KPMG FLASH NEWS KPMG IN INDIA Non-compete fees are capital in nature and therefore not allowed as a deductible expenditure, however, depreciation is allowed on the same. Payments for transfer of business along with contracts, etc are not for acquisition of know-how hence depreciation is not allowed 12 September 2012 Background Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Ind Global Corporate Finance Private Limited1 (the taxpayer) held that the non-compete fee is not a deductible expenditure since it is capital in nature. However, the non-compete right is an ‘intangible asset’ eligible for depreciation under the Income-tax Act, 1961 (the Act). During the year under consideration the taxpayer entered into a transfer of business agreement with Ind Global Financial Trust Ltd. for transfer of their merchant banking business to the taxpayer. • In terms of transfer of business agreement, the taxpayer paid an amount of INR 7 million to a shareholder cum Managing Director of Ind Global Financial Trust Ltd and also paid INR 10 million to Ind Global Financial Trust Ltd. as non-compete fee. Further, the Tribunal also held that payments for transfer of business along with contracts, clients and client relationship, etc. did not result in acquiring any know-how which can be considered as an ‘intangible asset’ hence depreciation is not allowed on such payments. • The non-compete fee had been paid for restricting Non-compete fees whether capital or revenue in nature and if it is capital in nature, whether depreciation is allowable on the same • The Facts of the case • The taxpayer is engaged in providing corporate these parties for a period of 36 months from carrying out similar business, soliciting present and past clients, etc. taxpayer had shown the non-compete expenditure at INR 17 million as deferred revenue expenditure in the books of account. However, in the return of income the taxpayer had claimed the same as revenue expenditure. advisory services and merchant banking services. _____________ 1 Ind Global Corporate Finance Private Limited v. ITO (ITA No.1258/Mum/08) – Taxsutra.com © 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. • The Assessing Officer (AO) held that the taxpayer • In case the payment was treated as capital in had acquired benefit of enduring nature for a fixed period and therefore, such expenditure was capital in nature. Accordingly, the AO disallowed the claim of the taxpayer. nature, depreciation should be allowed to the taxpayer. In order to support its contentions the taxpayer relied on the decision of Chennai Tribunal in the case of Real Image Tech (P) Ltd.4 and the decision of Mumbai Tribunal in the case of Schott Glass India Pvt. Ltd.5 where it was held that the depreciation was allowable on noncompete fee which is treated as capital expenditure. • The Commissioner of Income-tax Appeals [CIT(A)] held that the expenditure was revenue in nature. • The taxpayer had also raised an additional ground that in case the expenditure was considered by the Tribunal as capital in nature, depreciation should be allowed on the same. Issue before the Tribunal Tribunal’s ruling Non-compete fees is capital expenditure • The issue in the present case has been considered by the Delhi Special Bench Tribunal in case of Tecumseh India Private Ltd wherein it was held that the expenditure on account of noncompete fee has to be treated as capital expenditure. The case of the taxpayer in the present case is identical. • Whether payment for non-compete fees is capital or revenue in nature? If it is capital in nature, whether depreciation is allowable on the same? Tax department’s contentions • The taxpayer itself had treated the expenditure as deferred revenue expenditure and not claimed it in P&L Account, showing that the taxpayer was of the view that the expenditure was capital in nature. • The non-compete expenditure had been incurred in connection with setting up of the new business and the provisions for payment of non-compete fees were contained in the agreement for transfer of business. Therefore, following the above decision the expenditure has to be considered as capital in nature. • It was one-time payment which had given enduring benefit to the taxpayer and therefore, the expenditure had to be considered as capital in nature. In order to support its contentions the tax department relied on 2 the decision of Tecumseh India Private Ltd . • Non-compete agreement was valid for a period of three years which has to be considered as sufficient length of time to treat the expenditure as capital in nature. The protection acquired by the taxpayer from competition was not part of the working of the business, as held by the Hon'ble Supreme Court in the case of Assam Bengal Cement Co. Ltd. (supra). Therefore, the expenditure has to be disallowed since it a capital expenditure. Taxpayer’s contentions • The taxpayer contended that the decision of the Delhi Special Bench Tribunal in case of Tecumseh India Private Ltd. was not applicable to the facts of the present case. The said decision had been distinguished by the Delhi High Court in the case of 3 Eicher Ltd whose facts were similar to the present case. • Onetime payment for enduring benefit was not conclusive test to decide the true nature of expenditure as held by the Supreme Court in the case of Empire Jute Co. Ltd and it is required to be seen whether the advantage to the taxpayer was in revenue or capital field. In the present case, there was no advantage to the taxpayer in the capital field and, therefore, the expenditure has to be considered as revenue in nature. ____________ 2 Tecumseh India Private Ltd. v. ACIT [2010] 127 ITD 1 (Del) (SB) 3 CIT v. Eicher Ltd. [2008] 302 ITR 249 (Del) Depreciation is allowed on non-compete fee • As regards entitlement of depreciation, the issue has already been considered by the Chennai Tribunal in case of Real Image Tech (P) Ltd. where the Tribunal held that by obtaining noncompete right on payment of non-compete fee, the taxpayer can run its business without bothering about competition and, therefore, non- ___________ 4 5 ACIT v. Real Image Tech (P) Ltd. [2009] 120 TTJ 983 (Chen) Schott Glass India Pvt. Ltd (ITA No.1698/M/2003, dated 7 September 2011) © 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. compete right was an ‘intangible asset’ falling in the category of ‘any other business or commercial right’ under Section 32(1)(ii) of the Act. which had to be considered as know-how and depreciation had to be allowed. The taxpayer relied on various decisions6 in support of the case. • Further the decision of Real Image Tech (P) Ltd. has • The taxpayer also referred various decisions7 in support of the plea that in case the know-how is not held as intangible expenditure, the same should be allowed as revenue expenditure. been followed by the Mumbai Tribunal in the case of Schott Glass India Pvt. Ltd. and therefore, the depreciation claim is allowed on non-compete fees. Payments for transfer of business along with contracts, clients and client relationship are not eligible for depreciation Facts of the case • The taxpayer paid INR 2.5 million to Ind Global Financial Trust Ltd. for sale and transfer of business and contracts. The taxpayer had treated the said expenditure for acquisition of know-how and accordingly depreciation was claimed under Section 32 of the Act. • Even if the payment was considered as made for acquisition of goodwill, the depreciation was allowable on goodwill in view of the decision of the Tribunal in the case of Kotak Forex Brokerage Ltd. Tribunal’s ruling • According to the agreement, the word ‘business’ acquisition of goodwill and not for know-how and therefore such depreciation was disallowed. has been defined to mean the employees, customer and client relationship, customer and client list, certain know-how related to merchant banking business of the transferor but did not include the excluded assets, the creditors and liabilities. Thus, the payment had been made for the transfer of business and contracts which included customer and client relationship. • Before the CIT(A), the taxpayer filed business know- • Though the definition of ‘business’ in the • The AO held that the payment had been made for how manual relating to merchant banking acquired from Ind Global Financial Trust Ltd and claimed it as know-how. However, the CIT(A) observed that the manual did not contain any technique or skill but was only compilation of rules, regulations, etc which is otherwise available in the market in the form of books. Hence, the said payment could not be treated as expenditure on acquiring know-how. Accordingly, the CIT(A) upheld the disallowance made by the AO. agreement referred to know-how but there is no material produced by the taxpayer to show that any part of the payment was related to any knowhow which can be considered as an ‘intangible asset’ for the purpose of Section 32(1)(ii) of the Act. • There is no material produced by the taxpayer to show that the transferor had transferred any industrial information or technique developed by it which could assist in the manufacture or processing of goods. Moreover, the transferor was in the business of merchant banking which does not require any industrial information or technique useful in manufacture or processing of goods. Issue before the Tribunal • Whether payment for transfer of business along with contracts, clients and client relationship made by the taxpayer is for acquisition of know-how? Whether taxpayer is eligible for depreciation on such payments? Taxpayer’s contentions ___________ 6 Areva T&D India Ltd v. DCIT [2012] 345 ITR 421 (Del) ACIT v. American Express Services India Ltd. (ITA No.4106 M/2007, dated 3 February 2012) B. Raveendran Pillai [2011] 331 ITR 531 (Ker) Kotak Forex Brokerage Ltd. v. ACIT [2009] 33 SOT 237 (Mum) KEC International Ltd. v. ACIT [2010] 41 SOT 43 (Mum) Hindustan Coca Cola Beverages Pvt. Ltd. v. DCIT [2009] 34 SOT 171 (Del) 7 Denso India Pvt. Ltd. (ITA No.16 of 2008, dated 8 October 2010) Gannon Norton Metal Diamonds Dies Ltd. [1987] 163 ITR 606 (Bom) • The payment of INR 2.5 million had been made in terms of the transfer of business agreement for acquiring business methodology, business procedures and processes, technical skill etc. © 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. • It has not been explained as to why the taxpayer would pay for rules, regulations, etc which are available in the market and, therefore, the payment had been made for the transfer of business and contracts including clients and client relationship and cannot be considered as know-how. • No material has been produced to show that any part of the payment related to acquisition of goodwill. • Based on the above, the payment was neither for know-how nor for goodwill hence the various decisions relied upon by the taxpayer are not applicable to the facts of the present case. Accordingly, the depreciation claimed on such payments is disallowed. Our comments In past, there have been conflicting decisions8 on availability of depreciation on non-compete fees. The Mumbai Tribunal in this decision has held that the expenditure on account of non-compete fees are capital in nature and depreciation is allowable on the same. In the present case the Tribunal has relied on the judgment of the Chennai Tribunal in the case of Real Image Tech. (P) Ltd. where it was held that the commercial right acquired on payment for non-compete fees would be covered by the term “or any other business or commercial rights of similar nature” because taxpayer can develop and run his business without bothering about the competition. Hence, the right is an ‘intangible asset’ under Section 32(1) of the Act and eligible for depreciation. In case of GE Plastics Ind., the Ahmedabad Tribunal had considered the above mentioned conflicting decisions in relation to allowance of depreciation on non-compete fees and held that when there are two views possible, the view favourable to the taxpayer should be followed as was held by the Supreme Court 9 in the case of Vegetable Products Ltd. Accordingly, depreciation was allowed on the non-compete fees. _____________ 8 Allowing depreciation - ITO v. Medicorp Technologies India Ltd. [2009] 30 SOT 506 (Chen), CIT v. GE Plastics India Ltd. (ITA no.483/Ahd/2007); ACIT v. Real Image Tech (P) Ltd. [2009] 120 TTJ 983 (Chen); Not allowing depreciation Srivatsan Surveyors (P.) Ltd. v. ITO [2009] 32 SOT 268 (Chen) 9 CIT v. Vegetable Products Ltd. (1973) 88 ITR 192 (SC) © 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. www.kpmg.com/in Ahmedabad Safal Profitaire B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar Ahmedabad – 380 015 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Kochi 4/F, Palal Towers M. G. 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