High Court allows depreciation on non-compete fees

 

The High Court of Madras (‘HC’) in the case of M/s Pentasoft Technologies Ltd v. DCIT [1]has held that non-compete fee paid by taxpayer, as a part of bundle of other intangible rights obtained on purchase of a business division, is eligible for depreciation under section 32of the Income-tax Act, 1961 (‘the Act’).

Facts in brief

· The taxpayer acquired a business division from a seller company. The following terms were set out in the Agreement:

- Software business of the seller company was sold to the taxpayer;

- Seller company unconditionally transferred, assigned and permitted the taxpayer to use Intellectual Property Rights (‘IPRs’), consisting of trade names, trademarks and service marks together with the goodwill associated therewith, copyrights, trade secrets etc;

- Seller company also agreed not to engage in similar business activities to compete with the software business for a period of 10 years, and also not to use the transferred IPRs.

· The Revenue Authorities (‘RA’) disallowed the claim of depreciation made by the taxpayer on the consideration paid in respect of non-compete clause with the seller company.

· The RA had succeeded at the Tribunal level. The reason provided by the Tribunal for disallowing the depreciation on non-compete fee was that non-compete fee is not an asset, which the taxpayer could use like a license or franchise, and hence it was not eligible for depreciation.

Taxpayer’s contentions

· It was contended that the right granted to it under the non-compete clause are in the nature of a license. The non-compete fee is in fact an indirect license to carry on the business for a period of 10 years. Hence, the taxpayer is entitled to claim depreciation.

· It was alternatively submitted that the non-compete fee should be considered as revenue expenditure since it was to enable the taxpayer to carry on its business smoothly without interruption by the seller company.

RA contentions

· It was argued that transfer of compete fee is not a commercial right as it is not in the nature of the other positive rights enumerated in Section 32(1)(ii) of the Act[2].

· It was further submitted that the right over the trade mark is a right in rem (ie, a right enforceable against anyone in the world) whereas the non compete right is a right in personam (ie right enforceable against a particular person).

HC decision

· Though the HC rejected the taxpayer’s contention that the non-compete clause was in the nature of an indirect license, it observed that the Agreement in this case was a composite one, wherein the seller company had transferred its business division and IPRs to the taxpayer. The HC held that in facts of the present case the non-compete fee was paid to restrain the seller company from using the same IPRs that were purchased by the taxpayer.

· In view of the above, it was held that the non-compete condition should be read as a supporting clause to the transfer of IPRs, which strengthened the commercial right (viz, IPRs) transferred to the taxpayer. Accordingly, the HC allowed the depreciation on non-compete fee as being related to transfer of intangible assets.