2008 (12) TMI 231 - AT - Income Tax

Agency Termination Compensation Taxed as Business Income, Not for Restrictive Covenant

Chemet. Versus Additional Commissioner Of Income-Tax.

Chemet. Versus Additional Commissioner Of Income-Tax. - TTJ 122, 766, [2009] 27 SOT 574 (MUM.) Issues Involved:1. Taxability of compensation received on termination of the agency.2. Nature of the compensation received (capital receipt vs. revenue receipt).3. Applicability of Section 28(ii)(c) of the Income Tax Act.4. Attribution of compensation to restrictive covenants.Detailed Analysis:1. Taxability of Compensation Received on Termination of the Agency:The primary issue was whether the compensation of Rs. 2,56,59,783 received by the assessee on termination of the agency with Degussa was taxable. The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] concluded that the compensation was taxable as a business income under Section 28(ii)(c) of the Income Tax Act. The AO noted that the termination agreement and other documents clearly indicated that the compensation was for the termination of the agency. The assessee, however, argued that the compensation was for not competing with Degussa and was thus a capital receipt, not taxable.2. Nature of the Compensation Received (Capital Receipt vs. Revenue Receipt):The AO examined the nature of the compensation and concluded that it was a revenue receipt. The AO referred to the Supreme Court judgment in CIT vs. Best & Co. (P) Ltd., which held that compensation for termination of an agency could be a revenue receipt if the termination did not affect the business structure. The AO noted that the termination of the agency had only a marginal impact on the assessee's business structure, as evidenced by the comparative figures of gross receipts. The CIT(A) agreed with this finding, stating that the loss of the agency was an ordinary incident of business and the compensation was thus revenue in nature.3. Applicability of Section 28(ii)(c) of the Income Tax Act:The assessee contended that Section 28(ii)(c) was not applicable as the assessee was not an agent of Degussa in the legal sense. The assessee argued that the agreement did not confer authority to act on behalf of Degussa, and thus, the relationship was not that of a principal and agent. The assessee cited several judgments to support this argument, including CIT vs. R.D. Aggarwal & Co., Dharuvala Bros. (P) Ltd. vs. CIT, and CIT vs. T.I. & M. Sales Ltd., which emphasized the necessity of an agency agreement for the applicability of Section 28(ii)(c).4. Attribution of Compensation to Restrictive Covenants:The assessee also argued that part of the compensation was attributable to a non-compete clause in the termination agreement, which should be considered a capital receipt. The Tribunal agreed that part of the compensation should be attributed to the restrictive covenant, as held by the Supreme Court in Gillanders Arbuthnot & Co. Ltd. The Tribunal noted that the termination agreement included a clause prohibiting the assessee from competing with Degussa for one year, and thus, part of the compensation was for this restrictive covenant.Conclusion:The Tribunal held that the compensation received by the assessee was partly taxable and partly non-taxable. The Tribunal concluded that 75% of the compensation was a revenue receipt taxable under the Income Tax Act, while 25% of the compensation was attributable to the restrictive covenant and was a capital receipt, not taxable. The appeal of the assessee was thus partly allowed.