Section 4 – Sum received for transfer of intangible assets on discontinuance of business resulting in loss of enduring trading assets considered as capital receipt not chargeable to tax.
Section 4 – Non-compete fees received on transfer of sole and main business for not carrying on the same for a limited period was considered as capital receipts not chargeable to tax during the A.Y. 2001-02.
Facts
Assessee-company was engaged in the business of merchant banking. It had transferred its business of merchant banking in the form of employees, customer and client relationship, a list of 10 largest clients and certain know-how for a sum of Rs. 25 lakh. Further, it also received a sum of Rs. 1 crore as non-compete fees for a consideration towards not carrying on the same business for a period of 3 years after its transfer.
Assessee claimed that a sum of Rs. 1.25 crore was capital receipts not chargeable to tax.
The Ld. CIT(A) upheld the order of the AO and taxed the receipts of Rs. 1.25 crore under the head business income due to the following reasons:
I. Business was hampered only for the period of 3 years and not forever. Amount was received as compensation during the course of business and there was no loss of capital assets or capital structure of the assessee’s business. Business has been continued as evident from the annual accounts of subsequent years.
II. Amount received Rs. 1.25 crore was negligible as compared to the earnings from the business of Rs. 7.5 crore and it defies business prudence of the assessee.
III. There was no basis for computing the amount of consideration of Rs.1.25 crore.
Held:
The Hon’ble ITAT held that impugned receipt of Rs. 25 lakh was a capital receipt due to the following reasons:
The assessee received the consideration for the transfer of its merchant banking business and the same was discontinued by it. Hence, compensation received cannot be considered as receipts during the course of business.
Also the Revenue failed to show as to how the agreement was not bona fide. It has been accepted that the agreement was with unrelated and unknown party which at relevant point of time was reputed international firm of chartered accountants. It was intended to be acted upon by both.
Further, it has been held that it is for the transferor to fix the consideration for the transfer. It is not at the instance of the revenue to raise any issue on its adequacy. After discontinuing the merchant banking business, assessee did not have any active source of income and its income consist of mainly dividend from shares and mutual funds, profit on sale of shares, interest income and nominal consultancy charges. Hence there was substantial fall in profit earning of the assessee. It has also been held that the transfer of business has resulted in loss of enduring trading.
Following the decision of the Hon’ble Supreme Court in B.C. Shrinivasa Setty 128 ITR 294, it has been held that, as said intangible assets were self generated having no cost of acquisition the sum received from transfer of the same was not liable to tax under the head capital gains also.
The Hon’ble ITAT also held that impugned receipt of Rs. 1 crore was a capital receipt due to the following reasons:
It has been held that decisions relied by Ld. CIT(A) are not applicable to the facts of this case, as in this case sole and main business had been transferred and not one of the businesses.
Secondly, agreement was made only for a period of 3 years is not relevant as generally all the noncompete agreements are limited in point of time which prescribes period of non-competition.
Thirdly, non-competition fee is taxable capital receipt and not revenue receipt by specific legislative mandate vide section 28 (va) of Income Tax Act, 1961 and that too w.e.f. 1-04-2003. Hence, it is not applicable for relevant assessment year. The Hon’ble Supreme Court has held in case of Gufic Chem (P.) Ltd. vs. CIT [2011] 332 ITR 602 fees received under non-competition agreement is capital receipt as amendment does not cover the relevant assessment year.
Editor’s Note: The decision may not apply after the insertion of Section 28 (va)with effect from A.Y.2003-04
