2012 (6) TMI 549 - AT - Income Tax

Validity of Revisionary order u/s 263 - dispute regarding valuation of goodwill - Held that - AO has taken only the average of the five years profit as the value of the goodwill. The regular method accepted is to multiply the average profit with a suitable factor of three years or so, depending upon the nature and circumstances of the business transferred. If no multiplier is adopted, it was necessary on the part of the AO to explain the grounds of not applying the same. Further, assessing authority has not examined important aspects such as justification for the sister concern for paying any non compete fee to the assessee company - consideration paid for the transfer of intellectual property rights - deduction claimed by the assessee in respect of ESOP scheme. Therefore, CIT is justified in holding that the order of the AO is erroneous and prejudicial to the interests of the Revenue - Decided against the assessee. Validity of Revisionary order u/s 263 - transfer of software technology division to sister concern - No amount attributed towards goodwill, however was attributed towards non compete fee, sale of brand name, sale of IPR - AY 2000-01 - Held that - CIT has rightly pointed that assessee has made an attempt to suppress the true colour of the payment towards the goodwill by stating that payments were made towards non compete fee, IPR on brand/brand value, etc. Hence, factum and valuation of goodwill is confirmed. However the same cannot be treated as short-term capital gains, since assessee was in the business for more than five years. The goodwill is a self generated asset and generates along-with the commencement of the business, especially in the field of software technology. The capital gains must be treated as long-term capital gains and taxed accordingly - Decided partly in favor of assessee. Interest income earned on fixed deposit made for margin money - business income or income from other sources - deduction u/s 10B - Held that - The interest received by the assessee on margin money deposits were not generated out of export activity. Therefore, the assessee is not entitled to treat the interest income as business income eligible for deduction u/s 10B. However, if the assessee proves that some expenditure is incurred for earning that bank interest, that expenditure may be deducted while computing the income from other sources - Decided partly in favor of assessee Amount received on renting out of computers, insurance claims on damage to computers, sale of scrap and reimbursement of expenses incurred for agents abroad - business income or income from other sources - Held that - Incidental income arising from use of computers, insurance claims on damage to computers, etc. needs to be treated as operational income in the nature of business income since the same are installed for the purpose of carrying on business. This is the case with the sale of scrap as well. Also, reimbursement of expenses reduces the cost and results in overall increase in business income. Hence, aforesaid to be treated as business income - Decided in favor of assessee Rent received from employees occupying quarters of the assessee - recovery is reduced from staff welfare expenses - Held that - Since it reduces the business expenditure, hence rent recoveries are to be treated as business income - Decided in favor of assessee Exemption u/s 10B - denial in respect of trade advances written off - Held that - AO may verify the nature of advances made by the assessee and if they were trade advances, the same shall form part of the business income on writing back. If so, the assessee is entitled for deduction u/s 10B. Exemption u/s 10B - denial in respect of gain arising out of transfer of division to sister concern - assessee contended that upto the AY 2000-01, entire income earned by the STP undertaking is exempt u/s 10B as a tax holiday - Held that - The tax holiday benefit applies only to the income earned out of export of articles or things or computer software. Income arising out of sale of a business division and other items, etc. does not qualify for deduction u/s 10B - Decided in favor of Revenue On contention of Revenue of application of section 50 and capital gains to be treated as short-term capital gains it is held that Section 50 does not automatically apply to an asset only because of the reason that the asset is a depreciable asset. In the present case, there was no occasion to give any allowance of depreciation on the goodwill computed in the hands of the assessee. The assessee has been in business for a period of more than three years - Decided against Revenue

Summary

Issues Involved:
1. Revision order under Section 263 of the Income-tax Act.
2. Valuation and taxation of goodwill.
3. Treatment of non-compete fee, intellectual property rights (IPR), and brand value.
4. Expenditure claimed for Employee Stock Option Plans (ESOPs).
5. Classification of various incomes (e.g., interest income, rent from employees, etc.) under business income or income from other sources.
6. Applicability of Section 10B exemption.
7. Nature of capital gains (short-term vs. long-term).

Issue-wise Detailed Analysis:

1. Revision Order under Section 263:
The Commissioner of Income-tax (CIT) revised the assessment order under Section 263, identifying errors and prejudices to the interests of the Revenue. The CIT found that the Assessing Officer (AO) had not properly examined the valuation of goodwill, the justification for non-compete fees, and the treatment of ESOP expenditures. The Tribunal upheld the CIT's revision order, stating that the AO's failure to adopt a multiplier for goodwill valuation and to analyze the non-compete fee and ESOP expenditures rendered the order erroneous and prejudicial to Revenue interests.

2. Valuation and Taxation of Goodwill:
The AO initially valued goodwill at Rs. 31.74 crores based on the average profit of five years without applying a multiplier. The CIT revised this, directing the AO to revalue the goodwill using a multiplier. The AO then valued the goodwill at Rs. 126.67 crores, applying a three-year multiplier to the average profit of the last three years. The Tribunal upheld this revised valuation but clarified that the capital gains from goodwill should be treated as long-term, not short-term, given the business's duration and the nature of goodwill as a self-generated asset.

3. Treatment of Non-Compete Fee, IPR, and Brand Value:
The CIT found that the AO had not properly examined the justification for the non-compete fee, considering the common management of the assessee and its sister concern. The Tribunal agreed that the non-compete fee and other components like IPR and brand value were creatively accounted to avoid capital gains tax on goodwill. The AO was directed to re-examine these aspects.

4. Expenditure Claimed for ESOPs:
The CIT noted that the AO had not considered the expenditure claimed for ESOPs. The Tribunal upheld the CIT's direction to re-examine this issue, emphasizing the importance of addressing all significant aspects of the assessment.

5. Classification of Various Incomes:
- Interest Income: The Tribunal held that interest income from margin money deposits should be treated as income from other sources, not business income, as it was not derived from export activities.
- Rent from Employees: The Tribunal ruled that rent received from employees should be treated as business income, as it reduces staff welfare expenses and is not an independent income source.
- Other Incomes: Incidental incomes like renting out computers, insurance claims, sale of scrap, and reimbursement of expenses were directed to be treated as business income due to their clear nexus with the business.

6. Applicability of Section 10B Exemption:
The Tribunal directed the AO to verify if the amounts written back were trade advances. If so, they should be treated as business income eligible for Section 10B exemption. However, income from the sale of a business division does not qualify for this exemption.

7. Nature of Capital Gains:
The Tribunal concluded that the capital gains from the sale of goodwill should be treated as long-term, not short-term, as the business had been operational for more than three years and goodwill is a self-generated asset. Section 50, which applies to depreciable assets, was deemed inapplicable in this context.

Conclusion:
- The revision appeal by the assessee was dismissed.
- The appeals related to regular and revision assessments were partly allowed.
- The regular assessment appeal by the Revenue was dismissed.