Amount Received By Assessee Under Agreement To Not Carry On Competitive Business Is In Nature Of 'Capital Receipt', Not Exigible To Tax: Telangana HC

A division bench of Chief Justice Alok Aradhe and Justice J. Sreenivas Rao reasoned that the developer-assessee's right to promote, market, distribute or sell the vaccine or a new competitive product to a third party was taken away under the agreement.

“The payment of the amount under the agreement has been made to the assessee as it has surrendered its rights in a capital asset, namely patent and trademark. The agreement in question is a negative/ restrictive covenant and the amount has been paid to the assessee in lieu of the rights which it has surrendered under the agreement. The surrender of the rights results in impairment of profit making apparatus of the company and therefore, is a capital receipt,” it held.

The development comes in an appeal preferred by the Revenue against an ITAT order holding that Rs.6 crores received by the assessee from PFIZER was a capital receipt since the same was not only for transfer of capital assets but also for waiver of certain rights in enduring nature and for accepting certain restrictive covenants.

The Revenue sought the amount to be treated as revenue receipt, liable to be taxed.

It contended that the assessee is at liberty to carry on the trade; no capital asset has been transferred in favour of PFIZER Limited and there is no sale of the brand under the co-marketing agreement but only a sale of vaccines. It was contended that the said agreement neither affects the trading structure of the assessee in any manner nor the assessee is deprived of its source of income.

The assessee on the other hand claimed that it had surrendered its knowledge and technical know-how, which is a capital asset. It therefore contended that any compensation received in lieu of such surrender is a capital receipt. It was further contended that since the assessee has entered into a non-compete agreement, the same results in loss of source of income, which has an adverse impact on the brand and market share on account of co-marketing agreement.

Agreeing with the assessee, the High Court cited Kettlewell Bullen and Company Limited vs. Commissioner of Income Tax (1964) whereby the Supreme Court laid down the test to distinguish capital receipt from revenue receipt.

It was held that where payment is made under a covenant to compensate a person which does not affect his trading structure or his business or deprive him of his source of income, such a covenant being a normal incident of business, which leaves him free to carry on his trade shall be treated as revenue receipt. However, if the covenant impairs the trading structure of the assessee or results in loss of income to the source of income of the assessee, the payment made under such a covenant shall be treated as capital receipt.

The issue was again considered in Gillanders Arbuthnot and Company Limited vs. The Commissioner of Income-Tax, Calcutta (1965) and it was held that compensation received by assessee for restraining from carrying on competitive business is capital receipt.

In this backdrop, the High Court dismissed Revenue's appeal.

Appearance: Senior Standing Counsel JV Prasad for Income Tax Department; Advocate Rohan Aloor for respondent

Case title: The Commissioner Of Income Tax-III Hyderabad v. M/s. Satiofi Healthcare India Private Limited

Case no.: INCOME TAX TRIBUNAL APPEAL No.138 of 2007

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