2012 (2) TMI 217 - AT - Income Tax

Non-compete payment not taxable as capital gains under Income Tax Act; Special Bench ruling

Asstt Commissioner of Income tax Versus Late Dr. BV. Raju & Others

The Special Bench held that the sum of Rs. 11 crores accrued to the assessee under the non-compete agreement dated 27/10/1999 but was not assessable as ... Taxability of Non-Compete fees – Capital gain vs Business Income or capital receipt not chargeable to tax - assessee being director of RCL & SVCL hostily taken over by ICL – consideration paid by ICL vide adjustment towards amount due to RCL – Held that:- It is established that such adjustment of consideration towards amount due to RCL would qualify as non-compete fees. However, consideration was not for sale of any business nor was it for not carrying on any business which he was carrying on, which he had transferred. It was also not a payment for a “right to manufacture, produce or process any article or thing”. The provisions relating to capital gains are therefore not attracted.The amount was paid for “not carrying out any activity in relation to any business” and would fall within the ambit of Sec.28(va)(a), which at the relevant point of time of accrual in the hands of assessee viz., 27.10.1999, was a capital receipt not chargeable to tax. Such receipts became taxable on and from 1-4-2003. As held in the case of Guffic Chemical Industries (2011 - TMI - 202401 - Supreme Court), the provisions of Sec.28(va)(a) are not clarificatory and were applicable only prospectively from 1-4-2003. Therefore the receipts in question were capital receipts and not chargeable to tax in AY 00-01 – Decided against the Revenue. Issues Involved:1. Whether the consideration receivable by the assessee under the agreement dated 27.07.1999 is assessable to tax as capital gains.2. Whether there was an accrual of income of Rs. 11 crores to the assessee from ICL as a result of the non-compete agreement.3. The nature of the sum receivable under the non-compete agreement and its taxability under the provisions of the Income Tax Act.Issue-wise Detailed Analysis:1. Assessability of Consideration as Capital Gains:The core issue referred to the Special Bench was whether the consideration of Rs. 11 crores receivable by the assessee under the non-compete agreement dated 27.07.1999 is assessable as capital gains under the amended provisions of the Income Tax Act prevailing at the relevant point of time.2. Accrual of Income:The assessing officer (AO) concluded that there was a transfer by the assessee by way of relinquishment of his right to manufacture or involve in activities connected with the cement business to ICL for a period of five years. The AO worked out the capital gains chargeable to tax at Rs. 11 crores, taking the cost of acquisition of the said right at NIL as per the provisions of Section 55(2)(a) of the Act, as amended by the Finance Act, 1997 with effect from 1.4.1998.The CIT(A) found that the non-compete agreement was validly entered into between the assessee and ICL, according to which a sum of Rs. 11 crores was to be paid by ICL to the assessee. However, the CIT(A) held that the said amount due to him was foregone by the assessee for reasons best known to him and that the exact details or facts relevant to the adjustments made were not known. Consequently, the CIT(A) held that it could not be said with conviction that the assessee received the sum of Rs. 11 crores, and thus, the AO was not justified in bringing the said amount to tax.3. Nature of the Sum Receivable and Taxability:The CIT(A) examined the exact nature of the sum of Rs. 11 crores receivable by the assessee as per the non-compete agreement. He held that the non-compete fee was agreed to be paid by ICL to ensure no further competition from the assessee. The CIT(A) concluded that the personal skills and abilities of the assessee, which were placed under restraint in the non-competition agreement, were not in the nature of a capital asset as defined under Section 2(14) of the Income-tax Act. Therefore, there was no question of any capital gain arising as a result of the non-compete agreement. He also held that there was only a restraint on the use of personal skills and abilities of the assessee for five years, and there being no cessation or relinquishment or extinguishment of any right, there was no transfer within the meaning of Section 2(47) of the Act. Consequently, the sum of Rs. 11 crores was a capital receipt not chargeable to tax before the insertion of provisions of Section 28(va) of the Income-tax Act with effect from 1.4.2003.Special Bench Findings:The Special Bench held that the question referred to it was comprehensive enough to cover whether the CIT(A) was justified in holding that there was no evidence to show that a sum of Rs. 11 crores was received by the assessee under the agreement dated 27/10/1999. The Special Bench rejected the preliminary objection of the learned counsel for the assessee and proceeded to examine whether there was an accrual of income of Rs. 11 crores to the assessee from ICL as a result of the non-compete agreement.The Special Bench concluded that the sum of Rs. 11 crores accrued to the assessee under the non-compete agreement dated 27/10/1999, attracting the provisions of Section 45 of the Act to tax capital gain on the transfer of a capital asset. However, the Special Bench held that the payment in question was not for the transfer of any intangible right in respect of manufacture, production, or process of cement. The payment was for 'not carrying out any activity in relation to any business' and would fall within the ambit of Section 28(va)(a) of the Act, which was applicable only prospectively from 1-4-2003. Therefore, for the assessment year 2000-01, the receipts in question were capital receipts and not chargeable to tax.Conclusion:The Special Bench answered the question referred to it in the negative, holding that the sum of Rs. 11 crores being consideration receivable by the assessee in terms of the agreement dated 27.07.1999 is not assessable to tax as capital gains in accordance with the amended provisions of law relating to the levy of tax on capital gains prevailing at the relevant point of time. The appeal by the Revenue was dismissed.