2011 (3) TMI 6 - SC - Income Tax

Payment under an agreement not to compete (negative covenant agreement) - capital receipt or a revenue receipt? Held that - It is well settled that a liability cannot be created retrospectively. In the present case, compensation received under Non-Competition Agreement became taxable as a capital receipt and not as a revenue receipt by specific legislative mandate vide Section 28(va) and that too with effect from 1.4.2003. The agreement entered into by the assessee with Ranbaxy led to loss of source of business; that payment was received under the negative covenant and therefore the receipt of Rs.50 lakhs by the assessee from Ranbaxy was in the nature of capital receipt - judgment of the Karnataka High Court dated 29.10.2009 set aside.

Summary

Issues:
Whether a payment under a negative covenant agreement is a capital receipt or a revenue receipt?

Analysis:
In the present case, the main issue revolves around determining the taxability of a payment received under a negative covenant agreement. The assessee received Rs.50,00,000 from Ranbaxy as a non-competition fee under an agreement. The agreement involved the transfer of trademarks and a prohibition on the assessee from carrying on certain business activities for a specified period. The CIT (A) and the Tribunal considered this payment as a capital receipt not taxable under the Income Tax Act, 1961. However, the High Court disagreed, leading to the appeal before the Supreme Court.

The Supreme Court, in its decision, highlighted the dichotomy between compensation for the loss of agency and compensation for a negative/restrictive covenant. Referring to the judgment in Gillanders' case, it differentiated between revenue and capital receipts based on the nature of the compensation received. The Court emphasized that compensation for refraining from carrying on a competitive business constitutes a capital receipt. It noted that the High Court misinterpreted the precedent and erred in its decision. The Court also pointed out the legislative amendment through Section 28(va) of the Finance Act, 2002, which made such capital receipts taxable only from 1.4.2003 onwards.

Furthermore, the Court cited the case of Commissioner of Income-Tax, Nagpur v. Rai Bahadur Jairam Valji to support the distinction between revenue and capital receipts based on the circumstances of the agreement. In the present case, both the CIT (A) and the Tribunal concluded that the payment under the negative covenant agreement led to a loss of a business source, hence qualifying as a capital receipt. The Court emphasized that Parliament intervened to tax such receipts specifically under non-competition agreements from 1.4.2003.

In conclusion, the Supreme Court set aside the decision of the High Court and restored the order of the Tribunal, ruling in favor of the assessee. The Court also affirmed a judgment of the Delhi High Court in a related case. The civil appeal filed by the assessee was allowed, and the appeal filed by the Department was dismissed, with no order as to costs.