Case Law Details
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:
6.1 With regard to the first contention of the Revenue, it was stated that:
6.1.1 The Applicant does not have a ‘right to carry on a business’ of MPS. It reiterated its submissions that Applicant being only a shareholder of MPS did not have right to carry on the business of MPS. It only enjoyed rights such as right to profits, right to dividend, right to vote, etc. Thus, there did not exist any capital asset, as alleged by the Revenue, as per section 2(14) of the Act in order to attract capital gains.
6.1.2 Without prejudice to the above, non-compete fee is in consideration for a restrictive/negative covenant and not for ‘transfer of right to carry on business’. Referring to Clause 5 of the SPA, the Applicant submitted that it has only imposed a restriction upon itself to not compete with MPS since it was in possession of confidential and proprietary information relating to the business and operations of MPS.
Thus, the payer i.e. ADI entered into a non-compete clause with the Applicant to protect its own interests and not for gaining any rights of carrying on a business from the Applicant. Accordingly, the fee received by the Applicant is for a negative covenant to not compete with MPS and not for transfer of any right to carry on business to the payer as argued by the Revenue.
6.1.3 Such restrictive/negative covenant does not amount to ‘transfer’ under section 2(47)(ii) since there is no extinguishment of any right/capital asset in an agreement for non-compete. The Applicant argued that the word ‘extinguishment’ means destruction, implying that the right, contract, etc. which is extinguished is destroyed in perpetuity. Till the time the right is revocable, it could not be said that there was extinguishment of rights. At best, it can be said to be a case of suspension of rights. Since the non-compete fee was received by the Applicant in consideration for an agreement not to compete with MPS for 3 years only, it could not be said that rights were destroyed permanently so as to be called extinguishment of ‘right to carry on business’ amounting to ‘transfer’ under section 2(47)(ii). Reliance was placed on the Amritsar Tribunal’s decision in the case of Dy. CIT v. Max India Ltd. [2007] 112 TTJ 726 wherein it has been held that when the assessee signed the negative covenant not to carry on manufacture or trade in product for certain period of time, it amounted only to self-imposed restriction and not a transfer. Similar reliance was placed on decisions in the case of Ramesh D. Tainwala vs. ITO 48 SOT 324 (Mum. Trib.) (AY 2006-07) and John D’souza vs. CIT (226 CTR 540) (Bombay High Court).
6.2 As regards Revenue’s second argument that non-compete fee is taxable under the head business income only if the receiver of non- compete fee is already carrying on business which he has agreed not to carry on further, the Applicant submitted that the argument is incorrect and without any basis on the following counts:
6.2.1 The taxation of non-compete fee under the head business income has been specifically provided under section 28(va) of the Act, and it nowhere provides or in any way implies that the recipient of non-compete fee must already be carrying on business which he has agreed not carry on further. The section applies to any person who has received or is entitled to receive a sum in consideration for agreeing not to carry out any activity in relation to any business and is not restricted to only that business which he was already carrying on. In support of the above contention, the Applicant relied on the decision of the Hon’ble Mumbai Tribunal in the case of Anurag Toshniwal & Arun Toshniwal vs. DCIT (56 SOT 52) (Mum. ITAT) which has been affirmed by the Hon’ble Bombay High Court, in Arun Toshniwal and Ors. Vs. DCIT (375 ITR 270).
6.2.2 Further, the Applicant pointed that the issue involved in Chennai Properties (supra) was whether rental income of the assessee was chargeable under the head house property or business income. The issue involved in Associated Industrial Development (supra) was whether sale of shares is to be taxed under the head of business income or capital gains. Since the present case involves determining taxability of non-compete fee received by the Applicant under the head Business Income or Capital Gains which involves interpretation of very different sections under the Income-tax Act, the ratios of the aforesaid two decisions cited by the Revenue are not relevant for the instant case. Also, the facts of the Applicant’s case squarely fall within the provisions of section 28(va) and hence there is no requirement to apply a decisive test as proposed by the Revenue by relying on the decision of Chennai Properties (supra).
6.2.3 As regards Revenue’s reliance on the decisions of Hon’ble Mumbai Tribunal in the case of Hami Aspi Balsara Vs. ACIT (supra) and Savita Mandhan 2011 -LL-1 007-51 (Mum. ITAT) which has followed the ratio of Hami Aspi Balsara, the Applicant explained the facts involved in these cases and sought to distinguish them as under:
6.2.3.1 The applicant submits that the facts in the case of Hami Aspi Balsara were distinguishable. In that case the assessee had sold shares of target companies along with other sellers and received sales consideration from the purchaser M/s. Dabur India Limited. The share purchase agreement contained a non-compete clause since there was no separate consideration provided for it, moreover as the shares were sold at a much higher value than their book values, the assessing officer allocated a certain amount towards non-compete clause and held the same to be taxable under section 28(va). The Hon’ble Mumbai Tribunal reversed the finding of the AO and held the entire consideration received was taxable as capital gains.
6.2.3.2 In both the decisions mentioned above, the agreement was for sale of shares and there was no separate consideration provided for non-compete clause. In contrast, in the present case, the Applicant’s SPA provides for a separate non-compete fee payment under clause 5 of the SPA.
6.2.3.3 The assessee in those decisions did not have any knowledge or expertise of the business carried out by the companies whose shares they sold. In contrast, in the present case, the Applicant,
due to the nature of its association with MPS, had confidential and proprietary information relating to the business and operations of MPS. This information was material to the business of MPS and would continue to be so after the consummation of the transactions contemplated in the SPA. Disclosure of this information to others, especially competitors of MPS, or the unauthorised use of this information by others would cause substantial loss and harm to MPS and its shareholders. Hence there was justification for payment of non-compete provided under Clause 5 of the SPA.
6.2.4 The Applicant further submitted that the decision of Hami Aspi Balsara has been distinguished by the subsequent decision of Hon’ble Mumbai Tribunal in Anurag Toshniwal and Arun Toshniwal (supra) as follows:
“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 ”
This decision has been upheld by the Hon’ble Bombay High Court in 375 ITR 270, wherein the following questions of law were answered in the negative, in favour of the Revenue:
“I. Whether on the facts and in the circumstances of the case and in law, the Tribunal erred in holding that the amount received by the Appellant from Thermo was taxable as business income under the provisions of section 28(va) of the Act, despite the fact that the Appellant was not carrying on any business in the relevant previous year ?
II. Whether the Appellate Tribunal is correct in holding that carrying on of business is not a precondition was chargeability under the head ‘profits and gains of business ?”
6.2.5 The Applicant further placed reliance on a Special Bench decision in Addl. CIT vs. Late Dr. B.V. Raju (14 ITR 387) (Hyd.SB) and Sterling Re-rolling Mills (P.) Ltd. v. ACIT (53 SOT 41) (Mumbai ITAT) to explain its interpretation of law under section 28(va) of the Act.
6.3 As regards Revenue’s alternate argument, the Applicant submitted that the shares held by the Applicant in MPS were listed on the NSE, BSE and MSE. These shares had been sold at the prevalent market price calculated as per the 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 (as reflected in the SPA). Also, the SPA provides for a separate non-compete fee of Rs. 9,30,00,000. Thus, the Revenue should not delve into attributing any amount for transfer of controlling interest from the non-compete consideration and question the genuineness of the SPA in any manner. Also, Revenue’s reliance on the decision of Shiv Raj Gupta (supra) was misplaced since the Revenue failed to consider the facts and circumstances under which the High Court delivered the said decision.
7. We have considered the question raised before us, the arguments of the Applicant and the Revenue, and gone through the decisions relied upon by both sides.
7.1 We may first look at the relevant provisions of the Income-tax Act, 1961 and the India-UK DTAA governing the taxability of the non-compete fee received by the Applicant as business income.
Section 28(va) of the Act –
“(va) any sum, whether received or receivable, in cash or kind, under an agreement for –
(a) not carrying out any activity in relation to any business; or
(b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services:
Provided that sub-clause (a) shall not apply to-
(i) any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head “Capital gains”;
(ii) …………”
Article 7 of the India-UK Treaty
“Business Profits – 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is directly or indirectly attributable to that permanent establishment.”
7.2 The Applicant submits that section 28(va) was introduced by the Finance Act, 2002 w.e.f 1.4.2003. Prior to 1.4.2002, various courts including the Hon’ble Supreme Court in Guffic Chem (332 ITR 602) had held receipts for non-compete fee to be a capital receipt, not liable to tax. Hence, to bring such receipts in the tax net, a specific charge was introduced vide section 28(va) to tax receipts in the form of non-compete fee as business income. Thus, even though such a receipt may be capital in nature, the same is now required to be taxed as business income under section 28(va).
7.3 Further, the section provides that sub clause (a) shall not apply to a sum received or receivable inter-alia, on account of transfer of right to carry on business, which is chargeable under the head capital gains. Thus, 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”. For this purpose, it is important to analyse the terms “transfer” and “right to carry on any business” used in the said proviso. The definition of “transfer” as provided under Section 2(47) of the Act is as follows:
“(47) “transfer”, in relation to a capital asset, includes,—
i. the sale, exchange or relinquishment of the asset ; or
ii. the extinguishment of any rights therein ; or
iii. the compulsory acquisition thereof under any law ; or
iv. in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment ; or
iva. the maturity or redemption of a zero coupon bond; or
v. any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882) ; or
vi. any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.
Explanation – For the purposes of sub-clauses (v) and (vi), “immovable property” shall have the same meaning as in clause (d) of section 269UA.”
7.4 Before answering the question involved in this application, let us also examine the Special Bench decision in the case of Addl. CIT vs. Late Dr. B.V. Raju (14 ITR 387) (Hyd.SB) which has elaborately dealt with taxability under section 28(va) under various scenarios, which shall be relevant for answering the question put before us for a ruling.
“37. CAPITAL GAIN OR NON-COMPETE FEE:
The conclusion that emerges from the aforesaid discussion is that when a business is sold and the purchaser enters into agreements to ensure that there is no competition, he may enter into agreements not only with the transferor of the business but also with persons connected with the transferor. He may also pay consideration to the transferor for transfer of business, for not engaging in competition. He may also pay consideration to persons associated with the transferor not to indulge in competition. The receipts by the transferor or other persons connected with the transferor can be divided into the following categories;
a) The consideration paid by the transferee for transfer of the business to the transferor;
b) Consideration paid to the transferor not to carry on same business directly or indirectly not to indulge in manufacturing same or similar products, not to use the trade names etc. ;
c) Consideration paid to persons associated with the transferor to ensure that they also do not indulge in competing business; It has to be clarified that the case laws in which the transferee claims the consideration paid as above as revenue expenditure have no bearing whatsoever when we deal with the case of the tax treatment in the hands of the transferee. There are different considerations for determining whether the cost paid by the transferor is to be regarded as capital expenditure or revenue expenditure.
38. As far as category (a) is concerned the receipt would fall for consideration under the head capital gains as there is a transfer of capital asset in respect of which the machinery provisions of computation of capital gain can be applied. As far as category (b) is concerned the consideration received would fall for consideration under the head capital gain but depending upon the law that prevailed at the time of transfer. Self generated assets like, goodwill of a business or a trade mark or brand name associated with a business, a right to manufacture, produce or process any article or thing or right to carry on any business, tenancy rights, stage carriage permits or loom hours by their very nature could not have cost of acquisition and therefore machinery provisions were amended to provide cost of acquisition being treated as nil. These amendments are set out in the later part of this order. As far as category (c) is concerned, the same would fall for consideration to see if it is capital receipt chargeable to tax as on the date of transfer because after 1-4- 2003 such consideration even if regarded as capital receipt would be chargeable to tax u/s.28(va)(a) of the Act. Therefore the law as it prevails on the date on which a person agrees to desist from doing certain acts in relation to any business would be relevant.
39. If a payment is in the nature of non-compete fee received by the transferor when he sells his business and agrees not to carry on the business which he transfers then that would fall for consideration under (category (b) referred to earlier) section 55(2)(a) “right to carry on business”. If the non-compete fee is paid to persons associated with the transferor then the same would fall for consideration only under Sec.28(va)(a) of the Act introduced by the Finance Act, 2002, w.e.f 1-4-2003. It is significant to note that the words used in Sec.28(va) (a) of the Act are “not carrying out any activity in relation to any business”. The proviso (i) to Section 28(va)(a) provides for exception to cases where such receipts are taxable as capital gain viz., where any sum is received for transfer of a right to carry on any business which is chargeable to tax as capital gain. When the transferor is already carrying on business and agrees not to carry on business transferred, then the same would fall for consideration only under Sec.55(2) (a) of the Act.
40. With the change in the law receipts on account of giving up right to carry on business even if it is capital receipt would now be chargeable to tax as income from business. The difference would be that if it is paid to the transferor for giving up right to carry on business, it would be regarded as capital gain, the cost of acquisition of right to carry on business being determined in accordance with the provisions of Sec.55(2) (a) of the Act. If it is compensation paid for “not carrying out any activity in relation to any business”, which the transferor is not carrying on, the same would be chargeable u/s .28(va) (a) of the Act. If a receipt is considered as payment for not carrying on business which the transferor is already carrying on then it would be regarded as capital gain, being transfer of a capital asset viz., right to carry on business. Thus for the provisions of Sec.55(2) (a) of the Act to apply the transferor must be carrying on a business which he agrees not to carry on. If the transferor is not already carrying on business then he receives consideration only for “not carrying out any activity in relation to any business”. In that case the provisions of Sec.28(va)(a) of the Act would apply and not the proviso thereto.”
7.5. Before proceeding further, we may also refer to the relevant clause of the SPA between the Applicant and ADI which provides for the Non – compete fee, taxability of which in the hands of the Applicant is under consideration here. The Clause 5 – Non Compete of the SPA reads as under:
“5. NON-COMPETE
5.1 . ……………………………
……………………………
5.2 In further consideration of, and as a further inducement to the Purchaser entering into this Agreement, the Seller undertakes to the Purchaser that for a period of 3 (three) years commencing from the Completion Date, the Seller shall not and it 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:
5.2.1 carries on or is engaged in, concerned or interested with or otherwise competes with the Business in the jurisdiction in which the Company currently operates on the Closing Date as such involvement would have a detrimental effect on, and cause irreparable harm to the Business and the Company; or
5.2.2 solicits or entices away or offers employment to or endeavours to solicit or entice away or offer employment to any employee or officer of the Company, whether or not such person would commit a breach of contract by reason of leaving service or office.
5.3 Nothing contained in Clause 5.2 shall prohibit the Seller and/ or the Macmillan Group from, directly or indirectly:
5.3.1 enhancing and developing its educational and information businesses in India which is being carried out on the date of this Agreement or which may be carried out after the date of this Agreement; and
5.3.2 holding any interest in any securities of a company listed in or dealt on any stock exchanges, if the Seller and any entity Controlled by the Seller are together interested in securities which amount to less than 10% (ten percent) of the issued share capital of such company.
5.4 ……………….”
8. Keeping the above provisions of law and facts of the Applicant in mind, we shall now consider if the Applicant’s receipt of non-compete fee is chargeable to capital gains so as to attract the proviso to section 28(va). Here we shall also deal with the Revenue’s arguments for the case as their primary contention has been that the non-compete fee received by the Applicant is chargeable under the head ‘capital gains’ and not under the head of business income as contended by the Applicant. In contending so, the Revenue has stated that the Applicant had a right to carry on a business (i.e. the capital asset) and that this right was extinguished when the Applicant was paid non-compete fee as consideration for transfer of the said capital asset. Since there was extinguishment of the ‘right to carry on a business’, it amounts to ‘transfer’ within the meaning of section 2(47) of the Act.
8.1 Firstly, let us examine whether the Applicant had a capital asset i.e. whether it was having a right to carry on business. The facts of the present case are that the Applicant held shares of MPS to the extent of 61.46% but it did not have a right to carry on business of MPS. The right to carry on business of publishing BPO services is with the company MPS who is carrying on such business and not the Applicant. It is important to draw a distinction between the company (i.e. MPS) and its shareholders (i.e. Applicant). A company and its shareholders being distinct legal entities, enjoy different rights and obligations.
8.1.1 We are in agreement with the Applicant’s argument that shareholders enjoy rights such as right to profits, right to dividend, right to vote, etc. but they cannot be said to be carrying on the company’s business or having a right to carry on business of a company. The Applicant, in this case, was only a shareholder of MPS. Hence, the Applicant cannot be said to be enjoying a right to carry on business as contended by the Revenue. Accordingly, we hold that the Applicant does not hold a legally enforceable right which can be treated as a ‘capital asset’ within the meaning of section 2(14). In view of this position, there can be no question of transfer of any right to carry on business from the Applicant to ADI BPO.
8.2 Secondly, what needs to be considered is whether consideration received by the Applicant is for a restrictive/negative covenant or is it for a transfer of a positive right to carry on business. We note that it is explicit from the non-compete clause quoted above, that the non-compete fee received by the Applicant was a consideration for the Applicant agreeing to not carry on or be engaged or compete with the business of MPS in India for a period of 3 years. The non-compete clause as provided in the SPA nowhere contemplates a transfer of right to carry on business from the Applicant to the payer of non-compete fee. The Applicant had only imposed a restriction upon itself to not compete with MPS since it was in possession of confidential and proprietary information relating to the business and operations of MPS. Moreover, the Applicant being a publishing house, it was capable of competing with MPS which provides publishing BPO services, both businesses being inter connected and belonging to same industry. Such use of information could cause substantial loss and harm to MPS and its shareholders (including the payer). Thus, the payer entered into a non-compete clause with the Applicant to protect its own interests and not for gaining any rights of carrying on a business from the Applicant. We, therefore hold that the fee received by the Applicant is for a negative covenant to not compete with MPS and not for transfer of any right to carry on business to the payer as contended by the Revenue.
8.3 Thirdly, in order to fall within the definition of transfer u/s 2(47) of the Act, there must be extinguishment of a capital asset (in this case the right to carry on business). If there is no extinguishment of right in the capital asset, there cannot be a ‘transfer’ under section 2(47)(ii). The word ‘extinguishment’ means destruction, implying that the right, contract, etc. which is extinguished is destroyed in perpetuity. The extinguishment of a right is permanent in nature. Extinguishment of right implies that the right cannot be revived. Till the time the right is revocable, it could not be said that there was extinguishment of rights. At best, it can be said to be a case of suspension of rights. In the facts of the present case, the non-compete fee was received in consideration of a negative covenant i.e. agreement not to compete with MPS for a certain period of time only i.e. 3 years. Thus, after the period of 3 years as provided in the SPA got over, the Applicant would be free to compete with MPS without any of the restrictions provided in the SPA. Thus, the Applicant’s right to carry on business as that of MPS is restricted for 3 years and cannot be said to be destroyed permanently so as to be called extinguishment of ‘right to carry on business’ amounting to ‘transfer’ under section 2(47)(ii). We find support from the decision relied upon by the Applicant in the case of Dy. CIT v. Max India Ltd. (supra) wherein it has been held that negative covenant not to carry on manufacture or trade in product for certain period of time amounts only to self-imposed restriction and not a transfer.
8.4 In view of the above, we hold that the Applicant has received consideration in the form of non-compete fee for a negative covenant and not for transfer of any right to carry on business. As there is no capital asset as per section 2(14) and no transfer as per section 2(47), there can be no income chargeable to tax under the head of Capital Gains. Hence, the case of the Applicant does not fall under the proviso to section
28(va). We are, therefore, of the view that the receipts arising out of a negative covenant not to carry on a business is taxable as business income under section 28 (va). The ratio held in Late Dr. B.V. Raju (14 ITR 387) (Hyd.SB) clearly supports this view. We also gain support from the Hon’ble Madras High Court in Commissioner of Income-tax vs. M/s. Chemech Laboratories Ltd. (supra) wherein it has been held as follows:
“11. Legislature has thus made a conscious and clear distinction between the positive right to carry on a business or the activity of manufacture, production or process, consideration for the transfer of which would be chargeable under the head ‘capital gains’ and a negative right, being a covenant against the carrying on of any activity in relation to a business, the consideration for which would be taxable as business income. Thus, post 1 .4.2003, consideration received towards a negative covenant, as contra-distinguishable to consideration received towards the transfer of business rights, would be liable to tax as business profits. The question whether the activity of non-compete was incidental or dominant was thus irrelevant, and the Tribunal mis-directed itself in addressing itself to the same. This is particularly so since the parties themselves agree, in Article 3.6 8 (extracted above) of the Non-compete Agreement, that the total consideration of Rs. 6 crores shall include consideration towards the negative covenant as well.”
9. However, the Revenue has contended that if the receipt of non-compete fee is to be taxed as business income under section 28(va), it can be so taxed only if the recipient has received such consideration for agreeing not to carry on a business which he was already carrying on prior to non-compete agreement.
9.1 We find it difficult to agree with the aforesaid view of the Revenue. The taxation of non-compete fee under the head business income has been specifically provided under section 28(va) of the Act which states that “any sum, whether received or receivable, in cash or kind, under an agreement for – (a) not carrying out any activity in relation to any business”. The language of the section is very clear that any sum received or receivable under an agreement not to carry out any activity in relation to any business shall be chargeable to tax under the head business income. The words used in the section are ‘not carrying out any activity in relation to any business’ and it nowhere provides that the recipient of non-compete fee must already be carrying on business which he has agreed not to carry on further. Nothing provided in section 28(va) suggests that the recipient should agree not to carry on a business further which he was already carrying on.
9.1.1 There is no ambiguity in the provisions of section 28(va) so as to lead to such a conclusion that the recipient must first be carrying on a certain business and then should agree not to carry it out further for certain period of time. We agree with the Applicant that the section applies to any person who has received or is entitled to receive a sum in consideration for agreeing not to carry out any activity in relation to any business and is not restricted to only that business which he was already carrying on. The section also does not use the words ‘carry on further’ as contended by the Revenue so as to imply that the recipient should have already been carrying on the business.
9.2 In this regard, we derive support from the ratio in Addl. CIT vs. Late Dr. B.V. Raju (14 ITR 387) (Hyd.SB) and Sterling Re-rolling Mills (P.) Ltd. v. ACIT (53 SOT 41) (Mumbai ITAT). The Applicant’s case is also supported by the decisions in the case of Anurag Toshniwal & Arun Toshniwal vs. DCIT (supra), affirmed by the Hon’ble Bombay High Court in 375 ITR 270, wherein it has been held as under:
“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.”
9.3 We thus hold that the fact whether the receiver of non-compete fee was carrying on any business or whether he was carrying on the same business or a different business than that of the payer of non-compete fee or the transferor of shares, etc. is totally irrelevant while considering taxability under section 28(va)(a).
9.4 The above position gets further support from the fact that various High Courts and Tribunals have held non-compete fee to be taxable under section 28(va) in both the following scenarios:
i. Where assessee was carrying on a particular business and received a non-compete fee for agreeing not to carry on the same business, and
ii. Where assessee was carrying on a particular business and received a non-compete fee for agreeing not to carry on some other business, which could be any business, different from the one he was already carrying (the Applicant’s case falls in this scenario).
9.4.1 In the cases of John D’souza vs. CIT (226 CTR 540) (Bombay High Court), Chemech Laboratories Ltd. [Tax case appeal no. 1492 of 2007] [Madras HC] and Trans Global PLC vs. Director of Income –tax (International taxation) [158 ITD 230] [Kol. Trib.], the facts therein fall within scenario (i) above and it was held by the courts that non-compete fee was taxable as business income under section 28(va).
9.4.2 In the cases of Anurag Toshniwal & Arun Toshniwal vs. DCIT (56 SOT 52) (Mum. ITAT) (affirmed by Bombay HC), Ramesh D. Tainwala vs. ITO 48 SOT 324 (Mum. Trib.), Sterling Re-rolling Mills (P.) Ltd. v. ACIT (53 SOT 41) (Mumbai ITAT) and Addl. CIT vs. Late Dr. B.V. Raju (14 ITR 387) (Hyd.SB), the facts therein fall within scenario (ii) above and even in these decisions it was held that the non-compete fee was taxable as business income under section 28(va).
9.5 In view of the above, where the courts have arrived at the same conclusion of taxing a receipt under section 28(va) in both the above scenarios, it appears that in order to attract section 28(va)(a), there is no condition of receiving a non-compete fee for agreeing not to carry on a business which the assessee was already carrying on. Hence, we do not agree with the Revenue that the fee received by the Applicant cannot be taxable under section 28(va) because the Applicant and MPS were carrying on different businesses.
9.6 Moreover, we find that the Revenue has sought to determine the taxability of non-compete fee received by the Applicant under the head of Capital Gains and not business income by relying on the principles laid down by the Apex Court in Chennai Properties (supra) and Associated Industrial Development Co. (supra). However, in our opinion, the said reliance is misplaced. If the facts of a case squarely fall within the wordings used in the provisions of law, there is no requirement to apply a decisive test such as the one laid down in Chennai Properties which holds that while taxing an income under the head of business income, it is to be seen whether the activity resulting in the income is the business of the assessee.
9.6.1 In the present case, the receipt of non-compete fee is in fact a ‘capital receipt’ and not income as held by the Apex Court in Guffic Chem P. Ltd. (supra) and this capital receipt has been specifically brought under the definition of income under clause (vii) to section 2(24) of the Act, to be charged to tax under the head business income by virtue of section 28(va). The principles which the Revenue has relied upon to determine the taxability of non-compete fee will not apply to a receipt which has been brought under the tax net by virtue of specific charge under provisions of section 28(va) under the head of business income. We, thus hold that the Revenue’s interpretation of section 28(va) to hold that recipient of non-compete should already have been carrying on the business which he has agreed not to carry on further is erroneous and contrary to the provisions of the Act.
9.7 We also agree with the Applicant that the decisions in the cases of Savita Mandhan (supra) and Hami Aspi Balsara (supra) relied upon by the Revenue are distinguishable from the facts of the present case and hence not applicable.
10. The Revenue have made an alternative plea, by placing reliance on Hon’ble Delhi High Court’s decision in Shiv Raj Gupta (supra), that if non-compete fee is taxable under section 28(va), then the entire consideration of Rs. 9.3 crore should not be considered to be towards non-compete fee and some amount should be allotted to transfer of controlling interest by the Applicant to ADI.
10.1 We find this plea difficult to accept. It has been noted that the shares held by the Applicant in MPS were listed on the National Stock Exchange of India Limited, BSE Limited and Madras Stock Exchange Limited. These shares have been sold at the then prevalent market price calculated as per the 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. The SPA also provides the same share price for the sale of shares transaction. Also, a separate non-compete fee consideration of Rs. 9,30,00,000 has been provided in the SPA. It is well settled that when the document is plain and clear, and when the legitimacy and genuineness of the document has not been questioned there is no scope to suspect the legal character of the transaction. Hence, the Revenue cannot be allowed to delve into attributing any amount for transfer of controlling interest from the non-compete consideration and question the genuineness of the SPA in any manner.
10.2 Also, the reliance placed on the case of Shiv Raj Gupta is misplaced. We find that the facts of the said decision are vastly different from the facts in the Applicant’s case. In that case, the assessee had transferred its controlling interest in a company engaged in liquor business for Rs. 55,83,270 and had received non-compete fee vide a separate agreement of Rs. 6.60 crore. The High Court held that the bundle of rights including non-compete right acquired on the sale of shares of a thriving and running company was valued at Rs. 56 lakhs approximately and Rs. 6.60 crore was paid as consideration for non-compete agreement to the assessee who did not even have a license to manufacture alcohol. Thus, it held that the real and true nature of the transaction or event was the sale of shares and transfer of control and management which had been camouflaged as ‘non-compete fee’. It was under these peculiar circumstances that the High Court held that to hold the two agreements of sale of shares and non-compete as independent would be to ignore reality, and treat sham and deceit as a true and real event. In view of the aforesaid facts it was considered appropriate by the High Court to treat Rs. 6.60 crore as consideration paid for sale of shares, rather than a payment for non-compete. Thus, in the case of Shiv Raj Gupta, the non-compete agreement was held to be sham and allocation was made towards sale of shares which led to transfer of controlling interest. The High Court has not held that some amount, over and above the market price of shares must be allocated in every case where controlling interest is transferred.
11. We have already held that the non-compete fee is taxable as business income u/s 28(va) of the Act. In absence of any permanent establishment of the Applicant in India, such business income will not be taxable in India by virtue of Article 7 of the India-UK DTAA which provides that business income shall be taxable only in the UK in absence of a permanent establishment in India. While holding so, we agree with the reliance placed by the Applicant on the Kolkata Tribunal’s decision, rendered under similar facts as that of the Applicant, in Trans Global PLC vs. Director of Income tax (International taxation) (supra).
12. In view of the foregoing discussions, the question posed before us for a ruling is answered as under:
On the facts and circumstances of the case, the 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.
This Ruling is accordingly given and pronounced on this 6th day of June, 2018.
