2020 (12) TMI 1160 - HC - Income Tax

Karnataka High Court: Depreciation on Intellectual Property Rights not disallowable under Income Tax Act

The Karnataka High Court ruled in favor of the assessee, holding that depreciation on intellectual property rights is not subject to disallowance under ... Disallowance u/s 40(a)(ia) in respect of depreciation on intellectual property rights - Failure to deduct TDS - HELD THAT:- Section 40 refers to the outgoing amount chargeable under this Act and subject to TDS under Chapter XVII-B. The deduction under Section 32 is not in respect of the amount paid or payable which is subjected to TDS; but is a statutory deduction on an asset which is otherwise eligible for deduction of depreciation. Section 40(a)(i) and (ia) of the Act provides for disallowance only in respect of expenditure, which is revenue in nature, therefore, the provision does not apply to a case of the assessee whose claim is for depreciation, which is not in the nature of expenditure but an allowance. The depreciation is not an outgoing expenditure and therefore, provisions of Section 40(a)(i) and (ia) of the Act are not applicable. In the absence of any requirement of law for making deduction of tax out of expenditure, which has been capitalized and no amount was claimed as revenue expenditure, no disallowance under Section 40(a)(i) and (ia) of the Act would be made. It is also pertinent to note that depreciation is a statutory deduction available to the assessee on a asset, which is wholly or partly owned by the assessee and used for business or profession. The depreciation is an allowance and not an expenditure, loss or trading liability. The Commissioner of Income Tax (Appeals) has held that the payment has been made by the assessee for an outright purchase of Intellectual Property Rights and not towards royalty and therefore, the provision of Section 40(a)(ia) of the Act is not attracted in respect of a claim for depreciation. The aforesaid finding has rightly been affirmed by the tribunal. The findings recorded by the Commissioner of Income Tax (Appeals) as well as the tribunal cannot be termed as perverse. Substantial question of law framed by a bench of this court is answered against the revenue and in favour of the assessee. Issues:1. Interpretation of Section 40(a)(ia) of the Income Tax Act, 1961 regarding disallowance of depreciation on intellectual property rights.2. Application of Section 40 of the Act in cases of non-deduction of tax at source on payments made for purchase of software.3. Determination of whether depreciation is considered as an outgoing expenditure subject to disallowance under Section 40(a)(ia) of the Act.Analysis:Issue 1:The appeals before the Karnataka High Court revolved around the interpretation of Section 40(a)(ia) of the Income Tax Act, specifically concerning the disallowance of depreciation on intellectual property rights. The primary question was whether the Tribunal was correct in deleting the disallowance made under this section for failing to deduct tax on payments made for the purchase of software. The Court analyzed the provisions of Section 40(a)(ia) and emphasized that it applies to amounts payable on which tax is deductible at source, but depreciation is not considered an outgoing expenditure subject to this provision. The Court held that depreciation is a statutory deduction available to the assessee on assets owned and used for business purposes, and therefore, the disallowance under Section 40(a)(ia) does not apply to depreciation claims.Issue 2:Another significant issue addressed in the judgment was the application of Section 40 of the Act in cases where tax was not deducted at source on payments made for the purchase of software. The Revenue argued that since the payment for software purchase was in the nature of royalty and no TDS was deducted, the disallowance under Section 40(a)(ia) was justified. However, the Court held that Section 40 pertains to amounts payable subject to TDS, and depreciation, being a statutory deduction on assets, does not fall under this category. The Court emphasized that Section 40 does not apply to cases where the expenditure has been capitalized and no amount was claimed as revenue expenditure.Issue 3:The judgment also delved into the nature of depreciation as an outgoing expenditure and its eligibility for disallowance under Section 40(a)(ia) of the Act. The Court reiterated that depreciation is not an outgoing expenditure but an allowance on assets used for business or profession. It clarified that depreciation is not considered an expenditure, loss, or trading liability, and therefore, the provisions of Section 40(a)(ia) do not apply to claims for depreciation. The Court upheld the findings of the Commissioner of Income Tax (Appeals) and the Tribunal that the payment made for the purchase of Intellectual Property Rights was for an outright purchase and not towards royalty, hence not attracting the disallowance under Section 40(a)(ia).In conclusion, the Karnataka High Court dismissed the appeals, ruling in favor of the assessee based on the analysis that depreciation is not subject to disallowance under Section 40(a)(ia) of the Act and that the provisions of Section 40 do not apply to statutory deductions like depreciation on assets used for business purposes.