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Shivraj Gupta v. Commissioner of Income Tax, Delhi

BRIEF FACTS:

• One Shri Shiv Raj Gupta (‘the Assessee’), who was the Chairman and Managing Director of M/s Central Distillery and Breweries Ltd. (‘CDBL’) his wife, son, daughter-in-law and two daughters, being registered holders of 57.29% of the paid-up equity share capital of CDBL listed in the Bombay and Delhi Stock Exchanges, sold at theirs shareholding the price of INR 30 per share when the listed market price of the share was only INR 3 per share.

• The Assessee also entered into a non-compete agreement with the share purchaser with the restrictive covenant that the Assessee shall not carry on any manufacturing or marketing activities relating to Indian Made Foreign Liquor for 10 years, for a consideration of INR 66 crores.

ASSESMENT:

• The Assessing Officer held that despite the fact that the appellant owned a concern, namely, one M/s Maltings Ltd., which also manufactured IMFL, being a loss making concern, no real competition could be envisaged between a giant, namely, the SWC group and this loss making dwarf, as a result of which the huge amount paid under the deed of covenant cannot be said to be an amount paid in respect of a restrictive covenant as to non-competition.
• Further, there was no penalty clause to enforce the performance of obligations under the aforesaid deed of covenant, as a result of which, applying the judgment in McDowell & Co. Ltd. v. CTO [1985] 3 SCC 230, the deed of covenant was held to be a colourable device to evade tax that is payable under Section 28(ii)(a) of the Income Tax Act, 1961. As a result thereof, this amount was then brought to tax under the aforesaid provision.

APPEAL BEFORE FIRST & SECOND APPELLATE AUTHORITIES:

• The appeal filed by the Assessee against the assessment order before the learned Commissioner of Income-tax (Appeals) was dismissed and therefore, the Assessee preferred appeal before the Income-tax Appellate Tribunal (‘Appellate Tribunal’). When the matter came up before the Appellate Tribunal, the learned Accountant Member differed with the learned Judicial Member.
• A reference was then made to a Third Member, who was also a Judicial Member. The learned Third Member held that it cannot be said that these shares have been undervalued, neither can it be said that there was any collusion or other sham transaction, as a result of which the amount of INR 6.6 crores has escaped income tax.
• He pointed out that by a letter dated 2 April 1994, a “penalty clause” was provided for in that, out of the amount received by the Assessee an amount of INR 3 crore was to be deposited with the purchaser for two years under a public deposit scheme, it being made clear that in case there is any breach of the agreed terms resulting in loss, the amount of such loss will be deducted from this deposit. The result, therefore, was that the appeal stood allowed by a majority of 2:1 in the Appellate Tribunal.

APPEAL BEFORE THE HON’BLE HIGH COURT:

The Revenue preferred an appeal under Section 260-A of the Income Tax Act, 1961 to the Hon’ble High Court. In its grounds of appeal, the Revenue framed the substantial questions of law that arose in the matter as follows:

• Whether the Appellate Tribunal has correctly interpreted the provisions of Section 28(ii) of the Income-tax Act, 1961?

• Whether the Appellate Tribunal was correct in holding that receipt of Rs. 6.6 crores by the respondent/assessee as non-competitive fee was a capital receipt u/s 28(iv) income tax act and not a revenue receipt as envisaged in Section 28(ii) of Income-tax Act, 1961?

• Whether the Appellate Tribunal failed to distinguish between nature of capital and nature of benefit in commercial sense in respect of amount of Rs. 6.6 crores received in view of restrictive covenant of deed dated 13-4-1994?

• Whether Ld. Judicial Member of Appellate Tribunal was correct in recording his difference of opinion that receipt of Rs. 6.6 crores by respondent/assessee was actually a colourable exercise to evade tax and same was held to be taxable under section 28(ii) of the Income-tax Act, 1961?”

• The Division Bench of the Hon’ble Delhi High Court framed the following substantial question of law:

“Whether, on the facts and in the circumstances of the case, the amount of Rs. 6.6 crores received by the assessee from SWC is on account of handing over management and control of CDBL (which were earlier under the management and control of the assessee) to SWC as terminal benefit and is taxable u/s 28(ii) of the Income-tax Act or same is exempt as capital receipt being non-competition fee by executing deed of covenant”

• The Hon’ble High Court agreed with the Assessing Officer and the first Judicial Member of the Appellate Tribunal, stating that the deed of covenant could not be read as a separate document and was not in its real avatar a non-compete fee at all.

• However, in its ultimate conclusion, disagreeing with the learned Assessing Officer and the minority judgment of the Tribunal, the High Court went on to state that the said sum of INR 6.6 crores could not be brought to tax under Section 28(ii)(a), but would have to be treated as a taxable capital gain in the hands of the appellant, being part of the full value of the sale consideration paid for transfer of shares.

 SPECIAL LEAVE PETITION BEFORE THE HON’BLE SUPREME COURT:

As regards merits, a catena of judgments has held that commercial expediency has to be adjudged from the point of view of the Assessee and that the Income Tax Department cannot enter into the thicket of reasonableness of amounts paid by the Assessee. The reasons given by the learned Assessing Officer and the minority judgment of the Appellate Tribunal are all reasons which transgress the lines drawn by the judgments which state that the revenue has no business to second guess commercial or business expediency of what parties at arms-length decide for each other. Further, the fact that there was no penalty clause for violation of the deed of covenant, has been found to be incorrect. The deed of covenant does contain restrictive covenant and because of it payment of INR 6.6 crores has been made to the Assessee. In the case of Guffic Chem (P.) Ltd. v. CIT [2011] 4 SCC 254 it has been held that a payment under an agreement not to compete (negative covenant agreement) is a capital receipt, and therefore, amount of INR 6.6 crores received by the Assessee was not liable to tax under Section 28(ii)(a) of the Income Tax Act, 1961.