2016 (7) TMI 971 - AT - Income Tax

Non-compete fees deemed capital receipt, not taxable under Income Tax Act

Shri M.G. Mohan Kumar Versus Dy. Commissioner of Income Tax, Circle 5 (1), Bangalore

Shri M.G. Mohan Kumar Versus Dy. Commissioner of Income Tax, Circle 5 (1), Bangalore - TMI Issues Involved:1. Taxability of Rs. 2.5 Crores received as non-compete fees under Section 17(3)(iii) versus Section 28(va) of the Income Tax Act, 1961.2. Validity and enforceability of the non-compete agreement under Article 19(1)(g) of the Constitution of India and Section 27 of the Contract Act.3. Applicability of Section 234-D of the Income Tax Act regarding interest charges.Issue-wise Detailed Analysis:1. Taxability of Rs. 2.5 Crores under Section 17(3)(iii) versus Section 28(va):The core issue in this appeal is whether the Rs. 2.5 Crores received by the assessee as non-compete fees should be taxed under Section 17(3)(iii) or Section 28(va) of the Income Tax Act. The assessee, a Chartered Accountant and former Financial Director at Deccan Aviation Ltd. (DAL), claimed this amount as a non-taxable capital receipt. The Assessing Officer (AO) taxed it under Section 28(va) as business income, while the Commissioner of Income Tax (Appeals) [CIT(A)] assessed it under Section 17(3)(iii) as profit in lieu of salary.The Tribunal noted that the assessee was no longer an employee when the non-compete agreement was executed. The payment was for restricting the assessee from sharing confidential information and engaging in the airline business, not as compensation for loss of employment. The Tribunal relied on the Delhi High Court's judgment in Pritam Das Narang, which emphasized that Section 17(3)(iii) presupposes an employment relationship, which did not exist in this case. Therefore, the Rs. 2.5 Crores received was deemed a capital receipt, not taxable under Section 17(3)(iii).2. Validity and Enforceability of the Non-Compete Agreement:The assessee argued that the non-compete agreement was invalid under Article 19(1)(g) of the Constitution and Section 27 of the Contract Act, which render agreements in restraint of trade void. However, the Tribunal focused on the taxability issue and did not delve deeply into the validity of the agreement under these provisions. The Tribunal’s decision was primarily based on the nature of the payment and its connection to the employment status, rather than the enforceability of the non-compete clause.3. Applicability of Section 234-D:The assessee contested the liability to interest under Section 234-D of the Income Tax Act, which deals with interest on excess refund granted. However, this issue was not elaborated upon in the Tribunal's order, as the primary focus was on the taxability of the non-compete fees. The Tribunal's decision to allow the appeal implicitly suggests that any related interest charges would also be reconsidered in light of the main issue's resolution.Conclusion:The Tribunal concluded that the Rs. 2.5 Crores received by the assessee under the non-compete agreement could not be taxed as profit in lieu of salary under Section 17(3)(iii) of the Act. The payment was a capital receipt for not sharing business secrets and engaging in the airline business, thus not taxable under the cited provisions. Consequently, the Tribunal set aside the CIT(A)'s order and allowed the assessee's appeal, deleting the addition of Rs. 2.5 Crores from taxable income.