India: The Delhi Tribunal Strikes The Bullseye By Rejecting The Depreciation Claim Of The Taxpayer On Intangible Assets In The Nature Of Government Authorisations/Approvals, Non-Compete Fees And Goodwill

Last Updated: 27 June 2017
Article by SKP  

Background

The know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after 1 April 1998 are eligible for depreciation under the Income Tax Act, 1961 (Act).

In a recent decision1, the Delhi Tribunal disallowed depreciation on intangible assets in the nature of Government Authorisations/Approvals (GAs), non-compete fees and goodwill to the taxpayer.

Facts of the case

General facts

  • The taxpayer is a subsidiary of Pitney Bowes International Holding Inc, USA (PBIH).
  • Kilburn Office Automation Ltd (KOAL) was marketing the franking machines of PBIH in India to end users such as Department of Post (DoP).
  • The taxpayer took over the business of selling franking machines pursuant to Business Transfer Agreement (BTA) dated 15 October 2004 on slump sale basis.
  • The original assessment for Assessment Year (AY) 2005-062 was completed on 28 December 2007 after rejecting the claim of the taxpayer for allowance of a non-compete fee as revenue expenditure. Although the Tribunal confirmed the original assessment, it remanded the matter to the Assessing Officer (AO) for examining the issue of allowability of depreciation on non-compete fee. The Delhi High Court, as well as the Supreme Court, confirmed the Tribunal's order.
  • During the course of assessment proceedings for AY 2007-083, the AO noted that the taxpayer had claimed depreciation on GAs acquired pursuant to BTA. According to the AO, GAs are not forming a part of the specified intangible assets under the Act and hence, the taxpayer was not entitled to depreciation on GAs.
  • Accordingly, the AO issued a notice dated 25 March 2011 for reopening the assessment of AY 2005-06 on the ground that excessive depreciation on GAs was allowed in the original assessment completed on 28 December 2007.
  • In the reassessment order for AY 2005-06, the AO disallowed the claim of depreciation on GAs and also denied depreciation on non-compete fees.
  • The Commissioner of Income Tax (Appeals) (CIT(A))4 upheld the validity of reassessment proceedings as well as sustained the disallowances. The CIT(A) also rejected the additional ground of the taxpayer claiming depreciation on goodwill for the first time.
  • Being aggrieved, the taxpayer filed an appeal before the Delhi Tribunal.

Certain specific facts on GAs

  • In the BTA, no value was assigned to GAs, but GAs was listed as one of the assets acquired by the taxpayer.
  • The taxpayer assigned values to non-compete fees and GAs based on the valuation report dated 22 December 2005 of Deloitte, Haskins and Sells.
  • After acquiring the business from KOAL, the DoP issued a letter regarding GAs to the taxpayer on the basis of the request received from the taxpayer and No Objection Certificate (NOC) received from KOAL.

Ruling of the Delhi Tribunal

The Delhi Tribunal rejected all the claims of the taxpayer. The ruling of the Delhi Tribunal on various issues are summarised below:

On the legal validity of initiation of reassessment proceedings

  • In the instant case, the prerequisite for reopening of assessment under the Law was that there should be failure on the part of the taxpayer to fully and truly disclose material facts necessary for the assessment.
  • The mentioning of GAs as intangible assets in the audited financial statements, significant accounting policies or notes to account and tax audit report might be a disclosure by the taxpayer. However, such disclosure was not full and true when the entirety of facts are considered.
  • In the original assessment, the taxpayer replied in negative when the AO asked to submit the documentary evidence of acquisition of fixed assets above INR 1 million and the date of their put to use. This prevented the AO from making further enquiry on the issue of depreciation on GAs. Thus, there was no failure on part of the AO in applying the legal provisions to the facts of the case.
  • The taxpayer misrepresented the facts and the reason for failure to disclose fully and truly all material was squarely attributable to the taxpayer.
  • The discovery of the facts that the taxpayer claimed depreciation on GAs constitutes an information, which came to the AO after original assessment. Therefore, the issue of change of opinion in the reassessment proceedings cannot arise when no opinion was framed on the issue of depreciation on GAs in the original assessment.
  • In the circumstances, the reassessment proceedings were validly initiated under the Law.

On the eligibility of depreciation on GAs

  • The taxpayer did not produce GAs granted by the DoP/Regulatory Authority to verify the name of the entity to whom the GAs was addressed. The taxpayer also did not produce a copy of the letter issued by the DoP to KOAL.
  • However, a copy of the letter issued by DoP to the taxpayer was submitted. It was manifest from the content of the said letter that the DoP had approved specific franking machines of PBIH.
  • If it is presumed that similar letter would have been issued by the DoP to KOAL, it cannot create any rights in favour of KOAL. The letter issued to KOAL would be due to its status as a distributor of franking machines supplied by PBIH. The moment distribution agreement is terminated, the letter issued by DoP in name of KOAL would also lose its sanction.
  • There is no material to suggest that KOAL had the right of transferring the letter issued by the DoP to any person of its choice.
  • The right to sell franking machines was as a result of distribution rights granted by PBIH and not due to GAs.
  • As GAs were granted to machines of PBIH only and not to KOAL (which even it could not transfer to any person of its choice), GAs are neither license nor rights of a business/commercial nature in the hands of KOAL and transferrable to the taxpayer. Therefore, no depreciation on the value assigned to GAs could be allowed to the taxpayer.

On the eligibility of depreciation on non-compete fees

The Delhi Tribunal relied on the jurisdictional Delhi High Court judgment in Sharp Business System vs CIT [2012] 211 Taxman 576 and confirmed the disallowance of depreciation on non-compete fees.

On the eligibility of depreciation on goodwill

  • The list of transferred assets included business know-how, customer and vendor list, etc. which are business/commercial rights of similar nature as specified in the Act and constituted as a part of the goodwill of the business transferred to the taxpayer.
  • In light of CIT vs Smifs Securities Ltd [2012] 348 ITR 302 (SC), depreciation should be allowable on goodwill. It should be computed after reducing the value of all liabilities, tangible assets, GAs and non-compete fees valued by the valuer from the slump sale consideration.
  • However, the taxpayer did not claim depreciation on goodwill before the appellate authorities, High Court and Supreme Court consequent to the original assessment. This claim was made for the first time in the appellate proceedings consequent to the reassessment proceedings. Such claim cannot be allowed in view of the decision in CIT vs State Agro Development Corporation [2001] 248 ITR 487 (J&K).
  • The alternative plea of allocating the value of GAs towards goodwill also cannot be accepted as the taxpayer is bound to accept the value assigned to GAs by an independent valuer.

Footnotes

1. Pitney Bowes India (P) Ltd vs DCIT in ITA No. 289/Del./2013 dated 29 May 2017 [TS-208-ITAT-2017 (Del)]

2. Tax Year 2004-05. Please note that there are other Tax Years also involved in this case, but these Tax Years are not covered in this Alert

3. Tax Year 2006-07

4. The first appellate level in India

SKP's comments

This decision, though based on the peculiar facts, signifies the importance of taking proactive and conscious tax position at the right time. This applies not only at the stage of finalisation of transactional documents, obtaining valuation reports, etc. but also applies when the proceedings are in progress before the Indian Revenue Authorities (IRA).

An interpretation of the expression "any other business or commercial rights of similar nature" has been a subject matter of considerable litigation before the Indian Courts/Tribunals when it comes to the issue of allowability of depreciation on intangible assets. Going by the principles laid down in this decision, it is therefore quite critical to carry out a thorough exercise of:
  1. properly ascertaining the nature of intangible asset from the underlying records; and
  2. determining whether the taxpayer possesses rights akin to an owner of such asset.
It is only after the factual clarity emerges as a result of such exercise, a tax position should be taken after correlating such facts with the Law and principles laid down in the judicial precedents available. A document, such as valuation report, can only be a support to such exercise and it is obvious that such document cannot solely govern/determine the tax implications of any transaction. It is, therefore, appropriate that such exercise and the process of obtaining valuation report should run in parallel.

This decision may be a good example to drive home the point that if any taxpayer misrepresents the facts before the IRA, it can bounce back with a full force and may prove quite costly in terms of tax outgo along with interest and penalties. It is also better to keep in mind that if necessary/precise documents are not furnished to the IRA during tax proceedings, the IRA may be left with no choice but to make certain presumptions. This can lead to unintended and dire consequences for the taxpayer.

As regards depreciation on non-compete fees, there are contrary decisions of Indian Courts/Tribunals. The controversy is whether the non-compete rights, being restrictive and can be asserted only against a particular person (right in personam) and not against the world at large (right in rem), are eligible for depreciation or not. The taxpayer, in the instant case, lost the matter on this issue as the jurisdictional High Court (Delhi High Court) has decided this issue in favour of IRA. It looks like that only Supreme Court may bring an end to this controversy.

Although Delhi Tribunal accepted the claim of depreciation on goodwill on merits in light of favourable Supreme Court decision, the taxpayer lost the matter here also on technical grounds of raising this issue for the first time during the appellate proceedings consequent to reassessment proceedings.

The alternative claim of the taxpayer to allocate the value of GAs towards goodwill was also not accepted. The Delhi Tribunal rejected alternative claim since an independent valuer had assigned a value to GAs. Apparently, it looks like the Delhi Tribunal has been quite strict here since one gets an impression that the valuation report was impliedly rejected and GAs were considered worthless when the Delhi Tribunal rejected taxpayer's original claim of depreciation on GAs. The Delhi Tribunal, while rejecting the original claim, took a view that no rights were created in favour of KOAL when the DoP issued the letter and the DoP had only approved the specific franking machines of PBIH. In view of this, a question arises on the action of Delhi Tribunal going by the same valuation report while rejecting the alternative claim of the taxpayer of allocating a value of GAs towards goodwill.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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