2010 (12) TMI 258 - AT - Income Tax

Disallowance of expenditure - Whether goodwill is an intangible assets - Assessee had acquired a distillery unit by name Chagallu Distillery from M/s. Nizam Sugar Limited (NSL) - The excess of the amount paid over the value of the fixed assets acquired amounting to Rs. 4.75 crores has been termed as the payment towards goodwill as per the agreement - Held that depreciation u/s 32(l)(i)&(ii) is to be allowed on tangible and intangible assets. Intangible assets should either be knowhow, patents, copy rights, trade mark, license, franchise or any other business or commercial rights of similar nature. In the case of B. Ravindran (supra), it has been categorically held that the erosion in the value of the assets is not a relevant factor to decide whether it is entitled for depreciation or not. In clause (ii) of section 32(1) depreciation is to be outrightly allowed on knowhow, patents, copy rights, trade mark, licenses and franchise, but with respect to other intangible assets, depreciation would only be allowed if business or commercial rights are of similar nature, to that of knowhow, patents, copy right, trade mark, license or franchise. Business or a commercial rights which move along with the establishment on its sale and not akin to the know how, patents, copy rights, trade marks, license, franchises are not entitled for depreciation - not entitled to depreciaiton Business or commercial rights - which confers upon the purchaser a right to carry on its trade in a particular manner are akin to the know how, patents, copy rights, trade marks, license, franchises, etc. - Entitled to depreciation. Excess payment over and baove the cost of tangible assets - There is no bifurcation of the total cost which can be allocated towards the commercial benefits and the commercial rights acquired by the assessees. Complete details of cost of acquisition of the commercial benefits and the commercial rights cannot be available on record. It is only a question of estimate. - total goodwill cost should be bifurcated in two equal parts; one is for commercial benefits and the other is for commercial rights and the amount incurred in acquiring the commercial right should be eligible for depreciation u/s 32 of the Act. Therefore, we direct the A.O. to divide the entire cost of goodwill in two parts and 50% of the cost of the goodwill be treated as a cost of acquisition of the commercial rights and to allow the depreciation thereon at a prescribed rate.

Summary

Issues Involved:
1. Disallowance of expenditure incurred by the assessee for the units of the company.
2. Disallowance of claim of depreciation on intangible assets, specifically goodwill.

Detailed Analysis:

1. Disallowance of Expenditure:

The appeals by the assessee against the disallowance of expenditure incurred for the units of M/s. Ramakrishna Maize Products and M/s. GSR Sugars were dismissed. The Tribunal had consistently disallowed these expenditures in previous years (2002-03 to 2004-05), and the counsel for the assessee admitted that these grounds were covered against the assessee by earlier Tribunal orders. Consequently, the Tribunal followed its previous decisions and confirmed the order of the CIT(A), dismissing these grounds.

2. Depreciation on Goodwill:

The main issue in the appeals was the disallowance of depreciation on goodwill, claimed by the assessee under section 32(1)(ii) of the Income Tax Act. The assessee had acquired a distillery unit from M/s. Nizam Sugar Limited (NSL) for Rs. 9 crores, with the tangible assets valued at Rs. 4,75,46,800/-. The balance amount was considered as goodwill, representing the right to carry out the distillery business.

The CIT(A) disallowed the depreciation claim, stating that goodwill does not fall under the categories of intangible assets eligible for depreciation as specified in section 32(1)(ii) of the Act, which includes knowhow, patents, copyrights, trademarks, licenses, and franchises. The CIT(A) observed that goodwill is not similar in nature to these specified intangible assets and therefore, does not qualify for depreciation.

On appeal, the assessee argued that goodwill is a bundle of rights and should be considered similar to other intangible assets eligible for depreciation. The assessee relied on various judicial pronouncements, including the Kerala High Court's decision in B. Ravindran Pillai v. CIT, where depreciation on goodwill was allowed, and the Supreme Court's decision in Techno Shares and Stocks Limited v. CIT, which allowed depreciation on a BSE Membership card.

The Tribunal examined the nature of goodwill, referencing judicial definitions and interpretations. It noted that goodwill includes various commercial benefits and rights, such as location, reputation, and customer base, which are developed over time. The Tribunal distinguished between commercial benefits and commercial rights, stating that only those intangible assets that confer specific rights to carry on business, similar to knowhow, patents, copyrights, trademarks, licenses, and franchises, are eligible for depreciation.

In this case, the Tribunal found that the goodwill acquired by the assessee included both commercial benefits and commercial rights. Since the total cost of goodwill was not bifurcated into these components, the Tribunal directed the AO to divide the cost of goodwill into two equal parts: one for commercial benefits and the other for commercial rights. The depreciation was to be allowed on the portion attributable to commercial rights, as these are akin to the specified intangible assets eligible for depreciation under section 32(1)(ii).

Consequently, the Tribunal partly allowed the appeal, directing the AO to allow depreciation on 50% of the cost of goodwill, which represents the commercial rights acquired by the assessee.

Conclusion: The Tribunal dismissed the disallowance of expenditure and partly allowed the appeal regarding depreciation on goodwill, directing the AO to allow depreciation on the portion of goodwill attributable to commercial rights.