TaxTMI 
TaxTMI 
2012 (1) TMI 433
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....0/- is a capital receipts not liable to tax in view of the following decision of Supreme Court 1. C.I.T. Gujarat v/s Mohanbhai Pamabhai 165 ITR 166 (S.C) 2. Sunil Siddarthbhai v/s CIT 156 ITR 509 (SC) and so the same can not be taxed as capital gain u/s 45 of the Income-tax Act as has been done by the ld. ACIT Cir-2, Baroda and confirmed by the ICT Appeals. 2. Ld. CIT (A) has erred in law and on facts in confirming the addition of Rs. 27450000/- received by the appellant as non-competition fees. Under the facts and circumstances of the case the amount of Rs. 27450000/- is a capital receipts not liable to tax on the basis of the following decisions. A. CIT V/s. Kamal Behari Lal Singha 82 ITR 460 B. Gillandars Arbuthnot & Co. v/s CIT 53 ITR 283 C. Best & Co. Pvt. Ltd. 60 ITR 11 D. R.N. Agarwala v/s CIT 38 ITR 67 E. Oberoi Hotels Pvt. Ltd. V/s CIT 236 ITR 403 The appellant has received this amount for the negative convenient mentioned in the non-competition agreement executed in this behalf in view of the legal decisions the same is not liable to tax. Moreover the Financial Bill 2002 also support the case of the assessee by making the non compet....
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....ble only from A.Y. 2003-2004 on words and not before. (3) ld. CIT (A) as well as the ld. AO has erred in not considering various facts submissions, explanations and clarifications as given by the appellant. Both the lower authorities have further erred in not appreciating the facts and law in their proper perspective." The Revenue in the cross appeal in the case of Mayur S Sheth in ITA No. 3091/Ahd/2002 has raised the following grounds of appeal: "1. On the facts and in the circumstances of the case and in law, the ld. CIT (A) erred in holding that the entire capital gain be treated as long term capital gain. 2. On the facts and in the circumstances of the case and in law the ld. CIT (A) ought to have upheld the order of the Assessing Officer. 3. It is, therefore prayed that the order of the CIT (A) be set aside and that of the Assessing Officer be restored. Now we take up the appeal of the assessee and the revenue in the case of Mr. Samir S. Sheth in ITA No. 2919/Ahd/2002 and 3092/Ahd/2002 as under: 2. The brief facts of the case of the assessee and the revenue as appearing in the AO's order for the sake of clarity are reproduced as under: "3. In the note....
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....o amongst the partners from 1.7.1998 was as under:- a. Shri Samir Sheth 27% b. Shri Mayur Sheth 22% c. Ciba India Pvt. Ltd. 51% v. As per this partnership deed, Sheth Brothers were having authority to admit other members of Sheth family as partners by sharing their profit sharing ratio of 49%. Subsequently on 18.12.1998, a fresh deed of partnership was entered into and the members of Sheth Family were admitted and the profit sharing ratio with effect from 18.12.1998 is as under: a) Samir Sheth 19% b) Mayur Sheth 17% c) Ketki S Sheth 3% d) Nayana M Sheth 3% e) Suryakant G Sheth 3% f) Devang S Sheth 3% g) C.B. Thakkar 3% h) Ciba India Pvt. Ltd. 51% vi. Capital in the firm as on 1.4.1998 of Shri Samir Sheth and Shri Mayur Sheth was as under:- Shri Samir Sheth Rs. 9,28,27,002 Shri Mayur Sheth Rs. 7,24,04,941 Total Rs. 16,52,31,943 vii. Prior to admission of Ciba on 1.7.1998, various adjustment entries were made in the capital account of old partners i.e. Shri Samir Sheth and Shri Mayur Sheth. Investment allowance reserve and subsidy amount reserve of the firm were credited to the capital account of t....
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.... ii. Tribhovandas G Patel (1998) (8 SSC 509) iii. Sunil Siddarthbhai (156 ITR 509) 7. During the course of assessment proceedings, the assessee argued that on retirement of a partner, amount received by him from the continuing partners is nothing, but the amount which belonged to him as a partner and there is no element of transfer on the retirement by the partner from the firm and when a partner retires from the firm, the amount received is not chargeable to capital gains tax. It was further argued that the present case involved partial retirement of the assessee from the firm wherein his share in the profit of the firm was reduced. Therefore, legally it is at par with the total retirement of the partner. It was, therefore, claimed that amount received on partial retirement would not be chargeable to capital gains tax. It was further stated that the Gujarat High Court had held in the case of Rajendra B Modi (200 ITR 98) that the amount received on reduction of share in the firm constituted capital receipt. In view of these decisions, the assessee argued that the amount should not be taxed as it is not chargeable to capital gains tax. 8. In this connection, vide show cau....
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....r & Co. Margarine Ltd. (1901) (AC 217) (HL) has held that value of goodwill fluctuates depending on the changes in the reputation of the business. It is effected by the prevailing socio-economic ecology effective to old customers and absence of competition. 12. In the present case, Shri Samir Sheth and Shri Mayur Sheth were closely related to the business of marketing, development, manufacture of master batches and pigment preparation. Both the Sheth Brothers had specialized technical knowledge and know-how, information and process related to the marketing of products. Both Shri Samir Sheth and Shri Mayur Sheth had possessed information and experience in the chemical industry and due to their efforts, there was a tremendous growth in the prospectus of the firm M/s. Plastichemix Industries in such a prevailing scenario a new partner is admitted and acquires controlling interest of 51% in the partnership firm. 13. At the time of reconstitution of the firm on admission of a anew partner, one of the following methods are adopted by the parties for making payment on account of goodwill to the persons who relinquish their right to receive the profit:- i. The old partners value t....
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....rcumstances, the amount paid separately by the new incoming partner to the old partners without involving the firm is nothing, but consideration for intangible asset i.e. the loss of share of partner in the goodwill of the firm. Accordingly, this amount is to be charged to tax under the head capital gains. 16. AMOUNT PAID FOR NONCOMPETITION AGREEMENT As discussed in the preceding para, apart from making payment for loss of share in the profit of the firm, on 28.2.1998 itself separate agreements were entered by the new incoming partner Ciba with both the old partners of the firm separately wherein new partner had entered into a restrictive convenant and para "G" of this agreement reads as under:- "CiBA INDIA therefore desires to enter into a restrictive covenant with Mr. Samir Sheth and Mr. Mayur Sheth is agreeable to covenant with CIBA INDIA that for a minimum period of 5 (five) years from the effective date of this agreement and during the period that he is a whole time director and for a period of two years after ceasing to be a whole time director (hereinafter called "the term") he shall not render any consultancy or advise to any organization engaged in the manufacture....
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....n reply to the show cause letter, the assessee reiterated his stand and stated that the amount was paid for restrictive covenant and, therefore, the same cannot be treated as goodwill and the amount would be taxable as business receives from assessment year 20032004 only. 20. CONCLUSION As discussed in the preceding paras, both the Sheth Brothers were competent technical persons having expertise in the field of manufacturing and marketing of various grades of master batches and pigment preparations. The reputation of the firm soared due to the knowledge applied by the partners. While valuing the goodwill this aspect has to be considered specifically. Partnership deed and noncompetition agreement are inter-linked. There is no possibility of entering into noncompetition agreement by Ciba with Sheth Brothers, if it had not sought admission in the firm. On the other hand, any payment made towards relinquishment of rights by the Sheth Brothers in the firm would be meaningless if partnership deed itself does not contain restrictive covenant and in fact in the partnership deed itself the limits of authorities are included in clause 8 and sub-clause 8.11 reads as under:- 8.1. Exce....
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....ax and consider whether the situation created by the device could be related to the existing legislation with the aid of emerging techniques of interpretation to expose the devices for what they really are and to refuse to give judicial benediction......." 23. FOR VALUATION OF GOODWILL The working of goodwill supplied by the assessee is based on accounting principles. It has not taken into consideration the immediate effect of joining of hands by a multinational company Ciba with the professionally competent firm M/s. Plastichemix Industries. It has been earlier discussed that the valuation of goodwill is a complex process and it depends on the perspective of the specific person. In this case, the incoming partner Ciba has perceived an opportunity to gain foothold in this line of business by acquiring controlling interest in the firm. The firm was having knowledge and technical competence and MNC, Ciba was having other resources. Therefore, immediate effect of joing of hands by Sheth Brothers and Ciba must have weighed in mind of Ciba where it had decided to pay a total sum of Rs. 11,70,50,000/- to the Sheth Brothers on account of their relinquishing 51% share in the pro....
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....tner introduced the capital in the books of the firm. x. Over and above new incoming partner had paid total sum of Rs. 11,70,50,000/- to the above existing partners privately and directly. There is no doubt that this amount represents the loss of share of the then partners in the goodwill of the firm. xi. The agreement of non-competition agreement is nothing, but a colourable device to avoid payment of taxes. Therefore, I hold that the entire amount received by the assessee of Rs. 6,43,60,000/- is nothing, but consideration received for goodwill and the same has to be taxed under section 45 of the Income-tax Act. 25. QUESTION WHETHER SHORT TERM OR LONG TERM Shri Samir Sheth was having share in the firm @40% since very long period till 5.11.1996. Therefore, the share in the partnership firm increased to 55%. Out of this share of 55%, he has relinquished 28% on 1.7.1998. Since the assessee has gained addition 15% share on 5.11.1996 and relinquished the same on 1.7.1998, he has not completed 36 months. Therefore, the value of capital gain on account of 15% loss in the share of goodwill would be short term capital gain and balance 13% would be chargeable as long t....
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....: Deduction under Chapter VIA As per return Rs. 19,617 Total Income Rs. 8,09,29,360" 3. The ld. CIT (A) vide para 3.5 to 3.8 with respect to taxability of goodwill observed that it is not in dispute that the receipt is capital in nature and therefore to that extent the observations in the case of Rajindra Prasad Modi's case were accepted. After considering the decisions of Hon'ble Supreme Court of India in the case of CIT vs Chhotalal Mohanlal (1987) 166 ITR 124 (SC) it was observed that all the decisions cited by the assessee are the decisions where the assessee had retired from the firm and the additional consideration was received from the firm and not from the person obtaining the benefit of retirement or reduction in the share of the firm. The facts in the present case are different. After considering the decisions of various courts of law relied upon by the assessee, the ld. CIT (A) vide para 3.8 of this order observed that entire receipts towards reduction in the share of goodwill by way of assignment thereof in favour of Ciba (India) Pvt. Ltd. would be liable to be taxed as capital gains. 4. As regards amount received towards non-compete fees. The ld. CIT ....
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....ership and none of the case has been cited by the ld. Counsel for the assessee with regard to partners continuing. Therefore, none of the cases cited by the ld. Counsel for the assessee are applicable in the present facts and circumstances of the case. As regards the non-compete fee the cases cited by the ld. AR are not applicable since there is no issue of the competition in the circumstances and facts of the present case. He further argued that section 16 of Partnership Act provides that the partner cannot indulge in the competition. Therefore there is no question of compete fee. The ld. CIT(DR) also relied upon the decisions of various courts of law which are on record in support of his contention. 9. We have heard the rival contentions and perused the facts of the case. There is no dispute to the fact that the receipt is capital in nature and therefore to that extent observations of Hon'ble jurisdictional High Court in the case of CIT v. Rajendra Babubhai Modi (1993) 200 ITR 98 apply in the present facts and circumstances of the case. The Ld. CIT (A) has relied on the judgment in the case of CIT. v. South Indian Photographic and Allied Traders Association (1987) 166 ITR 124, w....