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TMI Blog2005 (3) TMI 23X X X X Extracts X X X X X X X X Extracts X X X X ..... als including the applicant. Of the five shareholders two are non-residents - applicant and his wife Mrs. Gunjan Jain - and the remaining three share holders are resident. M/s Vision Healthsource Inc. at Delaware USA, is a non-resident US company (referred to as the "American company"). The applicant, Mrs. Gunjan Jain and Mr. Vishal Gupta held 6,75,000 shares in the American company. They entered into an agreement (styled as Stock Purchase Agreement) for the transfer of entire 6,75,000 shares of the American Company in favour of Perot System Corporation, a Delaware Corporation, USA (referred to as "PSC") and PS BP Services LLC, a Delaware Corporation Limited Company and a subsidiary of PSC (referred to as "PSBV"). It is noteworthy that under the stock purchase agreement there is no element of contingent payment, the entire consideration is to be paid by the closing date. At the same time the Indian company and all its shareholders entered into another agreement to transfer its entire business and share capital in favour of: (1) M/s Perot Systems Investments BV, Netherlands (PSIBV) (taking 99,999 shares); and (2) M/s. Perot Systems BV, Netherlands (PSBV)(taking 1 share) for consider ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er is liable to be charged to capital gains tax, either wholly or in part, in which year of assessment does the liability to pay capital gains tax arise for the following amount received/receivable as consideration for the transfer of the shares aforesaid, which in aggregate amounts upto US $ 9,300,000 termed as purchase price as per clause 1 of the aforesaid Share Purchase Agreement dated 15.04.2003 ? • Initial lumpsum payment equal to US dollar 2,300,000 (referred to in the aforesaid Share Purchase Agreement as the closing payment) received on 1.7.2003 in the previous year relevant to the assessment year 2004-05. • Contingent payments as per clause 1 of the Share Purchase Agreement dated 15.4.2003 (referred to in Exhibit A therein) receivable for each of the three years as noted below having regard to the fact that these amounts, contingent on the existence of EBITDA, can be determined only when the EBITDA as per clause 1 of the said Share Purchase Agreement dated 15.4.2003 relating to the three contingent payments as defined in clause 1 therein, is computed. By whom paid and nature of payment Year in which to be paid Where defined Payer and provider First year Contingent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er Second Year Contingent Payments (each as defined in exhibit A), if any, and • The Payer and the Provider Third Year Contingent Payment (each as defined in Exhibit A), if any. The consideration to be paid by PSN for one share will be 1/1,00,000 of the Purchase Price and the consideration to be paid by PSI for 99,999 Shares will be 1/99,999 (sick) of the Purchase Price."[ It would read 99,999/1,00,000] It is not disputed that the transfer of 1,00,000 equity shares has been approved by the Reserve Bank of India stating that the seller applicant and the other four share holders are entitled to additional sale consideration equivalent to $7 Million over the next 4 years on a pro rata basis subject to the term of meeting revenue targets as agreed to by the sellers and purchasers and that the sale consideration payable to the applicant and Mrs. Gunjan Jain shall be credited to their NRI accounts in India. It is clarified that the actual inflow of FDI in the transaction would be $ 2.3 million. The applicant has also entered into a Non-Competition Agreement under which he would receive a portion of the purchase price in respect of his ownership interest and will also receive substanti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f non-competition fees. In supplementary comments, it is stated that in the return of income filed for the assessment year 2004-05, the assessee did not offer any income under the head capital gains; however, subsequently he filed the working sheet indicating "Nil" income on sale of shares of the Indian company claiming exemption under section 54ED/ 54F of the Act showing investment of $23 million in Nabard Capital Gain Bonds. The applicant left out the amount of $70 million which is taxable under the head "profit and gains of the business" under section 28(va). In the additional comments of the Commissioner, filed after rejoinder of the applicant, it is submitted that the sum of $9.3 million represents composite consideration for transfer of shares and payment for performance ensured non-competition agreement and goodwill. The closing payment constitutes full value of consideration as a result of transfer of shares but the contingent payments are meant for performance ensured by non-competition agreement and are not covered by the provision of section 45. Hence they do not form part of the full consideration and do not fall within the charging section of Section 45 of the Act. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purchaser company, such non-competition agreement is a natural corollary to the employment. In any event the contingent payments cannot be said to be received in the previous year in which the transfer took place and in view of the proviso to section 28(va), the amount is not taxable. 5. Mr. K. Ramalingam, DIT (International taxation), Chennai, appearing for the Commissioner, has submitted that having regard to the provisions of Section 45 of the Act, the full value of consideration for transfer of shares will be taxable in the year in which the transfer took place and merely because payment of a part of the consideration is postponed to a future date, it cannot be said that no capital gains have accrued to the applicant in the previous year. It is, further, contended that to ascertain the true nature of the part of the consideration by way of contingent payments, it is necessary to look into the non-competition agreement as well as the employment agreement which would disclose that contingent payments constitute consideration for performance ensured by non-competition and are taxable as profits and gains of business and on the facts of the case the proviso to section 28(va) of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of capital gains, the full value of the consideration is an important factor; it is from that amount that the aggregate of the expenditure incurred wholly and exclusively in connection with such transfer and the cost of the acquisition of the asset and the cost of any improvement thereto, are deducted. The following provisions, among others, grant relief from payment of tax on capital gains:- Capital gain on transfer of long term capital assets not to be charged in certain cases: 54 EB : (1) Where the capital gain arises from the transfer of a long-term capital asset [before the 1 st day of April, 2000] (the capital asset so transferred being hereafter in this section referred to as the original asset), and the assessee has, at any time within a period of six months after the date of such transfer invested the whole or any part of capital gains, in any of the assets specified by the Board in this behalf by notification in the Official Gazette (such assets hereafter in this section referred to as the long-term specified asset), the capital gain shall be dealt with in accordance with the following provisions of this section, this is to say - • if the cost of the long term specifie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he consideration is agreed to be paid at a future date or is paid in installments over a period, after the previous year in which transfer of the capital asset took place, the capital gains would, nonetheless, be treated as income of the previous year in which the transfer took place irrespective of the actual date of payment of the consideration and any hardship that may be caused to the transferor unless otherwise provided in the Act. In such a case the assessee obviously cannot avail the benefit of the aforementioned provisions. In the absence of any provision in the Act ameliorating the hardship caused in a case of payment of the full value of the consideration beyond the relevant previous year, there is nothing which this Authority can do to relieve the assessee of the hardship. We have seen above that section 48 of the Act speaks of the full value of the consideration which forms the basis for computation of capital gains. What then is meant by the full value of the consideration? This expression is not defined in the Act. However, judicial pronouncements amply spelled out its import. In Commissioner of Income-tax, West Bengal and another vs. George Henderson and Co. Ltd. , ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arties for any purpose may assign to a particular capital asset." In that case the firm of S.B. & Co. agreed to assign the managing agency and 4,736 shares of G.C. Mills to P.G & Co. for Rs.7,51,000/-. Subsequently, the firm sold 65,012 shares held by it in the company together with its managing agency rights at Rs.65 per share, though the market value of the share at that time was Rs.46 per share. For the purpose of computing the capital gains accruing to the assessee who was the partner of the firm, the Income Tax Officer adopted Rs.65 per share as the full value of consideration of shares negativing the contention of the assessee that the full value of the consideration was the market value and that the firm had inflated the value for the shares as it parted with its managing agency also. The Division Bench of the Bombay High Court held that the consideration received by the assessee's firm was really a composite consideration for transfer of the shares and the assignment of the managing agency, and it was not disputed that the real market value of the shares at the time of the sale was only Rs.46 per share, therefore the full value of the consideration should be taken at Rs.46 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the mortgaged property the excise arrears of Rs.1,29,020/- which were due to the Government should be deducted from the sale proceeds and only the balance be paid to the assessee. On reference, the High Court affirmed the decision of the Tribunal holding that to ascertain the real value of the property sold by public auction, the accepted bid amount had to be reduced to the extent of interest that was created in favour of the Government by mortgage. The above discussion leads to the conclusion that the full value of an asset for the purpose of section 48 is the true value bargained for by the parties, which need not necessarily be the market price and should not be an ersatz figure. The apparent consideration would generally represent the price bargained by the parties and therefore it would be the full value of consideration of an asset. However, the possibility of the apparent consideration being composite consideration and not depicting the full value of the consideration has also to be kept in mind. Whether the apparent consideration is the true full value of the consideration is a question of fact which has to be determined on the facts and in the circumstances of each case. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble by the company for a 'cause'. The term 'cause' is defined to include, inter alia, clause (e) - "the failure of the sum of aggregate EBITDA for both the Payer and Provider business for any applicable period set forth in annexure Exhibit A to the purchase agreement to equal or exceed the sum of the Payer Cumulative Threshold EBITDA and the Provider Cumulative Threshold EBITDA for such applicable period, without regard to the allocation between Payer EBITDA or Provider EBITDA. However, where the agreement is terminated for any of the specified cause which does not include the aforementioned clause (e), the applicant will no longer be entitled to any proceeds from future contingents payments payable under the purchase agreement including without limitation any contingent payments and if he had already received any such payment, he is obliged to pay back the amount immediately to the company. The non-competition agreement also includes a clause identical to clause (e) in the employment agreement, quoted above. Clause (4) of the employment agreement refers to "non-competition agreement" which in turn mentions that the applicant will receive a portion of the purchase price in respect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 28. The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession - (i) to (v) : xx xx xx xx xx x xx xx xx xx xx [(va) any sum, whether received or receivable, in cash or kind, under an agreement for - • not carrying out any activity in relation to any business; or • not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services: Provided that sub-clause (a) shall not apply to- • any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head "capital gains"; • any sum received as compensation, from the multilateral fund of the Montreal Protocol on Substances that Deplete the Ozone layer under the United Nations Environment Programme, in accordance with the terms of agreement entered into with the Government of India . Explanation - For the purposes of this clause - • "agreement" inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unnecessary to refer to the proviso in the light of the above discussion. Had it not been necessary to pronounce a ruling on question No. (3), as to under what head of income the contingent payments made to or received by the applicant would be chargeable, we would have allowed the discussion to rest with the aforementioned conclusion. This aspect is however, not adverted to by the parties. We have already opined that contingent payments have a real nexus with the employment agreement and not with non- competition agreement much less with the purchase agreement as the second part of consideration thereunder. We shall only add here that the period over which contingent payments are spread over and the period of employment agreement is almost the same. Contingent payments are, in our view, nothing but in the nature of incentives remuneration for achieving the target. They would, therefore, fall under section 17(1)(iv) which reads as follows:- "Salary", "perquisite" and "profits in lieu of salary" defined Section 17. For the purposes of sections 15 and 16 and of this section - (1) "salary" includes - (i) to (iii) x x x x x x x (iv) any fees, commissions, perquisites or profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the one-fourth share in the profits earned by the employer in addition to his salary. The additional amount was initially treated by the assessing officer as business income but later proceedings were initiated under section 154 of the Act to treat the said amount as salary. The Appellate Assistant Commissioner and the Income-tax Appellate Tribunal declined to interfere with the proceedings under section 154 of the Act. On reference to the High Court, the division bench of the Madras High Court held that the said amount of Rs. 25,233/- was remuneration received under the service agreement and was assessable as salary. In M. Krishna Murthy and Others v. Commissioner of Income-tax, A.P. Hyderabad and others 7 , the division bench of the Andhra Pradesh High Court had to consider, inter alia, the question whether the amount received by an employee on encashment of leave will fall within the meaning of profit in lieu of salary under section 17(3)(ii) of the Act. It was held that leave encashment satisfied all the essential ingredients of section 17(3)(ii) and would therefore fall within the meaning of salary. In the case of Commissioner of Income-tax v. B. Chinnaiah and others 8 , th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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