2017 (4) TMI 413 - HC - Income Tax

Non-compete agreement - Capital gain considered to be long term capital gain - Whether the ITAT was justified in holding that the amount paid by the Company to the assessee in terms of the agreement dt. 24.5.1999, would not fall within the meaning of words right to manufacture, produce or process any article or thing but, within the meaning of the words right to carry on any business? - Held that - As decided in Guffic Chem Private Limited vs. Commissioner of Income Tax, Belgaum and anr. 2011 (3) TMI 6 - Supreme Court Payment received as non-competition fee under a negative covenant was always treated as a capital receipt till the assessment year 2003-04. It is only vide Finance Act, 2002 with effect from 1.4.2003 that the said capital receipt is now made taxable See Section 28(va) . The Finance Act, 2002 itself indicates that during the relevant assessment year compensation received by the Assessee under non-competition agreement was a capital receipt, not taxable under the 1961 Act. It became taxable only with effect from 1.4.2003. It is well settled that a liability cannot be created retrospectively In view of the observations which are made by the Tribunal and the finding arrived at regarding capital gain and clause to carry on business as introduced in 2003, the observations made by the Tribunal are required to be upheld and same is upheld. - Decided in favour of the assessee

Summary

Issues:
- Interpretation of provisions of Income Tax Act, 1961 regarding capital gains
- Classification of receipt of non-compete fee as capital or revenue receipt
- Impact of legislative amendments on taxation of non-compete fees

Analysis:
1. The High Court addressed the issue of interpreting the provisions of the Income Tax Act, 1961 related to capital gains. The court considered the applicability of Section 55(2)(a) which defines the "cost of acquisition" in relation to various capital assets, including goodwill, trademarks, and rights to manufacture or carry on business.

2. The Court analyzed the classification of the receipt of non-compete fee as a capital or revenue receipt. The Tribunal had previously held that the non-compete fee received by the assessee was a capital receipt and not liable to income tax. This decision was based on the interpretation of the agreement between the company and the assessee, restricting competition in the business.

3. The Court discussed the impact of legislative amendments on the taxation of non-compete fees. Referring to a circular introduced in 1998, the Court highlighted the amendment to sections 55(1) and 55(2) of the Income-tax Act, which brought the extinguishment of the right to manufacture within the ambit of capital gains tax. The Court emphasized that such receipts would be subject to capital gains tax based on the same principles applied to goodwill and tenancy rights.

4. The Court considered the Supreme Court's decision in Guffic Chem Private Limited vs. Commissioner of Income Tax, which distinguished between revenue and capital receipts. The Court noted that compensation received for refraining from carrying on competitive business was considered a capital receipt. The Court also highlighted the Finance Act, 2002, which made non-compete fees taxable from April 1, 2003, indicating a shift in the tax treatment of such receipts.

5. Ultimately, the Court upheld the Tribunal's decision that the receipt of non-compete fee in question was a capital receipt and not liable to income tax. The Court concluded that the issue was to be decided in favor of the assessee and against the department. As a result, the appeals were dismissed, and the judgment was to be placed in each file for reference.