SUPREME COURT CLARIFIES DEPRECIATION ON NON-COMPETE FEE U/S 32(1)(ii) OF INCOME TAX ACT

SUPREME COURT CLARIFIES DEPRECIATION ON NON-COMPETE FEE U/S 32(1)(ii) OF INCOME TAX ACT

REPORTBALE

SUPREME COURT OF INDIA 

CIVIL APPEAL NO. 4072 OF 2014

SHARP  BUSINESS SYSTEM THR. FINANCE DIRECTOR MR. YOSHIHISA MIZUNO

VERSUS

COMMISSIONER OF INCOME TAX-III N.D.

BRIEF FACTS OF THE CASE-

The Assessee, M/s Sharp Business System (India) Ltd., a joint venture of Sharp Corporation, Japan and Larsen & Toubro Ltd., incorporated in 2000, engaged in importing and marketing electronic office products in India. During Assessment Year 2001–02, the assessee paid a sum of ₹3 crores to L&T as non compete fee for restraining L&T from engaging in similar business for seven years. The Assessee claimed the payment as deductible revenue expenditure under Section 37(1) of the Income Tax Act, 1961. In the alternative, it sought depreciation under Section 32(1)(ii) treating the non compete fee as an intangible asset. The Assessing Officer disallowed the claim, holding the payment to be capital expenditure conferring enduring benefit, and further denied depreciation.

Appeals Preferred:

• CIT(A): Confirmed disallowance, holding L&T was not a competitor and the agreement lacked justification. (Para 7.4)
• ITAT (Delhi): Held non‑compete fee to be capital expenditure but not an intangible asset eligible for depreciation. ITAT held that the non-compete fee would not create intangible asset eligible for depreciation under the provisions of Section 32(1)(ii) of the Act. Thus, depreciation was not allowable on the expenditure made by the assessee as non-compete fee. (Para 7.6)
• Delhi High Court: Dismissed assessee’s appeal, holding the right acquired was only in personam and not a depreciable commercial right. It was held that the right acquired by the assessee by payment of non compete fee was a right in personam only against L&T for a period of 7 years. It was not a right in rem.  (PARA 7.7)
• Connected Appeals:

• Madras High Court (Arising out of SLP(C) No. 16277/2014) : HC decides the appeal in favour of the assessee by holding  that assessee was entitled to depreciation on non-compete fee, it being an intangible asset u/s 32(1)(ii) of the Act. 
• Madras High Court (Arising out of SLP(C) No. 24756 of 2014): High Court was of the view that non compete agreement and the various terms and conditions contained therein, binds the parties. Non-compete fee was, therefore, held to be an intangible asset and in terms of Section 32(1)(ii) of the Act, it would be a capital asset entitled to depreciation.
• Bombay High Court (subsequent appeal): Held that A non-compete fee provides an enduring benefit and protects the assessee against competition. The expression ‘or any other business or commercial rights of similar nature’ appearing in Section 32(1)(ii) is wide enough to include non-compete fee. Therefore, Bombay High Court was of the view that no question of law arose in this regard. 
• Supreme Court: The batch of appeals raised the perennial question whether non‑compete fee is capital or revenue expenditure, and if capital, whether it qualifies as a depreciable intangible asset under Section 32(1)(ii). 

ISSUE FOR CONSIDERATION-

The core issue which arises for consideration in the facts of this batch of appeals is whether non compete fee paid by the assessee is a revenue expenditure or capital expenditure? and If it capital, whether it qualifies as a depreciable intangible asset under Section 32(1)(ii). 

RELEVANT PROVISIONS-

Sub-section (1) of Section 37 reads as follows: (1) Any expenditure not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ‘profits and gains of business or profession’. 

This provision contemplates that any expenditure incurred wholly and exclusively for the purposes of the business shall be allowed in computing the income chargeable under the head ‘profits and gains of business or profession.’ For such an expenditure to be allowed, it should fulfill the following criteria:
i) it should not be an expenditure described in Sections 30 to 36;
ii) it should not be in the nature of capital expenditure or personal expenses of the assessee.

Analysis of the Judgment-

• Referring earlier precedents (Empire Jute, Madras Auto Services, Coal Shipments, Assam Bengal Cement) establish that the test of enduring benefit is not absolute; the nature of the advantage and its impact on the profit‑earning apparatus must be considered. In the present case, the Court found that non‑compete fee did not merely facilitate efficient business operations but created a lasting commercial right by eliminating competition for a defined period. 

• The Court referred to various judicial pronouncements on the point, has observed that the the idea of ‘once for all’ payment and ‘enduring benefit’ are not to be treated as something akin to statutory conditions. These concepts require flexibility and not a rigid approach. There is no single definitive criterion which by itself is determinative as to whether a particular outlay is capital or revenue.
• As long as the enduring advantage is not in the capital field, where 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 (assessee) by incurring of such expenditure, the court noted. 
• “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 (assesee) may still not achieve the desired result. In so far the present case is concerned, on account of payment of non-compete fee, the assessee had not acquired any new business and there is no addition to the profit making apparatus of the assessee. The assets remained the same. The expenditure incurred was essentially to keep a potential competitor out of the same business. Further, there is no complete elimination of competition. Such payment made by the appellant to L&T did not create a monopoly of the appellant over the business of electronic products/ equipments. 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”. 

CONCLUSION:- Supreme Court Held-

1.  Payment made by the appellant to L& T as non-compete fee is an allowable revenue expenditure u/s 37(1) of the Act.
2.  The Impugned judgment and order of the Delhi High Court passed in Income Tax Appeal is set aside. The question framed in paragraph 5 of this judgment is thus answered in favour of the assessee and against the revenue. Civil Appeal No. 4072/2014 is allowed. 

The Supreme Court remitted the connected appeals concerning the issue of non‑compete fee to the Income Tax Appellate Tribunal (ITAT), directing that they be adjudicated in accordance with the ratio laid down in the present judgment.