The Commissioner Of Income Tax Tiruchy v. Pl Chemical Limited A-21, Industrial Estate Mettupalayam Pondicherry

IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED: 04.07.2011 CORAM: THE HONOURABLE MRS.JUSTICE CHITRA VENKATARAMANandTHE HONOURABLE MR.JUSTICE M.JAICHANDREN Tax Case Appeal No.471 of 2004 The Commissioner of Income TaxTiruchy. ..AppellantVersus PL Chemical LimitedA-21, Industrial EstateMettupalayamPondicherry. ..Respondent PRAYER: Tax Case Appeal filed under Section 260A of the Income TaxAct, 1961 against the order of the Income Tax Appellate Tribunal,Madras Bench ‘C’ dated 2.2.2001 in I.T.A.No.593/Mds/2000 againstthe order of the Commissioner of Income-Tax(Appeals)XI121,MahatmaGandhi Salai, Chennai-34 dated 21/01/2000 and made in ITA No.48/99-2000/PON against the order of the Assistant Cfommissioner ofIncome-Tax Circle-I(2) Pondicherry dated 30/03/98 in PAN/GIRNo.110-P. For appellant :Mr.T.RavikumarStanding Counsel for Income TaxFor respondent :Mr.C.V.RajanJUDGMENT (Judgment of the Court was delivered by CHITRA VENKATARAMAN,J.) The Revenue is on appeal as against the order of the IncomeTax Appellate Tribunal dated 2.2.2001 in I.T.A.No.593/Mds/2000. 2. Even though the grounds of appeal contain twosubstantial questions of law, since at the admission stage itselfthe substantial question of law is restricted as regards only onequestion, this Tax Case Appeal is decided on the first issue. 3. This Tax Case relates to the assessment year 1996-97. 4. The assessee herein is a company which was carrying onbusiness in manufacturing mosquito repellents and selling it in thename and style of “Banish Mats”, a patent owned by its sisterconcern. The assessee also had an agreement with M/s.Bayer IndiaLimited on 16.9.1994, for manufacture and sale of insecticides,https://hcservices.ecourts.gov.in/hcservices/including household insecticides (mats/mosquito destroyer), at anagreed price. It is seen from the facts projected before this 2. Even though the grounds of appeal contain twosubstantial questions of law, since at the admission stage itselfthe substantial question of law is restricted as regards only onequestion, this Tax Case Appeal is decided on the first issue. 3. This Tax Case relates to the assessment year 1996-97. 4. The assessee herein is a company which was carrying onbusiness in manufacturing mosquito repellents and selling it in thename and style of “Banish Mats”, a patent owned by its sisterconcern. The assessee also had an agreement with M/s.Bayer IndiaLimited on 16.9.1994, for manufacture and sale of insecticides,https://hcservices.ecourts.gov.in/hcservices/including household insecticides (mats/mosquito destroyer), at anagreed price. It is seen from the facts projected before this Court that upto the year 1995-96, the assessee was selling itsproducts manufactured under its trademark, apart from the agreementwith Bayer India Limited to manufacture and sell mats undercontract basis. Under agreement dated 24.5.1995 with TranselektraDomestic Products Limited, (hereinafter referred to as TDPLimited), the assessee agreed to receive non-compete fee, that theyshall not manufacture, sell or distribute mosquito repellents, matsor mat heater machines under the Trade Mark or otherwise, either onits own account or on behalf of any other person. Under the termsof the above agreement, the assessee received a sum ofRs.2,70,00,000/- (Rupees two crores seventy lakhs only) as by wayof non-compete fee. It is also seen from the documents placedbefore this Court that under agreement dated 24.5.1995 with M/s.TDPLimited, the assessee assigned its goodwill for a consideration ofRs.35 lakhs. In terms of the restrictive non-compete clause, theassessee contended that the said receipt was a capital receipt andhence, could not be assessed as income. The Assessing Authoritytreated the receipt of non-compete fee as a revenue receipt,viewing that the restrictive covenant for a term of five years, wasa normal incident of the business. Since the assessee was free tocarry on a similar trade with the use of infrastructure available,the receipt was to be assessed as a revenue receipt. The aggrievedassessee went on appeal before the Commissioner of Income Tax(Appeals), who confirmed the order of the Assessing Officer. Theassessee once again preferred a further appeal before the IncomeTax Appellate Tribunal. Following the decision of this Courtreported in [1998] 234 ITR 23 (Chemplant Engineers (P) Ltd. Vs.Commissioner of Income Tax), the Tribunal agreed with the assesseeand held that by its agreement with TDP Limited, the assessee hadagreed that it would not manufacture and sell insecticides usingits trade name. For this, the assessee had received Rs.2.70 croresas non-compete fee. Thus the business of the assessee carried onby using its trade name, had come to a stop. The assessee had noright to market, sell or distribute the products under its owntrade name. However, as far as the manufacturing activity carriedon for Bayer India Limited is concerned, the same could not beequated with the assessee selling and marketing the products underits brand name. In the circumstances, the Tribunal held that theagreement with TDP Limited had resulted in a loss of source ofincome and not just the loss of income. Hence, the receipt was tobe treated as capital in nature. Aggrieved by the same, theRevenue is on appeal before us. 5. Learned Standing Counsel appearing for the Revenue,after referring to the agreement between the assessee and TDPLimited, placed reliance on the decision of the Andhra Pradesh HighCourt reported in [1984] 148 ITR 546 (Coromandel Fertilizers Ltd.Vs. Commissioner of Income Tax), and submitted that considering thenature of covenant restricting the business of the assessee for aperiod of five years alone, there being no loss of enduring nature,the receipt has to be assessed only as a revenue receipt. LearnedStanding Counsel also placed reliance on the decision reported in[1998] 234 ITR 23 (Chemplant Engineers (P) Ltd. Vs. Commissioner ofIncome Tax), wherein, this Court considered the decision reportedhttps://hcservices.ecourts.gov.in/hcservices/in [1966] 60 ITR 11 (Commissioner of Income Tax, Madras Vs. Best &Company) and pointed out that when the assessee company before us was permitted to manufacture as before and sell the same, asevident from the contract with Bayer India Limited, there was noloss of source of income, much less of an enduring nature, as hadbeen contended by the assessee. He also referred to the decisionof the Commissioner of Income Tax (Appeals), pointing out to thedifference between the two sub clauses on the non-compete clausesunder the agreement which enabled the assessee to carry on businessas before. In the light of the fact that the assessee continued tomanufacture mosquito repellents, mats and mat heater machines asbefore, even after the agreement dated 24.5.1995, and that thebusiness practically continued, the non compete fee has to betreated only as a revenue receipt. He further submitted that apartial restriction in the business activity, per se, would notmake the receipt, capital in nature. 6. Per contra, learned counsel appearing for the assessee,referred to the decision of the Apex Court reported in [1966] 60ITR 11 (Commissioner of Income Tax, Madras Vs. Best & Company),which has been consistently followed by the Apex Court, the latestbeing the one reported in [2011] 332 ITR 602 (Guffic Chem P. Ltd.Vs. C.I.T., Belgaum and another), and submitted that with the lawthus established as regards the dichotomy between a compensationfor a loss of income and the loss of source of income, theagreement had to be read in the context of what it proposed torestrict as regards its business activity. Pointing out to thefact that the agreement put a clog on the assessee manufacturingand selling the products using its trade name, learned counselpointed out that the agreement with Bayer India Limited merelyenabled the assessee to manufacture insecticides, includinghousehold insecticides (mats and mosquito destroyer) and affix thetrademark of Bayer India Limited under the formula standard ofBayer. Thus the non-compete agreement specifically restricted thethe assessee from manufacturing and selling mats and mosquitorepellents under its trade name. In the light of the above, theperiodicity of the restriction is not the test to conclude thecharacter of the receipt. Learned counsel further submitted thatwith the restriction on manufacturing and marketing of the productas per its specification and trademark and thus with source ofincome thus lost, the receipt has to be necessarily characterisedas a capital receipt. Learned counsel also placed reliance on thedecision reported in [1981] 132 ITR 207 (Commissioner of Income TaxVs. Saraswathi Publicities), which, in turn, reaffirmed the law aspropounded in the decision reported in [1966] 60 ITR 11(Commissioner of Income Tax, Madras Vs. Best & Company). In thelight of the decisions of the Apex Court, learned counsel appearingfor the assessee submitted that no exception could be made to thereasoning given by the Tribunal in this regard. 7. Before going into the merits that were referred to, theclauses over which there has been much of a controversy raised bythe parties herein in the non-compete agreement dated 24.5.1995needs to be seen. The definition clause of the term "Business"reads as follows: https://hcservices.ecourts.gov.in/hcservices/ "Business" shall mean the business of themanufacture, marketing, distribution or sale of mosquito repellent mats and mat heatermachines. " 8. Clause (iii) therein, namely the covenant- the non-compete clause reads as follows:" (iii) Covenant: PLC hereby agrees with TDPthat, during the period, PLC shall not, withoutTDP's prior written consent, directly orindirectly own, manage, operate, join, have aninterest in, control or participate in theownership, management, operation or control of,or be otherwise connected in any manner with,anybodycorporate,partnership,proprietorship, trust, estate, association orother business entity which directly orindirectly engages, as a commercial activityanywhere in the Territory, in the Business thatPLC shall not in any manner whatsoevermanufacture, sell, or distribute MosquitoRepellent Mats or Mat Heater Machines under theTrade Marks or otherwise, either on its ownaccount or on behalf of any other personwhether as an agent or as a licensee or underany other relationship; Provided that nothingherein contained shall be deemed to prevent orrestrain PLC from carrying on and PLC shall beat liberty and shall have the full right andfreedom to carry out, indulge in manufactureand sell Mosquito Repellant Mats and Mat HeaterMachines, within and/or outside India, on acontractual basis and or on behalf of any otherperson whether as an agent or as a licensee orunder any other relationship provided that thesame is not ultimately distributed or marketedby PLC. " 9. On a reading of the above, it is clear that with theentering of the agreement, the assessee was no longer at liberty toengage itself in commercial activity either directly or otherwise,to manufacture and sell or distribute mosquito repellent, mats ormat heater machines under its trade name either on its own behalfor on behalf of anyone. At the same time, the agreement recognisedthat the assessee could carry on the manufacture and sell oncontractual basis on behalf of anyone as an agent or under anyother relationship. The only restriction there being that theassessee should not distribute or market the same. Thus it isclear from the agreement with TDP Limited that the restrictivecovenant therein practically prohibited the assessee in the matterof enjoying that source of income by exploiting the trademark ownedby it. 10. As rightly pointed out by the Commissioner of IncomeTax (Appeals), the covenant under Clause (iii) shows that what wasprohibited was that the assessee could not manufacture and sellhttps://hcservices.ecourts.gov.in/hcservices/mosquito mats and mat heaters under its trade name. It howeverrecognised the assessee carrying on its manufacturing activity and selling mosquito repellents, mats and mat heating machines, withinor outside India, on a contractual basis and or on behalf of anyother person either as an agent or as a licensee or under any otherrelationship, provided that the ultimate distribution and marketingare not done by the assessee. 11. Thus going by the latter portion of the said clause andgoing by the earlier agreement that the assessee had with BayerIndia Limited on 16.9.1994, the assessee continued itsmanufacturing activity and selling as before even after 24.5.1995but without its trademark affixed. selling mosquito repellents, mats and mat heating machines, withinor outside India, on a contractual basis and or on behalf of anyother person either as an agent or as a licensee or under any otherrelationship, provided that the ultimate distribution and marketingare not done by the assessee. 11. Thus going by the latter portion of the said clause andgoing by the earlier agreement that the assessee had with BayerIndia Limited on 16.9.1994, the assessee continued itsmanufacturing activity and selling as before even after 24.5.1995but without its trademark affixed. 12. The non-compete agreement entered into in 1995 thusmade the fact very clear that the assessee was left with only onesource of activity to manufacture and sell on contract basiswithout using its trademark. However, as far as manufacturing andmarketing of the products under its trade name is concerned, theassessee had to put a stop from carrying on its business activityfor a period of five years. As rightly contended by the learnedcounsel appearing for the assessee, with one source of income byexploiting its trademark and the goodwill thus no longer availableto the assessee, but the loss that the assessee suffered could notbe called just the loss of income, but loss of an income generatingaspect of the business; thus the compensation received in this lossof source of income makes the receipt a capital receipt at thehands of the assessee. 13. The controversy as to whether the non-compete fee isrevenue or capital was resolved by the Parliament by insertion ofClause Va to Section 28 of the Finance Act 2002 with effect from1.4.2003. Referring to the said amendment in Section 28, the ApexCourt in the decison reported in [2011] 332 ITR 602 (Guffic Chem P.Ltd. Vs. C.I.T., Belgaum and another)pointed out as follows: " Payment received as non-competition fee under anegative covenant was always treated as acapital receipt till the assessment under theyear 2003-04. It is only vide the Finance Act,2002 with effect from April 1, 2003 that thesaid capital receipt is now made taxable (Seesection 28(va)). The Finance Act, 2002 itselfindicates that during the relevant assessmentyear compensation received by the assesseeunder non-competition agreement was a capitalreceipt, not taxable under the 1961 Act. Itbecame taxable only with effect from April 1,2003. It is well settled that a liabilitycannot be created retrospectively. In thepresent case, compensation received under thenon-competition agreement became taxable as acapital receipt and not as a revenue receipt byspecific legislative mandate vide section 28(va) and that too with effect from April 1,2003. Hence, the said section 28(va) isamendatory and not clarificatory. " https://hcservices.ecourts.gov.in/hcservices/ 14. Referring to the decision reported in [1959] 35 ITR 148 (Commissioner of Income Tax, Nagpur Vs. Rai Bahadur Jairam Valjiand others), the Apex Court pointed out "if a contract is enteredinto in the ordinary course of business, any compensation receivedfor its termination (or loss of agency) would be a revenuereceipt." As far as the present case is concerned, the contractentered into led to the loss of source of income in the ordinarycourse of business. As rightly pointed out by the Tribunal, theassessee's business hitherto till 1995 to market its products andits brand name, thus no longer available in toto, the non-competefee thus received by the assessee, assumes the character ofcapital, which cannot be assessed under the provisions of the Act.In the circumstances, applying the decision of the Supreme Courtreported in [2011] 332 ITR 602 (Guffic Chem P. Ltd. Vs. C.I.T.,Belgaum and another), we have no hesitation in rejecting the TaxCase accepting the plea of the assessee. 15. As far as the decision reported in [1998] 234 ITR 23(Chemplant Engineers (P) Ltd. Vs. Commissioner of Income Tax) isconcerned, the said decision has to be understood on the factsraised therein. Even therein, this Court held that all that theassessee therein lost was only the business income and not thesource of income. This Court pointed out therein to the agreementnot to carry on the same business. It is well established that thecompensation received for the mere loss of profits will be arevenue receipt, while the compensation received for the loss of asource of income would be capital receipt. In the saidcircumstances, this Court held that the receipt of compensation wasa revenue receipt assessable under the provisions of the Act. Thefacts now projected herein stands on a totally different footing.The other decisions relied on by the learned Standing Counselappearing for the Revenue, reported in [1987] 165 ITR 63(Commissioner of Income Tax Vs. Late G.D.Naidu and others by Lrs.G.D.Gopal and another), [2004] 269 ITR 177 (Parry and Co. Ltd. Vs.the Deputy Commissioner of Income Tax, Special Range IV, and theAssistant Commissioner of Income Tax) and [2010] 326 ITR 474(Commissioner of Income Tax Vs. Hindustan Zinc Ltd.) are allrelatable to capital expenditure, a yardstick which cannot beextended for understanding the issue herein which necessarily hasto be decided in terms of the agreement. 16. In the light of the above, we have no hesitation inrejecting the case of the Revenue. Consequently, the question isanswered against the revenue and the Tax Case Appeal standsdismissed. No costs. Ksv Sd/ Assistant Registrar /True Copy/ Sub Assistant Registrar To 1. The Assistant Commissioner of Income Tax Circle-I(2), Pondicherry. Circle-I(2), Pondicherry. 2. The Commissioner of Income Tax (Appeals) XI Chennai-600 034. Chennai-600 034. 3. The Assistant Registrar, Income Tax Appellate Tribunal Madras Bench-C. Income Tax Appellate Tribunal Madras Bench-C. +1cc to Mr.C.V.Rajan Advocate SR.No.39158 +1cc to Mr.T.Ravikumar Standing counsel of (Income-Tax) Sr.No.39142 GV(CO)rvr28/07/2011Tax Case Appeal No.471 of 2004