ACIT 3(3), MUMBAI vs. SHEKHAR K SHAH, MUMBAI

ORDER

PER N.K. PRADHAN, AM

On the facts and circumstances of the cast and in law, the Ld.CIT (A) erred in deleting theaddition of Rs.5,00,000/- towards non-compete fees without appreciating the fact that the supplementary non-compete agreement dated Shri Shekhar K. Shah 14.01.2002 was an afterthought and the taxable income for future years AYs 2003-04 to 2008-09 was declared as non-taxable income in AY2002-03 by entering into the agreement dated 14.01.2002 with a view to evade tax on the non-compete fees and hence the addition made by the AO,was justified.

3. Briefly stated, the facts are that the assessee, a Director of Vossloh-Schwabe India Pvt. Ltd. (‘VSIN’) entered into a series of agreements culminating into a Joint Venture (JV) with Vossloh Group that took effect from 31.03.1998. Thereafter, VSIN and the assessee entered into another agreement i.e. Non Competition Agreement dated 14.07.1994. As per Article 3 of the said Agreement, the assessee was to receive compensation. As per clause 3.2 and 3.3 of the said Agreement, the Parties had agreed that out of the initial deposit of Rs.50,00,000/- paid to the assessee, a sum of Rs.5,00,000/- would be adjusted per annum beginning from 01.04.1998 for a period of 10 years. Also, in January 2002, the assessee and VSIN entered into a Supplementary Agreement to the Non-Competition Agreement, in which the assessee and VSIN revised the agreement. Further, the JV itself was re-negotiated in August 2003 under which the shareholding pattern in VSIN was modified along with several terms and conditions. Under the said re- negotiated agreement, all the agreements entered in 1998 were terminated including the Non-Competition Agreement dated 31.03.1998. The Non-Competition amount due to the assessee translated as under: “Under Agreement dated July 14, 1998, the appellant received a sum of Rs.50,00,000/- as a deposit to be adjusted over a period of 10 years @ Shri Shekhar K. Shah Rs.5,00,000/- subject to understanding that the arrangement can be terminated with a written notice at the end of each year. Under Supplementary Agreement dated January 14, 2002, the Appellant and Vossloh agreed that the condition for annual option to terminate was removed with the result the amount lying in deposit of Rs.35,00,000/- at the time became fully due to the Appellant. The Joint Venture itself was re-negotiated with effect from August 8, 2003 under which the Non-Competition Agreement along with all other documents were terminated and fresh arrangements were put in place. However, under the new agreement, the Parties did not negotiate a separate non-compete fee for the Appellant.” In the return of income, the assessee had offered the income from non-compete fees as under: “During the Assessment years 1999-00 to 2001-02, the appellant disclosed non-compete fee of Rs.5,00,000/- each and claimed that the said sums were capital receipts. This position was examined and duly accepted in the scrutiny assessment of the Appellant for Assessment year 1999-00. In the Return of Income of Assessment year 2002-03, the Appellant disclosed the balance sum of Rs.35,00,000/- as capital receipt.” During the course of assessment proceedings, the AO observed that (i) in the first three years, the assessee itself treated only an amount of Rs.5,00,000/- as income for the year, (ii) it was only in the AY 2002- 03 that the balance amount of advance was treated as income, (iii) this was a tool to evade taxes because non-compete fees was made taxable by virtue of insertion of sub-clause (va) to section 28 by the Finance Act, 2002 w.e.f. 01.04.2003, (iv) the assessee cannot claim taxable income of Shri Shekhar K. Shah (whether taxable or not taxable) of current year, because there is not provision in the Act in this regard. With the above observations, the AO concluded that the income accrued to the assessee for the year under consideration is Rs.5,00,000/- and as per the provisions of section 28(va), the same is taxable under the head ‘business and profession’.

4. Aggrieved by the order of the AO, the assessee filed an appeal before the Ld.CIT(A). In the order dated 26.04.2012, the Ld. CIT(A) observed that “the reason for entering into a supplementary non- competition agreement on 14.01.2002 has also been explained by the appellant as on account of the takeover of Vossloh, Germany by Matsuhita, Japan, which is a plausible reason. That a supplementary non-competition agreement was executed on 14.01.2002 is also borne out by the fact that in the minutes of the meeting of the Board of Directors of Vossloh Schwabe India Pvt. Ltd. held on 27.02.2002, the said supplementary non-competition agreement was approved.” Referring to clause 5 of the said agreement, the Ld. CIT(A) observed that all the balance amount remaining with the assessee on the date of execution of the agreement was to be the lumpsum consideration towards the non-compete covenants for the remaining period of the non-compete fees. Consequently, the balance amount of Rs.35,00,000/- ceased to retain the character of deposit in the hands of the assessee and thus became consideration for the previous year relevant to the AY 2002-03. Holding that the assessee has rightfully disclosed the said amount in the return of income for AY 2002-03, Shri Shekhar K. Shah Ld. CIT(A) deleted the addition of Rs.5,00,000/- made by the AO towards non-compete fees.

5. Before us, the Ld. DR relies on the order of the AO and submits that in the 1st three years, the assessee itself treated only an amount of Rs.5,00,000/- as income for the year. It was only in the AY 2002-03 that the balance amount was treated as income. The Ld. DR argues that this was done to avoid payment of taxes because non-compete fees was made taxable by virtue of insertion of sub-clause (va) to section 28 by the Finance Act, 2002 w.e.f. 01.04.2003. Thus it is argued that the addition made by the AO be restored.

6. On the other hand the Ld. counsel of the assessee submits that from a factual perspective, the non-compete agreement between the assessee and VSIN was originally for a period of 10 years, for which an initial amount of Rs.50,00,000/- was paid. Thereafter, the Parties mutually decided that the said amount would not be subject to annual review although the non-compete agreement would hold good for a period of 10 years. It is further stated by him that the JV was re- negotiated in August 2003 under which the shareholding pattern in the VSIN was modified along with several terms and conditions. Under the said re-negotiated arrangement, all the agreements entered in 1998 were terminated including the non-competition agreement dated 31.03.1998, which in letter and spirit factored non-competition after the termination of the JV and Agreement dated 14.07.1998 which in letter and spirit factored non-competition during the currency of the JV. Thus the Ld. counsel supports the order passed by the Ld. CIT(A).

8. The 2nd ground of appeal On the facts and circumstances of the case and in law, the Ld. CIT (A) erred in treating as Capital Gains the ‘Termination Fee’ of Rs.2,56,19,997/- and 'Severance' payment of Rs.45,12,446/- received by the assessee pursuant to the Termination Agreement dated 31stJuly, 2006 and offered to tax under the head 'Capital Gains' but taxed by the A.O. under the head "Income from Other Sources” and 'Salary' respectively, without appreciating the facts that the payment was in fact made by SKS Group including Candlelight to the assessee without any consideration. The ability of doing business which was terminated was in respect of me company which is a separate entity. The director of the company or any other person is a separate entity and cannot claim to be the same as the company unless the company is a farce. The injury to the company cannot be claimed to be to the individual in law, though it may entail the same in certain facts and circumstances. Hence, the income arising to the assessee on account of 'Termination Fees' was rightly assessed by the A.O. as 'Income from other sources' rather than capital gains. Further, the assessee was drawing Salary from both Xylon and VosslohSchwbe India Pvt. Ltd. and therefore the employer-employee relation did exist between the assessee and the said companies.

9. In a nutshell, the facts are that during the year under consideration the assessee entered into termination agreement dated 31.07.2006 in order to terminate the JV with M/s Panasonic Electronic Works Vossloh Schwabe GmbH. Pursuant to the said agreement, the Shri Shekhar K. Shah Rs.3,01,32,443/- being Rs.2,56,19,997/- as termination fee and Rs.45,12,446/- as severance fee. Both the amounts being received towards the termination of the JV, the assessee considered the same as capital receipt and offered the entire amount as income from Long Term Capital Gains (LTCG) in the relevant assessment year. In the assessment, the AO held that the termination fee was paid to the assessee without any consideration and thus brought to tax the said termination fee of Rs.2,56,19,997/- during the relevant assessment year under the head ‘Income from Other Sources’. Further, the AO brought to tax the severance fee of Rs.45,12,446/- paid to the assessee during the relevant assessment year as salary.

10. In appeal, the Ld. CIT(A) held that the termination fee of Rs.2,56,19,997/- and severance fee of Rs.45,12,446/- received by the assessee are taxable as income under the head ‘Capital Gains’ and not under the head ‘Income from Other Sources’ and ‘Salary’ respectively.

11. Before us, the Ld. DR relies on the order of the AO, whereas the Ld. counsel relies on the order of the Ld. CIT(A).