Facts of the Case

The assessee, GKN Driveline India Ltd., engaged in manufacturing front wheel drive axle assemblies, entered into an agreement dated 16 February 1995 with Shriram Mobiles Limited (SML) for acquisition of a manufacturing unit at Madras.

The consideration structure was bifurcated into:

  • Rs. 1.30 Crores towards net asset value of the unit
  • Rs. 70 Lakhs towards obligations and covenants, including a non-compete clause

The assessee claimed deduction of Rs. 70 lakhs as revenue expenditure in its return.

The Assessing Officer treated the payment as capital expenditure on the ground that it conferred enduring benefit.

CIT(A) reversed the finding and allowed deduction, holding the five-year non-compete restriction to be temporary.

ITAT restored the Assessing Officer’s order, holding the expenditure capital in nature.

The assessee filed appeal before the Delhi High Court under Section 260A.

Issues Involved

  1. Whether payment of Rs. 70 lakhs described as non-compete consideration for five years constituted capital expenditure or revenue expenditure?
  2. Whether the nature of the payment, viewed in entirety under the acquisition agreement, created an enduring business advantage?

Petitioner’s Arguments (Assessee’s Arguments)

The assessee contended that:

  • The payment represented non-compete fee for only five years.
  • A time-bound non-compete arrangement cannot be treated as capital expenditure.
  • The seller had not even commenced production, and therefore there was no serious competitive threat.
  • The payment was made to facilitate smooth business expansion and should qualify as business expenditure.
  • Reliance was placed upon CIT v. Eicher Ltd., where non-compete payments were held to be revenue expenditure.

Respondent’s Arguments (Revenue’s Arguments)

The Revenue argued that:

  • The payment resulted in elimination of competition at inception itself.
  • The expenditure gave enduring commercial advantage to the assessee.
  • The payment formed part of acquisition cost and therefore was capital in character.
  • Reliance was placed on Sharp Business System v. Commissioner of Income Tax, where non-compete fee was treated as capital expenditure.

Court Findings / Court Order

The Delhi High Court dismissed the appeal and held:

  • The payment of Rs. 70 lakhs was not exclusively for non-compete obligations.
  • The agreement clearly showed that the amount covered multiple obligations, including:
    • warranties
    • indemnity
    • confidentiality
    • approvals from authorities
    • title clearance
    • non-compete obligations

The Court held that:

  • The dominant purpose of the payment was to ensure smooth and complete acquisition of the manufacturing unit.
  • The obligations enhanced the value of the acquired asset.
  • The payment secured enduring business advantage.

Accordingly, the Court held the expenditure to be capital expenditure and not allowable as revenue deduction under Section 37(1).

Important Clarification

The Court clarified:

A payment cannot be treated as revenue expenditure merely because one component of the agreement contains a non-compete clause.

Where the payment is integrally connected with acquisition of capital assets and fulfillment of acquisition obligations, the expenditure assumes the character of capital expenditure.

The Court distinguished Eicher Ltd. on facts and emphasized that each case must be decided based on the nature and substance of the transaction.

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2017:DHC:7253-DB/PMS27112017ITA5422005.pdf


Disclaimer

This content is shared strictly for general information and knowledge purposes only. Readers should independently verify the information from reliable sources. It is not intended to provide legal, professional, or advisory guidance. The author and the organisation disclaim all liability arising from the use of this content. The material has been prepared with the assistance of AI tools.