2025 (5) TMI 1704 - AT - Income Tax

Disallowance of depreciation on non-compete fee - whether to be treated as intangible asset? - HELD THAT - In absence of relevant evidences the finding of facts given by the Tribunal to hold that the transaction is not between the related parties in our considered view is not based on any evidences but purely on the submissions of the appellant company. Therefore to this extent we cannot subscribe to the reasons given by the Tribunal to hold that non-compete agreement between the appellant company and other firms is not between the related parties and a third party interest is involved and therefore it cannot be said that it is a commercial agreement cannot be accepted and needs to be further examined by the Assessing Officer. Whether noncompete fee is an Intangible Asset falls under the definition of any other commercial or business rights of similar nature ? - It is necessary to examine the payment of non-compete fee in light of the right of person because as we already stated in earlier part of this order in case the appellant company restricted the two firms in carrying-out similar business for a period of 5 years there is no restriction for third party to carry-out similar business because what was transferred by the above two firms is not a product or a design but it is a copyright of feature films. Therefore this aspect also needs to be examined by the AO. Although these facts are required to be examined but while setting aside the matter to the file of AO the Tribunal has considered only one aspect of shareholding part of the company s and held that non-compete fee is an Intangible Asset . The issue of non-compete fee needs further examination from the Assessing Officer in light of discussion hereinabove and more particularly in light of decision of Sharp Business System 2012 (11) TMI 324 - DELHI HIGH COURT and also Feeromatic Milacron India (P) Ltd 2018 (10) TMI 1955 - GUJARAT HIGH COURT and thus we set-aside the order of the learned CIT(A) on this issue and restore the issue back to the file of Assessing Officer to reconsider the issue. The Assessing Officer is directed to reconsider the issue in light of our discussion hereinabove and decide the issue as per Law. Nature of expenditure - Disallowance of excess depreciation claimed on the cost of production of TV serials and programs - appellant company has claimed the entire cost of production of TV serials and programs as revenue expenditure in the year of incurring of said expenditure - HELD THAT - No error in the reasons given by the learned CIT(A) to allow deduction towards cost of production of TV serials and programs as revenue expenditure. Disallowance of excess depreciation on film software library by treating the same as an Intangible Asset - Since the issue is settled by the decision of ITAT Hyderabad Bench for earlier assessment years in our considered view on the issue of depreciation on film software library there is no disputed that appellant company is eligible for depreciation @ 25% as applicable to an Intangible Asset . However on the issue of valuation of film software library once again the matter is set aside to the file the AO with direction to re-examine the valuation of the film software library by conducting independent valuation by referring the matter to the independent valuer. Accordingly this ground of the Revenue is allowed for statistical purposes. Disallowance u/sec.14A r.w. Rule 8D - HELD THAT - AO has considered total investment including investment which yield exempt income and investment which does not yield exempt income in our considered view the matter needs further examination from the AO in light of the arguments of Assessee. Therefore we set aside the order of the CIT(A) and direct the AO to re-examine the claim of assessee in light of the nature of investment and amount of exempt income earned from each investment for the year under consideration. In case any investment which does not earn any exempt income for the year under consideration then the same needs to be excluded for the purpose of computing average of the monthly averages of opening and closing balances of the value of investment and compute disallowance as per Rule 8D(2) of I.T. Rules 1962. Disallowance of provision for expenses - HELD THAT - Once the expenditure is relates to the year under consideration and said expenditure has been accrued to the appellant company then in our considered view the appellant company should make a provision for the said expenditure even though the said expenditure has been paid or discharged in subsequent financial years. Since the appellant company has filed additional evidences which are not filed before the AO in our considered view the matter needs to go back to the file of AO for further verification. Thus we set aside the issue to the file of AO and direct the AO to verify the claim of the appellant company in light of any evidences that may be filled to justify the claim of provision for marketing expenses. Addition on Subscription Revenue - HELD THAT - Since the appellant company claims that there is a difference between actual revenue and provisional revenue and same has been adjusted in subsequent month i.e. April 2020 of each year in our considered view there is a short fall in revenue for the month of March 2020 as considered by the AO. Since the appellant company is not able to explain as to why the said revenue has not been accounted in the month of March 2020 in our considered view the AO has rightly assessed difference income on the basis of provisional and actual income accounted for the month of March 2020. CIT(A) after considering relevant facts has rightly sustained the addition made by the AO. Thus we are inclined to uphold the findings of the learner CIT(A) and reject the ground taken by the appellant company.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in these consolidated appeals relate primarily to the tax treatment of certain expenditures and assets claimed by the assessee company, specifically:

• Whether depreciation on non-compete fee paid by the assessee qualifies under section 32(1)(ii) of the Income Tax Act, 1961, as an intangible asset, given the nature of the non-compete agreement and its valuation.
• Whether the cost of production of TV serials and programmes can be claimed as revenue expenditure or should be capitalized and depreciated, considering the enduring benefit due to repeat telecast value.
• Whether depreciation claimed on film software library is allowable at 25% as an intangible asset or should be restricted to 15% as plant and machinery.
• The correctness of deletion of disallowance under section 14A read with Rule 8D of the Income Tax Rules, 1962, concerning expenditure relatable to exempt income.
• Whether the provision made for marketing expenses by the assessee is allowable as deduction, given the evidentiary support and accounting treatment.
• Whether addition on account of subscription revenue shortfall is justified, considering the assessee's accounting method for provisional revenue recognition.

2. ISSUE-WISE DETAILED ANALYSIS

Depreciation on Non-Compete Fee

Legal Framework and Precedents: Section 32(1)(ii) permits depreciation on intangible assets, including "any other business or commercial rights of similar nature." The Delhi High Court in Sharp Business System vs. CIT clarified that intangible assets must confer a right in rem, i.e., enforceable against the world at large, and be alienable. The Supreme Court's decision in Techno Shares & Stocks Ltd. limited the scope to rights conferring exclusive business advantages akin to licenses. The Gujarat High Court in PCIT vs. Feeromatic Milacron India (P) Ltd. recognized depreciation on intangible assets acquired for enduring benefits, emphasizing the need to satisfy section 32(1)(ii) requirements.

Court's Interpretation and Reasoning: The Assessing Officer disallowed depreciation on the non-compete fee, holding it was not an intangible asset under section 32(1)(ii), characterizing the non-compete right as a personal restriction (right in personam) without market value or alienability. The Assessing Officer also suspected the transaction was a sham for tax avoidance, given the related-party nature and transfer of copyrights leaving nothing for the transferor firms to compete with.

The Tribunal acknowledged that the non-compete fee is an intangible asset in principle but emphasized the need to verify the genuineness and necessity of the payment, and to examine the valuation by an independent valuer. The Tribunal found the related-party nature of the transaction undisputed and rejected the earlier Tribunal's assumption that a third party interest existed without evidence. It held that the non-compete agreement did not confer an exclusive right to carry on business against the world at large and was thus not a depreciable intangible asset under section 32(1)(ii).

Key Evidence and Findings: The scheme of demerger assigned the non-compete fee as an intangible asset to the appellant. The non-compete agreement was between related parties, with the transfer of copyrights of 3700 feature films. The valuation report was obtained from an independent valuer. The appellant failed to establish the non-compete fee as an alienable right with market value.

Application of Law to Facts: The Court applied the legal tests for intangible assets under section 32(1)(ii), particularly the requirement of exclusivity and alienability. It found the non-compete fee to be a right in personam, limited in time and enforceable only against specific parties, lacking the characteristics of intangible assets recognized under the Act and judicial precedents.

Treatment of Competing Arguments: The assessee relied on earlier Tribunal orders and valuation reports, asserting the non-compete fee was an intangible asset. The Revenue emphasized the sham nature of the transaction and lack of alienability. The Court found the Revenue's arguments persuasive regarding the nature of the non-compete fee and the need for further examination on genuineness and necessity.

Conclusion: The matter was remanded to the Assessing Officer for a detailed examination of the genuineness, necessity, and valuation of the non-compete fee in light of the discussed legal principles and precedents.

Cost of Production of TV Serials and Programmes

Legal Framework and Precedents: The question was whether production costs should be treated as revenue expenditure or capitalized as intangible assets subject to depreciation. Relevant precedents include the Bombay High Court decision in CIT vs. Dharma Productions and the Delhi High Court decision in CIT vs. Television Eighteen India Limited, which distinguished between content with repeat telecast value (capital asset) and news content (revenue expenditure).

Court's Interpretation and Reasoning: The Assessing Officer treated the production cost as capital expenditure, allowing depreciation at 25% and disallowing the balance claimed as revenue expenditure. The CIT(A) and the Tribunal, following earlier decisions on similar facts, held that the cost of production of TV serials and programmes could be claimed as revenue expenditure in the year incurred, as the expenditure did not create an intangible asset requiring capitalization.

Key Evidence and Findings: The appellant consistently claimed production costs as revenue expenditure and relied on judicial precedents allowing such treatment. The repeated telecast value was considered but distinguished from the nature of the expenditure and accounting treatment.

Application of Law to Facts: The Tribunal applied the principle that expenditure not creating an enduring intangible asset can be claimed as revenue expenditure. The repeated telecast value did not mandate capitalization given the nature of the content and business practice.

Treatment of Competing Arguments: The Revenue relied on the enduring benefit and repeated telecast value to argue for capitalization. The assessee relied on consistent accounting treatment and judicial precedents. The Tribunal favored the assessee's position.

Conclusion: The Tribunal upheld the CIT(A)'s order allowing the cost of production as revenue expenditure and dismissed the Revenue's grounds on this issue.

Depreciation on Film Software Library

Legal Framework and Precedents: The issue was whether film software library is an intangible asset eligible for depreciation at 25% or a tool integral to business operations treated as plant and machinery eligible for 15% depreciation. Earlier ITAT decisions in appellant's own case and in Prism TV Private Limited held film software library as an intangible asset.

Court's Interpretation and Reasoning: The Assessing Officer allowed depreciation at 15%, treating it as plant and machinery. The CIT(A) and Tribunal held it to be an intangible asset eligible for 25% depreciation but remanded the issue for independent valuation.

Key Evidence and Findings: The appellant purchased copyrights of feature films and TV programs constituting the film software library. Independent valuation reports were submitted.

Application of Law to Facts: The Tribunal applied earlier precedents recognizing film software library as an intangible asset and directed reassessment of valuation.

Treatment of Competing Arguments: The Revenue emphasized the integral nature to business tools; the assessee relied on precedents and valuation. The Tribunal agreed with the assessee in principle but required valuation verification.

Conclusion: The issue was remanded for valuation but the principle that film software library is an intangible asset eligible for 25% depreciation was affirmed.

Disallowance under Section 14A read with Rule 8D

Legal Framework and Precedents: Section 14A disallows expenditure incurred to earn exempt income. Rule 8D prescribes methods for computing such disallowance. The Bombay High Court decision in CIT vs. Reliance Utilities and Power Limited was considered, although the rule was amended post the relevant assessment years.

Court's Interpretation and Reasoning: The Assessing Officer computed disallowance at 1% of average investments including those not yielding exempt income. The CIT(A) deleted the addition relying on earlier judicial decisions. The Tribunal found the CIT(A)'s reliance misplaced due to amendments in Rule 8D and remanded the matter for reassessment excluding investments not yielding exempt income.

Key Evidence and Findings: The assessee made suo motu disallowance of direct expenses relatable to exempt income but did not disallow interest or other expenses. Investments included both yielding and non-yielding exempt income.

Application of Law to Facts: The Tribunal applied the amended Rule 8D requiring disallowance only in relation to investments yielding exempt income.

Treatment of Competing Arguments: The Revenue insisted on disallowance based on total investments; the assessee argued for exclusion of non-yielding investments. The Tribunal agreed with the assessee's position subject to verification.

Conclusion: The matter was remanded for reassessment in accordance with Rule 8D considering only relevant investments.

Provision for Marketing Expenses

Legal Framework and Precedents: Deductibility of provisions depends on whether the liability is ascertained and accrued. The Supreme Court in Rotork Controls India (P.) Ltd. vs. CIT held that provisions without a scientific basis for ascertainment are not deductible.

Court's Interpretation and Reasoning: The Assessing Officer disallowed provision for marketing expenses due to lack of substantiation. The CIT(A) upheld the disallowance. The Tribunal noted the appellant filed additional evidence including work orders and vendor bills showing the expenditure related to the year under consideration, albeit submitted after the assessment.

Key Evidence and Findings: Work orders and bills evidencing the marketing expenses were submitted post assessment proceedings.

Application of Law to Facts: The Tribunal emphasized that if the expenditure is wholly and exclusively for business and accrued in the relevant year, provision is allowable even if paid later, provided there is a scientific basis.

Treatment of Competing Arguments: The assessee sought remand for verification of additional evidence; the Revenue relied on lack of substantiation. The Tribunal favored remand for verification.

Conclusion: The issue was remanded to the Assessing Officer for verification of the claim based on additional evidence.

Subscription Revenue Addition

Legal Framework and Precedents: The mercantile system of accounting requires income to be recorded when accrued. The appellant's method involved provisional revenue recognition for March based on February billing, with subsequent adjustment in April.

Court's Interpretation and Reasoning: The Assessing Officer made addition for shortfall in subscription revenue for March 2020. The CIT(A) sustained the addition. The Tribunal observed that while the appellant's business model makes it difficult to collect data by year-end, the shortfall was not satisfactorily explained or adjusted in books before finalization.

Key Evidence and Findings: The appellant's business involves multiple operators making timely revenue recognition challenging.

Application of Law to Facts: The Tribunal held that despite practical difficulties, income must be accurately accounted for in the correct year. The shortfall not accounted for in March was rightly added back.

Treatment of Competing Arguments: The assessee argued for acceptance of the accounting method; the Revenue stressed adherence to accrual accounting principles. The Tribunal sided with the Revenue.

Conclusion: The addition was upheld and the assessee's ground rejected.

3. SIGNIFICANT HOLDINGS

On depreciation of non-compete fee, the Court held:
"...the non-compete fee is a right in personam, limited in time and enforceable only against specific parties, lacking the characteristics of intangible assets recognized under section 32(1)(ii) of the Act. The matter requires detailed examination of genuineness, necessity and valuation and is remanded to the Assessing Officer for fresh consideration."

On cost of production of TV serials and programmes:
"...the expenditure incurred on production of TV serials and programmes is allowable as revenue expenditure in the year of incurring, notwithstanding the repeat telecast value, and does not require capitalization as intangible asset."

On depreciation on film software library:
"...film software library is an intangible asset eligible for depreciation at 25%, but the valuation of the asset requires independent verification."

On disallowance under section 14A and Rule 8D:
"...disallowance under section 14A must be computed considering only investments yielding exempt income as per amended Rule 8D; matter remanded for reassessment."

On provision for marketing expenses:
"...provisions for expenses are allowable if there is a scientific basis and the liability is ascertained and accrued; additional evidence filed by assessee warrants remand for verification."

On subscription revenue:
"...income must be recorded on accrual basis; provisional revenue recognition without proper adjustment leads to addition; addition upheld."

The Tribunal consistently emphasized the need for detailed, evidence-based examination by the Assessing Officer in matters involving valuation, genuineness, and accounting treatment, remanding issues where necessary to ensure compliance with legal standards and accounting principles.