2014 (12) TMI 190 - HC - Income Tax

Royalty expenditure - Capital expenditure or revenue expenditure - music / songs - assessee acquired rights in respect of recording and for producing, selling and public performance etc. - Whether it has an enduring benefit Held that - If the enduring benefit test is fulfilled, the conclusion possible could be that the payment was for acquiring a capital asset and expenditure related to it is capital expenditure - music/film songs do not have a long life - each year, expenditure was incurred to acquire and procure similar rights in new music - It was a recurring expenditure quite similar and like acquiring and purchasing raw material, used in earning profits - Increase in raw material would increase production, turnover and corresponding profits - In case, such rights were not acquired and purchased from time to time, the assessee would go out of the business. Further and importantly, sale of new music initially, we all know is brisk but fades and ceases to be catchy after sometime - The percentage of such music and songs is abysmally small and probably in the range of 5% to 10% of the music/songs launched every year - These facts and factors have not been adverted to and elucidated in the assessment orders, as the AO with foreordained commitment disallowed the entire expenditure, unmindful that possibly, it would difficult to sustain the entire addition - the capital amount or asset so created would be of a minuscule value and there would be a minimal tax effect - accounts should not be re-written because of the smallness and minimum tax effect. Nature of expenses incurred on Royalty - Whether the royalty paid is a revenue expenditure and thereby should be allowed as a deduction - Held that - It is to be held as revenue expenditure, when it is clear that the main business of the assessees was manufacture of blank cassettes and pre-recorded cassettes - The purchase of music rights and reproducing is the purpose of its business - The royalty payment for the cassettes sold is an expenditure in relation to the business activity of the assessee and on this ground and reason, should be regarded as revenue expenditure - It was an expenditure incurred in the normal course of business and was related to the revenue generated and payable accordingly - It did not secure and add to value or create any new capital asset Decided against revenue. Nature of expenses on purchase of carpets Revenue expenses or not Held that - The Tribunal was rightly of the view that an atmosphere has to be created for recording of the cassettes - The recording rooms have to be sound proof and dust proof - by laying down the carpets in these rooms, it is augmentation of efficiently carrying on the business also in earlier assessment year, it has been held that the expenditure incurred for the purchase of carpet was revenue expenditure - It was a replacement costs and in the nature of current repairs relying upon Commissioner Of Income-Tax Versus Sri Hari Mills Pvt. Ltd. 1998 (9) TMI 57 - MADRAS High Court it has been held that the expenditure on replacement could not be treated as capital expenditure and having recorded a finding of fact that the life of the carpets is very short and have to be replaced at frequent intervals, the order of the Tribunal is upheld Decided against revenue. Business activity not started till the end of AY - Whether the Tribunal was correct in deleting an addition claimed to have been spent by Bombay Video Division Held that - The Tribunal rightly upheld the decision of CIT(A) as to the assessee was engaged in the manufacture of audio and video cassettes both blank and recorded, the video film division was closely linked up with the said business activity - The purpose of making video film was to increase the market of the video cassettes - The direct expenses linked to video movies was treated as a part of the stock in trade - The nature of expenses consist of salaries and wages, selling, distribution and administrative expenses etc. and the same could be claimed as a business expenditure because the video division at Bombay was closely linked with the day to day business activity of the assessee, being undertaken - the expenses were in the nature of salary, wages to employees, selling, distribution and administrative expenses thus, the order of the Tribunal is upheld Decided against revenue.

Summary

Issues Involved:
1. Whether the royalty paid is a revenue expenditure and thereby should be allowed as a deduction.
2. Whether the addition of Rs. 2,32,900/- on account of purchase of carpets should be treated as revenue expenditure.
3. Whether the addition of Rs. 2,13,801/- claimed to have been spent by Bombay Video Division is allowable despite the fact that the business activities of this unit had not started till the end of the assessment year in question.

Issue-wise Detailed Analysis:

1. Royalty as Revenue Expenditure:

The primary issue across multiple appeals was whether the royalty paid by the assessee should be treated as a revenue expenditure. The court examined various assessment years and the corresponding amounts disallowed by the Assessing Officer (AO) on the grounds that the royalty expenditure was for acquiring an asset of enduring nature, thus capital in nature. The AO argued that the rights acquired through royalty payments were permanent assets, and therefore, the expenditure should be capitalized.

However, the Commissioner of Income Tax (Appeals) [CIT(A)] and the Income Tax Appellate Tribunal (ITAT) consistently held that the royalty payments were revenue expenditures. The CIT(A) and ITAT relied on previous judgments and the nature of the business, which involved manufacturing and selling pre-recorded cassettes. They noted that the music rights acquired did not have a long life and were akin to raw material used in the production process, thus justifying the treatment as revenue expenditure.

The court referred to several judgments, including Empire Jute Co. Ltd. vs. CIT and Alembic Chemical Works Co. Ltd. vs. CIT, which established principles for distinguishing between capital and revenue expenditures. The court emphasized that the enduring benefit test is not conclusive and should be applied considering the commercial context. The royalty payments facilitated the assessee's trading operations without creating a new capital asset, thereby qualifying as revenue expenditure.

2. Purchase of Carpets as Revenue Expenditure:

In ITA No. 69/2004, the court addressed whether the expenditure of Rs. 2,32,900/- on the purchase of carpets should be treated as revenue expenditure. The AO had treated this expenditure as capital in nature, allowing depreciation instead. The CIT(A) initially upheld this view, considering the carpets as part of plant and machinery.

However, the ITAT reversed this decision, noting that the carpets were used in recording rooms to create a soundproof and dustproof environment, essential for the business operations. The ITAT referenced previous judgments, including Shri Hari Mills Pvt. Ltd., which held that such expenditures, being replacements and renewals necessary for business continuity, should be treated as revenue expenditures. The court agreed with the ITAT, concluding that the expenditure on carpets was for maintaining the business environment and thus, a revenue expenditure.

3. Expenditure by Bombay Video Division:

The final issue was whether the addition of Rs. 2,13,801/- spent by the Bombay Video Division was allowable despite the unit not having started business activities by the end of the assessment year. The AO had disallowed this expenditure, considering it pre-operative.

The CIT(A) and ITAT, however, found that the video division was closely linked with the assessee's primary business of manufacturing and selling audio and video cassettes. The expenses, including salaries, wages, and administrative costs, were directly related to the ongoing business activities. The court upheld this view, noting that the expenses were revenue in nature and necessary for the business operations, thereby allowing the deduction.

Conclusion:

The court concluded that the royalty payments were revenue expenditures, the expenditure on carpets was a revenue expenditure, and the expenses incurred by the Bombay Video Division were allowable as revenue expenditures. The appeals were dismissed, and the decisions of the CIT(A) and ITAT were upheld.