2006 (2) TMI 218 - AT - Income Tax

Payment of Non-compete fees - Nature of receipt of compensation received Capital or Revenue - sale of shares treated as business income or capital gains - HELD THAT - It is with this perception of a potential threat that GSL restrained the assessee by entering into an agreement with it not to be involved, directly or indirectly in any sugar industry/business within a radius of 100 kms. For a period of five years. It is a covenant restricting the assessee to enter into any sort of competition with GSL. The compensation received by the assessee is not in the course of its ordinary business operations. Therefore, as observed by the Supreme Court in the case of Gillanders Arbuthnot 1964 (5) TMI 5 - SUPREME COURT , the compensation received by the assessee has to be treated as a capital receipt and not a revenue receipt as held by the Revenue authorities. We have observed that acting as financiers may assume different shapes, one of them being to participate as promoters in new ventures. As a part of this activity, the assessee had participated in the promotion of GSL by subscribing to 55,480 shares of GSL and to 8,74,533 shares of KTI. The shares in GSL were acquired in December, 1994 and those of KTI during the financial years 1992-93 and 1995-96. Along with this activity, the assessee also carried on the activity of dealing in shares. This is evident from the balance sheet of the company as on 31st March, 1998. The assessee has trading activity only in shares. The shares in which it trades are separately shown in the balance sheet as stock-in-trade. The shares in which it does not trade or in other words the shares which are held as longterm investments are shown under the head investments . Since the assessee did not purchase further shares, strengthens the contentions of the assessee that they were held as investments. Moving further the shares have been sold after holding them for about four to six years. If the intention of the assessee was to deal in these shares, then perhaps, it would not have waited for this long a period to dispose off the shares. Moving still further, it is seen that the assessee has sold its entire holding in GSL and KTI. Again, had there been any intention of trading in these shares, then perhaps, it would have parted with only a part of the holding. The last stage of the entire operations is the disposal of the entire shareholding of the assessee in GSL and KTI at one go. Thus, applying the principle laid down in the case of H. Hock Larsen 1986 (5) TMI 30 - SUPREME COURT , this last stage in the entire operations clearly determines the issue and that is that the assessee was holding the impugned shares as investment and not as stock-in-trade. Accordingly, we hold that the profit earned by the assessee on the sale of the shares of GSL and KTI are to be assessed as capital gains giving due benefit of indexed cost of acquisition to the assessee. In the result, the appeal of the assessee is allowed.

Summary

Issues Involved:
1. Classification of non-compete fees as business income or capital receipt.
2. Classification of profit from the sale of shares as business income or capital gains.

Issue 1: Classification of Non-Compete Fees

The primary issue was whether the amount of Rs. 42,50,000 received by the assessee as non-compete fees should be treated as business income or a capital receipt. The assessee had entered into an agreement with Ghaghara Sugar Ltd. (GSL), agreeing not to compete in the sugar business within a 100 km radius for five years. The Assessing Officer (AO) treated this amount as business income, arguing that the assessee lacked the technical and managerial expertise to be a potential competitor and that the transaction was not at arm's length. The CIT(A) concurred, viewing the agreement as a sham and part of a broader compensatory payment for selling the shareholding in GSL.

The Tribunal analyzed the facts and the arguments presented by both parties. It referred to the Supreme Court judgment in the case of Gillanders Arbuthnot & Co. Ltd. vs. CIT, which held that compensation for refraining from carrying on a competitive business is a capital receipt. The Tribunal noted that the assessee had the financial capability to set up a sugar industry and that the non-compete agreement was a legitimate covenant restricting competition. Consequently, the Tribunal concluded that the compensation received by the assessee was a capital receipt, not a revenue receipt.

Issue 2: Classification of Profit from Sale of Shares

The second issue was whether the profit arising from the sale of shares should be treated as business income or capital gains. The assessee had sold shares of GSL and Kinetic Technology India (P) Ltd. (KTI), disclosing the profit as capital gains. The AO, however, treated this profit as business income, asserting that buying and selling shares was the assessee's ordinary line of business. The CIT(A) upheld this view.

The Tribunal examined the intention behind the purchase and sale of shares, referring to the Supreme Court's guidance in CIT vs. H. Hlock Larsen. It observed that the shares were classified as investments in the balance sheet, held for a long period, and sold in one go, which indicated that they were not held as stock-in-trade. The Tribunal noted that the assessee's primary object was to act as a financier, participating in the promotion of new ventures, and that the shares were acquired in this capacity. Therefore, the Tribunal concluded that the profit from the sale of shares should be assessed as capital gains, granting the assessee the benefit of indexed cost of acquisition.

Conclusion:

The appeal of the assessee was allowed, with the Tribunal ruling that the non-compete fees were a capital receipt and the profit from the sale of shares should be treated as capital gains.