2016 (3) TMI 237 - AT - Income Tax

Treatment to royalty payments - AO treating the royalty payments being 3% of the sales of the year, as capital expenditure and disallowing 75% of the same after allowing depreciation @ 25% - Held that - Judgment of the jurisdictional High Court in the case of CIT vs Hitech Arai Ltd, 2014 (8) TMI 459 - MADRAS HIGH COURT is applicable in his case wherein held that where the royalty payment made by the assessee under renewal agreements were for grant of license to an existing company for manufacture and sale of automobile parts and components for subsequent periods, after the expiry of original period of license and it was not technical know-how for setting up a new plant or for manufacturing a completely new product with aid and assistance of foreign company, payment made was purely revenue in nature, more so, when Department had for the nine earlier assessment years accepted the fact that the payment made towards royalty was revenue expenditure and had not raised dispute thereon.. Accordingly, in our opinion, the assessee s claim has to be allowed and it is to be treated as revenue expenditure only. - Decided in favour of assessee Disallowance u/s 14A - CIT(A) made disallowance of 2% of the exempt income earned - Held that - The assessment year under consideration is 2007- 08 and, therefore, the provisions of rule 8D cannot be applied. Rule 8D came into operation with effect from 24.3.2008 i.e from assessment year 2008-09. Disallowance 2% of the exempt income earned is reasonable. CIT(A) is justified in computing disallowance of 2% of the exempt income earned. We do not find any infirmity in the order of the CIT(A) and the same is confirmed.- Decided in favour of assessee in part

Summary

Issues Involved:
1. Treatment of royalty payments as capital or revenue expenditure.
2. Disallowance under section 14A of the Income Tax Act.

Analysis:

Issue 1: Treatment of Royalty Payments
The primary issue in this case revolved around the treatment of royalty payments made by the assessee to M/s Kokusan Denki Co. Ltd, Japan, during the financial year 2006-07. The Assessing Officer treated 25% of the royalty payment as capital expenditure, disallowing the same while allowing depreciation at 25%. The Commissioner of Income-tax (Appeals) upheld this decision based on the decision of the Madras High Court in the case of Southern Switch Gear Ltd, where it was held that benefits of enduring nature constitute capital expenses. However, the ITAT Chennai distinguished this case from the present scenario, emphasizing the case law of CIT vs Hitech Arai Ltd, which established that royalty payments for the grant of a license for existing operations are revenue in nature. The tribunal also cited similar decisions by the Madras High Court and other tribunals to support the view that the royalty payments should be treated as revenue expenditure. Consequently, the ITAT Chennai allowed the appeal of the assessee, concluding that the royalty payment should be considered as revenue expenditure.

Issue 2: Disallowance under Section 14A
The second issue pertained to the disallowance made by the Assessing Officer under section 14A of the Income Tax Act concerning expenses attributable to earning exempted income. The assessee had not segregated any expenditure related to investments and dividend income exempt from tax. The Assessing Officer applied Rule 8D to determine the disallowance amount. However, the ITAT Chennai noted that Rule 8D came into operation after the assessment year in question, and thus, it could not be applied. Referring to the decision of the Madras High Court in the case of M/s Simpson & Co. Ltd, the tribunal held that a disallowance of 2% of the exempt income earned was reasonable. The tribunal supported the CIT(A)'s decision in computing the disallowance based on this ratio. Additionally, the tribunal dismissed the Revenue's argument regarding the non-acceptance of the Madras High Court's decision and the pending SLP before the Apex Court. Ultimately, the ITAT Chennai confirmed the order of the CIT(A) and dismissed the appeal of the Revenue.

In conclusion, the ITAT Chennai allowed the appeal of the assessee regarding the treatment of royalty payments as revenue expenditure and dismissed the appeal of the Revenue concerning the disallowance under section 14A.