Madras High Court
P.L. Chemical Ltd. vs Asstt. Cit on 2 February, 2001
Equivalent citations: [2003]86ITD46(MAD)
ORDER
A. Kalyanasundharam, Sr. V. P. The appeal has been filed by the assessee, a limited company, aggrieved by the order of the Commissioner (Appeals)-XI, Chennai (hereinafter referred to as the Commissioner (Appeals), dated 31-1-2000 for the assessment year 1996-97. The appeal of the assessee is on the issue of taxability of Rs. 2.70 crores that was received by it as non-competitive fee in determining its total income with reference to the provisions of the Indian Income Tax, Act, 1961 (hereafter referred to as the Act).
2. The brief facts concerning the above claim of the assessee is brought hereunder for purposes of facility. The assessee up to assessment year 1995-96 was carrying on the business of manufacture of mosquito repellents, mats and mat heater machines under the name and style of "Banish mats". "Banish mats" was a patent that was owned by M/s. Freight Master Engineering P. Ltd., a sister concern of the assessee. The assessee after manufacturing the said mosquito repellents, mats, and mat heater machines, was also selling and distributing them in the States of Tamilnadu, Pondicherry, Andhra Pradesh, Kerala and Karnataka. During the previous year relevant to the assessment year under appeal M/s. Transelektra Domestic Pvt. Ltd. Bombay, (hereinafter referred to as TDP) on 24-5-1995 entered into an agreement with the assessee. The preamble of the agreement indicated that it was a non-competition agreement. The preamble also indicated that the assessee is to discontinue the marketing, sale and distribution of mosquito repellents, mats, etc., hitherto manufactured by it. The main clause of the said agreement is reproduced for the sake facility :
"Covenant : (Clause 3 of the agreement) PLC hereby agrees with TDP that, during the period PLC shall not, without TDP's prior written consent, directly or indirectly own, manage, operate, join have an interest in control or participate in the ownership, management, operation or control of, or be otherwise connected in any manner with, any body corporate, partnership, proprietorship, trust, estate, association or other business entity which directly or indirectly engages, as a commercial activity anywhere in the Territory in the business and that PLC shall not in any manner whatsoever manufacture, sell, or distribute Mosquito Repellent Mats or Mat Heater Machines under the Trade Marks or otherwise, either on its own account or on behalf of any other person whether as an agent or as a licensee or under any other relationship; provided nothing herein contained shall be deemed to prevent or restrain PLC from carrying on and PLC shall be at liberty and shall have the full right and freedom to carry out, indulge in manufacture and sell Mosquito Repellent Mats and Mat Heater Machines, within and/or outside India, on a contractual basis and or on behalf of any other person whether as an agent or as a licensee or under any other relationship provided that the same is not ultimately distributed or marketed by PLC."
3. TDP in consideration of the above agreement paid the assessee Rs. 2.70 crores on 24-5-1995. They further indicated that the term 'period' appearing in the columns meant five years commencing from 24-5-1995 and that the 'territory' would cover the entire world.
4. In addition to the above stated agreement, there was another agreement that the assessee entered into with TDP on 24-5-1995 and as per this agreement, the assessee gave over its right, title, and interest in its business for a consideration of Rs. 30 lakhs.
5. The assessing officer (hereinafter referred to as AO) noted that the assessee prior to the above stated agreements had entered into another agreement with one Bayer (India) Ltd., Bombay (hereinafter referred to as BIL) on 16-9-1994 by which agreement the assessee was to manufacture and sell insecticides including household insecticides (mats/mosquito destroyers) etc. The assessee was to manufacture the same and sell the entire products to BIL. Insofar as the sale part is concerned, BIL from time to time provided the list of its distributors and the places where the product was to be sent.
6. The assessing officer considered the above facts and the claim of the assessee with reference to the non-competitive fee of Rs. 2.70 crores which the assessee treated as capital receipt. The assessee placed reliance on certain decisions which were considered by the assessing officer. The assessing officer in his order observed that because the assessee had an agreement with BIL for the manufacture of mosquito mats etc., surrendering of the manufacturing rights and also distribution and sale rights of the mats in favour of TDP in no way affected the business of the assessee. The assessing officer further observed that the mention of the 5 year period during which the assessee was not to enter into any competition activity is only a normal feature. He referred to clause 9(b) of the non-competition agreement and concluded that the receipt could be treated as fees for technical know-how because the agreement in no way placed any restriction insofar as the operation and activity of the assessee. He noted that the bar was only with regard to the marketing of the products and not with manufacture. Because the assessee was carrying on job work for BIL, its business activity continued. He referred to Board's Instruction No. 1964 in F. No. 225/22/99-ITA-II, dated 17-3-1999 and observed that the nature and circumstances of each case would decide the issue. The assessing officer was of the opinion that the agreement was a mask and that the receipt could be a profit in view of parting with the technical know-how and the right to carrying on the business and that the component did not contain any remedial measures and the assessee is allowed to resume business after five years. He accordingly concluded that the Instruction of the Board was inapplicable and that the amount is taxable.
7. The assessee was aggrieved by the order of the assessing officer and carried the matter in appeal to the Commissioner (Appeals). The assessee reiterated similar submissions as were made before the assessing officer and placed reliance on various authorities. The Commissioner (Appeals) in para 3.1.1 of his order noted that the assessee by means of its non-competition agreement had placed restriction on itself to discontinue manufacturing and marketing of mosquito repellents and mats and surrendered the right to manufacture, produce, process and market mosquito repellents and machines in competition with TDR The submission of the assessee before the Commissioner (Appeals), as was noted by him, was that the BIL permitted the assessee to manufacture and sell the products to BIL only. Because the non-competition agreement with TDP existed, the assessee had to completely shut the door insofar as its marketing right is concerned and the basic source of its income namely through marketing having been closed down, one main source of income had come to a close.
8. The Commissioner (Appeals) noted what are the permissible activities and what are impermissible by virtue of the non-competition agreement. He observed in para 4.1(b) that the right to manufacture mosquito repellents, mat heater machines, etc., as it stood before 24-5-1995, continued even after that date and further the right of selling mosquito repellents also continued in the same manner with the only restriction of marketing and distribution of mosquito repellents and mat heater machines. In para 4.2 he was of the opinion that the restrictive covenant clause 4 of the said agreement when read with clause 1 and clause 3 of the said agreement, it would be clear that the amount of Rs. 2.70 crores is in consideration of the restriction insofar as marketing and distribution on contractual basis is concerned. In para 4.4 he prepared a comparative table of sales and profits for the years 31-3-1995 to 31-3-1998. He noted that the assessee was doing job work for BIL. He noted that even in regard to this particular job work the purchase of raw materials and stores was the responsibility of the assessee and because it was selling the same manufactured mosquito repellents and mat heater machines to BIL, the activity of the assessee continued to be manufacture and sale of mosquito repellents. Referring to the decision of the Bombay High Court in CIT v. Principal Officer, Lakshmi Surgical (P) Ltd. (1993) 202 ITR 601, he observed that a shift from manufacture to job work indicated the assessee to be continuing the same business.
He accordingly confirmed the order of the assessing officer insofar as the taxability of non-competition fee of Rs. 2.70 crores as revenue income.
9. The assessee is aggrieved by the order of the Commissioner (Appeals) and has come up in appeal before us stating that the amount of Rs. 2.70 crores received by it does not have the character of revenue income. The learned counsel for the assessee Mr. Vijayaraghavan carried us through the agreement with TDP. He referred to the preamble of the said agreement and the same is reproduced for the sake of appreciation of the entire issue :
"And whereas PLC has been approached by TDP to discontinue the marketing, sale and distribution of Mosquito Repellent Mats and Mat Heater Machines for which TDP has agreed to pay PLC an adequate consideration as per the terms and conditions contained in this agreement.
And whereas PLC has further agreed with TDP not to carry on for a term of five years in India any business which may compete with the business in respect of which the goodwill was assigned and transferred by PLC to TDP by and in accordance with the assignment;"
Clause 4 of the said agreement which insisted upon by the learned counsel as the restrictive one is also reproduced for the sake of facility :
"4. Restrictive Covenant : It is expressly clarified and the parties thereto expressly understand that PLC has agreed to be bound by the restrictive covenants mentioned in this agreement of its own free will in exchange for the consideration stated in this agreement being paid by TDP to PLC."
The learned counsel submitted that the assessee had two wings on which it was flying all along, one being the right of manufacture and the second being distribution, marketing and sale. One of these wings namely marketing, sale and distribution has been clipped by TDP and thereby the assessee is in no position to fly. Consequent to the clipping of the wing namely marketing, sale and distribution, Banish Mats that were manufactured by the assessee vanished from the market and this was taken advantage of by TDP and others. He submitted that the product which the assessee was manufacturing and selling namely Banish Mats, was purchased by customers in more than 5 or 6 States. Consequent to the closing down of distribution, sale and marketing of the said mats including its manufacture, it created a vacuum in the market insofar as the mosquito repellents are concerned and this gave an advantage to TDP in entering into the area which was hitherto captured by Banish Mats. The area that was covered by Banish Mats by its net work of distribution, marketing and sales was no longer approachable to the assessee. For surrendering such rights and giving them over to another for consideration, it is nothing but a non-competition fee or that the assessee accepted that it would not compete with the products that are manufactured and sold by TDP. Thus the main source of activity of the assessee has come to a stand still. He submitted that all that TDP was interested was in capturing the market and it wanted to abolish any competition and in that process it bought over the marketing, sale and distribution rights of the assessee and had further restricted that for a period of five years it would not carry on any activity that could be said to be marketing, sale and distribution of competitive products. He submitted that the restrictive covenant that is placed on the assessee is similar to an embargo preventing the assessee from entering into any territory that is forbidden by means of its own volition and agreement with TDP
10. He submitted that the agreement with BIL is in no way a substitution for the distribution, sale and marketing rights, which it had carried on earlier. Because the assessee had the required talent, machinery, labour, etc., BIL wanted to take advantage of the said facility and on that basis entered into an agreement with the assessee for manufacture of the products for which BIL had the patent rights. Further BIL had clearly stated that the assessee who is the manufacturer shall sell the manufactured product according to the terms of BIL to BIL only and it would be deemed to be a purchase by BIL from the assessee. The agreement with BIL clearly specified that the product so manufactured must conform to the quality control standards and specifications prescribed by BIL. The manufactured products would be bought by BIL from time to time by placing orders on the assessee at a price that would mutually agreed upon. The agreement with BIL for purchase is on a principal to principal basis. He submitted that with this agreement all that the assessee is required to do was to manufacture the products for BIL. BIL had made the assessee exclusively liable for all taxes and due on the manufacturing item and that the assessee at no circumstance will be treated as an agent of BIL. The assessee was only given permission of affixing the Trade Marks on the products manufactured as that of BIL.
11. The learned counsel Mr. Vijayaraghavan referred to the Board's Instruction No. 1964 dated 17-3-1999 before whom the question was in regard to the determination of cost of acquisition and taxability in case of self-generating assets and applicability clause (a) of sub-section (2) of section 55 of the Income Tax Act. He referred to para 4 of the said instructions wherein the issue of taxability of compensation for agreed absence of competition or agreement containing certain restrictive covenants was raised. Referring to the instruction in para 4, he submitted that section 55(2) of the Act would come into operation for the assessment year 1998-99 onwards which referred to transfer including extinguishment or curtailment of such rights. It was further brought to our notice that it has been noted by the Board that the extinguishment of such a right is in the nature of capital receipt up to the assessment year 1997-98. He further submitted that the clarification was : "1t is clarified that even where such transfer, extinguishment or curtailment of such a right is complete or in part, the taxability of the consideration will remain unaffected, i.e., the same will not be taxable under the head capital gains (sic.) assessment year" 1997-98 and will become taxable from the assessment year 1998-99 and subsequent assessment years!' He submitted that by means of this instruction, the Board had clarified that any restriction in regard to any of the activities which was carried on by the assessee, consideration received for such restriction up to the assessment year 1997-98 would not be brought to tax even as capital gains.
12. The learned Departmental Representative Mr. S. Ravi carried us through the agreement with TDP and BIL in his own inimitable style. He submitted that the agreement with TDP, called as "Non-competition agreement", is in fact similar to buying of one of the activities of the assessee. The activity that was the subject of the consideration between the assessee and the TDP - manufacturing of mosquito repellents, mats, and mat adapters for Banish Mats - shall be covering its areas of marketing, sale and distribution. By means of this agreement, TDP compelled the assessee to is continue the marketing, sale and distribution of mosquito repellents, mats and mat heater machines and this agreement was made effective for a period of five years only. He submitted that this cannot be read in isolation from the agreement that was entered into by the assessee with BIL. The agreement with BIL was a contract of work and sale. The contract of work covered manufacturing of identical products which hitherto the assessee was manufacturing in its own right and then distributing and selling and marketing the same in its own rights. The parallel of the activity of manufacture either on behalf of the assessee itself or on behalf of another needs to be appreciated. The other parallel that was pointed out was that the marketing, sale and distribution was carried out by the assessee on its own behalf and as far as BIL is concerned, the assessee is required to sell all those to BIL only. He accordingly pleaded that the activity which was carried on by the assessee earlier than 16-9-1994 and 24-5-1995 continued even after 24-5-1995. He submitted that the giving over of the distribution, sale and marketing of Banish Mats and agreeing not to do marketing sale and distribution of mosquito repellents, etc., on its own behalf for a period of five years in no way had impaired the functioning of the assessee. He submitted that the Commissioner (Appeals) had compared the sales turnover and profit for 4 years starting from 31-3-1995 and had demonstrated that the business income remained almost at par for various years and there has been no drastic fall in the commercial income. He submitted that the agreement with BIL and its nature as contract of work or sale can be appreciated with reference to the decisions of the Madras High Court in Madras Bar Association v. CBDT (1995) 216 ITR 240, Patna High Court in Associated Cement Co. Ltd. v. CIT (1979) 120 ITR 444 (Pat), and that of the Tribunal I.A.C. v. Punj & Sons (1996) 56 ITD 281 (Del). He submitted that it may be that the assessee is carrying on job work, but the nature of job work needs to be appreciated with reference to the tact that the raw materials and other items that go to make the mosquito repellents are purchased by the assessee and the sale price of the items so manufactured are determined by means of an arrangement between the assessee and BIL. Every time BIL required the product, it raised a purchase order on the assessee and settled the price at which the goods should be bought by BIL. The agreement with BIL also specifies clearly that it is principal to principal basis and, therefore, it is not correct to say that the assessee is only doing job work for somebody else. He drew our attention to the decision of the Madras High Court in Chemplant Engineers (P) Ltd. v, CIT (1998) 234 ITR 23 (Mad) and drew our attention to the observations of the court at page 29. He submitted that the ratio laid down by the Madras High Court was that the compensation received for loss of income is revenue in nature. He submitted that this decision squarely applies to the present case for he has demonstrated very clearly that in view of the agreement of the assessee giving over all the distribution, selling and marketing rights to TDP in no way had any effect on the activity of manufacture, sale and marketing and distribution of the assessee's business. He accordingly insisted that the restrictive covenant for a period of five years should not be taken seriously for the sole reason that the assessee is allowed from time to time to deal in similar kinds of business for anybody else with the only condition that he shall not carry on distribution, sale and marketing of competing product.
13. The rival contentions as raised before us, and the material that are placed on record have been very carefully perused. It is clear from the fact that are borne out from the records that the assessee had entered into an agreement with BIL on 16-9-1994 for the manufacture of mosquito repellents, mosquito mats, mosquito heaters, etc., and selling them to BIL and this agreement was on a principal to principal basis. The assessee had possessed the manufacturing capability of mosquito repellents which it was carrying on from 1986 onwards. The manufacturing capability and capacity which it possessed, BIL wanted to take advantage which it did by entering into an agreement with the assessee. BIL did not grant the marketing rights of the product so manufactured on its behalf. BIL was to raise its order on the assessee and the assessee would then raise its invoices on BIL. This was generating income to the assessee from 16-9-1994. On 24-5-1995 the assessee entered into an agreement with TDP by which agreement the assessee had agreed that it would not compete with TDP in any manner and it would market mosquito repellents, mosquito mats, mosquito heaters, etc., which hitherto the assessee was not only marketing but also manufacturing on its own right with payment of royalty for the patent called "Banish". For and from 24-5-1995 by means of this agreement the assessee brought down its shutters in regard to marketing, distribution and sale of any product on its own right. For this act of the assessee, the assessee was paid Rs. 2.70 crores.
14. The Madras High Court in Chemplant Engineers (P) Ltd. (supra) was considering the situation of the assessee, who entered into agreement with another for lining and bonding with rubber, agreed to modify the contract and accepted the condition that it would not carry on similar business for anybody else except through the other party for a year and with this modification the assessee received a particular sum. The question before the High Court was what was the nature of the receipt. It was in this connection that the High Court at page 29 of the report had observed that if the compensation received is for the loss capital structure, it would be capital in nature, but if it is so received as loss of income, it would be revenue in nature. The High Court further observed that rubber lining and rubber bonding are not the business of the assessee and the assessee used to procure the business on behalf of a party who was doing rubber lining and rubber bonding in the factory premises of the assessee. By means modification of the contract the other party prevented the assessee from carrying on similar activity of procuring rubber lining and bonding for any other party except through the party with which the assessee had been carrying on its business. The High Court noted that such restriction was for a period of one year only. The High Court further observed that by such restriction the assessee was not surrendering any right that was pre-existing to the contract. The assessee was known to be carrying on the business as engineering contractors and the procuring of rubber lining and rubber bonding was a separate and distinct source of income. On these facts, the High Court came to the conclusion that the compensation received of Rs. 20,000 was towards loss of commission for procuring orders and hence a revenue receipt.
15. To our mind the facts as were before the Madras High Court and the one before us are not parallel to one another and, therefore, the said decision cannot be applied. One distinguishing feature between the facts of the assessee and that of the Madras High Court is that the assessee had a pre-existing right before it entered into contract with the TDP and this pre-existing right was marketing, distribution and sale of mosquito repellents, mats and heaters, etc. The other distinguishing feature is that for a period of five years the assessee will not enter into any market in the same line of business as that of TDP The third distinguishing feature is that the assessee is carrying on the manufacture of mosquito repellents, mats, heaters, etc., and it is not a distinct business activity from one carried on by the assessee unlike in the case before the Madras High Court. The Madras High Court further in that case the assessee was not carrying on any rival business in the rubber lining and bonding. In the instant case, the assessee was carrying on the rival business in the sale, marketing and distribution of mosquito repellents, mats, heaters, etc. By means of its agreement with TDP it had agreed that it will not be a rival to the business of TDP and thus it had received Rs. 2.70 crores. The rivalry in business being closed, the activity of the assessee insofar as its business was concerned has come to a stop insofar as it related to marketing, sale and distribution of its own right is concerned.
Insofar as the manufacturing activity, which it continued as earlier, it could not be said to be on the same level because what it was selling, distributing and marketing hitherto, it having surrendered those rights in favour of TDP, it could not also manufacture those products and thereby it had resulted in curtailment of its manufacturing activity and closure of its marketing activity altogether.
16. The decision of the Tribunal in Punj & Son's case (supra) that was relied on by the learned Senior Departmental Representative is inapplicable to the facts of the instant case because in that case the question was with reference to the system of accounting followed on completed contract basis. The decision of the Patna High Court in Associated Cement Co. Ltd.'s case (supra) that was relied on purely with the purpose of indicating what was the job contract, to our mind, has no impact insofar as the decision to be made with reference to the nature of receipt on account of surrendering of market rights. Likewise, the decision of the Madras High Court in the case of Madras Bar Association (supra) was also relied upon for the same proposition of work and job-work, etc., which has no impact as far as the evaluation of the nature of receipt for surrendering all marketing rights is concerned.
17. As observed earlier, what the assessee had surrendered was no doubt its marketing, sale and distribution rights and with that evaporated even the manufacturing of certain products in its own right. The vacuum that was created in the market by the absence of that product because of the volition of the assessee not to be a rival to TDP and not the compete with the TDP is a matter of concern to TDP which it successfully got released from the assessee and further prevented the assessee from being its rival or competing with it for a period of five years. In any activity that could be said to be an activity as a rival or competing activity, five years period of non-competing is a long period in the present scenario of commerce and trade which is galloping at a very fast phase. In such a situation, the amount received for not being a competitor or rival in a business activity of another as not relatable to a profit-making apparatus but as a profit in itself, to our mind, would be grossly erroneous. One major activity which was developed over a period of years namely marketing, by one stroke of action the assessee is prevented from carrying on of that activity for a period of five years. No doubt the activity of the assessee insofar as BIL is concerned covering manufacture and sale to BIL only is in some manner gives an impression that there is no impairment of the functioning or the activity of the assessee. But it needs to be appreciated from the point that what the assessee was doing out of its own free will and volition of manufacturing and then marketing it, it had surrendered in favour of TDP and agreed not to be its competitor for a period of five years.
18. The surrendering of the rights of marketing, etc., in favour of TDP is an action of giving over its profit earning apparatus to TDP entirely. This activity happened to be its main activity for last several years. The curtailed activity of carrying on job work for BIL is only an aspect indicating that some experience in manufacturing is being exploited by that company. Therefore, the restriction that has been placed by TDP over the assessee not to be its competitor for the next five years is buying of the right of marketing that included manufacturing also of all product, which used to be its main activity, deprived the assessee of its main profit earning apparatus. The amount realised is, therefore, clearly capital in nature. The Board's Circular that had reference to section 55(2) in regard to the generated assets being sold, capital gains not levied thereon, are guidelines by the various authorities who have to implement the Act with the sole view of reducing avoidable litigation. Therefore, the right to manufacture and market Banish mosquito repellents, mats, etc., which was surrendered in favour of TDP, having been generated over the years, the capital asset, sale thereof that has resulted in capital gains in view of the Circular of the Board referred to earlier is not liable for capital gains tax.
19. In the result, the appeal of the assessee is allowed.