2014 (6) TMI 262 - HC - Income Tax

Compensation for termination of lease agreement Amount received capital in nature or not u/s 55(2)(a) of the Act Held that - The Mc Dowell & Co., had claimed revenue expenditure of ₹ 5.31 crores on account of lease foreclosure payment made to the assessee-company - the amount is a compensation towards the loss of source of income and also towards noncompetition fee to prevent the assessee from carrying on the similar business using the knowhow possessed by the assessee as a competitor, the amount of ₹ 5.31 crores paid was thus capital in nature - The amount is paid to prevent the assessee from carrying on a competitive business and also preventing the assessee to use the business apparatus or expertise - Accordingly the payment was a capital fee and thus it is only a capital receipt - There being no cost of acquisition, the capital gain was also not computable. Relying upon Guffic Chem (P) Ltd. & Mandalay Investment P. Ltd Versus Commissioner of Income-tax 2011 (3) TMI 6 - Supreme Court - the compensation received for loss of agency is a revenue receipt whereas the compensation attributable to a negative/restrictive covenant is a capital in nature - the compensation has been paid for loss of source of income and also for non17 competitive fee and it is capital in nature - payment made as non-competition fee under the negative covenant is always treated as a capital receipt and not liable to pay any tax till the AY 2003-04 in view of the amendment to the Finance Act 2002 w.e.f. 1-4-2003 that the capital receipt is now made taxable u/s 28(va) - The amendment is not as the amount received by the assessee is a capital receipt - The Appellate Authority as well as the Appellate Tribunal after considering the matter in detail held that the amount received is a capital receipt and not liable to tax under Section 55(2)(a) of the Act there was no infirmity in the order Decided against Revenue.

Summary

Issues Involved:
1. Whether the amount of Rs.5.31 crores received by the assessee from M/s. Mc Dowell as a result of arbitration award can be treated as a revenue receipt and brought to tax.
2. Whether the amount of Rs.5.31 crores received by the assessee from M/s. Mc Dowell is a capital receipt but cannot be brought to capital gains tax under Section 55(2)(a) of the Income-Tax Act, 1961.

Detailed Analysis:

Issue 1: Treatment of Rs.5.31 Crores as Revenue Receipt
The Revenue challenged the order of the Income Tax Appellate Tribunal (ITAT) which confirmed the decision of the Commissioner of Income-Tax (Appeals) that the compensation received by the assessee for the termination of the lease agreement is capital in nature. The Assessing Authority initially treated the sum as revenue in nature and taxed it accordingly. The assessee argued that the amount was compensation for the loss of the source of income and to prevent competition, making it capital in nature. The Tribunal, relying on various judgments, upheld that the compensation was capital in nature and not a revenue receipt. The High Court agreed with this conclusion, noting that the compensation was for the loss of the source of income and non-competition, thus capital in nature and not liable to tax as revenue receipt.

Issue 2: Applicability of Capital Gains Tax under Section 55(2)(a)
The Revenue contended that the compensation should be taxable under capital gains. However, the First Appellate Authority and the Tribunal found that the compensation received towards the loss of the source of income and non-competition fee could not be brought under capital gains tax. The High Court noted that the compensation was paid to prevent the assessee from carrying on competitive business and using its know-how, making it a capital receipt. The court referenced the Supreme Court's decision in GUFFIC CHEM case, which distinguished between compensation for loss of agency (revenue receipt) and compensation for a restrictive covenant (capital receipt). The High Court concluded that the amount was a capital receipt and not taxable under Section 55(2)(a) due to the absence of cost of acquisition and the non-applicability of the amendment to Section 28(va) for the relevant assessment year.

Conclusion:
The High Court dismissed the Revenue's appeal, affirming that the compensation received by the assessee was capital in nature and not liable to tax as either revenue receipt or under capital gains tax provisions. The judgments relied upon by the Revenue were found inapplicable to the facts of the present case. Both substantial questions of law were decided against the Revenue and in favor of the assessee.