Sharp Business System v. CIT‑III (2025): Non‑Compete Fees as Deductible Business Expenses

Sharp Business System v. CIT‑III (2025): Non‑Compete Fees as Deductible Business Expenses

Background: The case involved Sharp Business System India, a joint venture between Japan’s Sharp Corporation and Larsen & Toubro (L&T) in India[1]. In AY 2001‑02, Sharp India paid ₹3 crore to L&T under a non‑compete agreement: L&T agreed not to enter the Indian market for electronic office equipment for 7 years[2]. Sharp claimed this payment as a deductible revenue expenditure (a business expense) in its tax return. The Assessing Officer, however, treated the payment as creating an “enduring benefit” and classified it as a capital expenditure, adding it back to Sharp’s income[3]. This position was upheld by the Commissioner (Appeals) and the ITAT, and ultimately by the Delhi High Court[4][5]. The central question before the Supreme Court was whether such non‑compete fees are allowable deductions under the Income Tax Act or must be treated as capital outlays.

Legal Issue: The issue was whether a non‑compete fee – paid to secure exclusive market advantage – qualifies as an ordinary business expense under Section 37(1) of the Income Tax Act, 1961. Section 37(1) is a residuary provision allowing any expenditure “wholly and exclusively” for business, unless it is of capital nature or specifically disallowed by sections 30–36[6]. The Revenue argued that paying a competitor to stay out of the market provides an enduring advantage of a capital nature, akin to creating a new asset. The Assessee (Sharp) argued the fee was simply to run its business more efficiently and should be deductible as a normal business cost. (As an alternative, Sharp also sought depreciation under Section 32(1)(ii) on the ground that a non‑compete right is an intangible asset – an issue rendered moot once the Court found the fee was not capital[7][8].)

Arguments – Revenue vs. Assessee:

• Assessee’s case: Sharp’s counsel (Senior Adv. Ajay Vohra) emphasized the criteria of Section 37(1): the fee was incurred wholly and exclusively for business, in the relevant year, and was not a personal expense or falling under sections 30–36[9]. He relied on precedent (especially Empire Jute and Madras Auto Services), arguing that even an enduring benefit can be revenue expenditure if it merely facilitates the conduct of business rather than creating a new asset[10][11]. In this view, the payment only insulated Sharp’s existing business from competition; it did not enlarge Sharp’s profit‑earning apparatus. Thus, the benefit (though for 7 years) was not in the “capital field”[10][12]. In short, no new asset was created, and the fee simply helped Sharp trade more profitably. In the alternative, Sharp argued that if the fee were treated as capital, it qualified as a depreciable intangible under Section 32(1)(ii) of the Act[7].
• Revenue’s case: The tax department (represented by ASG Dwarakanath) countered that the non‑compete arrangement delivered a definite, long‑term benefit – namely, elimination of a competitor for 7 years. This, it argued, is a capital advantage. The department noted that Section 32 allows depreciation only on owned intangibles, and a non‑compete covenant (a “negative pledge”) is not an asset “in rem” but only a personal agreement[13][14]. In essence, Revenue viewed the fee as creating an “enduring benefit” like a proprietary right – not a mere trading expense.

Supreme Court’s Analysis: The Supreme Court (Bhuyan and Misra JJ.) reviewed leading precedents on capital vs. revenue outlays. It recalled the “enduring benefit” test (Atherton) and the fixed-vs-circulating capital test (John Smith v. Moore), and noted decisions like Coal Shipments, Empire Jute, Madras Auto, and Alembic Chemical Works. The Court emphasized that these tests are not absolutes; an enduring benefit does not automatically make an expense capital[15][16]. Instead, the key question is whether the payment creates a new fixed asset or expands the profit-making apparatus. For example, in Empire Jute, buying additional machinery-hours (even for six months) was held revenue because no new capital asset was created[17]. Similarly, in Madras Auto, an outlay to get a long-term lease at low rent was revenue expense since the asset built belonged to the landlord[18][19]. Drawing on these, the Court said that if an expenditure only facilitates the existing business – making it more efficient or profitable – without adding a new asset, it can be revenue expenditure, even if the benefit lasts long[17][19].

Turning to non‑compete fees, the Court described them as payments made “to restrain a party from competing” in the payer’s market[20]. The purpose is to give the payer a head start or protect profitability by reducing competition. Crucially, the Court found such fees do not create any new asset or expand Sharp’s “profit‑earning apparatus”[21]. The business’s fixed capital remained the same. Thus the only “advantage” was that the rival stayed away – a benefit commercially useful, but not a capital asset. The Court also noted that there was no guarantee the benefit would materialize (the competitor could still re‑enter after seven years, etc.)[22].

In effect, the Supreme Court treated non‑compete payments as typical revenue expenditures. The length of the restriction (7 years) or the fact it delivered an enduring benefit was not determinative. What mattered is that the fee “merely facilitates the carrying on of the business more efficiently and profitably” while leaving fixed assets untouched[21]. Because of this, the Court held that such a payment is deductible under Section 37(1). It explicitly stated:

“we are of the considered opinion that payment made by the appellant to L&T as non-compete fee is an allowable revenue expenditure under Section 37(1) of the Act.”[8]

The Court noted further that the payment did not create a monopoly or any new business for Sharp; it only kept a potential competitor at bay without building any new capital asset[23][24].

Decision: The Supreme Court set aside the Delhi High Court’s order. It answered the legal question in Sharp’s favor: the non‑compete fee was a revenue expenditure fully deductible under Section 37(1)[8]. Because the payment was not held to be capital, the issue of depreciation (Section 32) became moot[8]. The Court remanded the case to the ITAT for any further computation needed in light of this conclusion. It similarly remanded other related appeals (from Pentasoft, Piramal Glass, etc.) so that the tribunals could apply the same principle[25].

Implications for Businesses: This landmark ruling provides clarity for companies that use non‑compete agreements. Key takeaways include:

• Deductibility under Sec.37: Non‑compete payments can generally be treated as normal business expenses, deductible under Section 37(1) of the Income Tax Act[8][26]. In practice, a company paying for exclusivity can book the cost against profits, subject to meeting the usual tests of being “wholly and exclusively” for business[6].
• No New Capital Asset: The Court’s test makes it clear that if a payment does not add a new asset or fixed capital, it should not automatically be capitalized. In future tax planning, companies can rely on this ratio to expense non‑compete fees, as long as the primary intent is ordinary business advantage[21][27].
• Document Business Purpose: To satisfy Section 37, firms should document that the fee is for legitimate business reasons (e.g. market entry, brand protection) and that no physical asset was acquired. The ruling turned on the fact that Sharp’s existing profit‑making structure remained unchanged[23][27].
• Consistency Across Cases: The decision resolves a split in earlier High Court rulings. (For example, the Delhi High Court had disallowed a similar fee as capital, whereas Madras and Bombay High Courts had taken a more permissive view.) Going forward, the Sharp Business ratio will bind all tax authorities and tribunals[25].
• Tax Planning: From a planning perspective, companies can be more confident structuring deals that include non‑compete clauses. Such fees can be factored as tax-deductible costs, improving cashflow projections. However, taxpayers must still ensure the expense passes the ordinary tests (not personal, not a capital acquisition)[6][21].

In summary, the Supreme Court’s judgment in Sharp Business System v. CIT firmly establishes that properly documented non‑compete payments are deductible as revenue expenditures. This aligns tax treatment with commercial reality: paying a competitor to stay out of the market is like buying “peaceful trading conditions” and is now confirmed to be a legitimate business cost under Section 37[8][27].

Hritik Raina – LL.B. (Hons) & LLM ( International Taxation)

Sources: Supreme Court judgment, Sharp Business System v. CIT (2025

[1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13] [15] [16] [17] [18] [19] [20] [21] [22] [23] Sharp Business System Thr. Finance Director Mr. Yoshihisa Mizuno vs. Commissioner Of Income Tax-Iii N.D. | LawLens

https://lawlens.in/doc/c3331d5c-efd8-5da0-a677-305bed19a6ec?ref=caseciter.com

[14] [24] [26] [27] Non-Compete Fee Paid to Ward Off Competition is Revenue Expenditure, Not Capital Asset: Supreme Court [Read Judgment]

https://www.taxscan.in/top-stories/non-compete-fee-paid-to-ward-off-competition-is-revenue-expenditure-not-capital-asset-supreme-court-1440388

[25] [28] Non-Compete Fee Paid By Assessee Is Allowable Revenue Expenditure U/S 37(1) Income Tax Act: Supreme Court

https://www.verdictum.in/court-updates/supreme-court/sharp-business-system-v-commissioner-of-income-tax-2025-insc-1481-non-compete-fee-1601952