Tax Insights
from India Tax & Regulatory Services
Allocation of part of consideration
for transfer of shares towards noncompete fee held not justified
October 18, 2016
In brief
Recently, the Mumbai bench of the Income-tax Appellate Tribunal (Tribunal), in the case of the
taxpayer,1 held that the total consideration received by the taxpayer from sale of shares was the “full
value of consideration” for computation of capital gain, and that no part of such consideration should
have been attributed towards non-compete fees.
In detail
Facts
rate of INR 615.75 per
share.
 The taxpayer1 was a
promoter and director in a
private company. The
company was engaged in
the business of software
training. The taxpayer and
Mr. A were shareholders of
the company with 50%
share each.
 The taxpayer had entered
into a separate arrangement
for managing the
operations of the Company
in the name of “continuity
incentive” and “engagement
contract” and was
sufficiently compensated
under those agreements.
 The taxpayer sold 28,421
shares (being 70% of his
shareholding) to B Limited
vide share purchase and
subscription agreement
(SPSA). The 28,421 shares
were sold for INR 1.75
crores, that is, at INR
615.75 per share resulting in
long-term capital gain of
INR 41.85 lakhs.
 The Tax Officer (TO) took
the view that the sales
consideration of INR 1.75
crores was inclusive of noncompete compensation
liable to tax as his business
income under section
28(va) of the Income-tax
Act, 1961 (the Act).
 Mr. A also sold 70% of his
shares at the rate of INR
615.75 per share. B Limited
made further investment in
the Company at the same
1
 The Commissioner of
Income-tax (Appeals) [the
CIT(A)] rejected the TO’s
stand.
Issues before the Tribunal
by the taxpayer, as “full value
of consideration” under section
48 of the Act, as against noncompete fees assessed by the
TO ?
Taxpayer’s contentions
 The transfer of shares was
at a mutually negotiated
price, and the TO was not
justified in allocating a part
of such price towards noncompete clause.
 B Limited confirmed the
basis of valuation and also
the fact that it had not paid
any non-compete
compensation to the
taxpayer.
 That the transaction price
constituted a fair value of
the shares was also
substantiated by the fact
that B Limited had also
invested in the Company at
the same price.
Did the CIT(A) err in treating
entire consideration received
ITA No. 3963 /Mum/2011
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Tax Insights
 The SPSA did not specify any
part of consideration to be a
non-compete fee.
 Even after the sale of the
majority of his shareholding,
the taxpayer continued to be a
minority shareholder, and also
remained actively associated
with the management of the
company.
 The non-compete clause
placed in SPSA was in the
nature of a standard clause.
 The TO had completely
ignored the existence of
“continuity incentive” and
“engagement contract” and
compensation received
thereunder.
Revenue’s contention
The SPSA had a specific clause on
non-compete fees, and the
consideration paid towards
purchase of shares was inclusive
of payment towards such noncompete clause that was
separately assessable as business
income under section 28(va) of
the Act.
PwC
Tribunal’s ruling
 The term “full value of
consideration received or
accrued” in section 48 of the
Act implied that it was the full
value of consideration for the
transfer of capital asset. The
price for transfer was arrived
at after due negotiations
between both parties.
Therefore, there could not
have been any question of
applying a lower market price
to determine the sale
consideration.
 Non-compete compensation
referred to in section 28(va) of
the Act applied to any sum
received for not carrying out
any activity in relation to any
business, or for not sharing
any intellectual property
relating to the business sold or
transferred. In the instant
case, the taxpayer was not
restricted from carrying out
any activity. In fact, the
taxpayer was actively engaged
in the day-to-day business
affairs, for which he was being
adequately compensated.
 The non-compete clause was
in the nature of a standard
condition in SPSA that could
not form the basis for
allocating part of
consideration towards noncompete compensation.
 Therefore, the total
consideration received by the
taxpayer from sale of shares
should have been treated as
full value of consideration in
computation of capital gain,
and no part of the said
consideration could be
attributed towards noncompete compensation.
The takeaways
The Tribunal concluded that if the
transfer of shares is at fair value,
allocation of a portion thereof to
non-compete compensation by
considering the transfer of shares
to be at less than fair value, was
not justified.
Let’s talk
For a deeper discussion of how
this issue might affect your
business, please contact your
local PwC advisor.
Page 2
Tax Insights
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