2025 INSC 1481

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 4072 OF 2014

SHARP BUSINESS SYSTEM THR. FINANCE

DIRECTOR MR. YOSHIHISA MIZUNO APPELLANT(S)

VERSUS

COMMISSIONER OF INCOME TAX -III N.D. RESPONDENT(S)

With

CIVIL APPEAL NO. 15048 of 2025

(Arising out of SLP(C) NO. 16277/2014

CIVIL APPEAL NO. 15049 of 2025

(Arising out of SLP(C) NO. 719/2020

CIVIL APPEAL NO. 15050 of 2025

(Arising out of SLP(C) NO. 38046/2025

(Arising out of DIARY NO. 22308/2022

CIVIL APPEAL NO. 15051 of 2025

(Arising out of SLP(C) NO. 24756/2014

J U D G M E N T

UJJAL BHUYAN, J.

Delay in filing SLP(C) Diary No. 22308/2022 is

condoned.

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2. I.A. No. 114870/2022 is allowed.

3. Leave granted in SLP(C) No. 16277/2014, SLP(C)

No. 24756/2014, SLP(C) No. 719/2020 and SLP(C) No.__/2025

(arising out of Diary No. 22308/2022).

4. Civil Appeal No. 4072/2014 is directed against the

judgment and order dated 05.11.2012 passed by the High Court

of Delhi (briefly ‘the Delhi High Court’ hereinafter) dismissing

Income Tax Appeal No. 492/2012 (Sharp Business System Vs.

Commissioner of Income Tax – III) filed by the assessee for the

assessment year 2001-02.

4.1. SLP(C) No. 16277/2014 takes exception to the

judgment and order dated 20.11.2013 passed by the High Court

of Judicature at Madras (briefly ‘the Madras High Court’

hereinafter) in Tax Case (Appeal) No. 1134 of 2008 (M/s.

Pentasoft Technology Limited Vs. DCIT) for the assessment year

2001-02 allowing the appeal of the assessee.

4.2. The judgment and order dated 29.10.2013 passed by

the Madras High Court allowing Tax Case (Appeal) No. 1195 of

2008 (M/s. Pentasoft Technologies Limited Vs. DCIT) of the

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assessee for the assessment year 2002-03 is under impugnment

in SLP(C) No. 24756/2014.

4.3. In SLP(C) No. 719/2020, the challenge is to the

judgment and order dated 11.06.2019 passed by the High Court

of Judicature at Bombay (briefly ‘the Bombay High Court’

hereinafter) dismissing Income Tax (Appeal) No. 556 of 2017

(Principal Commissioner of Income Tax – VII Vs. Piramal Glass

Limited) of the revenue for the assessment year 2001-02.

4.4. SLP(C) D. No. 22308/2022 has been filed by the

revenue against the judgment and order dated 11.01.2022

passed by the Madras High Court dismissing Tax Case (Appeal)

No. 600 of 2010 (CIT, Chennai Vs. M/s. Pentasoft Technologies

Limited) of the revenue for the assessment year 2001-02.

5. The perennial question of whether an expenditure

incurred by an assessee is capital or revenue again confronts us

in this batch of appeals. The core issue which arises for

consideration in the facts of this batch of appeals is whether non-

compete fee paid by the assessee is a revenue expenditure or

capital expenditure?

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5.1. Corollary to the above question is whether such

expenditure, if considered to be an expenditure of capital nature,

is entitled to depreciation under Section 32(1)(ii) of the Income

Tax Act, 1961 (briefly ‘the Act’ hereinafter)?

5.2. In SLP(C) No. 719/2020, another issue involved is the

treatment of interest on borrowed funds invested by the assessee

in its sister concern and also provided as interest free advances

to the sister concern and its directors; whether such interest is

an allowable business expenditure?

6. Before we proceed to answer the above questions, it

would be appropriate to have a brief narration of essential facts

in each of the appeals relevant to the issues which have arisen

for our consideration.

Non-compete fee

Civil Appeal No. 4072/2014

7. Assessee is the appellant here. It is a company which

is engaged in the business of importing, marketing and selling

electronic office products and equipments in India. It was

incorporated on 29.02.2000 as a joint venture of M/s. Sharp

Corporation, Japan and M/s. Larsen and Toubro Limited (‘L&T’

5

for short). L&T is in the business of developing, manufacturing,

marketing, distributing and selling, amongst other things,

electronic equipments in India. In this connection, it has a well

established country-wide sales network. M/s. Sharp Corporation

was engaged in the business of designing, developing,

manufacturing, marketing, distributing and selling various

audio/visual products, household electronic appliances,

electronic office products, computers, etc. and other related

products on a worldwide basis.

7.1. During the assessment year 2001-02, assessee paid a

sum of Rs. 3 crores to L&T as consideration for the latter not

setting up or undertaking or assisting in the setting up of or

undertaking any business in India of selling, marketing and

trading in electronic office products for 7 years. The said amount

of Rs. 3 crores was claimed as a deductible revenue expenditure

in the return of income filed by the assessee on 31.10.2001 for

the assessment year 2001-02 as non-compete fee paid to L&T.

Initially, the return was processed under Section 143(1) of the

Act. Thereafter, the case was selected for scrutiny whereafter

notice under Section 143(2) of the Act was issued to the assessee.

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7.2. Following assessment proceedings, assessing officer

passed assessment order dated 19.03.2004 wherein it was noted

that by making payment of Rs. 3 crores to L&T, assessee could

ward of competition in business. The object of making such

payment to L&T was to derive an advantage by eliminating

competition for a period of 7 years. According to the assessing

officer, such an expenditure had brought into existence an

advantage of enduring nature and hence treated the payment of

Rs. 3 crores as capital expenditure. Therefore, the said amount

was added to the income of the assessee. There were other

aspects in the assessment order with which we are not

concerned in the present proceeding.

7.3. Aggrieved by the order of assessment, assessee

preferred an appeal before the Commissioner of Income Tax

(Appeals), ‘CIT(A)’ for short. In the appeal, assessee contended

that non-compete fee should be treated as an allowable revenue

expenditure. However, in the course of the appellate proceedings,

an alternative ground was put forth by the assessee that if the

amount of non-compete fee paid to L&T was treated as capital

expenditure, then the benefit of depreciation allowance should

be extended to the assessee under Section 32(1)(ii) of the Act.

7

7.4. CIT(A) vide the order dated 02.09.2004 held that such

expenditure was not in the nature of revenue expenditure. In so

far the alternative ground was concerned, CIT(A) held that there

was no apparent justification for the assessee to enter into a non-

compete agreement with L&T for a sum of Rs. 3 crores since L&T

was not a competitor of the assessee and that the business

interest of the assessee would not have suffered for want of such

an agreement. Since the true purport of the expenditure

remained unproved, the same was disallowed being regarded as

non-revenue expenditure, not for the purpose of business of the

assessee. Accordingly, the assessee was held to be not entitled

to depreciation. Consequently, appeal of the assessee was

dismissed by CIT(A).

7.5. Assessee preferred further appeal before the Income

Tax Appellate Tribunal, New Delhi (ITAT) against the order of the

CIT(A) dated 02.09.2004.

7.6. ITAT vide the order dated 30.06.2011 noted that the

assessee by paying a non-compete fee of Rs. 3 crores to L&T had

eliminated competition for a period of 7 years which is a duration

long enough to establish its reputation and a reasonable market

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share would have been acquired by the assessee. Payment made

by the assessee to L&T was not to increase its profitability. Thus,

the non-compete fee could not be treated as revenue expenditure

but it was in the nature of a capital expenditure. Further, ITAT

held that the non-compete fee would not create intangible asset

eligible for depreciation under the provisions of Section 32(1)(ii)

of the Act. Thus, depreciation was not allowable on the

expenditure made by the assessee as non-compete fee. ITAT held

that just as the right to trade freely or to compete in the market

is not an asset, similarly a right arising out of a non-compete

agreement would not constitute a commercial right falling within

the ambit of intangible asset under Section 32(1)(ii) of the Act.

ITAT found no infirmity in the order passed by the CIT(A) and

dismissed the appeal of the assessee.

7.7. It was thereafter that assessee filed Income Tax

Appeal No. 492/2012 before the Delhi High Court. Vide the

judgment and order dated 05.11.2012, Delhi High Court

dismissed the appeal of the assessee as being devoid of any

merit. Delhi High Court opined that expenditure incurred by the

assessee by way of non-compete fee paid to L&T could not be

claimed as a revenue expenditure as it was clearly a capital

9

expenditure. Despite holding the expenditure to be capital in

nature, Delhi High Court was of the further view that the non-

compete right of the kind acquired by the assessee against L&T

for 7 years did not result in depreciable intangible asset. It was

held that the right acquired by the assessee by payment of non-

compete fee was a right in personam only against L&T for a period

of 7 years. It was not a right in rem. Adverting to the expression

‘similar business or commercial rights’ appearing in Section

32(1)(ii) of the Act, Delhi High Court opined that it has to

necessarily result in an intangible asset against the entire world

to qualify for depreciation under the said provision. Delhi High

Court therefore dismissed the appeal of the assessee.

Civil Appeal No. of 2025

(Arising out of SLP(C) No. 16277/2014)

8. This appeal is by the revenue assailing the judgment

and order dated 20.11.2013 passed by the Madras High Court

allowing Tax Case (Appeal) No. 1134 of 2008 filed by the assessee

for the assessment year 2001-02.

8.1. As noted above, respondent is the assessee which is a

public limited company carrying on the business of software

development, hardware sales, technical training and engineering

10

services. Assessee exports software from its industrial units set

up in software technology parks and makes domestic sales from

its industrial units situated outside software technology parks.

8.2. Assessee filed its return of income for the assessment

year 2001-02 on 29.10.2001 claiming various exemptions.

Assessing officer passed assessment order dated 31.03.2004

under Section 143(3) of the Act raising a demand of Rs.

55,25,86,888.00 besides initiating penalty proceedings.

8.3. Aggrieved by the aforesaid order of assessment,

assessee preferred appeal before CIT(A). During the appellate

proceedings, assessee raised additional grounds of appeal, one

of which related to depreciation on intangible assets like

intellectual property rights and non-compete fee. Assessee

contended that assessing officer had not granted depreciation on

intangible assets as well as on non-compete fee. It may be

mentioned that assessee had paid Rs. 180 crores as non -

compete fee during acquisition of software development and

training division of M/s. Pentamedia Graphics Limited. In these

proceedings, we are not concerned with the claim of depreciation

on intangible assets like intellectual property rights.

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8.4. CIT(A) in the order dated 30.11.2006 held that non-

compete fee is nothing but a license. Non-compete fee paid to

M/s. Pentamedia Graphics Limited restrained it from using the

brand name ‘Pentasoft’, further restraining it from undertaking

any development of software. Assessee could therefore

exclusively carry on the business of software development,

training and export of such technologies by restraining M/s.

Pentamedia Graphics Limited from carrying out the same

activities. This commercial right acquired by payment of non-

compete fee was held to be an intangible asset entitled to

depreciation under Section 32(1)(ii) of the Act. Accordingly,

direction was issued to the assessing officer.

8.5. Aggrieved by the aforesaid order of CIT(A), revenue

preferred appeal before the ITAT, Chennai particularly the

finding of CIT(A) that non-compete fee is eligible for depreciation

under Section 32(1)(ii) of the Act.

8.6. ITAT vide the order dated 14.03.2008 relied on its

previous decision in the assessee’s own case and held that non-

compete fee was not an intangible asset and , therefore,

depreciation could not be allowed on non-compete fee.

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8.7. Assessee preferred appeal before the Madras High

Court. Madras High Court noted in the judgment and order

dated 20.11.2013 that the issue as to whether non-compete fee

was an intangible asset and hence entitled to depreciation was

already decided by it in the assessee’s own case dated

29.10.2013 for the assessment year 2002 -03. Accordingly,

Madras High Court decided the appeal in favour of the assessee

by holding that assessee was entitled to depreciation on non-

compete fee, it being an intangible asset, under Section 32(1)(ii)

of the Act.

Civil Appeal No. of 2025

(Arising out of SLP(C) No. 24756 of 2014)

9. This appeal is by the revenue. Respondent is the

assessee, details of which have already been mentioned in the

previous appeal.

9.1. For the assessment year 2002-03, respondent filed its

return of income on 31.10.2001 declaring net loss of Rs.

37,12,20,853.00. Initially the return was processed under

Section 143(1) of the Act but subsequently the case was selected

for scrutiny during which proceedings, assessee filed a revised

13

return increasing its loss. It also submitted a note on the

admissibility of depreciation on intellectual property rights and

on non-compete fee on 23.02.2000. Assessee stated that it had

entered into an agreement with M/s. Pentamedia Graphics

Limited for acquisition of the software development and training

division. In the agreement dated 23.02.2000, there was a clause

relating to non-competition by virtue of which M/s. Pentamedia

Graphics Limited agreed that it would not enter into the business

of the assessee either directly or indirectly in any country for a

period of 10 years. Assessee paid Rs. 180 crores as non-compete

fee to M/s. Pentamedia Graphics Limited.

9.2. Assessing officer vide the assessment order dated

30.03.2005 rejected capitalisation of non-compete fee as well as

disallowed the claim of depreciation.

9.3. Assessee preferred appeal before CIT(A), Chennai.

CIT(A) vide the order dated 27.02.2006 held that the assessee

could carry on the business in software development export and

training by restraining M/s. Pentamedia Graphics Limited from

carrying out the same activities. Assessee had acquired

commercial right to conduct training programmes with the use

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of the trademark ‘ Pentasoft’ and engaged in software

development and export of various software products. According

to CIT(A), accounting standard 26 of the Institute of Chartered

Accountants of India, non-compete fee is classifiable as

intangible asset since it satisfies the criteria of being: (i)

identifiable, (ii) controllable, and (iii) economic benefits flowed

out to the enterprise. Since the three criteria were satisfied and

the assets were unconditionally transferred by M/s. Pentamedia

Graphics Limited, CIT(A) held that the assessee had acquired the

absolute right to enjoy, utilize and exploit such commercial right.

Therefore, it was an intangible asset entitled to depreciation

under Section 32(1)(ii) of the Act.

9.4. Both revenue and assessee preferred separate

appeals before the ITAT, Chennai. In the order dated 06.02.2008,

ITAT held that non-compete fee was not an asset which the

assessee could use like a license or franchise in its business.

Non-compete fee was a payment made to ward off a competitor

for a specified number of years. It only conferred a right to sue

in case of breach by the person to whom the amount was paid.

It could only be enforced when a default occurred. As such, ITAT

held that depreciation could not be allowed on non-compete fee.

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9.5. Aggrieved by the order of ITAT, assessee preferred

appeal before the Madras High Court, being Tax Case (Appeal)

No. 1195 of 2008. Madras High Court held that non -compete

agreement between parties was a composite agreement. Under

the agreement, the transferor had transferred all its rights

including copyrights and trade marks as well as the training and

development division to the assessee. In the composite

agreement, there was a non-compete clause by virtue of which

the transferor was restrained from doing the same business as

that of the assessee. High Court held such a right to be a

commercial right. Thus, High Court was of the view that non-

compete agreement and the various terms and conditions

contained therein, binds the parties. Non-compete fee was,

therefore, held to be an intangible asset and in terms of Section

32(1)(ii) of the Act, it would be a capital asset entitled to

depreciation.

Civil Appeal No. of 2025

(Arising out of SLP(C) No. 719/2020)

10. This appeal is at the instance of the revenue assailing

the judgment and order dated 11.06.2019 passed by the Bombay

High Court in Income Tax Appeal No. 556 of 2017 (Principal

16

Commissioner of Income Tax Vs. Piramal Glass Limited)

preferred by the revenue . The assessment year under

consideration is 2001-2002.

10.1. Assessee, which is the respondent, is a subsidiary

company of Nicholas Piramal India Limited which holds 53.76

percent of equity shares of the assessee. The rest of the equity

shares have been subscribed by foreign parties. Assessee has

two manufacturing divisions, both in Gujarat.

10.2. Assessee had filed its return of income for the

assessment year under consideration on 30.10.2001 declaring

total income of Rs. 17,11,64,492.00 under Section 115JA of the

Act and a loss of Rs. 20,52,26,552.00. Though initially the return

was processed under Section 143(1) of the Act, subsequently,

assessment proceedings were initiated under Section 143

thereof.

10.3. During the assessment year 1999-2000, assessee had

acquired the glass division from Nicholas Piramal India Limited

for which a non-compete fee of Rs. 18,00,00,000.00 was paid.

10.4. In the assessment order dated 19.02.2004 passed by

the assessing officer under Section 143(3) of the Act the claim of

17

depreciation on non-compete fee was disallowed by following the

earlier order of assessment in the case of the assessee itself for

the assessment year 1999-2000 holding that the expenditure

was in no way connected with the acquisition of various assets.

The disallowance in this regard was worked out at Rs.

12,18,37,337.00.

10.5. Assessee preferred appeal before CIT(A) who, however,

in his appellate order dated 02.09.2004 upheld the decision of

the assessing officer disallowing depreciation on non-compete

fee.

10.6. Aggrieved thereby, assessee preferred further appeal

before ITAT, ‘B’ Bench, Mumbai. Cross appeal was also filed by

the revenue in respect of other issues. Vide its order dated

02.03.2016, ITAT held that so long as non -compete fee in

question is capital expenditure, the same would be entitled for

depreciation. ITAT, therefore, directed the assessing officer to

allow the claim of depreciation on the amount of non-compete

fee paid treating the same as intangible asset.

10.7. Assailing the aforesaid finding of the ITAT, revenue

preferred appeal before the Bombay High Court being Income

18

Tax Appeal No.556 of 2017. It was noted by the Bombay High

Court that on the question of grant of depreciation on non-

compete fee paid, various High Courts have held in favour of the

assessee. A non-compete fee provides an enduring benefit and

protects the assessee against competition. The expression ‘or any

other business or commercial rights of similar nature’ appearing

in Section 32(1)(ii) is wide enough to include non-compete fee.

Therefore, Bombay High Court was of the view that no question

of law arose in this regard.

Civil Appeal No. of 2025

(Arising out of SLP(C) No. of 2025)

(Arising out of Diary No. 22308 of 2022)

11. This appeal by the revenue is directed against the

judgment and order dated 11.01.2022 passed by the Madras

High Court dismissing Tax Case (Appeal) No. 600 of 2010 of the

revenue. Assessment year under consideration is 2001-02.

11.1. Assessee is the respondent. It is a public limited

company carrying on the business in software development,

hardware sales and technical training and engineering services.

It has software export unit situated in a software technology park

in India.

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11.2. Assessee filed return of income for the assessment

year under consideration on 29.10.2001 declaring a net loss of

Rs. 66,59,04,421.00. Initially the return was processed under

Section 143(1) of the Act but subsequently, assessment

proceedings were initiated under Section 143 of the Act.

11.3. In the assessment order dated 31.03.2004, total

income of the assessee was computed at Rs. 96,25,86,888.00

which resulted in net demand of Rs. 55,25,86,888.00 including

interest under Section 234B of the Act. Consequently, penalty

proceedings under Section 271(1)(c) of the Act were also initiated

by the assessing officer against the assessee. In the assessment

order, assessing officer made several disallowances which are

not the subject matter of the appeal.

11.4. Assessee preferred appeal before the CIT(A), Chennai.

During the appellate proceedings, assessee raised additional

grounds of appeal which according to it were ignored by the

assessing officer in the assessment proceedings. One of the

additional grounds raised by the assessee related to claim of

depreciation of intangible assets like intellectual property rights

and non-compete fee. It was stated that assessee had paid Rs.

20

180 crores as non-compete fee to M/s. Pentamedia Graphics

Limited for acquisition of its software development and training

division.

11.5. CIT(A) in its order dated 30.11.2006 held that non-

compete fee is nothing but a license. Assessee could exclusively

carry on the business of software development, training and

export of technologies by restraining M/s. Pentamedia Graphics

Limited from carrying out the same activities. Thus, payment of

non-compete fee was held to be an intangible asset entitled to

depreciation under Section 32(1)(ii) of the Act.

11.6. Revenue preferred appeal before ITAT, Chennai

challenging the decision of the CIT(A) holding that non-compete

fee is an intangible asset eligible for depreciation. Cross appeal

was also filed by the assessee on other grounds.

11.7. ITAT vide the order dated 14.03.2008 held that non-

compete fee is an intangible asset entitled to depreciation under

Section 32(1)(ii) of the Act.

11.8. This finding of the ITAT came to be challenged before

the Madras High Court by the revenue in Tax Case (Appeal) No.

600 of 2010. Madras High Court followed its earlier decision in

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the case of the assessee itself for the assessment year 2002-03

and dismissed the appeal filed by the revenue upholding the

decision of the ITAT on this point.

Submissions

12. Mr. Ajay Vohra, learned senior counsel appearing for

Sharp Business System (assessee) (appellant in Civil Appeal No.

4072/2014), at the outset submits that the expenditure incurred

on account of non-compete fee is a revenue expenditure and is,

therefore, an allowable deduction. He has referred to Section 37

of the Act, more particularly to sub-section (1) thereof, and

submits that any expenditure of an assessee may be allowed as

a deduction while computing the income chargeable under the

head ‘profits and gains of business or profession’ subject to

fulfillment of the following conditions:

(i) if the expenditure does not fall within the ambit of

Sections 30 to 36 of the Act;

(ii) if the expenditure has been incurred in the

accounting year relevant to the assessment year

under consideration;

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(iii) it should be expended wholly and exclusively for the

purpose of the business or profession carried on by

the assessee; and

(iv) it should not be in the nature of capital expenditure

or personal expenses of the assessee.

12.1. Adverting to the above, Mr. Vohra submits that the

expenditure incurred by the assessee in the form of non-compete

fee is certainly not a personal expense of the assessee; the

expenditure was wholly and exclusively incurred for the purpose

of its business, for the purpose of establishing and enlarging the

business of the assessee. There is no doubt it was expended

during the relevant accounting year.

12.2. Mr. Vohra asserts that such expenditure incurred by

the assessee is on revenue account since it was expended wholly

and exclusively for the purpose of business. Therefore, such an

expenditure should be allowed as a deduction.

12.3. He has referred to the decision of this Court in Empire

Jute Company Limited Vs. Commissioner of Income Tax

1 where it

has been held that in certain situations or circumstances, the

1

(1980) 124 ITR 1

23

test of enduring benefit may fail. In fact, learned senior counsel

submits that the test of enduring benefit may not be applicable

universally to determine the character of the expenditure. Even

when such an expenditure results in a benefit of enduring

nature, that by itself would not be conclusive to regard or treat

the expenditure as capital expenditure, if the benefit merely

facilitates in carrying on the business more profitably and

efficiently.

12.4. Applying the tests laid down by this Court in the case

of Empire Jute (supra), learned senior counsel submits that non-

compete fee only seeks to protect and enhance the business of

the assessee thereby facilitating the carrying on of the business

more efficiently and profitably. According to him, such payment

does not result in creation of a new asset or any accretion to the

business apparatus. The benefit, though of enduring advantage,

is due to restriction of a competitor or potential competitor in

business. Therefore, such a benefit even if of an enduring nature

is not in the capital field.

12.5. Continuing with his submissions, Mr. Vohra has

alluded to a judgment of this Court in Commissioner of Income

24

Tax Vs. Madras Auto Services (P) Limited

2. Relying on the

aforesaid decision, Mr. Vohra submits that the period or length

of time over which the enduring advantage may spread over is

not determinative of the nature of expenditure where the

advantage merely facilitates in carrying on the business more

efficiently and profitably, leaving the fixed assets untouched.

12.6. Mr. Vohra next refers to another decision of this Court

in CIT, West Bengal II, Calcutta Vs. Coal Shipments (P) Limited

3

and submitted that this Court considered its decision in Assam

Bengal Cement Company Limited Vs. CIT

4 and held that if

payment is made to ward off competition in business or with an

object of deriving an advantage by eliminating competition over

a period of time, the same would be in the nature of capital

expenditure. On the other hand, where there is no certainty of

the duration of the advantage and the same could be put to an

end at any time, such an expenditure would be a revenue

expenditure.

2

(1998) 233 ITR 468

3

(1971) 82 ITR 902

4

(1955) 27 ITR 34

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12.7. It is the submission of Mr. Vohra that if the aforesaid

decisions of this Court in Coal Shipments (supra) and Empire

Jute (supra) are read conjointly, the only legal inference that can

be drawn is that when the expenditure incurred by the assessee

brings into existence a benefit of enduring nature in the capital

field such payment of non-compete fee would be treated as

capital expenditure and not otherwise. If the expenditure so

incurred is for carrying on the business more efficiently or

profitably without any addition to the profit earning apparatus,

the same would be an allowable revenue deduction, irrespective

of the fact whether the benefit is enduring or ephemeral.

12.8. Applying the ratio of the aforesaid decisions to the

facts of the appeal, he submits that as a matter of fact there is

no elimination of competition; nor does the payment create any

monopoly over the business of electronic products etc. by

making the non-compete fee payment to L&T. Payment was

made to L&T not to eliminate competition or create a monopoly

but only to run the business more efficiently and profitably. Such

consideration paid to L&T cannot therefore be said to be for the

acquisition of any capital asset or towards bringing into

existence a new profit earning apparatus. Delhi High Court failed

26

to appreciate that payment of non-compete fee does not bring

into existence any capital asset or advantage of enduring benefit

in the capital field. Therefore, such an expenditure cannot be

treated as capital expenditure. Such expenditure only helps in

enhancing the profitability of business. Therefore, it is an

allowable expenditure under Section 37(1) of the Act.

12.9. He thereafter makes an alternative submission.

Referring to Section 32 of the Act, he submits that even if such

an expenditure is construed to be a capital expenditure,

depreciation cannot be denied. Section 32(1)(ii) of the Act

provides that in respect of depreciation of know-how, patents,

copyrights, trade marks, licences, franchises or any other

business or commercial rights of similar nature being intangible

assets acquired on or after the first day of April, 1998, not being

goodwill of a business or profession, owned wholly or partly by

the assessee, and used for the purposes of the business or

profession, the deductions as provided thereunder shall be

allowed. Explanation 3 to sub-section (1) of Section 32 explains

the meaning of the word ‘assets’ to mean (a) tangible assets,

being buildings, machinery, plant or furniture; and (b) intangible

assets, being know-how, patents, copyrights, trade marks,

27

licences, franchises or any other business or commercial rights

of similar nature, not being goodwill of a business or profession.

Mr. Vohra submits that the crucial expression to be noticed in

this provision is ‘any other business or commercial rights of

similar nature’. According to him, it would be too simplistic to

apply the doctrine of ejusdem generis to say that the aforesaid

expression would mean business or commercial rights of similar

nature like intellectual property rights, such as, know-how,

patents, copyrights, trade marks etc. Once the High Court held

that payment of non -compete fee gave the appellant an

advantage of enduring benefit, then the High Court could not

have denied depreciation thereon by taking the view that no

asset was brought into existence.

12.10. He then refers to the decision of this Court in the case

of Techno Shares & Stocks Limited Vs. CIT

5 which has held that

membership card of Bombay Stock Exchange is in the nature of

license to trade. Hence, it is an intangible asset entitled to

depreciation under Section 32(1)(ii) of the Act. Based on the

aforesaid decision, he submits that depreciation is allowable on

5

(2010) 327 ITR 323

28

payment of non-compete fee as such payment results in

acquisition of an intangible asset within the meaning of

Explanation 3 to Section 32(1) of the Act.

12.11. Learned senior counsel therefore submits that firstly

the expenses incurred by the assessee by way of non-compete

fee is a revenue expenditure and therefore is an allowable

deduction. Alternatively, he submits that if the same is

construed to be a capital expenditure, then depreciation would

be allowable thereon in terms of Section 32(1)(ii) of the Act.

13. Mr. Arvind P. Datar, learned senior counsel

representing M/s. Piramal Glass Private Limited (formerly

known as Piramal Glass Limited) submits that his client

acknowledges that non-compete fee paid is not a revenue

expenditure but a capital expenditure. However, the further

contention is that as a capital expenditure, it is entitled to

depreciation under Section 32 of the Act. Therefore, the question

which arises for consideration is whether the right which accrues

to the assessee on account of the non-compete agreement can

be said to be an ‘intangible asset’ qualifying for depreciation

under Section 32 of the Act.

29

13.1. Mr. Datar then refers to Section 32(1)(ii) of the Act and

submits that the said provision clearly provides for depreciation

on intangible assets owned and used for the purpose of business

and profession. Intangibles include know -how, patents,

copyrights, trade marks, licences, franchises or any other

business or commercial rights of similar nature. Explanation 3

to Section 32 defines the term ‘assets’ and clause(b) of the

Explanation defining ‘intangible assets’ is in similar terms as is

referred to in Section 32(1)(ii) of the Act. He then refers to the

definition of ‘block of assets’ as provided in Section 2(11) of the

Act, clearly bifurcating assets into tangible assets and intangible

assets. Intangible assets include ‘or any other business or

commercial rights of similar nature’. In this connection, Mr.

Datar has also referred to the old Appendix I of the Income Tax

Rules, 1962 (briefly ‘the Rules’ hereinafter) and submits that the

said provision would be applicable in the present appeal since

the assessment year under consideration is 2001-02. The said

Appendix I has two parts: Part A dealing with tangible assets and

Part B dealing with intangible assets.

13.2. Mr. Datar submits that the expression ‘any other

business or commercial rights of similar nature’ appearing in

30

Section 32(1)(ii) of the Act should take the meaning of or refer to

intangible assets and not the species of intangible assets, such

as, know-how, patents, copyrights, trade marks, licences and

franchises. Thus, the submission is that under intangible assets

the abovestated intellectual property rights are the first category;

and ‘other business or commercial rights’ fall within the second

category. According to him, in 1998 when this provision came to

be substituted, the legislature could not have envisaged any

other rights emanating from commercial arrangements and

hence deemed it fit to allow depreciation on ‘any other business

or commercial rights of similar nature’. The principle of ejusdem

generis requires a commonality; and in the present case, the

commonality is neither positive nor negative rights or either

rights in rem or rights in personam. The commonality is that all

are species of the genus ‘intangible assets’.

13.3. Adverting to the distinction made by the Delhi High

Court as regards rights in rem and rights in personam, Mr. Datar

submits that law does not require any such distinction for

allowability of depreciation: as to whether such rights are rights

in rem or rights in personam. While generally patents, copyrights

and trade marks confer rights in rem, other categories like

31

technical know-how, licences or franchises generally confer

rights in personam. Even under The Patents Act, 1970, The

Copyrights Act, 1957 and The Trade Marks Act, 1999, certain

rights can be in rem and certain in personam. Similar is the case

of a license being a privilege may be right in rem for some people

and right in personam for some other people. However, Mr. Datar

emphatically submits that such a debate qua rights in rem or

rights in personam should be avoided as it is not necessary for

determining the issue at hand.

13.4. Taking exception to the decision of the Delhi High

Court in Sharp Business System, Mr. Datar submits that such a

line of reasoning is against the uniform view taken by different

high courts of the country. In fact, on non-compete fee, the

Gujarat, Bombay, Madras and Karnataka High Courts have

taken a view favorable to the assessee.

13.5. In any view of the matter, the plea regarding positive

and negative rights was not taken by the revenue at any stage:

from the assessing officer to the High Court. Therefore, such a

plea cannot be entertained for the first time before the Supreme

Court under Article 136 of the Constitution.

32

13.6. Without prejudice to the above, it is the further

submission of Mr. Datar that the expression ‘any other business

or commercial rights of similar nature’ is intended to cover all

intangible assets other than know-how, patents, trade marks

etc. which are specifically enumerated. The scope of this

expression cannot be restricted or read down by carving out an

exception for so-called negative rights.

13.7. Positive or negative rights are just one of the nine

species of rights. As set out in Chapter VII of Salmond on

Jurisprudence, the classification of rights into positive or

negative rights, vested or tangible rights etc. is only for the

purpose of characterization of such rights in the context of co-

related duties. Such classification cannot be relied upon to

interpret the scope of the expression ‘any other business or

commercial rights of similar nature’ appearing in Section 32(1)(ii)

of the Act. That apart, emphasis on such a classification may

lead to absurd consequences because rights are not only divided

into positive and negative rights. Rights can also be partially

positive and partially negative. In such a case, it will be absurd

to suggest that depreciation will be granted only on prorata basis

by the assessing officer.

33

13.8. Mr. Datar submits that by the Finance Act, 2002,

legislature has inserted clause (va) to Section 28 of the Act to tax

such receipts. There is no distinction or test stating that only if

it is a receipt on account of positive rights, it would be taxable.

Irrespective of whether it is a positive right or a negative right,

such receipts from the assessment year 2003-04 onwards is

taxable. Based on this, Mr. Datar submits that for taxing such

receipts on account of non-compete fee, there is no distinction

for allowing depreciation. Therefore, revenue cannot approbate

or reprobate to contend that only positive rights are eligible for

claiming depreciation on intangible asset.

13.9. Dehors the aforesaid submission, Mr. Datar further

contends that the amount paid for non -compete fee gives a

positive advantage to the assessee who acquires such right. It

enables the assessee to expand its business because of reduced

competition. Thus in the hands of the acquirer, it has a positive

advantage; however in the hands of the recipient of non-compete

fee, the negative convenant results in a negative application or

duty. Therefore, there is no negative right at play here.

34

13.10. Adverting to Section 2(14) of the Act, Mr. Datar

submits that ‘capital asset’ has been defined to include property

of any kind held by an assessee. The word ‘property’ is defined

in the Explanation to sub-section (14) of Section 2 to include and

always be deemed to have included rights of management or

control or any other rights whatsoever. Based on such an

analogy, rights acquired on payment of non-compete fee are

property and hence assumes the character of a capital asset.

Such an asset is an intangible asset and thus will be entitled for

depreciation.

13.11. Mr. Datar then referred to the word ‘used’ appearing

in Section 32(1) of the Act. He submits that for claiming

depreciation, the assets whether tangible or intangible must be

owned by the assessee and used for the purpose of business or

profession. In any intangible asset, a physical or active

demonstrating user test cannot be satisfied as compared to

tangible asset. Therefore, the word ‘used’ has to be read in a

broader context. A passive use or latent use would also satisfy

the word ‘used’. In case of a non-compete covenant, the user is

using such a covenant the day he enters into the agreement for

keeping a dominant or established player out of the same

35

business, thereby earning better profits. Thus, there cannot be

any dispute that by a non-compete covenant, an intangible asset

is being used. No prudent businessman will pay non-compete fee

if he is not going to get a return.

13.12. Summing up his arguments, Mr. Datar, learned

senior counsel, submits that the view taken by the Delhi High

Court is wholly erroneous. Non -compete fee is a capital

expenditure and is entitled to depreciation in terms of Section

32(1)(ii) of the Act.

14. Appearing on behalf of the revenue, Mr. S.

Dwarakanath, learned Additional Solicitor General of India, at

the outset, submits that the issue which arises for adjudication

in the present matters is whether payment of non-compete fee is

in the nature of revenue expenditure or capital expenditure?

Corollary to the above is, if such payment is construed to be of

capital nature, then whether depreciation under Section 32(1) of

the Act is allowable on such payment?

14.1. Supporting the judgment of the Delhi High Court in

Sharp Business System , Mr. Dwarakanath submits that

payment of non-compete fee is not in the nature of revenue

36

expenditure. Delhi High Court has rightly held that such

payment constitutes capital expenditure in the hands of the

payer, having been incurred for acquiring an enduring benefit of

an ephemeral nature. In this connection, learned counsel has

placed reliance on the following decisions:

(i) Empire Jute Co. Ltd. (supra);

(ii) Guffic Chem (P.) Ltd. Vs. CIT

6;

(iii) CIT Vs. Bharti Hexacom Ltd.

7;

(iv) Pitney Bowes India (P) Ltd. Vs. CIT

8

14.2. From an analysis of the aforesaid decisions, it is

evident that by expending non -compete fee, assessee had

acquired an enduring benefit of an ephemeral nature. Therefore,

the question which follows is whether such payment would be

eligible for depreciation under Section 32(1) of the Act?

14.3. In this connection, Mr. Dwarakanath submits that

Section 32(1) allowing depreciation on tangible and intangible

assets must be read holistically. Insofar payment of non-compete

6

(2011) 332 ITR 602

7

(2023) 458 ITR 593

8

2011 SCC OnLine Del 5114

37

fee is concerned, it certainly results in creation of an intangible

asset. There are two aspects of allowance of depreciation in

respect of intangible assets. Firstly, it should fall within one of

the enumerated categories i.e. know-how, patents, copyrights,

trade marks, licenses, franchises or ‘any other business or

commercial rights of similar nature’; secondly, it should be

‘owned’, either wholly or partly, by the assessee and should be

‘used’ for the purpose of its business or profession.

14.4. Elaborating on the above aspect, learned Additional

Solicitor General submits that the issues to be adjudicated are

twofold: one, whether the right acquired on payment of non-

compete fee falls within the expression ‘any other business or

commercial rights of similar nature’; and two, whether such right

is ‘owned’ (wholly or partly) by the assessee and ‘used’ for the

purpose of its business or profession, business in this case.

14.5. In this regard, he submits that applying the principles

of statutory interpretation and ejusdem generis, the appropriate

construction of the expression ‘any other business or commercial

rights of similar nature’, appearing in Section 32(1) (ii) of the Act

would be to follow the preceding words i.e. know-how, patents,

38

copyrights, trade marks, licenses and franchises. In this

connection, reliance has been placed on the following decisions

of this Court:

(i) Siddeshwari Cotton Mills (P) Ltd. Vs. Union of India

9;

(ii) CIT Vs. McDowell & Co. Ltd.

10

14.6. Explaining the above, Mr. Dwarakanath submits that

the concept of ejusdem generis signifies a principle of

construction whereby the words in a statute which are otherwise

wide but are associated in the text with more limited words are,

by implication, given a restricted operation and are limited to

matters of the same class or genus as preceding them. That

apart, in the absence of a comma, after the word franchises,

either in Section 32(1)(ii) of the Act or in the Explanation thereto

or in Section 2(11) of the same defining block of assets, the

legislative intent becomes quite clear: the expression ‘any other

business or commercial rights of similar nature’ does not

constitute a separate category but is to be read alongwith the

preceding categories. In support of this contention, learned

9

(1989) 2 SCC 458

10

(2009) 314 ITR 167

39

Additional Solicitor General has placed reliance on the following

decisions:

(i) Sree Durga Distributors Vs. State of Karnataka

11;

(ii) Mohd. Shabir Vs. State of Maharashtra

12;

14.7. Applying the above principle to the issue in hand, it is

submitted that the specific words ‘know -how, patents,

copyrights, trade marks, licenses and franchises’ constitute a

distinct class or category of positive rights that are capable of

being used or put to use. Referring to the judgment of the Delhi

High Court in CIT Vs. Hindustan Coca Cola Beverages (P) Ltd.

13,

learned Additional Solicitor General submits that whether

owned, wholly or partially, either in rem or in personam, the

common underlying feature of the above set of intellectual

property rights is that these are positive rights, brought into

existence by experience and/or reputation, granted either under

a statute or under a contract and capable of being used or put

to use for the purpose of business.

11

(2007) 4 SCC 476

12

(1979) 1 SCC 568

13

(2011) 331 ITR 192

40

14.8. He further submits that the right acquired by the

payer on payment of non-compete fee does not fall in this

category. It is a negative covenant that imposes an obligation on

the recipient of the fee to desist from doing something and as

such, it cannot be ‘used’ by the payer for the purpose of its

business. Such a negative covenant on the part of the recipient

only ‘exists’ and it is vital to draw a distinction between a positive

right being ‘owned’ and ‘used’, whether actively or passively vis-

a-vis a negative obligation merely ‘existing’. The only ‘right’

obtained by the payer of non-compete fee is the right to pursue

legal remedies in the event of breach of contract on the part of

the payee. As such, there is no ownership or usage of any

intangible asset in the manner envisaged in case of other

specified items.

14.9. Positive rights can only be owned and/or used.

Negative covenants only exists - those cannot be owned and/or

used, whether actively or passively. The statute does not

envisage allowance of depreciation on such rights/assets that

are not inherently capable of being put to use for the purpose of

business.

41

14.10. Hence, the expression ‘any other business or

commercial rights of similar nature’ must be read as being

limited to rights/assets specified by the preceding words i.e.

know-how, patents, copyrights, trade marks, licenses and

franchises which are positive rights conferred by the statute or

by a contract and capable of being ‘owned’ and put to use for the

purpose of business. As to the interpretation of the words ‘owned’

and ‘used’ in the context of Section 32(1), learned counsel has

placed reliance on the following two decisions of this Court:

(i) Liquidators of Pursa Ltd. Vs. CIT

14;

(ii) Mysore Minerals Ltd. Vs. CIT

15;

14.11. By way of analogy, learned Additional Solicitor

General has referred to Section 66E(e) of the Finance Act, 1994

which deals with the concept of negative covenant/non-compete

fee qua declared services, relevant portion of which reads thus:

S.66E. Declared Services:

…

Explanation (II)

…

(e) agreeing to the obligation to refrain from an act, or to

tolerate an act or a situation, or to do an act;

…

14

(1954) 25 ITR 265

15

(1999) 239 ITR 775

42

14.12. In the context of the Act, more particularly Section 32

thereof, there is no similar provision which specifically lays down

that a right which is not capable of being put to use like the right

acquired on payment of non-compete fee is nonetheless eligible

for depreciation.

14.13. Summing up his arguments, Mr. Dwarakanath

asserts that firstly, non-compete fee is not a revenue expenditure

but a capital expenditure. Secondly, even though it is a capital

expenditure leading to accrual of intangible asset, it is not

eligible for deduction because it is not ‘owned’ and ‘used’ by the

assessee for the purpose of its business.

15. Submissions made by learned counsel for the parties

have received the due consideration of the Court.

Analysis

16. Let us advert to Section 37 of the Act at the outset. It

is a residuary provision. Sub-section (1) of Section 37 reads as

follows:

(1) Any expenditure not being expenditure of the

nature described in Sections 30 to 36 and not being

in the nature of capital expenditure or personal

43

expenses of the assessee laid out or expended wholly

and exclusively for the purposes of the business or

profession shall be allowed in computing the income

chargeable under the head ‘profits and gains of

business or profession’.

16.1. This provision contemplates that any expenditure

incurred wholly and exclusively for the purposes of the business

shall be allowed in computing the income chargeable under the

head ‘profits and gains of business or profession.’ For such an

expenditure to be allowed, it should fulfill the following criteria:

i) it should not be an expenditure described in

Sections 30 to 36;

ii) it should not be in the nature of capital expenditure

or personal expenses of the assessee.

16.2. It is axiomatic that such expenditure should be

incurred during the previous year relevant to the assessment

year under consideration.

17. This provision was examined by this Court in Alembic

Chemical Works Co. Ltd. (supra). It has been explained that in

computing the income chargeable under the head ‘profits and

gains of business or profession’, Section 37 of the Act enables

44

the deduction of any expenditure laid out or expended wholly

and exclusively for the purposes of business or profession, as the

case may be. The fact that an item of expenditure is wholly and

exclusively laid out for the purpose of business by itself is not

sufficient to entitle its allowance in computing the income

chargeable to tax. In addition, the expenditure should not be in

the nature of a capital expenditure. In the infinite variety of

situational diversities in which the concept of what is capital

expenditure and what is revenue expenditure arises, it is well

nigh impossible to formulate any general rule, even in the

generality of cases, sufficiently accurate and reasonably

comprehensive, to draw any clear line of demarcation. However,

some broad and general tests have been suggested from time to

time to ascertain on which side of the line the outlay in any

particular case might reasonably be held to fall. These tests are

generally efficacious and serve as useful servants but as masters

they tend to be over-exacting.

18. There is a classical test laid down by Lord Cave L.C.

in Atherton Vs. British Insulated and Helsby Cables Ltd.

16, where

it was held:

16

(1925) 10 TC 155

45

When an expenditure is made, not only once and for

all, but with a view to bringing into existence an asset

or an advantage for the enduring benefit of a trade, I

think that there is very good reason (in the absence of

special circumstances leading to an op posite

conclusion) for treating such an expenditure as

properly attributable not to revenue but to capital.

19. There is another test of contemporary vintage. This

test is based on the distinction between fixed and circulating

capital and was propounded by Lord Haldane in John Smith and

Son Vs. Moore

17. This test was explained in the following manner:

Fixed capital is what the owner turns to profit by keeping

it in his own possession; circulating capital is what he

makes profit of by parting with it and letting it change

masters.

20. In Assam Bengal Cement Company Ltd. (supra), this

Court opined that if the expenditure is made for acquiring or

bringing into existence an asset or advantage for the enduring

benefit of the business, it is properly attributable to capital and

is of the nature of capital expenditure. If on the other hand, it is

not made for the purpose of bringing into existence any such

asset or advantage but for running the business or working it

17

(1921) 12 TC 266

46

with a view to produce the profits, it is revenue expenditure. The

ratio laid down in this judgment was summed up by this Court

in the recent decision, Bharti Hexacom Ltd. (supra). This Court

explained that where the expenditure is made for the initial

outlay or for extension of a business or for substantial

replacement of the equipment, it is capital expenditure. If the

expenditure is for running the business or working it with a view

to produce profits, it is revenue expenditure. Expenditure which

relates to the very framework or structure or edifice of the

taxpayer’s business is capital expenditure.

21. Coal Shipments Pvt. Ltd. (supra) is a case which dealt

with export of coal from India to Burma. Shipment of coal to

Burma got disrupted because of the second world war, which

was resumed after the cessation of hostilities. In order to

overcome the difficulties in the conduct of the trade following the

war, members of the coal trade in Bengal formed an association.

Coal Shipments Pvt. Ltd. and M/S HV Low & Co. Ltd. were two

of the major members of the association. The two companies

came to an understanding and arrived at an agreement whereby

it was decided that M/S HV Low & Co. Ltd. would not export coal

47

to Burma during the subsistence of the agreement and that it

would assist Coal Shipments Pvt. Ltd. in procuring coal for

shipment to Burma. For this, Coal Shipments Pvt. Ltd. made

certain payments to M/S HV Low & Co. Ltd. which were taxed in

the hand of M/S HV Low & Co. Ltd.

21.1. Coal Shipments Pvt. Ltd. claimed the payment of the

above amounts as admissible business expenditure for the

relevant assessment year. Income Tax Officer was of the view

such expenditure could not be allowed as there was no written

agreement in proof of such arrangement. It was not possible to

say that the payments were made for the purpose of the

assessee’s business. It was further held that even if the

payments were held to have been made to keep off M/S HV Low

& Co. Ltd. from the Burma trade, those were payments made to

secure a monopoly and thus were not allowable as revenue

expenditure.

21.2. On appeal, the appellate authority i.e. Appellate

Assistant Commissioner upheld the order of the Income Tax

Officer.

48

21.3. On further appeal before the ITAT, it was held that the

impugned payments were made to carry on the trade in a more

facile and profitable manner. According to the ITAT, the

arrangement that was arrived at verbally between the parties

was a temporary measure liable to be terminated at will. Coal

Shipments Pvt. Ltd. did not derive any advantage of an enduring

character by such payments. The expenditure in question were

attributable to revenue and not to capital. Accordingly, those

were held to be permissible expenditure under Section 10(2)(xv)

of the Indian Income Tax Act, 1922 (corresponding to Section 37

of the Act).

21.4. On reference before the High Court, it was held that

such expenditure did not create any monopoly or bring about

any capital advantage to the assessee. Such arrangement was

not likely to have an enduring beneficial effect. It was held that

Coal Shipments Pvt. Ltd. was entitled to claim deduction of such

expenditure.

21.5. This Court after adverting to the facts noted that the

controversy between the parties was centered on the point as to

whether that part of the payment which was made because of

49

M/S HV Low & Co. Ltd. having agreed not to export coal to

Burma during the subsistence of the agreement constituted

capital expenditure or revenue expenditure. This Court

thereafter referred to several judicial decisions laying down

broad principles in order to determine whether an expenditure

is of a capital nature or revenue nature, such as, enduring

benefit and fixed capital vis-a-vis circulating capital. This Court

rejected the contention of the revenue that as the object of

making the payments in question was to eliminate competition

of a rival exporter, the benefit which enured to the respondent

was of an enduring nature and as such, the payment should be

treated as capital expenditure. Further it was noted that the

arrangement between the two parties was not for any fixed term

but could be terminated at any time at the volition of any of the

parties. This Court held that although an enduring benefit need

not be of an ever-lasting character, it should not, at the same

time, be so transitory and ephemeral that it can be terminated

at any time at the volition of any of the parties. That apart, this

Court was of the view that payments made to M/S HV Low & Co.

Ltd. were related to actual shipment of coal in the course of the

trading activities of Coal Shipments Pvt. Ltd. and had no relation

50

to the capital value of the assets. Accordingly, the appeal of the

revenue was dismissed.

22. In Empire Jute Company Ltd. (supra), this Court was

concerned with an agreement between members of the Indian

Jute Mills Association of which the assessee was also a member.

Clause 4 of the agreement provided that no signatory shall work

for more than 45 hours per week. As per Clause 6(b), the

signatories were entitled to transfer, either wholly or partly, their

allotment of hours of work per week to any one or more of the

signatories. Under this clause, the assessee had purchased ‘loom

hours’ from four other mills for the aggregate sum of R s.

2,03,255.00 during the previous year relevant to the assessment

year 1960-61 and claimed deduction of the said amount as

revenue expenditure. When the matter came before the High

Court, it was held that the amount paid by the assessee for

purchase of loom hours was in the nature of capital expenditure

and was, therefore, not deductable under Section 10(2)(xv) of the

Indian Income Tax Act, 1922.

22.1. Reversing the decision of the High Court, this Court

opined that whether it is capital expenditure or revenue

51

expenditure would have to be determined having regard to the

nature of the transaction and other relevant factors. This Court

observed that there may be cases where expenditure even if

incurred for obtaining an advantage of enduring benefit, may

nonetheless be on revenue account and the test of enduring

benefit may break down. It is not every advantage of enduring

nature acquired by an assessee that brings the case within the

ambit of capital expenditure. What is material to consider is the

nature of the advantage in a commercial sense and it is only

where the advantage is in the capital field that the expenditure

would be disallowable on an application of the test of enduring

benefit. If the advantage consists merely in facilitating the

assessee’s trading operations or enabling the management and

conduct of the assessee’s business to be carried on more

efficiently or more profitably while leaving the fixed capital

untouched, the expenditure would be on revenue account, even

though the advantage may endure for an indefinite future.

22.2. Applying the above test to the facts of that case, this

Court held that by purchase of loom hours, no new asset was

created. There was no addition to or expansion of the profit

52

making apparatus of the assessee. The income earning machine

remained what it was prior to the purchase of loom hours. The

assessee was merely enabled to operate the profit making

structure for a longer number of hours. That apart, the

advantage was clearly not of an enduring nature. It was limited

in its duration to six months; moreover, the additional working

hours per week transferred to the assessee had to be utilised

during the week and could not be carried forward to the next

week. This Court was, therefore, of the opinion that it was not

possible to say that any advantage of enduring benefit in the

capital field was acquired by the assessee in purchasing the loom

hours.

22.3. Even applying the test of fixed and circulating capital,

this Court was of the view that it would not be possible to

characterize the amount paid for purchase of loom hours as

capital expenditure because acquisition of additional loom hours

did not add at all to the fixed capital of the assessee. The

permanent structure remained the same; it was not enlarged.

Thus loom hours were not part of fixed capital on the basis of

53

which, it could be said that payment for purchase of loom hours

was in the nature of capital expenditure.

22.4. This Court opined that the question as to whether an

expenditure is capital or revenue must be viewed in the larger

context of business necessity or expediency. If the outgoing

expenditure is so related to the carrying on or the conduct of the

business that it may be regarded as an integral part of the profit

earning process and not for acquisition of an asset or a right of

permanent character, the possession of which is a condition of

the carrying on of the business, the expenditure may be regarded

as revenue expenditure. Thus, this Court concluded that the

payment of Rs. 2,03,255.00 made by the assessee for purchase

of loom hours represented revenue expenditure and was

allowable as a deduction under Section 10(2)(xv) of the Indian

Income Tax Act, 1922.

23. In Alembic Chemical Works Co. Ltd. (supra), the

assessee was the manufacture of the antibiotic penicillin. In its

initial years, it could produce only about 5000 units of penicillin

per milli-liter of the culture-medium. With a view to increase the

yield of penicillin, assessee negotiated with M/S Meiji Seika

54

Kaisha Ltd. of Japan. The negotiations ended in an agreement

whereby and whereunder, M/S Meiji agreed to supply the

technical know-how to increase production of penicillin to more

than 10000 units for a consideration of ‘once for all’ payment of

50,000 US dollars. In the assessment proceedings, assessee

claimed this expenditure as revenue expenditure. The Income

Tax Officer, on the other hand, took the view that the

expenditure was incurred for the acquisition of an asset or

advantage of an enduring benefit. Holding such expenditure to

be capital in nature, the Income Tax Officer declined the

deduction. This view of the Income Tax Officer was affirmed by

the first appellate authority i.e. Appellate Assistant

Commissioner. The further appeal of the assessee w as also

dismissed by the ITAT. At the instance of the assessee, a

reference was made to the High Court which was, however,

decided in the negative against the assessee. It was thereafter

that the matter travelled to this Court.

23.1. This Court after alluding to the judicial

pronouncements on this point, observed that the idea of ‘once

for all’ payment and ‘enduring benefit’ are not to be treated as

55

something akin to statutory conditions. These concepts require

flexibility and not a rigid approach. There is no single definitive

criterion which by itself is determinative as to whether a

particular outlay is capital or revenue. The ‘once for all’ payment

test is also inconclusive. What is relevant is the purpose of the

outlay and its intended object and effect considered in a common

sense way having regard to the business realities.

23.2. In the facts of that case, this Court held that the

financial outlay under the agreement was for the better conduct

and improvement of the existing business and should therefore

be treated as revenue expenditure. Consequently, the appeal by

the assessee was allowed and the question of law answered in

the affirmative and against the revenue.

24. The next case that we may advert to is the case of Madras

Auto Services (P) Ltd. (supra). In this case, the respondent

assessee, a tenant, had incurred expenditure on demolition and

construction of a new building which was to vest in the landlord.

Assessee in lieu of incurring the actual cost of construction was

entitled to use the premises for a period of 39 years at a reduced

rent. The entire capital cost of construction was claimed by the

56

assessee as revenue expenditure on the ground that the assessee

had not acquired any new asset or such expenditure did not

result in any enduring advantage to the assessee in the capital

field. The above stand of the assessee was accepted by the ITAT

and the High Court. When revenue came up in appeal before this

Court, it was held as under:

In order to decide whether this expenditure is revenue

expenditure or capital expenditure, one has to look at the

expenditure from a commercial point of view. What

advantage did the assessee get by constructing a building

which belonged to somebody else and spending money for

such construction? The assessee got a long lease of a

newly constructed building suitable to its own business at

a very concessional rent. The expenditure, therefore, was

made in order to secure a long lease of new and more

suitable business premises at a lower rent. In other words,

the assessee made substantial savings in monthly rent for

a period of 39 years by expending these amounts. The

saving in expenditure was a saving in revenue expenditure

in the form of rent. Whatever substitutes for revenue

expenditure should normally be considered as revenue

expenditure. Moreover, the assessee in the present case

did not get any capital asset by spending the said

amounts. The assessee, therefore, could not have claimed

any depreciation. Looking to the nature of the advantage

57

which the assessee obtained in a commercial sense, the

expenditure appears to be revenue expenditure.

* * * * *

Right from inception, the building was of the

ownership of the lessor. Therefore, by spending this

money, the assessee did not acquire any capital asset. The

only advantage which the assessee derived by spending

the money was that it got the lease of a new building at a

low rent. From the business point of view, therefore, the

assessee got the benefit of reduced rent. The High Court

has, therefore, rightly considered this as obtaining a

business advantage. The expenditure is, therefore, to be

treated as revenue expenditure.

* * * * *

All these cases have looked upon expenditure which

did bring about some kind of an enduring benefit to the

company as a revenue expenditure when the expenditure

did not bring into existence any capital asset for the

company. The asset which was creat ed belonged to

somebody else and the company derived an enduring

business advantage by expending the amount. In all these

cases, the expenses have been looked upon as having been

made for the purpose of conducting the business of the

assessee more profitably or more successfully. In the

present case also, since the asset created by spending the

said amounts did not belong to the assessee but the

assessee got the business advantage of using modern

premises at a low rent, thus saving considerable revenue

expenditure for the next 39 years, both the Tribunal as

well as the High Court have rightly come to the conclusion

58

that the expenditure should be looked upon as revenue

expenditure.

25. Having adverted to the relevant case laws, we may now

examine the nature and character of non-compete fee; whether

payment of non-compete fee is revenue expenditure or capital

expenditure. Non-compete fee is paid by one party to another to

restrain the latter from competing with the payer in the same

line of business. It may be by way of a written agreement or by

an oral understanding. The restriction may be limited to a

specified territory or otherwise; similarly, it can be for a specified

period or otherwise. Purpose of non-compete payment is to give

a head start to the business of the payer. It can also be for the

purpose of protecting the business of the payer or for enhancing

the profitability of the business of the payer by insulating the

payer from competition.

26. Thus non-compete fee only seeks to protect or

enhance the profitability of the business, thereby facilitating the

carrying on of the business more efficiently and profitably. Such

payment neither results in creation of any new asset nor

accretion to the profit earning apparatus of the payer. The

59

enduring advantage, if any, by restricting a competitor in

business, is not in the capital field.

27. Following the judicial trend, it can be safely inferred

that the length of time over which the enduring advantage may

enure to the payer is not determinative of the nature of

expenditure. As long as the enduring advantage is not in the

capital field, where the advantage merely facilitates in carrying

on the business more efficiently and profitably, leaving the fixed

assets untouched, the payment made to secure such advantage

would be an allowable business expenditure, irrespective of the

period over which the advantage may accrue to the paye r

(assessee) by incurring of such expenditure.

28. The non-compete compensation from the stand point

of the payer of such compensation is so paid in anticipation that

absence of a competition from the other party may secure a

benefit to the party paying the compensation. However, there is

no certainty that such benefit would accrue. Notwithstanding

such an arrangement, the payer (assesee) may still not achieve

the desired result. In so far the present case is concerned, on

account of payment of non-compete fee, the assessee had not

60

acquired any new business and there is no addition to the profit

making apparatus of the assessee. The assets remained the

same. The expenditure incurred was essentially to keep a

potential competitor out of the same business. Further, there is

no complete elimination of competition. Such payment made by

the appellant to L&T did not create a monopoly of the appellant

over the business of electronic products/ equipments. Payment

was made to L&T only to ensure that the appellant operated the

business more efficiently and profitably. Such payment made to

L&T cannot, therefore, be considered to be for acquisition of any

capital asset or towards bringing into existence a new profit

earning apparatus.

Conclusion

29. That being the position, 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.

30. Consequently, the impugned judgment and order of

the Delhi High Court dated 05.11.2012 passed in Income Tax

Appeal No. 492/2012 is hereby set aside. The question framed

61

in paragraph 5 of this judgment is thus answered in favour of

the assessee and against the revenue. Civil Appeal No.

4072/2014 is accordingly allowed.

31. In view of what we have held above, the

supplementary question framed in paragraph 5.1 of this

judgment has been rendered redundant. Therefore,

consideration of the submissions made in this regard is not

necessary.

32. As regards the remaining appeals, we are of the view

that it would be appropriate if the matters are remanded back to

the respective ITATs, all appeals/ cross-appeals filed are revived

and heard afresh having regard to the ratio laid down in this

judgment.

33. Ordered accordingly.

34. Since the appeals/ cross-appeals before the ITATs

have been revived, parties would be at liberty to raise additional

ground(s) based on the present judgment.

62

Interest on borrowed funds.

Civil Appeal No. _/2025

(Arising out of SLP(C) No. 719/2020,

PCIT Vs. Piramal Glass Ltd).

35. During the assessment proceedings for the

assessment year 2001-2002, the Assessing Officer noted the

claim of the assessee regarding interest on investments made in

subsidiary company as well as interest on borrowings for

payment of interest-free loan to sister concern and its directors.

Vide the assessment order dated 09.02.2004 passed under

Section 143(3) of the Act, the Assessing Officer noted from the

balance sheet of the assessee that it had invested Rs. 2,587.10

lakhs in the shares of the subsidiary company M/S Ceylon Glass

Company Ltd., Sri Lanka. At the same time, he found that there

were interest bearing borrowings of Rs. 3267.41 crores and

interest of 38.22 crores was debited to the profit and loss

account. This claim of deduction of the assessee under Section

36(1)(iii) of the Act to the extent of Rs. 3,36,32,300.00 was

disallowed by the Assessing Officer. According to the Assessing

Officer, interest on money borrowed for investment can be

allowed against income from investment. But if the shares are

acquired, not as an investment for earning income but to acquire

63

controlling interest in a company, it would not be entitled to

deduction of interest on borrowing. If the dominant purpose of

expenditure was not for earning profit but to acquire controlling

interest, it could not be allowed as a deduction. As a result,

interest @ 13% in investment made in the subsidiary company

was not allowed as a deduction. The total disallowance out of

interest payment was worked out at Rs. 3,36,32,300.00.

35.1. The Assessing Officer also noted that an amount of

Rs. 3,00,000.00 was outstanding from a director of the assessee

company and an amount of Rs. 346.43 lakhs was due from

companies where directors of the assessee were interested as

directors. After considering the explanation of the assessee, the

Assessing Officer made disallowance of an amount of

Rs.99,49,264.00. Assessing Officer held that assessee’s claim for

deduction of interest paid on loan, utilized for giving interest free

loan/ advances to sister concern, was not in accordance with

law. The assessee also could not establish the nexus with the

funds from which the advances were made to the subsidiary

company. In the absence of such details, the interest was worked

out to 13% per annum on account of the advances made to the

64

sister concern. It was disallowed on the ground that borrowed

funds were used for non-business purposes. Thus the amount

of disallowance at the interest rate of 13% per annum was

worked out at Rs.99,49,264.00.

35.2. The first appellate authority i.e. CIT(A) agreed with the

reasonings given by the Assessing Officer and disallowed the

interest payment on borrowed fund claimed under Section

36(1)(iii) of the Act and upheld the order of assessment.

35.3 On further appeal, ITAT observed that since the

investment was made for controlling interest in the sister

concern, assessee was entitled to the claim of allowance of the

interest. Investment was made in the shares of the sister

company with a similar line of business and for commercial

expediency. Thus no disallowance was warranted under Section

36(1)(iii) of the Act. ITAT following the decision of this Court in

SA Builders Ltd. Vs. CIT

18, directed the Assessing Officer to allow

the claim of the assessee in respect of interest on borrowed fund

18

288 ITR 1

65

since the advances were made for the purposes of commercial

expediency.

35.4. Revenue challenged the aforesaid decision of the ITAT

before the Bombay High Court. Adverting to one of its previous

decisions, High Court held that the assessee was entitled to

deduction of interest under Section 36(1)(iii) of the Act when the

investment was made by the assessee in a subsidiary company

to have control over the said company. With respect to interest

free advances made by the assessee to the sister concern out of

borrowed funds, High Court was of the view that this question

had become infructuous.

Submissions

36. Mr. Dwarakanath, learned Additional Solicitor

General of India appearing for the revenue, though made

extensive submissions on the issue of non-compete fee, did not,

however, advance any argument on the point of investment in

shares of the sister concern or on interest on borrowed funds

given to sister concern and its directors. However, Mr. Ajay

Vohra, learned senior counsel for the respondent assessee,

submitted that revenue was incorrect in contending that the

66

assessee had not established that the investment was made for

acquiring the controlling interest in the associate concern. In

fact, it was clearly mentioned by the assessee that it had made

investment of Rs. 2587.10 lakhs in the subsidiary company viz,

M/S Ceylon Glass Company Ltd. Dividend income from a foreign

company like the subsidiary company is taxable and not exempt

under Section 10(33) of the Act.

36.1. Assessing Officer had recorded that shares of the

subsidiary company were acquired not for earning profit but for

acquiring controlling assets. Where the Assessing Officer himself

recorded the finding that investment in the subsidiary company

was made for acquiring controlling interest, revenue was not

justified in contending that assessee had not established that

the investment was made for earning income. The fact that the

assessee had made investment for acquiring controlling interest

in the subsidiary company is itself sufficient for claiming

deduction of interest under Section 36(1)(iii) of the Act.

Investment made in the subsidiary company was in the line of

the existing business of the assessee and was for the business of

the assessee. In such circumstances, deduction is allowable

under Section 36(1)(iii) of the Act.

67

36.2. In this connection, Mr. Vohra, learned senior counsel,

relied upon the decision of this Court in SA Builders Ltd. (supra).

He submits that the assessee had duly established that the debit

balance in the account of the sister concern was for the purpose

of business, and therefore, on these facts, the decision of this

Court in SA Builders Ltd. (supra) would be squarely applicable to

the facts of the present case.

Analysis

37. Section 36 of the Act deals with other deductions that

may be allowed while computing the total income under the

heading ‘profits and gains of business or profession’ referred to

in Section 28 of the Act. Section 36(1)(iii) says that

the deductions provided for the amount of interest paid in

respect of capital borrowed for the purposes of the business or

profession shall be allowed in computing the income referred to

in Section 28.

38. In SA Builders Ltd. (supra), this Court considered the

question regarding allowability of interest on borrowed funds.

This Court referred to the provisions of Section 36(1)(iii) of the

Act and to the facts of that case. It was noted that the borrowed

68

amount in question was not utilized by the assessee in its own

business but was advanced as interest free loan to its sister

concern. This Court opined that this factum was not really

relevant. What was relevant was whether the assessee had

advanced such amount to its sister concern as a measure of

commercial expediency. Once it is established that there was

nexus between the expenditure and the purpose of the business,

which need not necessarily be the business of the assesee itself,

revenue cannot justifiably claim to put itself in the arm-chair of

the businessman or in the position of the board of directors and

then decide how much would be the reasonable expenditure.

Income tax authorities must put themselves in the shoes of the

assessee and see how a prudent businessman would act. We

have to see the transfer of the borrowed funds to a sister concern

from the point of view of commercial expediency and not from

the point of view of whether the amount was advanced for

earning profits. No businessman can be compelled to maximize

his profits. However, this Court put in a caveat that it is not in

every case interest on borrowed fund has to be allowed if the

assessee advances it to a sister concern. It all depends upon the

facts and circumstances of the case. This Court held thus:

69

34. We agree with the view taken by the Delhi High Court

in CIT v. Dalmia Cement (Bharat) Ltd. [2002] 254 ITR 377

that once it is established that there was nexus between

the expenditure and the purpose of the business (which

need not necessarily be the business of the assessee itself),

the revenue cannot justifiably claim to put itself in the

arm-chair of the businessman or in the position of the

board of directors and assume the role to decide how

much is reasonable expenditure having regard to the

circumstances of the case. No businessman can be

compelled to maximize its profit. The income tax

authorities must put themselves in the shoes of the

assessee and see how a prudent businessman would act.

The authorities must not look at the matter from their own

view point but that of a prudent businessman. As already

stated above, we have to see the transfer of the borrowed

funds to a sister concern from the point of view of

commercial expediency and not from the point of view

whether the amount was advanced for earning profits.

35. We wish to make it clear that it is not our opinion

that in every case interest on borrowed loan has to be

allowed if the assessee advances it to a sister concern.

It all depends on the facts and circumstances of the

respective case. For instance, if the Directors of the

sister concern utilize the amount advanced to it by the

assessee for their personal benefit, obviously it cannot

be said that such money was advanced as a measure

of commercial expediency. However, money can be

70

said to be advanced to a sister concern for commercial

expediency in many other circumstances (which need

not be enumerated here). However, where it is obvious

that a holding company has a deep interest in its

subsidiary, and hence if the holding company

advances borrowed money to a subsidiary and the

same is used by the subsidiary for some business

purposes, the assessee would, in our opinion,

ordinarily be entitled to deduction of interest on its

borrowed loans.

Conclusions

39. Adverting to the facts of this case, we find that the

respondent assessee had claimed interest on borrowed funds

under Section 36(1)(iii) of the Act which was utilized for

investment in M/S Ceylon Glass Company Ltd., a subsidiary

company of the assessee. T he investment was made for

controlling the interest in the associate concern by purchase of

shares. Thus the investment was clearly for commercial

expediency. We agree with the finding recorded by the ITAT and

affirmed by the High Court that assessee is entitled to claim

allowance of interest on the funds invested in sister concern for

acquiring of controlling interest.

71

40. Following the decision of this Court in SA Builders Ltd.

(supra), we find that the purpose for which the advances were

made to the sister concern and its directors would also be

covered by the principle of commercial expediency.

41. Accordingly, the decision of the ITAT on this point,

which was not interfered with by the High Court, is hereby

affirmed. Consequently, the appeal filed by the revenue on this

issue is dismissed. The question framed in paragraph 5.2 of this

judgment is thus answered in favour of the assessee and against

the revenue.

42. All the appeals are hereby disposed of in terms of

paragraphs 29 to 34 and 39 to 41 supra.

……………………………J.

[MANOJ MISRA]

……………………………J.

[UJJAL BHUYAN]

NEW DELHI;

DECEMBER 19, 2025.