DEPUTY COMMISSIONER OF INCOME-TAX, CIRCLE - 5,, PUNE vs. JAYANT AVINASH DAVE,, PUNE

PER R.S. SYAL, VP :

These two cross appeals – one by the assessee and the other by the Revenue along with one Cross-objection by the assessee emanate from the order dated 19.11.2018 passed by the ld. CIT(A) in relation to the A.Y. 2015-16. 2. The first issue raised in the cross appeals is against treating the extent of sale consideration received on transfer of shares as Business income chargeable u/s 28 of the Income-tax Act, 1961 (hereinafter also called ‗the Act‘).

The assessee, along with his wife, held 51% shares in the Indian company, while the remaining 49% held by BorgWarner Ludwigsburg GmbH, Germany (hereinafter called `the foreign company‘). The assessee‘s wife transferred her shares to the assessee, which point is not disputed. The assessee transferred the resultant total shareholding of 10,71,000 shares in the Indian company to the foreign company for a consideration of Rs.85.79 crore. After taking the benefit of cost of acquisition of these shares at Rs.3.82 crore, the assessee offered income on this score as long term capital gain. The Assessing Officer (AO) examined the terms and conditions of Share Sale and Purchase Agreement (SSPA) dated 29.01.2015 between the assessee and the foreign company and show caused as to why the consideration of Rs.85.79 crore be not treated as receipt for handing over the management and control of the Indian company and hence charged to tax as Business income as against capital gains shown. The assessee sought directions u/s 144A from the JCIT, Range-5, Pune, who also opined on the same lines as did the AO. This led the AO to finalize the assessment by treating receipts shown from sale of shares as business income u/s 28. He computed the business income at Rs.80,78,52,914/- after and CO No.11/PUN/2022

reducing the cost price along with certain other expenses from the sale price of Rs.85.79 crore. The ld. CIT(A), on appreciation of various clauses of the SSPA, observed that the assessee not only transferred his shares but also the right to manage along with agreeing not to compete, non solicitation and non interference, etc. He, thus, held that the consideration for termination of bundle of management rights and non-compete was liable to be considered u/s 28(va). Relying on the decision of Mumbai Bench of Tribunal in ACIT vs. Savita N Mandhana (ITA No.399/Mum/2010 & Ors), he held that some part of the sale consideration was required to be attributed to termination of management and non compete obligations. In the absence of SSPA specifying any consideration for non compete and termination of bundle of management rights, he held that 10% of the sale consideration should be treated as consideration for these. That is how, he held that Rs.8.57 crore was to be treated as ‗Business income‘ and balance consideration towards sale of shares for computing long term capital gain. Both the sides have come up in appeal before the Tribunal on their respective stands. and CO No.11/PUN/2022

Company Technical Information for a period of four years from the date of completion‘. Article 7.4 is Non compete clause which provides that: The Seller (the assessee) shall not directly or indirectly own, manage, operate, control or assist any person or participate in the ownership, management, operation or control of any Restricted Business in India‘. The term ‗Restricted business‘ has been defined to mean ―the manufacture, import, distribution or sale of Glow Plugs, heater plugs or controllers (for Glow Plugs only) for the automotive industry.‖ Precisely, this is a business carried on by the Indian company, whose shares were transferred by the assessee to the foreign company. It is thus explicit that the assessee agreed not to compete with the business of the Indian company for a period of two years. Article 7.6 is a `Non solicitation‘ clause, which provides that the assessee shall not solicit the existing employees or consultants of the Indian company for a defined period. Article 7.7 is a `Non interference‘ clause, which prohibits the assessee from causing or inducing or encouraging any existing customer or existing qualified supplier of the Indian company. Article 7.8 is a `Non disparaging‘ clause. and CO No.11/PUN/2022

also accepted by the assessee, it is simple and plain that the consideration of Rs.85.79 crore is towards sale of shares and also accepting the negative covenants.

Claim arising out of or in connection with any covenant and obligation of the Seller in Articles 7.4 (Non-compete) of this Agreement shall be limited to an amount equal to the amount specified in Article 12.6(b) (iii) that is Rs.150 million plus Indian Rupees One Hundred Million (INR 100,000,000). It thus crystallizes that the liability of the assessee to indemnify the Purchaser for violation of the negative covenants contained in Article 7 of the SSPA can extend up to a maximum of Rs.40.00 crore (Rs. 150 million + Rs. 150 million + Rs.100 million). No person will undertake the liability to indemnify the foreign company for a sum up to Rs.40.00 crore for violation of the negative covenants without receiving any consideration there against in the first instance. Had the consideration of Rs.85.79 crore been exclusively towards sale of shares, there was no question of the assessee accepting the obligation of indemnifying the buyer up to a sum of Rs.40.00 crore for the violation of the negative covenants. It is thus graphically glaring that even though there is no separate mention of the consideration for the negative covenants, but they, forming an essential and integral part of the SSPA, do carry value, which is embedded in total consideration. It is the substance rather and CO No.11/PUN/2022

than the form of the SSPA, which should be looked into. It is ergo held that the consideration of Rs. 85.79 crore was not only for transfer of shares but also for accepting the negative covenants. We, therefore, jettison the contention advanced on behalf of the assessee that the entire consideration was towards transfer of shares. II. HOW IS IT TAXABLE?

separate provisions enshrined in the Act dealing with their taxation independently (as will be discussed infra), then income from transfer of one of these (shares) needs to be computed by considering price paid for such item alone (share) and not the consolidated price. It is for the raison d’etre that income from the other (negative covenants) requires separate determination, governed by the independent provisions, with reference to the price paid for these.

case of the assessee is that the entire amount was received towards transfer of shares alone. The ld. AR relied on the judgment of Hon‘ble Bombay High Court in Premier Automobile Ltd. vs. ITO & Anr. (2003) 264 ITR 193 (Bom) to contend that when the business is transferred, chargeability arises in terms of section 50B. It is no doubt true that both the Hon‘ble High Courts have held as has been argued.

…….. (va) any sum, whether received or receivable, in cash or kind, under an agreement for— (a) not carrying out any activity in relation to any business or profession; or (b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services: and CO No.11/PUN/2022

Provided that sub-clause (a) shall not apply to— (i) any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business or profession, which is chargeable under the head "Capital gains"; (ii) any sum received as compensation, from the multilateral fund of the Montreal Protocol on Substances that Deplete the Ozone layer under the United Nations Environment Programme, in accordance with the terms of agreement entered into with the Government of India. Explanation.—For the purposes of this clause,— (i) "agreement" includes any arrangement or understanding or action in concert,— (A) whether or not such arrangement, understanding or action is formal or in writing; or (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings;‖

affairs of an Indian company. In order to be covered under this provision, firstly, the recipient of the compensation should have the management rights, which are later on terminated or modified. Lawful prior holding of managing rights is sine qua non for the attractability of this provision. The assessee in the instant case was only the Managing director of the Indian company and per se did not hold any management rights thereof. It is thus overt that section 28(ii)(a) is not applicable to the facts of the case. The sequitur is that the ld. CIT(A) was not justified in holding that the assessee received 10%, inter alia, for termination of management rights.

rendering of services etc., this provision taxes as business income a consideration for `not doing‘ the specified things. But for their inclusion in this provision, any sum received for such `not doings‘, being a capital receipt, was not chargeable to tax.

(a) of section 28(va) taxes any sum received by the assessee for `not carrying out any activity in relation to any business‘. Non- compete clauses contained in Articles 7.4 and 7.5 are directly covered within the purview of this provision. Similarly, Non- solicitation, Non-interference and Non-disparaging clauses contained in Articles 7.6, 7.7 and 7.8 are also extension of `not carrying out any activity in relation to the business‘. Sub-clause (b) of section 28(va) taxes any sum received by the assessee for `not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services. Articles 7.2 and 7.3 are for not sharing Company Technical Information, which gets covered within the term `know-how‘ given in the provision. Thus all the negative covenants contained in Article 7 of the SSPA are the items covered under sub-clauses (a) or (b) of section 28(va).

the ld. CIT(A) was not justified in not considering the sum received towards the remaining negative covenants within the overall scope of section 28(va). To this extent, the impugned order is modified.

Hon‘ble High Court held that the assessee transferred its business as a whole. Right now, we are concerned with the facts wherein the assessee had only 51% shares in the Indian company. By transferring these shares, it cannot be said that the assessee transferred the business.

an assessee accepts a negative covenant under an agreement, the quid pro quo for that should be taxed as business income u/s 28(va). No further stipulation has been set up in the provision that the agreement providing for the negative covenants should be exclusively for this purpose de hors the transfer of any shares.

Court upheld the view point of the AO. However, the Hon'ble Supreme Court reversed it by holding that it was case of purchase of shares of a Non-resident, namely, CGP Investments by a Non- resident, namely, Vodafone International, Netherlands from another Non-resident, namely, Hutchison International, Hong Kong under an agreement which was entered outside India and hence no capital gains chargeable to tax in India arose in the hands of Hutchison International, Hong Kong. To neutralize the ratio of the judgment of Hon'ble Supreme Court in Vodafone International, the legislature stepped in and carried out certain statutory amendments, including altering the definition of ‗capital asset‘ u/s 2(14), the definition of ‗transfer‘ u/s 2(47) and insertion of Explanations (4), (5), (6) and (7) to section 9(1)(i). When we examine the factual matrix under consideration in the hue of the judgment in Vodafone International, it becomes overt that the facts of both the cases are poles apart. In that case, the question was whether the shares of the foreign company, deriving value from assets situated in India, would constitute ‗capital asset‘ in India so as to magnetize the chargeability in the hands of the non-resident transferor? In other words, the issue was taxability vs. non-taxability of profits in India. and CO No.11/PUN/2022

In the oppugnation, the case under consideration does not involve any doubt about the taxability of the profits in India. In fact, the assessee itself offered the profit as chargeable to tax under the head ‗Capital gains‘. The dispute is only about the head under which such profits should be charged to tax, that is, whether ‗Capital gains‘ or ‗Business income.‘ Apart from the distinction in the factual panorama of the two cases, the decision in Vodafone International (supra) has been statutorily negated through the amendments discussed supra.

of business in slump sale. The assessee, being a shareholder, simply transferred his holding of 51% of the shares in the Indian company to the foreign company. Be that as it may, the position of law has underwent change by insertion of section 50B w.e.f. 01.04.2000 containing special provision for capital gains in case of slump sale. This section provides that any profit or gain arising out of slump sale shall be chargeable as capital gains arising from the transfer of long term capital asset. As the assessee has not transferred any business with all its assets and liabilities, the provisions of section 50B do not get not attracted.

the negative covenants as chargeable under section 28(va) of the Act. If however, the capital asset under transfer is any right to manufacture, produce or process any article or thing or right to carry on any business, income is computed under the head `Capital gains‘ by taking cost of acquisition of such right to manufacture etc. or right to carry on business u/s 55(2)(a) at Nil, unless the assessee or the previous owner paid some purchase price for acquiring such rights. In case the assessee transfers such right to manufacture etc. and also simultaneously accepts the negative covenant of non- compete, total consideration received is considered for computing capital gain u/s 45 without taking any recourse to the provisions of section 28(va) of the Act. This position is enshrined as the proviso to section 28(va). If however, an assessee accepts the negative covenant of non-compete along with the transfer of any capital asset such as shares, other than right to manufacture etc., entire consideration cannot be devoted to the transfer of shares for computing capital gain u/s 45. Recourse will have to be taken to the provisions of section 28(va) of the Act insofar as consideration for the negative covenant is concerned. The without prejudice contention of the ld. AR, invoking proviso to section 28(va), for and CO No.11/PUN/2022

buttressing his argument that no separate income should be determined as business income and the entire consideration, even relating to negative covenants, should be considered under the head `capital gains‘, therefore, does not hold water. Proviso to section 28(va) gets attracted only when the right to manufacture etc. or carry on business is transferred along with the assessee agreeing for non-compete [not the other negative covenants as mentioned in sub-clause (b) to section 28(va)]. In that case, no part of the total consideration on account of non-compete is separately charged to tax as business income under section 28(va), if the total consideration is chargeable under section 45. The proviso rather gives a clear clue that in all other cases where right to manufacture etc. or to carry on business is not transferred and there is a non- compete clause in the agreement, then the portion of the total consideration relatable to non-compete should be segregated and charged to tax as business income.

only 51% shareholding in the Indian company, which he transferred.

assigning the value of Rs.8.57 crore. This was strongly countered by the ld. DR. Referring to the Joint venture agreement dated 16.12.1996, the ld. DR submitted that Para 14 deals with ―Restriction on transfer of shares‖. While referring to para 14.5, he submitted that the sale of shares was required to be made on the basis of the Net Asset Value method. Drawing our attention towards the Valuation report submitted on behalf of the assessee, the ld. DR showed that the Valuer did not compute value of shares under the Net Asset Value method as was agreed under the JV Agreement. We find that para 14.5 of the JVA deals with the situation in which a shareholder agrees to purchase the shares of the company from another shareholder. This para states that: ―In the event the Shareholders agree to purchase the shares but do not agree to the price at which the same are offered for sale, then the sale shall take place at the net sale value of the shares to be determined by ….‘. Obviously, this para is referring to the situation of transfer of shares between the shareholders post the JV agreement, as is instantly prevailing. The Valuer did not value the shares under the Net asset value method, leave aside the determination of the value under this method. The AO treated full sale consideration of and CO No.11/PUN/2022

Rs.85.79 crore as attributable to the transfer of business, leaving no scope for finding out separate consideration towards the transfer of shares for the computation of capital gains. The ld. CIT(A) also did not go deep into the part of the consideration relatable to transfer of shares. He simply applied the magic wand and held that 10% of the consideration was towards non-compete and termination of role of the assessee in management. No reason or rationale has been given for the ad hoc figure of 10%. Under these circumstances, we are satisfied that the exercise of attributing sale consideration to the shares and the negative covenants is required to be done afresh by the AO. We order accordingly and direct him to segregate the consideration relatable to sale of shares and then accordingly compute the capital gains on transfer of such shares; and the remaining amount towards negative covenants should be taxed as business income u/s 28(va) of the Act. Needless to say, the assessee will be provided a reasonable opportunity of hearing.

included dividend from shares, dividend from mutual funds, income from PPF and income from tax free bonds. The assessee had not made any suo motu disallowance u/s 14A. On being called upon as to why no disallowance was offered, the assessee submitted a general reply about his having own capital more than the amount invested in securities yielding exempt income. The AO, on appreciation of entire material, made disallowance of Rs.16,86,377/- u/s 14A read with rule 8D(2)(iii) at 0.5% of average value of investments. This disallowance was echoed in the first appeal.

and sustained u/s 14A. We, therefore, dismiss this ground of appeal.

in respect of which deemed rent was calculated by the AO, was stock in trade of the assessee. The Pune Bench of Tribunal in M/s Cosmopolis Construction vs. ITO (supra) has held that no income from house property can result in respect of unsold flats held by the builder as stock in trade at the year-end. Insertion of sub-clause (5) to section 23 by the Finance Act, 2017 w.e.f. 01.04.2018, requiring determination of the ALV in respect of building and land appurtenant thereto which is held as stock in trade, is prospective and cannot apply to the assessment year 2015-16 under consideration. We, therefore, uphold the impugned order on this score.

आदेश की प्रतितिति अग्रेतिि/Copy of the Order is forwarded to: 1. अपील र्थी / The Appellant; प्रत्यर्थी / The Respondent

//// Senior Private Secretary आयकर अपीलीय अदिकरण ,पुणे / ITAT, Pune

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