1️⃣ Introduction
In India’s corporate ecosystem, it is not uncommon for promoters and directors to exit a company, either voluntarily or strategically. Sometimes, the continuing stakeholders may agree to pay an amount higher than the fair value of the outgoing shareholder’s shares. Such payments may cover not only the value of shares but also intangible benefits like preventing competition, securing control, or ensuring business continuity.
A critical question then arises:
How should such excess payments be treated in the company’s books — can it be recognised as goodwill, non-compete fee, or any other intangible asset?
This article analyses the accounting, taxation, and GST implications of such payments in light of the Companies Act, 2013, Income Tax Act, 1961, Indian Accounting Standards, and relevant judicial precedents.
2️⃣ Scenario: Payment of Excess by an Individual on Behalf of the Company
Let’s break down the typical facts:
- A director/shareholder is non-contributing and needs to exit.
- New shareholders are brought in to replace him.
- The continuing promoter personally pays the exiting director a bulk amount over and above the fair value of shares.
- The question is whether this excess can be booked by the company as an intangible asset such as goodwill or non-compete fee.
3️⃣ Core Principles under Companies Act and Accounting Standards
3.1 Who Bears the Cost?
✅ Under AS 26 (Intangible Assets) and Ind AS 38:
- Only costs incurred by the entity can be recognised as an intangible asset.
- Payments by a shareholder or director personally do not create an asset for the company, unless:
- There is a clear agreement that the payment was made for and on behalf of the company; and
- The company recognises this as a liability or loan to the director.
3.2 Goodwill vs Other Intangibles
👉 Goodwill can be recognised only when the company acquires an existing business as a going concern — not when a shareholder exits. Hence, paying excess to a shareholder is not a business acquisition; thus, no goodwill can arise under AS 14 or Ind AS 103.
👉 Other Intangibles like Non-Compete Rights, Relinquishment Rights, Business or Commercial Rights can be capitalised if:
- There is a clear agreement.
- The company pays for them (or records the obligation properly).
4️⃣ Income Tax Act, 1961 — Section 32(1)(ii)
Under the Income Tax Act, Section 32(1)(ii) allows depreciation on intangible assets like:
- Know-how,
- Patents,
- Copyrights,
- Trademarks,
- Licences,
- Franchises,
- Any other business or commercial rights of similar nature.
The Supreme Court in CIT v. Smifs Securities Ltd. (2012) held that “business or commercial rights of similar nature” is a wide expression and can include non-compete fees, trade relationships, customer lists, etc.
Therefore, if the company properly documents a non-compete agreement, the payment can be amortised over its useful life and depreciation can be claimed at 25% under Section 32(1)(ii).
However, the payment must be from the company, not the director personally.
5️⃣ GST Implications
✅ Non-Compete is a “supply of service” under the CGST Act:
- Schedule II, Para 5(e) — “Agreeing to the obligation to refrain from an act, or to tolerate an act, or to do an act” is treated as a supply of service.
- It attracts 18% GST under SAC 9983.
✅ Reverse Charge Mechanism (RCM) applies:
- If the service provider is an unregistered exiting director and the recipient is a registered company, the company must pay GST under RCM.
6️⃣ Computation of Non-Compete Fee
How to determine a reasonable non-compete amount?
In practice, there is no formula prescribed under Indian law. Courts have held that it must be reasonable and not in restraint of trade beyond necessity (Contract Act, Section 27).
Factors to consider:
- Nature of Business: How sensitive is the know-how?
- Market Position: Is the director likely to compete significantly?
- Duration: Usually 3–5 years is common.
- Territory: Local, national, or international?
- Past Contribution: Was the outgoing person key to client relationships?
👉 Illustrative Computation Approach:
| Particulars | Value |
|---|---|
| Average Annual Profit of Company | ₹ 2 crore |
| Estimated Profit Loss If Director Competes | 10% = ₹ 20 lakh/year |
| Reasonable Period of Restriction | 3 years |
| Total Reasonable Non-Compete Fee | ₹ 20 lakh × 3 = ₹ 60 lakh |
This is a reasonable, defendable approach. There must be legal documentation to match this computation.
7️⃣ Other Related Intangibles
Apart from Non-Compete Fee, other intangible assets which may be relevant:
- Customer/Client List — if the exiting director transfers a proprietary client database.
- Trademarks or Brand Rights — if the brand is in their name and is transferred.
- Franchise Rights — if the outgoing party held any exclusive business rights that are surrendered.
Again, only if the company pays for these, they can be capitalised and depreciated.
8️⃣ Proper Structuring: Step-by-Step
✅ Step 1: Draft a Non-Compete Agreement between the Company and the exiting director.
✅ Step 2: Pass a Board Resolution:
- Approve the agreement.
- Approve payment from company funds or acknowledge the director’s personal payment as a loan/shareholder advance.
✅ Step 3: Pay GST under RCM.
✅ Step 4: Capitalise as an intangible asset in the balance sheet.
✅ Step 5: Amortise over the useful life; claim depreciation at 25% per Income Tax Act.
9️⃣ Judicial Precedents
✔ Smifs Securities Ltd. (SC) — confirmed wide scope for intangibles under Section 32(1)(ii).
✔ Kotak Forex Brokerage Ltd. (Bombay HC) — non-compete fees are allowable as intangible assets.
✔ B.A. Plantations & Industries Ltd. (ITAT) — non-compete is a business or commercial right.
🔟 Conclusion
✅ DO:
- Proper legal agreements.
- Payments through company’s bank account or recognised as company’s liability.
- GST compliance.
❌ DON’T:
- Assume goodwill arises automatically — not permissible.
- Claim intangible benefit without documentation — will be disallowed in tax audits.
In summary, with careful structuring, you can legally and tax-efficiently convert such excess payments into a valid intangible asset like a non-compete fee, provided you follow the right process under Indian laws.
📘 Key References
- Income Tax Act: Section 32(1)(ii)
- Companies Act, 2013: Sections 179, 184, 188 (Board powers & related party)
- CGST Act: Schedule II, Para 5(e); RCM rules.
- AS 26 & Ind AS 38: Intangibles standard.
- Relevant cases: Smifs Securities, Kotak Forex Brokerage, B.A. Plantations.
Stox N Tax 
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