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Case Number

Income Tax Appeal No. 2170 of 2009

Advocates

Judges

J.P Devadhar
M.S Sanklecha, JJ.

Acts

INCOME TAX ACT 1961

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Smart Summary

Structured Summary of the Opinion (assessment year 2001-02)

Factual and Procedural Background

This appeal by the Revenue under section 260A of the Income-tax Act, 1961 challenges the Income-tax Appellate Tribunal's order dated July 9, 2008 in respect of assessment year 2001-02. The Revenue formulated five substantial questions of law (labelled (a)–(e) in the opinion) relating to: (a) deletion under section 14A of certain disallowances; (b) classification of non-compete fees (Rs. 2.25 crores) as revenue or capital; (c) classification of marketing know-how payments (Rs. 10 crores); (d) depreciation claimed on royalty payments (amounts described in the record, including Rs. 60.97 lakhs); and (e) charging of interest under sections 234B/234C when computing income under section 115JB.

Brief facts as stated in the opinion:

The respondent-assessee is a pharmaceutical company engaged in manufacturing and marketing. For AY 2001-02 it filed a return declaring a loss of Rs. 27.53 crores.
The respondent acquired three brands/trademarks from M/s Lyka Lab Ltd. for an aggregate consideration of Rs. 34.20 crores and, in its return, claimed as revenue expenditure non-compete fees of Rs. 2.25 crores, marketing know-how fees of Rs. 10 crores and depreciation claimed on royalty payments (figures in the record include Rs. 2.43 crores and Rs. 60.97 lakhs in respect of royalty-related items).
The Assessing Officer disallowed the non-compete fees, marketing know-how fees and depreciation on royalty for assessment purposes, computed book profits at Rs. 18.56 lakhs under section 115JB and directed charging interest under sections 234B/234C.
On first appeal, the Commissioner of Income-tax (Appeals) held non-compete fees to be revenue in nature, treated royalty payments as part of cost of acquisition (allowing depreciation), characterized marketing know-how as capital but granted alternative relief by allowing depreciation at 25% on Rs. 10 crores as applicable to plant; the AO's view on interest under 234B/234C was left undisturbed.
On second appeal the Tribunal: (i) held non-compete fees revenue in nature; (ii) treated marketing know-how as revenue expenditure (following its prior decision in USV Ltd. v. Joint CIT); (iii) treated royalty payments as part of the cost of acquiring the brand and allowed depreciation under section 32; and (iv) held that no interest can be charged when computing income under section 115JB.
The Revenue appealed to this Court challenging the Tribunal's order on the issues framed in questions (a)–(e).

Legal Issues Presented

Whether the Tribunal was correct in law in upholding deletion of an addition of Rs. 17,26,124 under section 14A of the Income-tax Act? (question (a))
Whether the Tribunal was correct in law in upholding deletion of an addition of Rs. 2,25,00,000 on account of non-compete fees by treating the same as revenue expenditure? (question (b))
Whether the Tribunal was correct in law in upholding deletion of an addition of Rs. 10,00,00,000 on account of marketing know-how claimed by the assessee? (question (c))
Whether the Tribunal was correct in law in upholding deletion of an addition of Rs. 60,97,585 being depreciation claimed by the assessee on account of royalty payments? (question (d))
Whether the Tribunal was correct in law in deleting the interest charged under sections 234B and 234C while computing income under section 115JB, having regard to the provisions relating to companies and insertion of sections 115JA and 115JB? (question (e))

Arguments of the Parties

Appellant (Revenue) — primary contentions as recorded

The Revenue challenged the Tribunal's deletions and classifications, specifically contending that non-compete fees and marketing know-how payments were capital in nature and should not have been allowed as revenue expenditure.
The Revenue argued that interest under sections 234B/234C should be chargeable even where income is computed under section 115JB, given the statutory framework and amendments to sections 115JA/115JB (question (e)).
On question (b) the Revenue took the point that the Tribunal did not independently deal with the Revenue's appeal on non-compete fees and the issue required a reasoned determination.

Respondent (Assessee) — primary contentions as recorded

Counsel for the respondent (Mr. Jasani) objected to entertaining question (b) because, he contended, the Tribunal had effectively upheld the Commissioner of Income-tax (Appeals)'s finding that non-compete fees were revenue in nature.
In relation to marketing know-how (question (c)), the respondent relied on the Tribunal's reasoning and its prior decision in USV Ltd. v. Joint CIT, arguing that marketing know-how/information acquired was used to carry on business and enhanced profit-earning capacity, and therefore constituted revenue expenditure.
For royalty payments, the respondent maintained (and both the CIT(A) and Tribunal found) that royalty was in substance part of the cost of acquiring the brand and therefore entitled to depreciation under section 32.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
USV Ltd. v. Joint CIT (I.T.A No. 376.Mum/2001), decision dated 18-12-2006	Held that information and data acquired (marketing know-how) used in the taxpayer's business facilitate and augment profit-earning capacity and may be revenue expenditure in circumstances where they improve the business.	The Tribunal followed this decision in treating the respondent's marketing know-how payments as revenue expenditure; this Court accepted the Tribunal's reliance on USV Ltd. when examining the marketing know-how agreement and upheld the Tribunal's conclusion that the payments were revenue in nature.
Joint Commissioner Of Income Tax, Mumbai v. Rolta India Limited, [2011] 330 ITR 470 (SC)	Applied to the question whether interest under sections 234B/234C can be charged when income is computed under section 115JB (as to interaction of advance tax/interest provisions with section 115JB).	The advocates for both parties agreed that this Supreme Court decision covered the point in favour of the Revenue; the Court therefore answered question (e) in favour of the Revenue and against the assessee following Rolta.

Court's Reasoning and Analysis

The Court considered each question in turn and explained the basis for admission or dismissal and for its conclusions:

Question (a) — section 14A disallowance (Rs. 17.26 lakhs):
The Tribunal had found as a matter of fact that the investments producing exempt income (dividends) were made from the assessee's own funds and not from borrowed funds, and consequently concluded no expenditure was incurred for earning the exempt income. The Revenue failed to demonstrate that the Tribunal's factual finding was arbitrary or perverse. Because the issue was essentially a question of fact, the Court held that question (a) did not raise a question of law and dismissed it.
Questions (b) — non-compete fees (Rs. 2.25 crores):
The Court observed that although the Tribunal's order upheld the Commissioner of Income-tax (Appeals)'s conclusion that non-compete fees were revenue in nature, the Tribunal did not independently deal with the Revenue's appeal on this point or provide a reasoned discussion before arriving at that conclusion. The Tribunal did make an observation (in paragraph 12 of its order) that non-compete fees were dictated by business and commercial expediency and not for acquisition of a capital asset, but without adequate reasoning. For that reason, the Court set aside the Tribunal's adjudication on non-compete fees and remitted the matter to the Tribunal for a fresh, reasoned determination after hearing the parties.
Question (c) — marketing know-how payments (Rs. 10 crores):
The Court examined the marketing know-how agreement and accepted the Tribunal's conclusion (which followed the USV Ltd. decision) that the marketing know-how would lead to improvement in the assessee's existing business, resulting in higher sales and profitability. The Court noted that outsourcing of the know-how did not change its character: if the expenditure enhances profit-earning capacity and is incurred in the course of the business, it may be revenue in nature. On this factual and legal basis, the Court agreed with the Tribunal and held the expenditure to be revenue expenditure.
Question (d) — royalty payments and depreciation (amounts including Rs. 60.97 lakhs):
Both the Commissioner of Income-tax (Appeals) and the Tribunal had found that the royalty payments were, in substance, part of the consideration for acquiring the brand and thus formed part of the cost of the acquired asset. Consequently, depreciation under section 32 was allowable on that component. The Court found no fault with this factual conclusion or with the Tribunal's application of law and therefore answered this question in favour of the assessee.
Question (e) — interest under sections 234B/234C when computing income under section 115JB:
Both sides' counsel agreed that this point was covered by the Supreme Court's decision in Joint Commissioner Of Income Tax, Mumbai v. Rolta India Limited ([2011] 330 ITR 470 (SC)), which favored the Revenue. The Court accepted that position and answered question (e) in favour of the Revenue and against the assessee.

Holding and Implications

Core Rulings:

Question (a): Dismissed — the Tribunal's factual finding under section 14A was not shown to be arbitrary or perverse; no question of law arises.
Question (b): The Tribunal's order is set aside to the extent it allowed non-compete fees as revenue expenditure; the matter is remitted to the Tribunal for fresh consideration with a reasoned order after hearing the parties.
Question (c): Answered in favour of the respondent-assessee — the marketing know-how payments were held to be revenue expenditure (Tribunal's view upheld).
Question (d): Answered in favour of the respondent-assessee — royalty payments are part of the cost of acquisition of the brand and depreciation under section 32 is allowable.
Question (e): Answered in favour of the Revenue — the Court applied the Supreme Court decision in Rolta India Ltd. to rule for the Revenue on the interest issue.

Implications (direct effects on the parties):

The Tribunal's deletion under section 14A stands; the Revenue's challenge to question (a) fails.
The Tribunal's favourable treatment of marketing know-how (question (c)) and of depreciation on royalty (question (d)) is sustained, benefiting the assessee.
The Tribunal's allowance of non-compete fees as revenue (question (b)) has been vacated and remitted for a reasoned rehearing; the ultimate outcome on that point will depend on the fresh adjudication by the Tribunal.
On the interest issue (question (e)), the Court ruled for the Revenue following the Supreme Court precedent, thereby reversing the Tribunal's view on that specific point.
No directions were made as to costs; the appeal was disposed of in the terms set out above.

Precedential effect: The Court applied existing case law (USV Ltd. at the Tribunal level and Rolta India Ltd. from the Supreme Court). The Court did not purport to create new legal doctrine; it remitted one factual/legal question (non-compete fees) to the Tribunal for a reasoned determination.

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Commissioner Of Income-Tax v. Glenmark Pharmaceutical Ltd.

M.S Sanklecha, J.:— This appeal by the Revenue, under section 260A of the Income-tax Act, 1961 (“the Act”), challenges the order dated July 9, 2008, of the Income-tax Appellate Tribunal (“the Tribunal”) relating to the assessment year 2001-02.

2. Being aggrieved by the order dated July 9, 2008, the Revenue has formulated the following questions of law for consideration by this court:

“(a) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in law in upholding the Commissioner of Income-tax (Appeals) order of deleting the addition of Rs. 17,26,124 under section 14A of the Income-tax Act, 1961?

(b) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in law in upholding the Commissioner of Income-tax (Appeals) order in deleting the addition of Rs. 2,25,00, 000 on account of the non-compete fees paid by the assessee by treating the same as revenue expenditure?

(c) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in law in upholding the Commissioner of Income-tax (Appeals) order in deleting the addition of Rs. 10,00,00,000 on account of marketing know-how claimed by the assessee?

(d) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in law in upholding the Commissioner of Income-tax (Appeals) order in deleting the addition of Rs. 60,97,585 being depreciation claimed by the assessee on account of royalty payments?

(e) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in law in deleting the interest charged under sections 234B and 234C while computing income under section 115JB without appreciating the facts that the said section specifically state that all provisions of the Act shall apply to the assessee being company mentioned in the said section and therefore, section 115J of the Act is no more available for the assessee for delaying the payment of advance tax in view of the insertion of sections 115JA and 115JB in the Act?”

3. Question (a) is concerned with the disallowance of expenditure under section 14A of the Act. We find that the expenses disallowed by the Assessing Officer under section 14A of the Act amounting to Rs. 17.26 lakhs has been deleted in first appeal by the Commissioner of Income-tax (Appeals) to the extent of Rs. 13.65 lakhs. The Tribunal, in second appeal, has deleted even the amount of Rs. 3.60 lakhs disallowed by the Commissioner of Income-tax (Appeals). Whether or not the particular expenses is incurred for earning exempt income is pure question of fact. The Tribunal has arrived at a finding of fact that no expenditure was incurred for earning the exempt income as the investment were made from its own funds and not borrowed funds. The Revenue has not been able to show how the finding of fact arrived at by the Tribunal that no expenses were incurred to earn the dividend income is either arbitrary or perverse. In view of the finding of fact, question (a) does not raise any question of law and is, therefore, dismissed. The appeal is admitted on questions (b) to (e). At the instance of the advocates of the parties to the appeal, the appeal is itself taken up for final disposal.

4. Brief facts

(a) The respondent-assessee is a pharmaceutical company engaged in manufacturing and marketing of pharmaceutical products. For the assessment year 2001-02, the respondent-assessee had filed its return of income declaring a loss of Rs. 27.53 crores. In its return of income, the respondent-assessee had claimed as revenue expenditure non-compete fees of Rs. 2.25 crores, marketing know-how fee of Rs. 10 crores and depreciation claimed on royalty paid of Rs. 2.43 crores of Rs. 60.97 lakhs incurred while acquiring three brands/trade marks from one M/s. Lyka Lab Ltd. for an aggregate consideration of Rs. 34.20 crores. The Assessing Officer disallowed the non-compete fees and marketing know-how fees besides disallowing the depreciation on royalty to determine the income. The Assessing Officer determined the book profits at Rs. 18.56 lakhs under section 115JB of Act and also directed charging of interest under section 234B/234C of the Act.

(b) In appeal, the Commissioner of Income-tax (Appeals), by an order dated July 22, 2004, held that the non-compete fees of Rs. 2.25 crores was in the nature of a revenue expenditure on examination of the agreement. This was particularly so as there is no benefit of enduring nature but incurred on account of commercial expediency to earn more profit. The royalty payment would be in the nature of a cost incurred for acquiring a brand and, therefore, the same is to be added to the cost of acquisition of the brand and depreciation on the same under section 32 would be allowable. The expenditure for marketing know-how is concerned, is not a revenue expenditure but a capital expenditure as the benefit acquired on account of marketing know-how is of enduring nature and is linked with the acquisition of a brand. However, the alternative claim of the respondent that they be allowed depreciation at 25 per cent on Rs. 10 crores expended on acquiring marketing know-how as applicable to plant was granted. So far as charging of interest on book profit is concerned the order of the Assessing Officer holding that interest is payable under sections 234B and 234C of the Act is concerned, was left undisturbed.

(c) Being aggrieved by the order of the Commissioner of Income-tax (Appeals) dated July 22, 2004, both the appellant as well as respondent-assessee preferred appeals to the Tribunal. The Tribunal, in its order dated July 9, 2008, held that the expenditure of Rs. 2.25 crores on non-compete fees was dictated by business necessity and commercial expediency and it related to enhancement of its profitability. Therefore, was revenue in nature. In respect of marketing know-how fees of Rs. 10 crores, the Tribunal held that the same was in the nature of revenue expenditure and for that purpose followed its own decision in the matter of USV Ltd. v. Joint CIT rendered on December 18, 2006, i.e, I.T.A No. 376.Mum/2001 wherein in almost identical circumstances held that information and data acquired are used to carryout by the respondent-assessee business activity. This information or marketing know-how enables the respondent-assessee to facilitate and augment its profit-earning capacity. Therefore, the same is in the nature of revenue expenditure. So far as royalty payments are concerned, the Tribunal upheld the finding of the Commissioner of Income-tax (Appeals) to hold that the royalty payment are in fact in substance a payment made to acquire a brand and, therefore, a part of acquisition of brand are entitled to depreciation under section 32 of the Act. The Tribunal overturned the decision of the Commissioner of Income-tax (Appeals) and held that no interest can be charged on computation of income under section 115JB of the Act.

(d) Being aggrieved by the order of the Tribunal, the Revenue is in appeal before us.

Regarding question (b)

5. Mr. Jasani, advocate for the respondent, strongly objects to this question being entertained as though the issue was raised, the Tribunal has not dealt with the same in the impugned order. We find that though the impugned order has not independently dealt with the Revenue's appeal from the order of the Commissioner of Income-tax (Appeals) that noncompete fees are not revenue expenditure. However, it has upheld the finding of the Commissioner of Income-tax (Appeals) that no-compete fees would be classified as revenue expenditure. At paragraph 12 of the impugned order, the Tribunal, while dealing with marketing know-how expenses, has also observed that non-compete fee was also dictated by business and commercial expediency and was not an expenses incurred for acquisition of capital assets but only enhanced its profitability. However, there is no discussion on the issue before coming to the above conclusion. Therefore, the issue with regard to the nature of non-compete fees whether revenue or capital has to be remanded to the Tribunal so as to enable it to pass an order with reasons while determining whether noncompete fees was revenue or capital expenditure.

Regarding question (c)

6. Mr. Suresh Kumar, counsel for the Revenue submits that the expenditure incurred for marketing know-how acquired by the respondent is not a revenue expenditure as the marketing know-how acquired along with the brands is a benefit of enduring nature. Therefore, the expenditure is of a capital nature and the Tribunal ought not to have allowed it as a revenue expenditure. On the other hand, Mr. Jasani, counsel for the respondent-assessee places reliance upon the reasons given by the Tribunal in the matter of USV Ltd. (supra) which dealt with a similar agreement to that involved in this case. We find that on an examination of the marketing know-how agreement it is very clear that this agreement would lead to an improvement in its existing business resulting in higher sales and consequently higher profitability. This is so as the amounts spent on marketing know-how would result in improving the profits of the business on the acquired brands as this knowledge would assist in improving the marketing strategy. The expenses incurred for acquiring this marketing know-how if incurred by the respondent would be revenue and merely because it is outsourced it does not cease to be revenue expenditure. The expenditure incurred on marketing know-how, according to the Tribunal, would result in higher sales as well as lead to higher profit. Consequently, the amount paid for marketing know-how is revenue expenditure as correctly held by the Tribunal. Therefore, the question would have to be answered in favour of the respondent-assessee and against the appellant-Revenue.

Regarding question (d)

7. So far as the royalty payment is concerned both the Commissioner of Income-tax (Appeals) as well as the Tribunal has reached a finding of fact that the royalty payment as paid by the respondent-assessee to M/s. Lyka Labs Ltd. was a part of the cost of the acquisition of the brand and, therefore, would form a part of the cost of the assets, namely, the brand. In the result, respondent-assessee was entitled to depreciation on the amount of royalty fees as the same is a part of the consideration paid for acquiring the brand and would be entitled to depreciation under section 32 of the said Act as a part of the brand. In view of the above, no fault can be found with the order of the Tribunal, therefore, the question would have to be answered in favour of the respondent-assessee and against the appellant-Revenue.

Regarding question (e)

8. It is agreed between by the advocates for the appellant as well as the respondent that the above question is covered in favour of the Revenue and against the assessee by the decision of the Supreme Court in the matter of Joint Commissioner Of Income Tax, Mumbai v. Rolta India Limited reported in [2011] 330 ITR 470 (SC). Therefore, question (e) has to be answered in favour of the Revenue and against the assessee.

9. Our answer to the substantial questions of law (b) to (e) admitted for our consideration is as under:

(i) So far as question (b) is concerned, the impugned order of the Tribunal is set aside to the extent it allows non-compete fees as revenue expenditure and matter is remitted back to the Tribunal to dispose of the issue of non-compete fees afresh with a reasoned order after hearing the parties.

(ii) So far as questions (c) and (d) are concerned, the same is answered in favour of the respondent-assessee and against the appellant-Revenue.

(iii) So far as question (e) is concerned, the same is answered in favour of the appellant-Revenue and against the assessee, in view of the decision of the apex court in the matter of Rolta India Ltd., [2011] 330 ITR 470 (SC).

10. The appeal is disposed of in above terms with no order as to costs.

Commissioner Of Income-Tax v. Glenmark Pharmaceutical Ltd.

Structured Summary of the Opinion (assessment year 2001-02)

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Appellant (Revenue) — primary contentions as recorded

Respondent (Assessee) — primary contentions as recorded

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Income-Tax v. Glenmark Pharmaceutical Ltd.

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