Tribunal rules termination compensation as capital receipt, not taxable under Income Tax Act

M/s. Sai Mirra Innopharm Private Limited Versus The Income Tax Officer, Corporate Ward – 2 (3), Chennai.

M/s. Sai Mirra Innopharm Private Limited Versus The Income Tax Officer, Corporate Ward – 2 (3), Chennai. - [2021] 87 ITR (Trib) 235 (ITAT [Chen]) Issues Involved:
1. Validity of reopening the assessment under Section 147 of the Income Tax Act.
2. Taxability of compensation received for termination of a manufacturing agreement under Section 28(va) of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Validity of Reopening the Assessment:
The assessee argued that the reopening of the assessment was invalid since it was based on the same materials available during the original assessment, thus constituting a mere change of opinion. The assessee cited various case laws including the decision of the Supreme Court in CIT vs. Kelvinator India Ltd. to support this claim. However, the Tribunal upheld the reopening, noting that there was no discussion or reference to the compensation received in the original assessment order. The Tribunal emphasized that the assessment was reopened within four years from the end of the relevant assessment year, and the AO had formed a reasonable belief of escapement of income based on tangible materials available within the assessment records. Therefore, the reopening was deemed valid.

2. Taxability of Compensation Received:
The main contention was whether the compensation received for the termination of the manufacturing agreement with Dr. Reddy’s Laboratories Ltd. should be taxed as revenue receipts under Section 28(va) of the Income Tax Act. The AO and CIT(A) treated the compensation as a non-compete fee, taxable under Section 28(va)(a). The assessee argued that the compensation was for the loss of investments and profits due to the premature termination of the agreement, thus constituting a capital receipt, not taxable under Section 28(va)(a). The Tribunal examined the agreements and found that the assessee was a contract manufacturer without possessing the technical know-how, which was provided by Dr. Reddy’s Laboratories Ltd. The Tribunal concluded that the compensation was for the loss of source of income and not for not carrying out any business activity or sharing any know-how, as specified under Section 28(va)(a). The Tribunal also noted that the amendment to Section 28(ii)(e), which would tax such compensation, was effective from AY 2019-20 and not applicable to the relevant assessment year. Citing the decision of the Bombay High Court in CIT vs. Parle Soft Drinks (Bangalore) P. Ltd., the Tribunal held that the compensation was a capital receipt and directed the AO to delete the addition.

Conclusion:
The Tribunal allowed the appeal, holding that the reopening of the assessment was valid, but the compensation received for the termination of the manufacturing agreement was a capital receipt and not taxable under Section 28(va)(a). The addition made by the AO was directed to be deleted.