Non-compete fee treated as business income, but not taxable in India absent a permanent establishment under the treaty.

A non-compete fee received under a share purchase agreement was treated as consideration for a restrictive covenant and therefore as business income under section 28(va) of the Income-tax Act. The AAR held that, as a shareholder, the recipient had no legally enforceable right to carry on the company's business and no capital asset of that kind was transferred, so capital gains treatment did not apply. It further held that section 28(va) does not require the recipient to have carried on the same business earlier, and the proviso for transfer of the right to carry on business was inapplicable. As the income was business profit and there was no permanent establishment in India, Article 7 of the India-UK DTAA made it taxable only in the State of residence.

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Issues: Whether non-compete fees received under a share purchase agreement were chargeable as business income under section 28(va) of the Income-tax Act, 1961, and, if so, whether such income was taxable in India in the absence of a permanent establishment under Article 7 of the India-UK DTAA.

Analysis: The fee was held to be consideration for a restrictive covenant by which the applicant agreed not to compete with the business for a fixed period. The applicant, being only a shareholder, had no legally enforceable right to carry on the company's business, and therefore no capital asset of that kind was transferred so as to attract capital gains. The covenant was treated as a negative covenant falling within section 28(va), and the proviso concerning transfer of the right to carry on business was held inapplicable. The ruling further held that section 28(va) does not require the recipient to have been carrying on the same business earlier. Since the income was business profit and the applicant had no permanent establishment in India, Article 7 of the DTAA made the income taxable only in the State of residence.

Conclusion: The non-compete fee was chargeable as business income under section 28(va), but it was not taxable in India in the absence of a permanent establishment; the answer was in favour of the assessee.

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