write-offs were justified on the facts) are not to be treated as accumulated profits or reserves for triggering enhanced mandatory dividend percentages. The Tribunal's approach of taking commercial profits alone (ignoring capital loss) to decide that a larger dividend could reasonably have been paid was overturned.
  • Scope and precedent: the court expressly limited the reach of Chunilal Prabhudas & Co. to the context of section 12B (capital gains) and declined to adopt it as a general proposition that goodwill can never be a capital/fixed asset for all provisions. The court applied and reaffirmed established principles from Bombay Cycle & Motor Agency, Lothian Jute Mills and the Supreme Court authorities cited on relevance of capital losses in dividend reasonableness. The opinion does not announce an expansive new legal doctrine beyond its application to the facts and questions referred.

Final note: The court returned its answers in favour of the assessee on the principal questions and recorded that there would be no order as to costs. Deb, J. concurred with the judgment of Dipak Kumar Sen, J.

Show full summary ...

    Commissioner Of Income-Tax, Central, Calcutta v. Bird And Co. (P.) Ltd.

    The Judgment of the Court was delivered by

    Dipak Kumar Sen, J.:— In this reference under section 66(1) of the Indian Income-tax Act, 1922, the following questions have been referred:

    Assessment year 1955-56

    “1. Whether, on the facts and in the circumstances of the case, the goodwill of the assessee-company constituted a ‘fixed asset’ within the meaning of proviso (b) to section 23A(1) of the Indian Income-tax Act, 1922, as the section stood at the relevant time?

    2. Whether, on the facts and in the circumstances of the case, the amounts written off from goodwill account by debiting capital reserve account and profit and loss account constituted ‘reserves representing accumulations of past profits’ within the meaning of proviso (b) to section 23A(1) of the Indian Income-tax Act, 1922?”

    Assessment years 1958-59, 1959-60 and 1960-61

    “1. Whether, on the facts and in the circumstances of the case, the goodwill of the assessee-company constituted a ‘fixed asset’ within the meaning of Explanation 2(iv)(a)to section 23A of the Indian Income-tax Act, 1922?

    2. Whether, on the facts and in the circumstances of the case, the amounts written off from goodwill account by debiting capital reserve account and profit and loss account constituted ‘accumulated profits and reserves’ within the meaning of Explanation 2(iv)(a)of section 23A of the Indian Income-tax Act, 1922?

    3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that in determining the commercial profits the write off of goodwill made in each of the relevant accounting periods was not a legitimate business expenditure?

    4. If the answer to question No. 3 is in the affirmative, whether the Tribunal was right in holding that having regard to the commercial profits a larger dividend than that declared by the company could reasonably have been distributed?”

    2. The facts found as appearing in the statement of the case and the annexures thereto can be shortly stated as follows:

    The relevant assessment years are 1955-56, 1958-59, 1959-60 and 1960-61, the corresponding previous years being the preceding calendar years. Bird & Co. (Private) Ltd., the assessee, is a private limited company and had been the managing agents of several companies.

    3. In each of the assessment years in question the assessee had declared dividends. Such dividend was not less than sixty per cent. of its distributable surplus for the assessment years 1955-56, 1958-59 and 1959-60 and not less than sixty-five per cent. thereof for the assessment year 1960-61 as normally required under section 23A of the Indian Income-tax Act, 1922. But such declared dividend fell short of the enhanced statutory percentage also laid down by the said section 23A. Under the said section the enhanced statutory percentage being 100% for the assessment year 1955-56 and 95% for the other assessment years was applicable where the accumulated profits and reserves (including the amounts capitalised from the earlier reserves) representing accumulation of past profits which had not been the subject of an order under section 23A(1) exceeded either the aggregate of the paid up capital and loan capital or the actual cost of the fixed assets, whichever was the greater.

    4. On the computation of the assessee in each of the assessment years in question the aggregate of its reserves and accumulated profits did not exceed the cost of its fixed assets and hence the assessee claimed exemption for higher statutory percentage.

    5. For such computation the assessee treated its goodwill to be a fixed asset and the value of such goodwill was taken at the original cost.

    6. In proceedings under section 23A the Income-tax Officer held that goodwill of the assessee was an intangible asset and could not be considered to be a fixed asset. Even otherwise he held the cost of the goodwill could not be taken at its original value ignoring the amounts written off from time to time. By such write-off the reserve and accumulated profits were found to have been depleted and thereby secret reserves were created. On such basis the Income-tax Officer held that the cost of the fixed assets of the assessee was not more than the aggregate of the reserves and accumulated profits and, further, such reserves and accumulated profits exceeded the paid up capital excluding bonus capital created out of profits and gains not subjected to the provisions of section 23A. He held that the assessee was liable to distribute dividend at the enhanced statutory percentage and levied additional surtax in each of the assessment years.

    7. The assessee appealed to the Appellate Assistant Commissioner. In disposing of the appeals the Appellate Assistant Commissioner held that goodwill was a fixed asset. He further held that to the extent the goodwill of the assessee was reduced by debiting the profit and loss account, the same could not be held to be nor did the same constitute a reserve. But he found that in the assessment year 1954-55 when the goodwill was written off to the extent of Rs. 30,00,000 a corresponding reduction was made in the capital reserve account on the liabilities side of the balance-sheet. He held that as the said amount had been treated as a reserve all along and in the assessment year in question though the same was deducted from the goodwill it still constituted reserve within the meaning of section 23A.

    8. He held, however, that the other amount of Rs. 22,00,000 debited in the profit and loss account of the assessee at the rate of Rs. 3 lakhs each year really came out of accumulated profits which was available for debiting against the goodwill. In the premises, he held that this amount should also be treated as accumulated profits for the purposes of the said section 23A.

    9. On such basis, he held that the accumulated profits and reserve including the amounts capitalised from the earlier reserves representing accumulations of past profits exceeded the actual cost of fixed assets in all the assessment years and the enhanced statutory percentage of 90% and 100% were applicable for the purpose of distribution of dividend. The orders of the Income-tax Officer passed under section 23A were confirmed.

    10. Being aggrieved by this appellate order the assessee went up on further appeal before the Tribunal. It was contended before the Tribunal on behalf of the assessee that there was sufficient evidence to indicate that the market value of the goodwill became lower than the balance-sheet value and that such evidence had been duly placed before the Appellate Assistant Commissioner. The Companies (Amendment) Bill was introduced on the 2nd September, 1953, when there was a recommendation that all managing agencies should cease by the 15th August, 1959. In view of the said Bill the directors of the assessee prudently scaled down the book value of the goodwill by Rs. 30 lakhs in that very year. The sole motive for the reduction in the value of the goodwill was the Companies (Amendment) Act, and there was no tax evasion nor even any tax avoidance angle to it. The subsequent annual reductions in value of the goodwill were also similarly motivated.

    11. It was further contended that the report of the valuers in the wealth-tax assessment of the assessee has also been tendered as evidence. For the assessment year 1957-58, the original two valuers had submitted different reports whereupon the matter was referred to a third valuer and the latter fixed the value of such goodwill for that particular year at Rs. 7 lakhs. For the next assessment year 1958-59, the unanimous valuation of such goodwill was Rs. 6 lakhs. It was submitted that in none of the years under appeal had the book value of the assessee's goodwill had fallen below that figure.

    12. The Tribunal held that the reduction in the book value of the goodwill was not without justification, and was, therefore, not open to challenge on that ground at least upon and including the assessment year 1960-61, the last of the five assessment years in issue.

    13. Following the principles laid down by the Bombay High Court in Bombay Cycle & Motor Agency Ltd. v. Commissioner of Income-tax [1964] 54 ITR 358 (Bom), the Tribunal further held that, as the reduction in the value of the goodwill was not without justification, the amounts written off from the goodwill account did not form part of the accumulated profits and reserves of the assessee in the respective assessment years.

    14. A new ground of appeal, viz., that having regard to the financial position, the declaration of a larger dividend would have been unreasonable, was also urged on behalf of the assessee before the Tribunal. The Tribunal found that, except for the assessment year 1955-56, the dividends exceeded the available surplus (as computed by the assessee) in all the years. The Tribunal, however, found that the commercial profit had been worked out by the assessee after charging a sum of Rs. 5 lakhs towards the writing off of the goodwill in each of the years. The Tribunal held that this was not a legitimate business expenditure. According to the Tribunal the commercial profit had to be enhanced by Rs. 5 lakhs in each of the assessment year in question and, in that view, there was no paucity of profits in the said assessment years except the year 1957-58. For the said assessment year 1957-58, the contentions of the department were that the capital loss for that year had not been proved and, secondly, the same being a capital loss should not be taken into account for the purpose of declaration of dividend. The Tribunal rejected the above contentions of the department and accepted the accounts of the assessee which were found to have been duly audited and passed. Following the decision of the Supreme Court in the case of Gangadhar Banerjee [1965] 57 ITR 176 (SC), the Tribunal held that capital gains or losses had to be taken into account in deciding the reasonableness of the dividend declared. The Tribunal held that the declaration of a larger dividend for the said assessment year 1957-58 would have been unreasonable and allowed the appeal for that year only.

    15. The department, in the appeal to the Tribunal, had also challenged the decision of the Appellate Assistant Commissioner that the goodwill of the assessee was a fixed asset. The Tribunal followed one of its earlier decisions and upheld the order of the Appellate Assistant Commissioner on this point. A decision of this court in the case of Commissioner of Income-tax v. Chunilal Prabhudas & Co. [1970] 76 ITR 566 (Cal) was cited before the Tribunal in support of the contentions of the department. The Tribunal found that the law laid down in that case did not apply to the facts and circumstances of the case before it.

    16. In the present reference before us, Mr. B.L Pal, learned counsel for the revenue, contended in respect of question No. 1 (for the assessment year 1955-56, as also the assessment years 1958-59, 1959-60 and 1960-61), that in view of the decision of this court in the case of Commissioner of Income-tax v. Chunilal Prabhudas & Co. [1970] 76 ITR 566 (Cal) referred to earlier, goodwill should not be held to be even a capital asset and, therefore, no question arose whether it was a fixed asset or not. He relied on the following passage from the judgment of P.B Mukharji J., as he then was (page 571).

    “But the question then finally boils down to this: whether goodwill is a ‘capital asset’ within the meaning of section 12B of the Indian Income-tax Act, 1922, read with section 2(4A) of the Act. In order to be taxable capital gain within the meaning of section 12B of the Income-tax Act, there has to be four primary tests, namely, (1) profit or gain, (2) capital asset, (3) arising out of and (4) sale, exchange and relinquishment or transfer.

    It is difficult to apply these tests to the case of goodwill. Goodwill fails in the test of capital asset. To begin with, goodwill is not any kind of usual capital asset with which a business is started. It is not a capital asset which can be divided into parts, fragments or fractions or entered on the stock book or register of capital assets nor can it, like capital asset, exist independently without the business itself and have any value apart from business usually associated with capital asset. Unlike capital assets goodwill as an asset is indivisible and cannot be sold, transferred or dealt with in fragments or fractions. On the interpretation of section 2(4A), section 2(4C) and section 12B and on their express words and tenor, goodwill does not come within the obvious meaning of capital asset. To bring goodwill within the meaning of capital asset and make it taxable would be to tax by implication or by analogy or by a forced and artificial construction.”

    17. This Bench had occasion to consider the above decision of this court in I.T.R Reference No. 5 of 1972 (K.N Daftary v. Commissioner Of Income-Tax, West Bengal. [1977] 106 ITR 998 (Cal)). In Chunilal's case [1970] 76 ITR 566 (Cal) goodwill was considered in the context of section 12B of the Indian Income-tax Act, 1922, and it was held that goodwill did not fall and was not intended to be brought within the ambit of the said section. It does not appear to us that it was laid down in Chunilal's case [1970] 76 ITR 566 (Cal) that goodwill should not be held to be a capital asset in the context of other sections of the Income-tax Act.

    18. In the case of R.C Cooper v. Union of India [1970] 40 Comp Cas 325, 385 (SC) the Supreme Court observed as follows:

    “Goodwill of a business is an intangible asset: it is the whole advantage of the reputation and connections formed with the customers together with the circumstances making the connection durable.”

    19. In the case of Devidas Vithaldas & Co. v. Commissioner of Income-tax [1972] 84 ITR 277, 286 (SC) the Supreme Court again observed as follows:

    “Acquisition of the goodwill of the business is, without doubt, acquisition of a capital asset, and, therefore, its purchase price would be capital expenditure. It would not make any difference whether it is paid in a lump sum at one time or in instalments distributed over a definite period.”

    20. Mr. Kalyan Roy, learned counsel on behalf of the assessee, cited a passage from the well-known treatise, Buckley on the Companies Acts, 13th edition, at page 967, as follows:

    “The Act (Companies Act, 1948, Sch. VIII) contains no definition of ‘fixed assets’ or ‘current assets’, but these terms must be intended to cover every kind of asset and to be mutually exclusive, so that every kind of asset which is not ‘fixed’ is ‘current’ and vice versa. An indication of the nature of ‘fixed assets’ may be gained from para. 5 and of ‘current assets’ from para. 11(7). Semble, any asset, such as stock-in-trade, cash, expendable stores and book debts, liable to be realised, expended or turned over in the ordinary course of the company's business is a ‘current asset’, whereas assets of a capital nature, such as the company's premises, plant machinery, investments and goodwill, are ‘fixed assets’.”

    21. In Halsbury's Laws of England, third edition, volume 6, at page 397, the law as prevailing in England is stated as follows:

    “Fixed capital.— Part of the capital of a company may consist of fixed capital and part of circulating capital. By fixed capital is meant that capital which a company retains in the shape of assets upon which the subscribed capital has been expended and which assets either themselves produce income independently of any further action by the company, or, being retained by the company, are made use of to produce income or gain profits… Good will is also part of the fixed capital.”

    22. Coming to the Companies Act, 1956, the statutory form of the balance-sheet set out in Part I of Schedule VI to the said Act has, under the heading “assets” a sub-heading “fixed assets”. It is stated that the items under this sub-heading should be distinguished as far as possible between expenditure upon, (a) “goodwill”, and (b) “land”, etc. From this it appears that so far as the law relating to companies in India is concerned, the statute also recognises goodwill to be a fixed asset.

    23. In such view of the law as noted above we hold that the goodwill of the assessee in the instant case constituted a fixed asset within the meaning of Explanation 2(iv)(a) to section 23A of the Indian Income-tax Act, 1922.

    24. On question No. 2 which has been raised for all the assessment years, Mr. Pal could not cite any authority supporting the contentions of the revenue. Nor could he distinguish the decision of the Bombay High Court in the case of Bombay Cycle & Motor Agency Ltd. v. Commissioner of Income-tax [1964] 54 ITR 358, 381 (Bom). In that case the Bombay High Court observed as follows:

    “……the company, if it wanted to bring back the goodwill as an asset on the balance-sheet of the company, would have been entitled to add the amount of profits applied in writing off the goodwill back to its accumulated profits or reserves, but it would be for the company to do so. If the company does not choose to do so and keeps the profits applied in writing off the goodwill as so applied, it will not be possible for anyone else to regard the said profits as still forming part of the accumulated profits or reserves. What the provision of section 23A(1), proviso (b), has asked the income-tax authorities to determine is to find out the accumulated profits and reserves which exist as accumulated profits or reserves. What is adjusted out of the profits cannot be regarded as still forming part of either the accumulated profits or reserves.”

    25. Nor could Mr. Pal distinguish the decision of this court in the case of Commissioner Of Income-Tax v. Lothian Jute Mills Co. Ltd. [1967] 66 ITR 630 (Cal). In this case the identical question arose in the calculation of accumulated profits and reserves of a company. G.K Mitter J., as he then was, dealt with the question whether depreciation was really a reserve created out of profits. He held as follows (page 636):

    “Under section 211 of the Indian Companies Act, the balance-sheet of the company has to be prepared in the form prescribed in Schedule VI. The heads of reserve there shown are: ‘(1) capital reserves, (2) capital redemption reserve, (3) share premium account, (4) other reserves specifying the nature of each reserve and the amount in respect thereof, (5) surplus i.e, balance in profit and loss account after providing for proposed allocations, namely, dividend, bonus or reserves, (6) proposed additions to reserves, and (7) sinking funds’. Depreciation does not find a place there but in Part III, clause 7(1)(b), the expression ‘reserve’ shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability. It would, therefore, appear that a provision for depreciation was not to be included in any reserves. We find a similar provision in Schedule VIII, Part IV, of the English Companies Act of 1948. Clause 27(1)(b) gives the same interpretation of ‘reserve’ as is to be found in our Companies Act. Mr. Pal drew our attention to the case of Commissioner Of Income-Tax, Calcutta v. Sri Bibhuti Bhusan Dutt. [1963] 48 ITR 233 (Cal) where a portion of the profits of a company was set apart for meeting depreciation of the fixed assets and this depreciation fund was added to year after year and was shown as a reserve in the balance-sheet. There it was held that it formed part of the accumulated profits for the purpose of section 2(6A) of the Income-tax Act. It was said in that case that the assessee might not have created a reserve fund in respect of the depreciation but having done so, it was bound by its own act. If the company is not obliged to show depreciation in its balance-sheet by way of reserves and indeed ought not to do so under the form prescribed by section 211, depreciation cannot be considered in the context of reserves.”

    26. Mr. Pal next sought to argue within the ambit of the question that, in any event, the amount of rupees five lakhs which had been deducted every year from the profit and loss account on account of depreciation of goodwill was an ad hoc calculation and that it has not been found as a fact that the goodwill of the assessee was in fact depreciating at the rate per year.

    27. It appears to us that it is no longer open to the revenue to raise this contention. From the order of the Tribunal in the instant case the revenue sought to raise an additional question as follows:

    “Whether, on the facts and in the circumstances of the case, there was evidence before the Tribunal to show that the goodwill of the assessee-company was going down and that the assessee was justified in reducing the value of goodwill to the extent it did?”

    28. The Tribunal did not allow that question to be raised and held as follows:

    “From the facts set out by us it is clear that the finding of the Tribunal that the value of goodwill of the assessee was declining from year to year and that the assessee was justified in reducing the value of the goodwill as appearing in the balance-sheet to the extent they did, was a decision arrived at solely with reference to the facts. No question of law arises therefrom and as such we decline to refer this question.”

    29. It appears to us that it has been now found as a fact that the goodwill of the assessee depreciated at a rate as shown in the balance-sheet and that finding has not been challenged either as being perverse or being based on no evidence. As such, we cannot accept the contentions of Mr. Pal. We hold that the amounts written off from goodwill account by debiting the capital reserve account and the profit and loss account do not constitute accumulated profits and reserves as contended on behalf of the revenue.

    30. Questions Nos. 3 and 4 were raised at the instance of the assessee. Mr. Ray, on behalf of the assessee, did not seriously press question No. 3 as the Tribunal itself had found as a fact that the goodwill had depreciated as the rates claimed by the assessee. The Tribunal had accepted the accounts of the assessee.

    31. Mr. Ray submitted that if the said sum of rupees five lakhs debited each year from the profit and loss account could not be treated as a legitimate business expenditure, still the same represented capital loss so far as the assessee was concerned and it had to be taken into account in determining whether the dividends distributed was reasonable or otherwise. Mr. Ray pointed out that the decision of the Supreme Court in the case of Commissioner of Income-tax v. Gangadhar Banerjee and Co. (P.) Ltd. [1965] 57 ITR 176 (SC) was in fact cited before the Tribunal and the Tribunal duly noted the propositions laid down in the decision, including the proposition that capital gains or losses should be taken into account in deciding the reasonableness of the dividends declared.

    32. Mr. Ray submitted that in any view of the matter the depreciation of the dividend for the said three assessment years had to be taken into account either as a business expenditure to be debited from the profit or loss account or as purely capital loss.

    33. In the case of Commissioner of Income-tax v. Gangadhar Banerjee and Co. (P.) Ltd. [1965] 57 ITR 176 (SC) the Supreme Court approved the law as laid down by the Judicial Committee in the case of Commissioner of Income-tax v. Williamson Diamonds Ltd. [1959] 35 ITR 290, 297 (PC). In that case, the Judicial Committee had construed section 21(1) of the Tanganyika Income-tax (Consolidation) Ordinance which is in pari materia with section 23A of the Indian Income-tax Act, 1922. Their Lordships of the Judicial Committee observed as follows (page 297):

    “The form of the words used no doubt lends itself to the suggestion that regard should be paid only to the two matters mentioned, but it appears to their Lordships that it is impossible to arrive at a conclusion as to reasonableness by considering the two matters mentioned isolated from other relevant factors. Moreover, the statute does not say ‘having regard only’ to losses previously incured by the company and to the smallness of the profits made. No answer, which can be said to be in any measure adequate, can be given to the question of ‘unreasonableness’ by considering these two matters alone. Their Lordships are of the opinion that the statute by the words used, while making sure that ‘losses and smallness of profits’ are never lost sight of, requires all matters relevant to the question of unreasonableness to be considered. Capital losses, if established, would be one of them.”

    34. We find that there is substance in the contentions of Mr. Roy and we hold that the Tribunal erred in holding that a larger dividend than that which had been declared by the assessee could reasonably have been distributed having only in view the commercial profits and ignoring the capital loss incurred.

    35. By reason of our findings as above, we answer the questions as follows:

    Question No. 1 for the assessment year 1955-56 is answered in the affirmative and in favour of the assessee. Question No. 2 for the same assessment year is answered in the negative and also in favour of the assessee.

    Questions Nos. 1 and 2 for the assessment years 1958-59, 1959-60 and 1960-61 are identical to the questions referred to above and are answered accordingly.

    36. We decline to answer question No. 3 for the assessment years 1958-59, 1959-60 and 1960-61.

    37. As we have declined to answer question No. 3, we reframe the question No. 4 for the said assessment years as follows.

    “Whether the Tribunal was right in holding that having regard to the commercial profits a larger dividend than that declared by the company could reasonably have been distributed?”

    38. So far as reframed question No. 4 for these assessment years are concerned, we have already held that the Tribunal erred in considering only the commercial profits ignoring the capital loss incurred. To that extent this question is answered in the negative and in favour of the assessee.

    39. We return our answers accordingly.

    40. There will be no order as to costs.

    Deb, J.:— I agree.

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    Commissioner Of Income-Tax, Central, Calcutta v. Bird And Co. (P.) Ltd.
    (Jul 28, 1975)