Non-compete fees received by a taxpayer will be a non-taxable capital receipts up to the financial year 2002-03: ITAT Mumbai
The Income-tax Appellate Tribunal (ITAT) Mumbai has recently ruled that non-compete fees received by taxpayers up to the financial year 2002-03 will be considered non-taxable capital receipts. The amendment classifying non-compete fees as taxable revenue receipts took effect only from April 1, 2003. This ruling was upheld by the ITAT, Mumbai bench, which supported the order of the Commissioner (Appeals). The Commissioner had treated the non-compete fee of Rs. 10 crore received by Lyka Labs, a pharmaceutical manufacturing company, as a capital receipt.
Lyka Labs had entered into a non-compete agreement with its joint venture company, Lyka Hetro Health Care Limited (LHHCL), on March 12, 2002. The agreement stipulated that Lyka Labs would not compete with LHHCL in the marketing, distribution, and selling of certain formulations associated with a registered or used trademark.
Both Lyka Labs and the Commissioner (Appeals) based their reliance on a prior Supreme Court ruling in the case of Guffic Chem. The Supreme Court had clearly stated that the amendment is effective only from April 1, 2003 (Assessment Year 2004-05 onwards) and does not apply retrospectively to non-compete fees received before this period.
In its decision, the Supreme Court distinguished between compensation received for the termination or loss of an agency, which would be a ‘revenue receipt,’ and compensation for the loss of a source of business under a negative covenant, which would be a ‘capital receipt.’ The agreement between Lyka Labs and LHHCL was identified as a negative covenant.
Consequently, the ITAT bench dismissed the appeal filed by the Income Tax department, affirming that the non-compete fee received by Lyka Labs should be treated as a non-taxable capital receipt for the period in question.
This ruling provides clarity on the tax treatment of non-compete fees received prior to April 1, 2003, and reinforces the principle that amendments to tax laws are not retroactive unless explicitly stated.
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