Karnataka H.C : Whether impugned payment was a capital fee and, thus, it was only a capital receipt

High Court Of Karnataka

CIT, Central Circle, Bangalore Vs. Sapthagiri Distilleries Ltd.

Section : 28(VA), 55 And 28(II)

Assessment Year : 1999-2000

Dilip B. Bhosale And B. Manohar, JJ.

IT Appeal No.795 Of 2007

April 7, 2014

JUDGMENT

B. Manohar, J. – The Revenue has preferred this appeal under Section 260-A of the Income-Tax Act, 1961 (for short ‘the Act’) challenging the order dated 31-05-2007 made in ITA No.1091/Bang/2002, by the Income Tax Appellate Tribunal, Bangalore Bench ‘A’ (for short ‘the Tribunal’) confirming the order passed by the Commissioner of Income-Tax (Appeals) VI, Bangalore (for short the ‘First Appellate Authority’) dated 22-05-2002 setting aside the assessment order dated 27-3-2002 passed by the Assessing Authority holding that the amount received by the assessee as compensation for termination of the lease agreement is capital in nature for the assessment year 1999-2000.

2. The respondent-assessee is a company registered under the Companies Act, 1956 carrying on business in the manufacture of Indian Made Foreign Liquor (for short ‘IMFL’) in the brand name of UB Products at Kumbalgodu. It has filed income-tax returns for the assessment year 1999-2000 on 31-12-1999 declaring a net loss from business of Rs.45,579/-. The return was processed and taken up for scrutiny after issuing notice under Section 143(2) of the Act. The authorized representative of the assessee appeared and produced necessary documents inter alia contending that the company has discontinued the manufacturing business from the financial year 1994-95 and as such, losses claimed on account of administration expenses were not allowed to be carried forward. No business operations in the nature of distillery are undertaken from that year.

3. While assessing the returns of M/s. Mc Dcwell and Co. Ltd., it was noticed that M/s. Mc Dowell had claimed a revenue expenditure of Rs.5.31 crores on account of lease foreclosure payment made to the assessee. The assessee has not declared the said transaction resulting in gain of Rs.5.31 crores in its return of income filed. A notice under Section 142(1) of the Act was issued on 11-2-2002 calling for necessary particulars regarding receipt of the said amount. In response to the said notice, the assessee by its letter dated 14-3-2002 filed detailed facts of the case contending that they were running the business of distillery manufacturing IMFL of various brands of UB products on the basis of the lease agreement entered into with the Mc Dowell from the year 1986. In view of sudden foreclosure of the lease agreement and taking over of the said running business, as per the agreement dated 25-3-1993, the assessee-company agreed to transfer the business of distillery to M/s. Mc Dowell and Co. Ltd., and Mc Dowell agreed to pay compensation as consideration towards loss to the company’s source of income. Further, in view of the dispute between the parties, the matter was referred to the sole Arbitrator and the Arbitrator passed an award fixing the quantum of compensation as Rs.5.31 Crores and to prevent the assessee from carrying on similar business. The said amount cannot be treated as revenue which was received towards the compensation for termination of the business and to prevent the assessee to carry on competitive business. Hence, it is capital in nature. The Assessing Authority after considering the matter and taking into consideration the agreement and other relevant records held that the sum of Rs.5.31 crores received is revenue in nature. However, the assessee has lost the right that he had to manufacture the Mc Dowell products. The entire amount of Rs.5.31 crores was taken as a long term capital gain and taxed accordingly and also imposed penalty and interest thereon by an order dated 27-3-2002.

4. The assessee being aggrieved by the said order preferred an appeal before the First Appellate Authority contending that the assessment order passed by the Assessing Authority is contrary to law. A sum of Rs.5.31 crores received as compensation by the assessee from M/s. Mc Dowell and Co. Ltd. towards loss of source of income and also towards non-competition fee by way of an award given by the Sole Arbitrator. Though the loss of source of income is a capital receipt, it shall not be subject to levy of capital gain tax. The First Appellate Authority after considering the matter held that the compensation received by the assessee cannot be brought under tax even as a capital gain and accordingly, set aside the assessment order by its order dated 22-5-2002.

5. The Revenue being aggrieved by the order passed by the First Appellate Authority preferred an appeal before the Appellate Tribunal contending that the order passed by the First Appellate Authority declaring that a sum of Rs.5.31 crores was not a managerial remuneration is contrary to law. The assessee even though received Rs.5.31 crores, has not disclosed the same in the returns. The finding recorded by the First Appellate Authority that the compensation has been given for loss of source of income and the said compensation amount cannot be brought to tax even under the capital gain is erroneous in law. The Appellate Tribunal after considering the matter in detail relying upon the various judgments of the Hon’ble Supreme Court dismissed the appeal by its order dated 31-5-2007 holding that the amount that is received as compensation towards termination of lease and non-competition fee would be capital in nature. The Revenue being aggrieved by the said order, preferred this appeal.

6. This appeal was admitted to consider the following substantial questions of law:

“(i)Whether the Tribunal was correct in holding that the amount of Rs.5.31 crores received by the assessee from M/s. Mc Do well as a result of arbitration award cannot be treated as a revenue receipt and brought to tax?

(ii) Whether the Tribunal was correct in holding that the amount of Rs.5.31 crores received by the assessee from M/s. Mc Dowell is a capital receipt but cannot be brought to capital gains tax under Section 55(2)(a) of the Act. ?”

7. Sri. K.V. Aravind, learned counsel appearing for the Revenue contended that the order passed by the Tribunal confirming the order of the First Appellate Authority and setting aside the order passed by the Assessing Authority is contrary to law wherein the Tribunal held that a sum of Rs.5.31 crores received by the assessee from M/s. Mc Dowell as a result of arbitration award cannot be treated as a revenue receipt. The assessee-company was carrying on distillery business in the manufacture of IMFL of various brands of UB products from the year 1986, taking the premises on lease from UB group. As per the agreement entered into between the assessee and UB company, the lease was foreclosed and foreclosure compensation has been paid. The said amount is to be treated as a revenue receipt. Hence, the order passed by the Appellate Authority as well as the Tribunal is contrary to law. The amount received by the assessee falls under Section 28(ii) of the Act. Section 28(ii) contemplates that any compensation or any payment due to or received by any person, by whatever name called, managing the whole or substantially the whole of the affairs of the Indian Company, at or in connection with the termination of its management or the modification of terms and conditions relating thereto. In support of his contention, he relied upon the judgment of the Hon’ble Supreme Court in Guffic Chem (P.) Ltd. v. CIT [2011] 332 ITR 602/198 Taxmann 78/10 taxmann.com 105 and in Gill Anders Arbuthnot & Co. Ltd. v. CIT [1964] 53 ITR 283 (SC) and contended that the compensation received by the assessee for foreclosure of lease agreement or handing over the distillery factory amounts to termination of the contract. The amount paid towards the said termination amounts to revenue and not the capital. Hence sought for setting aside the order passed by the Appellate Tribunal by allowing this appeal.

8. On the other hand, Sri. S. Parthasarathi, learned counsel appearing for the assessee argued in support of the order passed by the Appellate Authority as well as the Appellate Tribunal contending that Mc Dowell & Co. was running a business of distillery in the manufacture of IMFL of various brands taking the land, building and distillery on lease from M/s. Mysore Wine Products Limited. However, the Mc Dowell company could not run the distillery due to labour problem and was suffering huge loss. Accordingly, the said distillery was leased in favour of the assessee-company in the year 1986. From the year 1986, the assessee was running the distillery on the lease agreement entered into with Mc Dowell & Co. and solved the labour problems by installing new machineries thereby improved the performance of the distillery and started earning income. At that time, the UB group abruptly terminated the lease as per the memorandum of agreement entered into on 25-3-1993. Accordingly, the company was handed over as a running concern to Mc Dowell and Co. The said company agreed to pay the reasonable compensation as consideration for loss of source of income to the assessee-company and the assessee-company was prevent from using the knowhow for manufacturing of IMFL To avoid competition from the assessee, as per the award passed by the sole Arbitrator, a sum of Rs.5.31 Crores was paid to assessee. The said amount cannot be treated as a revenue. From the assessment year 1994-95, the assessee has not done any business. The compensation received does not fall under Section 28(ii) of the Act. The amount in question was paid in order to prevent competition or carry on similar business using the knowhow possessed by the assessee. The Appellate Tribunal as well as the Appellate Authority after considering the matter in detail have rightly set aside the order passed by the Assessing Authority and sought for dismissal of the appeal.

9. We have carefully considered the arguments addressed by the learned counsel for the parties and perused the orders impugned and other relevant records.

10. The records clearly disclose that while assessing the returns of Mc Dowell & Co., it was noticed that the Mc Dowell & Co., had claimed revenue expenditure of Rs.5.31 crores on account of lease foreclosure payment made to the assessee-company. The assessee-company had filed return on 31-12-1999 declaring net loss from the business. In the scrutiny, the assessee-company brought to the notice of the authority that the assessee-company had discontinued the business from the financial year 1994-95 and as such loss was claimed on account of administrative expenses. However, the assessee-company had not disclosed the receipt of Rs.5.31 crores from Mc. Dowell & Co. Accordingly, a notice was issued under Section 142(1) of the Act to the assessee-company calling for necessary information. In pursuance of the said notice, the assessee-company filed detailed objections contending that from the year 1986, the assessee-company was running distillery business taking the distillery on lease from Mc Dowell & Co., and manufacturing of IMFL of various brands of UB products. At the time of taking the distillery on lease Mc Dowell & Co., was suffering huge loss and due to the labour problem they could not run the distillery business. Taking the said distillery on lease by installing new machinery and solving the labour problem, the assessee was manufacturing various brands of UB products and the assessee-company started earning income. At that stage, the UB group abruptly terminated the lease. As per the memorandum of agreement entered into between the parties on 25-3-1993, the company had agreed to transfer the running concern to Mc Dowell & Co. and to receive reasonable compensation. In view of the dispute regarding the quantum of compensation, the matter was referred to the sole Arbitrator and the Arbitrator passed an award fixing the quantum of compensation and other consideration at Rs.5.31 crores. The assessee contended that the said amount was paid in order to prevent the assessee from carrying on similar business using the knowhow possessed by the assessee-company. In order to prevent competition in the business, the amount was paid and it is a capital in nature and not liable to tax. However, the Assessing Officer noticed that receipt of the amount has not been disclosed by the assessee in their declaration. The Assessing Authority held that the amount received is a revenue receipt and the same is liable to tax. Being aggrieved by the assessment order declaring the said amount as a revenue receipt, the assessee preferred an appeal before the first Appellate Authority. The First Appellate Authority after examining the matter in detail held that the compensation received towards the loss of source of income and also towards non-competition fee by way of an award passed by the sole Arbitrator and the said amount cannot be assessed as managerial compensation.

11. Paragraphs (a) and (b) of the award of the sole Arbitrator reads as under:

(a) A sum of Rs.4.5 crores paid by Mc Dowell shall be treated as a payment through CDL towards the consideration for the transfer of business on a going concern basis.

(b)The Mc Dowell shall pay SDPL the reasonable compensation as consideration for loss of business by assignment termination of the lease and handing over the facility by SDPL which causes loss of its source of income. The payment of compensation to SDPL as proposed above shall also be in consideration of SDPL refraining from introducing its own new product competing with Mc Dowell. The compensation payable herein shall be worked out by both the parties on a mutual agreed basis after going through the earning potential and other benefits which accrues to Mc Dowell by this transaction and also after taking into consideration the extent of effect on the future of SDPL. It is agreed that this arrangement shall not create any vested interest on the issue of compensation in favour of the either.

12. Reading of the award of the Arbitrator makes it clear that the amount in question being a compensation towards the loss of source of income and also towards non-competition fee to prevent the assessee from carrying on the similar business using the knowhow possessed by the assessee as a competitor, the amount of Rs.5.31 crores paid was thus capital in nature. The amount is paid to prevent the assessee from carrying on a competitive business and also preventing the assessee to use the business apparatus or expertise. Accordingly the payment was a capital fee and thus it is only a capital receipt. There being no cost of acquisition, the capital gain was also not computable.

13. The Hon’ble Supreme Court in GUFFIC CHEM case clearly held that the compensation received for loss of agency is a revenue receipt whereas the compensation attributable to a negative/restrictive covenant is a capital in nature. In the instant case, the compensation has been paid for loss of source of income and also for non-competitive fee and it is capital in nature. Further payment made as non-competition fee under the negative covenant is always treated as a capital receipt and not liable to pay any tax till the assessment year 2003-04 in view of the amendment to the Finance Act, 2002 w.e.f. 1-4-2003 that the said capital receipt is now made taxable under Section 28(va). The said amendment is not applicable to the case on hand. Section 28(ii) is not applicable to the present case. We find that the amount received by the assessee is a capital receipt. The Appellate Authority as well as the Appellate Tribunal after considering the matter in detail held that the amount received is a capital receipt and not liable to tax under Section 55(2)(a) of the Act. We find no infirmity or irregularity in the said finding. The judgments relied upon by Sri. K.V. Aravind, learned counsel appearing for the Revenue are not applicable to the facts of the present case and it is only a declaration of law by the Hon’ble Supreme Court. In view of that, both the substantial questions of law are held against the Revenue and in favour of the assessee. Accordingly, the appeal is dismissed.

[Citation : 366 ITR 270]