Transfer Of Non-Self Generated Goodwill At Book Value; No Tax Can Be Levied Despite Withdrawal Of Tax Exemption: ITAT

The Bench of V. Durga Rao (Judicial Member) and G. Manjunatha (Accountant Member) held that if the goodwill is acquired by incurring cost and is not self-generated, and if after considering the cost incurred, the capital gains on transfer of the said goodwill amounts to 'nil', then even after invoking Section 47A(3) of the Income Tax Act, there can be no liability with respect to capital gains on conversion of the proprietary concern into a company .

M/s. Univercell Telecommunications, a sole proprietary concern, was converted into a Private Limited Company (assessee company) - M/s. Univercell Telecommunications India Pvt. Ltd. and all the assets and liabilities of the proprietary concern were transferred to the said assessee company. During the course of the assessment proceedings, the Assessing Officer (AO) opined that the transfer of assets and liabilities of the proprietary concern on conversion is exempted under Section 47(xiv) of the Income Tax Act. However, the AO noted that the owner of the proprietary concern had transferred its shares in the assessee company within a period of five years from the date of transfer of the assets to the assessee company, and thus there was a violation of the conditions prescribed under Section 47(xiv)(b). Thus, the AO invoked Section 47A of the Income Tax Act, assessed the difference between the assets and liabilities of the assessee company as long term capital gains and made additions to the income of the assessee company.

Against this, the assessee company filed an appeal before the Commissioner of Income Tax (Appeals) (CIT(A)). The CIT(A) noted that after considering the cost incurred towards creation of the brand value, the capital gains on transfer of the goodwill became 'nil' and hence, there was no capital gain on transfer of the said goodwill at book value to the assessee company. Thus, the CIT(A) deleted the additions made by the AO. The revenue department filed an appeal before the ITAT, challenging the order of the CIT(A).

The revenue department submitted before the High Court that in order to be exempted from capital gains tax on conversion of a proprietary concern into a Private Limited Company, the assessee company should satisfy certain conditions as provided under Section 47(xiv) of the Income Tax Act.

The department pointed that in view of Section 47(xiv)(b) of the Income Tax Act, the sole proprietor is mandated to retain not less than 50% of the shares in the successor company for a period of five years from the date of transfer of the proprietary concern.

The department averred that the owner of the proprietary concern, by transferring his shareholding in the assessee company within five years from the date of transfer of the proprietary concern, had violated the provisions of Section 47(xiv)(b) of the Income Tax Act.

Hence, the department argued that the provisions of Section 47A(3) of the Income Tax Act would come into operation and thus, the capital gains on conversion must be taxed in the hands of the assessee company.

The assessee company, while admitting that certain conditions prescribed under Section 47(xiv)(b) of the Income Tax Act were violated, contended that all assets and liabilities of the proprietary concern were transferred at book value on its conversion into a Private Limited Company and hence, no capital gains could be said to arise.

Section 47A(3) of the Income Tax Act provides that where any of the conditions laid down in the proviso to Section 47(xiv) are not complied with, the profits or gains arising from the transfer of capital assets which are not charged as capital gains by virtue of the exemption provided under Section 47(xiv), shall be chargeable to tax as profits and gains of the successor company.

The ITAT noted that since the conditions mentioned in Section 47(xiv)(b) were not complied with, hence, the exemption granted on transfer of capital assets under Section 47(xiv) must be withdrawn in view of Section 47A(3) of the Income Tax Act.

However, the Tribunal held that even after invoking the provisions of Sections 47A(3), there can be no liability of capital gains on conversion of the proprietary concern into the assessee company, in view of the fact that all assets and liabilities of the proprietary concern, including the goodwill, were transferred to the assessee company at book value.

The ITAT took into account that the goodwill of the proprietary concern was not self-generated and that it was created by the proprietary concern, with certain expenditure being incurred for generation and creation of the goodwill in its books of accounts.

"From the above, it is very clear that even if you invoke the provisions of Sec.47A(3) of the Act, to withdraw exemption granted u/s.47(xiv)(b) of the Act, but, in principle there cannot be any capital gains on transfer of goodwill, because, said goodwill is not self-generated or created on account of conversion of proprietary concern into a Pvt. Ltd. Co., but acquired by incurring cost. If you consider cost incurred by the assessee for acquiring goodwill, then, capital gains on transfer of said goodwill would come to 'nil' amount. The Ld.CIT(A) after considering the relevant facts has rightly deleted the additions made by the AO.", the Tribunal held.

Hence, the ITAT dismissed the appeal of the revenue department.

Case Title: Dy. Commissioner of Income Tax versus M/s. Univercell Telecommunications India Pvt. Ltd.

Dated: 07.09.2022 (ITAT Chennai)

Representative for the Appellant/ Revenue Department: Mr. AR.V. Sreenivasan, Addl. CIT

Representative for the Respondent/ Assessee: Mr.Shrenik Chordia, CA

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