Section 32(1) not applicable If assessee is only permitted to use trade mark /brand name of foreign collaborator with certain conditions
IN THE ITAT CHENNAI BENCH ‘B’
Fenner (India) Ltd.
Additional Commissioner of Income-tax
IT APPEAL NOS. 722 & 1047 (MDS.) OF 2009
[ASSESSMENT YEAR 2005-06]
APRIL 23, 2012
Challa Nagendra Prasad, Judicial Member
These cross appeals one by the assessee and the other by the Department are against the order of the CIT(A) I, Madurai dated 11.03.2009 in ITA No. 0075/2008-09 for the assessment year 2005-06. Shri Vikram Vijayaraghavan, Advocate represented on behalf of the assessee and Dr. S. Moharana, CIT – DR represented on behalf of the Revenue.
2. The first ground in the appeal of the assessee is that the CIT(A) erred in holding that 25% of the royalty payment made by the assessee is in the nature of capital. The Department is in appeal against the order of the CIT(A) in holding that 75% of the royalty paid by the assessee is in the nature of revenue.
3. The assessee is a public limited company carrying on the business of manufacture and sale of V-belt, fan belt, oil seals and cotton yarn and engaged in installation of material handling equipments. The assessee filed its return of income on 30.10.2005 admitting total income of Rs. 2,72,07,140/-. The return was processed under section 143(1) on 21.08.2006 and the assessment was completed under section 143(3) on 19.12.2008 computing total income at Rs. 6,37,89,240/- after making certain disallowances and additions. While completing the assessment, the Assessing officer treated lump sum royalty of Rs. 4,77,90,000/- paid by the assessee to Fenner, U.K. for the use of trade mark as capital expenditure and allowed depreciation at the rate of 25% on such royalty treating it as intangible asset.
4. The assessee filed an appeal before the CIT(A) against the said disallowance made by the Assessing Officer and the CIT(A) held that 25% of the royalty of Rs. 4,77,90,000/- is to be considered only as expenditure in the nature capital and the remaining 75% of such royalty is allowed as revenue expenditure. Both the assessee and the Revenue are in appeal before us.
5. The ld. Counsel for the assessee submitted that the assessee entered into Trade Mark & Name Licence Agreement with Fenner, U.K. on 17.08.2004. The object for which the agreement was entered into by the assessee with Fenner, U.K. was for the use of trade mark for 10 years and use of name of “FENNER” forever on licensed products as defined in the schedule of the agreement. The agreement is renewable after 10 years as mutually agreed upon. It is submitted that for the use of trade mark and the name of “FENNER”, the assessee paid a lump sum royalty of Rs. 4,77,90,000/- to Fenner, U.K. The assessee’s counsel submitted that the payment of royalty was merely for the use of trade mark for a limited period and there was no acquisition of any asset on payment of such royalty. The ld. Counsel for the assessee submitted that the assessee has acquired only license to use the brand name and trade mark of the foreign collaborator FENNER, U.K. Therefore, the entire amount of royalty should be allowed as revenue expenditure. It is submitted that Fenner, U.K. is the owner of trade mark and the worldwide rights of the trade mark are still held by the Fenner, U.K. and the assessee has no right to alienate, transfer or whatsoever. It is also submitted that the right to use the trade mark did not created any asset or confer any permanent right in favour of the assessee and therefore, the royalty paid to Fenner, U.K. is in the nature of revenue. Further, the ld. Counsel for the assessee relied on the following decisions in support of his contention that royalty paid is in the nature of revenue:
CIT v. I.A.E.C. (Pumps) Ltd.  232 ITR 316 (SC)
Asstt. CIT v. Sierra Industrial Enterprises (P.) Ltd. [IT Appeal No. 3171 (Delhi) of 2007, dated 18-12-2008]
Dy. CIT v. DCM Benetton India Ltd.  178 Taxman 52 (Delhi) (Mag.)
CIT v. Lumax Industries Ltd.  173 Taxman 390 (Delhi)
Southern Switchgears Ltd. v. CIT  232 ITR 359 (SC)
CIT v. Panasonic Carbon India Ltd. [TC(A) Nos. 552, 553, 554 and 556 (Mad.) of 2010 dt. 12.07.2010].
India Japan Lighting (P.) Ltd. v. Asstt. CIT [I.T.A. Nos. 676 to 678/Mds/2010] & Asstt. CIT v. India Japan Lighting [I.T.A. No. 862/Mds/2010] – Chennai Tribunal
Panasonic Carbon India Ltd. [I.T.A. No. 1968 to 1973/Mds/2008] – Chennai Tribunal.
6. On the other hand, the ld. DR submitted that the assessee acquired an asset by paying lump sum royalty to Fenner, U.K., which is enduring in nature. Therefore, the expenditure incurred is capital in nature. The ld. DR submitted that the Assessing Officer has rightly treated the payment of royalty as an intangible asset and allowed depreciation. He further submitted that as per the provisions of section 32(1)(ii) of the Act, depreciation is allowable on knowhow, patents, copy rights, trade marks, licenses, franchise or any other business or commercial rights of similar nature being intangible asset acquired on or after 01.04.1998. He submitted that since the assessee has acquired an intangible asset by paying royalty for use of trade mark and used for the purpose of its business, the Assessing Officer is correct in allowing depreciation on such intangible asset.
7. We have heard both the sides, perused the materials filed before us and gone through the orders of lower authorities and the case laws relied on. The Assessing Officer disallowed the lump sum royalty paid by the assessee to Fenner, U.K. for use of trade mark on the ground that patents, copy rights, trade mark, know-how, etc., are intangible assets allowable for depreciation under sub-section (1)(ii) of section 32. The Assessing Officer was of the view that the lump sum royalty payment made to Fenner, U.K. is for acquiring intangible asset of enduring benefit and therefore is capital expenditure. The CIT(A), after considering the agreement entered into with Fenner, U.K. by the assessee and the decision of Hon’ble Jurisdictional High Court in the case of CIT v. Southern Switchgears Ltd.  148 ITR 272/16 Taxman 79 (Mad.), which was affirmed by the Hon’ble Supreme Court in the case of Southern Switchgears Ltd. (supra) and the decision in the case of CIT v. IAEC (Pumps) Ltd. (supra) held that 25% of royalty is towards capital expenditure and 75% of royalty is in the nature of revenue expenditure. The facts before the Hon’ble Supreme Court in the case of IAEC (Pumps) Ltd. (supra) are that under an agreement entered into by the assessee with a foreign company, the assessee was granted a license to use its patents and designs exclusively in India. The agreement was for a duration of 10 years with the parties having the option to extend or renew the agreement. The foreign company undertook not to surrender its patents without the consent of the assessee and to make available to the assessee any improvements, modifications and additions to designs. The foreign company had also undertaken to enable the assessee to defend any counterfeit by others. The assessee was not to disclose to the third parties any of the documents made available by the foreign company to the assessee without having received a written authorization from the foreign company. On these facts, the Hon’ble Supreme Court uphold the order of the Hon’ble High Court, wherein it held that these features of the agreement clearly established that what was obtained by the assessee was only a license and what was paid by the assessee to the foreign company was only a license fee and not the price for acquisition of any capital asset. The CIT(A), after going through various clauses of the Trade Mark and Name License Agreement entered into by the assessee with Fenner, U.K. held as under:
“12. Coming to the facts of the present case, what has been granted to the assessee company is the continued use of the name Fenner indefinitely and the use of the trademarks within India in respect of the licenced products for a period of 10 years and as renewed thereafter from time to time. In para 3.3 of the Agreement it has been clarified that the licensors retain the worldwide rights to use, licence and exploit the trademark except in the exclusive territory which has been defined in the Collaboration Agreement as India. The licensor in clause 3.3 of the Agreement has also undertaken not by itself or through any member of the Fenner Group, it use or authorise the use of any of the trademarks within the territory of India during the subsistence of this Agreement.
13. The jurisdictional Madras High Court in the case of CIT v. Southern Switchgear Limited [148 ITR. 272], which was subsequently affirmed by the Supreme Court in the decision reported as Southern Switchgear Limited v. CIT [232 ITR 359], accepted the proposition that a portion of the royalty payments, in the facts of a particular case, could be treated as towards acquisition of a capital asset by the assessee company, and the balance towards revenue expenditure allowable under the Act. The Supreme Court, while affirming the decision of the Madras High Court, held [as extracted from the head notes] as under:-
”Since the foreign company had agreed not to manufacture in India,. any of the products in question or grant or make available to any other person any information relating to manufacture, licence, or rights, for any of the products in question in India, thereby conferring on the assessee exclusive right of manufacture and sale of the products, the High Court held that the clauses in the agreement indicated that the assessee paid the royalty for the acquisition of a exclusive privilege of manufacturing and selling the products and selling the products and the acquisition of such a right was rightly treated by the Tribunal as partly towards capital and partly towards revenue. The High Court affirmed the disallowance of royalty estimated at 25% by the Tribunal. On further appeal to the Supreme Court, the Supreme Court affirmed the judgement of the Madras High Court.”
14. The assessee, in the present case, similar to the facts of the case being dealt by the Apex Court in the Southern Switchgear case, had acquired an exclusive right to continue to manufacture and sell its products in India. It is true that through the payment of the lump sum royalty the capital structure of the assessee company was not enhanced or improved, but such payment was to continue its business operations in spite of the exit of Fenner U.K as a shareholder. Expenses to protect the business and to retain the advantages accruing from the use of the brand name Fenner and the associated trade marks would also be in the nature of a capital expenditure. Sums paid as compensation to a vendor of an undertaking not to market its products in a particular territory is for an enduring benefit and, therefore, not allowable as a deduction. It was so held by jurisdictional Madras High Court in the case of Tamilnadu Dairy Development Corporation Limited v. CIT [239 ITR 142], a preposition which is well established long since the Apex Court decisions in Assam Bengal Cement Company Limited v. CIT [27 ITR 34] and CIT v. Coal Shipments Private Limited [82 ITR 902]. Similarly, in the case of the assessee company also, at least a part of the payment of royalty was towards retaining the exclusive right to manufacture and sell its products in India using the brand name and trade marks of the foreign collaborator. As has been noticed by the Madras High Court in the Tamilnadu Dairy Development case, the capital structure of a concern does not necessarily have to be enhanced for an expenditure to be considered as capital in nature. The Madhya Pradesh High Court decision in Grover Soaps Private Limited v. CIT [221 ITR 299] noted by the Assessing Officer emphasises the same point.
15. The assessee, in the facts of the present case, has acquired only a licence to use the brand name and trade marks of the foreign collaborator. A mere lience to use the other party’s patent and knowledge have been considered as permissible revenue expenditure by the Apex Court in the I.A.E.C (Pumps) case [232 ITR 316]. However, at the same time, a portion of such expenses would also be in the nature of a capital expenditure to the extent that such expenses were to protect the advantage of using the foreign collaborator’s brand name and trade marks. On these facts, in my opinion, 25% of the lump sum royalty payment could be attributed as a payment for acquisition of a capital asset in the form of a commercially valuable right to continue to use the Fenner brand name and trade marks, while the balance 75% would be permissible as a deduction, being a revenue expenditure for the mere use of the brand name and the trade marks. Reliance for such estimated bifurcation of the lump sum royalty payment is placed on the jurisdictional Madras High Court decision in the case of Southern Switchgear Limited [148 ITR 272], which was subsequently affirmed by the Apex Court in the decision reported in 232 ITR 359. Appeal filed by the assessee company on this ground may, accordingly, be treated as partly allowed.”
8. The CIT(A), on analyzing the facts of the assessee’s case, concluded that 25% of the lump sum royalty payment could be attributed to acquiring capital asset in the form of commercially valuable right to continuously use the Fenner brand name and trade mark and the balance 75% could be permissible as deduction as revenue expenditure for mere use of brand name and the trade mark. In coming to such conclusion and bifurcation of royalty paid towards capital and revenue expenditure, he placed reliance of Hon’ble Jurisdictional High Court in the case of Southern Switchgear Ltd. (supra), which was subsequently affirmed by the Hon’ble Supreme Court in the case of Southern Switchgear Ltd. (supra).
9. With regard to the contention of the ld. DR that the assessee has acquired intangible asset and therefore is allowable under section 32(1), we opined that the provisions of section 32(1) are applicable when the assessee acquires on or after 01.04.1998 and owned wholly or partly any know-how, patents, copy rights, trade mark, etc. by the assessee and used for the purpose of business or profession, depreciation is allowable. In this case, the assessee has not either owned wholly or partly any know-how, patents, copy rights, trade mark, etc. so as to apply the provisions of section 32(1). The assessee is only permitted to use trade mark and brand name of the foreign collaborator with certain conditions. Therefore, in our view, the provisions of section 32(1) are not applicable to the facts of the assessee’s case.
10. We are inclined to follow the decision of the Hon’ble Jurisdictional High Court in the case of Southern Switchgear Ltd. (supra), which was affirmed by the Hon’ble Supreme Court in the case of Southern Switchgear Ltd. (supra) and therefore, we see no reason to interfere with the reasoning of the CIT(A), which is well founded and is in accordance with the law laid down by the Hon’ble Jurisdictional High Court and the Hon’ble Supreme Court. Accordingly, we dismiss the grounds of appeal of the assessee on this issue.
11. The next issue in the appeal of the assessee is against the action of the CIT(A) in directing the Assessing Officer to recompute the quantum of expenses for disallowance under section 14A read with provisions of Rule 8D of the Income Tax Rules as against 5% of corporate expenses disallowed by the Assessing Officer.
12. We have heard both the sides and perused the materials available on record. This issue is decided by the Hon’ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT  328 ITR 81/194 Taxman 203 (Bom.) wherein their Lordships held as under:
“Held, that the provisions of rule 8D of the Rules which have been notified with effect from March 24, 2008, would apply with effect from assessment year 2008-09. Even prior to assessment year 2008-09, when rule 8D was not applicable, the Assessing Officer had to enforce the provisions of sub-section (1) of section 14A. For that purpose, the Assessing Officer is duty bound to determine the expenditure which has been incurred in relation to income which does not form part of the total income under the Act. The Assessing Officer must adopt a reasonable basis or method consistent with all the relevant facts and circumstances after furnishing a reasonable opportunity to the assessee to place all germane material on the record. The proceedings for assessment year 2002-03 would stand remanded to the Assessing Officer. The Assessing Officer should determine as to whether the assessee had incurred any expenditure (direct or indirect) in relation to dividend income/ income from mutual funds which does not form part of the total income as contemplated under section 14A. The Assessing Officer can adopt a reasonable basis for effecting the apportionment. While making that determination, the Assessing Officer should provide a reasonable opportunity to the assessee of producing its accounts and relevant or germane material having a bearing on the facts and circumstances of the case.”
Therefore, in view of the Hon’ble Bombay High Court’s decision (supra), we, set aside the orders of the lower authorities and direct the Assessing Officer not to apply Rule 8D in the present case since the assessment year under appeal is 2005-06 and Rule 8D is applicable only from the assessment year 2008-09. However, the Assessing Officer may reasonably estimate the expenses attributable to earning of exempt income as held by the Hon’ble Bombay High Court. Accordingly, this ground of appeal of the assessee is allowed for statistical purpose.
I.T.A. No. 1047/Mds/2009:
13. The first issue in the appeal of the Department is that the CIT(A) erred in holding that 75% of royalty paid by the assessee to Fenner, U.K. is in the nature of revenue. In view of our discussions on this issue in assessee’s appeal in I.T.A. No. 722/Mds/2009 and since we have agreed with the reasoning of the CIT(A) in holding that the royalty paid is partly towards capital and partly towards revenue for the reasons stated above, we dismiss this ground of appeal of the Revenue on this issue.
14. The next issue in the appeal of the Department is that the CIT(A) erred in allowing deduction under section 43B in respect of employees contribution to Provident Fund.
15. We have heard both the sides and perused the materials available on record. The Hon’ble Supreme Court in the case of CIT v. Alom Extrusions Ltd.  319 ITR 306/185 Taxman 416 (SC) held that the omission of second proviso to section 43B of the Income Tax Act, 1961 by the Finance Act, 2003 operated retrospectively from 01.04.1988 and not prospectively from 01.04.2004. Therefore, in view of the decision of the Hon’ble Supreme Court (supra), we direct the Assessing Officer to verify as to whether this contribution paid by the assessee before the due date for filing of return. If the payments were made before the due date for filing of return, such contributions are to be allowed as deduction in view of the Hon’ble Apex Court in the case of Alom Extrusions Ltd. (supra). The Assessing Officer is directed accordingly. The ground raised by the Department on this issue is allowed for statistical purpose.
16. In the result, the appeal of the assessee in I.T.A. No. 722/Mds/2009 and the Department’s appeal in I.T.A. No. 1047/Mds/2009 are partly allowed.