TMI Blog2006 (1) TMI 191X X X X Extracts X X X X X X X X Extracts X X X X ..... to have appreciated that in the assessee-company line of business goodwill does not exist. 5. Any other ground that may be urged at the time of hearing." Brief facts of the case are as follows: 3. The assessee was engaged in the business of distribution of soft drinks like Coca Cola, Thums Up, Limca, Maaza etc., which were produced by Spectra Bottling Company Ltd. (hereinafter referred to as Spectra). Spectra was a franchisee of the Coca-Cola Company, USA (hereinafter referred to as TCCC). The assessee states that it had developed a distribution network for marketing the soft drinks produced by Spectra and that it has its own fleat of vehicles which are sent to various distribution points as per requirements. It further states that the assessee, during the course of its business of distribution, had built and developed distribution network as it was also responsible for the proper conduct of the business of Spectra. The Franchisee Agreement given to Spectra was terminated by a Business Sale Agreement by TCCC and the business was purchased by Bharat Coca-Cola South East Pvt. Ltd. (hereinafter referred to as BCC). BCC purchased the business of Spectra as a going concern. Pursua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ete with the BCC in the very same line of business. When there was no competition in the business and cannot be any restrictive covenant and the agreements are only self serving colourable devices to claim the revenue receipt as capital receipt in the guise of compensation over restrictive covenant. (e) The assessee did not at any stage have any enforceable or otherwise agreement/understanding/contract with the BCC. (f) In the books of account, the principal company (BCC) has treated the amounts paid as a revenue expenditure and whereas the assessee claimed as received on capital account. This is nothing but a planned tax evasion tactics attempted by the principal company and the assessee-company, working in tandem. 38. In view of the above discussion, and also for the reason that the principal company i.e., M/s. BCC has treated the entire amount paid as revenue expenditure, I hold that receipt Rs. 4 crores in the hands of the assessee-company constitutes revenue receipt and is exigible to tax." 5. Alternatively, the Assessing Officer held that the amount is liable to tax as compensation for termination of agency under section 28(ii) of the Income-tax Act, 1961. The detaile ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able to tax as it is a capital receipt. Aggrieved by his orders, the Revenue is in appeal. 7. The learned departmental representative submitted that BCC had taken over a number of bottling companies as going concerns in the entire country, which involved a few hundred crores of rupees and that when the company had taken over Hyderabad Bottling Co. Ltd. as a going concern for a consideration of Rs. 43 crores, an amount of Rs. 17 crores was paid to the four directors of Hyderabad Bottling Company and there was no payment whatsoever to the distribution company connected with Hyderabad Bottling Company either towards goodwill or towards non-compete agreement though both the groups have more volume of business as compared to Spectra. With this background, the learned counsel submitted that the first appellate authority was wrong in holding that there was certain confidential information that the distribution company possessed. He vehemently contended that there was no confidential information whatsoever and the amounts received in the guise of compensation for non-competition is actually an amount received in the course of business of the assessee and therefore, liable to tax. He took ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y or negatively; (i) That the assessee-company has no technical competence or financial strength to compete with a multi-national giant like BCC and thus, the so-called competition is only imaginary and the receipt in question being termed as non-compete fee is only a guise; (j) That the ratio of the judgment of the Hon'ble Supreme Court in the case of McDowell Co. Ltd. v. CTO [1985] 154 ITR 148, applies as this is a colourable device; (k) That if it is not accepted that the receipt in question was a revenue receipt, then, alternatively, the receipt is taxable under sub-clause (a) of clause (iv) of section 28. For this proposition, the learned DR took this Bench through the findings of the Assessing Officer and relied on the same. The learned departmental representative emphasized that the Revenue relies more on the provisions of section 28(ii) and that the transaction falls within the ambit of the provisions, making it liable to tax. He also relied on the following case laws:- Kettlewell Bullen Co. Ltd.'s case Vadilal Soda Ice Factory v. CIT [1971] 80 ITR 711 (Guj.) CIT v. Dr. R.L. Bhargava [2002] 256 ITR 42 (Delhi) K. Ramasamy v. CIT [2003] 261 ITR 358 (Mad.) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rustam Cavasjee Cooper v. Union of India [1970] 40 Compo Cas. 325, and submitted that goodwill is an intangible asset and profits earned for assessment years 1996-97, 1997-98 and 1998-99 shows that vast improvement in the business of the assessee. He submitted that TCCC was aware of this position and came forward to make substantial payment by acquisition of goodwill. He relied on the observations of the CIT(A) in paragraph 9 of his order. Alternatively, the learned counsel submitted that if it is held that this amount was not received for goodwill, then it partakes the nature of a capital receipt similar to the consideration received for restrictive covenant. 10. On application of section 28(ii), the learned counsel submitted that the agreement falls within the effect of new clause (v)(a) of section 28 introduced with effect from 1-4-2003 and that it does not come within the purview of section 28(ii)(a), (b), (c) and (d). He took this Bench through section 28(ii) and submitted that Spectra had nothing to do with the arrangement between the assessee and TCCC and that section 28(ii) as it stood at the material time does not cover this type of cases. He relied on the judgment of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s satisfaction as to how the business of TCCC will be adversely affected by cancelling the distribution agreement and in the absence of proof to the effect that the business of TCCC would suffer an adverse effect if the assessee continues to be in the business of distributor of soft drinks, the Assessing Officer was right in arriving at the conclusion. Further, that it is for the assessee to prove that TCCC claimed the above expenditure as capital expenditure and not as revenue expenditure. (e) That the assessee's contention that restrictive covenant is not an empty formality is not supported by the agreement entered into between Spectra and the assessee and that in respect of each and every aspect of work relating to sales, it was only the manufacturer, i.e., Spectra, which took care. He reiterated the contention on confidential information and as to whether it can be said that the assessee has any goodwill. In the other part of the written submissions, he reiterated the contentions raised before the Bench, trying to distinguish the case laws. 12. We have heard rival contentions. On a careful consideration of the facts and circumstances of the case and study of the case laws r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... while coming to a conclusion that it was just an agreement for transporting goods and not an agreement for distributorship: Clause 1 of the agreement: "The goods i.e., Soft Drinks bottled by the manufacturer will be supplied to the distributor who in turn will sell the products to the retailers or district dealers. In the event the rates are changed the manufacturer will inform the distributor with a written notice." Clause 2: "The manufacturer will prescribe the rates at which the retailer has to sell to consumer and it is the responsibility of the distributor to regulate and supervise the retailer and make sure that the product is made available to the majority of consumers at the suggested retail price." Clause 4: "The distributor has to service the retail outlets at least once in three days and district dealer at least once in a week during the off season. During the peak season the service frequency will have to be more often and will be determined by the market needs." Clause 6: "The distributor has to work for business improvement and should take all responsible care to keep up the image of the manufacturer and the Coca Cola Company." Clause 7: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee-company at an agreed price. The transactions in question cannot be termed as transactions within the group of connected persons. The Assessing Officer has not brought any evidence whatsoever to prove that these agreements are bogus agreements. As stated earlier, all that the Assessing Officer wanted to say is that "If I were to decide the matter by getting into the shoes of BCC, then I would not have made this payment". To hold that a transaction is colourable device, there should be something more than mere surmises and conjectures. The fact remains that BCC has paid the assessee certain amounts in pursuance of an agreement entered into between them and the taxability or otherwise of these amounts has to be considered by applying the settled law to these agreements. Merely saying that we do not believe these agreements, without an iota of evidence, cannot be countenanced. Even if it is to be held that the assessee had arranged its affairs in such a manner as to minimise its tax liability, then it has to be held that a citizen has the freedom to act in a manner according to his requirement, his wishes in the manner of doing any trade, activity or planning his affairs with cir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have drawn from the enunciation made in McDowell's case [1958] 154 ITR 148 (SC). The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell's decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity.' This accords with our own view of the matter." At page 762 of the report, it was observed: "If the court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the court might be justified in overlooking the intermediate steps, but it would not be permissible for the court to treat the intervening legal steps as non est based upon some hypothetical assessment of the "real motive" of the assessee. In our view, the court must deal with what is tan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be considered for the purpose of ascertaining whether the receipt in question is a capital receipt or a revenue receipt, we find that it is against the settled propositions of law. To give an example of the case of a real estate businessman, sites and buildings are stock-in-trade and sale of the same is a revenue receipt. But, if a buyer buy it as a capital asset, then it would be a capital expenditure in the hands of the buyer and just because the real estate dealer treated it as a revenue receipt, the buyer cannot claim the same as his revenue expenditure. Similarly, on the contra, if a company or an individual has a fixed asset being land and building, which it holds for a number of years as investment/fixed asset and sells the same to a real estate agent who deals in property, then in the hands of the seller it is a capital receipt and in the hands of the buyer, who is a real estate agent, it is a revenue expenditure. The legal propositions in this regard are fairly well settled. 19. Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1, held: "It is not a universally true proposition that what may be a capital receipt in the hands of the paye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital receipt or a revenue receipt. 20. Now, we consider the terms of the agreements and the tax effect. In the Non-compete Agreement dated 19-9-1997, it was mentioned as follows:- "1. Scope of Agreement (a) In consideration of the amount set forth below, the Covenantor covenants and agrees that, for five (5) years from the execution hereof the Covenantor shall not at any time disclose to any person for any purpose or use any confidential information in any business or venture, either directly or indirectly through any person, firm, company or other body corporate in which the Covenantor owns equity or otherwise, in and around the State of Andhra Pradesh. (b) Covenantor further agrees that after the execution hereof it shall use all reasonable endeavours to prevent the publication or disclosure of any Confidential Information. (c) For purposes of this Agreement, Confidential Information shall mean all information (including that comprised in or derived from manual instructions, catalogues, booklets, data disks, tapes, source codes, formula cards and flow charts) relating to the business of the Covenantor and that of BCC, if any, in possession or the control of the Cov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t for purchase of goodwill, in clause 5 at page 3, the assessee is required to even change its registered name within 60 days. The distribution agreement with Spectra formed a capital asset of the assessee's business, and this distribution agreement was a means with which the assessees entered into business transactions and that which the assessees worked or exploited. The distribution agreement constituted or formed part of the fixed capital of the assessees' business and it was neither the stock-in-trade nor the circulating capital of assessees. It really formed the profit-making apparatus of the assessees' business. 21. It is necessary to bear in mind the following principles enunciated by various courts, including the Hon'ble Supreme Court- (A) In the case of Blue Star Ltd. Hon'ble Bombay High Court observed that if a payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of the recipient's business nor deprive the recipient of what in substance is the source of income, termination of the contract being a normal incident of the business, and such cancellation leaving the recipient of the amount free to carryon his t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ether a receipt is of revenue character or capital in nature, one must try to ascertain the true nature and character of the payment. In border-line cases, the controversy has to be resolved on the facts and circumstances of the individual case. If the payment is received on account of sterilisation and destruction of a capital asset and if the assessee was permanently deprived of a source of income, it could be held as a capital receipt; otherwise, it is a revenue receipt. (G) In the case of CIT v. Shams her Printing Press [1960] 39 ITR 90, Hon'ble Supreme Court observed that if an amount was received for an injury to the assessee's capital assets including goodwill, it would be treated as a capital receipt, and if it was received as a compensation for loss of profit, it was a revenue receipt liable to tax. (H) In the case of Gillanders Arbuthnot and Co. Ltd. the Apex Court observed that there is no immutable principle that compensation received on cancellation of an agency must always be regarded as capital. If by cancellation of an agency the trading structure of the assessee is impaired, the payment should be treated as a capital receipt. In this regard, the court followed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d was not an ordinary trading agreement and thus the receipt is capital in nature. (K) In the case of Dr. K.P. Karanth, the assessee having technical know-how for manufacture of drugs, had given up his right to manufacture drugs and such receipt was held to be capital in nature. (L) In the case of CIT v. C.R. Karthikeyan [1993] 201 ITR 866 Hon'ble Supreme Court observed that the expression "income" should be given a wider meaning and though an income is casual in nature, it can nevertheless be treated as income assessable to tax. (M) In the case of Elegant Chemicals Enterprises (P.) Ltd. v. Asstt. CIT [2004] 271 ITR (AT) 56, this Bench had an occasion to consider the issue as to whether an amount received by the assessee is capital or revenue in nature. In that case, the Bench observed that the surrounding circumstances have to be taken into consideration to find out the reality of the recitals made in the documents, and by applying the test laid down by the Apex Court, it was held that the particular receipt was a revenue receipt liable for taxation. The Bench observed that the totality of the circumstances indicate that the trading structure of the assessee was not impaired ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s as well as the judgment of the Hon'ble Supreme Court, is applicable to the facts of this case. At pages 576 to 578, the Hon'ble High Court observed as follows:- "In CIT v. Best and Co. (Pvt.) Ltd. [1966] 60 ITR 11 (SC), the respondent was a company carrying on business including distribution of their explosives of Imperial Chemical Industries (Exports) Ltd., Glasgow. The Imperial Chemical Industries (Exports) Ltd., Glasgow decided that all its agencies in India should be taken over by Imperial Chemical Industries (India) Ltd., and gave notice to respondent terminating the agency from April 1, 1948. On termination of the agency some compensation has been paid which includes compensation for undertaking of the assessee, that assessee for 5 years shall refrain from selling or accepting any agency for explosives competitive with those covered by the agency agreement. The question before Their Lordships whether the amount of compensation for the 'non-compete agreement' is a revenue receipt. Their Lordships held that receipt is a capital receipt and not taxable. At page 22 their Lordships observed as under: 'In the present case, the covenant was an independent obligation undertaken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... G.D. Naidu [1987] 165 ITR 63, the dispute before the Madras High Court was that the compensation received by the assessee for not carrying on bus business for five years, whether the payment was 'restrictive covenant' is a revenue receipt. The deceased and his son with others were partners in five different firms carrying on business. During the year 196364 relevant for the assessment year 1964-65, all the old partners of the firms retired in stages so that by April 1, 1964 all the various firms were composed of entirely new groups of partners. The deceased and his son were paid varying amounts by the various firms toward off competition from them in regard to the bus service business. The firms in their assessments claimed this amount as revenue expense. The assessee (deceased and his son) claimed that the amount received from the various firms towards restrictive covenant is not taxable as it is a capital asset. The Madras High Court has taken the view that the amount of compensation is not liable to tax either as income or capital gains. From the decisions referred above it is made clear that if the amount of compensation has been received not to compete in business from th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting; or (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings; (ii) 'service' means service of any description which is made available to potential users and includes the provision of services in connection with business of any industrial or commercial nature such as accounting, banking, communication, conveying of news or information, advertising, entertainment, amusement, education, financing, insurance, chit funds, real estate, construction, transport, storage, processing, supply of electrical or other energy, boarding and lodging;" The first issue is whether the provisions of this clause is declaratory or retrospective in nature, as this clause was not in the Act during the impugned assessment year. We do not think so. The provision introduced is of substantive character. The Legislature has not made this amendment retrospective either expressly or by necessary implication. On the contrary, it is specifically stated that it is with effect from 1-4-2003. Hon'ble Supreme Court in the case of P. Mahendran v. State of Karnataka [1990] 1 SCC 411, has laid down: "Every statute or statutory rule is prospective unless i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o agree with the contentions of the learned DR (CIT). What section 28(ii) specifically deals with is with reference to compensation for general termination of agency or modification of terms and conditions relating thereto. These provisions were brought in only in the context of managing agency agreements. The assessee in its own right distributed products bottled by Spectra in pursuance of a distribution agreement, which definitely is not an agency agreement. The first appellate authority, in the case of Kode Enterprises (P.) Ltd. in his order dated 11-3-2002, observed at paragraph 8, page 9, as follows:- "I agree with the Appellant's submissions. Invoking the provisions of section 28 and discussing the various case law by the A.D. from para 43 onwards is not relevant as appellant is not a management agent nor the agreement with Spectra was an agency agreement. So I hold that the provisions of section 28 do not apply to the agreement entered into by the Appellant with that of BCC." We agree with the findings of the first appellate authority at paragraph 8 on page 11 of his order that the receipt in question does not fall within the ken of section 28(ii) of the Act. Thus, the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... atsoever, that too without any rhyme or reason. We are dismayed at the observations made by the Assessing Officer which are without an iota of evidence that the agreement in question is a make-believe agreement. 28. The Hon'ble Supreme Court, in Rustom Covasjee Cooper's case observed that "Goodwill of a business is an intangible asset; it is the whole advantage of the reputation and connections formed with the customers together with the circumstances making the connections durable. It is that component of the total value of the undertaking which is attributable to the ability of that concern to earn profits over a course of years or in excess of normal amounts because of its reputation, location and other features. Goodwill of an undertaking, therefore, is the value of the attraction to customers arising from the name or reputation for skill, integrity, efficient business management or efficient service." 29. At para 9 on page 8 of the order of the CIT(A) in the case of M/s. Sri Kode Enterprises (P.) Ltd., the first appellate authority held as follows:- "I also do not agree with the Assessing Officer's observation that the Appellant company did not have any goodwill. Goodwil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icer does not empower us to go into the issue. Even otherwise, section 50(2) refers to block of assets ceasing to exist as such by reason of transfer of the entire "block of assets". The term "block of assets" is defined in section 2(11) of the Act and comprises of certain tangible assets as well as intangible assets, but the primary requirement is that a rate of depreciation has to be prescribed i.e., in other words the asset should be a depreciable asset. E.g., "land" does not fall in a "block of assets" though it is a tangible asset. Thus, an amount received for a restrictive covenant cannot be said to have been received for transfer of an asset which forms "part of a block of assets". The Assessing Officer has not stated as to how he considers these receipts as those which are received for transfer of "block of assets" nor has he given any finding that in fact, after the transaction, there are no more assets left in the block. Without a factual finding that the block of assets ceased to exist, section 50(2) cannot be invoked. Even if it is taken as a capital asset, then, on merits, the assessee relied on the decision of the Visakhapatnam Bench of the Tribunal in the case of Amb ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot be applied must be regarded as never intended by section 45 to be the subject of the charge. This inference flows from the general arrangement of the provisions in the Act where under each head of income the charging provision is accompanied by a set of provisions for computing the income subject to that charge. 21. In the case of Sunil Sidharthbhai v. CIT [1985] 156 ITR 506/23 Taxman 14W, the Supreme Court has observed that the provision of section 48 is fundamental to the computation machinery incorporated in the scheme relating to the determination of the charge provided in section 45 and where section 48 cannot be effectuated, such a case must be regarded as falling outside the scope of capital gains taxation altogether. Right to manufacture has been generated over a period since the assessee was engaged in this business. It would not be possible to conceptualise the cost of acquisition of such a right as well as date of acquisition thereof. If the cost of acquisition and/or the date of acquisition of the asset cannot be determined, then it cannot be brought within the purview of section 45 for levy and computation of capital gains. Looking to the nature and character of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profit for taking cost of such assets to be Nil. Initially, the amendment was made to take the cost of goodwill to be Nil with effect from assessment year 1988-89. Thereafter with effect from assessment year 1995-96, the cost of acquisition of tenancy rights to be Nil. With effect from assessment year 1998-99, the cost of acquisition of the right to manufacture, produce and process any article or thing was taken to be Nil and thereafter from the assessment year 2002-03, the cost of trademarks associated with the business was taken to be Nil Finally with effect from assessment year 2003-04, it has been provided that the cost of acquisition of right to carryon any business is taken to be Nil. Till the said amendments no capital gain is leviable on the transfer of any of the above assets for the simple reason that the computational provisions of section 48 failed. They were all capital assets and technically, taxes under the head 'Capital gains' is chargeable on the transfer in terms of section 45, but only because their cost of acquisition and their cost of improvement in terms of section 48 was not ascertainable in respect of these assets no capital gain tax was chargeable on the tr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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