Bombay Hc Confirmed Addition Of Non-compete Fee Paid Under Restrictive Covenant Agreement

While upholding the ITAT’s order deleting disallowance of expenses incurred towards compensation for premature termination of Advertising & Sale Agreement, the Bombay High Court confirmed the addition of non-compete fee paid under Restrictive Covenant Agreement (RCA) by Assessee to Star India.

The Division Bench comprising of Justice K. R. Shriram and Justice Firdosh P. Pooniwalla observed that the payment of compensation is revenue in nature as the Assessee did not acquire any enduring benefit or any income yielding asset by avoiding certain business expenditure due to termination of the agreement.

The Bench also observed that the sum paid as non-compete fees is capital in nature but eligible for depreciation as an intangible asset.

Advocate Suresh Kumar appeared for the Appellant, whereas Advocate Dharan Gandhi appeared for the Respondent.

As per the brief facts, the Assessee had paid Rs.12.60 Crore as compensation for premature termination of Advertising & Sale Agreement and Rs.19.40 Cr. under RCA for restricting Star India for not competing against the Assessee in similar business for another two & half years. The AO however dismissed the claim made by the Assessee that such expenditure is revenue in nature and added the same considering it as capital expenditure under Section 28(va) of the Income Tax Act, 1961.

On appeal, the CIT(A) partly answered in favour of Assessee and deleted the addition of Rs.12.60 Cr. Made by AO by treating the same to be revenue expenditure. However, the CIT(A) sustained the addition of Rs.19.40 Cr. and allowed depreciation on the same treating it to be an intangible asset. The order passed by the CIT(A) was confirmed by the ITAT.

After considering the submission, the Bench referred to the decision of the Apex Court in case of Commissioner of Income Tax V/s. Ashok Leyland Ltd [(1972) 86 ITR 549 (SC)], wherein it was held that a payment made for termination of contract by way of compensation would be an allowable deduction in computing the total income of Assessee.

The Bench therefore highlighted that when an expenditure is made with a view to bring into existence an asset or an advantage for the enduring benefit of a trade, it shall, generally, be treated as an expenditure attributable to capital and not to revenue.

Proceeding further, the Bench observed that the Assessee, by terminating the services, saved the expense that it would have had to incur in the relevant Assessment Year and therefore, the termination of services was for business consideration and was a matter of commercial expediency.

While deciding the characteristic of the payment made under RCA as non-compete fees, the Bench referred to decision in case of Principal Commissioner of Income Tax V/s. Piramal Glass Ltd [IT Appeal No.556 of 2017], wherein it was held that the rights acquired by the assessee through non-compete agreement provides enduring benefit to the Assessee by protecting its business against competence from a person who had closely worked with the Assessee in the same business.

Thus, the Bench reiterated that the payment made under RCA as non-compete fee is eligible for depreciation under Explanation 3 to Section 32(1)(ii).

Cause Title: Pr. Commissioner of Income Tax v. Music Broadcast Private Limited [ITA No.675 OF 2018 / 2023-Enterslice-6-HC-Bom-IT]

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