Non-compete obligation to be treated as “receipt of income” from 01.04.2003: ITAT

The Mumbai Bench of Income Tax Appellate Tribunal (ITAT) has held that the non-competitive consideration received by the taxpayer will be treated as ‘receipt of income’ in the hands of the taxpayer, but only after the amendment i.e. from 1.4.2003.

The bank of Kavitha Rajagopal (Judicial Member) And Om Prakash Kant (accountant member) has noted that the amendment to Section 28(va) of the Finance Act, 2002 is relevant to AY 2004-05 only from 01.04.2003 and has no retroactive effect for taxing the non-compete compensation received before the period.

The bench held that there was no weakness on the order of ld. CIT(A) by holding that the non-competition allowance was in the nature of a ‘capital receipt’ for the period before April 1, 2003.

The respondent/assessee company is engaged in manufacturing and sale of bulk formulations of pharmaceutical products. The manufacturing units are located in Mumbai, Valsad, Ankleshwar and Tarapur. The assessee company had filed its return of income declaring loss under normal provisions and book profit under section 115JB. The assessor’s case was selected for examination, and the assessment order was issued by the AO, fixing the total income at zero after disallowing receipts for non-competitive scientific and technical information.

The assessee appealed to the first appellate authority challenging the additions made by the AO. The CIT(A) confirmed the addition of receipt for non-competent scientific and technical information amounting to Rs. 17,40,00,000/-.

The assessee and the department had filed an appeal before the Tribunal challenging the order of the CIT(A), wherein the Tribunal set aside the issue of receipt of non-compete compensation amounting to Rs. 10 crore and confirmed the addition of Rs. 7.40 crore for transfer of scientific know-how and technical information. The AO passed the assessment order and upheld the addition of non-compete clauses of Rs. 10 crores as ‘revenue receipt’.

The first appellate authority in an appeal filed by the taxpayer deleted the addition by treating it as a ‘capital receipt’ and the such receipt was taxable only after AY 2003-04 as per the amendment of section 28(va) of the Finance Act, 2002, of 1.4.2003.

The payment received as non-compete consideration under a negative covenant was always treated as a capital receipt until FY 2003-2004. It was only through the Finance Act 2002 that the clause (va) was inserted into Article 28 of the Income Tax Act 1961 with effect from 1 April 2003, making capital income taxable.

The department has submitted that the taxpayer has not declared his source of income through the agreement signed by the taxpayer with LHHCL and has not proved that he has abandoned the marketing and sale of products other than those mentioned in the agreement. The non-compete fee of Rs. 10 crore was a ‘receipt of income’ which was taxable in the hands of the taxpayer.

The taxpayer argued that the non-compete compensation could only be taxed as ‘receipt of income’ under the Finance Act 2002 after AY 2003-2004 and was not subject to tax before AY 2003-2004. During the years 1998-1999 and 2001-2002, the Coordinate Bank considered the non-compete fee as a “capital receipt” that was not taxable in the hands of the taxpayer.

The court dismissed the department’s appeal but held that the compensation received by the taxpayer for the non-compete compensation is ‘capital in nature’ as it has already been held that the amendment to Article 28 (va) does not apply to the years under consideration. The intention of the legislator was to clarify the ambiguity of the non-compete compensation received by the taxpayer by treating it as an ‘income receipt’ in the hands of the taxpayer, but only after the amendment, i.e. from April 1, 2003 .

Appellant’s counsel: Samir Shah

Counsel for the defendant: Manish Sareen

Case Title: ACIT-2(2)(1) vs. Lyka Labs Ltd.

Case number: IT A No. 2520/Mum/2023

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