Non compete fee paid under deed of covenant held not taxable. Revenue has no business to second guess commercial or business expediency – SC
ABCAUS Case Law Citation:
ABCAUS 3340 (2020) (07) SC
Important case law relied upon by the parties:
Guffic Chem (P) Ltd. v. CIT (2011) 4 SCC 254
McDowell & Co. Ltd. v. CTO(1985) 3 SCC 230
Vodafone International Holdings BV vs Union of India(2012) 6 SCC 613
Kshitish Chandra Purkait v. Santosh Kumar Purkait (1997) 5 SCC 438
Dnyanoba Bhaurao Shemade vs Maroti Bhaurao Marnor (1999) 2 SCC 471
Biswanath Ghosh vs Gobinda Ghosh (2014) 11 SCC 605
CIT vs Walchand & Co. (1967) 3 SCR 214
K. Woollen Manufacturers vs CIT (1969) 1 SCR 525
CIT vs Panipat Woollen & General Mills Co. Ltd. (1976) 2 SCC 5
In the instant case the appellant assessee was the Chairman and Managing Director of a company engaged in the manufacturing of beer and Indian Made Foreign Liquor (IMFL). The appellant along with his family members had majority shareholdings in the company.
Due to suspension of company’s manufacturing activity, the appellant, by way a MoU sold the controlling block of shares to the purchaser company and irrevocably handed over physical possession, management and control of the distillery. The appellant was also to resign as Chairman and Managing Director and personal guarantees given by the appellant and his son to the Banks was to be indemnified.
Further by a Deed of Covenant it was agreed that the buyer company shall pay to the appellant non compete fee i.e. for not carrying on directly or indirectly any manufacturing or marketing activities relating to the products manufactured by the sold company for a period of 10 years.
However, the Assessing Officer (AO) held that despite the fact that the appellant was left with one concern which also manufactured IMFL, being a loss making concern, no real competition could be envisaged between a the buyer which was a giant company and the loss making dwarf, as a result of which the huge amount paid under the Deed of Covenant could not be said to be an amount paid in respect of a restrictive covenant as to non-competition.
The said Deed of Covenant was held to be a colourable device to evade tax that is payable under Section 28(ii)(a) of the Income Tax Act, 1961 (the Act). As a result, the amount paid was brought to tax.
The CIT(A) dismissed the appeal. However, by a majority decision the Tribunal allowed the appeal of the assessee holding that the amount paid was non-competitive fee and a capital receipt under section 28(iv) of the Act and not a revenue receipt as envisaged in Section 28(ii).
The revenue preferred an appeal u/s 260-A of the Act to the High Court.
The Hon’ble High Court framed the substantial question of law as to whether the amount paid is taxable u/s 28(ii) of the Act or same is exempt as capital receipt being non-competition fee?
The High Court held that the said sum could not be brought to tax under Section 28(ii)(a), but would have to be treated as a taxable capital gain in the hands of the appellant, being part of the full value of the sale consideration paid for transfer of shares.
Non compete fee paid under deed of covenant held not taxable
Before the Hon’ble Supreme Court, the appellant raised a preliminary objection that u/s 260-A, it is only the substantial question of law that is framed can be answered and no other. If some other question is to be answered, the Court must first give notice of the same to both sides.
It was contended that the entire judgment was vitiated and must be set aside on the ground alone that the substantial question of law framed by the High Court did not contain the question as to whether the assessee could be taxed outside the provisions of Section 28(ii)(a).
The Hon’ble Supreme Court observed that section 260A of the Act is modelled on a similar provision that is contained in Section 100 of the Code of Civil Procedure, that the High Court’s jurisdiction depends upon a substantial question of law being involved in the appeal before it.
As per the provisions, if the High Court wishes to hear the appeal on any other substantial question of law not formulated by it, it may, for reasons to be recorded, formulate and hear such questions if it is satisfied that the case involves such question.
The Hon’ble Supreme Court noted that the High Court, without recording reasons and without framing any substantial question of law on whether the said amount could be taxed under any other provision of the Income Tax Act, went ahead and held that the amount taxable as capital gain.
The Hon’ble Supreme Court held that the finding of the High Court would clearly be in the teeth of Section 260-A (4), requiring the judgment to be set aside on this score alone.
With respect to the observation of the High Court that the figure of amount paid did not appear to be a realistic payment made on account of non-compete fee, the Hon’ble Supreme Court stated that catena of judgments had held that commercial expediency has to be adjudged from the point of view of the assessee and that the Income Tax Department cannot enter into the thicket of reasonableness of amounts paid by the assessee.
The Hon’ble Supreme Court stated that Revenue has no business to second guess commercial or business expediency of what parties at arms-length decide for each other.
The Hon’ble Supreme Court stated that the finding of the AO that there was no rationale behind the payment and that the assessee was not a probable or perceptible threat or competitor to the giant buyer group was the perception of the Assessing Officer, which could not take the place of business reality from the point of view of the assessee.
The Hon’ble Supreme Court noted that in one of the case it dealt with a question as to whether the payment under an agreement not to compete is capital receipt or a revenue?
Their Lordships negated the application of Section 28(ii)(a) to such receipt and held that here is a dichotomy between receipt of compensation by an assessee for the loss of agency and receipt of compensation attributable to the negative/ restrictive covenant. The compensation received for the loss of agency is a revenue receipt whereas the compensation attributable to a negative/ restrictive covenant is a capital receipt.
Accordingly, following the decision stated, the Apex Court allowed the appeal and set aside the impugned judgment.
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