Can a Assessee claim any deduction on expenditure for acquisition of patent, trademarks, copyrights and know-how as depreciation?

Depreciation under the Income Tax Act is a deduction allowed for the reduction in the real value of a tangible or intangible asset used by a taxpayer. The concept of depreciation is used for the purpose of writing off the cost of an asset over its useful life. While computing one’s income, the depreciation as per Income Tax Act, 1961 is allowed while the book depreciation is disallowed. This is because the Income Tax Act prescribes its own rate of depreciation. The Income Tax Act allows depreciation on the Written down Value of the assets. The depreciation is computed on ‘Block of assets’ at the rates prescribed rates provided in the Income Tax Rules, 1962.

As per section 32 of Income Tax Act, 1961, an assessee is entitled to claim depreciation on fixed assets only if the following conditions are satisfied:

• Assessee must be owner of the asset – registered owner need not be necessary.
• The asset must be used for the purposes of business or profession
• The asset must be used during the previous year.

Co-owners can claim depreciation to the extent of the value of the assets owned by each co-owner. Depreciation is mandatory from A.Y. 2002-03 and shall be allowed or deemed to have been allowed as a deduction irrespective of a claim made by a taxpayer in the profit & loss account.

However, can a Assessee claim any deduction on the alleged expenditure for acquisition of patent [trademarks] rights, copyrights and know-how as depreciation? Let us refer to the case of Mangalore Ganesh Beedi Works v. CIT (2015), to find the answer to this question.

Facts of the Case:

• In 1939 late Sri S. Raghuram Prabhu started the business of manufacturing beedis.
• He was later joined in the business by Sri Madhav Shenoy as a partner and thus M/s. Mangalore Ganesh Beedi Works (MGBW) came into existence
• The partnership firm was reconstituted from time to time and its last reconstitution and partnership deed contained Clause 16 relating to the manner in which the affairs of the partnership firm were to be wound up after its dissolution.
• According to Clause 16, if the partnership was dissolved, the going concern carried on under the name of the Firm Mangalore Ganesh Beedi Works and all the trademarks used in course of the said business by the said firm and under which the business of the partnership was carried on shall vest in and belong to the partner who offered and paid or two or more partners who jointly offered and paid the highest price
• The other partners shall execute and complete in favour of the purchasing partner or partners at his/her or their expense all such deed, instruments and applications and otherwise and him/her name or their names of all the said trademarks and do all such deed, acts and transactions as are incidental or necessary to the said transferee or assignee partner or partners.
• Due to differences between the partners of MGBW, the firm was dissolved when two partners of the firm applied for its winding up by filing Petition in the High Court (HC).

• While entertaining the Company Petition the HC appointed an Official Liquidator and eventually, after hearing all the concerned parties, a winding up order was passed
• High Court held that the firm was dissolved and directed the sale of its assets as a going concern to the highest bidder amongst the partners.
• Pursuant to the order passed by the HC, an auction was conducted in which three of the erstwhile partners forming an association of persons (AOP) emerged as the highest bidders and their bid of Rs.92 crores for the assets of MGBW was accepted by the Official Liquidator.
• The business of the firm was then passed on into the hands of AOP
• MGBW (Assessee) while filing its return, claimed a deduction of Rs. 12,24,700 as a revenue expenditure permissible under Section 37 of the Income-Tax Act, 1961 towards legal expenses incurred.
• The Assessee also claimed depreciation under Section 35A and 35AB towards acquisition of Intellectual Property Rights such as rights over the trademark, copyright and technical know-how.
• In the alternative, the Assessee claimed depreciation on capitalizing the value of the Intellectual Property Rights by treating them as plant.
• Assessing Officer (AO) passed an order rejecting the claim of the Assessee under all the three Sections.

Order passed by Appellate Authorities

• Feeling aggrieved, the Assessee preferred an appeal before the Commissioner of Income-Tax (Appeals) [CIT(A)].
• The appeal was allowed in part inasmuch as it was held that the Assessee was entitled to a deduction towards legal expenses.
• However, the claim of the Assessee regarding deduction or depreciation on the Intellectual Property Rights was rejected by the CIT(A).
• As a result of the appellate order, the Revenue was aggrieved by the deduction granted to the Assessee in respect of legal expenses and so it preferred an appeal before the Tribunal.
• The Assessee was aggrieved by the rejection of its claim in respect of the Intellectual Property Rights and also filed an appeal before the Tribunal.
• The Tribunal allowed the appeal of the Assessee while rejecting the appeal of the Revenue

Appeal before the High Court (HC)

The three substantial questions of law considered by the High Court were as follows:

• Whether amount claimed as revenue expenditure by the AOP which was constituted by the three partners of the erstwhile firm, MGBW, could be allowed as permissible deduction in the hands of the said AOP under Section 37 of the Income-Tax Act, 1961, as being laid out or expended wholly and exclusively for the purpose of business of the said Association of Persons?
• Whether the Assessee was entitled to claim any deduction on the alleged expenditure for acquisition of patent [trademarks] rights, copyrights and know-how, in terms of Section 35A and 35AB of the Act?
• Whether the Tribunal had erred in directing the AO to capitalize the value of trademarks, copyright and technical know-how by treating the same as plant and machinery and grant depreciation therein?

In its conclusion, HC answered the first two questions in the negative and the third question in the affirmative in favour of the Revenue and against the Assessee. While doing so, the High Court set aside the findings of the Tribunal and restored the order of the AO.

Observations of the SC on whether legal expenses incurred for defending the business of the going concern and for protecting its interest could be said to be incurred for the purpose of the business and therefore, allowable under section 37(1)

• SC observed that in Dalmia Jain & Co. Ltd. v. CIT [1971] (SC), it was held that the expenses for the purposes of protecting the business of the assessee as a going concern was allowable under section 37(1) of the Act.
• SC held that there is a clear finding of fact by the Tribunal that the legal expenses incurred by the assessee were for protecting its business and there was no reason to reverse this finding of fact particularly since nothing has been shown to conclude that the finding of fact was perverse in any manner whatsoever.
• Therefore, the legal expenses incurred for protecting the business were allowable as deduction under section 37(1) of the Act. 

Observations of the SC on whether expenditure incurred on the acquisition of trademarks, copyrights and know-how is allowed for depreciation under Section 32

• The Intellectual Property Rights such as trademarks, copyrights and know-how come within the definition of ‘plant’ for the reason that in a large business, control over intellectual property rights such as brand name, trademark etc. are absolutely necessary.
• Moreover, the acquisition of such rights and know-how is acquisition of a capital nature.
• Therefore, the trademarks, copyrights and know-how acquired by the assessee would come within the definition of ‘plant’ being commercially necessary and essential as understood by those dealing with direct taxes.
• Therefore, the assessee was entitled to the benefit of section 32 read with section 43(3) of the Act.

Therefore, in conclusion, even prior to the insertion of “intangible assets” in section 32, intellectual property rights such as trademarks, copyrights and know-how constitute “plant” for purposes of depreciation. The department is not entitled to rewrite the terms of a commercial agreement. Also legal expenses incurred for defending the business of the going concern and for protecting its interest could be said to be incurred for the purpose of the business and therefore, allowable under section 37(1).

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