2017 (1) TMI 738 - AT - Income Tax

Nature of compensation/settlement amount paid to the erstwhile MD - addition on the ground that the payment was for non- competition and being in capital nature - Held that - We are of the view that the services of the MD were terminated because the merger of the assessee company took place. Therefore, the compensation paid to the MD was as per the agreement between the assessee and the MD. The AO was wrong in disallowing the amount as capital in nature. The material placed in the paper book demonstrates that the compensation paid to MD is as per the agreed terms. Also, it is common practice in case of termination of employment to put forth the condition not to engage in act of competition for a year. This cannot be considered to treat the above payment as capital in nature. Therefore, we set aside the order of the CIT(A) and delete the addition made by the AO towards compensation/settlement payment made to the MD of the assessee. - Decided in favour of assessee.

Summary

Issues:
1. Disallowance of compensation payment to former Managing Director as capital expenditure.
2. Treatment of payment as non-compete fees.
3. Failure to produce Managing Director's income tax return.
4. Treatment of payment as salary under Section 17.

Analysis:
1. The appeal was filed against the order of the Commissioner of Income-tax (Appeals) regarding the disallowance of a compensation payment made by the assessee to its former Managing Director. The assessing officer added the payment amount to the total income, considering it as capital in nature. The appellant company argued that the payment should be treated as salary. The termination and payment were due to a merger, and the appellant provided documentation supporting the nature of the payment.

2. The Commissioner of Income-tax (Appeals) upheld the assessing officer's decision, emphasizing the failure to produce the former Managing Director's income tax return disclosing the payment as income. The Commissioner viewed the payment as non-compete fees and capital in nature. However, the Appellate Tribunal disagreed, highlighting that the relevant aspect is the accounting treatment by the assessee. The Tribunal found that the compensation payment was in accordance with the employment agreement and not for non-compete purposes.

3. The Tribunal reviewed the documentation, including the agreement and settlement agreement with the Managing Director, which indicated the payment was a result of the merger and as per the agreed terms. The Tribunal noted that it is customary to include non-compete clauses in such settlements but clarified that this does not automatically classify the payment as capital in nature. Therefore, the Tribunal set aside the Commissioner's decision and deleted the addition made by the assessing officer.

4. Ultimately, the Tribunal allowed the appeal of the assessee, emphasizing that the compensation payment to the Managing Director was in line with the employment agreement and related to the merger, not non-compete fees. The Tribunal's decision was based on the understanding that the payment was made as per the agreed terms and should be treated as salary, overturning the previous disallowance.