2008 P T D (Trib.) 679
[Income-tax Appellate Tribunal Pakistan]
Before Syed Nadeem Saqlain, Judicial Member and Mazhar Farooq Shirazi, Accountant Member
I.T.As. Nos. 7261/LB of 2005 and 1291/LB of 2006, decided on 28/09/2007.
(a) Income Tax---
----Company---Amalgamation of companies---Shares---Goodwill---Cash payment---Issuance of shares in lieu of goodwill was a payment equating with cash payment.
(b) Income Tax---
----Company---Merger of company---Shares---Treatment of value of shares against the goodwill as notional value---Validity---As result of merger of the assessee company and the amalgamating company shares were issued in lieu of goodwill of the amalgamating company---Taxation Officer erred in law while treating the value of the shares against the goodwill as notional value---Even otherwise, under the principle of accounting, goodwill had always been considered an item of balance sheet, and shown as an asset though intangible.
1999 PTD (Trib.) 2152 and Seth Kishori Lal Babulal v. C.I.T. (1963) 49 ITR 502 rel.
(c) Income Tax---
----Goodwill---Explained.
1974 PTD 1; Black's Law Dictionary, Sixth Edition; North Clackamas Community Hospital v. Harris C.A. Or., 664 F.2nd 701, 706 and Bump v. Steward, Wimer & Bump, P.C. Lowa, 336 N.W. 2nd 731, 736 rel.
(d) Income Tax Ordinance (XXXI of 1979)---
----S.24---Deductions not admissible---Intangibles---Goodwill---Difference in value between the net assets and the purchase price at the time of merger of company was goodwill which was purchased through issuance of shares---Section 24 of the Income Tax Ordinance, 1979 allowed writing off of intangibles assets and the same could be claimed as an expense by the assessee---Order passed by the First Appellate Authority was confirmed by the Appellate Tribunal.
1999 PTD (Trib.) 2152 and Seth Kishori Lal Babulal v. C.I.T. (1963) 49 ITR 502 ref.
(e) Income Tax---
----Capital gain---Receipts arising out of sale of shop was capital receipt---Treatment accorded to the assessee on the issue by the First Appellate Authority was confirmed.
2006 PTD (Trib.) 1979 rel.
(f) Income Tax---
----Capital gain---Allocation of expenses---Expenditure actually incurred by the assessee on earning the exempt income could be set off against the exempt income---Assessee declared gross gain after deducting the expenses incurred in respect thereof, and after setting off these expenses against the said gain, the net gain was declared---Since assessee had already set off the actual expenses relating to the earning of capital gain, no expenses could be allocated to exempt income.
2005 PTD 2586 rel.
M. Asif, D.R. for Appellant.
Yousaf Saeed, F.C.A. for Respondent.
ORDER
SYED NADEEM SAQLAIN (JUDICIAL MEMBER).---The captioned two appeals at the instance of the department, pertaining to the Tax Years 2004 and 2005, have been directed against two separate orders, dated 14-9-2005 and 22-4-2006, passed by the learned C.I.T. (A), Zone-I, Lahore.
2. Succinctly, facts relevant for the disposal of present appeals, are that the taxpayer is a public limited company, listed on stock exchange, derived income from payphone services. Returns for the years under appeal were tiled and deemed to be assessed under section 120 of the Income Tax Ordinance, 2001 (hereinafter called the Ordinance). Later on, the Inspecting Additional Commissioner of the Income flax invoked section 122(5A) of the Ordinance and proceeded to amend the deemed assessments, completed earlier.
3. The assessee succeeded at the first appellate level, whereby the learned C.I.T. (A) allowed relief to the assessee under the head of amortization of goodwill, treating the gain of sale of shop as capital, and also deleted expenses allocated to capital.
4. Feeling aggrieved with the said impugned order, the revenue has come up in appeal before the Tribunal.
Tax Year 2004
For the present year, the learned DR assailed the relief allowed to the assesssee by the learned C.I.T. (A) under the head "amortization of goodwill". It was submitted that another associated company, namely, `Worldcall Payphone Cards Ltd.' was merged with the assessee company against the issuance of the shares. It was elaborated that difference between the value of the shares issued to the shareholders of Worldcall Payphone Cards Limited and the net assets acquired on the merger, was treated as goodwill amounting to Rs.3,98,20,000 in the accounts of the company. The assessee in the financial accounts had written off 10% of the amount i.e. Rs.39,82,000 and the balance was carried forward, however, in the computation of income attached with the return, the balance amount of Rs.3,58,38,000 was also written off as an expense by the assessee. Learned DR argued that this was a notional amount as no payment was made by the assessee for acquiring the tangible asset of the associated company at the time of its merger. It was contended that only shares were issued by the assessee-company to the shave-holders of the merging company, hence it was not an allowable expense as envisaged under the law.
(ii) Conversely, the learned AR opposed the arguments advanced by the learned DR with great vehemence. It was averred that the assessee company acquired all the assets and liabilities of the merging company through a merger. He explained that' the difference of value between the purchase price paid for the net assets of Worldcall Payphone Cards Ltd., and the payment made in the nature of share is termed as goodwill. It was pointed out by the learned AR that assessing officer had observed while rejecting the contention of the assessee, appearing on page 6 of the impugned order that it is a notional amount and the assessee did not pay anything for acquiring the goodwill. The learned AR clarified that as a matter of fact, the, assessee did pay a purchase price of Rs.14,44,60,0007 for the assets and liabilities in the form of shares. Hence, as mentioned in Note 7-1 to the accounts, the excess of amount paid over the value of the net assets of Worldcall Payphone Cards Ltd. will be treated as goodwill. The learned AR contested the stance of the department that no amount was paid for the goodwill acquired. It was pleaded that in such like circumstances, issuance of shares was a payment as held in a case reported as 1999 PTD (Trib.) 2152. The learned AR also referred to section 24 of the Ordinance where an assessee is allowed to write off any intangible used in the business of the assessee. The learned AR argued that the goodwill acquired by the company was an intangible and could be written off as per section 24 (ibid.).
5. We have heard the learned counsel for the respective parties, and have also gone through the relevant orders along with the case law cited at the bar. The learned DR failed to persuade us on the issue that amount of goodwill was a notional figure, hence a write off of a notional amount was not provided under the law. There is no denying the fact that shares of the assessee company were issued to the shareholders of the merging company. In our considered view, issuance of shares in lieu of goodwill was a payment equating with cash payment. At this juncture, it would not be out of place to refer to the judgment relied upon by the learned AR. The facts in brief of the cited case are that a company namely, Hub Power Company (HUB CO.) was incorporated in Pakistan to construct a power project for the generation of electricity. The said Co. was sponsored by a foreign consortium called as Hub River Power Group (HRPG), who were responsible for developing the power project and HRPG incurred substantial expenses in this regard. It was agreed between the sponsors and the Government of Pakistan through Ministry of Water and Power that the project development costs incurred by the sponsors (HRPG) would be recognized as contribution towards equity in the project company i.e. HUB CO. As per agreement between the two, the assessee company reimbursed the project development costs to HRPG in the form of fully paid up shares issued at a discount. Requisite show-cause notice was issued as to why the assessing company should not be treated as assessee in default under section 52 of the repealed ordinance for not deducting tax under section 50(3) while issuing shares to HRPG. Responding to the show-cause notice, the assessee company took the stance that shares had been issued for the specific costs incurred by the sponsors (HRPG) and these did not contain any element of profit. Hence, tax under section 50(3) was not deductible. However, the assessing officer did not agree with the plea of the assessee company and treated the assessee as assessee in default under section 52 and charged the tax for failing to deduct under section 50(3). The said treatment accorded to the assessee was upheld by the learned C.I.T. (A). Before the learned Tribunal, the exact issue which came up for adjudication was that whether the shares issued in lieu of expenditure incurred by the sponsors (HRPG) were to be treated as "sum paid" in terms of cash payment entailing deduction of tax at source. The Tribunal, while taking lead from judgment from the Indian jurisdiction in re: Seth Kishori Lal Babulal v. C.I.T., reported as (1963) 49 ITR 502, through an elaborated judgment, thoroughly thrashed out the said issue. To highlight the reasoning, which weighed with the learned Tribunal, observation given by his Lordship, Brijlal Gupta, J., appearing in the judgment of the Tribunal is once again being reproduced:
"The rule is firmly fixed that where in settlement of a claim a creditor accepts money's worth or in other words payment in kind, it is just the same as if he has received cash payment and where he chooses to retain the thing which he has received it merely amounts to re-investment of money in the thing acquired. The above cited case has been discussed at some length, in the hope that it will explain the position of law with reference to facts of the case we are presently dealing with. In the present case also, the HRPG, in settlement of their claim, accepted shares of the assessee company and hence, it amounts to receipt of cash. If the shares so acquired are retained, it simply amounts to reinvestment of money in the shares. Seen in this perspective, it is clear that issuance of shares in lieu of money, which the assessee company owed to HRPG, amounts to payment of sum i.e. money."
6. Now reverting to the facts of the instant case, which is subject matter of appeal before us, undoubtedly, as a result of merger of the assessee company and the amalgamating company shares were issued in lieu of the goodwill of the amalgamating company. Following the ratio settled in supra cited case, we have no hesitation in holding that taxation office erred in law while treating the value of the shares against the goodwill as notional value. Even otherwise, under the principles of accounting, goodwill has always been considered an item of balance sheet, and shown as an asset though intangible. The term `goodwill' was explained in the Honourable Lahore High Court Lahore's judgment reported as 1974 PTD 1. For the sake of our discussion, the relevant paragraph of the said judgment is also being reproduced as under:---
"A goodwill is a thing very easy to describe, very difficult to define, it is the benefit and advantage of the good name and reputation and connection of business. It is the attractive force which brings in customers. It is the one thing which distinguishes an old established business from a new business at its first start. The term goodwill is nothing more than a summary of the rights accruing to the purchasers from their purchase of the business and property employed in it.
The goodwill of partnership may be said in a general way to be the value of its business, over and above the value of its tangible assets and which grows out of the firm's name, trade worked up and publicity obtained. It is as much an asset of the firm, to the amount of its actual value to the business, as its physical property, and consequently, is the subject of sale and other contract or of a right of action for a trust concerning it, as is any other property of the firm. Like any other form of goodwill, the goodwill of partnership depends very largely upon the continuance of the business and a cessation of the business, for any extended time will generally in whole or in part, destroy the value of the goodwill Goodwill being an asset of the firm is subject to a partial ownership of every member thereof and is ascertained in the same manner as any other asset, by settlement of partnership."
The word `goodwill' has also been defined in Black's Law Dictionary, Sixth Edition in the following manner:---
"The excess of Cost of an acquired firm or operating unit over the current or fair market value of net assets of the acquired unit. Informally used to indicate the value of the good customer relations, high employee moral, a well respected business name etc. which are expected to result in greater than normal earning power. The ability of a business to generate income in excess of normal rate on assets, due to superior managerial skills, market position, new product technology, etc. The capacity to earn profits in excess of a normal rate of return due to establishment of favourable community reputation and consumer identification of the business name. North Clackamas Community Hospital v. Harris, C.A. Or. 664, F.2nd 701, 706.
As applied to firms, term refers to ability to attract client as result of firm's name, location, or the reputation of the lawyers. Bump v. Stewart, Wimer and Bump, P.C, Iowa, 336 N.W. 2nd 731, 736. For accounting purposes, goodwill has no basis unless it is purchased. In the purchase of business goodwill generally is the difference between the purchase price and the value of the assets acquired. Goodwill is an intangible asset and cannot be amortized for tax purposes."
7. To cater for law dealing with intangible, the lawmakers gave statutory recognition to this aspect by incorporating section 24 in the newly introduced Income Tax Ordinance, 2001, which reads as under:---
"S. 24: Intangibles (1) Person shall be allowed an amortization deduction in accordance with this section in a tax year for the cost of the person's intangibles"--
(a) that are wholly or partly used by the person in, the tax year in deriving income from business chargeable to tax; and
(b) that have a normal useful life exceeding one year.
8. To sum up, we must say that difference in value between the net assets and the purchase price at the time of merger, was goodwill which was purchased through issuance of shares. We also tend to agree with the findings recorded by the learned C.I.T. (A) that section 24 (ibid.) allows writing off of intangibles and the same could be claimed as an expense b by the assessee. Therefore, we do not feel persuaded to warrant our interference in the impugned order passed by the learned C.I.T. (A) which is hereby confirmed.
9. Consequently, departmental appeal being devoid of any merit, is hereby dismissed.
Tax Year 2005
For the aforesaid year, the revenue has challenged the relief allowed by the learned C.I.T. (A) under different heads of accounts.
(ii) On the issuance of treating the gain on sale of shop as capital gain, the learned DR contended that the property purchased by the assessee was by itself a commercial asset, purchased with the intention of reselling it to make a profit, therefore, the receipts made out of sale were revenue receipts. It was entreated by the learned DR that the learned first appellate authority erred in law while holding that gain on sale of shop was a capital receipt and thus exempt from tax. Conversely, the learned AR opposed the arguments advanced by the learned DR with vehemence. It was argued that the assessee company never indulged in sale/purchase of any property other than the property in question, hence the stance adopted by the revenue that the company was involved in the business of sale/purchase of property was misconceived. It was stated by the learned AR that the shop in question was acquired by the company for running a public call office to provide telephone facilities to the general public and the same was in operation ever since the shop was purchased. It was further narrated that due to introduction of cheap mobile phones as well as availability of Telecard services, the business of all the PCOs decreased, resulting in heavy losses. This factum forced the company to close down the Call Centre and ultimate sale of shop. It was averred by the learned AR that the assessee company was not involved in the business of sale/purchase of property, and the sale in question was the only transaction made by the assessee, that too, under compelling circumstances. While summing up the learned AR submitted that since the shop was not originally purchased with the intention to sell it with a view of making profit and also the fact that it was disposed of in peculiar circumstances i.e. loss of business, the receipt made out of sale was a capital receipt which is exempt from tax. Therefore, the learned C.I.T. (A) was well within the domain of law, when the same was treated as such. In support of his contentions, the learned AR relied upon a judgment of the Tribunal, reported as 2006 PTD (Trib.) 1979.
10. After considering the contentions urged by the respective parties, we are of the considered view that the learned C.I.T. (A) rightly E upheld the receipt arising out of sale of shop to be capital receipt, and thus, the same does not warrant our indulgence in favour of the revenue. The treatment accorded to the assessee on the issue by the learned C.I.T.(A) is, therefore, confirmed. Departmental appeal in this regard fails.
11. Next issue which was contested by the revenue did relate to deletion of expenses allocated to capital gain accrued on account of disposal of company shares. The learned DR vehemently argued that learned C.I.T. (A) was not justified in deleting the addition made on account of expenses allocated to capital gain. Contention of the learned DR was that the assessee had declared a gain on the sale of shares at Rs.17,801,146 for the year under appeal. It was stated that it was not possible that the assessee did not incur any expense in earning such a huge amount. On the contrary, the learned AR appearing on behalf of the assessee defended the impugned oilier passed by the learned C.I.T. (A), it was averred by the learned AR that first of all, it was to be ascertained if any expenditure was incurred in earning the exempt income and only then the expenditure could be allocated to taxable and exempt income and no allocation could be made on pro-rata basis. He pointed out that learned C.I.T. (A) has considered this aspect of the case and has categorically mentioned in his order that the assessee had earned a gross gain of Rs.18,121,870 and after deducting expenses amounting to Rs.3,20,722 incurred in earning this gain, a net gain of Rs.17,801,146 was declared by the assessee. It was explained that since the assessee had already deducted the expenses relating to earning of the capital gain, hence expenditure could not be allocated as done by the revisional authority. It was also brought to the notice of the Court that for the Tax Year 2004, assessee was also confronted on the issue of allocation of expenses, but after considering the reply of the assessee, no adverse inference was drawn by the same authority. Hence, there was no justification to allocate expenses to capital gain in the current year.
12. The learned AR while defending the impugned order of learned C.I.T. (A), referred to a case reported as 2005 PTD 2586, wherein it was specifically observed that law relating to allocation of expenses to exempt income and taxable income has been given statutory sanction by the legislature through Income Tax Ordinance, 2001. He referred to the relevant part of the judgment, which is reproduced as under:--
"Previously, the concept was being acted upon on the basis of judicial pronouncements and on the interpretation of provisions contained in the law, and now principle has been given legislature recognition. Simply because a principle already being acted upon has been given a legislature recognition, it would not amount to introduction of some new concept.
As regards the second question, we are of the opinion that the Tribunal has merely made an observation on the basis of which this question has been framed. In fact the point, what has been decided by the Tribunal, is that after determining the fact as to what was the expenditure incurred for earning the income in two categories, the expenditure shall be allocated accordingly and the Tribunal has expressly given a finding that no allocation is to be made on pro rata basis, meaning thereby, that question of admissibility of expenditure is to be decided after determining the fact whether any expenditure was incurred for earning of exempt income or not. If it is in negative, then no expenditure is to be allocated".
13. We have heard the learned counsel for both the parties and have also scanned through the relevant orders passed by the learned lower officers along with the case law cited at the bar. The learned DR has not been able to persuade us to warrant our indulgence in the impugned order in favour of department. As per the ratio laid down in the supra cited case, it was held that first thing, which is to be determined as to what expenditure was actually incurred by the assessee on earning the exempt income and only that expenditure could be set off against the exempt income. It is matter of record that in the instant case too, the assessee declared gross gain at Rs.18,121,870 and after deducting the expenses amounting to Rs.3,20,722 incurred in respect thereof, and after setting off these expenses against the said gain, the net gain was declared. Since, the assessee had already set off the actual expenses relating to the earning of capital gain, no expenses could be allocated to exempt income. This fact also stands substantiated from the judgment cited at the bar.
14. In view of afore-going discussion, we are not inclined to interfere in the impugned findings recorded by the learned C.I.T.(A), which are hereby confirmed. Hence, the departmental appeal on the issue entails dismissal.
15. The next ground of appeal taken up by the department relates to the deletion of addition on account of amortization of goodwill. This issue has already been discussed in detail in the appeal for the Tax Year 2004, hence following the treatment accorded to the assessee in the proceeding year, the action of the learned (A) is confirmed.
16. On the issue of exclusion of staff retirement benefits, the learned DR assailed the finding given by the learned C.I.T. (A) urging that the some was without cogent reason. The learned A.R. submitted that similar provisions were made in the previous year but no add hack was made on this account by the department, therefore, the learned C.I.T. (A) rightly directed to delete the same. The learned DR has failed to convince us on the issue. Thus, the impugned order on the issue is upheld.
14. Departmental appeal fails.
C.M.A./8/Tax (Trib.)Appeal dismissed.