Takeover Code, Contract Act, Competition law - non compete clauses have made headlines in all these areas of law. But now, non-competes have the tax department foxed! Payaswini Upadhyay reports on why non-competes have become a taxing issue!
The Income Tax Act treats know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature as intangible assets and allows tax payers to claim depreciation on all these.
Taxpayers have contested before Tribunals across the country that depreciation should be allowed on payments made in the nature of non-competent fees as they amount to a commercial right. The tax department has argued that non-compete is not a commercial right as it is a negative right that cannot be construed either as a license or as a commercial right eligible for deduction.
BM SinghFormer Chairman, CBDT“The point is this was an amendment made to Section 32(1)(ii) – in 2005 I think- that they were allowing deduction of depreciation on intangible assets like patents etc. Before that no deduction on depreciation was being allowed. After the amendment, persons started asking for a claim of deduction on depreciation on the amount paid as non-compete fee. And it has been the stand of the department that this is not something on which a taxpayer is allowed a deduction of depreciation.”
Last month, the Madras High Court became the first High Court to strike down the tax department’s view in the case of Pentasoft Technologies. It looked at the transfer of Intellectual Property Rights and non-compete as a composite agreement and concluded that when a business acquisition is made, non compete payment to the seller is an intangible right as it helps the buyer in strengthening its business assets. And so, such payments are eligible for depreciation claim.
Pranay BhatiaPartner, ELP“In my view, this is the right way of reading it because when you pay a non-compete fee to not allow someone to do a particular business, then you are really getting a commercial right against the whole world- that entity cannot do that activity against the whole world as it is a right in rem and therefore eligible for depreciation as an intangible asset.”
BM SinghFormer Chairman, CBDT“The Madras High Court has not given much reasoning as to why they were allowing it as a deduction except to say that this was in line with other rights which a taxpayer could acquire such as patents and license etc. And they allowed Pentasoft’s appeal to claim deduction on depreciation of non-compete fee.”
The Madras High Court is the only High Court so far to have allowed the claim of depreciation on non-competes. In 2012, the Delhi HC had disallowed such a claim saying for a right to qualify as an intangible asset, it should be in rem i.e. as against the worLd and should also be transferable. There is another Delhi High Court decision in play here.
In 2011 – the Delhi High Court had in the Hindustan Coca Cola Beverages case ruled goodwill to be a depreciable item. In 2012 the Chennai ITAT used that decision to distinguish between goodwill and non-compete and ruled that unlike goodwill, non-compete is an outcome of an agreement entered into between two parties and does not represent any intangible asset. Hence it cannot be depreciated.
Pranay BhatiaPartner, ELP“If you look at the Hindustan Coca Cola decision i.e. the Delhi HC decision – it talks of whether goodwill is an intangible and therefore eligible for depreciation. It has gone into explaining that goodwill is an intangible and therefore eligible for depreciation because it’s a commercial right. Chennai Tribunal has taken that decision and said when you look at goodwill, it is a commercial right but when you look at non-compete it is not similar and they brought out that distinction. They have not really relied on the Delhi HC order but they’ve taken its help to say why a non compete is not eligible for depreciation.”
Last week the Hyderabad ITAT relied on that Chennai ITAT decision to deny Mylan Laboratories depreciation on a non-compete. So in toto – there are a bunch of ITAT decision saying no to depreciation on non-competes. there’s a Delhi High Court ruling from 2012 that says to qualify as an intangible asset a non-compete should be against the world and transferable and now there is the Chennai High Court decision that doesn’t impose any such burden in ruling non-competes as depreciable.
BM SinghFormer Chairman, CBDT“It’s a very grey area for the time being – I think the department will continue to agitate till the highest court. And try to see what they can get as a decision. Its an amount which has gone out from the coffers on the taxpayer – of course its not a revenue expenditure. It does not appear to fall squarely under the provisions of Section 32 that provides for depreciation. So how it would pan out in the end is difficult to say.”
Like most other cases – this one too will be ultimately decided only when it has its day in the Supreme Court. Till then non-competes are depreciable…or not, depending on which decision you want rely on.
In Mumbai, Payaswini Upadhyay
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