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TMI Blog2012 (2) TMI 217X X X X Extracts X X X X X X X X Extracts X X X X ..... stries (2011 - TMI - 202401 - Supreme Court), the provisions of Sec.28(va)(a) are not clarificatory and were applicable only prospectively from 1-4-2003. Therefore the receipts in question were capital receipts and not chargeable to tax in AY 00-01 – Decided against the Revenue. - ITA No. 1034/Hyd/2004 - - - Dated:- 13-2-2012 - SHRI P.M.JAGTAP, SHRI N.V.VASUDEVAN, SHRI CHANDRA POOJARI, JJ. Appellant by : Shri V.Srinivas, CIT D.R. Respondent by : Shri K.Vasant Kumar, Advocate O R D E R PER N.V.VASUDEVAN, J.M.: This Special Bench has been constituted by the Hon ble President, ITAT, under S.255(3) of the Income Tax Act, 1961 (the Act) to consider and decide the following question, which covers the solitary issue arising out of the appeal filed by the Department for assessment year 2000-01 being ITA No.1034/Hyd/2004 Whether on the facts and in the circumstances of the case the consideration receivable by the assessee in terms of the agreement dated 27.07.1999 is assessable to tax as capital gains in accordance with the amended provisions of law prevailing at the relevant point of time relating to the levy of tax on capital gains. 2. The assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eedings for assessment of income that has escaped assessment of the deceased for the AY 00-01. 4. The preamble to the non-compete agreement dt.27.10.99 narrates the reason why the agreement was being entered into. Mr.B.V.Raju during the course of his employment with the above referred Companies acquired a corpus of knowledge, skill, expertise, and experience related to the production, distribution, marketing, running and managing of cement plants and has also acquired or otherwise come in possession of various secret information, know-how and trade secrets relating to the Cement line of business. India Cements Ltd. and its associate companies had acquired RCL from the original promoters during April, 1998. Mr.B.V.Raju together with his family members thereafter continued their business in Cement line with SVCL till October, 1999, when SVCL was proposed to be taken-over by India Cements Ltd., and its associate companies. Mr.B.V.Raju along with other persons entered into an agreement with ICL by which they sold the shares held by them in SVCL. With the acquisition of SVCL, the core family promoters of RCL SVCL were out of Cement business. ICL with a view to ward off competition, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t line of business to ICL for a period of five years and taking the cost of acquisition of the said right at NIL as per the provisions of S.55(2)(a) of the Act as amended by the Finance Act, 1997 with effect from 1.4.1998, he worked out the capital gains chargeable to tax in the hands of the assessee at Rs.11 crores. Accordingly, addition of Rs.11 crores was made by the assessing officer to the total income of the assessee on account of capital gain arising from the transfer by way of relinquishment of his right by the assessee to manufacture cement and the assessment was completed under S.143(3) of the Act read with S.147 of the Act, vide order dated 26.3.2004. 7. Against the order passed by the assessing officer under S.143(3) of the Act read with S.147 of the Act, an appeal was preferred by the assessee before the learned CIT(A), challenging the addition of Rs.11 crores made by the assessing officer on account of capital gains. Before CIT(A) it was submitted as follows: (i) It was submitted that it is not known as to for what reasons the entire agreement was made. It was submitted that the letter dated 27th October, 1999 purportedly written by late Dr.BV Raju authorizing M/s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... time of integration, the India Cements Limited did not carry these balance in the books and when a recovery was made through the amounts payable to late Dr.B.V.Raju, the entire sum so recovered was considered as income. In other words, the India Cements Limited never claimed these amounts as expenditure (write off) at any point in time on the other hand when the amounts were recovered through late Dr.B.V.Raju, the entire amount of Rs.11 crores was offered as income and subjected to tax. The Assessee argued that M/s.ICL had first of all accepted the so-called dues in the name of above parties at NIL value. If those were correct facts as per the admission of M/s. ICL itself, then there was no case for M/s. ICL to say that they had paid Rs.11 crores to late Dr.BV Raju and the same was adjusted against the NIL dues. (iv) The Assessee also submitted that if M/s. ICL had not claimed the expenditure of Rs.11 crores at any point of time shows that no such monies were ever paid. The Assessee submitted that by showing the entire sum of Rs.11 crores as if recovered through late Dr.BV Raju, M/s.ICL was making an effort to create a false reserve in their own books of accounts. (v) The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f Rs.11 crores which was receivable by the assessee as per the noncompete agreement dated 27.10.1999. In this regard, he analysed the relevant terms and conditions of the said agreement as well as all the relevant facts and circumstances of the case in which the said agreement was entered into by and between the assessee and the ICL. He held on the basis of such analysis that even after the hostile takeover of his company, ICL was apprehensive that the assessee was always capable and competent to start his business afresh and give tough competition to it. He held that the non-compete fee of Rs.1 crore thus was agreed to be paid by ICL to the assessee to ensure that no further competition was faced. He held that the assessee had personal skills and abilities which were placed under restraint in the non-competition agreement, and the said personal abilities and skills not being in the nature of capital asset, as defined under S.2(14) of the Income-tax Act, there was no question of any capital gain arising as a result of non-compete agreement, which could be brought to tax in the hands of the assessee. He also held that there was only a restraint on the use of personal skills and abil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which the Special Bench has been called upon to decide. The preliminary objection of the learned counsel for the Assessee is therefore rejected. 12. We shall first take up for consideration the question as to whether there was accrual of income of Rs. 11 crores to late Shri B.V.Raju from ICL as a result of non-compete agreement. On this issue, the ld. D.R. drew our attention to the findings of the AO given in para 2.5 to 2.12 of the assessment order. It was further submitted by him that when there was a merger of ICL RCL as on 1/4/1998. RCL had given nil value to the aforesaid dues. According to him though the Non- Compete Agreement (NCA) is dated 27/10/1999, the adjustment of payment of Rs. 11 crores payable under the said agreement relates back to the date on which the debts due to RCL by the various debtors were considered as nil. In this regard ld. D.R drew our attention to the letter dated 27/10/1999 by Shri B.V.Raju, whereby he had agreed to treat the adjustment of dues by various debtors of RCL as payment to himself of the consideration payable under the NCA. His further submission was that the CIT(A) himself accepts that Shri B.V.Raju did not want the true nature of thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he time of integration. In effect there is no write off in the books of Raasi Cement Limited prior to integration. (ii) the details of the parties whose outstandings were adjusted against the amount payable to Late B. V. Raju was already furnished to you vide our communication dated 17.11.2003. (iii) The amount paid to Late Dr. B.V.Raju as Non-Compete Fees (set off against advances from certain parties) was debited to the Investment Account. The recoveries of advances have been credited to P L Account as the advances were at NIL value as mentioned in para (1) above. In effect, having considered these balance at nil value at the time of integration, The India Cements Limited did not carry these balance in the books and when a recovery was made through the amounts payable to Late Dr.B.V. Raju, the entire sum so recovered was considered as income. In other words, The India Cements Limited never claimed these amounts as expenditure (write off) at any point of time. On the other hand when the amounts were recovered through Late Dr.B. V.Raju, the entire amount of Rs. 11 crores was offered as income and subject to tax. 14. Thus ICL claimed that it paid a sum of Rs.11 crore to Dr.B ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtaining further facts about the entire transaction. Pending reconsideration and final decision by the Board these amounts have not been charged off and is treated as recoverable. v) A sum of Rs. 356 lacs has been paid to coal suppliers for open market purchase of coal during 1997-98, which includes Rs. 82.56 lakhs to Sri Vishnu Cement Ltd in which the Former Executive Chairman is the Chairman. The management on noticing certain infirmities is in the process of ascertaining further facts about the entire transaction. Pending final outcome of the review the said amount has not been charged off and is treated as recoverable. 15. We are of the view that the monies have flown out of M/s Raasi Cements Ltd and the same are reflected as debtors in their audited accounts. When RCL was taken over by M/s India Cements Ltd. , the said debts were assigned Nil value. There exists an authorisation of Sri B.V.Raju, that the debts were to be adjusted by M/s India Cements Ltd against the Non-Compete fee payable to B.V.Raju. Therefore, the conclusion of the AO that Late Sri B.V.Raju was paid Rs 11 Crores by M/s India Cements Ltd as Non-Compete fee, in our view is proper. In this regard, we are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aju as well Shri Ravindra Verma. The Tribunal had an occasion to consider taxability of such receipts. In the case of Shri. Ravindra Verma and Shri K.B.V Raju ITA No.640/HYD/2004 and 328/HYD/2004 for A.Y2000-01 order dated 26/6/2009. The Tribunal held that the receipts were not taxable on two counts. (1) The payment in question was a payment as consideration for not indulging in competition (which was chargeable to capital gains tax only w.e.f 1-4-2003 by virtue of amendment to Sec.55(2)(a) of the Act by the Finance Act, 2002) and was not a payment made for a right to manufacture, produce or process any article or thing (which was chargeable to capital gains tax w.e.f 1-4-1998 by virtue of amendment to Sec.55(2)(a) of the Act by the Finance Act, 1997). The assessment year with which we are concerned in this appeal is AY 2000-01. (2) The Tribunal held that it was only SVCL and RCL that were manufacturing cement and, therefore, the amount received by the Assessees who were individuals and promoters of those companies were not engaged in any manufacturing of cement and therefore it cannot be said that the consideration paid for not indulging in competition was a consideration for givi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndment to Sec.55(2)(a) of the Act by the Finance Act, 1997 whereby cost of acquisition of Right to Manufacture, produce or process any article or thing was specifically fixed by the legislature. It was his contention that the Assessee (late B.V.Raju) had the expertise to manufacture cement and had the right of manufacturing, though he was not manufacturing cement himself. RCL and SVCL were companies promoted by him and right of manufacturing could be said to be with Mr.B.V.Raju also. Therefore he could validly assign a right to manufacture also and had assigned such rights for which he received a sum of Rs.11 crores. 21. It was further submitted by him that the definition of capital asset under section 2(14) of the Act is very wide and includes even right of management which can be called a capital asset. In this regard reference was made to the decision of the Hon ble Bombay High Court in the case of CIT vs. New India Assurance Company Ltd., 122 ITR 633 and the decision of the Hon ble Calcutta High Court in the case of CIT vs. National Insurance Company Ltd., 113 ITR 437 (Cal). The ld. D.R also submitted that the decision of the Division Bench of the ITAT Hyderabad Bench in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evant AY. CAPITAL GAIN VS. NON-COMPETE FEE: 25. CAPITAL GAIN: Under the Income Tax Act, 1922 capital gain was not included as a head of income and therefore capital gain did not form part of the total income. Certain important amendments were effected in the Income-tax Act by Act XXII of 1947. A new definition of "capital asset" was inserted as Section 2(4A) and "capital asset" was defined as "property of any kind held by an assessee, whether or not connected with his business, profession or vocation", and the definition then excluded certain properties mentioned in that clause. The definition of "income" was also expanded, and "income" was defined so as to include "any capital gain chargeable according to the provisions of Section 12B". Section 6 of the Income-tax Act was also amended by including therein an additional head of income, and that additional head was "capital gains," Section 12B, provided that the tax shall be payable by an assessee under the head "capital gains" in respect of any profits or gains arising from the sale, exchange or transfer of a capital asset effected after 31st March, 1946, and that such profits and gains shall be deemed to be income of the pre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Act is an asset which possesses the inherent quality of being available on the expenditure of money to a person seeking to acquire it. The Hon ble Court held that goodwill is something built up by the carrying on of a business or profession and cannot be acquired by just paying money. Therefore there can be no cost of acquisition for goodwill which is a self - generated. The Court held that Sec.45 which is the charging section and Sec.48 which is the computation provision together constitutes an integrated code. When there is a case to which the computation provisions cannot apply at all, such a case was not intended to fall within the charging section. In such a case, when the asset is sold and the consideration is brought to tax, what is charged is the capital value of the asset and not any profit or gain. 26. It can thus be seen that for attracting charge to tax under the head capital gain there are certain conditions necessary to be fulfilled, viz., (a) There must be a capital asset; (b) There should be a transfer of the capital asset; (c) The capital asset should be something which can be acquired by paying a cost i.e., it should be capable of determining the cost of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of improvement of goodwill was provided for. Where goodwill is purchased by the transferor, the cost of acquisition is taken to be the purchase price and in all other cases it is taken to be nil. The cost of improvement in either case is taken to be nil. 30.2 Instances have come to light where rights to manufacture, produce or process any article or thing have been extinguished for a consideration and claimed to be not taxable. 30.3 The Act has, therefore, amended sections 55(1) and 55(2) of the Income-tax Act in order to bring extinguishment of such a right to manufacture, etc., within the ambit of capital gains tax. Capital gains tax would be leviable only where such an extinguishment of right to manufacture, etc., is for any consideration. Such receipts will be subjected to capital gains tax on the same basis as already adopted for taxing transfer of goodwill and tenancy rights. The cost of acquisition and cost of improvement will be determined in the same manner as for goodwill. 29. By the Finance Act, 2002, w.e.f. 1-4-2003, the provisions of Sec.55(2)(a) was amended as follows: (2) For the purposes of sections 48 and 49, "cost of acquisition",-- (a) in relation to a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ror of the business agrees not to engage in competition against the transferee. Where transferor is a corporate entity, key personnel of the transferor company are also restrained from engaging in competing lines of business either directly or indirectly or by participating in management or otherwise of a competitor. 32. Whether the receipts in the hands of the recipient of consideration under a non compete agreement or clause in any other agreement whereby a person is restrained from carrying on business in competition, would constitute income or not has engaged the attention of Courts. The first principle to be kept in mind in this regard is the one laid down by the Hon ble Privy Council in CIT Vs. Shaw Wallace Co. Ltd. 6 ITR 178 (PC). It was explained by the Hon ble Privy Council in the said decision that Income is likened to fruits of a tree, while the tree being a source is capital. Income is a periodic return in money or moneys worth coming with some sort of regularity or expected regularity from definite source. When amounts are received with the source being intact, it will be income, while amounts received as compensation for the loss or sterilisation of the source wil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bsection (va) was inserted in section 28 to bring in the non-compete fess within the preview of section 28 to make it taxable in the hands of the recipient of such income. 28. The following income shall be chargeable to income tax under the head "Profits and gains of business or profession": (va) any sum, whether received or receivable in cash or kind, under an agreement for- (a) not carrying out any activity in relation to any business; Provided that sub-clause (a) shall not apply to- (i) any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head "Capital gains"; 35. In Circular No.8 of 2002 dt. 27.8.2002 the CBDT has explained the above provisions of Finance Act, 2002, as below: 26. New provisions for taxing the receipts in the nature of noncompete fees and exclusivity rights 26.1 For the purpose of giving certainty to taxation of receipts in the nature of non-compete fees and fees for exclusivity rights, the Finance Act, 2002, has included within the scope of profit and gains of business or profession , ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid to persons associated with the transferor to ensure that they also do not indulge in competing business; It has to be clarified that the case laws in which the transferee claims the consideration paid as above as revenue expenditure have no bearing whatsoever when we deal with the case of the tax treatment in the hands of the transferee. There are different considerations for determining whether the cost paid by the transferor is to be regarded as capital expenditure or revenue expenditure. 38. As far as category (a) is concerned the receipt would fall for consideration under the head capital gains as there is a transfer of capital asset in respect of which the machinery provisions of computation of capital gain can be applied. As far as category (b) is concerned the consideration received would fall for consideration under the head capital gain but depending upon the law that prevailed at the time of transfer. Self generated assets like, goodwill of a business or a trade mark or brand name associated with a business, a right to manufacture, produce or process any article or thing or right to carry on any business, tenancy rights, stage carriage permits or loom hours by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing on business which the transferor is already carrying on then it would be regarded as capital gain, being transfer of a capital asset viz., right to carry on business. Thus for the provisions of Sec.55(2)(a) of the Act to apply the transferor must be carrying on a business which he agrees not to carry on. If the transferor is not already carrying on business then he receives consideration only for not carrying out any activity in relation to any business . In that case the provisions of Sec.28(va)(a) of the Act would apply and not the proviso thereto. 41. Now in the case before the special bench we are concerned with consideration paid to persons associated with the transferor. Late B.V.Raju was not carrying on business of manufacture of cement. He was associated with two cement manufacturing companies RCL and SVCL in various capacities. With this background, we will examine the meaning of the expression a Right to Manufacture, produce or process any article or thing and Right to carry on any business used in Sec.55(2)(a) of the Act. 42. RIGHT TO MANUFACTURE, PRODUCE OR PROCESS ANY ARTICLE OR THING: What was intended to be covered by the aforesaid expression Right t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons of Sub-section (2) of Section 55 of the Income Tax Act, the cost of acquisition of an intangible capital asset, being goodwill of a business or a right to manufacture, produce or process any article or thing, tenancy rights, stage carriage permits or loom hours, is the purchase price in case the asset is purchased by the Assessee from a previous owner, and nil any other case. It was pointed out that certain similar self-generated intangible assets like brand name or a trade mark may not be considered to form part of the goodwill of a business, and consequently it may not be possible to compute capital gains arising from the transfer of such asset. 42.2 The Act has therefore amended cluse (a) of sub-section (2) .. (underlining by us for emphasis) 43. It is clear from the legislative intention that it is an intangible capital asset that was sought to be covered by the expression a right to manufacture, produce or process any article or thing . One such intangible asset that one can think of is a patent. A Patent is a monopoly right granted by the government to a person who has invented new useful articles or an improvement of an article or a new process of making an art ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection 45, any capital receipts arising out of transfer of any business or commercial rights are taxable under the head Capital gains . The amount of capital gains is computed according to section 48 of the Income-tax Act, 1961. For this purpose, cost of acquisition and cost of improvement are defined under section 55. At present, in case of receipts for transfer of right to manufacture, produce or process any article or thing the cost of acquisition and cost of improvement are taken as nil under section 55. 39.2 The Finance Act, 2002, has amended section 55 so as to provide that the cost of a cquisition and cost of improvement for working out capital gains on capital receipts arising out of transfer of right to carry on any business would also be taken as Nil . 46. If the expression a right to manufacture, produce or process any article or thing covers a right to carry on business then there was no necessity for the Amendment as aforesaid. Thus the two expression have definite and different connotations. 47. We will now advert to the facts of the case before the Special Bench. The relevant clauses of the Non-compete Agreement dt. 27.10.1999 have to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ove clause are accepted as reasonable by Dr. BVR but in the event that any such restriction are found void but would valid if some part of it were deleted or modified or the period or area of application altered, such restriction shall apply with such modifications as may be necessary to make them valid and effective. In clause-3 of the Agreement, ICL refers to the payment of Rs.11 crores as consideration payable for the undertaking given in clause-2 as above. The same is as follows: 3. COVENANTS OF THE COMPANY: i. The company hereby agrees that it shall, in consideration of Dr. BVR agreeing to the restrictions as set out in clause 2 herein above, pay to Dr. B.V.R a sum of Rs. 11,00,00,000/- (Rupees Eleven crores only) simultaneously on the execution of this Agreement, the receipt of which Dr. BVR hereby admit and acknowledge. 48. Keeping in mind the discussion in para 37 to 41 of this order, let us see what was transferred by Mr.B.V.Raju under the agreement dt. 27.10.1999 for which he was paid a sum of Rs.11 crores by ICL. One should also read the above covenants in the non-compete agreement in the light of the preamble to the agreement which gives the background as to ..... X X X X Extracts X X X X X X X X Extracts X X X X
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