Non-Compete Fee Paid to Ward Off Competition is Revenue Expenditure, Not Capital Asset: Supreme Court [Read Judgment]

The Supreme Court of India has ruled that non-compete fees paid by an assessee to prevent competition are allowable as revenue expenditure under the Income Tax Act, 1961, and do not amount to capital expenditure.

The case arose from a judgment of the Delhi High Court in Sharp Business System v. Commissioner of Income Tax, where the High Court had ruled in favour of the Revenue and held that the non-compete fee paid by the assessee was capital in nature and not eligible for deduction. The High Court had also held that such non-compete rights were not depreciable intangible assets.

Aggrieved by the Delhi High Court’s decision dated 5 November 2012, the assessee filed an appeal before the Supreme Court. Similar questions arising from conflicting judgments of the Madras and Bombay High Courts in connected matters were also placed before the Supreme Court.

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Sharp Business System, the assessee was engaged in the business of importing, marketing, and selling electronic office products in India. During the relevant assessment year, it paid a sum of Rs. 3 crore to Larsen & Toubro under a non-compete agreement, by which L&T agreed not to engage in competing business for a period of seven years. The assessee claimed this payment as revenue expenditure under Section 37(1) of the Income Act.

The Assessing Officer disallowed the claim and treated the payment as capital expenditure on the ground that it resulted in an enduring benefit by eliminating competition. This view was upheld by the Commissioner (Appeals), the Income Tax Appellate Tribunal, and the Delhi High Court.

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Before the Supreme Court, counsel for the assessee argued that the non-compete fee was paid wholly and exclusively for the purpose of business and did not lead to the creation of any capital asset. It was argued that the payment merely facilitated the efficient conduct of business by reducing competition and did not add to or alter the profit-making structure.

The assessee’s counsel also argued in the alternative that even if the payment was treated as capital expenditure, it should be eligible for depreciation as an intangible asset under Section 32(1)(ii) of the Income Act.

On the other hand, the Revenue argued that the payment gave the assessee an enduring advantage by keeping a competitor out of the market for a fixed period. The department argued that such advantage was capital in nature and that a non-compete right was only a negative covenant, which could not be treated as a depreciable intangible asset.

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A Bench of the Supreme Court comprising Justice Ujjal Bhuyan and Justice Manoj Misra observed that the test of enduring benefit is not decisive by itself and must be applied in a practical and commercial manner.

The court explained that non-compete fees are paid to protect or enhance business profitability and only help the assessee carry on its business more efficiently. The payment does not create any new asset, nor does it expand or modify the profit-earning apparatus of the business.

The court further observed that the absence of competition does not result in a monopoly or acquisition of a capital asset. It pointed out that the business structure of the assessee remained unchanged and that the payment merely facilitated smoother business operations.

Based on this reasoning, the Supreme Court held that

“we are of the considered opinion that payment made by the appellant to L&T as non compete fee is an allowable revenue expenditure under Section 37(1) of the Act.”

The judgment of the Delhi High Court was set aside, and the appeal filed by the assessee was allowed. In view of this conclusion, the court held that the question of depreciation on non-compete fees did not survive for consideration.

The Supreme Court also directed that other connected appeals involving similar issues be remanded to the respective Income Tax Appellate Tribunals to be decided afresh in light of the legal principles laid down in this judgment.

Senior Advocate Ajay Vohra represented the assessee and Additional Solicitor General S. Dwarakanath represented the Revenue before the Supreme Court.

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