SC Ruled Non – Compete Fees as Allowable Revenue Expenditure

Introduction
The Hon’ble Supreme Court (“SC”) held that non-compete fees are in the nature of revenue expenditure and thus, are eligible for deduction as per the Income Tax Act, 1961 (“the Act”). The SC observed that the payment neither created any new asset nor resulted in any income generating source. It therefore opined that, as long as the benefit from the expenditure pertains to business being run more efficiently and profitably, it will be considered
as revenue expenditure despite the benefit being enduring in nature. The said decision was given in the case of M/s Sharp Corporation vs CIT(A) New Delhi ¹ , for the Assessment Year (“AY”) 2001-02.

Facts of the case

• M/s. Sharp Business Systems (India) Pvt. Ltd. (“Assessee”) is a company incorporated on February 29, 2000, as a joint venture of M/s. Sharp Corporation, Japan and M/s. Larsen and Toubro Limited (‘L&T’). It is engaged in the business of importing, marketing and selling electronic office products and equipment in India.

• In AY 2001-02, the Assessee paid INR 3 Crore to L&T as non-compete fees for not setting up business of electronic office products in India for 7 years.

• The Assessee claimed it as deductible revenue expenditure in the Income Tax Return.

• Following the scrutiny and assessment proceedings, the Assessing Officer (“AO”) passed an order that the non-compete fees was capital expenditure due to its enduring advantage over 7 years, and hence added this to the income of Assessee.

• The aggrieved Assessee preferred the appeal before Commissioner of Income Tax (“CIT(A)”). In the course of appellate proceedings, he also put fourth alternative ground that if the fees is treated as capital expenditure, the Assessee should be provided the benefit of depreciation on the same. 

• The CIT(A) upheld the AO’s contention. In addition to the same, it disallowed the depreciation claim on the fees as the purpose of this expenditure was not proved. It submitted that there was no reason for Assessee to enter into a non-compete agreement with L&T as it was not a competitor and the business of the Assessee would not have been impacted by absence of such an agreement.  Hence, Assessee’s appeal got dismissed.

• The aggrieved Assessee preferred the appeal before Income Tax Appellate Tribunal, New Delhi (“ITAT”). The ITAT contended that the expenditure does not impact Assessee profitability. Therefore, the same could not be treated as revenue expenditure and should be treated as capital expenditure. Further, it submitted that just as the right to trade freely is not an asset, the right from non-compete agreement do not constitute an intangible asset.

• Aggrieved, the Assessee appealed to Delhi High Court (“HC”). The Hon’ble HC upheld the decision of CIT(A). It held that despite the expense being capital in nature, right of non-compete was a right only enforceable against L&T (i.e. right in persona).  As per the expression ‘similar business or commercial rights’ mentioned in Section 32(1)(ii) of the Act, the right should be enforceable against anyone (i.e. right in rem) to qualify as intangible asset eligible for depreciation.

Assessee’s Contention

• The Assessee submitted that the period over which the benefit is claimed cannot be the criteria for determining the nature of expenditure pursuant to cases CIT vs. Jute Company Limited² and CIT vs. Madras Auto Services Pvt. Ltd.³ 
• Further, relying on the cases CIT, West Bengal II, Calcutta Vs. Coal Shipments Pvt. Ltd.⁴ and Assam Bengal Cement Company Limited Vs. CIT⁵, the Assessee contended that when such expenditure results in benefit of enduring nature in the capital field, it would be treated as capital expenditure. However, when the same is incurred for carrying on business profitably without any addition to the profit earning apparatus, the same should be an allowable revenue deduction, irrespective of the period.

• The expenditure in current case merely facilitates carrying on the business more efficiently, leaving the fixed assets untouched. Further, the Assessee highlighted that it was not of personal nature and was wholly incurred for business in the relevant accounting year, thus satisfying all the conditions u/s 37(1) of the Act. He also clarified that due to this expense, there is no elimination of competition, nor does it create any monopoly.
• Hence, the Assessee contended that non-compete fees in current case should be treated as revenue expenditure eligible for deduction. 
• Alternatively, the Assessee submitted that should the expenditure be classified as capital, it must be eligible for depreciation under Section 32(1)(ii) as an intangible asset, irrespective of the fact that the right is positive or negative. This position was supported by the Bombay High Court’s ruling in CIT vs. Piramal Glass Limited⁶, which categorized non-compete fees as “commercial rights of similar nature,” and the Supreme Court’s decision in Techno Shares & Stocks Limited Vs. CIT⁷, which affirmed that intangible commercial rights qualify for depreciation benefits. Further, he contended that law does not require the distinction as to whether the rights are rights in rem or in personam for the same being eligible for depreciation.

Revenue’s Contention

• Revenue referred multiple case laws⁸ and contended that since the expenditure results in enduring benefit, the same constitutes capital expenditure.
• It further submitted that as per the principles of ‘ejusdem generis’, the term ‘any other business or commercial rights of similar nature’ is to be read with the preceding words i.e. ‘know-how, patents, copyrights, trademarks, licenses and franchises’ mentioned in Section 32(1)(ii) of the Act⁹. Referring to case CIT vs. Hindustan Coca Cola Beverages¹⁰, Revenue contended that these Intellectual property rights are all positive rights, and are capable of being owned and put to use for business. 
• In present case, the Assessee has only received the right to sue by payment of non-compete fees and it imposes an obligation on the recipient to desist from doing similar business, which is a negative covenant. Hence, there is no creation, usage or ownership¹¹ of any intangible asset. 
• Revenue contended that since this right cannot be owned or used, it is not eligible for depreciation.

Issues raised before the ITAT

1. Whether non-compete fee paid by the Assessee is a revenue expenditure or a capital expenditure? If capital expenditure, can Assessee claim depreciation benefit on the same?

Decision of Supreme Court

1. Whether non-compete fee paid by the Assessee is a revenue expenditure or a capital expenditure? If capital expenditure, can Assessee claim depreciation benefit on the same?

• As per section 37 of the Act, any residuary expenditure not covered u/s 30 to 36 of the Act, which is incurred for business purpose in the relevant accounting year and is not of capital nature, is allowed to be deducted. 
• The Hon’ble SC observed cases quoted by the assessee^2,3,4,5 and multiple other cases¹², and concluded that every benefit of enduring nature or making the payment ‘once for all’ don’t necessarily constitute capital expenditure.
• The SC opined that the understanding the nature of advantage in a commercial sense is material to classify the expenditure as revenue or capital. 

It held that the expense for acquisition of an asset or right of permanent character, is attributable to capital. On the other hand, if it is made for running the business & is an integral part of profit earning process, it is of revenue nature. 

• The SC contended that, in current case, the purpose of the non-compete fees, is to enhance the profitability of the business of the Assessee, by protecting the Assessee from competition, and there is no certainty that the Assessee would get the desired result. 
• The SC held that the non-compete fees does not constitute creation of any new asset or monopoly or accretion of profit earning apparatus, and hence, the enduring advantage in this case is not in the capital field. Thus, the same is allowed to be deducted u/s 37 of the Act as revenue expenditure. Further, it held that since the nature is not capital, the question of claiming depreciation on it is redundant and hence not considered. 

Conclusion
In this landmark judgement, the SC concluded that the non-compete fees are an allowable revenue expenditure under Section 37(1) of the Act and effectively reversed previous decisions that treated such fees as capital in nature, since it is paid to run business more efficiently and profitably by warding off competition, rather than to create a new capital asset or a new profit-earning apparatus. As the fixed assets of the business remain untouched and no monopoly is created, the “enduring advantage” gained is in the revenue field and not the capital, regardless of period of agreement.

1 Supreme Court, Civil Appeal No. 4072/2014
2 Empire Jute Company Limited Vs. Commissioner of Income Tax: (1980) 124 ITR 1
3 Commissioner of Income Tax Vs. Madras Auto Services (P) Limited: (1998) 233 ITR 468
4 CIT, West Bengal II, Calcutta Vs. Coal Shipments (P) Limited: (1971) 82 ITR 902
5 Assam Bengal Cement Company Limited Vs. CIT: (1955) 27 ITR 34
6 CIT vs. Piramal Glass Limited, Bombay HC, SLP(C) No. 719/2020
7 CIT vs. Techno Shares & Stocks Limited, Bombay HC, Appeal No. 556 of 2017
8 Empire Jute Company Limited Vs. Commissioner of Income Tax: (1980) 124 ITR 1,
Guffic Chem (P.) Ltd. Vs. CIT: (2011) 332 ITR 602,
CIT Vs. Bharti Hexacom Ltd.: (2023) 458 ITR 593,
Pitney Bowes India (P) Ltd. Vs. CIT: 2011 SCC Online Del 5114
9 Sree Durga Distributors Vs. State of Karnataka: (2007) 4 SCC 476,
Mohd. Shabir Vs. State of Maharashtra: (1979) 1 SCC 568
10 CIT Vs. Hindustan Coca Cola Beverages (P) Ltd: (2011) 331 ITR 192
11 Liquidators of Pursa Ltd. Vs. CIT: (1954) 25 ITR 265,
Mysore Minerals Ltd. Vs. CIT: (1999) 239 ITR 775
12 Atherton Vs. British Insulated and Helsby Cables Ltd.: (1925) 10 TC 155,
John Smith and Son Vs. Moore: (1921) 12 TC 266,
Alembic Chemical Works Co. Ltd. (supra)