The Supreme Court of India has held that the payment of a non-compete fee constitutes revenue expenditure and is an allowable deduction under Section 37(1) of the Income Tax Act, 1961. The Court ruled that such expenditure, incurred to protect or enhance business profitability by eliminating competition, does not create a new capital asset or add to the profit-earning apparatus.
The Division Bench comprising Justice Manoj Misra and Justice Ujjal Bhuyan set aside the judgment of the Delhi High Court which had treated the non-compete fee as capital expenditure and denied depreciation on it.
Background of the Case
The lead appeal, Sharp Business System v. Commissioner of Income Tax-III, involved the assessee, a joint venture between Sharp Corporation, Japan, and Larsen & Toubro Limited (L&T). The assessee paid Rs. 3 crores to L&T as consideration for L&T not entering the business of selling, marketing, and trading electronic office products in India for seven years.
The assessee claimed this amount as a deductible revenue expenditure for the Assessment Year 2001-02. The Assessing Officer treated the payment as capital expenditure, reasoning that it brought an “advantage of enduring nature” by eliminating competition. The Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal (ITAT) upheld this view, further denying depreciation on the amount.
The Delhi High Court dismissed the assessee’s appeal, holding that the expenditure was capital in nature but did not result in a depreciable “intangible asset” under Section 32(1)(ii) of the Act, as it was a “right in personam” and not a “right in rem.”
Conversely, the Madras High Court and Bombay High Court, in connected matters involving Pentasoft Technology Limited and Piramal Glass Limited, had taken views favorable to the assessees, allowing depreciation on non-compete fees by treating them as intangible assets.
Arguments of the Parties
Mr. Ajay Vohra, learned Senior Counsel for Sharp Business System, argued that the expenditure was incurred wholly and exclusively for business purposes to run the business more efficiently. Relying on the Supreme Court’s decision in Empire Jute Company Limited v. Commissioner of Income Tax (1980), he contended that the “test of enduring benefit” is not conclusive if the advantage merely facilitates business operations without adding to the fixed capital. He argued that the payment did not create a monopoly or a new asset but only removed obstruction.
Alternatively, he argued that if treated as capital expenditure, it should qualify for depreciation as an “intangible asset” under Section 32(1)(ii) of the Act, akin to business or commercial rights.
Mr. Arvind P. Datar, learned Senior Counsel for Piramal Glass Limited, argued that while his client acknowledged the payment as capital expenditure, it was entitled to depreciation. He submitted that the expression “any other business or commercial rights of similar nature” in Section 32(1)(ii) is wide enough to include non-compete rights.
Additional Solicitor General S. Dwarakanath, appearing for the Revenue, supported the Delhi High Court’s view. He argued that the payment brought an enduring benefit, making it capital expenditure. Further, he contended that non-compete rights are “negative covenants” that cannot be “owned” or “used” like patents or trademarks, and thus do not qualify for depreciation.
Court’s Analysis
The Supreme Court analyzed Section 37(1) of the Act and various precedents, including Empire Jute Company Ltd., Alembic Chemical Works Co. Ltd., and Madras Auto Services (P) Ltd.
The Court observed that the distinction between capital and revenue expenditure depends on the nature of the advantage in a commercial sense. The Bench noted:
“If the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future.”
Applying this to the nature of non-compete fees, the Court stated:
“Thus 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 Court further held that the length of time over which the benefit accrues is not determinative. It emphasized that in the present case, the assessee did not acquire a new business or monopoly; the assets remained the same.
“Payment was made to L&T only to ensure that the appellant operated the business more efficiently and profitably. Such payment made to L&T cannot, therefore, be considered to be for acquisition of any capital asset or towards bringing into existence a new profit earning apparatus.”
Decision
The Supreme Court allowed the appeal of Sharp Business System, holding that the payment of Rs. 3 crores to L&T is an allowable revenue expenditure under Section 37(1) of the Act. The judgment of the Delhi High Court was set aside.
Regarding the connected appeals, the Court remanded the matters back to the respective ITATs to be decided afresh in light of this judgment.
Interest on Borrowed Funds
In the connected appeal of Piramal Glass Limited, the Court also addressed the issue of deduction of interest on borrowed funds under Section 36(1)(iii). The assessee had used borrowed funds to invest in a subsidiary company to acquire controlling interest.
Relying on S.A. Builders Ltd. v. CIT (2007), the Court affirmed the ITAT’s finding that the investment was made for “commercial expediency.”
The Court held:
“We agree with the finding recorded by the ITAT and affirmed by the High Court that assessee is entitled to claim allowance of interest on the funds invested in sister concern for acquiring of controlling interest.”
The Revenue’s appeal on this issue was dismissed.
Case Details:
- Case Title: Sharp Business System Thr. Finance Director Mr. Yoshihisa Mizuno v. Commissioner of Income Tax-III N.D. (and connected appeals)
- Case No.: Civil Appeal No. 4072 of 2014
- Citation: 2025 INSC 1481
- Coram: Justice Manoj Misra and Justice Ujjal Bhuyan
