Indo Tech Electric Co vs. DCIT (Madras High Court)

Form of transaction can be ignored & Corporate Veil lifted if attempt is to “evade” taxes

The assessee, a partnership firm comprising of father & son, sold its business as a going concern to a limited company. The partners of the firm were the directors of the company. The company paid the assessee Rs. 1.25 crores towards “technical know-how”, Rs. 36 lakhs as “non-compete compensation for pending orders” and Rs. 33 lakhs as “non-compete compensation for future orders”. The entire amount of Rs. 1.94 crores was claimed to be a non-taxable capital receipt. However, the AO held the entire sum to be assessable as consideration for transfer of “goodwill” u/s 55. On appeal, the CIT (A) upheld the assessee’s stand with regard to the technical know-how & “non-compete compensation for pending orders” and rejected the balance. On cross appeals, the Tribunal upheld the stand of the AO on the ground that the arrangement to pay technical know-how etc was a “colourable device to evade tax” and the entire amount was assessable as “goodwill”. On appeal by the assessee, HELD dismissing the appeal:

(i) Given that the assessee was taken over as a going concern, it could not have been taken over without the so-called technical know-how. The assessee could not have sold the other tangible assets keeping with it the so-called technical know-how. Accordingly, the receipts for technical know-how and the compensation for non-competing fees are nothing but a part of composite receipt to diminish the value of the assets of the assessee. The assessee has termed the said amount as technical know-how in order to escape from the clutches of s. 55(2) under which goodwill is taxable. The assessee has clearly attempted to evade tax by claiming the amount received as goodwill into one of technical know-how in order to evade tax;

(ii) The question of non-compete fee does not arise given that the assessee was taken over as a going concern in its entirety by the new company. The partners of the assessee are the directors of the company and the consideration was paid to the assessee and not to the partners. There was no competition between the assessee and the new company;

(iii) Both the Tribunal and the AO have held that what was done by the assessee is clearly an attempt to evade tax in order to get over s. 55(2). It is a well settled principle of law that what is permissible is avoidance but not evasion. When an attempt is made by a company to evade tax it is the bounden duty of the authorities to lift the corporate veil and find out the real intention behind the same. It is the duty of the Court in every case, where ingenuity is expended to avoid taxing and welfare legislation, to get behind the smoke screen and discover the true state of affairs. The Court is not to be satisfied with form and leave well alone the substance of a transaction.