Case Note & Summary
The case involves two appeals by Arun Toshniwal and Anurag A. Toshniwal against the order of the Income Tax Appellate Tribunal (ITAT) which held that amounts received by them under non-compete and non-solicitation agreements with Thermo Electron LLS India Pvt. Ltd. were taxable as business income under Section 28(va) of the Income Tax Act, 1961. The assessees were directors of Chemito Technologies Pvt. Ltd., which sold one of its divisions to Thermo on 27th May 2008. Subsequently, on 2nd June 2008, the assessees entered into agreements with Thermo agreeing not to compete or solicit clients for a period. The Assessing Officer treated the receipt as business income, which was upheld by the Commissioner of Income Tax (Appeals) and the ITAT. The High Court framed three substantial questions of law: whether the amount is taxable as business income under Section 28(va) despite the assessees not carrying on any business in the relevant year; whether carrying on business is a precondition for chargeability under the head 'profits and gains of business'; and whether the amount falls under Section 28(va) or is taxable as capital gains. The court analyzed the language of Section 28(va), which was inserted by the Finance Act, 2002, and noted that it applies to amounts received for non-compete agreements only if the assessee is carrying on a business. Since the assessees were not carrying on any business in the relevant previous year, the receipt could not be taxed under Section 28(va). The court also considered whether the amount could be taxed as capital gains, but held that the non-compete agreement did not involve transfer of a capital asset as defined under Section 2(14). The court allowed the appeals, setting aside the ITAT order and answering the questions in favor of the assessees.
Headnote
A) Income Tax - Business Income vs. Capital Receipt - Section 28(va) of Income Tax Act, 1961 - Non-Compete Fee - The court considered whether a non-compete fee received by a director who was not carrying on business in the relevant year is taxable as business income under Section 28(va). Held that Section 28(va) requires the assessee to be carrying on a business; if no business is carried on, the receipt is not business income but may be capital gains. (Paras 1-10) B) Income Tax - Capital Gains - Transfer of Right to Manufacture - Sections 45, 2(14) of Income Tax Act, 1961 - The court examined whether the non-compete and non-solicitation agreement amounts to transfer of a capital asset, such as a right to manufacture or carry on business, taxable under capital gains. Held that the agreement restricts the assessee from competing, which is a negative right and not a transfer of a capital asset; thus, not taxable as capital gains. (Paras 11-15) C) Income Tax - Non-Compete Agreement - Nature of Receipt - The court analyzed the nature of the receipt under a non-compete agreement entered into by directors who sold their company's division. Held that the amount received is a capital receipt not chargeable to tax under the head 'profits and gains of business' or 'capital gains' in the absence of a specific provision. (Paras 16-20)
Issue of Consideration
Whether the amount received by the Appellant from Thermo under a non-compete and non-solicitation agreement is taxable as business income under Section 28(va) of the Income Tax Act, 1961, despite the Appellant not carrying on any business in the relevant previous year, and whether such amount is taxable as capital gains.
Final Decision
Appeals allowed. ITAT order set aside. Questions answered in favor of assessees. Amount received under non-compete agreement is not taxable as business income under Section 28(va) nor as capital gains.
Law Points
- Non-compete fee is capital receipt
- not business income
- Section 28(va) requires carrying on of business
- Non-solicitation agreement is akin to non-compete
- Transfer of right to manufacture is capital gains
