Transfer of right to carry on business by transferee carrying on business would be taxable as capital gain

Brief of the case:

• The ITAT Mumbai in the case of Monsanto India Limited held that when the assessee at the time of transfer of business agrees for a consideration not to carry on same line of business for a certain period of time , then such an arrangement is definitely a transfer(surrender) of right to carry on business . Such right being capital asset would result in capital gain as result of transfer thereof. Henceforth , in such an arrangement the transaction cannot be taxed as business income u/s 28(va).
• Further, since the right to transfer accrues from commencement of business itself , the period of holding of such capital gain would be reckoned from the date of commencement of business. In the present case , since prior to date of transfer assessee was nearly 10 years in its business , the capital gain arising would be taxable as long term.

Contention of the Assessee:

• It was submitted that the non-compete fee was received for giving up right to carry on the Leader business and thus , it is transfer of right to carry on business which is covered by proviso to Sec 28(va) for which the income is assessable as capital gains as per Sec 55(2)(a).
• As regards the issue of determining nature of capital gain i.e. short or long term the assessee contended that since the consideration has been received for transfer of business along with right to not carry on business for a period of 10 years, being a fairly long period, the consideration for non-compete fees is liable to be treated as long term capital gain.

Contention of the Revenue:

• Revenue contended that the consideration received as non-compete fee is covered by Sec 28(va) of the Act and taxable under the business head. It is because the assessee has agreed not to compete with the transferee in the similar line of business, thus , there was no transfer of any right which could be taxed as capital gains.
• As regards nature of capital gains , Revenue supported the findings of CIT(A) that the capital gain is short term because the right of non-compete came into existence at the time of disinvestment of the Leader business and therefore, the period of holding being less than 36 months, the consideration received would be taxable as short term capital gains

Held by ITAT:

• As per the business transfer agreement, the entire was transferred to Sumitomo Chemicals with the condition that the assessee company would not engage in or carryon any business for a period of 10 years, which competes directly or indirectly with whole or part of the herbicide business carried on by the buyer. Against such an arrangement a consideration of Rs. 2 crore towards Non- Compete fee was paid to assessee.
• The tribunal observed that Sec 28(va) provides that any sum received under an agreement for not carrying out any activity in relation business shall be chargeable to tax under the business head of income. Sec 55(2)(a) provides that transfer of “right to carry on business” is taxable as capital gain.
• Further, proviso to Sec 28(va) provides an exception to application of this section where any sum, whether is received 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.
• The tribunal relied on the decision of its Special Bench given in the case of Dr. B.V. Raju where the special bench held that for the provisions of section 55(2)(a) of the Act to apply the transferor must be carrying on a business which the transferor 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 section 28(va)(a) of the Act would apply.
• In the instant case, the non-compete fee has been received by the assessee-company for not carrying on the Leader business. Thus, there was a transfer of right to carry on business, which is a capital asset. Accordingly, such sum chargeable to capital gains in accordance with section 55(2)(a) of the Act.
• As regards , the dispute regarding type of capital gain tribunal observed that as per section 2(29A) of the Act, long term capital asset means a capital asset which is not a ‘short term capital asset. Further , as per Sec 2(42A) defines ‘short term capital asset as a capital asset held for not more than 36 months immediately preceding the date of transfer.
• Thus, to decide the issue we need to check the period of holding capital asset upto the date of transfer.
• The non-competing arrangement was attached to and arised as a result of a business which was being carried out by the transferor since last 10 years. And even the non-competing arrangement was also for a period of 10 years which is quite long.
• Therefore, tribunal rejected the CIT(A)’s claim to assess the same as short term capital gain.