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2015 (12) TMI 1187 - DELHI HIGH COURT

2015 (12) TMI 1187 - DELHI HIGH COURT - [2016] 385 ITR 35 - Compensation on termination of joint-venture agreement - whether taxable as income under the Head ‘Capital Gains’ - Held that:- In the present case what stood extinguished as a result of the termination of the JVA was a bundle of rights of the Assessee. This included the right to manufacture computers using HP knowhow and HP labels, trademarks and patents. At the same time it was not as if the Assessee's right to manufacture its own com .....

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result of the termination of the JVA, of the entire bundle of rights not limited to the right to manufacture HP computers. The right of HCL HP to revive manufacturing its computers cannot be construed as a 'transfer' of a right. At the same time HP HCL lost its status as an exclusive distributor of HP products. The transfer, if any, of the intangible assets of the kind described under the JVA could not, at the relevant time, be held to fall within the ambit of the kinds of capital assets that we .....

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to capital gains tax. At the relevant time, there was no provision in regard to determining the cost of acquisition of the above intangible assets for the purposes of computing capital gains tax. - Decided in favour of the Assessee. - ITA 167/2003 - Dated:- 21-12-2015 - S. Muralidhar And Vibhu Bakhru, JJ. For the Appellant : Mr. Raghvendra K. Singh, Junior Standing counsel For the Respondent : Mr. Ajay Vohra, Senior Advocate with Ms. Kavita Jha and Ms. Mehak Gupta, Advocates JUDGMENT Dr. S. Mur .....

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s compensation on termination of joint-venture agreement was not taxable as income under the Head Capital Gains ? Background Facts 3. The facts leading to the filing of the present appeal are that the Assessee, HCL Infosystems Limited ( HIL ), which was initially incorporated as HCL Limited under the Companies Act, 1956 on 17th April 1986, was engaged in the manufacture, distribution and sale of computers and services in India. At that stage most of the computer products being manufactured by it .....

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e JVA 5. On 2nd April 1991 HCL Limited, HP, HPI and a majority of its shareholders which included, Mr. Shiv Nadar, Ms. Kiran Nadar, Roshini Nadar, S.S. Nadar, Shiv Nadar Investments Pvt Ltd. and certain other individuals, viz., Ajai Chowdhry, D.S. Puri, Arjun Malhotra, Y.C. Vaidya and Subhash Arora and the companies and individuals named in Exhibit A attached to the Agreement (hereinafter referred to collectively as the Control Group ) entered into a Joint Venture Agreement ( JVA). The agreement .....

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Packard under the JVA. The joint venture company was accordingly renamed as HCL Hewlett-Packard Ltd ( HCL HP Ltd. ) 6. The basic idea behind the JVA was indicated in the preamble to the JVA. It was that "HCL had been and continues to be recipient of workstation computer technology from HP pursuant to an agreement entered into with Apollo Computers Domain GMBH, a subsidiary of Apollo Computer Inc. (Apollo) which was subsequently assumed by HP when it acquired Apollo." Further, HCL was, .....

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o enter, either directly or indirectly, into any business in India which would be in competition with HCL HP Ltd. For purposes of para 14.3, the manufacture, marketing, sale or support of laptop computers by HCL or its successor in India shall not be considered a breach of this provision so long as such activities occur prior to any similar activities undertaken by the company. In terms of the JVA, the following rights were available to HCL HP Ltd: (a) the right to use the name HP; (b) the licen .....

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P would grant certain limited and restricted rights in HP copyrights, HP trademarks and HP patent rights to the HCL HP Ltd on terms and conditions to be negotiated between the two companies. It was made clear that no such grant shall confer upon HCL, the Control Group or HCL HP Ltd. any rights of ownership whatsoever in HP copyrights, HP trademarks or HP patent rights. In terms of Clause 7.5 of the JVA to the extent certain intellectual property rights used by the computer division of HCL Ltd. w .....

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was separately executed between HP and HCL HP on 30th October/24th November 1992. 10. Clause 2.2 of the JVA stated that in addition to the provisions of Article 12.4, should HP, in its sole discretion, determine that the HCL HP Ltd had breached any trademark or other agreement which has been or may be entered into between HP and HIL or has engaged in any business practices which violate Indian or US Laws or HP s standards of business conduct, or has failed to meet HP s standards of excellence in .....

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HCL HP Ltd were to be deposited into an Escrow and were to be released to HP upon HP s depositing into the Escrow an amount equal to ₹ 46.8 crores, which amount would be distributed to the share shareholders in accordance with their entitlement. 11. The term Annual Business Plan was defined under Clause 1.3 of the JVA as the annual plan of HCL and HPI for the current financial year consisting of a. R & D manufacturing and sales plan; b. The projected profit and loss statement and bala .....

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years after commencement of commercial production by HCL HP Ltd or six years from the effective date which was earlier. The effective date was the date on which the agreement would be finally approved by the Reserve Bank of India ( RBI ). This NCA provided for licencing of HP transfer products, HP patent rights, HP know-how, HP copyrights and HP trademarks. The licence fee was stipulated in the said agreement. 14. The idea behind the NCA was that the parties desired to avoid competition with ea .....

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8377; 4.30 crores at a mutually agreed time. The NCA was to be in force for a period of five years from the effective date. The termination agreement 15. The JVA was terminated by an agreement dated 1st April 1997. The termination agreement was entered into between HP, HCL HP, HPI and the Control Group. It was acknowledged that since the formation of HCL HP, the competitive landscape had changed significantly due to increased investment and interest in India by HP s global competitors. It was ac .....

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It was further stated that HP was to develop a more flexible relationship with HCL HP, fully compensate HCL HP for its agreement to allow HP to develop competing channels of distribution as provided in this and related agreements and provide HCL HP key business and financial support to asset it in the transition period from a licensed manufacturer of HP products to a premier solutions partner as well as strong competitor in a field of multiple HP distributors. HP has, therefore, offered for sale .....

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CL HP s principal business activities. 17. Clause 1 of the Termination Agreement dated 1st April 1997 sets out the offered price by HP to sell all of the shares in HCL HP held by it to all the members of the Control Gupta and to stipulate the time limit within which the offer is to be satisfied. Clause 2 which is relevant for the present case reads as under: 2. HP shall pay to HCL HP as full compensation to HCL HP, its shareholders, creditors and any other interested persons for the past and fut .....

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e million dollars ($9,000,000) (hereinafter referred to as the Final Instalment ). HP s obligations to pay instalments under this Article are expressly conditioned on SAAP s being in full compliance with the terms of this Agreement. 18. The payment of the aforementioned sum by HP to HCL HP was ₹ 60.82 crores, which forms the subject matter of the case. The question is about treating the aforesaid sum as income under the Head Capital Gains . The Assessment order 19. In the assessment order .....

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ent to Finance Act, 1997 also very clearly states that if the extinguishment of the capital right to manufacture is for consideration it will fall under Section 55. The Assessee is, therefore, covered by the provision of Section 45 read with Section 55 of the Income Tax Act, 1961. The intent of the legislative on this issue is very clear. Section 55(2)(1i) has been amended w.e.f. 1.4. 98 in order to ensure payments such as these are brought to tax. Section 55 (2) (ii) states that in such cases, .....

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other. Accordingly, the entire sum received by HCL HP was brought to tax under Section 45 read with Section 55 of the Act as income from capital gain . The order of the CIT (A) 21. The Assessee took the matter in the appeal before the Commissioner of Income Tax (Appeals) [ CIT (A) ]. By an order dated 31st March 2002 the CIT (A) dismissed the appeal as far as the above issue is concerned. The CIT (A) concurred with the AO and held that under the JVA, the Assessee had acquired a bundle of rights .....

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and brand name of HCL computers. Even after termination of the JVA, the Assessee continued to manufacture computers under its own brand name. The sale of the computers for the year ended 31st March 1997 was shown at ₹ 54164.10 lakhs and at ₹ 55993.54 lakhs as on 31st March 1998. Therefore, it could not be said that the Assessee surrendered the right to manufacture computers and had received compensation for it. 23. The amendment to Section 55 (2) of the Act to treat a trade mark or .....

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see. Reference was made to the decision of the Supreme Court in Commissioner of Income Tax v. B.C. Srinivasa Setty 128 ITR 294. Accordingly, the ITAT agreed with the Assessee that the amount received upon termination of the JVA was not taxable as income under the head capital gains . Submissions of counsel 24. It is submitted by Mr. Raghvendra K. Singh, learned counsel for the Revenue, that the Assessee had by its own admission enjoyed a bundle of rights under the JVA including a right to manufa .....

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) (a) with effect from 1st April 1998, the cost of acquisition of the capital asset was rightly taken to be nil by the AO and the capital gains was rightly calculated on that basis. 25. In reply, Mr. Ajay Vohra, learned Senior counsel for the Assessee, submitted that it was not disputed that upon termination of the JVA, the Assessee s business identity underwent a change affecting its income earning apparatus. Its source of income was sterilised. The termination affected the corporate structure .....

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arket the products using the trade mark/HP, which also was extinguished. In fact, simultaneously the parties entered into a distribution agreement whereunder HIL continued to distribute HP products although as an exclusive distributor. Mr. Vohra has placed reliance on a large number of decisions which would be discussed thereafter. The sum received upon termination is a capital receipt 26. Section 45 of the IT Act deals with capital gains . Section 45 (1) states that any profit or gains arising .....

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nt, Kettlewell Bullen & Co. Ltd. ( KBCL ) was a managing agent of six companies including Fort Williams Jute Co. (FWJC). KBCL entered into an agreement with Mugneeram Bangur & Co. (MBC), whereunder MBC agreed to purchase the entire shareholding of KBCL in FWJC; procure repayment of all the loans advanced by KBCL to FWJC and to procure that FWJC will compensate KBCL for the loss of office in the sum of ₹ 3,50,000 after KBCL resigned as its managing agent. KBCL tendered its resignati .....

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hat what is determinative of the nature of a receipt on the cancellation of a contract of agency or office is the extinction or compulsory cessation of the agency or office. Where payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business or deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade .....

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bay Burmah Trading Corporation Ltd (1986) 161 ITR 386 (SC) the Respondent took a forest lease from the Government of Burma. At the relevant time the company held about 15 forest leases for a period of 15 years each. With the commencement of the Second World War, the Government extended the lease for indefinite periods to enable its renewal. On 4th January 1948 the Government of Burma came into existence and the new government nationalized forest exploitation. The government took over 1/3rd of th .....

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ent. These aforesaid tons of logs were sold from time to time and a sum of ₹ 1,35,55,611 was realised which was allocated to four years on an agreed basis. The cost incurred for getting these logs was ₹ 225 per ton. The question was whether the sale proceeds were revenue receipts. It was held that agreement under which the transaction took place did not involve any transaction of sale between the Respondent and the Government. There was merely a barter, viz., an exchange with a trans .....

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unt to a capital receipt in the hands of the recipient. On the other hand, if forest leases were merely stock-in-trade and payments were made for taking over the stock-in-trade, then no question of capital receipt arises. The sum would represent payments of revenue nature or trading receipts. Whether, in a particular case, payments were capital receipts or not would depend upon the facts and circumstances of the case. 29. In Khanna and Annadhanam v. Commissioner of Income Tax (2013) 351 ITR 110 .....

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to represent its work in India. A release agreement was entered on 14th November 1996 under which the Assessee was no longer to represent the foreign firm in India and after which the foreign firm would not refer any work to the Assessee. In consideration of the termination of the services the Assessee received a sum of ₹ 1,15,70,000. The AO took the view that the receipt was taxable as part of the professional income of the Assessee. That decision was reversed by the CIT (A). Thereafter, .....

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rom a reading of the various clauses of the JVA and the other concomitant agreements, as well as the termination agreement, that as a result of the termination of the JVA, the Assessee s income earning apparatus was impaired and its source of income got sterilised. The Court, therefore, concurs with the ITAT that the amount received by the Assessee upon termination of the JVA was in the nature of a capital receipt. Is the amount received taxable as capital gains? 31. In order to determine the ca .....

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culty as determining the cost of acquisition' of an intangible asset. Section 49 deals with the determination of cost with reference to certain modes of acquisition. This is a deeming provision. Under Section 49 (1) (i) to (iv), where the capital asset became the property of an Assessee in any of the circumstances outline thereunder, the cost of acquisition of the asset shall be deemed to be the cost for which the previous owner of the property acquired it. For determining the cost of acquis .....

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n the case of acquisition of such asset by the Assessee by purchase from a previous owner, means the amount of the purchase price; and (ii) in any other case (not being a case falling under sub-clauses (i) to (iv) of Sub-section (1) of Section 49, shall be taken to be nil. 34. While the words "or a right to manufacture" was inserted in clause (a) of sub-section (2) with effect from 1st April 1998, the words or a trade mark or brand name associated with a business was inserted by the Fi .....

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ermits or loom hours, shall be taken to be the purchase price in case the asset is purchased by the Assessee from a previous owner and in any other case such cost shall be taken to be nil. It is proposed to amend clause (a) of sub-Section (2) to provide that the cost of acquisition in relation to a trade mark or brand name associated with a business shall also be taken to be the purchase price in case the asset is purchased from a previous owner and nil in any other case. This amend will take ef .....

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have a purchase price. The expression or right to carry on any business was inserted with effect from 1st April 2003. 36. That the above amendments were intended to be prospective, since there is nothing to the contrary stated therein, is fairly well settled. The decisions in Guffic Chem. P. Ltd. v. Commissioner of Income Tax (2011) 332 ITR 602 (SC) and Commissioner of Income Tax v. Vatika Township P. Ltd. (2014) 367 ITR 466 (SC) are illustrative of this legal position. 37. This has also to be .....

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of April 2003, namely (vii) any sum, whether received or receivable in cash or kind, under an agreement for- (a) not carrying out any activity in relation to any business; or (b) not sharing any know-how, patent, copyright, trade mark, licence, franchise or any other business of commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services. Explanation - For the purposes of this clause - (i) agreement includes .....

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onveying 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. 38. The explanatory notes to the above amendment read as under: It is proposed to insert a new clause (vii) in Section 28 of the Income Tax Act vide Clause 13 of the Bill so as to provide that any sum whether received or receivable in cash or kind, under an agreem .....

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o provide that the said sum received or receivable shall be included within the definition of income as defined in that clause. This amend will take place from 1st April 2003 and will, accordingly, apply in relation to the assessment year 2003-04 and subsequent years. 39. What emerges from the above amendments is that till 1st April 2003 there was no provision under which the capital gains arising from the transfer of a trade mark or brand name associated with a business could be brought to tax. .....

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rmination of the JVA was a bundle of rights of the Assessee. This included the right to manufacture computers using HP knowhow and HP labels, trademarks and patents. At the same time it was not as if the Assessee's right to manufacture its own computers was also taken away by the termination. That stood revived. In any event, there has been no attempt at unbundling the compensation amount, as it were, to determine how much of it pertained to the above constituent rights in the bundle of righ .....

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