THE issue before the Bench is - Whether payment made by a foreign company consequent to a non-competition agreement for purpose of restraining the assessee from engaging in a particular business that will jeopardize its principal shareholding in a JVC of assessee & the foreign company, can be treated as goodwill u/s 55(2)(a)(ii). NO is the answer.
Facts of the case
The assessee is an individual. He has rich experience and proficiency in design, development and commissioning of Industrial Drives, power electronic equipments, such as High Power Battery Chargers and UPS Systems. Based on his experience, the assessee, along with another colleague, started a Private Limited Company in the year 1990 by the name RSM Electronics Pvt. Ltd. (RSM) for manufacture of Industrial Drives, Battery Charges and UPS Systems, with reasonable success. Coming to know of the assessee's capacity in these fields, an UK based company, viz., M/s.Control Techniques PLC (CT-PLC) joined hands with the assessee and RSM was engaged as sales agent for selling of products of CT-PLC by way of marketing and offering application/commissioning together with after sales service support to the clients. In the meanwhile, in September, 1993, CT-PLC and RSM formed a Joint Venture company in September, 1993, by name Control Techniques India Pvt. Ltd. (CTIL) with 51% share held by CT-PLC and 49% share held by RSM. Since the expertise of the technical personnel of RSM would be the key to success of this joint venture, the Directors of RSM were asked to assume executive responsibility in the joint venture company and, accordingly, an employment contract was signed by the assessee and he became the employee of CTIL. The salary of the assessee was paid by CTIL. The percentage of shareholding continued in the manner upto 26th Sep, 1995. On the same date, the Department of Industrial Policy & Promotion granted approval for changing the shareholding pattern. After obtaining approval, since the stakes of the UK company, viz., CT-PLC was increased from 51% to 85%, correspondingly, the shareholding of RSM came to be reduced from 49% to 15%. In order to ensure that there would be no competition of any kind by the assessee consequent to reduction of the share capital in CTIL, CT-PLC entered into a non-competition agreement with the assessee on 14th Dec, 1995. The non-competition agreement provides for a consideration of 18,000 Pound Sterling in recognition of the assessee's expertise in industrial drives system and taking note of the business of RSM and the good reputation and market that it enjoys, which was the main source of income for the assessee. In turn, the assessee agreed to give up, part with, cease and desist from carrying on the business of industrial drives anywhere in the territory, subject to certain conditions, on receipt of consideration of 18,000 Pound Sterling.
The assessee in his return showed this amount as capital receipt. In the statement of income, besides this amount received from CT-PLC, the assessee also showed salary that he received from the CTIL. According to the assessee, this amount was a capital receipt and, hence, exempt from tax and also entitled to immunity from capital gains as the cost of acquisition is 'Nil'. The AO took the view that non-competition agreement, which was a fall out of the formation of the joint venture company between CT-PLC and RSM with 51% share to the UK company and 49% share to the Indian company resulting in formation of CTIL, held that the business of RSM was taken over by CTIL and consequent to the merger of CT-PLC with the RSM, the assessee and two other Directors of RSM became Directors of CTIL. The assessee continued in the post and received salary, which income was shown as salary for the A.Y 1996-97. The AO further went on to observe that RSM was taken over by CTIL as per agreement and all the Directors of RSM were taken as Directors of CTIL. The AO, therefore, went on to hold that on the date of non-competition agreement, neither the assessee nor his old company, viz., RSM, was in a position to compete with CTIL when the assessee undertook not to work against the interest of the business of the CTIL. The AO further gave a finding that the sum of Rs.9,83,385/- was not the outcome of non-competition agreement as there was no competition on the right to carry on business, as the assessee was not doing any competing independent business on that date. According to the AO, the entire payment was attributable to the goodwill of the assessee and that goodwill was self-generated and as the cost was 'Nil', the provisions of Section 55(2)(a)(ii) would get attracted and as a result, the entire receipt would be taxable as capital gains, and would be assessable under the head 'salary'. On appeal, the CIT(A) confirmed the order of AO holding that non-competition allowance was addition or payment in lieu of salary. On further appeal, the Tribunal observing that there existed an employer employee relationship between the assessee and the CT-PLC, the amount received would be taxable as salary, confirmed the view taken by AO and the CIT(A).
Having heard the parties, the High Court held that,
++ it is seen that in a recent decision in Guffic Chem Pvt. Ltd. vs. CIT, Belgaum & Anr., the Supreme Court has distinguished the difference between 'capital receipt' and 'revenue receipt' by holding that there is a dichotomy between receipt of compensation by an assessee for the loss of agency and receipt of compensation attributable to the negative/restrictive covenant. The compensation received for the loss of agency is a revenue receipt whereas the compensation attributable to a negative/restrictive covenant is a capital receipt. Moreover, payment received as non-competition fee under a negative covenant was always treated as a capital receipt till the A.Y 2003-04. It is only vide Finance Act, 2002 that the said capital receipt is now made taxable u/s 28(va). The Apex Court thus held, that, a liability cannot be created retrospectively. It is, therefore, clear from the decision of the Supreme Court that non-competition fee was a capital receipt till 31st Mar, 2003 and w.e.f 1st Apr, 2003, it became taxable.
++ the non-competition agreement and the payment made consequent to the non-competition agreement dated 14th Dec, 1995, according to the assessee is a capital receipt and it is not paid by the employer and that no capital gains would arise as there was no cost incurred. This argument is repelled by the Department stating that the person, who made the payment, viz., CT-PLC, holds 51% share in CTIL and the assessee also, through the joint venture Indian company, viz., CTIL, holds 49% as Director of the company and, therefore, the amount paid pursuant to the non-competition agreement should be considered as salary. To come to a conclusion as to the nature of receipt of the amount, at the first instance, it is necessary to look into the order of the AO as to whether the reasonings given by him to support his findings, that what was paid and received by the assessee is salary, is correct. On reading of the clauses, it is clear that there is nothing in the agreement to indicate that there was any restriction insofar as industrial drives is concerned. The restriction is only a general restriction to an employee not to accept paid employment from any other person or organisation and that he should discharge his duties in accordance with law and should safeguard the interests of the company. Therefore, the finding of the AO that the assessee was prevented from doing anything in the line of business against the interests of CTIL, does not have any relevance to the non-competition agreement. On the contrary, the non-competition agreement, it appears, has been entered into subsequently after nearly two years and two months to safeguard the interests of the foreign collaborator, who increased his stakes from 51% to 85% on and from 27th Sep, 1995 in the joint venture Indian company. The AO is not right in saying that there is no sanctity for this non-competition agreement in this case, because his reasoning that the old company was not in a position to compete with the CTIL, is not the issue, as CTIL is only in the business of industrial drives as a joint venture company. The point in issue is whether the assessee, as an individual, can compete with the business of CTIL, if there is no restriction. To avoid any loophole in that, the non-compete agreement was signed by CT-PLC to restrain the assessee from embarking on any such business, which is akin to industrial drives. The finding of the AO is merely based on surmises and conjectures and not borne by any documents. Employment by itself is not reason to say that it amounts to non-competition agreement. Such a finding cannot be accepted, since a person with wide knowledge, as that of the assessee, in a particular field, is a potential threat to the foreign company, viz., CT-PLC, as well as to CTIL and, therefore, to curb any such threat of any kind, the non-competition agreement appears to have been signed by CT-PLC with the assessee and by no stretch of imagination, the payment in lieu of the non-competition agreement could be called as salary;
++ the further finding of AO is that there was no reason to pay the amount of Rs.9,83,385/- as on 14th Dec, 1995, as there was no competition and that if there was any competition, it ended 27 months earlier when RSM merged with CT-PLC to form CTIL and the assessee was made a Director. It is to be kept in mind that RSM never was merged with CT-PLC to form CTIL. CTIL is a joint venture company with 51% shares being held by CT-PLC and 49% shares being held by RSM as on 1st Oct, 1993 and there appears to be no dispute on that. The AO has further held that the nature of payment, at best, could be attributed as goodwill, paid by the foreign company to the assessee and to substantiate the same, falls back on Section 55(2)(a)(ii) and comes to the conclusion that it has to be taxed as capital gains. However, the AO, without following the said string to its logical conclusion, further states that the payment in this case was received from his employer and, therefore, it is salary for all purposes u/s 17(1). It is clear from the record that the payment made by the foreign company, viz., CT-PLC, consequent to the non-competition agreement is for the purpose of restraining the assessee from engaging in any form of business that will jeopardize its principal shareholding of 51%, which was later on enhanced to 85%, as the same should not be compromised on account of the wealth of knowledge and capacity of the assessee in the particular field, viz., industrial drives. The AO himself has accepted that the receipt of the amount is not capital gain, but only salary. In any event, such a plea would arise if the transaction had arisen after 1st Apr, 2003, whereas the transaction in this case culminated on 14th Dec, 1995. A reading of the provisions of Section 17 makes it clear that for the purpose of Sections 15 and 16, 'salary' would include, salary, wages, any annuity or pension, gratuity and any fees, commission, perquisites or profits in lieu of or in addition to any salary or wages. A conjoint reading of both Sections 15 and 17 make it clear that salary that is due from an employer or former employer alone should be taken for the purpose of computation of total income. The plea of the Revenue that it will fall u/s 17(1)(iv), that any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages would bring within its ambit the non-competition fee, is totally misconceived as the pre-condition for bringing any payment under the head 'salary' as defined u/s 17 is that it should be a salary due from an employer or former employer. In this case, CT-PLC is neither the employer nor the former employer and of the assessee and, therefore, bringing the above payment under the head 'salary' is unsustainable;
++ it is evident that the Tribunal has to come to the conclusion that the payment received by the assessee is salary since the non-competition fee, if at all, has to be paid to RSM and not to the assessee because even as per the admission of the assessee, RSM continued to be in existence and they alone are a threat to the foreign company, viz., CT-PLC. To buttress this finding, the Tribunal records the reason that the foreign company, CT-PLC is having 51% share in the newly formed joint venture company, viz., CTIL and, therefore, to look after the business and overall interests of the joint venture Indian company, the foreign company has to nominate somebody and probably they have nominated the assessee and as a consideration to take care of the entire joint venture company, the assessee received the amount. This finding of the Tribunal is purely based on surmises and conjectures. It is purely due to misreading of the nature of business of the joint venture company and the nature of payment made under the non-competition agreement. Further, it is evident from the record that when the shareholding pattern of the Indian company, viz., RSM, was reduced from 49% to 15% in lieu of the grant of approval by the Government of India for increasing the shareholding pattern of the foreign company, viz., CT-PLC, at that stage, the foreign collaborator thought it fit to enter into a non-competition agreement with the assessee, since the assessee had the knowledge, experience and capacity in the field of industrial drives and, therefore, to safeguard the interests of the joint venture company, in which the stakes of the foreign company was increased from 51% to 85%, the foreign company thought it fit to make the non-competition agreement with the assessee. There is no material anywhere before the AO or the CIT(A) or the Tribunal to say that to look after the business and overall interests of the joint venture company, the foreign company had nominated somebody, much less the assessee and they paid the consideration to take care of the entire joint venture company on such payment. This fact is not supported by any document or statement. A cursory glance at the non-competition agreement would throw enough light that the compensation received from CT-PLC by the appellant/assessee cannot be regarded as profits in lieu of salary and brought to tax under the head salaries. By accepting the terms and conditions of the non-competition agreement, the assessee has restrained himself from setting up any business, joining any employment or becoming a director of some concern so as to open competition. Such restrictions have adversely affected his income earning potential by exploiting his skills, knowledge, experience, etc. The clear intention behind CT-PLC entering into the non-competition agreement with the assessee is only to ward off any competition from the assessee, as he could exploit his knowledge, skill and experience to the disadvantage of the shareholding of CT-PLC in the joint venture Indian company, which is evident from the non-competition agreement;
++ in the present case, this Court finds that the employment contract is between the joint venture Indian company, viz., CTIL and the assessee and the terms and conditions of the employment is restricted only in relation to three items, and there is nothing to show that it has any relation with the industrial drives in question and, therefore, the foreign collaborator was justified in entering into a non-competition agreement, i.e., only after 26th Sep, 1995 when the Ministry of Industries, granted approval to increase the shareholding of the foreign company in the joint venture Indian company. There are clear indications as to why the foreign company entered into the non-competition agreement after this approval given by the Department of Industrial Policy and Promotion. On a plain interpretation of Section 15 r/w/s 17, this Court is unable to subscribe to the view of the Revenue as has been confirmed by the CIT(A) and the Tribunal, that the payment received in this case is in the nature of salary. The principles, as laid down by the Supreme Court in Guffic's case is squarely applicable to the facts of the present case. In view of the said reasoning and findings, this Court holds that the payment in this case, received by the assessee, is not in the nature of a salary and it is only a capital receipt. Accordingly, the order passed by the Tribunal is set aside.
No comments:
Post a Comment