2024 (11) TMI 646 - HC - Income Tax

Royalty payments - treated as revenue expenditure or capital expenditure - HELD THAT - Division Bench of this Court in the case of the very assessee before us 2022 (6) TMI 1428 - MADRAS HIGH COURT in TCA.Nos.755 of 2009 and batch dated 30.06.2022 held every expenditure incurred to acquire some right over intangible asset, cannot be ipso facto termed as capital expenditure. The nature of the assets, right, information or technical know-how that is transferred, must be such that without which the transferee could never commence the business. As rightly contented by the learned senior counsel appearing for the assessees, the benefit granted by the licensor is not enduring in nature in the present cases. AO without appreciating the terms of the licence agreement and ascertaining the nature of the expenditure incurred by the assessee companies, disallowed the deduction of royalty payment and allowed the depreciation at 25% treating it as capital expenditure. However, the appellate authorities, while deleting the disallowances made by the assessing officer, have rightly treated the royalty payment as revenue expenditure. Once the payment of royalty is treated as revenue expenditure, automatically, it goes without saying that the assessees would be entitled to 100% deduction. Therefore, we need not interfere with the orders passed by appellate authorities. Accordingly, the substantial questions of law relating to royalty, are answered in favour of the assessees. Disallowance of bad debts - After a detailed discussion in regard to the the judgment of the Supreme Court in Shriram Chits and Investments Private Limited 1993 (7) TMI 338 - SUPREME COURT which dealt with the vires of the Chit Funds Act, 1982, the issue of bad debts has been discussed and concluded as not denied by the Revenue that the payment made in the course of the business had resulted in a loss of the chit amount which is also allowable under Section 28. Given the above-said fact, we have no hesitation in rejecting the Revenue's appeal on this question. Decided in favour of assessee.

Issues Involved:

1. Whether the royalty payments should be treated as revenue expenditure or capital expenditure, and the implications of Section 32 of the Income Tax Act.
2. Whether the disallowance of bad debts by the Tribunal was justified.

Detailed Analysis:

1. Royalty Payments as Revenue or Capital Expenditure:

The primary issue revolves around whether the royalty payments made by the assessee companies to their parent company for the use of a trademark should be classified as revenue expenditure, which is fully deductible, or as capital expenditure, which is only eligible for depreciation under Section 32 of the Income Tax Act. The Tribunal had previously allowed the royalty payments as revenue expenditure, which was contested by the Revenue.

The court analyzed the nature of the royalty payments and the terms of the agreement between the assessee companies and the parent company. It was noted that the license to use the trademark was non-exclusive, non-transferable, and renewable, which did not confer any proprietary rights to the assessee companies. The court relied on precedents, including the Supreme Court's decision in CIT v. Ciba of India Ltd., which held that payments for the use of intellectual property without transfer of ownership are typically revenue in nature.

The court also considered the enduring benefit test from the Supreme Court's judgment in Honda Siel Cars India Ltd. v. CIT, which distinguishes between capital and revenue expenditure based on whether the payment results in an enduring benefit. The court concluded that since the royalty payments were for the use of the trademark and did not result in the acquisition of any enduring asset or benefit, they should be treated as revenue expenditure.

The court further noted that the Revenue had previously accepted similar claims by the assessee companies in past assessment years, which supported the consistency of treating such payments as revenue expenditure. Therefore, the court upheld the Tribunal's decision, affirming that the royalty payments were revenue in nature and fully deductible.

2. Disallowance of Bad Debts:

The second issue pertained to the disallowance of bad debts amounting to Rs.22,93,94,972/- by the Tribunal. The court referred to a previous decision by a Division Bench, which had addressed similar issues concerning the treatment of bad debts under the Chit Funds Act and the Income Tax Act.

The court examined the obligations of the foreman under the Chit Funds Act, which required the foreman to ensure the continuity of the chit cycle, even if it meant using its own funds to cover defaults by subscribers. The court noted that the assessee had to advance its own funds to maintain the chit operations, which were later claimed as bad debts when subscribers defaulted.

The court emphasized the amendment to Section 36(1)(vii) of the Income Tax Act, which no longer required the assessee to prove that the debt had become irrecoverable, as long as it was written off in the accounts. The court also considered the Revenue's acceptance of similar claims in previous years, reinforcing the legitimacy of the assessee's claim.

The court concluded that the bad debts were indeed part of the business operations and were allowable as deductions under Section 36. The Tribunal's decision to allow the bad debts as a deduction was upheld, and the Revenue's appeal on this matter was dismissed.

Conclusion:

The court resolved both issues in favor of the assessee. It affirmed that the royalty payments were revenue expenditures eligible for full deduction, and the disallowance of bad debts was unjustified, thus dismissing the Revenue's appeals. The substantial questions of law were answered in favor of the assessee, and the appeal was dismissed without costs.

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