[2018] 99 taxmann.

com 220 (Madras)/[2018] 407 ITR 674 (Madras)[10-04-2017]

IT : Where assessee engaged in business of manufacture, marketing and distribution

of ice cream and dairy based frozen products, made payment of non-compete fee to
two of its directors, since advantage of restraining individuals from engaging in
competition was in field of facilitating assessee's own business and rendering it
more profitable and there was no increase in fixed capital, payment in question was
to be allowed as revenue expenditure

■■■

[2018] 99 [Link] 220 (Madras)

HIGH COURT OF MADRAS
Hatsun Agro Products Ltd.
v.
Joint Commissioner of Income-tax*
HULUVADI G. RAMESH AND DR. ANITA SUMANTH, JJ.
T.C. (APPEAL) NO. 1173 OF 2005†
APRIL 10, 2017

Section 37(1) of the Income-tax Act, 1961 - Business expenditure - Allowability of (Non-
Compete fee) - Assessee-company, engaged in business of manufacture, marketing and
distribution of ice cream and dairy based frozen products, made payment of non-compete
fee to two of its directors - Assessee's claim for deduction of said expenditure was rejected
by Assessing Officer on ground that it was in nature of capital expenditure - Tribunal upheld
order passed by Assessing Officer - Whether since advantage of restraining individuals from
engaging in competition was in field of facilitating assessee's own business and rendering it
more profitable and there was no increase in fixed capital, payment in question was to be
allowed as revenue expenditure - Held, yes [Paras 12 and 15] [In favour of assessee]
FACTS

■ The assessee was initially a private company engaged in business of manufacture, marketing and
distribution of ice cream and dairy based frozen products.
■ Subsequently, assessee initiated the process of conversion from private limited to a public limited
company to facilitate growth and expansion in business at that stage, assessee made payment of non-
compete fee to two of its directors to ensure that it was not deprived of their services, or worse, lost to a
competitor.
■ The assessee's claim for deduction of said expenditure under section 37(1) was rejected by Assessing
Officer on ground.
■ The benefit obtained under the agreement was an enduring one, and consequently expenditure in question
was capital in nature.
■ The Tribunal upheld the order of Assessing Officer.
■ On appeal:
HELD
■ The question comes up before the Court is the categorization of expenditure of non-compete fee as either
capital or revenue. The distinction is fine. Courts have, over time, evolved various tests to determine such
categorization, but there is no straightjacket method and the application of the tests would vary upon the
facts of the case in hand. In the present case, while neither the Assessing Officer nor the Tribunal dispute
the long association and valuable services rendered by the individuals as well as the importance of
retaining these advantages, particularly at the time when it was going public, both officers deny the claim
solely based on the fact that the payments results in an enduring benefit.
■ The test of enduring benefit cannot be applied blindly without regard to the facts and circumstances that
arise in the given case. The conclusion of the Tribunal that the payment has an enduring benefit and is
capital in nature does not take into account the commercial benefit received by the company. In fact, the
Tribunal appears to have been guided solely by an earlier decision. [Para 11]
■ The advantage of restraining the individuals from engaging in competition was in the field of facilitating
assessee's own business and rendering it more profitable. Since there is no increase in fixed capital, the
payment does not encroach in the capital field. [Para 12]
■ The payments made towards restrictive covenants ensured the continued presence and support of the
individuals in its business operations. Equally importantly, it also ensured credibility in public perception
and reassured potential investors that the performance of the company would remain optimum through
this continued association. Though there was no actual or impending threat of the Directors severing their
ties with the company or starting competing businesses, the possibility was always real and prudence
dictates that the company protect itself against such a probability. This assumed particular significance at
a time when the company was proposing to go public and it thus becomes vital that the public continued
to see that the company was associated with, and had the benefit of services and loyalty of the individuals
who had been, and were continuing to be, fundamental to the growth of the company. [Para 13]
■ In the light of the above discussion it is held that the payments towards non-compete fee to two directors
constitute revenue expenditure in the hands of the assessee. [Para 15]
CASES REFERRED TO

Asianet Communications (P.) Ltd. v. Dy. CIT [2006] 7 SOT 496 (Chennai) (para 7), Alembic Chemical Works
Co. Ltd. v. CIT [1989] 177 ITR 377/43 Taxman 312 (SC) (para 8), CIT v. Coal Shipment (P.) Ltd. [1971] 82
ITR 902 (SC) (para 8), Chelpark Co. Ltd. v. CIT [1991] 191 ITR 249/56 Taxman 29 (Mad.) (para 8),
Carborandum Universal Ltd. v. Jt. CIT [2012] 26 [Link] 268 (Mad.) (para 8) and Empire Jute Co. Ltd.
v. CIT [1980] 124 ITR 1/3 Taxman 69 (para 10).
S. Sridhar for the Appellant. T.R. Senthil Kumar for the Respondent.
JUDGMENT

Dr. Anita Sumanth, J. - The Assessee is a company engaged in the business of manufacture, marketing and
distribution of ice cream and dairy based frozen products. The facts in brief as presented by the Appellant are
as follows;—
The Appellant Company had its beginnings in a partnership firm started by two individuals, Mr. Raja KSP
Ganesan and Mr. R.G. Chandramogan, a father and son duo, in 1970. The firm was converted into a Private
Limited Company in 1986 and in 1995, the Appellant initiated the process of conversion from Private Limited
to a Public Limited Company to facilitate growth and expansion in business. The individuals had nurtured the
business from inception and continued their association with the entity over the years. Intellectual property
had been developed by them and the brand name 'ARUN' had been transferred by Mr. R.G. Chandramogan to
the Appellant in April 1987. The individuals were highly experienced in the business of dairy based frozen
food products. The Appellant thus wanted to ensure that the association with the individuals continued both in
the public eye as well as in its own interests, seeing that the appellant had benefitted greatly from their
services over the years.
2. Accordingly, it entered into agreements dated 20.7.1995 for non-compete with the two individuals
restraining them from carrying on, for twenty years, any competing trade, business or activity in connection
with the manufacture of ice creams or dairy products in any part of the world. The relevant clause, common to
both agreements, is:
 'WHEREAS the party of the first part has been actively engaged in the business of manufacture,
marketing and distribution office Cream and other dairy-based frozen food products, in India and
particularly in the Southern States of Tamilnadu, Karnataka, Kerala and Pondicherry, for the past more
than two decades and has, during the said period, acquired and accumulated considerable expertise in
manufacturing, technological and marketing in respect of such food products.' ……
"1. The party of the first part agrees that during the currency of the agreement, the party of the first part
shall not directly or indirectly without the prior consent in writing of the party of the second part,
manufacture or market or deal in Ice Creams any where in the world, either by himself, or in association
with other or others nor shall he involve himself in such manufacture and marketing of Ice Creams either
as an employee, agent, representative or through the medium of a company, partnership, or association of
persons of in any other form."
3. The expenditure of Rs.400 lakhs incurred on non-compete fee, Rs.300 lakhs to Mr. Chandramohan and
Rs.100 lakhs to [Link] Ganesan, was claimed as expenditure in the computation of income in respect of A Y
1996-97. The Assessing Authority was of the view that the benefit obtained under the agreement was an
enduring one, and consequently held the same to be capital, liable to be disallowed.
4. The Commissioner of Income Tax (Appeals) before whom an Appeal was filed, reversed the order of
assessment. The Commissioner of Income Tax (Appeals) held that the restriction placed on the directors
resulted in a business advantage and the payments were thus revenue in nature. The Tribunal, in an appeal
filed by the Income Tax Department, reversed the order of the CIT(A) restoring that of the Assessing Officer.
The assessee is in appeal against the aforesaid order of the Tribunal dated 27.2.2015, raising the following two
substantial questions of law for adjudication:

1. Whether the Tribunal is correct in concluding that the payment of Rs.4,00,00,000/- towards non-
competition was correctly disallowed on the facts and in the circumstances of the case?
2. Whether the Tribunal is correct in concluding that the above disallowance was warranted in the
light of the decision rendered in the case of Asia Net Communications (P.) Ltd. in ITA
No.443/Mds/2004 dated 03.01.2005 (unreported) even though the said decision was not made
available to the parties at the time of hearing?
5. Heard Mr. [Link] appearing for the appellant and [Link] Kumar appearing for the respondent.
6. In the present case, there is no dispute with the position that the two individuals, [Link] KSP Ganesan and
[Link] were intrinsically connected with the business of the appellant. At a time when the
company was in the process of conversion from private limited to public, it is a matter of business expediency
to ensure that the appellant is not deprived of their services, or worse, lost to a competitor. The payment of
non-compete fee seeks to ensure this commercial benefit.
7. The Tribunal, in allowing the Revenue's appeal, has relied on its own decision in the case of Asianet
Communications (P.) Ltd. v. Dy. CIT [2006] 7 SOT 496 (Chennai). The main ground on which the payment
has been held to be capital is that the restrictive covenant gives an enduring benefit which falls squarely in the
capital field.
8. The Revenue would rely on two judgments of the Supreme Court in the case of Alembic Chemical Works
Co. Ltd. v. CIT [1989] 177 ITR 377/43 Taxman 312 and CIT v. Coal Shipment (P.) Ltd. [1971] 82 ITR 902
(SC) and a decision of the Madras High Court in the case of Chelpark Co. Ltd. v. CIT [1991] 191 ITR 249/56
Taxman 29. The assessee, on the other hand, would rely on a decision of this Court in the case of
Carborandum Universal Ltd. v. Jt. CIT [2012] 26 [Link] 268 (Mad.).
9. The question before us is the categorization of expenditure of non-compete fee as either capital or revenue.
The distinction is fine. Courts have, over time, evolved various tests to determine such categorization, but
there is no straightjacket method and the application of the tests would vary upon the facts of the case in hand.
In the present case, while neither the assessing officer nor the Tribunal dispute the long association and
valuable services rendered by the individuals as well as the importance of retaining these advantages,
particularly at the time when it was going public, both officers deny the claim solely based on the fact that the
payments results in an enduring benefit.
10. We could do no better than to quote the Supreme Court, in the case of Empire Jute Co. Ltd. v. CIT [1980]
124 ITR 1/3 Taxman 69 stating as follows:
 '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 a
permanent character, the possession of which is a condition of the carrying on of the business, the
expenditure may be regarded as revenue expenditure. See Bombay Steam Navigation Co. (1953) P. Ltd's
case (supra). The same test was formulated by Lord Clyde in Robert Addie and Sons' Collieries Ltd.'s
case (supra) (C Sess) in these words: "Is it a part of the company's working expenses?-- is it expenditure
laid out as part of the process of profit earning?-- or, on the other hand, is it a capital outlay?-- is it
expenditure necessary for the acquisition of property or of rights of a permanent character, the possession
of which is a condition of carrying on its trade at all?" It is clear from the above discussion that the
payment made by the assessee for purchase of loom hours was expenditure laid out as part of the process
of profit earning. It was, to use Lord Sumner's words, an outlay of a business "in order to carry it on and
to earn a profit out of this expense as an expense of carrying it on". [John Smith and Son v. Moore [1921]
12 TC 266 (HL)]. It was part of the cost of operating the profit-earning apparatus and was clearly in the
nature of revenue expenditure.' ……
'..there may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit,
may, nonetheless, be on revenue account and the test of enduring benefit may break down. ... 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 this test.
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.'
11. Thus, the test of enduring benefit cannot be applied blindly without regard to the facts and circumstances
that arise in the given case. We find that the conclusion of the Tribunal that the payment has an enduring
benefit and is capital in nature does not take into account the commercial benefit received by the company. In
fact, the Tribunal appears to have been guided solely by an earlier decision rendered by it in the case of
Asianet Communications. The assessee would incidentally point out that a copy of this decision was not
circulated and hence reliance by the Tribunal on this decision is in itself incorrect. He would urge us to
consider, as an alternate submission, the remand of the matter to the tribunal in order that he meet and
distinguish this decision in full.
12. The advantage of restraining the individuals from engaging in competition is in the field of facilitating its
own business and rendering it more profitable. Since there is no increase in fixed capital, the payment does
not encroach in the capital field.
13. The payments made towards restrictive covenants ensured the continued presence and support of the
individuals in its business operations. Equally importantly, it also ensured credibility in public perception and
reassured potential investors that the performance of the company would remain optimum through this
continued association. Though there was no actual or impending threat of the Directors severing their ties with
the company or starting competing businesses, the possibility was always real and prudence dictates that the
company protect itself against such a probability. This assumed particular significance at a time when the
company was proposing to go public and it thus becomes vital that the public continued to see that the
company was associated with, and had the benefit of services and loyalty of the individuals who had been,
and were continuing to be, fundamental to the growth of the company.
14. The judgments cited by the Revenue turn on differing facts and do not therefore not support its case. In
fact the Supreme Court in Coal Shipments (P.) Ltd. (supra), relied upon by the Revenue has stated that the
question as to whether an expenditure is revenue or not has to be seen from the context of an expenditure
forming 'part of the cost of the income-earning machine or structure' as opposed to part of 'the cost of
performing the income-earning operations'.
15. In the light of the above discussion, we hold that the payments towards non-compete fee to [Link] KSP
Ganesan and [Link] constitute revenue expenditure in the hands of the appellant. The
substantial questions of law are answered in favour of the appellant and against the revenue.
SUNIL
*In favour of assessee.
†Arising out of order of ITAT, Chennai in IT Appeal No. 1200 (Mds.), dated 27-7-2005.