| SooperKanoon Citation | sooperkanoon.com/74738 |
| Court | Income Tax Appellate Tribunal ITAT Delhi |
| Decided On | Feb-24-2006 |
| Judge | P Parikh, Vice, A Jain |
| Reported in | (2006)100TTJ(Delhi)1132 |
| Appellant | Gomti Credits (P) Ltd. |
| Respondent | Deputy Commissioner of Income Tax |
2. The assessee-company was a holder of 55,480 equity shares of Ghaghara Sugar Ltd. (GSL) which is a group concern of DGM Shree Ram Consolidated Ltd. (DCMSC). This holding constituted 21 per cent of the total share capital of GSL. These shares were acquired way back on 6th Dec., 1994 when GSL was in the process of setting up a sugar factory.
Purportedly, the intention to acquire these shares was to participate in the management and control of GSL as the assessee was one of the promoters of GSL. On 15th April, 1997 i.e. during the year under consideration, the assessee entered into an agreement with GSL whereby the assessee agreed to transfer its entire shareholding in favour of DCMSC and their associates. The agreement, inter alia, provided that the assessee will not, for a period of five years, directly or indirectly promote or set up sugar business/factory or purchase/invest in sugar business/factory within a radius of 100 k.m. from the factory of GSL. In consideration of this undertaking, GSL paid to the assessee a sum of Rs. 42,50,000 as non-compete fees. The assessee claimed this as a capital receipt not chargeable to tax. The AO referred to the agreement wherein the assessee was described as having adequate technical and managerial expertise in promoting and setting up sugar factory. According to the AO this was completely divorced from reality.
According to him, there was no evidence to show that the assessee possessed either all or any of the four essentials of entrepreneurship viz. land, labour, capital and organization. He also observed that the transaction was not at arm's length insofar as that GSL and Hind Industrial Resources Ltd. (HIR) were companies of the same group.
Therefore, he held that the sum of Rs. 42,50,000 received by the assessee was an income in the line of the assessee's business and hence added it to the total income of the assessee.
3. The CIT(A) observed that the non-compete agreement was a part of a broader design whereby a compensatory payment had been made to the assessee to sell its shareholding in GSL. He also observed that no source of income of the assessee had been extinguished or sterilized.
Thus, he concurred with the view of the AO holding the agreement to be a sham one.
4. After apprising us of the facts as narrated above, the learned Counsel took us to the various clauses of the agreement as per which the assessee was not to compete with GSL, directly or indirectly, for a period of five years and was also restricted to draw key personnel from GSL. His main stress was on the point that for setting up a sugar industry, one did not require actual technical skill relating to the said industry. If one had enough capital, then the industry could be set up by hiring skilled people. It was contended that the assessee was financially capable of setting up such an industry and hence GSL had to enter into a non-compete agreement with the assessee. It was also pointed out that the assessee-company had no connection whatsoever with the DCMSC group of companies and hence it was not proper on the part of the CIT(A) to hold the agreement to be sham, that too without bringing any material on record to support such an allegation. It was submitted that Clause (va) inserted in Section 28 w.e.f. 1st April, 2003 was prospective in operation and hence did not apply. For his various contentions, the learned Counsel relied on various decisions of the Tribunal and in particular in the case of Shri Sunil Lamba [sic-Ashok Behari Lal (HUF)] v. Asstt. CIT (2006) 99 TTJ (Del) 513 where the aforesaid amendment was also considered.
5. The learned Departmental Representative, supporting the orders of the lower authorities, contended that in order to pay non-compete fees, the payee should be a potential competitor. There were no such facts on record which indicated such a potentiality. Even remotely, there was no threat to GSL from the assessee. The learned Departmental Representative relied on the judgment of the Supreme Court in the case of Gillanders Arbuthnot & Co. Ltd. v. CIT .
6. We have carefully considered the rival contentions and the material on record. Since the learned Departmental Representative has relied on the judgment of the Supreme Court, we shall first deal with the same.
In that case, amongst various businesses and agencies that the assessee had, it had a sole agency of explosives manufactured by Imperial Chemical Industries (Export) Ltd., Scotland. Later on, the principal company desired to set up its own organization and intimated the assessee that its agency may be cancelled after two or three years. The agency was subsequently terminated by way of a letter for which the assessee was paid certain compensation by way of commission on sales.
The letter also mentioned that as a condition for paying the compensation, the assessee would give a formal undertaking to refrain from selling or accepting any agency for explosives or other commodities competitive with those covered by the agency agreement. The assessee claimed this as a capital receipt not liable to tax. The Supreme Court took note of the fact that the formal undertaking required from the assessee to refrain from selling or accepting any agency for explosives was never given by the assessee. Also, it appeared that at the time of payment of the compensation and thereafter also both sides ignored this condition. The payment did not appear to be to enforce the undertaking. Whether the assessee carried out any competitive business was never investigated. The payment clearly appeared to be for the termination of the agency. While considering the facts and the arguments of the assessee in this context, the Supreme Court observed as follows (on p. 287 of 53 ITR): The principal question in dispute is whether the amounts received by the appellant as compensation for loss of agency are of the nature of capital or revenue. It is necessary in the first instance to eliminate two subsidiary contentions raised by the appellant. It was urged that the amounts received by the appellant were in lieu of compensation for cancellation of the agency by the principal company, for loss of goodwill of the appellant's business, and also in consideration of the appellant's agreeing not to carry on any competitive business in explosives or other commodities in which business was carried on by the appellant under the agency agreement.
It cannot seriously be disputed that compensation paid for agreeing to refrain from carrying on competitive business in the commodities in respect of which the agency was terminated, or for loss of goodwill would, prima facie, be of the nature of a capital receipt.
But there is no evidence that compensation was paid to the appellant as consideration for giving the undertaking not to carry on a competitive business, or as compensation for loss of goodwill.
It was found that the assessee had many agencies and a large amount of business was done by it as an agent of foreign companies. The Court observed that cancellation of the contract of agency did not affect the profit-making structure of the assessee, nor did it involve a loss of an enduring trading asset. It merely deprived the assessee of a trading avenue, leaving it free to .devote its energies after the cancellation to carry on the rest of the business, and to replace the contract lost by a similar contract. The compensation paid, therefore, was held to be not representing the price paid for loss of a capital asset. From the observations of the Supreme Court reproduced above and in particular, the portion underlined by us clearly shows that compensation paid for refraining a person from carrying on a competitive business would be a capital receipt. In any case, the decision relied upon by the learned Departmental Representative does not help the Department but in fact, it helps the assessee, though the facts in that case are quite different.
7. In the present case, the main reason for treating the compensation as revenue receipts by the Department is that there was no potential threat to GSL from the assessee. This is contrary to the facts on record. The main objects for which the assessee-company was incorporated as averred by the AO himself in his order are to carry on the business of financiers, trading, hire charges, leasing, moneylending etc. Here, the object to act as financiers has to be construed in a wide term. If the term financiers has to be construed in a narrow sense, then, there was no need to mention the object of moneylending. Moneylending is certainly a narrower term than, financiers. Moneylending would constitute merely giving money as a loan with or without interest. On the other hand, financier would be including not only moneylending but would also include an activity like financing a project. Financing a project may be in any of the modes like giving money as loan or subscribing to the capital or providing capital in kind. Thus, it cannot be said that by being one of the promoters of GSL, the assessee had acted beyond the objects permitted by its memorandum of association. In fact, providing capital is one of the ingredients of entrepreneurship as mentioned by the AO in his order. The assessee does possess this ingredient which is evident from the fact that as on 31st March, 1998, total funds available with it were to the tune of Rs. 5.33 crores. With the help of these funds only, the assessee had acguired 21 per cent shareholding in GSL by a meagre investment of Rs. 3,28,450. If this financial muscle is not a threat to GSL, what else can it be. Just as the assessee was a co-promoter of GSL, likewise it can promote any other sugar industry also. It is with this perception of a potential threat that GSL restrained the assessee by entering into an agreement with it not to be involved, directly or indirectly in any sugar industry/business within a radius of 100 kms.
for a period of five years. It is a covenant restricting the assessee to enter into any sort of competition with GSL. The compensation received by the assessee is not in the course of its ordinary business operations. Therefore, as observed by the Supreme Court in the case of Gillanders Arbuthnot (supra), the compensation received by the assessee has to be treated as a capital receipt and not a revenue receipt as held by the Revenue authorities.
8. Second ground in the appeal is against treating the profit arising from the sale of shares as business income instead of as capital gains.
During the year under consideration, the assessee sold 55,480 shares of GSL and 8,74,533 shares of Kinetic Technology India (P) Ltd. (KTI) and earned a total profit of Rs. 67,15,480 thereon. The assessee disclosed the same as capital gains. It was explained by the assessee that these shares were held as investments as was evident from the classification in the balance sheet. However, the AO was of the view that, buying of shares was the ordinary line of assessee's business and that the entries in the books of account were not decisive of the issue.
Accordingly, he treated the said profit as business income instead of as capital gains as declared by the assessee. CIT(A), in his cryptic order, confirmed the action of the AO.9. The learned Counsel reiterated the fact of classification in the balance sheet and further submitted that this was a one-time transaction so far as these shares were concerned. It was also pointed out that the shares were held for a long time and were riot shown as stock-in-trade. The learned Counsel relied on several decisions in support of his contentions.
10. The learned Departmental Representative, quoting from some judgment (citation not mentioned), to contend that law cannot follow the changing footprints of accountancy but accountancy had to follow the law. It was contended that the primary object of the assessee was to deal in shares and moreover, there was no bifurcation of shares between those held as investments and those held as stock-in-trade. Thus, he strongly supported the orders of the authorities below.
11. We have duly considered the rival contentions and the material on record. At the outset, it may be mentioned that there can be no dispute with regard to the two main arguments of the learned Departmental Representative that law cannot follow the changing footprints of accountancy and that the entries in the books are not determinative of the issue. In questions like the one before us, the Supreme Court provides the best guidance which we find in the case of CIT v. H. Hlock Larsen . In the said judgment their Lordships referred to the judgment of the House of Lords in J.P. Hamson (Watford) Ltd. v.Griffths 40 Tax Case 281. As per the said judgment, the real question was riot whether the transaction of buying and selling the shares lacks the element of trading, but whether the later stages of the whole operation show that the first step--the purchase of the shares was not taken as, or in the course of a trading transaction. Let us examine the facts of the case in the light of these principles.
12. While dealing with the first ground of this appeal, we have observed that the assessee, inter alia, acts as financier as mentioned in the main objects of its memorandum of association. We have also observed that acting as financiers may assume different shapes, one of them being to participate as promoters in new ventures. As a part of this activity, the assessee had participated in the promotion of GSL by subscribing to 55,480 shares of GSL and to 8,74,533 shares of KTI. The shares in GSL were acquired in December, 1994 and those of KTI during the financial years 1992-93 and 1995-96. Along with this activity, the assessee also carried on the activity of dealing in shares. This is evident from the balance sheet of the company as on 31st March, 1998.
The assessee has trading activity only in shares. The shares in which it. trades are separately shown in the balance sheet as stock-in-trade.
The shares in which it does not trade or in other words, the shares which are held as long-term investments are shown under the head "investments". We are conscious of the proposition that entries in the books are not determinative of the issue. It is the intention with which the shares were purchased can determine the issue. However, the intention cannot be what the assessee says. It has to be gathered from other attendant circumstances. Thus, the fact that the shares have been classified into investments and stock-in-trade is an indication about the intention of the assessee. The shares in question have been classified as investments. Further, since the shares were acquired by the assessee in its capacity as one of the promoters, subsequently there was no occasion for the assessee to buy further shares. By this, we do not mean that had the assessee purchased further shares of the same companies, it would have been its stock-in-trade, Again, everything would depend on the facts of each case. But the fact that in the instant case, since the assessee did not purchase further shares, strengthens the contentions of the assessee that they were held as investments. Moving further, the shares have been sold after holding them for about four to six years. If the intention of the assessee was to deal in these shares, then perhaps, it would not have waited for this long a period to dispose off the shares. Moving still further, it is seen that the assessee has sold its entire holding in GSL and KTI.Again, had there been any intention of trading in these shares, then perhaps, it would have parted with only a part of the holding. The last stage of the entire operations is the disposal of the entire shareholding of the assessee in GSL and KTI at one go. Thus, applying the principle laid down in the case of H. Hock Larsen (supra), this last stage in the entire operations clearly determines the issue and that is that the assessee was holding the impugned shares as investment and not as stock-in-trade. Accordingly, we hold that the profit earned by the assessee on the sale of the shares of GSL and KTI are to be assessed as capital gains giving due benefit of indexed cost of acquisition to the assessee.