IMPORTANT POINT
Compensation received under non-competition agreement is a capital receipt which was made taxable from 01.4.2003.

JUDGMENT

S.H. Kapadia, CJI —

Leave granted.

2. 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?

FACTS

3. During the assessment year 1997-98 the assessee received ‘50,00,000/- (Rupees Fifty Lakhs only) from Ranbaxy as non-competition fee. The said amount was paid by Ranbaxy under an agreement dated 31.3.1997. Assessee is a part of Gufic Group. 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. Assessee was carrying on business of manufacturing, selling and distribution of pharmaceutical and medicinal preparations including products mentioned in the list in Schedule-A to the agreement. 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. 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.

4. On perusal of the said agreement, the CIT (A) while overruling the decision of AO observed that the AO had not disputed the fact that ‘50 lakhs received by the assessee from Ranbaxy was towards non-competition fee; that under the said agreement the assessee agreed not to manufacture, itself or through its associate, any of the products enlisted in the Schedule to the agreement for 20 years within India and the rest of the world; that the assessee and Ranbaxy were both engaged in the business of pharmaceuticals and to ward off competition in manufacture of certain drugs, Ranbaxy had entered into an agreement with the assessee restricting the assessee from manufacturing the drugs mentioned in the Schedule and consequently the CIT(A) held that the said sum of ‘50 lakhs received by the assessee from Ranbaxy was a capital receipt not taxable under the Income Tax Act, 1961 (hereinafter for short ‘the 1961 Act’) during the relevant assessment year. This decision was affirmed by the Tribunal. However, the High Court reversed the decision of the Tribunal by placing reliance on the judgment of the Supreme Court in the case of Gillanders Arbuthnot and Co. Ltd. v. CIT, Calcutta1 53 ITR 283. Against the said decision of the High Court assessee has come to this Court by way of petition for special leave to appeal, hence this civil appeal.

DECISION

5. The position in law is clear and well settled. There is a dichotomy between receipt of compensation by an assessee for the loss of agency and receipt of compensation attributable to the negative/restrictive covenant. The compensation received for the loss of agency is a revenue receipt whereas the compensation attributable to a negative/restrictive covenant is a capital receipt.

6. The above dichotomy is clearly spelt out in the judgment of this Court in Gillanders’ case (supra) in which the facts were as follows. The assessee in that case carried on business in diverse fields besides acting as managing agents, shipping agents, purchasing agents and secretaries. The assessee also acted as importers and distributors on behalf of foreign principals and bought and sold on its own account. Under an agreement which was terminable at will assessee acted as a sole agent of explosives manufactured by Imperial Chemical Industries (Export) Ltd. That agency was terminated and by way of compensation the Imperial Chemical Industries (Export) Ltd. paid for first three years after the termination of the agency two-fifths of the commission accrued on its sales in the territor