Supreme Court: Formulation of a Substantial Question of Law is Essential to Appeal to High Court

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A Full bench comprising of Justice R. F Nariman, Justice Naveen Sinha and Justice B. R. Gavai heard the case of Shiv Raj Gupta v. Commissioner of Income Tax. It set aside the High Court’s judgment for answering a substantial question of law without first formulating it. The High Court had not given the parties an opportunity to frame such a question.

Brief facts of the Case

CDBL is Appellant’s company that manufactures beer and Indian Made Foreign Liquor. The Appellant and also the Assessee (in law, one who is liable to pay tax), Mr. Shiv Raj Gupta is the Chairman of CDBL.

The Appellant entered into Memorandum of Association (“MoU”) with the SWC group of companies for the sale of his company. Thereby, the Appellant handed over physical possession, management and control of the said brewery to the SWC group. The shares were sold at Rs. 30 when its market value was only Rs. 3. Later a Deed of Covenant was signed. It restricted the manufacturing and allied activities related to Indian Made Foreign Liquor. In return, a huge amount of non-competition fees was given to him.

The issue arose if the payment received under the Deed was taxable or not. It was said that one, the Deed be treated as a restrictive covenant the payment of which belongs to the Appellant. Two, the payment received by the Appellant is as compensation for terminating management.

The Income Tax Assessing Officer held the Deed to be a device to evade tax. The Income Tax Appellate Tribunal, on a majority, differed with the Assessing Officer and did not permit tax to be charged on the non-compete fees. The Revenue Authorities filed an appeal in the High Court with four questions of law. The High Court stated that the non-compete fees could not be brought to tax under Section 28(ii)(a) of Income Tax Act. Rather, it would have to be treated as a taxable capital gain, being part of the full value of the sale consideration paid for the transfer of shares.

The Appellant filed this appeal in response to the High Court’s order.

Appellant’s Arguments

The Appellant raised the contention of procedural inaccuracy. It was was said that, that the question of taxing the Assessee outside the provisions of Section 28(ii)(a) was not formulated. Even then, the High Court answered the question without giving notice or opportunity to the parties to dispute on the same.

Respondent’s Arguments

The amount of INR 6.6 crores as non-compete fees, that was received by the Assessee was payment for the sale of shares. According to the decision by the Assessing Officer and the minority decision of the Tribunal, it would fall under Section 28 (ii)(a) of the Income Tax Act.

Court’s Observations

The appellate jurisdiction of High Courts under Section 260A of the Income Tax Act is like Section 100 of the Criminal Procedure Code. This makes it clear that the High Court’s jurisdiction depends upon a substantial question of law, involved in the appeal before it.

Hence, the substantial question of law did not contain any question on, whether the non-compete fee could be taxed under any provision other than Section 28(ii)(a) of the Income Tax Act, 1961.

Hence, the judgment of the High Court was set aside on this ground. On the subject matter of the case, the Bench agreed with the Appellate Tribunal. The extra price of shares, over the market and face value, was due to the control premium attached to it. Each major shareholder was paid according to the proportion of shares held.

The non-compete fee was paid only to the assessee. This was owing to his skills and knowledge in the field for 35 years. The restrictive Deed of Covenant for 10 years was to prevent a rival business set up owing to the personal expertise of the Appellant. Further, such an amount for the fee was based on negotiations and agreement between the parties.

Court’s Decision

The Bench allowed the appeal by reiterating the judgment of the Income Tax Appellate Tribunal. A sum of INR 3 crores out of INR 6.6 crores of the non-compete fees was withheld for two years by way of a public deposit with the SWC group. Such a deposit was like a penalty clause for any breach. This was for deduction of any loss on account of any breach of the MoU.

This made it clear that there was no conflict involved in having two separate agreements for two separate and distinct purposes. The appeal was hence, allowed.


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