Post amendment in s. 28(va) Non-compete fee is liable to be taxed under business income

IN THE ITAT MUMBAI BENCH ‘A’

Anurag Toshniwal

Versus

Deputy Commissioner of Income-tax – 1(3), Mumbai

D. Manmohan, VICE-PRESIDENT
AND N.K. BILLAIYA, ACCOUNTANT MEMBER

IT APPEAL NOs. 7032 & 7034 (MUM.) OF 2012
[ASSESSMENT YEAR 2009-10]

JANUARY  16, 2013

ORDER

N.K. Billaiya, Accountant Member

These two separate appeals pertaining to two different assessees are directed against the two different orders of the Ld. CIT(A)-2, Mumbai dt.11.10.2012 pertaining to A.Y. 2009-2010. As common issues are involved in both these appeals, these appeals were heard together and dispose of this common order for the sake of convenience & brevity.

ITA No 7034/Mum/2012

2. The assessee has challenged the correctness of the order of the Ld. CIT(A) by raising following three grounds of appeal:

1.  On the facts and circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) has erred in holding that the amount of Rs.5 crore received from M/s. Thermo Electron LLS India P. Ltd. by the appellant was a revenue receipt taxable under the head “profits and gain of business”. He failed to appreciate that when admittedly the appellant is not at all carrying on any business in the previous year, there is no question of any chargeability under the head “profits and gains of business”, as carrying on business is a sine qua non for applicability of s.28.

2.  The learned Commissioner of Income-tax (Appeals) failed to appreciate that the payment of Rs.5 Crores was compensation for the total destruction of a source of income, and as such was a capital receipt and not a revenue receipt. The sum was not of revenue character at all.

3. The Learned Commissioner of Income-tax (Appeals) erred in holding that the amount was taxable u/s.28(va), without appreciating that the amount was not received for ‘not carrying out any activity in relation to any business’; and at best, the amount would only be chargeable under the head Capital Gains, as being an amount received on transfer if any, of right to carry on business. He ought to have held that s.28(va) only creates a fiction as to source, but does not deem a capital receipt as income.

3. The facts giving rise to these grievances emanates from the assessment order passed u/s. 143(3) of the Act dt. 30.9.2011. During the course of the scrutiny assessment, the Assessing Officer noted that the assessee has declared a sum of Rs. 5 crores under the head Long Term capital gain being ‘Non-compete fees’ received from M/s. Termo Electron LLS India Pvt. Ltd., against which the assessee has claimed deduction u/s. 54EC of I.T. Act to the tune of Rs. 50 lacs and the balance amount of Rs. 450 lacs claimed to have been deposited in Capital Gain Savings account. The AO questioned the claim of the assessee by issue of notice dt. 12.8.2011 telling the assessee why the sum of Rs. 5 crores declared as ‘Non-compete fees’ should not be treated as income under the head ‘Profit or Gain from business or profession’ u/s. 28(va) of the I.T. Act.

3.1 In response to the said query, the assessee filed a detailed reply dt. 26.9.2011. The assessee strongly contended that the sum of Rs. 5 crores received by the assessee under the agreement as ‘Non-compete fees’ will not be taxable u/s. 28 because the basic condition for assessment under the head “profits & gains of business”, is that the business must be carried out during the previous year. The assessee pointed out that the basic condition is clearly mentioned in sub-cl (1) of Sec. 28 as the assessee is not carrying out any business in the relevant previous year, therefore the basic test or condition for applicability of Sec. 28 is not at all applicable to the facts of the case. The assessee further relied upon the decision of the Hon’ble Supreme Court in the case of Gillanders Arbuthnot & Co. Ltd. v. CIT [1964] 53 ITR 283 wherein the Hon’ble Supreme Court has held that compensation received by the assessee for loss of agency was a revenue receipt whereas compensation received for refraining from carrying on competitive business was a capital receipt. It was claimed by the assessee that on the facts of the present case, the receipt is a capital receipt hence there is no question of bringing it to tax u/s. 28(va) of the Act.

3.2 The submissions of the assessee were carefully perused by the AO who was of the opinion that the ‘Non-compete fees’ received by the assessee is clearly taxable u/s. 28(va) of the Act and accordingly rejected the treatment of Rs. 5 crores as Long term Capital gains as claimed by the assessee and treated the said receipts of Rs. 5 crores as ‘Non-compete fees’ under the head ‘Profit or Gain from business or profession’.

4. The assessee strongly agitated this matter before the Ld. CIT(A) and strongly contended that the assessee himself was not carrying on any business whatsoever and reiterated that it is a basic condition for taxability under the head ‘Profit & Gain of business that the assessee must be carrying on business. It was further pointed out by the assessee that Sec. 28(va) does not indicate that the assessee is deemed to be carrying on any business. It only applies when the basic condition is fulfilled, and has no application in the absence of the assessee carrying on business. The assessee placed reliance on the decision of the Hon’ble ITAT in the case of Mrs. Hami Aspi Balsara v. Asstt. CIT [2010] 126 ITD 100 (Mum). The assessee further pointed out to the Ld. CIT(A) that on a proper interpretation of the agreement between the parties, it will be seen that the fee is not merely a non compete or a fee for not carrying on an activity in relation to business, rather it is paid for transfer of a right to carry on business itself. Therefore, it is taxable under the head ‘capital gains’ u/s. 55(2)(a) of the Act. Since the assessee has transferred its right to carry on business itself, therefore it falls within the proviso of Sec. 28(va) and the amount received brought to tax only under the head ‘capital gains’.

5. The Ld. CIT(A) considered the submissions and the facts of the case and came to a conclusion that as per the agreement, the non compete fee paid to the assessee is for Non competing with the purchaser of the undertaking for only four years which means that the sum of Rs. 5 crores is paid to the assessee for not carrying out the business of similar nature only for four years which means that the payment is not for any transfer of any capital asset which is very much essential for the taxation of capital gains. In the instant case, the assessee has simply agreed not to do similar business for four years. According to the Ld. CIT(A) this action cannot be considered as “Extinquishment of any right in capital asset” because after extinquishment no right will exist thereafter. The Ld. CIT(A) went on to rely on the decisions of Dy. CIT v. Max India Ltd. [2007] 112 TTJ (ASR) 726, Asstt. CIT v. Dr. B.V. Raju [2012] 135 ITD 1. The Ld. CIT(A) also relied upon the decision of John D’Souza v. CIT [Writ Petition No. 321 of 2009, dated 13-8-2009] and in particular relying upon the decision of the ITAT Hyderabad Special Bench (supra) and the Hon’ble Supreme Court’s decision (supra) agreed with the findings of the AO that the Non compete fee of Rs. 5 crores is taxable as business income u/s. 28(va) of the Act.

6. Aggrieved by the findings of Ld. CIT(A) assessee is before us. The Ld. Counsel for the assessee once again strongly relied upon the provisions of Sec. 28(1) and reiterated the stand of the assessee that it is a primary condition that the assessee must carry on the business during the previous year only then the profits and gains will be taxable under the head ‘profits and gains of business’. The Ld. Counsel further argued that Sec. 28(va)(a) has been inserted by the Finance Act, 2002 w.e.f 1.4.2003 and reference is only to any sum whether received or receivable in cash or kind under an agreement for not carrying out any activity in relation to any business. The Ld. Counsel thus concluded that as the main provision of Sec. 28 and also Sec. 28(va) refers to carrying on of business and as the assessee has not carried out any business, therefore there is no question on the taxability of Non compete fee under the head profits and gains of business. On the contrary, it is a capital receipt and has been rightly returned under the head capital gains by the assessee in his return of income. The Ld. Counsel filed a Paper book relying upon the decision of ITAT in the case of Mrs. Hami Aspi Balsara (supra), ACIT v. Savita Mandhana in ITA No. 3900/Mum/2010, Dr. B.V. Raju (supra), Guffic Chem (P.) Ltd. v. CIT [2011] 332 ITR 602.

7. Per contra, the Ld. Departmental Representative strongly relied upon the findings of the lower authorities and pointed out that the Tribunal in the case of Dr. B.V. Raju (supra) has clearly held that prior to amendment brought with effect from 1.4.2003 when there are receipts by a person as Non compete fee under an agreement not to carry on particular business, then it was regarded as capital receipt not chargeable to tax. However, with effect from April 1st 2003, provisions of Sec. 28 has been amended by inserting sub sec. (va) in section 28 and with the amendment to the law Non compete fee even if it is a capital receipt is now chargeable to tax as income from business. The Ld. DR further relied upon the decision of Hon’ble Supreme Court in the case of Guffic Chem (P.) Ltd. (supra) and submitted that with the amendment Non compete fees is taxable under the head profit and gains of business or profession.

8. We have considered the rival submissions and carefully perused the orders of the lower authorities and the decision relied upon by the rival parties. The facts giving rise to the entire dispute show that the assessee is one of the Directors of a company called Chemito Technologies Pvt. Ltd. since 1.7.1983. The said Chemito Technologies Pvt. Ltd. is engaged in the manufacture and assembling of various types of laborating equipment. The said company also owned a division called “Technologies and the Environmental Instrumentation Divison”. Vide agreement dt. 27.5.2008, the company sold this division to M/s. Thermo Electron LLS India Pvt. Ltd. for a consideration of Rs. 58 crores. In this agreement there were Non compete provisions by which the seller for an aggregate period of 4 years shall not , in India , without the prior written consent of purchaser directly or indirectly, whether through affiliates or otherwise :

9. It is provided in the said agreement that for an aggregate period of four years for the entire period shall, without the prior written consent of the other party, directly or indirectly, solicit any employee of the other party to work in any way whatsoever for that party or its affiliates or to terminate an existing relations with the employee party.

10. Subsequent to this agreement on 2.6.2008, the purchaser company M/s. Thermo Electron LLS India Pvt. Ltd., entered into a separate Non compete and non Solicitation Agreement with the assessee and also with his some Mr. Anurag Toshniwal and agreed to pay Rs. 5 crores to the assessee and Rs. 2 crores to his son. The entire dispute relates to this receipt of Rs. 5 crores by the assessee. Before proceeding further, let us first see the provisions of Sec. 28(va) as inserted by the Finance Act 2002 w.e.f. 1.4.2003

Sec. 28[(va) any sum, whether received or receivable, in cash or kind, under an agreement for—

Provided that sub-clause (a) shall not apply to—

Explanation.—For the purposes of this clause,—

11. A perusal of the aforesaid provision clearly show that with this amendment any sum received in cash or kind under an agreement for not carrying out any activity in relation to any business shall be taxed under the head Profits and gains of business. It is the say of the assessee that carrying on of the business is a must. Let us see what is provided u/s. 28(1) of the Act.

“The profits and gains of any business or profession which was carried on by the assessee at any time during the previous year.”

12. A perusal of this provision clearly shows that for the applicability of Cl. (1), the profits and gains should arise from the business carried on by the assessee. However in Cl. (va) of Sec. 28, no such mandate as “carried on by the assessee” is provided. On the contrary, Cl. [Va] refers to “any business” which means not necessarily the business of the assessee. Moreover, it is the company, in which the assessee was only a Director, has transferred one of its divisions on a slump sale basis. Assuming, yet denying, that carrying of business is a necessity even on that note, it has to be kept in mind that the transferor company Chemito Technologies Pvt. Ltd has only transferred one of its division to M/s. Thermo Electron LLS India Pvt. Ltd. and not the entire business which negates the submission of the Counsel for the assessee. The ITAT Hyderabad Special Bench had the occasion to deal in similar issue in the case of Dr. B.V. Raju (supra) wherein the Tribunal was seized with the situation which was prior to the amendment of Sec. 28. Therefore, the Tribunal has held that prior to the amendment, Non compete fee was regarded as capital receipt. However, the Tribunal at para-38 of its order has emphatically made it clear that w.e.f. 1.4.2003, a new sub-sec (va) is inserted in Sec. 28 to bring in the Non compete fees within the purview of Sec. 28 to make it taxable in the hands of the recipient of such income. Hon’ble Supreme Court in the case of Guffic Chem. (P.) Ltd. (supra) held that payment received as Non Compete fee under a negative covenant was always treated as a capital receipt till the assessment year 2003-04. It is only vide Finance Act, 2002 w.e.f. April 2003 that receipt by way of Non compete fee was made taxable u/s. 28(va) of the Act. The Hon’ble Supreme Court was dealing with the situation wherein it was to be decided whether Non compete fees could be charged under the head profits and gains of business or profession prior to amendment brought w.e.f. 1.4.2003 to which the Hon’ble Supreme Court held that liability cannot be created retrospectively therefore the said section 28(va) is amendatory and not clarificatory, which observation fortifies our view that w.e.f. 1.4.2003 Non compete fees is taxable under the head “profits and gains of business or profession” as a revenue receipt.

13. Hon’ble Jurisdictional High Court of Bombay in the case of John D’Souza (supra) has also held that any payment for not carrying out any activity or for refraining from carrying out activity in relation to business which otherwise was being allowed to be carried out by the assessee, by the erstwhile owner was assessable u/s. 28(va), squarely applies. The Hon’ble Jurisdictional High Court further held that question of capital gains did not arise as the assessee was not owner of any asset in the first place and there is no transfer of such alleged capital asset during the previous year.

14. Considering the facts of the case in totality in the light of the judicial decisions discussed hereinabove, in our considerate view, post amendment in Sec. 28 with the insertion of Cl (va), the Non compete fee of Rs. 5 crores received by the assessee is liable to be taxed under the head profits and gains of business or profession. On that note we do not find any error or infirmity in the findings of the Ld. CIT(A).

15. Before parting, the assessee has placed reliance upon the decision of the Tribunal in the case of Mrs. Hami Aspi Balsara (supra). The facts of that case are clearly distinguishable from the facts of the instant case inasmuch as in that case, for the difference in the sale consideration vis-à-vis book value of the shares, the AO was of the opinion that the difference is nothing but a Non Compete fees and therefore the Tribunal rejected the contention of the AO holding that there was no such mention in the agreement between the purchaser and the seller of the shares therefore the difference cannot be said to be Non compete fee. However, in the present case, there is a separate agreement termed as ‘Non compete and Non solicitation agreement’. Further in the case of Mrs. Hami Aspi Balsara (supra), the transaction was clearly covered by the exemption provided u/s. 28(va) wherein it has been provided that receipts for transfer of right to manufacture, produce or process any article or thing or right to carry on business, which are chargeable to tax under the head ‘capital gain’ would not be taxable as profits and gains of business and since in that case, the transfer of shares were subjected to tax under the head capital gains. Therefore, the Tribunal held that Sec. 28(va) is not applicable. However, in the present case, there is no transfer of any capital asset therefore there is no question of the applicability of the exemption provided in sec.28[va] therefore the receipt is rightly being taxed under the head capital gains.

16. In the result, the appeal filed by the assessee is dismissed.

ITA No. 7032/Mum/2012

17. The issues involved are identical with the issue in ITA No. 7034/M/12, though quantum may differ, therefore, on similar lines, similar reasons, the appeal filed by the assessee in ITA No. 7032/M/12 for assessment year 2009-2010 is dismissed.