NEW DELHI, DEC 06, 2012: THE issue before the Bench is - Whether when the assessee while working as an employee of a firm controlled by him, earns salary as well as commission arising out of non-compete agreement signed between him and the firm, the commission paid by the firm is to be treated as part of his salary and not business income. And the answer goes against the assessee.

Facts of the case

Assessee was a General Sales Agent (GSA) of Uzbekistan Airways (UA) - Uzind Corporation (UC) and received a salary of Rs. 1,32,000 per annum in that capacity. By a non-compete agreement (NCA) dated 15-03-2002, the assessee received an amount of 7% of the cargo freight and cost of tickets payable by UC to UA in addition to his regular salary. Under Clause 4 of the agreement, the commission payable to the assessee was separate from the remuneration given to him for other services provided by him to UC. It further stipulated that the relationship was on principal-to-principal basis, not intended to be construed as either a partnership or agency. For assessment year 2003-2004, UC showed the non-compete fees as business expenditure and assessee was showing only a part of it (the amount actually received by him during each assessment year) as business income. The AO concluded that commission credited to the firm, UC was Rs. 8.47 crores, while the assessee had shown Rs. 74 lakhs as business income, which was to be taxed as salary.

On appeal, the CIT(A) took the view that by stating that there was no relationship of control or supervision over him, the assessee had admitted to being the de-facto owner of the firm. Thus entering into a non-compete agreement with a firm of which he was the de-facto owner was unnecessary and could be seen as measure to reduce the income of the firm. The assessee, by following a separate method of accounting, only showed the amounts received by him from UC, while UC was claiming that the non-compete fee was business expenditure and was crediting the amount to him. Therefore, the CIT (A) concluded that characterization of the amount as non-compete fees was an attempt to reduce the tax liability and bring it under the head of business income of the assessee.

The Tribunal, by its impugned order, reversed the findings of the CIT (A). The Tribunal felt that none of the lower authorities disputed that commission received was for carrying out any activity that was related to the business. Thus the amount could only be assessed under the head of income from business. Further, an arrangement where the source followed the mercantile system of accounting and the recipient followed the cash system was well recognized and followed, and was thus not a colourable device to evade taxes. Since it was specifically assessable under Section 28 (va), it will be classifiable as income from business and not salary. Further, if UC continued to only show that the amount was credited without the assessee receiving the amount, the revenue had a right to enforce other remedial provisions in the hand of the firm to bring the amount not paid to tax. The Tribunal also based its finding on the contractual clauses of the Non-compete agreement which stated that the relationship was not employer- employee relationship.

The Revenue argued that the non-compete fee was part of 'salary' under Sections 16 & 17 of the Income Tax Act which included, within its definition any fees, wages, commission, bonus, perquisite or profit in lieu of or in addition to salary. Thus the whole amount of fees received should have been taxed as income from salary. It was contended that the assessee had been paid salary by UC since its inception and the employer- employee relationship thus continued even after the non-compete agreement was entered into.

It was submitted that UC was nothing but a partnership firm of assessee's wife and daughter and the agreement was only entered into to camouflage this fact. The assessee had admitted to controlling the firm (All the employees received directions from him and he was the authorized signatory to operate all the bank accounts.) It was emphasized that Section 28(va) only taxes that amount of the income earned by the assessee for the condition for not carrying out any business of which already had an enterprise. It could not thus apply when the assessee did not have any other business.

The assessee argued, on the other hand, that he was the controller of the business and not the two partners, who were his daughter and wife. Since the partners of the firm exercised no control and supervision over him, no employer- employee relationship existed. Since control was by him, it was his business and therefore the amount was business income. It was argued that after the agreement was entered into, he began receiving amounts from UC in a dual capacity-salary in his capacity as an employee of UC and non-compete fees for not taking away business of the firm. Thus the assessee was entitled to receive the amount under the commission even after termination of employment with UC. Therefore, commission was paid out of a separate agreement which did not flow from the employer-employee relationship. It was thus taxable as a business income under Section 28(va).

It was also argued that the question as to under which head the income was to be charged had to be assessed in accordance to the addition of Section 28(va)(a) inserted by the Finance Act 2002, w.e.f. AY 2003-2004 which stated that any amount received under an agreement for not carrying out any activity in relation to any business will be assessable as business income. Thus, as the amount received under the non-compete agreement fell squarely under this clause, it could not be taxed under any other charging section under the Act.

Having heard the parties, the HC held that,

++ in this case, the assessee has argued that he is the controller of the firm, which translates to him carrying on the business of the firm. Therefore, according to his showing, the control needed to establish an employer-employee relationship is absent. However, if that is correct then he cannot claim the Rs. 1,32,000 received by him to be the salary paid by the firm to him in his capacity as an employee. Consequently, all the amounts received by him should be income from business. However, that is not what he contends. Apart from this anomaly, another unexplained factor is why the assessee had to entered into a non-compete agreement with a firm that he controls. In any case, it would have been taxed under the head “income from business” under Section 28 (va);

++ the UC was deducting the amount being paid under the non-compete agreement as business expenditure. However, under Section 36 (1)(iii), any amount paid as a bonus, or commission to be deductible, must only be made to employees. As per settled law, the expressions 'bonus' and 'commissions' under this clause also include payments made under a contract. Thus, in this case it could be applied to the payments being made to the assessee under the NCA. What then follows, is that if the deduction is to be allowed, the assessee must be an employee of UC. If this is so, then the amount received by him is taxable in his hands under the head of income from salary. This Court in CIT v Eicher Limited has also held payments made under a NCA to an employee to be a business expenditure. On the other hand, if the assessee is not an employee, and is in fact the controller of the firm, the deduction of the amount paid, as NCA, is impermissible, in the hands of the firm, though it can be taxed as his income from business;

++ the question of law is answered in favour of the revenue, and against the assessee.

(See 2012-TIOL-968-HC-DEL-IT)