Bombay High Court Upholds Tata Chemicals' Tax Deduction For Non-Compete Fee Paid To Former Employee

The Bombay High Court on 8 October held that payments made to a former employee under a non-compete agreement qualify as revenue expenditure for income tax purposes, even when paid in instalments across multiple financial years.

A Division Bench comprising Justices Suman Shyam and Gautam A. Ankhad dismissed the Income Tax Department's appeal against Tata Chemicals Ltd., upholding deductions claimed by the company for non-compete compensation and expenditure on projects that were later written off. The judges held:

“Once it is held that such payment is of revenue nature, it is of no consequence if the same is paid as a lump-sum or in installments over different financial years,”

Tata Chemicals paid Rs. 40 lakh to its former Managing Director, Dr. Seth, under a settlement agreement. In return, he agreed not to compete with the company or disclose confidential information obtained during his employment. The company claimed the payment as a business expense to reduce its taxable income.

The Income Tax Department disallowed the deduction, treating the payment as capital expenditure. It argued that the payment differed from the expenditure considered by the Supreme Court in an earlier ruling because Tata Chemicals had paid the amount over three financial years.

The Income Tax Appellate Tribunal ruled in favour of Tata Chemicals, finding that the payment protected the company's existing business and did not create a new asset.

Upholding the Tribunal's decision, the High Court relied on the Supreme Court's ruling in Sharp Business System v. Commissioner of Income-tax. It held that a payment to prevent competition protects a company's business interests and profitability but does not necessarily create a new asset or confer an enduring advantage. The payment's treatment as revenue expenditure does not change merely because the company pays it in instalments.

The Bench also upheld Tata Chemicals' deduction for expenditure on projects that were subsequently written off. It found that the expenditure related to improvements to existing plants and did not result in the creation of a new asset. It noted that it had already decided a similar issue in Tata Chemicals' favour in an earlier case.

Accordingly, the High Court dismissed the Income Tax Department's appeal and answered both questions of law in favour of Tata Chemicals.

Appearances: Advocate Abhishek Mishra appeared for the Revenue, while Advocate Shrihari Iyer represented Tata Chemicals Ltd.