The specific provision: Any sum received or receivable, in cash or kind, under an agreement for not carrying out any activity in relation to any business or profession, or for not sharing any know-how, patent, copyright, trademark, licence, franchise, or any other business or commercial right of similar nature, or information or technique likely to assist in the manufacture or processing of goods or provision of services, is specifically chargeable to tax as profits and gains of business or profession. This is a deliberate provision designed to bring such 'non-compete' or restrictive covenant payments squarely into the tax net as business income, rather than allowing them to be argued as tax-free capital receipts (a position that was sometimes taken before this provision was introduced).
Who Typically Receives Such Payments?
Non-compete payments commonly arise in business sale transactions (where the seller, often a promoter or key person, agrees not to start a competing business for a defined period), in professional partnership exits (where an outgoing partner agrees not to solicit clients or set up a competing practice nearby), and in employment exit arrangements for senior executives with access to sensitive business information.
Worked Example
A promoter's exit payment, split into two componentsMr Chawla sells his controlling stake in a manufacturing company to a larger group for Rs 20 crore. As part of the same transaction, the agreement separately specifies that Mr Chawla will receive an additional Rs 2 crore in exchange for agreeing not to set up or be involved with any competing manufacturing business in the same product category for five years. The Rs 20 crore relates to the sale of his shares and is taxed under the capital gains provisions applicable to the sale of shares. The separate Rs 2 crore non-compete payment, however, is taxable as business income under the specific provision for non-compete payments, taxed at the rates applicable to business income (not at capital gains rates), regardless of how the agreement might otherwise be framed.
Why the Drafting of the Agreement Matters
Because the tax treatment of a non-compete payment (business income, taxed at applicable slab/business rates) can differ meaningfully from a capital gains characterisation (which might attract concessional rates and exemptions), the way a transaction agreement allocates value between the underlying sale (of a business, shares, or similar) and a separate non-compete clause has real tax consequences. Tax authorities scrutinise such allocations, particularly where a disproportionately large amount is attributed to a non-compete clause that appears designed to convert what is economically a sale consideration into a different tax characterisation, or vice versa.
TDS Implications
Since non-compete payments are taxable as business income, payments of this nature by a payer to a recipient may attract TDS obligations under the provisions applicable to payments for professional or technical services or other relevant categories, depending on how the payment is structured and the status of the payer and recipient, and the payer should evaluate withholding tax obligations at the time of structuring such payments.
Frequently Asked Questions
Does this provision apply to an employee who simply signs a non-compete clause in their employment contract without any separate payment for it? ▼
The specific charge applies to sums received or receivable under an agreement for not carrying out an activity or not sharing certain rights/information. Where no separate consideration is identified or paid specifically for a non-compete clause embedded within a broader employment or service contract, there may be no distinct 'sum received' for this provision to apply to; however, where a specific, identifiable payment is made in connection with such a restrictive covenant, this provision becomes relevant.
Is a non-compete payment received by an individual (not a business) also taxed as 'business income'? ▼
The provision characterises the receipt itself as chargeable under the head profits and gains of business or profession, regardless of whether the recipient otherwise carries on a business, because the law specifically deems this type of receipt to fall under that head. This is a deeming provision aimed at this specific category of payment.
If the non-compete period is very long (say, 10 years) and the payment is received as a lump sum upfront, is the tax payable all at once in the year of receipt? ▼
Generally, the taxability follows the year in which the sum is received or becomes receivable, as specified by the provision, rather than being spread over the period of the restrictive covenant. The lump sum would typically be taxed in the year of receipt as business income, regardless of how many years the non-compete obligation itself extends for.