Mumbai Tribunal rules compensation for termination of Right of First Refusal for grant of manufacturing rights is not taxable

 

This Tax Alert summarizes a recent decision of the Mumbai Income Tax Appellate Tribunal (Tribunal) in the case of Parle Soft Drinks Pvt. Ltd. (Taxpayer) on the issue of taxation of compensation received towards termination of “Right of First Refusal” (ROFR) for grant of bottling rights of soft drinks. Such rights provided the Taxpayer with a preferential opportunity to prove its credentials for grant of bottling rights before the grantor could approach any other party.

Considering the facts of the case and recognizing the well-settled distinction between capital receipt and revenue receipt, the Tribunal held that such receipt was capital receipt since it resulted in deprivation of a source of income for the Taxpayer. The Tribunal further held that the receipt was towards breach of contract by another party which had granted ROFR to the Taxpayer but had decided to set up a bottling plant under the fold of its own subsidiary. Furthermore, the Tribunal also held that the receipt was not towards termination of ”right to manufacture” which is liable to capital gains since ROFR, by itself, did not enable the Taxpayer to manufacture any goods but was merely a prelude to granting full-fledged manufacturing rights.

This Tribunal ruling represents application of the well-recognized distinction between capital receipt and revenue receipt in the context of compensation received towards breach of contract and/or termination of commercial right. In the facts of the case, the Tribunal has also recognized a distinction between ROFR and right to manufacture inasmuch as that ROFR, by itself, did not permit the Taxpayer to manufacture goods but merely granted a preferential opportunity to prove itself as worthy of being granted such a right.