IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCH `A'(SPECIAL BENCH), HYDERABAD
BEFORE SHRI P.M.JAGTAP, ACCOUNTANT MEMBER,
SHRI N.V.VASUDEVAN, JUDICIAL MEMBER
AND SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER
ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
Asstt Commissioner of Income- V/s Late Dr.B.V.Raju, Hyderabad
tax Circle 2(3), Hyderabad (Rep. by L/Rs Smt.I.Rama-
vathy,Smt. K.Usha Rani and
Smt. N.Shobha Rani), Hyderabad
(PAN/GIR No. R-705 )
(Appellant) (Respondent)
Appellant by : Shri V.Srinivas, CIT D.R.
Respondent by : Shri K.Vasant Kumar, Advocate
Date of Hearing 6 1.2012
Date of 13.2.2012
Pronouncement
ORDER
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 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
2. The assessee is an individual. He was a chemical engineer with
degrees in Management from Harvard University, USA and Doctorate in
Science from JNTU, Hyderabad. He was a doyen of cement industry, who
started his carreer as a technocrat and rose to the level of Chairman &
Managing Director of Cement Corporation of India, a public sector
Corporation. While in this job, he had set up many cement factories in
various sites in Madhya Pradesh, Andhra Pradesh, Himachal Pradesh,
Assam and Karnatka. The Government of India recognized his services with
an award of "Padmasree" and "Padmabhushan". He promoted and was
Chairman of two cement companies, M/s. Raasi Cements Ltd.(RCL) and
M/s. Sri Vishnu Cements Ltd.(SVCL). He did not have controlling interest in
RCL and SVCL and therefore M/S.India Cements Ltd., took over RCL and
SVCL. Both these companies were subject matter of a hostile corporate
takeover by rival company viz. M/s. India Cements Securities Ltd. (ICL) and
its associated companies. After the takeover, the assessee lost his business
and died in pain on 8th June, 2002.
3. Meanwhile, there was a search conducted in the case of one Shri
Ravindra Varma, a close relative of the assessee, who had also worked as
Vice Chairman of M/s. Sri Vishnu Cements Ltd. During the course of
search, a document was found from the residence of Shri Ravindra Varma in
the form of a non-compete agreement. The said agreement was entered into
by and between the assessee and M/s. ICL on 27th October, 1999, whereby
a sum of Rs.11 crores was agreed to be paid by ICL to the assessee for
agreeing not to participate either directly or indirectly in the business of
cement/industry. Late Dr.B.V.Raju filed his return of income for the year
under consideration on 30th June, 2000, declaring total income of
Rs.2,04,549, besides agricultural income of Rs.41,620. Since this amount
of Rs.11 crores received under the agreement dated 27th October, 1999 was
not disclosed by the assessee in his return of income filed for the year under
consideration, a notice under S.148 of the Act was issued by the assessing
3 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
officer to the assessee on 7th May, 2002, which was duly served on the
Mr.B.V.Raju. Mr.B.V.Raju however died on 8th June, 2002 without
complying with the said notice. The assessing officer therefore issued fresh
notices under S.148 of the Act to the legal heirs of the assesse and initiated
the assessment proceedings 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, desired that Mr.B.V.Raju should be restrained from
starting a fresh cement unit, lest it should have a bearing on their business.
With that object in view, ICL entered into a Non-Compete Agreement with
Mr.B.V.Raju.
5. During the course of assessment proceedings, the assessing officer
confronted the legal heirs of Mr.B.V.Raju with regard to the receipt of Rs.11
crores by the assessee as per the non-compete agreement. They however
expressed complete ignorance about the said transaction. The assessing
4 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
officer, therefore, made a direct enquiry with ICL which revealed that the
sum of Rs.11 crores payable to the assessee as per the non-compete
agreement was not paid to him in cash and the same was adjusted against
the sums which were due to M/s. Raasi Cement Ltd. by some of the
erstwhile customers known to the assessee. RCL got merged with India
Cements Ltd., with effect from 1-4-1998. ICL also informed the AO that
Mr.B.V.Raju had given an authorization for such adjustment. A copy of
such authorization was also furnished to the AO by ICL. The authorization
reads thus:
"ICL Securities Limited, Chennai October, 27, 1999
Raasi Cements Limited, Hyderabad
Dear sir,
This has reference to the Non Compete Agreement executed by me
today with yourselves. The consideration payable by yourselves
aggregating to Rs.11 Crores may please be adjusted as mentioned in
annexure.
Dr.B.v.Raju
Encl: Annexure"
The annexure referred to above to the aforesaid letter reads thus:
"Annexure forming part of the Non Compete Agreement dated October
27,1999
Total amount payable towards Non-competition Rs.11,00,00,000
Less amount to be paid to Raasi Cement Limited
towards
1. Dues by Viswam Cement Limited Rs. 67,34,000
2. Dues by Maatha Cement Limited Rs.1,41,36,000
3. Dues by Various Transport Con-
tractors Rs.5,35,30,000
4. Dues by Coal suppliers Rs.3,56,00,000
Rs.11,00,00,00
Balance payable towards Non-compete fee to Dr.B.V.Raju Nil
6. ICL also confirmed having squared off the relevant accounts after
adjustment by debiting the amounts of the assessee by Rs.11 crores and
5 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
crediting the accounts of the said parties thereby reducing their dues to NIL.
Based on this information collected by him, the assessing officer concluded
that there was a transfer by the assessee by way of relinquishment of his
right to manufacture or involve in activities connected with the cement 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. ICL, to
adjust the sum of Rs.11 crores payable to Dr.B.V.Raju under the Non-
compete Agreement refers to an annexure to the said letter. But the
annexure has a title stating that it forms a part of the non-compete
agreement dated 27.10.1999. It was submitted that the annexure refers
to various parties but there is no reference to these parties in the non-
compete agreement. It was argued that the annexure cannot be
considered to be a part of the non-compete agreement. It was argued that
there is no privity of contract between Dr.B.V.Raju and the parties
referred to in the annexure. The Assessee also relied upon the fact that in
the letter dated 27.10.1999 produced by M/s. ICL there was reference
6 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
only to two debtors, though subsequently, M/s. ICL claimed to have
squared off accounts of 8 parties. These eight parties were never
informed by M/s. ICL of any such write-off of their dues. Therefore, the
agreement cannot be considered to be complete in respect of right and
duties of contracting parties.
(ii) It was argued that the AO has relied totally upon a letter dated
27.10.1999 given by M/s.ICL, wherefrom they have stated that monies
due to them were adjusted in lieu of the non-compete fee. The AO's basis
to justify the claim of M/s. ICL is the audited books of accounts of M/s.
ICL. The assessee argued that they have also produced confirmations
from the parties, which were alleged to have dues payable to M/s. RCL
and as per those confirmations; there were no dues to be paid to M/s.
RCL. The books of these parties were also audited. The AO has not
examined the books of accounts of these parties denying the liabilities,
nor have given them any opportunity to prove their case. The AO has
merely accepted the version of M/s. ICL.
(iii) It was submitted that the AO has relied on submission of M/s.
ICL regarding accounting entries relating to above transactions. Attention
of the CIT(A) was drawn to the version of M/s. ICL as contained in para 3
of their letter dated 9th March, 2004 which is also part of the assessment
order which reads thus:
"The amount paid to late Dr.B.V.Raju as Non-Compete fee (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 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 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."
7 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 Assessee also submitted that in case M/s. ICL had initially
given a NIL value to all these outstanding as on 1.4.1998, the date of
amalgamation, then the same amount should have also been reduced by
them from their liability side of the balance sheet or some other asset
should have been created. The AO has not examined this aspect and,
therefore, the claim made by M/s. ICL appears to be suspect.
(vi) The Assessee also argued that even if this agreement was genuine, no
monies were received either in cash or indirectly through the medium of
these so-called debtors of M/s. RCL by late Dr. BV Raju. The AO has not
brought any evidence by which it can be said that late DR.BV Raju
received the money either directly or indirectly.
(vii) It was argued by the assesse that the alleged payment of non compete
fee was made after hostile takeover of M/s.SVCL which was in October,
1999. The transactions of adjustments relates to dues of Ms/. RCL.
Apparently, there was no occasion for such consideration of such dues of
M/s. RCL, since that takeover was complete long time back in 1997-98."
8 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
8. After having considered the submissions made on behalf of the
assessee as well as the material available on record before him, the learned
CIT(A) found that non-compete agreement was validly entered into between
the assessee and the ICL, according to which a sum of Rs.11 crore was to be
paid by ICL to the assessee. He held that the said amount due to him was
foregone by the assessee for the reasons best known to him. According to
the learned CIT(A), the assessee voluntarily did not want the true nature of
the transactions to be examined and although there were some adjustments
made settling the pending transactions, the exact details thereof or the facts
relevant thereto were not known. He noted that ICL itself assigned NIL
value to the dues of the concerned parties to ICL on the date of merger, i.e.
1.4.1998. Therefore, the letter given by the assessee on 27.10.1999
authorising the ICL to adjust the sum of Rs.11 crores against the said dues
was inconsequential. He held that in these facts and circumstances, the
assessee could not with conviction be said to have received the sum of Rs.11
crores and the assessing officer was not justified in bringing to tax the said
amount in the hands of the assessee.
9. The learned CIT(A) then proceeded to examine the exact nature of the
sum of Rs.11 crores which was receivable by the assessee as per the non-
compete 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
9 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 abilities of the assessee for a period of five years and
there being no cessation or relinquishment or extinguishment of any right,
there was no transfer within the meaning of S.2(47) of the Act, so as to give
rise to any capital gain. The learned CIT(A) held that the sum of Rs.11
crores itself was agreed to be paid by ICL to the assessee as per the non-
compete agreement against a restrictive covenant on the right to exercise the
business, and the same was in the nature of a capital receipt not
chargeable to tax, before the insertion of provisions of S.28(va) of the
Income-tax Act, with effect from 1.4.2003. Accordingly, the addition of
Rs.11 crores made by the assessing officer to the total income of the
assessee on account of capital gains was deleted by the learned CIT(A).
Aggrieved by the order of the learned CIT(A), Revenue has filed this appeal
before the Tribunal.
10. The ld. Counsel for the assessee at the outset submitted that the scope
of the question before the Special Bench is as to whether the amendment
made to Sec.55(2)(a) of the Act by the Finance Act 1997 w.e.f. 1/4/1998 will
apply or whether the amendment made to the aforesaid provisions by the
Finance Act of 2002 w.e.f. 1/4/2003 whereby "right to carry on business"
when transferred would have nil cost of acquisition and improvement for
computing capital gains, would apply. His submission was that the CIT(A)
has given a finding that there was no evidence about receipt of Rs.11 crores
by the assessee and that issue is not before the Special Bench.
11. On this submission, we are of the view that the question referred to the
Special Bench is comprehensive enough to cover the question as to whether
the CIT(A) was justified in holding that there was no evidence to show that a
sum of Rs. 11 crores was received by the assessee under the agreement
10 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
dated 27/10/1999. Even the grounds of appeal of the Revenue before the
Tribunal challenges the entire findings of the CIT(A). Admittedly as per NCA
dated 27/10/1999 a sum of Rs. 11 crores was receivable by the assessee.
The plea of the assessee was that it was not actually received. The question
referred to the Special Bench, contemplates two issues to be decided, one is
as to whether the amount mentioned in the NCA was income that actually
accrued to the Assessee and if so whether they could be brought to tax.
This in our view is the scope of the question 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 this transaction to be examined.
It was his further submission that the CIT(A) has accepted the fact that
there was an accrual of income but has come to the conclusion that it
cannot be said with conviction that Shri B.V.Raju had received a sum of Rs.
11 crores, without any basis. According to the ld. D.R if there is a doubt or
want of corroboration the CIT(A) cannot leave the matter as it is and was
11 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
duty bound to make further investigation. If there were doubts as to
whether a sum of Rs. 11 crores was received by the assessee as
consideration under the NCA dated 27/10/1999, deletion of the addition
made by the AO was not the natural consequence and the CIT(A) ought to
have exercised his plenary powers and made further investigation. In this
regard reliance was placed by Ld. D.R on the decision of the Hon'ble Delhi
ITAT in the case of Swaroop Vegetable Products, 96 ITR 468 (Del) and
Commissioner of Income-tax v. Late Begum Noor Banu Alladin 204 ITR 166
(AP) (FB). It was his further submission that the CIT(A) had not given
positive finding that the assessee did not receive a sum of Rs. 11 crores as
non-compete fee. His further submission was that once there is evidence to
show that sum of Rs. 11 crores has accrued as income in the hands of the
assessee under the non-compete agreement dated 27/10/1999, the burden
was on the assessee to show that there was no accrual of income. It was not
for the revenue to show that there was no accrual of income. The ld.
Counsel for the assessee on the other hand, reiterated the submissions as
were made before the lower authorities.
13. We have considered the rival submissions. We have already seen that
the legal heirs of Dr.B.V.Raju pleaded complete ignorance of the transaction.
The AO therefore called for complete details of the transaction and the
accounting treatment given by M/s India Cements Ltd in its books
alongwith the relevant extracts of the books of account from M/s India
Cements Ltd. In its reply dated 9-3-2004, M/s India Cements Ltd submitted
as under:
"(i) The debts that were adjusted against the amount payable to Late
Dr. B. V.Raju were outstandings appearing in the erstwhile cement
division of Raasi Cement Limited, which was integrated with The
India. Cements with effect from 1.4.1998. As explained, these
amounts were considered doubtful of recovery and hence The India
Cements Limited assigned nil value at the time of integration. In
effect there is no write off in the books of Raasi Cement Limited prior
to integration.
12 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
(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.V.Raju by
way of adjustment of debts due to RCL. The Annual Report of M/s Raasi
Cement Ltd for the F.Y. 1997-98 also corroborates the version of ICL. The
said debts claimed to have been adjusted against the Non-Compete fee are
reflected in the audited accounts of the company. The relevant extracts of
the Annual Report which have a bearing in the case are reproduced below:
"6. CURRENT ASSETS, LOANS AND ADVANCES
A) SUNDRY DEBTORS
a) .............................
b).............................
B) Sales include sale of 13,025.83 tons of clinker to Viswam Cements
Limited at prices substantially below the average variable cost of
production. The management is reviewing the transaction. Further a
sum of Rs. 67.34 lacs is due to from the party and is grouped under
the head Sundry debtors.
C) Transactions with Maatha Cements Limited (MCL)
a) Sales include sale of 9517 tons of clinker to Maatha Cements
Limited at prices below the average variable cost of production. The
management is reviewing the transaction.
13 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
b) The Company, pursuant to a contract for manufacture of Slag
Cement, advanced a sum of Rs. 75.00 lacs as on interest free advance
to MCL. Notwithstanding that the company has terminated the
contract with manufacturing unit the above mentioned advance has
not been recovered.
c) To facilitate manufacture of slog cement, the company has been
transferring material to MCL's plant from time to time. As on March
31, 1998, the value of materials lying with MCL as per the shortages
and deterioration in the quality of materials have been reported. In
view of the aforesaid the value to the extent of shortage i.e., Rs. 49.05
tons has been classified as Advance Recoverable and the balance Rs.
35.38 lacs has been grouped under inventory.
d) Sundry Debtors include a sum of Rs. 17.31 lacs due front MCL
towards sale of Clinker.
The aggregate amount outstanding from MCL is Rs. 141.36 lacs
(excluding value of inventory Rs. 35.38 lacs). The entire amount is
outstanding as on date and the management is initiating action for
recovery of the outstanding.
D) LOANS ANDADVAAYCLS
a).................................
b)...............................
c) Loans and advances include
iv) Rs.549.39 lacs towards incentives paid to some transport
contractors of the company during the year 1997-98. The said
incentive pertain to the financial year 1996-97 and 1997-98. The
management on noticing certain infirmities, is in the process of
ascertaining 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
14 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 of the view that the letters given by M/s Maata Cements Ltd and M/s
Viswam Cements Ltd stating that no amount is payable to M/s Raasi
Cements Ltd as per their books of account cannot be the basis to hold that
there was no constructive payment of Rs.11 crores by ICL to Dr.B.V.Raju.
16. We are of the view that in the light of the evidence available on record
one has to come to the conclusion that amount of Rs.11 crores accrued to
the assessee under the NCA dated 27/10/1999 and that was enough to
attract the provisions of Sec.45 of the Act to tax capital gain on transfer of a
capital asset. The facts on record further show there were certain debts due
to RCL to the extent of Rs. 11 crores. These debts were considered at nil
value when ICL took over RCL. Thus these amounts were treated as paid to
RCL. ICL when it took over RCL had duly taken into consideration the
discharge of these debts by the debtors to RCL. Thus there was an
adjustment of the monies payable by ICL to Shri B.V.Raju under the NCA
dated 27/10/1999 by treating the debts payable by debtors of RCL to RCL,
as discharged. We therefore, restore the findings of the AO in this regard.
In our view the discrepancies pointed out by the CIT(A) will not stop accrual
of income in the hands of the assessee.
17. Having held that a sum of Rs.11 Crores accrued in the hands of late
B.V.Raju during the previous year relevant to AY 2000-01, we shall now
examine the chargeability of the same to tax as income under the head
"Capital Gains". This will depend on the purpose for which the payment of
Rs.11 crores was made by ICL Securities Ltd., to Late B.V.Raju and what
was the right that was transferred by Late B.V.Raju for which the amount in
15 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
question was paid and the law as it existed at the relevant point of time viz.,
27.10.1999.
18. Before we set out the rival contentions on this issue, it has to be
highlighted that ICL took over RCL as well as Shri Vishnu Cement
Ltd.(SVCL) and the takeover was hostile takeover since both RCL and SVCL
were public limited companies whose shares were widely spread out in the
market and nobody had controlling block of shares. Ultimately the
promoters of RCL and SVCL namely Shri B.V.Raju, Shri K.B.V.Raju and
Shri Ravindra Verma sold their share in a negotiated deal to ICL. The
aforesaid three persons were promoters of the two companies. Similar
payments were made to Shri K.B.V.Raju 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
giving up right to manufacture, produce or process any article or thing.
When the present appeal of the Assessee Mr.B.V.Raju came up before the
16 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
Division Bench, the Division Bench had some reservations on the aforesaid
view and hence a reference was made to the Special Bench.
19. The ld. D.R in this regard submitted that the NCA in clause-1 defines
business to mean the business of manufacture, production, development,
sale etc. of cement. According to him, therefore, the amount in question
was paid for giving up a right to manufacture, produce, or process any
article or thing. In this regard ld. D.R submitted that the assessee had vast
experience in the cement industry and ICL wanted to restrain him from
manufacturing cement and hence a sum of Rs.11 crores was paid.
20. The ld. D.R submitted that it is not correct to say that it is only when
the person is already manufacturing a product that he can give up the right
to manufacture. In this regard he submitted that right to manufacture and
manufacturing rights are akin to right of occupancy and right to occupy. In
this regard the following passage from Ramnath Iyer Law Lexicon 5th edition
page 4144 was referred to:
"RIGIT OF OCCUPANCY" AND "RIGHT TO OCCUPY". A right of
occupancy must not be confounded with a right to occupy. Those two
rights may co-exist in the same person, as when an occupancy tenant
himself or by his servants, cultivates his occupancy holding. Or, those
two rights may be vested in two different persons, the right of
occupancy being vested in the occupancy tenant, and the right to
occupy being vested in his tenant during the currency of the latter's
tenancy. In the latter case, the position is similar in some respects to
the position of a proprietor who lets his land to a tenant, the
proprietary right remaining vested in the landlord and the right to
occupy the land vesting in the tenant. [15 A. 219 13 AWN 125 (FB)]
It was his submission that a right to manufacture will also take within its
fold a right of manufacturing in the sense capacity to indulge in
manufacturing. According to him, the right to manufacture is more than
what is conferred in the sense of a licence or manufacturing permit. It also
17 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
takes into its compass a right that has been generated in any other way, or
is self-acquired. According to him ICL has recognised this fact and paid
Late B.V.Raju. He also highlighted the amendment 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 the case of
Shri. M. Ravindra Verma (supra) should not be followed. It was submitted
by him that the Tribunal in the aforesaid decision has proceeded on the
basis that since the assessee was not engaged in manufacturing he could
not have transferred a right to manufacture. In this regard ld. D.R
submitted that when the agreement dated 27/10/1999 says that right to
manufacture was being transferred it was not possible for anybody to say
that such an undertaking could not have been given by Shri B.V.Raju.
22. The learned counsel for the Assessee reiterated submission as was
made before the CIT(A). In short the contention on behalf of the assessee
was that the amount if considered as received by the assesse, is only for
18 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
undertaking not to compete in similar business as carried on by ICL and
that there was no right to manufacture that was given up by the assessee.
Another submission that was made was that right to manufacture cement
can be exercised by any person. The question is that whether the assessee
was the owner of such right. It was his submission that SVCL and RCL had
a right to manufacture but not the assessee. Therefore, the assessee could
not have transferred a right which he did not possess. Further reliance was
also placed by the ld. Counsel for the assessee on the decision of the Hon'ble
Supreme Court in the case of Guffic Chemical Industries Pvt. Ltd. , 320 ITR
602(SC), wherein it was held by the Hon'ble Supreme Court that prior to
1/4/2003 non-compete fee was a capital receipt not chargeable to tax.
23. In his rejoinder ld. D.R relied on the decision of the Division Bench of
ITAT, Hyderabad Bench in the case of ACIT vs. J.V.Choudhary, ITA
No.486/Hyderabad/02 for A.Y 1998-99, wherein this Tribunal while deleting
the addition made on account of non-compete fee was please to observe in
Para 8 last few sentence that non-compete fee was equivalent to right to
manufacture, produce or process any article or thing and that after
assessment year 1998-99 the same would be taxable.
24. We have considered the rival submissions. Before we analyse the rival
contentions and the terms of the agreement dt. 27.10.1999, it would be
useful to narrate the relevant provisions of the Act as it existed during the
relevant A.Y., the law as it existed prior to the insertion of the statutory
provisions and the amendments to the relevant provisions of law after the
relevant 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
19 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 previous year in which the sale, exchange or
transfer took place. The Indian Finance Act, 1949, virtually abolished the
levy and restricted the operation of section 12B to "capital gains" arising
before the 1st April, 1948. But section 12B, in its restricted form, and the
VIth head, "capital gains" in section 6, and sub-sections (2A) and (2B) of
section 24 were not deleted and continued to form part of the Act. The
Finance (No. 3) Act, 1956, reintroduced the "capital gains" tax with effect
from the 31st March, 1956. As a result of the Finance (No. 3) Act of 1956,
"capital gains" again became taxable in the assessment year 1957-58. In
the Income Tax Act, 1961, the provisions of Sec.45 which are in pari-materia
the same as Sec.12B of the Income Tax Act, 1922, have been retained. The
same is as follows:
"45. (1) Any profits or gains arising from the transfer of a capital asset
effected in the previous year shall, save as otherwise provided in
sections 53 and 54, be chargeable to income-tax under the head
'Capital gains', and shall be deemed to be the income of the previous
year in which the transfer took place."
The Hon'ble Supreme Court in the case of in CIT v. B. C. Srinivasa Shetty
[1981] 128 ITR 294(SC) dealt with the question whether capital gain accrue
or arise when "Goodwill" of a business is transferred. The Hon'ble Supreme
Court held that section 45 of the Act operates if there is a transfer of a
20 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
capital asset giving rise to a profit or gain. The Hon'ble Court held that the
expression "capital asset" is defined in section 2(14) to mean "property of
any kind held by an assessee" and therefore was of the widest amplitude,
and apparently covers all kinds of property and goodwill is not expressly
excluded by the definition. The Hon'ble Court however held that the
definitions in section 2 of the Act are subject to an overall restrictive clause
viz., "unless the context otherwise requires". The Hon'ble Court therefore
went into the question whether contextually section 45, in which the
expression "capital asset" is used, excludes goodwill. The Hon'ble Court
after referring to Sec.48 which provides the mode of computation of capital
gain viz., deducting from the full value of the consideration received or
accruing as a result of the transfer of the capital asset "the cost of
acquisition of the capital asset ", held that the asset contemplated in sec.45
of the 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;
21 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
(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
acquisition of the capital asset.
(d) There must be accrual of consideration for transfer of capital asset.
27. THE STATUTORY AMENDMENTS TO OVERCOME THE
DIFFICULTIES IN BRINGING TO TAX RECEIPTS ON TRANSFER OF
SELF GENERATED ASSETS IN THE HANDS OF THE TRANSFEROR
To overcome the decision in the case of B.C.Srinivasa Shetty (supra) and
with a view to ensure that computation provisions do not fail when there is a
transfer of goodwill, the provisions of Sec.55(2)(a) were introduced by the
Finance Act, 1988 w.e.f 1-4-1989. These provisions read as follows:
55. Meaning of "adjusted", "cost of improvement" and "cost of
acquisition".--
(1) .............
(2) For the purposes of sections 48 and 49, "cost of acquisition",--
(a) in relation to a capital asset, being goodwill of a business,--
(i) in the case of acquisition of such asset by the assessee by
purchase from a previous owner, means the amount of the
purchase price ; and
(ii) in any other case, shall be taken to be nil ;
By the Finance Act, 1997 w.e.f 1-4-1998, provisions of Sec.55(2)(a) were
again amended as follows:
(2) For the purposes of sections 48 and 49, "cost of acquisition",--
(a) in relation to a 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, --
(i) in the case of acquisition of such asset by the assessee by purchase
from a previous owner, means the amount of the purchase price ; and
(ii) in any other case not being a case falling under sub-clauses (i) to
(iv) of sub-section (1) of section 49, shall be taken to be nil ;
(underlining by us for emphasis)
22 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
28. Circular No. 763, dated 18th February, 1998 explaining the above
provisions of Finance Act, 1997 is as follows:
"Cost of acquisition and cost of improvement of certain capital assets
30.1 Up to the assessment year 1988-89, the gains arising on the
transfer of goodwill were not liable to tax. This was on account of the
judicial view approved by the Supreme Court in CIT v. B. C. Srinivasa
Shetty [1981] 128 ITR 294. The rationale of the decision was that
goodwill being a self-generated asset and not costing anything in
terms of money, the gains could not be computed in accordance with
the provisions of the Act. By the Finance Act, 1987, the method of
computing the cost of acquisition as well as the cost 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 capital asset, being goodwill of a business, or a
trade mark or brand name associated with a business or 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, --
(i) in the case of acquisition of such asset by the assessee by purchase
from a previous owner, means the amount of the purchase price ; and
23 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
(ii) in any other case not being a case falling under sub-clauses (i) to
(iv) of sub-section (1) of section 49, shall be taken to be nil ;
(underlining by us for emphasis)
30. In Circular No.8 of 2002 dt. 27.8.2002 the CBDT has explained the
above provisions of Finance Act, 2002, as below:
"39. Amendment of section 55 of the Income-tax Act, 1961
39.1 Under section 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."
Thus with the aforesaid amendments the difficulty in bringing to tax capital
gain on transfer of self generated assets were remedied by the legislature by
assigning nil value or actual purchase value as cost of acquisition and nil
value as cost of improvement.
31. NON-COMPETE FEE:
An agreement or a clause in an Agreement by which one person agrees not
to pursue a similar line of business or profession or trade in competition
against another party and the consideration paid for refraining from doing
so is called non-compete fee. It is generally found in agreements between
employer and employee. The use of such clauses is premised on the
possibility that upon their termination or resignation, an employee might
begin working for a competitor or starting a business, and gain competitive
advantage by abusing confidential information about their former employer's
operations or trade secrets, or sensitive information such as customer/client
lists, business practices, upcoming products, and marketing plans. Similar
covenants are found when businesses are acquired whereby the transferor
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
24 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 will be
capital. The Hon'ble Supreme Court in the case of CIT Vs. Best & CO. 60
ITR 11 (SC) held on the taxability of non-compete fee as follows:
"The House of Lords in Beak v. Robson (1942) 25 Tax Cas. 33. had to
consider whether compensation paid for a restrictive covenant was a
capital receipt or a revenue receipt. Under a service agreement the
respondent therein covenanted in consideration of the payment to him
of 7,000 pounds on the execution of the agreement, that if the
agreement were determined by notice given by him or by his breach of
its provisions, he would not compete directly or indirectly with the
company within a radius of fifty miles of its place of business until the
five years had expired. The House of Lords held that the said amount
was a payment for giving up a right wholly unconnected with his office
and operative only after he ceased to hold that office, and, therefore, it
was not taxable under Schedule E of the Income Tax Acts.
This court in Gillanders Arbuthnot and Co. Ltd. v. Commissioner of
Income-tax 53 I. T. R. 283 (S. C.) accepted the said principle and held
that the compensation paid for agreeing to refrain from carrying on
competitive business in the commodities in respect of the agency
terminated or for loss of goodwill was prima facie of the nature of a
capital receipt.
25 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
In the present case, the covenant was an independent obligation
undertaken 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. We, therefore, hold that part of the compensation
attributable to the restrictive covenant was a capital receipt and hence
not assessable to tax."
33. The principle as laid down above has been followed in number of
judicial pronouncement of various Hon'ble High Courts as also the Hon'ble
Supreme Court. It can thus be seen from the above that when there are
receipts by a person as Non-compete fee under an agreement not to carry on
particular business, then it was regarded as a capital receipt not chargeable
to tax.
34. THE STATUTORY AMENDMENTS TO OVERCOME THE
DIFFICULTIES IN BRINGING TO TAX RECEIPTS ON ACCOUNT OF NON-
COMPETE AGREEMENTS EVEN IN CASE WHERE THERE SUCH
RECEIPTS ARE FOR LOSS OF A SOURCE OF INCOME:
With effect from 01.04.2003 vide finance Act 2002 a new subsection (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 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
"26. New provisions for taxing the receipts in the nature of non-
compete 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", any sum received or receivable in cash or in
kind under an agreement for not carrying out activity in relation to
any business ; or not to share any know-how, patent, copyright,
trade-mark, licence, franchise or any other business or commercial
right of similar nature or information or technique likely to assist in
the manufacture or processing of goods or provision for services.
However, the provisions clarify that receipts for transfer of right to
manufacture, produce or process any article or thing or right to carry
on any business, which are chargeable to tax under the head "Capital
gains", would not be taxable as profits and gains of business or
profession.
36. Thus with the amendment to the law, non-compete fee even if it is
capital receipt is now chargeable to tax as Income from business. In Guffic
Chem. P. Ltd. v. Commissioner of Income-tax, 320 ITR 602 (SC) the Hon'ble
Supreme Court held that payment received as non-competition fee under a
negative covenant was always treated as a capital receipt till the assessment
year 2003-04. It is only vide the Finance Act, 2002 with effect from April 1,
2003 that receipt by way of non-compete fee was made taxable u/s. 28(va)).
The Hon'ble Court also held that it was well settled that a liability cannot be
created retrospectively. The Hon'ble Court held that the amendment by
insertion of clause (a) to section 28(va) was amendatory and not
clarificatory.
37. CAPITAL GAIN OR NON-COMPETE FEE:
The conclusion that emerges from the aforesaid discussion is that when a
business is sold and the purchaser enters into agreements to ensure that
there is no competition, he may enter into agreements not only with the
transferor of the business but also with persons connected with the
transferor. He may also pay consideration to the transferor for transfer of
business, for not engaging in competition. He may also pay consideration to
27 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
persons associated with the transferor not to indulge in competition. The
receipts by the transferor or other persons connected with the transferor can
be divided into the following categories;
a) The consideration paid by the transferee for transfer of the business to
the transferor;
b) Consideration paid to the transferor not to carry on same business
directly or indirectly not to indulge in manufacturing same or similar
products, not to use the trade names etc. ;
c) Consideration paid 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 their very nature could not have cost of
acquisition and therefore machinery provisions were amended to provide
cost of acquisition being treated as nil. These amendments are set out in
the later part of this order. As far as category (c) is concerned, the same
would fall for consideration to see if it is capital receipt chargeable to tax as
on the date of transfer because after 1-4-2003 such consideration even if
28 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
regarded as capital receipt would be chargeable to tax u/s.28(va)(a) of the
Act. Therefore the law as it prevails on the date on which a person agrees to
desist from doing certain acts in relation to any business would be relevant.
39. If a payment is in the nature of non-compete fee received by the
transferor when he sells his business and agrees not to carry on the
business which he transfers then that would fall for consideration under
(category (b) referred to earlier) section 55(2)(a) "right to carry on business".
If the non-compete fee is paid to persons associated with the transferor then
the same would fall for consideration only under Sec.28(va)(a) of the Act
introduced by the Finance Act, 2002, w.e.f 1-4-2003. It is significant to note
that the words used in Sec.28(va)(a) of the Act are "not carrying out any
activity in relation to any business". The proviso (i) to Section 28(va)(a)
provides for exception to cases where such receipts are taxable as capital
gain viz., where any sum is received for transfer of a right to carry on any
business which is chargeable to tax as capital gain. When the transferor is
already carrying on business and agrees not to carry on business
transferred, then the same would fall for consideration only under
Sec.55(2)(a) of the Act.
40. With the change in the law receipts on account of giving up right to
carry on business even if it is capital receipt would now be chargeable to
tax as income from business. The difference would be that if it is paid to
the transferor for giving up right to carry on business, it would be regarded
as capital gain, the cost of acquisition of right to carry on business being
determined in accordance with the provisions of Sec.55(2)(a) of the Act. If it
is compensation paid for "not carrying out any activity in relation to any
business", which the transferor is not carrying on, the same would be
chargeable u/s.28(va)(a) of the Act. If a receipt is considered as payment
for not carrying on business which the transferor is already carrying on then
29 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 to
Manufacture, produce or process any article or thing" in Sec.55(2)(a) of the
Act, can be ascertained by looking into the legislative intention behind
introduction of the aforesaid expression. As we have already seen self-
generated assets like goodwill were not considered as "Capital Assets"
because of the impossibility of computing their cost of acquisition and
consequently capital gain on their transfer. By the Finance Act, 1987, the
method of computing the cost of acquisition as well as the cost of
improvement of goodwill was provided for in Sec.55(2)(a) of the Act. 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. On the same principle
on which capital gain on transfer of goodwill of a business was held to be not
30 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
Taxable, other self-generated assets like tenancy rights, stage carriage
permits or loom hours, were also held to be not taxable. To bring to tax
capital gain on such transfer, Finance Act, 1994 amended Sec.55(2)(a) of the
Act w.e.f. 1-4-1995 whereby covered u/s.55(2)(a)of the Act whereby tenancy
rights, stage carriage permits or loom hours were also covered and the cost
of acquisition and cost of improvement of these capital assets were also to
be computed in the same manner as goodwill. By the Finance Act, 1997
w.e.f.1-4-1998, the same principle was also extended to "Right to
Manufacture, produce or process any article or thing" by inserting the said
expression in Sec.55(2)(a) of the Act and providing method of computing
their cost of acquisition and cost of improvement. It is significant to note
that in the Board Circular No.763 dt. 18.2.1998 explaining the aforesaid
amendment, it has been mentioned that the amendment is being brought to
bring to tax extinguishment of such a right to manufacture etc., within the
ambit of capital gains tax. By the Finance Act, 2001 w.e.f. 1-4-2002, the
principle of ascertaining cost of acquisition and cost of improvement of
capital asset being " a trademark or brand name associated with a business"
was introduced in the form of amendment to Sec.55(2)(a) of the Acct. In
Board Circular No.14/2001 dated 12.12.2001, the scope of the amendment
has been explained ( in Para 42.1) as follows:
"42. Providing for cost of acquisition of certain intangible capital
assets under Section55-
42.1 Under the existing provisions 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)
31 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 article. It consists
of an exclusive right to manufacture the new article invented or
manufacture an article according to the invented process for a limited
period. After the expiry of the duration of patent, anybody can make use of
the invention. Any Person being the inventor of an invention or his assignee
can apply alone or jointly with any other person. As per the Indian Patents
Act, 1970 invention means any new or useful (i) art, process, method or
manner of manufacture, (ii) machine, apparatus or other article., (iii)
Substance produced by manufacture and includes any new and useful
improvement of any of them and alleged invention. As can be seen from the
legislative intention, there should be a transfer of right to manufacture,
produce or process any article or thing by way of extinguishment or
curtailment of such right. Thus the provisions contemplate existence of a
right to manufacture, produce or process an article or thing. Otherwise the
question of extinguishment or curtailment of such a right would not have
been contemplated by the legislature. It would therefore be reasonable to
presume that what is sought to be covered by the expression "a right to
manufacture, produce or process any article or thing" found in Sec.55(2)(a)
of the Act, is intangible asset in the form of a patent or similar right.
44. RIGHT TO CARRY ON ANY BUSINESS:
The above expression was introduced in Sec.55(2)(a) of the Act, by the
Finance Act, 2002 w.e.f. 1-4-2003. Finance Act, 2002, w.e.f. 1-4-2003, the
provisions of Sec.55(2)(a) were amended as follows:
(2) For the purposes of sections 48 and 49, "cost of acquisition",--
(a) in relation to a capital asset, being goodwill of a business, or a
trade mark or brand name associated with a business or a right to
32 ITA No.1034/Hyd/2004
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manufacture, produce or process any article or thing or right to carry
on any business, tenancy rights, stage carriage permits or loom
hours, --
(i) in the case of acquisition of such asset by the assessee by purchase
from a previous owner, means the amount of the purchase price ; and
(ii) in any other case not being a case falling under sub-clauses (i) to
(iv) of sub-section (1) of section 49, shall be taken to be nil ;
45. In Circular No.8 of 2002 dt. 27.8.2002 the CBDT has explained the
above provisions of Finance Act, 2002, as below:
"39. Amendment of section 55 of the Income-tax Act, 1961
39.1 Under section 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 seen to ascertain what was the right that was transferred by Mr.B.V.Raju
to ICL. The Agreement in clause-1 defines Business as follows:
33 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
"Business" shall mean the business of manufacture, production,
development, sale, marketing and distribution of and research into
cement and other business related to or connected with the
manufacture, production, sale marketing and distribution of and
research into cement."
Clause-2 which contains the undertaking of B.V.Raju for which he received
a sum of Rs.11 crores, which is the main clause which will decide the
nature of right transferred, reads as follows:
"2. COVENANT'S OF THE PARTIES OF THE ONE PART
i. The SECOND PART requires that Dr.BVR shall not, for a period of 5
years after the execution of this First Agreement, either on his own
account or on behalf of any other person, directly or indirectly, own,
manage, operate, acquire shares, Control or participate in the
management, operation or control of any corporate entity,
partnership, proprietorship, association or other business entity
which directly or indirectly engage in the Business to which Dr. BVR
hereby agrees and confirm.
ii. In addition to the above, Dr. BVR agrees that he shall not, in the
future.
a) do or commit any act or permit any deed or act to be done, either by
himself or through anyone else acting on his behalf to induce, solicit
or endeavour to entice away from the Company, any person, firm or
company who was a customer of or had dealings with the company in
any manner with a view to divert their customer or patronage any
other entity engaging in the Business.
b) induce, solicit or endeavour to entice away from the Company or
any of its subsidiaries or any other company in the same group as the
Company for the time being, on its own account or on the account of
any other entity, any director, manager, senior employee or employee
of the Company with a view to employ such person with themselves or
with such other or any other entity for the purpose of the Business.
c) for a period of' five years after the execution of this agreement,
tender any consultancy services relating to the Business or provide
any other services to the Business.
d) do or allow to be done by any other person, firm, company or entity
acting on his behalf, any act or deed that may affect the Business of
the Company.
iii) The restrictions contained in the above 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
34 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
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 why the
agreement was being entered into. The preamble to the non-compete
agreement refers to the fact that Mr.B.V.Raju during the course of his
employment with Cement Corporation of India, RCL and SVCL 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. The preamble refers to India Cements Ltd. and its associate
companies having acquired RCL from the original promoters during April,
1998. There is also a reference to the fact that 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. The preamble further refers to
the fact that 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.
35 ITA No.1034/Hyd/2004
(Assessment Year 2000-01)
The preamble further declares that with the acquisition of SVCL, the core
family promoters of RCL & SVCL were out of Cement business. It is
thereafter that ICL with a view to ward off competition desired that
Mr.B.V.Raju should be restrained from starting a fresh cement unit, lest it
should have a bearing on their business. With that object in view, ICL
entered into a Non-Compete Agreement with Mr.B.V.Raju.
49. The consideration of Rs.11 crores received by BVRaju was not for sale of
any business nor was it for not carrying on any business which he was
carrying on, which he had transferred. It was also not a payment for a
"right to manufacture, produce or process any article or thing". As
explained earlier, the sum in question was not paid for transfer of any
intangible right in respect of manufacture, production or process of cement.
The provisions relating to capital gains are therefore not attracted. The
amount was paid for "not carrying out any activity in relation to any
business" and would fall within the ambit of Sec.28(va)(a) of the Act. The
payment in question clearly falls under the category of a payment for "not
carrying out any activity in relation to any business" which at the relevant
point of time of accrual in the hands of B.V.Raju, viz., 27.10.1999, was a
capital receipt not chargeable to tax. Such receipts became taxable on and
from 1-4-2003. As held by the Hon'ble Suprme Court in the case of Guffic
Chemical Industries (supra), the provisions of Sec.28(va)(a) are not
clarificatory and were applicable only prospectively from 1-4-2003. For AY
00-01, they were not applicable. Therefore the receipts in question were
capital receipts and not chargeable to tax in AY 00-01. For the reasons
given above, the order of CIT(A) is upheld and the appeal by the Revenue is
dismissed.
50. We thus answer the question referred to the special Bench in the
negative that is in favour of the Assessee by holding that a sum of Rs.11
36 ITA No.1034/Hyd/2004
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crores being consideration receivable by the assessee in terms of the
agreement dated 27.07.1999 is not assessable to tax as capital gains in
accordance with the amended provisions of law relating to the levy of tax on
capital gains prevailing at the relevant point of time viz., 27.10.1999 when a
sum of Rs.11 crores accrued as non-compete fee to Mr.B.V.Raju.
Order pronounced in the court on 13th February, 2012
Sd/- Sd/- Sd/-
(Chandra Poojari) (P.M.Jagtap) (N.V.Vasudevan)
AccountantMember Accountant Member. Judicial Member
Dt/- 13th February, 2012
Copy forwarded to:
1. The Appellant
2. The Respondent
3. The CIT City concerned
4. The CIT(A)- concerned
5. The D.R., ITAT, Hyderabad.
BVS/VM
(True copy) By Order
Asst. Registrar, ITAT, Hyderbad Benches
HYDERABAD.
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