2015 (12) TMI 1187 - HC - Income Tax

Compensation on termination of joint-venture agreement - whether taxable as income under the Head Capital Gains - Held that - In the present case what stood extinguished as a result of the termination of the JVA was a bundle of rights of the Assessee. This included the right to manufacture computers using HP knowhow and HP labels, trademarks and patents. At the same time it was not as if the Assessee s right to manufacture its own computers was also taken away by the termination. That stood revived. In any event, there has been no attempt at unbundling the compensation amount, as it were, to determine how much of it pertained to the above constituent rights in the bundle of rights of the Assessee that were extinguished. The AO proceeded on the basis that the entire sum received by the Assessee was for it giving up the right to manufacture HP computers. This overlooked the factual position concerning the extinguishment, as a result of the termination of the JVA, of the entire bundle of rights not limited to the right to manufacture HP computers. The right of HCL HP to revive manufacturing its computers cannot be construed as a transfer of a right. At the same time HP HCL lost its status as an exclusive distributor of HP products. The transfer, if any, of the intangible assets of the kind described under the JVA could not, at the relevant time, be held to fall within the ambit of the kinds of capital assets that were contemplated in Section 55 (2) (a) as it then stood. Therefore, their cost of acquisition could not have been deemed to be nil in terms of Section 55 (2) (a) (ii) of the Act as it stood at the relevant time. The Court, therefore, holds that the receipt of ₹ 6080.95 lakhs by the Assessee as a result of the termination of the JVA during AY 1998-99 was a capital receipt but in light of Section 55 (2) (a) of the Act as it stood at the relevant time, the said amount cannot be brought to capital gains tax. At the relevant time, there was no provision in regard to determining the cost of acquisition of the above intangible assets for the purposes of computing capital gains tax. - Decided in favour of the Assessee.

Issues Involved:
1. Whether the receipt of Rs. 6080.95 lakhs by the Assessee as compensation on termination of the joint-venture agreement was taxable as income under the head 'Capital Gains'.

Issue-wise Detailed Analysis:

1. Background Facts:
The Assessee, HCL Infosystems Limited (HIL), initially incorporated as HCL Limited, was engaged in the manufacture, distribution, and sale of computers and services in India. Hewlett Packard Inc (HP), a US company, entered into a Joint Venture Agreement (JVA) with HCL Limited and its shareholders on 2nd April 1991, which was later amended on 27th May 1991. The joint venture aimed to combine the computer manufacturing, marketing, servicing, and sales activities of both HCL and HP in India. The agreement included a non-compete clause and provided HCL HP Ltd. with rights to use HP's name, technology, patents, trademarks, and other intellectual property.

2. Termination Agreement:
The JVA was terminated on 1st April 1997 due to changes in the competitive landscape and HP's desire to implement its global distribution model in India. HP offered to sell its shares in HCL HP to HCL's shareholders and agreed to pay HCL HP Rs. 60.82 crores as compensation for the loss of exclusivity and non-competition obligations.

3. Assessment Order:
The Assessing Officer (AO) treated the compensation as a capital receipt but held it taxable under Section 55(2) of the Income Tax Act, 1961, as the extinguishment of rights under the JVA resulted in the transfer of a capital asset. The AO considered the cost of acquisition to be nil and brought the entire sum to tax under 'income from capital gain'.

4. Order of the CIT (A):
The Commissioner of Income Tax (Appeals) [CIT (A)] upheld the AO's decision, agreeing that the extinguishment of the bundle of rights under the JVA constituted a transfer of a capital asset, making the capital receipt taxable as long-term capital gains.

5. Impugned Order of the ITAT:
The Income Tax Appellate Tribunal (ITAT) reversed the CIT (A)'s decision, noting that the Assessee continued to manufacture computers under its own brand name even after the termination of the JVA. The ITAT held that the compensation received was not taxable as capital gains because, at the relevant time, there was no provision for taxing such compensation under Section 55(2) of the Act.

6. Submissions of Counsel:
The Revenue argued that the Assessee enjoyed a bundle of rights under the JVA, including the right to manufacture, and that the cost of acquisition could be determined based on the surrender of these rights. The Assessee contended that the termination of the JVA affected its income-earning apparatus and corporate structure, making the compensation a capital receipt, but not taxable under 'capital gains' due to the absence of a cost of acquisition.

7. Legal Analysis:
The Court examined several precedents, including Kettlewell Bullen & Co. Ltd. v. CIT, Calcutta, Commissioner of Income Tax v. Bombay Burmah Trading Corporation Ltd, and Khanna and Annadhanam v. Commissioner of Income Tax, to determine the nature of the receipt. It concluded that the compensation received by the Assessee was a capital receipt as it impaired the Assessee's income-earning apparatus and sterilized its source of income.

8. Taxability as Capital Gains:
The Court noted that determining the cost of acquisition of intangible assets like the rights under the JVA was complex. Section 55(2)(a) of the Act, as it stood at the relevant time, did not provide for taxing the capital gains arising from the transfer of such intangible assets. The amendments to Section 55(2) and Section 28, which introduced provisions for taxing such capital gains, were prospective and not applicable to the assessment year in question.

Conclusion:
The Court held that the receipt of Rs. 6080.95 lakhs by the Assessee as a result of the termination of the JVA during AY 1998-99 was a capital receipt but could not be brought to capital gains tax due to the absence of provisions for determining the cost of acquisition of the intangible assets at the relevant time. The question framed was answered in favor of the Assessee, and the appeal was dismissed with no order as to costs.

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