Income Tax Appellate Tribunal - Mumbai
Govindlal C. Mandhana Huf, Mumbai vs Department Of Income Tax on 31 January, 2012
ITA Nos.3881 3905 3906 & 3877 of 2010
Govindlal Mandhana Mumbai
IN THE INCOME TAX APPELLATE TRIBUNAL
"G" Bench, Mumbai
Before Shri B. Ramakotaiah, Accountant Member
and Shri V. Durga Rao, Judicial Member
ITA No. 3881 & /Mum/2010
(Assessment Year: 2006-07)
Govindlal Mandhana Addl. CIT Range-18(2)
338 A to Z Indl.Estate 1st Floor, Pirmal Chambers
Ganpatrao Kadam Marg Lalbaugh, Parel
Lower Parel, Mumbai 400013 Vs Mumbai 400012
PAN - AAUPM 8565 E
Appellant Respondent
ITA No.3877/Mum/2010
(Assessment Year 2006-07)
Govindlal Mandhana (HUF) Addl. CIT Range-18(2)
338 A to Z Indl.Estate 1st Floor, Pirmal Chambers
Ganpatrao Kadam Marg Lalbaugh, Parel
Lower Parel, Mumbai 400013 Vs Mumbai 400012
PAN - AACHG 2774 B
Appellant Respondent
ITA No.3905/Mum/2010
(Assessment Year 2006-07)
Addl. CIT Range-18(2) Govindlal C Mandhana
1st Floor, Pirmal Chambers 338 A to Z Indl.Estate
Lalbaugh, Parel Ganpatrao Kadam Marg
Mumbai 400012 Vs Lower Parel, Mumbai 400013
Addl. CIT Range-18(2) PAN - AAUPM 8565 E
Appellant Respondent
ITA No.3906/Mum/2010
(Assessment Year 2006-07)
Dy. CIT Range-18(2) Govindlal C Mandhana HUF
st
1 Floor, Pirmal Chambers 338 A to Z Indl.Estate
Lalbaugh, Parel Ganpatrao Kadam Marg
Mumbai 400012 Vs Lower Parel, Mumbai 400013
PAN - AACHG 2774 B
Appellant Respondent
Page 1 of 15
ITA Nos.3881 3905 3906 & 3877 of 2010
Govindlal Mandhana Mumbai
Assessee by: Shri Rajan Vora
Revenue by: Shri A.K. Nayak
Date of Hearing: 31/01/2012
Date of Pronouncement: 15/02/2012
ORDER
Per Bench.
These cross appeals are by the assessee and the Revenue in the case of Govindlal Mandhana on individual capacity as well as HUF capacity against the orders of the CIT (A)-29, Mumbai dated 26/02/2010 respectively.
2. The assessee earned gain on sale of shares held in a company managed by Mandhana family and offered the same as capital gains. The Assessing Officer was of the view that as there is non-compete clause in the sale of shares to a foreign company, a portion of the amount received as part of sale consideration was attributable to non-compete clause. Accordingly the Assessing Officer bifurcated the amount and took `205/- per share out of 570/- received by the assessee per share as towards non-compete fee and brought to tax as business income under section 28(va). Aggrieved the assessee carried the matter in appeal before the CIT(A). The learned CIT(A) upheld the action of the Assessing Officer in principle but reworked the amount to `41/- per share which can be attributable to non-compete fees. He differed from the decision of Coordinate Bench in the case of Homi Apsi Balsara's vs. ACIT 30 DTR 576 to hold that there is specific mention of non-compete obligation and accordingly decided the appeal. Hence both the Revenue and the assessee are in appeal before us.
3. The Revenue is contesting in its two grounds about CIT(A) differing from the earning capitalization method for valuation of Page 2 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai shares and restricting the amount of non compete amount from `205/- per share taken by the Assessing Officer to `.41/- per share. The assessee, however, questions the entire action of the Assessing Officer, as confirmed by the CIT (A), in bifurcating the sale price towards non compete value and further, without prejudice, in treating the non compete portion of sale consideration received as business income and not as capital gain without appreciating the fact that the assessee was not carrying on any business where as the company was carrying on the business whose shares were transferred.
4. At the outset the learned Counsel submitted that this issue was covered by the decision of the Coordinate Bench in the case of Savita N Mandhana and Shashikant Mandhana who are the other share holders in the transaction wherein the Coordinate Bench upheld the assessee's contentions. The learned Departmental Representative however, objected to treating the case as covered and argued that there was a finding in the ITAT order that there is no business in the individual capacity, whereas the facts indicate that the assessees are in the business and further there was an amount paid as non compete fees in the agreement which should have been considered. The Ld. DR also relied on the Coordinate Bench decision in the case of Nayan C. Shah 14 Taxmann.com 155 (Mum) and Ramesh D. Tainwala 15 Taxmann.com 181 (Mum).
5. The learned Counsel however, submitted that the company is in the business and the respective assessees were having different businesses but not the business in which company was involved as suggested by the learned Departmental Representative and further submitted that the amount received as non compete fees by the Managing Director who was managing the affairs of the company to whom exclusively non compete amount was paid was offered by him as business income, the fact of which was recorded by the ITAT in Page 3 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai the cases supra. It was further submitted that the amounts were received from a foreign company under Arms Length principles as a total consideration on sale of 50% shares in the company. Therefore, there is no need for bifurcating the amount partly towards the value of the share of the company and partly towards non-compete fees when no amount was paid towards non compete fees to other share holders except to the managing Director. Even if a non compete fees was paid/ considered the same cannot be considered as business income as the respective assessees are not in the same business and the entire exercise of bifurcating the amount towards share value and non compete fees was also not necessary when the sale consideration received was taxable as capital gains only. Provisions of section 28(va) are not applicable to the facts of the case and so there is no merit in the action of the Assessing Officer and the CIT (A). He also distinguished the cases relied on by the learned Departmental Representative.
6. We have considered the issue. Before adverting to the arguments of the learned Departmental Representative, the following facts are to be placed on record. The assessees before us were shareholders in Mandhana Exports Pvt Ltd - a closely held company owned and managed by Mandhana family for a number of years. In the year 1996, the assessee company entered into a joint venture arrangement with Bornemann and Bick GmbH, Germany, under which 50% of Equity shares were allotted to this German company and the name of the company was changed to Mandhana Boremann Industries Pvt Ltd ('Mandhana Boremann', in short) . As this German company was acquired by a Dutch company by the name of Paxar BV, the shareholdings in Mandhana Boremann were transferred to Paxar BV. In the relevant previous year, Paxar BV acquired all the shares held by Mandhana family for a consideration of `570 per share which worked out to ` 45.60 crores. All the Page 4 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai shareholders in Mandhana family entered into an agreement with Paxar BV for the purpose of this transfer of shares, and one of the clauses in the agreement also provided that the transferor shall not carry on, or be interested in, any business which competes with the business of Mandhana Boremann.
7. As seen from the share purchase agreement placed on record, 19 Members entered into agreement with Paxar BV Corporation of Netherland for sale of their 50% shares of 8 lakh fully paid up equity shares of `10/- each. The consideration on payment was fixed at a fixed price of 456 million at a price of `570/- per share and purchase consideration shall be payable to pro-rata to each of the sellers in lump sum simultaneously at completion of the agreement. There is a non-compete clause against all sellers as part of sale covenants vide Para 5.6 wherein each and every seller agrees not to compete with the business directly or indirectly for a period of 2 years from the date of completion of sale. However, this clause exempts Mr. Nitin Mandhana for a period of one year as there is separate retention agreement indicating his services for a period of one year and for which separate amount was paid. Clause 5.6(c) specifies 'business' as under:-
"The expression business for purposes of the foregoing provisions shall mean and include generally the Garment Accessories line of business and specifically all the business activities being carried on by MBIL as of December 8, 2004"
The above covenant indicate that after sale of shares, the group of persons collectively were prevented in dong any business in the garment accessories line of business carried on by the company and this was part of many sale covenants agreed at the time of sale of 50% of share holding in the company to the foreign company. There is no specific consideration paid as non-compete amount. Even Page 5 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai though respective assessees have business income, only the company is doing the 'business' as specified in the agreement. Respective assessees business is independent and separate of the line of business in which company was involved and for which non- compete clause was agreed. Therefore, even if Assessing Officer's opinion is to be considered as correct that the share price was fixed for non-compete clause also, since respective persons are not in the business of company's line of business, the amount cannot be considered as business income in the absence of any business activity in similar line. It can only be considered as capital gain amount received as part of sale consideration upon sale of shares by individual members. These aspects were considered in the Coordinate Bench decision of Homi Apsi Balsara's vs. ACIT 30 DTR 576 wherein that assessee also sold shares through share purchase agreement which had also a clause for non compete. Considering the fact that the assessee on her own was not carrying on the business and it is the company which was carrying in the business and as per Section 55(2)A where the capital asset is in nature of right to carry on business, it was held that it will fall within the ambit of capital gains. The facts in the above said case equally applies to the facts in the present case.
8. Considering these aspects the Coordinate Bench decided in favour of the assessee in the case of Shashikant G. Mandhana, HUF in ITA No.3908/Mum/2010 and in the case of Savita N. Mandhana in ITA Nos.3900 and 3878/Mum/2008. The Coordinate Bench decision is as under:
"4. We find that, even in the case of Homi Aspi Balsara (supra) there was a specific non compete obligation and yet the coordinate bench was of the view that no part of the sale consideration of shares could be attributed to be taxed in the hands of the assessee as business income under section 28(va)- as is clearly discernable from the following observations made by the coordinate bench:Page 6 of 15
ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai The A.O has determined the book value of shares and has treated the difference between the sale price of shares and its book value as consideration towards non- compete fees. Admittedly, in the share purchase agreement no consideration was assigned towards non- compete fees and the parties had entered into the share purchase agreement after mutually settling the price of shares. The A.O. has primarily relied on Article 11.1 of the share purchase agreement to infer that assessee had paid amount towards non-compete fees.
Article 11.1 reads as under:-
"In consideration of the Purchase price received by the Sellers under this Agreement, the sufficiency of which is hereby acknowledged, the Sellers agree that for a period of 5 years from Completion, the Sellers shall not be engaged in any of the Restricted Business in India."
This clause clearly shows that in the purchase price of shares, consideration towards Restraint Clause was embedded. But the same was not specifically mentioned in the Share Purchase Agreement, As rightly pointed by the ld. Counsel for the assessee, non-compete fees could be payable primarily with respect to manufacturing company viz. Balasara Home Products. As regards other two IPR companies viz. Balasara Hygiene Products and Besta Cosmetics, since value of IPR was not reflected in the balance sheet, which constituted major part of the share price, the same had to be determined before arriving at the true book value of share of these two companies. The A.O. has computed approximately 80% of the consideration towards non-compete fees which, in any case, is not in conformity with the settled principles of valuation of shares. Therefore, we are of the opinion that the basis adopted for assigning consideration towards non-compete fees was not correct. Now the question would be how to assign the consideration towards non-compete fees. We really do not need to enter this area particularly because the difference, between the sale price of share and the true book value of the share, if allocated towards non-compete fees, was to be computed u/s.55(2)(a). This would be clear from subsequent discussions. Admittedly, assessee on her own was not carrying on business and it was the company in which Page 7 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai she was share holder was carrying on the business. Section 55 2(a) reads as under:-
"Section 55(2)(a) " (a) in relation to a capital asset, being goodwill of a business [or a trade mark or brand name associated with a business] [or a right to manufacture, produce or process any article or thing] [or right to carry on any business], tenancy rights, stage carriage permits or look hours, -"
Thus, it is evident that where capital asset is in the nature of right to carry on business, then the same will come within the ambit of capital gain tax.
Section 28 (va) reads as under:-
Section 28 (va) "any sum, whether received or receivable, in cash or kind, under an agreement for - (a) Not carrying out any activity in relation to any business; or (b) Not sharing any know- how, patent, copy right, trade-mark, license, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services. Provided that sub-clause (a) shall not apply to -
(i) Any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head "Capital gains", Thus, section 28 (va) would be attracted where the assessee was carrying on business and not where assessee only had right to carry on business in the form of capital asset. Further as per Circular No. 763 dated 18/2/1998 by Finance Act, 1997 the amendments were made in section 55(2)(a) of the Act to bring extinguishment of right to manufacture, produce or process any article or thing or right to carry on any business within the ambit of capital gain tax. Similarly Circular No.8 of 2002 dated 27/8/2002 explaining the provisions of Finance Act, 2002 by which clause (va) was inserted in section 28 of the Act, clarifies that receipts for transfer of rights to manufacture produce or process any article or thing or right to carry on any business, which are chargeable to tax under the head capital gain would not be taxable as profits and gains of business. Thus, the Page 8 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai difference between the sale consideration and true value of shares was chargeable as capital gains. .........
5. Respectfully following the esteemed views of the coordinate bench, with which we are in respectful agreement, we hold that the amounts held to be attributable to non compete obligations are taxable as capital gains and not as business income. To this extent, we hold that the order of the CIT(A) is indeed vitiated in law, and, to that extent, that grievance of the assessee must be upheld. There is no dispute that the assessee has already included entire consideration for sale of shares, including what could be attributed to non compete obligations, as capital gains. In this view of the matter, the exercise of bifurcation between consideration attributable to sale of shares and for non compete obligations is rendered academic and infructuous. We may also add that it is not even in dispute that the assessee before us was not actively engaged in the business and so far as the assessee actively engaged in the business is concerned, it has been stated at the bar that income attributable to non compete obligations has been offered to tax as business income, but then, given the uncontroverted position that the assessee was not actively engaged in business, it is not really necessary to examine that aspect of the matter any further. The stand of the assessee, in treating entire consideration received on sale of shares as taxable under the head 'capital gains' must therefore be upheld.
6. For the detailed reasons set out above, and respectfully following the coordinate bench in Homi Apsi Balsara's case (supra), we hold that the entire consideration has been rightly offered to tax under the head capital gains. The partial relief granted by the CIT(A), by reducing the quantum of amount attributable to non compete obligations, is thus rendered academic and infructuous. The grievance and the stand of the assessee, on the other hand, is upheld".
9. The learned Departmental Representative in the course of the argument relied on the decision of Coordinate Bench in the case of Nayan C. Shah vs. DCIT 14 Taxmann.com 155 (Mum). In that the facts are:
Page 9 of 15ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai "The assessee had promoted a company called Paramount Health Care Management Company Pvt. Ltd. (PHMC) for the purpose of providing Third party administration and managed care service. A German Company namely 'MR' was interested in becoming a shareholder of the said company. For this purpose a Memorandum of Understanding (MoU) was entered into between the assessee and 'MR'. Under the MoU, it was inter alia agreed that 'PHMC'. will increase its share capital by issue of further shares and 'MR' would subscribe to 500000 no. of shares being 33.33 per cent of shareholding in the 'PHMC'. As 'MR' had acquired 33.33 per cent of shares in the 'PHMC' and had the option to go upto 51 per cent they insisted that assessee should give up right to carry on such business as may be carried on by 'PHMC'. Accordingly, the assessee entered into a non-compete agreement with 'MR'. In terms of said agreement the assessee received an amount of `43,14,775/-. The said payment was made to assessee for agreeing not to carry on the business in competition with Indian company into which 'MR' had invested. The assessee claimed that said amount was a capital receipt. The assessee's case was that the payment was for not carrying on any business and hence provisions of section 28(va) would not be applicable, in view of the proviso under that section. The Assessing Officer did not accept the submissions of the assessee and brought to tax the entire amount as business profits under section 28(va). On appeal, the Commissioner (Appeals) also held that the payment fell under section 28(va) and confirmed the action of the Assessing Officer, in treating the entire receipt as business profits".
It was held that:
"On reading of the non-compete agreement gives the impression that 'MR' and the assessee had agreed upon two types of payments (i) US$1.25 million on the first year for the assessee not to undertake various activities provided in clause 1 of the Non compete agreement. And
(ii) a further compensation to the assessee, who is also the Managing Director of the Joint Venture companies, based on the business results of the company to be computed on the basis of the formula given in the non-
compete agreement, which is based on the performance and profitability for a period of 5 years. Thus the Page 10 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai payment made during the year can be considered only as payment made for the services rendered by the assessee to the non-resident transferee, based on the performance/profitability. Thus the payment has been rightly assessed as revenue receipt. Even if the entire agreement is considered as a single one and the payment is part of the non compete fee paid, the issue has to be considered in the context of section 28(v)(a) introduced w.e.f. 1.4.2003. The compensation accrues and is receivable only under the year in appeal. Therefore, the taxability of the amount is considered as per the provisions of law prevailing for this year. Hence the receipt should be analyzed in the context of section 28(va). Section 28(va) deems that payment for certain restrictive covenants would be in the nature of business income/revenue receipt. The exception to this would be any amount received on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business which is chargeable under the head capital gains.
In the present case, the assessee has agreed not to do any business in competition with 'MR'. At the same time he has continued to do business which he was carrying on earlier, for the foreign company. The assessee argued that professional activities of radiology and imaging has been given up in view of non compete agreement and that should be considered as giving up his right to carry on any business. But it is a fact that even after the non- compete agreement the assessee is continuing with the same activities for German company. Therefore, whether the restrictive covenant agreed to by the assessee would amount to transfer of right to carry on any business is to be seen.
The first aspect is that the assessee has not transferred any right to do business. It is only self imposed restriction upon himself not to enter into business in competition with the non-resident. The Amritsar Tribunal in the case of Dy. CIT vs. Max India Ltd (2007) 112 TTJ 726 has held that when the assessee signed the negative covenant not to carry on manufacture or trade in produce for certain period of time, it amounted not only to self imposed restriction and not a transfer. The right to manufacture or trade remained intact after the period for which negative covenants were signed. Even though the Page 11 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai Tribunal in that case held in favour of the assessee as it related to the year prior to 2003-04, the ratio that mere restriction not to carry out manufacture or trade in competition would not amount to transfer of right to carry on any business, would be applicable to the instant case.
In the circumstances, it cannot be said that the assessee had transferred completely its right to carry on any business; in fact, the assessee had continued to do his activity in the same line even after entering into this non- compete agreement. Agreement not to compete with the third party in the business will not encompass totality of right to carry on any business. The right to carry on any business is larger in scope and range and agreement not to complete with the business of a particular person is only part of its right. The agreement not to compete with the particular person in his business does not prevent the assessee from carrying on the same business in a manner which will not compete with the business of that person. Therefore, it is opined that the agreement not to compete with the business of the person would not amount to restriction of carrying on any business and much less constitute a transfer of right to carry on any business.
Therefore, when the assessee entered into an agreement not to carry on any business in competition with the transferee, the consideration for the negative covenant of non-competition will fall within the sub-clause (2) of section 28(va), i.e. sum received for not arriving on any activities in relation to any business and cannot fall within the exclusion contemplated in the proviso viz., not transfer of right to carrying on any business. Thus, it is held that the payment restriction for not to compete German company can be classified only as agreement not transfer of a right to carry on any activities in relation to any business and will not fall under transfer of right to carry on business.
Although the impugned payment made to the assessee is to be considered as a part of the non-compete agreement, it cannot be considered as payment made to the assessee for transfer of the right to carry on any business during the year. It cannot be agreed that this payment made after five years, on the basis of the performance and profitability of the company for the past five years is also Page 12 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai part of the compensation for the assessee for refraining from carrying on any business. It is in the nature of share of profits earned by the joint venture in excess of the estimated profits. That is why the payment is made after 5 years taking into account performance of the company for all the 5 years.
Therefore, the amount of `43,14,775/- received by the assessee during the year, can be considered either as compensation for the assessee agreeing not to carry out any activity in relation to any business (attracting clause
(a) of section 28(va) or the payment is for the services rendered by the assessee for the non-resident computed on the basis of the profitability of the venture for the 5 years. Either way, it is revenue receipt in the hands of the assessee. In this view of the matter, it is held that the amount received by the assessee has been properly assessed as revenue receipt in the hands of the assessee".
10. As can be seen from the above the facts in the case more relate to Nitin Mandhana case ( managing Director and one of the Share holder), the case in which the assessee offered the amount as business income accordingly. Since the facts in the assessee's case are entirely different, the principles laid down by the above Coordinate bench does not apply to the present case.
11. Further in the case of Ramesh D. Tainwala vs. Income Tax Officer 15 taxmann.com 181 (Mum.), the facts are as under.
"The assessee was one of the promoters of 'TP Ltd' and together with other promoters held substantial shares in the company. By an agreement 'I Ltd' (acquirer) agreed to purchase shareholding of the assessee along with other promoters of 'TP Ltd'. The acquirer with a view to ensure that the promoters after sale of the shares did not indulge in competing business entered into a non- compete agreement whereby the assessee was paid `2 crores for agreeing not to carry on or be engaged, concerned or interest in any competing business for a period of 11 years. The sum of 2 crores was not offered to tax by the assessee in the return of income filed for Page 13 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai the relevant assessment year. Later on, the assessee filed a letter in which he claimed that sum of `2 crores being compensation for agreeing not to engage in the business in which the assessee had sole expertise and knowledge was compensation received for giving up a source of income which was a capital receipt and not income chargeable to tax. The Assessing Officer held that the receipt in question was a fee received for not carrying out any activity in relation to any business and, therefore, chargeable to tax under section 28(va). On appeal, the Commissioner (Appeals) confirmed the view of the Assessing Officer. In the instant appeal, the assessee contended that sum received in cash, on account of transfer of right to carry on any business would be chargeable under the head 'capital gains'. ...
It was held as seen from the above facts, there was a separate share purchase agreement as well as non-compete agreement for which an amount of `2 crores was paid, the amount of which was not offered to tax by assessee. On the set of facts, it was held that the amount was taxable as business income.
12. In this case, the assessee was only share holder in the company in which the entire group was having 50% share holding and upon acquiring the 50% share, there are sale covenants towards non-compete. Considering the above facts, while appreciating the efforts made by the Departmental Representative in trying to distinguish, we are unable to differ from the findings of the Coordinate bench in the other shareholder's cases. Respectfully following the decision of coordinate bench in other share holders case with which we agree, we hold that the assessee's contentions are to be upheld and accordingly the Assessing Officer is directed to treat the entire amount as sale consideration for sale of shares and no amount be assigned to non-compete and to assess under the head Capital gains only.
13. Since the assessee's grounds are allowed, the Revenue grounds in reducing the amount from `205/- to `41/- as was done Page 14 of 15 ITA Nos.3881 3905 3906 & 3877 of 2010 Govindlal Mandhana Mumbai by the CIT (A) becomes infructuous and academic in nature and therefore, the Revenue grounds are dismissed.
14. In the result the assessee's appeals are allowed and Revenue appeals are dismissed.
Order pronounced in the open court on 15th February, 2012.
Sd/- Sd/-
(V.Durga Rao) (B. Ramakotaiah)
Judicial Member Accountant Member
Mumbai, dated 15th February, 2012.
Vnodan/sps
Copy to:
1. The Appellant
2. The Respondent
3. The concerned CIT(A)
4. The concerned CIT
5. The DR, "G" Bench, ITAT, Mumbai
By Order
Assistant Registrar
Income Tax Appellate Tribunal,
Mumbai Benches, MUMBAI
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