Mr. Kanchun Kaushal Vs Ms. Kavita Pandey (AAR Delhi)
Non-compete fees received by the Applicant from ADI BPO Services Private Ltd., an Indian Company, as a part of the consideration for transfer of the shares held in MPS Ltd. an Indian Company, though income from “Profits and gains of business or profession” as provided under Section 28(va) of the Act, shall not be chargeable to tax in India in the absence of any Permanent Establishment of the Applicant in India, by virtue of Article 7 of the Double Taxation Avoidance Agreement (‘DTAA’) between India and United Kingdom.
FULL TEXT OF ADVANCE RULING
HM Publishers Holdings Limited (the Applicant) filed an application on 09.01.2012, seeking an Advance Ruling under Section 245Q(1) of the Income Tax Act, 1961 (the ‘Act’). The same was admitted on 10.01.2014.
2. The Applicant is a company incorporated under the Company laws of England and Wales, United Kingdom and its control and management of the affairs are situated wholly outside of India. It is the holding company of the Macmillan Group, a leading international publisher. MPS Limited is a limited company incorporated under the laws of India and has its registered office in Chennai, India. The equity shares of MPS are listed on the National Stock Exchange of India Limited, BSE Limited and Madras Stock Exchange Limited.
2.1 It is stated that the applicant is the legal and beneficial owner of 1,03,29,980 equity shares representing 61.46% of the issued, subscribed and fully paid up share capital of MPS. ADI BPO Services Private Limited (ADI), a company incorporated under the laws of India with its registered office at New Delhi, is in the business of publishing BPO services in India. It is stated that the Applicant and ADI had entered into a Share Purchase Agreement dated October 11, 2011 (SPA) whereby ADI will purchase all the shares held by the Applicant in MPS.
As per clause 3 of the SPA, ADI will pay to the Applicant the following consideration for the share purchase:
a. Purchase Price – calculated as per SEBI circular dated 2 September, 2005 bearing circular No. MRD/ DoP / SE / Cir – 19/05, on the basis of a price of INR 36.15 per share aggregating to INR 37,37,90,277.
b. Non-compete fee – in consideration of the undertaking set out in clause 5 of the SPA will also pay the Applicant the non-compete fee of INR 9,30,00,000.
2.2 It is stated by the Applicant that as per clause 5 of the SPA, the non-compete fees were to be paid by ADI to the Applicant in addition to the share purchase price for the following reasons and under certain conditions:
a. The Applicant, due to the nature of its association with MPS, has confidential and proprietary information relating to the business and operations of MPS. This information is material to the business of MPS and shall continue to be so after the consumption of the transactions contemplated in the SPA. Disclosure of this information to others, especially competitors of MPS, or the unauthorized use of this information by others would cause substantial loss and harm to MPS and its shareholders.
b. For a period of three years commencing from the completion date of the share purchase, the Applicant shall not, and shall procure that no member of the Macmillan Group, directly or indirectly, alone or jointly with any other person, and whether as a shareholder, partner, director, principal, consultant, agent, employee, manager, adviser , consultant or otherwise:
i. carryon or is engaged in, concerned or interested with or otherwise competes with the business of MPS in !ndia as such involvement would have a detrimental effect, and cause irreparable harm to the business of the MPS; or
ii. solicit or entice away or offer employment to or endeavour to solicit or entice away or offer employment to any employee or officer of MPS.
c. Point (b) above will not prohibit the Applicant and / or the Macmillan Group from directly or indirectly:
i. enhancing and developing its educational and information businesses in !ndia after the date of the agreement; and
ii. holding any interest in any securities of a company listed in or deal on any stock exchanges, if the Applicant and any entity controlled by the Applicant are together interested in securities which amount to less than 10% of the issued share capital of that company.
3. On the above facts, the Applicant has posed the following question to us, seeking an Advance Ruling:
“Whether on the facts and circumstances of the case the non-compete fees received by the Applicant from AD! BPO Services Private Ltd., an !ndian Company, as a part of the consideration for transfer of the shares held in MPS Ltd. an Indian Company, shall be chargeable under the head “Profits and gains of business or profession” as provided under Section 28(va) of the Income-tax Act read with Article 7 of the Double Tax Avoidance Agreement (‘DTAA’) between India and United Kingdom, in absence of any Permanent Establishment of the Applicant in India?”
4. The Applicant has submitted that the non-compete fees received by it from ADI though would be business income under section 28(va) of the Income-tax Act, 1961 (the “Act”), in absence of any permanent establishment in India, would not be taxable in India as per Article 7 of the India-UK Double Taxation Avoidance Treaty (DTAA).
4.1 The Applicant explained the basis and circumstances under which it received the non-compete fees from ADI as follows –
4.1.1 The Applicant received the non-compete fee for not carrying out any business activity which can compete with MPS for a period of three years as per the terms and consideration set out in Clause 5 of the SPA. While the Applicant itself was not engaged in carrying out the same business as that of MPS prior to sale of its shares, the Applicant being an international publisher was operating in the same industry.
4.1.2 The Applicant’s Group of companies i.e. the HMPHL Group, had contacts and expertise to arrange to carry out publishing solution services similar to those being provided by MPS Limited. MPS Limited was carrying out services for third parties and Macmillan Publishers Limited (MPL), a wholly owned UK subsidiary of the HMPHL Group. MPL was publishing books and scientific journals, and MPS Limited was providing services in relation to the publishing of the journals.
4.1.3 ADI BPO knew that HMPHL had contacts, expertise and production departments in other parts of the Group, and hence they were concerned that they could set up another operation to provide publishing solution services and simply terminate MPL’s contracts with MPS Limited. Hence, ADI BPO in order to protect its customer base stipulated the non-compete fee to be paid to the Applicant for not carrying out any business activity which can compete with MPS for a period of three years.
4.2 It was submitted that the provisions of Section 28(va) of the Act treat the consideration received for “not carrying out any activity in relation to any business” as “Income from Business or Professions”. Accordingly, since the non-compete fee was received by the Applicant for not carrying out any activity in relation to any business (in this case, in relation to not carrying out business of publishing BPO services), the said sum should be held to be business income as per section 28(va) of the Act. The Applicant relied on the Hon’ble Madras High Court’s decision in Commissioner of Income-tax vs. M/s. Chemtech Laboratories Ltd. [Tax case appeal no. 1492 of 2007] [Madras HC] wherein rreceipts arising out of a negative covenant not to carry a business was held taxable as business income under section 28 (va) of the Act.
4.3 However, it is submitted that receipt of non-compete fee would not be chargeable under section 28(va) if it is covered by the proviso to Section 28(va). The said proviso excludes a consideration on account of “transfer” of “right to carry on any business” from the head ‘Profits from Business and Profession’ which is chargeable under the head “Capital Gains”.
4.3.1 With respect to taxability under the head capital gains, it was submitted that the agreement by which the Applicant agreed to refrain from indulging in a business competing with another is independent by itself to the transfer of shares (though it is included in the same agreement). An agreement to refrain from carrying out competing business does not fall within any of the modes of transfer as given in the definition of transfer under Section 2(47) of the Act.
4.3.2 Without prejudice, it was further submitted that there was no capital asset also which could be transferred under section 2(47). By entering into a non-compete clause with ADI, the Applicant was restrained from carrying out similar activities as those of MPS for a period of three years, so as to enable ADI to understand and establish itself in the business carried out by MPS. Thus, the Applicant had simply imposed a restriction upon itself and not transferred any right to ADI BPO. The Applicant is only a shareholder of MPS with controlling interest in it and was not carrying on nor had the right to carry on business of MPS. Being a shareholder, it enjoyed rights such as right to profits, right to dividend, right to vote, etc. However, the Applicant contended that in the present facts of the case, it cannot be said to be enjoying a right to carry on business. A company and its shareholders are distinct entities enjoying different rights and obligations. The Applicant, thus, at best, can be said to be enjoying controlling interest in MPS which is not separately identifiable nor legally enforceable. In view of the above, the Applicant submitted that since there did not exist any right to carry on a business, there did not exist any capital asset as required under section 2(14) of the Act for the purpose of transfer.
4.3.3 Thus, the non-compete fee received, is not on account of transfer of right to carry on business and hence not chargeable under ‘Capital Gains’. Accordingly, the non-compete fee is not covered by the proviso to section 28(va), and the case of the Applicant squarely falls under the provisions of Section 28(va)(a). Therefore, the non-compete fee received would be business profits in the hands of the Applicant.
4.4 It is further submitted that as per section 90 sub-section (2) of the Act, the assessee has an option of being taxed as per the provisions of the India-UK Treaty, should such provisions be more beneficial to it. Accordingly, the Applicant contended that once it is ruled that non-compete fees would be chargeable to tax under the head “Income from Business or Profession”, then as per Article 7 of the Treaty, such business profits would be taxable in India only if it carries out any business activity through a permanent establishment (PE) in India. In the absence of any PE in India, the non-compete fees receivable would not be chargeable to tax in India. In support of its contention, the Applicant relied on the decision of Trans Global PLC vs. Director of Income tax (International taxation) [158 ITD 230] [Kol. Trib.], wherein non – compete fees received by a UK based non – resident company not having a PE in India was held as not liable for taxation in India. The following extract of the decision was highlighted by the Applicant –
“6. We have heard the Ld. Sr. counsel Shri R. N. Bajoria and gone through facts and circumstances of the case. Before us, the issue is limited whether the receipt of noncompete premium is taxable as capital gains u/s. 55(2)(a) read with proviso (1) of section 28(va) of the Act, when the assessee is a nonresident company of UK in term of Article7 of Double Taxation Avoidance Agreement (DTAA) with UK. Admittedly, the assessee is a nonresident British Company liable to tax in UK only and does not have a permanent establishment in India. The assessee received noncompete premium during the relevant AY 200809 and claimed that the amount received on account of noncompete fee is not for transfer of any right to carry on any business or for transfer of any right to manufacture. According to assessee, this noncompete fee premium is a mere refraining from carrying on activity, which can be taxed u/s. 28(va) of the Act as amended by the Finance Act, 2002 w.e.f. 01.04.2003. The assessee also pleaded that this can be assessed as business income but assessee being a nonresident having no permanent establishment in India and accordingly, in term of Article 7 of DTAA with UK any business income arising to the enterprise of a contracting state is taxable only in that state unless the enterprise is carrying on business in the other contracting state through a permanent establishment situated therein. We find that it is not the case of the revenue that the assessee is having a permanent establishment in India and as such in term of Article7 of DTAA, being noncompete premium received by assessee cannot be taxed in India. The AO while framing assessment u/s. 143(3) of the Act, after considering the provisions has not taxed the noncompete premium in accordance with the provisions of the Act and the provisions of the DTAA. The DIT(IT) has relied on the case law of Hon’ble Supreme Court in the case Mangalore Electric Supply Co. Ltd. v. CIT [1978] 113 ITR 655 wherein the transfer has been discussed and not the taxability in term of DTAA. The another precedent cited by Ld. DIT (IT) of Hon’ble Supreme Court in the case of CIT v. Narayan Dairy Products [1996] 219 ITR 4 78/85 Taxman 375 (SC) (SC) wherein the similar word transfer was interpreted. Further, he also referred to the decision of Hon ‘ble Kerala High Court in the case of Blue Bay Fisheries (P.) Ltd. v. CIT [1987] 166 ITR 1/31 Taxman 393 (Ker), wherein the same issue of transfer is discussed. According to DIT(IT), transfer of shares of Moran Tea Co. (I) Ltd., transferring the controlling interest in the business of the said company and accordingly, the resultant receipt is capital gains taxable u/s. 55(2)(a) of the Act.
7. In view of the above facts, we are of the view that a perusal of noncompete agreement clearly shows that by any stretch of imagination it cannot be held that there is a transfer within the meaning of section 2(4 7) of the Act resulting in assessment being erroneous and prejudicial to the interest of revenue for not assessing noncompete premium as capital gains. The assessee clearly accepted that the provisions of section 28(v)(a) of the Act will apply to this noncompete section 28(va) premium being business income but that will be taxed in UK being assessee a nonresident British Company having no permanent establishment in India in term of Article7 of DTAA.
8. Before us, Ld. Counsel for the assessee having relied on the decision of Hon’ble Supreme Court in the case of Gufic Chem (P.) Ltd. v. CIT [2011] 332 ITR 602/198 Taxman 78/10 com105, wherein it is held as under: “7
9. In view of the above facts and circumstances and case law of Hon’ble Supreme Court in the case of Guffic Chem (P.) Ltd., supra, we hold that the above said noncompete premium received by assessee is a business receipt assessable u/s. 28(va) of the Act but in terms of Article 7 of DTAA any business income arising to the enterprise of a contracting state is taxable only in that state, assessee being a nonresident company and does not have a permanent establishment in India, liable to tax in UK only. Accordingly, the assessment framed by AO is neither erroneous nor prejudicial to the interest of revenue and hence, the revision order passed by DIT(IT) is without any basis and quashed.”
5. The Revenue has contended that the non-compete fee received by the Applicant is chargeable under the head ‘Capital Gains’ and not under the head of business income. A report dated 1-09-2017 was filed by the Revenue wherein it was argued as under:
5.1 That the receipt of non-compete fee is for transfer of right to carry on business covered under the definition of ‘transfer’ as per section 2(47) of the Income-tax Act. As per the said section, extinguishment of any right in a capital asset amounts to transfer. In the case of non-compete fee, the right to carry on a business is a capital asset and that right is extinguished when the payment is made to a person for not carrying out that business. Thus in the present case when payment is made to the applicant for not carrying out a business, his right in the capital asset is extinguished and there is a transfer within the meaning of Section 2(47) of the Act.
5.2 That section 28(va) is attracted only in a case where assessee receives non-compete fee to not carry on a business further, which it was already carrying on prior to agreement for non-compete. Reliance was placed upon decisions of the Apex Court in the cases of Chennai Properties and Investment Limited SC-2015-LL-0409 and Associated Industrial Development Company (P.) Limited 1971-LL- 0907- 6, which have laid down the ratios for determining taxability of a particular income under appropriate heads of income under Income-tax Act. Further, reliance was placed on the case of Savita Mandhan 2011 -LL-1 007-51 (Mum. ITAT) which has followed the ratio of Hami Aspi Balsara Vs. ACIT (30 DTR 576) to hold that amounts attributable to non-compete obligations are taxable as capital gains and not as business income where the assessee was not carrying on a business.
5.3 It is submitted, on a without prejudice basis, that the entire consideration of non-compete fee is not towards non-compete agreement and some amount should be allotted to transfer of controlling interest by the Applicant. Thus, in case the non-compete fee is held as business income, then according to the Revenue, the entire consideration of INR 9.3 crores does not represent non-compete fee. It was contended that since the Applicant has sold shares along with controlling interest and the shares have been sold at market price, no consideration has been allotted to the control and management which has been transferred. Reliance was placed on the decision of the Delhi High Court in case of Shiv Raj Gupta [2014] 52 taxmann.com 425 (Delhi).
6. In its rejoinder to the above contentions of the Revenue, the Applicant stated during the course of these proceedings as well as in its letter filed with us on 15.09.2017, as under:
