COMMISSIONER OF INCOME TAX V. EPHORIC PHARMACEUTICALS ANKLESHWAR PVT. LTD.

ITR/22/2001

AI Insights

The case revolves around the valuation of goodwill and the taxability of a sum received from the transfer of technical knowhow by Ephoric Pharmaceuticals Ankleshwar Pvt. Ltd. The Commissioner of Income Tax challenged the decisions of the CIT(A) and the Tribunal, which had upheld the valuation of goodwill at Rs. 1,60,00,000 as determined by the assessee's registered valuers and deleted the addition of Rs. 78,65,000 related to technical knowhow. The High Court examined whether the Tribunal's decisions were legally sound and based on proper valuation methods and legal principles.

• Counselvise Citation: [2014] 140 COUNSELVISE.COM (IT) 733254 (HC-GUJARAT)
• Appeal Type: Others
• Pronouncement Date: 13-10-2014
• Assessment Year: misc
• Other Referred Cases: Balkrishna V. Doshi vs. ITO, ITO vs. S.C.A. (P) LTD., DY. CIT vs. GUJARAT SMALL INDUSTRIES CORPORATION, DY. CIT vs. G.S.I.C.
• Laws Referred To: Income-tax Act
• Result in Favour of: Others
• Court: HIGH COURT
• Department Lawyers: TEJ SHAH
• Assessee Lawyers: K M PARIKH
• Keywords: Capital receipt; Departmental Valuer; Registered Valuer; Technical Knowhow; Goodwill valuation
• Section: 143(3); 250; 263

Judgement Text

"O/ITR/22/2001 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE NO. 22 of 2001 FOR APPROVAL AND SIGNATURE: HONOURABLE MR.JUSTICE KS JHAVERI and HONOURABLE MR.JUSTICE K.J.THAKER ================================================================ 1 Whether Reporters of Local Papers may be allowed to see the judgment ? 2 To be referred to the Reporter or not ? 3 Whether their Lordships wish to see the fair copy of the judgment ? 4 Whether this case involves a substantial question of law as to the interpretation of the Constitution of India, 1950 or any order made thereunder ? 5 Whether it is to be circulated to the civil judge ? ================================================================ COMMISSIONER OF INCOME TAX....Applicant(s) Versus EPHORIC PHARMACEUTICALS ANKLESHWAR PVT. LTD.....Respondent(s) ================================================================ Appearance: MR KM PARIKH, ADVOCATE for the Applicant(s) No. 1 MR TEJ SHAH, ADVOCATE for the Respondent(s) No. 1 ================================================================ CORAM: HONOURABLE MR.JUSTICE KS JHAVERI and HONOURABLE MR.JUSTICE K.J.THAKER Page 1 of 11 O/ITR/22/2001 JUDGMENT Date : 13/10/2014 ORAL JUDGMENT (PER : HONOURABLE MR.JUSTICE KS JHAVERI) Pursuant to the directions of this Court vide order dated 24.9.1998, the following questions of law arising out of the order of the Tribunal dated 15.10.1996 in ITA No. 2979 of 1993 for Assessment Year 1987-88 are referred for the consideration of this Court: “1. Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the value of goodwill determined by the registered valuers viz. M/s. S.I. Mogul & Co., at Rs. 1,60,00,000/- is fair and reasonable instead of restoring the matter back to the A.O. to decide the issue after getting the departmental valuer’s report? 2. Whether, on the facts and in the circumstances of the case, the Tribunal is justified in upholding the findings of the CIT(A) in deleting the addition made on account of technical knowhow of Rs. 78,65,000/-? 2. The assessee company was incorporated on 19.3.1976 and was carrying on business of manufacturing and selling of pharmaceutical formulations. Original assessment was made on 29.3.1990 under Section 143(3) of the Act and total income was determined at Rs. 75,02,179/-. 3. Thereafter, CIT(A) vide order dated 15.11.1990 set Page 2 of 11 O/ITR/22/2001 JUDGMENT aside the assessment order on the issue of determination of income in respect of Rs. 79,15,000/- received by the assessee from transfer of technical knowhow. The CIT, Baroda, passed an order under Section 263 of the Income-tax Act and directed the Assessing Officer to examine the taxability of the whoe or part of the amount of Rs. 1,60,00,000/- received by the assessee on transfer of goodwill. In consequence to the directions given by the CIT(A) and CIT, Baroda, the Assessing Officer had passed order under Section 143(3) read with Section 250 and Section 263 of the Income-tax Act. In the said order the Assessing Officer concluded that instead of value of Rs. 160 lakh shown by the assessee, value of goodwill was concluded at Rs. 64,37,000/-. 4. With regard to the issue of technical knowhow, the Assessing Officer concluded that for the reasons that the assessee has been incurring losses right from its inception the cost of development of products and the use of expertise, was estimated at Rs. 50,000/- which included the expenses incurred by the assessee in connection with the obtaining and transfer of drug licences for the manufacture of drugs. 5. The assessee filed appeal before the CIT(A) who held that in respect of goodwill, the method adopted by the Registered valuer was in consonance with the law. The Assessing Officer had not referred the matter to the valuation cell. The Assessing Officer was directed to accept the valuation of goodwill at Rs. 1,60,00,000/-. The CIT(A) further held that the acquisition of technical knowhow did not cost the assessee something in terms of money and directed the Assessing Officer to delete the addition of Rs. 78,65,000/- to the total income on account of the amount received on technical knowhow. . Page 3 of 11 O/ITR/22/2001 JUDGMENT 6. On further appeal, at the instance of the revenue, the Tribunal upheld the findings of the CIT(A) on both the issues and dismissed the revenue’s appeal. Hence the above questions of law are referred for the opinion of this Court. 7. Learned counsel Mr. Parikh for the applicant has taken us to the orders of the Assessing Officer, CIT(A) as well as the Tribunal. He has also taken us to both the round of litigation and thereafter contended that the view taken by the Tribunal is not correct. He submitted that the Tribunal instead of accepting the value determined the the Registered Valuer, ought to have referred the matter to the department’s valuer. 8. Learned counsel for the respondent has submitted that the Tribunal is right in upholding the decision of CIT(A) and therefore the same is not required to be interfered with. 9. We have heard learned counsel for the parties. We have gone through the report as well as the reasoning of the Tribunal. The findings recorded by the Tribunal so far as the first question is concerned, are as under: “para 6 - We have considered the rival submissions and perused the facts on record. The assessee company transferred its Unit II to its 100% subsidiary viz. E.D.O.P. for a consideration of Rs. 4,65,90,306/- out of which Rs. 1,60,00,000/- was claimed as the value of goodwill. The claim of the assessee was supported by the report of the Registered Valuers M/s. S.I. Mogul & Co., of Bombay. In the original order the Assessing Officer accepted this value. In the revised order passed in pursuance of the directions of the C.I.T. under Section 263, the A.O. Assumed the role of the valuer and determined the value of the goodwill at Rs. 64,27,000/-. So the main contention of the revenue that there would not be goodwill for a Page 4 of 11 O/ITR/22/2001 JUDGMENT newly started business, does not survive before us. The only issue before us is whether the value of such goodwill is Rs. 1,60,00,000/- or Rs. 64,37,000/-. The question of determining the value of goodwill was referred to an Expert viz. M/s. S.I. Mogul & Co., Bombay and the Expert has worked out the value of the goodwill by applying accepted principles of accountancy i.e. the value of expected super profits over a certain number of years. In advanced accounting by Batliboi 16th Edition at pages 807 and 808 the method of valuation of goodwill has been explained as under: `Before, therefore, it can be said that a particular business has an exchangeable value of goodwill attached to it, it must be seen that the annual profits which that business is expected to earn in the future will exceed the normal return on the capital invested, with due regard to the nature of the risk involved. In other words, while determining the value of goodwill, the purchaser has mainly to ascertain as to what future annual super profit he can reasonably expect from the business he wishes to acquire, and for this purpose, super profit may be defined as the amount by which the future profits of any undertaking are likely to exceed a normal rate of interest as would ordinarily be earned in a like business. The first step towards, arriving at a fair exchangeable value of goodwill is to ascertain the net annual earnings of the business. For this purpose, it would not be safe to take the net earning of any one normal year, but to find out after a careful and exhaustive investigation of the books of accounts, the average net annual earnings on the basis of the past three to five years. From the Page 5 of 11 O/ITR/22/2001 JUDGMENT average net profits arrived at, there should be deducted interest at least 6 per cent on the capital outlay involved in the carrying on of the business, and a sum as would cover the proprietor’s services to the business, if the same has not been charged against the profits, in the past. The prospective purchaser having thus ascertained the probable net annual income to be derived from the business he is out to take over, must next determine how much of such income represents an excess over what would be deemed to be a fair return on the capital outlay involved on the acquisition of such business with due regard to the risks involved. The purchase price of goodwill thus resolves itself into the value of expected super profits over a certain number of years, that is, profits in excess of a reasonable return on the amount invested in the acquisition of the net tangible assets (i.e. assets minus liabilities) of the business. The only question then remains to be settled is for the purchaser to come to an agreement with the vendor as to the number of years for which such excess shall be paid for. The number of years, purchase also varied considerably, but this will mostly depend on the expectation of the business likely to yield similar results in the future to what it did in the past. Thus, the price to be paid for goodwill is at best a matter of negotiation between the buyer and the seller and also dependent on the form of purchase consideration, that is, whether it is to be paid for in cash or kind.’ In Dymond’s Death Duties (14th Edition) at pages 613-14 the learned Author observed as under: Page 6 of 11 O/ITR/22/2001 JUDGMENT `With business of a substantial size, there are two common ways of computing the goodwill value, viz. the “super profits” method and the “total capitalisation” method, the two methods which are complementary and may often be used as a check upon each other, and which may theoretically give the same results may conveniently be illustrated by an example (the figures given are purely illustrative and not to be regarded as any indication of the appropriate yields in any particular case). In each case it is necessary to estimate the probable amount of the future profits (after making a reasonable allowance for management remuneration.’ In Advanced Accounting by M.C. Shukla, T.S. Garewal and S.C. Gupta (third Reprint of Twelfth Revised and Enlarged Edition) the nature of goodwill and valuation thereof has been explained as under: `Goodwill may be defined as the value of the reputation of a business house in respect of profits expected in future over and above the normal level of profits earned by undertakings belonging to the same class of business. (Chapter 20, page 1). `One must realise at the very outset that when one acquires a firm and its goodwill, one is hoping to earn good profits in the future. If, for any reason, it is evident that profits in future will be low, one will not pay much for goodwill perhaps one will decline to acquire the firm itself. Good past profits are not relevant except to the extent they point to the possibility of earning good profits in the future also. ‘ Chapter 20, page 3. One who pays for goodwilll can look only to the future Page 7 of 11 O/ITR/22/2001 JUDGMENT profits. Hence, the business will be thoroughly examined to see what special advantage it is in possession of and which of then are likely to continue with the change in ownership and passage of time. The attempt is to establish the future maintainable profits.” From the above extracts from the standard books of accountancy, it is evident that expected super profits method of valuation of goodwill is an accepted method. This method was adopted by the Hon’ble Patna High Court in the case of DASS & CO. (supra); a part of quotation that we have extracted from Batliboi’s book was also quoted with approval. The above method was also adopted by the Hon’ble Madras High Court in the case of K.A. Subramaniam (supra) following the judgement of the Patna High Court in the case of DASS & CO. (supra). The said method has also been accepted as the correct method for valuation of good will by the Hon’ble Calcutta High Court in the case of C.E.D. Vs. BISWANATH RUNGTA (supra). Para – 7 We find that the Registered Valuers of the assessee adopted the method of “expected super profits” which was in consonance with the accepted methods of accountancy and principles of law. The A.O. On the other hand, rejected this detailed report without any cogent reasons and proceeded to value the goodwill by adopting the method which is contrary to the accepted principles of accountancy and the settled principles of law. It is noteworthy that the A.O. Accepted the report of the Registered Valuers in the original order without referring this issue of valuation to the Departmental Valuation Officer and even when the case was restored to him by Page 8 of 11 O/ITR/22/2001 JUDGMENT the CIT u/s. 263, he did not refer the case to the Departmental Valuation Officer and adopted his own method and arrived at erroneous conclusions. We accordingly hold that the value of goodwill determined by the Registered Valuers viz. M/s. S.I. Mogul & Co., Rs. 1,60,00,000/- being based on accepted method of accountancy and settled principles of law, is fair and reasonable and accordingly, we uphold the findings of the CIT(A). This ground fails and is accordingly dismissed.” 10. So far as question No. 2 is concerned, the facts are that the assessee company received a sum of Rs. 79,15,000/- on transfer of technical knowhow. It was claimed that the amount represented capital receipt that technical knowhow was acquired in the course of day to-day business and the assessee had not paid anything to acquire such an asset. The A.O. was of the opinion that the assessee might have incurred some expenses on acquisition of such technical knowhow. He estimated such expenses at Rs. 1,00,000/- in the original assessment order but later on when the matter restored to him by the then CIT(A), he estimated such expenses at Rs. 50,000/- and worked out long term capital gains at Rs. 78,65,000/- (Rs. 79,15,000/- - Rs. 50,000/-). The assessee preferred appeal to CIT(A) who relying on the decision of the Tribunal in the case of BALKRISHNA V. DOSHI VS. ITO (1986) 24 TTJ (Ahd) 424 and ITO Vs. S.C.A. (P) LTD. (1980) 4 Taxman 568 (Bom) deleted the addition. The Tribunal upheld the findings of the ld. CIT(A). The Tribunal has given its reasoning at paragraph No. 12 which is reproduced as under: “We have considered the rival submissions and perused the facts on record. We accept the assessee’s plea that technical knowhow was generated in the course of day Page 9 of 11 O/ITR/22/2001 JUDGMENT to-day business operations of the assessee company. It did not separately pay for acquiring this capital asset. The ratio laid down by the Tribunal in the case of BALKRISHNA V. DOSHI VS. ITO (24 TTJ 424); ITO VS. S.C.A. (P) LTD. (4 Taxman 568) and DY. CIT VS. GUJARAT SMALL INDUSTRIES CORPORATION (supra), will squarely apply to the facts of the present case. In the latest decision reported in DY. CIT VS. G.S.I.C. (supra), the Tribunal has held as under: `The technical know how is obviously a capital asset. The price realised on sale of capital asset would be a capital receipt. The only facts certain expenses for calender years 1968 and 1969 of research section had been allowed as deduction. It is not brought on record by the ITO as to what was the nature of those expenses which had been allowed and what amount has been allowed. If they represented salary and over head expenses, nothing would turn on said facts. Beside, the technical know how had developed in the course of time. It had not been acquired by the assessee by paying any specific price. It was not stock in trade of the assessee; the assessee was not a dealer in this item. It has, therefore, been held that there was no cost of this asset and it could not be therefore liable to capital gain tax.’ Respectfully following the above observations of the Tribunal, we decline to interfere and uphold the finding of the CIT(A). This ground fails and is dismissed.” 11. We have carefully perused the order of the Tribunal. The Tribunal after considering the relevant case laws on goodwill and after taking into consideration whether goodwill is property or not, has given its reasoning in its order. We are of Page 10 of 11 O/ITR/22/2001 JUDGMENT the opinion that the goodwill which was assessed by the valuer in scientific method. There was no substitute opinion by any competent officer. In that view of the matter, the Tribunal has not committed any error in dismissing the appeal. Though the matter was once remanded to the A.O. to refer to Departmental Valuation Officer but the A.O. without referring the matter to the Departmental Valuation Officer, made addition. Therefore, in our opinion, the Tribunal has not committed any error in deleting the addition. The appeal is dismissed accordingly and we answer the question against the revenue and in favour of the assessee. (K.S. JHAVERI, J.) (K.J. THAKER, J) (pkn) Page 11 of 11 "