2022 (2) TMI 878 - HC - Income Tax

Nature of receipt - termination of employment - non-compete agreement - amount received under the Deed for restrictive covenant - revenue or capital receipt - appellant agreeing not to compete with the company for a period of 10 years after termination, under Article 2 of the agreement the company agreed to pay compensation amount by allotting 20,00,000 Equity Shares of the nominal face value of ₹ 10 each to appellant - HELD THAT - The agreement expressly provides that appellant shall not directly or indirectly engage in or be concerned or connected with any business which is similar to and/or in competition with the business of the company in the metro cities of Bombay, Delhi, Ahmedabad and Bangalore and appellant shall not directly or indirectly control or operate or cause to control or operate or participate in any similar business in the metro cities. In fact, the agreement goes to the extent of even stating that appellant shall not associate himself or be an advisor, employee or be a partner in any similar business as that of the company and he shall cease and desist from participating in similar business activities as that of the company and not to use his goodwill or expertise in respect of similar business as that of the company. To that extent, in our view it was loss of source of income for him in the future. The agreement, i.e., the deed for negative covenants was an independent obligation undertaken by appellant with the company in same field for a period of ten years.The compensation attributable to restrictive covenant, i.e., 20,00,000 Equity Shares of ₹ 10/- each in the hands of appellant was a capital receipt in as much as it was appellants profit making capabilities for a period of ten years from the date of appellant leaving the employment of the company either on his own or in association with professional competitors. ITAT, CIT and the AO have proceeded on an erroneous footing that the company came into existence only on 22nd June, 2000 and the assessee was inducted into its employment on 30th June, 2000 and therefore it was not feasible and it is inconceivable that appellant can be a privy to the business secrets of the company within a period of eight days of his employment. The deed of negative covenant does not provide or even indicate that appellant was privy to the business secrets of the company within a period of eight days. The objective for entering into agreement was because the company was engaged in the business of maintenance and collection of art and sale of art by conducting auctions, exhibitions etc., and appellant has been actively and closely associated with the Indian Art Industry for over seven years and was a pioneer in his field with extensive knowledge of the history and aesthetics of Indian Classical Modern Contemporary Art and has considerable skills, expertise, goodwill and experience in the aforesaid business. Respondents have also proceeded on an erroneous basis that statement of income filed by appellant for A.Y. 2000-01 does not show that appellant had income from business of maintenance and collection of art and sale of art and the assessee was showing only interest income and therefore he cannot be stated to be in a position to compete in any manner with the employer company because he did not have any existing business running. According to respondent for any sum stated to be non-compete fess, the same should be paid to any person from whom the real threat of competition exists and because his return of income for A.Y. 2000-01 does not show any income or business of maintenance and business of collection of art and sale of art, the value of shares received by appellant should be treated as revenue receipt and not capital receipt. In our view, these things really does not matter. No material has been brought on record to show that the negative covenant agreement is a sham agreement. All judgments/orders relied upon by Mr. Kaka certainly hold that whether compensation is received for negative restrictive covenant or non-compete with business of the company, compensation relatable to such activity would be a capital receipt. See GUFFIC CHEM (P) LTD. MANDALAY INVESTMENT P. LTD VERSUS COMMISSIONER OF INCOME-TAX 2011 (3) TMI 6 - SUPREME COURT Thus Tribunal erred not treating that the amount received under the Deed for restrictive covenant as a Capital Receipt not liable to tax - Decided in favour of assessee.

Issues Involved:
1. Whether the amount received under the Deed for restrictive covenant should be treated as a Capital Receipt not liable to tax.
2. Whether the Tribunal's finding that the Appellant could not be viewed as a threat to the Company’s business is perverse and contrary to the material on record.
3. Whether the Tribunal’s failure to follow the decision of a Special Bench and citing cases never raised during the hearing renders the decision bad in law.
4. Whether the Tribunal sitting as a Division Bench should have referred the matter to the President to constitute a larger Bench.

Issue-wise Detailed Analysis:

1. Treatment of Amount Received under Restrictive Covenant as Capital Receipt:
The appellant was appointed as a whole-time Director of the Company and entered into a non-compete agreement termed as "Deed for Negative Covenants." The agreement imposed restrictions on the appellant from engaging in similar business activities for ten years post-termination. In return, the appellant was allotted 20,00,000 equity shares valued at ?2 Crores. The respondent invoked Section 147 read with Section 148 of the Income Tax Act, 1961, to tax the consideration, treating it as salary income. The appellant contended that the amount received under the negative covenant was a capital receipt, not liable to tax. The High Court concluded that the compensation attributable to the restrictive covenant was a capital receipt, not taxable, as it was for the loss of the appellant's profit-making capabilities for ten years. The court relied on the Supreme Court's judgment in Guffic Chem P. Ltd., which held that compensation received under a non-competition agreement was a capital receipt and taxable only from 1st April 2003 under Section 28(va) of the Act.

2. Perverse Finding by Tribunal on Appellant as a Threat to the Company:
The Tribunal, CIT (A), and Assessing Officer held that the threat from the appellant to the company was theoretical and not real, as the company was newly incorporated, and the appellant was employed only for eight days. The High Court found this reasoning erroneous, noting that the agreement's objective was to prevent potential threats from the appellant, who had extensive knowledge and skills in the Indian Art Industry. The court emphasized that the agreement aimed to bind the appellant by a negative covenant due to his capabilities and potential threat to the company’s business.

3. Tribunal’s Failure to Follow Special Bench Decision:
The appellant argued that the Tribunal failed to consider relevant decisions, including those of the Hon'ble Apex Court, which held that payments made to compensate for future income should be treated as capital receipts. The High Court noted that the Tribunal dismissed the appeal without considering these decisions, leading to an erroneous conclusion.

4. Tribunal's Referral to Larger Bench:
Given the High Court's affirmative answers to the first two questions, the necessity to address whether the Tribunal should have referred the matter to a larger Bench did not arise.

Conclusion:
The High Court answered affirmatively to the questions regarding the treatment of the amount received under the restrictive covenant as a capital receipt and the perverse finding of the Tribunal. Consequently, the appeal was disposed of with no order as to costs, and the related writ petition was dismissed as it did not survive in light of the appeal's decision.

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