In India, any Mergers & Acquisitions (M&A) now include a non-compete agreements; most of these agreements are treated as just boilerplate by deal teams and this approach is increasingly risky.Since the Supreme Court's ruling in Sharp Business System v Commissioner of Income Tax (2025) SCCOnLine SC 2892 on December 19, 2025 , the tax treatment of fees received for non-compete agreements has reached a point where it depends primarily on the structure of the non-compete. If the structure is wrong, you face either disallowance of a deduction for a payment of a non-compete or prolonged tax litigation.
What is a Non-Compete Fee?
A non-compete fee is paid by an acquirer or employer to a seller or outgoing executive to keep them out of the same business for a set period and geography. Under Section 28(va) of the Income Tax Act 1961, inserted by the Finance Act 2002 with effect from 1 April 2003, any amount received under an agreement not to carry on a business or profession is taxable as business income in the recipient's hands. Before 2003, courts treated such receipts as capital and therefore tax-free. That position has been settled for over two decades.
When Does it Apply in M&A and Employment?
Non-compete fees come up in two situations most commonly:
- In corporate M&A, an acquirer pays the promoter or founder not to restart a competing venture after the sale.
- In senior executive exits, the company pays to protect client relationships and trade secrets when a key person walks out.
In both cases, the fee looks simple on paper. The tax implications, however, are complex . For a closer look at how employment exits create legal complexity, see our piece on when technicalities mask justice.
Employer vs Employee Tax Exposure: The 2026 Shift
1. The Payer (Employer/Acquirer) Perspective
For years, the Revenue argued that non-compete fees were capital expenditure because they gave the payer an "enduring advantage." The Supreme Court in Sharp Business System (2025) SCCOnLine SC 2892 settled thisposition for standalone arrangements. Drawing on Empire Jute Co Ltd v Commissioner of Income Tax (1980) 4 SCC 25, the Court confirmed that an enduring benefit alone does not make a payment capital unless it results in the creation ofa new asset. Where a non-compete fee simply protects existing profitability without expanding the profit-earning apparatus, it is revenue expenditure deductible under Section 37(1) of the Income Tax Act 1961.
On depreciation, the Court overruled the Delhi High Court's narrow position. For acquisition-linked payments, such as those made by Pentasoft Technologies and Piramal Glass alongside business division purchases, the Court remanded those matters to the respective Income Tax Appellate Tribunal benches. In those cases, depreciation under Section 32(1)(ii) remains a live question. Accordingly, the position is not uniform; it depends on whether your non-compete is standalone or tied to a larger acquisition.
2. The Recipient (Employee/Seller) Perspective
Section 28(va) of the Income Tax Act 1961 has not moved. Irrespective of the payer’s treatment, the recipient is taxed. The capital gains route, available only where the fee forms part of the transfer of a right to carry on a business, applies on narrow facts and courts examine it closely, case by case.
When can it be Denied or Challenged?
The Income Tax Department attacks these deductions regularly on three grounds:
- Colourable devices, where the fee is really a disguised salary or an inflated purchase price.
- Lack of commercial substance, where the recipient never posed a real competitive threat, or instance, where the recipient no longer poses a credible competitive threat with no capacity to restart anything.
- Vague clauses. Broad, non-specific restrictions that do not define geography or duration properly fail under Section 27 of the Indian Contract Act 1872 and simultaneously are unlikely to withstand tax scrutiny. A clause that cannot be enforced commercially will not survive a Revenue challenge either.
Draf Both courts and tax authorities assess reasonableness. ting Clauses to Minimize Future Litigation Risk
Bifurcate the non-compete consideration clearly from the share purchase price and from any terminal benefits. These should be reflected as separate line items in the SPA, not bundled together. Build a commercial justification file that documents specifically why this individual was a competitive threat and what their re-entry into the market would have cost the business. Keep the duration and geography proportionate. Both courts and tax authorities assess reasonableness. For a broader approach to building compliance-first deal structures, our regulatory compliance framework guide covers this in depth.
Practical Implications for Startups in Mumbai and Bengaluru
In the startup world, the founder is often the entire competitive threat. Non-compete fees in founder exits are inevitable. But incorrect structuring creates two problems that create significant downstream issues..
First, if the founder's receipt is classified as business income rather than capital gains, they will demand a higher gross payout to net the same amount. This can materially affect deal valuation.
Second, TDS defaults under Section 194J of the Income Tax Act 1961 are expensive. The rate is 10% on non-compete fees paid to residents where the aggregate payment in the financial year exceeds Rs 50,000, a threshold revised upward from Rs 30,000 effective 1 April 2025. M Failure to deduct may result in disallowance of the entire expense. For more on how withholding tax obligations interact across transaction types, our TDS vs TCS breakdown is a useful reference.
Frequently Asked Questions
What is non-compete fee taxability in India in 2026?
A non-compete fee is taxed as business income in the recipient's hands under Section 28(va) of the Income Tax Act 1961. For the payer, the Supreme Court in Sharp Business System v Commissioner of Income Tax (2025) SCC OnLine SC 2892 held that standalone payments are revenue expenditure deductible under Section 37(1). Acquisition-linked payments are still being reconsidered at the ITAT level.
Is a non-compete fee deductible for the employer?
Yes, in standalone arrangements, where the payment protects existing business profitability without creating a new capital asset, it is deductible under Section 37(1) of the Income Tax Act 1961 following the December 2025 Supreme Court ruling.
Can a non-compete fee be taxed as Capital Gains?
Only if it is paid as part of the transfer of a right to carry on a business. Otherwise, Section 28(va) of the Income Tax Act 1961 applies, and it is taxed as business income.
What is the TDS rate on non-compete fees in FY 2025-26?
TDS at 10% under Section 194J of the Income Tax Act 1961 applies where aggregate payments to a resident in a financial year exceed Rs 50,000.
Conclusion
The Sharp Business System ruling has given Indian deal-making a cleaner framework, but it is not a free pass. Acquisition-linked non-compete payments are still live at the ITAT level. The recipient's exposure under Section 28(va) has not softened at all. And TDS defaults under Section 194J still carry full disallowance consequences. What the ruling has done is reward deals that are properly documented and correctly structured, and while exposing poorly structured arrangements to scrutiny.
In practice, the key to managing exposure lies in structuring and documenting non-compete arrangements correctly at the transaction stage, rather than attempting to address issues during assessment.
At Commercial Law Chamber, we work specifically on keeping M&A transactions out of the litigation pipeline. If you are a business law chambers in Mumbai or a tax law firm in Delhi advising on a deal where non-compete fees are in play, the time to get the structure right is before the SPA is signed, not after the assessment notice arrives.
Want a deal-specific M&A tax review? Talk to our experts at CLC.
For the latest circulars and official guidance, visit the Income Tax Department's official portal.