KPMG FLASH NEWS KPMG IN INDIA Slump sale of taxpayer’s business is taxable as capital gains and not 'business income' under Section 28(va) of the Act 29 June 2012 Background Recently, the Delhi Bench of the Income Tax Appellate Tribunal (the Tribunal), in the case of Mrs. 1 Sangeeta Wij (the taxpayer), held that the consideration received for slump sale of business as a going concern will be considered as a capital receipt chargeable to tax as capital gains and not as a compensation for ‘not carrying out any activity in relation to any business’ which is chargeable to tax as business income under Section 28(va) of the Incometax Act, 1961 (the Act). • The proprietary concern was taken over by ICTSD Engineering Consultants Pvt. Ltd. (the purchaser) with effect from 31 October 2007 for a consideration of INR 12 million vide agreement dated 4 December 2007 (the Agreement). • The purchaser is a joint venture between the taxpayer and Shri K.K. Kapila, CMD, ICT Pvt. Ltd. • Para 11 of the Agreement provided that the taxpayer shall work exclusively as a whole-time director of the company for a minimum period of 5 years and that the taxpayer shall not carry out any activity related to business of the purchaser, however, the taxpayer shall be at liberty to do any business after quitting or leaving the purchaser. • The taxpayer treated the consideration as capital receipts chargeable to tax under the head of income of ‘capitals gains’ and offered the same for tax accordingly. Facts of the case • • The taxpayer is an M.Tech (Structures) from IIT, Delhi specialising in designing of structures, Public Health Engineering and Fire Protection Services and has completed 500 projects over 11 years and having experience of 25 years. The taxpayer was the proprietor of S.D. Engineering Consultants (Proprietary concern) and was engaged in providing consultancy in Civil Engineering. ________________ 1 ACIT v. Mrs. Sangeeta Wij (ITA No. 4274(Del)2011 for Assessment Year: 2008-09) © 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. • According to the Assessing Officer (AO) the consideration was received for ‘not carrying out any activity in relation to any business’ chargeable to tax as profits and gains of business under Section 28(va) of the Act. • The Commissioner of Income-tax Appeals [CIT(A)] deleted the addition made by the AO contending that the consideration received should be treated as capital receipts chargeable to capitals gains tax. any activity in relation to the business purchased by the purchaser which as per Section 28(va)(a) of the Act shall be chargeable to tax under the head ‘profits and gains of business or profession’. • Tribunal’s ruling • The AO was wrong in observing that the taxpayer had received ‘compensation’. • The AO was wrong in observing that the taxpayer had received compensation for the discontinuance of the proprietary concern. • The consideration has been received for the takeover of the assets and liabilities of the business of the proprietary concern as a going concern on the closure of the business on 31 October 2007, inclusive of goodwill, empanelment, receivables, work in progress and all other rights and entitlements. This fact has not been disapproved by the AO. • The AO read the Agreement providing that the taxpayer was to work exclusively as a whole time Director of the Purchaser as a circumstance going against the claim of the taxpayer, ignoring the fact that a whole time employment entails refraining from engaging in any other activity related to the business of the Company. • The genuineness of the Agreement is beyond any doubt, even as per the AO. • The Agreement could have either been rejected in totality or accepted in its entirety. • Despite the lucid contents of the Agreement, the AO tried to re-write the Agreement, which is wholly impermissible in law. • The case is covered by the Proviso (i) to Section 28(va) of the Act. The taxpayer has transferred right to carry on business and that being so, application of the main Section 28(va)(a) of the Act is foreclosed and forbidden, by the use of the words ‘shall not’ in the Proviso. • There is no merit in grievance raised by the tax department and therefore, the tax department’s appeal is rejected. Issue before the Tribunal • Whether the consideration received by the taxpayer is liable to tax as capital gains or business income under Section 28(va) of the Act? Taxpayer’s contentions • The Agreement provided for as under :   • • The purchaser had taken over the assets and liabilities of the proprietary concern as a going concern, inclusive of Goodwill, on the close of business as on 31 October 2007 for a total consideration of INR 12 million. The taxpayer would work exclusively as a wholetime Director of the purchaser for a minimum period of 5 years. The AO has made the addition as a result of complete misreading of the Agreement. The present case squarely falls under the Proviso (i) to Section 28(va) of the Act, where-under, any sum received on account of transfer of the right to carry on any business is not taxable under Section 28(va) of the Act, the same being taxable under the head ‘capital gains’. Tax department’s contentions • The net worth of the proprietary concern being of INR 4,73,725/- as on 31 October 2007 gave rise to a goodwill of INR 11.52 million which had been grossly over-valued and not been substantiated by the financial statement of the proprietorship concern. • Para 11 of the Agreement provided that the taxpayer shall not carry out any activity in any other business directly or indirectly related to the business of the purchaser which made it evident that the compensation of INR 12 million was not a capital receipt liable for capital gains as claimed by the taxpayer, but compensation was not for carrying out The consideration is received for discontinuation of the taxpayer’s business. © 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Our comments The Tribunal has re-confirmed the principle that the authorities are not allowed to rewrite the documents. It is also confirmed that unless the facts suggest, consideration for sale of business cannot be arbitrarily treated as compensation for non-compete taxable under Section 28(va) of the Act. © 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. www.kpmg.com/in Ahmedabad Safal Profitaire B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar Ahmedabad – 380 015 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Kochi 4/F, Palal Towers M. G. 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