Compensation received for the mere loss of profits will be a revenue receipt, while the compensation received for the loss of a source of income would be capital receipt

CIT, Tiruchy Vs P L Chemical Limited (Madras High Court)- The contract entered into led to the loss of source of income in the ordinary course of business. As rightly pointed out by the Tribunal, the assessee’s business hitherto till 1995 to market its products and its brand name, thus no longer available in toto, the non-compete fee thus received by the assessee, assumes the character of capital, which cannot be assessed under the provisions of the Act.

In the circumstances, applying the decision of the Supreme Court reported in [2011] 332 ITR 602 (Guffic Chem P. Ltd. Vs. C.I.T., Belgaum and another), we have no hesitation in rejecting the Tax Case accepting the plea of the assessee.

The Commissioner of Income Tax, Tiruchy Vs PL Chemical Limited

High Court of Madras

DATED: 04.07.2011

Tax Case Appeal No. 471 of 2004

PRAYER: Tax Case Appeal filed under Section 260A of the Income Tax Act, 1961 against the order of the Income Tax Appellate Tribunal, Madras Bench, dated 2.2.2001 in I.T.A. No. 593/Mds/2000.

JUDGEMENT

(Judgement of the Court was delivered by CHITRA VENKATARAMAN, J.)

The Revenue is on appeal as against the order of the Income Tax Appellate Tribunal dated 2.2.2001 in I.T.A. No. 593/Mds/2000.

2. Even though the grounds of appeal contain two substantial questions of law, since at the admission stage itself the substantial question of law is restricted as regards only one question, this Tax Case Appeal is decided on the first issue.

3. This Tax Case relates to the assessment year 1996- 97.

4. The assessee herein is a company which was carrying on business in manufacturing mosquito repellents and selling it in the name and style of ‘Banish Mats’, a patent owned by its sister concern.  The assessee also had an agreement with M/s.Bayer India Limited on 16.9.1994, for manufacture and sale of insecticides, including household insecticides (mats/mosquito destroyer), at an agreed price.  It is seen from the facts projected before this Court that up to the year 1995-96, the assessee was selling its products manufactured under its trademark, apart from the agreement with Bayer India Limited to manufacture and sell mats under contract basis.  Under agreement dated 24.5.1995 with Transelektra Domestic Products Limited, (hereinafter referred to as TDP Limited), the assessee agreed to receive non-compete fee, that they shall not manufacture, sell or distribute mosquito repellents, mats or mat heater machines under the Trade Mark or otherwise, either on its own account or on behalf of any other person.  Under the terms of the above agreement, the assessee received a sum of Rs. 2,70,00,000/- (Rupees two crores seventy lakhs only) as by way of non-compete fee.  It is also seen from the documents placed before this Court that under agreement dated 24.5.1995 with M/s. TDP Limited, the assessee assigned its goodwill for a consideration of Rs. 35 lakhs.  In terms of the restrictive non-compete clause, the assessee contended that the said receipt was a capital receipt and hence, could not be assessed as income.  The Assessing Authority treated the receipt of non-compete fee as a revenue receipt, viewing that the restrictive covenant for a term of five years, was a normal incident of the business.  Since the assessee was free to carry on a similar trade with the use of infrastructure available, the receipt was to be assessed as a revenue receipt.  The aggrieved assessee went on appeal before the Commissioner of Income Tax (Appeals), who confirmed the order of the Assessing Officer.  The assessee once again preferred a further appeal before the Income Tax Appellate Tribunal.  Following the decision of this Court reported in [1998] 234 ITR 23 (Chem plant Engineers (P) Ltd. Vs. Commissioner of Income Tax), the Tribunal agreed with the assessee and held that by its agreement with TDP Limited, the assessee had agreed  that it would not manufacture and sell insecticides using its trade name.  For this, the assessee had received Rs.2.70 crores as non-compete fee.  Thus the business of the assessee carried on by using its trade name, had come to a stop. The assessee had no right to market, sell or distribute the products under its own trade name.  However, as far as the manufacturing activity carried on for Bayer India Limited is concerned, the same could not be equated with the assessee selling and marketing the products under its brand name. In the circumstances, the Tribunal held that the agreement with TDP Limited had resulted in a loss of source of income and not just the loss of income.  Hence, the receipt was to be treated as capital in nature.  Aggrieved by the same, the Revenue is on appeal before us.

5. Learned Standing Counsel appearing for the Revenue, after referring to the agreement between the assessee and TDP Limited, placed reliance on the decision of the Andhra Pradesh High Court reported in [1984] 148 ITR 546 (Coromandel Fertilisers Ltd. Vs. Commissioner of Income Tax), and submitted that considering the nature of covenant restricting the business of the assessee for a period of five years alone, there being no loss of enduring nature, the receipt has to be assessed only as a revenue receipt.  Learned Standing Counsel also placed reliance on the decision reported in [1998] 234 ITR 23 (Chem plant Engineers (P) Ltd. Vs. Commissioner of Income Tax), wherein, this Court considered the decision reported in [1966] 60 ITR 11 (Commissioner of Income Tax, Madras Vs. Best & Company) and pointed out that when the assessee company before us was permitted to manufacture as before and sell the same, as evident from the contract with Bayer India Limited, there was no loss of source of income, much less of an enduring nature, as had been contended by the assessee.  He also referred to the decision of the Commissioner of Income Tax (Appeals), pointing out to the difference between the two sub clauses on the non-compete clauses under the agreement which enabled the assessee to carry on business as before. In the light of the fact that the assessee continued to manufacture mosquito repellents, mats and mat heater machines as before, even after the agreement dated 24.5.1995, and that the business practically continued, the non compete fee has to be treated only as a revenue receipt. He further submitted that a partial restriction in the business activity, per se, would not make the receipt, capital in nature.

6. Per contra, learned counsel appearing for the assessee, referred to the decision of the Apex Court reported in [1966] 60 ITR 11 (Commissioner of Income Tax, Madras Vs. Best & Company), which has been consistently followed by the Apex Court, the latest being the one reported in [2011] 332 ITR 602 (Guffic Chem P. Ltd. Vs. C.I.T., Belgaum and another), and submitted that with the law thus established as regards the dichotomy between a compensation for a loss of income and the loss of source of income, the agreement had to be read in the context of what it proposed to restrict as regards its business activity.  Pointing out to the fact that the agreement put a clog on the assessee manufacturing and selling the products using its trade name, learned counsel pointed out that the agreement with Bayer India Limited merely enabled the assessee to manufacture insecticides, including household insecticides (mats and mosquito destroyer) and affix the trademark of Bayer India Limited under the formula standard of Bayer. Thus the non-compete agreement specifically restricted the the assessee from manufacturing and selling mats and mosquito repellents under its trade name. In the light of the above, the periodicity of the restriction is not the test to conclude the character of the receipt. Learned counsel further submitted that with the restriction on manufacturing and marketing of the product as per its specification and trademark and thus with source of income thus lost, the receipt has to be necessarily characterised as a capital receipt.   Learned counsel also placed reliance on the decision reported in [1981] 132 ITR 207 (Commissioner of Income Tax Vs. Saraswathi Publicities), which, in turn, reaffirmed the law as propounded in the decision reported in [1966] 60 ITR 11 (Commissioner of Income Tax, Madras Vs. Best & Company).  In the light of the decisions of the Apex Court, learned counsel appearing for the assessee submitted that no exception could be made to the reasoning given by the Tribunal in this regard.

7. Before going into the merits that were referred to, the clauses over which there has been much of a controversy raised by the parties herein in the non-compete agreement dated 24.5.1995 needs to be seen. The definition clause of the term “Business” reads as follows:

“Business” shall mean the business of the manufacture, marketing, distribution or sale of mosquito repellent mats and mat heater machines. ”

8. Clause (iii) therein, namely the covenant- the non-compete clause reads as follows:

“iii) Covenant: PLC hereby agrees with TDP that, during the period, PLC shall not, without TDP’s prior written consent, directly or indirectly own, manage, operate, join, have an interest in, control or participate in the ownership, management, operation or control of, or be otherwise connected in any manner with, any body corporate, partnership, proprietorship, trust, estate, association or other business entity which directly or indirectly engages, as a commercial activity anywhere in the Territory, in the Business that PLC shall not in any manner whatsoever manufacture, sell, or distribute Mosquito Repellent Mats or Mat Heater Machines under the Trade Marks or otherwise, either on its own account or on behalf of any other person whether as an agent or as a licensee or under any other relationship; Provided that nothing herein contained shall be deemed to prevent or restrain PLC from carrying on and PLC shall be at liberty and shall have the full right and freedom to carry out, indulge in manufacture and sell Mosquito Repellant Mats and Mat Heater Machines, within and/or outside India, on a contractual basis and or on behalf of any other person whether as an agent or as a licensee or under any other relationship provided that the same is not ultimately distributed or marketed by PLC. “

9. On a reading of the above, it is clear that with the entering of the agreement, the assessee was no longer at liberty to engage itself in commercial activity either directly or otherwise, to manufacture and sell or distribute mosquito repellent, mats or mat heater machines under its trade name either on its own behalf or on behalf of anyone.  At the same time, the agreement recognised that the assessee could carry on the manufacture and sell on contractual basis on behalf of anyone as an agent or under any other relationship.  The only restriction there being that the assessee should not distribute or market the same.  Thus it is clear from the agreement with TDP Limited that the restrictive covenant therein practically prohibited the assessee in the matter of enjoying that source of income by exploiting the trademark owned by it.

10. As rightly pointed out by the Commissioner of Income Tax (Appeals), the covenant under Clause (iii) shows that what was prohibited was that the assessee could not manufacture and sell mosquito mats and mat heaters under its trade name.  It however recognised the assessee carrying on its manufacturing activity and selling mosquito repellents, mats and mat heating machines, within or outside India, on a contractual basis and or on behalf of any other person either as an agent or as a licensee or under any other relationship, provided that the ultimate distribution and marketing are not done by the assessee.

11. Thus going by the latter portion of the said clause and going by the earlier agreement that the assessee had with Bayer India Limited on 16.9.1994, the assessee continued its manufacturing activity and selling as before even after 24.5.1995 but without its trademark affixed.

12. The non-compete agreement entered into in 1995 thus made the fact  very clear that the assessee was left with only one source of activity to manufacture and sell on contract basis without using its trademark.  However, as far as manufacturing and marketing of the products under its trade name is concerned, the assessee had to put a stop from carrying on its business activity for a period of five years.  As rightly contended by the learned counsel appearing for the assessee, with one source of income by exploiting its trademark and the goodwill thus no longer available to the assessee, but the loss that the assessee suffered could not be called just the loss of income, but loss of an income generating aspect of the business; thus the compensation received in this loss of source of income makes the receipt a capital receipt at the hands of the assessee.

13. The controversy as to whether the non-compete fee is revenue or capital was resolved by the Parliament by insertion of Clause Va to Section 28 of the Finance Act 2002 with effect from 1.4.2003.  Referring to the said amendment in Section 28, the Apex Court in the decison reported in [2011] 332 ITR 602 (Guffic Chem P. Ltd. Vs. C.I.T., Belgaum and another)pointed out as follows:

” Payment received as non-competition fee under a negative covenant was always treated as a capital receipt till the assessment under the year 2003-04.  It is only vide the Finance Act, 2002 with effect from April 1, 2003 that the said capital receipt is now made taxable (See section 28(va)).  The Finance Act, 2002 itself indicates that during the relevant assessment year compensation received by the assessee under non-competition agreement was a capital receipt, not taxable under the 1961 Act.  It became taxable only with effect from April 1, 2003.  It is well settled that a liability cannot be created retrospectively.  In the present case, compensation received under the non-competition agreement became taxable as a capital receipt and not as a revenue receipt by specific legislative mandate vide section 28(va) and that too with effect from April 1, 2003.  Hence, the said section 28(va) is amendatory and not clarificatory. “

14. Referring to the decision reported in [1959] 35 ITR 148 (Commissioner of Income Tax, Nagpur Vs. Rai Bahadur Jairam Valji and others), the Apex Court pointed out “if a contract is entered into in the ordinary course of business, any compensation received for its termination (or loss of agency) would be a revenue receipt.”  As far as the present case is concerned, the contract entered into led to the loss of source of income in the ordinary course of business.  As rightly pointed out by the Tribunal, the assessee’s business hitherto till 1995 to market its products and its brand name, thus no longer available in toto, the non-compete fee thus received by the assessee, assumes the character of capital, which cannot be assessed under the provisions of the Act.  In the circumstances, applying the decision of the Supreme Court reported in [2011] 332 ITR 602 (Guffic Chem P. Ltd. Vs. C.I.T., Belgaum and another), we have no hesitation in rejecting the Tax Case accepting the plea of the assessee.

15. As far as the decision reported in [1998] 234 ITR 23 (Chem plant Engineers (P) Ltd. Vs. Commissioner of Income Tax) is concerned, the said decision has to be understood on the facts raised therein.  Even therein, this Court held that all that the assessee therein lost was only the business income and not the source of income.  This Court pointed out therein to the agreement not to carry on the same business. It is well established that the compensation received for the mere loss of profits will be a revenue receipt, while the compensation received for the loss of a source of income would be capital receipt. In the said circumstances, this Court held that the receipt of compensation was a revenue receipt asses-sable under the provisions of the Act. The facts now projected herein stands on a totally different footing.  The other decisions relied on by the learned Standing Counsel appearing for the Revenue, reported in [1987] 165 ITR 63 (Commissioner of Income Tax Vs. Late G.D.Naidu and others by Lrs. G.D. Gopal and another), [2004] 269 ITR 177 (Parry and Co. Ltd. Vs. the Deputy Commissioner of Income Tax, Special Range IV, and the Assistant Commissioner of Income Tax) and [2010] 326 ITR 474 (Commissioner of Income Tax Vs. Hindustan Zinc Ltd.) are all relatable to capital expenditure, a yardstick which cannot be extended for understanding the issue herein which necessarily has to be decided in terms of the agreement.

16. In the light of the above, we have no hesitation in rejecting the case of the Revenue. Consequently, the question is answered against the revenue and the Tax Case Appeal stands dismissed.  No costs.