Income Tax Appellate Tribunal - Ahmedabad
Samir S Sheth, Baroda vs Assessee
IN THE INCOME TAX APPELLATE TRIBUNAL AT
AHMEDABAD
AHMEDABAD "D"BENCH
Before Shri G.C.Gupta, Vice-President (AZ) and
Shri B.P. Jain, Accountant Member
IT A No.2919 & 3092/ Ahd/2002
Assessment Year:1999-00
Mr. Samir Suryakant बनाम Asstt. Commissioner
Sheth of Income-tax, Circle-
/V/s.
C/o. Plastichemix 2, Baroda
Industries, 6 t h Floor, Kirti
Tower, Tilak Road,
Baroda
PAN No. AFOPS8295Q
ACIT, Baroda, Circle-2, Shri Samir S Sheth
Baroda बनाम 6 t h Floor, Kirti Tower,
/V/s. Tilak Road, Baroda
अपीलाथȸ/ Appellant .. ू×यथȸ/ Respondent
IT A No.2920 &3091/ Ahd/2002
Assessment Year: 1999-00
Mr. Mayur Suryakant बनाम Asstt. Commissioner
Sheth of Income-tax, Circle-
/V/s.
C/o. Plastichemix 2, Baroda
Industries, 6 t h Floor, Kirti
Tower, Tilak Road,
Baroda
PAN No. AACHS4090T
ACIT, Baroda, Circle-2, Shri Ma yur S Sheth
Baroda बनाम 6 t h Floor, Kirti Tower,
/V/s. Tilak Road, Baroda
अपीलाथȸ/ Appellant .. ू×यथȸ/ Respondent
आवेदक कȧ ओर से /Assessee by Shri S.N.Soparkar, SR-
AR
राजःव कȧ ओर से /Revenue by Shri S.S.Parida, CIT-DR
सुनवाई कȧ तारȣख / Date of Hearing 30-12-2011
घोषणा कȧ तारȣख/Date of Pronouncement 25-01-2012
ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00
Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 2
आदे श/ORDER
PER BENCH:-
These two cross-appeals of the two assesses arise from two different orders of the ld. CIT(A) each dated 09.07.2002 for the assessment year 1999-2000. Since the issues in both the appeals are common, therefore both the cross appeals are being decided by this consolidated order. The assessee, Mr. Samir S Sheth has raised the following grounds of appeal in ITA No.2919/Ahd/2002:-
"1. The ld. CIT(A) has erred in law and on facts in confirming the addition of Rs.3,69,10,000/- under the facts and circumstances of the case the amount of Rs.3,69,10,000/- is a capital receipts not liable to tax in view of the following decision of Supreme Court
1. C.I.T. Gujarat v/s Mohanbhai Pamabhai 165 ITR 166 (S.C)
2. Sunil Siddarthbhai v/s CIT 156 ITR 509 (SC) and so the same can not be taxed as capital gain u/s 45 of the Income-tax Act as has been done by the ld. ACIT Cir-2, Baroda and confirmed by the ICT Appeals.
2. Ld. CIT(A) has erred in law and on facts in confirming the addition of Rs.27450000/- received by the appellant as non-competition fees. Under the facts and circumstances of the case the amount of Rs.27450000/- is a capital receipts not liable to tax on the basis of the following decisions.
A. CIT V/s. Kamal Behari Lal Singha 82 ITR 460 B. Gillandars Arbuthnot & Co. v/s CIT 53 ITR 283 C. Best & Co. Pvt. Ltd. 60 ITR 11 D. R.N. Agarwala v/s CIT 38 ITR 67 E. Oberoi Hotels Pvt. Ltd. V/s CIT 236 ITR 403 The appellant has received this amount for the negative convenient mentioned in the non-competition agreement executed in this behalf in view of the legal decisions the same is not liable to tax. Moreover the Financial Bill 2002 also support the case of the assessee by making the non competition fees as taxable only from A.Y. 2003-2004 on words and not before.
3.Ld. CIT(A) as well as the ld. AO has erred in not considering various facts submissions, explanations and clarifications as given by the appellant. Both the lower authorities have further erred in not appreciating the facts and law in their proper perspective."
ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 3
The Revenue in the cross appeal in ITA No.3092/Ahd/2002 has raised the following grounds of appeal:
"1.On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in holding that the entire capital gain be treated as long term capital gain.
2. On the facts and in the circumstances of the case and in law the ld. CIT(A) ought to have upheld the order of the Assessing Officer.
3. It is, therefore prayed that the order of the CIT(A) be set aside and that of the assessing officer be restored."
The assessee, Mr. Mayur S Sheth in his appeal in ITA No. 2920/Ahd/2002 has raised the following grounds of appeal:
"1. The ld. CIT(A) has erred in law and on facts in confirming the addition of Rs.30190000/- under the facts and circumstances of the case the amount of Rs.30190000/- is a capital receipts not liable to tax in view of the following decision of Supreme Court
1. C.I.T. Gujarat v/s Mohanbhai Pamabhai 165 ITR 166 (S.C)
2. Sunil Siddarthbhai v/s CIT 156 ITR 509(SC) and so the same can not be taxed as capital gain u/s 45 of the Income-tax Act as has been done by the ld. ACIT Cir-2, Baroda and confirmed by the ICT Appeals.
(2) Ld. CIT(A) has erred in law and on facts in confirming the addition of Rs.22500000/- received by the appellant as non-competition fees. Under the facts and circumstances of the case the amount of Rs.27450000/- is a capital receipts not liable to tax on the basis of the following decisions.
A. CIT V/s. Kamal Behari Lal Singha 82 ITR 460 B. Gillandars Arbuthnot & Co. v/s CIT 53 ITR 283 C. Best & Co. Pvt. Ltd. 60 ITR 11 D. R.N. Agarwala v/s CIT 38 ITR 67 E. Oberoi Hotels Pvt. Ltd. V/s CIT 236 ITR 403 The appellant has received this amount for the negative convenient mentioned in the non-competition agreement executed in this behalf in view of the legal decisions the same is not liable to tax. Moreover the Financial Bill 2002 also support the case of the assessee by making the non competition fees as taxable only from A.Y. 2003-2004 on words and not before.
(3) ld. CIT(A) as well as the ld. AO has erred in not considering various facts submissions, explanations and clarifications as given by the appellant. Both ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 4 the lower authorities have further erred in not appreciating the facts and law in their proper perspective."
The Revenue in the cross appeal in the case of Mayur S Sheth in ITA No.3091/Ahd/2002 has raised the following grounds of appeal:
"1. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in holding that the entire capital gain be treated as long term capital gain.
2. On the facts and in the circumstances of the case and in law the ld. CIT(A) ought to have upheld the order of the Assessing Officer.
3. It is, therefore prayed that the order of the CIT(A) be set aside and that of the Assessing Officer be restored.
Now we take up the appeal of the assessee and the revenue in the case of Mr. Samir S. Sheth in ITA No.2919/Ahd/2002 and 3092/Ahd/2002 as under:
2. The brief facts of the case of the assessee and the revenue as appearing in the AO's order for the sake of clarity are reproduced as under:
"3. In the notes forming part of the return of income, the assessee had mentioned that he was holding 55% share in the profit of the firm M/s.
Plastichemix Industries prior to the admission of new partner namely Ciba India Pvt. Ltd. (herein after called as "Ciba". On 1.7.1998, Ciba was admitted in the partnership firm having 51% share in the profit of the firm. As a result of this, the assessee's share has fallen from 55% to 27%. The assessee admittedly received Rs.3,69,10,000/- towards goodwill and impairment to the assessee's interest in the firm. He had further received Rs.2,74,50,000/- as a consideration for non-competition fee from the new partner. The assessee claimed these total receipts of Rs.6,43,60,000/- as capital receipt not chargeable to tax. During the course of assessment proceedings, these issues were examined in detail. Prior to discussing legal issues involved, it would be worthwhile to note down the facts of the case.
4. FACTS RELATED TO ADMISSION OF NEW PARTNER i. The firm M/s. Plastichemix Industries was engaged in the business of manufacturing, buying, selling and processing of plastic master batches, plastic colours, plastic materials and pigments for plastic and fibres. Prior to admission of Ciba, the last reconstitution of firm had taken place on 5.11.1996. According to the partnership deed dated 5.11.1996, the assessee Shri Samir Sheth was having 55% of share in the firm and his brother Shri Mayur Sheth was having 45% share in the profit of the firm.
ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 5
ii. On 28.2.1998, the firm M/s. Plastichemix Industries was reconstituted and the partners Shri Samir Sheth and Shri Mayur Sheth agreed to admit Ciba as partner in the firm. As per Clause 1.3 of the partnership deed dated 28.02.1998 between Shri Samir Sheth, Shri Mayur Sheth and Ciba, the effective date of commencement for the partnership deed dated 28.02.1998 was to be 1st April, 1998 or the date from which Foreign Investment Permission Board (FIPB) grants its approval, whichever was later.
iii. There was delay in obtaining approval from the FIPB and accordingly the partnership deed became effective from 1.7.1998. A supplementary deed of partnership was signed by Shri Samir Sheth, Shri Mayur Sheth and Ciba and the deed of Partnership dated 28.02.1998 became the main deed to this supplementary deed.
iv. As per Annexure-I to the partnership deed, the profit sharing ratio amongst the partners from 1.7.1998 was as under:-
a. Shri Samir Sheth 27%
b. Shri Mayur Sheth 22%
c. Ciba India Pvt. Ltd. 51%
v. As per this partnership deed, Sheth Brothers were having authority to admit other members of Sheth family as partners by sharing their profit sharing ratio of 49%. Subsequently on 18.12.1998, a fresh deed of partnership was entered into and the members of Sheth Family were admitted and the profit sharing ratio with effect from 18.12.1998 is as under:
a) Samir Sheth 19%
b) Mayur Sheth 17%
c) Ketki S Sheth 3%
d) Nayana M Sheth 3%
e) Suryakant G Sheth 3%
f) Devang S Sheth 3%
g) C.B. Thakkar 3%
h) Ciba India Pvt. Ltd. 51%
vi. Capital in the firm as on 1.4.1998 of Shri Samir Sheth and Shri Mayur Sheth was as under:-
Shri Samir Sheth Rs. 9,28,27,002
Shri Mayur Sheth Rs. 7,24,04,941
Total Rs.16,52,31,943
vii. Prior to admission of Ciba on 1.7.1998, various adjustment entries were made in the capital account of old partners i.e. Shri Samir Sheth and Shri Mayur Sheth. Investment allowance reserve and subsidy amount reserve of the firm were credited to the capital account of the old partners in their profit sharing ratios. Thereafter, to match the capital with the new profit sharing ratio of capital was partly withdrawn ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 6 and partly transferred to unsecured loan account of the old partners. The amount transferred to unsecured loan account in the case of Shri Samir Sheth was Rs.3,88,70,151/- and in the case of Shri Mayur Sheth, it was Rs.2,81,68,112/-. Further amount of Rs.3,09,92,500/- was withdrawn by Shri Samir Sheth from the firm for personal FDRs and by Shri Mayur Sheth of Rs.2,53,57,500/- for personal FDRs. Similar withdrawals from capital accousnt were made prior to subsequent reconstitution of firm in December, 1998. On the other hand, newly admitted partner Ciba contributed Rs.5,63,51,000/- as capital contribution for its share in profit of 51%.
viii. Apart from the contribution of Rs.5,63,51,000/- by newly admitted partner Ciba on 1.7.1998, no other payments were made to or through the firm.
ix. However, newly admitted partner Ciba had privately made two separate payments to the old partners and the details of such payment are as under:-
Samir Sheth(Rs.) Mayur Sheth (Rs.) For reduction in profit Share in the firm 3,69,10,000 3,01,90,000 Noncompetition Agreement 2,74,50,000 2,25,00,000 Total 6,43,60,000 5,26,90,000 Grand Total Rs.11,70,50,000
5. LOSS IN THE PROFIT SHARING RATIO AND THE AMOUNT RECEIVED Among the old partners Shri Samir Sheth had 55% share in profit and which got reduced to 27% and, thus, he relinquished 28% of his share.
Similarly, Shri Mayur Sheth was holding 45% share in the profit of the firm and the share was reduced to 22% and he had relinquished 23% of the share in profit.
Ratio of right relinquished by Shri Samir Sheth and Shri Mayur Sheth 28=1.22 23 Ratio of payment received by Shri Samir Sheth and Shri Mayur Sheth on account of relinquishment 3,69,10,000 = 1.22 of shares in the profit 3,01,90,000 Noncompetition agreement 2,74,50,000 = 1.22 2,25,00,000
6. ISSUE INVOLVED ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 7 Whether the amount received by the old partners from the newly admitted partners is chargeable to tax.
Assessee's contention In the notes forming part of the return of income the assessee relied on the decision of the Supreme Court in the following cases:-
i. Mohanbhai Pamabhai (165 ITR 166)
ii. Tribhovandas G Patel (1998) (8 SSC 509)
iii. Sunil Siddarthbhai (156 ITR 509)
7. During the course of assessment proceedings, the assessee argued that on retirement of a partner, amount received by him from the continuing partners is nothing, but the amount which belonged to him as a partner and there is no element of transfer on the retirement by the partner from the firm and when a partner retires from the firm, the amount received is not chargeable to capital gains tax. It was further argued that the present case involved partial retirement of the assessee from the firm wherein his share in the profit of the firm was reduced. Therefore, legally it is at par with the total retirement of the partner. It was, therefore, claimed that amount received on partial retirement would not be chargeable to capital gains tax. It was further stated that the Gujarat High Court had held in the case of Rajendra B Modi (200 ITR 98) that the amount received on reduction of share in the firm constituted capital receipt. In view of these decisions, the assessee argued that the amount should not be taxed as it is not chargeable to capital gains tax.
8. In this connection, vide show cause letter No.cir.2/SS/01-02 dated 7.3.2002, the assessee was informed that all the Supreme Court citations referred by him were on the facts where a partner retire from the firm and received amount on settlement of capital account and the remaining partners continued with the business. However, in this case of the assessee, there is admission of a new partner and the share of the assessee in profit of firm got reduced from, 55% to 27% and in lieu of this reduction of his right to receive profit, he had directly received payments from the new incoming partner i.e. Ciba. Therefore, the decisions of the Supreme Court were not applicable in his case. Further, it was also informed that in the case of Rajendrakumar Modi (Supra), the decision that amount received on reduction of the right to receive profit is capital receipt in nature. There is no difference of opinion on this account as the amount received is not in nature of revenue receipt. The decision was related to assessment year 1971- 72 when the amount received on account of goodwill was not chargeable to tax. The assessee was further informed that right to receive profit in a partnership firm is a capital asset under section 2(14) of the Act and relinquishing the right to receive profit is a transfer within the definition of section 2(47) of the Act.
ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 8
9. The assessee was further asked to furnish the basis on which the amount of Rs.3,69,10,000/- received by him was worked out on account of his relinquishing the share in profit by 28%.
10. The assessee failed to furnish any basis on which the consideration for relinquishing the right to the extent of 28% was worked out at Rs.3,69,10,000/-. The assessee reiterated his earlier stand that there is no transfer of interest of assessee in the goodwill of the firm and no amount is assessable under section 45 of the Income- tax Act.
11. CHARACTER OF THE RECEIPT A business builds up some reputation after it is continued for sometime. It is a valuable asset and the value of it depends on personal reputation of the owners/management/the peculiar advantage of the site/with regard to sale of material and the pattern, copy right, trade marks owned by the firm. According to Courts, variety of elements go into making of goodwill and its composition varies in different trades and in different business. In the case of Lord Macnaghten IRC v/s. Muller & Co. Margarine Ltd. (1901) (AC 217) (HL) has held that value of goodwill fluctuates depending on the changes in the reputation of the business. It is effected by the prevailing socio-economic ecology effective to old customers and absence of competition.
12. In the present case, Shri Samir Sheth and Shri Mayur Sheth were closely related to the business of marketing, development, manufacture of master batches and pigment preparation. Both the Sheth Brothers had specialized technical knowledge and know-how, information and process related to the marketing of products. Both Shri Samir Sheth and Shri Mayur Sheth had possessed information and experience in the chemical industry and due to their efforts, there was a tremendous growth in the prospectus of the firm M/s. Plastichemix Industries in such a prevailing scenario a new partner is admitted and acquires controlling interest of 51% in the partnership firm.
13. At the time of reconstitution of the firm on admission of a anew partner, one of the following methods are adopted by the parties for making payment on account of goodwill to the persons who relinquish their right to receive the profit:-
i. The old partners value the goodwill of the firm at agreed amount, which could have been credited in the proportion of their existing profit sharing ratio to their capital accounts. The incoming partner would have contributed towards his own capital and the old partners would have withdrawn excess capital having regard to their final capital contribution.
ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 9
ii. Goodwill so revalued could have been either written off immediately in the capital accounts of the partners in their new profit sharing ratio.
iii. As against this manner, there is another option in which the new incoming partner agrees to make payment directly to the old partners without involving the firm.
In this case, new incoming partner has made payment directly to him for relinquishing his right to share profit by 28% and adopted third option referred above.
14. On raising specific querry, the assessee had failed to work out the basis on which consideration in lieu of relinquishing his share was decided. Therefore, he was asked to work out the value of goodwill of the firm at the time of reconstitution as per normal accounting policies and accordingly the assessee furnished the working in which details are as under:-
Simple average of past 5 years' Profit (after considering the Tax payment Rs.3.58 crore Average capital employed Rs.19.09 crore The assessee considered normal rate of return at 11% and valued the goodwill by capitalization method for the business at Rs.13.46 crores. By super profit method the goodwill was worked out at Rs.3.77 crores. Since the value of goodwill is higher by capitalization method, it was furnished as the value of goodwill of the firm i.e. Rs.13.46 crore which according to the assessee for 28% share relinquished by Shri Samir Sheth comes to Rs.3.76 crores and by Shri Mayur Sheth, it comes to Rs.3.09 crore for relinquishing 23% share.
15. CONCLUSION At the time of admission of new partner, the capital accounts of old partners were adjusted and the amount of various reserves of the firm were transferred to the credit of old partners. This has taken care of the fair market value of all tangible assets and liabilities existing as on 30.06.1998. The assessee had adjusted his capital in the firm to match new profit sharing ratio and the new incoming partner Ciba had contributed its share of capital to the firm. Therefore, in these circumstances, the amount paid separately by the new incoming partner to the old partners without involving the firm is nothing, but consideration for intangible asset i.e. the loss of share of partner in the goodwill of the firm. Accordingly, this amount is to be charged to tax under the head capital gains.
16. AMOUNT PAID FOR NONCOMPETITION AGREEMENT ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 10 As discussed in the preceding para, apart from making payment for loss of share in the profit of the firm, on 28.2.1998 itself separate agreements were entered by the new incoming partner Ciba with both the old partners of the firm separately wherein new partner had entered into a restrictive convenant and para "G" of this agreement reads as under:-
"CiBA INDIA therefore desires to enter into a restrictive covenant with Mr. Samir Sheth and Mr. Mayur Sheth is agreeable to covenant with CIBA INDIA that for a minimum period of 5 (five) years from the effective date of this agreement and during the period that he is a whole time director and for a period of two years after ceasing to be a whole time director (hereinafter called "the term") he shall not render any consultancy or advise to any organization engaged in the manufacture, sale and distribution of the products and that during the term he shall not disclose the knowledge to any person or entity in consideration of CIBA INDIA paying Mr. Samir Sheth a lump-sum of Rs.2,74,50,000/-".
17. ASSESSEE'S ARGUMENT During the course of assessment proceedings, the assessee argued that in view of various Court decisions, the amount received for sterilization or annihilation of source of income would not be income at all and the amount received on loss of source of income constitutes capital receipt in the hands of the assessee. The assessee relied on the decision of the Supreme Court in the following cases:-
i. Karanpura Development 44 ITR 362
ii. Oberoi Hotel Pvt. Ltd. 236 ITR 903
iii. Gillandars Arbuthnot & Co. 53 ITR 283
The assessee, therefore, argued that on assessee's agreeing to restrict from competition, he has not acquired any right and there is no transfer involved as such.
18. Vide show cause letter No.Cr.2/SSS/01-02 dated 7.3.2002, the assessee was informed that under section 16 of the Partnership Act, all the continuing partners are legally bound not to compete or carry out any kind of business with that of the firm in which a person is a partner. Therefore, it was out of question that till the time the assessee was a partner in the firm, he can any way compete with the firm. Further, the event when he would retire is contingent in nature and, therefore, the condition of noncompetition was inbuilt as the assessee was a partner in the firm. Further attention was drawn to the fact that in the noncompetition agreement, the world "wholetime director / director" has crept-in, which is no way applicable in this case as the assessee at best can be Managing Partner / Partner. Therefore, it appeared that some other agreement related to some company had been hurriedly ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 11 copies and applied in this case which has different set of facts. It was further stressed that in case of noncompetition, both Shri Samir Sheth and Shri Mayur Sheth who were equally competent technical persons, the amount paid to them ought to have been equal and not in the ratio of their right relinquished by them. Therefore, it would be easily concluded that the further amount paid by the new partner directly to the old partner in the name of noncompetition agreement was nothing, but towards loss of share of goodwill in the firm.
19. In reply to the show cause letter, the assessee reiterated his stand and stated that the amount was paid for restrictive covenant and, therefore, the same can not be treated as goodwill and the amount would be taxable as business receives from assessment year 2003- 2004 only.
20. CONCLUSION As discussed in the preceding paras, both the Sheth Brothers were competent technical persons having expertise in the field of manufacturing and marketing of various grade4s of master batches and pigment preparations. The reputation of the firm soared due to the knowledge applied by the partners. While valuing the goodwill this aspect has to be considered specifically. Partnership deed and noncompetition agreement are inter-linked. There is no possibility of entering into noncompetition agreement by Ciba with Sheth Brothers, if it had not sought admission in the firm. On the other hand, any payment made towards relinquishment of rights by the Sheth Brothers in the firm would be meaningless if partnership deed itself does not contain restrictive covenant and in fact in the partnership deed itself the limits of authorities are included in clause 8 and sub-clause 8.11 reads as under:-
8.1. Except where otherwise provided in this deed, no partner shall without consent of all the others.
8.11. Either directly or indirectly and whether on his own account or otherwise engaged in India in any other competing business profession or occupation or uphold any office or employment in the competing business while remaining as a partner.
Even this part of partnership deed and Appendix G to Annexure-3 of the partnership deed contain name of other family concerns - M/s. Plastic Compound Inds. and spectramix Plastics who would not conduct any business or compete with the business of the firm M/s. Plastichemix Industries.
21. In view of section 16 of the Partnership Act and clause 8.1 and 8.11 of the partnership deed, the assessee was legally bound not to compete with the business of the firm, till he is a partner in the firm. Therefore, this condition itself has enhanced the value of goodwill of ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 12 the firm and the payments separately made in the name of noncompetition agreement is nothing, but the payment made for the loss of partner's share in the goodwill. Further facts that in case it was a noncompetition agreement, the consideration paid to both the Sheth Brothers ought to have been equal and not in the ratio of loss of their share in the goodwill of the firm.
22. All these facts suggest that non competition agreement is merely a devise to avoid the tax. In fact it is the consideration received for loss of share in the goodwill. One has to look into the substance of the transaction and not into the mere legal form of a document presented by the assessee. The Supreme Court had observed in the cases of McDowell & Co. Ltd. (154 ITR 148) and B.M. Kharve (72 ITR
603) as under:-
".........The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the 'substance or transaction'........".
".......It is neither fair nor desirable to expect the legislature to intervene a take care of every devices and scheme to avoid taxation. It is upto the Court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the device could be related to the existing legislation with the aid of emerging techniques of interpretation to expose the devices for what they really are and to refuse to give judicial benediction......."
23. FOR VALUATION OF GOODWILL The working of goodwill supplied by the assessee is based on accounting principles. It has not taken into consideration the immediate effect of joining of hands by a multinational company Ciba with the professionally competent firm M/s. Plastichemix Industries. It has been earlier discussed that the valuation of goodwill is a complex process and it depends on the perspective of the specific person. In this case, the incoming partner Ciba has perceived an opportunity to gain foothold in this line of business by acquiring controlling interest in the firm. The firm was having knowledge and technical competence and MNC, Ciba was having other resources. Therefore, immediate effect of joing of hands by Sheth Brothers and Ciba must have weighed in mind of Ciba where it had decided to pay a total sum of Rs.11,70,50,000/- to the Sheth Brothers on account of their relinquishing 51% share in the profit share of the firm. Without considering impact of this event, the assessee himself had worked out the goodwill of the business at Rs.13.46 crore. It was stated that Shri Samir Sheth had received Rs.3.69 crore as against his share for ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 13 relinquishment of goodwill which comes to Rs.3.76 crore. Similarly, Shri Mayur Sheth whose share as per valuation of the assessee was Rs.3.09 crore has received Rs.3.02 crore.
24. On the cost of repetition, I summarise the facts as under:-
i. Newly admitted partner Ciba entered in a partnership deed with the assessee and his brother dated 28.02.1998 and simultaneously entered into an agreement for noncompetition on 28.2.1998 itse4lf.
ii. The effective date for both the agreements was 1.7.1998.
iii. Prior to admission of new partner, the capital accounts of then existing partners Shri Samir Sheth and Shri Mayur Sheth were credited with reserves outstanding in the firm as on 30.6.1998 in their profit sharing ratios.
iv. The then existing partners Shri Samir Sheth and Shri Mayur Sheth partially withdrawn the capital in the firm and partially transferred the capital in the unsecured loan account so that balance in the capital account matches with new profit ratio in the firm.
v. The new incoming partner Ciba contributed its own share in the capital of the firm at Rs.5,63,51,000/-. This had taken care of valuation of assets and liabilities as on 30.06.1998.
vi. In addition to this, the new incoming partner had directly paid two separate amounts to the assessee - one in lieu of relinquishing the share in the partnership firm and other in the name of noncompetition agreement.
vii. In view of the fact that the assessee continued to be partner in the firm and express clause in the partnership deed, which prohibited competition by the continuing partners, there was no occasion to make payment separately for noncompetition.
viii. The amount paid in name of noncompetition to both the partners were in ratio of their loss in the profit share of the firm, which clearly suggests that it is nothing, but the amount paid for loss of their share in the partnership firm.
ix. Once the capital accounts were settled prior to reconstitution of firm every tangible asset was taken care of and in consideration for tangible asset, the then existing partners withdrawn the capital and new partner introduced the capital in the books of the firm.
ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00
Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 14
x. Over and above new incoming partner had paid total sum
of Rs.11,70,50,000/- to the above existing partners privately and directly. There is no doubt that this amount represents the loss of share of the then partners in the goodwill of the firm.
xi. The agreement of non-competition agreement is nothing, but a colourable device to avoid payment of taxes. Therefore, I hold that the entire amount received by the assessee of Rs.6,43,60,000/- is nothing, but consideration received for goodwill and the same has to be taxed under section 45 of the Income-tax Act.
25. QUESTION WHETHER SHORT TERM OR LONG TERM Shri Samir Sheth was having share in the firm @40% since very long period till 5.11.1996. Therefore, the share in the partnership firm increased to 55%. Out of this share of 55%, he has relinquished 28% on 1.7.1998. Since the assessee has gained addition 15% share on 5.11.1996 and relinquished the same on 1.7.1998, he has not completed 36 months. Therefore, the value of capital gain on account of 15% loss in the share of goodwill would be short term capital gain and balance 13% would be chargeable as long term capital gain.
26. ALTERNATIVE CONTENTION Without prejudice to the discussion in connection with noncompetition agreement which was held as a colourable device to suppress the amount paid for loss of share in the goodwill, it is alternatively contended that if the agreement is accepted as a genuine one, the aspect of period of restraint is to be considered. The period is very short i.e. 5 years. The assessee was a partner in the firm and had no other source of income. His source of income was share of income from the firm, which got reduced, but he had not lost his source of income. He had not in any way annihilated his source of income but his source of income is partially impaired and in lieu of that assessee received amount from new incoming partner. The condition that assessee would not compete for two years after the retirement is uncertain and contingent event. If the assessee resigns immediately receiving the amount, then his period of restraint is only 5 years. The fact that assessee had no independent source of income and restraint is otherwise in built in the partnership deed, the agreement for a short period of 5 years does not amount to loss of source of income to the assessee and, therefore, the receipt is revenue in nature and chargeable to tax as business receipt under section 28 of the Income- tax Act.
27. The assessee argued that this amount would be chargeable to tax as business income from assessment year 2003-2004. This contention of the assessee is also not correct. From assessment year 22003-2004, those receipts, which are otherwise in nature of capital receipt where source of income is lost for indefinite period are to be taxed as business income. In the cases like that of assessee. Where ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 15 the restraint of source of income is for a very short period, the amount is otherwise chargeable to tax as revenue receipt of business/profession. Therefore, if the noncompetition agreement is held to be a genuine one, the amount of Rs.2,74,50,000/- should be taxed as business receipt.
28. Subject to above remarks, total income of the assessee is competed as under:-
Income from business as per return Rs. 34,99,230 Income from other sources as per return Rs.1,30,89,747 Income under the head capital gain
i) Short Term Rs.3,44,78,571
ii) Long term Rs.2,98,81,429 Gross Total Income Rs.8,09,48,977 LESS: Deduction under Chapter VIA As per return Rs. 19,,617 Total Income Rs.8,09,29,360"
3. The ld. CIT(A) vide para 3.5 to 3.8 with respect to taxability of goodwill observed that it is not in dispute that the receipt is capital in nature and therefore to that extent the observations in the case of Rajindra Prasad Modi's case were accepted. After considering the decisions of Hon'ble Supreme Court of India in the case of CIT vs Chhotalal Mohanlal (1987) 166 ITR 124 (SC) it was observed that all the decisions cited by the assessee are the decisions where the assessee had retired from the firm and the additional consideration was received from the firm and not from the person obtaining the benefit of retirement or reduction in the share of the firm. The facts in the present case are different. After considering the decisions of various courts of law relied upon by the assessee, the ld. CIT(A) vide para 3.8 of this order observed that entire receipts towards reduction in the share of goodwill by way of assignment thereof in favour of Ciba (India) Pvt. Ltd. would be liable to be taxed as capital gains.
4. As regards amount received towards non compete fees. The ld. CIT(A) vide para 4.5 of his order confirmed the action of the AO.
ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 16
5. As regards the nature of gain whether short term or long term, the ld. CIT(A) found force in the arguments made by the ld. Authorized representative with regard to the succession of interest in the firm and also in regard to the FIFO Method of treating the holding of shares. Therefore the ld. CIT(A) directed the AO to treat the entire capital gain as long term capital gain.
6. The ld counsel for the assessee Mr. Soparkar Advocate argued with respect to the taxability of goodwill that Department cannot rewrite the contract between the unrelated parties. He relied upon the decision of Hon'ble Gujarat High Court in the case of tax appeal no.157 of 2000. Assuming it to be so, in the absence of transfer, no tax is payable. He further argued that retirement is not a transfer. The reduction in the shares in the partnership is nothing but mini retirement. Mr. Soparkar relied upon various decisions in this regard as under:
(i) ACIT v. Mohanbhai Pamabhai (1987) 165 ITR 166 (SC)
(ii) CIT v. R Lingmallu Raghukumar (2001) 247 ITR 801 (SC)
(iii) Tribhuvandas A Patel v. CIT (1999) 236 ITR 515 (SC) Mr. Soparkar further argued that Hon'ble Mumbai High Court in 324 ITR 153 at page 163 accepts even post amendment of section 45 and there is no charge of tax in hands of a partner on the retirement.
7. As regards non compete fee Mr. Soparkar argued that it is not a case of goodwill and department cannot rewrite the contract between unrelated parties, as already argued hereinabove. On the facts such a payment is justified. Such a payment has been held to be a capital receipt. He relied upon the decisions of various courts of law as under:
1) Guffic Champ Ltd. v. CIT (2011) 332 ITR 602 (SC)
2) 305 ITR 18 (MP)
3) Rohitasavachand v. CIT (2008) 306 ITR 242 (Del.)
4) 246 CTR 190 (Bom.)
5) CIT v. Sarajkumar Poddar (2005) 279 ITR 573 (Cal.) ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 17
8. The ld. CIT(DR) on the other hand argued that the department is also of the view that it is a capital receipt. It is a case of transfer of a capital asset and therefore it is taxable as a capital gain. He further argued that section 14 Partnership Act itself includes goodwill. The present case is the case of transfer of share in the partnership. The ld. Counsel for the assessee has cited the decisions of various courts of law with regard to retirement of partnership and none of the case has been cited by the ld. Counsel for the assessee with regard to partners continuing. Therefore, none of the cases cited by the ld. Counsel for the assessee are applicable in the present facts and circumstances of the case. As regards the non compete fee the cases cited by the ld. AR are not applicable since there is no issue of the competition in the circumstances and facts of the present case. He further argued that section 16 of Partnership Act provides that the partner cannot indulge in the competition. Therefore there is no question of compete fee. The ld. CIT(DR) also relied upon the decisions of various courts of law which are on record in support of his contention.
9. We have heard the rival contentions and perused the facts of the case. There is no dispute to the fact that the receipt is capital in nature and therefore to that extent observations of Hon'le jurisdictional High Court in the case of CIT v. Rajendra Babubhai Modi (1993) 200 ITR 98 apply in the present facts and circumstances of the case. The Ld. CIT(A) has relied on the judgment in the case of CIT. v. South Indian Photographic and Allied Traders Association (1987) 166 ITR 124, where issue arose whether reduction in the share of the partner would involve a case of transfer exigible to gift tax. The Hon'ble Supreme Court of India while holding against the assessee held that such reduction is liable to gift tax. As regards the various decisions relied upon by the Learned Counsel for the assessee, the same are with respect to where the assessee had retired from the firm and additional consideration is received from the firm and not from the person obtaining the benefit of the retirement or reduction in the share of the firm. In the various such decisions, the retirement does not involve any transfer "qua" the firm. The facts in the present case are different i.e. the assessee has transferred his share in favour of M/s. Ciba India Private Ltd., a third party who in consideration thereof has paid certain sum of money. Therefore, the Ld. CIT(A) has rightly observed that the decisions of various ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 18 courts of law relied upon by Ld. AR are not applicable in the present facts and circumstances of the case. In the judgment of Hon'ble Supreme Court in the case of Chhotalal Mohenlal (supra) which is relevant in the present case, where the Hon'ble court has held that there was an assignment in favour of third party without consideration and the same has been held to be a transfer in favour of such party which amounted to gift. Therefore, we concur with the findings of the Ld. CIT(A) which does not require any interference. Also we concur with the views of Ld. CIT(A) with regard to the valuation of goodwill.
10. As regards non-compete fees the judgments of various courts of law relied upon by the Learned Counsel for the assessee cannot help the assessee. Since in the present facts and circumstances of the case the payment in the present case has been made only for compensating for the loss due to the reduction in the share of goodwill of the firm. We are convinced with the arguments made by Ld. CIT-DR that Section 16 of Partnership Act provides that the partner cannot indulge in the competition and therefore there is no question of compete fee in the present case and the amount received is a compensation received for reduction of share in the partnership firm which is shown as compete fee is required to be taxed in the same way as the amount of goodwill is taxed.. Therefore, we do not find any error in the order of Ld. CIT(A) in this respect, who has rightly confirmed the action of Assessing Officer.
11. As regards taxability of the capital gains in para-5.5 in the order of Ld. CIT(A), he has rightly treated the entire capital gains as Long Term Capital Gains. We find no infirmity in the order of Ld. CIT(A). Thus, all the grounds of assessee and also that of Revenue are dismissed.
Now we take up the appeal of assessee In ITA No.2920/Ahd/2002 and that of Revenue in ITA No.3091/Ahd/2002.
12. The grounds taken by the assessee and the Revenue in the present cross- appeals are identical to the grounds taken by the assessee in ITA No.2919/Ahd/2002 and the Revenue in ITA No.3092/Ahd/2002 in the case of Samir S Sheth for assessment year 1999-00. The facts in the present appeal of the assessee and the Revenue are identical to the facts in the case of Samir S Sheth, ITA No.2919, 3092, 2920 & 3091/Ahd/2002 A.Y. 1999-00 Samir & Mayur S Sheth v ACIT Cir-2, BRD Page 19 which has been decided by us hereinabove. Therefore, our findings in the case of Samir S Sheth in ITA No.2919/Ahd/2002 and Revenue's appeal in ITA No.3092/Ahd/2002 shall be applicable in the case of Mayur S Sheth in the present appeals being the identical issues. Thus, all the grounds of assessee in ITA No.2920/Ahd/2002 and all the grounds of Revenue in ITA No.3091/Ahd/2002 are dismissed.
13. In the result, the appeals of assessee in ITA No.2919/Ahd/2002 and ITA No.2920/Ahd/2002 and appeals of Revenue in ITA No.3091-3092/Ahd/2002 are dismissed.
इस आदे श कȧ घोषणा Ǒदनांकः 25/01/2012 को खुले Ûयायालय मɅ कȧ गई । This Order pronounced in Open Court on 25/01/2012.
Sd/- Sd/- (G.C.Gupta) (B.P. Jain) (Vice President) (Accountant Member) Ǒदनांकः- 25/01/2012 अहमदाबाद । Dkp*
आदे श कȧ ूितिलǒप अमेǒषत / Copy of Order Forwarded to:-
1. अपीलाथȸ / Appellant
2. ू×यथȸ / Respondent
3. संबिं धत आयकर आयुƠ / Concerned CIT
4. आयकर आयुƠ- अपील / CIT (A)
5. ǒवभागीय ूितिनिध, आयकर अपीलीय अिधकरण, अहमदाबाद / DR, ITAT, Ahmedabad
6. गाड[ फाइल / Guard file.
By order/आदे श से, /True copy/ उप/सहायक पंजीकार आयकर अपीलीय अिधकरण, अहमदाबाद ।