Non-Compete Fee Paid By Assessee Is Allowable Revenue Expenditure U/S 37(1) Income Tax Act: Supreme Court

The Supreme Court held that a non-compete fee paid by an assessee is an allowable revenue expenditure under Section 37(1) of the Income Tax Act, 1961 (ITA).

The Court held thus in a batch of Civil Appeals in which the perennial question that arose was whether an expenditure incurred by an assessee is capital or revenue. The core issue which arose for consideration was whether non-compete fee paid by the assessee is a revenue expenditure or capital expenditure.

The two-Judge Bench comprising Justice Manoj Misra and Justice Ujjal Bhuyan observed, “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. … That being the position, we are of the considered opinion that payment made by the appellant to L&T as non-compete fee is an allowable revenue expenditure under Section 37(1) of the Act.”

The Bench elucidated that the length of time over which the enduring advantage may enure to the payer is not determinative of the nature of expenditure.

Senior Advocate Ajay Vohra appeared for the Appellants, while Additional Solicitor General (ASG) S. Dwarakanath and Senior Advocate Arvind P. Datar appeared for the Respondents.

Factual Background

In the lead case, the Appellant-assessee was a company which was engaged in the business of importing, marketing, and selling electronic office products and equipments in India. It was incorporated in 2000 as a joint venture of M/s. Sharp Corporation, Japan and M/s. Larsen and Toubro Limited (L&T). During the assessment year (AY) 2001-02, assessee paid a sum of Rs. 3 crores to L&T as consideration for the latter not setting up or undertaking or assisting in the setting up of or undertaking any business in India of selling, marketing, and trading in electronic office products for 7 years. The said amount was claimed as a deductible revenue expenditure in the return of income filed by the assessee for AY 2001-02 as non-compete fee paid to L&T. Initially, the return was processed under Section 143(1) of ITA and thereafter, a case was selected for scrutiny whereafter notice under Section 143(2) was issued to the assessee.

Following assessment proceedings, Assessing Officer (AO) passed an assessment order wherein it was noted that by making payment of Rs. 3 crores to L&T, assessee could ward of competition in business. Therefore, the said amount was added to the income of the assessee. Aggrieved by such an order, the assessee preferred an Appeal before the Commissioner of Income Tax (Appeals) [CIT(A)], contending that non-compete fee should be treated as an allowable revenue expenditure. The CIT(A) dismissed the Appeal holding that such expenditure was not in the nature of revenue expenditure. The case went to the Income Tax Appellate Tribunal, New Delhi (ITAT), which affirmed the CIT(A)’s Order. This was challenged before the Delhi High Court, which dismissed the assessee’s Appeal and confirmed the challenged Order. Hence, the assessee was before the Apex Court.

Court’s Observations

The Supreme Court after hearing the contentions of the counsel, noted, “… 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 said that 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 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”, it observed.

Conclusion

The Court further noted that the assets remained the same and 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”, it added.

The Court was of the view that it would be appropriate if the matters are remanded back to the respective ITATs, all Appeals/Cross-Appeals filed are revived and heard afresh having regard to the ratio laid down in this Judgment.

Accordingly, the Apex Court allowed the Appeal and remanded back the case to the ITAT.

Cause Title- Sharp Business System v. Commissioner of Income Tax-III N.D. (Neutral Citation: 2025 INSC 1481)

Appearance:

Appellants: Senior Advocate Ajay Vohra, AORs Raj Bahadur Yadav, Aniket Deepak Agrawal, Advocates Vaibhav Kulkarni, and Akash Shukla.

Respondents: ASG S. Dwarakanath, Senior Advocate Arvind P. Datar, AORs Rahul Gupta, Raj Bahadur Yadav, Advocates Prakash Kumar, Amarjit Singh Bedi, Surekha Raman, Shreyash Kumar, Harshit Singh, Yashwant Sanjenbam, Sidharth Nair, Prashant Singh Ii, Siddharth Sinha, Sonali Jain, Sarthak Karol, Arun Kumar Yadav, Aditi Dani, Abhyudey Kabra, Rajat Vaishnaw, Mudit Bansal, S Vijay Adithya, Prabhakar Yadav, and Abhyudey Kabra.

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