TMI Blog2005 (11) TMI 381X X X X Extracts X X X X X X X X Extracts X X X X ..... ,25,000 as the appellant s income chargeable under the head "Profits and gains of business". ( ii )For that on the facts and in the circumstances of the case, the authorities below totally failed to appreciate that the said consideration of Rs. 2,02,25,000 having been received for transfer of business network including goodwill thereof, such income was not assessable under the head "Profits and gains of business". ( iii )For that on the facts and in the circumstances of the case, the authorities below failed to appreciate that the said consideration having been received for transfer of "capital asset", the income, if any, could not be assessed under the head "Profits and gains of business". ( iv )For that on the facts and in the circumstances of the case, the said consideration of Rs. 2,02,25,000 having been received for transfer of "capital asset", cost of acquisition of which was incapable of being measured in monetary terms the said amount was not includible in the total income since capital gain could not be quantified. ( v )For that on the facts and in the circumstances of the case, income attributable to the said sum of Rs. 2,02,25,000 be either deleted from the total ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... competition from the financially sound multinational companies. One of the foreign entrants in India in the field of industrial gases was Praxair India Ltd., a wholly-owned subsidiary of Praxair Inc., USA. The said Praxair had set up manufacturing bases in different parts of India either by acquisition of existing plants or through green field projects. However, although the said Praxair had manufacturing facilities, it lacked sufficient marketing and distribution expertise, information, data and network. In order to increase its business volume M/s. Praxair India Ltd. therefore approached the assessee with an offer to buy out assessee s marketing and distribution network including Goodwill of assessee s business. After due consideration of the offer made by Praxair the assessee-company agreed for transfer of its business of marketing of industrial gases and agreed to sell, convey and assign to Praxair the marketing and distribution network. The scope of the business transfer was set out in Article 1 of the Agreement dated 23-9-1999, copy of which is enclosed herewith and marked as Annexure-II. In the said Clause 1, the assessee agreed to sell free of all charges, lien, mortgage, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... so desired. Accordingly, the company terminated its leases and fresh lease agreements were directly executed between the landlords and Praxair. Thus in terms of the Agreement for Transfer of network, the company also undertook to extinguish and determine its leases with the landlords of the said depots. The consideration for extinguishments or termination of leases was included in the said amount of Rs. 2,02,25,000. The company, in terms of the said agreement, had agreed to transfer and provide the detailed list of all the customers of the company to Praxair and had also agreed to provide the complete list of pending orders received from customers. Accordingly, the company submitted to Praxair the detailed list of the customers along with its pending contracts for supply of products to Praxair. For receipt of this valuable information relating to assessee s customer database and further transferring such business volumes and also for the transferee the information and distribution network including sales depots, the assessee had been paid consolidated lump sum consideration of Rs. 2,02,25,000 by Praxair. In modern business, the commercial success of corporation depends not only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... customers as Network inclusive of goodwill . Your honour will appreciate that as in the case of goodwill , this business network was also a self-generating asset, cost of acquisition was ascertainable in precise monetary terms. Taking cue from provisions of section 55(2)( a ), the assessee had considered the cost of acquisition of such self-generating asset as Nil . Accordingly, in computing the total income, the assessee had declared the entire receipt of Rs. 2,02,25,000 as its Long-term capital gains . The Assessing Officer has, however, held that there was no question of transfer of goodwill because Praxair was selling it s products under it s own name. Further, no business name or brand name was transferred by the assessee. As such the main ingredient of goodwill was absent Assessing Officer therefore, held that there being no transfer of goodwill, there could not be any consideration attributable to such non-existing transaction. The appellant submits that the findings of the Assessing Officer are based on surmise, conjecture and suspicion. The Assessing Officer has not properly considered the true scope of the agreement between the assessee and Praxair. As admitt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e case of CIT v. TI M Sales Ltd. ], a copy of the said judgment is enclosed and marked as Annexure 4. In this case, the assessee was engaged in the business of distribution of products manufactured by three companies. Such business of distribution was carried on by the assessee for 20 years. The agreement for marketing was on principal-to-principal basis. On termination of distributorship agreement, the assessee was paid a lump sum amount of Rs. 42 lakhs. The said amount was paid for having agreed to transfer staff, dealership network, brand image and other marketing infrastructure and also for arising out of termination of distributorship agreement with further restrictive condition that assessee should not, for a period of three years, act as distributor, stockist, dealer or agent of any other manufacturer similar to or competing with company s products. On these facts, the Hon ble Madras High Court held that the amount was received by the assessee as compensation for impairment of profit-making apparatus of assessee and for sterilization of the very source of income. Hon ble Madras High Court, therefore, held that the lump sum amount, so received, represented capital receipt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt executed in September 99, no revenue was generated by the company from its erstwhile main activity of marketing and trading of gases. In view of the ratio laid down by the Hon ble Madras High Court ( supra ), it is thus established that the consideration received by the assessee was for causing impairment to the profit-making apparatus and for sterilization of source of income and therefore the said amount of Rs. 2,02,25,000 received by the assessee was a capital receipt not liable to tax. The appellant, therefore, submits that the Assessing Officer was entirely wrong both in facts and in law in holding that the amount of Rs. 2,02,25,000 was a revenue receipt assessable as business profits of the company. The appellant submits that the said amount be held to be capital receipt not liable to tax even under the head capital gain". 5. Besides relying on the written submissions the Ld. A/R also carried us through the documents filed in the paper book. Referring to clause 1 of the Agreement dated 23rd September, 1999 with M/s. Praxair, he submitted that under the agreement the assessee transferred it s business network, benefits and obligations of and under pending contracts t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t. 6. On behalf the Revenue Sri A. Bhatnagar, the Ld. CIT D/R placed strong reliance on the orders of the authorities below. The Ld. CIT D/R also placed before us a note giving summary of the findings recorded by the authorities below which is reproduced below for the sake of brevity. "( i )Payment made by Praxair, Rs. 2,02,25,000 to the appellant cannot be attributed to the transfer of goodwill as Praxair has not acquired the business name/brand name etc. from the appellant. In fact, Praxair uses its old name while selling the industrial gases. Praxair is one of the largest manufacturer and distributor of industrial/ medical gases and above. So it is but natural that there is no need for it to use the appellants name and brand. ( ii )In fact, the consideration of Rs. 2,02,25,000 is attributable to transfer of current assets like pending contracts and list/profile of customers, marketing selling and distribution network (kindly refer terms and conditions of the agreement) and accordingly, is not a capital receipt but revenue receipt. ( iii )The appellant s reliance on the decision of Hon ble High Court of Madras in the case of CIT v. T.I. M. Sales Ltd. 129 Taxman 44 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Co. Ltd. v. CIT [1964] 53 ITR 261 . The Ld. D/R also relied on the decision of the Supreme Court in the case of V. Venugopala Varma Rajah v. CIT [1970] 76 ITR 460 to argue that where trees of spontaneous growth are cut, leaving stumps then sale proceeds constitute revenue receipt because the trees were not uprooted. The Ld. D/R submitted that in the present case the assessee had transferred the business network, customer database and pending contracts but did not transfer the manufacturing infrastructure to Praxair and therefore it could not be said that the assessee s business was uprooted and therefore the amount was received in the course of assessee s business which was revenue receipt liable to be taxed. 8. We have heard the rival submissions, perused the documents filed before us in the form of paper book and considered various case laws cited at the Bar. In the present case the basic facts giving rise to the grounds of appeal are not in dispute. The assessee was engaged in manufacture, sale and distribution of industrial gases and the assessee s principal activity was trading. From the information on record we note that in the recent past almost 90 per cent of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the assessee was predominantly a trading company dealing in industrial gases and, therefore, the distribution network; customer database and pending contracts constituted the "business apparatus" with the help of which the trading business was carried on. Such business apparatus was different and distinct from the stock in trade or current assets of the business and, therefore, such business apparatus constituted a distinct capital asset which under the Agreement dated 23-9-1999 was transferred to Praxair for a specified consideration. The authorities below have held that the assessee s business did not enjoy any goodwill because no brand name was associated with the assessee s business nor such brand name was transferred. In the above circumstances, the basic question to be decided in the present case is : what was the subject-matter of "transfer" under the Agreement dated 23-9-1999 with Praxair and what was the nature of the amount received by the assessee from Praxair. From the combined reading of Clauses 1, 2, 3 and 4 and considering other obligations which the assessee undertook under the agreement we find that the assessee had effectively transferred business network includ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h s case ( supra ) do not advance the case of the Revenue. Therefore following facts emerged from the above discussion : ( a )In the present case the consideration of Rs. 2,02,25,000 was paid for transferring the business network and not for stock in trade or sundry debtors. Clause 1.5 and 1.9 provided separate and distinct payment for transferring sundry debtors and stock in trade on the transfer date. ( b )We also note that the assessee had only one business till September 1999 which was one of manufacture and sale of industrial gases. ( c )We note that under Clause 1.1 the assessee transferred the business network relating to its trading business. We also note that the assessee also sold and/or transferred gas cylinders for a separate consideration. ( d )We also note that as per Clause 2.3 the assessee had agreed to decommission and close down the said manufacturing facility. Under the agreement dated 23-9-1999 the assessee had thus agreed to effectively close down the only business which it was carrying on till it entered into Agreement with Praxair. ( e )We therefore note that in fact the assessee effectively uprooted and closed its business. We therefore find that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of the agency agreement is normally a capital receipt." Applying the aforesaid criteria in the present case, we find that the transactions entered into by the assessee in the present case is not a normal incidence of business. The trading structure of the company has been affected. There has been deprivation of source of income permanently. The company had to close down the business of gas by surrendering the excise licence as we find in pages 115 and 116 of the paper book. Further the company entered into an agreement for non-competing in the same line of business. If we consider the totality of the circumstances of the case it can be concluded that the entire business net work was transferred by the assessee. Therefore, as held by the Hon ble Supreme Court, the consideration is a capital receipt. 12. We find that our view is supported by the decision of the Madras High Court in the case of CIT v. TI M Sales Ltd. [2003] 129 Taxman 444. In that case also the assessee had received a lump sum amount for transferring dealership network; brand image and other marketing infrastructure. Besides the assessee had also agreed not to carry on competing business. On these fact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eption clause the nature of business carried on by the assessee was relevant and accordingly in applying the second exception the composition of income was not material. He further submitted that the decision of the Bombay High Court in CIT v. Amritlal Co. Ltd. [1995] 212 ITR 540 on which authorities below relied; was not applicable in the present case because the said decision was rendered in the context of ascertaining the principal business of an assessee for the purpose of applicability of provisions of section 104 of the I.T. Act. The AR relying on the Special Bench decisions of the ITAT in Dy. CIT v. Venkateswar Investment Finance (P.) Ltd. [2005] 93 ITD 177 (Kol.) and Asstt. CIT v. Concord Commercial (P.) Ltd. [2005] 95 ITD 117 (Mum.) argued that where income criteria was applicable then regard was to be given only to the composition of gross total income and not to the principal business activity. According to him the two exceptions incorporated in the Expla-nation were mutually exclusive. He therefore submitted that since in the present case the assessee s gross total income mainly consisted of short- term capital gains, therefore Explanation to section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Explanation to section 73 were based on two "independent" tests laid down in the Explanation itself. The test to be applied in the first category was the character of company s gross total income whereas the test to be applied in the second category was the nature of the principal business carried on. If by applying the test of character of gross total income the company falls under the exception category then the test relating to nature of principal business does not apply. The Tribunal observed that the two exceptions provided in Explanation to section 73 were governed by two different tests and, therefore, each exception is to be examined and applied strictly in accordance with the tests laid down in the Explanation . In the said decision the Special Bench of the Tribunal also considered in detail the decision of the Bombay High Court in the case of CIT v. Amritlal Co. Ltd. [1995] 212 ITR 540 on which reliance was placed by the authorities below in the present case. The Tribunal observed that in Amritlal Co. Ltd. s case ( supra ) the Court applied the test of "principal business" carried on by the company in its normal course. The real intention of the Cour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ving certainty to the taxation of receipts in the nature of non-compete fees and fees for exclusivity right, the Finance Act, 2002 has included within the scope profits and gains of Business or profession. " 7.For these and such other grounds that may be urged at the time of hearing, it is humbly prayed that the order of the CIT (Appeals) be set-aside and that of the Assessing Officer be restored. 18. At the time of hearing Shri A. Bhatnagar the ld. CIT DR filed a written Note in support of the above-mentioned grounds of appeal which are reproduced below for the sake of brevity: "In consideration of Praxair purchasing and paying for the said business, the said Network all the goodwill thereof and the non-compete fee, AIGL hereby irrevocably agrees and will ensure, that neither AIGL nor its associates Goa Oxygen (P.) Ltd., Decan Gases and Allied Industries (P.) Ltd., nor Mrs. Pramilla Jalan, Ms. Kalpana Jalan and Mr. Ashok Kumar Dabriwala, nor their respective spouses and children, nor any companies or other entities owned or controlled by any of them (hereinafter collectively referred to as the Jalans ) will compete with Praxair in any of the products and any mixtures of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ived on account of transfer/sale of business assets like pending contracts and list/profile of customers which were also parted with. No doubt, they are assets but they are non-capital fixed assets but are current assets (a part of the circulating capital) as they keep changing everyday with the business. Any proceeds on sale of current assets of the business would be business income and not capital receipts. Thus sum of Rs. 2,02,25,000 and Rs. 2,02,00,000 are treated as business receipts and taxed as such. As regards the case laws cited by the Ld. AR of the assessee (on account of non-compete fees), the same are distinguishable on facts. In most of the cases (cited by the Ld. AR), the courts have observed that whereby cancellaton of agency, the trading structure of the assessee is impaired, such cancellation results in loss of what may be regarded as the source of the assessee s income, the payment made to compensate for cancellation of the agency agreement is a capital receipt. However, in this case there is no pre-existing contract between the assessee company and Praxair and it is also not a case where there was an existing agency arrangement between the assessee company and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wal. The Managing Agency right given up under that agreement is a capital asset for the firm and therefore, any compensation paid for the extinguishment of that right is a capital receipt. It was also argued that one of the rights that the assessee firm parted with under that agreement was the goodwill of the company which is also a capital asset. Consequently, compensation paid in respect of the same must also be considered as capital receipt. In our opinion the aforementioned arguments are fallacious. The managing agency rights vested with Bagla-Jaipuria Co. Similar is the case so far as the goodwill is concerned assuming that any goodwill had been built up by that time. Bagla-Jaipuria and Co. continues to be in existence. It had not parted with managing agency rights nor its goodwill taken away. What has happened is that the partners representing the assessee-firm in Bagla-Jaipuria and Co. had surrendered their rights in partnership to the remaining partners and obtained certain payments for surrendering their rights. This is not a case of parting with any agency rights. This is really a case of cancellation of a contract which had been entered into in the ordinary course o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid sub-clause ( va ) any amount whether received or receivable in cash or in kind under an agreement for not carrying out an activity in relation to any business is considered as business income. In the Memorandum explaining provisions of Finance Bill, 2002 [wherein clause ( va ) was inserted] it has been clarified as follows: (254 ITR 219 statute). " New provisions for taxing the receipts in the nature of non-competing fees and exclusivity rights . This amendment proposes to insert a new provision in the Income-tax Act, 1961 for charging any sum received or receivable in cash or in kind under an agreement for not carrying out activity in relation to any business; or not to share any know-how, patent copyright, franchise or any business or commercial right of a similar nature or information or technique likely to assist in the manufacture or processing of goods under the head Profits and gains of business or profession. The proposed amendment will take effect from 1-4-2003 and will accordingly apply in relation to the assessment year 2003-04 and subsequent years". Your honour will thus note that the Income-tax Act, 1961 has also recognized the statutory effect of the agreeme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Assuming though not admitting the said ratio was applicable; the appellant fails to appreciate as to how the said decision helps the cause of the revenue. After analyzing the terms and conditions of the transaction in that case, the court held that the amount paid really represented the gift. If the analogy is to be accepted then it would mean that the amount paid by Praxair was a gracious payment in the nature of gift. Such gracious payment in the nature of gift could not be regarded as "revenue income" of the assessee. The said amount, if regarded as gift still represented capital receipt of the assessee not liable to tax. The Assessing Officer has held that the case laws cited by the appellant company were not applicable. Before the Assessing Officer the assessee had relied on the following laws : ( i ) CIT v. Shaw Wallace Co. AIR 1932 PC 138 ( ii ) CIT v. Vazir Sultan Sons [1959] 36 ITR 175 (SC) ( iii ) P.H. Divecha v. CIT [1963] 48 ITR 222 (SC) ( iv ) Kettlewell Bullen Co. Ltd. v. CIT [1964] 53 ITR 261 (SC) ( v ) Karam Chand Thapar Bros. (P.) Ltd. v. CIT [1971] 80 ITR 167 (SC) ( vi ) Gillanders Arbuthnot Co. Ltd. v. CIT [1964] 5 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1] 77 ITD 405 , your honour will note that after taking into account the aforesaid judicial decisions, the Hon ble court held that the amount received for restrictive covenant were capital receipt not liable to tax. The ratio laid down by these judicial decisions fully apply. In the present case, a separate and distinct amount of Rs. 2,02,00,000 was paid by Praxair to the assessee. The said amount was paid for specific restrictive covenant of not carrying on competing business by assessee and its associates for a period of 10 years. During such period, there was total sterilization and impairment of assessee s income yielding appara- tus and therefore the lump sum amount received represented capital receipt not liable to tax. The same view is also expressed by judicial authorities in the following decisions : ( i ) CIT v. Saraswathi Publicities [1981] 132 ITR 207 (Mad.) ( ii ) CIT v. P.K. Das [1958] 34 ITR 729 (Cal.) ( iii ) CIT v. G.D. Naidu [1987] 165 ITR 63 (Mad.) ( iv ) CIT v. P. Mariappa Gounder [1984] 147 ITR 676 (Mad.) ( v ) CIT v. Automobile Products of India Ltd. [1983] 140 ITR 159 (Bom.) All the above decisions clearly support the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee s income earning apparatus. I agree with the submissions of the appellant that the income earning capacity of the appellant from the business of industrial gases was effectively plugged by the non-compete agreement." The appellant was also carrying on the business of marketing its industrial gases in the Southern States of Karnataka and Andhra Pradesh where the assessee was the competitor of Asiatic Oxygen Ltd. M/s Praxair therefore felt that continuance of the said business by the appellant would pose serious competition and threat to its industrial gas business which it had acquired from Asiatic Oxygen Ltd. at a considerable price. M/s. Praxair thought it commercially prudent to buy off the marketing, selling, distribution network including customer base and list of the appellant company so that it would effectively neutralize the threat that the appellant company posed to Praxair. In addition to buying off such network, customers and pending contracts, Praxair also desired to ensure that no threat or competition is posed to its business from the assessee and its associates who also had experience and knowledge in the business of industrial gases. In order to ward of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee agreed not to carry on business activity directly or indirectly in competition to the business carried on by Praxair for a period of 10 years and the amount received for accepting such restrictive covenant which effectively plugged assessee s income yielding capacity for 10 years was capital receipt. This view is well supported by large number of judicial decisions cited in the foregoing. The appellant, therefore, submits that the Assessing Officer be directed to exclude from total income the sum of Rs. 2,02,00,000. 20. In the Paper-book filed, the assessee also furnished copy of the unreported decision of the Calcutta High Court in the case of CIT v. A.S. Wardekar [IT Appeal No. 333 of 2000, dated 3-5-2005] wherein the Calcutta High Court while upholding the order of the Tribunal held that the amount received by the assessee in consideration of accepting restrictive covenant was capital receipt not liable to tax. The Ld. A/R also filed a copy of the decision of A Bench of the ITAT, Kolkata in the case of Asstt. CIT v. Ajay Kumar Kanoria, E/E of Late B. K. Jalan [IT Appeal No. 1707 (Kol.) of 2002, dated 25-3-2004] wherein the ITAT held that Rs. 900 lakhs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idered as void under the Contract Act, yet that fact in itself does not lead to conclusion that the amount received for accepting restrictive covenant is a revenue receipt. In this appeal, therefore, we have to decide the question of taxability of such compensation independent of provisions of the Indian Contract Act. 22. The Hon ble Supreme Court in the cases reported in CIT v. Best Co. (P.) Ltd. [1966] 60 ITR 11 , Kettlewell Bullen Co. Ltd. v. CIT [1964] 53 ITR 261, Madras High Court in the case of CIT v. Saraswathi Publicities [1981] 132 ITR 207, CIT v. G.D. Naidu [1987] 165 ITR 63, CIT v. P. Mariappa Gounder [1984] 147 ITR 676 1 (Mad.), CIT v. TI M Sales Ltd. [2003] 129 Taxman 444, Calcutta High Court in the case of Saroj Kumar Poddar ( supra ) and A.S. Wardekar ( supra ) considered the question of taxability of compensation received by an assessee as a consideration for accepting restrictive covenant of not carrying on competitive business. On due consideration of the nature of restrictive covenant the Courts held that the amount received by an assessee for agreeing not to carry on the competitive business was a capital receipt not liabl ..... X X X X Extracts X X X X X X X X Extracts X X X X
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