Non-compete fee is revenue expenditure, tax deductible: Supreme Court

The Supreme Court on Friday ruled that non-compete fees paid by a company to restrain another entity from competing in the same line of business constitute revenue expenditure and are therefore allowable as deductions under the Income Tax Act, 1961.

Rejecting the income tax department’s contention that such payments amount to capital expenditure, the apex court said non-compete fees are typically paid to protect or enhance the payer’s business by giving it a competitive head start or insulating it from competition. Such payments, the court held, do not result in the creation of a new asset or add to the profit-earning apparatus of the business.

“The purpose of non-compete payment is to give a headstart to the business of the payer, protect its business or enhance its profitability,” the court said. Any enduring benefit that may arise from restricting competition does not fall in the capital field, as it merely facilitates the more efficient and profitable conduct of business, it added.

A bench comprising Justice Manoj Misra and Justice Ujjal Bhuyan observed that as long as the advantage obtained does not affect the fixed capital structure of the business, the expenditure incurred to secure such advantage would qualify as an allowable business expense, regardless of the duration over which the benefit may accrue.

The court also noted that payment of a non-compete fee is made in anticipation of potential benefits, with no certainty that the payer will actually derive the expected gains. “Notwithstanding such an arrangement, the payer may still not achieve the desired result,” the bench said.

Setting aside a 2012 Delhi High Court ruling, the Supreme Court held that the non-compete fee paid by Sharp Business System to Larsen & Toubro Ltd

. could not be treated as capital expenditure. The high court had earlier ruled against Sharp, holding that the payment resulted in an enduring advantage.

Sharp Business System, incorporated in 2000 as a joint venture between Sharp Corporation of Japan and Larsen & Toubro, was engaged in importing, marketing and selling electronic office products in India. During the assessment year 2001–02, the company paid ₹3 crore to L&T as consideration for the latter agreeing not to enter or assist in a competing business in India for seven years. Sharp claimed the payment as a deductible revenue expense.

The income tax department, however, disallowed the claim, arguing that the payment eliminated competition for a fixed period and created an advantage of enduring nature, warranting treatment as capital expenditure. The amount was consequently added back to Sharp’s taxable income.

Similar disputes involving companies such as Pentasoft Technology Ltd. and Piramal Glass Ltd. were also before the court. The Supreme Court said these matters should be remanded to the respective Income Tax Appellate Tribunals, with all appeals and cross-appeals revived and heard afresh in light of the legal principles laid down in its judgment.

The ruling is expected to have significant implications for corporate tax treatment of non-compete payments, particularly in mergers, joint ventures and restructuring transactions.