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Non compete fees

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Court :
Delhi High Court

Brief :
Non-compete fee paid to ward off competition but no period recorded in agreement - Since no capital asset created nor any advantage of enduring nature acquired, it is business expenditure, eligible for deduction

Citation :

NEW DELHI, MAR 26, 2008 : WHETHER an expenditure is capital or revenue in nature is a complex issue which can be decided based on facts of the individual case. In this high-profile case, involving Eicher Ltd, where a payment of Rs four crore was made as a non-compete fee to one of its employees and a rival company which had joined hands to come out with a potential competition in the two-wheeler segement, the High Court has held that since the assessee did not acquire any capital asset by paying non-compete fee and merely neutralised competition for a while, such an expenditure cannot be treated as capital expenditure. What makes it further clear is the fact that it was no clear from the records how long the restrictive covenant was to last - it was neither permanent nor ephemeral. In simple words, the assessee did not acquire any advantage of an enduring nature. There is also no evidence to indicate that the fee of Rs four crore was taken out of the capital of the assessee. Thus, such an expenditure is to be treated as business expenditure, eligible for deduction. Matrix of facts of the case : A full time employee of the Assessee called Vishwanathan had acquired, during the course of his employment, specialized knowledge of technology in the two-wheeler industry as well as of managing the dealership of the market place and other specialized knowledge relating to the two-wheeler business. Vishwanathan entered into an agreement with a company called VCPL to the effect that he would promote VCPL and collaborate with it to set up manufacturing facilities for two-wheelers upon his retirement from the Assessee. On coming to know of this, the Assessee negotiated a non-compete agreement with VCPL and Vishwanathan whereby the Assessee paid a sum of Rs.4 crores to VCPL so that VCPL and Vishwanathan would not carry out any business activity with regard to two wheelers. The Assessee claimed this amount as a business expenditure but it was disallowed by the Assessing Officer. The Assessee preferred an appeal, and the CIT(A) set aside the assessment order and held that the expenditure incurred was a business expenditure. The Revenue then preferred a second appeal, which was dismissed by the Tribunal. Thus the issue went to the HC. Before the bench the Revenue argued that there is nothing to show how the Assessee's business would be adversely affected if VCPL and Vishwanathan had a tie up. It is also submitted that there is nothing to show how long VCPL and Vishwanathan would not concern themselves with the two wheeler business to the advantage of the Assessee. As such, it is submitted that the payment made to Vishwanathan cannot be treated as a business expenditure. The Bench observed that, ++ These contentions were dealt with both by the CIT (A) as well as by the Tribunal. The undisputed fact is that the payment of Rs. 4 crores is to restrain or prevent VCPL and Vishwanathan from becoming potential business rivals of the Assessee. The payment is to protect the Assessee's business interests, its market position and profitability. No new asset is created thereby nor is the Assessee's profit making apparatus expanded or increased. The Assessee does not suffer any loss or diminution or erosion in its capital assets. On these conclusions, the CIT (A) and the Tribunal decided that the payment was allowable as a business expenditure and that it was not a capital expenditure. ++ The Bench admitted that there is no substantial reason for us to depart from the concurrent views already taken by the CIT (A) and the Tribunal. However, while taking a look at the facts it observed that eliminating competition over some length of time is important factor. While the length of time for which competition is eliminated may not strictly be decisive in all cases, yet, at the same time, it should not be so brief as to virtually be transitory. Applying various decided principles, the Bench concluded that the assessee did not acquire any capital asset by making the payment of non-compete fee. It merely eliminated competition in the two wheeler business, for a while. From the record, it is not clear how long the restrictive covenant was to last, but it was neither permanent nor ephemeral. In that sense, the advantage was not of an enduring nature. Thus, it is allowable revenue expenditure. (See 2008-TIOL-173-HC-DEL-IT in 'Income Tax' + 2008-TIOL-173-HC-DEL-IT in 'Legal Corner')
 

CA Praveen Chopra
on 26 March 2008
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