2025 (4) TMI 937 - AT - Income Tax

Nature of expenditure/payment - Commercial rights acquired under an agreement for providing commercialisation services across the globe for underlying Intellectual Property Rights (IPR) for technologies identified - asset eligible for depreciation u/s. 32 or as revenue expenditure eligible for deduction u/s. 37(1) - HELD THAT - Assessee has capitalized the consideration under this agreement payable to EADS as an Intangible asset claiming depreciation on the same which the AO as disallowed. Recognition of business or commercial rights of similar nature as its peculiar nuances. In the present case facts of undertaking business transaction by the assessee with EADS in terms of aforesaid agreement is not in dispute. As already analysed the contents of the agreement entered by the assessee with EADS for rendering commercialisation services cooperation in technology licensing initiative for specified time period upto 31.12.2021 commencing from 28.07.2011. Assessee has demonstrated generation of revenue under this agreement over the period from 01.04.2010 to 31.03.2017 tabulated above. In terms of section 37(1) assessee has incurred the expenditure which is laid out wholly and exclusively for the purposes of the business. Keeping the above terms and conditions in the agreement in perspective with the alternate claim made by the assessee of treating the amount payable under the aforesaid agreement as a revenue expenditure allowable u/s. 37(1) of the Act we find it proper to allow the said alternate claim. Ld. Assessing Officer is directed to recompute the total income while giving effect to the aforesaid finding of considering the claim allowable u/s 37(1). Accordingly ground no. 3(e) raised by the assessee is allowed. Alternative claim towards foreign exchange loss actually paid as revenue expenditure which it has considered as part of cost of intangible - This ground is covered by our above stated observations and finding since it stems from the same transaction of impugned agreement under which assessee had recognized it as an intangible asset having consequential effect. Accordingly in terms of our aforesaid finding ground no. 4(c) is allowed. AO is directed to give appropriate effect in computing the total income. Appeal of the assessee is allowed.

The core legal questions considered in this appeal revolve around the tax treatment of payments made under an agreement for commercialisation services related to intellectual property rights (IPRs). Specifically, the issues are:

1. Whether the amount paid by the assessee under the agreement with EADS France SAS qualifies as acquisition of an intangible asset, namely "commercial rights" under Explanation 3 to Section 32 of the Income-tax Act, thereby entitling the assessee to claim depreciation on the said asset.

2. In the alternative, whether the amount paid should be treated as revenue expenditure allowable as a deduction under Section 37(1) of the Act, being expenditure incurred wholly and exclusively for the purpose of business.

3. Consideration of the claim relating to foreign exchange loss associated with the transaction, whether it should be treated as part of the cost of intangible asset or allowable as revenue expenditure.

Regarding the first issue, the relevant legal framework is Section 32 of the Income-tax Act, which allows depreciation on tangible and intangible assets used for business or profession. Explanation 3 to Section 32 defines "assets" to include intangible assets such as know-how, patents, copyrights, trademarks, licences, franchises, or any other business or commercial rights of similar nature, excluding goodwill. The assessee claimed that the rights acquired under the agreement constituted such intangible assets and hence depreciation was allowable at 25% on the capitalized amount.

Precedents emphasize that the recognition of "business or commercial rights of similar nature" depends on the facts and circumstances of each case, with the key consideration being ownership and use of the asset for business purposes. Mere signing of an agreement or payment alone does not necessarily confer ownership of an intangible asset eligible for depreciation.

The Court examined the terms of the agreement titled "Agreement for services related to support of licensing activities" entered into between the assessee and EADS. The agreement appointed the assessee as a global consultant to provide commercialisation services for EADS's IPRs, including marketing, licensing negotiations, and generating licensing revenues. The assessee was required to pay a sum of 2 million Euros, with a guarantee to generate minimum net licensing revenue of 50 million Euros over ten years.

However, the agreement also stipulated that failure to make payments could lead to termination, and the payment schedule indicated that the amount was payable in instalments. The Assessing Officer observed that the agreement was essentially for providing services related to licensing support, not for acquisition of any rights or business assets. The intangible asset claimed was not owned by the assessee, nor was there evidence that it was put to use during the year. The CIT(A) upheld this view, stating that mere signing of the agreement was insufficient to acquire any rights, and the agreement was for services at a predetermined price with commission payable upon achieving targets.

The Court concurred with the authorities below that the assessee did not acquire any commercial rights or intangible asset as defined under Explanation 3 to Section 32, and hence depreciation was not allowable. The Court emphasized that the agreement was a commercial arrangement for services and not a transfer of ownership or rights qualifying as an intangible asset.

On the second issue, the Court considered the alternate plea of the assessee that if the amount paid was not capital in nature, it should be allowed as revenue expenditure under Section 37(1) of the Act, which permits deduction of any expenditure incurred wholly and exclusively for business purposes, not being capital expenditure.

The assessee demonstrated that the payments were made in the course of business and generated substantial revenue over the period from 2010 to 2017, as reflected in detailed ledger entries showing international sales revenue attributed to the agreement. This evidence supported the claim that the expenditure was incurred wholly and exclusively for business purposes.

Given that the issue was essentially a timing difference on the allowability of the claim-whether to allow depreciation spread over years or full deduction in the year of expenditure-the Court found merit in the assessee's alternative claim. It directed the Assessing Officer to allow the amount as revenue expenditure under Section 37(1) and recompute the total income accordingly.

Regarding the third issue on foreign exchange loss, the assessee had initially claimed the loss as part of the cost of the intangible asset under Section 43A, but later withdrew the claim and alternatively sought to allow the foreign exchange loss as revenue expenditure. The Court held that this claim was consequential to the main issue and allowed the foreign exchange loss as revenue expenditure under Section 37(1), directing appropriate adjustments in the income computation.

Competing arguments from the Revenue emphasized the non-acquisition of any intangible asset and the nature of the agreement as a service contract, supported by the payment schedule and termination clauses. The assessee argued for recognition of exclusive commercial rights and demonstrated revenue generation under the agreement. The Court balanced these views by denying depreciation but allowing the expenditure as revenue expense.

Significant holdings include the following verbatim extract from the appellate order:

"Mere signing a legal document is not sufficient for acquiring any rights therein as in the payment schedule it clearly mentioned that in case of failure for making payment the agreement will terminate. The agreement may be called as 'Agreement for services related to Support of Licensing activity' clearly speaks that this is an agreement between the assessee and EADS for providing services as per terms and condition mentioned therein for predetermine price and commission will be payable after achieving requisite target. In view of the above the assessee has neither acquired any rights or business or commercial rights of similar nature nor being put to use for the business purpose of the assessee during the year."

Core principles established are:

- The characterization of payments under a commercial agreement depends on the substance and terms of the contract, not merely on the nomenclature or claimed rights.

- For depreciation under Section 32 on intangible assets, the assessee must demonstrate ownership and use of an identifiable intangible asset as defined under Explanation 3.

- If the payment does not result in acquisition of an intangible asset, the amount may be allowable as revenue expenditure under Section 37(1) if incurred wholly and exclusively for business purposes.

- Foreign exchange losses related to such transactions may be allowed as revenue expenditure if not capitalized.

Final determinations:

1. The claim for depreciation on the amount paid under the agreement was disallowed as the assessee did not acquire any intangible asset or commercial rights eligible for depreciation.

2. The alternate claim to treat the amount as revenue expenditure under Section 37(1) was accepted, and the Assessing Officer was directed to allow the deduction accordingly.

3. The foreign exchange loss associated with the transaction was allowed as revenue expenditure.

4. Other grounds raised by the assessee were left open and not adjudicated upon.

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