2014 (11) TMI 688 - AT - Income Tax

Tribunal decision on Income Tax Act - Section 14A disallowance and software acquisition charges

ACIT – 1(1), Mumbai Versus M/s. Clariant Chemicals (I) Ltd.

The Tribunal allowed the assessee's appeal in relation to the disallowance under Section 14A of the Income Tax Act, 1961, for statistical purposes. The ... Disallowance u/s 14A r.w Rule 8D – 0.5% of average investments – interest expenses – Held that:- The issue of disallowance u/s 14-A has come up for consideration, the matter has been restored back to the file of the AO for fresh adjudication to work out the some reasonable basis for disallowance - Rule 8-D is not applicable and therefore some reasonable basis has to be adopted as decided in GODREJ AND BOYCE MFG. CO. LTD. Versus DEPUTY COMMISSIONER OF INCOME-TAX AND ANOTHER [2010 (8) TMI 77 - BOMBAY HIGH COURT] - the entire issue of disallowance u/s 14-A is set aside to the file of the AO, to examine and work out some reasonable basis for disallowance having regard to the facts of the case, dehors rule 8D and after giving proper opportunity to the assessee – Decided in favour of assessee. Software acquisition expenses – Capital expenses or not – Held that:- The assessee has debited a sum, being payment made to Clariant International Ltd. for software development and consulting charges – as decided in assessee’s own case for the earlier assessment year, it has been held that the expenditure incurred by the assessee on the software was in the nature of the revenue expenditure - a sum of ₹ 23,30,9261 was claimed by the assessee as software expenses - This amount represent payment made to Clariant International Ltd. Towards acquisition of right to use the software 'Lotus Notes' developed by Clariant International Ltd which according to assessee is powerful, multifaceted software that help to wo effectively - if the expenditure incurred on software are to facilitate the assessee's business or enabling the management to conduct the business more efficiently or more profitably then it cannot be said to be in the nature of profit making and has to be treated as 'revenue expenditure - the expenditure incurred by the assessee on the software is to be treated as revenue expenditure – Decided against revenue. Non-compete fees paid to Ex-Managing Director disallowed – Held that:- The assessee had paid non-compete fee to its Ex-Managing Director for restricting him to share his expertise or to join any other company in a similar line of business of chemicals for a period of three years on a consideration of ₹ 154.20 lakhs - Since the agreement for restrictive covenant was only for the period of three years to ward off a potential threat or completion, we are of the opinion that, there can no question of enduring benefit for a long period - such a payment is also to be seen from the context of commercial and business expediency - If the outgoing expenditure is so inextricably linked or related to carrying on or conduct of the business, that is, it can be regarded as integral part of the profit earning process and not for any acquisition of asset or a right of permanent character and incurring of the expenditure is a condition for carrying on the business, then such an expenditure may be regarded as revenue expenditure - Here the agreement for payment of non-compete fee was only to protect the existing business for a temporary period to ward off completion so that assessee company can get stabilizing period without its long serving MD - If the advantage is not for longer period and not enduring in nature, then such a payment of noncompete fee is nothing but business expenditure which is on revenue account – the order of the CIT(A) is upheld – Decided against revenue. Issues Involved:1. Disallowance under Section 14A of the Income Tax Act, 1961.2. Treatment of software acquisition charges.3. Treatment of non-compete fee paid to the Ex-Managing Director.Detailed Analysis:1. Disallowance under Section 14A of the Income Tax Act, 1961:The sole issue raised by the assessee in its appeal relates to the disallowance u/s 14A of the Income Tax Act, 1961 after applying Rule 8-D (2)(ii) of the Income Tax Rules, 1962, by taking 0.5% of the average investments. The Revenue's appeal also concerns the disallowance u/s 14A made on account of interest expenditure, which was deleted by the ld. CIT(A) on the ground that the assessee had surplus funds of its own for making the investment.The brief facts are that the assessee received dividend income of Rs. 97,26,000/- claimed as exempt but did not offer any disallowance u/s 14A. The AO noted an interest expenditure of Rs. 260.75 lakhs in the P&L account and attributed no indirect expenditure for earning the exempt income. Relying on the ITAT Special Bench decision in I.T.O. Vs. Daga Capital Management (P) Ltd. and the Bombay High Court decision in Godrej and Boyce Mfg. Co. Ltd. vs. DCIT, the AO worked out a disallowance of Rs. 47,97,915/- including interest and indirect expenses.Before the ld. CIT(A), the assessee argued the availability of surplus funds and indirect expenses attributable to earning exempt income. The ld. CIT(A) deleted the disallowance of interest expenditure, citing investments made from surplus funds, but upheld the indirect expenditure disallowance by applying 0.5% of the average investment.The Tribunal, consistent with earlier years' precedents, set aside the entire issue of disallowance u/s 14A to the AO to work out a reasonable basis for disallowance without resorting to Rule 8-D, giving proper opportunity to the assessee.2. Treatment of Software Acquisition Charges:The department challenged the deletion of addition made on account of software acquisition charges treated by the AO as capital expenditure. The assessee debited Rs. 4,98,85,521/- for software development and consulting charges paid to Clariant International Ltd. The AO disallowed this as capital expenditure, but the ld. CIT(A) deleted the addition, following earlier years' orders.The Tribunal, relying on earlier decisions and the Bombay High Court decision in CIT v/s Raychem RPG Ltd., held that the software expenditure was revenue in nature, facilitating the assessee's business without acquiring any enduring benefit. Thus, the expenditure was treated as revenue expenditure, and the department's ground was dismissed.3. Treatment of Non-Compete Fee Paid to the Ex-Managing Director:The department challenged the deletion of disallowance of non-compete fee paid to the Ex-Managing Director amounting to Rs. 154.20 lakhs. The assessee paid this fee to restrict the Ex-Managing Director from joining competitors for three years. The AO treated this as capital expenditure, but the ld. CIT(A) relied on the Delhi High Court decision in CIT vs. Eicher Ltd., treating it as revenue expenditure since it provided no enduring benefit and the Ex-Managing Director expired before the three-year period.The Tribunal, considering commercial and business expediency, held that the non-compete fee was to ward off competition temporarily, not creating any enduring benefit. Relying on the Supreme Court and various High Court judgments, the Tribunal confirmed the ld. CIT(A)'s order, treating the non-compete fee as revenue expenditure.Conclusion:The appeal of the assessee in ITA No. 8079/Mum/2011 is allowed for statistical purposes, and the appeal of the Revenue in ITA No. 7428/Mum/2011 is partly allowed for statistical purposes.