2008 (12) TMI 247 - AT - Income Tax

Tribunal overturns tax disallowance, remands goodwill depreciation, and orders recalculation of interest charges.

The Tribunal allowed the appeal, overturning the disallowance under Section 40(a)(ia) for failure to deduct tax at source, ruling that the arrangement ... Business Expenditure Issues Involved1. Disallowance of expenditure under Section 40(a)(ia) due to non-deduction of tax at source under Section 194C.2. Disallowance of depreciation on goodwill.3. Charging of interest under Sections 234B, 234C, and 234D.Issue-wise Detailed Analysis1. Disallowance of Expenditure under Section 40(a)(ia)The primary issue revolves around the disallowance of expenditure amounting to Rs. 11,22,89,184 by the Assessing Officer (AO) under Section 40(a)(ia) on the grounds that the assessee failed to deduct tax at source under Section 194C. The assessee, a private company engaged in the manufacture and sale of kitchen appliances under the brand name 'Inalsa,' argued that the payments made to contract manufacturers were for the purchase of goods and not for carrying out any work, thus not attracting the provisions of Section 194C.The AO, however, contended that the assessee was liable to deduct tax at source as the arrangement constituted a work contract. This was based on the fact that the assessee provided moulds, dies, and jigs to the contract manufacturers, and the products were manufactured exclusively for the assessee under the brand name 'Inalsa.'The CIT(A) upheld the AO's decision, stating that the arrangement was indeed a work contract and thus subject to TDS under Section 194C. The CIT(A) noted that the assessee's provision of machinery to the contract manufacturers indicated an extended business activity, making it a work contract.Upon appeal, the Tribunal examined various precedents, including:- Seagram Manufacturing (P) Ltd.: Held that customization according to customer specifications does not convert a sale into a work contract.- Samsung India Electric Ltd.: Concluded that agreements for the supply of goods manufactured as per specifications are contracts of sale, not work contracts.- Whirlpool of India Ltd.: Affirmed that contracts where the vendor purchases raw materials and manufactures goods at their own risk are sale contracts.The Tribunal found that the manufacturing activity was carried out at the risk of the contract manufacturers, who also purchased raw materials independently. The ownership of goods passed to the assessee only upon delivery, and sales tax was charged, indicating a sale transaction. Therefore, the Tribunal held that the arrangement was a contract of sale and not a work contract, reversing the AO's and CIT(A)'s decisions and deleting the disallowance.2. Disallowance of Depreciation on GoodwillThe second issue concerned the disallowance of Rs. 2,50,000 claimed as depreciation on goodwill. The AO disallowed the claim, stating that depreciation on goodwill is not allowable under the Act. The CIT(A) upheld this decision, emphasizing that for depreciation to be allowable, the asset must be capable of diminishing in value, owned by the assessee, and used for business purposes. The CIT(A) referenced the Tribunal's decision in Bakliwal Corporate Services (P) Ltd. vs. ITO, which clarified that mere existence of an asset is insufficient for depreciation; it must be capable of diminishing in value.The assessee argued that the goodwill represented a bundle of commercial rights, including business contracts, distribution network, and brand name, which qualify as intangible assets under Section 32(1)(ii). The Tribunal noted that the AO and CIT(A) had not thoroughly examined the nature of the rights acquired. Therefore, the Tribunal remanded the issue back to the AO for a fresh examination of the agreement and valuation report, directing the AO to pass a reasoned order after considering the relevant facts and legal position.3. Charging of Interest under Sections 234B, 234C, and 234DThe final issue related to the charging of interest under Sections 234B, 234C, and 234D. These issues were deemed consequential and were restored to the AO for fresh computation as per the law. The AO was instructed to provide the assessee with a reasonable opportunity to be heard on this matter.ConclusionThe Tribunal allowed the assessee's appeal, reversing the disallowance under Section 40(a)(ia) and remanding the issue of depreciation on goodwill for fresh examination. The matter of interest under Sections 234B, 234C, and 234D was sent back to the AO for recalculation.