2015 (9) TMI 663 - HC - Income Tax

Use of drawings, procedure and trademark of MPL - whether was going to bring an advantage of an enduring nature to the Assessee, therefore, capitalized as royalty paid by the Assessee to MPL also confirmed by CIT(A)? - ITAT was of the view that the CIT(A) was not justified in enhancing the addition made by the AO by capitalising the royalty - Held that - There was sufficient opportunity for the AO, if he doubted the genuineness of the payment of royalty by the Assessee to MPL, to have conducted a detailed inquiry. The Assessee on its part furnished the agreement between itself and MPL under which it was inter alia permitted to use the trademark Macnaught on its products. The royalty was payable per unit of the product and, therefore, was clearly linked to sales. There was also no doubt that such payment was in fact made by the Assessee to MPL. It is also not in doubt that MPL was not related to the Assessee in any manner. In the circumstances, there should have been some reasonable basis for the CIT(A) to simply conclude that this was a sham transaction and proceed to enhance the disallowance. The interpretation of the agreement by the ITAT appears to be plausible. The Court is not persuaded to hold that the impugned order of the ITAT is perverse. - Decided in favour of assessee.

Summary

Issues:
1. Capitalization of royalty expenses claimed by the Assessee.
2. Validity and legal sanctity of the royalty agreements.
3. Disallowance of royalty payments by the Assessing Officer and Commissioner of Income Tax (Appeals).
4. Interpretation of the royalty agreement by the Income Tax Appellate Tribunal (ITAT).

Capitalization of Royalty Expenses:
The Assessee, an export-oriented unit engaged in manufacturing machine tools, claimed royalty expenses paid to a foreign company. The Assessing Officer (AO) capitalized the royalty, adding it to the Assessee's income for the year. The Commissioner of Income Tax (Appeals) enhanced the disallowance, questioning the justification for the royalty payments. However, the ITAT observed that the royalty was for using the trademark and other benefits, incurred for business purposes, and allowed the Assessee's appeals.

Validity of Royalty Agreements:
The CIT (A) raised doubts on the legal sanctity of the royalty agreements, considering them casual and lacking proper legal sanction. The Revenue argued that the agreements were vague and lacked clarity on the duration and terms of trademark use. However, the ITAT found the agreements genuine, emphasizing the business purpose and the clear linkage of royalty to sales. The Court upheld the ITAT's interpretation, rejecting claims of the agreements being sham.

Disallowance of Royalty Payments:
Both the AO and CIT (A) disallowed royalty payments, suspecting the genuineness of the transactions. The CIT (A) enhanced the disallowance amount based on doubts regarding the agreements. However, the ITAT considered the payments legitimate, as evidenced by tax deductions and business necessity. The Court found no basis for the CIT (A) to enhance the disallowance, supporting the ITAT's decision.

Interpretation by ITAT:
The ITAT's interpretation of the royalty agreement, focusing on the business purpose and genuineness of payments, was deemed reasonable by the Court. The Revenue's argument of the agreement being vague and lacking legal sanctity was dismissed, emphasizing the Assessee's compliance with tax deductions and absence of any relationship with the foreign company. The Court concluded that no substantial legal question arose, leading to the dismissal of the appeals.