The Supreme Court on Thursday brought clarity to a question that has troubled tax officers and businesses alike for over two decades: how should non-compete fees be treated under income tax law? Hearing a batch of civil appeals involving Sharp Business System and other companies, the bench examined whether such payments are revenue expenses or capital assets-and what follows from that classification.
Background
The lead case arose from Sharp Business System’s payment of ₹3 crore to Larsen & Toubro in 2001–02, under a non-compete agreement barring L&T from entering the electronic office products market for seven years. The company claimed the amount as a deductible business expense. Tax authorities disagreed, calling it a capital outlay. Similar disputes from Madras, Bombay and other High Courts, involving much larger non-compete payments, were tagged together, reflecting conflicting judicial views across the country.
Court’s Observations
Writing for the bench, Justice Ujjal Bhuyan noted that the “real test” is not labels but the commercial effect of the payment. The court observed that a non-compete fee is paid to secure an advantage that endures over time by keeping competition away. “Such a benefit,” the bench remarked, “goes beyond day-to-day business operations and strengthens the business structure itself.”
At the same time, the court carefully examined whether this advantage qualifies as an intangible asset eligible for depreciation. It rejected the argument that only “positive rights” like patents or trademarks deserve depreciation. The bench observed that the Income Tax Act uses broad language-“any other business or commercial rights of similar nature”-and does not exclude rights arising from restrictive covenants. In simple terms, even a right that prevents someone else from competing can have real commercial value.
Decision
The Supreme Court held that non-compete fees are capital expenditure, not routine business expenses. However, it ruled that such payments do create an intangible asset, making them eligible for depreciation under Section 32(1)(ii) of the Income Tax Act. In doing so, the court set aside the restrictive view taken by the Delhi High Court in Sharp Business System’s case and affirmed the approach adopted by other High Courts. The appeals were accordingly disposed of, bringing much-needed certainty to corporate tax treatment of non-compete agreements.
Case Title: Sharp Business System (Through Finance Director Mr. Yoshihisa Mizuno) vs Commissioner of Income Tax–III
Case No.: Civil Appeal No. 4072 of 2014 (along with connected Civil Appeals Nos. 15048–15051 of 2025)
Case Type: Civil Appeal (Income Tax – Non-Compete Fee & Depreciation)
Decision Date: 2025