2011 (6) TMI 505 - AT - Income Tax

Non compete fees - Capital or revenue expenditure - Held that - L & T Ltd entered into the agreement with the assessee undertaken not to set up any undertaking or assist in setting up, undertaking any business in India of selling/marketing and trading of electronic office products for a period of 7 years in lieu of which payment of ₹ 3 crores had been received. Non-compete agreement between two parties is like personal services contract which is un-assignable. Personal services contract cannot survive on the demise of either of the parties - The payment has been made to ward off the competition for a period of 7 years during which any company could have set up its products and reputation in the market. Thus the payment for non compete fees is capital in nature As decided in Madras Industrial Investment Corpn. Ltd. v. CIT 1997 (4) TMI 5 - SUPREME Court wherein it was held that expenditure which is revenue in nature and is incurred to secure a benefit over a number of years can be spread over the period of benefit derived by an assessee - Since the expenditure incurred by way of non-compete fee is capital in nature, it cannot be allowed to be spread over for the period of seven years - against assessee.

Issues Involved:
1. Disallowance of Rs. 3,00,00,000/- non-compete fee as capital expenditure.
2. Treatment of non-compete fee as revenue expenditure.
3. Allowability of non-compete fee over the benefit period.
4. Depreciation claim on non-compete fee as an intangible asset.

Issue-wise Detailed Analysis:

1. Disallowance of Rs. 3,00,00,000/- non-compete fee as capital expenditure:
The first issue concerns the disallowance of Rs. 3,00,00,000/- paid to M/s. Larsen and Toubro Ltd. (L&T) as a non-compete fee, which the assessing officer treated as capital expenditure. The assessee argued that this payment was to facilitate its business operations and should be considered revenue expenditure. The assessing officer, however, held that the payment ensured no competition from L&T for seven years, thereby providing an enduring benefit, and thus classified it as capital expenditure. The CIT (Appeals) upheld this view, noting that L&T was not engaged in the business of electronic office equipment and the agreement was for a period of seven years, indicating that the expenditure was not solely related to the year under consideration.

2. Treatment of non-compete fee as revenue expenditure:
The assessee contended that the non-compete fee was paid to ward off competition temporarily and did not result in acquiring any capital asset. The payment was argued to be essential for securing the market share and protecting profitability, thus having a direct nexus with the business. The CIT (Appeals) disagreed, stating that the payment provided an enduring benefit by eliminating competition for a significant period, which aligns with capital expenditure characteristics. The Tribunal supported this view, emphasizing that the payment was made to establish the company in the market and acquire a market share, not merely to increase profitability.

3. Allowability of non-compete fee over the benefit period:
The assessee alternatively argued that if the expenditure was considered capital, it should be allowed over the benefit period of seven years. The Tribunal, referencing the Special Bench decision in Tecumseh India (P.) Ltd., held that since the expenditure was capital in nature, it could not be spread over multiple years. The Tribunal noted that while revenue expenditure benefiting multiple years could be spread, capital expenditure could not be treated similarly.

4. Depreciation claim on non-compete fee as an intangible asset:
The assessee claimed depreciation on the non-compete fee, arguing it constituted an intangible asset. The Tribunal examined Section 32(1)(ii) of the Income-tax Act, which allows depreciation on intangible assets like know-how, patents, copyrights, trademarks, licenses, and franchises. The Tribunal concluded that non-compete fees do not fall under the category of intangible assets as defined in the Act. Non-compete agreements are personal service contracts and non-assignable, unlike intellectual property rights, which can be transferred or sold. Therefore, the Tribunal denied the depreciation claim on the non-compete fee.

Conclusion:
The Tribunal dismissed the appeal, affirming that the non-compete fee was capital expenditure and not allowable as revenue expenditure. It also rejected the claim for depreciation on the non-compete fee, concluding it was not an intangible asset under Section 32(1)(ii) of the Income-tax Act. The Tribunal further denied spreading the expenditure over the benefit period, adhering to the principle that capital expenditure cannot be amortized over multiple years.

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