Amounts received under non-compete agreements are capital receipts and not taxable till amendment by Finance Act, 2002 :Supreme Court

Guffic Chem P.Ltd. vs C.I.T,Belgaum and anr., decided on 16^th March, 2011

CIVIL APPEAL NO.2522 OF 2011 (arising out of S.L.P. (C) No. 6081 of 2010)

Assessment Year: 1997-98

Relevant facts:

1. The assessee received Rs. 50,00,000/- from Ranbaxy as non-competition fee under an agreement dated 31.3.1997.

2. Assessee agreed to transfer its trademarks to Ranbaxy and in consideration of such transfer assessee agreed that it shall not carry on directly or indirectly the business hitherto carried on by it on the terms and conditions appearing in the agreement.

3. The agreement defined the period, i.e., a period of 20 years commencing from the date of the agreement. The agreement defined the territory as territory of India and rest of the world.

4. In short, the agreement contained prohibitive/restrictive covenant in consideration of which a non-competition fee of ` 50 lakhs was received by the assessee from Ranbaxy. The agreement further showed that the payment made to the assessee was in consideration of the restrictive covenant undertaken by the assessee for a loss of source of income.

Question/s before the Hon’ble Court:

1. Whether a payment under an agreement not to compete (negative covenant agreement) is a capital receipt or a revenue receipt is the question which arises for determination in this case?

Upholding the appeal of the assessee, the Hon’ble Court held that:

Para 7: “Two questions arose for determination, namely, whether the amounts received by the appellant for loss of agency was in normal course of business and therefore whether they constituted revenue receipt? The second question which arose before this Court was whether the amount received by the assessee (compensation) on the condition not to carry on a competitive business was in the nature of capital receipt? It was held that the compensation received by the assessee for loss of agency was a revenue receipt whereas compensation received for refraining from carrying on competitive business was a capital receipt. This dichotomy has not been appreciated by the High Court in its impugned judgment. The High Court has misinterpreted the judgment of this Court in Gillanders' case (supra). In the present case, the Department has not impugned the genuineness of the transaction. In the present case, we are of the view that the High Court has erred in interfering with the concurrent findings of fact recorded by the CIT(A) and the Tribunal. One more aspect needs to be highlighted. Payment received as non-competition fee under a negative covenant was always treated as a capital receipt till the assessment year 2003-04.”

The decision is available here.