Case Note & Summary
The case involves two appeals by shareholders (K. Pandiarajan and R. Hemalatha) against the order of the Income Tax Appellate Tribunal (ITAT) which upheld the assessment order treating a sum of one million Euros received by them as revenue receipt. The appellants were founders of Ma Foi Management Consultants Limited and had entered into a shareholders agreement with Vedior NV in 2004, under which Vedior held 76.33% shares and the appellants held 23.52%. The agreement contained a right of first refusal (ROFR) clause. In 2008, Vedior was being acquired by Randstad Holding, and the appellants invoked their ROFR. However, after negotiations, the appellants agreed not to exercise their ROFR and also entered into a non-compete agreement, receiving one million Euros each. The Assessing Officer treated this sum as revenue receipt, which was confirmed by the Commissioner of Income Tax (Appeals) and the ITAT. The High Court allowed the appeals, holding that the receipt was capital in nature. The court reasoned that the ROFR was a capital asset, and the compensation was for loss of that asset. Additionally, the non-compete fee was part of the same transaction and not a separate revenue receipt. The court also noted that Section 28(va) of the Act did not apply as the receipt was not in the nature of a revenue receipt. The court set aside the orders of the ITAT and allowed the appeals.
Headnote
A) Income Tax - Capital Receipt vs Revenue Receipt - Compensation for Loss of Source - Section 4, Income Tax Act, 1961 - The issue was whether a sum of one million Euros received by the appellants, founders of a company, from a strategic partner (Vedior) as consideration for not exercising their right of first refusal (ROFR) and for agreeing to a non-compete clause was a capital receipt or a revenue receipt. The court held that the receipt was capital in nature as it was compensation for the loss of a capital asset (the right to acquire shares) and for agreeing to restrictive covenants that affected the appellants' source of income. The court relied on the principle that compensation for loss of a source of income is capital, not revenue. (Paras 2-18) B) Income Tax - Non-Compete Fee - Capital Receipt - Section 28(va), Income Tax Act, 1961 - The court examined whether the non-compete fee received by the appellants was taxable under Section 28(va) of the Act. It held that Section 28(va) was inserted with effect from 01.04.2003 and applies only to sums received under an agreement not to carry out any activity in relation to any business or profession. However, the court found that the non-compete fee in this case was part of a larger arrangement for the sale of shares and was not a separate payment for non-compete. The court also noted that the receipt was capital in nature and not covered by Section 28(va) as it was not in the nature of a revenue receipt. (Paras 14-18) C) Income Tax - Right of First Refusal - Capital Asset - Section 2(14), Income Tax Act, 1961 - The court considered whether the right of first refusal (ROFR) held by the appellants under the shareholders agreement constituted a capital asset. It held that the ROFR was a right to acquire shares, which is a capital asset, and the compensation received for not exercising that right was a capital receipt. The court distinguished between compensation for loss of an asset and compensation for loss of income, holding that the former is capital. (Paras 10-13)
Issue of Consideration
Whether the sum of one million Euros received by the appellants from Vedior NV is a capital receipt exempt from tax or a revenue receipt chargeable to tax under the Income Tax Act, 1961.
Final Decision
Appeals allowed. The orders of the Income Tax Appellate Tribunal are set aside. The sum of one million Euros received by each appellant is held to be a capital receipt not chargeable to tax.
Law Points
- Capital receipt
- income tax
- exemption
- shareholders agreement
- right of first refusal
- compensation for loss of source
- capital asset
