Madras H.C : The amounts written off are eligible for deduction as business expenditure even though they are incurred in the capital field

High Court Of Madras

CIT vs. Spencers And Co. Ltd. (No.1)

Assessment Year : 2000-01

Section : 37(1), 36(1)(vii), 4

Elipe Dharma Rao And M. Venugopal, JJ.

T.C. (A.) No. 299 Of 2008

July 9, 2013

JUDGMENT

Elipe Dharma Rao, J.-This appeal is filed against the order dated May 4, 2007, passed by the Income-tax Appellate Tribunal, Madras “C” Bench in I. T. A. No. 598/Mds/2004.

2. The Assessing Officer, after complying with all the formalities, completed the assessment in respect of the assessee-company for the assessment year 2000-01. While completing the assessment, the Assessing Officer disallowed the claims made by the assessee in respect of licence fee ; bad debts ; voluntary compensation and pre-operative expenses added an amount of Rs. 5 crores received by the assessee towards non-compete fee ; brought to tax a sum of Rs. 75 lakhs towards surrender of property and a sum of Rs. 62,10,286 towards profit on sale of undivided land at Anna Salai. The appeal filed by the assessee as against the said order was partly allowed. Aggrieved by the said order, the Revenue filed an appeal before the Income-tax Appellate Tribunal in I. T. A. No. 598/Mds/2004, which was also partly allowed. Challenging the said order, the Revenue has filed Tax Case Appeal No. 299 of 2008. At the time of admitting the above tax case appeal, the following substantial, questions of law were framed :

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amounts written off are eligible for deduction as business expenditure even though they are incurred in the capital field ?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that advances made to sister concerns, which had already been sold in an earlier year could be treated as business loss/business expenditure in the current financial year ?

3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amount of Rs. 5 crores received by the assessee in the course of a slump sale could be treated as ‘non-compete fee’ and not liable to tax as a capital receipt ?

4. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amount received is a non-compete fee, when the assessee had, even prior to the agreement, given up its rights to compete in the same business in the course of a joint venture agreement ?”

Substantial question of law Nos. 1 and 2

3. The Revenue challenges the decision of the Tribunal in setting aside the order of the Commissioner of Income-tax (Appeals) and deleting the disallowance of Rs. 2,18,67,610 on account of bad debts. In their return filed for the assessment year 2000-01, the respondent-assessee claimed bad debts to the tune of Rs. 264.70 lakhs. On scrutiny of the details furnished by the assessee, the assessing authority disallowed a sum of Rs. 2,41,29,784 and added the same to the business income. The Assessing Officer disallowed the said amount on the ground that no evidence has been furnished to show that the said amount, written off as bad debts, has suffered tax earlier and now became irrecoverable and that the debt has become a bad debt. The order of the Assessing Officer disallowing a sum of Rs. 2,41,29,784 was upheld in appeal by the Commissioner of Income-tax (Appeals). The Commissioner of Income-tax (Appeals) was of the view that unless it was proved that the bad debts claimed were the debts in the course of the assessee’s business, they could not be allowed as revenue expenditure or revenue loss and, therefore, held that the amounts claimed could not be allowed as bad debts as they were advanced from capital account and could not be allowed as a business loss. In the appeal filed by the respondent-assessee challenging the disallowance of bad debts, the Tribunal set aside the order of the Commissioner of Income-tax (Appeals) and deleted the disallowance of Rs. 2,18,67,610 on account of bad debts. The Revenue in this appeal challenges the order of the Tribunal in deleting the disallowance on account of bad debts.

4. Learned standing counsel for the Revenue submitted that the Tribunal had erred in setting aside the orders of the Assessing Officer and the Commissioner of Income-tax (Appeals) in disallowing Rs. 2,18,67,610 on account of bad debts. Learned standing counsel submitted that the Assessing Officer had found that the bad debts claimed were never offered for tax at any point of time and that they were on capital account and, therefore, could not be claimed as bad debts. The finding of the Assessing Officer was upheld by the Commissioner of Income-tax (Appeals). Learned standing counsel submitted that the Tribunal, glossing over the findings of the authorities below, erred in holding the amounts claimed as bad debts to be allowed as business expenditure. It was further submitted that the Tribunal failed to appreciate the amounts written off as bad debts had occurred in the capital field and under section 37 of the Income-tax Act expenditure could be allowed only if it was revenue expenditure. Learned counsel further submitted that the amounts which were advanced to the four subsidiary companies in question and claimed to have been written off as bad debts could not be allowed since under section 36(2) of the Income-tax Act, advances made in the previous year were not offered as income in the earlier years. Learned counsel submitted in the alternative that the amount could not be treated as bad debt as it was not a loss which occurred during the ordinary course of business of the assessee but was only a capital loss and, therefore, could not be written off from the business income arising in the assessment year. Learned counsel submitted that the order of the Tribunal in deleting the disallowance of Rs. 2,18,67,610 on account of bad debts may be set aside and the disallowance ordered by the Assessing Officer and confirmed by the Commissioner of Income-tax (Appeals) may be restored. Learned counsel relied on the following decisions :

(a) In Hasimara Industries Ltd. v. CIT [1998] 230 ITR 927 (SC), the Supreme Court held as follows (page 933) :

“We are in no doubt whatever that the High Court was right in concluding that the amount of Rs. 20 lakhs had been deposited by the assessee with the licensor company for the purpose of securing the licence under which the assessee had acquired the right to work the licensor’s cotton mills. This is clear from the fact that the deposit was made pursuant to a clause in the leave and licence agreement. Had a deposit as required by that clause not been made, the assessee would not have secured the licence of the cotton mill. At that time the assessee was doing no business in cotton. The deposit was, clearly, made for the purpose of acquiring a profit-making asset to carry on business in cotton. It cannot, therefore, be held that the deposit was made on the revenue account or that the loss thereof must be treated as a business loss. The loss thereof was a loss suffered on the capital account and could not be deducted on the basis that it was a business loss.”

(b) Salem Magnesite (P.) Ltd. v. CIT [2010] 321 ITR 43/[2009] 180 Taxman 545 (Bom). It was held as under (page 47) :

“In the present case, there are concurrent findings of three authorities that the assessee-company was not in the business of lending money. There is a further concurrent finding of fact that the money was lent to its subsidiary company to enable the subsidiary company to construct a jetty which was clearly a capital asset of the subsidiary company. All authorities had concluded that the loan granted to the subsidiary company did not spring directly from the business of the assessee-company or was incidental to it. On the facts of this case we find no reason to take a different view.”

5. On the other hand, learned senior counsel for the respondent-assessee submitted that the Tribunal was right in deleting the disallowance ordered by the authorities below. Learned counsel submitted that before the authorities below, reference was made to the details in the balance-sheets of other parties which clearly showed that the amounts were not recoverable at all. Learned counsel vehemently submitted that writing off if not considered as bad debt, in the alternative the same may be treated, as was rightly done so by the Tribunal, as business expenditure or business loss. Learned senior counsel submitted that the four companies in question, in respect of which the assessee claimed bad debts, are subsidiary companies of the assessee-company. On business exigency and expediency, the respondent-assessee offered guarantees on behalf of the said subsidiary companies. When the Spencer Pharmaceuticals Ltd., one of the subsidiary companies, failed to repay their debt to State Bank of Travancore, the guarantee given by the assessee was invoked by the said bank. When the efforts made by the assessee to recover the money from the Spencer Pharmaceuticals Ltd. were in vain, the assessee realised that there was no chance of recovery. Referring to the relevant details in the balance-sheet of the Spencer Pharmaceuticals Ltd., learned counsel submitted that there was no chance of recovery of the amount and, therefore, the assessee was left with no option but to write off as bad debt a sum of Rs. 1,77,48,993. Learned senior counsel further submitted that similar was the position in the case of other subsidiary companies with which the assessee was having strategic business relationship and for whom bank guarantees were given and later invoked by the banks concerned, on their default. Learned counsel submitted that the amounts due from M/s. Kelliq Pvt. Ltd. (Rs. 10,00,000) and M/s. Harrison Aquaculture Ltd. (Rs. 28,30,563) could not be recovered and, therefore, the same were written off as bad debt. Learned counsel submitted that the assessee incurred the expenditure to the tune of Rs. 2,88,054 towards formation and other allied activities of M/s. RPG Institute of Retail Management and this expenditure was incurred for the business purpose of the assessee when the assessee had started retail chain store business under the name and style of “Food World Super Market.”

6. Learned senior counsel vehemently argued that the amounts given to the subsidiary companies or guarantees given on their behalf were done to run effectively the business of wholly owned subsidiary companies and were mainly for the purpose of business and, therefore, the amount written off as bad debts as against the subsidiary companies was an allowable deduction as bad debts or in the alternative, as a loss arising from normal conduct of a business or a business loss from the business income. Learned senior counsel further argued that the Assessing Officer as well as the Commissioner of Income-tax (Appeals) failed to appreciate the claim in proper perspective and laid their emphasis on an erroneous direction that the above payments were not incurred for the business purpose of the assessee and that since such payments were made for the benefit of the subsidiary companies, the claim made by the assessee could not be allowed.

7. In support of the above submissions, learned senior counsel relied on the following decisions.

(a) In T.R.F. Ltd. v. CIT [2010] 323 ITR 397/190 Taxman 391 (SC), the honourable Supreme Court held as follows (page 398) :

“This position in law is well-settled. After 1st April, 1989, it is not necessary for the assessee to establish that the debt, in fact, has become irrecoverable. It is enough if the bad debt is written off as irrecoverable in the accounts of the assessee. However, in the present case, the Assessing Officer has not examined whether the debt has, in fact, been written off in accounts of the assessee. When a bad debt occurs, the bad debt account is debited and the customer’s account is credited, thus, closing the account of the customer. In the case of companies, the provision is deducted from sundry debtors. As stated above, the Assessing Officer has not examined whether, in fact, the bad debt or part thereof is written, off in the accounts of the assessee. This exercise has not been undertaken by the Assessing Officer. Hence, the matter is remitted to the Assessing Officer for de novo consideration of the abovementioned aspect only and that too only to the extent of the write off.”

(b) In DIT (International Taxation) v. Oman International Bank Saog [2009] 313 ITR 128 (Bom)/184 Taxman 314 (Bom.), it was held as follows (page 135) :

“All this would indicate that when the assessee treats the debt as a bad debt in his books the decision which has to be a business or commercial decision and not whimsical or fanciful. The decision must be based on material that the debt is not recoverable. The decision must be bona fide. The difference between the position, pre-amendment and post-amendment would be that the burden is no longer on the assessee and can be claimed in the year it is written off in the books of account as irrecoverable. The Assessing Officer if he is to disallow the debt as a bad debt must arrive at a conclusion that the decision was not bona fide. The Assessing Officer only in those circumstances and to that extent may interfere. All that the assessee must do is to be prima facie satisfied based on the information available that the debt is bad and that would be sufficient requirement of the amended provisions…

Considering the above discussion, in our opinion, to treat the debt as bad debt has to be commercial or business decision of the assessee based on the relevant material in possession of the assessee. Once the assessee records the debt as bad debt in his books of account that would prima facie establish that it is a bad debt unless the Assessing Officer for good reasons holds otherwise. The writing off in the accounts no doubt, has to be bona fide. Once that be the case, the assessee is not called upon to discharge any further burden. In our opinion, therefore, we are in agreement with the view taken by the majority constituting the Bench of the learned Tribunal.

The question as framed will have to be answered by holding that after the amendment it is neither obligatory nor is the burden on the assessee to prove that the debt written off by him is indeed a bad debt as long as it is bona fide and based on commercial wisdom or expediency. Appeal disposed of accordingly.”

8. On a close scrutiny of the order passed by the authorities below, we find that the claim of bad debts was disallowed by the Assessing Officer on the ground that the debt had not arisen at the time of assessment and that the assessee has not proved that such amounts were not actually recoverable. The amounts claimed by the respondent-assessee towards bad debts written off were disallowed by the assessing authority, which was confirmed by the Commissioner of Income-tax (Appeals) on the ground that the debt had not arisen at that point of time and that nature of the debt was not explained. It is not in dispute that the amount claimed as bad debts written off were against the subsidiary companies of the respondent-assessee. In so far as the amount claimed as bad debts against M/s. Spencer Pharmaceuticals Ltd., from the materials on record, it was found that the respondent-assessee, which offered guarantee to the State Bank of Travancore, on behalf of the said subsidiary company, on invocation of the guarantee paid the bank the amount payable by the subsidiary company, believing that it could virtually recover anything from the said subsidiary company. The respondent-assessee, therefore, wrote off the amount recoverable from the Spencer Pharmaceuticals Ltd. as bad debts and claimed allowance for the same in their return of business income. In so far as M/s. Kelliq Private Ltd., a fully owned subsidiary company of the assessee is concerned, for business prospects of the subsidiary company, the assessee lent loan but later, due to the Government policy of taking over the business in question, the subsidiary company was closed and the amount let to the subsidiary company could not be recovered by the assessee, which amount was written off as bad debts and allowance was claimed by the respondent in their return of business income. Similar was the situation in respect of the amount spent by the assessee for the business expediency of the other two subsidiaries, viz., Harrison Aquaculture Ltd. and RPG Institute of Retail Management and when the said subsidiaries failed to repay the amount due, the same were written off by the assessee as bad debts and claimed allowance for the same in their return of business income.

9. On a careful analysis of the matter in the light of the materials available on record and the decisions cited, we are of the view that since the amounts in question were incurred by the assessee for the business expediency of the wholly owned subsidiary companies and when it is not disputed that there existed a business nexus between the assessee and the subsidiary companies, such expenditure should be treated as having been incurred for the purpose of business and directly relatable to the business of the assessee and thus eligible for deduction as business expenditure in their return of business income. The assessing authority and the Commissioner of Income-tax (Appeals) failed to appreciate the claim in proper perspective. The alternative argument of learned senior counsel for the assessee that the claim of written off bad debts should be allowed as business expenditure or business loss, in our considered view, merit acceptance. The Tribunal has given a cogent and convincing reasons for reaching a finding of fact that expenditure incurred was directly relatable to the business of the assessee and should be allowed as business expenditure.

10. Furthermore, the decision in Hasimara Industries Ltd. (supra) relied upon by the Revenue pertain to money lent to licensor under leave and licence agreement and it was treated as capital loss. The facts therein are totally distinct from the case on hand. In the case of Salem Magnesite, (P.) Ltd. (supra), the issue was that the loan amount was used by the subsidiary company to create a capital asset and, therefore, the court held that it was a capital loss. In this case, advances were made to various subsidiary companies for their business purposes and in furtherance to the business objectives of the assessee-company and not for creation of any capital asset. Therefore, the facts of the present case, in our view, are distinct and the above decisions do not come to the rescue of the Revenue.

11. With regard to the decision cited by the assessee, the Supreme Court in the case of T.R.F. Ltd., (supra), held that it was sufficient to record in the books as an irrevocable debt and not necessary for the assessee to establish that the debt had become irrevocable. Similarly in the case of Oman International Bank’s case (supra), the Bombay High Court held that as long as the debt established and written off in the books the assessee is not required to establish that it was a bona fide and not based on commercial wisdom or expediency. We are in agreement with the above propositions.

12. We find no illegality or infirmity in the findings arrived at by the Tribunal. The Tribunal was, therefore, perfectly right in setting aside the order of the authorities below and deleting the disallowance of Rs. 2,18,67,610 on account of bad debts. The Revenue’s challenge to the order of the Tribunal is devoid of merits. For the reasons stated above, these substantial questions of law are answered in favour of the assessee and against the Revenue.

Substantial questions of law Nos. 3 and 4

13. These questions relate to “non-compete fee” of a sum of Rs. 5 crore, claimed by the assessee in their return of income as receipt of non-compete fee, not liable to tax. The assessing authority disallowed the claim treating the payment as a sale of goodwill and added the said amount, as capital gain on sale of goodwill. The Commissioner of Income-tax (Appeals) confirmed the addition made by the assessing authority but on a different reasoning that the payment was only part of sale consideration and therefore the entire amount received was nothing but purchase consideration. The Tribunal set aside the order of Commissioner of Income-tax (Appeals) and held that the amount received towards restrictive covenant or non-compete fee was a capital receipt and non-taxable. It is this finding of the Tribunal which is assailed by the Revenue by raising the aforesaid substantial questions of law.

14. Learned standing counsel for the Revenue argued that the Tribunal erred in holding that the amount of Rs. 5 crores received by the assessee was a capital receipt not liable to tax. Learned counsel submitted that the assessee had already given up its right to compete with the business at the time of entering into a joint venture agreement and therefore, at the time of sale of the business, the assessee had no such right. The amount therefore could not be considered for non-competition. Sustaining the orders of the assessing authority and the Commissioner of Income-tax (Appeals), learned counsel argued that the amount received was in the nature of goodwill and liable to tax. Learned standing counsel argued that the Tribunal erred in overlooking the well-reasoned findings given by the Commissioner of Income-tax (Appeals) in confirming the addition of non-compete fee to taxable income.

15. In support of the contentions raised, learned standing counsel for the Revenue relied on the following decisions :

(a) CIT v. Mugneeram Bangur & . Co. [1965] 57 ITR 299 (SC), wherein the honourable Supreme Court held as under (page 305) :

“The learned counsel for the appellant relies on two grounds to support the contention that there is profit attributable to the sale of land which was the stock-in-trade of the vendors. He says first that in the schedule to the agreement the value of the land and the value of goodwill and other items is specified. He says that although the amount of Rs. 2,50,000 was shown as price of goodwill, it was really excess value of the land sold along with other assets. Secondly, he says, relying on the passage already cited above from Doughty’s case [1927] AC 327 that the vendor’s business was a business of purely buying and selling land. In our opinion, on the facts of this case, it cannot foe said that the vendors were carrying on the business of purely buying and selling land. In this case the vendors were engaged in buying land, developing it and then selling it. The agreement itself shows that the vendors had already incurred debts and liabilities for development expenses such as opening out roads, laying out drains and sanitary, arrangements, providing electricity and providing for a school.

It seems to us that in the case of a concern carrying on the business of buying land, developing it and then selling it, it is easy to distinguish a realisation sale from an ordinary sale, and it is very difficult to attribute part of the slump price, to the cost of land sold in the realisation sale. The mere fact that in the schedule the price of land is stated does not lead to conclusion that part of the slump price is necessarily attributable to the land sold. There is no evidence that any attempt was made to evaluate the land on the date of sale. As the vendors were transferring the concern to a company, constituted by the vendors themselves, no effort would ordinarily have been made to evaluate the land as on the date of sale. What was put in the schedule was the cost price, as it stood in the books of the vendors. Even if the sum of Rs. 2,50,000 attributed to goodwill is added to the cost of land, it is nobody’s case that this represented the market value of the land.
In our view the sale was the whole concern and no part of the slump price is attributable to the cost of the land. If, this is so, it is clear from the decision of this court in CIT v. West Coast Chemicals & Industries Ltd. [1962] 46 ITR 135 (SC) and Doughty v. Commissioner of tax case [1927] AC 327 that no part of the slump price is taxable.”
(b)
In CIT v. Electric Control Gear Mfg. Co. [1997] 227 ITR 278/93 Taxman 384 (SC), the honourable Supreme Court has held as under (page 281) :

“The High Court has placed reliance on its judgment in Artex Manufacturing Co. v. CIT [1981] 131 ITR 559 (Guj). The said judgment of the High Court has been considered by us in our judgment pronounced today in C. A. No. 2276 (NT) of 1981, CIT v. Artex Manufacturing Co. [1997] 227 ITR 260 (SC). In that case, we have held that section 41(2) was applicable since price attributable to the plant, machinery and dead-stock which were transferred had been disclosed by the assessee during the course of assessment proceedings before the Income-tax Officer and that the said price was as per the value assessed by the valuers at the time of execution of the agreement. In the present case there is nothing to indicate the price attributable to the assets like the machinery, plant or building out of the consideration amount of Rs. 8 lakhs. Merely because a sum of Rs. 3,32,863 had been allowed as depreciation to the assessee firm, it could not be said that was the excess amount between the price and the written dawn value.”

16. Learned senior counsel for the assessee, on the other hand, submitted that the assessee along with a foreign partner, M/s. DFI, promoted a company called “Food World Supermarket Ltd.” which took over the Food World Retail business from the assessee as a on-going concern basis and paid the assessee sale consideration based on the business taken over and in addition, also paid a non-compete fee of Rs. 5 crores separately. Learned senior counsel submitted that the payment of non-compete fee was due to the fact that the assessee at the relevant time was strong in retail business. The non-compete agreement between the joint venture parties was independent of the non-compete agreement between the assessee and Food World Supermarket Ltd. Food World Supermarket Ltd. paid the non-compete fee since either of the partners could have left Food World any time and, therefore, the non-compete agreement between the companies was independent and was supported by separate non-compete fee.

17. Learned senior counsel further submitted with emphasis that the amount received for non-compete fee was assessed by the assessing authority as goodwill but the appellate authority, the Commissioner of Income-tax (Appeals) had directed the same to be assessed as part of the capital receipt for the sale of the on-going business. The Revenue has not filed any appeal against this direction. Nor any cross-objection filed. Learned counsel submitted that this would mean that the Revenue has accepted that the receipt of this amount was not to be treated as goodwill and was to be taken as only capital receipt and not as revenue receipt. Learned senior counsel reiterated the contentions put forth before the Tribunal in the light of the materials on record, more particularly the joint venture agreement dated August 2, 1999, and submitted that the business of Food World Supermarket belonging to the assessee was not transferred to the new joint venture company and that a new company called Food World Supermarket Ltd. entered into business purchase agreement with the assessee. Learned counsel argued that in view of the various clauses in the joint venture agreement with DFI and the business purchase agreement with Food World Supermaket Ltd., the appellate authority was correct in holding that fee received for restrictive covenants was integral part of the sale consideration for transfer of the business undertaking. Learned senior counsel reiterated with emphasis that the restrictive covenants imposed in the joint venture agreement and business purchase agreement were distinct and different. While the joint venture agreement stipulated restrictive covenants on both the parties on reciprocal basis which constituted consideration for each other, the covenants contained in the business purchase agreement were applicable only to the respondent-assessee. Therefore, when only one party was subjected to restrictive covenants, it was required to be compensated for accepting such covenants.

18. Learned senior counsel submitted that the Tribunal on a proper appreciation of the issue in the light of the covenants contained in the joint venture agreement and business purchase agreement has rightly concluded that the whole compensation received towards the restrictive covenant for carrying on the retail business was capital receipt not liable to tax. The order of the Tribunal does not call for any interference in this appeal. In support of his arguments, learned senior counsel relied on the following decisions :

(a) In CIT v. Amol Narendra Dalal [2009] 318 ITR 429 (Bom), it has been held as follows (page 432) :

“After hearing advocates of the parties and perusing the impugned order, we are of the view that the Tribunal has taken a correct view that the said amount of Rs. 11 lakhs has been received by the assessee for having undertaken not to carry on any business in future in competition with M/s. Aasia Industrial Technologies Pvt. Ltd. (purchaser) within the territory of Mumbai suburbs. The finding of the Tribunal that there is no evidence that the said agreement is sham is accepted by the Revenue. The Department’s argument before the Tribunal and before us that after having transferred his clientele by the first agreement, dated November 25, 1994, the assessee had nothing left with him to make any further transfer under the second agreement and, therefore, the second agreement was only for transfer of the goodwill for which the assessee received Rs. 11 lakhs and which ought to be taxed is untenable and baseless. It is very clear that under the first agreement the assessee transferred his entire clientele (business) to M/s. Aasia Industrial Technologies Pvt. Ltd. (purchaser) for a consideration of Rs. 12,50,000 and under the second agreement undertook not to compete with the said company in future, in the suburbs for a consideration of Rs. 11 lakhs which amount admittedly cannot be made taxable under the heading ‘Capital gains’.”
(b)
In CIT v. Real Image (P.) Ltd. [2013] 359 ITR 606/213 Taxman 169/23 taxmann.com 30 (Mad) ; [2012] (4) CTC 303, it was held (page 611 of 359 ITR) :

“The aforesaid decision has amply made it clear that the payment received as non-competition fee under a negative covenant was a capital receipt and not taxable under the Act. Since the Commissioner of Income-tax (Appeals) and the Tribunal have concurrently held that the payment received as non-compete fee by the assessee from the purchaser company is a capital receipt and not the amount received towards the transfer of goodwill, applying the principle laid down in the aforesaid decision of the Supreme Court, we are not inclined to interfere with such a concurrent finding.

The decision in Lachminarayan Madan Lal v. CIT [1972] 86 ITR 439 (SC), relied on by the learned standing counsel to the effect that the surrounding facts and circumstances have established the true nature of the transaction to the effect that the goodwill has also been transferred along with the business of the assessee-company, is not applicable to the facts of the case as the agreement entered into between the parties have amply made it clear that the payment received by the assessee-company was only towards non-compete fee and not towards the goodwill.

For the aforesaid reasons, the substantial question of law raised in this appeal is answered against the Revenue and in favour of the assessee. Accordingly, the tax case appeal is dismissed. No costs.”

(c) In CIT v. G.D. Naidu [1987] 165 ITR 63/[1986] 24 Taxman 255 (Mad), this court held as follows (page 77) :

“So far as the amount received by the old partners referable to their share in the partnership and the goodwill is concerned, though they are received on capital account as held by the Supreme Court in Malabar Fisheries Co. v. CIT [1979] 120 ITR 49 (SC), it is only a distribution of the assets of the partnership among the partners involving no transfer of an asset and, therefore, there could be ho question of any capital gains also. The question whether the compensation received for restrictive covenant, can be, taxed as income or capital is directly covered by the decision in CIT v. Saraswathi Publicities [1981] 132 ITR 207 (Mad). In that case, it was held that a receipt referable to the restrictive covenant was a capital receipt not liable to income-tax. The decision in CIT v. N. Palaniappa Gounder [1983] 143 ITR 343 (Mad), is an authority for the position that the compensation received by the outgoing partners or the old partners in respect of their share in the partnership cannot be taxed as revenue receipts nor can it be said that there was any element of capital gains arising merely because of the valuation of his share on the retirement of the assessee from the firm resulted in an excess over the book value of the net assets of the firm referable to his share. The above two decisions are directly applicable to the facts of this case and we confirm the finding of the Tribunal and accordingly we answer the first five questions referred to above relating to the recipients in the affirmative and in favour of the assessee.”
(d)
In CIT v. Ambadi Enterprises Ltd. [2004] 267 ITR 702/139 Taxman 96 (Mad), it has been held as follows (page 704) :

“One test for ascertaining as to whether what was received was a capital receipt or a revenue receipt is to find out whether the assessee had snapped his link with the profit-making apparatus, that was transferred. In this case, in pursuance of the termination agreement, the source of income is totally severed whereby the profit-earning apparatus could never be utilised by the assessee. The entire trained manpower and customer network were handed over to the other party to the agreement. In such a situation, the payment received by the assessee had the imprint of a capital receipt. The assessee had a well developed large-scale organisation and marketing network and had given a go by to the enjoyment of good profits that they had in all these years till the date of termination of the agreement. The assessee had also entered into a restrictive covenant. All these facts would indicate that the termination of agreement had materially crippled the structure of the assessee’s profit-making apparatus, what was received was only a capital receipt. The questions referred are answered in favour of the assessee and against the Revenue.”

(e) In Guffic Chem (P.) Ltd. v. CIT [2011] 332 ITR 602/198 Taxman 78/10 taxmann.com 105 (SC), it was held by the honourable Supreme Court as follows (page 607) :

“Two questions arose for determination, namely, whether the amounts received by the appellant for loss of agency was in normal course of business and therefore whether they constituted revenue receipt ? The second question which arose before this court was whether the amount received by the assessee (compensation) on the condition not to carry on a competitive business was in the nature of capital receipt ? It was held that the compensation received by the assessee for loss of agency was a revenue receipt whereas compensation received for refraining from carrying on competitive business was a capital receipt. This dichotomy has not been appreciated by the High Court in its impugned judgment. The High Court has misinterpreted the judgment of this court in Gillanders’ case [1964] 53 ITR 283 (SC). In the present case, the Department has not impugned the genuineness of the transaction. In the present case, we are of the view that the High Court has erred in interfering with the concurrent findings of fact recorded by the Commissioner of Income-tax (Appeals) and the Tribunal. One more aspect needs to be highlighted. 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 the said capital receipt is now made taxable (see section 28(va)). The Finance Act, 2002, itself indicates that during the relevant assessment year compensation received by the assessee under non-competition agreement was a capital receipt, not taxable under the 1961 Act. It became taxable only with effect from April 1, 2003. It is well-settled that a liability cannot be created retrospectively. In the present case, compensation received under the non-competition agreement became taxable as a capital receipt and not as a revenue receipt by specific legislative mandate, vide section 28(va) and that too with effect from April 1, 2003. Hence, the said section 28(va) is amendatory and not clarificatory. Lastly, in CIT v. Rai Bahadur Jairam Valji reported in [1959] 35 ITR 148 (SC) it was held by this court that if a contract is entered into in the ordinary course of business, any compensation received for its termination (loss of agency) would be a revenue receipt. In the present case, both the Commissioner of Income-tax (Appeals) as well as the Tribunal, came to the conclusion that the agreement entered into by the assessee with Ranbaxy led to loss of source of business ; that payment was received under the negative covenant and therefore the receipt of Rs. 50 lakhs by the assessee from Ranbaxy was in the nature of a capital receipt. In fact, in order to put an end to the litigation, Parliament stepped in to specifically tax such receipts under non-competition agreement with effect from April 1, 2003.”

19. We have meticulously gone through the orders passed by the authorities below and that of the Tribunal. The assessing authority disallowed the assessee’s claim of non-compete fee on the reasoning that it was goodwill but the appellate authority, the Commissioner of Income-tax (Appeals) treated the same as part of sale consideration for sale of business and disallowed. The Revenue, as rightly submitted by learned senior counsel for the respondent-assessee, had not challenged the finding of the Commissioner of Income-tax (Appeals) treating the non-compete fee as a part of capital receipt. The Tribunal held that the non-compete fee was a capital receipt not liable to tax.

20. The respondent-assessee entered into a joint venture agreement with DFI Mauritius Ltd. for opening retail outlets in the form of supermarkets in India. The said agreement contained a clause regarding non-compete fee. When a company was floated under the name and style of “Food World Supermarket Ltd.”, the assessee entered into a business purchase agreement with the said new company for sale of retail business as a going concern. The said business purchase agreement contained various covenants to be observed by the parties. Under the said business purchase agreement, the assessee was restricted from carrying on competing business, for which the assessee which was by then successfully running more than 30 retail outlets with a turnover of more than 80 crores, was eligible and justified to claim some compensation for not carrying on competing business. The new company floated pursuant to the joint venture agreement was, therefore, a separate and independent legal entity distinct from the assessee company. In the facts and circumstances of the matter, we are of the considered view that when the assessee, who was successfully running business of retail supermarket stores, sold their profitable running retail business to a new company and in terms of the restrictive covenant prohibited from carrying on competing business in retail the amount received by the respondent-assessee as non-compete fee was to be treated as capital receipt, not taxable.

21. The issue regarding the non-compete fee, in our view, is no more res integra as the same has been concluded by the decisions reported in CIT v. Real Image (P.) Ltd. (supra); Guffic Chem (P.) Ltd. (supra) and G.D. Naidu (supra) . In the above cases, the hon’ble Supreme Court as well as this court has held that the receipt in the nature of a non-compete fee should be treated only as a capital receipt and not a revenue receipt. The decisions cited by the learned standing counsel for the Revenue, in our view, are relatable to the facts of the said cases where the issue was to treat the receipts as capital or revenue receipt. The said decisions do not lay down a general proposition of law and the facts of each case have to be looked into while determining as to whether a particular income is a capital receipt or a revenue receipt.

22. For the reasons stated above, we see no infirmity in the order passed by the Tribunal in setting aside the order of the authorities below and treating the whole non-compete fee as capital receipt not liable to tax. These substantial questions of law raised by the Revenue are accordingly answered in the affirmative and in favour of the respondent-assessee.

23. In the result, we confirm the order passed by the Tribunal. The appeal stands dismissed.

[Citation : 359 ITR 612]