HARITA FEHRER LTD.,,CHENNAI vs. DCIT, CC - 2 (2),, CHENNAI

Aforesaid appeals by assessee for different Assessment Years (AY) assail separate appellate orders and one of the issues is stated to be common issue. The Ld. AR placed on record issue-wise chart and advanced arguments. To support the same, our attention has been drawn to various documents and reliance has been placed on various judicial pronouncements, the copies of which have been placed on record. The Ld. Sr. DR also advanced arguments controverting the arguments of Ld. AR and filed written submissions which have been duly been considered while adjudicating the appeals. Having heard rival submissions and after due consideration of case records, our adjudication would be as under.

The lead appeal is for AY 2011-12 which arises out of the order of Ld. Commissioner of Income Tax (Appeals)-13 [CIT(A)] dated 07-05- 2018 in the matter of an assessment framed by Ld. Assessing Officer [AO] u/s. 143(3) of the Act on 21-02-2014. The grounds raised by the assessee read as under: - Ground No 1: The learned Commissioner of Income Tax (Appeals) erred in denying depreciation of Rs.1,07,81,250/- on non-compete fee capitalized which represents intangible assets being technical know-how, processes etc., used in the business and hence is entitled to depreciation. The learned CIT (A) ought to have appreciated the fact that the appellant had received technical know-how and special processes from the transferor along with the foam division, which are of the nature of intangible assets and are entitled to depreciation. (CIT vs Smifs Securities Ltd- 348 ITR 302 -SC). Without prejudice, if the amount is held to be as non-compete, the same is allowable as revenue expenditure. (Carborundum Universal Ltd vs JCIT - 2012-TIOL-790 - Madras HC and Orchid Chemicals & Pharmaceuticals Ltd vs Assistant Commissioner of Income tax, 131 ITD 385- IT AT Chennai). Ground No 2:

As is evident, the issues that fall for our consideration in this year are – (i) Depreciation on non-complete Fees; (ii) Applicable Rate of depreciation on computer software; (iii) Claim of additional depreciation; (iv) Assessee’s claim of bad-debts written-off. The assessee being resident corporate assessee is stated to be engaged as foam manufacturer.

Issue No.1 - Disallowance of depreciation on Non-complete fees paid by the assessee 4.1 The erstwhile assessee M/s Harita Polymer Pvt. Ltd. purchased foam division from another entity i.e., Polyflex India Pvt. Ltd. (PIPL) on a slump-sale basis for total consideration of Rs.47.30 Crores under a ‘Business Purchase Agreement’ (BPA) dated 10-11-2008. The agreement had non-compete clause wherein PIPL was precluded from establishing the foam business within a period of 2 years from the date of sale of the business to the assessee. Accordingly, a sum of Rs.5.50 Crores was capitalized by the assessee as 'non-compete fees' in the books of accounts and written-off over a period of 2 years. However, in the computation of income, the assessee claimed depreciation on this amount @25% being depreciation rate as applicable to an ‘intangible asset’. The same was on the ground that the payment of non-compete fees confers a right on the assessee to enforce the other person not to do a particular commercial activity and hence, it constitutes a commercial right. This clause was incorporated as a negative covenant to preclude PIPL from competing with the business of the assessee. 4.2 However, Ld. AO opined that the BPA did not contain quantification of allocation of the consideration of Rs.5.50 Crores as paid by the assessee. The allocation of expenditure towards ‘non-compete fees’ was against Sec.2(42C) which define ‘slump sale’ to mean transfer of one or more undertaking for a lump sum consideration without assigning any values to the assets and liabilities. The claim of the assessee was neither evidenced by an agreement nor has any basis or justification under the Income Tax Act. It was more in the nature of facilitation and reduction of its profits and not a prudent commercial practice as claimed by the assessee. The non-compete fees so paid by the assessee was not an asset which the assessee could use like license or franchise etc. in its business. Actually, it was a payment made to ward-off a competitor for a specified number of years. In other words, it only confers a right to sue in case of breach by a person to whom the amount is paid. Further, it could be enforced only when the default occurs. Further, the sum so received by recipient would be liable to tax u/s 28 (va) except when the receipts are chargeable to tax under the head ‘capital gains’. The assessee has not treated the payment on revenue account but treated the same as intangible asset and incorrectly claimed depreciation. Accordingly, the depreciation claim of Rs.107.81 Lacs was disallowed. 4.3 The Ld. CIT(A) endorsed the views of Ld. AO that non-compete fees so paid by the assessee was not an asset which the assessee could use like license or franchise etc. in its business. It was a payment made to ward-off competition for a specified number of years. In other words, it only confers a right to sue in case of breach by a person to whom the amount is paid. Further, it can be enforceable only when default occurs. Accordingly, the impugned disallowance was confirmed against which the assessee is in further appeal before us. Our findings and Adjudication 5. From the fact, it emerges that the assessee has purchased foam division from PIPL vide business purchase agreement dated 10-11-2008 on slump sale basis for aggregate consideration of Rs.47.30 Crores. Under this method of acquisition, separate values to assets and liabilities are not assigned and the business is acquired on lump sum basis. For the purpose of accounting, the assessee would allocate the consideration towards each assets and liabilities so acquired which would equate to total consideration paid by the assessee under the agreement. It could be seen that the business purchase agreement contain a non-compete clause wherein the seller i.e., PIPL was precluded from establishing the foam business within a period of 2 years from the date of sale of the business to the assessee. The same was with a view to ward-off the competition in the same line of business. The assessee has assigned valuation of Rs.5.5 Crores to this right and accordingly, capitalized the same in the books of accounts and wrote-off the same over a period of two years i.e. over the period during which this right was enforceable. For the purpose of computation of income, the assessee treated the payment so made as ‘intangible asset’ and claimed applicable depreciation of 25%. This exercise, for the first time, has been done by the assessee in AY 2010-11 which is precisely the argument of Ld. AR.

The Ld. AR has submitted that under block of asset concept, once an asset forms block of assets and depreciation is claimed as well as allowed, the individual asset looses identity and the depreciation is allowed on a block as a whole. Accordingly, once this position has been accepted by revenue in initial year, the depreciation claim could not be denied in subsequent years following rules of consistency as laid down by Hon’ble Supreme Court in the case of Radhasoami Satsang vs. CIT (60 Taxman 248). The Ld. Sr. DR, on the other hand, submitted that rule of consistency would have no application and the principles of res- judicata are not applicable to Income Tax proceedings and each year is a separate unit of assessment. The Ld. Sr. DR submitted that the said case law would have no application since in that case, a particular position continued for more than 20 years. Further, error committed by Ld. AO in one year would not bind the department and the error need not be continued. In the present case, no findings were rendered by Ld. AO in AY 2010-11 on this issue and therefore, the arguments of Ld. AR could not be accepted. The Ld. Sr. DR relied on the decision of Hon’ble Delhi High Court in the case of Sharp Business System vs. CIT (27 Taxmann.com 50) which was followed by same court in Fortis Hospitals Ltd. vs. ACIT (ITA No.132/2021 dated 29.07.2021). The Ld. AR, on the other hand, inter-alia, relied on the decision of Hon’ble High Court of Madras in Pentasoft Technologies Ltd. vs. DCIT (41 Taxmann.com 120) as well as the decision of Hon’ble High Court of Delhi in Areva T & D India Ltd. (345 ITR 421) besides the decision of Hon’ble Apex Court in CIT vs. Smifs Securities Ltd. (348 ITR 392) to support the argument that the non-compete fees would constitute intangible asset which would be eligible for depreciation at applicable rate.

We find that this claim has been made by the assessee for the first time in AY 2010-11. The return for that year was scrutinized by Ld. AO and no addition was made on this account. The assessees’ return of income for AY 2012-13 as well as for AY 2015-16 has been processed u/s 143(1) wherein this issue has reached finality and the similar claim made by the assessee has been accepted. The only dispute is with respect to AY 2011-12, 2013-14, 2014-15 and 2016-17. Thus, from AYs 2010-11 to 2016-17, the claim has been accepted in three years whereas the claim has not been accepted in four years. Considering the same, the arguments of Ld. Sr. DR that it was the error of initial year, could not be accepted. The rule of consistency would clearly favor the case of the assessee and the ratio of decision of Hon’ble Supreme Court in the case of Radhasoami Satsang vs. CIT (60 Taxman 248), in our considered opinion, could be applied to the case of the assessee.

Proceeding further, the term ‘intangible asset’ as defined in Sec.32(1)(ii) would mean: - Know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April, 1998, not being goodwill of a business or profession. The expression ‘business or commercial rights of similar nature’, in our considered opinion, is sufficient enough to cover the right acquired by the assessee against PIPL precluding it to compete with the assessee in same line of business for 2 years. The assessee, by law, has right to seek exclusion of PIPL from competing in the same line of business for 2 years. This right would possibly enable the assessee to run its business more profitably and would enable it to ward-off at least one of the competitors in the market. The decision of Hon’ble High Court of Madras in Pentasoft Technologies Ltd. vs. DCIT (41 Taxmann.com 120), rendered on similar facts, supports our view. In that case, the assessee made payment towards acquisition of intellectual Property Rights (IPR) and non-compete fees and claimed depreciation. The Tribunal allowed depreciation on IPR but denied depreciation on non-compete fees on the ground that it was not an asset. Further, there was no break up of amount as to how much amount was allocable towards IPR and how much amount was allocable towards non-compete fees. Upon further appeal, Hon’ble Court adjudicated the issue in assessees’ favor as under: - 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.

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.

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.

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.

In the case of Techno Shares & Stocks Ltd. (supra), the assessee therein before the Hon'ble 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.

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.

While answering the question, the Hon'ble 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 Hon'ble 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."

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.

We are conscious of the fact that the Hon'ble 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.

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.

Similar is the decision of Hon’ble High Court of Delhi in Areva T & D India Ltd. (345 ITR 421). The Hon’ble Court, elaborating on the concept of ‘business or commercial rights of similar nature’ held as under: - 12. In the present case, it is seen that the assessee vide slump sale agreement dated 30th June, 2004, acquired, as a going concern, the transmission and distribution business of the transferor Company w.e.f. 1st April, 2004. As a result thereof, the running business of transmission and distribution was acquired by the transferee lock, stock and barrel minus the trademark of the transferor which was retained by the transferor, for lump sum consideration of Rs.44.7 Crores. It is further seen that the book value of the net tangible assets (assets minus liabilities) acquired was recorded in the balance sheet of the transferor as on the date of transfer as Rs.28.11 Crores. The said assets and liabilities were recorded in the books of transferee at the same value as appeared in the books of the transferor. The balance payment of Rs.16,58,76,000/- over and above the book value of net tangible assets, was allocated by the transferee towards acquisition of bundle of business and commercial rights, clearly defined in the slump sale agreement, compendiously termed as "goodwill" in the books of accounts, which comprised, inter alia, the following:- (i) Business claims, (ii) Business information, (iii) Business records, (iv) Contracts, (v) Skilled employees, (vi) knowhow. It is also observed that the AO accepted the allocation of the slump consideration of Rs.44.7 Crores paid by the transferee, between tangible assets and intangible assets (described as goodwill) acquired as part of the running business. The AO, however, held that depreciation in terms of Section 32(1)(ii) of the Act was not, in law, available on goodwill. The CIT(A) and the ITAT approved the reasoning of the AO thereby holding disallowance of depreciation on the amount described as goodwill. It was thus argued on behalf of the assessee Company that Section 32(1)(ii) would mean rights similar in nature as the specified assets, viz., intangible, valuable and capable of being transferred and that such assets were eligible for depreciation. On behalf of the respondent it was argued that applying the doctrine of noscitur sociis the expression "any other business or commercial rights of similar nature" used in Explanation 3(b) to Section 32(1) has to take colour from the preceding words "knowhow, patents, copyrights, trademarks, licenses, franchises". It was urged that the Supreme Court had clearly held in Techno Shares & Stocks Ltd. ( supra) that "Our judgment should not be understood to mean that every business or commercial right would constitute a "licence" or a "franchise" in terms of section 32(1)(ii) of 1961 Act".

This decision has subsequently been followed by Hon’ble High Court of Madras in the case of the same assessee for AY 2006-07 which is reported as 129 Taxmann.com 55. In this decision, Hon’ble Court has distinguished the decision of Hon’ble Delhi High Court in Sharp Business System vs. CIT (27 Taxmann.com 50) as under: - 11. The second question is as to whether the non compete fee is an asset in the nature of patents, copyrights, trademark, licence, franchises or any other business or commercial right of similar nature and as to whether the assessee is eligible to claim depreciation under section 32 of the Act.

The Tribunal took note of the decision of the High Court of Delhi in the assessee's own case for the Areva T & D India Ltd. v. Dy. CIT [2012] 20 taxmann.com 29/208 Taxman 252/345 ITR 421 and allowed the appeal filed by the assessee thereby reversing the findings of the CIT(A).

Mrs. R. Hemalatha, learned Senior Standing Counsel appearing for the appellant/Revenue has placed reliance on the decision of the Delhi High Court in the case of Sharp Business System v. CIT [2012] 27 taxmann.com 50/211 Taxman 576 in support of her contention that the amount paid as non compete fee did not qualify for depreciation under section 32(1)(ii) of the Act.

In the decision in the case of Asianet Communications Ltd. v. CIT [2018] 96 taxmann.com 399/257 Taxman 473/407 ITR 706, a Division Bench of this Court, to which, one of us (TSSJ) was a party, had considered the same issue as to, where the non compete fee paid by the assessee was for the purpose of its business and it did not entail an enduring benefit to the assessee in its business, whether the payment of such fee was to be allowed as revenue expenditure. In this decision, the Court took note of the decision of the Delhi High Court in the case of Sharp Business System and it has been held as follows : "36. So far as the decision in Sharp Business System (supra) is concerned, as pointed out earlier, in paragraph 5 of the judgment, it has referred to the decision of this Court in G.D. Naidu. The discussion is in paragraph 9 and the conclusion is in paragraph 10.

In paragraph 9 of the judgment, the Court has not discussed the decision of G.D. Naidu, though it has referred to it in paragraph 5 of the judgment. This is pointed out because, the Court has discussed the decision in Blaze & Central (P.) Ltd. (supra), which was distinguished in G.D. Naidu. We find that in paragraph 9 of the judgment, the Court after referring to Empire Jute Co. Ltd. (supra) and Alembic Chemical Works Co. Ltd. (supra), has pointed out that the single test, that is, whether the payment results in an enduring benefit cannot be conclusive in a decision as to whether an expenditure qualifies as one falling or in the capital field and that the decisions have emphasized the need to shift from a narrower field to a broader one, to ascertain the real nature of the advantage, which the taxpayer would derive.

Thus, the test to be applied following Empire Jute Co. Ltd. (supra) is to see as to whether it added to the capital of the assessee, whether a new asset was created and whether there was an addition or expansion of the profit making apparatus of the assessee and whether the assessee acquired source of profit or income when such investment was made. However, the Court in our respectful view, applied the test, which does not flow from the test laid down in Empire Jute Co. Ltd. (supra) by observing that the test is one of ascertaining whether from commercial angle and the advantage results in a capital field or it is the expenditure falls legitimately within the revenue field. Ultimately, the Court held that the arrangement for a period of 7 years is an enduring benefit. This in our respectful view, does not fulfil the test laid down by Empire Jute Co. Ltd. (supra) and in fact, the Court itself had pointed out that is not the conclusive test to determine whether expenditure is in capital field or revenue. Thus, for the above reasons, we are not in respectful agreement with the reasoning given by the Hon'ble Division Bench in Sharp Business System (supra).

It would be relevant to note that, in the case of Sharp Business System (supra), the Joint-venture company was incorporated in the assessment year 2001-02 and in the first year of business, with a view to warding off competition, it entered into agreement by paying a non-compete fee of Rs. 73 Crores to L & T Ltd., of setting-up or undertaking or assisting in the setting-up or undertaking any business in India, of selling, marketing and trade of electronic office products for seven years and this amount was treated as deferred revenue expenditure in the assessees books of accounts and written-off over corresponding period of seven years.

There is a marked difference in the factual position in Sharp Business System (supra) and the factual position in the case on hand where the assessee's business continues to remain the same, and this is also one more reason to hold that the decision in Sharp Business System (supra) is not applicable to the facts of the case apart from the reservation expressed by us above."

In the decision of this Court in the case of Asianet Communications Ltd., the Court distinguished the decision of the Delhi High Court in the case of Sharp Business System. We would hasten to add that the facts in the case of Sharp Business System were couched differently in the sense that a sum of Rs. 73 Crores was paid to M/s. L & T Ltd., as consideration for the latter in setting-up or undertaking or assisting in the setting-up or undertaking any business in India, of selling, marketing and trade of electronic office products for seven years. The facts of the case of the assessee before us are entirely different. This aspect had been noted by the Tribunal in paragraph 11 of the impugned order. The Tribunal also took note of the fact that in the assessee's own case, the High Court of Delhi decided the issue in favour of the assessee.

Before us, a chart has been filed showing the issue relating to depreciation on non compete fee. From the chart, we find that for the assessment year 2001-02, the Assessing Officer himself allowed it, which was confirmed by the CIT(A) and the decision of the CIT(A) was accepted by the Department. For the assessment year 2002-03, no scrutiny assessment had been carried out. For the assessment year 2003-04, the CIT(A) allowed it and the Assessing Officer gave effect to the order passed by the CIT(A). For the assessment year 2004-05, no scrutiny assessment was carried out and for the assessment year 2005-06, the claim was allowed by the CIT(A) and it was given effect to by the Assessing Officer. Thus, the Assessing Officer was bound to be consistent with the earlier decisions.

Therefore, we find that the Tribunal rightly granted relief to the assessee. Accordingly, substantial question of law No. 2 is answered against the Revenue.