The High Court of Punjab and Haryana (‘HC’) in the case of Sumeet Taneja v CIT, Supneet Kaur v CIT [#_ftn1][1] has affirmed the ruling of the Income tax Appellate Tribunal (‘ITAT‘) (for summary of the ITAT ruling, please click here) that transfer of equity shares in a company by the individual promoters (‘taxpayers’) tantamounts to a sale of business, which is liable to tax as business income under section 28(va) of the Income-tax Act, 1961 (‘the Act’)[#_ftn2][2]. The HC did not accept the taxpayers’ contention that it is a case of sale of investments held by them that gives rise to income under the head ’capital gains’. The HC also rejected the alternate plea of the taxpayer that even if they transferred any management rights vis-à-vis the Company, such rights also qualified as ‘capital assets’ and hence, income from transfer of such rights should qualify as ‘capital gains’.
Facts in brief
· The taxpayers had subscribed to equity shares in an unlisted Indian company (‘the Company’), as the promoters of the Company, at INR 7.29 per share. The taxpayers were also Directors of the Company. The taxpayers sold their shares in the Company to the Purchasers vide a Share Purchase Agreement dated March 26, 2005 (‘SPA’), at INR 94 per share.
· The taxpayers declared the income from the above sale transaction as capital gains. However, the Revenue Authorities (‘RA’) held that transfer of such shareholding by promoters was in the nature of sale of business assets, not capital assets. According to the RA, the SPA, though styled as an agreement for purchase of shares, in fact envisages purchase of business. Accordingly, the RA treated the income arising from the transaction as ‘business income’.
· The ITAT[#_ftn3][3]recorded the following factual findings upon analysis of the terms of the SPA:
- The SPA not only provided for transfer of shares but also envisaged transfer/ renunciation of management of the Company by the taxpayers to the Purchasers.
- Taxpayers were required to hand over business assets such as employee database, products database, customer proposals in pipeline, customer data, contracts, etc.
- Taxpayers agreed to non-compete covenants in the SPA, which prevented them from undertaking similar businesses in the designated territories for a period of 2 years.
- There were specific covenants in the SPA regarding non-usage of brand equity (i.e. logos, trademarks etc) or web domain of the Company, non-solicitation of present and future employees of the Company, etc.
· On the basis of the above factual findings, the ITAT held that the transfer of shareholding was in fact transfer of a business and resulted in business income.
Taxpayers’ contentions
· The shares sold by the taxpayers were held as investments and for the purpose of earning dividends and not for the purposes of trading in shares. Hence, the shares qualified as ‘capital assets’. The entire sale consideration was for sale of these shares only. Non-compete covenants were agreed upon as a result of the sale of the shares and no separate consideration has been received for the same.
· The taxpayers were salaried employees of the Company which was undertaking the business of call centers and it was not the taxpayers’ business. Accordingly, the consideration received is not for sale of the business but for sale of the shares.
· By virtue of retrospective amendment to section 2(14) of the Act, the term ’capital asset‘ includes ’any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever’. In view of this clarification, the rights transferred pursuant to the SPA were in the nature of ’capital asset‘ and hence, the transfer of such rights ought to result in capital gains and not business income.
HC decision
· The HC relied on the factual findings of the RA and ITAT, and upheld the view taken by these authorities that the said transaction was a transfer of business, in which all pervasive control was entrusted to the Purchaser to the absolute exclusion of the taxpayers.
· Though the HC mentioned that the retrospective amendment to definition of ’capital asset’ does not impact its decision, it did not elaborate on any reasoning on this aspect.
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