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Non-Compete Covenants Result in More Business Tax
The Chandigarh Income Tax Appellate Tribunal in a recent ruling has held that income from transfer of promoter shares is liable to tax as business income. Taxand India investigates what this means for business taxpayers in India.
- The taxpayers or the Sellers were promoters of M/s Excel Callnet Pvt Ltd and were also on the Board of Directors of the Company. The taxpayers transferred their shareholding in the Company under a Share Purchase Agreement and offered the gains on the sale of shares to tax as long term capital gains.
- The Revenue Authorities held that since the Sellers were promoters of the Company, the shares of the Company were not held by the Sellers as investments. Accordingly, the shares were held as 'business assets' and not 'capital assets'.
- The SPA provided for the following:
- Transfer/ renunciation of management rights in favor of the purchaser
- Hand over the business to the purchaser including employees, database, customers contracts, etc
- Specific non compete covenants viz, Sellers not engaging in any call center activity within a specified region for 2 years
- Prohibited the taxpayers from using the brand equity of the Company, logos, trademarks, domain name, etc along with agreeing not to solicit the employees
In this ruling, the Tribunal relied on section 28(va) of the Act to hold that the income under the SPA would be in the nature of business income due to the presence of non-compete covenants. However, the Tribunal failed to appreciate that the non-compete covenants were a part of the entire agreement to sell shares and entailed (along with the agreement to not compete or not use brand equity, trademark, logo, etc) a transfer of shares and certain other rights including the right to carry on business and that at best only a part (if any) of the consideration pertaining to such transfer could be liable to tax as 'business income' under section 28(va) of the Act.