2017 (4) TMI 1387 - HC - Income Tax

Categorization of expenditure of non-compete fee - either capital or revenue - nature of expenditure - Held that - The test of enduring benefit cannot be applied blindly without regard to the facts and circumstances that arise in the given case. Conclusion of the Tribunal that the payment has an enduring benefit and is capital in nature does not take into account the commercial benefit received by the company. In fact, the Tribunal appears to have been guided solely by an earlier decision rendered by it in the case of Asianet Communication 2005 (1) TMI 620 - ITAT CHENNAI . The assessee would incidentally point out that a copy of this decision was not circulated and hence reliance by the Tribunal on this decision is in itself incorrect. He would urge us to consider, as an alternate submission, the remand of the matter to the tribunal in order that he meet and distinguish this decision in full. The advantage of restraining the individuals from engaging in competition is in the field of facilitating its own business and rendering it more profitable. Since there is no increase in fixed capital, the payment does not encroach in the capital field. Though there was no actual or impending threat of the Directors severing their ties with the company or starting competing businesses, the possibility was always real and prudence dictates that the company protect itself against such a probability. This assumed particular significance at a time when the company was proposing to go public and it thus becomes vital that the public continued to see that the company was associated with, and had the benefit of services and loyalty of the individuals who had been, and were continuing to be, fundamental to the growth of the company. Thus we hold that the payments towards non-compete fee to Mr.Raja KSP Ganesan and Mr.R.G.Chandramogan constitute revenue expenditure in the hands of the appellant. The substantial questions of law are answered in favour of the appellant and against the revenue.

Summary

Issues:
1. Categorization of expenditure of non-compete fee as capital or revenue.
2. Correctness of disallowance of payment towards non-compete fee.
3. Application of the test of enduring benefit in determining the nature of the expenditure.

Issue 1: Categorization of expenditure of non-compete fee as capital or revenue:
The case involved the assessment of whether the expenditure of non-compete fee, incurred by the appellant company, should be classified as capital or revenue. The tribunal held the payment to be capital due to the enduring benefit provided by the restrictive covenant. The appellant argued that the payment was revenue in nature as it facilitated business operations without increasing fixed capital. The court referred to various judgments and emphasized that the test of enduring benefit should consider the commercial advantage received. The court concluded that since the payment did not affect fixed capital and aimed at rendering business more profitable, it should be treated as revenue expenditure.

Issue 2: Correctness of disallowance of payment towards non-compete fee:
The appellant contested the disallowance of the payment towards non-compete fee by the Income Tax Department. The department argued that the benefit obtained was enduring and hence capital in nature. However, the Commissioner of Income Tax (Appeals) initially ruled in favor of the appellant, considering the restriction placed on the directors as a business advantage. The tribunal later reversed this decision, leading to the appeal. The court analyzed the situation and concluded that the payments were revenue expenditure, ensuring the continued presence and support of the individuals in business operations without increasing fixed capital.

Issue 3: Application of the test of enduring benefit in determining the nature of the expenditure:
The court discussed the application of the test of enduring benefit in determining the nature of the expenditure. While acknowledging the importance of this test, the court highlighted that it should not be applied blindly and must consider the specific facts and circumstances of each case. The court criticized the tribunal for solely relying on a previous decision without fully assessing the commercial benefits received by the company. Ultimately, the court held that the payments towards non-compete fee were revenue expenditure, emphasizing the importance of retaining credibility and support in business operations without impacting fixed capital.

This detailed analysis of the judgment from the Madras High Court highlights the intricate legal considerations surrounding the categorization of expenditure, the correctness of disallowance, and the application of the test of enduring benefit in determining the nature of the expenditure in question.