2020 (7) TMI 544 - SC - Income Tax

Receipt of non-competitive fee - non-compete fee payable under the Deed of Covenant - capital receipt or revenue receipt - substantial question of law that was raised by the High Court - difference in members of ITAT - majority decision of ITAT said that non-competitive fee was a capital receipt u/s 28(iv) income tax act and not a revenue receipt as envisaged in Section 28(ii) of I.T. Act - whether the said Deed of Covenant can be said to contain a restrictive covenant as a result of which payment is made to the appellant, or whether it is in fact part of a sham transaction which, in the guise of being a separate Deed of Covenant, is really in the nature of payment received by the appellant as compensation for terminating his management of CDBL, in which case it would be taxable under Section 28(ii)(a)? HELD THAT - Clearly, without any recorded reasons and without framing any substantial question of law on whether the said amount could be taxed under any other provision of the Income Tax Act, the High Court went ahead and held that the amount of INR 6.6 crores received by the assessee was received as part of the full value of sale consideration paid for transfer of shares and not for handing over management and control of CDBL and is consequently not taxable under Section 28(ii)(a) - Nor is it exempt as a capital receipt being non-compete fee, as it is taxable as a capital gain in the hands of the respondent-assessee as part of the full value of sale consideration paid for transfer of shares. This finding would clearly be in the teeth of Section 260-A (4), requiring the judgment to be set aside on this score. The reasons given by the learned Assessing Officer and the minority judgment of the Appellate Tribunal are all reasons which transgress the lines drawn by the judgments cited, which state that the revenue has no business to second guess commercial or business expediency of what parties at arms-length decide for each other. As decided in Guffic Chem (P) Ltd. 2011 (3) TMI 6 - SUPREME COURT the agreement entered into by the assessee with Ranbaxy led to loss of source of business; that payment was received under the negative covenant and therefore the receipt of ₹ 50 lakhs by the assessee from Ranbaxy was in the nature of capital receipt. In fact, in order to put an end to the litigation, Parliament stepped in to specifically tax such receipts under the non-competition agreement with effect from 1-4-2003. Decided in favour of assessee.

Issues Involved
1. Whether the Deed of Covenant is a restrictive covenant or a sham transaction.
2. Whether the payment received under the Deed of Covenant is taxable under Section 28(ii)(a) of the Income Tax Act, 1961.
3. Whether the High Court correctly interpreted and applied the provisions of Section 28(ii)(a) of the Income Tax Act, 1961.
4. Whether the High Court could treat the non-compete fee as a taxable capital gain without framing a substantial question of law on this issue.

Detailed Analysis

Issue 1: Nature of the Deed of Covenant
The primary contention in this appeal was whether the Deed of Covenant constituted a genuine restrictive covenant or if it was a sham transaction designed to evade tax. The appellant argued that the Deed of Covenant, which included a non-competition fee of ?6.6 crores, was a legitimate agreement to prevent the appellant from engaging in the liquor business for ten years. The Deed of Covenant explicitly stated that Mr. Shiv Raj Gupta would not engage in any activities related to IMFL or beer manufacturing, marketing, or supply. The payment was justified by the appellant's extensive experience and expertise in the liquor industry.

Issue 2: Taxability under Section 28(ii)(a)
The Assessing Officer initially held that the payment under the Deed of Covenant was not for a restrictive covenant but was compensation for terminating the appellant's management of CDBL, thus taxable under Section 28(ii)(a) of the Income Tax Act, 1961. This section taxes any compensation received by a person managing the whole or substantially the whole of the affairs of an Indian company at or in connection with the termination of his management. The High Court agreed with this interpretation, stating that the Deed of Covenant was not a separate document but part of the overall transaction for transferring control of CDBL.

Issue 3: Interpretation by the High Court
The High Court framed the substantial question of law as whether the ?6.6 crores received by the assessee was taxable under Section 28(ii)(a) or as a capital gain. The High Court concluded that the payment was part of the sale consideration for the shares and not a non-compete fee. However, the Supreme Court found that the High Court did not follow the correct procedure under Section 260-A of the Income Tax Act, 1961, as it did not formulate a substantial question of law regarding the taxability of the amount as a capital gain.

Issue 4: Procedural Lapse by the High Court
The Supreme Court highlighted that the High Court did not provide an opportunity to the parties to argue on whether the amount could be taxed under any provision other than Section 28(ii)(a). The High Court's judgment was found to be in violation of Section 260-A(4) of the Income Tax Act, 1961, which mandates that the appeal shall be heard only on the substantial questions of law formulated by the court.

Conclusion
The Supreme Court set aside the High Court's judgment, emphasizing that the amount received by the appellant was for a legitimate restrictive covenant and not taxable under Section 28(ii)(a) of the Income Tax Act, 1961. The Court also reiterated that commercial expediency should be judged from the point of view of the businessman and not the revenue authorities. The appeal was allowed, and all pending applications were disposed of accordingly.

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