In a landmark judgment the Mumbai bench of the Income Tax Appellate Tribunal has said that non-compete fees paid by an acquiring company to exiting promoters can be treated as an expense if the fees are not central to the deal. In the past the income tax department considered such payments as part of the deal and treated them as capital expenditure. 

 

Given that non-compete payments are a standard feature in most M&A deals the order will have wide implications. The order pertains to an appeal filed by the deputy commissioner of income tax against a Hyderbad-based company Intervet India - an arm of a Dutch based animal health company Intervet BV in `97.

Intervet India, which was earlier called BE Animal Health, was bought by the Dutch multinational . Following the memorandum of understanding for the purchase, the buyers entered into two separate non-compete agreements with Dr Vijay Kumar Datla and Dr Renuka Datla - erstwhile directors who were at the helm of operations at the company. 

 

Until now most non-compete fees were regarded as capital expenditure based on an order issued by a special bench of the tribunal in New Delhi in the matter of Tecumesh India v/s the Assistant Commissioner of Income Tax. In this matter the tribunal had decided on the issue of non-compete fee and held it to be capital in nature.

Arguing for the assessee Kanchun Kaushal and Dhanesh Bafna of PricewaterhouseCoopers pointed out that in the Intervet case the non-compete agreement was not central to the acquisition and was paid for protecting business interest. In the case of Tecumesh non-compete fees were part of the deal and it therefore took the part of capital expenditure. 

 

In their order issued last month PM Jagtap, accountant member and Amit Shukla, Judicial member said that in the present case the execution of non-compete agreement was not a precondition for the survival of the share purchase. The order also noted that the fact that the agreement value was approved by RBI as fair value of the shares.

Finally, the tribunal observed that in the case of Tecumesh the payment was toward the initial capital outlay and hence treated as capital expenditure. In the case of Intervet India, the non-compete fees paid to two persons was to enable its management to run its business effectively and profitably. "We thus, hold that, in the present case the entire payment of Rs 4 crore paid by the assessee to Dr Vijay Datla and Dr Renuka Datla towards non-compete fee is revenue expenditure". (Times of India.)