Ashish Tandon Vs ACIT (ITAT Ahmedabad)
Conclusion: Income on sale of a technical concept, that assessee developed on his own, with respect to website malware monitoring was non-compete fee taxable as business income under section 28(va) as the consideration was in respect of parting the knowledge by assessee concerning confidential information relating to the business.
Held: Assessee had claimed an exempt income being income on sale of a technical concept, that assessee developed on his own, with respect to website malware monitoring to safeguard websites from getting infected with malware. Assessee entered into an agreement with his employer, i.e. Indusface India for investment in further development of the concept for commercial exploitation. As per the agreement, assessee had “coined the interesting concept for providing round the clock [24X7X365] or daily or on demand malware monitoring of websites in a zero touch and security as a service (SAAS)” basis and had expressed the willingness to provide the said concept to the company and to assist the company to develop the same into a business idea” on the terms and conditions of the agreement. Indusface India had represented and assured that “it has the necessary expertise and capabilities for exploiting the concept and had intention of developing product and services by utilizing the said concept and was also ready and willing to allocate reasonable funds for developing the product and/ or services and marketing the same”. AO noted that the sale consideration represented sale consideration of a developed concept in which a sum of Rs 4,78,52,797 was invested by the employer (i.e. Indusface India)”. He was of the view that sale consideration was of a developed concept and not the original cost, and, therefore, it could not be said that the asset sold did not have a cost of acquisition. AO concluded that the exemption claimed by assessee was unsustainable in law and proceeded to bring the exempt amount to tax in the hands of the assessee as income from other sources. It was held if “coining of the concept”, as assessee put it, was indeed so valuable that it would, on standalone basis, fetch the assessee Rs 10 crores, there could not have been any logic in allowing a company to commercially exploit or develop the same for 7 years, without any royalty, consideration and arrangement for sharing the results of its commercial exploitation. The terms of the provisions of the agreement do not make commercial sense at all. What was being shown in this agreement, not real. Hon’ble Supreme Court, in Durga Prasad More’s case held that,”If all that an assessee who wants to evade tax is to have some recitals made in a document either executed by him or executed in his favour then the door will be left wide open to evade tax . The taxing authorities were not required to put on blinkers while looking at the documents produced before them. They were entitled to look into the surrounding circumstances to find out the reality of the recitals made in those documents”. It was for assessee to decide as to what was appropriate for justifying his case, and when he did not file a document, with specific prayer for admission of such additional evidence, he could not have a grievance about not been given an opportunity to furnish that evidence. The concept developed by assessee, during the course of his employment, was sold to a third party, and, going by the claim of assessee, the amount of US $ 15,75,000 was received on account of sale of this concept. That was the logical conclusion that must follow in the event of our accepting bonafides of the agreements filed by assessee. What assessee had got as a result of the impugned sale of business by his employer to Trend Micro was a result of fruit of his employment, but, as it had not been received from employer, it was taxable under the head ‘income from other sources’. It was also important to note in the non compete agreement that assessee entered into with Trend Micro, it was specifically stated , the restricted party had obtained knowledge concerning confidential information of IFI and IDFC relating to the business” and it was in consideration thereto, the payment had been made. Thus, it was held that the amount received by assessee was revenue receipt and was taxable as business income u/s 28(va). In any case, cost of acquisition, in the case of non compete rights, under section 55(2)(a) was to be taken as NIL, and, as a corollary thereto, the entire receipts was to be taxed in the hands of assessee. Further, the non compete agreement was not in relation to the concept because at the time of sale of the business by IFC to Trend Micro, IFC had already developed the intangible product in the form of M/s, Indus Guard by utilizing such concept and was earning revenue, by selling products manufactured by utilizing Indus Guard. Thus, the non-compete fee received by assessee was not related to the original right granted by him for exploitation of the concept to M/s. IFC. Hence, the consideration received in lieu of entering into non competent Agreement was not taxable as capital gain in the hands of assessee under any circumstances.Only a part of the consideration received against the foregoing of reversionary right could be held to be a capital gain and in that condition also, the cost of acquisition of such right had to be taken at Nil and the capital gain was to be computed as short term capital gain. There was no escape from the taxation of these receipts in the hands of assessee. The impugned receipt was not in the nature of an exempt income.
FULL TEXT OF THE ITAT JUDGEMENT
1. This is an appeal filed by the assessee and is directed against the order dated 27th June 2017, passed by the CIT(A) in the matter of assessment under section 143(3) of the Income Tax Act, 1961, for the assessment year 2013-14.
2. Grievances raised by the assessee are as follows:
Capital Receipt not chargeable to tax:
1. The learned Commissioner of Income Tax (Appeals)-1, Vadodara [“the CIT(A)”] erred in fact and in law in confirming the action of the Assistant Commissioner of Income Tax, Circle 1(1)(2), Vadodara (“the AO”) in rejecting the contention of the Appellant that the sum of Rs.9,70,59,873, received on transfer of an asset is a capital receipt not chargeable to tax since the asset was a self-generated asset, having no cost of acquisition / improvement and therefore any gains arising on its transfer is not chargeable to tax.
2. The learned CIT(A) erred in fact and in law in computing the cost of acquisition of the capital asset at Rs. Nil by invoking the provisions of section 55 (2)(a) of the Income Tax Act, 1961 (“the Act”).
Business Income:
3. The learned CIT(A) erred in fact and in law in treating the sum of 9,70,59,873, received on transfer of capital asset, as business income and thereby taxing the amount as revenue receipt invoking section 28(va) of the Act.
4. Without prejudice to Ground No. 3, the learned CIT(A) erred in fact and in law in attributing the entire receipt of Rs.9,70,59,873 towards non-compete fees.
Capital Gains – Alternate Grounds of Appeal: Without prejudice to Grounds No. 1 and 2:
5. The learned CIT(A) ought to have directed the AO to tax the receipts of 9,70,59,873 under the head capital gains u/s. 45 of the Act instead of business income.
6. The learned CIT(A) erred in fact and in law in not directing the AO to allow deduction u/s 54F of the Act by treating the receipts as income under the head capital gains.
7. The learned CIT(A) erred in fact and in law in observing that the transfer of the capital asset is taxable as short term capital gains instead of long term capital gain.
3. The issue in appeal lies a rather narrow compass of interesting facts. The assessee before us is an individual deriving income under the head salaries, capital gains, house property and income from other sources, such as dividends etc. On 31st July 2013, he filed his income tax return disclosing an income of Rs 29,63,542. When this return was subjected to scrutiny assessment proceedings, the Assessing Officer noticed that the assessee has claimed an exempt income of Rs 9,70,59,873 being income on sale of a technical concept, that the assessee developed on his own, with respect to website malware monitoring. In essence, as noted by the Assessing Officer, the sequence of events was this. A technical concept was conceptualized by the assessee to safeguard websites from getting infected with malware. On 26thMarch, 2009, the assessee entered into an agreement with his employer, i.e. Indusface Consulting Pvt Ltd (Indusface India, in short), for investment in further development of the concept for commercial exploitation. Between 26th March 2009 and 13th September 2012, Indusface India makes an investment of Rs 4,78,52,797. Thereafter, on 13th September 2012, an agreement is entered into between the assessee, the employer- Indusface India, Indusface Inc (Indusface Canada, in short)- a Canada based entity, on one hand, and Trend Micro Inc, USA, (Trend Micro, in short) on the other, for sale of all the rights in the concept so developed. Under this sale agreement, the assessee got, net of holdback amounts, US $ 15,75,000, Indusface India got US $ 6,70,000 and Indusface Canada got US $ 13,50,000. On these facts, the claim of the assessee was that the amount received by the assessee from Trend Micro India Pvt Ltd was a capital gain in his hands, but as it had no cost of acquisition and in the light of law laid down by Hon’ble Supreme Court in the case of CIT Vs B C Srinivas Shetty [(1981) 128 ITR 1 (SC)], this capital gain was not taxable in nature. The Assessing Officer took note of the agreement that the assessee entered into with Indusface India and analysed the same in considerable detail. He noted that, as per the said agreement, the assessee has “coined the interesting concept for providing round the clock [24X7X365] or daily or on demand malware monitoring of websites in a zero touch and security as a service (SAAS)” basis and had expressed the willingness to provide the said concept to the company and to assist the company to develop the same into a business idea” on the terms and conditions of the agreement. He further noted that, under the said agreement, Indusface India had represented and assured that “it has the necessary expertise and capabilities for exploiting the concept and has intention of developing product and services by utilizing the said concept and is also ready and willing to allocate reasonable funds for developing the product and/ or services and marketing the same”. The Assessing Officer then also noted that as per the details furnished by the assessee, the Indusface India had incurred expenses on this project, under the heads (i) salary and other employee benefits, (ii) direct production and service overheads, and (iii) other expenses, aggregating to Rs 64,81,413 in the financial year 2012-13, aggregating to Rs 1,56,85,551 in the financial year 2011-12, aggregating to Rs 1,67,54,423 in the financial year 2010-11, and aggregating to Rs 89,3 1,410 in the financial year 2009-10. The Assessing Officer was of the view that “it can thus be seen that the sale consideration represents sale consideration of a developed concept in which a sum of Rs 4,78,52,797 was invested by the employer (i.e. Indusface India)”. The Assessing Officer was of the view that sale consideration was of a developed concept and not the original cost, and, therefore, it could not be said that the asset sold did not have a cost of acquisition. He thus rejected the assessee’ s reliance on Hon’ble Supreme Court’s judgment on B C Srinivas Shetty’s case (supra). Without prejudice to this line of reasoning, the Assessing Officer further observed that, in any event, the “concept” is a subject matter of copyright under the Copyright Act, 1957, and “indisputably was authored by the assessee during his tenure as Chief Executive Officer of Induface Pvt Ltd”, and, “accordingly, in terms of Section 17 of the Copyright Act 1957, employer of the assessee is the first owner of the copyright contained in the concept developed by the assessee and is eligible to reap all the benefits from its further development, particularly when a substantial sum is invested by Indusface”. The amount received by the assessee could not, therefore, be said to be capital gain on sale of an asset without any cost of acquisition. The Assessing Officer also noted reliance of the assessee on Hon’ble Bombay High Court’s judgment in the case of Cadell Wvg Mills Co Ltd Vs CIT [(2001) 249 ITR 265 (Bom)], which stands approved by Hon’ble Supreme Court in judgment reported as CIT Vs D P Sandhu Bros Chembur Pvt Ltd [(2005) 273 ITR 1 (SC)], the Assessing Officer observed that the issue adjudicated by Hon’ble Court was taxability of consideration against surrendering the tenancy rights which had no cost of acquisition but then in the present case the consideration paid was for a developed cost for which Rs 4,78,52,797 was invested by employer of the assessee. Similarly, assessee’s reliance on a coordinate bench decision in the case of Niyati B Yodh Vs ACIT [(2004) 4 SOT 941 (Mum)], the Assessing Officer observed that the issue in the said case was regarding taxability of receipt not in the nature of revenue receipts and, for that reason not taxable under the head ‘income from other sources’, but then in the present case the income is generated on sale of a concept, developed by the employer in the normal course of business of developing software, and is thus materially different. In the light of this detailed analysis, the Assessing Officer concluded that the exemption of Rs 9,70,59,873 claimed by the assessee is unsustainable in law. He rejected the claim and proceeded to bring the said amount of Rs 9,70,59,873 to tax in the hands of the assessee as income from other sources. Aggrieved, assessee carried the matter in appeal before the CIT(A) but without any success. While doing so, learned CIT(A) observed as follows:
“5.5 I have considered the facts of the case, the appellant’s submissions and the AO’s observations. The appellant Shri Ashsish R Tandon is working as an Executive Director of the company M/s. Indusface Pvt. Ltd. w.e.f. 1 6.05.2005. The terms and conditions, mentioned in the appointment letter issued by the company to the appellant are crucial in deciding the issues involved in this appeal. Hence, a copy of the appointment letter as provided by the appellant has been scanned and pasted in this appellate order as below
“INDUSFACE
Consulting
Dear Mr. AshishTandon
I am pleased to inform you that at the meeting of Board of Directors of the Company held on 1 6/05/2005, you were unanimously appointed to the position of Executive Director of the Company subject to following terms and conditions viz.: With effect from 16th May, 2005, you will hold position of Executive Director for a initial period of 5 years and then automatically renew annually for subsequent years until decided otherwise.
2. Remuneration:
You shall be paid consolidated remuneration of Rs. 80,000/- per month, making effective from 01/04/2005. Remuneration payable to you will be divided in to such break up of Salary. Allowances and Perquisites, as may be decided by you and the Board of Directors, from time to time!
In addition to the salary, you will also be entitled to perquisites and allowances including benefits of Gratuity, Leave Encashment and facilities of telephone, mobile, internet, club membership fees and Company’s owned and maintained Car for official purpose.
3. Sitting Fees:
As long as you function as Executive Director, you will not be paid any sitting fees for attending the meetings of the Board of Directors or any committee(s) thereof.
4. Scope of Work:
Subject to the supervision and control of the Board of Directors of the Company, you as a Executive Director, shall look after overall business operations, technology, marketing and strategic business development, government Liaison etc, and other day to day affairs of the Company and perform all other duties that the Board may delegate to you from time to time.
5. Duties and Responsibilities
Unless prevented by ill health or otherwise granted prior consent by the Board, you will devote all of your working time, attention and ability to the business, and affairs of the Company in your capacity as Executive Director and you shall not be employed by, provide services to, or otherwise be engaged in, any other organization or employment.
Notwithstanding the foregoing, it is recognized that it will be a normal and expected part of your duties and responsibilities that you may represent the Company on suitable external task groups and committees, when such activity does not conflict with your roles and responsibilities as Executive Director of the Company.
During the course of your appointment hereunder you will truly and faithfully account for and deliver to the Company all money, securities and things of value belonging to the Company that you may from time to, time receive for, from or on account of the Company. You will perform the duties and responsibilities assigned to you in an efficient and competent manner and will devote your skills and best efforts to the business affairs of the Company.
6. Re-imbursement of Expenses, Costs etc.:-
I
You will be entitled to be paid I reimbursed all costs, charges and expenses as may be incurred by him for the purpose of or on behalf of the Company.
7. Policies and Procedures
You will be bound by and will faithfully observe and abide by all the rules, regulations, policies and procedures of the Board of Directors of the Company in force from time to time which are brought to your notice or of which you should reasonably be aware. You will at all times uphold the highest standards conduct and fiscal practices.
8. Termination:
Kindly note that this appointment is a contractual appointment which is terminable in the manner provided herein. The terms thereof are not that of an employee and special terms govern this appointment including the termination thereof.
The Company may terminate this appointment at any time without any cause upon giving of 180 (six months) working days written notice. The Company may waive the notice period by paying o you an amount equivalent to the salary you would have received during the notice period.
You may terminate this appointment upon giving of 180 (six months) working days written notice to the Company. The Company may waive the notice period by paying to you an amount equivalent to the salary you would have received during the notice period.
On behalf of the Board, I would like to mention that the BOD is looking is looking forward to you to play a comprehensive leadership role in all areas of the organization, and mentor, coach,, lead, guide organization to higher, level of performance and achievements.
Wishing you all the very best and good luck!
201/B, SUN, race Cource Circle (W), Baroda, Gujarat- 390007.
SUN, Race Course Circle(W),Baroda, Gujarat
www.indusfaceconsulting.com“
5.5.1. The other crucial issue involved in deciding the appeal is the pattern of share holding in M/s. Indusface Pvt. Ltd. over the years. The same has also been provided by the appellant during the course of the appellate proceedings, which is reproduced below for ready reference:
