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Income Tax Officer Versus Smartchem Technologies Ltd.

2016 (8) TMI 559 - GUJARAT HIGH COURT

Non-compete fees payment - whether an allowable business expenditure of revenue? - Held that:- In the present case, the “Non-compete fees” paid by the assessee company to the transferor company under an agreement where the transferor company shall not directly or indirectly manage, operate or have an interest in control or participate or compete against the assessee anywhere in the world for five years. Thus, the expenditure incurred primarily and essentially related to the non-competition of th .....

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is answered in favour of the assessee - Tax Appeal No. 128 of 2006 - Dated:- 13-7-2016 - KS Jhaveri And G. R. Udhwani, JJ. For the Appellant : Mr KM Parikh, Advocate For the Opponent : Mr Manish J Shah, Advocate JUDGMENT ( Per : Honourable Mr. Justice KS Jhaveri ) 1. By way of this appeal, the revenue has challenged the order of the Income Tax Appellate Tribunal, Ahmedabad Bench C , Ahmedabad, (For short, the Tribunal ) in ITA No.3955/Ahd/2003 dated 28.7.2005, whereby the Tribunal has reversed t .....

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such notice, reply was filed by the assessee. During the course of assessment proceedings, the Assessing Officer had noticed that the assessee-company, which was formerly known as Arlem Investment & Finance Ltd had during the previous year relevant to Assessment Year 2001-02, acquired an Industry/Plant Manufacturing Nitric Acid (NA) & Ammonium Nitrite (AN) belonging to another company styled as M/s. VBC Industries Ltd. for a total consideration of ₹ 29 crores. The Industry/Plant so .....

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hich the assessee paid a lumpsum of ₹ 6 Crores to them. The relevant part of the Agreement so entered into has been discussed by the Revenue Authorities in their respective order and, therefore, need not to be reproduced here. In the books of account, the assessee wrote off 1/5th of the expenditure of ₹ 6 Crores because the period during which agreement was to remain in force was five years, but in computation of income furnished along with return the assessee claimed whole of the ex .....

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framed:- Whether on the facts and circumstances and in law the ITAT was right in holding that the payment of ₹ 6 Crores made by the Assessee, as Non-compete fees, to VBC Industries Ltd. and other was an allowable business expenditure of revenue nature incurred by the assessee? 4. Mr.K.M.Parikh, learned advocate for the appellant submitted that Clauses 1, 2 and 3 of the Non-Competition Agreement dated 22.3.2000 are required to be considered for the purpose of deciding this appeal. Said clau .....

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request of the Assignees the Assignors have agreed to grant to the Assignees as per the BPA and that the Assignors are bound to grant to the Assignees a covenant to non-compete in the said business transferred under the BPA i.e. manufacture and/or selling and/or trading of Nitric Acid and Ammonium Nitrate directly and/or indirectly for a period of 5 (five) years. 3. The parties hereto have desired and do hereby record the terms and conditions of the non-compete agreement as follows:- NOW THIS A .....

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e an interest in, control or participate in the ownership, management, operation or control of, or be otherwise connected in any manner with, any corporate, partnership, proprietorship, trust, estate, association or other business entity which directly or indirectly engages, as a commercial activity anywhere in the World in the Business or any business similar to the Business; (ii) The Assignors' and Individual shall not in any manner whatsoever render, sell, supply, market or distribute, ad .....

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ation in any manner and form whatsoever for the purpose of and/or relating to the rendering, selling, supplying, marketing or distributing of products or services constituting part of the Business including rendering any assistance for the purpose of improving, modifying, upgrading or making any betterment to any existing process, know-how, software methodology or technology whatsoever for the purpose of and/or relating to the manufacturing, selling, supplying, marketing or distributing of the s .....

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nature of creating enduring benefit and, therefore, the same is capital investment. 4.2 He has relied upon the decision of the Apex Court in Guffic Chem P. Ltd. v. Commissioner of Income Tax, Belgaum and Another reported in 332 ITR 602 (SC), wherein it is held as under:- 7. Two questions arose for determination, namely, whether the amounts received by the appellant for loss of agency was in normal course of business and therefore whether they constituted revenue receipt? The second question whi .....

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rpreted the judgment of this Court in Gillanders' case (supra). In the present case, the Department has not impugned the genuineness of the transaction. In the present case, we are of the view that the High Court has erred in interfering with the concurrent findings of fact recorded by the CIT(A) and the Tribunal. One more aspect needs to be highlighted. Payment received as non-competition fee under a negative covenant was always treated as a capital receipt till the assessment year 2003-04. .....

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ed under Non-Competition Agreement became taxable as a capital receipt and not as a revenue receipt by specific legislative mandate vide Section 28(va) and that too with effect from 1.4.2003. Hence, the said Section 28 (va) is amendatory and not clarificatory. Lastly, in Commissioner of Income- Tax, Nagpur v. Rai Bahadur Jairam Valji reported in 35 ITR 148 it was held by this Court that if a contract is entered into in the ordinary course of business, any compensation received for its terminatio .....

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competition agreement with effect from 1.4.2003. 5. On the other hand, learned counsel for the respondent has supported the impugned order passed by the Tribunal and submitted the Tribunal has not committed any error while passing the impugned order. 6. We have heard learned counsel appearing for both the sides. We have also perused the material on record as well as the impugned order. We have also gone through the judgments relied upon by the learned advocates. The Tribunal reversed the finding .....

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Every case has to be decided on its own facts, keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred. But a few tests formulated by the courts may be referred to as they might help to arrive at a correct decision of the controversy between the parties. One celebrated test is that laid down by Lord Cave L.C. in Atherton v. British Insulated and Helsby Cables Ltd. [1925] 10 TC 155, 192 (HL), where the learned Law Lord stated: "........ .....

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and, as pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1965] 58 ITR 241 (PC), it would be misleading to suppose that in all cases, securing a benefit for the business would be, prima facie, capital expenditure so long as the benefit is not so transitory as to have no endurance at all. There may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit, may, none the less, be on revenue account and the test of endur .....

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duct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case. But even if this test were applied in the present case, it .....

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, the additional working hours per week transferred to the assessee have to be utilised during the week and cannot be carried forward to the next week. It is, therefore, not possible to say that any advantage of enduring benefit in the capital field was acquired by the assessee in purchasing loom hours and the test of enduring benefit cannot help the revenue. Another test which is often applied is the one based on the distinction between fixed and circulating capital. This test was applied by Lo .....

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clearly referred to the acquisition of an asset which falls within one or the other of these two categories, such a test would be a critical one. But this test also sometimes breaks down because there are many forms of expenditure which do not fall easily within these two categories and not infrequently, as pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1965] 58 ITR 241 (PC), the line of demarcation is difficult to draw and leads to subtle dist .....

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is test, it would not be possible to characterise the amount paid for purchase of loom hours as capital expenditure, because acquisition of additional loom hours does not add at all to the fixed capital of the assessee. The permanent structure of which the income is to be the produce or fruit remain, the same; it is not enlarged. We are not sure whether loom hours can be regarded as part of circulating capital like labour, raw material, power, etc., but it is clear beyond doubt that they are not .....

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ight to produce a larger quantity of goods and to earn more income and this, according to the revenue, amounted to acquisition of a source of profit or income which though intangible was nevertheless a source or " spinner " of income and the amount spent on purchase of this source of profit or income, therefore, represented expenditure of capital nature. Now it is true that if disbursement is made for acquisition of a source of profit or income, it would ordinarily, in the absence of a .....

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ture of relaxation of restriction on working hours imposed by the working time agreement, so that the assessee could operate its profit-earning structure for a longer number of hours. Undoubtedly, the profit-earning structure of the assessee was enabled to produce more goods, but that was not because of any addition or augmentation in the profit-making structure, but because the profit-making structure could be operated for longer working hours. The expenditure incurred for this purpose was prim .....

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present context, the analogy of quota right may not be inappropriate. Take a case where acquisition of raw material is regulated by quota system and in order to obtain more raw material the assessee purchases the quota right of another. Now, it is obvious that by purchase of such quota right, the assessee would be able to acquire more raw material and that would increase the profitability of his profit-making apparatus, but the amount paid for purchase of such quota right would indubitably be re .....

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h would enable the assessee to operate the profit-making structure for a longer number of hours than those permitted under the working time agreement would also be part of the cost of performing the income earning operations and hence revenue in character. When dealing with cases of this kind where the question is whether expenditure incurred by an assessee is capital or revenue expenditure, it is necessary to bear in mind what Dixon J. said in Hallstorm's Property Ltd. v. Federal Commission .....

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duct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure. See Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52 (SC). The same test was formulated by Lord Clyde in Robert Addie and Sons' Collieries Ltd. v. IRC [1924] 8 TC 671, 676 (C Sess .....

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out as part of the process of profit earning. It was, to use Lord Sumner's words, an outlay of a business " in order to carry it on and to earn a profit out of this expense as an expense of carrying it on ". [John Smith and Son v. Moore [1921] 12 TC 266, 296 (HL)]. It was part of the cost of operating the profit-earning apparatus and was clearly in the nature of revenue expenditure. It was pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines L .....

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present one that we can find is Nchanga Consolidated Copper Mines'case [1965] 58 ITR 241 (PC). The facts of this case were that three companies which were engaged in the business of copper mining formed a group and consequent on a steep fall in the price of copper in the world market, this group decided voluntarily to cut its production by 10 per cent. which for the three companies together meant a cut of 27,000 tons for the year in question. It was agreed between the three companies that fo .....

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this payment was in the nature of capital expenditure or revenue expenditure. The Privy Council held that the compensation paid by the assessee to company B in consideration of the latter agreeing to cease production for one year was in the nature of revenue expenditure and was allowable as a deduction in computing the taxable income of the assessee. Lord Radcliffe, delivering the opinion of the Privy Council, observed that the assessee's arrangement with companies R and B " out of whic .....

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o company B for acquiring an advantage by way of entitlement to produce more goods notwithstanding the cut of 10 per cent. was regarded by the Privy Council as revenue expenditure, a fortiori, expenditure incurred by the assessee in the present case for purchase of loom hours so as to enable the assessee to work the profit making apparatus for a longer number of hours and produce more goods than what the assessee would otherwise be entitled to do, must be held to be of revenue character. The dec .....

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ers of the assessee-company and these features severely handicapped the assessee-company in the development of its trading activities. The House of Lords held that the expenditure incurred for obtaining the revised charter eliminating these features which operated as impediments to the profitable development of the assessee-company's business was in the nature of revenue expenditure since it was incurred for facilitating the day-to-day trading operations of the assesseecompany and enabling t .....

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