2015 (12) TMI 1187 - HC - Income Tax

Court rules termination compensation as capital receipt, not taxable as capital gains.

The Commissioner of Income Tax Versus HCL Infosystems Ltd.

The Commissioner of Income Tax Versus HCL Infosystems Ltd. - [2016] 385 ITR 35 Issues Involved:1. Whether the receipt of Rs. 6080.95 lakhs by the Assessee as compensation on termination of the joint-venture agreement was taxable as income under the head 'Capital Gains'.Issue-wise Detailed Analysis:1. Background Facts:The Assessee, HCL Infosystems Limited (HIL), initially incorporated as HCL Limited, was engaged in the manufacture, distribution, and sale of computers and services in India. Hewlett Packard Inc (HP), a US company, entered into a Joint Venture Agreement (JVA) with HCL Limited and its shareholders on 2nd April 1991, which was later amended on 27th May 1991. The joint venture aimed to combine the computer manufacturing, marketing, servicing, and sales activities of both HCL and HP in India. The agreement included a non-compete clause and provided HCL HP Ltd. with rights to use HP's name, technology, patents, trademarks, and other intellectual property.2. Termination Agreement:The JVA was terminated on 1st April 1997 due to changes in the competitive landscape and HP's desire to implement its global distribution model in India. HP offered to sell its shares in HCL HP to HCL's shareholders and agreed to pay HCL HP Rs. 60.82 crores as compensation for the loss of exclusivity and non-competition obligations.3. Assessment Order:The Assessing Officer (AO) treated the compensation as a capital receipt but held it taxable under Section 55(2) of the Income Tax Act, 1961, as the extinguishment of rights under the JVA resulted in the transfer of a capital asset. The AO considered the cost of acquisition to be nil and brought the entire sum to tax under 'income from capital gain'.4. Order of the CIT (A):The Commissioner of Income Tax (Appeals) [CIT (A)] upheld the AO's decision, agreeing that the extinguishment of the bundle of rights under the JVA constituted a transfer of a capital asset, making the capital receipt taxable as long-term capital gains.5. Impugned Order of the ITAT:The Income Tax Appellate Tribunal (ITAT) reversed the CIT (A)'s decision, noting that the Assessee continued to manufacture computers under its own brand name even after the termination of the JVA. The ITAT held that the compensation received was not taxable as capital gains because, at the relevant time, there was no provision for taxing such compensation under Section 55(2) of the Act.6. Submissions of Counsel:The Revenue argued that the Assessee enjoyed a bundle of rights under the JVA, including the right to manufacture, and that the cost of acquisition could be determined based on the surrender of these rights. The Assessee contended that the termination of the JVA affected its income-earning apparatus and corporate structure, making the compensation a capital receipt, but not taxable under 'capital gains' due to the absence of a cost of acquisition.7. Legal Analysis:The Court examined several precedents, including Kettlewell Bullen & Co. Ltd. v. CIT, Calcutta, Commissioner of Income Tax v. Bombay Burmah Trading Corporation Ltd, and Khanna and Annadhanam v. Commissioner of Income Tax, to determine the nature of the receipt. It concluded that the compensation received by the Assessee was a capital receipt as it impaired the Assessee's income-earning apparatus and sterilized its source of income.8. Taxability as Capital Gains:The Court noted that determining the cost of acquisition of intangible assets like the rights under the JVA was complex. Section 55(2)(a) of the Act, as it stood at the relevant time, did not provide for taxing the capital gains arising from the transfer of such intangible assets. The amendments to Section 55(2) and Section 28, which introduced provisions for taxing such capital gains, were prospective and not applicable to the assessment year in question.Conclusion:The Court held that the receipt of Rs. 6080.95 lakhs by the Assessee as a result of the termination of the JVA during AY 1998-99 was a capital receipt but could not be brought to capital gains tax due to the absence of provisions for determining the cost of acquisition of the intangible assets at the relevant time. The question framed was answered in favor of the Assessee, and the appeal was dismissed with no order as to costs.