M/S. S. C. Cambatta and Co. Private Ltd. vs The Commissioner Of Excess Profits Tax

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: supreme-court

Case Number: Civil Appeals Nos. 776 and 777 of 1957

Decision Date: 30 November 1960

Coram: M. Hidayatullah, J.L. Kapur, J.C. Shah

In this matter the petitioner identified as M/S. S. C. Cambatta & Co. Private Ltd., a company based in Bombay, challenged the assessment of the respondent, the Commissioner of Excess Profits Tax, also situated in Bombay. The judgment was delivered on 30 November 1960 by a three‑judge bench of the Supreme Court of India consisting of Justice M. Hidayatullah, Justice J. L. Kapur and Justice J. C. Shah. The official citation of the decision is 1961 AIR 1010 and 1961 SCR (2) 805, and it is recorded in the citator as R 1972 SC2373 (11). The case concerned the application of the Excess Profits Tax Act, 1940 (XV of 1940), specifically the assessment of capital for the purposes of excess profits tax in relation to the sale of a theatre and restaurant and the valuation of goodwill arising from that business.

The petitioner operated several enterprises, one of which was the management of a theatre and restaurant. In October 1943 a subsidiary company was incorporated which, from April 1944, occupied the premises of the theatre under a lease granted by the parent. When the capital of the two entities was being computed for excess profits tax, the subsidiary’s claim for goodwill amounting to five lakh rupees was omitted from the assessment. The matter was referred to the High Court, which held that the Tribunal should have allowed a reasonable valuation of goodwill as of the date of the transfer. Nevertheless, the Tribunal considered only the lease‑hold value of the site transferred to the subsidiary and concluded that no goodwill pertaining to the theatre’s business itself had been acquired; it held that any goodwill was limited to the value of the building site and fixed the goodwill at two lakh rupees. The petitioner’s petition under sections 66(1) and 66(2) read with section 21 of the Excess Profits Tax Act was rejected both by the Tribunal and by the High Court, leading the petitioner to appeal to the Supreme Court by special leave. The Court observed that the goodwill of a business must be assessed in a broader sense, taking into account a variety of circumstances, either singly or in combination. Factors such as the nature of the business, its location, the service rendered, the standing and honesty of its operators, the absence of competition and other elements contribute to goodwill, though locality generally plays a significant role. Relocating the business may diminish goodwill, but it is not the sole determinant; the ability to attract custom also depends on other factors. The Court identified a legal question as to whether the goodwill of Eros Theatre and Restaurant Ltd. had been calculated in accordance with law. In addressing this question the Court referred to earlier authorities, namely Cruttwell v. Lye (1810) 17 Ves. 335, Trego v. Hunt (1896) A.C. 7 (H.L.), Inland Revenue Commissioners v. Muller & Co.’s Margarine Ltd. (9101 A.C. 217 (H.L.)), and Daniell v. Federal Commissioner of Taxation (1928) 42 C.L.R. 296.

The Court noted that the present matter consisted of two appeals filed with special leave. Both appeals challenged orders that had been rendered by the High Court of Bombay and by the Income‑tax Appellate Tribunal, Bombay. The High Court order dated 25 September 1956 had dismissed a petition presented under section 66‑2 of the Indian Income‑tax Act, while the Tribunal order dated 17 March 1954 concerned the same dispute in the context of excess‑profits tax. The appellants were Messrs S C Cambatta & Co. (Private) Ltd., a company incorporated in Bombay, and the respondent was the Commissioner of Excess Profits Tax, also based in Bombay. The Court recorded that the appeals were directed against the assessment of three distinct accounting periods, each of which terminated on 31 December and covered the fiscal years 1943, 1944 and 1945 respectively. The appellants carried on a variety of commercial undertakings, one of which involved the operation of a theatre and a restaurant known as the Eros Theatre and Restaurant. In October 1943 the appellants formed a subsidiary company under the name Eros Theatre and Restaurant Ltd. The subsidiary was issued a paid‑up capital of Rs 7,91,100, divided into 7,911 shares of Rs 100 each. Of these shares, 7,901 were allotted to the appellant company as consideration for the transfer of assets, goodwill, stock‑in‑trade and book debts, while the remaining ten shares were retained by members of the Cambatta family. The assets transferred to the subsidiary comprised stock‑in‑trade valued at Rs 1,28,968, stock‑in‑trade specifically valued at Rs 40,000 and book debts amounting to Rs 100, which together summed to Rs 1,69,068. When this figure was added to a capital reserve of Rs 6,21,032, the total amount arrived at Rs 7,90,100. In the subsidiary’s books the share‑capital account was shown separately, and the following entries were recorded: a debit of Rs 2,50,000 to various asset accounts, a debit of Rs 5,00,000 to a goodwill account, a debit of Rs 40,000 to the stock‑in‑trade account and a debit of Rs 100 to the book‑debts account. From these entries it was apparent that the appellants themselves did not display goodwill as a distinct item in their own accounts; instead, goodwill appeared only in the books of the subsidiary company.

The Court further explained that in computing the capital of the two companies for the purpose of excess‑profits tax, the appellants had claimed a sum of Rs 5,00,000 as goodwill, treating it as part of the subsidiary’s capital. Both the tax Department and the Tribunal, however, held that section 8‑3 of the Excess Profits Tax Act was applicable and consequently excluded the claimed goodwill from the capital calculation. The Tribunal chose not to state a case on the matter, but the High Court directed that the issues be referred for determination on two specific questions. The first question concerned whether, based on the facts of the case, the Appellate Tribunal had been correct in applying section 8‑3 of the Excess Profits Tax Act. The second question asked whether, in the computation of the capital employed in the assessee’s business, the Tribunal had erred by not including the value of the goodwill or any portion thereof. The High Court, in its judgment and order, answered the first question in the negative, indicating that the Tribunal had not applied the correct provision, and answered the second question in the affirmative, holding that sub‑section 5, rather than sub‑section 3, of section 8 of the Excess Profits Tax Act should have been applied. Accordingly, the High Court concluded that the Tribunal ought to have allowed for the value of goodwill as it deemed reasonable at the date of the transfer.

In the appeal, the High Court framed two questions for consideration. The first question asked whether the Appellate Tribunal had been correct in applying section 8(3) of the Excess Profits Tax Act to the facts of the case. The second question inquired whether, in calculating the capital employed in the assessee’s business, the Tribunal had erred by not including the value of the goodwill or any portion of it. The High Court answered the first question in the negative, indicating that the Tribunal had not applied the proper provision. Regarding the second question, the Court answered affirmatively, holding that sub‑section (5) rather than sub‑section (3) of section 8 of the Excess Profits Tax Act was applicable. Consequently, the Court concluded that the Tribunal should have allowed for the value of the goodwill whatever it thought was reasonable at the date of the transfer.

When the matter returned to the Tribunal, the parties submitted three affidavits together with a valuation report prepared by a firm of architects. The architects’ report placed the value of the goodwill at twenty‑five lakh rupees. It is relevant that the subsidiary company occupied premises under a lease dated 20 November 1944, which covered a three‑year period beginning 1 April 1944, with a monthly rent of nine thousand five hundred rupees. After reviewing the submissions, the Tribunal concluded that the theatre business itself had not acquired any goodwill, and that any goodwill present was attributable solely to the site and the building. The Tribunal then proceeded to determine the appropriate amount of goodwill to be assigned as of the transfer date, as directed by the High Court.

In reaching its assessment, the Tribunal first examined the earning capacity of the business. It observed that before 1942 the business had not generated profits, and that the name “Eros Theatre and Restaurant” by itself did not create any goodwill. Accordingly, the Tribunal held that the only goodwill accrued was linked to the lease granted by the trustees to Eros Theatre and Restaurant Ltd. By valuing the leasehold interest of the subsidiary, the Tribunal arrived at a liberal estimate of two lakh rupees as the goodwill held by Eros Theatre and Restaurant Ltd. at the relevant time.

The appellants had earlier filed petitions under sections 66(1) and 66(2) read with paragraph 21 of the Excess Profits Tax Act, which were dismissed by both the Tribunal and the High Court. Nevertheless, they obtained special leave to appeal before this Court. In our view, a legal issue arose concerning whether the goodwill of Eros Theatre and Restaurant Ltd. had been calculated in accordance with law. The Tribunal appeared to consider only the leasehold value of the site when determining goodwill, disregarding other elements that normally contribute to business goodwill. As observed in Cruttwell v. Lye, Lord Eldon, L.C. described goodwill as “nothing more than the probability that the old customers would resort to the old place.”

The Court observed that the earlier view of goodwill had been regarded as exceedingly narrow, and stressed that the assessment of goodwill must be rooted in the nature of the business, because the goodwill of a public inn cannot be measured by the same criteria that apply to a large departmental store. The House of Lords examined this issue in two leading cases. The first case, Trego v. Hunt (2), reviewed the various definitions that had previously been offered, and Lord Macnaghten declared that goodwill constituted “the whole advantage, whatever it may be, of the reputation and connection of the firm, which may have been built up by years of honest work or gained by lavish expenditure of money.” In a later authority, Inland Revenue Commissioners v. Muller & Co.s.Margarin, Ltd. (3), Lord Macnaghten, at pages 223 and 224, explained that goodwill was “a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good‑name, reputation, and connection of a business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old‑established business from a new business at its first start… If there is one attribute common to all cases of goodwill it is the attribute of locality. For goodwill has no independent existence. It cannot subsist by itself. It must be attached to a business. Destroy the business, and the goodwill perishes with it, though elements remain which may perhaps be gathered up and be revived again.” The Court noted that these English decisions, together with other authorities, were subsequently examined in two Australian cases. In Daniell v. Federal Commissioner of Taxation (1), Chief Justice Knox observed that, although goodwill could not be said to be absolutely and necessarily inseparable from the premises or to have no separate value, it could prima facie be treated as attached to the premises and, whatever its value, should be regarded as an enhancement of the value of the premises. In the second Australian case, Federal Commissioner of Taxation v. Williamson (2), Justice Rich, at p. 564, explained that determining the nature of goodwill required consideration of the type of business, the type of customers that the business was likely to attract, and the surrounding circumstances. He further described goodwill as “a composite thing referable in part to its locality, in part to the way it is conducted and the personality of those who conduct it, and in part to the likelihood of competition, many customers being no doubt actuated by mixed motives in conferring their custom.” Finally, the Court cited Earl Jowitt’s Dictionary of English Law, 1959 edition, which defined goodwill as “the benefit which arises from its having been carried on for some time in”.

In the passage quoted, it was observed that goodwill may arise from a particular house, from a particular person or firm, or from the use of a particular trade mark or trade name. From this observation the Court concluded that the goodwill of a business depends on a variety of circumstances or on a combination of those circumstances. The Court listed several factors that may individually or jointly constitute goodwill, namely the location of the business, the nature of the service provided, the reputation or standing of the business, the honesty of the persons who manage it, the absence of competition, and many other factors. The Court referred to two earlier authorities, namely (1) (1928) 42 C.L.R. 296 and (2) (1943) 67 C.L.R. 561, to support the proposition that locality always plays a considerable part in the existence of goodwill. The Court noted that a change of locality may cause the loss of goodwill, but also stressed that locality is not the sole determinant; the ability to attract customers also depends on one or more of the other factors. The Court further explained that in the context of a theatre or a restaurant, the type of cuisine served, the manner in which service is conducted, and the nature of the competition also contribute to the goodwill of the establishment. From the foregoing discussion the Court held that the matter of goodwill must be examined in a much broader perspective than the Tribunal had adopted. The Court observed that a question of law arose in the case and, in its view, the High Court ought to have directed the Tribunal to state the case on that question. Accordingly, the Court allowed Civil Appeal No. 776 of 1957. The Court directed that the High Court should frame an appropriate question, require the Tribunal to give a statement of the case, and then decide the question according to law. The Court ordered that the costs of this appeal be borne by the respondent, while costs in the High Court would depend on the result. No order was made in Civil Appeal No. 777 of 1957. The appeal numbered 776 of 1957 was thus allowed.