2008-Tiol-08-Itat-Del-Sb

2008-TIOL-08-ITAT-DEL-SB

IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : NEW DELHI
(SPECIAL BENCH)

ITA No. 3104(Del)/2004
Assessment Year : 1998-99

SHRI SAURABH SRIVASTAVA
C-482, DEFENCE COLONY, NEW DELHI

Vs

Dy COMMR OF INCOME-TAX
CIRCLE-46(1), NEW DELHI

Shri Vimal Gandhi, President, Sh. Jonginder Pall, AM and Sh. A D Jain, JM

Dated : December 7, 2007

Appellant Rep. by : Shri Ajay Vohra, Adv. & Ms. Anju Dudeja, CA
Respondent Rep. by : Sh. Durga Charan Dash, CIT(DR), Amit Govil, DR & Smt. Y.S. Kakkar, DR

Income Tax - Assessee, a computer engineer, runs a software company - sells his entire stake to a non-resident company and pays capital gains on the consideration received fromn transfer of shares - However, the non-compete fee received for not competing against the company or working with any other company which could be a competitor in the same type of business was claimed to be a capital receipt - AO disallows the same on the ground that the assessee did not lose his source of income as he was hired to remain Managing Director of the same company and the curbs imposed are only for a temporary period - CIT (A) agrees with the AO and the issue finally goes to the Special Bench after the Members referred the issue to the President following a difference of opinion - Going by the facts it is clear that the nature and character of the non-compete fee received by the assessee was for undertaking restrictive covenant to compete with the business of the assessee directly or indirectly and such a payment did not spring from relationship of an employer and employee; the nature and scope of activities spelt out in the new services agreement was different and independent from the non-compete agreement and therefore, not linked directly or indirectly with the employment of the assessee as Managing Director of the Company and thus the non-compete fees is not taxable under the head 'Income from salary' - The non-compete fee is also not taxable under section 28(ii) and 28(iv) of the Act because the assessee was not carrying on any business or profession - Such receipt is also not liable to tax under the head 'Capital Gains' or 'Income from other sources' as it was capital in nature and hence, not liable to tax under any head of income mentioned u/s 14 of the Act - The receipt of a non-compete fees under an agreement has been specifically made taxable under clause (va) of section 28 inserted by the Finance Act, 2002 w.e.f. 1.4.2003 and the legislature has thought of making such amendment applicable from assessment year 2002-2003 and, Therefore, the same is not applicable to the assessment year under consideration.

ORDER

Per : Jonginder Pall :

This appeal of the assessee has been filed against the order of the Commissioner of Income tax (Appeals) (In short 'the CIT(A)'), New Delhi, for the assessment year 1998-99 and the following question has been referred to this Special Bench for its decision :

"Whether, the non-compete fee received by the assessee from FI Plc., U.K. is not liable to tax being in the nature of capital receipt?"

2. The material facts relevant to the question referred to this Bench are that the assessee was a Computer Engineer associated with Software and Information Technology. He was the promoter and founder of as well as the Managing Director in one Software Company, viz M/s. IIS Infotech Ltd. He held 8,66,450 shares of the said company. The said company was agreed to be taken over by the FI Group Plc. UK and as per the shares purchase agreement dated 4.12.1997 entered into by the U.K. company with the shareholders of M/s. IIS Infotech Ltd, including the assessee, 76% of the subscribed equity capital was agreed to be transferred in favour of the U.K. company by the shareholders in order to effect the said take over. In terms of the said agreement, the assessee sold 8,66,450 shares of M/s. IIS Infotech Ltd to the U.K. Company. The assessee filed return of income for the assessment year under consideration on 31.10.1999 declaring therein total income of Rs.38,29,590/-. In the return, the assessee had shown long-term capital gain of Rs. 8,71,21,723/- on the said sale of 8,66,450 shares of M/s. IIS Infotech Ltd to the U.K. company, in respect of, which exemption was claimed under section 54EA of the Income Tax Act, 1961 (for brevity 'the Act'). In addition to the share transfer agreement, the FI Group also entered into a non-compete agreement with the assessee on the same date, i.e., 4.12.1997, whereby the assessee received a sum of Rs. 1,07,36,570/- during the financial year 1997-98 relevant to the assessment year under consideration. A similar instalment of 1,69,000 £ (Pound sterling) was to be received by the assessee in the subsequent financial year 1998-99 relating to the assessment year 1999-2000. Although the assessee had paid advance tax and self assessment tax in respect of the non-compete fees of Rs.1,07,36,570/- yet in the return of income filed, the assessee claimed exemption in respect of the non-compete fees as being a capital receipt. The assessee also entered into yet another new service agreement with M/s. IIS Infotech Ltd., on 24.02.1998, i.e., after the said company was taken over by the U.K. Company, whereby, the assessee was employed as the Managing Director of the U.K. Company. The salary income received from the said Company in terms of the said agreement was also shown in the return of income filed for the assessment year under consideration. The return filed was processed under section 143(1). However, subsequently, the AO initiated proceedings under section 147 by issue of a notice under section 148 on 31.01.2003, for the reason that the non-compete fees received by the assessee was a revenue receipt liable to tax. In response to such notice, the assessee filed a return on 3.3.2003 declaring the same income as shown in the original return. During the course of assessment proceedings, it was submitted before the AO that as per the Non-Compete Agreement (In short, 'the NCA') entered into with the U.K. Company on 4.12.1997, the assessee was restrained from carrying out any soft-ware development activity for any other person who directly competed with FI and its associate and subsidiary companies in the U.K., the USA, Singapore, Japan and India, for a period of 18 months and the amount of Rs. 1,07,36,570/- paid to him as compensation was in the nature of non-compete fees. Thus, it was contended that the non-compete agreement put a restriction on carrying on any soft-ware development activity for any other person and, therefore, the said amount was a capital receipt. However, the AO took notice of the subsequent services agreement entered into with M/s. IIS Infotech Ltd after the take over, on 24.02.1998, whereby, the assessee continued to be the Managing Director of the Company. He also took notice of the fact that restrictions imposed were only for a limited period of 18 months and these were not absolute restrictions on running any business or such activity by the assessee. He observed that the only limitation undertaken by the assessee was not to harm the business interest of M/s. FI Group Plc. UK. The AO also observed that the very fact that the assessee received a lump sum payment did not make the receipt as that of a capital nature. He also observed that the assessee was not running, or carrying on any business. He was working in the capacity of Managing Director of M/s. IIS Infotech Ltd before entering into non-compete agreement with U.K. Group and continued to work in that capacity after its take over by the U.K.Group. His capacity to work or earn income was not affected adversely because of the non-compete agreement and there was no loss of source of income to the assessee. The AO also referred to the various judgments of the courts relied on by the assessee and observed that the facts of those cases were distinguishable from the facts of the present case. Therefore, the AO held that the ratio of those judgments was not applicable to the facts of the present case. Thus, he rejected the claim of the assessee that the non-compete fees of Rs. 1,07,36,570/- was a capital receipt. Accordingly, the AO held that the amount in question was a revenue receipt liable to tax under section 28(ii) of the Act. In this manner, the AO made an addition of Rs. 1,07,36.570/-.

3. Being aggrieved, the assessee filed an appeal before the CIT(A), where the action of the AO for initiating the proceedings u/s 147 was inter-alia challenged. The submissions made before the AO were reiterated. However, the Ld. CIT(A) upheld the action of the AO for initiating the proceedings u/s 147, by observing that the information with the AO was sufficient to entertain as ex-facie belief that income chargeable to tax had escaped assessment. As regards the merits of the case, the Ld. CIT(A) took notice of the fact that as per the share purchase agreement dated 4.12.1997 with the U.K. Group, the shareholders transferred 76% of the subscribed equity capital to the Indian Company at the agreed price of Rs. 100.90 per share. The assessee was also promoter, founder and the Managing Director of the Indian Company. He also observed that as per the non-compete agreement of the same date made by the U.K. group, the assessee was restrained from engaging in or carrying on any activity or business, which directly competed with M/s. FI. U.K. Group, its associate and subsidiary companies in the U.K., the U.S.A., Singapore, Japan and India. However, the Ld. CIT(A) observed that the assessee continued to work with the group as Managing Director after the take over and therefore, was not, in effect, restrained or inhibited from exploiting his talent to the full, much less from sterlising his income earning apparatus and that in fact, the assessee received a much higher salary and other benefits from the U.K. Group after its take over. He also noticed that the very fact that the nomenclature given in the agreement was 'non-compete agreement', would not change the character of the receipt and, that therefore, the same was a revenue receipt. While taking such a view, the Ld. CIT(A) referred to the decision of his predecessor in the case of Shri S. Dhanbal, another shareholder and a Director of M/s. IIS Infotech Ltd., who too had received a similar amount by way of non-compete fees. The said Director also continued to work for the U.K. based company after its take over and the amount paid was held to be a revenue receipt. It was also held that the so-called non-compete agreement was a collusive and self serving document executed with the sole purpose to evade income-tax. Thus, the action of the AO was upheld. Hence, this appeal before the Tribunal.

4. The Ld. Counsel for the assessee, Sh. Ajay Vohra submitted that the assessee is a computer engineer and has been actively associated with computer software and information technology through his association with a variety of companies and industry associations. The assessee was having a considerable expertise, skills and experience in the knowledge of the business and supply of information technology and computer software products, application and services, etc. The assessee was a promoter and founder of M/s. IIS Infotech Ltd, i.e., "the Indian Company" engaged in the business of computer software development. He was also appointed as Managing Director of the Company since its inception. He submitted that the FI Group Plc. (In short 'FT), a U.K. based public limited company, was engaged in the supply of computer software to major organisations whose business depended mainly on information technology. In order to increase its capacity, facilitate further growth and establish an overseas service provider within the group, the said company evinced interest to take over the Indian Company and entered into a share purchase agreement dated 4.12.1997 with the major shareholders of the Indian Company to purchase 76% of the subscribed equity capital of M/s. IIS Infotech Ltd at an agreed price of 100.90 per share. This agreement was subject to approval from the Govt. of India, the Reserve Bank of India, etc. The Share Purchase Agreement (SPA) was at an arm's length and it is not the allegation of the Revenue that the same was a collusive arrangement. He submitted that shares were purchased at the same rate at which other shareholders also sold the shares to the F.I. Group.

4.1. Shri Vohra further submitted that simultaneously, the FI group U.K. also entered into a non-compete agreement on 4.12.1997 with the assessee and three other Directors of the Company, viz., S/Sh. Rohitsava Chand, S. Dhanabal and Mohit Goyal. A copy of the said agreement is placed at pages 40 to 49 of the paper book. He submitted that as per non-compete agreement, the assessee and three other directors were restrained from engaging in or carrying on any activity or business, which directly competed with the FI Group, its associates and subsidiary companies in the U.K., the U.S.A., Singapore, Japan and India. Besides, the Directors agreed to various restrictive covenants under the said agreement. This agreement was separately signed by each of the four Directors/Managing Director, i.e., the assessee. He submitted that the non-compete agreement was made effective for a period of 18 months. He submitted that clause (d) of article 8.1 of the share purchase agreement contained an obligation of the sellers, as per which, each of the four Directors, viz., S/Sh. Rohitsava Chand, the assessee, S. Dhanbal and Mohit Goyal shall enter into contracts of employment with the company in the agreed form and remain in employment of the company as per the terms and conditions, except if prevented by disability or death. In consideration of the non-compete agreement, each of the four Directors was to receive from the FI Group, U.K., a sum of 1,69,000/- £ (pounds sterling) each on the completion date (i.e., on completion of the share purchase agreement) and on 31st May, 1999, along with interest accrued thereon. An amount of Rs. 1,07,36,570/- was received in the accounting year relevant to the assessment year under consideration. He submitted that subsequently the assessee entered into a fresh service agreement dated 24.02.1998 with M/s. IIS Infotech Ltd; ( a copy placed at pages 50 to 67 of the paper book) whereby, the assessee was appointed as Managing Director of the Company after its take over. Sh. Vohra submitted that the execution of the services agreement was not dependent on payment of the non-compete fees. The other two directors, namely, Sh. S. Dhanbal and Mr. Mohit Goyal also entered into a fresh service agreement on 24.02.1998. However, Shri Rohitsava Chand did not accept the new service agreement and opted out of employment of the company once there was a change of its ownership. Nevertheless, Sh. Rohitsava also received non-compete fees as per agreement dated 4.12.1997. He submitted that like the assessee, Sh. Rohitsava also claimed the first instalment of the non-compete fees as capital receipt. This claim of the assessee was accepted for the assessment year 1998-99. However, for the subsequent assessment year 2000-01, the AO rejected the claim of the assessee for capital receipt and held that since the assessee was not carrying on any business of computer software, there was no question of the foreign company putting any restrictions on him through a non compete agreement. The Ld. AR submitted that the AO further referred to the definition of the term 'income' in clause 24 of section (2) and observed that the same was inclusive in nature and the same took into account not only income in its normal connotation, but also other receipts, to save artificial categories of income. Thus, the AO held that such income was liable to tax as income from other sources. He submitted that in appeal, the Ld. CIT(A) upheld the action of the AO. When the matter was carried in appeal before the Tribunal, the ITAT, Delhi 'B" Bench in ITA No. 4713(Del)/2003, for the assessment year 2000-2001, held that no dent was made in the income earning apparatus of the assessee through a non-compete agreement and, therefore, non-compete fees was a revenue receipt. A copy of the order of the Tribunal is placed at pages 173 to 227 of the paper book. However, the Tribunal has not clarified that if it is a revenue receipt, under what head of income the same is liable to tax.