TMI Blog2004 (12) TMI 327X X X X Extracts X X X X X X X X Extracts X X X X ..... sment year 1998-99 under the head 'capital gain'; the Assessing Officer considered the receipt as a return for the sale of goodwill. In the case of VCN it was assessed as income from other sources. 3. Under another agreement dated 7-9-1998, Shri VCN received a sum of Rs. 2 crores from Sun Pharmaceutical Industries Limited (SPIL in brief). The payment is stated to be 'Non-competition Fee'. Since this payment was received during the previous year relevant to assessment year 1999-2000, the Assessing Officer brought to tax the said income under the head 'income from other sources' by treating it as a revenue receipt. 4. The first appellate authority confirmed the orders passed by the Assessing Officer in all the three cases; detailed case of Shri VCN in respect of assessment year 1998-99 and by following the said order, other two appeals were also dismissed. Thus, the discussion and reasons given by the CIT(A) are found in the appellate order for assessment year 1998-99 in the case of Shri VCN. 5. Further aggrieved, the assessees are in appeal before us. Before we record the submissions of the learned counsel for the assessee as well as the learned departmental representative, it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment amounts to transfer of goodwill of Natco in Russia and CIS countries in favour of a competitor. The Assessing Office) has also considered in detail the meaning of the term 'goodwill'. In the backdrop of the facts and circumstances of the case, he was of the view that the assessee company had transferred its goodwill for a consideration, under the fourth agreement and thus it is not simply a case of losing a source of income. Since the consideration was held to be a capital receipt, for sale of goodwill, it was brought to tax under the head 'capital gains' as per section 55(2)(a) of the Income-tax Act, 1961. The Assessing Officer was of the view that the goodwill is self-generated and hence the cost of acquisition has to be taken at Nil. Thus, the entire sum of Rs. 1.46 crores was brought to tax under the head 'long-term capital gain'. While dealing with the cases relied upon by the assessee's counsel, the Assessing Officer observed that the case laws have no application here inasmuch as the dispute in those cases was whether the relinquishment of a managing agency was a revenue receipt or a capital receipt, whereas in this case it is accepted that the receipt is a capital rece ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bring home the point that what had been transferred by Natco was its goodwill and it was not simply a case of losing a source of income, but he quickly added that the above discussion is valid only from the point of view of Natco Pharma Ltd., since the brand names in question belonged to Natco and no one else. The brands transferred were not perceived to be products belonging to or associated with Shri VCN but to Natco. The company had its own status both legally and in terms of goodwill and reputation in the market and by no stretch of imagination can the status and goodwill of Natco become coterminus with that of the assessee. The Assessing Officer observed that if the brands transferred were to be perceived as brands belonging to or associated with Shri VCN, the head of R D Division and the head of marketing or any other shareholder can also lay a claim to a share of the non-competition fee. He thus concluded that the goodwill, which had accrued on these products, was of Natco and not of the assessee. He thus concluded that the entire consideration received by the assessee in pursuance of the so-called non-competition agreement was assessable to tax under the head 'other sourc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le money was spent on R D. He also noticed that Shri VCN had received royalty income from Time Cap Inc. for invention of time release technology. In other words, the specified products were developed, marketed and owned by Natco and Shri VCN cannot claim any share in it on the transfer of such technology. 11. The learned CIT(A) further observed that as per the agreement, Natco Group consisting of Shri VCN, his wife and children, agreed not to carry on any business in countries specified in Annexure II to the Non-competition agreement, but the statistics show that from the accounting year 1997-98 onwards the sales had slightly decreased and the company had incurred losses. The said losses were not due to stoppage of sales to Russia and CIS countries but due to other reasons, as the percentage of drop in the profit/loss was more than the percentage of sales in Russia and CIS countries. Thus, according to the learned CIT(A), even after the stoppage of sales to Russia and CIS countries, Natco could make profit and the source of income of Natco being sale of pharmaceutical formulations, there was no extinguishment of source to the company - the impact of the extinguishment on sales ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er the head 'Capital gains' and the observations of the CIT(A) would give an indication that the head under which it was brought to tax was affirmed by the CIT(A). However, the detailed reasons given by the learned CIT(A) in the appellate order for assessment year 1998-99 in the case of Shri VCN indicate that the learned CIT(A) was of the view that it was a revenue receipt in the hands of Natco also, though it was not stated in so many words in his appellate order. 15. Before us, the learned counsel for the assessee as well as the learned departmental representative advanced their arguments in great detail and also filed written submissions. Upon exchanging written submissions, the learned DR has also filed reply to the submissions filed by the assessee's counsel. It may be noticed that barring minor differences, the arguments advanced for all the three cases were same and hence we proceed to record the submissions of the parties accordingly. 16. The case of the learned counsel for the assessee is that Shri VCN is a Postgraduate in Pharmacy and Science and worked in the R D Department in a reputed company of USA for 13 years and, apart from gaining sufficient experience in phar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or not, one has to look at it from the perception of the parties. The case of the learned counsel is that in the perception of RLL, Shri VCN and his family members having promoted the company Natco and introduced into the market several time release drugs under specified brand names, Shri VCN is capable of entering into the market again in any form such as advising, assisting etc., and to put an embargo on such capability, a restrictive covenant was entered into whereby the assessee was paid the impugned sum. Similar is the case with regard to the payment received from SPIL. Thus, it is not a payment made for transfer of goodwill as mentioned by the Assessing Officer. The learned counsel asserted that future capacity or possibility of a person, who can be a threat, was taken into account by RLL and SPIL. 17. Meeting the observations of the learned CIT(A), the learned counsel submitted that the learned CIT(A) has mistakenly understood the term 'non-competition' as a covenant which requires the agreed party to stop doing any other profit making business, whereas the real import of the term 'non-competition' is to restrict the party from embarking upon any venture in that direction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is assessable under the head 'other sources'. He has taken us through the order of the CIT(A) to submit that there is no impairment of the profit making structure on account of the restrictive covenant and thus the amount received both by the company and the individual would partake the character of revenue receipt. Explaining further, it was submitted that Natco manufactured and marketed 150 products out of which only 15 products are subject to restrictive agreement, that too in a limited territory. For example, with regard to the agreement entered into with RLL, the territory was Russia and CIS countries. It was also submitted that Shri VCN was only a salaried employee and had never manufactured or marketed the products mentioned in the agreement, in his individual capacity, and hence the restriction is applicable only to the company and not to Shri VCN. Even the so-called restriction to the company has not hampered the income earning source of Shri VCN in any form. Adverting our attention to paragraph 5 of the order of the learned CIT(A), the learned DR submitted that the percentage of sales in Russia and CIS countries to the total sales was not substantial and Shri VCN conti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re is no loss of source of income, but in fact gain of new source of income. In other words, it cannot be said that a trading avenue is completely lost to the assessee or there was loss of earning. The learned DR relied upon the following case laws in support of his contention that under such circumstances the receipt in the hands of Natco as well as Shri VCN has to be treated as revenue in character:- Kettlewell Bullen Co. Ltd. v. CIT [1964] 53 ITR 261 (SC) Vadilal Soda Ice Factory v. CIT [1971] 80 ITR 711 (Guj.) at 720 CIT v. Dr. R.L. Bhargava [2002] 256 ITR 42 (Delhi) K. Ramasamy v. CIT [2003] 261 ITR 358 (Mad.) Chemplant Engineers (P.) Ltd v. CIT [1998] 234 ITR 23 (Mad.) Blue Star Ltd. v. CIT [1996] 217 ITR 514 (Bom.) CIT v. Manna Ramji Co. [1972] 86 ITR 29 (SC) The learned DR submitted that even as per the assessee's statement, because of certain problems in those countries, Natco could not run the business in those countries. Thus, there is no loss of revenue either to Natco or to Shri VCN. 20. The learned DR distinguished the case laws relied upon by the learned counsel for the assessee on facts by submitting that in those cases it was a true and genuin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e learned counsel submitted that there are various ways of earning income and the assessee has earned income in the form of royalty, but that does not prove that the income earned from imparting technical know-how would not amount to use of a capital asset. Placing reliance upon the decision of the House of Lords in the case of Rolls-Royce Ltd. v. Jeffrey (Inspector of Taxes) [1965] 56 ITR 580, in particular the observations of Lord Radcliffe, he submitted that earning income from imparting know-how is part of business. He also relied upon the decision of the Hon'ble Bombay High Court in the case of CIT v. Cilag Ltd. [1968] 70 ITR 760. The case of the learned counsel is that the knowledge in Time Release Technology is the capital Of Shri VCN and that capital is being used to earn business income. Thus, any receipt on account of a restrictive covenant to make use of his intellect in a particular territory would partake the character of a capital receipt. He also submitted that the issue of application of section 10(3) of the Act was not raised by the Revenue earlier and even otherwise, merely because an amount is not assessable to capital gains tax, it cannot be treated as casual or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee is impaired or such cancellation results in the loss of what may be regarded as the source of the assessee's income, payment made to compensate for such cancellation of agency is normally a 'capital receipt'. (B) In the case of CIT v. Dr. R.L. Bhargava [2002] 256 ITR 42, Hon'ble Delhi High Court extracted the following observations of Hon'ble Bombay High Court in the case of CIT v. Ralliwolf Ltd. [1983] 143 ITR 720, to come to the conclusion that if there had been no absolute parting by the assessee with the technical know-how and consideration was received for imparting know-how, not in association with the disposal of a capital asset, such receipt should be treated as a revenue receipt: "The legal opposition on these authorities, therefore, is that know-how is not strictly a fixed asset and the nature of receipts from the know-how would essentially depend upon the transactions out of which the receipts arise and the context in which the receipts are received. If the imparting of know-how is really in the nature of services rendered without anything more, the receipt must be treated as a revenue receipt. But when consideration is received for imparting in assoc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TR 261 (SC). Further, having regard to the vast area of business done by the assessee as an agent, it was held that the acquisition of agency was in the normal course of business and determination of individual agencies a normal incident not affecting or impairing the trading structure and, therefore the amount received for the cancellation of such agency did not represent price paid for loss of a capital asset. However, if the compensation was for agreeing to refrain from carrying on a competitive business in the commodities in respect of the agency terminated, or for loss of goodwill, such receipt was held to be in the nature of a capital receipt. (I) In the case of Godrej Co. v. CIT [1959] 37 ITR 381, the Apex Court observed that although the language used in the resolution was not decisive and the question had to be determined by a consideration of all the attending circumstances, it could not be ignored altogether but had to be taken into consideration along with other relevant circumstances. It was further observed that if the compensation was for the deterioration or injury to the managing agency, the receipt is capital in nature. (J) In the case of P.H. Divecha v. CIT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... circumstances indicate that the trading structure of the assessee was not impaired and it was a normal incident of the business, i.e., loss of the future profits. 24. Reverting to the facts of the case before us, Shri VCN, who pioneered the Time Release Technology, promoted the company by name Natco Pharma Ltd. and handed over the technical know-how with regard to the manufacture of certain medicines to the said company. Thus, the technical know-how has become the property of the company. Though Shri VCN was the Managing Director, further research was done at the expense of the company, brand names were the property of the company and the goodwill, if any, was the property of the company. Thus, Shri VCN has no right whatsoever in the products specified in the agreement and has never entered the market in his individual capacity in the specified territory. The surrounding circumstances show that Shri VCN never intended to carry on business in his individual capacity. As rightly observed by the learned CIT(A), there is no change in the income pattern of Shri VCN in the subsequent years, i.e., after the agreement was entered into with RLL and SPIL. Knowledge with regard to manufact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eceipt. In fact, the Assessing Officer has admitted in his order that it was a capital receipt, but sought to tax it by treating it as goodwill, overlooking the fact that goodwill was separately transferred by another agreement. Thus, the amount received by the assessee-company cannot be treated as a consideration for transfer of goodwill. In other words, the impugned sum received by Natco is a capital receipt not liable to tax, and we direct the Assessing Officer accordingly. 26. At the time of hearing, the learned counsel for the assessee raised an additional ground in the appeal of Shri VCN in respect of assessment year 1998-99. The case of the learned counsel is that the assessed had borrowed funds for investment in shares of Natco Pharma Ltd. and the interest on such loan is allowable as a deduction against the income from other sources. The learned counsel submitted that though the facts are on record by inadvertence, the issue had not been raised before the first appellate authority and, being a legal issue, it can be raised at any stage. Placing reliance upon the decision of the Apex Court in the case of National Thermal Power Co. Ltd. v. CIT [1998] 229 ITR 383, the learn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ahmedabad Bench 'B', in the case of Harish Krishnakant Bhatt v. ITO [2004] 91 ITD 311, wherein the decision of the ITAT, Bombay Bench, was considered in detail. The same view was taken by the ITAT, Kolkata Bench, in the case of Dy. CIT v. S.G. Investments Industries Ltd. [2004] 89 ITD 44. 29. This leaves us with the only issue as to whether expenditure referable to the period up to 1-6-1997 is allowable as deduction. Admittedly, section 10(33) of the Act does not cover the period upto 1-6-1997. In other words dividend income received or receivable on or before 1-6-1997 is includible in the total income. Since the income is not exempt for such period, merely because there was no actual income earned by the assessee for such period expenditure incurred in order to earn dividend income cannot be disallowed in the light of the decision of the Apex Court in the case of CIT v. Rajendra Prasad Moody [1978] 115 ITR 519. We may further clarify that section 14A of the Act comes into play only when the income received or receivable does not form part of total income and not otherwise. We, therefore, direct the Assessing Officer to consider the claim of the assessee for deduction with reg ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
