M/S. Gkn Driveline India Ltd v. P. Gupta And Mr.anunav Kumar, Advocates

$~ * IN THE HIGH COURT OF DELHI AT NEW DELHI+ITA 542/2005 Reserved on : 16[th]November, 2017Date of decision : 27[th]November, 2017 M/S. GKN DRIVELINE INDIA LTD...... Appellant Through:Mr. V. P. Gupta and Mr.Anunav Kumar, Advocates. Versus COMMISSIONER OF INCOME TAX ..... Respondent Through:Mr. Asheesh Jain, SeniorStanding Counsel with Mr.Shahrukh Ejaz, Advocate. CORAM:HON'BLE MR. JUSTICE SANJIV KHANNAHON'BLE MS. JUSTICE PRATHIBA M. SINGH JUDGMENT Prathiba M. Singh J., This appeal under Section 260A of the Income Tax Act,1961 (Act, for short) arises out of order dated 26[th]October, 2004passed by the Income Tax Appellate Tribunal (for short ‘ITAT’) inITA No.1281/Del/1999. 2.On 14[th]December, 2005, the appeal was admitted and thefollowing questions of law were framed. “1. Whether the ITAT was right in holding thatpayment of Rs.70 lakhs made by the appellant on account of non-competition for a period of fiveyears was in the nature of capital expenditure? 2. Whether the ITAT was right in holding that theinterest income earned by the appellant ondeposits in banks towards margin money is notincome derived for industrial undertaking?” 3.The short question that arises in the present appeal is as towhether the amount of Rs.70 lakhs paid by the Appellant/Assessee(hereinafter referred as ‘Assessee’) to M/s. Shriram MobilesLimited (hereinafter referred as ‘SML’) is a non-compete fee andwhether the Assessee is entitled to deduction on the ground that itis a revenue expenditure. Brief Background 4.The Assessee claims to be the Indian Arm of the GKN groupbased in Germany and engaged in the manufacture and sale of frontwheel drive axle assembly for vehicles. It is the Assessee’s casethat some of its customers during the relevant period includedcompanies such as Maruti Udyog Limited and Bajaj Tempo.AccordingtotheAssessee,itwasthemarketleaderinmanufacturing of these products. 5.TheAssesseewasintheprocessofexpandingitsmanufacturing capacity and since demand for axles was increasingand new models of cars were coming into the market, it enteredinto an agreement dated 16th February 1995, for purchase of assetsand liabilities of a newly set up factory, established by a companynamed Shriram Mobiles Limited in Madras.According to the ITA 542/2005 Assessee, the consideration in the said agreement was in two parts -first Rs.1.30 Crores towards the net asset value and secondly Rs.70lakhs paid on account of non-compete clause. 6.The Assessee filed its return of income on 30[th]November,1995. One of the issues raised during the course of assessment wasin relation to the nature of the payment of Rs.70 lakhs. TheAssessing Officer (hereinafter ‘AO’) after discussing the case law,held that the Assessee obtained an advantage of an enduring natureand hence the expenditure is in the nature of capital expenditure.The AO held that the intention of the Assessee was to keepcompetitors out of the market thereby increasing sales, the saidamount could not be held to be revenue expenditure as it derivedlong term benefit. 7.The Assessee approached the Commissioner of Income Tax(Appeals) [hereinafter ‘CIT(A)’] who held that since the non-competition period was for a short term of five years theexpenditure is revenue in nature. The CIT (A) relied upon CIT v.G.D. Naidu [1987] 165 ITR 63 (hereinafter ‘G.D. Naidu’) of theMadras High Court and gave relief to the Assessee to the tune ofRs.70 lakhs. 8.The ITAT vide order dated 26[th]October, 2004 reversed theorder of the CIT(A) and restored the finding of the AO. Thereasoning of the ITAT was that the Assessee was the onlymanufacturer in India for front wheel drive axle assembly forvehicles and being the sole manufacturer, it acquired an enduring ITA 542/2005 benefit. Thus, according to the ITAT, the expenditure was capitalin nature as the Assessee eliminated its only competitor afteracquiring the factory, thereby perpetuating its exclusivity in themarket. Submission of the Appellant/Assessee 8.The ITAT vide order dated 26[th]October, 2004 reversed theorder of the CIT(A) and restored the finding of the AO. Thereasoning of the ITAT was that the Assessee was the onlymanufacturer in India for front wheel drive axle assembly forvehicles and being the sole manufacturer, it acquired an enduring ITA 542/2005 benefit. Thus, according to the ITAT, the expenditure was capitalin nature as the Assessee eliminated its only competitor afteracquiring the factory, thereby perpetuating its exclusivity in themarket. Submission of the Appellant/Assessee 9.Mr. V. P. Gupta, learned counsel appearing on behalf of theAssessee submits that the ITAT has erred in holding that theexpenditure is capital in nature, inasmuch as it is the settled legalposition that a non-compete fee paid for a short term of five yearsis a revenue expenditure. Mr. Gupta took us through variousclauses in the agreement as also the annual report of the Assesseeto demonstrate that the Assessee was the market leader and the solemanufacturer of these products. In fact, the factory of SML had notyet commenced manufacturing and there was no serious threat tothe market leadership position of the Assessee and hence the non-compete fee was a revenue expenditure incurred by the Assessee.Mr. Gupta specifically relied upon the judgment of this Court inCIT v. Eicher Ltd.[2008] 302 ITR 249 (Del) (hereinafter ‘EicherLtd.’) wherein a Division Bench of this Court held that a non-compete fee is in the nature of business/revenue expenditure. It wasfurther submitted that the SLP against this judgment was alsodismissed. Submissions of the Revenue 10.Mr.AsheeshJain,learnedSeniorStandingCounselappearing for the Revenue, heavily relied upon the judgment of this Court in Sharp Business System v. Commissioner of Income Tax[2012] 254 CTR 233 (Delhi) (hereinafter ‘Sharp Business System’)to submit that a non-compete fee for a period of seven years washeld to be a capital expenditure and not a revenue expenditure. Hesubmitted that the Assessee obtained a benefit of an enduringnature by ensuring that competition was eliminated at the inceptionitself. Agreement dated 16[th]February 1995 11.Before embarking upon and deciding the question of lawframed in this case, it is important to discuss the nature of theagreement entered into between the Assessee and SML. In fact, theclauses in the agreement tell a different tale. 12.It is surprising to note that none of the authorities beginningfrom the AO to the ITAT have referred to the clauses of theagreement which would have made the decision on the questionquite easy, inasmuch as, the nature of the rights and obligations ascaptured in the agreement would enable one to come to theconclusion as to whether the expenditure is capital or revenue innature. A few relevant clauses of the agreement are set out hereinbelow: “3.1The consideration payable by ITL to SML shallconsist of:I. Rs 1,30,00,000 (Rupees one crore and thirtylakhs only) being Net Asset Value, i.e. difference of thevalue of assets and value of the liabilities as perSchedule No. 5 subject to adjustment as hereinafterprovided. II. A further sum of Rs. 70,00,000/- (RupeesSeventy lakhs only) for obligations and covenants setout in this Agreement. 4. Payment Schedule: ITL shall pay consideration asset out in Article 3.1 above as follows: 4.1On or after the Completion Date by issue of100,000 (One lac) equity shares of ITL at suchpremium and on such terms and conditions as may beapproved by ITL shareholders at a general meeting,SEBI and other relevant Government authorities, ifany. These shares will be forwarded to ICICI at therequest of SML. 4.2Balance of the consideration as reduced byadjustment pursuant to ArticleIIIand payment'under 4.1 above shall be paid In cash on or after thecompletion date. This amount shall be deposited in anEscrow Account with ICICI Banking Corporation,Madras at the request of SML and shall be payable toSML subject to a no objection certificate form ICICI,Madras and IFCI, Madras. 4. Payment Schedule: ITL shall pay consideration asset out in Article 3.1 above as follows: 4.1On or after the Completion Date by issue of100,000 (One lac) equity shares of ITL at suchpremium and on such terms and conditions as may beapproved by ITL shareholders at a general meeting,SEBI and other relevant Government authorities, ifany. These shares will be forwarded to ICICI at therequest of SML. 4.2Balance of the consideration as reduced byadjustment pursuant to ArticleIIIand payment'under 4.1 above shall be paid In cash on or after thecompletion date. This amount shall be deposited in anEscrow Account with ICICI Banking Corporation,Madras at the request of SML and shall be payable toSML subject to a no objection certificate form ICICI,Madras and IFCI, Madras. 6.1SMLshallindemnifyITLandholdITLharmless from and against any damages, deficiencies,losses, costs, liabilities and expenses (including legalfees and disbursements) and in particular, but withoutprejudice to the generality of the foregoing, from andagainst any depletion or diminution of the assetsresulting directly and indirectly from or arising out ofany breach of any of the representation, warrantiesand undertakings made or given by SML. 8.1SML agrees and undertakes to obtain within 45days or within such further period as may be mutuallyagreed upon by the parties in writing, all necessaryapprovals/sanction form Income Tax Authorities asmay be required. 10.1(a)OnandaftertheexecutionofthisAgreement neither party shall directly or indirectlydisclose or divulge to any third party the terms of this Agreement or any previous communication either oralor written between the parties hereto with respect tothesubjectmatterhereoforanyConfidentialInformation as defined in sub-article (b) below exceptwith prior written consent of other party or to complywith law or guidelines issued by any regulatoryauthority. (b)Forthepurposeofsub-article(a)theexpression"ConfidentialInformation"shallmeaninformation relating to the products, services, business,personnel or commercial activities of the other party orits affiliates including but not restricted to formulas,compilations, programs, devices, concepts, inventions(whetherornotpatentable),designs,methods,technique,marketingandcommercialstrategies,process, data concepts, customer, client and contactlists and know - how, unique combinations of separateitemswhichindividuallymayormaynotbeconfidential, which information is not generally knownto the public and either derives economic value, actualor such that the other party or its affiliates has alegitimate interest in maintaining its secrecy. AlldocumentswillbeconsideredCONFIDENTIALINFORMATION whether or not marked with anyproprietary notice or legend when the disclosure takesplace. 11.It is hereby expressly declared that SML shallnot for a period of five years from the Appointed Datedirectly or indirectly manufacture, market or distributeconstant velocity joints or any other product orproducts that may be of a competitive nature. 14.SML shall within a period not exceeding 45days from the Effective Date or within such furtherperiod as may be mutually agreed upon between theparties in writing (time being of the essence in thisbehalf) obtain all necessary sanctions and approvals necessary or required to comply with the terms of thisagreement.” The agreement has the following Schedules: Schedule -1: Lists all the fixed assets of SML as on 1[st]April, 1994. Schedule -2: Gives the value of current assets as on 1[st]April, 1994. Schedule -3: Gives the institutional liabilities as on 1[st]April, 1994.Schedule -4: Enumerates the current liabilities and provisions as on1[st]April, 1994. Schedule-5: Depicts the calculation of net asset value as on 1[st]April, 1994. The same is set out below: NET ASSET VALUE AS ON 01/04/1994 13.A perusal of the agreement clearly points to the fact thatwhile the consideration of Rs.1.30 Crores was towards the netvalue of assets as per Schedule 5, the payment of Rs.70 lakhs is“for obligations and covenants” which include the following: necessary or required to comply with the terms of thisagreement.” The agreement has the following Schedules: Schedule -1: Lists all the fixed assets of SML as on 1[st]April, 1994. Schedule -2: Gives the value of current assets as on 1[st]April, 1994. Schedule -3: Gives the institutional liabilities as on 1[st]April, 1994.Schedule -4: Enumerates the current liabilities and provisions as on1[st]April, 1994. Schedule-5: Depicts the calculation of net asset value as on 1[st]April, 1994. The same is set out below: NET ASSET VALUE AS ON 01/04/1994 13.A perusal of the agreement clearly points to the fact thatwhile the consideration of Rs.1.30 Crores was towards the netvalue of assets as per Schedule 5, the payment of Rs.70 lakhs is“for obligations and covenants” which include the following: Warranty and representations – Clause 5.1Warranty and representations – Clause 5.1 Indemnification of SML – Clause 6.1 Prompt execution of documents for effective transfer ofmarketable title in all the assets – Clause 7.1Prompt execution of documents for effective transfer ofmarketable title in all the assets – Clause 7.1 Obtainingapprovalsfromthefinancialinstitutionsconfirming the release of charge on the assets – Clause 7.2confirming the release of charge on the assets – Clause 7.2 Approval from the income tax authorities – Clause 8.1Approval from the income tax authorities – Clause 8.1 Maintenanceofconfidentialityincludingconfidentialinformationrelating tothe productservices,businesscommercial activities, formulas, compilations, programs,devices, concepts, inventions, designs, methods, techniques,marketing and commercial strategies, client and contact listsand customers list etc. – Clause 10.1 (A) & (B)informationrelating tothe productservices,businesscommercial activities, formulas, compilations, programs,devices, concepts, inventions, designs, methods, techniques,marketing and commercial strategies, client and contact listsand customers list etc. – Clause 10.1 (A) & (B) Non-compete clause – Clause 11Non-compete clause – Clause 11 Obligation of SML to obtain all necessary sanctions andapprovals required for compliance of the agreement - Cl. 14Obligation of SML to obtain all necessary sanctions andapprovals required for compliance of the agreement - Cl. 14 14.The above clauses of the agreement go to show that theamount of Rs.70 lakhs is not merely payment towards the non-compete clause but also towards various other obligations whichwere imposed upon SML and had a direct bearing on the finalexecution and implementation of the agreement. To argue that theentire consideration was towards the non-compete fee would therefore be an incorrect statement, inasmuch as the clauses of theagreement do not reflect so. The emphasis in the agreement istowards the takeover of the assets of SML, and it was to ensure thatthe agreement bears fruition that the consideration of Rs.70 lakhshas been apportioned for various obligations and covenantsimposed on SML. 14.The above clauses of the agreement go to show that theamount of Rs.70 lakhs is not merely payment towards the non-compete clause but also towards various other obligations whichwere imposed upon SML and had a direct bearing on the finalexecution and implementation of the agreement. To argue that theentire consideration was towards the non-compete fee would therefore be an incorrect statement, inasmuch as the clauses of theagreement do not reflect so. The emphasis in the agreement istowards the takeover of the assets of SML, and it was to ensure thatthe agreement bears fruition that the consideration of Rs.70 lakhshas been apportioned for various obligations and covenantsimposed on SML. 15.Under these circumstances, the question that is to be decidedis whether the expenditure of Rs.70 lakhs incurred is of capital orrevenue in nature. The consideration of Rs.70 lakhs is clearlytowards ensuring that there is no impediment in the smooth transferof SML’s factory to the Asssessee. It should be complete and final.From the facts placed before the Court, there really did not appearto be any serious threat whatsoever in order for the Assessee to paythe non-compete fee to SML which had not even commenced itsmanufacturing. From the nature of the transaction, it is clear thatthe acquisition of SML’s unit in Madras was, as submitted bylearned counsel for the Assessee, for expansion purposes. It was toexpand and increase production by acquiring a new undertaking.The entire business with capital assets was acquired. The paymentwas bifurcated into two parts, Rs.130 lakhs towards net assets andRs.70 lakhs for other obligations and recitals. The payment wastowards all the obligations and covenants imposed upon SML, i.e.,obtainingpermissionsfromfinancialinstitutions,obtainingapprovals from governmental authorities, income tax authorities,indemnity towards other losses, if any, and maintenance of confidentiality about the agreement as also all the intellectualproperty and other data and information. This goes to show thatthe said payment was clearly for an enduring benefit and not justtowards the non-compete obligation. 16.Even the non-compete obligations in clause 11 appear to beillusory in nature and restricted to ‘constant velocity joints or anyother competitive products’. Clearly, the same is of limited natureand there was also no obligation of non-compete imposed upon thepromoter directors of SML. In fact, as stated during the course ofarguments, the managing director of SML became the corporatedirector of the Madras Division of the Assessee. Thus, the non-compete clause and the consideration of Rs.70 lakhs are notcompletely and exclusively inter-linked. The payment of Rs.70lakhs, which is a substantial sum, i.e., more than half of theconsideration paid for the net assets of the unit itself, was for amultitude of obligations and covenants which were fastened uponSML and not only towards the non-compete obligations. 17.Insofar the authorities cited are concerned, including EicherLtd (supra) and Sharp Business System (supra), it is clear thatneither of the cases are comparable on facts to the present case, interms of the nature of consideration or the non-compete clause. InEicher Ltd (supra) the employee, with whom the non-competeagreement was executed, was a person who possessed specializedknowledge of the technology as also specialized knowledge relating to two wheelers. The Court in Eicher Ltd (supra) held asunder: “12. It is quite clear from the above that to decidewhether an expenditure of this nature is a capitalexpenditure or not would depend on the facts of thecase. However, it is necessary to know whether theadvantage derived by the prayer is of an enduringnature, and for this one of the considerations is thelength of time for which the non-compete agreementwould operate although that is not decisive. While thelength of time for which competition is eliminated maynot strictly be decisive in all cases, yet, at the sametime, it should not be so brief as to virtually betransitory.” relating to two wheelers. The Court in Eicher Ltd (supra) held asunder: “12. It is quite clear from the above that to decidewhether an expenditure of this nature is a capitalexpenditure or not would depend on the facts of thecase. However, it is necessary to know whether theadvantage derived by the prayer is of an enduringnature, and for this one of the considerations is thelength of time for which the non-compete agreementwould operate although that is not decisive. While thelength of time for which competition is eliminated maynot strictly be decisive in all cases, yet, at the sametime, it should not be so brief as to virtually betransitory.” In the facts of the said case, this Court came to the conclusion thatthe Assessee did not acquire any capital asset by making thepayment of the non-compete fee. It merely eliminated competitionin the two wheeler business for a while. Eicher Ltd (supra) clearlyholds that if the advantage is of an enduring nature, then it could bea capital expenditure. 18.The test laid down by the Supreme Court in Empire Jute Co.Ltd Vs. CIT [1980] 124 ITR 1 (SC), to determine as to whether aparticular expenditure is capital or revenue in nature is also appliedin Eicher Ltd (supra) as also Sharp Business System (supra). It isclear that the consideration of Rs.70 lakhs was not expresslytowards the non-compete obligation, but towards smoothening theprocess of acquisition of the asset, i.e., the unit of SML in Madras.Approvals that were required from the financial institutions,income tax authorities and other governmental authorities were ITA 542/2005 towards the finalisation and closure of the acquisition process.OthercovenantsandobligationsimposeduponSML,i.e.,warranties, confidentiality, etc., added value to the asset beingacquired. There is no doubt that in the facts of the present case, thepayment of Rs.70 lakhs is a capital expenditure and hence thequestion of law is answered in favour of the Revenue and againstthe Assessee. 19.The appeal is dismissed with no orders as to costs. PRATHIBA M. SINGH, J NOVEMBER 27, 2017dk SANJIV KHANNA, J