Income Tax Appellate Tribunal - Mumbai
Montgomery Watson Consultants India ... vs The A.C.I.T. on 1 January, 1800
Equivalent citations: [2004]90ITD324(MUM), [2005]272ITR153(MUM)
ORDER
K.K. Boliya, A.M.
1. This appeal has been filed by the assessee against the order dated 18.9.98 of CIT(A)-XXV, Mumbai. The grounds of appeal raised by the appellant pertain to only one issue i.e., confirmation by the Id. CIT(A) of disallowance of Rs. 6,50,000/- being competition fee, treating the same as capital expenditure.
2. The relevant facts are that during the previous year relevant to the AY under appeal, the shares of the company were bough over by erstwhile management. The aforesaid payment of Rs. 6.5 lakh was treated as capital expenditure by the AO and M/s Montgomery Watson Ltd. (MWL) through M/s Western India Energy Industries Ltd. (WIEIL) from its erstwhile management vis., Prof. S.J. Arceivala, Mrs. N.S. Arceivala and Mrs. Zavera Banaji. With a view to prevent the erstwhile management from competing with the assessee company, a non-competition agreement was executed on 7.4.94 and as per this agreement a sum of Rs. 6.5 lakh was paid by the assessee company as consideration for preventing the erstwhile management to compete with the assessee company for a period of 10 years. There were certain other restrictions also placed on the AO's finding has been confirmed by the Id. CIT(A). Aggrieved by this, the assessee is in appeal before us.
3. In the backdrop of the abovementioned facts, the Id. counsel for the assessee invited out. attention to clause 2 of the agreement which stipulates that certain activities shall not be carried on by MWL and WIEIL over a period of 10 years without the written approval of the assessee company. It is submitted that the condition of abstaining from carrying on the same business is not absolute, but, it can be relaxed on the written approval of the assessee company. The Id. Counsel has also invited our attention to clause 5 of the agreement which is reproduced below :
"It is hereby provided that whilst the restriction in the aforesaid clauses is considered to be reasonable in the circumstances as at the relevant date, it is hereby agreed that is any of such restrictions shall be adjudged invalid because of changing or other unforeseen circumstances as going beyond what is reasonable in all the circumstances for the protection of the legitimate interests of MWL, WIEIL or the company but would be valid if part of the wording thereof were deleted, altered or the period reduced, or the range of activities or area cover reduced in scope, such restrictions shall apply with such modifications as may be necessary to make them valid and effective."
It is submitted by the Id. counsel for the assessee that as per clause 5, alterations and variations can be made and thus it is further proved that the restrictions are not absolute. It is argued that in these circumstances, it is allowable as Revenue expenditure. Reliance is placed on the following cases :
i. CIT Vs. Coal Shipments Pvt. Ltd. - 2002-Taxindiaonline-75-SC-IT ii. CIT Vs. Late G.D. Naidu & Others - 165 ITR 63 (Mad.) iii. CIT Vs. Dalmia Jain & Co. Ltd., - 81 ITR 754 (SC) iv. ACIT Vs. Pathare Dhru & Co. - 54 ITD 746 (Mumbai 'C' Bench) Alternatively, the Id. counsel for the assessee submitted that the expenditure should be deferred and allowed over a period of 10 years. For this proposition, reliance is placed on the Hon'ble Bombay High Court decision in the case of Taparia Tools Ltd. Vs. JCIT 2003-Taxindiaonline-16-HC-MUM-IT.
4. The Id. DR supported the orders of the Revenue authorities and contended that the expenditure is clearly in the nature of capital expenditure as the assessee derived advantage of enduring nature by warding off competition for a period of 10 years. The Id. Dr relied upon the following cases :
i. CIT Vs. Tamil Nadu Diary Development Corporation - 2002-Taxindiaonline-17-HC-MAD-IT ii. CIT Vs. Grover Soap Pvt. Ltd. - 221 ITR 299 (M.P.) CIT Vs. Chelpark Co. Ltd. - 191 ITR 249 (Mad.) The Id. DR also pointed out that the Madras High Court decision relied upon by the Id. counsel for the assessee (165 ITR 63) has been considered by the Hon'ble Madras High Court in the later case (191 ITR 249). In his rejoinder, the Id. Counsel for the assessee submitted that the facts of the cases cited by the Id. DR are distinguishable.
5. We have given a careful consideration to the rival submissions vis-a-vis the facts of the case and have gone through the various judicial pronouncements cited before us. There is no dispute that the one time lump sum payment of Rs. 6.5 lakh has been made by the assessee company to ward off competition for a period of 10 years. The relevant clause 2 of the agreement may be reproduced below:
"The firm and each of the partner (each being a Covenanted) hereby separately covenants with the Company and (as a separate covenant) with each of MWL and WIEIL that none of them will either alone or jointly with others at any time during the period commencing on the Relevant Date and ending on the expiry of the tenth anniversary thereof without the written approval of the Company, MWL and WIEIL either on his own account or in conjunction with or on behalf of any person, firm or company (other than the Company) within West and South Asia (being the India sub-continent and any Gulf country) directly or indirectly -
a) carry on or be engaged, concerned or interested in carrying on any business carried on at the Relevant Date by the Company and which the company then continues to so carry on ('the Business');
b) offer to employer or endeavor to entice away from the Company any person who is at the Relevant Date employed by the Company;
c) canvas or solicit or endeavor to solicit business in competition with any of the Business from any person firm or company who is at the Relevant Date a customer of the Company;
d) interfere with dissuade or discourage any person firm or company from using or employing the Company; or
e) interfere or seek to interfere with the continuance of supplies to the Company (or the terms of such supplies) from any suppliers who have supplied components, materials or services to the Company prior to the Relevant Date."
The Id. counsel for the assessee has argued that in clause 2, there is a provision that the erstwhile management shall refrain from engaging into various stipulated activities without the written approval of he assessee company. On that basis, the Id. counsel has canvassed that the non-competition agreement is not absolute and the same can be relaxed. In our view, this argument is fallacious. It does not stand to logic that the assessee company would give written permission to the erstwhile management for engaging in the same business and other activities without demanding appropriate compensation. In our view, for all practical purposes, the non-competition agreement is effective for a period of 10 years and the erstwhile management has no unilateral right to alter any of the conditions of the agreement. The Id. Counsel for the assessee tried to buttress his argument from the stipulations of clause 5 of the agreement which has been reproduced above. In our view, clause 5 is only an enabling provision to make various conditions of the agreement valid and effective if on account of certain unforeseen circumstances such conditions become invalid. It cannot be said that clause, 5, in any way, dilutes the legally binding nature of the non-competition agreement. Thus the correct factual position is that the assessee company has paid the impugned sum of Rs. 6.5 lakh to restrain the erstwhile management for a period of 10 years from engaging into the same business and also to engage into several other activities as stipulated under clause 2.
6. With this factual position, legal position as emerging from the cases cited may be considered. In the case of Coal shipments Pvt. Ltd. (Supra), the Hon'ble Supreme Court held as under (reproduced from the head note):
"Held that the payment made by the assessee were not of a capital nature and were allowable u/s. 10(2)(xv) of the IT Act, 1922; because, (i) the arrangement between the assessee and H.V. Low & Co. was not for any fixed term but could be terminated at any time at the volition of any of the parties; (ii) the payments made to H.V. Low & Co. were related to the actual shipment of coal in the course of the trading activities of the assessee and were not related to or tried up in any way to any fixed sum agreed to between the parties.
Payment made to ward off competition in business to a rival would constitute capital expenditure if the object of making that payment is to derive an advantage by eliminating the competition over some length of time; the same result would not follow if there is no certainty of the duration of the advantage and the same can be put to an end at any time. How long the period of contemplated advantage should be, in order to constitute enduring benefit, would depend on the circumstances and the facts of each individual case.
Although an enduring benefit need not be of an everlasting character it should not be so transitory and ephemeral that it can be terminated at any time at the volition of any of the parties."
From the above, it is clear that in the case which came up before the Hon'ble Apex Court, the agreement was not for a fixed term and was terminable at any time at the will of any of the parties. Further, the payment related to the actual shipment of coal in the course of trading activity. It was, therefore, held that the payments were in the nature of revenue expenditure. The Hon'ble Supreme Court further observed that payment made to ward off competition in the business would constitute capital expenditure if the object is to derive an advantage by eliminating competition over some length of time. As a matter of fact, the Hon'ble Supreme Court decision is in Revenue's favour for the simple reason that the assessee company has apparently derived benefit of enduring nature by entering into the agreement to ward of business competition for a sufficiently long period of 10 years.
7. The Hon'ble Supreme Court decision in the case of Dalmia Jain & Co. (supra) is totally irrelevant to the issue as in that case, it was held that litigation expenses incurred by the assessee to resist a legal suit in order to protect its business, are in the nature of revenue expenditure. Even in the case, the Hon'ble Apex Court held that where litigation expenses are incurred by the assessee for creating, curing or completing the assessee's title to the capital, then expenditure incurred must be considered as capital expenditure. But if the litigation expenses are incurred for protecting business, it must be considered as revenue expenditure. In our view, the non-competition fee paid by the assesee cannot be said to be the expenditure incurred to protect the business.
8. In the case of Late G.D. Naidu (supra), decided by the Hon'ble Madras High Court, the facts and the ratio are as under (reproduced from the headnote):
"The deceased and his son along with others were partners in five different firms carrying on business in transport services. During the year 63-64 relevant for the AY 64-65, all the old partners of the firms retired in stages so that by April 1, 1964, all the various firms were composed of entirely new groups of partners. The deceased and his son were paid varying amounts by the various firms to ward off competition from them in regard to the bus services. In the assessments of the various firms, the amounts so paid were claimed as a deduction. The assessee and his son also claimed that the amounts received by them were exempt from tax. The ITO held that these amounts were paid by the various new partners to acquire the business along with the route permits which were capital assets and hence the payments were not revenue expenditure and not allowable as a deduction. In the case of the assessee and his son, the ITO held that the compensation received should be treated as revenue in character. The Tribunal held that the compensation paid by the firms should be for the three components, viz., (a) share in the assets, (b) share in the goodwill, and (c) share in the restricted covenant in terms of Sec. 36(2) of the Partnership Act and the payments in respect of (a) and (b) would not be deductible in the hands of the firm because these were only payments to retiring partners but the contribution attributable to item (c) was deductible. The Tribunal thereafter held that the payments to the retiring partners to the extent of the amounts in the capital accounts would relate to the first component and the value of the goodwill in the case of the firms was estimated and the balance would represent the compensation paid for the restrictive covenants. In the case of the recipients, the Tribunal held that (a) the compensation attributable to the relinquishment of the shares of the retiring partners and the share of the goodwill which they allowed the firm to retain was on capital account; (b) no transfer was involved when a partner retired from a firm receiving his shires of assets or money in lieu thereof and hence no capital gains was chargeable to tax; (c) goodwill was not a capital asset and hence no capital gains arose out of the transfer of the goodwill; (d) the compensation relatable to the restrictive covenant was a capital receipt not liable to capital gains tax and hence there was no liability to tax on any part of the amounts received by the recipients either as income or as capital gains. On a reference :
Held, that so far as the cash compensation paid by the new partners referable to the assets and goodwill of the firm was concerned, the cash took the place of the assets of the partnership and the compensation paid for restrictive covenant not to carry on similar business for a period or five years was is the nature of a separate transaction unconnected with the business of the assets of the partnership. The Tribunal was right in its view that the total compensation paid by the firms to the old partners was for (a) the share in the assets, (b) the share of the goodwill, and (c) for the restrictive covenant and that the part of the amount referable to the acquisition of the share in the assets and the share of the goodwill would be on capital account as it was in the nature of an initial outgoing and the payment towards the restrictive covenant was on revenue account and it would not amount to an acquisition of an advantage of an enduring nature. The Tribunal was also right in its view that the amount received by the recipients was not liable to tax either as income or capital gains. No question of any liability to penalty would also arise in the instant case, because the assessee were merely contending for a particular position contrary to the view taken by the ITO which would not call for any penalty."
9. The aforesaid Madras High Court judgment has to be considered in the light of the subsequent Madras High Court decision in the case of Chelpark Co. Ld. (supra), where the earlier decision in the case of Late Shri G.D. Naidu has been duly considered. The observations from the case of Chelpark Co. Ltd. may be reproduced below from the page 255 of the report:
"The reliance placed by Id. counsel for the assessee upon the decision in CIT Vs. G.D. Naidu (1987) 165 ITR 63 (Mad.) does not, in our view, assist the assessee. Amongst others, payments were made for a restrictive covenant and the Tribunal found that, by securing that covenant, no asset or advantage of enduring nature was acquired and that finding was accepted and on that footing, it was held that there was no acquisition of any business by payment of the amounts referable to the restrictive covenant and there was not benefit of any enduring nature acquired and, therefore, the payment should be regarded as revenue outgoing. That decision cannot have any application whatever on the facts and circumstances of this case where we have held that the assessee did acquire an enduring benefit or advantage."
The Hon'ble Madras High Court, in the case of Chelpark Co. Ltd. held that payment made to Ex-Managing Director to eliminate competition and not to carry on any competitive business over five years was capital expenditure. The Id. counsel for the assessee has also referred to ITAT, Bombay Bench decision in the case of Pathare Dhru & Co. In this case, the assessee was a law firm and certain amount was paid to the retiring partner as a premium on the understanding that he would not render professional service for a period of two years. It was held that since the restriction was only for a period of two years, the payment was in the nature of revenue expenditure. This case, in our view, does not come to the assessee's assistance because the facts are obviously different.
10. The Hon'ble Madhya Pradesh High Court, in the case of Grower Soap Pvt. Ltd., relied upon by the Id. DR, has observed as under (reproduced from the headnote):
"Payment made to ward off competition in business to a rival would constitute capital expenditure if the object of making that payment is to derive an advantage by eliminating the competition over some length of time; the same result would not follow if there is no certainty of the duration of the advantage and the same cannot be put to an end at any time. How long the period of contemplated advantage should be, in order to constitute enduring benefit, would depend on the circumstances and the facts of each individual case."
In the above case, the ratio of Hon'ble Supreme Court decision in the case of Coal Shipments Pvt. Ltd. (supra) was applied. The Hon'ble Madras High Court, in the case of Tamil Naidu Dairy Development Corporation Ltd. (supra), relied upon by the Id. DR, held that the sum paid as compensation to vendor against the undertaking not to market milk in Madras city resulted into enduring advantage to the assessee and was, therefore, a capital expenditure. In our view, both these cases apply to the facts of the assessee's case.
11. In view of the legal position an emerging from the various cases discussed above, we have no hesitation in holding that the payment of Rs. 6.5 lakh is in the nature of capital expenditure.
12. Coming to the alternative submission of the Id. counsel for the assessee that the expenditure should be allowed as deferred expenditure over a period of 10 years, in our view, it cannot be accepted. The Hon'ble Bombay High Court decision in the case of Taparia Tools Ltd., relied upon by the Id. counsel for the assessee is applicable only where the lump sum payment is in the nature of deferred revenue expenditure. In the present case, we have already recorded a finding that the expenditure is in the nature of capital expenditure and not revenue expenditure. Therefore, the Hon'ble Bombay High Court decision will not apply. The order of the Id. CIT(A) is, therefore, confirmed.
13. In the result, the assessee's appeal stands dismissed.