2019 (4) TMI 2072 - AT - Income Tax

Depreciation on the goodwill and knowhow - determination is what is the actual cost in the hands of the respondent-assessee company - HELD THAT - The provisions of s. 32 of the Act lays down that the depreciation shall be allowed to the assessee on the actual cost of the asset. The term actual cost is defined under the provisions of s. 43(1) of the Act. The expression actual cost had come-up for interpretation before Hon ble High Court of Delhi in the case of CIT V. Dalmia Dadri Cement Ltd. 1980 (2) TMI 51 - DELHI HIGH COURT In the present case, admittedly there was no cost involved on the acquisition of goodwill, know-how in the hands of the firm. The goodwill, know-how was merely created by book entry by debiting the goodwill, know-how and crediting partners accounts. This partners account was not treated as a part of capital accounts of the partners of the firm. Therefore, the question that arises is whether or not the act of creating goodwill, know-how is a colourable device adopted with the intention of inflating the cost in order to claim higher depreciation. It is important to note here that the seller firm as well as the successor company is owned and controlled by very same persons. No doubt, the respondent-assessee filed a report of valuation on goodwill, knowhow done by M/s. G.Sekar Associates, Charted Accountant Chennai, the said report does not contain report of valuation on goodwill, know-how of M/s. RMKV Silks. In respect of other concerns, it is not clear on what basis he assumed normal profits and super profits and the multiplying factors applied to value the goodwill, know-how he merely discussed the theory and principles governing the valuation of goodwill, know-how. Thus, the valuation report is bald cannot be accepted as the basis of valuation of goodwill, know-how. No credence can be given to the valuer s report. Whether or not the act of creation of goodwill, know-how by debiting to goodwill and knowhow and crediting to the partners account is valid under law? - It is a fundamental principle under the Partnership Act that during the subsistence of the partnership the value of interest of each partner qua the assets of the firm cannot be isolated or carved out from the value of the partners interest in the totality of the partnership asset. It is only when a partner retires or the partnership is dissolved what partner receives is his share in the partnership firm. The action of the Assessing Officer in determining the actual cost at Nil in the hands of the successor company i.e., respondent-assessee cannot be found fault with. Merely because, the firm had recorded the value of goodwill, knowhow at certain price the same would not conclusively establish the correctness of the claim, if the Assessing Officer is of the opinion that the transaction is by way of subterfuge or device in order to avoid tax which the assessee is otherwise liable to pay or that the transaction is illusory or colourable or that the assessee has acted fraudulently. The material pointed to be noted is that the partners of the erstwhile firm and the Members and Directors of the assessee-company are the same. They adopted the character of the corporate entity for the purpose of availing inflated depreciation and expenditure and benefiting the Directors in the form of interest income. Therefore, it is a fit case to disregard the corporate entity and treat as one entity by lifting the corporate veil. In the light of above, the Assessing Officer had rightly exercised his duty by determining the actual cost of the goodwill, know-how at nil. CIT(A) had not examined the issue in proper perspective, failed to examine the relevant provisions of the Act finally passed superficial order allowing claim of the respondent-assessee. Therefore, we reverse the order of ld. CIT(A) and restore the order of assessment on this issue. Appeal of revenue allowed. Interest expenditure claimed on the partner s credit balances standing in the books of accounts of the company as liabilities - liabilities in the form of credit balance of partners of the firm were taken over by the respondent-assessee company in terms of the business takeover agreement, respondent-assessee is liable to pay interest on such credit balances and such interest was claimed as deduction in the hands of the respondent-assessee - HELD THAT - The allowance of interest as a deduction is governed by provisions of s. 36(1)(iii) of the Act, an assessee is entitled to deduction only that part of the amount paid by him for the money borrowed which can be genuinely regarded as interest. The interest payable on a loan of money not any other asset acquired under a contract. The another important point to be noted is that the assessee firm had not credited the goodwill, know-how to the capital accounts of the partner - it is a device adopted by the assessee and as well as respondent-assessee to claim deduction in the hands of the company and benefit the partners of the erstwhile firm and who are also the Directors of the assessee firm. It is again another dubious device adopted with an intention of avoiding the payment of taxes. In fact, the segregation of the partners accounts into capital and current account is only for operation convenience and it constitutes one account only namely capital accounts of the partners. By segregating the capital account, into capital and current account, the seller firm conveniently avoided payment of capital gains on slump sale transaction by availing the exemption conferred under the provisions of s. 47(xiii) of the Act. Thus, viewed from any angle the interest paid on the credit balance of the partners of the seller firm is not allowable as a business deduction. The ld. CIT(A) had not examined the issue in proper perspective. Hence, we reverse the findings of ld. CIT(A) and restore the order of assessment. Addition on account of under valuation of closing stock - HELD THAT - The principle is well settled to the extent that an assessee may value the stock at the cost or market rate but is not entitled to value below both. The fact that the wrong valuation of stock was accepted by the Department in the earlier years and Assessing Officer had failed to notice the defect in the valuation cannot be a bar to adopt the correct method of valuation in the current year. As regards to the issue of following the decision of Co-ordinate Benches on the similar issue, we feel that it has no relevance since, our decision is premised on the well accepted principles of law and facts peculiar to the case followed the ration on decision of Hon ble High Court of Madras and Allahabad High Court. Thus, we do not find any merit in the ground of appeal filed by the assessee. Accordingly, we dismiss the ground of appeal No.2 filed by the assessee. Allowability of provision made for liability towards unredeemed bonus points - HELD THAT - It is only on the subsequent purchases, there is an obligation on the part of the assessee-company to redeem the points which results in outflow of resources, it is only at this point of time the liability can be recognized. Indisputedly, in the present case, the liability is recognized at the time of earning the bonus points. The number of points earned would only enable the assessee to estimate the liability of the obligation. Further, the Assessing Officer had made a note of material fact that the assessee-company has an absolute discretion to withdraw the scheme without assigning any reasons. This goes to show that there is no absolute obligation on the part of the assessee-company to redeem the bonus points earned. These facts would go to show that the conditions required for recognizing the liability for the purpose of provision does not stand satisfied. The principles governing the allowability of provision of warranty cannot be applied to the provision of the kind on hand for the reason that the provisions for warranty is based on the principle of matching, which has no application to the provision on hand. CIT(A) without properly appreciating the scheme of the bonus points had wrongly applied the ratio of the decision of the Hon ble Supreme Court in the case of Rotorck Controls India P. Ltd. 2009 (5) TMI 16 - SUPREME COURT . Therefore, we reverse the findings of the ld. CIT(A) and confirm the action of the Assessing Officer in making the addition of provision for liability for bonus card points. Hence, this ground of appeal filed by the Revenue is allowed. Nature of expenditure - whether the expenditure incurred by the respondent-assessee on interior decoration, false ceiling and wooden structures carried out on the leased premises constitutes whether revenue or capital expenditure? - HELD THAT - On bare reading of the above Explanation, it is clear and categoric that the expenditure contemplated in the said Explanation is capital in nature as the assessee enjoying the lease hold rights on the building is deemed to be the owner of the building. Once the assessee is deemed to be the owner of the building, any improvements or decoration carried out on the building partakes the character of the building, and by refurbishing, decorating or by doing interior work in the building an enduring benefit was derived by the assessee for the period of occupation and therefore, the expenditure incurred cannot be treated as revenue expenditure. The language of the Explanation 1 is very plain and clear and there was no scope to give a different meaning. It is the bounden duty of the Courts to give literal meaning to the expressions and phraseology used by the legislature in the absence of any ambiguity in the provisions. The decision relied upon by the ld. Counsel for the assessee i.e., CIT v. Madras Auto Service (P.) Ltd. 1998 (8) TMI 1 - SUPREME COURT etc. are rendered prior to introduction of Explanation 1 to s. 32(1) of the Act and therefore, the principles laid down in the said decisions have no application after insertion of the Explanation 1 to s. 32(1) of the Act. The ld. CIT(A) without properly appreciating the legal provisions governing the issues had granted relief. Therefore, we reverse the findings of ld. CIT(A) and restore the assessment order on this issue. Hence, this ground of appeal filed by the Revenue is allowed.

Summary

Issues Involved:
1. Depreciation on Goodwill.
2. Disallowance of Interest on Credit Balances.
3. Under Valuation of Closing Stock.
4. Provision for Unredeemed Bonus Points.
5. Capital vs. Revenue Expenditure on Renovation of Leased Premises.

Issue-wise Detailed Analysis:

1. Depreciation on Goodwill:
The Revenue challenged the allowance of depreciation on goodwill, arguing that the goodwill was created through book entries without actual cost. The Assessing Officer (AO) disallowed the depreciation, referencing the ITAT Mumbai decision in DCIT vs. Toyo Engineering India Ltd. The CIT(A) allowed the depreciation, but the Tribunal reversed this decision, holding that the goodwill was created by book entries and not an actual transaction involving cost. The Tribunal cited the principle that depreciation is allowed on the actual cost incurred, and since no real cost was incurred, depreciation on goodwill was not permissible.

2. Disallowance of Interest on Credit Balances:
The AO disallowed the interest claimed on credit balances of directors, arguing that these balances were created by book entries without actual cash flow. The CIT(A) allowed the interest, but the Tribunal reversed this decision. The Tribunal held that the book entries did not create enforceable liability and were a device to avoid taxes. The Tribunal emphasized that interest is deductible only when it pertains to actual borrowed funds, which was not the case here.

3. Under Valuation of Closing Stock:
The AO added amounts to the closing stock value, arguing that the assessee's method of valuation (reducing value based on the age of stock) was arbitrary and not justified. The CIT(A) confirmed this addition. The Tribunal upheld the AO's decision, stating that the valuation must be based on cost or market price, whichever is lower, and arbitrary reductions without evidence of obsolescence or lack of demand were not acceptable.

4. Provision for Unredeemed Bonus Points:
The AO disallowed the provision for unredeemed bonus points, considering it a contingent liability. The CIT(A) allowed the provision, but the Tribunal reversed this decision. The Tribunal held that the liability for bonus points was not a present obligation but contingent on future events, such as customers redeeming the points. The Tribunal emphasized that provisions must be based on present obligations arising from past events, which was not the case here.

5. Capital vs. Revenue Expenditure on Renovation of Leased Premises:
The AO treated the expenditure on renovation of leased premises as capital expenditure, allowing depreciation instead of full deduction. The CIT(A) treated it as revenue expenditure, allowing full deduction. The Tribunal reversed the CIT(A)'s decision, holding that the expenditure resulted in an enduring benefit and was therefore capital in nature. The Tribunal cited Explanation 1 to Section 32, which treats such expenditure as capital.

Judgment Summary:
The Tribunal allowed the Revenue's appeals and disallowed the claims for depreciation on goodwill, interest on credit balances, provision for unredeemed bonus points, and treated the renovation expenditure as capital. The Tribunal upheld the AO's additions for under valuation of closing stock. The decisions were based on principles of actual cost for depreciation, enforceable liability for interest, present obligation for provisions, and enduring benefit for capital expenditure.