Income Tax - Payment of non-compete fee made to restrict competition in business is a revenue expenditure

Supreme Court Upholds Revenue Expenditure Deduction for Non-Compete Fee Landmark Judgment by Supreme Court Clarifies Non-Compete Fee as Revenue Expenditure Under Section 37(1) of the Income Tax Act

In a significant ruling, the Supreme Court of India has set a precedent by classifying non-compete fees as revenue expenditure, allowing them to be deducted under Section 37(1) of the Income Tax Act, 1961. The judgment was delivered by Justices Manoj Misra and Ujjal Bhuyan in the case of Sharp Business System v. Commissioner of Income Tax-III, N.D.

The case revolved around Sharp Business System, which paid Rs. 3 crores to Larsen and Toubro Limited (L&T) as a non-compete fee to restrict L&T from entering the electronic office products market for seven years. The Supreme Court overturned the Delhi High Court's earlier decision, which had treated this payment as a capital expenditure. The apex court emphasized that such payments do not create new assets or increase the profit-earning apparatus but merely enhance business efficiency and profitability, thus qualifying as revenue expenditure.

Justice Bhuyan, writing the judgment, highlighted the core issue of whether a non-compete fee is a capital or revenue expenditure. He underscored the principle that if the expenditure facilitates the business operations more efficiently without adding to the profit-earning apparatus, it qualifies as revenue expenditure. The court considered previous judgments, including Empire Jute Company Limited v. Commissioner of Income Tax and Madras Auto Services (P) Limited v. CIT, to affirm that enduring benefits must be in the capital field to be classified as capital expenditure.

The Supreme Court's decision is poised to have wide-ranging implications for businesses, potentially altering the landscape of tax deductions related to non-compete fees. It aligns with the judicial trend of flexibility in interpreting 'enduring benefit,' emphasizing business reality over rigid statutory conditions.

Furthermore, the court remanded related cases back to the respective Income Tax Appellate Tribunals for fresh hearings, allowing parties to raise additional grounds based on the present judgment. This judgment clarifies that businesses can deduct non-compete fees as revenue expenditure, facilitating greater financial leeway in structuring competitive strategies without the burden of capital expenditure classification.

In addition, the court addressed the issue of interest on borrowed funds used for investment in subsidiary companies and interest-free advances to sister concerns, affirming the deduction under Section 36(1)(iii) of the Act, provided the expenditure is for commercial expediency.

Bottom Line:

Payment of non-compete fee made to restrict competition in business is a revenue expenditure and deductible under Section 37(1) of the Income Tax Act, 1961. Additionally, interest on borrowed funds utilized for investment in a subsidiary company or for giving interest-free advances to sister concerns is allowable as a deduction under Section 36(1)(iii) of the Income Tax Act, provided the expenditure is for commercial expediency.

Statutory provision(s): Income Tax Act, 1961 Section 37(1), Section 36(1)(iii), Section 32(1)(ii)

Sharp Business System v. Commissioner of Income Tax-III N.D., (SC) : Law Finder Doc Id # 2824393