Non‑Compete Fees as Revenue Expenditure and Commercial Expediency in Intra‑Group Financing: Commentary on Sharp Business System v. CIT‑III (2025 INSC 1481)

Non‑Compete Fees as Revenue Expenditure and Commercial Expediency in Intra‑Group Financing: A Commentary on Sharp Business System v. Commissioner of Income Tax‑III, 2025 INSC 1481

I. Introduction

The Supreme Court of India’s decision in Sharp Business System thru Finance Director Mr. Yoshihisa Mizuno v. Commissioner of Income Tax‑III, N.D., reported as 2025 INSC 1481, is a significant pronouncement on two recurring issues in income‑tax law:

  1. Whether non‑compete fees paid by an assessee are to be treated as capital expenditure or revenue expenditure, and, if capital, whether they are depreciable as “intangible assets” under Section 32(1)(ii) of the Income‑tax Act, 1961.
  2. Whether interest on borrowed funds used to:
    • invest in a subsidiary to acquire/retain controlling interest, and
    • extend interest‑free advances to sister concerns and directors,
    is deductible under Section 36(1)(iii) on the ground of commercial expediency.

The Court, speaking through Justice Ujjal Bhuyan (with Justice Manoj Misra concurring), resolves conflicting High Court views on non‑compete fees, reaffirming and applying the classic capital vs. revenue expenditure tests laid down in earlier Supreme Court decisions such as Assam Bengal Cement, Coal Shipments, Empire Jute, Alembic Chemical and Madras Auto Services. It also reiterates the principle in SA Builders on commercial expediency in intra‑group financing.

While the Court finally classifies the non‑compete payment in Sharp Business System as revenue expenditure deductible under Section 37(1), it deliberately leaves open — for the other batch matters — the broader question whether non‑compete payments can ever qualify as depreciable intangible assets, remitting those appeals to the respective Income Tax Appellate Tribunals (ITATs) to reconsider in light of its reasoning.

II. Factual and Procedural Background

A. The Lead Case: Sharp Business System (Civil Appeal No. 4072 of 2014)

  • Assessee: Sharp Business System, a joint venture between Sharp Corporation (Japan) and Larsen & Toubro Ltd. (L&T), engaged in importing, marketing and selling electronic office products in India.
  • Transaction: In A.Y. 2001‑02, Sharp paid ₹3 crores to L&T under a non‑compete agreement whereby L&T agreed, for 7 years, not to set up, undertake, or assist in any business in India relating to selling, marketing or trading in electronic office products.
  • Return position: Sharp claimed the ₹3 crores as a revenue deduction under Section 37(1) as “non‑compete fee”.
  • AO’s view:
    • The payment secured an “advantage of enduring nature” by warding off competition for 7 years.
    • Held the amount to be capital expenditure and disallowed deduction.
  • CIT(A):
    • Rejected the claim that the non‑compete fee was revenue.
    • Also denied depreciation: held there was no justification to pay L&T (not a real competitor), the “true purport” of the expenditure remained unproved, and it was not for the assessee’s business.
  • ITAT:
    • Held the payment to be capital expenditure because it eliminated competition for a sufficiently long period to build market share.
    • Refused depreciation: a non‑compete right was not an “intangible asset” under Section 32(1)(ii) — it was not a “commercial right” akin to know‑how, patents etc.
  • Delhi High Court (appeal by assessee dismissed on 05.11.2012):
    • Agreed that the non‑compete fee was capital — it conferred an enduring benefit.
    • However, held it was not a depreciable asset:
      • The right was in personam (only against L&T), not in rem.
      • To qualify under the phrase “any other business or commercial rights of similar nature” in Section 32(1)(ii), the right had to be enforceable against the world at large (in rem), akin to the enumerated intellectual property (IP) rights.

Sharp appealed to the Supreme Court, contesting both the characterization as capital expenditure and the denial of depreciation in the alternative.

B. The Pentasoft and Piramal Glass Appeals (Non‑Compete Fee as Intangible Asset)

The batch also included appeals from the Madras and Bombay High Courts, all turning on whether non‑compete fees were depreciable intangible assets under Section 32(1)(ii).

1. Pentasoft Technologies (Madras High Court appeals)

  • Assessee: Pentasoft Technologies Ltd., engaged in software development, hardware sales, technical training and engineering services, with units both inside and outside Software Technology Parks (STPs).
  • Transaction: Pentasoft acquired the software development and training division of Pentamedia Graphics Ltd. and paid ₹180 crores as non‑compete fee under an agreement by which Pentamedia agreed not to compete in similar business for 10 years and to refrain from using the “Pentasoft” brand.
  • Return position: Claim for depreciation on:
    • intangible assets such as IPR, and
    • non‑compete fee.
  • CIT(A):
    • Treated non‑compete fee as an intangible asset — a commercial right or licence enabling exclusive use of “Pentasoft” brand and business.
    • Allowed depreciation under Section 32(1)(ii), applying Accounting Standard 26 (identifiability, control, and future economic benefits).
  • ITAT, Chennai:
    • Disallowed depreciation: non‑compete fee merely warded off competition and created only a right to sue for breach — not an asset usable like a licence or franchise.
  • Madras High Court:
    • In Tax Case (Appeal) No. 1195/2008 (A.Y. 2002‑03), held the non‑compete covenant was part of a composite agreement transferring the business, IPR and brand; the non‑compete right was a commercial right and therefore an “intangible asset” for depreciation.
    • In Tax Case (Appeal) No. 1134/2008 (A.Y. 2001‑02), followed its earlier decision for A.Y. 2002‑03 and again allowed depreciation.
    • In TCA No. 600/2010 (revenue appeal), it again upheld ITAT’s grant of depreciation.

The revenue appealed all these decisions to the Supreme Court. The central question in these appeals is not the allowability of the non‑compete payment per se (which all parties treated as capital), but whether such capitalised non‑compete payments qualify as depreciable intangible assets.

2. Piramal Glass Ltd. (Bombay High Court appeal)

  • Assessee: Piramal Glass Ltd. (formerly a subsidiary of Nicholas Piramal India Ltd.), operating glass manufacturing units in Gujarat.
  • Transaction: In A.Y. 1999‑2000, the assessee acquired the glass division from Nicholas Piramal and paid ₹18 crores as non‑compete fee.
  • AO/CIT(A): Disallowed depreciation on non‑compete fee, viewing it as unconnected with asset acquisition.
  • ITAT:
    • Held that if non‑compete fee is capital expenditure, it must be eligible for depreciation as an intangible asset.
    • Directed the AO to allow depreciation treating non‑compete fee as an intangible asset under Section 32(1)(ii).
  • Bombay High Court:
    • Noted favourable High Court precedent on depreciation for non‑compete fees.
    • Held that non‑compete fees confer enduring protection against competition and fall within “any other business or commercial rights of similar nature”.
    • Dismissed the revenue’s appeal, holding that no substantial question of law arose.

The revenue challenged this before the Supreme Court. In this appeal, there was also a separate, important issue regarding deduction of interest on borrowed funds — discussed below.

C. Piramal Glass: Interest on Borrowed Funds (Section 36(1)(iii))

In the Piramal Glass matter (A.Y. 2001‑02), the AO:

  • Disallowed ₹3.36 crores as interest on borrowed funds used to invest in shares of the Sri Lankan subsidiary, Ceylon Glass Company Ltd.:
    • Investment in subsidiary: ₹2,587.10 lakhs.
    • Interest‑bearing borrowings: ₹3,267.41 crores; interest debited: ₹38.22 crores.
    • AO’s reasoning: investment was for acquiring controlling interest, not for earning income; hence interest was not deductible.
  • Disallowed ₹99.49 lakhs as interest relatable to interest‑free advances to:
    • a director (₹3 lakhs), and
    • companies in which directors were interested (₹346.43 lakhs).
    • AO held borrowed funds were used for non‑business purposes and that assessee failed to show nexus; hence no deduction under Section 36(1)(iii).

CIT(A) upheld these disallowances. ITAT, relying on SA Builders Ltd. v. CIT, allowed the interest deduction, holding that:

  • Investment in the subsidiary was for commercial expediency (controlling interest and same line of business).
  • Interest‑free advances too were made for business purposes, and were therefore covered by Section 36(1)(iii).

The Bombay High Court affirmed ITAT’s decision. The revenue carried this to the Supreme Court as well.

III. Questions of Law Before the Supreme Court

The Supreme Court formulated the key questions as follows:

  1. Non‑compete fee: capital vs. revenue Whether the non‑compete fee paid by an assessee is revenue expenditure deductible under Section 37(1) or capital expenditure.
  2. Depreciation on non‑compete fee (if capital) If such expenditure is of a capital nature, whether it is an “intangible asset” within Section 32(1)(ii), being “know‑how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature”.
  3. Interest on borrowed funds (in Piramal Glass) Whether interest on borrowed funds:
    • invested in a subsidiary (to obtain/retain controlling interest), and
    • advanced interest‑free to sister concerns and directors,
    is allowable as business expenditure under Section 36(1)(iii) on the basis of commercial expediency.

IV. Summary of the Supreme Court’s Decision

A. Characterisation of Non‑Compete Fee

  • Non‑compete fee paid by Sharp Business System to L&T was held to be a revenue expenditure:
    • It did not create a new capital asset.
    • It did not add to or modify the profit‑making apparatus.
    • It simply protected or enhanced business profitability by restricting a potential competitor.
    • Any enduring advantage was not in the capital field.
  • The Court held that:
    Non‑compete fee only seeks to protect or enhance the profitability of the business, thereby facilitating the carrying on of the business more efficiently and profitably. Such payment neither results in creation of any new asset nor accretion to the profit earning apparatus of the payer.
  • Accordingly, Sharp’s payment of ₹3 crores to L&T was deductible under Section 37(1) as revenue expenditure.

B. Depreciation on Non‑Compete Fee

  • Because the non‑compete payment in Sharp was held to be revenue, the Court held that the question of depreciation under Section 32(1)(ii) (if treated as capital) did not arise in this case (para 31).
  • However, recognising that other appeals (Pentasoft, Piramal) had proceeded on the premise that non‑compete fee was capital and focused on depreciation, the Court:
    • Set aside nothing directly on depreciation in those cases.
    • Remanded the matters to the respective ITATs, directing that:
      all appeals/cross‑appeals filed are revived and heard afresh having regard to the ratio laid down in this judgment.
    • Allowed parties liberty to raise additional grounds based on the present judgment (para 34).

In substance, the Court has directed that before deciding on depreciation, tribunals must first freshly determine whether the non‑compete payment is really capital or, in light of this judgment, revenue.

C. Interest on Borrowed Funds (Piramal Glass)

  • The Court reaffirmed SA Builders Ltd. v. CIT and held that:
    • Interest on borrowed funds used to invest in a subsidiary company, in which the assessee has a deep business interest, and for acquiring/retaining controlling interest, is deductible under Section 36(1)(iii).
    • The decisive test is commercial expediency, not whether the borrowing directly yields income in the hands of the assessee.
  • On the facts:
    • The investment in Ceylon Glass Co. Ltd. (subsidiary in the same line of business) was found to be made for commercial expediency.
    • The long‑term interest of the assessee company in its subsidiary justified the interest deduction.
    • Similarly, interest‑free advances to sister concerns and directors were also treated as covered by commercial expediency per SA Builders, and deduction was upheld.
  • The Supreme Court affirmed the ITAT and High Court and dismissed the revenue’s appeal on this issue.

V. Detailed Legal Analysis

A. Capital vs. Revenue Expenditure and the Nature of Non‑Compete Fee

1. Statutory Framework: Section 37(1)

Section 37(1) of the Income‑tax Act is the residuary deduction provision for business expenditure. An amount is deductible under Section 37(1) if:

  1. it is an expenditure (i.e., not capital invested or returned capital),
  2. it is not covered by Sections 30‑36,
  3. it is not capital expenditure,
  4. it is not personal expenditure, and
  5. it is laid out or expended wholly and exclusively for the purposes of the business or profession carried on by the assessee during the relevant previous year.

The case turned on criterion (3): is non‑compete fee “capital” or “revenue” expenditure?

2. The Classic Judicial Tests

The Court revisits the line of authorities that have developed the tools to distinguish capital from revenue expenditure.

(a) Enduring benefit – Atherton and Assam Bengal Cement
  • Atherton v. British Insulated and Helsby Cables Ltd. (UK) propounded the well‑known test:
    When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade… there is very good reason… for treating such an expenditure as… capital.
  • Assam Bengal Cement Co. Ltd. v. CIT (1955) 27 ITR 34 (SC) adapted this to Indian law and held:
    • Expenditure to acquire or bring into existence an asset or advantage of enduring benefit for the business is normally capital.
    • Expenditure for running the business or working it to produce profits is revenue.
    • Expenditure relating to the framework or structure of the business is capital.
(b) Fixed vs. circulating capital – John Smith & Son v. Moore

The Court recalls Lord Haldane’s distinction:

Fixed capital is what the owner turns to profit by keeping it in his own possession; circulating capital is what he makes profit of by parting with it and letting it change masters.

If the expenditure brings into existence or modifies the fixed capital structure, it is capital; if it relates to circulating capital or day‑to‑day operations, it is revenue.

(c) Payments to ward off competition – Coal Shipments

In CIT v. Coal Shipments (P) Ltd. (1971) 82 ITR 902 (SC), the assessee paid a rival exporter under a verbal arrangement so that the rival would not export coal to Burma and would assist the assessee in procuring coal. The Court:

  • Rejected the revenue’s contention that the payment created a monopoly and was capital.
  • Emphasised that the arrangement was:
    • not for any fixed term,
    • terminable at will, and
    • linked to actual trading (shipments).
  • Held that the payments were revenue expenditure as they facilitated trading operations and did not create an enduring capital advantage.

The Court in Sharp Business explicitly draws on this reasoning to evaluate non‑compete payments.

(d) When “enduring benefit” test breaks down – Empire Jute

Empire Jute Co. Ltd. v. CIT (1980) 124 ITR 1 (SC) is pivotal. There the assessee bought additional “loom hours” from other mills under a restrictive agreement. The Court held:

  • Enduring benefit is not conclusive; not every enduring benefit implies capital expenditure.
  • The key question is:
    What is the nature of the advantage in a commercial sense?
  • Where the advantage:
    • merely facilitates trading operations,
    • enables the business to be carried on more efficiently or profitably, and
    • leaves the fixed capital structure untouched,
    the expenditure remains revenue even if the benefit endures.
  • In Empire Jute, no new asset was created; the profit‑making apparatus remained the same; it was only operated for longer hours — hence the payment was revenue.
(e) Business expediency and technical know‑how – Alembic Chemical Works

In Alembic Chemical Works Co. Ltd. v. CIT (1989) 177 ITR 377 (SC), a one‑time payment to obtain improved technical know‑how to produce more penicillin was held to be revenue expenditure. The Court held that:

  • Concepts like “once for all” and “enduring benefit” are not statutory conditions; they must be applied flexibly.
  • The critical inquiry is the purpose and effect of the outlay, in the context of business realities.
  • Where the payment is for better conduct and improvement of an existing business, rather than to acquire a new business or asset, it is revenue.
(f) Substituted revenue expenditure – Madras Auto Services

In CIT v. Madras Auto Services (P) Ltd. (1998) 233 ITR 468 (SC), the assessee demolished an old building (belonging to the landlord) and constructed a new one on leased land at its own cost in return for a long‑term lease at a nominal rent. The building always belonged to the landlord. The Court held:

  • The assessee acquired no capital asset; it merely obtained modern premises at a low rent.
  • The expenditure effectively represented savings in revenue expenditure (rent) over the lease term.
  • “Whatever substitutes for revenue expenditure should normally be considered as revenue expenditure.”
  • Thus the capital outlay was held to be revenue expenditure.

This reasoning is closely analogous to non‑compete payments that substitute for other forms of business‑facilitation costs.

3. Application to Non‑Compete Fee in Sharp Business System

Relying on this body of precedent, the Supreme Court interrogates the nature and function of the non‑compete fee paid by Sharp to L&T.

(a) What does a non‑compete fee achieve?
The Court describes non‑compete fee as:
  • a payment to restrain the other party from competing in the same line of business,
  • usually for a defined period and/or territory,
  • intended to give the payer a head start, protect its business, or enhance profitability by insulating it from competition.

Critically, the Court underscores:

  • Such fee “only seeks to protect or enhance the profitability of the business, thereby facilitating the carrying on of the business more efficiently and profitably.”
  • It does not result in creation of any new asset.
  • It does not represent accretion to the profit‑earning apparatus.
  • Even if there is an enduring advantage (e.g., 7 or 10 years), it is not in the capital field.
(b) No new business, no monopoly
On the specific facts of Sharp:
  • The payment:
    • did not acquire a new business for the assessee,
    • did not alter or enlarge the existing business apparatus, and
    • did not create a monopoly in electronic office products.
  • There was “no complete elimination of competition”; only one potential competitor (L&T) was kept out.

The Court explicitly notes (para 28) the uncertainty of benefit: even after paying non‑compete fee, the payer may or may not achieve the desired commercial result.

(c) Length of benefit is not determinative

The Court stresses that:

  • “The length of time over which the enduring advantage may enure… is not determinative of the nature of expenditure.”
  • So long as the advantage:
    • is not in the capital field, and
    • merely facilitates carrying on business more efficiently and profitably without touching fixed capital,
    the corresponding outlay remains revenue, “irrespective of the period over which the advantage may accrue”.
(d) The decisive characterisation

From this analysis, the Court concludes (para 29) that:

Payment made by the appellant to L&T as non‑compete fee is an allowable revenue expenditure under Section 37(1) of the Act.

This is a clear rejection of the Delhi High Court’s view that the same payment was capital expenditure, and it implicitly disapproves using the mere “enduring benefit” and “warding off competition” as sufficient to classify an expenditure as capital.

B. Depreciation on Non‑Compete Fee: Question Left Open but Reframed

The Court was invited to rule on whether non‑compete payments, if capital, constitute “intangible assets” within Section 32(1)(ii). Extensive arguments were advanced:

  • Assessees’ arguments (notably by Mr. Datar):
    • The phrase “any other business or commercial rights of similar nature” is intended as a wide, residual category for intangible assets, distinct from the enumerated IP rights (know‑how, patents, copyrights, trade marks, licences, franchises).
    • “Similar nature” refers to the genus “intangible assets used for business”, not to narrow common features like being “rights in rem” or “positive rights”.
    • Non‑compete covenants confer tangible commercial advantages and should be treated as “business/commercial rights”.
    • There is no statutory distinction, for depreciation purposes, between positive and negative rights.
  • Revenue’s arguments:
    • Invoked ejusdem generis to argue that “other business or commercial rights” must share critical characteristics with the enumerated rights — particularly:
      • they are positive rights, and
      • are inherently capable of being owned and used in business.
    • A non‑compete covenant is a negative obligation (a restraint on the other party), not a right that the payer “uses”.
    • The payer only acquires a right to sue on breach, which is not the kind of business/commercial right envisaged by Section 32(1)(ii).

The Delhi High Court had accepted a version of this argument, insisting that depreciable intangible rights must be rights in rem (against the world) and typically positive in nature.

However, the Supreme Court, once it held the non‑compete fee in Sharp to be revenue expenditure, expressly stated that the depreciation question (para 5.1) had become “redundant” (para 31) and did not adjudicate on:

  • whether non‑compete rights constitute “intangible assets”, or
  • whether the ejusdem generis / positive vs. negative / rights in rem vs. in personam distinctions are valid markers.

Instead, the Court restructured the approach for the other batch appeals:

  • ITATs must first determine, afresh, whether the non‑compete payments in those cases — on their own facts — are genuinely capital in nature or should now be seen as revenue expenditure under Section 37(1) following this decision.
  • Only if a payment is properly classified as capital does the question of depreciation under Section 32(1)(ii) arise.

The practical effect is to narrow the room for treating non‑compete fees as capital intangibles at all, thereby reducing the need to resolve the jurisprudential dispute on the scope of “other business or commercial rights of similar nature.” It is also a clear signal that several High Court decisions which had straightaway treated non‑compete fees as capital intangibles are to be reconsidered through the capital vs. revenue lens first.

C. Commercial Expediency and Interest on Borrowed Funds (Piramal Glass)

1. Statutory Provision: Section 36(1)(iii)

Section 36(1)(iii) allows as a deduction:

the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession.

Two conditions are crucial:

  1. There must be capital borrowed, and
  2. The borrowing must be for the purposes of the business or profession.

2. The SA Builders Principle

In SA Builders Ltd. v. CIT 288 ITR 1 (SC), the Court had held:

  • The core test is commercial expediency, not immediate profit.
  • Once nexus is established between the borrowing and a business purpose (including for the business of a sister concern in which the assessee has a deep interest), interest on the borrowing is deductible.
  • Income‑tax authorities cannot sit in judgment over how much expenditure is “reasonable” or how a prudent businessman should structure his affairs.
  • However, interest will not be deductible if funds are plainly diverted for personal purposes (e.g., directors using funds for personal benefit).

The Court in Sharp Business reiterates this principle and applies it to Piramal Glass.

3. Application to Investment in Ceylon Glass and Interest‑free Advances

  • The AO himself recorded that the investment in the Sri Lankan subsidiary was made to acquire controlling interest, not as a passive income‑yielding investment.
  • The assessee contended, and ITAT/High Court accepted, that:
    • the subsidiary operated in a similar line of business,
    • investment was made for business expansion and synergy, and
    • such integration was part of the assessee’s business strategy.
  • The Supreme Court agreed:
    • Investment in the subsidiary was for commercial expediency, squarely within the principle of SA Builders.
    • Therefore, interest on borrowed funds used for such investment was deductible under Section 36(1)(iii).
  • As for interest‑free advances to sister concerns and directors:
    • On the particular facts, the Court accepted that these, too, were covered by business purpose/commercial expediency, and thus interest remained deductible.
    • It reaffirmed that once business purpose is shown, the AO cannot second‑guess the prudence of such advances.

The Court therefore affirmed the ITAT’s and Bombay High Court’s decisions and dismissed the revenue’s appeal on this issue (paras 39–41).

D. Simplifying Key Legal Concepts

1. Capital vs. Revenue Expenditure (in plain terms)

  • Capital expenditure is money spent to:
    • acquire or improve a long‑term asset (like machinery, building, patents), or
    • alter or strengthen the basic structure of the business itself (e.g., setting up a new line of business).
  • Revenue expenditure is money spent on the day‑to‑day running of the existing business:
    • to generate sales,
    • to protect existing markets, or
    • to operate more efficiently and profitably without changing the capital structure.

Non‑compete fees, when they merely help the assessee run its existing business better (by fending off competitors) but do not create a new asset, are now squarely placed in the category of revenue expenditure.

2. Intangible Assets and “Business or Commercial Rights of Similar Nature”

Section 32(1)(ii) allows depreciation on:

  • specified intangible assets: know‑how, patents, copyrights, trade marks, licences, franchises, and
  • “any other business or commercial rights of similar nature”.

The controversy is whether “similar nature” requires:

  • similarity to the legal characteristics of the labelled rights (e.g., rights in rem, IP‑like, positive rights), or
  • similarity at a broader level (i.e., intangibility + business utility).

The Supreme Court, in this judgment, does not decide this question; instead, it focuses on whether the payment is capital or revenue in the first place.

3. Rights in Rem vs. Rights in Personam (and Positive vs. Negative Rights)

  • Right in rem: enforceable against the world (e.g., ownership of property, patents).
  • Right in personam: enforceable only against a particular person (e.g., a contractual promise between A and B).
  • Positive right: right to do something (e.g., exploit a patent).
  • Negative right: right to restrain others from doing something (e.g., someone agreeing not to compete).

The Delhi High Court had tried to limit depreciation to rights in rem and (implicitly) to positive rights. The Supreme Court in Sharp Business records opposing arguments but, crucially, does not endorse these distinctions as determinative in the context of Section 32(1)(ii).

4. Commercial Expediency

“Commercial expediency” refers to a decision made by a prudent businessman to benefit his business, even if:

  • the benefit is indirect,
  • the return is uncertain or long‑term, or
  • the immediate transaction is with a related entity (e.g., subsidiary or sister concern).

Under SA Builders and reaffirmed in this case:

  • The tax authority cannot dictate business strategy or insist on maximisation of profits.
  • If there is a clear business nexus (e.g., supporting a subsidiary, securing group‑level synergies), interest on the borrowed funds remains deductible.

VI. Impact and Implications

A. For Taxpayers Paying Non‑Compete Fees

  • The Supreme Court’s ratio is strong authority that, in many typical commercial settings, non‑compete payments will be treated as revenue expenditure where:
    • they protect or enhance profitability of an existing business,
    • they do not create or acquire a distinct business or asset, and
    • they do not restructure the capital framework or profit‑making apparatus.
  • Practically, this means:
    • The entire non‑compete payment is generally deductible under Section 37(1) in the year in which it is incurred (subject to general principles against artificial deferral/amortisation unless specifically required by law).
    • The need to litigate over depreciation under Section 32(1)(ii) becomes secondary; the primary contest will be whether the expenditure is capital at all.
  • However, fact patterns matter. If a non‑compete fee is part of a composite acquisition of a business (e.g., slump sale of a whole undertaking), revenue authorities may still argue that part of the consideration is capital. Post‑this judgment, tribunals must examine:
    • what exactly the assessee got in exchange for the payment, and
    • whether there is any change in the capital structure or acquisition of a separable asset.

B. For Depreciation Claims on Non‑Compete Payments

  • High Court decisions (Bombay, Madras, Gujarat, Karnataka) that had treated non‑compete payments as capital intangible assets automatically eligible for depreciation now stand on a weaker footing.
  • The Supreme Court’s remand instructions signal that:
    • Capital vs. revenue characterisation must be revisited first.
    • Only if the payment is properly characterised as capital should tribunals proceed to decide the Section 32(1)(ii) question.
  • This could lead to:
    • Many existing “non‑compete intangible” balances on corporate balance sheets being re‑examined.
    • Assessees potentially shifting arguments from “capital + depreciation” to “revenue deduction” where factually supportable.

C. For Interest on Borrowed Funds and Group Financing Structures

  • The judgment reinforces that:
    • Investment in subsidiaries, even for the purpose of acquiring/maintaining controlling interest, can be a valid business purpose.
    • Interest on borrowings used for such investments is deductible, provided commercial expediency is demonstrated.
    • Interest‑free advances to sister concerns/directors also attract deduction if they can be linked to bona fide business purposes, and not personal use.
  • For tax planning and compliance:
    • Corporate groups should carefully document the business rationale for inter‑company investments and advances (e.g., synergies, market entry, supply chain integration).
    • Boards should minute reasons showing that such advances are driven by business strategy, not mere accommodation.

D. For Pending and Future Litigation

  • All related appeals and cross‑appeals on non‑compete fee in the Pentasoft and Piramal matters have been revived and remanded to ITATs:
    • Tribunals must reconsider both parties’ appeals in the light of this judgment.
    • Parties may raise additional grounds (including arguing that what was previously capital is, in truth, revenue post‑this judgment).
  • Other taxpayers with pending disputes over non‑compete fees should:
    • Reassess their litigation strategy in light of the capital vs. revenue emphasis in this judgment.
    • Consider seeking to rely on this precedent to classify such expenditures as revenue, where factually appropriate.
  • For revenue authorities:
    • The judgment discourages simplistic reliance on “enduring benefit” or “warding off competition” as automatic markers of capital expenditure.
    • Officers must conduct a fact‑specific, commercial analysis of what the assessee actually obtained and whether the fixed capital structure changed.

VII. Conclusion

The Supreme Court’s decision in Sharp Business System v. CIT‑III clarifies two important areas of Indian income‑tax jurisprudence.

  1. Non‑Compete Fees The Court firmly anchors the characterisation of non‑compete payments in the capital vs. revenue framework developed in earlier cases. It holds that where:
    • the payment does not create a new asset or alter the profit‑making structure,
    • it merely protects or enhances profitability in an existing business, and
    • any enduring benefit is not in the capital field,
    non‑compete fees are revenue expenditure deductible under Section 37(1). This marks a significant shift away from treating such payments routinely as capital intangible assets eligible for depreciation, and restores primacy to the functional analysis of the expenditure.
  2. Interest on Borrowed Funds and Commercial Expediency By affirming the decision in SA Builders, the Court reiterates that commercial expediency — broadly and realistically understood — is the governing test for interest deductions under Section 36(1)(iii). Investments in subsidiaries and interest‑free advances to group entities can qualify, provided they serve a genuine business purpose. Tax authorities are reminded that they cannot substitute their judgment for that of prudent businessmen.

In combination, these holdings reinforce a business‑oriented, substance‑over‑form approach in tax adjudication, emphasising the real commercial purpose and effect of transactions rather than rigid or formalistic characterisations. The decision will likely influence the structuring of M&A and group financing transactions as well as the handling of existing non‑compete and intra‑group interest disputes across the country.

Case Details

Year: 2025
Court: Supreme Court Of India

Judge(s)

Justice Manoj MisraJustice Ujjal Bhuyan

Advocates

KAVITA JHA

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