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High Court allows depreciation on non-compete fees

28 Nov 2013

The High Court of Madras (HC) in the case of M/s Pentasoft Technologies Ltd v. DCIT has held that non-compete fees paid by the taxpayer, as a part of bundle of other intangible rights obtained on purchase of a business division, is eligible for depreciation under section 32 of the Income Tax Act. Taxand India investigates the case which led to the judgment. 

The taxpayer acquired a business division from a seller company.  The following terms were set out in the Agreement:

  • Software business of the seller company was sold to the taxpayer
  • Seller company unconditionally transferred, assigned and permitted the taxpayer to use Intellectual Property Rights (IPRs), consisting of trade names, trademarks and service marks together with the goodwill associated therewith, copyrights, trade secrets etc
  • Seller company also agreed not to engage in similar business activities to compete with the software business for a period of 10 years, and also not to use the transferred IPRs

The Revenue Authorities (RA) disallowed the claim of depreciation made by the taxpayer on the consideration paid in respect of non-compete clause with the seller company. The RA had succeeded at the Tribunal level. The reason provided by the Tribunal for disallowing the depreciation on non-compete fee was that non-compete fee is not an asset, which the taxpayer could use like a license or franchise, and therefore it was not eligible for depreciation. 

The case was escalated to the High Court, who rejected the taxpayer’s contention that the non-compete clause was in the nature of an indirect license and observed that the Agreement in this case was a composite one, wherein the seller company had transferred its business division and IPRs to the taxpayer. The HC held that in facts of the present case the non-compete fee was paid to restrain the seller company from using the same IPRs that were purchased by the taxpayer.  

In view of this, it was held that the non-compete condition should be read as a supporting clause to the transfer of IPRs, which strengthened the commercial right (viz, IPRs) transferred to the taxpayer.  Accordingly, the HC allowed the depreciation on non-compete fee as being related to transfer of intangible assets.

Discover more:  High Court allows depreciation on non-compete fees 

Your Taxand contact for further queries is:
Mukesh Butani
T. +91 124 339 5010 

Also published in Thomson Reuters' Taxnet Pro, 29 November 2013

Taxand's Take

The issue of eligibility of depreciation on non-compete fee is a vexed one, with various judicial views being expressed by the Courts in past. Last year, the High Court of Delhi in case of Sharp Business System v. CIT had held that non-compete fees paid by the taxpayer to an outgoing joint venture partner would neither be allowed as revenue expenditure nor be considered eligible for depreciation. In that case, the Court had held that the all the commercial rights mentioned in section 32(1)(ii) of the Act clearly establish certain rights as against the world at large, whereas the advantage bestowed under a non-compete agreement is a restricted one enforceable only against the other contracting party.

The 2 High Court rulings are distinguishable on facts, and since in most transactions, the facts surrounding the non-compete payments are likely to be peculiar in each case, it seems that a conclusive legal position is some time away. 

Taxand's Take Author

Mukesh Butani
Taxand Board member