Supreme Court ruling holds non-compete fee is allowable as revenue expenditure

 The Hon’ble Supreme Court settled the long-standing controversy surrounding the tax treatment of non-compete fees and, based on the facts of the case held that such payments are allowable as revenue expenditure as it was incurred only to protect or enhance profitability of the business, thereby facilitating the carrying on of the business more efficiently and profitably.

Background

• Taxpayer has paid a non-compete fee to its joint venture partner to restrain it from undertaking the taxpayer’s business in India for a period of 7 years. This amount was claimed as revenue expenditure.
• The Assessing Officer treated it as capital expenditure and this view was upheld by the CIT(A), ITAT and the Delhi High Court.

Revenue’s Arguments:

• The payment resulted in an enduring advantage and therefore constituted capital expenditure.
• Relied on Delhi High Court ruling emphasising on common underlying feature of all the intangible assets is that they are positive rights.
• Argued that non-compete fee does not create any intangible asset, as covenants are negative restrictions, only exist but cannot be used. The Act does not envisage allowance of depreciation on rights/assets that are not inherently capable of being put to use for the purpose of business.

Taxpayer’s Arguments:

• Expenditure was made wholly and exclusively for the purposes of establishing and enlarging the business of the taxpayer.
• There is neither elimination of competition nor creation of any monopoly. The fee was made to protect and enhance business profitability and did not result in the creation of any new asset or addition to the profit-earning apparatus.
• Without prejudice, it was argued that depreciation should be allowed by treating the payment as intangible assets if the payment were to be treated as capital in nature.

Supreme Court:

• The non-compete fee was revenue in nature as the payment did not create any capital asset or monopoly and merely enabled the business to be carried on more efficiently.
• The Court observed that by payment of non-compete fees, taxpayer had not acquired any business and there is no addition to the profit-earning apparatus of the payer.
• The duration of the benefit is not a determinative factor for deciding nature of the expense, if the advantage was not in the capital field.
• Where enduring advantage is not in capital field and facilitates efficient and profitable business operations, leaving fixed assets untouched, payment is allowable expenditure.
• Relied on a ruling emphasising that the nature of advantage should be assessed in a commercial sense for determining of nature of expenditure. Expenditure improving efficiency or profitability without affecting fixed capital is revenue in nature, even if the benefit endures.

Interestingly, this ruling was rendered on the specific facts of this case, where non-compete fee was paid to joint venture partner in relation to an existing business, without acquisition of any new business and without complete elimination of competition. The other tagged cases have been remanded back by the Court, largely involving non-compete payments made in connection with business acquisitions, to the ITAT for fresh consideration. It will be interesting to observe how non-compete fees linked to acquisitions are characterised.

Key Takeaway
This ruling reinforces the principle that duration of an advantage is not, by itself, determinative of whether an expenditure is capital or revenue. There is no single criterion to determine the nature of the expense, however, the purpose and intended object of the expense are relevant considerations. The non-compete payments, when made to protect or facilitate the conduct of an existing business without creating a new asset or monopoly, qualify as an allowable revenue expenditure.