The question whether a particular receipt has been a revenue receipt or a capital receipt has constantly been inviting the attention of tax payers, the law makers, the tax advisors and the Courts. The controversy around this concept has been there in the taxing laws, occupying a long list of litigation judgment by various Courts. Before going ahead for discussion on this issue one has to look and understand the exact meaning of a capital receipt and a revenue receipt.
Meaning of Capital receipt and Revenue Receipt
The Income Tax Act 1961 (The Act) does not provide any definition for the terms capital receipt and the revenue receipts. In the absence of the any definition of word in the Statue books, to help in deciding the meaning of that word one has to look at the meaning available beyond the statue books. The definition provided by various courts decision and the dictionary meaning of the word have been world wide accepted by the judiciary to reach a conclusion on the meaning of such words. The definition of capital has been provided by various dictionaries. The Shorter English Dictionary defines the word capital as following –
Capital means “Accumulated wealth employed reproductively” and revenue means “the return, yield or profit of any lands property or any other important source if income; that which comes in to one as a return from property or possessions; income from any source.
Following the above meaning various courts have interpreted the word capital and revenue in the light of the context and the factual situation. The capital has been interpreted to be a part the earnings which are retained by the owner over a period of time for generating the revenue income.
A receipt which is capital in nature is not taxable in the hands of the person receiving it while the revenue is taxable. Certain capital receipts are taxable in the hands of the assessee which are covered under the head capital gains arising from the transfer of certain capital assets. The other kind of capital receipt which are not covered under the head capital receipt, are not treated as taxable in the hands of the receipt. This has led to a fierce controversy as to what is capital receipt and what is revenue. Form the various decided cases a general rule can be drawn a receipt which is received in lieu of source of income is a capital receipt while the a receipt only in lieu of income, will be a revenue Income. To clarify it further the interpretation provided by Supreme Court in the case of Kailas Rubber & Co Limited 60 ITR 435 can be of great help. The Assessee in this case is a company which owned a rubber estate purchased by it along with the plantation thereon. The estate included rubber trees which, at the time of purchase, were in a condition of producing latex. The rubber trees were sold by the company after they ceased to yield latex any further. the Assistant Commissioner of Agricultural Income-tax, by his order dated February 2, 1962, included the sum of Rs. 8,532.50 representing the sale proceeds of rubber trees which were cut down and sold after they became useless. The Apex court in this case while rejecting the plea of the department has observed as following
“Admittedly, the respondent did not grow the rubber trees for the purpose of selling them. It was getting income from these rubber trees in the shape of latex. In course of time the rubber trees became old and unyielding. When the trees were no longer productive of latex, the respondent felled them and sold them. The Appellate Tribunal and the High Court were, therefore, right in holding that the sale proceeds of these trees should be treated as capital receipt and not taxable as agricultural income”.
The similar observation has been made by the Apex Court in the case of A.K.T.K.M 78 ITR 58.
Thus in deciding that the a particular receipt is capital receipt or revenue receipt, among other things it is pertinent to see whether the amount received is a compensation for the loss of profit or for loss of a source of profit. Non compete fees is a sum received under an agreement from a person for not competing in the business or for not taking a similar assignment for a period of time. Before the insertion of subsection va in section 28 the matter of taxability of non compete fees has been examined by various courts The Supreme Court in the case of CIT vs Best & Co 60 ITR 11 has observed that the where the compensation is paid for loss of agency on the condition that the assessee shall not carry any competitive business for five years, the portion of compensation which is attributable to the loss of profit is revenue in nature while the portion for prohibiting the assessee for taking an assignment for five years is capital receipt.
In CIT vs Ashok Mehra 2009 27 SOT 15 ITAT Delhi for AY 2001-02 has held that the fees received from employer company for not taking any direct or indirect employment or providing advice etc. to any other person engaged in competing business. The amount received was capital receipt and was not liable to tax.
The Mumbai ITAT in the case of ACIT vs Ashit M. Patel 96 TTJ 439 has held that the non-competition fees that the assessee had received from his company for agreeing not to take up assignments for the company's competitors in India, was required to be treated as capital receipt and was therefore not taxable. There was no cogent evidence to prove that the agreement between the assessee and the company was a sham and had been executed merely to avoid taxes. Moreover, s.28(va), which was inserted in the Income Tax Act 1961, was effective only from 1 April 2003; the section was not retrospective in nature and therefore was not applicable to the assessment year 1997-98.
Similarly in the case of GILLANDERS ARBUTHNOT AND CO., LTD. v. THE COMMISSIONER OF INCOME-TAX, CALCUTTA. 53 ITR 283 Supreme Court Of India held that it is important to know whether the by loss of agency the trading structure of the assessee has been disturbed or not. If no the compensation received by the assessee is a revenue receipt. The Apex Court observed that –
“On a careful consideration of all the circumstances we agree with the High Court that cancellation of the contract of agency did not effect the profit-making structure of the appellant, nor did it involve a loss of an enduring trading asset; it merely deprived the appellant of a trading avenue, leaving him free to devote his energies after the cancellation to carry on the rest of the business, and to replace the contract lost by a similar contract. The compensation paid, therefore, did not represent the price paid for loss of a capital asset”
In Indo Tech Electric Co. vs DCIT 282 ITR 197 Chennai ITAT observed as under
“The assessee company had sold its manufacturing business to another company as a going concern for which it received certain amount for transfer of know how and non-compete fees, apart from the consideration received for transfer of assets. This amount received by the assessee was on account of transfer of goodwill. Since there was no cost of acquisition incurred by the assessee for acquiring the goodwill, the whole of such amount was assessable to capital gains u/s
45 and s.55(2) of the Income Tax Act 1961.
In the case of CIT vs D.P. Sandu Bros. Chembur (P) Ltd. 273 ITR 1 the Apex Court the country in the assessment year.1987-88 has decided that the tenancy rights surrendered by assessee for a consideration of Rs. 35 Lakhs. However, capital gains could not be computed u/s 45 of the Income Tax Act 1961 r/w S.48 of the Act, as the cost of acquisition of tenancy rights was not ascertainable.
ITAT, Chennai in the case of A B Mauria India (P) Ltd. vs ACIT ITA No. 1293/Mds/2006, Assessment Year 2001-02 has upheld the order of the CIT u/s 263 disallowing the 25% depreciation claimed by assessee company on non compete Fees. The facts of the case are as under -
The brief facts are that the assessee is a company engaged in the business of dealing and manufacturing of compressed yeast, dried yeast, yeast extract, bakery and other ingredients. The Assessing Officer framed the assessment under Section 143(3) read with Sec. 115JA of the IT. Act on 31.3 2004.
The ld. CIT noted from the order of the Assessing Officer that the assessee's claim of depreciation at the rate of 25% on non compete Fee was wrongly allowed by the Assessing Officer. According to the ld CIT. the allowance of deduction without due verification was considered as erroneous and prejudicial to the interest of the Revenue which made the ld. CIT to proceed under Section 263 of the Act by issuing a notice to the assessee. On considering the submission the ld CIT found that certain basic facts relevant to the acquisition of the business and determining of non compete Fee earned are to be examined by the Assessing Officer. After discussing in detail, the ld. CIT by following the decision of Hon'ble Supreme Court in the case of Malabar Industrial Co. Ltd v CIT (2000) 243 ITR 83 (SC), he set aside the assessment with the direction to the Assessing Officer to examine the various agreements entered into by the assessee for the purchase of Biofoods, the justification for payment of non compete Fee, the basis of its valuation, the advantage which actually accrued to the assessee, etc. Against this direction, the assessee is in appeal before us.
On the basis of the above facts the Hon’ble ITAT observed as following -
“As rightly observed by the ld. CIT, Non compete Fee is not an asset which the assessee could use like licence or franchise etc in its business. Actually, it is a payment made to ward off a competitor for a specified number of years. In other words, it only confers a right to sue in case of breach by a person to whom the amount is paid. Further, it can be enforceable only when default occurs. This is obvious out of the records that the Assessing Officer has not examined the issue relating to acquisition of Biofoods and payment of non compete Fee. Therefore, the depreciation allowed on the non compete Fee is without examining the various aspects of the transaction. In our view this is a right stage and a fit case where a Commissioner has to invoke his jurisdiction conferred on him under Section 263 of the Act so as to correct the assessment order. It is clearly established in the findings of the Id Commissioner that the assessment order is both erroneous and prejudicial to the interest of the Revenue. We, therefore, confirm the action of the ld Commissioner under Section 263 which is justified. The ld. CIT has rightly set aside the assessment order which is erroneous and prejudicial to the interest of the Revenue, with a direction to the Assessing Officer to redo the assessment in accordance with law. Under the above circumstances, we reject the arguments of the learned counsel for the assessee and accept that of the learned D.R. to confirm the order of the ld CIT passed under Section 263 of the Act. Hence, the appeal deserves to be dismissed.”
ITAT, Mumbai in the case of ACIT vs Asea Brown Boveri Ltd.ITA Nos. 2714 and 2715/Mum/2003 Asst. yrs. 1996-97 and 1997-98 has decided the matter against the assessee. The summry of the order is as following.
“Having transferred the 'transport' business, the assessee was not in a position of compete with the purchaser. The purchaser company was also a group company. Further, gestation period for starting the industry was much longer. The actual non-competitive fee received was income. Matter remanded to decide whether section 10(3) or section 56 was applicable”
The Amendment – an end of controversy
Thus from the above analysis of the various court cases it can be observed that the courts have delivered differing views on the issue of taxability of non compete fees aa capital receipt or a revenue receipt. To put a rest on this controversy with effect from 01.04.2003 vide finance Act 2002 a new subsection (va) was inserted in section 28 to bring in the non compete fess within the preview of section 28 to make it taxable in the hands of the recipient of such income.
The part D of chapter IV of The Income Tax Act 1961 (the Act ) deals with the taxation computation of Taxable income from head business and profession. This part of chapter IV of the Act contains section 28 to section 44DB. These sections contain the provisions dealing with the computation of taxable income from business and professions. Section 28 define the incomes which are chargeable under the head income from Business and profession. Among other items incomes, one of the items of the income is receipts in the nature of non compete fees and exclusivity rights. The relevant portion of the section 28 is reproduced herewith -
28. The following income shall be chargeable to income tax under the head "Profits and gains of business or profession":
(va) 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 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-
(i) 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";
(ii) 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.
From the perusal of the above subsection va it is clear that with effect from 01.04.2003 any sum received by any person from other person under an agreement shall be liable to be taxed under section 28 if the sum is received for not carrying out any activity in relation to any business. Or any sum received for not sharing any know patient or any information having some business or commercial right or similar information. It is pertinent to note here that the sum received must be under an agreement. The explanation to section 28va provides the meaning of an agreement. According to the explanation an agreement includes any arrangement or understanding or action, whether formal or in writing and whether intended to be legally enforceable.
The exception to the taxability of certain incomes are provided in proviso to sub section va to section 28. Any sum received on account of transfer of the right to manufacture, produce or process any article or thing which is chargeable as capital gains and any sum received on account of transfer of a right to carry on business which is chargeable as capital gains are not covered under section 28va.
A minute perusal of the explanation to section 28va provides an insight as to why the these exceptions have been provided in this section. The kind of transaction mentioned in that section are “Right” to do any business or manufacture or produce. As per section 45 any gain arising on the transfer of the any capital asset is taxable under the head income from capital gains. The term capital assets has been defined in section 2(14) to mean “property of any kind’ whether or not connected with the business or profession except those specifically excluded. Stock in trade, raw material, consumable stores held for business and personal effects are the specifically excluded assets which are not treated as capital assets. Apart from these items of exception every other asset is a capital assets within the meaning of section 2(14). It is clear from the definition of the capital assets that for this purpose property is a word of wide import and signifies every possible interest which a person can hold or enjoy.
A right to carry any of the activity as mentioned in explanation to section 28va becomes interest or property or right in those activity, thus establishing it as a capital assets. Since the gain arising out of transfer of any capital asset is taxable as capital gains, these gains have been specifically included in the list of exception in section 28va. Thus the exception to non compete fees, is only limited to a right to do the business or manufacture etc, any non compete fees received on or after 01.04.2003 will be taxable as business income in the hands of the recipient.
Published in Income Tax
Source : Various case laws, commentry in Caturvedi & Pithisaria and other books.
Views : 9020