2005 (1) TMI 35 - HC - Income Tax

Compensation paid on termination of the agreement with the marketing distributor - Whether Tribunal was right in law in holding that the compensation paid on termination of the agreement with the marketing distributor would be a capital expenditure? - As we have stated it is a case of acquisition of a profit-making apparatus of distributorship agency for which amounts were paid to the distributors and hence the Appellate Tribunal in our view was right in holding that the amount was capital in nature.

Summary

Issues:
1. Characterization of compensation paid on termination of marketing distributor agreement as capital or revenue expenditure.

Analysis:
The High Court of Madras considered the case where the Income-tax Appellate Tribunal referred three questions of law regarding the nature of compensation paid to marketing agents on termination of their agreements. The primary issue revolved around whether the compensation of Rs. 2,40,000 constituted capital or revenue expenditure for the assessee company engaged in manufacturing cycle chains and industrial chains. The Income-tax Officer, Commissioner of Income-tax (Appeals), and the Income-tax Appellate Tribunal had previously held that the compensation was a capital expenditure as it was paid to acquire a profit-making apparatus rather than to get rid of onerous agreements. The High Court reframed the questions and focused on the central issue of whether the compensation paid would be considered a capital expenditure.

The court examined the facts where the agreements with the selling agents were terminated, and the assessee took over the marketing establishments of the agents. The compensation was not only for plant and machinery but also for acquiring intangible assets like staff, personnel, and infrastructure. The distributors had developed a substantial sales organization and marketing network, which the assessee acquired. The court noted a negative covenant in the agreements restricting distributors from dealing with similar products for a few years. The assessee argued that the compensation was a revenue expense paid out of commercial expediency and that taking over staff and managerial personnel did not amount to acquiring assets.

In analyzing the legal precedent, the court considered various decisions, including the Supreme Court's rulings in Empire Jute Co. Ltd. v. CIT and Ashok Leyland Ltd., along with the Bombay High Court's decision in CIT v. Glaxo Laboratories (India) P. Ltd. The court distinguished these cases based on the specific circumstances and nature of payments involved. It emphasized that the compensation paid by the assessee was for acquiring the profit-making apparatus of the distributorship agency, including staff, dealership network, brand image, and marketing infrastructure. The court rejected the argument that no new asset was acquired through the termination, emphasizing the substantial transfer of the distributor's business to the assessee.

Ultimately, the High Court held that the compensation paid by the assessee was a capital expenditure, affirming the decision of the Appellate Tribunal. The court answered the reframed question in the affirmative, ruling against the assessee and in favor of the Revenue. The Revenue was awarded costs of Rs. 1,000 in the matter.