2024 (8) TMI 1622 - HC - Income Tax

Payments for agreeing not to trade held taxable as business income under s.28(va)(a), not capital gains

GEOJIT INVESTMENT SERVICES LTD. (EARLIER KNOWN AS 'GEOJIT COMMODITIES LIMITED') Versus COMMISSIONER OF INCOME TAX, ERNAKULAM

HC held that amounts received by the assessee from a third party for not carrying out any activity in relation to its business are taxable as 'Profits and ... Taxability of compensation received - Amounts so received by the assessee company would attract the provisions of Section 28(va)(a) or capital receipt - any sum, whether received or receivable, in cash or kind, under an agreement for not carrying out any activity in relation to any business, is chargeable to income tax under the head “Profits and gains of business or profession”? HELD THAT:- Section 28(va)(a) of the Act does not restrict the operation of the said provision to only amounts received by way of non-compete fee. The words used in the said provision do not admit of any such restricted meaning. So long as the amount received by the assessee was received for not carrying out any activity in relation to any business and the amount received was not on account of transfer of the right to manufacture, produce or process any article or thing or on account of the transfer of the right to carry on any business, which receipts would have been chargeable under the head “capital gains”, there was no reason to interfere with the order of the Assessing Authority that brought the amounts received by the assessee from BNP Paribas to tax under the head “Profits and gains of business or profession”. We are also not impressed with the submission of the learned senior counsel that a specific provision to subject to tax under the Act, amounts akin to those received from BNP Paribas, was introduced only with effect from 01.04.2019 through the Finance Act, 2018 that introduced sub clause (e) to Section 28(ii) of the Act. It is apparent from a reading of the said provision that it is attracted only to payments received by a person at or in connection with the termination or the modification of the terms and conditions of any contract relating to his business. In the instant case, there was no subsisting agreement between BNP Paribas and the assessee, the terms and conditions of which agreement were modified in consideration of the receipt of the payment from BNP Paribas. On the contrary, the arrangement between BNP Paribas and the assessee required the assessee to give up his business in commodity trading so as to enable BNP Paribas to increase its shareholding in the parent company of the assessee. In our view, as discussed above, the said payments would have to be seen as payments received in connection with a negative covenant imposed on the assessee and, therefore taxable under Section 28(va)(a) of the Act. Decided against the assessee and in favour of the Revenue. ISSUES PRESENTED AND CONSIDERED 1. Whether compensation received for discontinuing a line of business as consideration for surrendering memberships/licenses and ceasing activity is capital receipt not liable to tax or is taxable as business receipt? 2. Whether cessation of a line of business by one group company is to be assessed from a consolidated/group perspective (denying sterilisation of profit-earning apparatus) or from the separate legal entity's perspective? 3. Whether the impugned compensation falls within Section 28(va)(a) (amounts received under an agreement for not carrying out any activity in relation to any business) and is taxable under 'Profits and gains of business or profession'. 4. Whether Section 28(ii)(e) (inserted prospectively w.e.f. 01.04.2019) applies retrospectively to bring such termination/compensation receipts to tax in the facts of this case. 5. Whether the compensation should be excluded from book profit for computation under Section 115JB (minimum alternate tax) as a capital receipt. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Characterisation of the Rs.40 crores receipt as capital or revenue Legal framework: Pre-amendment jurisprudence recognised compensation for extinction/sterilisation of a source of income or profit-earning apparatus as capital receipt (non-taxable under income head), whereas Section 28(va)(a) (w.e.f. 01.04.2003) expressly taxes 'any sum ... under an agreement for not carrying out any activity in relation to any business'. Precedent treatment: Earlier Supreme Court decisions treated payments for loss of source of income (extinction/immobilisation of profit-earning apparatus) as capital receipts. Those authorities pre-date the 01.04.2003 amendment which specifically taxed payments under negative covenants. Interpretation and reasoning: The Court reads Section 28(va)(a) purposively to tax amounts received as consideration for desisting from carrying out an activity in relation to any business, particularly where the receipt compensates for loss of an earning opportunity in relation to one line of business while the assessee continues other activities. The amendment of 2003 is held to represent a 'radical departure' from the prior position and to bring within tax receipts that would previously have been capital in character when received under an agreement imposing a negative covenant. Ratio vs. Obiter: Ratio - the 2003 amendment changes the law so that compensation under an agreement to forgo any activity in relation to a business is taxable under business income; prior authorities are distinguished to the extent they reflect pre-2003 law. Observations about the nature of compensation where there is an absolute transfer of business rights (see Issue 3 cross-reference) are explanatory. Conclusion: The Rs.40 crores received in consideration for discontinuing the commodity brokerage activity falls within Section 28(va)(a) and is taxable as business income; it is not a non-taxable capital receipt on the facts of this case. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Separate-entity versus consolidated/group perspective for sterilisation of profit-earning apparatus Legal framework: Tax characterisation depends on whether there is real sterilisation/extinction of the profit-earning apparatus of the recipient company; this is assessed on facts but legal identity of the assessee as a separate entity is relevant. Precedent treatment: Authorities recognising capital character of termination payments focused on whether the source of income of the recipient was destroyed; however, the statutory amendment (Section 28(va)) addresses payments received under agreements to forgo activities regardless of whether the group continues similar activity. Interpretation and reasoning: The Tribunal's findings that the same business was continued by a newly incorporated company with same promoters, clientele transfers, use of premises/trademark/administration and that therefore there was no sterilisation from a consolidated group view, were upheld. The Court emphasises that even if the payer's motive related to group restructuring, the statutory phrase 'any agreement for not carrying out any activity in relation to any business' captures the receipt received by the separate legal entity in respect of cessation of its activity. Ratio vs. Obiter: Ratio - group or consolidated continuity does not preclude application of Section 28(va) to the separate entity which agreed to desist from carrying on the activity; Tribunal's factual findings of continued activity by related entity support taxing the receipt. Observations on separate legal entity status are explanatory but do not alter statutory application. Conclusion: The Tribunal correctly considered group facts but the primary test remains whether the recipient undertook an agreement to desist from activity; here there was no sterilisation of the earning opportunity in the group sense and, critically, the receipt by the separate entity was chargeable under Section 28(va). ISSUE-WISE DETAILED ANALYSIS - Issue 3: Application and scope of Section 28(va)(a) versus transfer of business (capital gains/Section 45) or non-compete Legal framework: Section 28(va)(a) taxes sums received under an agreement for not carrying out any activity in relation to any business. The proviso excludes sums on account of transfer of right to carry on business (capital gains). Distinction exists between (i) payment for restrictive/negative covenant (non-compete) and (ii) transfer of right to carry on business (sale/transfer). Precedent treatment: Judicial precedents drawn from pre-2003 era treated termination/sterilisation payments as capital. Post-2003, Section 28(va) alters this analysis by capturing negative-covenant receipts as business income. Subsequent insertion of Section 28(ii)(e) (see Issue 4) was held not to apply retrospectively. Interpretation and reasoning: The Court analyses factual matrix: there was no transfer of the right to carry on the commodity business to the payer; the payment was for the recipient to desist from carrying on that activity (negative covenant). The statutory words 'any' and 'any activity' are read broadly; the provision is not confined to classical 'non-compete fees' between commercial competitors - its scope includes payments received to refrain from carrying out any activity relating to a business. The proviso's carve-out for transfer of right to carry on business was not attracted on these facts. Ratio vs. Obiter: Ratio - receipt for abstaining from an activity falls squarely within Section 28(va)(a) unless the receipt is on account of transfer of right to carry on business (proviso). Observations distinguishing transfer from negative covenant are part of the binding reasoning. Conclusion: The payment was a receipt under an agreement to forgo carrying out activity in relation to a business and is taxable under Section 28(va)(a); it is not a capital gains receipt under the proviso. ISSUE-WISE DETAILED ANALYSIS - Issue 4: Effect of Section 28(ii)(e) (Finance Act, 2018) and whether it applies to the facts Legal framework: Section 28(ii)(e) (inserted by Finance Act, 2018 with effect from 01.04.2018) taxes payments received at or in connection with termination/modification of terms of any contract relating to business - a specific provision enacted prospectively. Precedent treatment: The Court refers to principle that specific later provisions may override general provisions prospectively, but cannot be given retrospective effect to alter tax liability for earlier assessment years. Interpretation and reasoning: The Court holds Section 28(ii)(e) is not attracted because (a) it is prospective (w.e.f. 01.04.2018) and cannot be applied to the assessment year in question, and (b) the arrangement here was not payment in connection with termination/modification of a subsisting contract between the payer and recipient but rather payment to induce cessation of an activity to enable the payer's regulatory approvals. The Court therefore rejects the contention that Section 28(ii)(e) should apply to relieve or alter the tax character in this case. Ratio vs. Obiter: Ratio - Section 28(ii)(e) does not apply retrospectively to alter taxation of receipts in earlier years; it does not displace Section 28(va)(a) in the facts of this case. Conclusion: Section 28(ii)(e) is not applicable to the facts and time frame of the present case and does not affect the conclusion that the receipt is taxable under Section 28(va)(a). ISSUE-WISE DETAILED ANALYSIS - Issue 5: Effect on computation of book profit under Section 115JB Legal framework: Book profit computation under Section 115JB starts from accounting profit as per profit & loss account, subject to statutory adjustments; characterization of a receipt as capital or revenue affects whether it should be included. Precedent treatment: If a receipt is held to be taxable business income, it will be included in book profits; if a genuine capital receipt, it may be excluded depending on facts and accounting treatment. Interpretation and reasoning: The Tribunal denied the appellant's plea to exclude the compensation from book profit because it held the receipt to be taxable as business income under Section 28(va). The Court affirms that finding: having determined the receipt is taxable under Section 28(va), the claim for exclusion from book profits fails. Ratio vs. Obiter: Ratio - once a receipt is taxable as business income under Section 28(va), it cannot be excluded from book profit computation under Section 115JB on the ground that it is capital in nature. Conclusion: The Tribunal rightly refused to reduce the compensation while computing book profit under Section 115JB; no reduction is directed. OVERALL CONCLUSION The Court affirms the Tribunal's conclusions: the Rs.40 crores received for discontinuing the commodity brokerage activity is taxable under Section 28(va)(a) as profits and gains of business or profession; group continuity does not negate the statutory charge on the recipient company; Section 28(ii)(e) is neither applicable nor operative retrospectively for the assessment year in question; and the compensation must be included in book profit computation under Section 115JB. The appeal is dismissed and the questions of law answered against the assessee and in favour of the Revenue.