Depreciation on Stock Exchange Membership rights/ card allowed by Supreme Court.

[C.A. DEV KUMAR KOTHARI]

(views expressed by the author in an earlier find approval)

Relevant links:

Section 2(11) definition of block of asset of Income Tax Act, 1961.

Section 32 of Income Tax Act, 1961.

Appendix to Income Tax Rules 1962.

M/s Techno Shares & Stocks Ltd. Versus The Commissioner of Income Tax IV [2010 -TMI - 77379 - SUPREME COURT OF INDIA]

Vinay Bubna v. Stock Exchange, Mumbai [2010 -TMI - 77382 - SUPREME COURT OF INDIA]

Stock Exchange, Ahmedabad v. Assistant Commissioner of Income-Tax [2008 -TMI - 5984 - SUPREME Court] 

Earlier article by the same author:

Capital or revenue expenses:- membership fees etc, having enduring advantage http://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=93

From an earlier article:

In the above referred article the author had discussed issue of depreciation allowance on intangible assets including membership of stock exchange. The relevant paragraph is reproduced below:

"A case for depreciation allowance:

It is true that a membership of institution like a Stock Exchange, which is allowed on some substantial payment, is a necessity for the purpose of carrying such business. The right of membership is for a period spread over more than one year, the rights of membership can also be transferred. Therefore, such rights are in nature of business rights which entitle the holder to carry such business may be subject to some more requirements or compliances like training or continuing training, some annual payments etc.

Therefore, rights obtained on payment of such amount can be considered as an intangible asset acquired for the purpose of carrying business. In section 32 we find mention of intangible assets as follows:

"know-how, patents, copyrights, trademarks, license, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April, 1998".

A membership of stock exchange is like a license or any other business or commercial right to carry business of share and security brokers. Therefore, costs of such membership is eligible for depreciation allowance u/s 32 if acquired on or after 1st April, 1998.

Similarly route permit is in nature of a license for plying a vehicle on specified route. The cost of route permit can therefore be amortized u/s 32 read with the appendix to the I.T. Rules.

Expenditure incurred for obtaining an industrial licence can also be considered as cost of acquiring an intangible asset and it can be amortized by way of claiming depreciation allowance.

It is desirable that expenses considered as capital expenditure in earlier years, which resulted into acquisition of some enduring rights, should also be allowed to be amortized by way of depreciation allowance. "

Thus the author has expressed views that depreciation allowance on Stock Exchange membership should be allowed. Recently the Supreme Court has allowed such depreciation.

Membership Card of BSE - Eligible for depreciation u/s 32 held by the Supreme Court -

In a recent judgment the Supreme Court upheld the order of ITAT in which tribunal has allowed deprecation on membership card of Stock Exchange treating the same as an intangible asset entitled to depreciation u/s 32. The case reported is M/s Techno Shares & Stocks Ltd. Versus The Commissioner of Income Tax IV [2010 -TMI - 77379 - SUPREME COURT OF INDIA]

Though the Bombay High Court [2009 -TMI - 34562 - BOMBAY HIGH COURT] took different view and held that the order of ITAT was not justified and disallowed the depreciation on membership card by holding that the expression "licence" as well as the expression "business and commercial rights of similar nature" in Section 32(1)(ii) of the 1961 Act are referable to Intellectual Property Rights (IPRs) such as know-how, patent, copyright, trademark and franchise and since the BSE membership card does not fall in any of the above categories, the claim for depreciation was not admissible on the BSE membership card acquired by the assessee u/s 32(1)(ii). That view has been reversed by the Supreme Court, however with some riders about peculiar circumstances prevailing in a case of valid and effective membership right which has not been vested in the stock Exchange due to default of the member / card holder.

Honorable Supreme Court has analyzed the provisions of Bye Laws of BSE to determine the nature of membership card and held on the following lines:

It is clear that the right of membership (including right of nomination) gets vested in the Exchange on the demise/ default committed by the member; that, on such forfeiture and vesting in the Exchange the same gets disposed of by inviting offers and the consideration received thereof is used to liquidate the dues owed by the former/ defaulting member to the Exchange, Clearing House, etc. This is provided in Rule 16 and Bye-law 400.

It is this right of membership which allows the non-defaulting member to participate in the trading session on the floor of the Exchange.

The said membership right of a non defaulting member is a "business or commercial right" which is conferred by the Rules of BSE on the non-defaulting continuing member.

Membership right could be said to be owned by the assessee and used for the business purpose in terms of Section 32(1)(ii) because as per the Rules and the Bye-laws right of a member vests in the Exchange only when a member commits default.

Before such vesting of membership the member continues (rather say is entitled to-added by author) to participate in the trading session on the floor of the Exchange and he continues to deal with other members of the Exchange and even has the right to nominate subject to compliance of the Rules.

Under Rule 5, membership is a personal permission from the Exchange which is nothing but a "licence" which enables the member to exercise rights and privileges attached thereto including inter alia right to trade on the floor of the Exchange and to participate in the trading session on the floor of the Exchange. It is this licence which enables the member to access the market. (On trading floor as well as through websites- added by author).

Considering the provision relating to depreciation the Court observed that by virtue of Explanation 3 to Section 32(1)(ii) the commercial or business right which is similar to a "licence" or "franchise" is declared to be an intangible asset.

On consideration of the said provision the court held that "the right of membership, which includes right of nomination, is a "licence" or "akin to a licence" which is one of the items which falls in Section 32(1)(ii) of the 1961 Act. The right to participate in the market has an economic and money value. It is an expense incurred by the assessee which satisfies the test of being a "licence" or "any other business or commercial right of similar nature" in terms of Section 32(1)(ii)."

Counsels of revenue relied upon the following two decisions :

(i) Vinay Bubna v. Stock Exchange, Mumbai [2010 -TMI - 77382 - SUPREME COURT OF INDIA]

(ii) Stock Exchange, Ahmedabad v. Assistant Commissioner of Income-Tax [2008 -TMI - 5984 - SUPREME Court]

These judgments were not in context of depreciation allowance but on other aspects of the rights of members, vesting of rights etc. The Court held that these judgments were in different context and were not against the assessee rather supported assessee on some relevant aspects as to ownership, right to nominate or transfer and rights of non defaulting members to work on platform of the stock exchange. Thus these rulings supported the case of assessee who was a non defaulting member and his rights were not vested in the stock Exchange.

Intangible assets acquired before 1st day of April, 1998 not entitled:

As per the existing law, depreciation allowance on intangible assets was introduced by the Finance (No.2) Act, 1998 and depreciation was started to be allowed only from Assessment year 1999-2000 (that is w.e.f. 01.04.1999). It has also been provided that the intangible assets should have been acquired on or after 01.04.1998. Thus old intangible assets have not been made eligible for depreciation allowance. It would have been proper course to allow deprecation on such assets w.e.f. 01.04.199 but without condition that assets should have been acquired on or after 01.04.1998.

As such assets acquired prior to 01.04.1998 were not made eligible for depreciation allowance, the assesses who acquired them prior to that date were denied depreciation. Therefore, many has to find out a way to get depreciation allowance. Therefore, we find cases of change in ownership by way of sale, transfer, merger, demerger, corporatization of proprietary or partnership concerns etc. By this way, the hidden value of intangible assets have also been brought on face of books of account and deprecation can also be claimed on higher amount because the transferee acquired such assets on or after 01.04.1998 and at the fair market value or the negotiated price which is his cost of acquisition.

If the old owners were also allowed depreciation on such assets acquired prior to 01.04.1998, perhaps the revenue would have been gainer. For the reason that the old owner could have (rather must have) claimed depreciation allowance for assessment year 1999-2000, and in that case the transfer of such assets, after having been subject matter of depreciation allowance, would be subject to taxation as short-term capital gains under section 50 instead of long-term capital gains claimed by many of them on transfer of such assets without having claimed depreciation allowance.

Limitation of the ruling- a word of caution:

In paragraph 24 their lordships have clarified that their present judgment is strictly confined to the right of membership conferred upon the member under the BSE membership card during the relevant assessment years. Accordingly they held that the said right of membership is a "business or commercial right" which gives a non-defaulting continuing member a right to access the Exchange and to participate therein and in that sense it is a licence or akin to licence in terms of Section 32(1)(ii) of the 1961 Act.

Such a right vests in the Exchange only on default/ demise in terms of the Rules and Bye-laws of BSE, as they stood at the relevant time.

The judgment should not be understood to mean that every business or commercial right would constitute a "licence" or a "franchise" in terms of Section 32(1)(ii) of the 1961 Act. In conclusions in paragraph 25 of the judgment the court answered the question in the affirmative by holding that on the facts and circumstances of these cases the Tribunal was right in holding that depreciation was allowable on the cost of the membership card under Section 32(1)(ii) of the 1961 Act.

Accordingly, the impugned judgment(s) of the Bombay High Court was set aside and the appeal(s) filed by the nominated non-defaulting continuing member were allowed.

Cautionary note for other cases:

It is necessary to examine the Rules and Regulations as applicable at the relevant time. In case there is some difference and the position prevailing in any particular case (due to time difference or difference of relevant Rules etc. say in case of any other stock exchange), the law laid down by the Supreme Court need to be applied with a proper analysis and not in a routine manner.