Challenges on deductibility of non-compete fees

Article 19(1)(g) of India’s constitution permits every citizen to practise any profession, or to carry on any occupation, trade or business. This fundamental right means that the purchasers of a business always run the risk of competition from the sellers of the business. To safeguard the purchaser’s interests, the purchaser generally includes a non-compete fee while negotiating the business takeover price to prevent the seller from competing for a stipulated period of time.

Indian income tax law treats the receipt of non-compete fees as business income in the hands of payee. However, its treatment seems to be unclear from the perspective of the payer. Section 37(1) of the Income Tax Act, 1961, permits the deduction of expenses, other than capital or personal expenditures, incurred wholly and exclusively for the purpose of a business or profession. Although non-compete fees are incurred for the purpose of a business or profession, there has always been a debate with respect to their deductibility.

One test which is generally determinative of the deductibility of an expense is whether the expenditure incurred creates enduring benefit for the payer. If there is an enduring benefit, the expenditure is treated as a capital expenditure and therefore not allowable under section 37(1) of the act.

Economic Laws Practice is a full-service law firm with headquarters in Mumbai and offices in New Delhi, Pune and Ahmedabad. Pranay Bhatia is a partner at the firm and Hardik Choksi is an associate.