Whether when agency agreement between assessee and non-resident continues

Whether when agency agreement between assessee and non-resident continues even after expiry but no royalty is paid, compensation paid for formal termination of contract is akin to loss of profit making apparatus, and thus, is capital receipt - NO: ITAT

MUMBAI, AUG 23, 2011: THE issue before the Tribunal is - Whether when the agency agreement between the assessee and the non-resident continues even after expiry but no royalty is paid during this period, compensation paid to the assessee after many years later for formal termination of the agreement is akin to loss of profit-making apparatus, and thus, is capital receipt. NO, rules the ITAT.

Facts of the case

The assessee company, engaged in the business of sales and manufacture of vibration analysing equipments, had entered into a joint venture agreement with IRD Mechananalysis Inc. USA in March 1979, renewed in October 1990, whereby the assessee was entitled to make use of the trade name / patents of IRD, USA and its associate concerns besides being licensed to manufacture for sale of certain products in India. The company had thus established its market presence in India under the name of "IRD Mechanalysis". The assessee had also entered into a separate Sales Representative Agreement with IRD, U.K. in respect of goods and products produced by the UK company, which were not manufactured by the assessee in India. The agreement had continued since January 1989, having been renewed in 1992, under which the assessee company received commission for sales. The joint venture agreement had expired in 1992 but continued thereafter without the approval of the Central Government until it was terminated in 2000-01, whereby no further royalty was paid, and the assessee was duly compensated for the termination of the joint venture. The sales representative agreement was terminated during the assessment year 2003-04.

The assessee had claimed the compensation received for termination of the joint venture as a capital receipt exempt from tax as it was for loss of capital or intangible asset. Following the cessation of collaboration, in view of the non-availability of technical assistance hitherto rendered by M/s Entek IRD UK, the assessee had made payment to its sister concern M/s Concast India Ltd, towards design engineering consultancy and technical support for submission of quotations for large value tender enquiries and claimed this amount as professional fees. The assessee had also claimed deduction on commission payments made to M/s Mistry Engineers, a proprietary concern of the relative of one of the directors.

The AO disallowed the professional fees paid to Concast India on the ground that there was no evidence to prove whether such services were taken by the assessee. It was held that the assessee merely handled Sales Representation for Entek IRD and had not obtained any consultancy from them towards designs for tender quotation in the last few years. Besides being unable to prove the genuineness of the transaction, the assessee company already employed a good enough number of engineers and technical personnel as its own employees whereby there was no business requirement for such consultancy. The entire technical fees paid to Concast India were disallowed. The AO also disallowed the sales commission paid to Mistry Engineers on the ground that the assessee failed to furnish the bills as required besides which it had its own large team of qualified personnel to carry out the job of sales and services. This payment of commission was thus unreasonable and unwarranted and disallowed under section 40A(2). The AO also disallowed the compensation received by the assessee on termination of the joint venture. The assessee being unable to file a copy of the joint venture agreement which expired in 1992, the AO held that the assessee had no joint venture with the foreign collaborator during the year 2001-02 and 2002-03, the period when the separation from M/s Entek IRD International Ltd., U.K. had occurred. Thus the assessee company had been acting as trading agent on behalf of Entek IRD International of UK and the termination was of the agency and not that of any joint venture, corroborated by the non-payment of any royalty, as required in the case of joint venture.

In appeal before the CIT(A) the assessee submitted that while the consultancy fees paid by the assessee were assessed to tax as income in the hands of Concast India, as business expenses these were disallowed. The CIT(A) allowed the claim holding that Concast India had rendered the services as there was no engineer engaged for designing in the assessee company. Payment had been made for business purpose and was hence allowable as business expenditure. Similarly, the commission paid to M/s Mistry Engineers had been allowed earlier and accepted as genuine, whereby there was no justification for making this disallowance. Both these disallowances were deleted. However, ruling in favour of the Revenue, the CIT(A) confirmed the taxability of the compensation received by the assessee towards termination of collaboration under section 28(ii), holding that there was no joint venture collaboration in existence during the relevant assessement years as no royalty had been paid by the assessee to Entek IRD of UK. Therefore the sum, received from Entek IRD U.K. was not on account of a termination of joint venture which had already expired in the year 1992.

Having heard the cross appeals, the Tribunal held that,

++ regarding the consultancy fees paid by the assessee, in response to the CIT(A)'s query, the AO had specifically stated that the evidences of services rendered by Concast India had been verified and found in order. If the AO had considered the payment as unreasonable, under sec 40A(2), he should have determined the reasonable charges, having regard to the market rate for such services. Revenue had not brought in any further evidence whereby the CIT(A) decision was confirmed regarding the allowability of the professional fees paid to M/s. Concast India;

++ regarding commission payment to M/s Mistry Engineers, the AO had accepted the evidence and similar commission payment by the assessee to the same party had also been accepted by the department. There was no further evidence to doubt the commission payment. The order of the CIT(A) deleting this disallowance was therefore upheld on account of consultancy charges paid to M/s Concast India and on account of commission paid to M/s Mistry Engineers. Thus the appeal filed by the Revenue was dismissed;

++ regarding the taxability of the compensation, the assessee had claimed that the income earning apparatus of the company had been lost on the termination of the joint venture agreement, impairing the complete manufacturing apparatus and trading structure of the assessee company from gaining any income. But the facts proved otherwise. The assessee had not renewed the collaboration agreement but taken the help of M/s Concast India for providing the technical knowhow for continuation of the business. This showed that the termination of collaboration was replaced by technical consultancy support from M/s Concast India. The royalty payable to M/s Entek IRD, UK for the technical assistance was replaced by technical fees, which had been upheld as business expenditure. Under the circumstances therefore, the joint venture had not resulted in any serious impairment of the profit making apparatus of the assessee, which had continued the business. Further, the collaboration agreements did not provide for payment of compensation on termination. Therefore, the payment made by M/s. Entek IRD was towards the termination of the agency agreement which was terminated during the year under appeal. Hence the amount received by the assessee was business income under section 28(ii). The CIT(A) order, upholding the payment as a revenue receipt, was therefore confirmed and the appeal of the assessee dismissed.