2017 (3) TMI 1699 - AT - Income Tax

Supreme Court: Non-compete fees not business income for 2002-03, assess under section 28(va) next year.

Asst. Commissioner of Income Tax, Chennai Versus K. Rajiv

The Supreme Court clarified that 'non-compete fees' cannot be assessed as business income for the assessment year 2002-03 but should be assessable under ... Exigibility to tax in law of the ‘non-compete fees’ arising to the assessee - whether treated as profit in lieu of salary - Held that:- Given the huge outlay of capital and business risk involved in a new business, highly improbable for a person to, at an advanced stage of his life, start a new venture, risking both, the regular income that he could otherwise fetch by self-employment or by service, as he actually does by becoming a director (in CABL, i.e., the payer company), as well as his savings generated over the years. Why, the very fact that all such persons, whose cases stand referred to in this order, were directors and majority shareholders in the old company, were paid a ‘non compete fee’ and later co-opted as directors, itself indicates the same to be a part of a plan, a pre-mediated transaction, and integral to the takeover of the business of Citadel Fine Pharmaceutical Company Ltd. The same could be a part of the business restructuring as well, though the claim cannot be lightly made, nor can, like-wise, the Revenue’s claim of the impugned sum being profit-in-lieu of salary, assessable u/s. 15 r/w s. 17(3), be brushed aside so (lightly), particularly in this context. The assessee shall have to bring material or evidence on record to substantiate/prove his claims, which can only be decided on the basis of the facts borne out thereby, i.e., on the basis of given/proven facts. CIT(A) shall then, where relevant, determine whether the assessee’s method of accounting, which is only for income from business and from other sources, regularly followed, is, as contended by him, ‘cash’, in which case the un-received sum of ₹ 500 lacs could be considered for its assessibility as income only on its receipt. Two, where not so, so that the assessee’s method of accounting, which has to be either cash or accrual, is indeed accrual, can the said amount be considered as accrued under the given facts and circumstances. The matter, accordingly, as afore-stated, is restored back to the file of the ld. CIT(A) – who was bound by the order by the tribunal in the first round, and whose directions shall continue to obtain, for a decision on merits, issuing definite finding of facts upon allowing the parties opportunity to represent their case before him. Issues:Exigibility to tax of 'non-compete fees' under Income Tax Act, 1961 for assessment year 2002-03.Detailed Analysis:Issue 1: Exigibility to tax of 'non-compete fees'The appeal concerns the taxability of 'non-compete fees' received by the assessee from a company acquiring another company where the assessee had critical knowledge about certain processes. The Assessing Officer (AO) brought the entire amount to tax, while the first appellate authority held it as a capital receipt for AY 2002-03. The Tribunal, in a previous case, had held a similar amount as profit in lieu of salary. The Revenue challenged the first appellate authority's decision, leading to the current appeal. The Apex Court decision in Guffic Chem Pvt. Ltd. v. CIT clarified that non-compete fees could not be assessed as business income for AY 2002-03 and should be assessable under section 28(va) from AY 2003-04 onwards. The Tribunal found discrepancies in the orders below and emphasized the need to determine the nature of the receipt and its accrual status.Issue 2: Nature of the receipt and accrual statusThe Tribunal highlighted the importance of determining the nature of the receipt, emphasizing that merely labeling it as a 'non-compete fee' in the agreement does not settle the taxability issue. It questioned the critical knowledge claim of the assessee and the subsequent appointment as a director in the acquiring company, indicating a pre-mediated transaction. The Tribunal stressed the need for the assessee to substantiate claims with evidence, especially regarding the method of accounting (cash or accrual) and the accrual status of the un-received balance. Citing legal precedents, the Tribunal directed the first appellate authority to issue definite findings after allowing both parties to present their case.Conclusion:The Tribunal partially allowed the Revenue's appeal for statistical purposes, emphasizing the need for a thorough examination of the nature of the receipt, accrual status, and accounting method employed by the assessee. The decision was in line with the non-compete fee being considered a capital receipt for AY 2002-03. The matter was remanded to the first appellate authority for a detailed assessment based on the facts and circumstances of the case.