Summary
| Category | Data |
|---|---|
| Court | Supreme Court of India |
| Case Number | C.A. No.-004072-004072 – 2014 |
| Diary Number | 5229/2013 |
| Judge Name | HON’BLE MR. JUSTICE MANOJ MISRA |
| Bench | HON’BLE MR. JUSTICE MANOJ MISRA; HON’BLE MR. JUSTICE UJJAL BHUYAN |
| Precedent Value | Binding on all subordinate courts and tribunals |
| Overrules / Affirms |
|
| Type of Law | Direct tax—characterisation of expenditure; depreciation; interest deduction |
| Questions of Law |
|
| Ratio Decidendi |
The Supreme Court held that payments for non-compete agreements do not create a new asset or add to the profit-earning apparatus and merely facilitate business efficiency; therefore they fall on revenue account and are deductible under Section 37(1). The tests of “enduring benefit” and “fixed vs circulating capital” confirm that an advantage confined to improving trade operations, even if durable, remains revenue expenditure. Consequently, no depreciation under Section 32(1)(ii) is available since no intangible asset in rem is brought into existence. On interest claims, funds advanced for commercial expediency—even to subsidiaries or sister concerns—meet the requirement of nexus with business and are deductible under Section 36(1)(iii). |
| Judgments Relied Upon |
|
| Logic / Jurisprudence / Authorities Relied Upon by the Court |
|
| Facts as Summarised by the Court |
The appellant paid ₹ 3 crore in 2001-02 to prevent its partner L&T from competing for seven years; claimed deduction as revenue under Section 37 and alternatively depreciation under Section 32. Assessing Officer, CIT(A), ITAT and Delhi HC held the payment capital and denied depreciation. Supreme Court reversed, finding no new intangible asset and allowing full deduction. On interest, the respondent advanced borrowed funds to a Sri Lankan subsidiary and related parties; AO disallowed under Section 36(1)(iii). ITAT and Bombay HC held the advances served commercial expediency and allowed the interest deduction. |
Practical Impact
| Category | Impact |
|---|---|
| Binding On | All subordinate courts and tribunals |
| Persuasive For | High Courts and the Income-tax Appellate Tribunal |
| Overrules | Sharp Business System v. CIT (Delhi HC, 05.11.2012)—capitalisation of non-compete fee |
| Distinguishes | Madras HC’s Pentasoft decisions on intangible asset depreciation—remanded for reconsideration under this ratio |
| Follows | Coal Shipments (P.) Ltd.; Empire Jute Co. Ltd.; Alembic Chemical Works; SA Builders Ltd. |
What’s New / What Lawyers Should Note
- Clarifies that non-compete payments, even if they ward off competition for several years, do not create a capital asset and are revenue‐deductible under Section 37(1).
- Affirms that the “enduring benefit” and “fixed vs circulating capital” tests govern capital vs revenue characterisation.
- Confirms no depreciation under Section 32(1)(ii) on non-compete fees due to absence of intangible asset “in rem”.
- Validates deduction of interest on borrowed funds advanced to subsidiaries or sister concerns when done for commercial expediency under Section 36(1)(iii).
- Sets binding precedent overturning conflicting High Court rulings and guiding tribunals on classification of business-related payments.
Summary of Legal Reasoning
-
Residue provision and tests
- Section 37(1) allows deduction of any expenditure (not covered by Sections 30–36) wholly and exclusively for business, but not capital or personal.
- Capital vs revenue tests: enduring benefit (Atherton); fixed vs circulating capital (John Smith).
-
Non-compete fee characterisation
- Payment does not create a new asset or add to profit-earning structure; it simply aids business efficiency.
- Duration of benefit immaterial if advantage is not in the capital field.
- Applying Empire Jute and Coal Shipments: payment enabling extended use of existing capacity is revenue.
-
Depreciation under Section 32(1)(ii)
- Requires intangible assets in the nature of know-how, patents, trademarks, licences or similar rights owned and used.
- Non-compete fee produces a negative covenant (right to sue) and not a positive right or asset in rem; hence no depreciation.
-
Interest deduction under Section 36(1)(iii)
- Funds borrowed and invested or advanced to related companies for commercial expediency create nexus with business.
- SA Builders: income-tax authority must assess from a prudent businessman’s viewpoint, not substitute its own.
-
Outcome for other appeals
- Appeals on Pentasoft decisions (Madras HC) remanded to ITATs to apply this ratio.
- Interest‐on‐borrowed‐funds appeals allowed following commercial expediency principle.
Arguments by the Parties
Petitioner (Revenue)
- Non-compete fees yield an enduring commercial advantage akin to creating an asset; thus capital in nature and non-deductible under Section 37.
- Negative covenant cannot be “used” as an intangible asset eligible for depreciation under Section 32.
- Interest paid on borrowings for controlling stakes or non-business advances lacks nexus and should not be deductible under Section 36(1)(iii).
Respondent (Assessee)
- Non-compete payment merely ensures efficiency, leaves fixed assets intact, and is revenue expenditure deductible under Section 37(1).
- Alternatively, if capital, the payment confers a commercial right similar to licences and qualifies for depreciation under Section 32(1)(ii).
- Advances and investments for commercial expediency in related companies satisfy nexus and attract interest deduction under Section 36(1)(iii).
Factual Background
A joint-venture importer and marketer of electronic office equipment paid ₹ 3 crore to its partner L&T in AY 2001-02 to prevent competition for seven years. The return claimed it as revenue expenditure; AO, appellate authorities and Delhi HC treated it as capital and denied depreciation. Separately, a glass-manufacturing subsidiary advanced borrowed funds to its Sri Lankan sister concern and directors; AO disallowed interest; ITAT and Bombay HC allowed it as commercially expedient.
Statutory Analysis
- Section 37(1): Deduction of any expense wholly and exclusively for business, except capital or personal expenses and those covered by Sections 30–36.
- Section 32(1)(ii): Depreciation on intangible assets (know-how, patents, copyrights, trademarks, licences, franchises or other similar commercial rights) owned and used.
- Explanation 3 to Section 32(1): Defines intangible assets to include “any other business or commercial rights of similar nature.”
- Section 36(1)(iii): Deduction of interest on capital borrowed for purposes of business.
- Section 2(11): “Block of assets”—tangible and intangible assets classification.
Procedural Innovations
- Revives and remands conflicting appeals from Madras HC on Pentasoft depreciation for fresh adjudication under this ratio.
- Grants liberty to parties to raise additional grounds before ITATs in light of this judgment.
Alert Indicators
- 🚨 Breaking Precedent – overturns Delhi High Court on non-compete fee characterisation
- ✔ Precedent Followed – Coal Shipments (P.) Ltd.; Empire Jute Co. Ltd.; Alembic Chemical Works; SA Builders Ltd.
- 🔄 Conflicting Decisions – remands Madras HC Pentasoft appeals for reconsideration under unified ratio