Non competes / negative covenants

This query is : Resolved

Sunil (Querist)
Follow

08 October 2012 Non Competes are liable to service tax in India.

In case of a contract of employment where there is an employer employee relationship, the salary paid is not liable for service tax. However, many of these employment contracts contain certain clauses imposing restrictions on the employee as a condition of employment itself. Example of such restrictions are say not to become a partner or proprietor in any firm. Even government imposes such restrictions by law that are spelt out in such contracts, eg. teacher not being allowed to give private tuitions.

Would such non competes in the employment contract in any way change the nature of the employment contract to a non compete agreement for purpose of Service Tax. Could it be read as the entire employment being the consideration for not doing those acts or is there a formula for taking part of the salary as employment contract and part of it towards act of forbearance? Basically there is no specific monetary consideration for the non compete.

Another scenario is similar to transfer of controlling stake in a company. Example is Kingfisher and Air Deccan where condition was imposed on Captain Gopinath that he could not run a scheduled airlines for 5 years. The basic agreement would have been to transfer the shares in the company which itself is not taxable. However, do the restrictions of forbearance imposed in any way change the nature of the contract? There may be no consideration per se for the act of forbearance but there could be a penalty for violation.

SARATHY RP

SARATHY RP (Expert)
Follow

09 October 2012 Dear Sunil,

Very nice situation explained by you. According to my limited understanding, unless each activity is backed by a separate consideration, it would be very difficult to bring to service tax those activities. The assessee can resort to Bundled Service concept, where the intention of each contract will play a major role. In the case of employer employee relationship explained by you, such conditions not backed by a separate consideration would not be a subject of levy. If Such consideration recieved by an employee specifically at the time of exit of service as a part of his final settlement would definitely be subject to service tax. The department has got recourse in the form of Section 67 & 66F. In the course of time, we would definitiely come across such cases.

Message likes : 1 times

Sunil

Sunil (Querist)
Follow

09 October 2012 Dear RP Sarathy,

True bundled service concept would come into play where salary is consideration of employment and the transfer of controlling interest comes under sale of securities.

If a consideration is given for forbearance during course of employment I think it is not leviable to service tax. Example is Doctor in Civil hospital receiving a consideration for not doing a private practice. It is left to be seen whether the forbearance is for a taxable or exempt service. To my mind, forbearance during subsistence of employer employee relationship will not fall under declared service as employer employee relationship is the essence of the contract itself as you rightly say with the bundled service concept.

You are right. Complications will come up.

Upgrade to CAclubindia Pro. Subscribe Now!