Tecumseh India vs. ACIT (ITAT Delhi Special Bench)

DATE: (Date of pronouncement)
DATE: August 2, 2010 (Date of publication)

Click here to download the judgement (tecumseh_non_compete_capital_revenue_expenditure.pdf)

Amount paid for non-compete rights while acquiring business is capital expenditure

Tecumseh USA, a global compressor manufacturer, was interested in entering the Indian market. It entered into a MOU with Whirlpool India & Whirlpool-USA under which Whirlpool-India agreed to sell its compressor business to the assessee, a wholly owned subsidiary of Tecumseh USA, for the total consideration of Rs. 52.5 crores. The agreement also provided that Whirlpool would not compete with Tecumseh. To give effect to the MOU, the assessee entered into an agreement dated 2.7.97 with Whirlpool India. The agreement provided a split of the consideration of up to Rs. 49.85 crores between land, building, inventories etc. The agreement provided that a separate non-compete agreement would be entered into which was entered into on 10.7.1997 and provided for a consideration of Rs. 2.65 crores. The period of non-compete was 5 years. The consideration of Rs. 52.5 crores agreed to in the MOU was accordingly bifurcated between the assets (Rs. 49.85 crores) and the non-compete covenant (Rs. 2.65 crores). The Special Bench had to consider whether the said payment for the non-compete was capital or revenue expenditure. HELD deciding against the assessee:

(i) The contention that the non-compete agreement should be considered separately from what was paid by the assessee to acquire the business is not acceptable. The terms of the MOU and agreement made it clear that the parties had agreed on the total consideration of 52.5 crores and it was allocated between the assets and the non-compete covenant. Accordingly, the non-compete agreement cannot be considered on a stand alone basis. All agreements form one transaction which are interwoven by a common thread. The agreements are not mutually exclusive as one cannot be fulfilled without fulfilling the other;

(ii) The general proposition of the assessee that in all cases of payment of non-compete fee, the purpose of making such payment is to maintain/protect the profitability of the business by insulating the same from the risk of competition and that it is, therefore, revenue in nature is not acceptable;

(iii) There are several tests formulated by Courts to distinguish between capital and revenue expenditure such as the test of initial outlay of the business, the aim and object of the expenditure, enduring benefit test and the test of fixed and circulating capital. These tests continue to be applicable even in the context of the modern situation. (Case Laws discussed in detail);

(iv) As the ‘non-compete agreement’ is part & parcel of the entire transaction of acquisition of business, it falls under the first test which is that if the expenditure is made for the initial outlay or for the expansion of business or a substantial replacement of the equipment, then, it is capital expenditure. The incurring of expenditure also brought enduring benefit to the assessee. In Assam Bengal Cement Company a period of five years was regarded as providing enduring advantage to the assessee irrespective of the fact that the payment was to be made annually. The argument that this was a case of acquiring monopoly rights is not right because in Coal Shipment it was held that even payment made to ward off competition from a rival dealer would constitute capital expenditure;

(v) Accordingly, the amount paid under the non-compete agreement is capital expenditure.

Note: In Real Image Tech 177 TM 80 (Che) and Medicorp Technologies 30 SOT 506 (Che) it was held that non-compete rights are an “intangible asset” and eligible for depreciation u/s 32(1)(ii) w.e.f. 1.4.1999. But also see Techno Shares & Stocks 323 ITR 69 (Bom) on the interpretation of the term “intangible asset”.

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  1. […] Note: Narendra Desai 214 CTR (Bom) 190 is impliedly approved. See Tecumseh India 127 ITD 1 (Del) (SB) for deductibility of non-compete expenditure. On whether non-compete rights […]