Mr. Sham v. N. J. Jamadar, Jj

PURTIPRASADPARAB IN THE HIGH COURT OF JUDICATURE AT BOMBAYDigitally signed byPURTI PRASADPARABORDINARY ORIGINAL CIVIL JURISDICTIONDate: 2022.02.1615:38:50 +0530 INCOME TAX APPEAL NO. 950 OF 2009 Neville Tuli V/s. ….Appellant The ITO 3(2)(4), Mumbai …Respondent ALONGWITHWRIT PETITION NO. 602 OF 2011 Neville Tuli V/s. ….Petitioner Income Tax Appellant Tribunal,Mumbai Bench …Respondent ---- Mr. Porus Kaka, Senior Advocate a/w Mr. Aditya Vora i/b Mr. Atul K. Jasani for Appellant/Petitioner. Mr. Sham V. Walve for Respondent-Revenue. ---- CORAM : K.R. SHRIRAM & N. J. JAMADAR, JJ. DATED : 4[th] FEBRUARY, 2022 P.C. : INCOME TAX APPEAL NO. 950 OF 2009 1. On 29[th] July, 2009 the following substantial questions of law were framed. a) Whether, on the facts and the circumstances of thecase, the Tribunal erred not treating that the amountreceived under the Deed for restrictive covenant as aCapital Receipt not liable to tax ? b) Whether, on the facts and the circumstances of thecase, and in law, the finding of the Tribunal that theAppellant could not be viewed as a threat to the Company’sbusiness is perverse, contrary to the material on record andought to be set aside ? c) Whether the failure on the Tribunal to follow thedecision of a Special Bench by citing cases never cited byeither party nor raised nor argued during the course ofhearing, and contrary to the principle of natural justice andwithout the issue being put to the Appellant renders thedecision bad in law and liable to be set aside ? d) Whether the Tribunal sitting as Division Bench oughtto have either followed the larger Special Bench decision orin accordance with judicial propriety and practice referredthe matter to the President to constitute a larger Bench ? The facts in brief are as under : 2.Osian’s – Connoisseurs of Art Private Limited (hereinafterreferred to as the Company) which was incorporated on 22[nd] June, 2000appointed appellant as its whole time Director on 10[th] July, 2000 for a salaryof Rs.1,00,000/- per month with effect from 1[st] July, 2000. In view of hiscapabilities and knowledge and in order to ensure that appellant did notact/harm the interest of the company upon termination of his employment,the company entered into non-compete agreement dated 7[th] August, 2000termed as “Deed for Negative Covenants” (hereinafter referred to asagreement) imposing certain restriction on appellant from carrying outcertain professional activities over a period of 10 years after the termination of his employment. Some relevant provisions of the agreement are : i)not directly or indirectly engage in or beconcerned or connected with any business which issimilar to and/or competitive with the business of thecompany in the metro cities of Bombay, Delhi,Ahmedabad and Bangalore. ii)not directly or indirectly control or operate orcause to controlled or operated or participate in any similar business in the metro cities. iii)not associate himself or be an advisor, employeeor be a partner in any similar business as aforesaid; iv)to cease and desist from participating in similarbusiness activities as aforesaid and not to use his goodwill or expertise in respect of similar business asaforesaid; In lieu of appellant agreeing not to compete with the companyfor a period of 10 years after termination, under Article 2 of the agreementthe company agreed to pay Rs.2 Crores to appellant. The company satisfiedsuch payment by allotting 20,00,000 Equity Shares of the nominal facevalue of Rs.10 each to appellant. Articles 3 and 4 of the agreement which contain various further restrictions and obligations are reproduced below : “3.In the event that Nevile breaches any covenantsherein the company shall be entitled to recover andNevile shall be liable to reimburse the amount of Rs.2Crores with interest calculated at the rate 15% p.a. fromthe date the consideration is paid or shares issued, as thecase may be, till the date of reimbursement.” In lieu of appellant agreeing not to compete with the companyfor a period of 10 years after termination, under Article 2 of the agreementthe company agreed to pay Rs.2 Crores to appellant. The company satisfiedsuch payment by allotting 20,00,000 Equity Shares of the nominal facevalue of Rs.10 each to appellant. Articles 3 and 4 of the agreement which contain various further restrictions and obligations are reproduced below : “3.In the event that Nevile breaches any covenantsherein the company shall be entitled to recover andNevile shall be liable to reimburse the amount of Rs.2Crores with interest calculated at the rate 15% p.a. fromthe date the consideration is paid or shares issued, as thecase may be, till the date of reimbursement.” “4.For the purpose of enforcement Nevile herebygrants to the company lien in respect of anyassets/property of Nevile or amounts due to him thatmay be lawfully held by the company at the time anybreach is committed by Nevile of this agreement till thedate of reimbursement.” 3.In the assessment framed by respondent for A.Y. 2001-02,respondent invoked the provision of Section 147 read with Section 148 ofthe Income Tax Act, 1961 (the Act) for the purpose of taxing the saidconsideration of Rs.2 Crores which in the opinion of respondent had escaped assessment. Respondent considered the provision of Section 17(1)(iv) read with Section 17(3)(i) of the Act in adding the amount, i.e., valueof the equity shares received by way of the agreement to the salary income.The Assessing Officer contended that the threat from appellant to thecompany if and when he left the employment, was theoretical and not real,as appellant never had a substantial source of income in the previousassessment years. Hence, respondent took up the contention that appellantwould never leave the company or there was any constructive interest onthe part of appellant to leave the employment. It was only when appellanthad left the employment and at the time of leaving any amount is paidunder a negative covenant would there could be a justification or else it hasto be treated as salary income. 4.Impugning the Assessment Order, appellant filed an appealbefore the Commissioner of Income Tax (Appeals) [CIT (A)] on 25[th] July,2005.Before the CIT (A), appellant contended that the amountreceived under a negative covenant was not taxable as it was capital receipt.Copious material and evidence was shown to CIT (A) evidencing thecapability of appellant and his knowledge in the field. The CIT (A) took theview that amount paid by the company to appellant cannot be termed as apayment towards the negative covenant. The CIT (A) rejected thesubmissions of appellant and upheld the stand of the Assessing Officer in holding that the threat from appellant to the company was theoretical andnot real. 5.Aggrieved by the order of the CIT (A), appellant filed an appealbefore the Income Tax Appellate Tribunal (ITAT) on 8[th] January, 2007. ITATdismissed the appeal by an order dated 12[th] December, 2008. 6.Impugning this order of the ITAT, appellant has filed this appeal.It is appellant’s case that the tribunal has failed to consider the evidencefurnished by appellant in regard to the background, capability and capacityof appellant by merely relying on the lower authorities without, taking intoconsideration the relevant facts of the case. It is also appellant’s case thatthe ITAT failed to consider several decisions cited before it including that ofthe Hon’ble Apex Court in CIT v. Best and Co. (Private) Ltd.1 and theSpecial Bench in the case of Saurabh Srivastava v. DCIT[2] by stating that therelevant cases only dealt with loss or destruction of existing source ofincome of the party which are different from the facts of the present case. Itis appellant’s case that both these judgments categorically and clearly heldthat in case of payments made to compensate for future income it has to becapital receipt even in the case of salaried employees. 7.Mr. Kaka submitted that payment received as non- competition 1 (1966) 60 ITR 11 (SC) 7.Mr. Kaka submitted that payment received as non- competition 1 (1966) 60 ITR 11 (SC) 2 (2008) 111 ITD 287 (Delhi) (SB) fee under the negative covenant was always treated as capital receipt till theassessment year 2003-2004 and it is only vide the Finance Act, 2002 witheffect from 1[st] April, 2003 that the said capital receipt is now made taxableunder Section 28 (va) of the Income Tax Act, 1961. Mr. Kaka submitted thatthe Finance Act, 2002 itself indicates that during the relevant assessmentyear compensation received under non-competition agreement was capitalreceipt not taxable under the Act and it become taxable only with effectfrom 1[st] April, 2003 and the Hon’ble Apex Court in Guffic Chem P. Ltd. vs.Commissioner of Income Tax3, has held that said Section 28(va) isamendatory and not clarificatory and therefore, as held by the Hon’ble ApexCourt, compensation received under non-competition agreement becametaxable as a capital receipt and not as a revenue receipt by specificlegislative mandate vide Section 28(va) of the Act and that too with effectfrom 1[st] April, 2003. 8. 8.Mr. Walve justified the stand taken by the Assessing Officer, CIT(A) as well as the ITAT. Mr. Walve submitted that by virtue of the definitionof the term salary as per Section 17(1)(iv) read with Section 17(3)(i) of theAct receipt of 20,00,000 Equity Shares received by appellant from hisemployer valued at Rs.2 Crores would be a profit, gain or advantage inaddition to salary though not termed as salary but part and parcel of incomeby way of salary, which would be taxable. 3 (2011) 332 ITR 602 (SC) 9.We have considered the orders annexed to the Appeal Memoand also heard counsel and also considered the compilation of judgmentstendered by Mr.Kaka. Relying on these judgments/orders, Mr.Kakasubmitted that compensation paid by way of 20,00,000 Equity Shares of thecompany was in lieu of appellant accepting: (a) restrictive covenant and (b)the restrictive covenant was an independent application and thecompensation which was attributable to the restrictive covenant, i.e.,20,00,000 Equity Shares of the company, was a capital receipt and hencenot taxable. Mr. Kaka also relied on the following judgments/orders : 1.Beak (Inspector of Taxes) v. Robson, (1943) 11 ITR 23 (House Lords) 2. Gilladers Arbuthnot & Co. Ltd. v. CIT, (1964) 53 ITR 283 (SC) 3.CIT v. Saroj Kumar Poddar, (2005) 279 ITR 573 (Cal) 4.CIT v. Late G.D. Naidu, (1987) 165 ITR 63 (Mad) 5.CIT v. A.S. Wardekar, (2006) 283 ITR 432 (Cal) 6.B.K. Kotru v. CIT, (2006) 282 ITR 1 (Bom) 7.Rohitasava Chand v. CIT, (2008) 306 ITR 242 (Delhi) 8.CIT v. Shyam Sundar Chhaparia, (2008) 305 ITR 181 (MP) 9.CIT v. Varas International P. Ltd., (2006) 283 ITR 484 (SC) 10. CIT v. Sunil Kinik, (2013) 354 ITR 623 (Karn) 11. Hari Shankar Bhartia v. CIT, (2011) 15 taxmann.com 113 (Calcutta) 12. CIT v. K. Chandrakanth Kini, (2012) 347 ITR 388 (Karn) 13. CIT v. Sapthagiri Distilleries Ltd., (2014) 366 ITR 270 (Karn) 14. CIT v. Wintac Ltd., (2014) 360 ITR 614 (Karn) 15. CIT v. Real Image Pvt. Ltd., (2013) 359 ITR 606 (Mad) 16. CIT v. Spencers & Co. Ltd., (2013) 359 ITR 612 (Mad) 17. CIT v. Shri. Saurabh Srivastava, ITA 116/2009 and CM 1343/2009Order dated 17-03-2009 (Delhi)Order dated 17-03-2009 (Delhi) 18. CIT v. Rohtisava Chand, Civil Appeal No. (S). 7467 of 2009Order dated 04-09-2014 (SC)Order dated 04-09-2014 (SC) 10.Though Mr. Walve first submitted that Section 28(va) of the Act was clarificatory and not amendatory, but after considering Guffic Chem P. Ltd. (supra) fairly agreed that the Hon’ble Apex Court has held that the saidSection 28(va) of the Act is amendatory and not clarificatory. 13. CIT v. Sapthagiri Distilleries Ltd., (2014) 366 ITR 270 (Karn) 14. CIT v. Wintac Ltd., (2014) 360 ITR 614 (Karn) 15. CIT v. Real Image Pvt. Ltd., (2013) 359 ITR 606 (Mad) 16. CIT v. Spencers & Co. Ltd., (2013) 359 ITR 612 (Mad) 17. CIT v. Shri. Saurabh Srivastava, ITA 116/2009 and CM 1343/2009Order dated 17-03-2009 (Delhi)Order dated 17-03-2009 (Delhi) 18. CIT v. Rohtisava Chand, Civil Appeal No. (S). 7467 of 2009Order dated 04-09-2014 (SC)Order dated 04-09-2014 (SC) 10.Though Mr. Walve first submitted that Section 28(va) of the Act was clarificatory and not amendatory, but after considering Guffic Chem P. Ltd. (supra) fairly agreed that the Hon’ble Apex Court has held that the saidSection 28(va) of the Act is amendatory and not clarificatory. 11.It is settled law that after the Finance Act, 2002 coming intoeffect from 1[st] April, 2003 capital receipt is now made taxable under Section28(va) of the Act. Whether the amount is received by way of compensationunder a restrictive covenant or under a non-competition agreement it wouldamount to capital receipt in the hands of the recipient. Of course, it woulddepend on the agreement entered into between the parties. We haveconsidered the agreement and we find that the agreement incorporatedrestrictive covenant on the right of appellant. 12.The agreement expressly provides that appellant shall notdirectly or indirectly engage in or be concerned or connected with anybusiness which is similar to and/or in competition with the business of thecompany in the metro cities of Bombay, Delhi, Ahmedabad and Bangaloreand appellant shall not directly or indirectly control or operate or cause tocontrol or operate or participate in any similar business in the metro cities.In fact, the agreement goes to the extent of even stating that appellant shallnot associate himself or be an advisor, employee or be a partner in anysimilar business as that of the company and he shall cease and desist fromparticipating in similar business activities as that of the company and not touse his goodwill or expertise in respect of similar business as that of the company. To that extent, in our view it was loss of source of income forhim in the future. The agreement, i.e., the deed for negative covenants wasan independent obligation undertaken by appellant with the company insame field for a period of ten years. Therefore, the compensationattributable to restrictive covenant, i.e., 20,00,000 Equity Shares of Rs.10/-each in the hands of appellant was a capital receipt in as much as it wasappellants’ profit making capabilities for a period of ten years from the dateof appellant leaving the employment of the company either on his own or inassociation with professional competitors. 13.The ITAT, CIT and the Assessing Officer have proceeded on anerroneous footing that the company came into existence only on 22[nd] June,2000 and the assessee was inducted into its employment on 30[th] June, 2000and therefore it was not feasible and it is inconceivable that appellant canbe a privy to the business secrets of the company within a period of eightdays of his employment. The deed of negative covenant does not provide oreven indicate that appellant was privy to the business secrets of thecompany within a period of eight days. The objective for entering intoagreement was because the company was engaged in the business ofmaintenance and collection of art and sale of art by conducting auctions,exhibitions etc., and appellant has been actively and closely associated withthe Indian Art Industry for over seven years and was a pioneer in his fieldwith extensive knowledge of the history and aesthetics of Indian Classical Modern Contemporary Art and has considerable skills, expertise, goodwilland experience in the aforesaid business. Appellant had agreed to be anemployee director of the company and by virtue of his employment and onaccount of his knowledge and skill and since he will be privy to the businesssecrets of the company, appellant could have been a potential threat in theevent of his leaving the employment of the company either on his own or inassociation with others. To prevent the potential threat being effected, thecompany believed that appellant should be bound by a negative covenantfor a period of ten years from the date when appellant may leave theemployment of the company. In consideration of appellant agreeing for thenegative covenant, company decided to pay compensation by way of20,00,000 Equity Shares of Rs.10/- each. We are informed across the barthat the company is in liquidation process before NCLT and the value of thisshares today is practically worthless. 14.Respondents have also proceeded on an erroneous basis thatstatement of income filed by appellant for A.Y. 2000-01 does not show thatappellant had income from business of maintenance and collection of artand sale of art and the assessee was showing only interest income andtherefore he cannot be stated to be in a position to compete in any mannerwith the employer company because he did not have any existing businessrunning. According to respondent for any sum stated to be non-competefess, the same should be paid to any person from whom the real threat of competition exists and because his return of income for A.Y. 2000-01 doesnot show any income or business of maintenance and business of collectionof art and sale of art, the value of shares received by appellant should betreated as revenue receipt and not capital receipt. In our view, these thingsreally does not matter. All this cannot be the basis for determining whetherthe amount received by appellant should be revenue receipt or capitalreceipt. The department has to only consider the agreement entered intoand if the agreement indicates that the amount paid by way ofcompensation was against restrictive covenant or for non-compete thatwould amount to capital receipt. Of course, unless respondent proves thatrestrictive covenant or negative covenant agreement was a sham agreement.No material has been brought on record to show that the negative covenantagreement is a sham agreement. All judgments/orders relied upon by Mr. Kaka certainly holdthat whether compensation is received for negative restrictive covenant ornon-compete with business of the company, compensation relatable to suchactivity would be a capital receipt. 15.The Hon’ble Apex Court in Guffic Chem P. Ltd. (supra) afterdetermining the question of law whether a payment under an agreementnot to compete (negative covenant agreement) is a capital receipt or arevenue receipt held as under : 6. The above dichotomy is clearly spelt out in the judgmentof this Court in Gillanders' case (supra) in which the factsof this Court in Gillanders' case (supra) in which the facts were as follows. The assessee in that case carried on businessin diverse fields besides acting as managing agents, shippingagents, purchasing agents and secretaries. The assessee alsoacted as importers and distributors on behalf of foreignprincipals and bought and sold on its own account. Under anagreement which was terminable at will the assessee acted asa sole agent of explosives manufactured by Imperial ChemicalIndustries (Export) Ltd. That agency was terminated and byway of compensation the Imperial Chemical Industries(Export) Ltd. paid for first three years after the terminationof the agency two-fifths of the commission accrued on its salesin the territory of the agency of the appellant and in additionin the third year full commission was paid for the sales in thatyear. The Imperial Chemical Industries (Export) Ltd. took aformal undertaking from the assessee to refrain from sellingor accepting any agency for explosives. 7. Two questions arose for determination, namely, whetherthe amounts received by the appellant for loss of agency wasin normal course of business and therefore whether theyconstituted revenue receipt? The second question which arosebefore this Court was whether the amount received by theassessee (compensation) on the condition not to carry on acompetitive business was in the nature of capital receipt? Itwas held that the compensation received by the assessee forloss of agency was a revenue receipt whereas compensationreceived for refraining from carrying on competitive businesswas a capital receipt. This dichotomy has not beenappreciated by the High Court in its impugned judgment. TheHigh Court has misinterpreted the judgment of this Court inGillanders' case (supra). In the present case, the Departmenthas not impugned the genuineness of the transaction. In thepresent case, we are of the view that the High Court has erredin interfering with the concurrent findings of fact recorded bythe Commissioner of Income-tax (Appeals) and the Tribunal.One more aspect needs to be highlighted. Payment receivedas non-competition fee under a negative covenant was alwaystreated as a capital receipt till the assessment year 2003-04.It is only vide the Finance Act, 2002 with effect from April 1,2003 that the said capital receipt is now made taxable [See:Section 28(va)]. The Finance Act, 2002 itself indicates thatduring the relevant assessment year compensation received bythe assessee under non- competition agreement was a capitalreceipt, not taxable under the 1961 Act. It became taxableonly with effect from April 1, 2003. It is well settled that aliability cannot be created retrospectively. In the present case,compensation received under non-competition agreementbecame taxable as a capital receipt and not as a revenuereceipt by specific legislative mandate vide Section 28(va) and that too with effect from April 1, 2003. Hence, the saidSection 28(va) is amendatory and not clarificatory. Lastly, inCIT v. Rai Bahadur Jairam Valji reported in [1959] 35 ITR 148it was held by this Court that if a contract is entered into inthe ordinary course of business, any compensation receivedfor its termination (loss of agency) would be a revenuereceipt. In the present case, both the Commissioner ofIncome-tax (Appeals) as well as the Tribunal, came to theconclusion that the agreement entered into by the assesseewith Ranbaxy led to loss of source of business; that paymentwas received under the negative covenant and therefore thereceipt of Rs. 50 lakhs by the assessee from Ranbaxy was inthe nature of capital receipt. In fact, in order to put an end tothe litigation, Parliament stepped in to specifically tax suchreceipts under non-competition agreement with effect fromApril 1, 2003. 16.For the above reasons, we answer the questions as under : In view of our answer to Question (a) and Question (b) answering Question (c) and (d) would not arise. 17.Appeal disposed with no order as to costs. WRIT PETITION NO. 602 OF 2011 18.In view of deciding the Appeal No.950 of 2009 in favour of appellant, this petition will not survive. 19.Petition dismissed. (N. J. JAMADAR, J.) (K.R. SHRIRAM, J.)