By TIOL News Service

CHENNAI, AUG 21, 2017: THE ISSUE BEFORE THE COURT IS - Whether remuneration paid to Assessee for loss of business occasioned to him by virtue of non-compete agreement, is not 'restrictive covenant, if agreement allows Assessee to work for others, provided he pays 5% of her earnings to company. YES is the verdict.

Facts of the case:

The Assessee i.e., R Radikaa, is an artist and film director with a significant presence in the big as well as small screens. M/s. Radaan Pictures Private Limited, the assessee in TC(A) 1175/2007 had entered into an agreement with Ms.Radikaa, for recognition of her expertise and skill in the area of film making desired to utilise her services and intellectual capacity for the purpose of its business. As per the agreement, the Artist agreed to spend a minimum of four hours a day in providing her expertise in film making & tele seriels. The Artist also agreed that she would not compete with the business of the Company in India or elsewhere and she agreed to take the consent of the Company prior to accepting an engagement as an actor by any other film director. She further agreed to remit 5% of her individual earnings to the Company. The agreement, in force for a period of 5 years provided for consideration, of an amount of Rs. 75 lakhs by way of allotment of 75,000 equity shares of a nominal value of Rs.100/- each. That apart, the parties had entered into a Succession Agreement that provided for the succession of the company to the business of the individual as a going concern, taking over all the assets and liabilities in its books for a consideration of Rs.4,37,38,900/- by way of allotment of Rs.4,37,389/- equity shares of a face value of Rs.100/- each. The entire business of 'Radaan T.V.' thus stood transferred by the individual to the company. Assessments were framed in case of both individual as well as the company. The AO in the case of individual was of the view that the amount of 75 lakhs was in the nature of a remuneration paid to the individual for loss of business occasioned to her by virtue of the terms of non-compete. The AO analysed her business receipts noticing that there was a steady increase in receipts from 1997-98 to 2000-01. In the present A.Y, she received remuneration of Rs.5 lakhs of which, 5 % was handed over to the company in terms of agreement. Accordingly, the AO arrived at a conclusion that there was drop in business revenue from the sole proprietary that stood compensated by the arrangement for non-compete with the company. The payment of the non-compete fee was thus, according to him, on revenue account.

On appeal, the HC held that,

++ as far as non compete fee is concerned, it is seen that sole proprietary was succeeded to by the company on Mar 31, 2000. The proprietrix was duly compensated for the assets transferred. Parallelly an agreement was entered into between the parties to provide for a more systematic utilization and exploitation of the creative talents and skills of the Artist. The Artist, who was managing the business as a proprietary concern continued to be part of the corporate structure, employing the same skill sets as always employed by her. It was only the business setting that was enlarged over the relevant period. Though exclusivity of engagement with the company is sought to be portrayed post execution of the non-compete, her services are still available to third parties, subject to consent by, and receipt of 5% of the income therefrom by the company. Though the counsel would point out that the latter has been occasioned only once, in the case of Oscar Films, the very presence of such a clause in the agreement would support the conclusion that the arrangement between parties is only a smokescreen. Ms.Radhikaa was, and continues to be, the face of the business and as proprietrix and thereafter, a director with substantial shareholding, she retained a firm hold on the reins of decision making. The transaction of non compete is thus an illusion in the aforesaid facts and circumstances. The finding of the AO is that the individual artiste continued to be in control of the affairs of the business both prior to and after the date of agreement entered into in March 2000. There is no dispute with regard to the position that while Ms.Radhikaa held more than 99.99% of the shares as on 2.4.2000, the percentage of shareholding before and after the public issue in February 2003 was 68.37 % and 51.33 % respectively;

++ the argument of the counsel for assessee is to the effect that the agreements executed in march and april 2003 should be viewed as part of a sequence of events and not in isolation. He would urge that the payment of non-compete fee was, but one factor in a composite business arrangement designed to elevate the business from a small proprietorship to a company and this resulted in sterilization of a source of income. Despite our best efforts, we are at a loss to visualize this scheme in the sequence of events presented. The company went public three years after the date of agreement between the parties and this factor would hardly come to the aid of the assessee. The period between 2000, when the agreements were executed and 2003 when the company went public, have not seen seen any momentous developments along the lines of what the counsel for assessee has indicated. We thus conclude that the agreements entered into in March and April 2000 are stand alone incidents and not part of a design or scheme of business organization as projected, persuading us to take a conclusion different than what we have indicated above. As such, the agreement would have to be interpreted solely on its own strength. The counsel for Assessee relied upon the judgement of the Supreme Court in the matter of Vodafone International Holdings B V Vs. Union of India - 2012-TII-01-SC-LB-INTL and the decision of the Madras High Court in Commissioner of Income Tax Vs. High Energy Batteries (India) Limited for the proposition that in order to ascertain the legal nature of a transaction, one has to look at the entire transaction as a whole and cannot adopt a dissecting approach. In this context, the Supreme Court cautioned that the transaction should be 'looked at' and not 'looked through'. The burden on the assessee to establish that the transaction is bonafide and genuine has not been discharged, particularly in the light of the admitted facts set out by the AO relating to the continued control exercised by the assessee in the business. Therefore, the substantial question is answered in favour of the Revenue.

(See 2017-TIOL-1614-HC-MAD-IT)