2025 (2) TMI 697 - AT - Income Tax

Royalty expenses - assessee has acquired license of Audio Audio visual rights of the non- Bollywood regional music content for exclusive commercial exploitation on mobiles digital platform and for physical distribution public performance - HELD THAT - Assessee company was established to commercially exploit the music albums of various tracks available with Hungama and Zee Music. Assessee and Hungama entered into license agreement on 20.12.2015 and the license holder Hangama granted permission to the assessee to use the above license held by it which was previously acquired by another agreement entered by Hungama with Zee Music. As per the terms of license agreement the assessee has agreed pay the licensor i.e. Hangama a minimum guarantee fee of Rs. 11, 73, 62, 500/- for 6 years. Therefore it is only a minimum guarantee license fee not a Royalty payment towards transfer of property. The property right was only with licensor. Technically the assessee has given only a guarantee of revenue for 6 years that means the assessee has given guarantee of license fee. It is only a guaranteed amount and the assessee has to meet out the above license fees otherwise it has to recompensate the same to the licensor. In the agreement there is no mention of any commitment that guarantee is for every year or to be compensated at the end of the 6th year. Therefore it is closely linked to the earning of revenue. It is relevant to point out that the Hangama also entered into similar agreement with Zee Music and the same chart of music albums and date of commencement of dates are mentioned. Licensor has taken similar license from Zee and sublet the same to the assessee. It cannot be treated as license fees paid and claimed as expenditure. The dates mentioned in the start date of each album are the starting date of commercial utilization of respective album not the payment of license fees. Whether the license fees paid are to be considered as prior period expenses? - We observed that the AO has not understood the transaction and disallowed the part of royalty expenses as prior period expenses by observing the dates mentioned in the individual music titles which is not date of acquiring the license but it is the date of start date of commercial exploitation of relevant tracks. In our considered view the method adopted by the assessee as well as the disallowance made by the AO is not appropriate. Therefore we direct the Assessing Officer to redo the assessment denovo and consider the above observation and allow the relevant expenditure as per law. At this stage we cannot change the Balance Sheet even though followed the wrong method of recognition of income expenditure. AO has to determine the actual income and expenses by treating the license fees paid as deferred revenue expenditure and allow the relevant cost during the license period of six years. Needless to add that assessee may be given proper opportunity of being heard.

Summary

ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this judgment include:

• Whether the royalty expenses claimed by the assessee for acquiring music licenses should be treated as prior period expenses and thus disallowed for the assessment year 2016-17.
• Whether the accounting method adopted by the assessee in recognizing income and expenses was appropriate and in compliance with applicable accounting standards.
• Whether the Assessing Officer (AO) correctly interpreted the agreements and transactions between the parties involved in determining the tax liabilities.

ISSUE-WISE DETAILED ANALYSIS

1. Treatment of Royalty Expenses as Prior Period Expenses

• Relevant Legal Framework and Precedents: The court considered the legal principle that expenses are allowable in the year in which the liability to make payment crystallizes. Relevant case laws cited include CIT Vs. Exxon Mobil Lubricants P. Ltd and Times Internet Ltd Vs. Add. CIT.
• Court's Interpretation and Reasoning: The Tribunal noted that the liability for the royalty expenses crystallized in FY 2015-16 when the agreement was executed, not in the prior period. The court found that the AO incorrectly treated the royalty expenses as prior period expenses by misinterpreting the agreement dates.
• Key Evidence and Findings: The agreements between the parties, including the dates of execution and the terms of the license agreements, were crucial in determining when the liability crystallized.
• Application of Law to Facts: The Tribunal applied the principle that liability crystallizes when the agreement is executed, thus supporting the assessee's claim that the expenses should be recognized in FY 2015-16.
• Treatment of Competing Arguments: The Tribunal rejected the AO's interpretation that the expenses were prior period based on the dates of music title releases, emphasizing the distinction between the execution of agreements and commercial exploitation dates.
• Conclusions: The Tribunal concluded that the royalty expenses should not be treated as prior period expenses and should be recognized in the year the liability crystallized.

2. Appropriateness of Accounting Methods

• Relevant Legal Framework and Precedents: The Tribunal considered accounting standards, particularly the matching concept and standards for revenue recognition.
• Court's Interpretation and Reasoning: The Tribunal found that the assessee did not follow a commercially viable method of accounting, as the expenses were not matched with the corresponding income.
• Key Evidence and Findings: The Tribunal noted discrepancies in how the assessee accounted for income and expenses, particularly the mismatch in recognizing income from licensing fees.
• Application of Law to Facts: The Tribunal directed that only the license fees relevant to the current period should be allowed, with the remainder treated as deferred revenue expenditure to be amortized over the license period.
• Treatment of Competing Arguments: The Tribunal acknowledged the assessee's argument regarding the timing of income recognition but emphasized the need for a consistent and commercially viable accounting approach.
• Conclusions: The Tribunal concluded that the assessee's accounting method was improper and directed a reassessment to align with proper accounting practices.

SIGNIFICANT HOLDINGS

• The Tribunal held that royalty expenses should be recognized in the year the liability crystallized, not as prior period expenses. This aligns with the principle that liability arises upon execution of agreements.
• The Tribunal emphasized the importance of matching expenses with corresponding income, directing the AO to allow only the current period's license fees and treat the remainder as deferred revenue expenditure.
• The Tribunal directed a de novo assessment to properly account for the license fees over the six-year period, ensuring compliance with applicable accounting standards.
• Verbatim Quote: "The method of accounting adopted by the assessee is not proper... Therefore, we direct the Assessing Officer to redo the assessment denovo and consider the above observation and allow the relevant expenditure as per law."