Income Tax Appellate Tribunal - Chandigarh
A.C.I.T. vs Tarun Kumar Ghai on 19 September, 2005
Equivalent citations: (2006)99TTJ(CHD)1240
ORDER
N.K. Saini, Accountant Member
1. This appeal by the department is directed against the order of Ld. CIT(A), Chandigarh dated 10.10.2002. 2 The only effective ground raised in this appeal reads as under:
On the facts and circumstances of the case, Ld. CIT(A), Chandigarh in appeal No. 76-P-31/97-98 vide order dated 10.10.2002 has erred in deleting the addition of Rs. 31 lacs out of total addition of Rs. 36 lacs which was made by the Assessing Officer on account of profit in lieu of salary.
3. The facts of the case in brief are that the assessee was drawing salary income from Bausch & Lomb Ltd (in short B&L Ltd) during the year under consideration. He had shown a receipt of Rs. 32 lacs as ex- gratia from the said company and claimed it to be exempt in view of judgment of Hon'ble Supreme Court in the case of Davecha v. CIT reported at 48 ITR 222. However, to verify the contention of the assessee, the Assessing Officer called for information Under Section 133(6) of I.T. Act regarding details of this receipt from B&L Ltd. In response to that the President of that company vide letter dated 18.2.97 stated as under:
1 Mr. Ghai is technical person and was mainly responsible for manufacturing operations of our company's products. Mr, Ghai's responsibilities included the following:
A Manufacturing activities Establishing and implementation of quality parameters to make sure that they conform to the Bausch and Lomb's International Standards and industry specifications.
Evaluation of different processes of manufacturing and selection of the most appropriate process for manufacturing glalsses and lenses to enable optimum use of equipments.
Selection of the appropriate temperature and load requirements at the commencement of the process of a specific produce.
Selection of the appropriate raw material to be used in the manufacturing process of a specific product.
Establishing tolerances for different types of material at various levels of temperature and load to ensure optimum utilization of the material in the manufacturing process and prevent wastage,"
Identification of staff requirements to be utilized in the manufacturing process of a specific product. Establishing maintenance guidelines for the machines used in the manufacturing process. Periodic evaluation and maintenance of control equipments used in manufacturing process to ensure that the equipment does not create friction beyond acceptable limits. Daily evaluation of production dimensions to ensure that the dimensions of the manufactured products do not change on account of high temperature used in the process. B Other activities Identification of training needs and training of local technicians to B & L's International Standards. Ensure that the environmental protection guidelines are complied with in accordance with B&L's International standards and local regulations. Evaluation and selection of systems to support the manufacturing process.
Development of manufacturing plans and strategy for reduction of inventory costs.
2 The amount of ex gratia was paid to Mr. Ghai under an agreement dated 1.2.96 (copy enclosed). The payment made to Mr. Ghai as ex gratia is classified as "salary and establishment expenses" and debited to P&L account and claimed as revenue deduction under the provisions of Section 37 of I.T. Act.
3 The ex gratia was made to Mr. Ghai as a special case, on the understanding that he will not divulge the technology secrets of our company to any one nor should use them for setting up a competitive business any where in India. It was also stipulated and agreed by Mr. Ghai that he will not join for next 2 years any business activity which is competitive in nature and which can make potential Use of Bausch & Lomb technology. No such payments were made in the past to any of our employees. ' In view of the business necessity and exigency explained above, Mr. Ghai was considered as a special case for payment of ex-gratia.
4 In our books of account we have treated the compensation payment to Mr. Tarun Kumar Ghai as a revenue item and debited to P&L account more particularly explained in answer to para (1) above. Under the provisions of I.T. Act (section 37) these expenses are allowed as revenue deduction.
5 The nature of payment explained above is ex gratia which is not earned and due to Mr. Ghai by exercise of his employment with us, but to restrain him from doing competitive activity to protect the business interest. However, provisions of Section 192 requires every employer to deduct the tax on payment to the employees. As explained in the circular by Central Board of Direct Taxes the disbursing officer (hereto mean employer) has to follow the instructions given in circular for calculating the withholding tax. We have therefore, complied with the withholding tax requirements to avoid the possible disputes about the withholding tax. As an employer, we are not obliged to see the ultimate taxability or non taxability of these types of payments. In view of the above, you would appreciate that we have in fact complied with the law correctly.
We have pleasure in advising you that on completion of your contract of services with the company on 31st December, 95 the company has as a special case, decided to pay you an ex gratia amount of Rs. 32,00,000 subject to deduction of income tax at source on the understanding that you will not divulge the technology secrets of the company to any one nor will use them for setting up a competitive business anywhere in India. You shall also not join f or next 2 years any business activity which is competitive in nature and which can make potential use of B&L technology.
With the payment of aforesaid amount of Rs. 32,00,000 you shall have no further claim of any nature whatsoever against the company in respect of your employment with the company.
The Assessing Officer after considering the reply of the said company was of the view that the receipt was nothing else but compensation received on account of loss of employment and for not disclosing the trade secrets known to the assessee. According to him the compensation received by the assessee par-takes the character of revenue receipt taxable Under Section 17(3) as profit in lieu of salary and hence was taxable. He also stated that the case relied on by the assessee i.e. P. Devecha v. CIT, was of no help because in that case, the compensation was received on account of loss of business and fast net work of sales organisation. Accordingly the amount was held as taxable.
4. The assessee carried the matter to the Ld. CIT(A) and submitted that the amount was received as compensation for non competitive business and for not divulging the technology secrets of the company with whom he was an employee. It was further stated that the assessee was barred for not only doing competitive business but also from joining any company or organization carrying on the business activity which was competitive in nature and which could make potential use of technology of M/s B&L Ltd with whom the assessee was a senior functionary. It was explained that the assessee had Master's degree in Chemical Engineering from Kanas State University, USA and had working experience of 23 years in the pharmaceutical industry in USE, Brazil, Mexico and India and worked for leading multi national pharmaceutical companies like American Cyanamid and P fizer International. It was further stated that during the course of service with Bausch & Lomb Ltd. the assessee as the Head and Vice President of manufacturing had the access to confidential technology which included information about the manufacturing process, formulaes, drawings, results of experiments and investigations, customer list and accounts, method of cost calculation, sales and prices intelligence, marketing information and current and future strategies of the company. It was argued that the assessee was having access to confidential technology and trade secrets of M/s B&L Ltd world wide operations and the areas in which the assessee was dealing, included technology of contract lenses for therapeutic purposes, number of Pharmaceuticals solutions used f or eye surgeries and administration of contact lenses. It was further stated that the amount paid to the assessee was compensation by the employer to an ex-employee for non competition in a business because there was chances of assessee to become a likely competitor of the company. Therefore, in order to ward off competition from such employees/directors after their retirement, the employers entered into non competition agreement with such employees. Such compensation paid to an ex-employee in view of the restrictive convenant was a capital receipt and was not liable to tax under the provisions of I.T. I.T. Act. Reliance was placed on the following case laws:
Gillanders Arbuthonot & co. v. CIT 53 ITR 283 (S.C) CIT v. Best & Co. (Pvt) Ltd. 60 ITR 11 (S.C) CIT v. G.D. Naidu CIT v. Saraswati Publicities CIT v. Ajit Kumar Bose 165 ITR 90 (Cal) CIT v. Jamini Mohan Kkar R.B. Aggarwal v. CIT Bombay City, 38 ITR 67 (Bom) CIT v. Seshasayee Bros (P) Ltd. 222 ITR 818 B.K. Roy Pvt Ltd v. CIT and Ors. 211 ITR 500 M.N. Karani v. ACIT, 64 ITD 119.
It was further stated that in the case of M/s Kwality Cafe & Restaurants Pvt Ltd, in similar facts, the predecessor of Ld. CIT(A) had held the amount to be a capital receipt. A copy of the said order was also filed before the Ld. C I T(A).
5. After considering the submissions and the material on record, Ld. CIT(A) observed that the assessee joined B&L Ltd on 17.1.94 and was relieved on 31.12.95. Thus he worked in the company for a period of two the company for a period of two years and while leaving the company, it had been noted in the final settlement that he had to refrain from joining any business activity next two years which was competitive in nature and which could make potential use of B&L technology, he was also restrained from divulging the technology secrets of the company to any one nor he would use them for setting up competitive business in India. Ld. CIT(A) further observed that the assessee was a technical expert having technical knowledge about company's manufacturing process which was clear from the letter dated 18.2.97 written by the President of the company to the Assessing Officer which revealed that the assessee was appointed as Vice President (Works) and was looking after the manufacturing operations of company's products. Therefore, on resignation he had the potential to harm the business prospects of the company. He lost job which was permanent loss to him and in fact, after leaving the job he joined Montari Industries which was engaged in the business of production and marketing of pesticides. His later activities, thus, revealed that he had acted as per the restrictive agreement between him and B&L Ltd. He further pointed out that the persons who leave the job after considerable number of years, get some amount as compensation against the services rendered by him but in the case of the assessee service was only of two years and remuneration received was of Rs. 3.60 lacs and no company would pay an amount of Rs. 32.00 lacs for two years' service against a salary receipt of Rs. 3.60 lacs. Therefore, the amount against loss of service could be not more than Rs. 1.00 lac. He, therefore, held that the assessee got the maximum of Rs. 1.00 lac as compensation on retirement from service which could be treated as revenue receipt Under Section 17(3) and the balance of Rs. 31.00 lacs was capital receipt. Now the department is in appeal.
6 Ld. DR for the revenue strongly supported the order of Assessing Officer and vehemently argued that the amount received by the assessee was taxable Under Section 17(3)(i) of I.T. Act and since the compensation was in connection with the services and salary received by the assessee, so it was profit in lieu of salary and was taxable as revenue receipt. Reliance was placed on the following case laws:
Karamchari Union v. Union of India and Ors.
CIT v. D.R. Sondhi CIT v. Dr. P.L Meyyappan
7 In his rival submissions, Ld. Counsel for the assessee reiterated the submissions made before the authorities below and further stated that the assessee was restrained to join any concern having similar type of job or business and was also restricted not to do any business which could harm the profitability of the business of the company, B&L ltd. He further stated that there was a fear in the mind of the company that the assessee by joining another concern or by doing similar work could harm the prospects of the company, for that reason the agreement was entered into with the assessee and he was restrained to do any similar type of services or the business. Therefore, the compensation for restrictive covenant was a capital receipt as such the Assessing Officer was not right in treating the same as revenue receipt and the Ld. CIT(A) was fully justified in considering the receipt as capital receipt and deleting the addition made by the Assessing Officer. He further submitted that an amendment had been made in the I.T. Act w.e.f. 1.4.2002 in sub-clause (iii) of Sub-section (3) of Section 17 and it had been inserted that any amount in lieu of salary will include any amount due to receive whether in lump sum or otherwise by any assessee from any person before his joining any employment with that person or after cessation of his employment with that person, however, in the present case, the compensation was received for not joining any business activity and the assessee in fact, wanted to leave the employment for better prospects and the company to restrain him entered into an agreement, so, the amount received was a capital receipt. Reliancewas placed on the following case laws:
Gillanders Arbuthnot and Co. Ltd v. CIT K.S.S. Mani v. ITO (1995) 54 ITD 76 (Mad) D.C.I.T. v. Nimar Kshitriya Gramin Bank (1998) 64 ITD 190 A.C.I.T. v. A.S. Wardekar (2001) 77 ITD 405 (Cal) It was also stated that the cases relied on by the Ld. DR for the revenue were on different facts and are distinguishable.
8. We have considered the rival submissions and carefully gone through the material available on record. As regards to the facts of the case are concerned, there is no dispute that the assessee received a sum of Rs. 32.00 laics from the company B&L Ltd and the said company entered into an agreement with the assessee on the understanding that he should not divulge the technology secrets of the company to any one nor should use them for setting up a competitive business anywhere in India. It was also stipulated and agreed that the assessee will not join any business activity for next two years which is competitive in nature and which could make potential use of B&L Ltd technology. Therefore, the assessee was restrained from doing any competitive activity. In the instant case, from the fact available on record, it is abundantly clear that the assessee received compensation in consideration of his agreement and undertaking not to engage himself directly or indirectly in the business activity which are competitive to the company and also not to join any service in the similar type of trade. Thus, the amount received was not a profit in lieu of salary but capital receipt in lieu of profit earning source. Therefore, the amount received against the restrictive covenant was not exigible to tax. The amount received was neither a remuneration nor reward or return for the services rendered by the assessee but it was to restrain him from joining any employment in the similar business or to establish similar type of business to avoid competition or conflict with the existing business of the assessee company M/s B&L Ltd in which the assessee was working as the Head and Vice President of the manufacturing unit and was having access to confidential technology.
8.1 Hon'ble Supreme Court in the case of Gillanders Arbuthonot & Co v. CIT Calcutta, 53 ITR 283 (supra) held that -
compensation paid for agreeing to refrain from carrying on competitive business in the commodities in respect of the agency terminated or for loss of goodwill is prima facie of the nature of a capital receipt.
In the instant case also, the compensation paid to the assessee was for agreeing to refrain from carrying on the competitive business and to refrain from joining the similar type of employment. So, it was in the nature of capital receipt.
8.2 In a similar case of ACIT v. A.S. Wardekar (2001) 77 ITD 405 (Cal) decided by ITAT Calcutta Bench 'C' wherein one of us (Accountant Member) was the party, it has been held that the agreement was a restrictive covenant between the assessee and the UBL (who acquired controlling interest in WIEL). This receipt, thus was capital in nature and not liable to income tax.
8.3 Similarly in the case of K.S.S. Mani v. ITO (1995) 54 ITD 76, ITAT Madras Bench 'B' held t hat -
payment made to the assessee was in consideration of all he restrictive covenants undertaken by the assessee or In other words, for loss of profit from business or profession in which the assessee could have profit against the income. Thus compensation received by the assessee was nothing but a capital receipt for loss of profit earning source of income and not loss on profit as such.
8.4 In an another case before the ITAT Mumbai Bench 'D" in the case of M.N. Karani v. ACIT 64 ITD 119 (supra) facts were that the assessee by an agreement dated 11.4.83 agreed not to engage for five years in any activity by which the business secrets and technical knowledge maybe passed on to any other person. He also agreed not to take up any employment with any concern carrying on similar business, as a result the assessee was given Rs. 11.00 lacs and that amount was claimed as capital receipt. In the said case it had been held that -
Further the amount of Rs. 11.00 lacs received by the assessee could not be said to be profit from his employment. It was not a remuneration or reward or return for his services in any sense of the word. The fact of employment was the cause without which the occurrence would not have happened (CAUSA SINE QUA NON). It was not the immediate cause (CAUSA CAUSANS). It did not, therefore, arise there from. Hence the receipt in question could not be construed to be of revenue nature. It was clearly a capital receipt. In view of this, the amount of Rs. 11.00 lacs being the compensation paid to the assessee by HCGL against a restrictive covenant was not exigible to tax.
The facts of the present case are identical to the facts involved in the case of M.N. Karani (supra), Therefore, it can safely be held that the view taken by us is also in consonance with the view taken by the other Benches of ITAT as had been discussed in the aforesaid paras of this order.
8.5 As regards to the case law relied on by the Ld. DR for the revenue is concerned, in the case of CIT v. D.R. Sondhi , the issue related to compensation received by the M.D on retiring prematurely whereby his group sold its shares to rival group and the compensation received was held to be business income Under Section 28(ii)(a) of I.T. Act. The another issue was related to gratuity and the issue was restored back to be decided as to whether the allowance Under Section 10(10) was permissible to the assessee or not. So the facts involved in this case are different from the facts of the assessee's case.
8.6 Similarly, in the case of CIT v. Dr. P.L. Meyyappan, 244 ITR 543, the issue related to family allowance received by the assessee during his employment. Therefore, the facts in this case are clearly distinguishable from the facts of assessee's case.
8.7 As regards to the case of Karamchari Union v. Union of India and Ors. 243 ITR 143 (supra) relied on by the Ld. DR for the revenue is concerned, Hon'ble Supreme Court held as under:
A reading of clause (1) of Section 17 of act makes it abundantly clear that the word "salary" is given an exhaustive meaning as stated in sub-clauses (i) to (vii). The inclusive definition of the word "salary" given in Section 17 provides that apart from salary received by the employee, it includes wages, any annuity or pension, any gratuity any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages, any advance of salary, any payment received by an employee in respect of any period of leave not availed of by him and other payments mentioned in sub-clauses (va), (vi) and (vii). These sub-clauses (i) to (vii) of clause (1) indicate that the Legislature intended to include in salary, the specified or names, amount paid to the employee in respect of the services rendered by him. Sub-clause (iv) of clause (1) provides for inclusion of four types of payments in the word "salary" - (i) fees, (ii) commissions, (iii) perquisites and (iv) profits in lieu of or in addition to salary. In common parlance fees, commissions, perquisites or payments of profits in lieu of salary may not be considered to be salary. But by this inclusive definition it has been provided so. Clause (3) provides for an inclusive definition of the phrase "profits in lieu of salary."
This would not man that by giving an exhaustive and inclusive meaning, the word "profits" can be given a meaning only when it pertains to sharing of profits by the employer. For the assessee, the receipt of such amount would be a profit gain or advantage in addition to salary, even though it is not named as salary. Therefore, the word "profits" in the context is required to be understood as a gain or advantage to the assessee. May be t hat to the extent that Govt or statutory corporations do pay something less than what is required to be reimbursed, the receipt of city compensatory allowance cannot be termed as "profit" in common parlance. However, for "income" "salary" and its taxability under the I.T. Act the meaning given by the Legislature is to be taken into consideration, as for that purpose, it is a complete code. Income is not dependent upon its destination or the manner of its utilisation. Therefore, there is no question of referring to the Fundamental Rules framed by the Central Govt. or by the statutory authorities for payment of city compensatory allowance, house rent allowance or other such allowances for reimbursing the expenditure incurred by the employees. Further, equity or hardship would hardly be a relevant ground for interpretation of tax law. It is for the Govt or the statutory bodies to do the needful. DA (dearness allowance), CCA (city compensatory allowance) and HRA (House rent allowance) would be taxable income."
From the above, it is clear that their Lordships held that Section 17 provides that apart from salary received by the assessee, it includes wages, any annuity or pension, any gratuity, any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages, any advance of salary, any payment received by an employee in respect of any period of leave ; not availed of by him and other payments mentioned in sub-clauses (va) (vi) & (vii). But in the present case, the assessee had not received any of the aforesaid items during his employment. It was only a compensation given to him to restrain him to join any service of similar nature or doing similar type of business. So, it cannot be said that the compensation received by the assessee was profits in lieu of salary. Therefore, the aforesaid case is also of no help to the department.
8.8 Considering the entire facts discussed herein above, we are of the opinion that the Ld. CIT(A) was justified in treating the compensation, received by the assessee for acting in accordance with restrictive covenant of agreement between him and B&L Ltd, as a capital receipt not chargeable to tax. We do not see any infirmity in the order of Ld. CIT(A) on this issue.
9 In the result, the appeal of the department is dismissed.