Compensation To Discontinue Commodity Brokerage Business Chargeable To Income Tax: Kerala High Court

The Kerala High Court has held that the amount received by the assessee is under an agreement for not carrying out any activity in relation to any business that was carried on by the assessee; it would attract the provisions of Section 28(va)(a) of the Income Tax Act and make the receipt chargeable to income tax under the heading of “Profits and gains of business or profession.”.

The bench of Justice A.K. Jayasankaran Nambiar and Justice Syam Kumar V.M. has observed that Section 28(va)(a) of the Income Tax Act does not restrict the operation of the provision to only amounts received by way of non-compete fee. The words used in the said provision do not admit any restricted meaning. So long as the amount received by the assessee was received for not carrying out any activity in relation to any business and the amount received was not on account of the transfer of the right to manufacture, produce, or process any article or thing or on account of the transfer of the right to carry on any business, which receipts would have been chargeable under the head “capital gains," there was no reason to interfere with the order of the Assessing Authority that brought the amounts received by the assessee from BNP Paribas to tax under the head “Profits and gains of business or profession”.

The appellant/assessee was a wholly owned subsidiary of Geojit Financial Services Ltd. (GFSL), a public listed company, which was primarily engaged in the business of equity and derivatives brokerage. In March 2007, BNP Paribas S.A. (BNP Paribas), a French bank, acquired a 27.18% equity stake in GFSL through a preferential issue.

In order to increase its stake in GFSL, BNP Paribas was informally intimated by the Reserve Bank of India (RBI) in December 2007 that before approval could be given to BNP Paribas for acquiring further shares through making an open offer, it was necessary that the appellant, being a wholly owned subsidiary of GFSL, should discontinue the commodity brokerage business.

The BNP Paribas approached GFSL to consider discontinuing the commodity brokerage business undertaken by its subsidiary, i.e., the appellant, in order to comply with the requirements prescribed in the Indian Banking Regulation Act, 1949, being enforced by the RBI. In lieu of the appellant discontinuing the commodity brokerage business, BNP Paribas offered compensation of Rs. 40 crore based on a valuation report obtained by BNP Paribas from an independent advisor, Ernst & Young. In a meeting held on May 23, 2008, a 2008, a resolution was passed by the Board of Directors of the appellant accepting the offer.

BNP Paribas confirmed the payment of Rs. 40 crores to the appellant as compensation for shutting down the commodity brokerage business and for surrendering its membership in various commodity exchanges. The RBI granted conditional permission to BNP Paribas to acquire additional equity shares in GFSL through an open offer, in accordance with the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.

The compensation of Rs. 40 crores paid by BNP Paribas to the appellant was credited to the Profit & Loss account of the appellant and disclosed as an 'extra ordinary item'. In the income tax return, the appellant included the compensation of Rs. 40 crores while computing book profit and paid tax thereon as per provisions of Section 115JB of the Income Tax Act, 1961. The appellant excluded compensation, considering it to be in the nature of a non-taxable 'capital receipt'. In the assessment framed under Section 143(3), the assessing officer held that the appellant continued the commodity business in the name of a newly incorporated company that was incorporated by common promoters, and there was, therefore, no loss of the profit-making apparatus of the appellant.

The assessing officer held that even if it was assumed that the profit-making apparatus of the appellant was impaired, the compensation received by the appellant was taxable in terms of provisions of Section 28(va) of the Income Tax Act.

The appellant preferred an appeal before the CIT(A), who not only confirmed the order of the assessing officer but invoked Section 28(ii)(c) of the Act to sustain the addition. The CIT(A) held that the compensation received by the appellant was taxable as income under the normal provisions of the Income Tax Act.

The Tribunal sustained the addition of Rs. 40 crores, holding that there is no sterilization of profit-earning apparatus for the appellant since the new company, GCL, set up by the same promoters, continued to carry on the same business by obtaining new licenses, for which all the existing clients as well as their credit balance were transferred by the appellant to GCL. The Tribunal found that the GCL carried out business on the same premises by using the trademark, administrative setup, equipment, manpower, etc. of the appellant's parent company.

The appellant contended that the provisions of Section 28(va) are applicable where an assessee receives payment from a competitor in the same business in lieu of accepting a restrictive or negative covenant not to carry out any particular activity in relation to the business without there being any transfer of the right to carry on the business. The payment restrains the recipient payee from carrying on competitive business for the period for which the non-compete agreement is to last, in order to protect the profitability of the payer, who is a competitor or rival in the same business. Such payment of non-compete fees creates rights in personam in favor of the payer qua the payee. BNP Paribas, a French bank, was, in terms of the Banking Regulation Act, 1949, barred in law from carrying on, directly or indirectly, commodity brokerage business and did not, in fact, carry on such business in India. The payment of compensation to the appellant to discontinue the commodity brokerage business in order to enable BNP Paribas to enhance its equity stake in GFSL could not be said to be in the nature of non-compete fees to ward off competition, to be caught within the ambit of Section 28(va) of the Income Tax Act.

The department contended that a perusal of Section 28(va) of the Income Tax Act would clearly indicate that any sum, whether received or receivable, in cash or kind, under an agreement for not carrying out any activity in relation to any business or profession would be chargeable to income tax under the heading “Profits and gains of business or profession." It is pointed out that the statutory provision does not use the word “non-compete fee,” and therefore, so long as the amount received by the assessee is under an agreement for not carrying out any activity in relation to any business that was carried on by the assessee, it would attract the provisions of Section 28(va)(a) of the Act and make the receipt chargeable to income tax under the heading “Profits and gains of business or profession.”.

The court while dismissing the assessee's petition held that the arrangement between BNP Paribas and the assessee required the assessee to give up his business in commodity trading so as to enable BNP Paribas to increase its shareholding in the parent company of the assessee. The payments would have to be seen as payments received in connection with a negative covenant imposed on the assessee and, therefore taxable under Section 28(va)(a) of the Income Tax Act.

Counsel For Petitioner: Ajay Vohra

Counsel For Respondent: Jose Joseph

Case Title: Geojit Investment Services Ltd. Versus Commissioner Of Income Tax

Case No.: I.T.A.No.16 Of 2019

Citation: 2024 LiveLaw (Ker) 535

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