Income Tax Appellate Tribunal - Madras
Indo Tech Electric Co. vs Deputy Commissioner Of Income-Tax, ... on 23 December, 2005
Equivalent citations: [2006]99ITD325(CHENNAI), [2006]282ITR197(CHENNAI), (2006)101TTJ(CHENNAI)1044
ORDER
Chandra Poojari, Accountant Member.
1. These appeals by the assessee as well as the revenue are directed against the order of the CIT (Appeals) dated 28-9-1998. In the assessee's appeal, the assessee is aggrieved against confirmation of disallowance of Rs. 33 lakhs received by the assessee towards compensation for expected orders under negotiation, i.e., for not competing or indulging in the transformer business.
2. The revenue, in its appeal has taken the following grounds :--
(i) The CIT (Appeals) erred in deleting the addition of Rs. 1.25 crores being technical know-how fee for the reason that there is no provision in the Act to tax it.
(ii) The CIT (Appeals) erred in deleting the addition of Rs. 36,16,139 being receipt as compensation on pending orders for not competing.
3. First we proceed to dispose of the revenue's appeal. The brief facts of the case are that the assessee entered into an agreement with M/s. Indo Tech Transformers Ltd., on 15-7-1994 for transfer of the firm as a going concern for a consideration of Rs, 4,70,65,056. The component and payment of this amount works out as follows:--
(A) Value of net assets ... Rs. 2,76,49,617
(B) Value of technical know-how ... Rs. 1,25,00,000
(C) Compensation for pending orders
ie., for not to compete and
indulge in transformers business
by the firm ... Rs. 36,16,139
(D) Compensation for expected orders
under negotiations (i.e., for not
to compete and indulge in
transformers business by the Firm). ... Rs. 33,00,000
------------------
Rs. 4,70,65,756
------------------
MODE OF PAYMENT
(i) Share to Sri P.E. Subramaniam ... Rs. 87,86,800
(ii) Payment to Sri P.E. Subramaniam ... Rs. 1,15,00,000
(iii) Share to Sri P.S. Jagdish ... Rs. 87,86,800
(iv) Payment to Sri P.S. Jagdish ... Rs. 1,15,00,000
(v) Balance payment to Sri P.E.
Subramaniam and P.S. Jagdish ... Rs. 64,92,156
------------------
Rs. 4,70,65,756
------------------
Incidentally, the promoter and Director of the transferee-company are the partners of the erstwhile transferor-company viz., P.E. Subramaniam and P.S. Jagdish. The Assessing Officer treated the receipt of Rs. 1.25 crores towards technical know-how as goodwill and as it is self-generated asset, determined the cost of acquisition as nil, treating it as long-term capital gain. Similarly, the non-competing fee of Rs. 69,16,139 was also treated as long-term capital gain and was brought to tax. Aggrieved, the assessee went in appeal before the CIT (Appeals).
4. The CIT (Appeals), after hearing the learned authorised representative in the matter, has held that the assessee has received Rs. 1.25 crores towards sale of right to manufacture or process of article and there was no provision at that prevalent time to tax such nature of technical know-how fee. Accordingly, he deleted the addition. Further, a sum of Rs. 36,16,139 received by the assessee towards compensation for pending orders and for noncompetition was also deleted holding that there was a practice in the field of business that while transferring the asset, to keep up the secured orders and for not allowing other parties to compete in the future business of the transferor-company, such compensation is paid. Against these findings of the CIT (Appeals), the revenue is in appeal. The CIT (Appeals), however, has confirmed the addition of Rs. 33 lakhs received by the assessee as compensation towards future expected orders as these are only imaginary in nature. Against this finding the assessee is in appeal before us.
5. As regards the deletion of Rs. 1.25 crores claimed as technical know-how fee, the learned departmental representative submitted that the assessee-company was sold as a going concern and the promoters of the new company were the two partners of the transferor-company who were holding majority of shares. Till the date of transfer of the business, there was no technical know-how in the balance sheet of the assessee. On the date of signing the agreement, the technical know-how came into existence. He further submitted that the company has been in existence for several years and it has been making huge amount of profit since so many years. The learned departmental representative drew our attention to the profit earned by the assessee in earlier years which is as under :--
Assessment year Amount of profit (Rs.)
1993-94 ... 87.56 lakhs
1994-95 ... 214.85 lakhs
1995-96 ... 73.59 lakhs
This being the position, the company was sold without any goodwill and non-existing asset came into picture as technical know-how. It, therefore, shows that the goodwill of the company was coloured as technical know-how with an intention to evade tax. If there is a technical know-how, the assessee should have incurred the cost for it and the same should have been reflected in the balance sheet. As there was no item of technical know-how in the balance sheet of the company, it is far from imagination that the assessee has sold technical know-how. In other words, he submitted that though the assessee has incurred technical know-how fees, it has already claimed that expenditure as revenue expenditure in earlier assessment years and the same was allowed as deduction while computing the income of the assessee. He contended that a profit-making company cannot be transferred without any goodwill. Therefore, the assessee has chosen to call the goodwill as technical know-how with an intention to evade payment of tax. When the assessee has adopted fraudulent method to avoid tax, the Assessing Officer is entitled to lift the curtain and see the real character of the transaction and find out the truth. For this purpose, the learned Departmental Representative relied on the judgment of Hon'ble Jurisdictional High Court in the case of CIT v. Indian Express Newspaper (P.) Ltd. [1999] 238 ITR 70 104 Taxman 578 (Mad.) and submitted that the corporate veil of the company can be lifted for the purpose of ascertaining the real character of the transaction and to ascertain whether a transaction is genuine or not. He also relied on the judgment of Hon'ble Supreme Court in the case of Workmen, Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd. and submitted that it is the duty of the Court in every case where ingenuity is expended to avoid taxing and welfare legislations to get behind the smoke screen and discover the true state of affairs. If the Assessing Officer is not satisfied with the form, go into the substance of the transaction and submitted that there is no basis for valuation of non-existing asset as technical know-how fees at Rs. 1.25 crores. He further relied on the judgment of Hon'ble Jurisdictional High Court in the case of CIT v. Mineral Mining Co. (P.) Ltd. and submitted that incomplete or uncomprehensive data said to have been transferred cannot be considered as know-how. Further, he relied on the judgment of Hon'ble Delhi High Court in the case of CIT v. Dr. R.L. Bhargava and submitted that a contract or an agreement must be construed having regard to the intention of the parties thereto. Such intention must be gathered from the language used therein and contended that the consideration received was for imparting know-how not in association with the disposal with the capital asset as there was no capital asset in the balance sheet on the date of transfer of the firm.
6. The learned Departmental Representative vehemently argued that the right to manufacture is different from skill to manufacture. In the present case, the assessee has not transferred any manufacturing technology, but the goodwill in the market has been transferred and not only the trading activity has the goodwill but also the industrial activity.
7. Conclusively the learned Departmental Representative submitted that the CIT (Appeals) ought to have noticed that the assessee had not imparted any technical know-how to the transferee so as to say that the transfer was that of a technical know-how and the amount shown as receipt towards technical know-how actually was part and parcel of the total composite consideration and the impugned receipt was towards goodwill though cloaked as technical know-how and as such, the same is taxable.
8. On the other hand, the learned Counsel for the assessee submitted that the assessee has commenced manufacturing and marketing of Distribution and Medium sized Power Transformers, relatively small sized Distribution Transformers with OLTC's, Arc Furnace transformers, Induction furnace transformers, special application transformers etc. to the Industrial Sector. It took a lot of Engineering to manufacture these transformers, which is generally custom built as per individual client requirements. From 1988 till July 1994, Indo Tech Electric Company has supplied over 2,000 transformers to these Industrial clients which were more than 250 different types, sizes, etc. The manufacturing know-how developed during the period is well documented and available in the Data Bank. Indo Tech Electric Company's Design Data Bank which consists of over 500 different designs, drawings and technical particulars is completely comprehensive, ready to use. On an average it takes between 2 weeks to 10 weeks to design a particular rating of transformer from start to finish with the help of one Senior Engineer and two assistants. Indo Tech Electric Company's discussions and initiative enabled Indo Tech Transformers Limited to sign the MOU and the licensee agreement with M/s. Allied Signals, USA in 1995. Indo Tech Electric Company's technology bank, i.e., complete comprehensive designs were available for :--
(a) distribution transformers of 25, 40, 63, 100, 160, 250, 315, 400, 500KVA in 11KV, 22KV and 33 KV with different losses and different specifications.
(b) Industrial transformers of 100, 160, 200, 250, 315, 400, 500, 630, 750, 800, 900, 1,000, 1,250, 1,500/1,600, 2,000, 2,250, 2,500, 3,000, 3,150, 3,600, 4,000, 4,500, 5,000, 6,300, 7,500, 8,OOOKVA in 11 KV/22KV/33KV class with various different options, features as per different customer requirements.
(c) Arc Furnace transformers from 750 KVA to 10,000 KVA up to 33 KV ranges.
(d) Induction Furnace transformers from 250 KVA up to 5,000 KVA 11/22 and 33 KV class.
(e) Fail safe Distribution transformers up to 630 KVA/11KV ratings.
(f) Other special application transformers which includes basic designs, complete manufacturing designs for costings, various material specifications. Most of the designs are proven with successful tests conducted on transformers at various laboratories like CPRI, IIT, etc. for Short Circuit and impulse Voltage Withstand Capability.
In case of any one requiring this complete know-how from any leading company in USA/Europe it will cost not less than US $ 3 million upfront fees and also a Royalty which varies from 3 per cent to 5 per cent on gross sales. For example M/s. Crompton Greaves had to agree to a 4 per cent of their sales as Technical know-how transfer fees to M/s. Westinghouse Electric, USA for a period of 7 years in an arrangement entered into in or about 1985. In terms of actual payment (even at a very moderate estimate of US $ 125 million sales per year) this would amount to a figure of US $ 35 million over a period of 7 years. Based on the above facts Rs. 125 lakhs paid by Indo Tech Transformers Limited to Indo Tech Electric Company is very much a nominal amount. All these designs, drawings, technical data, specifications etc. formed part of the technical know-how.
9. The learned Counsel for the assessee submitted that in the light of the foregoing, only technical know-how was transferred which is a capital asset and the transfer of profit-earning apparatus is in the nature of capital asset, not chargeable to tax. He further submitted that the intention of the assessee must be ascertained from the Transfer Deed itself and it is not permissible to go outside the word set down and taxation authorities cannot substitute or guess as to what the parties might have intended in the circumstances. The authorities cannot deny the propriety of looking at an agreement between the parties as a whole and the authorities cannot re-write the agreement according to their convenience and also cannot import some new things or materials into the agreement. They cannot change any terms and condition of the agreement to bring the transaction into taxation. Words in the agreement should be read in ordinary and literal meaning. The intention of the parties should be collected from the whole of the agreement. The issue regarding the taxability of any sum received under a non-compete arrangement is also squarely covered by the Instruction No. 1964, dated 17-3-1999, issued by the CBDT. The relevant extracts of the instructions read as under:--
Recently, the Board has received references where clarifications have been sought on the taxability of compensation received for agreed absence of competition or under agreement containing restrictive covenants. In this connection, it may be clarified that the taxability of such compensation under the IT Act depends upon the nature and circumstances of each case with reference to the agreement in question. The first issue that may have to be decided in such cases is whether the capital asset in question is goodwill of a business or a right to manufacture, produce or process any article or thing. This is because the amendment made by the Finance Act, 1997, in Section 55(2) enlarging the scope of a capital asset is structured in such a manner that it is either "goodwill" or "a right to manufacture produce or process an article or thing--
(i) where the capital asset transferred is in the nature of goodwill of a business, recourse to Section 55(2) can be made only from assessment year 1988-89 and subsequent assessment years.
(ii) Where the capital asset transferred is in the nature of a right to manufacture produce or process an article or thing, recourse to Section 55(2) can be made only from assessment year 1998-99 in respect of any consideration received for the transfer thereof which includes extinguishment or curtailment of such right. In this connection, attention is invited to Clause 19 of the memorandum explaining the provisions of the Finance Bill, 1997, wherein it has been pointed out that consideration received on extinguishment of such right is in the nature of capital receipt and is not liable to tax under the head 'Capital gains' up to assessment year 1997-98. It is clarified that even where such transfer, extinguishment or curtailment of such a right is complete or in part the taxability of the consideration will remain unaffected, le., the same will not be taxable under the head 'Capital gains' only up to assessment year 1997-98 and will become taxable from the assessment year 1998-99 and subsequent assessment years.
(iii) where the capital assets are intangible assets (like trademark, etc., listed in para 2 above) not being in the nature of goodwill of a business, the issue to be decided, depends upon one vital factor whether such assets ought to be transferred was initially acquired at a cost or whether it was self-generated. In the event, such asset was acquired at a consideration, capital gains will have to be calculated in accordance with law in this behalf. However, where such asset in question is a self-generating asset, no capital gains will be levied up to assessment year 1997-98, after which date capital gains will become leviable. It may be clarified that mere payment of some amount for registration of such intangible asset like trademark, etc., may not constitute the cost of acquisition for the purpose of computation of capital gains.
10. We have heard the rival submissions and perused the material on record. We have also carefully gone through the Deed of Transfer and the case law relied on by both the parties. As per the agreement, the assessee has transferred net asset worth of Rs. 2,76,49,617 and technical know-how for Rs. 1.25 crores and non-competing fee amounting to Rs. 36,16,139 (sic). As on the date of transfer of the business of the assessee, there was no technical know-how in the balance sheet. However, as per the Write-Up submitted by the assessee, the assessee has been in the business of manufacture of transformer since 1975 and developed designs, drawings and comprehensive technology, for which it has employed technical persons and assistants having experience of about 2 decades and the assessee has incurred a huge amount towards this. However, this has not been reflected in the balance sheet. This technical know-how came to existence only at the time of signing the transfer agreement for transfer of the firm as a going concern. This leaves a big question in the minds of the authorities as to from where this element of know-how suddenly appeared. Has it come from vacuum?
11. The Technical know-how' is defined as an intangible revenue producing asset which can be put to use so as to produce revenue in two ways. The manufacturer can use it himself to make things for sale and make profit in that way, or he can teach it to others, so that they can make their own things, in which case he gets paid for the knowledge and information which he imparts to them. His fees and rewards are then revenue in his hands. Under the Income-tax Act, transfer of Technical know-how is subject to tax only from the assessment year 1998-99 by the amendment through Finance Act, 1997.
12. On the other hand, "Goodwill" means, it is the benefit and advantage of the good name, reputation and connection of the business. It is the attractive force which brings the customer. If the business is destroyed, the goodwill perishes with it, though elements remain which may be gathered up and revived again. Goodwill is affected by everything relating to the business, the personality and business rectitude of the owners, the nature and character of the business, the name and reputation, its location, its impact on the contemporary market, the prevailing socio ecology, introduction to old customers and absence of competition. It is impossible to predict the date of coming into existence and it is a continuous process. Though it is attached to the business, it can be sold with the business or independently. It is not taxable till the amendment to Income-tax Act, 1961 in view of the judgment of the Hon'ble Supreme Court in the case of CIT v. B.C. Srinivasa Setty as this was self-generated and date of acquisition cannot be determined. However, Income-tax Act was amended and goodwill was brought into tax with effect from 1-4-1988 by the Finance Act, 1987.
13. In the present case, the assessee has transferred the firm as a going concern for a consideration of Rs. 4.71 crores though its net asset was Rs. 2.76 crores. Now the question for consideration is, what is the balance consideration represents. The assessee is a profit-making concern and was earning profit for the last many years. We cannot accept the argument of the assessee that it has sold the business without any goodwill. In our opinion, the consideration of Rs, 1.25 crores which was termed as consideration for technical know-how is nothing but a colourable device adopted by the assessee with a view to evade tax. It is well-settled that the corporate veil of a company can be lifted for the purpose of ascertaining the real character of a transaction, if that transaction was a fraudulent one or was intended to evade payment of tax. While legitimate tax avoidance is always permissible, however, the devise adopted to evade tax is not permissible. It is the duty of the Assessing Officer to tax the right person for right amount and to discover the true state of affairs. The agreement to be read as per its construction when there is no doubt regarding the intention but the authorities have the right to go behind the documents to find out the real intention of the parties has always been recognized. This rule pre-supposes that in a given case, the real intention of the parties to the agreement is different from what it appears from its face. The authorities must normally proceed on the basis of the professed intention, but if there is a doubt, then its power to find out real intention of the parties, ignoring the apparent has to be, and has always been conceded. It is difficult to imagine whether this is possible, except in cases of a make believe arrangement, or devices adopted to evade tax. In such an event, the authorities will be removing the cover to expose the real intention of the parties intelligently cloaked and if that intention is discovered, which is meant to evade the tax, it cannot be acted upon because all the steps taken as a component part of the arrangements are legally correct or valid. This is not the rewriting of the agreement for the parties or importing something outside from the agreement. The question of rewriting arises when the Income-tax authorities have not doubted the genuineness of the agreement, however, add or delete new terms to the agreement as they think with an intention to interpret the agreement in their favour to collect more tax. The assessee has every right to enter into agreement according to its tree will or choice, but me professed intention and real intention should be the same. The taxation authorities must consider that the apparent is real until it is shown that there are reason to believe that the apparent is not real and the authorities are entitled to look into the surrounding circumstances to find out the reality.
14. Here in this case, the assessee has taken the plea that it has sold the technical know-how instead of goodwill. The technical know-how was non-existing in the balance sheet of the assessee. Had the assessee capitalized the technical know-how, it should have appeared in the balance sheet. As per the argument of the assessee, it has developed through the expertise and knowledge of technocrats for which assessee might have incurred cost. But actually, it is not so. The technical know-how newly came into existence by signing the transfer agreement. There is no material on record to establish the cost of it other than mentioning in the transfer deed. There is no material also to show the method of quantification of the technical know-how and there is no technical appraisal report. It is an admitted fact that the assessee has not transferred any patented process, trade mark, trade name, know-how relating to plant and machinery, process of manufacturing, technical data relating to maintenance of quality of product etc. In our opinion, what was sold, was nothing but goodwill only and the assessee has chosen to label this goodwill as "Technical Know-How" in order to evade tax, as the 'goodwill' is exigible to tax with effect from 1-4-1988 and the technical know-how was not liable to tax during the relevant period. It is unimaginable that the assessee has sold the profit-making unit without any goodwill and this action goes to prove that that the assessee has cleverly chose to show the goodwill under the name of technical know-how, with a sole intention of evading tax. In view of this elaborate discussion, we hold that the Assessing Officer is justified in treating it as goodwill as against the claim of the assessee towards technical know-how. Accordingly, we reverse the order of the CIT (Appeals) on this issue.
15. As regards the ground relating to deletion of addition of Rs. 36,16,139 towards compensation for non-competing fee for pending orders, the learned Departmental Representative submitted that the assessee has received non-competing fee from the transferee though there was no person to compete with the transferee after dissolution to the Transferor-firm. The consideration was paid to the Transferor and not to the partner of the Transferor-firm. When the new company has come into existence, the Transferor-firm got dissolved and the partners of the Transferor-firm are the promoters/Directors of the Transferee-company. There is no potential threat to the transferee. Hence, there is no question of paying non-competing fees. He relied on the judgment of Hon'ble Jurisdictional High Court in the case of K. Ramaswamy v. CIT wherein it was held that in cases where the same persons enter into transactions though by introducing a corporate personality into some of those transactions, the income-tax authorities are entitled to pierce the veil of the corporate personality and look at the reality of the transaction.
16. On the other hand, the learned Counsel for the assessee submitted that Clause (va) of section 28 was inserted, which provides that in some receipt for not carrying out any activity in relation to any business, shall be chargeable to tax under the head 'Profits and gains of business and profession'. Further, Section 55(2)(6)(z) and Section 55(2)(a) were also amended by the Finance Act with effect from 1-4-2003 to deem the cost of improvement and acquisition in relation to capital asset if right to carry on any business is Nil. The said amendments are applicable prospectively from the assessment year 2003-04 and thereafter. The amendments do not have retrospective effect and, therefore, not applicable to the year under appeal. The non-competing fee is in the nature of capital receipt and not chargeable to tax. He further submitted placing reliance on the decision of the Bombay Bench of the Tribunal in the case of Asstt. CIT v. Ashit M. Patel [2005] 96 TTJ (Mum.) 439 that all sums received or receivable in cash and kind under an agreement for not carrying out any activity in relation to any business is not liable to tax till the assessment year 2003-04. He also placed reliance on the decision of the Delhi Bench of the Tribunal in the case of P.L. Lamba (HUP) v. Asstt CIT [2005] 90 TTJ 389 for the same proposition. He also submitted that non-competition fee received by the assessee due to restrictive covenant imposed on it for not carrying on competitive business cannot be subjected to tax. For this proposition, he relied on the decision of Chennai Bench of the Tribunal in the case of R.K. Swamy v. Asstt CIT [2004] 88ITD 185. He further submitted that the consideration received by the assessee for surrendering the right to manufacture of transformer cannot be taxed as this is a capital receipt. For this purpose he relied on the decision of the Chennai Bench of Tribunal in the case of P.L. Chemical Ltd. v. Asstt CIT [2003] 86 ITD 46. Further he relied on the decision of the Mumbai Bench of the Tribunal in the case of R.V. Pandit v. Asstt. CIT [1999] 70 ITD 1 and the decision of Bangalore Bench of the Tribunal in the case of Jayaprakash Mady v. ITD [2001] 79 ITD 1.
17. We have heard the rival submissions and perused the material on record. The business of the partnership firm was transferred to the new Private Limited company. The partners of the Transferor-firm are the Promoter Directors of the transferee-company. The impugned amount of non-competing fee for pending contract was paid to the firm vide transfer agreement. To compete with the new firm, there should be a person in existence. In the present case, on transferring the business to the new company, the existing firm, i.e., the assessee ceases to be in existence. Hence, the question of competition does not arise. When there is no competitor to compete with the pending orders, there is no question of competition and paying consideration for non-person is beyond one's imagination. There is a sense, however, had there been any contract or agreement with the partners of the assessee-firm by the new company, for payment of such amount. In the present case, such an agreement does not exist. Payment to the non-existing person for non-competition cannot be treated as paid for non-competition. In our opinion, the Assessing Officer is fully justified in treating such transaction as part and parcel of the goodwill and accordingly, we reverse the order of the CIT (Appeals) on this issue as the real nature and character of the non-competition fee is nothing but goodwill as discussed elsewhere in this order. The case law relied on by the assessee are distinguishable on facts as in the present case, the agreement was entered into by the transferee-company with the transferor and not with the individual partners of the transferor-firm.
18. The assessee, in its appeal is aggrieved against confirmation of disallowance of Rs. 33 lakhs received by the assessee towards compensation for expected orders under negotiation i.e., for not competing or indulging in the transformer business. As discussed in the earlier paragraphs, there is no existence of competitors and the assessee-firm cease to exist. Hence, impugned amount of payment of Rs. 33 lakhs towards non-competition fee in respect of future orders is unwarranted. For the same reasons advanced above for allowing Revenue's appeal, on the issue of non-competition fee for pending orders, we reject this ground of the assessee and confirm the order of the CIT (Appeals) on this issue. The case law relied on by the assessee are distinguishable on facts as in the present case, the agreement between the assessee-firm and the new company was not with the partners of the assessee-firm and the new company.
19. In the result, the appeal filed by the Revenue is allowed and the appeal filed by the assessee is dismissed.