2007 (3) TMI 308 - AT - Income Tax

Summary

Issues Involved:
1. Classification of royalty income as business income or income from other sources.
2. Allowability of expenditure claimed against royalty income.
3. Setting off brought forward unabsorbed depreciation.

Summary:

Issue 1: Classification of Royalty Income
The primary issue was whether the royalty income should be treated as "business income" or "income from other sources." The AO argued that the business was discontinued in 1996 and thus, the royalty income should be classified as income from other sources. However, the CIT(A) and ITAT found that the manufacturing activity was temporarily suspended due to the sealing of the premises by the District Collector and not permanently discontinued. The assessee continued to exploit its commercial assets, such as brand names, through "manufacturing and selling license agreements" with various parties. The ITAT concluded that the royalty income was indeed business income, as the assessee intended to resume its manufacturing activities once circumstances became conducive.

Issue 2: Allowability of Expenditure
The AO disallowed various expenditures claimed by the assessee, arguing that these expenses were related to a closed business and not necessary for earning royalty income. However, the CIT(A) and ITAT disagreed, stating that the expenses were incurred for the purpose of business operations. The ITAT emphasized that litigation expenses, retrenchment compensation, advertisement expenses, and payments to MCD were intimately connected with the running of the business. The ITAT cited several Supreme Court cases, including *Shri Meenakshi Mills Ltd. vs. CIT* and *Sassoon J. David & Co. (P) Ltd. vs. CIT*, to support the allowability of these expenditures as business expenses.

Issue 3: Setting Off Brought Forward Unabsorbed Depreciation
The AO did not allow the set-off of brought forward unabsorbed depreciation, arguing that the business was not in existence. However, the CIT(A) and ITAT found that the business was temporarily suspended and not discontinued. Therefore, the ITAT directed the AO to allow the set-off of brought forward unabsorbed depreciation as per the provisions of the IT Act.

Conclusion:
The ITAT upheld the CIT(A)'s decision to treat the royalty income as business income, allow the claimed expenditures, and permit the set-off of brought forward unabsorbed depreciation. The appeal of the Revenue was dismissed.