2014 (9) TMI 624 - AT - Income Tax

Appellant wins claim on royalty expense but disallowance under Rule 8D(2)(iii) upheld.

JL. Morison (India) Ltd. Versus Deputy Commissioner Of Income Tax

The Tribunal allowed the appellant's claim regarding the disallowance of 25% of royalty paid as capital expenditure, recognizing it as a revenue ... Royalty paid treated as capital expenses - Held that:- The amounts were kept by the assessee for use of trademark and knowhow for certain period that too under strict terms and conditions and not for setting up any factory - after the termination of agreement in both the cases, the use of knowhow or trademark was not available to the assessee – the assessee company did not obtain any proprietary or ownership right of trademark or knowhow, no asset was created or acquired - there was no enduring benefit to the assessee and there was no element of capital expenditure in the payment of royalty - The royalty paid to BDF or Dr. Wild & Co. was not for any outright or acquisition of knowhow or trademark or any other asset but was for the use only for a specified period that too under various restrictive covenants - The payment made by the assessee to the Hungarian company on the basis of the collaboration agreements was a capital expenditure incurred by it - the drawings/designs etc. were actually “plant” as defined u/s 43(3) of the Act and would therefore, be a depreciable asset - it is not an admitted fact that the expenditure incurred by the assessee was of a capital nature. – Decided in favour of assessee. Issues Involved:1. Disallowance of 25% of royalty paid as capital expenditure.2. Disallowance made by AO by applying Rule 8D(2)(iii) of the I.T. Rules, 1962 read with section 14A of the Act.Issue-wise Detailed Analysis:1. Disallowance of 25% of Royalty Paid as Capital Expenditure:The appellant, a company engaged in manufacturing cosmetic and dental care products, had technical collaboration agreements with two foreign collaborators, Beirsdorf AG, Germany (BDF) and Dr. Wild & Co., Switzerland, for the use of trademarks and know-how. The agreements stipulated royalty payments of 5% on domestic sales, which were approved by the Ministry of Commerce and Industries and the Reserve Bank of India.The appellant paid a total royalty of Rs. 1,50,54,077 during the assessment year under consideration. The Assessing Officer (AO) disallowed 25% of the royalty paid, treating it as capital expenditure, amounting to Rs. 28,23,639, on the assumption of an exclusive license for the trademark and know-how. The CIT(A) confirmed the AO's action, citing decisions from the Hon'ble Supreme Court in Southern Gear Ltd. Vs. CIT and Jones Woodhead & Sons Ltd. Vs. CIT.Upon appeal, it was argued that the agreements did not confer any proprietary or ownership rights to the appellant, and no asset was created or acquired. The agreements were for a limited period and included restrictive covenants, indicating no enduring benefit to the appellant. The Tribunal referred to the Hon'ble Delhi High Court's decision in Shriram Pistons & Rings Ltd. Vs. CIT, which held that payments for the use of technical know-how for a limited period without acquiring ownership rights are revenue expenditures.Consequently, the Tribunal allowed the appellant's claim, concluding that the royalty payments were not capital expenditures since they did not result in the acquisition of any asset or enduring benefit.2. Disallowance Under Rule 8D(2)(iii) Read with Section 14A:The AO disallowed Rs. 4,98,615 under Rule 8D(2)(iii) of the I.T. Rules, 1962, read with section 14A of the Act, which pertains to disallowance of expenditure incurred in relation to exempt income. The AO calculated the disallowance as 0.5% of the average investment, excluding investments in bonds of the National Housing Bank.The CIT(A) upheld the AO's disallowance, referencing the decision in I.T.O vs. Daga Capital Management (P) Ltd. and the Hon'ble Bombay High Court's ruling in Godrej & Boyce Vs. DCIT, which validated Rule 8D as constitutionally valid and applicable from AY 2008-09.Upon appeal, the Tribunal noted that the appellant had not claimed any administrative expenses related to the exempt income. However, since Rule 8D(2)(iii) mandates a specific method for disallowance, the Tribunal confirmed the AO's and CIT(A)'s disallowance.Conclusion:The Tribunal allowed the appellant's claim regarding the disallowance of 25% of royalty paid as capital expenditure, recognizing it as a revenue expenditure. However, it upheld the disallowance made under Rule 8D(2)(iii) read with section 14A, confirming the AO's and CIT(A)'s actions. The appeal in ITA No. 912/K/2011 was allowed, and the appeal in ITA No. 913/K/2011 was partly allowed. The order was pronounced in the open court on 30.06.2014.