Guffic Chem P.Ltd vs C.I.T,Belgaum & Anr

Civil Appeal No.2523 of 2011 (arising out of S.L.P. (C) No.

222 of 2011)

J U D G M E N T

S.H. KAPADIA, CJI

Leave granted.

2. Whether a payment under an agreement not to

compete (negative covenant agreement) is a capital receipt

or a revenue receipt is the question which arises for

determination in this case?

FACTS

3. During the assessment year 1997-98 the assessee

received `50,00,000/- (Rupees Fifty Lakhs only) from

Ranbaxy as non-competition fee. The said amount was

paid by Ranbaxy under an agreement dated 31.3.1997.

Assessee is a part of Gufic Group. Assessee agreed to

transfer its trademarks to Ranbaxy and in consideration of

such transfer assessee agreed that it shall not carry on

directly or indirectly the business hitherto carried on by it

on the terms and conditions appearing in the agreement.

Assessee was carrying on business of manufacturing,

selling and distribution of pharmaceutical and medicinal

preparations including products mentioned in the list in

Schedule-A to the agreement. The agreement defined the

period, i.e., a period of 20 years commencing from the date

of the agreement. The agreement defined the territory as

territory of India and rest of the world. In short, the

agreement contained prohibitive/restrictive covenant in

consideration of which a non-competition fee of `50 lakhs

was received by the assessee from Ranbaxy. The

agreement further showed that the payment made to the

assessee was in consideration of the restrictive covenant

undertaken by the assessee for a loss of source of income.

4. On perusal of the said agreement, the CIT (A) while

overruling the decision of AO observed that the AO had not

disputed the fact that `50 lakhs received by the assessee

from Ranbaxy was towards non-competition fee; that under

the said agreement the assessee agreed not to

manufacture, itself or through its associate, any of the

products enlisted in the Schedule to the agreement for 20

years within India and the rest of the world; that the

assessee and Ranbaxy were both engaged in the business

of pharmaceuticals and to ward off competition in

manufacture of certain drugs, Ranbaxy had entered into an

agreement with the assessee restricting the assessee from

manufacturing the drugs mentioned in the Schedule and

consequently the CIT(A) held that the said sum of `50 lakhs

received by the assessee from Ranbaxy was a capital receipt

not taxable under the Income Tax Act, 1961 (hereinafter for

short `the 1961 Act') during the relevant assessment year.

This decision was affirmed by the Tribunal. However, the

High Court reversed the decision of the Tribunal by placing

reliance on the judgment of the Supreme Court in the case

of Gillanders Arbuthnot and Co. Ltd. v. CIT, Calcutta

53 ITR 283. Against the said decision of the High Court

assessee has come to this Court by way of petition for

special leave to appeal, hence this civil appeal.

DECISION

5. The position in law is clear and well settled. There

is a dichotomy between receipt of compensation by an

assessee for the loss of agency and receipt of compensation

attributable to the negative/restrictive covenant. The

compensation received for the loss of agency is a revenue

receipt whereas the compensation attributable to a

negative/restrictive covenant is a capital receipt.

6. The above dichotomy is clearly spelt out in the

judgment of this Court in Gillanders' case (supra) in which

the facts were as follows. The assessee in that case carried

on business in diverse fields besides acting as managing

agents, shipping agents, purchasing agents and secretaries.

The assessee also acted as importers and distributors on

behalf of foreign principals and bought and sold on its own

account. Under an agreement which was terminable at will

assessee acted as a sole agent of explosives manufactured

by Imperial Chemical Industries (Export) Ltd. That agency

was terminated and by way of compensation the Imperial

Chemical Industries (Export) Ltd. paid for first three years

after the termination of the agency two-fifths of the

commission accrued on its sales in the territory of the

agency of the appellant and in addition in the third year full

commission was paid for the sales in that year. The

Imperial Chemical Industries (Export) Ltd. took a formal

undertaking from the assessee to refrain from selling or

accepting any agency for explosives.

7. Two questions arose for determination, namely,

whether the amounts received by the appellant for loss of

agency was in normal course of business and therefore

whether they constituted revenue receipt? The second

question which arose before this Court was whether the

amount received by the assessee (compensation) on the

condition not to carry on a competitive business was in the

nature of capital receipt? It was held that the

compensation received by the assessee for loss of agency

was a revenue receipt whereas compensation received for

refraining from carrying on competitive business was a

capital receipt. This dichotomy has not been appreciated

by the High Court in its impugned judgment. The High

Court has misinterpreted the judgment of this Court in

Gillanders' case (supra). In the present case, the

Department has not impugned the genuineness of the

transaction. In the present case, we are of the view that

the High Court has erred in interfering with the concurrent

findings of fact recorded by the CIT(A) and the Tribunal.

One more aspect needs to be highlighted. Payment

received as non-competition fee under a negative covenant

was always treated as a capital receipt till the assessment

year 2003-04. It is only vide Finance Act, 2002 with effect

from 1.4.2003 that the said capital receipt is now made

taxable [See: Section 28(va)]. The Finance Act, 2002 itself

indicates that during the relevant assessment year

compensation received by the assessee under non-

competition agreement was a capital receipt, not taxable

under the 1961 Act. It became taxable only with effect from

1.4.2003. It is well settled that a liability cannot be created

retrospectively. In the present case, compensation received

under Non-Competition Agreement became taxable as a

capital receipt and not as a revenue receipt by specific

legislative mandate vide Section 28(va) and that too with

effect from 1.4.2003. Hence, the said Section 28(va) is

amendatory and not clarificatory. Lastly, in Commissioner

of Income-Tax, Nagpur v. Rai Bahadur Jairam Valji

reported in 35 ITR 148 it was held by this Court that if a

contract is entered into in the ordinary course of business,

any compensation received for its termination (loss of

agency) would be a revenue receipt. In the present case,

both CIT (A) as well as the Tribunal, came to the conclusion

that the agreement entered into by the assessee with

Ranbaxy led to loss of source of business; that payment

was received under the negative covenant and therefore the

receipt of `50 lakhs by the assessee from Ranbaxy was in

the nature of capital receipt. In fact, in order to put an end

to the litigation, Parliament stepped in to specifically tax

such receipts under non-competition agreement with effect

from 1.4.2003.

8. For the above reasons, we set aside the impugned

judgment of the Karnataka High Court dated 29.10.2009

and restore the order of the Tribunal. Consequently, the

civil appeal filed by the assessee is allowed with no order as

to the costs.

Civil Appeal No.2523 of 2011 (arising out of SLP(C) 222/2011)

9. For the reasons given hereinabove, we affirm the

judgment of the Delhi High Court in CIT Vs. Mandalay

Investment Pvt. Ltd. decided on 29.07.2009 in ITA No.

728/2009. Consequently, we dismiss the civil appeal filed

by the Department against the decision of the Delhi High

Court dated 29.07.09 with no order as to the costs.

...........................................CJI

(S. H. Kapadia)

.............................................J.

(K.S. Panicker Radhakrishnan)

.............................................J.

(Swatanter Kumar)

New Delhi;

March 16, 2011