2015 (8) TMI 426 - HC - Income Tax

Royalty payment to a related person - whether would be allowable for business expenditure u/s 37(1) whereas the same has not been exclusively and wholly incurred for business purposes? - whether ITAT erred holding that royalty payment would be allowable business expenditure u/s 37(1) when the same has not been paid to the owner/holder of the patent, design, copyright and technical know how or to an inventor and where there is no transfer/acquisition of any assets? - Held that - Tarun Mohan retained the brand name phoneytunes.com. He merely permitted the assessee to use the intellectual property right acquired by him, namely, the brand name/trade-mark phoneytunes.com. He had not assigned the same to the assessee, but only licensed the same to the assessee. Assessing Officer and the CIT (Appeals) wrongly came to the conclusion that Tarun Mohan being a Director of the respondent was not entitled to enter into an agreement for the transfer of his assets to the company. They held that the same person cannot enter into an agreement with himself. This ignores the fundamental concept that the assessee being a company incorporated under the Companies Act, 1956 is a separate legal juristic entity. The Tribunal, therefore, rightly disagreed with this finding. The Tribunal also rightly observed that Tarun Mohan had in any event paid the entire taxes in respect of the royalty received by him. That, however, would not make a difference for if the deduction sought by the assessee is wrongful, the Assessing Officer is bound to disallow the same. The CIT (Appeals) observed that there was no evidence to prove that Tarun Mohan had developed any product for which he had any copyright or trade mark. Firstly, as we noted earlier, he had obtained the copyright in respect of the artistic work comprised in the name phoneytunes.com. Registration of the copyright is, however, not compulsory. In any event, phoneytunes.com was a part of his trading style and constitutes a trade mark. This is not a ground for challenging his entitlement to the trade mark. The assesee was entitled, therefore, to use the trade mark as a licensee thereof. The payment of royalty for the same is nothing unusual or out of place. In these circumstances, the deletion by the Tribunal of the addition of royalty by the Assessing Officer and confirmed by the CIT (Appeals) was rightly set aside by the Tribunal. - Decided against revenue.

Summary

Issues:
- Dispute over the allowability of royalty payment as business expenditure under section 37(1) of the Income Tax Act.
- Whether the royalty payment was exclusively and wholly incurred for business purposes.
- Whether the payment was made to the owner/holder of the patent, design, copyright, or technical know-how.
- Determining if the royalty payment was capital in nature.
- Whether the transaction was a colorable device to reduce tax liability.
- Validity of the agreement between the parties for the transfer of assets and payment of royalty.

Analysis:
1. The case involved a dispute regarding the allowability of royalty payment as business expenditure under section 37(1) of the Income Tax Act for the assessment years 2006-2007, 2007-2008, and 2008-2009. The CIT (Appeals) had dismissed the appeal against the Assessing Officer's decision to add back the amounts paid as royalty for the use of the brand name "phoneytunes.com."

2. The appellant raised substantial questions of law challenging the justification of the ITAT's decision regarding the allowability of royalty payment. The Tribunal found that the individual receiving the royalty had invented technology for creating ring tones, even though the invention itself was not the focus. The individual had also registered copyright for the brand name "phoneytunes.com."

3. The agreement between the parties outlined the transfer of assets and the payment of royalty for the use of the brand name. It was clarified that the individual retained ownership of the brand name and only licensed it to the company, making the payment of royalty a legitimate business expense.

4. The Assessing Officer and the CIT (Appeals) incorrectly concluded that the individual, being a Director of the company, could not enter into an agreement for the transfer of assets. The Tribunal rightly disagreed with this finding, emphasizing the separate legal entity status of the company.

5. The Tribunal also noted that the individual had paid taxes on the royalty received, but this did not impact the allowability of the deduction sought by the company. The absence of evidence regarding product development by the individual did not invalidate the royalty payment, as the brand name constituted a trademark that the company was entitled to use.

6. Ultimately, the Tribunal set aside the addition of royalty payment by the Assessing Officer and confirmed by the CIT (Appeals), as the payment was legitimate and not a colorable device to reduce tax liability. The appeals were dismissed, and no question of law was found to arise from the Tribunal's decision.