2018 (5) TMI 337 - AT - Income Tax

E-commerce business - Selling at a price lower (predatory pricing) than the cost price - disallowance of loss - business model of creating marketing intangible assets for long-term benefits - expenditure of a capital nature - Held that - The action of the AO in disregarding the books results cannot be sustained and the further conclusion that the action of the AO in presuming that the Assessee had incurred expenditure for creating intangible assets/brand or goodwill is without any basis, we do not think it necessary to deal with the arguments that even assuming that expenditure was incurred by the Assessee the expenditure for building brand or creating intangible or goodwill is revenue expenditure and allowable as deduction. It is also not necessary for us to go into the question of estimation of quantum of expenditure on creating intangibles, in view of the above conclusions. Thus we hold that the loss as declared by the Assessee in the return of income should be accepted by the AO and his action in disallowing expenses and arriving at a positive total income by assuming that there was an expenditure of a capital nature incurred by the Assessee in arriving at a loss as declared in the return of income and further disallowing such expenditure and consequently arriving at a positive total income chargeable to tax is without any basis and not in accordance with law and the said manner of determination of total income is hereby deleted. - Decided in favour of assessee

Issues Involved:
1. Whether the Assessing Officer (AO) was justified in disregarding the book results and estimating the income of the assessee.
2. Whether the AO was correct in concluding that the assessee incurred expenditure on creating intangibles/brand or goodwill.
3. Whether such expenditure, if incurred, should be treated as capital expenditure.
4. Whether the CIT(A) was justified in enhancing the assessment without giving notice to the assessee.
5. Whether the methodology adopted by the AO for computing the value of intangibles was correct.
6. Whether the CIT(A) was right in disallowing the depreciation on intangibles allowed by the AO.

Issue-wise Detailed Analysis:

1. Justification of AO in Disregarding Book Results:
The AO disregarded the book results, arguing that the assessee, a wholesale trader, was selling goods at a loss to capture market share, which was not a normal business practice. The AO assumed that the profits foregone were spent on creating intangibles/brand value. However, the tribunal held that the AO was not empowered to disregard the book results unless the provisions of Sec.145(3) of the Act were invoked, which was not the case here. The tribunal cited precedents, including the Supreme Court's ruling in Calcutta Discount Co. Ltd., which established that income which has accrued or arisen can only be taxed, not hypothetical income.

2. Conclusion of AO on Expenditure for Intangibles/Brand:
The AO concluded that the assessee incurred expenditure on creating intangibles/brand by selling goods below cost price. The tribunal found no basis for this conclusion, as there was no actual outflow of funds or accrual of liability. The tribunal emphasized that the creation of intangibles like goodwill cannot be quantified in terms of money and cited the Supreme Court's ruling in B.C. Srinivasa Setty, which explained the nebulous nature of goodwill.

3. Treatment of Expenditure as Capital Expenditure:
Even assuming that the assessee incurred expenditure on creating intangibles, the tribunal noted that such expenditure could be considered revenue expenditure. The tribunal referred to the Supreme Court's decision in Empire Jute Co. Ltd., which held that not all enduring benefits are capital in nature. The tribunal also cited decisions from various High Courts, which ruled that expenses incurred for developing a brand are revenue expenditures.

4. Enhancement by CIT(A) Without Notice:
The CIT(A) enhanced the assessment without giving notice to the assessee, which violated Sec.251(2) of the Act. The tribunal noted that the CIT(A) relied on a misinterpretation of the assessee's grounds of appeal, assuming that the assessee admitted to owning and transferring intellectual property, which was not the case.

5. Methodology for Computing Value of Intangibles:
The AO adopted a cost approach to value the intangibles, attributing a profit margin to the cost of purchases and considering the foregone profit as the value of intangibles. The tribunal found this methodology flawed, as it was based on assumptions without concrete evidence. The tribunal emphasized that traditional methods of income assessment should be followed unless specific provisions in the Act allow otherwise.

6. Disallowance of Depreciation on Intangibles by CIT(A):
The CIT(A) disallowed the depreciation on intangibles allowed by the AO, arguing that the assessee did not own the intangibles. The tribunal found this conclusion unjustified, as it was based on a misinterpretation of the assessee's grounds of appeal and violated principles of natural justice.

Conclusion:
The tribunal allowed the assessee's appeal, holding that the AO's action in disregarding the book results and assuming expenditure on intangibles was not justified. The tribunal directed the AO to accept the loss declared by the assessee in the return of income. The revenue's appeal was dismissed, and the tribunal emphasized that the determination of total income must be based on actual income accrued or arisen, not hypothetical income.

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