2011 (10) TMI 90 - AT - Income Tax

Non-compete Fee Taxable as Business Income, Not Sale Consideration

The Tribunal classified the Rs. 2 Crore non-compete fee as business income under Section 28(va) of the Income Tax Act, rejecting the assessee's argument ... Taxability of receipt u/s 28(va) - a sum of ₹ 2 crores received by the Assessee pursuant to agreement which the sellers sold their shareholding to the acquirer and further the sellers undertook not to engage directly or indirectly in any business which competes with that of the Assessee for a period of 11 years. - Held that:- For proviso(i) to Sec.28(va)(a) to apply there must be transfer of the right to carry on any business. The Assessee in the present case was not carrying on any business on his own but was the promoter and director of the company whose shares were purchased by the Acquirer. - Payments on account of non-compete fees cannot be brought to tax u/s.45 of the Act. - in the present case the proviso(i) to Sec.28(va)(a) of the Act will not apply. The provisions of Sec.28(va)(a) would apply and consequently the receipt in question would be chargeable to tax as business income and not under the head capital gain. - Decided against the assessee. Issues Involved:1. Classification of Rs. 2 Crore receipt as income under Section 28(va) of the Income Tax Act.2. Consideration of Rs. 2 Crore receipt as part of 'Full Value of Consideration Received' under Section 48 of the Income Tax Act.Issue-wise Detailed Analysis:1. Classification of Rs. 2 Crore Receipt as Income under Section 28(va):The primary issue was whether the Rs. 2 Crore received by the assessee as a non-compete fee should be classified as income under Section 28(va) of the Income Tax Act. The assessee, a director and promoter of M/s. Samsonite South Asia Pvt. Ltd., received Rs. 2 Crore for agreeing not to engage in a competing business for 11 years. The assessee argued that this amount was a capital receipt, relying on judicial precedents such as V. Venugopala Varma Rajah v. CIT and Gillanders Arbuthnot & Co. Ltd. v. CIT, which held that compensation for giving up a source of income is a capital receipt.The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] disagreed, noting that the Finance Act, 2002, had amended Section 28 to include non-compete fees within its purview, making them taxable as business income. The AO emphasized that the amendment was specifically designed to tax such receipts. The CIT(A) upheld this view, stating that the non-compete fee was clearly a payment for not carrying out any business activity, thus falling under Section 28(va).The Tribunal agreed with the AO and CIT(A), stating that the non-compete agreement did not transfer any right to carry on business but merely restricted the assessee from engaging in competing activities. Therefore, the Rs. 2 Crore receipt was classified as business income under Section 28(va).2. Consideration of Rs. 2 Crore Receipt as Part of 'Full Value of Consideration Received' under Section 48:The alternative argument by the assessee was that if the Rs. 2 Crore receipt was taxable, it should be considered as part of the 'Full Value of Consideration Received' under Section 48, thus subject to capital gains tax. The assessee contended that the non-compete fee should be treated as part of the sale consideration for shares, which would result in a lower tax rate.The CIT(A) rejected this argument, stating that the share purchase agreement clearly separated the sale price of shares from the non-compete compensation. The CIT(A) noted that the non-compete fee was explicitly mentioned as a separate payment in the agreement, and thus could not be considered part of the sale consideration for shares.The Tribunal concurred, emphasizing that for the proviso to Section 28(va)(a) to apply, there must be a transfer of the right to carry on any business. In this case, the assessee was not transferring any business right but merely agreeing not to compete. The Tribunal further noted that the definition of 'transfer' under Section 2(47) of the Act did not encompass an agreement to refrain from competition. Consequently, the Rs. 2 Crore receipt could not be taxed as capital gains under Section 45 but was correctly classified as business income under Section 28(va).Conclusion:The Tribunal upheld the classification of the Rs. 2 Crore non-compete fee as business income under Section 28(va) and rejected the assessee's alternative claim to tax it as part of the sale consideration under Section 48. The appeal by the assessee was dismissed.