Whether payment of non-compete fee is a revenue expenditure or capital expenditure? The Supreme Court faced with the abovementioned issue, ruled that the payment made to Larsen and Toubro (L&T) only to ensure that the appellant (taxpayer) operated the business more efficiently and profitably, cannot be considered as an expenditure incurred for acquisition of any capital asset or towards bringing into existence a new profit earning apparatus. That being the position, the payment to L&T as noncompete fee is an allowable revenue expenditure under Section 37(1) of the Income Tax Act.
On account of payment of non-compete fee, the Court found that the appellant had not acquired any new business and there is no addition to the profit-making apparatus of the appellant. The assets remained the same, and the expenditure incurred was essentially to keep a potential competitor out of the same business.
Therefore, the Court concluded that when there is no complete elimination of competition, then payment made by the appellant to L&T did not create a monopoly of the appellant over the business of electronic products/ equipment, and hence, such payment of non-compete fee cannot be treated as capital expenditure.
A Two-Judge Bench comprising Justice Manoj Misra and Justice Ujjal Bhuyan observed that the non-compete fee only seeks to protect or enhance the profitability of the business, thereby facilitating the carrying on of the business more efficiently and profitably. Such payment neither results in creation of any new asset nor accretion to the profit earning apparatus of the payer. The enduring advantage, if any, by restricting a competitor in business, is not in the capital field.
The Bench explained that the length of time over which the enduring advantage may enure to the payer is not determinative of the nature of expenditure. If the advantage merely facilitates in carrying on the business more efficiently and profitably, leaving the fixed assets untouched, the payment made to secure such advantage would be an allowable business expenditure, irrespective of the period over which the advantage may accrue to the payer (appellant) by incurring of such expenditure.
The non-compete compensation from the stand point of the payer of such compensation is so paid in anticipation that absence of a competition from the other party may secure a benefit to the party paying the compensation. However, there is no certainty that such benefit would accrue. Notwithstanding such an arrangement, the payer (appellant) may still not achieve the desired result, added the Bench.
Briefly, the appellant, engaged in the business of importing, marketing and selling electronic office products and equipment in India, and incorporated as a joint venture of M/s. Sharp Corporation, Japan and M/s. Larsen and Toubro Limited, had paid a sum of Rs. 3 crores to L&T as consideration for the latter not setting up or undertaking or assisting in the setting up of or undertaking any business in India of selling, marketing and trading in electronic office products for 7 years. The said amount of Rs. 3 crores was claimed as a deductible revenue expenditure in its return filed by the appellant as non-compete fee paid to L&T.
The AO noted that by making payment of Rs. 3 crores to L&T, appellant could ward of competition in business, and the object of making such payment to L&T was to derive an advantage by eliminating competition for a period of 7 years. According to the AO, such an expenditure had brought into existence an advantage of enduring nature and hence treated the payment of Rs. 3 crores as capital expenditure. Therefore, the said amount was added to the income of the appellant.
On appeal, the ITAT noted that the appellant by paying a non-compete fee of Rs. 3 crores to L&T had eliminated competition for a period of 7 years which is a duration long enough to establish its reputation and a reasonable market share would have been acquired by the appellant. Thus, the non-compete fee could be treated as capital expenditure. Further, ITAT held that the non-compete fee would not create intangible asset eligible for depreciation under the provisions of Section 32(1)(ii). Similarly a right arising out of a non-compete agreement would not constitute a commercial right falling within the ambit of intangible asset under Section 32(1)(ii) of the Income Tax Act.
On further appeal, the High Court affirmed that non-compete fee paid to L&T was a capital expenditure. However, it clarified that the right acquired by the appellant by payment of noncompete fee was a right in personam only against L&T for a period of 7 years. It was not a right in rem.
Appearances:
Senior Advocate Ajay Vohra, AORs Aniket Deepak Agrawal and Raj Bahadur Yadav, along with Advocates Vaibhav Kulkarni, and Akash Shukla, for the Appellant/ Taxpayer
Senior Advocates Arvind P. Datar and Rupesh Kumar, ASG S. Dwarkanath, AORs Rahul Gupta, Raj Bahadur Yadav and M. Upadhyay, along with Advocates Prakash Kumar, Amarjit Singh Bedi, Surekha Raman, Shreyash Kumar, Harshit Singh, Yashwant Sanjenbam, Prashant Singh Ii, Siddharth Sinha, Sonali Jain, Sarthak Karol, Rajat Vaishnaw, Mudit Bansal, S. Vijay Adithya, Aditi Dani, Prabhakar Yadav, and Abhyudey Kabra, for the Respondent/ Revenue
