2021 (10) TMI 615 - AT - Income Tax

Tax Appeals Outcome: Depreciation & Motor Vehicle Deduction Allowed, Deemed Dividend Upheld, Expenditure Disallowance Limited

The Tribunal partly allowed the appeals filed by the assessee. The disallowance of depreciation on non-compete fees and the disallowance of deduction ... Non-compete fee as intangible asset - depreciation on intangible assets - inclusive interpretation of 'any other business or commercial rights of similar nature' - deduction under section 35 for research and development expenditure - deemed dividend under section 2(22)(e) - disallowance of expenditure relatable to exempt income under section 14ANon-compete fee as intangible asset - depreciation on intangible assets - inclusive interpretation of 'any other business or commercial rights of similar nature' - Entitlement to depreciation on non-compete fee paid in connection with acquisition of trademark and associated rights. - HELD THAT: - The Tribunal held that a non-compete fee paid pursuant to the memorandum of understanding for acquisition of a trademark and associated know-how constitutes an intangible asset falling within 'any other business or commercial rights of similar nature' and is therefore eligible for depreciation under section 32(1)(ii). The Tribunal rejected the Assessing Officer's view that a non-compete is merely a negative right incapable of being owned or transferred; noted that the clause strengthens the commercial right transferred with the trademark and that the inclusive phraseology of clause (ii) indicates the provision is not exhaustive. The Tribunal followed the decision of the Jurisdictional High Court in Pentasoft Technologies Ltd v. DCIT and, in view of that binding precedent, allowed depreciation on the non-compete fee and directed deletion of the addition. [Paras 7]Depreciation on the non-compete fee allowed; addition deleted.Deduction under section 35 for research and development expenditure - Allowability of deduction under section 35 in respect of motor cars provided to staff of the R&D unit. - HELD THAT: - The Tribunal accepted the assessee's undisputed fact that the cars were provided to staff who are employed in the R&D unit and held that, once that fact is accepted, denial of the deduction merely because a log book was not produced was not justified. The Tribunal concluded that it is immaterial whether the vehicles were exclusively used so long as they were given to staff of the R&D unit and the expenditure therefore qualified as incurred for R&D purpose; directed the Assessing Officer to delete the disallowance. [Paras 8]Deduction under section 35 in respect of the motor cars allowed; addition deleted.Deemed dividend under section 2(22)(e) - Whether loan from a sister concern constituted deemed dividend under section 2(22)(e). - HELD THAT: - The Tribunal found that the two statutory conditions for invoking section 2(22)(e) were satisfied: payment by way of loan/advance by a company to a concern in which a shareholder is a member, and the company having accumulated profits in excess of the loan. The assessee's argument that the loan ceased to be such because of a subsequent court-ordered amalgamation was rejected: what matters is the existence of the loan for the relevant previous year and the factual existence of accumulated profits. The Tribunal, following the Supreme Court authority cited, sustained the addition under section 2(22)(e). [Paras 9]Addition under section 2(22)(e) upheld.Disallowance of expenditure relatable to exempt income under section 14A - Extent of disallowance under section 14A for expenditure relatable to exempt income (dividend from mutual funds) for years prior to applicability of Rule 8D. - HELD THAT: - Recognising that Rule 8D was not applicable for the relevant years, the Tribunal followed earlier coordinate-bench practice and case law estimating the expenditure relatable to exempt income and concluded that the Assessing Officer's flat 5% estimate was excessive. On facts and consistent with the Tribunal's prior decision in TIL Healthcare Pvt. Ltd., the Tribunal restricted the scope of disallowance to 2% of the exempt income for the year and directed the Assessing Officer to compute accordingly. [Paras 10]Disallowance under section 14A restricted to 2% of exempt income.Final Conclusion: Both appeals partly allowed: depreciation on non-compete fee and deduction under section 35 for R&D vehicles were allowed (additions deleted); addition under section 2(22)(e) upheld; disallowance under section 14A reduced to 2% of exempt income for the years 2005-06 and 2006-07. Issues Involved:1. Disallowance of depreciation on non-compete fees.2. Disallowance of deduction claimed under section 35 of the Income Tax Act.3. Addition towards deemed dividend under section 2(22)(e) of the Income Tax Act.4. Disallowance of expenditure related to exempt income under section 14A of the Income Tax Act.Detailed Analysis:1. Disallowance of Depreciation on Non-Compete Fees:The assessee entered into a Memorandum of Understanding (MoU) to acquire the trademark 'Ruchi' and associated rights, including a non-compete agreement for which Rs. 3 crores was paid. The assessee claimed depreciation on this non-compete fee under section 32(1)(ii) of the Income Tax Act, treating it as an intangible asset. The Assessing Officer (AO) disallowed this claim, arguing that the non-compete fee did not confer any right that could be used for business purposes and was merely a negative right. The Tribunal, however, disagreed with the AO, citing that non-compete fees are generally paid to prevent competition and ensure smooth business operations, thus qualifying as a commercial right of similar nature eligible for depreciation under section 32(1)(ii). This view was supported by the decision of the Hon'ble Madras High Court in Pentasoft Technologies Ltd vs DCIT and the Hon'ble Bombay High Court in PCIT vs Ferromatic Milacron India Pvt Ltd.2. Disallowance of Deduction Claimed Under Section 35:The assessee claimed a 100% deduction under section 35 of the Income Tax Act for two motor vehicles used by staff in the Research & Development (R&D) unit. The AO denied the deduction, stating that the assessee failed to prove the exclusive use of these vehicles for R&D purposes. The Tribunal found this reasoning flawed, noting that once vehicles are given to staff working in the R&D unit, the specific use of these vehicles becomes immaterial. Therefore, the Tribunal directed the AO to allow the deduction.3. Addition Towards Deemed Dividend Under Section 2(22)(e):The assessee received a Rs. 50 lakhs loan from its sister concern, which the AO treated as deemed dividend under section 2(22)(e) of the Income Tax Act. The assessee argued that the loan was for commercial expediency and that the companies were later amalgamated, making the loan irrelevant. The Tribunal upheld the AO's decision, stating that the subsistence of the loan at the end of the financial year is what matters, not its subsequent status. The Tribunal cited the Hon'ble Supreme Court's decision in Miss. P. Sarada vs. CIT to support this view.4. Disallowance of Expenditure Related to Exempt Income Under Section 14A:The assessee earned exempt income but did not disallow any related expenditure. The AO estimated and disallowed 5% of the exempt income as related expenditure. The Tribunal found this excessive and, following the ITAT Chennai's decision in TIL Healthcare Pvt. Ltd. vs. DCIT, directed the AO to restrict the disallowance to 2% of the exempt income.Conclusion:Both appeals filed by the assessee were partly allowed. The Tribunal directed the AO to delete the disallowance of depreciation on non-compete fees and the disallowance of deduction under section 35 for motor vehicles. The addition towards deemed dividend under section 2(22)(e) was upheld, and the disallowance of expenditure related to exempt income under section 14A was restricted to 2% of the exempt income.