In absence of tax free income claim, no disallowance can be made U/s.14A
The pre-requisite to invoke the provisions of section 14A read with rule 8D of the Rules is that the assessee should have claimed some expenditure against exempt income. In the case under consideration, no exempt income was shown by the assessee in its return, so, there was no justification for making disallowance of any kind.
Income from Assignment of patent for exploiting it commercially is Capital Gain
The patent was for the purpose to have right to manufacture/produce/process some article/thing. The patent was registered for commercial exploitation of the same in India as well as in the international market. It was transferred to the assignee for exploiting it commercially. Section 55(2)(a) talks of right to manufacture, produce or process any article or thing. Therefore, as per the amended provisions, the right to manufacture/produce/process would be taxable under the head capital gains and cost has to be taken at Rs. Nil. In these circumstances, in our opinion the FAA has rightly invoked the provisions of section 55 and taxed the disputed amount under the head capital gain.
Full Text of the ITAT Order is as follows:-
Challenging the order, dated 15-2-2012, of the Commissioner (Appeals)-5, Mumbai the assessee and the assessing officer (AO) have filed cross appeals for the year under consideration. The assessee and the assessing officer have also filed additional Grounds of appeal.
2. During the course of hearing before us, it was stated that additional Grounds were legal in nature and did not require clarification/verification of any facts. We have gone through the additional Grounds and find that they are of pure legal nature and arising out of the order of the First Appellate Authority (FAA), so, we admit the same.
2.1. Assessee-company, engaged in the business of manufacturing and trading of pharmaceuticals filed its return of income on 27-9-2008 declaring Loss of Rs. 27.97 crores under the normal provisions and book profit of Rs. 7.5 crores under section 115JB of the Act. The assessing officer completed the assessment under section 143(3), on 20-12-2010, determining its income at Rs. (-)20.47 crores under normal provisions and at Rs. 13.25 crores under section 115JB of the Act.
ITA No. 3091/Mum/2012:
3. First Ground of Appeal raised by assessee is about holding disallowance of Rs. 1.25 crores read with rule 8D of the Income Tax Rules, 1962 (Rules). During the assessment proceedings the assessing officer found that the assessee had made investment in shares of various companies and units of mutual funds, that the long-term investment made by it amounted to Rs. 14.38 crores. He observed that investments would give rise to exempt income, that the assessee had not made any dis allowance under section 14A. He directed the assessee to file details of expenses incurred for earning exempt income and to show cause as to why the expenses incurred and claimed in respect of exempt income should not be disallowed. The assessee stated that it had not incurred any expenditure for earning exempt income. Referring to the case of Godrej and Boyce Mfg. Ltd. of the Hon’ble Bombay High Court he made a dis allowance of Rs. 1,25,21,298. The same amount was also added to the book profit while computing income under section 115JB of the Act.
3.1. Aggrieved by the order of the assessing officer, the assessee preferred an appeal before the First Appellate Authority (FAA), before whom it made elaborate submissions. After considering the submission of the assessee and the assessment order he referred to the case of Daga Capital Management (P.) Ltd. 117 ITD 169, Cheminvest Ltd. 124 TTJ 577; Walfort Shares and Stock brokers Ltd. 310 ITR 421 and held that the assessing officer was not satisfied with the claim of the assessee, that assessing officer could follow a reasonable method of apportionment of expenditure, that he had rightly applied section 14A read with rule 8D of the Rules.
3.2. During the course of hearing before us, the Authorised Representative (AR) contended that assessee had not claimed any exempt income in the return of income, that in absence of claim of tax free income no disallowance could be made under section 14A. He referred to the case of Cheminvest 378 ITR 33. The Departmental Representative (DR) supported the order of the FAA.
3.3. We have heard the rival submissions and perused the material before us. We find that the assessee had not claimed any exempt income in its return. However he made disallowance of Rs. 1.25 crores (Rs. 1.19 crores interest expenditure + Rs. 6.89 lakhs administrative expenses) and same was upheld by the FAA. The pre-requisite to invoke the provisions of section 14A read with rule 8D of the Rules is that the assessee should have claimed some expenditure against exempt income. In the case under consideration, no exempt income was shown by the assessee in its return, so, there was no justification for making disallowance of any kind. The Hon’ble Delhi High Court in the case of Cheminvest (supra) has held as under :–
“The expression “does not form part of the total income” in section 14A of the Income Tax Act, 1961, envisages that there should be an actual receipt of income, which is not includible in the total income, during the relevant previous year for the purpose of disallowing any expenditure incurred in relation to the income. In other words, section 14A will not apply if no exempt income is received or receivable during the relevant previous year.”
Respectfully, following the above we allow first ground of appeal.
4. Second Ground deals with upholding the dis allowance of Rs. 4.74 crores being loss incurred due to revaluation of open forward exchange contract. During the assessment proceedings the assessing officer found that the assessee had entered into derivative agreement to swap term loans taken in Rupees against foreign currency, that it had debited “marked to market” losses of Rs. 4,74,24,891 to the P&L A/c. stating that the said liability had crystallized owing to the revaluation. The assessing officer called for details about the transaction. After considering the same he held that it had entered into derivative transaction by swapping the loan, that the liability was paid in the subsequent year, that the notional loss of Rs. 4.74 crores could not be allowed. He referred to Instruction of CBDT date 23-3-2010 and added the disputed amount to the total income of the assessee. He further held that it was provision and not an ascertained liability, as specified in Explanation 1 to clause (c) to the provisions of section 115JB. Therefore, he added Rs. 4.74 crores to the book profit of the assessee.
4.1. After considering the submission of the assessee, the FAA held that the assessee had borrowed funds in foreign currency, that in order to hedge against the exchange fluctuation it had entered into foreign currency swap agreements, that the contracts were of one year, that the loss claimed by the assessee could not be allowed for the year under consideration, that it was a notional/contingent loss, that it was allowed in the next assessment year.
4.2. Before us, the AR relied upon the case of M/s. D. Chetan & Co. [Income Tax Appeal No. 278 of 2014 dt. 1-10-2016]; Woodward Governor India Pvt. Ltd. 312 ITR 254; Oil and Natural Gas Corporation Ltd. 322 ITR 18. The DR supported the order of the FAA.
4.3. We have heard the rival submissions and considered the available material. We find that in the case of M/s. D. Chetan & Co. the Hon’ble Bombay High Court had considered the following question of law :–
“Whether on the facts and in the circumstances of the case and in law, the Tribunal was justified in deleting the addition of ‘Mar to Market’ Loss of Rs. 78,10,000 made by the assessing officer on account of disallowance of loss on foreign exchange forward contract loss and not appreciating the fact that the said loss was a notional loss and hence cannot be allowed?”
It was held by the Hon’ble Bombay High Court that question formulated by the department did not give rise to any substantial question of law.
Considering the above, we decide second Ground of appeal in favour of the assessee.
5. Ground No. 3 is about upholding the addition of Rs. 1.25 crores, made under section 14A read with rule 8D of the Rules for computing the book profit. While deciding the Ground No. 1 we have held that no addition should have been made under section 14A for the year under consideration. Following the same, we hold that addition confirmed by the FAA for computing the book profit under section 115JB has to be deleted. Third Ground of appeal is allowed.
6. Next Ground is also about computing book profit with regard to dis allowance of Rs. 4.74 crores. We have allowed Ground No. 2 filed by the assessee. Following the same, we hold that there was no justification in making addition of Rs. 4.74 crores to the book profit computed under section 115JB of the Act. Fourth Ground stands allowed.
7. Last Ground of appeal is about consideration received on assignment of patent, amounting to Rs. 1.5 crores and applicability of provisions of section 55(2) of the Act. During the assessment proceedings, the assessing officer found that the assessee had sold a paten namely Profafal for 1.5 crores, that it had claimed that no expenditure was incurred for acquiring the patent, that the patent was a capital asset, that the entire receipt on assignment of patent were not taxable. The assessee submitted explanation in this regard, vide its letter date 23-11-2010, in response to the directions of the assessing officer. The assessing officer held that the assessee was engaged in the business of research development, manufacturing, wholesale trading and licensing of bio-pharmaceuticals, bio-technology products, serums and process related technology for human therapeutic, that it had manufacturing facility and state-of-art research facilities, that developing a process, a technology was part of the business of the assessee, that it was not possible to develop a process/patent without input from specialized/ skilled personnel in a state-of-art research facility, that process of developing a patent was a part of a business of the assessee, that it had claimed all the expenses for skilled personnel and research facility in the P&L account, that the claim made by it in not incurring any cost for developing the patent was not acceptable. Finally, he held that receipt from sale of patent was a revenue receipt. He added Rs. 1.50 crores to the total income of the assessee.
7.2. During the appellate proceedings, before the FAA, the assessee argued that it had an in-house research laboratory, that over a period of time it had developed several products, that product research and development was highly uncertain matter requiring substantial research work, that it had developed several patents, that one of the products developed by it was “Profofal”, that in order to continue further development it assigned the know-how of “Profofal” for a consideration of Rs. 1.50 crores, that the patents are legal rights created to protect the know-how which was a self generated asset, that it could not be equated with a commercial asset/ inventory held for business, that know-how or patent was an Intellectual Proprietary Right (IPR), that it had personal attachment to the developers, that the know-how was unique and could not be generalised, that the appellant perceived its IPR holdings to be a tool of its trade and not an inventory held for sale/ disposal, that the transaction was on capital account, that surplus could not be subjected to tax under the head business income. It referred to matter of Srinivasa Shetty 128 ITR 294, that know-how was outside the net of section 55 and was regarded as a no cost asset, that sale of patent know-how was a capital receipt and not chargeable.
The FAA referred to various paragraphs of the patent assignment agreement (PAA) dt. 28-3-2008 and held that the assessee had developed an invention which was patented in India and International market, that it was for the purpose of commercial exploitation, that the same was transferred and assigned to the assignee, thus the assessee had commercially exploited it. Referring to the provisions of section 55(2)(a) of the Act, the FAA held that the said section covers a right to manufacture/produce/process any article or thing, that the facts of present case were squarely covered by the provisions of section 55 of the Act, that the receipt had to be taxed as capital gains.
7.3. During the course of hearing, the AR argued that the assessee had transferred know how and patent, that section 55(2) did not talk of assets in question, that even if expenditure was incurred for developing the patent no cost was ascertainable. He referred to the case of Kwality Biscuit (P.) Ltd. 135 ITD 35 and Fernhill Laboratories and Industrial Establishment 348 ITR 1. The DR contended that the sole object was to earn profit, that the assessee had incurred huge expenditure, that it was wrong to claim that no expenditure was incurred, that the receipt in question was trade receipt, that the cases relied upon by the AR were of no help.
7.4. We have heard the rival submissions and perused the material before us. We find that the assessee had assigned patent of “Profofal” for a consideration of Rs. 1.5 crores, that it had claimed that same is not taxable, that the FAA held that provisions of section 55(2) were applicable to the facts of the case and the amount received by it was taxable under the head capital gains.
7.4.1. Before proceeding further, it would be useful to discuss the concept of patent and to take notice of the history of patents. Patent is a long-term process of visualizing an idea, experimenting, reaching at certain conclusions and testing of such conclusions, so that the fruit of the labor are enjoyed by the person who tirelessly pursues a goal for years together. It is a culmination of extensive research work and logical analysis. Patent is a legal document that is granted by the Sovereign and gives an inventor exclusive right to make/ use/ sale an invention for a specified number of years. Previously invented items can also be subject matter of patents, provided they demonstrate significant improvement.
Patent prevents all others, not only the imitators, but even the independent entrepreneurs, having the same idea but not implemented till that date, from using the invention for a specified period. It may pose serious difficulty for the competitors, but the proverbial early-birds are always rewarded. Though a patent could affect a large number of people, patents are not freely available for all improvements. Only patentable inventions are recognized by the authorities concerned. A patentable invention must pass three basic tests namely it must be novel, it must be non-obvious and it must be useful. In other words, invention should not previously exist and it should be a significant improvement to the existing technology. Besides, patents cannot be granted for invention that would only be used for an illegal or immoral purpose. No patent can be granted on a law of nature or scientific principles even if a person discovers it for the first time. It is said that the goal for resisting the patents is to encourage people to bring qualitative and far-reaching changes in the technology so that it could benefit the society at large.
7.4.2. As per the available records, city of Venice passed the first patented law in the year 1474. In the year 1624 Statute of Monopolies was enacted in England. The 1883 Paris Convention provided a guarantee of equal treatment for patent applicants in all its member states. Twenty countries adopted it initially and later on other countries followed the suit. More than 120 countries have signed Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS), in 1994. This treaty has strengthened the legal protection for patents all over the globe.
Indian patent law requires an invention to be new and useful for the purpose of registration. The invention should relate to machine/ article/ substance produced by manufacturer/process of manufacturer of an article. Patenting process was governed by Indian Patents and Design Act, 1911. It was replaced by Patents Act, 1970 that came into force from 20-4-1972. India has become a member of Paris Convention with effect from 7-12-1998 and by virtue of this, the Head Office of Patent Office and its branches have become receiving office for purpose of international application for patents. As per the Patent Rules, 1972 applications for international patents can be filed at HO/Branch Offices with effect from 17-11-1999.
7.5. Here, we would also like to mention two important things. Firstly, it is necessary to make a distinction between cases where consideration is paid to acquire the right to use a patent or a copyright and cases where payment is made to acquire patented or a copyrighted product or material. In cases where payments are made to acquire products which are patented or copyrighted, the consideration paid would have to be treated as a payment for purchase of the product rather than consideration for use of the patent or copyright.
7.6. Secondly, a trade mark fundamentally differs from a patent. In the case of the former the property and the right to protection are in the device or symbol adopted to designate the goods sold, and not in the article which is manufactured and sold. That article is open to the whole world to manufacture and sell; and all that the owner of the trade mark is entitled to prevent is the use of his trade mark by other traders. On the other hand, a patent right protects the substance of the article, i.e., the stock-in-trade and any unauthorised manufacture is prohibited.
7.7. Now, we would like to discuss about the patented medicine. ‘Profofal’, marketed as Diprivan among others, was discovered in 1977. It is available as a generic medication. It is on the World Health Organization’s List of Essential Medicines. It is not a pain medication. It has been referred to as ‘milk of amnesia ‘because of the milk-like appearance of the intravenous preparation. It is a short- acting medication that results in a decreased level of consciousness and lack of memory for events. Its uses include the starting and maintenance of general anesthesia, sedation for mechanically ventilated adults and procedural sedation. It is also used for status epilepticus if other medications have not worked. Common side effects include an irregular heart rate, low blood pressure, burning sensation at the site of injection, and the stopping of breathing. Other serious side effects may include seizures infections with improper use, addiction and Propofol infusion syndrome with long-term use.
Medical Patents require clinical tests and administering drugs to the patients. Clinical tests have to be performed under controlled conditions. For understanding the effective mass and the side-effects of the medicine large sample survey spread over a reasonable time span is a must. Considering the side-effects of ‘Profofal’, as narrated earlier, the research work is to be done with care. In short, before getting a patent of medicine like the item under consideration, the assessee has to carry out a lot of research analysis and experimentation. Naturally it would require incurring of expenditure for both the activities. Such a tedious and cumbersome process was adopted by the assessee to have a right to manufacture/produce/process ‘Profofal’.
While differentiating the trade mark and patent, we have mentioned that it protects substance of article. We would like to mention the relevant terms of the assignment agreement that would lead to the conclusion that it was held for commercial exploitation. Following are some of the terms of the agreement :–
A. The assignor manufactures and markets biological, pharmaceutical and biotechnological products and has a range of products based on strong research and development initiatives and efforts.
B. *** *** ***
C. The assignee is desirous of acquiring the patent and has requested the assignor to transfer and assign all its rights, title and interest in the patent to the assignee for the purpose of commercial exploitation of the same in India and in the rest of International market …………”.
From above is clear that the patent was for the purpose to have right to manufacture/produce/process some article/thing. The patent was registered for commercial exploitation of the same in India as well as in the international market. It was transferred to the assignee for exploiting it commercially. Section 55(2)(a) talks of right to manufacture, produce or process any article or thing. Therefore, as per the amended provisions, the right to manufacture/produce/process would be taxable under the head capital gains and cost has to be taken at Rs. Nil. In these circumstances, in our opinion the FAA has rightly invoked the provisions of section 55 and taxed the disputed amount under the head capital gain.
7.8. We are also of the opinion that the cases relied upon by the assessee, are of no help to it. In the case of Kwality Biscuits Pvt. Ltd. (supra), the issue before the Tribunal was different. In that case, the Tribunal has dealt with trade mark and brand name. In the earlier part of our order, we have brought out the distinction between patent and trade-mark. It is also found that in that matter the assessee continued to carry out manufacturing and trading business of biscuits. Considering those facts, it was held by the Tribunal that the assessee had not transferred right to manufacture, produce or process biscuits. Similarly, in the case of Fernhill Laboratories and Industrial Establishment (supra), the Hon’ble Bombay High Court was deciding the issue of applicability of the amendments from a particular date. We hold the facts under consideration are totally different from that case.
Considering the above, we decide last ground against the assessee.
I.T.A. No. 3375/Mum/2012:
8. Effective Ground of appeal raised by the assessing officer is about treating the sum of Rs. 1.5 crores, received on sale of “Profofal” as capital receipt instead of a trading receipt. While discussing the last Ground of appeal, raised by the assessee, we have narrated the facts about sale of patent by the assessee. As stated earlier, the assessing officer had held that the amount received by the assessee had to be assessed under the head business income and the FAA held that it was to be taxed as capital gains.
8.1. Before us, the DR relied upon the order of the assessing officer and stated that process of developing patent was part of the regular business activity of the assessee. The AR stated that the assessing officer was not justified in treating the transaction as a trading-transaction. After hearing the rival submissions, we are of the opinion that the FAA had rightly treated the disputed amount as capital receipt and had taxed it as capital gain under section 55(2) of the Act. The assessee was not in the business of purchase and sale of patents, so the sale proceed of the assignment agreement could not be treated a revenue receipt.
9. Additional grounds raised by the assessing officer with regard to re-opening are not being adjudicated as we have decided the appeals filed by the assessee and assessing officer on merits.
As a result, appeal filed by the assessee is partly allowed and appeal of the assessing officer stands dismissed.