Mr. Justice KS Jhaveri- By way of this appeal, the revenue has challenged the order of the Income Tax Appellate Tribunal, Ahmedabad Bench "C", Ahmedabad, (For short, "the Tribunal") in ITA No.3955/Ahd/2003 dated 28.7.2005, whereby the Tribunal has reversed the finding of the CIT (Appeals).
2. The assessee company had filed return of income on 31/10/2001 declaring total loss of Rs. 6,92,03,450/-. The same was processed under Section 143 (1) on 21.1.2002 and the case was selected for scrutiny by issuing notice under Section 143 (2) dated 23.1.2002. The same was served upon the assessee on 25.1.2002. Notice under Section 142 (1) along with detailed questionnaire was issued on 28.1.2002, which was served upon the assessee on 29.1.2002. In reply to such notice, reply was filed by the assessee. During the course of assessment proceedings, the Assessing Officer had noticed that the assessee-company, which was formerly known as "Arlem Investment & Finance Ltd" had during the previous year relevant to Assessment Year 2001-02, acquired an Industry/Plant Manufacturing Nitric Acid (NA) & Ammonium Nitrite (AN) belonging to another company styled as M/s. VBC Industries Ltd. for a total consideration of Rs. 29 crores. The Industry/Plant so purchased was to include entire business undertaking situated at Ponada including movable and immovable properties and all other tangible and intangible assets relating to the business of manufacturing of aforesaid chemicals. In addition to payment of Rs. 29 Crores paid for purchase of the so-called Industry/Plant Manufacturing Unit, by whatever name it may be called, the assessee entered into another 'Non Compete Agreement' with VBC and its founder Shri MVVS Murthy as a result of which the assessee paid a lumpsum of Rs. 6 Crores to them. The relevant part of the Agreement so entered into has been discussed by the Revenue Authorities in their respective order and, therefore, need not to be reproduced here. In the books of account, the assessee wrote off 1/5th of the expenditure of Rs. 6 Crores because the period during which agreement was to remain in force was five years, but in computation of income furnished along with return the assessee claimed whole of the expenditure of Rs. 6 Crores, as Revenue expenditure. Such claim of the assessee was disallowed by the Assessing Officer, against which an appeal was preferred before the Commissioner of Income Tax (Appeals), who confirmed the order of the Assessing Officer. Therefore, an appeal was preferred before the Income Tax Appellate Tribunal, which came to be dismissed by the impugned order against which present appeal is preferred.
3. At the time of admitting this Appeal, following question of law was framed:-
"Whether on the facts and circumstances and in law the ITAT was right in holding that the payment of Rs. 6 Crores made by the Assessee, as Non-compete fees, to VBC Industries Ltd. and other was an allowable business expenditure of revenue nature incurred by the assessee?"
4. Mr.K.M.Parikh, learned advocate for the appellant submitted that Clauses 1, 2 and 3 of the Non-Competition Agreement dated 22.3.2000 are required to be considered for the purpose of deciding this appeal. Said clause reads as under:-
"1. The assignors have entered into a Business Purchase Agreement "with the Assignees to assing to the Assignees all that Acquired Business Undertaking consisting of immovable properties, movable properties, liabilities, receivables, etc. as more particularly recited in the Business Purchase Agreement dated 22nd March, 2000 (The BPA), including the business of manufacture of Nitric Acid, Ammonium Nitrate as also alll that their Brands, Labels, etc. (The said Business)
2. At the request of the Assignees the Assignors have agreed to grant to the Assignees as per the BPA and that the Assignors are bound to grant to the Assignees a covenant to non-compete in the said business transferred under the BPA i.e. manufacture and/or selling and/or trading of Nitric Acid and Ammonium Nitrate directly and/or indirectly for a period of 5 (five) years.
3. The parties hereto have desired and do hereby record the terms and conditions of the non-compete agreement as follows:-
NOW THIS AGREEMENT HEREBY WITNESSETH AND THE PARTIES HERETO HEREBY MUTUALLY AGREE AS FOLLOWS:
1. The recitals contained herein shall constitute an integral operative part of this Agreement.
2. This agreement and the covenants recited hereunder shall be effective and binding on both the parties for a period of five years.
3. Covenant
The Assignors' and Individual hereby agree with the Assignees that:-
(i) the Assignors' and Individual shall not directly or indirectly own, manage, operate, join, have an interest in, control or participate in the ownership, management, operation or control of, or be otherwise connected in any manner with, any corporate, partnership, proprietorship, trust, estate, association or other business entity which directly or indirectly engages, as a commercial activity anywhere in the World in the Business or any business similar to the Business;
(ii) The Assignors' and Individual shall not in any manner whatsoever render, sell, supply, market or distribute, advise, assist, aid in establishing, managing, providing or developing or act as Consultant or professional advisor in respect of the Business or any products or services constituting part of the Business or similar thereto either on its own account or on behalf of any other person whether as an agent or as a licensee or as an advisor, consultant under any other relationship; and
(iii) The Assignors' and Individual shall not in any manner provide any technical know-how, expertise or any information in any manner and form whatsoever for the purpose of and/or relating to the rendering, selling, supplying, marketing or distributing of products or services constituting part of the Business including rendering any assistance for the purpose of improving, modifying, upgrading or making any betterment to any existing process, know-how, software methodology or technology whatsoever for the purpose of and/or relating to the manufacturing, selling, supplying, marketing or distributing of the same whether or not the same is patended or properietary or otherwise.
(iv) The covenant shall be interpreted in the widest possible commercial sense and shall be observed, in letter and spirit."
4.1 He submitted that in view of above, it is clear that this is nothing but capital investment and the Tribunal has committed an error in holding that the payment of Rs. 6 Crores as Noncompete fees was an allowable business expenditure without considering the fact that the said expenditure was in the nature of creating enduring benefit and, therefore, the same is capital investment.
4.2 He has relied upon the decision of the Apex Court in Guffic Chem P. Ltd. v. Commissioner of Income Tax, Belgaum and Another reported in 332 ITR 602 (SC), wherein it is held as under:-
"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. It is only vide Finance Act, 2002 with effect from 1.4.2003 that the said capital receipt is now made taxable [See: Section 28(va)]. The Finance Act, 2002 itself indicates that during the relevant assessment year compensation received by the assessee under non-competition agreement was a capital receipt, not taxable under the 1961 Act. It became taxable only with effect from 1.4.2003. It is well settled that a liability cannot be created retrospectively. In the present case, compensation received under Non-Competition Agreement became taxable as a capital receipt and not as a revenue receipt by specific legislative mandate vide Section 28(va) and that too with effect from 1.4.2003. Hence, the said Section 28 (va) is amendatory and not clarificatory. Lastly, in Commissioner of Income- Tax, Nagpur v. Rai Bahadur Jairam Valji reported in 35 ITR 148 it was held by this Court that if a contract is entered into in the ordinary course of business, any compensation received for its termination (loss of agency) would be a revenue receipt. In the present case, both CIT (A) as well as the Tribunal, came to the conclusion that the agreement entered into by the assessee with Ranbaxy led to loss of source of business; that payment was received under the negative covenant and therefore the receipt of 50 lakhs by the assessee from Ranbaxy was in the nature of capital receipt. In fact, in order to put an end to the litigation, Parliament stepped in to specifically tax such receipts under noncompetition agreement with effect from 1.4.2003."
5. On the other hand, learned counsel for the respondent has supported the impugned order passed by the Tribunal and submitted the Tribunal has not committed any error while passing the impugned order.
6. We have heard learned counsel appearing for both the sides. We have also perused the material on record as well as the impugned order. We have also gone through the judgments relied upon by the learned advocates. The Tribunal reversed the findings of the CIT (Appeals) by mainly relying upon the judgment of the Apex Court in the case of Empire Jute Co. Ltd. v. Commissioner of Income-Tax reported in [1980] 124 ITR 1 (SC), wherein the Supreme Court held as under:-
"The decided cases have, from time to time, evolved various tests for distinguishing between capital and revenue expenditure but no test is paramount or conclusive. There is no all embracing formula which can provide a ready solution to the problem; no touchstone has been devised. Every case has to be decided on its own facts, keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred. But a few tests formulated by the courts may be referred to as they might help to arrive at a correct decision of the controversy between the parties. One celebrated test is that laid down by Lord Cave L.C. in Atherton v. British Insulated and Helsby Cables Ltd. [1925] 10 TC 155, 192 (HL), where the learned Law Lord stated:
"........ when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital." This test, as the parenthetical clause shows, must yield where there are special circumstances leading to a contrary conclusion and, as pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1965] 58 ITR 241 (PC), it would be misleading to suppose that in all cases, securing a benefit for the business would be, prima facie, capital expenditure so long as the benefit is not so transitory as to have no endurance at all. There may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit, may, none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case. But even if this test were applied in the present case, it does not yield a conclusion in favour of the revenue. Here, by purchase of loom hours no new asset has been created. There is no addition to or expansion of the profit-making apparatus of the assessee. The income-earning machine remains what it was prior to the purchase of loom hours. The assessee is merely enabled to operate the profit making structure for a longer number of hours. And this advantage is clearly not of an enduring nature. It is limited in its duration to six months and, moreover, the additional working hours per week transferred to the assessee have to be utilised during the week and cannot be carried forward to the next week. It is, therefore, not possible to say that any advantage of enduring benefit in the capital field was acquired by the assessee in purchasing loom hours and the test of enduring benefit cannot help the revenue.
Another test which is often applied is the one based on the distinction between fixed and circulating capital. This test was applied by Lord Haldane in the leading case of John Smith and Son v. Moore [1921] 12 TC 266, 282 (HL) where the learned law Lord drew the distinction between fixed capital and circulating capital in words which have almost acquired the status of a definition. He said:
"Fixed capital as what the owner turns to profit by keeping it in his own possession ; circulating capital as what he makes profit of by parting with it and letting it change masters."
Now so long as the expenditure in question can be clearly referred to the acquisition of an asset which falls within one or the other of these two categories, such a test would be a critical one. But this test also sometimes breaks down because there are many forms of expenditure which do not fall easily within these two categories and not infrequently, as pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1965] 58 ITR 241 (PC), the line of demarcation is difficult to draw and leads to subtle distinctions between profit that is made " out of " assets and profit that is made " upon " assets or " with " assets. Moreover, there may be cases where expenditure, though referable to or in connection with fixed capital, is nevertheless allowable as revenue expenditure. An illustrative example would be of expenditure incurred in preserving or maintaining capital assets. This test is, therefore, clearly not one of universal application. But even if we were to apply this test, it would not be possible to characterise the amount paid for purchase of loom hours as capital expenditure, because acquisition of additional loom hours does not add at all to the fixed capital of the assessee. The permanent structure of which the income is to be the produce or fruit remain, the same; it is not enlarged. We are not sure whether loom hours can be regarded as part of circulating capital like labour, raw material, power, etc., but it is clear beyond doubt that they are not part of fixed capital and hence even the application of this test does not compel the conclusion that the payment for purchase of loom hours was in the nature of capital expenditure. The revenue, however, contended that by purchase of loom hours the assessee acquired a right to produce more than what it otherwise would have been entitled to do and this right to produce additional quantity of goods constituted addition to or augmentation of its profitmaking structure. The assessee acquired the right to produce a larger quantity of goods and to earn more income and this, according to the revenue, amounted to acquisition of a source of profit or income which though intangible was nevertheless a source or " spinner " of income and the amount spent on purchase of this source of profit or income, therefore, represented expenditure of capital nature. Now it is true that if disbursement is made for acquisition of a source of profit or income, it would ordinarily, in the absence of any other countervailing circumstances, be in the nature of capital expenditure. But we fail to see how it can at all be said in the present case that the assessee acquired a source of profit or income when it purchased loom hours. The source of profit or income was the profit-making apparatus and this remained untouched and unaltered. There was no enlargement of the permanent structure of which the income would be the produce or fruit. What the assessee acquired was merely an advantage in the nature of relaxation of restriction on working hours imposed by the working time agreement, so that the assessee could operate its profit-earning structure for a longer number of hours. Undoubtedly, the profit-earning structure of the assessee was enabled to produce more goods, but that was not because of any addition or augmentation in the profit-making structure, but because the profit-making structure could be operated for longer working hours. The expenditure incurred for this purpose was primarily and essentially related to the operation or working of the looms which constituted the profit-earning apparatus of the assessee. It was an expenditure for operating or working the looms for longer working hours with a view to producing a larger quantity of goods and earning more income and was, therefore, in the nature of revenue expenditure. We are conscious that in law as in life, and particularly in the field of taxation law, analogies are apt to be deceptive and misleading, but in the present context, the analogy of quota right may not be inappropriate. Take a case where acquisition of raw material is regulated by quota system and in order to obtain more raw material the assessee purchases the quota right of another. Now, it is obvious that by purchase of such quota right, the assessee would be able to acquire more raw material and that would increase the profitability of his profit-making apparatus, but the amount paid for purchase of such quota right would indubitably be revenue expenditure, since it is incurred for acquiring raw material and is part of the operating cost. Similarly, if payment has to be made for securing additional power every week, such payment would also be part of the cost of operating the profit-making structure and hence in the nature of revenue expenditure, even though the effect of acquiring additional power would be to augment the productivity of the profit-making structure. On the same analogy payment made for purchase of loom hours which would enable the assessee to operate the profit-making structure for a longer number of hours than those permitted under the working time agreement would also be part of the cost of performing the income earning operations and hence revenue in character.
When dealing with cases of this kind where the question is whether expenditure incurred by an assessee is capital or revenue expenditure, it is necessary to bear in mind what Dixon J. said in Hallstorm's Property Ltd. v. Federal Commissioner of Taxation (72 CLR 634) : " What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. " The question must be viewed in the larger context of business necessity or expediency. If the outgoing expenditure is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure. See Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52 (SC). The same test was formulated by Lord Clyde in Robert Addie and Sons' Collieries Ltd. v. IRC [1924] 8 TC 671, 676 (C Sess) in these words : " Is it a part of the company's working expenses ?-is it expenditure laid out as part of the process of profit earning ?-or, on the other hand, is it a capital outlay ?-is it expenditure necessary for the acquisition of property or of rights of a permanent character, the possession of which is a condition of carrying on its trade at all ? " It is clear from the above discussion that the payment made by the assessee for purchase of loom hours was expenditure laid out as part of the process of profit earning. It was, to use Lord Sumner's words, an outlay of a business " in order to carry it on and to earn a profit out of this expense as an expense of carrying it on ". [John Smith and Son v. Moore [1921] 12 TC 266, 296 (HL)]. It was part of the cost of operating the profit-earning apparatus and was clearly in the nature of revenue expenditure. It was pointed out by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1965] 58 ITR 241 (PC) that "in considering allocation of expenditure between the capital and income accounts, it is almost unavoidable to argue from analogy". There are always cases falling indisputably on the one or the other side of the line and it is a familiar argument in tax courts that the case under review bears close analogy to a case falling on the right side of the line and must, therefore, be decided in the same manner. If we apply this method, the case closest to the present one that we can find is Nchanga Consolidated Copper Mines'case [1965] 58 ITR 241 (PC). The facts of this case were that three companies which were engaged in the business of copper mining formed a group and consequent on a steep fall in the price of copper in the world market, this group decided voluntarily to cut its production by 10 per cent. which for the three companies together meant a cut of 27,000 tons for the year in question. It was agreed between the three companies that for the purpose of giving effect to this cut, company B should cease production for one year and that the assessee-company and company R should undertake between them the whole group programme for the year reduced by the overall cut of 27,000 tons and should pay compensation to company B for the abandonment of its production for the year. Pursuant to this agreement the assessee paid to company B, pounds.1,384,569 by way of its proportionate share of the compensation and the question arose whether this payment was in the nature of capital expenditure or revenue expenditure. The Privy Council held that the compensation paid by the assessee to company B in consideration of the latter agreeing to cease production for one year was in the nature of revenue expenditure and was allowable as a deduction in computing the taxable income of the assessee. Lord Radcliffe, delivering the opinion of the Privy Council, observed that the assessee's arrangement with companies R and B " out of which the expenditure arose, made it a cost incidental to the production and sale of the output of the mine " and as such its true analogy was with an operating cost. The payment of compensation represented expenditure incurred by the assessee for enabling it to produce more goods despite the cut of 10 per cent. and it was plainly part of the cost of performing the income-earning operation. This decision bears a very close analogy to the present case and if payment made by the assesseecompany to company B for acquiring an advantage by way of entitlement to produce more goods notwithstanding the cut of 10 per cent. was regarded by the Privy Council as revenue expenditure, a fortiori, expenditure incurred by the assessee in the present case for purchase of loom hours so as to enable the assessee to work the profit making apparatus for a longer number of hours and produce more goods than what the assessee would otherwise be entitled to do, must be held to be of revenue character. The decision in IRC v. Carron Company [1968] 45 TC 18 (HL), also bears comparison with the present case. There certain expenditure was incurred by the assessee-company for the purpose of obtaining a supplementary charter altering its constitution, so that the management of the company could be placed on a sound commercial footing and restrictions on the borrowing powers of the assesseecompany could be removed. The old charter contained certain antiquated provisions and also restricted the borrowing powers of the assessee-company and these features severely handicapped the assessee-company in the development of its trading activities. The House of Lords held that the expenditure incurred for obtaining the revised charter eliminating these features which operated as impediments to the profitable development of the assessee-company's business was in the nature of revenue expenditure since it was incurred for facilitating the day-to-day trading operations of the assesseecompany and enabling the management and conduct of the assessee-company's business to be carried on more efficiently. Lord Reid emphasised in the course of his speech that the expenditure was incurred by the assessee-company " to remove antiquated restrictions which were preventing profits from being earned " and on that account held the expenditure to be of revenue character. It must follow on an analogical reasoning that expenditure incurred by the assessee in the present case for the purpose of removing a restriction on the number of working hours for which it could operate the looms, with a view to increasing its profits, would also be in the nature of revenue expenditure. We are, therefore, of the view that the payment of Rs. 2,03,255 made by the assessee for purchase of loom hours represented revenue expenditure and was allowable as a deduction under s. 10(2)(xv) of the Act. We accordingly allow the appeal and answer the question referred by the Tribunal in favour of the assessee and against the revenue. The revenue will pay to the assessee costs throughout."
7. In the present case, the "Non-compete fees" paid by the assessee company to the transferor company under an agreement where the transferor company shall not directly or indirectly manage, operate or have an interest in control or participate or compete against the assessee anywhere in the world for five years. Thus, the expenditure incurred primarily and essentially related to the non-competition of the transferor company against the assessee in the same business, which constituted the profit-earning apparatus of the assessee.
8. Therefore, in view of the aforesaid decision of the Honourable Supreme Court and also considering the observations made by the Tribunal in the impugned order, we are of the opinion that the view taken by the Tribunal is just and proper and it is not required to be interfered with. Therefore, we are in complete agreement with the view taken by the Tribunal and it is held that the Tribunal was right in holding that the payment of Rs. 6 Crores made by the Assessee, as Non-compete fees, to VBC Industries Ltd. and other was an allowable business expenditure of revenue nature incurred by the assessee. The question posed for our consideration is answered in favour of the assessee and against the revenue. Accordingly, the appeal is dismissed.