Article on Non - compete Fees
Article on Non - compete Fees

    Depreciation U/S 32 on Non Compete Fees

    Meaning of Depreciation:
    Depreciation as per law of lexicon is defined as positive decline in the real value of a tangible asset because of consumption, wear and tear or obsolescence. The concept of depreciation is widely used for the purpose of writing off the cost of an asset against profit over an extended period (its depreciable life), irrespective of the real value of the asset. Depreciation is charged against income or the profit and loss account, and there are different methods of calculating it like straight line method or written down value method. The Income-tax Act save and except for undertaking engaged in generation and/or distribution of power the method of computing the depreciation is WDV method.

    Conditions for Claiming Depreciation [ Section 32(1) ]
    The assets must be owned, wholly or partly, by the assessee.
    Co-owners are entitled to claim depreciation to the extent of the value of the asset owned by each co-owner.
    The asset should be actually used for the purpose of business or profession of the assessee ……………………… ..
    This indicates that depreciation may be claimed on any asset owned or controlled by the assessee and used in his business.

    Recent Case of Sharp Business Systems:
    Recently Delhi High Court has ruled in the case of Sharp Business System ( ITA 492/2012 & C.M. APPL. 14836/2012) that the amount paid towards non compete fees, is not eligible for depreciation as an intangible asset as the same represents non transferable personal right capable of being enforced only against the covenanter. In HC’s view, the payment does not represent any business or commercial right.
    The assessee, a joint venture of Sharp Corp, Japan, and L&T Ltd, paid Rs. 3 crores to L&T as consideration for the latter not competing with the assessee for 7 years. The assessee claimed that the non-compete fee was revenue in nature. It also claimed, in the alternative, that the rights under the non-compete agreement were an “intangible asset” u/s 32(1)(ii) eligible for depreciation. The AO, CIT(A) & Tribunal rejected the assessee’s claim. On further appeal by the assessee before the Tribunal, HELD dismissing the appeal in :
    “The non-compete rights cannot be treated as an “intangible asset” u/s 32(1)(ii) because (a) the nature of the rights mentioned in the definition of “intangible asset” spell out an element of exclusivity which endures to the assessee as a sequel to the ownership. But for the ownership of the intellectual property or know-how or license or franchise, it would be unable to assert the right “in rem”, as against the world. In the case of a non-competition agreement, it is a right “in personam” where the advantage is restricted & does not confer an exclusive right to carry-on the primary business activity. (b) Another way of looking at the issue is whether such rights can be treated or transferred. Every species of right spelt-out such as know-how, franchise, license etc. and even those considered by Courts, such as goodwill, can be said to be alienable. Such is not the case with an agreement not to compete which is purely personal ( Techno Shares & Stocks 327 ITR 323 (SC), Hindustan Coco Cola Beverages 331 ITR 192 (Del) & B. Ravindran Pillai 332 ITR 531 (Ker) distinguished)” (ITA 492-12 Page 12)

    Meaning of Non Compete Fees:
    In our humble view, depreciation U/S 32 should be allowed on non- compete fees as any other business or commercial asset. First of all let us understand the meaning of the term ‘Non Compete Fees’. The Income Tax Act, 1961 does not provide any meaning to the word Non Compete Fees. In trade parlance, some agreements contain a contractual clause that prevents a person or company from competing with another, especially a former employer or partner for a fee. These fees are called in trade parlance as ‘Non Compete Fees’. This clause in an agreement binds a person or company with whom the agreement is entered into, from entering into competing business. Thus in case the business of a company is proposed to be taken over by another company, the second company may restrict the promoters of the first company to continue with the same business for a particular period of time. This gives the acquirer company exclusive rights to conduct the business of the acquired company. Typically the acquirer company takes over in addition to the tangible assets, business along with the customers, trademark, patent, goodwill and a right restricting the promoters of the acquired company from conducting similar business. These ‘exclusive rights’ in fact enables the acquirer company to peacefully conduct the business of the acquired company without any fear of the erstwhile promoters poaching on the same. The argument that, these rights are not transferrable is not tenable. In fact, just like any other intangible asset, these rights enhance the valuation of a company for the period in which the rights are enforceable. In case the acquired company desires to merge their company into other company, these rights would get transferred to the acquired company too. In such a situation, it is sufficient to say that these rights are in fact transferrable.

    Other Precedents on the Issue:
    The Delhi High Court with due respect has considered whether the rights as such can be individually sold without bundling them with other assets of the company. Under the Income Tax Act, depreciation is a statutory allowance, which is not confined to the diminution in value of an asset by wear and tear but also contains an “incentive” element and is governed by fiscal policies and considerations. The Chennai ITAT in (Radaan Mediaworks India Ltd (2007), Real Image Technologies (Pvt.) Ltd (2008) and Medicorp Technologies India Ltd (2009) has observed that depreciation under the ITA does not reflect purely economic criteria. The ITAT gave as an example items for which the rate of depreciation provided under the ITA is 100% and observed that this does not mean that the effective life of the items is only one year. As another example, the ITAT referred to the fact that depreciation is allowed on computer software, which, once loaded, cannot be resold, loses its assignability and transferability, and has practically no market value. The ITAT noted that the depreciation provisions do not necessarily follow the traditional concept of an “asset” and an accountant’s approach to “depreciation,” reiterating that the tax law sometimes implements the government’s economic and/or fiscal policies.

    Our View based on the provisions of the Act as they stand:
    Sec 32 empowers an assessee to provide depreciation on assets. Explanation to Sec 32 states that: “For the purposes of this sub-section, the expressions `assets' and `block of assets' shall mean -
    [a] tangible assets, being buildings, machinery, plant or furniture;
    [b] intangible assets, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature."
    The term business or commercial rights mean some rights that are acquired by a company which allows it to commercially exploit the right for business purposes. Non Compete fees prevent a person or company with whom the agreement is entered into, from entering into competing business. So these fees allow a person to exclusively conduct a business of another person, without any interference or competition from the other person. This also satisfies the requirement of Clause c of Sec 32(1) that the asset should be used for the purpose of business for qualifying for depreciation U/S 32. So these are commercial rights which the acquirer of these rights can enforce. Thus, these rights fulfil the criteria of Explanation to Sec 32. Thus going by the aforementioned Explanation, ‘Non Compete Fees’ are intangible assets eligible for Depreciation U/S 32. The framers of law have certainly not laid down rules for classifying an asset as a commercial asset. Conventional wisdom suggests that a commercial asset enables the owner of the asset to use the asset for commercial needs i.e. running and expanding the business and maximise the profits. In such a situation, extending the meaning to whether the asset can be transferable individually seems too farfetched.

    Conclusion:
    As stated above, there is no need to extend the meaning of commercial rights to whether these commercial rights are transferrable. If we do that, we are in danger of assigning a meaning to a statutory allowance, not intended to be assigned by the framers of law. The Judgement of the Honourable Delhi High Court has opened up a can of worms for opaque assets like computer software, wherein the tax authorities could also hold to be non transferable and hence not an intangible asset U/S 32 and disallow the depreciation thereon. The matter is not expected to rest here. The possibility of the matter getting carried to the Supreme Court cannot be ruled out.

    Aniket Kulkarni
    Aniket Kulkarni & Associates
    Chartered Accountants