Business Transfer Agreements having a non-compete clause cannot be classified as Declared Service for demanding Service Tax

Naveen Chava Vs Commissioner of Central Tax (CESTAT Bangalore)

Introduction: In a recent ruling by the Hon’ble CESTAT, Bangalore, in the case of Naveen Chava Vs Commissioner of Central Tax, the classification of business transfer agreements (BTA) with a non-compete clause as Declared Service for demanding Service Tax was deliberated. This article delves into the facts, issues, and the key findings of the case.

The Hon’ble CESTAT, Bangalore, in the case of Naveen Chava v. Commissioner of Central Tax [Service Tax Appeal No. 20013 of 2021 dated January 30, 2024], held that in the current case, no evidence establishes that a substantial portion of the agreement refers to the obligations that are to be followed by the Appellants. Further, if any payment has been made for an independent activity of tolerating an act under an independent arrangement, such payments will not constitute ‘consideration.’ Therefore, business transfer agreements (“BTA”) entered by the Appellants having a non-compete clause cannot be classified as Declared Service under Section 66E (e) of the Finance Act, 1994 (“the Finance Act”) for demanding Service Tax.

Facts:

Naveen Chava and Others (“the Appellants”) were engaged in designing integrated sheets/circuits for the telecom industries. They entered into a BTA of a going concern as a whole with M/s. Altran Technologies India Pvt. Ltd. (“M/s. Altran”) on July 27, 2020. They agreed to sell, transfer, grant, assign, and deliver to M/s. Altran all their rights, title, and interests with respect to the business as a going concern, free and clear from all encumbrances on a slump sale basis as defined in Section 2(42C) of the Income Tax Act, 1961 (“the IT Act”).

The Director General of Goods and Service Tax Intelligence (“the DGGI”) investigated and alleged that the activities of agreeing to refrain from certain activities for 2 years were required to be treated as a Declared Service. Thereafter, a Show Cause Notice dated December 19, 2019 (“the Impugned SCN”) was issued to the Appellants wherein it was alleged that the services provided by the Appellants to M/s. Altran fall under the category of Service under Section 66E (e) of the Finance Act. Thereafter, the Adjudication Authority (“the Respondent”) passed an Order dated August 28, 2020 (“the Impugned Order”) and confirmed the demand of Service Tax and penalty on the Appellants.

Hence, aggrieved by the Impugned Order, the present appeal was filed by the Appellants.

Issue:

Whether the BTA entered by the Appellant had a non-compete clause can be classified as Declared Service for demanding Service Tax?

Held:

The Hon’ble CESTAT, Bangalore in Service Tax Appeal No. 20013 of 2021 held as under:

• Observed that, as per the facts, the business transfers carried out by the Appellants were related to an ongoing concern and as per the Notification No. 25/2012-Service Tax dated June 20, 2012 (“the Exemption Notification”), service by way of transfer of a going concern is fully exempt from all of the Service Tax leviable thereon. In the current case, no evidence establishes that a substantial portion of the agreement refers to the conditions/obligations to be followed by the Appellants, like non-compete clauses, performance guarantee for two years, etc., for which they have received consideration of INR 1,06,79,67,816/- as held by the Respondent.
• Opined that, non-compete clauses are normal in transfer of business and their condition cannot be separated from the contract that ended between the parties to bring the transaction under the ambit of Service Tax by denying the benefit of the Exemption Notification.
• Relied on, Ishikawajma Harima Heavy Industries v. Director of Income Tax, Mumbai [2007 (3) SCC 481)] wherein it was held that in construing a contract, the terms and conditions thereof are to be read as a whole. A contract must be construed keeping in view the intention of the parties. No doubt, the applicability of the tax laws would depend upon the nature of the contract, but the same should not be construed keeping in view the tax provisions.
• Relied on, M/s. Universal Medicare Pvt. Ltd. v. C.C.E. & S.T., [Service Tax Appeal No. 11161 of 2017-DB dated June 02, 2019] wherein the Tribunal held that an agreement has to be interpreted as per the language and intention of the parties to such agreement. Once an ongoing concern is transferred along with assets and liabilities by paying a huge amount, it is obvious that if such a non-compete clause is absent, the Appellants could immediately start the same business.
• Held that, the CBIC vide Circular No. 178/10/2022 dated August 03, 2022 clarified that under Service Tax, the GST demand unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity of tolerating an act, such payments will not constitute ‘consideration.’ Hence, such activities do not constitute “supply”.
• Therefore, the appeal was allowed, and the Impugned Orders were set aside.

Conclusion: In conclusion, the Hon’ble CESTAT, Bangalore allowed the appeal, setting aside the Impugned Orders. The ruling emphasized that non-compete clauses in BTAs are normal, integral conditions, and, in this case, did not attract Service Tax. The decision provides clarity on the tax implications of non-compete clauses in business transfer agreements, aligning with the Exemption Notification and legal principles.

FULL TEXT OF THE CESTAT BANGALORE ORDER

The issue in these appeals is whether the Business Transfer Agreement (BTA) entered by the Appellant having a non-compete clause can be classified as Declared Service under Section 66 E(e) of the Finance Act, 1994 for demanding service tax.

2. The brief facts of the case are that the Appellants are engaged in designing integrated sheets/circuit for Telecom The Appellants had entered into a business transfer agreement of an going concern as a whole with M/s Altran Technologies India Pvt Ltd (herein after referred as M/s Altran) on 27.07.2020 and as per the said agreement, Appellant agreed to sell, transfer, grant, assign and deliver to M/s Altran all its rights, title and interest with respect to the business, as a going concern, free and clear from all encumbrances on a slump sale basis (as defined in Section 2(42C) of the Income Tax Act, 1961). Alleging that the activities of agreeing to obligations/refrain from certain activities for 2(two) years should be treated as a Declared service, investigation was carried out by DGGI and a Show Cause Notice(SCN) was issued on 19.12.2019. As per the SCN, it is alleged that the services provided by the Appellant to M/s Altran Technologies India Pvt Ltd is falling under the category of service under Section 66(E)(e). Thereafter the Adjudication authority confirmed demand of service tax and also imposed penalty on Appellants. Aggrieved by said order, present appeals are filed.

3. When the matter taken up for hearing, Learned Counsel for the Appellants drew our attention to the mega exemption Notification No.25/2012-Service Tax dated 20/06/2012 issued by Ministry of Finance, where it is stated that “Services by way of transfer of a going concern, as a whole or an independent part thereof “is exempted from taxable service. Thus impugned order is prime facie illegal and unsustainable.

4. Further, Learned Counsel for the Appellants submits that transfer of an ongoing concern is carried out through such contract as entered by the Appellants with M/s Altran and entire value offered by the buyer for the ongoing concern is towards the market value and not for the indemnity clause as alleged by the Respondent. Learned Counsel drew our attention to the clauses of the agreement relied by the Respondent for demanding service tax which is reproduced below:-

“In consideration of the purchase of the entire Business and the goodwill of the Business by the Buyer, the Seller and the Promoters shall not, for a period of 2 (two) years from the Closing Date, whether by themselves or through or on behalf of any other person, firm, company, Affiliate or organization or as a Director, shareholder, trustee, committee member, manager, office bearer or agent, any of their respective Family Members or in any manner whatsoever whether for profit or otherwise, within India or USA, China, as the case may be carried any business identical or similar to the business, nor be concern or interested in any business, ie, identical or similar to the business.”

5. Learned Counsel further submits that the terms of indemnifying the buyer is the routine condition for transferring any such running business concern and demand of service tax is illegal and unsustainable. Learned Counsel submits that the terms of contract cannot be read in isolation. In support of their contentions, they have relied on the following case laws:-

i. Universal Medicare Pvt Ltd Vs C.C.E & S.T, Daman (2019 (3) TMI 166-CESTAT Ahmedabad

ii. Swastik Household and Industrial Products (P) Ltd Vs Income Tax Officer (1998 (25) ITD 479 (Mum)

iii. Ishikawajma Harima Heavy Industries Ltd Vs Director of Income Tax, Mumbai (2007 (3) SCC 481)

iv. Reliance Industries Ltd Vs State of Uttar Pradesh (2012 (194) ECR 293 (Allahabad)

v. Super Poly Fabriks Ltd Vs Commissioner of Central Excise, Punjab (2008 (217) CTR (SC) 107)

vi. Vodafone International Holdings Vs Union of India (2012 (1) JT SC 410)

6. As regards the issue related to tenability of non-compete clause, the Learned Counsel relied on the decision of Hon’ble High Court of Mumbai in the matter of Assistant Commissioner of Income Tax Vs Asea Brown Boveni Ltd (2007 (110) TTJ (Mum) 502. Thus, there is no such separate services intended to be received and no consideration assigned for the indemnity clause as alleged by the Respondent to demand service tax.

7. Learned Counsel further submits that determination of dominant character of an agreement is essential to demand tax. Learned Counsel drew our attention to the judgment of Hon’ble Supreme Court in the matter of M/s Bharat Sanchar Nigam Ltd (2006 (2) STR 161 (SC). Relevant paragraph reproduced is below:-

“41. Gannon Dunkerley survived the 46th Constitutional Amendment in two respects. First with regard to the definition of ‘sale’ for the purposes of the Constitution in general and for the purposes of Entry 54 of List II in particular except to the extent that the clauses in Art. 366(29A) operate. By introducing separate categories of ‘deemed sales’, the meaning of the word ‘goods’ was not altered. Thus the definitions of the composite elements of a sale such as intention of the parties, goods, delivery etc. would continue to be defined according to known legal connotations. This does not mean that the content of the concepts remain static. Courts must move with the times. But the 46th Amendment does not give a licence for example to assume that a transaction is a sale and then to look around for what could be the goods. The word “goods” has not been altered by the 46th Amendment. That ingredient of a sale continues to have the same definition. The second respect in which Gannon Dunkerley has survived is with reference to the dominant nature test to be applied to a composite transaction not covered by Article 366(29A). Transactions which are mutant sales are limited to the clauses of Article 366(29A). All other transactions would have to qualify as sales within the meaning of Sales of Goods Act, 1930 for the purpose of levy of sales tax.”

8. Ld. Counsel for the Appellant also drew our attention to the larger Bench decision in the matter of Commissioner of Central Tax, Chennai Vs. M/s Repco Home Finance (2020 (42) G.S.T.L 104 (Tri. Larger Bench). Relevant paragraph reproduced is below:-

“21. It is, thus, clear that where service tax is chargeable on any taxable service with reference to its value, then such value shall be determined in the manner provided for in (i), (ii) or (iii) of sub­section (1) of Section 67. What needs to be noted is that each of these refer to “where the provision of service is for a consideration”, whether it be in the form of money, or not wholly or partly consisting of money, or where it is not ascertainable. In either of the cases, there has to be a “consideration” for the provision of such service. Explanation to sub-section (1) of Section 67 defines “consideration” to include any amount that is payable for the taxable services provided or to be provided, or any reimbursable expenditure, or any amount retained by the lottery distributor or selling agent. It is clear from the aforesaid definition of “consideration” that only an amount that is payable for the taxable service will be considered as “consideration”. This apart, what is important to note is that the term “consideration” is couched in an “inclusive” definition.

22. A Larger Bench of the Tribunal in Bhayana Builders (P) Ltd. v. Commissioner of Service Tax [2013 (32) S.T.R. 49 (Tri. – LB)] observed that “implicit in the legal architecture is the concept that any consideration whether monetary or otherwise, should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the latter.” In the said decision, the Larger Bench made reference to the concept of “consideration”, as was expounded in the decision pertaining to Australian GST Rules, wherein a categorical distinction was made between “conditions” to a contract and “consideration”. It has been prescribed under the said GST Rules that certain “conditions” contained in the contract cannot be seen in the light of “consideration” for the contract and merely because the service recipient has to fulfil such conditions would not mean that this value would form part of the value of the taxable services that are provided.

23. The Supreme Court in Commissioner of Service Tax vs. M/s. Bhayana Builders [2018 (2) TMI 1325 = 2018 (10) G.S.T.L. 118 (S.C.)], while deciding the appeal filed by the Department against the aforesaid decision of the Tribunal, also explained the scope of Section 67 of the Act, both before and after the amendment, in the following words :

“The amount charged should be for “for such service provided”: Section 67 clearly indicates that the gross amount charged by the service provider has to be for the service provided. Therefore, it is not any amount charged which can become the basis of value on which service tax becomes payable but the amount charged has to be necessarily a consideration for the service provided which is taxable under the Act. By using the words “for such service provided” the Act has provided for a nexus between the amount charged and the service provided. Therefore, any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable under Section 67. The cost of free supply goods provided by the service recipient to the service provider is neither an amount “charged” by the service provider nor can it be regarded as a consideration for the service provided by the service provider. In fact, it has no nexus whatsoever with the taxable services for which value is sought to be determined.”

24. The aforesaid view was reiterated by the Supreme Court in Union of India vs. Intercontinental Consultants and Technocrafts [2018 (10) G.S.T.L. 401 (S.C.)] and it was observed that:-

“23. Obviously, this Section refers to service tax, i.e., in respect of those services which are taxable and specifically referred to in various sub-clauses of Section 65. Further, it also specifically mentions that the service tax will be @ 12% of the “value of taxable services”. Thus, service tax is reference to the value of service. As a necessary corollary, it is the value of the services which are actually rendered, the value whereof is to be ascertained for the purpose of calculating the service tax payable there upon.

24. In this hue, the expression “such” occurring in Section 67 of the Act assumes importance. In other words, valuation of taxable services for charging service tax, the authorities are to find what is the gross amount charged for providing “such” taxable services. As a fortiori, any other amount which is calculated not for providing such taxable service cannot a part of that valuation as that amount is not calculated for providing such “taxable service”. That according to us is the plain meaning which is to be attached to Section 67 (unamended, i.e., prior to May 1, 2006) or after its amendment, with effect from, May 1, 2006. Once this interpretation is to be given to Section 67, it hardly needs to be emphasised that Rule 5 of the Rules went much beyond the mandate of Section 67. We, therefore, find that High Court was right in interpreting Sections 66 and 67 to say that in the valuation of taxable service, the value of taxable service shall be the gross amount charged by the service provider “for such service” and the valuation of tax service cannot be anything more or less than the consideration paid as quid pro qua for rendering such a service.

25. This position did not change even in the amended Section 67 which was inserted on May 1, 2006. Sub-section (4) of Section 67 empowers the rule making authority to lay down the manner in which value of taxable service is to be determined. However, Section 67(4) is expressly made subject to the provisions of sub­section (1). Mandate of sub-section (1) of Section 67 is manifest, as noted above, viz., the service tax is to be paid only on the services actually provided by the service provider.”

 …………………………………. ………………………………

27. What follows from the aforesaid decisions is that “consideration” must flow from the service recipient to the service provider and should accrue to the benefit of the service provider and that the amount charged has necessarily to be a consideration for the taxable service provided under the Act. It should also be remembered that there is marked distinction between “conditions to a contract” and “considerations for the contract”. A service recipient may be required to fulfil certain conditions contained in the contract but that would not necessarily mean that this value would form part of the value of taxable services that are provided.”

9. Learned Counsel also drew our attention to the judgment of M/s Bhai Mumbai Trust (2019 (31) GSTL 193 (Mum) where it is held that:-

“55. In the present case, royalty is paid towards damages of compensation of securing any future determination of compensation or damages for a prima facie violation of the Plaintiff’s legal right in the Suit Premises. The Prima facie finding is that the Defendant has no semblance of right to be in occupation of the Suit Premises. The permission granted to the Defendant to remain in possession subject to payment of royalty is an order to balance the equities of the case. The basis of this payment is the alleged illegal occupation or trespass by the Defendant. Such payment lacks the necessary quality of reciprocity to make it a ‘supply’. Hence no GST is payable.”

10. Learned Counsel also drew our attention to the Circular 178/10/2022 dated 03.08.2022, where Ministry of Finance issued clarification regarding demand of GST against the service under agreeing to obligation to refrain from act of tolerate an act or a situation for do an act and draw certain samples of such cases under service tax, GST Demand. Relevant paragraph reproduced below:-

“7. There has to be express or implied agreement; oral or written, to do or abstain from doing something against payment of consideration for doing or abstaining from such act, for a taxable supply to exist. An agreement to do an act or abstain from doing an act or tolerate an act or a situation cannot be imagined or presumed to exist just because there is a flow of money from one party to another. Unless there is an express or implied promise by the recipient of money to agree to do or abstain from doing something in return for the money paid to him, it cannot be assumed that such payment was for doing an act or for refraining from an act or for tolerating and act or situation. Payments such as liquidated damage for breach of contract, penalties under the mining act for excess stock found with the mining company, forfeiture of salary or payment of amount as per the employment bond for leaving the employment before the minimum agreed period, penalty for cheque dishonour, etc., are not a consideration for tolerating an act or situation. There are rather amounts recovered for not tolerating an act or situation and to deter such acts; such amounts are for preventing breach of contract or non-performance and are thus mere “events” in a contract. Further such amounts do not constitute payment (or consideration) for tolerating an act, because there cannot be any contract: (a) for breach thereof, or (b) for holding more stock than permitted under the mining contract, or (c) for leaving the employment before the agreed minimum period of (d) for doing something leading to the dishonour of the cheque. As has already being stated, unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity of tolerating an act, such payments will not constitute ‘consideration’ and hence such activities not constitute “supply” within the meaning of the Act.

11. Learned Authorised Representative (AR) drew our attention to the finding of the Adjudicating authority and submits that the Non-compete and Non-solicit agreement contained in the agreement amount to Declared Services, since there is an obligation to refrain from an act, or to tolerate or a situation or to do an act. The Learned AR further submits that the value for the asset in the above transaction is negligible and entire amount involved in the transactions are towards the non-compete clause, which is the essence of the contract. Actual business transfer agreement is only about Rs. 60 lakhs and rest of Rs.106 crores is towards the intangible asset. Learned AR also draw our attention to the provision of Section 65(B)(44) and Section 66(E)(e) of the Finance Act, 1994. Learned AR further submits that the essence of the agreement is the non-compete clause. Thus, the service is squarely falling under the provision of Declared services under Section 6(E)(e) of the Finance Act, 1994. Further submits that Declared service is a deeming fiction and similar such agreement have been held to be divisable/vivisected in BSNL Case.

12. Learned AR also relied on the decision of the Tribunal in the case of M/s Godrej Consumer Products (2014 (305) E.L.T 61)

“6.4 The next issue for consideration is whether the non-compete fee of Rs. 34 crore paid by PGG to GSL can be included in the assessable value of toilet soaps manufactured by GSL. As per the Non-Competition Agreement dated 16-12-1992 among GSL, PGFE and PGG, at the request of PGFE and PGG, from the date of physical transfer of the business of marketing, distribution and the sale of Toilet Soaps to PGG, GSL shall not undertake as a commercial activity, anywhere in the specified territory, the distribution, marketing or sale of Toilet Soaps. The non-compete agreement, trademark agreement and the manufacturing agreement are an integral part of the JVA as can be seen from clauses 2.1, 2.6 and 9.1 (A). All these agreements are co-terminus with the JVA. One does not exist without the other. In view of this factual position, these agreements cannot be viewed separately or as existing independently. The manufacturing agreement would not have been entered into without the non-compete agreement or the trademark agreement. Therefore, the consideration paid under any one of the agreements cannot be viewed as a separate transaction in itself and has a bearing on the entire transaction. The very fact that when the JVA was terminate din 1996, all the 3 agreements also ceased to operate/exist is a clear pointer to the fact of inseparability of these agreements. If that be so, the consideration paid by PGG to GSL under the non-compete agreement and through G &B to GSL under the trademark agreement should have a definite bearing on the price paid by PGG to GSL under the manufacturing agreement and the pricing formula adopted therein. It is in this factual matrix, the applicability of Rule 5 of the Central Excise Valuation Rules, 1975 has to be considered. The said rule, as we have seen, provides for including additional consideration received from the buyer, whether directly or indirectly, by the assessee in the assessable value of the goods sold/supplied.”

13. Learned DR also relied on the judgment of the Hon’ble Supreme Court in the M/s Bharat Sanchar Nigam Ltd (2006 (2) S.T.R 161 (SC) and submitted that if the composite contract of service and sale, it is possible for the State to tax sale elements provided therein as describable sale and only to the extent related to such sale. Also relied on the decision of Tribunal in the matter of M/s Jamna Auto Industries 2017 (5) S.T.L 410 (Tri.-Del), M/s Tata Global Beverage (2015 (40) S.T.R 909.

14. Heard both sides and perused the records.

15. The Adjudication authority in the impugned order categorically admits that “From the facts it is seen that M/s Sicon entered into a Business Transfer Agreement (BTA) dated 27.07.2015 with M/s Altrab Technology India Pvt Ltd for transfer their business activities in entirety” The Adjudicating authority further observed that as per the BTA, M/s Sicon were to transfer all the specified employees (most of the employees); all the customers of the company; and the existing hardware/ infrastructure. Apart from that M/s Sicon were also to fulfil the major conditions and obligations like (1) Seller Operation Warranties (2) Promoter Warranties (3) Performance Guarantee for two years (4) Non-Compete and Non-Solicitation Restrictions by the company etc. From the above finding of the adjudication authority, it is an admitted fact that the business transfer carried out by the Appellant is related to an ongoing concern and as per the mega exemption vide Notification No. 25/2012-Service tax dated 20/06/2012 “Service by way of transfer of a going concern is fully exempted from all of the service tax leviable thereon. From the evidence on record, no finding can be made that substantial portion of the agreement refers to the conditions/obligations to be followed M/s Sicon like non-compete clauses, performance guarantee for two years etc., for which they have received consideration of Rs. 106,79,67,816/- as held by the Adjudicating authority.

16. Even on merit, as submitted by the Learned Counsel for the Appellant, terms and conditions in the agreement entered by the Appellant and M/s Altran is general in nature and considering the indemnity clause, there is no amount involved in the present agreement to quantify the service element in the above said agreement. As held by Hon’ble Apex Court in the matter of Ishikawajma Harima Heavy Industries (supra), “in construing a contract, the terms and conditions thereof are to be read as a whole. A contract must be construed keeping in view the intention of the parties. No doubt, the applicability of the tax laws would depend upon the nature of the contract, but the same should not be construed keeping in view the taxing provisions”. Similarly, as observed by the Tribunal in the matter of M/s Universal Medicare (supra), an agreement has to be interpreted as per the language and intention of the parties to such agreement. Once an ongoing concern is transferred along with assets and liabilities by paying huge amount, it is just obvious that if such non‑ compete clause is not present, the appellant could immediately start the same business. Hence such clause is normal in transfer of business and the condition of non-compete clause cannot be separated from the contract ended between the parties to bring the transaction under the ambit of service tax by denying the benefit of Notification No. 25/2012-Service tax. Moreover, Ministry of Finance vide Circular No. 178/10/2022 dated 03.08.2022 clarified that under service tax, GST demand, unless payment has been made for an independent activity of tolerating an act under an independent arrangement entered into for such activity of tolerating an act, such payments will not constitute ‘consideration’ and hence such activities do not constitute “supply” within the meaning of the Act.

17. In view of the above discussion the Appeals are allowed and the impugned order is set aside. Since the entire service tax liability is set aside, interest and penalty imposed on Appellants in Appeal Nos. ST/20015/2021, ST/20014/2021 and ST/20013/2021 are also set aside with consequential relief, if any, as per law.

(Order pronounced in open court on 30.01.2024)

***

(Author can be reached at [email protected])