Is expenditure incurred on a non-compete fee allowable revenue expenditure under Section 37(1) of the Income Tax Act?
Income Tax Act, 1961 — s.37(1) — Non-compete fee — Revenue expenditure — Wholly and exclusively for business — Treatment in books of accounts — Capitalisation — Alternate claim not decided by Tribunal — Appeal under s.260A —
Income Tax Act, 1961 — s.260A — Alternate claim left undecided below — Decision on merits —
Held: Where the claim under Section 37 had been on record from the assessment stage and every fact bearing on it was available, the High Court would decide it on merits though neither the CIT(A) nor the Tribunal had adjudicated it; the preliminary objection was rejected. (¶10, 11, 12)
Accounting treatment — Tax treatment —
Held further: How an amount is treated in the books does not govern its treatment for tax; capitalisation in the accounts was no reason to deny the claim. (¶14)
Income Tax Act, 1961 — s.37(1) — Non-compete fee — Revenue expenditure —
Held further: A non-compete fee paid to the promoters satisfied the ingredients of Section 37 and is allowable revenue expenditure; the Tribunal decision relied on below had been reversed by the Supreme Court. Appeal allowed. (¶15, 16)
Is expenditure incurred on a non-compete fee allowable revenue expenditure under Section 37(1) of the Income Tax Act?
Yes. Expenditure incurred on a non-compete fee is allowable revenue expenditure under Section 37(1) of the Income Tax Act. The fee paid so that the seller group would give up the right to carry on the peroxide business in India satisfied every ingredient of Section 37, and the Tribunal decision on which the authorities had relied had been reversed by the Supreme Court in similar circumstances. [¶13, ¶15]
Does treatment of an amount in the books of accounts determine its treatment for tax purposes?
No. Treatment of an amount in the books of accounts does not determine its treatment for tax purposes. The assessing officer refused the claim because the assessee had capitalised the payment in its accounts, but the settled position, stated in Kedarnath Jute Manufacturing Co., is that accounting entries do not decide how the law taxes an amount. [¶14]
Can the High Court decide an alternate claim under Section 37 of the Income Tax Act on merits where all facts relating to it are on record?
Yes. The High Court can decide an alternate claim under Section 37 on merits where all facts relating to it are on record. The Revenue objected that the question did not arise because the Tribunal had not considered it, but the claim had been on record since the assessment and the material was complete, so the Court rejected the preliminary objection and decided the issue. [¶10, ¶11, ¶12]
What did the High Court decide on the assessee's appeal?
The appeal was allowed and the substantial question of law was decided in favour of the assessee. The non-compete fee is to be allowed as expenditure under Section 37; the separate claim to depreciation on it had been rejected at the admission stage and was not revived. [¶3, ¶16]
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“12. Mr.Ravikumar raises a preliminary objection stating that as the claim under section 37 has not been considered, that issue does not arise from the order of the Tribunal. However, we do not propose to let that deter us, as the claim of expenditure is on record since the stage of assessment and all facts in relation to that claim are available on record. Hence, we proceed to decide the question on merits and reject the preliminary objection raised.”
“14. The assessing officer has rejected the claim as it has been capitalised by the assessee in its accounts. He also opines that the structure of the transaction did not justify the claim under Section 37. It is however a settled position that treatment in the books of accounts would not determine the treatment of the amount for tax purposes (See Kedarnath Jute Manufacturing Co Ltd v Commissioner of Income Tax, Central Calcutta[^1]).”
“15. We find that, the ingredients of Section 37 have been fully satisfied in this case. In Sharp Business Systems (India) Limited (supra) the Supreme Court, in similar circumstances as before us, has reversed the decision of the Income tax Appellate Tribunal, relied upon by the Tribunal, holding that the expenditure incurred on non-compete is an allowable revenue expenditure under Section 37(1) of the Act.”
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(Judgment of the Court was delivered by Dr.Anita Sumanth J.) This Tax Case (Appeal) has been filed by the assessee challenging order dated 13.10.2012 passed by the Income Tax Appellate Tribunal (in short ‘ITAT’/’Tribunal’) for assessment year (AY) 2003-2004 in ITA No.2212/Mds/2006.
The substantial question of law admitted on 03.03.2014 is as follows: Whether on the facts and the circumstances of the case, the Tribunal was right in holding that the expenditure towards payment of non-compete fee to the promoters of the assessee company is not an allowable expenditure?
The appellant had raised a second question in relation to the grant of depreciation under the Income-tax 1961 (in short ‘Act’) on non-compete fee, that had come to be rejected by this Court even at the time of admission on 03.03.2014 and that order has attained finality. Hence, what remains is only the question of allowability of non-compete fee as expenditure under Section 37 of the Act.
The question is to be set in the context of the following facts. A Company by name Sanmar Properties and Investments Ltd. (in short ‘Sanmar’) and three of its nominees had transferred certain equity shares in favour of a foreign company and two nominees. As a result of this transaction, the assessee became a 100% subsidiary of Atofina, France.
A share purchase agreement had been executed between the foreign company and Sanmar on 28.08.2002, providing for remittance of an amount of USD 7,50,000 by the appellant to Sanmar in consideration of the Managing Director of Chemplast Sanmar Ltd. agreeing to give up their right to carry on business in Atofina peroxide business in India for a period of 5 years.
The parties also entered into a separate agreement dated 11.10.2002 whereunder a sum of Rs.3,62,85,000/- (Rs.3.62 crores approx.), was to be paid by the appellant to Sanmar, in order for Sanmar to give up its right to the carry on the business of Atofina peroxide business in India.
The appellant had classified the right as an intangible asset, within the meaning of Explanation 3 to Section 32 of the Act, claiming depreciation at 12.5% thereupon.
The claim was taken up for examination by the assessing authority who found the same not justified, for various reasons. As far as this claim is concerned, relating to depreciation, the same has been dismissed at the time of admission of this appeal on 03.03.2014.
In the course of the assessment, an alternate claim had been put forth with respect to allowability of the expenditure under section 37 of the Act. The assessing authority however repelled the claim finding that the expenditure could not be characterised as incurred wholly and exclusively for the purpose of business. In fine, both claims, relating to Section 37 as well as depreciation came to be rejected.
The appellant filed a first appeal challenging both rejection of claim of depreciation as well as the disallowance of expenditure claimed as revenue. While the CIT (A), vide order dated 22.09.2006 finds against the assessee on the ground of depreciation, the ground in regard to claim under Section 37 was not adjudicated.
In second appeal before the Tribunal too, the assessee reiterated both claims, specifically raising a ground assailing non-consideration of the plea under section 37. The Tribunal, by way of impugned order dated 13.01.2012, rejected the appeal, following the ratio of the Delhi Bench of the Income tax Appellate Tribunal in the case of Sharp Business Systems (India) Limited v. DCIT ((2011) 140 TTJ (Del) 607) on an identical issue. The Tribunal also did not decide on the alternate contention relating to allowability under Section 37 of the Act. It is as against the aforesaid order that the present appeal has been filed.
Mr.Ravikumar raises a preliminary objection stating that as the claim under section 37 has not been considered, that issue does not arise from the order of the Tribunal. However, we do not propose to let that deter us, as the claim of expenditure is on record since the stage of assessment and all facts in relation to that claim are available on record. Hence, we proceed to decide the question on merits and reject the preliminary objection raised.
Mr.R.Venkatanarayanan, learned counsel for the appellant would submit that the non-compete fee is allowable as revenue expenditure as it was incurred wholly and exclusively for the purpose of business.
The assessing officer has rejected the claim as it has been capitalised by the assessee in its accounts. He also opines that the structure of the transaction did not justify the claim under Section 37. It is however a settled position that treatment in the books of accounts would not determine the treatment of the amount for tax purposes (See Kedarnath Jute Manufacturing Co Ltd v Commissioner of Income Tax, Central Calcutta1).
We find that, the ingredients of Section 37 have been fully satisfied in this case. In Sharp Business Systems (India) Limited (supra) the Supreme Court, in similar circumstances as before us, has reversed the decision of the Income tax Appellate Tribunal, relied upon by the Tribunal, holding that the expenditure incurred on non-compete is an allowable revenue expenditure under Section 37(1) of the Act.
In light of the above discussion, this Tax Case (Appeal) is allowed answering the substantial question of law in favour of the assessee. (A.S.M.,J.) (S.R.K.,J.) 15-09-2026
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