M/S. Sundaram Finance Limited, (Formerly M/S.lakshmi General Finance Ltd.,) v. The Deputy Commissioner Of Income Tax, Company Circle - Iii, Chennai - 600 034

IN THE HIGH COURT OF JUDICATURE AT MADRASDATED : 25.11.2021 CORAM : THE HON'BLE MR. JUSTICE R. MAHADEVANANDTHE HON'BLE MR. JUSTICE MOHAMMED SHAFFIQ TAX CASE APPEAL NOS. 429 AND 430 OF 2009 M/s. Sundaram Finance Limited, (Formerly M/s.Lakshmi General finance Ltd.,)21, Patullos Road, Chennai - 600 002. ...Appellant in both the appeals Versus The Deputy Commissioner of Income tax, Company Circle - III, Chennai - 600 034. ... Respondent in both the appeals Tax Case Appeals filed under Section 260A of the Income TaxAct, 1961 against the order of the Income Tax AppellateTribunal, “B” Bench Chennai dated 07.05.2008 passed inITA.Nos.325/Mds/2005 and 2122/Mds/2006. And against the O/o Commissioner of Income tax (Appeals)-XI, 121, Mahatma Gandhi Salai, Chennai 600 034 and made inITA.No.114/ITA.No.266/2004-05 and ITA.No.278/2005-2006 orderdated 04.01.2005 and 22.06.2006 and against the O/o AssistantCommissioner of Income tax and Company Circle II(4)(I/C)Chennai-34 and made in PAN.No. date of order15.03.2004 (ii) the Deputy Commissioner of Income tax CompanyCircle II(4)(I/C), Chennai 34 and made in PAN/GIR.No.AAACL0502Bdate of order 30.03.2005 for the assessment year 2001-2002 &2002-2003 respectively. For Appellant :Mr.R.Venkatanarayanan for M/s.Subbaraya Aiyar in both appeals For Respondent :Mrs. Hemalatha, Senior standing counsel in both appeals https://hcservices.ecourts.gov.in/hcservices/ COMMON JUDGMENT (Judgment of the Court was delivered by R. MAHADEVAN, J.) These tax case appeals have been filed by the appellant /assessee, calling in question the correctness of the order dated07.05.2008 passed by the Income Tax Appellate Tribunal, Chennai“B” Bench, in I.T.A.Nos.325/Mds/2005 & 2122/Mds/2006respectively, relating to the assessment years 2001-02 & 2002-03. 2. On 07.07.2009, this Court admitted these two tax caseappeals on the following common substantial questions of law:- "(i) Whether on the facts and circumstances ofthe case the Tribunal was right in law in holdingthat the amount received towards restrictivecovenant is revenue receipt chargeable to tax thoughreceipt of compensation for restraining one'sbusiness has been brought only with effect from01.04.2003 vide amendment to Section 28 by theFinance Act, 2002? (ii) Whether on the facts and circumstance ofthe case the Tribunal was right in law in holdingthat the appellant is not entitled to deduction ofthe provision made in respect of Non performingAssets which are considered irrecoverable? 3.1 The learned counsel for the appellant / assesseesubmitted that the first question of law involved in theseappeals has already been considered and decided by this Court byjudgment dated 19.06.2019 in TCA No.1938 of 2008 in respect ofthe assessee's own case. For better appreciation, the relevantportion of the said judgment is extracted below: “5. The assessment for the year underconsideration, namely, 2001- 02 was completed by theassessing officer under Section 143(3) of the Act,vide order dated 31.03.2004. Though there wereseveral issues which were dealt with by the assessingofficer, we are concerned only with regard to thefinding pertaining to the amount received by theassessee towards Restrictive Covenant, whether it isa revenue receipt or capital receipt?. 6. The assessee is the company engaged in thebusiness of hire purchase financing, equipmentleasing and allied activities. For the assessmentyear under consideration, namely, 2001-02, theassessee filed Return of Income on 31.10.2001declaring the total income of Rs.8,58,48,600/-. In “5. The assessment for the year underconsideration, namely, 2001- 02 was completed by theassessing officer under Section 143(3) of the Act,vide order dated 31.03.2004. Though there wereseveral issues which were dealt with by the assessingofficer, we are concerned only with regard to thefinding pertaining to the amount received by theassessee towards Restrictive Covenant, whether it isa revenue receipt or capital receipt?. 6. The assessee is the company engaged in thebusiness of hire purchase financing, equipmentleasing and allied activities. For the assessmentyear under consideration, namely, 2001-02, theassessee filed Return of Income on 31.10.2001declaring the total income of Rs.8,58,48,600/-. In the scrutiny assessment, which was completed on31.03.2004, the total income was determined atRs.120,65,85,728/-. The assessing officer whilecompleting the assessment disallowed the amountreceived as compensation for restrictive covenant. Inthe agreement entered into between Royal and SunAlliance Insurance (RSA), U.K., and General InsuranceCompany, India, the assessee was paid Rs.16.80 Croresbased on the agreement which according to theassessee is the receipt in the capital field, as itwas received as consideration for restraining theassessee from entering into insurance business on itsown and also restraining itself from negotiating withany other party for entering into insurance business. 7. The assessee filed an appeal before theCommissioner of Income Tax [Appeals]-VI, Chennai['CIT-(A)' for brevity] . The appeal was allowed byorder dated 13.01.2005. The CIT-(A) held that therestrictive clause in the agreement for which amountof Rs.16.80 Crores was paid to the assessee was inview of the commitment given by the assesseerestraining itself from negotiating with any otherparty and restraining itself from entering intoinsurance business. Thus, it held that this amountwas paid on account of the restrictive covenant andhence it is a capital receipt. Furthermore, it heldthat the payment was received by the assessee beforethe commencement of the business activity andtherefore, it opined that the amount received by theaseessee was a capital receipt and accordingly, theaddition made by the assessing officer was deleted. 8. The assessing officer did not agree with thesaid contention primarily on the ground that theassessee was not paid any money by the U.K.Companytowards the restrictive covenant and only when theassessee subscribed to the share capital on19.10.2000, this amount was paid and therefore, itcannot be treated as a capital receipt. Accordingly,the assessment is completed. 9. The Revenue filed an appeal before theTribunal and the Tribunal after taking note of thefinding of the assessing officer and finding of theCIT-(A), reversed the order passed by the CIT(A)particularly on the ground that the so called 'Noncompete Fee' is being received by the assessee, whichis not for the business of insurance and the paymentis clearly towards 'exploitation of the service and infrastructure' of the assessee and hence falls underthe revenue field. The assessee is before us onappeal challenging the said finding and we arerequired to answer the above framed substantialquestion of law. 10. The agreement entered into between theassessee and the U.K.Company is tiled as “Letter ofIntent” agreed and accepted by the parties on 5[th]April, 2000 in London. The following clause is thesubject matter of interpretation: “At the instance of the U.K.Company,assessee restrained itself from interferingwith any other party and also refrained fromitself entering the insurance business. Inconsideration of this restraint and theassurance to join hands only withU.K.Company, agreed to pay lumpsum of E 2.4million to the assessee.” infrastructure' of the assessee and hence falls underthe revenue field. The assessee is before us onappeal challenging the said finding and we arerequired to answer the above framed substantialquestion of law. 10. The agreement entered into between theassessee and the U.K.Company is tiled as “Letter ofIntent” agreed and accepted by the parties on 5[th]April, 2000 in London. The following clause is thesubject matter of interpretation: “At the instance of the U.K.Company,assessee restrained itself from interferingwith any other party and also refrained fromitself entering the insurance business. Inconsideration of this restraint and theassurance to join hands only withU.K.Company, agreed to pay lumpsum of E 2.4million to the assessee.” 11. While completing the assessment, theassessing officer cannot examine the exigency ofbusiness as to what would be the prudent decisionfrom the point of view of the assessee. What isrequired to be seen is the interpretation which hasto be given to the covenant in the Letter of Intent.The assessee has been non-suited on the ground thatthey were never in the insurance business and thecovenant cannot be considered as a restrictivecovenant. We do not agree with the said finding ofthe assessing officer because there is a backgroundwhich cannot be ignored by the assessing officerduring the relevant point when the “Letter of Intent”was signed. It was the first time, the Government ofIndia took a decision to permit foreign insurancecompanies to set up general insurance business inIndia. The entire matter was regulated by theGovernment of India under the relevant regulations.Thus, several competing companies in India weredesirous of starting insurance business with foreignpartnerships / Joint ventures. Therefore, commercialprudence demanded the U.K.Company to restrain theassessee, preventing them from entering intoinsurance business, which they had not done earlier,secondly, preventing the assessee from entering intoan agreement with any other foreign insurancecompany. The condition is clear and lucid and it isto be treated as a 'restrictive covenant' and merelybecause the assessee was not in the insurance business is not a ground to read down the condition.Thus, we are of the considered view that theinterpretation given by the CIT(A) to the saidcovenant is just and proper and we do not agree withthe finding of the assessing officer as well as theTribunal in this regard. 12. Mr.T.Ravikumar, learned Senior Counsel forthe respondent / revenue vehemently contended thatthe factual finding that the payment was received bythe assessee before the commencement of business isthe finding, which stares against the assessee andthe same has not been challenged. In our consideredview, we are afraid that such a finding cannot workagainst the assessee. The terms and conditions of theLetter of Intent is clear, in the sense, that it isthe condition which precedes other conditions, whichrelates to 'Investment for allotment of shares'. Infact, this amount which was agreed to be paid as non-compete has been received by the assessee on23.10.2000 and immediately invested in the shares ofthe company. To be noted that all the transactionsare in the same assessment year, i.e., 2001-2002. 13. In the light of the above, we are of theclear view that the CIT(A) was fully justified inholding that the amount received by the assessee wasa capital receipt and was right in deleting theaddition made by the assessing officer. Further, wenote that the amount has been credited to the capitalreceipt account in the balance sheet for the yearending 31.03.2001 and the amount does not comeanywhere within the inclusive definition of Income asenvisaged in Section 2(24). 13. In the light of the above, we are of theclear view that the CIT(A) was fully justified inholding that the amount received by the assessee wasa capital receipt and was right in deleting theaddition made by the assessing officer. Further, wenote that the amount has been credited to the capitalreceipt account in the balance sheet for the yearending 31.03.2001 and the amount does not comeanywhere within the inclusive definition of Income asenvisaged in Section 2(24). 14. At this juncture, it will be beneficial torefer to the decision of Hon'ble Supreme Court inGuffic Chem (P) Ltd., V. Commissioner of Income Tax &Another reported in (2011) 332 ITR 0602. The Hon'bleSupreme Court has held that 'payment received as non-competition fee under a negative covenant has to betreated as a capital receipt till the Assessment Year2003-04'. The said decision supports the case of theassessee. 15. The learned counsel appearing for theassessee referred to the decision of the assessee'sown case in TCA No.159 of 2009 dated 06.03.2019,which pertains to the capital subsidy received by theassessee from the U.K.Company. 16. It is the submission of Mr.Ravikumar,learned Senior Standing Counsel for the respondent /revenue that the substantial question of law No.1pertains to capital subsidy and in fact, the decisionwould enure in favour of the Revenue. We do not agreewith the said submission as the Letter of Intentprovides “additional investment” at the instance ofthe assessee and the condition stated 'if at the timeof finalisation of shareholders agreement it is foundthat assessee is required to further infuse equityduring the initially agreed pay-back period,U.K.Company will make a compensatory payment toassessee in an amount to be mutually agreed, beforethe finalisation of the shareholders agreement'. 17. Thus, we are of the clear view that theorder passed by the Tribunal dated 31.07.2007reversing the order passed by CIT(A) calls forinterference. In the light of the above, the appealfiled by the assessee is allowed and the order passedby the tribunal is set aside and the order passed bythe CIT(A) dated 13.01.2005 is restored and thesubstantial question of law framed is answered infavour of the assessee. No costs.” Therefore, the learned counsel sought to allow these appeals inrespect of the first question of law raised herein. 3.2On the other hand, the learned Senior Standing Counselappearing for the respondent/Revenue has opposed the submissionsmade on the side of the appellant / assessee, by referring tothe decision of the High Court of Delhi in the case of SharpBusiness System vs. Commissioner of Income - tax - III,reported in 24/5 CTR 233, wherein similar issue was decidedagainst the assessee and in favour of the Revenue and inparagraph 10, it was held as under: "10. In the present case, the appellant is ajoint - venture between M/s.Sharp & L&T. Apparently,the agreement entered into with the L&T in view of thechanged relationship ensures that the latter does notenter into the same business. Although it iscontended that the advantage is only by way offacilitation of the appellant's business and ensuringgreater efficiency as well as profitability, on theother side, what can be seen is that the arrangementis to endure for a substantial period, i.e.7 years.Coupled with the fact that the L&T has its ownpresence in consumer goods sector and would be, if itchooses - able to put up an effective competition for "10. In the present case, the appellant is ajoint - venture between M/s.Sharp & L&T. Apparently,the agreement entered into with the L&T in view of thechanged relationship ensures that the latter does notenter into the same business. Although it iscontended that the advantage is only by way offacilitation of the appellant's business and ensuringgreater efficiency as well as profitability, on theother side, what can be seen is that the arrangementis to endure for a substantial period, i.e.7 years.Coupled with the fact that the L&T has its ownpresence in consumer goods sector and would be, if itchooses - able to put up an effective competition for business engaged in by the assessee, there is no doubtthat the amount is to ensure a certain position in themarket by keeping - out L&T. Applying the testindicated in the Empire Jute Co. Ltd (supra), AlembicChemical Works Co. Ltd. (supra) and Coal Shipments (P)Ltd. (Supra), this Court is the opinion that thededuction cannot be claimed as a revenue expenditure;it clearly falls within the capital field. The firsttwo questions are, therefore, answered against theassessee and in favour of the Revenue.” Stating so, the learned counsel prayed for dismissal of thesetax case appeals, by confirming the order passed by theTribunal, insofar as this issue is concerned. 3.3It is evident from the records that there was ashareholders agreement, as per which, a non-compete restrictionwas imposed to the effect that “the assessee received the amountas consideration with an undertaking to restrain themselves fromentering into insurance business either on their own or joiningwith others”. Due to the said restriction, it has lost its rightto transact with other companies and hence, the same wascompensated by the lump sum, which cannot be brought to tax asrevenue receipt, but is a capital receipt. Further, it is to benoted that the introduction of sub clause (va) to section 28 totax this kind of receipt is applicable only from the assessmentyear 2003-04. That apart, there is no material to show that thesaid compensation amount received by the assessee during theyears in question, was diverted for any other purpose, exceptfor being invested in the share capital of the joint venturecompany. Therefore, following the earlier orders of this courtin TCA No.159/2009 dated 06.03.2019 and TCA No.1938/2008 dated19.06.2009, we answer this issue in favour of the assessee andagainst the Revenue. 4.1 Regarding the second question of law, it is submittedby the learned counsel on both sides that the same is covered infavour of the assessee, as per the decision of the Delhi HighCourt in the case of Commissioner of Income Tax v. Vasisth ChayVyapar Limited reported in (2011) 330 ITR 044, which wassubsequently confirmed by the Honourable Supreme court in theorder dated 13.12.2017 passed in Civil Appeal No. 5811 of 2012etc., batch. The relevant paragraphs of the said decision of theDelhi High Court can profitably be extracted hereunder:- "17. In this scenario, we have to examine thestrength in the submission of learned counsel for theRevenue that whether it can still be held that incomein the form of interest though not received had stillaccrued to the assessee under the provisions of Income Tax Act and was, therefore, eligible to tax.Our answer is in the negative and we give thefollowing reasons in support:- "17. In this scenario, we have to examine thestrength in the submission of learned counsel for theRevenue that whether it can still be held that incomein the form of interest though not received had stillaccrued to the assessee under the provisions of Income Tax Act and was, therefore, eligible to tax.Our answer is in the negative and we give thefollowing reasons in support:- (1) First of all we would discuss the matter inthe light of the provisions of Income Tax Act and toexamine as to whether in the given circumstances,interest income has accrued to the assessee. It isstated at the cost of repetition that admittedposition is that the assessee had not received anyinterest on the said ICD placed with Shaw Wallcesince the assessment year 1996-97 as it had becomeNPAs in accordance with the Prudential norms whichwas entered in the books of accounts as well. Theassessee has further successfully demonstrated thateven in the succeeding assessment years, no interestwas received and the position remained the same untilthe assessment years 2006-07. Reason was adversefinancial circumstances and the financial crunchfaced by Shaw Wallace. So much so, it was facingwinding up petitions which were filed by manycreditors. These circumstances, led to an uncertaintyin so far as recovery of interest was concerned, as aresult of the aforesaid precarious financial positionof Shaw Wallace. What to talk of interest, even theprincipal amount itself had become doubtful torecover. In this scenario it was legitimate move toinfer that interest income thereupon has not"accrued". We are in agreement with the submission ofMr. Vohra on this count, supported by variousdecisions of different High Courts including thiscourt which has already been referred to above. (2) In the instant case, the assessee companybeing NBFC is governed by the provisions of RBI Act.In such a case, interest income cannot be said tohave accrued to the assessee having regard to theprovisions of section 45Q of the RBI and PrudentialNorms issued by the RBI in exercise of its statutorypowers. As per these norms, the ICD had become NPAand on such NPA where the interest was not receivedand possibility of recovery was almost nil, it couldnot be treated to have been accrued in favour of theassessee. 18. As noted above, Mr. Sabharwal, argued thatthe case of the assessee was to be dealt with for thepurpose of taxability as per the provisions of theAct and not the RBI Act which was the accounting (2) In the instant case, the assessee companybeing NBFC is governed by the provisions of RBI Act.In such a case, interest income cannot be said tohave accrued to the assessee having regard to theprovisions of section 45Q of the RBI and PrudentialNorms issued by the RBI in exercise of its statutorypowers. As per these norms, the ICD had become NPAand on such NPA where the interest was not receivedand possibility of recovery was almost nil, it couldnot be treated to have been accrued in favour of theassessee. 18. As noted above, Mr. Sabharwal, argued thatthe case of the assessee was to be dealt with for thepurpose of taxability as per the provisions of theAct and not the RBI Act which was the accounting method that the assessee was supposed to follow. Wehave already held that even under the Income Tax Act,interest income had not accrued. Moreover, thissubmission of Mr. Sabharwal is based entirely on thejudgment of the Supreme Court in the case of SouthernTechnology (supra). No doubt, in first blush, readingof the judgment gives an indication that the Courthas held that RBI Act does not override theprovisions of the Income Tax Act. However, when weexamine the issue involved therein minutely anddeeply in the context in which that had arisen andcertain observations of the Apex Court contained inthat very judgment, we find that the propositionadvanced by Mr. Sabharwal may not be entirelycorrect. In the case before the Supreme Court, theassessee a NBFC debited Rs.81,68,516 as provisionagainst NPA in the profit and loss account, which wasclaimed as deduction in terms of Section 36 (1) (vii)of the Act. The assessing officer did not allow thededuction claimed as aforesaid on the ground that theprovision of NPA was not in the nature of expenditureor loss but more in the nature of a reserve, and thusnot deductible under Sectrion 36 (i) (vii) of theAct. The assessing officer, however, did not bring totax Rs.20,34,605 as income (being income accruedunder the mercantile system of accounting). Thedispute before the Apex court centered arounddeductibility of provision for NPA. After analyzingthe provisions of the RBI Act, their Lordships of theApex Court observed that in so far as the permissibledeductions or exclusions under the Act are concerned,thesameareadmissibleonlyifsuchdeductions/exclusions satisfy the relevant conditionsstipulated therefor under the Act. To that extent, itwas observed that the Prudential Norms do notoverride the provisions of the Act. However, the ApexCourt made a distinction with regard to "IncomeRecognition" and held that income had to berecognized in terms of the Prudential Norms, eventhough the same deviated from mercantile system ofaccounting and/or Section 45 of the Income Tax Act.It can be said, therefore, that the Apex Courtapproved the 'real income" theory which is engrainedin the Prudential Norms for recognition of revenue byNBFC. The following passage from the judgment of theApex Court would bring out the distinction noticed bytheApexCourtbetweenpermissibledeductions/exclusions, on the one hand, and incomerecognition on the other:- ........ ........ 40. At the outset, we may state that inessenceRBIDirections1998arePrudential/Provisioning Norms issued by RBI underChapter IIIB of the RBI Act, 1934. These Normsdeal essentially with Income Recognition. Theyforce the NBFCs to disclose the amount of NPA intheir financial accounts. They force the NBFCs toreflect "true and correct" profits. By virtue ofSection 45Q, an overriding effect is given to theDirections 1998 vis-a-vis "income recognition"principles in the Companies Act, 1956. TheseDirections constitute a code by itself. However,these Directions 1998 and the IT Act operate indifferent areas. These Directions 1998 havenothing to do with computation of taxable income.These Directions cannot overrule the "permissibledeductions" or "their exclusion" under the ITAct. The inconsistency between these Directionsand Companies Act is only in the matter of IncomeRecognition and presentation of FinancialStatements. The Accounting Policies adopted by anNBFC cannot determine the taxable income. It iswell settled that the Accounting Policiesfollowed by a company can be changed unless theAO comes to the conclusion that such change wouldresult in understatement of profits. However,here is the case where the AO has to follow theRBI Directions 1998 in view of Section 45Q of theRBI Act. Hence, as far as Income Recognition isconcerned, Section 145 of the IT Act has no roleto play in the present dispute." 19. We have also noticed the other line of caseswherein the Supreme Court itself has held that whenthere is a provision in other enactment which containsa non-obstante clause, that would override theprovisions of Income Tax Act. TRO Vs. Custodian,Special Court Act (supra) is one such case apart fromother cases of different High Courts. When the judgmentof the Supreme Court in Southern Technology (supra) isread in manner we have read, it becomes easy toreconcile the ratio of Southern Technology with TRO Vs.Custodian, Special Court Act. 20. Thus viewed from any angle, the decision ofthe Tribunal appears to be correct in law. The questionof law is thus decided against the Revenue and in https://hcservices.ecourts.gov.in/hcservices/ favour of the assessee. As a result, all these appealsare dismissed."4.2 In the light of the above decision, the second questionof law framed for consideration in these appeals is alsoanswered in favour of the assessee and against the revenue. 5.In the result, both the appeals filed by the assesseestand allowed. No costs. Sd/- Assistant Registrar //True Copy// Sub Assistant Registrar av/rsh To1. The Deputy Commissioner of Income Tax, Company Circle - III, Chennai - 600 034.2. The Income Tax Appellate Tribunal, “B” Bench, Chennai.3. The Commissioner of Income tax (Appeals)-XI, 121, Mahatma Gandhi Salai, Chennai 600 034.4. The Assistant Commissioner of Income tax, Circle-II, (A) (I/C), Chennai-34. +2ccs to Mr.T.Ravikumar, Advocate, S.R.No.60971+1cc to M/s.Subbaraya Aiyar, Advocate, S.R.No.61316 TCA Nos.429 & 430/2009 RR(CO)PM/28/01/2022