Non-compete fee issue becomes contentious

The non-compete fee is increasingly turning out to be a contentious issue. The Securities and Exchange Board of India (Sebi) is yet to step in, but the recommendations of the Takeover Regulations Advisory Committee are loud and clear: No differential pricing. Now, the tax authorities are going all out to make their presence felt.

Recently, a ruling by the Income Tax Appellate Tribunal (ITAT), Delhi, said non-compete fees were capital expenditure and therefore liable to be taxed.

The special bench of ITAT, Delhi, gave this ruling on July 30 on an appeal filed by Tecumseh India, the Indian arm of the US-based Tecumseh. The company had purchased the assets of Whirlpool at Faridabad and Ballabgarh on July 2, 1997, with an agreement for non-compete fees of Rs 2.65 crore signed on July 10, 1997.

Since the non-compete fee was claimed by Tecumseh as revenue expenditure, it thus deducted the amount from computation of taxable income. The Income Tax Department held the payment of non-compete fee as capital expenditure and therefore tax had to be paid.

The debate on non-compete fee has gained steam in the past few days with Cairn India’s $8.48-billion takeover by the Anil Agarwal-led group.

The Vedanta group plans to acquire 51-60 per cent of Cairn India Ltd for a consideration of $8.5 billion to $9.6 billion in an all-cash deal. As a part of the deal, the promoters will get a non-compete fee of about Rs 6,000 crore. The non-promoter shareholders will lose out Rs 3,570 crore, as they will not receive any benefits of non-compete fee.

“Non-compete fee is being paid by Vedanta Plc which is not an Indian company and hence not relevant for us,” said Tarun Jain, director (finance), Sterlite, and part of Vedanta management.

Vedanta had earlier said that tax would have to be paid by Cairn Energy Plc at an applicable rate of tax on capital gains.

According to an income-tax official, if a non-compete fee is capital in nature, it will not be taxable, but if it is revenue, it will be taxable. Capital receipts other than capital gains, are not taxable, according to a tax expert.

“There is a lot of debate surrounding the issue of non-compete fee being treated as revenue or capital. The court judgments are also varying. But, it cannot be a case that the income of revenue expenditure in case is one party, and capital income on the other,” said an I-T department official.

Thus, in case of Cairn India, the taxibility of non-compete fee will depend on whether it is revenue or capital receipt in nature.

Cairn Energy is likely to pay close to $1 billion as capital gains tax to the Indian I-T department.

“It can be debated both ways whether non-compete fee is to be included as cost of investment or it is a revenue expenditure,” said senior chartered accountant Abhijit Bandyopadhyay.

“There are decisions either way on non-compete fee. It depends on the terms of contracts. It depends if the non-compete fee is of enduring nature, or a short-term gain,” said a tax consultant.

Tax issue apart, non-compete fee as a concept, is turning out to be a source of resentment.

“The Takeover Committee has said there cannot be any differential pricing. It is more to give a fair price to all. It should be a one-price formula,” Koushik Chatterjee, Tata Steel group chief financial officer, and a member of the Takeover Committee, said.

“There should not be any non-compete fee, as it is against the interest on shareholders. If it is equal to the 10-15 per cent of the deal value, it is tantamount to treating the minority shareholders unfairly. Sebi had already said institutions should take the lead to oppose it. Institutions should oppose this,” said Arun Kejriwal, director of research firm KRIS.

If non-compete fee exceeds 25 per cent of the offer price, then all shareholders have to be paid the negotiated price, according to Sebi regulations.

The Cairn-Vedanta deal has shown that all shareholders are not equal.