Madras High Court
M/S.Hatsun Agro Products Ltd vs The Joint Commissioner Of Income Tax on 10 April, 2017
Author: Anita Sumanth
Bench: Huluvadi G.Ramesh, Anita Sumanth
IN THE HIGH COURT OF JUDICATURE AT MADRAS Reserved on : 09.01.2017 Pronounced on : 10 .04.2017 Coram: The Hon'ble Mr.Justice HULUVADI G.RAMESH AND The Hon'ble Dr. Justice ANITA SUMANTH T.C.(Appeal) No.1173 of 2005 M/s.Hatsun Agro Products Ltd., 5A, Vijayaraghava Road, Chennai-600 017. .. Appellant Versus The Joint Commissioner of Income Tax, Special Range XI, Chennai. .. Respondent Appeal under Section 260A of Income Tax Act, 1961 against the order passed by the Income Tax Appellat Tribunal, Chennai 'A' Bench in ITA. No.1200/MDS/1999 dated 27.07.2005. For Appellant .. Mr.S.Sridhar For Respondent .. Mr.T.R.Senthil Kumar ----- JUDGMENT
(DR.ANITA SUMANTH, J.) The Assessee is a company engaged in the business of manufacture, marketing and distribution of ice cream and dairy based frozen products. The facts in brief as presented by the Appellant are as follows;-
The Appellant Company had its beginnings in a partnership firm started by two individuals, Mr.Raja KSP Ganesan and Mr.R.G.Chandramogan, a father and son duo, in 1970. The firm was converted into a Private Limited Company in 1986 and in 1995, the Appellant initiated the process of conversion from Private Limited to a Public Limited Company to facilitate growth and expansion in business. The individuals had nurtured the business from inception and continued their association with the entity over the years. Intellectual property had been developed by them and the brand name 'ARUN' had been transferred by Mr.R.G.Chandramogan to the Appellant in April 1987. The individuals were highly experienced in the business of dairy based frozen food products. The Appellant thus wanted to ensure that the association with the individuals continued both in the public eye as well as in its own interests, seeing that the appellant had benefitted greatly from their services over the years.
2. Accordingly, it entered into agreements dated 20.7.1995 for non-compete with the two individuals restraining them from carrying on, for twenty years, any competing trade, business or activity in connection with the manufacture of ice creams or dairy products in any part of the world. The relevant clause, common to both agreements, is:
WHEREAS the party of the first part has been actively engaged in the business of manufacture, marketing and distribution office Cream and other dairy-based frozen food products, in India and particularly in the Southern States of Tamilnadu, Karnataka, Kerala and Pondicherry, for the past more than two decades and has, during the said period, acquired and accumulated considerable expertise in manufacturing, technological and marketing in respect of such food products. 1. The party of the first part agrees that during the currency of the agreement, the party of the first part shall not directly or indirectly without the prior consent in writing of the party of the second part, manufacture or market or deal in Ice Creams any where in the world, either by himself, or in association with other or others nor shall he involve himself in such manufacture and marketing of Ice Creams either as an employee, agent, representative or through the medium of a company, partnership, or association of persons of in any other form.
3. The expenditure of Rs.400 lakhs incurred on non-compete fee, Rs.300 lakhs to Mr.Chandramohan and Rs.100 lakhs to Mr.Raja Ganesan, was claimed as expenditure in the computation of income in respect of A Y 1996-97. The Assessing Authority was of the view that the benefit obtained under the agreement was an enduring one, and consequently held the same to be capital, liable to be disallowed.
4. The Commissioner of Income Tax (Appeals) before whom an Appeal was filed, reversed the order of assessment. The Commissioner of Income Tax (Appeals) held that the restriction placed on the directors resulted in a business advantage and the payments were thus revenue in nature. The Tribunal, in an appeal filed by the Income Tax Department, reversed the order of the CIT(A) restoring that of the Assessing Officer. The assessee is in appeal against the aforesaid order of the Tribunal dated 27.2.2015, raising the following two substantial questions of law for adjudication:
1. Whether the Tribunal is correct in concluding that the payment of Rs.4,00,00,000/- towards non-competition was correctly disallowed on the facts and in the circumstances of the case?
2. Whether the Tribunal is correct in concluding that the above disallowance was warranted in the light of the decision rendered in the case of Asia Net Communications (P) Ltd. in ITA No.443/Mds/2004 dated 03.01.2005 (unreported) even though the said decision was not made available to the parties at the time of hearing?
5. Heard Mr. S.Sridhar appearing for the appellant and Mr.T.R.Senthil Kumar appearing for the respondent.
6. In the present case, there is no dispute with the position that the two individuals, Mr.Raja KSP Ganesan and Mr.R.G.Chandramogan were intrinsically connected with the business of the appellant. At a time when the company was in the process of conversion from private limited to public, it is a matter of business expediency to ensure that the appellant is not deprived of their services, or worse, lost to a competitor. The payment of non compete fee seeks to ensure this commercial benefit.
7. The Tribunal, in allowing the Revenues appeal, has relied on its own decision in the case of Asianet Communications Pvt. Limited. The main ground on which the payment has been held to be capital is that the restrictive covenant gives an enduring benefit which falls squarely in the capital field.
8. The Revenue would rely on two judgments of the Supreme Court in the case of Alembic Chemical Works Co. Ltd vs CIT (177 ITR 377) and CIT vs Coal Shipment Private Limited (82 ITR 902) and a decision of the Madras High Court in the case of Chelpark Company Limted vs. CIT (191 ITR 249). The assessee, on the other hand, would rely on a decision of this Court in the case of Carborandum Universal Limited vs. Joint Commissioner of Income Tax, Special Range -1, Chennai (2012) 26 taxmann.com 268.
9. The question before us is the categorization of expenditure of non-compete fee as either capital or revenue. The distinction is fine. Courts have, over time, evolved various tests to determine such categorization, but there is no straightjacket method and the application of the tests would vary upon the facts of the case in hand. In the present case, while neither the assessing officer nor the Tribunal dispute the long association and valuable services rendered by the individuals as well as the importance of retaining these advantages, particularly at the time when it was going public, both officers deny the claim solely based on the fact that the payments results in an enduring benefit.
10. We could do no better than to quote the Supreme Court, in the case of Empire Jute Ltd vs CIT (124 ITR 1) stating as follows:
If the outgoing expenditure is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure. See Bombay Steam Navigation Co. (1953) P.Ltds case (supra). The same test was formulated by Lord Clyde in Robert Addie and Sons' Collieries Ltd.s case (supra) (C Sess) in these words: "Is it a part of the company's working expenses?-- is it expenditure laid out as part of the process of profit earning?-- or, on the other hand, is it a capital outlay?-- is it expenditure necessary for the acquisition of property or of rights of a permanent character, the possession of which is a condition of carrying on its trade at all?" It is clear from the above discussion that the payment made by the assessee for purchase of loom hours was expenditure laid out as part of the process of profit earning. It was, to use Lord Sumner's words, an outlay of a business "in order to carry it on and to earn a profit out of this expense as an expense of carrying it on". [John Smith and Son v. Moore [1921] 12 TC 266 (HL)]. It was part of the cost of operating the profit-earning apparatus and was clearly in the nature of revenue expenditure. ..there may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may break down. ... What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future.
11. Thus, the test of enduring benefit cannot be applied blindly without regard to the facts and circumstances that arise in the given case. We find that the conclusion of the Tribunal that the payment has an enduring benefit and is capital in nature does not take into account the commercial benefit received by the company. In fact, the Tribunal appears to have been guided solely by an earlier decision rendered by it in the case of Asianet Communications. The assessee would incidentally point out that a copy of this decision was not circulated and hence reliance by the Tribunal on this decision is in itself incorrect. He would urge us to consider, as an alternate submission, the remand of the matter to the tribunal in order that he meet and distinguish this decision in full.
12. The advantage of restraining the individuals from engaging in competition is in the field of facilitating its own business and rendering it more profitable. Since there is no increase in fixed capital, the payment does not encroach in the capital field.
13. The payments made towards restrictive covenants ensured the continued presence and support of the individuals in its business operations. Equally importantly, it also ensured credibility in public perception and reassured potential investors that the performance of the company would remain optimum through this continued association. Though there was no actual or impending threat of the Directors severing their ties with the company or starting competing businesses, the possibility was always real and prudence dictates that the company protect itself against such a probability. This assumed particular significance at a time when the company was proposing to go public and it thus becomes vital that the public continued to see that the company was associated with, and had the benefit of services and loyalty of the individuals who had been, and were continuing to be, fundamental to the growth of the company.
14. The judgments cited by the Revenue turn on differing facts and do not therefore not support its case. In fact the Supreme Court in Coal Shipments (supra), relied upon by the Revenue has stated that the question as to whether an expenditure is revenue or not has to be seen from the context of an expenditure forming part of the cost of the income-earning machine or structure as opposed to part of the cost of performing the income-earning operations.
15. In the light of the above discussion, we hold that the payments towards non-compete fee to Mr.Raja KSP Ganesan and Mr.R.G.Chandramogan constitute revenue expenditure in the hands of the appellant. The substantial questions of law are answered in favour of the appellant and against the revenue.
(H.G.R.,J) (A.S.M.,J)
10.04.2017
Speaking Order/non-speaking order
Index: Yes/No
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HULUVADI G.RAMESH, J
AND
Dr.ANITA SUMANTH,J
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PRE DELIVERY JUDGMENT IN
T.C.A.No.1173 of 2005
.04.2017
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