2013 (9) TMI 45 - AT - Income Tax

Transfer of capital or transfer of business - Sale of equity shares of the private limited company - applicability of provisions of section 28(va) - transfer of management - non-compete agreement - Held that - It is apparent that the transaction in question was in the nature of purchase of business by the incoming company. The transaction entered into between the assessee before us as shareholder of M/s Excel Callnet Private Limited and the Managing Directors of M/s Pugmarks Interweb Pvt. Ltd. was not merely for the transfer of shares of the company but was in fact transfer of management of the company to the purchaser with a rider of non-interference by the sellers who were the Directors of the company. Because of the complexity of the handing over operation by the sellers i.e. the shareholders of the company to the Managing Director of the new company, the parties entered in to agreement on 26.3.2005 and had completed the process on 24.7.2005. If it was a mere sale of the investment by way of shareholding by the assessee then the said exercise was not required. Even the sale consideration agreed upon between the parties including the consideration on account of non-compete covenant was paid in installment over a period of time. Further the transfer of shares in effect translated into renunciation of management by the seller Directors in favour of the purchaser which is apparent from Article 5.1.1 of the agreement which enunciated the delivery of effective resignation in writing by the Directors as part of the activities of the completion. The next point under consideration is the non-compete covenants agreed upon between the parties as per Article 8, under which Article 8.4 clearly stated the seller agrees not to engaged in any call centre, business process outsourcing or IT enabled services business in the States of Chandigarh, Punjab, Haryana or Himachal Pradesh within a radius of 100 Kms from Chandigarh for a period of 2 years from the date of this agreement. Further non-compete covenants imposed a restriction upon the seller Directors to directly or indirectly solicit a business that the company has done since its inception without prior written permission of the company. Under Article 8.10 there was renunciation of brand equity of the company by the sellers in favour of the purchaser as the parties agreed that the sellers will not take advantage of the brand equity of the company by using any names, logos, trademarks, partnerships, affiliations, names etc. As per para 8.11 the sellers cannot use domains that contain the word Excel and would not use or claim the domain name www.Excel.net com. Article 9 of the agreement further refer to non-solicitation of employees covenant where by the seller will not directly or indirectly solicit, hire, employ, induce or attempt to induce any present or future employee of the company or the purchaser. The gain arising from the transfer of share is to be assessed as income from business. The provisions of section 28(va) of the Act are squarely applicable to the present facts of the case. - Decided against assessee.

Summary

Issues Involved:
1. Classification of income from the sale of equity shares as "Capital Gains" versus "Business Income" under section 28(va) of the IT Act, 1961.

Issue-wise Detailed Analysis:

1. Classification of Income from Sale of Equity Shares:

Facts and Background:
The appeals concern the assessment of income from the sale of equity shares by two different assessees for the Assessment Year 2006-07. The assessees declared the income as "Capital Gains," whereas the Assessing Officer (AO) classified it as "Business Income" under section 28(va) of the IT Act, 1961. The shares in question were of Excel Callnet Pvt Ltd, and the sale was part of a Share Purchase Agreement with Pugmarks Interweb Pvt Ltd.

Assessment by AO:
The AO scrutinized the nature of the transaction and concluded that the shares were not held as an investment but were business assets. The AO noted that the shares were part of a broader agreement that included non-compete clauses and the transfer of management control. This indicated that the transaction was not merely a sale of shares but involved the renunciation of business control and management.

Key Observations by AO:
- The transaction effectively transferred the management of Excel Callnet Pvt Ltd to the purchaser.
- The agreement included clauses that prevented the sellers from engaging in similar businesses within a specified radius and timeframe.
- The sale price included a premium, which the AO attributed to the non-compete clauses rather than just the value of the shares.

Findings by CIT(A):
The CIT(A) upheld the AO's decision, emphasizing that the transaction was not a simple transfer of shares. The CIT(A) noted that the assessees, as directors and major shareholders, had significant control over the company. The non-compete clauses and other conditions in the agreement supported the view that the transaction involved the transfer of business control.

Arguments by Assessees:
The assessees argued that the shares were held as investments and the income should be classified as "Capital Gains." They contended that the non-compete clauses were incidental and did not warrant the classification of the income as "Business Income." They relied on various judicial precedents to support their claim.

Decision by the Tribunal:
The Tribunal analyzed the agreement and the surrounding circumstances, concluding that the transaction was indeed a transfer of business control and not just a sale of shares. The Tribunal highlighted several key points:
- The agreement included comprehensive non-compete clauses that restricted the sellers from engaging in similar businesses.
- The sale price was significantly higher than the face value of the shares, which indicated that it included consideration for the non-compete clauses.
- The transaction involved the transfer of management and control, as evidenced by the resignation of the directors and the handover of business operations.

Conclusion:
The Tribunal agreed with the findings of the AO and CIT(A) that the income from the sale of shares should be classified as "Business Income" under section 28(va) of the IT Act, 1961. The appeals were dismissed, and the income was assessed as "Business Income."

Final Judgment:
Both appeals relating to the assessment year 2006-07 filed by the different assessees were dismissed, upholding the classification of the income as "Business Income" under section 28(va) of the IT Act, 1961.