GST on Non-Compete Fees: A Key Consideration for Business Transactions

In the complex landscape of India’s Goods and Services Tax (GST), the tax treatment of non-compete fees has emerged as a critical area for businesses during mergers, acquisitions, or even employment contracts. Simply put, a non-compete fee is a payment made by one party to another in exchange for an agreement to refrain from conducting a similar business or profession within a specified geographical area and time period.

The central question is: Is such a payment subject to GST? The answer, as per prevailing law and rulings, is generally yes, GST is applicable.

The Legal Basis: Supply of a Service

GST is levied on the supply of goods or services. Under the CGST Act, “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” is explicitly deemed to be a supply of services (Schedule II, Para 5(e)).

A non-compete covenant perfectly fits this definition. The recipient (payer) is paying to secure an obligation from the provider (payee) to refrain from competing. This is not merely a passive promise; it is considered an actionable and valuable right granted for consideration, thus constituting a taxable supply.

Illustrative Authority: The Gujarat Urja Vikas Nigam Case

A significant precedent was set by the Supreme Court in the case of Gujarat Urja Vikas Nigam Ltd. vs. Chief Commissioner of Central Goods and Services Tax (2022). The Apex Court examined a payment made for a non-compete agreement ancillary to a share purchase. It ruled that such a fee, paid for the separate and distinct obligation not to compete, is indeed a taxable supply of service and not merely a part of the share sale (which is itself non-taxable as a sale of securities). This clarified that the taxability of a non-compete covenant is independent of the main transaction it accompanies.

Transactional Context and Valuation

The GST implications can vary based on the context:

1. As part of a Business Transfer or M&A: Often, a non-compete agreement is bundled with the sale of a business or shares. It must be segregated for GST purposes if separately valued in the contract. GST is levied on the specified non-compete fee.

2. In Employment Contracts: Payments made by a company to an employee or a departing promoter for a non-compete promise are also subject to GST, as it is a service supplied by the individual to the company.

3. Rate and Compliance: The service is classified under SAC 9997 as an “other service,” attracting a standard GST rate of 18%. The supplier (the party agreeing not to compete) must issue a tax invoice and discharge the GST liability, even if they are an individual or a firm not regularly liable for GST registration, as this constitutes a taxable business activity.

Conclusion and Prudent Action

The principle is clear: non-compete fees are generally taxable under GST. Businesses must exercise diligence in:

• Explicitly documenting the non-compete arrangement and its valuation separately in contracts.

• Ensuring GST compliance by the supplier, including registration, invoicing, and tax payment.

• Claiming Input Tax Credit (ITC) appropriately as the recipient, if the services are used in the course of furtherance of business.

Given the nuances, especially in high-stakes transactions, seeking expert advice is paramount to ensure accurate tax treatment and avoid future disputes with tax authorities. Proper planning turns a potential compliance risk into a managed aspect of the deal.