IN THE HIGH COURT OF JUDICATURE AT MADRAS Dated :
29. 10.2013 Coram The Honourable Mrs.Justice CHITRA VENKATARAMAN and The Honourable Mr.Justice T.S.SIVAGNANAM Tax Case (Appeal) No.1195 of 2008 M/s.Pentasoft Technologies Ltd., 'Taurus', No.25, I Main Road United India Colony Kodambakkam Chennai 600 024. ... Appellant vs The Deputy Commissioner of Income Tax Company Circle V (2) Chennai 600 034. ... Respondent Tax Case Appeal filed under Section 260A of the Income Tax Act, 1961 against the common order passed by the Income Tax Appellate Tribunal, Madras 'B' Bench dated 06.02.2008 in ITA No.1540/Mds/2006 for the assessment year 2002-2003. For appellant : Dr.Anita Sumanth For respondent : Mr.N.V.Balaji Standing counsel for Income Tax Department JUDGMENT
(The Judgment of the Court was made by T.S.SIVAGNANAM, J.) This appeal by the assessee is directed against the order dated 06.02.2008 passed by the Income Tax Appellate Tribunal [Tribunal]. in ITA No.1540/Mds/2006 for the assessment year 2002-2003.
2. The assessee/appellant is a public limited company carrying on business in software development, hardware sales and educational training. It also exports software from its Software Technology Park unit (STP unit) and also engaged in domestic sales of software developed in Non-STP units. For the assessment year 2002-03, the assessee filed its return of income admitting the loss of Rs.37,12,20,853/- after claiming deduction under Section 10A of the Income Tax Act, 1961 (The Act) to the extent of Rs.50,44,22,294/-. The Assessing Officer after issuing intimation under Section 143(1) of the Act, determined the total income at Rs.3,91,06,337/- applying the principles of Section 115 JB of the Act. Thereafter, proceedings were initiated under Section 143(2) of the Act and the assessee filed revised statement declaring the loss of Rs.108,99,06,618/-. According to the assessee, the increase in loss was due to write-off of unrealized sales during the relevant previous year, which was approved by the order passed by this Court dated 28.06.2004. The Assessing Officer completed the assessment by order dated 30.03.2005 computing the total income of Rs.40,05,43,280/- as against the loss returned by the assessee. The disallowance of which, we are concerned in this appeal and it relates to the disallowance of depreciation on the value of Non-compete Fee.
3. Pursuant to agreement dated 23.02.2000 entered into between the appellant and M/s.Pentamedia Graphics Limited (PMGL) for hiving off and transfer of software development and training divisions from PMGL to the assessee, the assessee paid Rs.626.08 crores towards acquisition of Intellectual Property Rights and Non-compete Fee. The break-up of the same was Rs.180 crores towards Non-compete Fee; Rs.364.21 crores towards IPRs on brand and Rs.81.87 crores towards excess of transfer price of fixed assets in excess over their WDV as per Companies Act and in all Rs.626.08 crores. The assessee claimed depreciation for the assessment year 2001-02 and 2002-03 on the above figures and valuation report was filed before the Assessing Officer to support their claim for depreciation on the IPRs, which included Non-compete Fee. The Assessing Officer rejected the claim made by the assessee.
4. Aggrieved by the same, the assessee preferred appeal to the Commissioner of Income Tax (Appeals) and the First Appellate Authority held that the assessee had acquired the trade mark and licence to use the mark ".Pentasoft". exclusively and also to carry on business in software development, export and training by restraining Pentamedia Graphics Limited from carrying out the same activities and therefore, they were intangible assets entitled to depreciation under Section 32(1)(ii) of the Act. As against the order passed by the First Appellate Authority the Revenue filed appeal before the Tribunal. The Tribunal upheld the order of the First Appellate Authority allowing depreciation on Intellectual Property Rights but reversed the order insofar as it relates to depreciation on non-compete fee. This portion of the order is impugned in this tax case appeal filed by the assessee raising the following questions of law:
1. Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in law in holding that the appellant was not entitled to depreciation on non-compete fee as an intangible asset under Section 32(1)(ii) of the Income Tax Act, 1961?.
2. If the answer to the first question is negative, is the appellant entitled to claim deduction of the non-compete fee as a Revenue expenditure under Section 37 of the Income Tax Act, 1961?.
5. We have heard Dr.Anita Sumanth, learned counsel appearing for the assessee/appellant and Mr.N.V.Balaji, learned Standing Counsel appearing for the Revenue.
6. Learned Counsel for the assessee contended that the right granted to the assessee is in the nature of the licence and non-compete fee is in fact an indirect licence to enable the assessee to carry on business for a period of ten years and therefore, the assessee would be entitled to claim depreciation under Section 32(1)(ii) of the Act. By relying upon the findings given by the First Appellate Authority, the learned counsel submitted that the Tribunal erred in reversing the finding recorded by the First Appellate Authority and there was no basis to reverse such a finding. Further, the learned counsel submitted that while having accepted the position that the agreement and the payment in respect of non-compete fee conferred a right to the assessee, ought to have held that it is a commercial right falling within the scope of Section 32(1)(ii) of the Act as intangible assets eligible for depreciation.
7. Learned Counsel in the alternative submitted that the Tribunal ought to have allowed the payment of non-compete fee as Revenue expenditure in view of the fact that the advantage obtained by the assessee by virtue of the non-compete fee agreement was only in the Revenue field to enable the assessee to carry on the business smoothly without interruption by the transferor company.
8. In support of her contention she placed reliance on the decision of the Hon'ble Supreme Court reported in 327 ITR323SC) [Techno Shares and Stocks Ltd. vs. Commissioner of Income Tax]. and the decision of the Delhi High Court reported in (2012) 254 CTR233(Delhi)[Sharp Business System vs. Commissioner of Income Tax]..
9. Per contra, learned Standing Counsel appearing for the Revenue submitted that even if the transfer of Intellectual Property Right is taken as a commercial right, then the non-compete fee is not a commercial right as it is not of similar nature as that of the other positive rights as enumerated under clause (ii) of Sub-Section 1 of Section 32 of the Act.
10. Learned Standing Counsel for the Revenue further submitted that the right over the trade mark is a right in rem and the right under the agreement is a right in personam. It is further submitted that the decision of the Honble Supreme Court reported in 327 ITR323SC) [cited supra]. cannot be applied to the facts of this case since the said decision applied to a transfer of licence to be a member in a Stock Exchange.
11. We have carefully considered the submissions made on either side and perused the materials available on record.
12. The assessee entered into an agreement dated 23.02.2000 with Pentamedia Graphics Limited. Under the said agreement PMGL was a transferor and the assessee was the transferee. The transferor was carrying on business in multimedia and software development and it identified the multimedia, which is poised for major growth in future as its core business and decided to hive off the software business and training and the assessee/appellant agreed to acquire the software business and accordingly, PMGL unconditionally transferred, assigned and permitted the assessee to use the Intellectual Property Rights. Under the same agreement dated 23.02.2000, there was a clause relating to non-competition by virtue of which, PMGL agreed that they shall not within the geographical limits of all countries for a period of 10 years after the closing, either on its own behalf or on behalf of the association with any third person, act or advise or consult or be as a trustee either directly or indirectly compete with the software business among other things. The IPRs which stood transferred under the said agreement were trade names, trade marks or service marks together with the goodwill associated therewith; copy rights pending or issued registrations for any of the foregoing inventions, trade secrets and other confidential or proprietary information, computer programs and all other intangible property rights of the software business. That apart the product also meant to include banking product, insurance product, finance products etc., and PMGL bound themselves not to use the name Pentasoft in the business transactions or any products developed by them and what they permitted the assessee unreservedly and without encumbrance is to utilise the said name in any of the product transferred with the software business or any of the products that may be developed by them in future. The other rights owned by PMGL with regard to the development and training also stood approval under the said agreement. Further in the agreement, the assessee had agreed that the consideration for transfer of the Intellectual property and agreeing to non compete shall be Rs.544.21 crores. It is to be pointed out that in the agreement there was no break-up details given as to how much of the above amount is allocable towards the transfer of IPR and how much towards non-compete fee. Nevertheless such details has been furnished by the assessee before the Authorities below. The Assessing Officer, after taking note of the opinion of the Chartered Accountant of the assessee held that the opinion was not based on any scientific valuation and it is not a proper professional approach and accordingly, the capitalization of the goodwill , i.e. Intellectual Property Rights and non compete fee was rejected and the claim for depreciation was disallowed.
13. The First Appellate Authority, on appeal by the assessee against the said finding of the Assessing Officer, observed that the assessee has not only acquired trade mark but also licence to sell 25 different types of products acquired from PMGL, which it had sold to India and abroad after acquisition i.e. on 1.4.1999 and that the assessee also acquired commercial right to conduct training programmes with the use of trade mark pentasoft and engaged in software development and export in the line of various software products acquired from PMGL exclusively. Further it took note of the fact that PMGL has been restrained to engage in the two activities by virtue of the non-competition agreement between them for which the assessee paid Rs.180 crores to PMGL. Therefore, after taking note of the AS26 issued by ICAI, that IPRs and non compete fee are classifiable as intangible assets as in the assessees case it satisfies the criteria, viz., it was identifiable; it was controllable and economic benefits flowed out to the enterprise. Since the three criteria were satisfied and the assets were unconditionally transferred by PMGL, the First Appellate Authority held that the assessee had acquired absolute rights to enjoy, utilize and exploit such exclusive rights.
14. After referring to the decision of the Honble Supreme Court in the case of Tata Consultancy Services vs. State of Andhra Pradesh reported in 271 ITR401(SC), the First Appellate Authority held that the assessee has acquired trade marks and licence to use the trade mark pentasoft exclusively and also to carry on business and software development export and training by restraining PMGL from carrying out the same activities. Hence, such trade mark licence and the commercial rights acquired by payment of non-compete fee are intangible assets entitled to depreciation under Section 32(1)(ii) of the Act.
15. The Revenue preferred appeal before the Income Tax Appellate Tribunal. In fact, the assessee also preferred appeal as against the other issues, which we are not presently concerned. On the appeal preferred by the Revenue, the Income Tax Appellate Tribunal held that non-compete fee is not an asset, which the assessee could use like licence or franchise etc., in its business and it is a payment to ward off the competitor for a specified number of years and it confers the right to sue in case of breach by a person and depreciation cannot be allowed on non-compete fee.
16. The Tribunal in para No.21 of its order relied on its earlier decision passed in ITA No.1293(Mds)/2006 dated 23.11.2007 [M/s.A.B.Mauria India Pvt.Ltd. vs.ACIT].. Learned Counsel on either side fairly stated that they are unable to get a copy of the said decision as the said decision has not been reported.
17. Be that as it may, the only reason assigned by the Tribunal is that the non-compete fee is not an asset, which the assessee could use like a licence or franchise and therefore, depreciation cannot be allowed.
18. In the preceding paragraphs, we have referred to the agreement entered into between the parties. The said agreement dated 23.02.2000 is a composite agreement by virtue of it, there was transfer of all rights over the IPRs as well as the training and development programmes to be exclusively used by the assessee for a fixed fee. Under the agreement, the consideration payable for transfer of IPRs and towards non compete fee have not been segregated or distinctly mentioned. In order to qualify for a depreciation under Section 32(1)(ii) of the Act, it would first be relevant to refer to the said provision,which reads as under: ".Depreciation:
32. 1) [in respect of depreciation of (i)............ (ii) know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April 1998, owned, wholly or partly, by the assessee and used for the purposes of the business or profession, the following deductions shall be allowed -]. Therefore, in terms of the above provision, deduction is allowable in respect of depreciation of patents, copy rights, trade marks, licence, franchise, etc or any other business or commercial rights of similar nature. There is no difficulty insofar as the trade mark and copy rights, which have been transferred in favour of the assessee.
19. The only issue is whether non compete agreement/arrangement would fall within the ambit of clause (ii) of Section 32(1) of the Act.
20. It is the case of the Revenue that this non-compete fee is in the nature of a negative right and it cannot be of a commercial right of similar nature and the expression similar nature shall be relatable to patents, copy rights and trade mark licence or franchise or any other business. Therefore, it is submitted that this negative right cannot be construed either as a licence or as a commercial right to be eligible for deduction.
21. We are unable to agree with the stand taken by the Revenue for the simple reason that the agreement between the parties is a composite agreement. Under the agreement, the transferor had transferred all its rights, copy rights, trade marks in respect of the word pentasoft as well as the training and development division exclusively to be exploited by the assessee. In order to strengthen those rights transfer under the said composite agreement, there was a non compete clause by virtue of which, the transferor was restrained from using the same trade mark, copyrights etc., in favour of the assessee. Therefore, the non compete clause under the agreement should be read as a supporting clause to the transferor of the copy rights and patents rather to strengthen the commercial right, which was transferred in favour of the assessee.
22. Learned counsel for the assessee contended that the non-compete is in effect an indirect licence. However, we are not inclined to agree with the said submission since non compete, at best could be a commercial right because that right is relatable to the transfer of trade mark, copy rights and patents. Therefore, the view taken by the Commissioner of Income Tax(Appeals) in this regard is acceptable.
23. In the case of Techno Shares and Stocks Ltd vs. Commissioner of Income Tax reported in 327 ITR323(SC), the assessee therein before the Honble Apex Court claimed depreciation on the membership card held by it with the Bombay Stock Exchange enables it to trade on the floor, is a business or commercial right in the nature of a licence under Section 32 (1)(ii) of the Act.
24. The Department on the other hand, pointed out that membership is a personal privilege and that it is not an asset and that it is not owned by the assessee and therefore, the claim of the assessee for depreciation was not admissible under Section 32(1)(ii) of the Act.
25. While answering the question, the Honble Supreme Court considered the rules of the Bombay Stock Exchange and after perusing Rules 5 to 10, it held thus: .........".that the right of nomination is conferred on the member of the exchange; that , the said right shall cease and vest in the exchange when his membership gets forfeited to the exchange; that on such forfeiture the right of membership gets vested in the exchange and on such vesting the exchange has the right to deal with it as it may think fit. That, on forfeiture even the right of nomination vests in the exchange. Thus, a non-defaulting continuing member owns the right of nomination with respect to the membership of the exchange till his right of membership is forfeited to the exchange.". However, the Honble Supreme Court observed that the right of membership including the right of nomination gets vested in the exchange on the demise/default committed by the member; that on such forfeiture and vesting in the exchange, the same gets disposed of by inviting offers and the consideration received thereof is used to liquidate the dues owed by the former/defaulting member to the exchange or clearing house.
26. It further held that it is this right of membership, which allows the non-defaulting member to participate in the trading session on the floor of the exchange. The said membership right is the business or commercial right conferred by the rules of the Bombay Stock Exchange on the non-defaulting continuing member.
27. We are conscious of the fact that the Honble Supreme Court clarified that the said judgment is strictly confined to the right of the membership conferred upon the member under the Bombay Stock Exchange membership card during the relevant assessment years and that judgment should not be understood to mean that every business or commercial right would constitute a 'licence' or a 'franchise'. Therefore, the said decision was rendered after taking into consideration the Rules of the Bombay Stock Exchange.
28. In the case of hand, we have analysed the agreement and also in the previous portion of this order elaborated upon the various terms and conditions, which bind the parties had observed that the earlier transfer of the trade mark, patents and other rights in favour of the assessee was undoubtedly the transfer of intangible assets, which in terms of section 32(1)(ii) of the Act would be a capital asset entitled to depreciation.
29. In the light of the above, we have no hesitation in setting aside the order passed by the Income Tax Appellate Tribunal and answer the issue in favour of the assessee. In such circumstances, there is no necessity for us to consider the alternative submission made by the learned counsel for the assessee.
30. In the result, the Tax Case(APpeal) is allowed. However, there shall be no order as to costs. (C.V.,J.) (T.S.S.,J.) 29.10.2013 Index : Yes Internet: Yes vj2 To 1. The Deputy Commissioner of Income Tax Company Circle V (2), Chennai.
2. The Commissioner of Income Tax (Appeals)-V121 Mahatma Gandhi Road, Chennai 600 034.
3. The Income Tax Appellate Tribunal Chennai ".B". Bench, Chennai. CHITRA VENKATARAMAN, J.
vj2 Tax Case (Appeal).No.1195 of 2008 29.10.2013