Non-Compete Fee Can Be Deducted As Revenue Expenditure Under Section 37(1) Income Tax Act: Supreme Court

The Supreme Court has held that payment of non-compete fee does not result in acquisition of a capital asset or alteration of the profit-making structure of the business, and is allowable as revenue expenditure under Section 37(1) of the Income Tax Act, 1961.

“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 observed.

A bench of Justice Manoj Mishra and Justice Ujjal Bhuyan allowed assessee Sharp Business Systems to claim deduction of Rs. 3 crores paid as non-compete fee to Larsen and Toubro Limited, holding the expenditure to be revenue in nature.

The Court passed the judgment in a batch of appeals arising from conflicting views of the Delhi, Madras and Bombay High Courts on whether non-compete fee can be treated as revenue expenditure or as a depreciable capital asset.

The core issue before the Court was whether non-compete fee paid by an assessee to restrain another entity from carrying on a competing business is revenue expenditure deductible under Section 37(1) of the Act, or capital expenditure. A connected issue was whether, if treated as capital expenditure, such payment qualifies for depreciation as an “intangible asset” under Section 32(1)(ii).

In the Sharp Business System case, the assessee had paid Rs. 3 crore to Larsen and Toubro Limited to restrain it from competing in the electronic office products business for seven years. The assessing officer treated the payment as capital expenditure, a view upheld by the Commissioner of Income Tax (Appeals), the Income Tax Appellate Tribunal and the Delhi High Court, which also held that depreciation was not allowable as the right was only personal against the payee.

In contrast, in cases relating to Pentasoft Technologies Limited and Piramal Glass Limited, the Madras and Bombay High Courts had held that non-compete fee constituted an intangible asset and allowed depreciation under Section 32(1)(ii).

The Supreme Court referred to various previous judgments on the distinction between capital and revenue expenditure. It noted that the distinction between capital and revenue expenditure cannot be decided by any single rigid test and must be assessed in a practical, commercial sense.

The Court highlighted that if an expenditure is incurred for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business in the capital field, it is capital expenditure, whereas if it is incurred for running the day-to-day business or working it with a view to earning profits, it is revenue expenditure.

The Court noted that the test of “enduring benefit” is not conclusive by itself and may break down in certain situations. What is material is the nature of the advantage in a commercial sense.

If the advantage merely facilitates the carrying on of business more efficiently or profitably while leaving the fixed capital structure untouched, the expenditure would be on revenue account, even if the benefit lasts for some time, the Court highlighted from previous judgments. Conversely, expenditure that relates to the framework, structure or profit-making apparatus of the business falls in the capital field, the Court noted.

Section 37(1) allows deduction of any expenditure laid out wholly and exclusively for the purposes of business or profession, provided the expenditure is not of a capital nature and is not covered by Sections 30 to 36.

Applying these principles to the facts of Sharp Business System, the Court held that the non-compete fee paid for a limited period did not create a new asset or add to the fixed capital of the assessee. The payment only enabled the assessee to operate its existing business more efficiently by reducing competition.

“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”, the Court observed.

The Court therefore held that the expenditure was revenue in nature and allowable under Section 37(1). The contrary view taken by the Delhi High Court was set aside. In view of this finding, the Court held that the alternative claim for depreciation under Section 32(1)(ii) did not arise in the Sharp Business System appeal.

The Court sent back the connected appeals involving the issue of non-compete fee to the ITAT, to be decided on the basis of the ratio laid down in the present judgment.

Case no. – Civil Appeal No. 4072 of 2014

Case Title – Sharp Business System Thr. Finance Director Mr. Yoshihisa Mizuno v. Commissioner Of Income Tax-III N.D.

Citation : 2025 LiveLaw (SC) 1241

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