Sharp Business System v. CIT: Landmark Ruling on Tax Treatment of Non-Compete Payments and Commercial Expediency in Group Funding

 

Supreme Court of India | 2025 INSC 1481 | Decided: 19 December 2025

1. Factual Background

This batch of civil appeals before the Supreme Court concerned multiple assessees and assessment years, revolving around two critical tax issues under the Income Tax Act, 1961:

(A) Non-Compete Fee Payments

The principal case involved Sharp Business System, a joint venture between Sharp Corporation (Japan) and Larsen and Toubro Limited (L&T). During the assessment year 2001-02, the assessee paid ₹3 crores to L&T as a 'non-compete fee.' In exchange, L&T agreed not to set up, undertake, or assist in any competing business of selling, marketing, or trading electronic office products in India for a period of 7 years.

Other cases in the batch included:

• Pentasoft Technologies paid ₹180 crores as a non-compete fee to restrain Pentamedia Graphics Ltd. from undertaking similar software development and training activities after acquisition of a division.

Initial Dispute: The assessee claimed the non-compete fee as deductible revenue expenditure under Section 37(1). However, the Assessing Officer treated it as capital expenditure, arguing it brought an advantage of 'enduring nature.' The ITAT and Delhi High Court upheld this view but further held that the payment did not qualify for depreciation as an intangible asset under Section 32(1)(ii).

(B) Interest on Borrowed Funds

In PCIT v. Piramal Glass Ltd., the assessee had borrowed funds and: (i) invested in shares of a subsidiary to acquire controlling interest, and (ii) advanced interest-free sums to group concerns. The Assessing Officer disallowed interest under Section 36(1)(iii) on the ground that funds were used not for earning income but for acquiring control or for non-business purposes. The ITAT and High Court, however, allowed the claim on grounds of commercial expediency.

2. Questions of Law

The Supreme Court addressed the following core legal questions:

(a) Whether a non-compete fee paid by an assessee is revenue expenditure or capital expenditure?

(b) If such expenditure is considered capital in nature, is it entitled to depreciation as an 'intangible asset' under Section 32(1)(ii) of the Income Tax Act, 1961?

(c) Whether interest on borrowed funds invested in a subsidiary or provided as interest-free advances to sister concerns is an allowable business expenditure under the principle of commercial expediency?

3. Legal Framework and Case Law Analysed

The Court relied on several landmark precedents to distinguish between capital and revenue expenditure and to interpret the scope of depreciable intangible assets:

(A) Capital vs Revenue Expenditure

Empire Jute Co. Ltd. v. CIT (1980): Established that the 'enduring benefit' test is not universal. If the advantage only facilitates carrying on business more efficiently while leaving fixed capital untouched, it is revenue expenditure.

CIT v. Coal Shipments (P) Ltd. (1971): Analysed the treatment of payments made to ward off competition.

CIT v. Madras Auto Services (P) Ltd. (1998): Cited to show that the length of time of the advantage is not determinative if the expenditure merely facilitates more profitable operations without creating a new asset.

Assam Bengal Cement Co. Ltd. v. CIT (1955): Discussed the distinction between initial outlay (capital) and operational expenditure (revenue).

Guffic Chem (P) Ltd. v. CIT: Noted that non-compete fee can be capital where it secures an enduring business advantage, though the Court emphasized context-dependency.

(B) Depreciation on Intangible Assets

Techno Shares & Stocks Ltd. v. CIT: BSE membership card treated as a 'licence' and thus a depreciable intangible asset under Section 32(1)(ii).

The Revenue argued that a non-compete covenant is only a negative, personal right (in personam), not a transferable commercial asset akin to a licence or franchise. The assessees countered that it confers a valuable commercial advantage, enabling business expansion and profit generation.

(C) Interest Deduction – Commercial Expediency

S.A. Builders Ltd. v. CIT (288 ITR 1): Applied to the issue of interest on borrowed funds. The Court held that interest on borrowed funds advanced to a sister concern is deductible under Section 36(1)(iii) if done for commercial expediency, even if not directly earning profit. Tax authorities cannot sit in the 'armchair of a businessman.'

4. Supreme Court's Reasoning and Holdings

Issue 1: Nature of Non-Compete Fee

The Court held that the non-compete fee is allowable as revenue expenditure under Section 37(1). The Court's reasoning was as follows:

• The payment did not create a new business, add to the profit-making apparatus, or result in a monopoly.

• It merely allowed the assessee to operate more efficiently and profitably by reducing competition.

• The length of time (7 years) is not determinative. As long as the advantage is not in the capital field and leaves fixed assets untouched, it remains revenue expenditure.

• Payment to ward off competition does not ordinarily result in acquisition of a capital asset or new profit-making apparatus; competition is not eliminated permanently.

Held: Non-compete fee in the facts of these cases was revenue expenditure allowable under Section 37(1). The Delhi High Court's view treating it as capital was set aside.

Issue 2: Depreciation on Non-Compete Fee (Alternative Claim)

Since the Court held the expenditure itself to be revenue, the alternative claim of depreciation as an intangible asset became largely academic for most cases. However, the Court provided doctrinal clarification:

• A non-compete right does not automatically fall within 'any other business or commercial rights of similar nature' under Section 32(1)(ii).

• It is a restrictive covenant, not a freely transferable or enduring commercial asset comparable to licence, patent, or franchise.

• Where treated as capital, depreciation is not a matter of automatic entitlement and depends on whether the right truly answers the statutory description.

Held: The Court did not endorse the broad proposition that every non-compete right is a depreciable intangible asset, thereby narrowing the automatic classification.

Issue 3: Interest on Borrowed Funds (Piramal Glass)

Applying the S.A. Builders precedent, the Court held:

• Investment in a subsidiary for acquiring controlling interest can be for commercial expediency.

• Once nexus with business purpose is shown, deduction under Section 36(1)(iii) cannot be denied merely because the dominant purpose was not immediate profit generation.

• Tax authorities must evaluate from the standpoint of a prudent businessman, not revenue maximisation logic.

Held: Interest deduction was rightly allowed on grounds of commercial expediency. The Revenue's appeal was dismissed.

5. Final Conclusions

Revenue Expenditure: The Supreme Court ruled that the non-compete fee paid to L&T is an allowable revenue expenditure under Section 37(1). The payment did not create a new profit-making apparatus or result in acquisition of a capital asset.

Enduring Benefit: The Court clarified that the length of time (7 years) is not determinative. The functional test is whether the expenditure impacts the business structure or merely facilitates more efficient operations.

Commercial Expediency: Interest on borrowed funds advanced to a sister concern is allowable under Section 36(1)(iii) if done for commercial expediency, regardless of whether utilized in the assessee's own business.

Result: The Delhi High Court's judgment was set aside, and the appeals were disposed of in favor of the assessees.

6. Significance of the Judgment

This decision has far-reaching implications for tax law and corporate structuring:

• Re-centres the capital–revenue test on functional impact on business structure rather than mere 'enduring benefit.'

• Narrows the automatic classification of non-compete payments as capital or depreciable intangible assets, bringing clarity to business acquisitions.

• Strengthens the S.A. Builders doctrine, reaffirming commercial expediency as the governing principle for inter-corporate advances and group-company funding structures.

• Provides relief to assessees who enter into non-compete arrangements during business restructuring or joint ventures.

• This decision is now a leading authority on the tax characterization of non-compete payments and group-company funding structures in India. 

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