Compensation for Business Closure is Taxable: Kerala HC
Last Updated on August 15, 2024 by NewsDesk SLC
Lately, the Kerala High Court made a decision that is likely to affect many business entities seeking exemption from taxation for amounts received for the purpose of winding up a business entity. In this decision, the law becomes more certain in a realm that was previously ambiguous and it extends the coverage of taxable activity further.
The case was about a company which received Rs. 40 crores from a foreign bank for exiting the commodity brokerage business. It said that this payment was in the nature of a capital receipt representing the value of the business that the company had let go of, and thus free from income-tax. However, the Kerala High Court, in this case, did not concur in such a view pointing out that the amount received as compensation would be treated as business income.
The main issue of concern in the court is the meaning that should be ascribed to Section 28(va)(a) of the Income Tax Act. This section indicates that where under an agreement, money is received to refrain from carrying out certain business, such amount is liable to taxation under business income. The court underlined that this rule is not restricted to the payment of non-compete fees alone but any fees for not carrying on a business. The court opined that the amount received by the company was for compliance with a negative plan set by the foreign bank to put an end to the company’s commodity brokerage operations. Due to this structure, the bank was in a position to consolidate its majority shareholding in the parent company of the firm. Therefore, the court held that the payment fell under Section 28(va)(a), and thus it can be charged as business income.
There are several reasons why this judgment is important. First, it increases the base of taxable income with the addition of an area that was poorly defined before. Second, it clears issues on the closure of businesses or their reorganization. Firms are now required to consider the impacts of such decisions from the taxation perspective and incorporate them as part of their finances.
While this decision might seem to impose a greater tax burden on businesses, it’s crucial to see it in the context of tax fairness. The court’s ruling ensures that companies can’t turn ordinary income into tax-exempt capital gains through business closure agreements.
However, this kind of judgment also raises controversy on how these transactions should be taxed. While some scholars have argued that rules governing exemptions should be elaborate, others have provided specific factors that need consideration including the nature of the business, duration of the agreement, and the level of compensation.
As such, whether one agrees or disagrees with the Kerala High Court’s judgement, it has set a precedent that is going to have significant bearing on the extent to which business exit structures will be eligible for tax relief. However, as the tax authorities and the businesses are shifting to adapt to this kind of reality, this ruling will still be subject to constant legal cases and debates in the future.
Case Law: Geojit Investment Services Ltd. Vs Commissioner Of Income Tax.
Written By: Amit Kumar Patra
