Transfer of non-self-generated goodwill to book value; No tax can be levied despite the withdrawal of the tax exemption: ITAT

The Chennai Bench of the Income Tax Appeal Tribunal (ITAT) ruled that where goodwill is acquired by way of expense and transferred at its book value, no tax may be levied on the transfer of goodwill despite the removal of the tax exemption capital gains tax on the conversion of a sole proprietorship into a corporation, for breach of the conditions under section 47(xiv)(b) of the Income Tax Act 1961.

The panel of V. Durga Rao (judicial member) and G. Manjunatha (accounting member) considered that if goodwill is acquired by incurring costs and is not self-generated, and if after reviewing the costs incurred, the plus- disposal values ​​of said goodwill amounts to “nil”, so even after invoking Section 47A(3) of the Income Tax Act, there can be no liability to with respect to capital gains on the conversion of the owner business into a corporation.

Ms. Univercell Telecommunications, a proprietary business, was transformed into a Limited Liability Company (Assessed Company) – M/s. Univercell Telecommunications India Pvt. ltd. and all assets and liabilities of the heritage business have been transferred to said transferee company. During the valuation process, the valuation agent (AO) considered that the transfer of the assets and liabilities of the owner company upon conversion is exempt under section 47 (xiv) of the Income Tax Act. However, the AO noted that the owner of the heritage business had transferred his shares in the appraised company within five years from the date of the transfer of the assets to the appraised company, and therefore there was violation of the conditions prescribed by Article 47(xiv)(b). So the AO invoked Section 47A of the Income Tax Act, assessed the difference between the assets and liabilities of the assessed company as long-term capital gains and made additions to the income of the assessed company.

Against this, the assessed company filed an appeal with the Commissioner of Income Tax (Appeals) (CIT(A)). The CIT(A) noted that after taking into account the cost incurred for the creation of the value of the brand, the capital gain on the sale of the goodwill became “nil” and that there is therefore no there was no capital gain on the sale of said goodwill at book value to the assessed company. Thus, the CIT(A) deleted the additions made by the AO. The tax authorities filed an appeal with the ITAT, challenging the CIT(A) order.

The Revenue Department argued in the High Court that in order to be exempt from capital gains tax when converting from a proprietary business to a limited liability company, the assessed company must meet certain conditions set out in Section 47 (xiv) of the Income Tax Act. .

The department pointed out that, in view of section 47(xiv)(b) of the Income Tax Act, the sole proprietor is required to retain at least 50% of the shares of the successor company for a period five years from the date of transfer of the heritage operation.

The ministry claimed that the owner of the owner company, by transferring his interest in the valued company within five years from the date of the transfer of the owner company, violated the provisions of article 47 (xiv) (b) the Income Tax Act.

Therefore, the Department argued that the provisions of Section 47A(3) of the Income Tax Act would come into force and therefore the conversion gains should be taxed between the hands of the assessed company.

The valued company, while admitting that certain conditions prescribed under Section 47(xiv)(b) of the Income Tax Act have been breached, maintained that all assets and liabilities of the company owner were transferred at book value upon its conversion to a limited liability company. and therefore no capital gain can be said to occur.

Section 47A(3) of the Income Tax Act provides that where any of the conditions set out in the proviso of Section 47(xiv) are breached, the profits or Gains arising from the transfer of fixed assets which are not charged as capital Gains under the exemption provided for in Article 47 (xiv) are taxable as profits and gains of the successor company.

ITA noted that since the conditions referred to in Section 47(xiv)(b) were not met, the exemption granted on the transfer of fixed assets under Section 47(xiv) had to be withdrawn in view of Section 47A(3) of the Income Tax Act.

However, the Tribunal held that even after invoking the provisions of Section 47A(3), there could be no liability for capital gains on the conversion of the owner business to a valued corporation, given the fact that all assets and liabilities of the company owning the company, including goodwill, have been transferred to the company measured at book value.

The ITA considered that the owner company goodwill was not self-generated and was created by the owner company, with some expenses incurred for the generation and creation of the goodwill. goodwill in its accounting books.

“From the foregoing, it is very clear that even if you invoke the provisions of Section 47A(3) of the Act, to remove the exemption granted u/s.47(xiv)(b) of the law, but, in principle, there can be no capital gain on the transfer of goodwill, because said goodwill is not self-generated or created due to the conversion of a company owner in a Pvt. Ltd. Co., but acquired by incurring costs.If you consider the costs incurred by the assessee for the acquisition of the goodwill, then, the capital gains from disposal of said goodwill would amount to a “nil” amount. The Ld.CIT(A) after reviewing the relevant facts correctly deleted the additions made by the AO.”, the Tribunal held.

Therefore, the ITAT rejected the Revenue Department’s appeal.

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

Date: 07.09.2022 (ITAT Chennai)

Representative of the Appellant/Tax Department: Mr. AR.V. Sreenivasan, Addl. ICT

Respondent/Assessed Representative: Mr. Shrenik Chordia, CA

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