ORDER
Shamim Yahya, Accountant Member
1. This appeal by the assessee is directed against the order of Commissioner of Income Tax (Appeals)-III, Chennai-34 dated 6.8.2004 and pertains to assessment year 2000-01.
2. The issue raised is that Commissioner of Income Tax (Appeals) erred in confirming the action of Assessing Officer in treating the non compete fee as revenue receipt.
3. The facts of the case are briefly stratified as under:
M/s TTK Bio-med Ltd. was merged with TTK Health Care Ltd. (formerly known as TTK Pharma Ltd.) w.e.f. 1.7.99. M/s TTK Bio-med Ltd. was manufacturing condoms and gloves and they entered into Non-compete Agreement with London International Group for discontinuing their condom business. London International Group is in the business of manufacturing and selling rubber contraceptives all over the world on its own and through its subsidiaries, joint venture companies and in India it is in joint venture with M/s TTK & Co. (Joint Venture Company TTK-LIG). London International Group paid 4,99,000 pounds as non-compete fee to M/s TTK Bio-med Ltd. Since TTK Bio-med Limited has merged with the assessee company, the transaction has been claimed by the assessee company for the assessment year 2000-01.
The assessee company has claimed that the amount of Rs. 3,44,92,800/- which was received by it from London International Group was not taxable in its hands because the whole structure of the assessee’s profit making apparatus, being advantage of an enduring nature and hence the capital asset was given up by the assessee company.
It has relied on the following decisions:
i) CWT v. Late G.D. Naidu and Ors.
ii) CIT, Tamil Nadu v. Saraswathi Publicities
iii) P.H. Divecha v. CIT, Bombay
iv) Gillanders Arbuthnot & Co. v. CIT, Calcutta
v) CIT, Punjab, Haryana, J & K and H.P. v. Prabhu Dayal .
On the other hand, the Assessing Officer has disallowed the non-compete fee for the following reasons:
The assessee was earlier doing condom manufacturing (by TTK Bio-med Ltd.) and marketing (by TTK Pharma Ltd. which now re-named as TTK Healthcare Ltd.) business and the non-compete fee received by it was a compensation for loss of business profit in the next few years. It is taxable in its hands as receipts Under Section 10(3) of the Income Tax Act. The said receipts were not casual and nonrecurring in nature and were taxable Under Section 10(3). Reliance can be placed on Hon’ble Supreme Court judgment in the case of Ramkumar Agarwal & Bros. 63 ITR 622 as well as Hon’ble Madras High Court’s decision in the case of Mineral Mining Co. Pvt. Ltd. 194 ITR 258 wherein similar issue has been decided in favour of the Department. It may also be mentioned that the said intention of the legislature has been incorporated in the Income Tax Act by introducing Section 28(va) with effect from 1.4.2003 whereby the non-compete fee has been made as taxable income.
4. Upon assessee’s appeal the learned Commissioner of Income Tax. (Appeals) relied upon the same decisions as quoted by the Assessing Officer. Apart from the above, the learned Commissioner of Income Tax (Appeals) further noted that the assessee company has not completely given up the whole structure of its profit making apparatus as per Clause (iv) and (vii) of the Non-compete Agreement. Accordingly, the learned Commissioner of Income Tax (Appeals) upheld the Assessing Officer’s action. Aggrieved by the aforesaid order, the assessee is in appeal before us.
5. We have heard the rival contentions and perused the relevant records. The learned Departmental Representative vehemently supported the order of the authorities below. He vehemently contended that there was no destruction profit making apparatus.
6. On the other hand, assessee’s submissions are as under:
The Commissioner of Income Tax (Appeals) erred in brushing aside the terms of the agreement which clearly stipulate that the foreign company has paid Rs. 3,44,92,800/- towards non compete fee.
The Commissioner of Income Tax (Appeals) ought to have held that the non-compete fee is a capital receipt and not assessable to capital gains on the basis of various decisions furnished before him.
The Commissioner of Income Tax (Appeals) ought to have appreciated that the foreign company had apprehended that if the assessee were to start a competing business it would adversely affect their business in the initial period and therefore paid the assessee a sum of Rs. 3,44,92,800/- towards non-compete fee.
The Commissioner of Income Tax (Appeals) ought to have appreciated that the main purpose of the Non Compete Agreement was to restrain the assessee from carrying on the business and as such any prudent person would certainly insist on forwarding enquiries received by the assessee to the foreign company.
TTK Biomed had two divisions, namely, Condoms Division and Gloves Division. TTK Biomed was mainly supplying to Government tenders and to export tenders. There were no brands in TTK Biomed Ltd. The goods were supplied with clients’ brands.
TTK LIG who is in the same line found assessee was competing with them in Government tenders and tender for export. Hence, LIG London who is joint venture partner in TTK LIG approached assessee to discontinue the business.
Non Compete amount was paid to discontinue the business. The payment was for closure of business which resulted in impairment of profit earning capacity of the business.
There was no transfer of brands by TTK Biomed Ltd. nor any selling infrastructure. The assessee was permitted to complete only the existing contracts within a year and as an incidental point they said assessee may pass on the enquiries received by them. In actuality, there was no such enquiry passed on.
Further, the learned Counsel of the assessee placed reliance upon Hon’ble Apex Court decision in the case of Oberoi Hotel Pvt. Ltd. v. CIT 236 ITR 903.
7. Upon giving a careful consideration of the submissions above, we adjudicate the matter as under:
Firstly, the Assessing Officer has held that the sum involved is taxable in the hands of the assessee Under Section 10(3) of the Income Tax Act as the said sum is not casual and non recurring in nature. We find that the extant provisions of Section 10(3) read as under:
(3) any receipts which are of a casual and non-recurring nature, to the extent such receipts do not exceed five thousand rupees in the aggregate:
Provided that where such receipts relate to winnings from races including horse races, the provisions of this clause shall have effect as if for the words “five thousand rupees”, the words “two thousand five hundred rupees” had been substituted:
Provided further that this clause shall not apply to:
(i) capital gains chargeable under the provisions of Section 45; or
(ii) receipts arising from business or the exercise of a profession or occupation; or
(iii) receipts by way of addition to the remuneration of an employee
Upon a careful reading of the aforesaid, we are unable to find any cogency in the reasoning that the sum involved is taxable Under Section 10(3) of the Income Tax Act.
8. The decisions relied upon by Revenue are dealt as under:
In the case of CIT v. Mineral Mining Company Pvt. Ltd. 194 ITR 258, the Hon’ble Madras High Court has held that, “where the assessee was carrying on business of prospecting and mining, the assessee and another Corporation were trying to get mining lease and the assessee entered into an agreement with the Corporation that the assessee would cease effort to get the lease and hand over Prospecting Report to the Corporation. The amount paid by the Corporation could not be said to be compensation for loss of an enduring capital asset.
In Ram Kumar Agarwal & Brothers case 63 ITR 622, the Hon’ble Madras High Court was considering a case where the assessee and another person were having joint negotiations to purchase the controlling interest in a company. Another person was also negotiating and an agreement was entered with that other person that, “in the event of your securing for us the controlling interest and upon your giving up all claims to purchase the same and assigning to us and our associates any interest that you may have acquired therein, we hereby agree to pay you and your colleagues a capital sum of Rs. 6,00,000/-“. On these facts, the Hon’ble High Court has held that the same was received not in consideration of refraining from competing in the purchase of controlling interest but as remuneration for services rendered.
The above case laws are not applicable on the facts of the present case.
9. We find that in CIT v. Prabhu Dayal (Deed. By legal representation) 82 ITR 804 SC, the Hon’ble Apex Court has held as under:
The assessee entered into an agreement for exploitation of kankar deposits. The company agreed to pay commission to the assessee, but it failed to do so. Compromise was arrived at for termination of the agreement. Whether compensation for termination is income or capital? The assessee’s activities neither in respect of the services rendered by him in the past nor towards the accumulated commission due to him. It was paid because he gave up his right to get commission in future to which he was entitled under the agreement. It was price paid for surrendering a valuable right which was a capital asset.
10. Again in CIT v. Best & Co. (P) Ltd. 60 ITR 11 SC, the Hon’ble Apex Court has held that,
While the income tax authorities have to gather the relevant material to establish that the compensation given for the loss of agency was a taxable income, adverse inference could be drawn against the assessee if he had suppressed documents and evidence, which were exclusively within his knowledge and keeping the loss of the agency by the assessee was only a normal trading loss the covenant was an independent obligation under taken by the assessee not to compete with the new agents in the same field for a specified period. It came into operation only after the agency was terminated. It was wholly unconnected with the assessee’s agency termination therefore, that part of the compensation attributable to the restrictive covenant was a capital receipt and hence not assessable to tax.
11. From the above exposition, it is clear that sum paid pursuant to a restrictive covenant as non compete fee are not taxable as revenue receipts. The fact that the sum involved in this case is non compete fee has also been accepted by the Assessing Officer. However, the Assessing Officer has proceeded on a premise that in order to bring into the ambit of taxation amount as involved in this case, that provision has been incorporated in the Income Tax Act by introducing 28(v)(a) w.e.f. 1.4.2003 whereby the non compete fee has been made as taxable income. Thus, it is not the case of the Assessing Officer that the sum involved is not compete fee; rather he is making a case for the retrospective operation of Section 28(v)(a) which was incorporated w.e.f. 1.4.2003. However, this view is not sustainable. This Tribunal, in the case of R.K. Swamy v. Assistant Commissioner of Income Tax 88 ITD 185 has clearly held that these provisions are prospective and not retrospective. Hence, this plank of argument of the Assessing Officer clearly fails.
12. Another aspect held against the assessee by the Commissioner of Income Tax (Appeals) is that the assessee company has not completely given up the! whole structure of its profit making apparatus as per the Non Compete Agreement.
13. However, upon a careful perusal of the said agreement, we are of the opinion that there is no basis for the Commissioner of Income Tax (Appeals) coming to the said conclusion. The profit making apparatus which is the subject matter of this agreement has been undoubtedly given up. In this regard, we also place reliance upon Hon’ble Apex Court decision in the case of Oberoi Hotel Pvt. Ltd. v. CIT 236 ITR 903, wherein following was expounded:
It may be broadly stated that what is received for loss of capital is a capital receipt: what is received as profit in a trading transaction is a taxable income. But the difficulty arises in ascertaining whether what is received in a given case is compensation for loss of a source of income, or profit in a trading transaction. Where on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue: Where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee’s income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt.
The assessee-company was operating, managing and administering many hotels belonging to others for a fee at several places. As per the Memorandum of Association of the company, it was authorised to run hotels on its own account and also to operate, manage and administer hotels belonging to others for a fee. In terms of an agreement dated November 2, 1970, the company agreed to operate the hotel known as Hotel Oberoi Imperial for which the assessee-company was to receive a certain fee called management fee which was calculated on the basis of gross operating profits as provided in the agreement. The agreement was to run for an initial period of ten years; the assessee had the option to ask for renewal of the said agreement for two further periods of 10 years each by mutual agreement. Article XVIII of the said agreement gave the assessee a right to exercise the option of purchasing the hotel in case its owners desired to transfer the same during the currency of the agreement. Thereafter on September 14, 1975, a supplementary agreement was executed between the assessee and the receiver who had been appointed for the property. The right to exercise its option was given up by the assessee. It was agreed that the receiver would be at liberty to sell or otherwise dispose of the said property at such price and on such terms as he may deem fit and was not under any obligation requiring the purchaser thereof to enter into any agreement with the operator (assessee) for the purpose of operating and managing the hotel or otherwise and in its return agreed consideration was to be paid to the assessee. On the basis of the agreement, the assessee received the amount of Rs. 29,47,500/- and claimed that it was a capital receipt. The Income Tax Officer rejected the claim but the Commissioner of Income Tax (Appeals) and the Tribunal upheld it. The High Court arrived at the conclusion that it was a revenue receipt assessable to income tax as business income for the assessment year 1979-80. On appeal to the Supreme Court:
Held, reversing the decision of the High Court, that the amount received by the assessee was the consideration for giving up its right to purchase and / or to operate the property or for getting it on lese before it was transferred or let out to other persons. It was not for settlement of rights under a trading contract, but the injury was inflicted on the capital asset of the assessee and giving up the contractual right on the basis of the principal agreement had resulted in loss of source of the assessee’s income. The receipt in the hands of the assessee was a capital receipt.
From the above it is also clear that, in order to prove that a particular receipt is in the nature of capital receipt, it is sufficient to prove that a particular source of income has been given up. This is exactly the case in the present appeal.
14. Our view is also fortified by following exposition of Hon’ble Jurisdictional High Court in the case of Commissioner of Income Tax v. Late G.D. Naidu and Ors. , wherein the Hon’ble Madras High Court has held that, “Payment towards restrictive covenant is Revenue expenditure and allowable”. In that case, Assessee and son were partners in firms carrying on bus business. Entirely new partners took over firms. Payments by firms to assessee and son for not carrying on bus business for five years was held to be not liable to tax either as income or capital gains.
15. Again, the Hon’ble Madras High Court in the case of Commissioner of Income Tax v. Saraswathi Publicities has held that, “Compensation for agreeing to refrain from carrying on competitive business is Capital receipt not liable to tax”. In that case, the assessee had secured the rights for distribution and exhibition of advertisement films, with a right to enter into agreement with other persons for distribution and exhibition. The assessee entered into an agreement with which had similar agreements with various firms for the purpose of seeing that the business of ach other did not suffer by competition in certain States. The agreements were extended and modified. Under the agreement of 16th May, 1965, the assessee agreed not to represent or otherwise do business in film shows and any sort of advertisement on the cinema screens for Hindustan Lever Ltd. or Lintas Ltd. in the agreed area. The assessee had agreed also to “taking over and handling” the said business from April 1, 19666 and further agreed to refrain from carrying on the business with Hindustan Lever Ltd. or handle any film advertising business till the end of 1975. In consideration of these terms, Blaze agreed to pay the assessee a sum of Rs. 1,50,000/-. The assessee’s claim that this amount was a capital receipt not liable to tax was negatived by the Income Tax Officer but upheld by the AAC and the Tribunal. On a reference:
Held, that as the receipt was referable to the restrictive covenant, it was a capital receipt not liable to income tax.
16. In the background of above discussion, we are of the considered opinion that the sum of Rs. 3,44,92,800/- received by the assessee in this case pursuant to a restrictive covenant amounts to non compete fee which was not taxable for the relevant assessment year. Hence, we set aside the order of authorities below and decide the issue in favour of assessee.
In the result, this appeal by the assessee is allowed.