Brief of the Case
Delhi High Court held In the case of CIT vs. HCL Infosystems Ltd. that the receipt by the Assessee as a result of the termination of the JVA during AY 1998-99 was a capital receipt but in light of Section 55 (2) (a) as it stood at the relevant time, the said amount cannot be brought to capital gains tax. At the relevant time, there was no provision in regard to determining the cost of acquisition of the above intangible assets for the purposes of computing capital gains tax.
Facts of the Case
The Assessee, HCL Infosystems Limited (HIL), which was initially incorporated as HCL Limited under the Companies Act, 1956 on 17th April 1986, was engaged in the manufacture, distribution and sale of computers and services in India. Hewlett Packard Inc (HP), a company incorporated in the United States of America (USA), is engaged in the design, engineering, manufacture, assembly and sale of certain types of computers, along with their components and peripherals. It has substantial experience, expertise and reputation in its area of operations. Hewlett-Packard India Pvt. Ltd. (HPI) is the subsidiary of HP in India and is engaged in the manufacture of computers in India under licences from HP.
On 2nd April 1991 HCL Limited, HP, HPI and a majority of its shareholders and the companies and individuals named in Exhibit ‘A’ attached to the Agreement (‘the Control Group’) entered into a ‘Joint Venture Agreement (JVA). The agreement was described as ‘An Agreement Regarding HCL HEWLETT-PACKARD LTD’. This JVA was further amended on 27th May 1991. In terms of the JVA, the parties agreed to combine their respective computer manufacturing, marketing, servicing and sales activities in India of both HCL Limited (subsequently renamed as HIL, the Assessee) and HPI. 26% equity in the JVA was held by HP, through its wholly-owned subsidiary, Hewlett-Packard Delaware Capital Inc. (‘HPDC’). HIL was permitted to use the name ‘Hewlett Packard’ under the JVA. The joint venture company was accordingly renamed as HCL Hewlett-Packard Ltd (‘HCL HP Ltd.’).
The basic idea behind the JVA was indicated in the preamble to the JVA. It was that “HCL had been and continues to be recipient of workstation computer technology from HP pursuant to an agreement entered into with Apollo Computers Domain GMBH, a subsidiary of Apollo Computer Inc. (Apollo) which was subsequently assumed by HP when it acquired Apollo.” Further, HCL was, pursuant to a certain Representation Agreement dated 24th October 1990, the exclusive representative of HP’s computer products in India. The idea was that instead of both HCL and HPI separately representing HP’s interests, it was decided to combine their respective activities into one operation to be conducted by a company in India owned jointly by HP and the shareholders of HCL.
The JVA was terminated by an agreement dated 1st April 1997. The termination agreement was entered into between HP, HCL HP, HPI and the Control Group. It was acknowledged that since the formation of HCL HP, the competitive landscape had changed significantly “due to increased investment and interest in India by HP’s global competitors.” It was accordingly decided that the implementation of HP’s worldwide model for the distribution of personal computers would be in their mutual best interest and the best approach to ensure long term market growth, pursuant to a letter dated 5th September 1995 (referred to as the ‘Letter Agreement’), was to allow HPI the temporary right to establish and manage multiple channels for the distribution and sale of HP personal computer products in India, while retaining HCL HP as a premier channel partner.
Clause 1 of the Termination Agreement dated 1st April 1997 sets out the offered price by HP to sell all of the shares in HCL HP held by it to all the members of the Control Gupta and to stipulate the time limit within which the offer is to be satisfied The payment of the aforementioned sum by HP to HCL HP was Rs. 60.82 crores, which forms the subject matter of the case. The question is about treating the aforesaid sum as income under the Head ‘Capital Gains’. In the assessment order dated 31st January 2001 under Section 143 (3), the AO noted that the compensation was indeed a capital income but held that it was nevertheless taxable under Section 55 (2). The AO held that the extinguishment of these bundle of rights by termination of the JVA resulted in transfer of an asset in terms of Section 2(47) (ii). The AO rejected the contention of the Assessee that the said capital receipt was not taxable.
Contention of the Assessee
The ld counsel of the assessee submitted that it was not disputed that upon termination of the JVA, the Assessee’s business identity underwent a change affecting its income earning apparatus. Its source of income was sterilised. The termination affected the corporate structure itself severely and not merely the profitability of the company. Therefore, the amount received by the Assessee upon termination of the JVA was in the nature of a capital receipt. However, it was another thing to say that the said sum could be brought to tax under the head ‘capital gains’ by treating the cost of acquisition to be ‘nil’. The error lay in treating the entire bundle of rights as only a right to manufacture. The bundle of rights also included the exclusive right to market the products using the trade mark/HP, which also was extinguished. In fact, simultaneously the parties entered into a distribution agreement where under HIL continued to distribute HP products although as an exclusive distributor. Mr. Vohra has placed reliance on a large number of decisions.
Contention of Revenue
The ld counsel of the revenue submitted that the Assessee had by its own admission enjoyed a bundle of rights under the JVA including a right to manufacture, and not merely the brand name associated with the business. Further, the Assessee had stopped manufacturing its own computers. Instead, it began manufacturing in-house developed high-end computer products which were technologically more superior. According to him, the cost of acquisition could be determined on the basis of surrender of the right to manufacture computer products and correspondingly capital gain could be computed. He submitted that in terms of the amendment to Section 55 (2) (a) with effect from 1st April 1998, the cost of acquisition of the capital asset was rightly taken to be nil by the AO and the capital gains was rightly calculated on that basis.
Held by CIT (A)
By an order dated 31st March 2002 the CIT (A) dismissed the appeal as far as the above issue is concerned. The CIT (A) concurred with the AO and held that under the JVA, the Assessee had acquired a bundle of rights and privileges, which clearly and patently constitute a capital asset. Their extinguishment has resulted in transfer of a capital asset and the capital receipt for such transfer can be taxable as long term capital.
Held by ITAT
The ITAT noted that even prior to entering into JVA, the Assessee was engaged in the business of manufacture of computer products as per in-house technology under the trade and brand name of HCL computers. Even after termination of the JVA, the Assessee continued to manufacture computers under its own brand name. The sale of the computers for the year ended 31st March 1997 was shown at Rs. 54164.10 lakhs and at Rs. 55993.54 lakhs as on 31st March 1998. Therefore, it could not be said that the Assessee surrendered the right to manufacture computers and had received compensation for it.
The amendment to Section 55 (2) to treat “a trade mark or brand name associated with the business” as a capital asset for the purposes of computing capital gains was inserted with effect from 1st April 2002. Therefore, the ITAT held that at the relevant time there was no provision for subjecting the compensation received pursuant to the termination of the JA to capital gains tax. The ITAT held that no capital gains tax could be levied under Section 45 in respect of those capital assets for “which no cost of acquisition is incurred by the Assessee.” Reference was made to the decision of the Supreme Court in Commissioner of Income Tax v. B.C. Srinivasa Setty 128 ITR 294. Accordingly, the ITAT agreed with the Assessee that the amount received upon termination of the JVA was not taxable as income under the head ‘capital gains’.
Held by High Court
It is plain from a reading of the various clauses of the JVA and the other concomitant agreements, as well as the termination agreement, that as a result of the termination of the JVA, the Assessee’s income earning apparatus was impaired and its source of income got sterilised. The Court, therefore, concurs with the ITAT that the amount received by the Assessee upon termination of the JVA was in the nature of a capital receipt.
Is the amount received taxable as capital gains?
The words “or a right to manufacture” was inserted in clause (a) of sub-section (2) with effect from 1st April 1998, the words ‘or a trade mark or brand name associated with a business’ was inserted by the Finance Act, 2002 with effect from 1st April 2002 . Prior to the above insertion of “or a trade mark or brand name” the cost of acquisition in relation to a capital asset, being goodwill of a business, or a right to manufacture, produce or process any article or thing, or right to carry on any business, the tenancy rights, stage carriage permits or loom hours would be taken to be nil under Section 55 (2) (a) (ii) if it did not have a purchase price. The expression ‘or right to carry on any business’ was inserted with effect from 1st April 2003.That the above amendments were intended to be prospective, since there is nothing to the contrary stated therein, is fairly well settled. The decisions in Guffic Chem. P. Ltd. v. Commissioner of Income Tax (2011) 332 ITR 602 (SC) and Commissioner of Income Tax v. Vatika Township P. Ltd. (2014) 367 ITR 466 (SC) are illustrative of this legal position.
What emerges from the above amendments is that till 1st April 2003 there was no provision under which the capital gains arising from the transfer of a trade mark or brand name associated with a business could be brought to tax. Likewise till 1st April 2003, the capital gains arising from the transfer of a right to carry on business or any negative ‘non-compete’ right also could not be brought to tax. In terms of the decisions in CIT v. B.C. Srinivasa Setty 128 ITR 294 and PNB Finance Limited v. CIT, New Delhi (2008) 307 ITR 75 the settled legal position is that in the absence of a machinery provision, an item of income cannot be assessed to tax.
In the present case what stood extinguished as a result of the termination of the JVA was a bundle of rights of the Assessee. This included the right to manufacture computers using HP knowhow and HP labels, trademarks and patents. At the same time it was not as if the Assessee’s right to manufacture its own computers was also taken away by the termination. That stood revived. In any event, there has been no attempt at unbundling the compensation amount, as it were, to determine how much of it pertained to the above constituent rights in the bundle of rights of the Assessee that were extinguished.
The AO proceeded on the basis that the entire sum received by the Assessee was for it giving up the right to manufacture HP computers. This overlooked the factual position concerning the extinguishment, as a result of the termination of the JVA, of the entire bundle of rights not limited to the right to manufacture HP computers. The right of HCL HP to revive manufacturing its computers cannot be construed as a ‘transfer’ of a right. At the same time HP HCL lost its status as an exclusive distributor of HP products. The transfer, if any, of the intangible assets of the kind described under the JVA could not, at the relevant time, be held to fall within the ambit of the kinds of capital assets that were contemplated in Section 55 (2) (a) as it then stood
The Court, therefore, holds that the receipt of Rs. 6080.95 lakhs by the Assessee as a result of the termination of the JVA during AY 1998-99 was a capital receipt but in light of Section 55 (2) (a) as it stood at the relevant time, the said amount cannot be brought to capital gains tax. At the relevant time, there was no provision in regard to determining the cost of acquisition of the above intangible assets for the purposes of computing capital gains tax.
Accordingly appeal of the revenue dismissed.