2011 (7) TMI 62 - HC - Income Tax

Capital or revenue receipt - Non compete fees - it is clear that with the entering of the agreement the assessee was no longer at liberty to engage itself in commercial activity either directly or otherwise to manufacture and sell or distribute mosquito repellent mats or mat heater machines under its trade name either on its own behalf or on behalf of anyone - it is clear from the agreement with TDP Limited that the restrictive covenant therein practically prohibited the assessee in the matter of enjoying that source of income by exploiting the trademark owned by it - It is well established that the compensation received for the mere loss of profits will be a revenue receipt while the compensation received for the loss of a source of income would be capital receipt - Decided in favour of the assessee

Summary

Issues Involved:

1. Classification of non-compete fee as capital or revenue receipt.

Issue-wise Detailed Analysis:

1. Classification of Non-Compete Fee as Capital or Revenue Receipt:

The primary issue in this case revolves around whether the non-compete fee received by the assessee should be classified as a capital receipt or a revenue receipt. The assessee, a company manufacturing mosquito repellents, entered into a non-compete agreement with M/s. Transelektra Domestic Products Limited (TDP Limited) on 24.5.1995. According to this agreement, the assessee received a non-compete fee of Rs.2,70,00,000/- for agreeing not to manufacture, sell, or distribute mosquito repellents, mats, or mat heater machines under its trade name for a period of five years. The assessee contended that this receipt was a capital receipt and hence, not taxable as income.

The Assessing Authority, however, treated the non-compete fee as a revenue receipt, arguing that the restrictive covenant was a normal business incident and that the assessee was still free to carry on similar trade using its existing infrastructure. The Commissioner of Income Tax (Appeals) upheld this view. However, the Income Tax Appellate Tribunal disagreed, ruling that the non-compete agreement resulted in a loss of source of income, not just a loss of income, and thus, the receipt should be treated as capital in nature.

The Revenue appealed, citing the decision of the Andhra Pradesh High Court in Coromandel Fertilizers Ltd. Vs. Commissioner of Income Tax, which held that a restriction of business for a limited period does not constitute a loss of enduring nature and should be treated as a revenue receipt. The Revenue also referred to the decision in Chemplant Engineers (P) Ltd. Vs. Commissioner of Income Tax, arguing that the assessee continued to manufacture mosquito repellents for Bayer India Limited, indicating no loss of source of income.

In contrast, the assessee's counsel referred to the Supreme Court's decision in Commissioner of Income Tax, Madras Vs. Best & Company, which established the dichotomy between compensation for loss of income and loss of source of income. The counsel argued that the non-compete agreement specifically restricted the assessee from manufacturing and selling products under its trade name, resulting in a loss of source of income and thus, the receipt should be classified as a capital receipt. The counsel also cited the Supreme Court's decision in Guffic Chem P. Ltd. Vs. C.I.T., Belgaum and another, which held that non-competition fees were treated as capital receipts until the assessment year 2003-04, after which they became taxable as revenue receipts under Section 28(va) of the Finance Act, 2002.

The Court examined the non-compete agreement, noting that it prohibited the assessee from engaging in commercial activities related to mosquito repellents under its trade name but allowed manufacturing on a contractual basis without marketing or distributing the products. The Court concluded that this restriction led to a loss of the income-generating aspect of the business, making the receipt a capital receipt.

The Court also referred to the Supreme Court's decision in Commissioner of Income Tax, Nagpur Vs. Rai Bahadur Jairam Valji and others, which stated that compensation for loss of a source of income is a capital receipt. The Court found that the non-compete fee received by the assessee was for the loss of a source of income, not just a loss of income, and thus, should be classified as a capital receipt.

The Court rejected the Revenue's reliance on Chemplant Engineers (P) Ltd. Vs. Commissioner of Income Tax, noting that the facts of the present case were different. The Court also dismissed other decisions cited by the Revenue, stating that they related to capital expenditure and did not apply to the issue at hand.

In conclusion, the Court dismissed the Revenue's appeal, upholding the Tribunal's decision that the non-compete fee received by the assessee was a capital receipt and not taxable as income.