Ita/795/2007 Of The Commissioner Of Income Tax v. M/S Sapthagiri Distilleries Ltd

IN THE HIGH COURT OF KARNATAKA AT BANGALORE DATED THIS THE O/ DAY OF APRIL 2014 PRESENT. THE HON'BLE MR.JUSTICE DILIP B.BHOSALE AND THE HON BLE MR.JUSTICE B. MANOHAR. ITA NO.795/2007 BETWEEN: 1. The Commissioner of Income-Tax,Central Circle,C.R Building,|Queens Rodd,Bangalore. 2. The Deputy Commissioner of Income-Tax, Central Circle -2 (1),C.R.Building, Queens Road,Bangalore...Appellants (By Sri.K.V.Aravind, Advocate) AND" M/s.Saptnagiri Distilleries Ltd.,.No.480S. 8[. ]Fioor, High Point — IV,No.45, Palace Road, Bangalore.... Respondent(By Sri.S.Parthasaratni, Advocate) This ITA ts filed under Sec.260-A of Income Tax Act1961, arising out of order dated 31/05/2007 passed in ITA|No.1091/Bang/2002, for the Assessment Year 1999-2000,praying tnat for the reasons stated therein this Hon bileCourt may be pleased to: formulate the substantial questions of law.stated therein,stated therein, aliow the appeal and set aside the orderpassedby.ITATBangalore,In.ITANo.1091/Bang/2002dated31/05/2007confirmingthe.Order|Of|tneAppellateCommissioner, & confirm the order passed bythe Deputy Commissioner of Income _ TaxCentral Circle -2(1), Bangalore, in the interestof justice and equity.passedby.ITATBangalore,In.ITANo.1091/Bang/2002dated31/05/2007confirmingthe.Order|Of|tneAppellateCommissioner, & confirm the order passed bythe Deputy Commissioner of Income _ TaxCentral Circle -2(1), Bangalore, in the interestof justice and equity. TnIsappealcomingforadmission|tnis|day,B. MANOHAR.‘7delivered tne following: | JUDGMENT The Revenue has preferred this appeal under Section260-A of the Income-Tax Act, 1961 (for short ~the Actonchalienging the order dated 31-05-2007 made in ITA)No.1091/Bang/2002,DYtneIncome.TaxAppellateTribunal, Bangalore Bench ‘A’ (for short *the Tribunal“)confirming the order passed by the Commissioner of) Income-Tax (Appeals) VI, Bangalore (for short *the First Appellate Authority‘) dated 22-05-2002 setting aside the assessment order dated 2/7-3-2002 passed by theAssessing Authority holding that the amount received by)the assessee as compensation for termination of the leaseagreement is capital in nature for the assessment year.1999-2000.| 2.The respondent-assessee is a company registeredunder the Companies Act, 1956 carrying on business in the|manufacture of Indian Made Foreign Liquor (for short)‘IMFL") in the brand name of UB Products at Kumbalgodu.It nas filed income-tax returns for the assessment year.1999-2000 on 31-12-1999 declaring a net loss from)business of Rs.45,5/79/-. The return was processed and)taken up for scrutiny after issuing notice under Section.143(2) of tne Act. Tne autnorized representative of theassessee appeared and produced necessary documents.inter allacontending that the company has discontinued|the manufacturing business from the financial year |1994-95 and as such, losses claimed on account ofadministration expenses were not allowed to be carried) forward. No business operations in the nature of distilleryare undertaken from tnat year. ‘3.While assessing the returns of M/s. Mc Dowell andCo. Ltd., it was noticed that M/s.Mc Dowell nad claimed a|revenue expenditure of Rs.5.31 crores on account of leaseforeciosure payment made to the assessee. The assessee.has not declared the said transaction resulting in gain ofRs.5.31 crores in its return of income filed. A notice under.Section 142(1) of the Act was issued on 11-2-2002 callingfor necessary particulars regarding receipt of the said)amount. In response to the said notice, the assessee by.its letter dated 14-3-2007 filed detailed facts of the case|contending that they were running the business of.distillery manufacturing IMFL of various brands of UB)products on the basis of the lease agreement entered intowith the Mc Dowell from the year 1986. In view of sudden.foreclosure of the lease agreement and taking over of the)Said running business, as per the agreement dated25-3-1993, the assessee-company agreed to transfer the. business of distillery to M/s. Mc Dowell and Co. Ltd., andMc Dowell agreed to pay compensation as consideration|towards loss to the company’s source of income. Further,in view of the dispute between the parties, the matter was)referred to the sole Arbitrator and the Arbitrator passed an-award fixing the quantum of compensation as Rs.5.31)Crores and to prevent the assessee from carrying onSimilar business. The said amount cannot be treated as/§revenue which was received towards the compensation for|termination of the business and to prevent the assessee tocarry on competitive business. Hence, it is capital in)nature. The Assessing Authority after considering thematter and taking into consideration the agreement and)other relevant records held that the sum of Rs.5.31 crores|received is revenue in nature. However, the assessee has|lost the right that he had to manufacture the Mc Dowellproducts. The entire amount of Rs.5.31 crores was taken |as a long term capital gain and taxed accordingly and also.imposed penalty and interest thereon by an order dated|2/-3-7002. 4Tne assessee being aggrieved by the said orderpreferred an appeal before the First Appellate Authority|contending that the assessment order passed by the.Assessing Authority is contrary to law. A sum of Rs.5.31)crores received as compensation by the assessee fromM/s.Mc Dowell and Co. Ltd. towards loss of source of|income and also towards non-competition fee by way of an.award given by the Sole Arbitrator. Though the loss of)source of income is a capital receipt, it shall not be subject.to levy of capital gain tax. The First Appellate Authority|after considering the matter held that the compensation.received by the assessee cannot be brought under tax.even as a capital gain and accordingly, set aside the)assessment order by its order dated 22-5-2002. | 5.Tne Revenue being aggrieved by the order passed bythe First Appellate Authority preferred an appeal before the)Appellate Tridunal contending that the order passed by the)First Appellate Authority declaring that a sum of Rs.5.31|crores was not a managerial remuneration is contrary to) law. The assessee even though received Rs.5.31 crores,|nas not disciosed the same in the returns. The finding|recorded by the First Appellate Authority that the)compensation nas been given for loss of source of income.and tne said compensation amount cannot be brought to)tax even under the capital gain is erroneous in law. The)Appellate Tribunal after considering the matter in detailrelying upon the various judgments of tne Hon bileSupreme Court dismissed the appeal by its orderdated 31-5-2007 nolding that the amount tnat is received|as compensation towards termination of lease and non-competition fee would be capital in nature. The Revenue.being aggrieved by tne said order, preferred this appeal. 6.This appeal was admitted to consider the followingsubstantial questions of law: (1)Whether the Tribunal was correct [nnoiding that the amount of Rs.5.31|crores received by the assessee from|M/s.McDowelldS|aresultof.arbitration award cannot be ftreetednoiding that the amount of Rs.5.31|crores received by the assessee from|M/s.McDowelldS|aresultof.arbitration award cannot be ftreeted as a revenue receipt and brought to}tax? (iI)Whnetner the Tribunal was correct [nholding that the amount of Rs.5.31|crores received by tne assessee from|M/s. Mc Dowell ts a capital receipt but|cannot be brought to capital gains tax|under Section 55(2)(a) of the Act. ?holding that the amount of Rs.5.31|crores received by tne assessee from|M/s. Mc Dowell ts a capital receipt but|cannot be brought to capital gains tax|under Section 55(2)(a) of the Act. ? (1)Whether the Tribunal was correct [nnoiding that the amount of Rs.5.31|crores received by the assessee from|M/s.McDowelldS|aresultof.arbitration award cannot be ftreetednoiding that the amount of Rs.5.31|crores received by the assessee from|M/s.McDowelldS|aresultof.arbitration award cannot be ftreeted as a revenue receipt and brought to}tax? (iI)Whnetner the Tribunal was correct [nholding that the amount of Rs.5.31|crores received by tne assessee from|M/s. Mc Dowell ts a capital receipt but|cannot be brought to capital gains tax|under Section 55(2)(a) of the Act. ?holding that the amount of Rs.5.31|crores received by tne assessee from|M/s. Mc Dowell ts a capital receipt but|cannot be brought to capital gains tax|under Section 55(2)(a) of the Act. ? J.Sri.K.V.Aravind, learned counsel appearing for theRevenue contended tnat the order passed by the Tribunalconfirming the order of the First Appellate Authority andsetting aside the order passed by the Assessing Authority|is contrary to law wherein the Tribunal held that a sum of.Rs.5.31 crores received by the assessee from M/s. McDowell as a result of arbitration award cannot be treated.as a revenue receipt. The assessee-company was carrying |on distillery business in the manufacture of IMFL of various|brands of UB products from the year 1986, taking thepremises on lease from UB group. As per the agreement.entered into between the assessee and UB company, the. lease was foreclosed and foreclosure compensation hasbeen paid. The said amount is to be treated as a revenue.receipt. Hence, the order passed by the AppellateAutnority as well as the Tribunal is contrary to law. The)amount received by the assessee falls under Section 28(ii)of the Act. Section 28(ii) contemplates tnat any'|compensation or any payment due to or received by any.person, Dy whatever name called, Managing the whole or)substantially the whole of the affairs of tne Indian)Company, at or in connection with the termination of itsmanagement or the modification of terms and conditions|relating thereto. In support of his contention, he reliedupon the judgment of the Hon'’bie Supreme Court reportedIn,(2011) 332 ITR 602(SC)InGUFFIC CHEM (P) LTD.v/s COMMISSIONER OF INCOME-TAX AND ANOTHERand.(1964)53|TTR|283(SC)In,GILLANDERSARBUTHNOT & CO. LID. v/s COMMISSIONER OFINCOME-TAX~ and contended that the compensationreceived by the assessee for foreciosure of lease.agreement or handing over the distillery factory amounts. to termination of the contract. The amount paid towardstne said termination amounts to revenue and not tne!capital. Hence sought for setting aside the order passedby the Appellate Tribunal by allowing this appeal. 8.On the otner nand, Sri.S.Parthasaratni, learned|counsel appearing for the assessee argued in support of.the order passed by the Appellate Authority as well as the)Appellate Tribunal contending that Mc Dowell & Co. was.running a business of distillery in the manufacture of IMFLof various brands taking the land, building and distillery on)lease from M/s.Mysore Wine Products Limited. However,the Mc Dowell company could not run the distillery due to)labour problem and was suffering huge loss. Accordingly,the said distillery was leased in favour of the assessee-company in the year 1986. From the year 1986, tne.assessee was running the distillery on the lease agreement.entered into with Mc Dowell & Co. and solved the labour|problems by installing new machineries thereby improved|the performance of the distillery and started earning) income. At that time, the UB group abruptly terminated|the lease as per the memorandum of agreement entered.into on 25-3-1993. Accordingly, the company was.handed over as a running concern to Mc Dowell and Co.Tne.SalcdCOMpaNnyagreedTO Daytnereasonablecompensation as consideration for loss of source of income)to the assessee-company and the assessee-company was.prevent from using the knowhow for manufacturing of.IMFL. To avoid competition from the assessee, as per the)award passed by the sole Arbitrator, a sum of Rs.5.31.Crores was paid to assessee. The said amount cannot be)treated as a revenue. From the assessment year 1994-95,|theaSSeSSECChas|notdone|any.business.The.compensation received does not fall under Section 28(ii) ofthe Act. The amount in question was paid in order to)prevent competition or carry on similar business using the)knowhow possessed by the assessee. The Appellate|Tribunal|as|well|as|tneAppellateAuthorityafter|considering the matter in detail have rightly set aside the) order passed by the Assessing Authority and sought fordismissal of the appeal. QO.We,navecarefullyconsideredtneargumentsaddressed by the learned counsel for the parties and.perused the orders impugned and other relevant records. 10.Tne records clearly disciose that while assessing tnereturns of Mc Dowell & Co., it was noticed that the |Mc Dowell & Co., nad claimed revenue expenditure of Rs.5.31 crores on account of lease foreclosure paymentmade to the assessee-company. The assessee-company.had filed return on 31-12-1999 declaring net loss from thebusiness. In the scrutiny, the assessee-company brougnt|to the notice of the authority that the assessee-companynad discontinued the business from the financial year)1994-95 and as such loss was claimed on account of administrative expenses. However, the assessee-company|nad not disciosed the receipt of Rs.5.31 crores from Mc.|Dowell & Co. Accordingly, a notice was issued under|Section 142(1) of the Act to the assessee-company calling for necessary information. In pursuance of the said notice,the assessee-company filed detailed objections contending|that from the year 1986, the assessee-company wasrunning distillery business taking the distillery on lease)from Mc Dowell & Co., and manufacturing of IMFL ofvarious brands of UB products. At the time of taking the)distillery on lease Mc Dowell & Co., was suffering huge lossand due to the labour problem they could not run the)distillery business. Taking the said distillery on lease by|installing new machinery and solving the labour problem,|the assessee was manufacturing various brands of UB.products and the assessee-company started earning.income. At that stage, the UB group abruptly terminated|the lease. As per the memorandum of agreement enteredinto between the parties on 25-3-1993, the company had)agreed to transfer the running concern to Mc Dowell & Co.and to receive reasonable compensation. In view of the)dispute regarding the quantum of compensation, thematter was referred to the sole Arbitrator and the'Arbitrator passed an award fixing the quantum of. compensation and other consideration at Rs.5.31 crores.Tne assessee contended that the said amount was paid in)order to prevent the assessee from carrying on similarbusiness using the Knowhow possessed by the assessee-company. In order to prevent competition in the business,|the amount was paid and it is a capital in nature and not)liable to tax. However, the Assessing Officer noticed thatreceipt of the amount has not been disciosed by the.assessee in their deciaration. The Assessing Authority held|that the amount received is a revenue receipt and the.Same is liable to tax. Being aggrieved by tne assessment.Order declaring the said amount as a revenue receipt, the|assessee preferred an appeal! before the first AppellateAuthority. The First Appellate Authority after examiningthe matter in detail held that the compensation received|towards the loss of source of income and also towards|non-competition fee by way of an award passed by the)sole Arbitrator and the said amount cannot be assessed asmanagerial compensation. | 11.Paragraphs (a) and (b) of the award of the sole|Arbitrator reads as under: 6+7A sum of Rs.4.5 crores paid by Mc DowellSnall be treated as a payment througn CDLtowards tne consideration for tne transfer ot business on a going concern Dasis. 6A7Tne Mc Dowell snall pay SDPL thereasonable compensation as consideration forloss of business by assignment termination ofthe lease and handing over the facility by SDPLwhich causes loss of its source of Income. The|payment of compensation to SDPL as proposedabove snall also be In consideration of SDPL|refrainingfromintroducingIts|Ow?)newproduct competing with Mc Dowell. The|compensation payable nerein shall be workedout by both the parties on a mutual agreedbasis after going through the earning potentialand other benefits which accrues to Mc Dowell|by this transaction and also after taking intoconsideration tne extent of effect on tne futureof SDPL. It is agreed tnat this arrangementSnall not create any vested interest on tneissue of compensation in favour of the either. 17).Reading of the award of the Arbitrator makes it cleartnat the amount in question being a compensation towards|the loss of source of Income and also towards non-competition fee to prevent the assessee from carrying on.the similar Dusiness using the Knowhow possessed by the.assessee aS a competitor, the amount of Rs.5.31 crores.paid was thus capital in nature. The amount is paid to.prevent the assessee from carrying on a competitive|business and also preventing the assessee to use the.business apparatus or expertise. Accordingly the payment.was a Capital fee and thus it is only a capital receipt.There being no cost of acquisition, the capital gain wasalso not computable. 13.Tne Hon'ble Supreme Court in GUFFIC CHEM caseclearly held that the compensation received for loss of.agency is a revenue receipt whereas the compensation|attributable to a negative/restrictive covenant is a capital|in nature. In the instant case, the compensation has been |paid for loss of source of income and also for non- 13.Tne Hon'ble Supreme Court in GUFFIC CHEM caseclearly held that the compensation received for loss of.agency is a revenue receipt whereas the compensation|attributable to a negative/restrictive covenant is a capital|in nature. In the instant case, the compensation has been |paid for loss of source of income and also for non- competitive fee and it is capital in nature. Furtherpayment made as non-competition fee under the negative|covenant is always treated as a capital receipt and not.liable to pay any tax till the assessment year 2003-04 in|view of the amendment to the Finance Act 2OO?7 w.e.f. |1-4-2003 tnat the said capital receipt is now made taxableunder Section 28(va). The said amendment is not.applicable to the case on hand. Section 28(ii) is not)applicable to the present case. We find that the amount.received by the assessee is a capital receipt. The|Appellate Autnority as well as tne Appellate Tribunal after|considering the matter in detail held that the amount.received is a capital receipt and not liable to tax under)Section 55(2)(a) of the Act. We find no infirmity orirregularity in the said finding. The judgments relied upon|by Sri.K.V.Aravind, learned counsel appearing for theRevenue are not applicable to the facts of the present case|and it is only a declaration of law by the Hon’ble SupremeCourt. In view of that, both the substantial questions of| /+C�+'!� !/1�+2+$&%.�. !��!:!&0!�+&1�$&�(+:"0'�"(�. !�+%%!%%!!����))"'1$&2/5-�. !�+44!+/�$%�1$%#$%%!1�� ������������������� ������������������������������������������������ �������