TMI Blog2005 (3) TMI 23X X X X Extracts X X X X X X X X Extracts X X X X ..... vate Ltd. (for short the "Indian company"), incorporated under the Companies Act 1956. The Indian company carries on business in information technology enabled services involving processing of medical billing and medical insurance claims. The authorised capital of the Indian company is Rs. 10,00,000/- which is divided into 1,00,000 equity shares of Rs. 10 each. The entire share capital is held by five individuals 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e applicant was asked to re-frame the questions. The re-framed questions are as under: • Whether the gains arising from the transfer of 15,000 equity shares in Vision Health Source India (P) Ltd. covered by the Share Purchase Agreement dated 15.4.2003 read with Exhibit "A" and "B" thereto is chargeable to capital gains tax or not, either wholly or in part ? • If the aforesaid gains arising from the above transfer 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 y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5 th April, 2003, PSIBV undertook to purchase 99,999 shares and PSBV agreed to purchase 1 share from the said shareholders. The purchase price mentioned in clause 1.3 of that agreement is as follows: "PSI and PSN will pay an aggregate amount of up to US $ 93,00,000/- which consists of the following: • an amount equal to US $ 23,00,000 (closing payment) • the Payer and the Provider First Year Contingent Payments (each as defined in Exhibit A), if any. • The Payer and the Provider 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , therefore, the same is liable to be taxed under section 28(va) of the Act. By linking capital gains with non-competition fees, the applicant has attempted to claim the benefit of lesser rate of tax. It is, however, added that the contingent payments depend upon the performance of the company and they are not in the nature of capital gains so they are taxable under the head "profit and gains of the business". The transaction of sale of shares is designed, prima facie, to avoid taxation of 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 repre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fer; in view of the contingent payments the capital gains if any arising could not be so invested and thus the applicant will be deprived of the benefit of the said provision. He has argued that the plea of the Revenue that consideration by way of contingent payments would be taxable as payment for non-competition under section 28(va) of the Act, is untenable as the non-competition agreement is not subject to earning future profit by the company and as the applicant has been employed by the 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her with the cost of improvement thereto and the expenditure incurred wholly and exclusively in connection with such transfer. Thus it is clear that irrespective of mode of payment of the consideration for the transfer of a capital asset, capital gains arising from such transfer are deemed to be the income of the previous year in which the transfer took place and are chargeable to income-tax in the assessment year relevant to the said previous year. It is important to note that for the purpose of computation 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 refer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lear that the germane condition to claim the relief, provided therein, from payment of tax on capital gains, is that the assessee should invest the whole or any part of capital gains, as the case may be, in the long term specified asset within six months after the date of transfer of the capital asset. Where the full value of the consideration is paid before or immed i ately on transfer of the capital asset in the previous year in which such transfer takes place, no difficulty arises. Where, however, the full value of the 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 b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es and securities was only rupees seventy-five lakhs. The facts of this case squarely falls within the rule laid down by this court in Commissioner of Income-tax vs. George Henderson and Co. Ltd. " Chagla,C.J. illustrated the meaning of the expression in Baijnath Chaturbhuj And Another v. Commissioner of Income-tax, Bombay City II 3 , thus: "It is erroneous to suggest that the full value is necessarily the value which the parties place upon a capital asset. The value must be the true value, not any artificial value, which parties 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... property in public auction and realized a sum of Rs.5,62,980/-. The assessee contended that the amount of Rs.1,29,020/- which was due to the Government, ought to be deducted from Rs.5,62,980/- in computing the capital gains. This plea was rejected by both the Income-tax Officer as well as Income-tax Commissioner. However, the Income-tax Appellate Tribunal accepted the contention of the assessee and took the view that the assessee held the property subject to mortgage or charge for the amount due to the Government. On the sale of 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 sho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsideration. This plea necessitates a careful reading of the stock purchase agreement, associate employment agreement with the applicant (Exhibit B) and the share purchase agreement which are contemporaneous because from the share purchase agreement alone, the true nature of the second part of the consideration cannot be ascertained. The employment agreement is for the period commencing from 2003 (no specific date is noted in Ex. B - the copy of the associate employment agreement) and ending on 31 st December, 2006 which is terminable 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 proc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and substance for achieving the target of EBITDA. We are, therefore, of the view that the consideration mentioned in the purchase agreement is a composite consideration and that the closing payment alone represents the full value of the consideration for the said agreement for purposes of section 48 of the Act. This conclusion takes us to the question of taxability of contingent payment; as to whether they are taxable under section 28(va) of the Act. The said provision reads as under: Profits and gains of business or profession. 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 receiv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rrying out any activity in relation to any business'. Under the non-competition agreement the remedy for violation of its terms and conditions, is to obtain an order of injunction against the applicant whereas under the employment agreement the consequence of failure of specified cause is termination of that agreement coupled with not making further contingent payments as well as refunding amounts of such payments if already received. It follows that contingent payments, referred to above, do not fall under clause (va) of Section 28 of the Act. It is 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contingent payments satisfy all the aforementioned requirements, therefore, they would, in our view , fall within the purview of salary. It would be useful to refer to the following decision which would elucidate the point:- In VR.C.RM. Adaikkappa Chettiar v. Commissioner of Income-tax, Madras 6 , under the agreement of service the assessee-employee was entitled to a fixed salary of Rs. 1000/- per month; in addition he was entitled one-fourth share of the profit earned by the employer from his partnership business. The assessee-employee received Rs. 25,233/- towards 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 salar ..... X X X X Extracts X X X X X X X X Extracts X X X X
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