Supreme Court held In the case of M/s. Mangalore Ganesh Beedi Works vs. CIT, that High Court was not justified in upsetting a finding of fact arrived at by the Tribunal, particularly in the absence of a substantial question of law being framed in this regard. Therefore, we set aside the conclusion arrived at by the High Court on this question.
Further there can be no doubt that for the purposes of a large business, control over intellectual property rights such as brand name, trademark etc. are absolutely necessary. Moreover, the acquisition of such rights and know-how is acquisition of a capital nature, more particularly in the case of the Assessee. Therefore, it cannot be doubted that the trademarks, copyrights and know-how acquired by the assessee would come within the definition of ‘plant’ being commercially necessary and essential. Act does not clothe the taxing authorities with any power or jurisdiction to re-write the terms of the agreement arrived at between the parties with each other at arm’s length and with no allegation of any collusion between them. ‘The commercial expediency of the contract is to be adjudged by the contracting parties as to its terms.’
Facts of the Case
M/s. Mangalore Ganesh Beedi Works (MGBW), a partnership came into existence with effect from 28th February, 1940. Due to differences between the partners of MGBW, the firm was dissolved on or about 6th December, 1987 when two partners of the firm applied for its winding up. The High Court held that the firm is dissolved with effect from 6th December, 1987 and directed the sale of its assets as a going concern to the highest bidder amongst the partners which was as per clause 16 of partnership deed. With effect from 18th November, 1994 the business of the firm passed on into the hands of three of the erstwhile partners forming an association of persons (AOP-3) but the tangible assets were actually handed over by the Official Liquidator to AOP-3 on or about 7th January, 1995.
MGBW filed its return for the period 18th November, 1994 to 31st March, 1995 and subsequently filed a revised return. Broadly, the Assessee claimed a deduction of Rs. 12,24,700/- as a revenue expenditure towards legal expenses incurred, depreciation under Section 35A and 35AB towards acquisition of Intellectual Property Rights such as rights over the trademark, copyright and technical know-how. Alternatively, the Assessee claimed depreciation on capitalizing the value of the Intellectual Property rights by treating them as plant. AO rejected the claim of the assessee.
Contention of the Revenue
The ld counsel of the revenue contended that the highest bid of AOP-3 was accepted by the High Court on or about 21st September, 1994 and therefore there was no question of the expenses being incurred for protecting the business of the going concern subsequent to that date. In other words all the legal expenses incurred were prior to 21st September, 1994 and were therefore personal in nature.
Held by CIT (A)
CIT (A) partly allowed the appeal of the assessee. It was held that the Assessee was entitled to a deduction towards legal expenses. However, the claim of the Assessee regarding deduction or depreciation on the Intellectual Property Rights was rejected.
Held by ITAT
The Tribunal allowed the appeal of the Assessee while rejecting the appeal of the Revenue. It was held by the Tribunal that the concern was in fact a going concern and therefore, the legal expenses incurred were for defending the business of the going concern and for protecting its interests. It could not be said that the expenses were personal in nature, nor could it be said that the expenses were unreasonable or not bona fide. It was found that the expenses incurred did not pertain to the period prior to the AOP-3 taking over the going concern but they were expenses incurred after the business was taken over by AOP-3 and that they related to legal proceedings that were pending in the High Court. The Tribunal noted that even the Assessing Officer did not treat the expenditure as being of a capital nature. Referring the decision in the case of Dalmia Jain and Company Limited v. Commissioner of Income Tax  81 ITR 754 (SC) it was held that the expenses incurred by the Assessee were honest and reasonable and were incurred for the purposes of protecting the business of the firm as a going concern.
Held by High Court
The following questions of law were admitted:
Whether Rs. 12,24,700/- claimed as revenue expenditure towards legal expenses by the Association of persons which was constituted by the three partners of the erstwhile firm, MGBW, can be allowed as permissible deduction in the hands of the said Association of persons under Section 37 of the Income-Tax Act, 1961, as being laid out or expended wholly and exclusively for the purpose of business of the said Association of Persons? – High court disallowed the deduction u/s 37.
Whether the Assessee was entitled to claim any deduction on the alleged expenditure for acquisition of patent [trademarks] rights, copyrights and know-how, in terms of Section 35A and 35AB of the Act? – High court disallowed the deduction u/s 35A & 35 AB on the ground that what was sold by way of auction to the highest bidder was the goodwill of the partnership firm and not the trademarks, copyrights and technical know-how.
Whether the Tribunal had erred in directing the Assessing Officer to capitalize the value of trademarks, copyright and technical know-how by treating the same as plant and machinery and grant depreciation therein? – High court denied the capitalization.
Held by Supreme Court
In relation to question no. 1, there is a clear finding of fact by the Tribunal that the legal expenses incurred by the Assessee were for protecting its business and that the expenses were incurred after 18th November, 1994. There is no reason to reverse this finding of fact particularly since nothing has been shown to us to conclude that the finding of fact was perverse in any manner whatsoever.
In the case of K. Ravindranathan Nair v. Commissioner of Income Tax  247 ITR 178 (SC), it was held that if the finding of fact arrived at by the Tribunal were to be set aside, a specific question regarding a perverse finding of fact ought to have been framed by the High Court. Accordingly, we hold that the High Court was not justified in upsetting a finding of fact arrived at by the Tribunal, particularly in the absence of a substantial question of law being framed in this regard. Therefore, we set aside the conclusion arrived at by the High Court on this question and restore the view of the Tribunal and answer the question in favour of the Assessee and against the Revenue.
In relation to question no. 2 & 3, we must accept and acknowledge that intellectual property rights have a value. In the case of Bharat Beedi Works (P) Ltd. v. CIT (1993) 3 SCC 252 wherein it has been observed that there is a value attached to a brand name. In the valuation report obtained by AOP-3, the technical know-how was valued at Rs. 36 crores, copyright was valued at Rs 21.6 crores and trademarks were valued at Rs. 14.4 crores making a total of Rs. 72 crores. It is not necessary to go into calculating the bifurcated value of the three intangible assets except to say that the trademarks were given a value since in the beedi industry the trademark and brand name have a value and the Assessee’s product under trademark ‘501’ had a national and international market. As far as the copyright valuation is concerned, beedis are known not only by the trademark but also by the depiction on the labels and wrappers and colour combination on the package. The Assessee had a copyright on the content of the labels, wrappers and the colour combination on them. Similarly, the know-how had a value since the aroma of beedis differs from one manufacturer to another, depending on the secret formula for mixing and blending tobacco.
In the case of M. Ramnath Shenoy ITA No.258 (Bangalore/1997) decided on 10th July, 1997 (an erstwhile partner of MGBW) the Tribunal accepted the contention of the Assessee that trademarks, copyrights and technical know-how alone were comprised in the assets of the business and not goodwill. It was also held that when the Revenue alleges that it is goodwill and not trademarks etc. that is transferred, the onus will be on the Revenue to prove it, which it was unable to do. The Tribunal then examined the question whether the sale of these intangible assets would attract capital gains. The question was answered in the negative and it was held that the assets are self-generated and would not attract capital gains. The decision of the Tribunal has been accepted by the Revenue and we really see no reason why a different conclusion should be arrived at in so far as the Assessee is concerned.
We leave open the question of the applicability of Section 35A and Section 35AB of the Act for an appropriate case. This is because learned counsel submitted that if the Assessee is given the benefit of Section 32 read with Section 43(3) of the Act (depreciation on plant) as has been done by the Tribunal, the Assessee would be quite satisfied.
The question is would intellectual property such as trademarks, copyrights and know-how come within the definition of ‘plant’ in the ‘sense which people conversant with the subject-matter with which the statute is dealing, would attribute to it’? – In our opinion, this must be answered in the affirmative for the reason that there can be no doubt that for the purposes of a large business, control over intellectual property rights such as brand name, trademark etc. are absolutely necessary. Moreover, the acquisition of such rights and know-how is acquisition of a capital nature, more particularly in the case of the Assessee. Therefore, it cannot be doubted that so far as the Assessee is concerned, the trademarks, copyrights and know-how acquired by it would come within the definition of ‘plant’ being commercially necessary and essential as understood by those dealing with direct taxes. Also earlier there was no distinction between tangible & intangible assets while calculating depreciation. We are, therefore, in agreement with the view taken by the Tribunal in this regard that the Assessee would be entitled to the benefit of Section 32 of the Act read with Section 43(3) thereof.
It may also be mentioned that by denying that the trademarks were auctioned to the highest bidder, the Revenue is actually seeking to re-write clause 16 of the agreement between the erstwhile partners of MGBW. This clause specifically states that the going concern and all the trademarks used in the course of the said business by the said firm and under which the business of the partnership is carried on shall vest in and belong to the highest bidder. Under the circumstances, it is difficult to appreciate how it could be concluded by the Revenue that the trademarks were not auctioned off and only the goodwill in the erstwhile firm was auctioned off. In D. S. Bist & Sons v. CIT  149 ITR 276 (Delhi) it was held that the Act does not clothe the taxing authorities with any power or jurisdiction to re-write the terms of the agreement arrived at between the parties with each other at arm’s length and with no allegation of any collusion between them. ‘The commercial expediency of the contract is to be adjudged by the contracting parties as to its terms.’
Accordingly, appeal of the assessee allowed.