2014 (8) TMI 353 - HC - Income Tax

Nature of franchise expenses 25% expenses treated as capital expenses Held that - The rights under the agreement acquired by the assessee could be lost during the tenure of the agreement itself and the assessee was utilising the goodwill and the trademark, which was owned by a third party CIT(A) has rightly relied upon CIT versus J.K. Synthetics 2008 (12) TMI 21 - DELHI HIGH COURT Tribunal was rightly of the view that no new asset came into existence on account of payment of franchise fee and the rights under the agreement were only for the tenure of the agreement and no enduring benefit was derived by the assessee - it was not an expenditure incurred for acquisition of source of profit, but enabled the assessee to run the business profitably - The fixed assets of the assessee remained untouched and no enduring asset came into existence - the brand or the trademark in question was not owned by the assessee - No facts were highlighted and stated to justify the conclusion Decided against Revenue. Advertisement expenses u/s 37 Whether 25% of the advertisement expenditure should be capitalized or not Held that - Following the decision in Commissioner of Income Tax versus Salora International Limited, 2008 (8) TMI 138 - DELHI HIGH COURT - the expenditure on advertising was of revenue nature - Advertisement expenses when incurred to increase sales of products are usually treated as a revenue expenditure, since the memory of purchasers or customers - Advertisement are issued from time to time and the expenditure is incurred periodically, so that the customers remain attracted and do not forget the product and its qualities - Advertisements and sales promotion are conducted to increase sale and their impact is limited and felt for a short duration - Expenses for advertising consumer products generally are a part of the process of profit earning and not in the nature of capital outlay - expenses were not incurred once and for all, but were a periodical expenses which had to be incurred continuously in view of the nature of the business - It was an on-going expense Decided against Revenue.

Summary

Issues:
1. Whether entire franchise fee was revenue expenditure or capital expenditure?
2. Whether entire expenditure on advertisement was revenue expenditure or capital expenditure?

Analysis:
1. The first issue revolves around the classification of the franchise fee as either revenue or capital expenditure. The court differentiated the present case from the Madras High Court decision cited by the Assessing Officer. The respondent-assessee paid a franchise fee based on turnover, not a lump sum, for using the trademark "Dominos." The court emphasized that the respondent did not acquire ownership of the trademark, and the agreement could be terminated, indicating no enduring benefit. Referring to the J.K. Synthetics case, the court highlighted tests to determine capital vs. revenue expenditure, focusing on asset acquisition, business advantage, and enduring benefit. The court concluded that no new asset emerged, and the expenditure enabled profitable business operation without creating an enduring asset.

2. The second issue concerns the treatment of advertisement expenses as revenue or capital expenditure. The court cited the Salora International case, where it was held that advertising expenses are typically revenue in nature, especially in competitive markets with short customer memory. The court emphasized that such expenses are periodic, aimed at maintaining customer attraction, and not a one-time capital outlay. The court rejected the idea that the expenses were for setting up a profit-earning mechanism, as they were part of the ongoing business process. The decision in the Monto Motors case further supported the view that advertisement expenses are generally revenue in nature, aimed at increasing sales without creating a lasting advantage.

In conclusion, the court dismissed the appeal, upholding the lower authorities' decisions on both issues, emphasizing the nature of the expenses, lack of enduring benefits, and the ongoing business nature of the expenditures.