Holding

Goodwill generated in a newly commenced business is not a capital asset within the meaning of section 45, and its transfer is not subject to capital gains tax.

Summary

The assessee, a partnership firm engaged in manufacturing agarbattis, was dissolved in 1965 and its goodwill was valued at Rs.1,50,000. The goodwill was transferred to a newly formed partnership of the same name. The Income‑Tax Officer did not tax any gain on this transfer, but the Commissioner invoked revisional jurisdiction and directed a fresh assessment to include capital gains under s.45 of the Income Tax Act, 1961. The Income Tax Appellate Tribunal and the Karnataka High Court held that the goodwill of a newly commenced business is not a capital asset within s.45 and therefore not taxable as a capital gain. On appeal, the Supreme Court affirmed this view, reasoning that goodwill generated in a new business cannot be treated as an asset having a cost of acquisition, and the computation provisions of s.48, 49, 50 and 55 cannot be applied. Consequently, the Court dismissed the appeals, holding that the transfer of such goodwill does not attract capital gains tax.

Issues considered

Whether goodwill generated in a newly commenced business qualifies as a 'capital asset' under section 45 of the Income Tax Act, 1961.
Whether the transfer of such goodwill gives rise to taxable capital gains under section 45.

Legislation cited

Income Tax Act, 1922s. 12B
Income Tax Act, 1961s. 2(14), s. 45, s. 48, s. 49, s. 50, s. 55

Subjects

goodwillcapital assetsection 45capital gains taxincome taxpartnership dissolutionintangible assetvaluation

Judgment

938

A COMMISSIONER OF INCOME TAX,
BANGALORE ETC. ETC.
v.
B. C. SRINIVASA SETTY, ETC. ETC.
February 19, 1981
:B
[P. N. BHAGWATI, V. D. TuLZAPURKAR AND R. S. PATHAK, JJ.]

Goodwill of a nett:ly conunenced business-Whether, (i) a capital asset and •
(ii) if so, an asset falling within the contemplation of section 45 of Income Tax
Acr, 1961 giving rise to a capital gain.

·C The assessee, a registered firm, manufactured and sold agarbattis. Clause
(13) of the Ins1ru1ncnt of Partnership executed on 28th of July, 1954 and
subsequently extenda~ by another instrument dated 31st March, 1964 showed
that the goodv; ill of the firm had not been valued, and the valuation would be
1

made on dissolntion of the partnership. The assessee firm was dissolved by a
deed dated 31st December, 1965. At the time of dissolution the goodwill of
the firm was valued at Rs. 1,50,000/-. A new partnership by the same name
io was constituted under an instrument subsequently and it took over all the assets
including the goodwill and liabilities of the dissolved firm. The Income Tax
Offieer made an assessment on the dissolved firm for the assessment year 1966-
67 but did not include any an1ount on account of the gains arising on transfer
of the goodwill. 'fhc Commissioner, being cf the view that the assessment
order was prejudicial to the Revenue, decided to invoke his revisional jurisdic-
tion and setting aside the assessment order directed the Incon1e Tax Officer to
E make a fresh assessment r1fter taking into account the capital gain arising on
the sale of the goodwill. The Income Tax Appellate Tribunal in appeal
accepted the contention of the assessee that the sale did not attract tax on capi...
ta! gains under section 45 of the Income Tax Act, 1961. The High Court o~
Karnataka on a reference, at the instance of the Commissioner of Income Tnix
affirmed the Tribunal's view and held that the value of the consideration receive-
ed by the assessee for the transfer of its goodwill was not liable to capit&l gains
f1 tax under section 45 of the Income Tax Act. Hence the three a'Jlpeals as to
the taxability of the transfer of the goodwill to capital gain tax.

Dismissing the appeals, the Court

HEID: 1. The gocxlwill generated in a newly commenced business cannot
be described as an asset within the terms of section 45 of the Income Tax Act,
·G 1961 and therefore its transfer i'l not subject to Income Tax under the head
"capit_al gains". [946 B-C]

2.1. Goodwill denotes the benefit arising from connection and reputation.
The benefit to the business varies with the nature of the business and also from
one business to another. No business commenced for the first time possesses
goodwill fronL the start. It is generated as the business. is carried on and may
•
be augmented with the passage of time. A variety of elements goes into its
ll
making, and its composition varies in different trades and in different businesses
in the same trade, and while one element may preponderate in one business, '•
another may dominate in another business. And yet because of its intangible
C.I.T, V. B. C. SRINIVASA 939

-natW'e, it remains insubstantial in form and nebulous in character. In a progres• A
·sing business goodwill tends to show progr~ive increase. And in a failing
business it may begin to wane. Its value may fluctuate from one moment to
another depending on changes in the reputation of the business. It is affected
by everything relating to the business, the personality and business rectitude of
the owners, the nature and character of the business, its name and reputation, ill
location, its impact on the contemporary inarket, the prevailing socio-economic
ecology, intrOOuction to old customers and agreed absence of competition. Thero B
can be no account in value of the factors producing it. It is also lillpossible to
predicate the moment of its birth. It comes silently into the world, unhearalded
• and unproclaimed and its impact may not be visibly felt for an undefined period.
Imperceptible at birth it exists enwrapped in a concept, growing or fluctuating
with the numerous imponderables pouring into, and affecting the business.
[942 F, H, 943 A, E-H, 944 Al
Crultwell v. Lye, 1810, 17 Ves 335; Churton v. Douglas, 1859 John 174;
c
Tregu v. Hun1, 1896 A.C. 7; Commissioner of Inland Revenue v. Muller &: Co.'s
Margarine Limited, [1901] A.C. 217. quoted with approval.
3.1. Section 45 of the Income Tax Act operates if there· is a transfer of a
· carital asset giving rise to a profit or gain. The expression "capital asset"
defmed in section 2 ( 14) to mean "property of any kind held by an assessee" is
of the widest amplitude and covers all kinds of property except the property D
expressly excluded by clauses (i) to (iv) of the sub-section which do not
include goodwill. [942 D-E]
3.2. Section 45 is a charging section, charging the profits or gains. arising

- from the transfer of a capital asset to income-tax, according to the detailed
provisions for computing the profits or gains under that head. The charging
section and the computation provisions together constitute an integrated code~
When there· is a case to which the computation provisions caonnot apply at all, E
it is e\'ident tha-t such a case was not intended to fall within the charging section.
(944 C, D-E]
3.3. The mode of computation and deductions set forth in section 48
provides the principal basis for quantifying the income chargeable under the
head "capital gains". Section 48 contemplates an asset in the acquisition of
which it is possible to envisage a co5t. The intent goes to the nature and F
character of the asset, that it is an asset which possesses the inherent quality of
being available on the expenditure of money to a person seeking to acquire it.
None of the provisions pertaining to the head "capital g~ins" suggests that they
·--4 include an asset in the acquisition of which no cost at all can be conceived.
[945 A, C-E]
3.4. The date of acquisition of the asset is a material factor in applying the
computation rrovisions perta-ining to capital gains. The "cost of acquisition" G
mentioned in section 48 ilnplies a date of acquisition, an inference as strengthen~
ed by the provi<iions of sections 49, 50 and sub-section (2) of section 55. If
the goodwill generated in a new business is regarded as acquired at a cost and
subsequently passes to an assessee in any of the modes specified in sub-section
• ( 1) of section 49, it v.·ill become necess~ry to determine the cost of acquisition
to the previous owner. I-laving regard to the nature of the asset, it will be
\IDpoosibTe- to determine such cost of acquisition. Nor can sub-section (3) of H
.ection 55 be nvoked, because the date of acquisition by the previous owner
•' · will remain unknown. [945 F-G, H. 946 A]
9~0 SUPREME COURT REPORTS [1981] 2 s.c.R.

A Commissioner of J,zcon1c-tax v. K. Rathnam Nadar, (1969) 71 I.T.R. 433-
(Mad.); Conunissioner of Income-tax v. Chunilal Prabhudas & Co., (1970) 76
l.T.R. 566 (Cal.); Jagdev Su1gh A1unuCk v. Comnlissioner oj Income-tax,
(1971) 81 I.T.R. 500 (Delhi); Commissioner of Income-tax v. E. C. Jacob,
(1973) 89 I.T.R. 88 (Kerala): c~on1missioner of Income-tax v. Honie IndustrfeJ
& Co., (1977) 107 l.T.R. 609 (Born.); Commissioner of Income-tax v. Michel
Postal, (1978) 112 I.T.R. 315 (Born.); Commissioner of Income-tax v. Jaswant
B Lal Dayabhai, (1978) 114 J.T.R. 798 (M.P.) approved.

Conunissioner of !11con1c-ta.l. v. Mohanbha1 Pamablzai, (1978) 91 I.T.R. 393
(Guj.); K. N. Daftary v. Conunissioner of !11con1e-tax (1977) 106 I.T.R. 998, •
overruled.

c CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1146 of 1975,
Appeal by Special Leave from the Judgment and order dated
4-7-1974 of the Karnataka High Court i'n l.T.R. No. 38/72.
CONNECTED WITH
Civil Appeal No. 1378 of 1976.
D
Appeal by Special Leave from the Judgment and Order dated
1-12-1975 of the Karnataka High Court in I.T.R.C. No, 32/74,

E
Civil Appeal No. 926 of 1973.
AND

From the Judgment and Order dated 2-11-1972 of the Kera!a
-
High Court in Income Tax Reference No. 120/70.
C.A. No. 1146/75.
Soli J, Sorabjee, Addi. Sol. General, B. B. Ahuja and Miss A.
Subhashini for the Appellant.
T. A. Ramachandran, B. Partha Sarathi and Miss R. Vaigai for
the Respondent.
K. K. Goswami, S. P. Mehta, Dinesh Vyas, P. H. Par~kh, C. B.
Singh, Miss Vineeta Caprihan and B. L. Verma for the intervener.
C.A. No. 1378/76.
G
Soli J. Sorabjee, Addi- Sol. General, B. B. Ahuja and Miss A.
Subhashini for the Appellant.
Vineet Kumar and A. K. Srivastava for the Respondent. •
C.A. No. 926/73.
H
V. S. Desai, K. C. Dua and Miss A. Subhashini for the Appellant. .. '•
A. S. Nambiar and P. P. Namboodiri for the Respondent,
c.I.T. v. B. c. SRINIVASA (Pathak, J.) 941

The Judgment of the Court was delivered by A
PATHAK, J.-The question in these appeals is whether the transfer
of the goodwill of a newly commenced business can give rise to a
capital gain taxable under s. 45, Income Tax Act, 1961.
The assessee, a registered firm, mo nufactured and sold agarbattis.
B
Clause ( 13) gf the Instrument of Partnership executed on 28th July,
• 1954 showed that the goodwill of the firm had not been valued, and
the valuation would be made ou dissolution of the partnership. The
period of the partnership was extended by an instrument dated 31st
March, 1964, and it contained a similar clause (13). Subsequently,
the assessee firm was dissolved by a deed dated 1st December, 1965. c
At the time of di~solution, it seems, the goodwill of the firm was valued
at Rs. 1,50,000/-. A new partnership by the same name was cons-
tituted under an instrument dated 2nd December, 1965 and it took
overall the assets, including the goodwill, and liabilities of the dis-
solved firm.
D
The Income-Tax Officer made an assessment on the dissolved firm
for the assessment year 1966-67 but did not include any amount on
account of the gain arising on transfer of the goodwill. The Com-
• missioner, being of the view that the assessment order was prejudicial
to the Revenue, decided to invoke his revisional jurisdiction and setting
aside the assessment order directed the Income-Tax Officer to make E
a fresh assessment after taking into account the capital gain arising
on the sale of the goodwill.
In appeal before the Income Tax Appellate Tribunal, the assessee
maintained that the sale did not attract tax on capital gains nnder
s. 45 of the Income-Tax Act, 1961. Accepting the contention, the p
Tribunal allowed the appeal. At the instance of the Commissioner
of Income-Tax it referred a question of law to the High Court of
Karnataka which, as reframed by the High Court, reads as follows
"Whether, on the facts and in the circumstances of the
case, the Tribunal was right in holding that no capital gains
can arise under s. 45 of the Income Tax Act, 1961 on the G
traasfer by the assessee firm of its goodwill to the newly con-
stituted firm ?"
•' By its judgment dated 4th July, 1974 the High Court answered the
question in the affirmative, holding that the value of the consideration
j received by the assessee for the transfer of its goodwill was not liable H
• to capital gains tax under s. 45 of the Act. Civil Appeal No. 1146
of 1975 is directed against that judgment.
942 SUPREME COURT REPORTS [1981] 2 S.C.R.

A Civil Appeal No. 1378 of 1976 arises out of a judgment by !he
same High Qmrt in which it has followed its earlier view.
Civil Appeal No. 926 of 1973 has been preferred against tl1e
judgment of the Kerala High Court where a similar opinion has been
expressed, but in respect of the provisions of s. 12-B, Indian Income
B Tax Act, 1922.
At the relevant time s. 45, Income Tax Act, 1961 provided :
•
"45.(1) Any profits or gains arising from the transfer of
a capital asset effected in the previous year shall, save as
otherwise provided in sections 53 and 54, be chargeable to
c income-tax under the head "Capital gains", and shall be
deemed to be the income of the previous year in which the
transfer took place."
The section operates if there is a transfer of a capital asset giving
rise to a profit or gain. _The expression "capital asset" is defined in
D s. 2 (14) to mean "property of any kind held by an assessee". It is
of the widest amplitude, and apparently covers all kinds of property
except the property expressly excluded by clauses (i) to (iv) of the
sub-section which, it will be seen, do not include goodwill. But the
definitions in s. 2 are subject to an overall restrictive clause. That
-
is expressed in the opening words of the section : "unless the context
E otherwise requires". We must therefore enquire whether contextu-
ally s. 45, in which the expression "capital asset" is used, excludes
goodwi!l.
Goodwill denotes the benefit arising from connection and reputa-
tion. The original definition by Lord Eldon in Cruttwell v. Lye(')
F that goodwill was nothing more than "the probability that the old cus-
tomers would resort to the old places" was expanded by Wood V. C.
in Churton_ v. Douglas(') to encompass every positive advantage "that
has been acquired by the old firm in carrying on its business, whether
connected with the premises in which the business was previously
carried on or with the name of the old firm, or with any other matter
G
carrying with it the benefit of the business". In Trego v. Hunt(')
Lord Herschell described goodwill as a connection which tended to
become permanent because of habit or otherwise. The benefit to the
•
business varies with the nature of the busine.ss and also from one busi-
ness to another. No business commenced for the first time possesses
------
B (1) 1810 17 Yes 335. •'
(2) 1859 John 174.
(3) 1896 A.C. 7.
C.I.T. V, B. c. SRINIVASA (Pathak, J.) 943

goodwill from the start. It is generated as the business is carried on
and may be augmented with the passage of time. Lawson in hiS
"Introduction to the Law of Property'' describes it as property of a
highly peculiar kind. In Commissioner of Income-tax, West Bengal
Ill v. Chunilal Prabhudas & Co.,(') the Calcutta]ligh Court reviewed
the different approaches to the concept :
B.
"It has been horticulturally and botanically viewed as "a
seed sprouting" or an "acorn growing into the mighty oak of
• goodwill". It has been geographically described by locality.
It has been historically described by locality. It has been
historically explained as growing and crytallising traditions
in the business. It has been described in terms of a magnet c
as the "attracting force". In terms of comparative dynamics,
goodwill has been described as the "differentfail return of
profit". Philosophically it has been held to be intangible.
Though immaterial, it is materially valued. Physically and
psychologically, it is a "habit" and sociologically it is a
"custom". Biologically, it has been described as Lord Mac- D·
naghten in Trego v. Hunt as the "sap and life" of the busi-
ness. Architecturally, it has been described as the "cement"

- binding together the business and its assets as a whole and a
going and developing concern."

E
A variety of elements goes into its making, and its composition varies
in different trades and in different businesses in the same trade, and
while one element may preponderate in one business,. another may
dominate in another business. Amd yet because of its intangible nature,
it remains insubstantial in form and nebulous in character. Those
features prompted Lord Macnaghten to remark in Commissioner of
Inland Revenue v. Muller & Co.'s Margarine Limited(') that although
goodwill was easy to describe, it was nonetheless difficult to define.
In a progressing business goodwill tends to show progressive increase.
And in a failing business it may begin to wane. Its value may fluc-
tuate from one moment to another depending on changes in the reputa-
tion of the business. It is affected by everything relating to the busi- G
ness, the personality and business rectitude of the owners, the nature
and character of the business, its name and reputation, its location, its
impact on the contemporary market, the prevailing socio-economic
• ecology, introducton to old customers and agreed absence of competi-
' tion. There can be no account in value of the factors producing it. It
is also impossible to predicate the moment of its birth. It comes silently
{ (I) [1970] 76 J.T.R. 566.
(2) [1901] A.C. 217.
-
944 SUPREME COURT REPORTS [1981] 2 S.C.R.

into the world, unheralded and unproclaimed and its impact may not
be visibly felt for an undefined period. Imperceptible at birth it exists
enwrapped in a concept, growing or fluctuating with the numerous im-
ponderables pouring into, and affecting, the business. Undoubtedly,
it is an asset of the business, but is it an asset contemplated by s. 45 ? i
Section 45 charges the profits or gains arising from the transfer of
a capital asset to income-tax. The asset must be one which falls
within the contemplation of the section. It must bear that quality
which brings s. 45 into play. To determine whether the goodwill of a
new business is such an asset, it is permissible, as we shall presently
• I
show, to refer to certain other sections of the head, "Capital gains".
Section 45 is a charging section. For the purpose of imposing the
cbarge, Parliament has enacted detailed provisions in order to compute
the profits or gains under that head. No existing principle or provision
at variance with them can be applied for determining the chmgeable •
D
profits and gains. All transactions encompassed by s. · 45 must fall
under the governance of its computation provisions. A transaction to
which those provisions cannot be 11pplied must be regarded as ncYer in-
tended by s. 45 to be the subject of the cbarge. This inference flows
-
from the general arrangement of the provisions in the Income-tax Act,

E
where under each head of income the charging provision is accompanied
by a set of provisions for computing the income subject to that charge.
The character of the computation provisions in each case bears a
-
relationship to the nature of the charge. Thus the charging section and
the computation provisions together constitute an integrated code. When
there is a case to which the computation provisions cannot apply at all,
it is evident that such a case was not intended to fall within the charging ,
section. Otherwise one would be driven to conclude that while a cer-
tain income seems to fall within the charging section there is no scheme

-
1·==
of computation for quantifying it. The legislative pattern discernible
in the Act is against such a conclusion. It must be borne in mind that I
~ J
the legislative intent is presumed to run uniformly through the entire
conspectus of provisions pertaining to each head of income. No doubt ii
there is a qualimtive difference between the charging provision and a
G computation provision. And ordinarily the operation of the charging
provision cannot be affected by the construction of a particular compu-
tation provision. But the question here is whether it is possible to
apply the computation provision at all if a certain interpretation is
pressed on the charging provision. That pertains to the fundamental •
integrality of the statutory scheme provided for each head. '
H
The point to consider then is whether if the expression "asstt" in \
s. 45 is construed as including the goodwill of a new business, it is

;
C.l.T. v. B. C. SRINIVASA (Pathak, J.) 945

possible to apply the computation sections for quantifying the profits A
and gains on its transfer.

The mode of computation and deductions set forth in >. 48 provide
the principal basis for quantifying the income chargeable under the
head "Capital gains". The section provides that the income charge-
able under that had shall be computed by deducting from the full value B
of the consideration received or accruing as a result of the transfer of
,, the capital asset :
• "(ii) the cost of acquisition of the capital asset ...... "
What is contemplated i~ an asset in the acquisition of which 1! "
possible to envisage a cost. The intent goes to the nature and character c
of the asset, that it is an asset which possesses the inherent quality of
being av-ailable on the expenditure of money to a person seeking to
acquire it. It is immaterial that although the asset belongs to such a
class it may, on the facts of a certain case, be acquired without the
payment of money. That kind of case is covered by s. 49 and its cost, D
for the purpose of s. 48 is dctedmined in accordance with those provi-
sions.. There are other provisions which indicate that s. 48 is concerned
with an asset capable of acquisition at the cost. S. 50 is one such provi-
sion. So also is sub-section (2) of s.55. None of the provisions per-
taining to the head "Capital gairis" suggests that they include an asset
in the acquisition of which no cost at afl can be conceived. Yet there E
are assets which are acquired by way of production in which no cost
element can be identified or envisaged. From what has gone before, it
is apparent that the goodwill generated in a new business has been so
regarded. The elements which create it have already been detailed. In
such a case, when the asset is sold and the consideration is brought to
F
tax, what is charged is the capital value of the asset and not any profit
or gain.
In the case of goodwill generated in a new business there is the
further circumstance that it is not possible to detennine the date when
it comes into existence. The date of acquisition of the asset is a. mate-
rial factor in applying the computation provisions pertaining to capital G
gains. It is possible to say that the "cost of acquisition" mentioned in
s. 48 implies a d1te of acquisition, and that inference is strengthened by
the provisions of ss. 49 and 50 as well as sub-section (2) of s.55.
It may also be noted that if the goodwill generated in a new busi-
• ne!! is regarded as acquired at a cost and subsequently passes to an 8
assessec in any of the modes specified in sub-section ( 1) of s. 49, it will
{ become necessary to determine the cost of acquisition to the provious
owner. Having regard to the nature of the aseet, it will be impossible
Il-214 SCl/81
'946 'llPREME COURT REPORTS [1981] 2 S.C.R. _

A tn dc<crmine such cost of acquisition. Nor can sub-section (3) of s. 55
bl' invoked, because the date of acquisition by the previous owner will
remain unknown.

We arc of opinion that the goodwill generated in a newly com-
menced business cannot be described as an ""asset" within the terms of
s. "45 and therefore its transfer is not subject to income-tax under the
head "Capital gains".

The question which has been raised before us, has been considered
by some High Courts, and it awears that there is a conflict of opinion.
The Madras High Court in Commissioner of Income-tax v. K. Rathnam
c Nadar( 1), the Calcutta High Court in Commissioner of Income-tax v.
Chunilal Prabhudas & Co., (supra) the Delhi High Court in Jagdev
Singh Mumick v. Commissioner of Income-tax('), the Kerala High
Court in Commissioner of Income-tax v. E. C. Jacob('), the Bombay
High Court in the Commissioner of Income-tax v. Home Industries &
D Co.(4) and Commissioner of Income-tax v. Michel Postal(•) and the
Madhya Pradesh High Court in Commissioner of Income-tax v. Jaswant
Lal Dayabhai( 6 ) have taken the view that the receipt on the transfer
of goodwill generated in a busiuess is not subject to income-tax as a
capital gain. On the other side lies the view taken by the Gujarat High
Court in Commissioner of Income-tax v. Mohanbhai Pamabhai( 7 ) and
E the Calcutta High Court in K. N. Daftary v. Commissioner of Income-
tax(8) that even if no cost is incurred in building up the goodwill of
the business, it is nevertheless a capital asset for the purpose of capital
gains, and the cost of acquisition being nil the entire runount of sale
proceeds relating to the goodwill must be brought to tax under the head
"Capital gains". It is apparent that the preponderance of judicial
opinion favours the view that the transfer of goodwill initially generated
in a business does not give rise to a capital gain for the purposes of
income-tax.

Upon the aforesaid considerations, Civil Appeal No. 1146(T) of
1975 and Civil Appeal No. 1378 of 1976 must be dismissed.
G
(1) [19691 71 J.T.R. 433.
(2) [1971] 81 J.T.R. 500.
(3) [1973] 89 J.T.R. 88. •
(4) [19771 107 J.T.R. 609. •
(5) [19781 112 I.T.R. 315
(6} [1978] 114 J.T.R. 798.
(7) [19781 91 J.T.R. 393.
(8) [1977] 106 J.T.R. 998.
C.J.T. v. B. c. SRINIVASA (Pathak, J.) 94 7

Civil Appeal No. 926 of 1973 raises the same question with refe- A
rence to s. 12B, lndian Income Tax Act, 1922. As the relevant statu-
tory provisions of the Indian Income Tax Act, 1922 are substantially
·similar to the corresponding provisions of the Income Tax Act, 1961,
that appeal is also liable to be dismissed.
Accordingly, the appeals are dismissed with costs. B

• S.R. Appeals dim1isscd.

J
•