Sharp can't use non-compete fee to lower tax outgo: Delhi High Court

MUMBAI: A company cannot use non-compete fee to lower its tax outgo, according to a recent order by the Delhi High Court.

The court accepted the income-tax department’s argument that non-compete fees are in the nature of capital expenditure and, therefore, not entitled to deduction.

The order was given on an appeal filed by the taxpayer company, Sharp Business System, a joint venture between Sharp Corporation, Japan and L&T India.

Sharp Business system is a company that imports, markets and sells electronic office products in India.

The taxpayer company paid Rs 3 crore to L&T as non-compete fees to stay out of the same business for seven years.

During the relevant year, the taxpayer company claimed deduction for the entire amount of non-compete fee.

The taxpayer company argued that it was entitled to deduction as the non-compete terms did not alter the fixed capital of the company, though it facilitated the business and, therefore, ought to be treated as revenue expenditure.

The assessing officer, however, disallowed the deduction on account of the non-compete fees on the ground that the non-compete terms provided a capital advantage of enduring nature to the taxpayer company.

The first appellate authority Commissioner Income tax (Appeal) and the second appellate authority Incometax Appellate Tribunal (ITAT) gave decisions in favour of the department.

Following this the taxpayer company moved the high court. The income-tax department argued that the non-compete fee had ensured that L&T stayed out of business for seven years.
Therefore, the company’s business was not threatened by the competition from L&T, its erstwhile partner for seven years. Therefore, the purpose of paying non-compete fees was not restricted to facilitating business as was claimed by the taxpayer company.

Further, there is a need to see whether the advantage of paying non-compete fees was short term or long term. In this case, the non-compete fees were paid to stay out of business for seven years. Therefore, the non-compete fee was in the nature of capital expenditure.