2012 (11) TMI 324 - HC - Income Tax

Non-compete fee - Revenue v/s Capital - Held that - The appellant is in a joint-venture between M/s. Sharp & L&T. Apparently, the agreement entered into with the L&T in view of the changed relationship ensures that the latter does not enter into the same business. Although it is contended that the advantage is only by way of facilitation of the appellant s business and ensuring greater efficiency as well as profitability, on the other side, what can be seen is that the arrangement is to endure for a substantial period, i.e. 7 years. Coupled with the fact that the L&T has its own presence in consumer goods sector and would be, if it chooses - able to put up an effective competition for business engaged in by the assessee, there is no doubt that the amount is to ensure a certain position in the market by keeping-out L&T. Applying the test indicated in the Empire Jute Company Limited Versus Commissioner of Income-Tax (1980 (5) TMI 1 - SUPREME COURT) have emphasized that a single test, i.e. whether the payment results in an enduring benefit cannot be conclusive in a decision as to whether an expenditure qualifies as one falling or in the capital field - this Court is the opinion that the deduction cannot be claimed as a revenue expenditure, it clearly falls within the capital field - in favour of the Revenue. Whether a non-compete right acquired for seven years amounts to a depreciable intangible asset - Held that - Each of the species of rights spelt-out in Section 32(1)(ii), i.e. know-how, patent, copyright, trademark, license or franchise as or any other right of a similar kind which confers a business or commercial or any other business or commercial right of similar nature has to be intangible asset . The nature of these rights mentioned clearly spell-out an element of exclusivity which enures to the assessee as a sequel to the ownership - the 7 years period spelt-out by the non-competing covenant brings the advantage within the public policy embedded in Section 27 of the Contract Act, which enjoins a contract in restraint of trade would otherwise be void. very species of right spelt-out expressly by the Statute - i.e. of the intellectual property right and other advantages such as know-how, franchise, license etc. and even those considered by the Courts, such as goodwill can be said to be alienable. Such is not the case with an agreement not to compete which is purely personal. - Thus it is to concluded that the words similar business or commercial rights have to necessarily result in an intangible asset against the entire world asserted to qualify for depreciation under Section 32(1)(ii) - depreciation not allowed - in favour of the Revenue.

Issues Involved:
1. Whether the non-compete fee paid was allowable as a revenue deduction.
2. Whether the non-compete fee was in the nature of capital expenditure.
3. Whether depreciation on the non-compete fee should be allowed if it is considered as capital expenditure.
4. Whether the Tribunal's conclusion was reasonable based on the position of law.

Issue-wise Detailed Analysis:

1. Allowability of Non-Compete Fee as Revenue Deduction:
The appellant, a joint-venture company, paid Rs. 3 crores to L&T to prevent it from competing in the electronic office products market for seven years. The appellant treated this amount as deferred revenue expenditure in its books and claimed it as a revenue deduction. The Assessing Officer (AO) disallowed the deduction, treating the non-compete fee as capital expenditure. The Tribunal upheld the AO's decision, reasoning that the payment was made to establish market presence and acquire market share, not merely to increase profitability. The Tribunal emphasized that the seven-year period was substantial enough to confer a capital advantage.

2. Nature of Non-Compete Fee as Capital Expenditure:
The Tribunal held that the non-compete fee constituted capital expenditure, referencing the CIT v. J.K. Synthetics Ltd. case, which states that expenditure for initial outlay or business extension falls under capital expenditure. The Tribunal reasoned that the payment to L&T was made at the start of the joint venture business, thus falling under capital expenditure. The appellant argued that the expenditure facilitated business operations without altering fixed capital, citing cases like Empire Jute Co. Ltd. v. CIT and Alembic Chemical Works Co. Ltd. v. CIT. However, the Court concluded that the non-compete fee provided an enduring benefit by keeping L&T out of the market for seven years, thus qualifying as capital expenditure.

3. Depreciation on Non-Compete Fee:
The appellant argued that if the non-compete fee is treated as capital expenditure, it should qualify for depreciation under Section 32(1)(ii) of the Income Tax Act, which covers intangible assets like know-how, patents, copyrights, trademarks, licenses, franchises, or other business or commercial rights of similar nature. The Tribunal rejected this claim, and the Court upheld this decision, stating that the non-compete agreement did not create an intangible asset akin to those specified in Section 32(1)(ii). The Court distinguished the non-compete right from other intangible assets by emphasizing its limited duration and personal nature, which does not confer an exclusive right to carry on business activities.

4. Reasonableness of Tribunal's Conclusion:
The Court examined whether the Tribunal's conclusion was reasonable based on the position of law. The Court noted that the Tribunal applied established legal principles and relevant case law to determine that the non-compete fee was capital expenditure and did not qualify for depreciation. The Court found no error in the Tribunal's reasoning and upheld its decision.

Conclusion:
The Court dismissed the appeal, holding that the non-compete fee was capital expenditure and did not qualify for depreciation. The Court emphasized that the non-compete agreement provided a substantial advantage by keeping L&T out of the market for seven years, thus falling within the capital field. The appeal was found to be meritless and was accordingly dismissed.

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