The Hindu Business Line : Depreciation on rights acquired under contract

Allowability of depreciation vis-À-vis rights acquired under contracts in the course of business has always been a subject matter of considerable uncertainty and litigation.

Surojit Ray

With the objective of overcoming glaring inconsistencies, the law makers have made certain conscious efforts to achieve alignment to the extent possible between provisions of the Income-Tax Act, 1961 and the accounting methodologies regularly followed by tax assessees.

A notable step in this regard was the introduction of depreciation (under Section 32 of the I-T Act) in relation to intangible assets acquired on or after April 1, 1998.

Further to the above amendment to Section 32, allowability of depreciation vis-À-vis rights acquired under contracts in the course of business has always been a subject matter of considerable uncertainty and litigation.

The few existing judicial precedents on this subject have not been too successful in putting a conclusive end to this issue. Recently, The Mumbai Tribunal had the opportunity to revisit this issue in the Skyline Caterers (P) Ltd case.

Facts of the case

As per the facts of the case, the assessee-company was engaged in the business of providing catering, house-keeping and allied services to a client company. Prior to the assessee-company, an individual was providing the said services (for approximately 30 years) to the client company.

Accordingly, the assessee-company had entered into an agreement with the individual for taking over the catering contract between the individual and the client company for a lumpsum consideration of Rs 27 lakh.

The said agreement provided that of this consideration of Rs 27 lakh, a sum of Rs 25 lakh was being paid for acquiring all the rights under the catering contract and some tangible assets belonging to the individual. Further, the balance Rs 2 lakh was being paid as non-compete fees to the individual.

The assessee-company characterised this entire sum of Rs 27 lakh in its balance-sheet as “goodwill” and claimed depreciation thereon as per clause (ii) to Section 32(1) of the I-T Act.

In this context, it is pertinent to note that clause (ii) to Section 32(1) provides for depreciation in relation to knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after April 1, 1998.

Tribunal’s view

While addressing this appeal, the Mumbai Tribunal at the outset held that the nomenclature given to the entries in the books of account is not relevant for ascertaining the real nature of the transaction (thus following the decision of the Supreme Court in the Kedarnath Jute Mfg. Co. Ltd vs CIT (82 ITR 363) case).

Further, the Mumbai Tribunal held that a combined reading of all the clauses of the agreement and the preamble clearly reveals that the assessee-company has paid a sum of Rs 25 lakh for acquiring all rights under the contract between the individual and the client company as well as certain tangible assets belonging to the individual. Further, a sum of Rs 2 lakh has been paid to the individual as non-compete fees.

Going further, on the question as to whether the rights transferred under the agreement are covered within the ambit of clause (ii) to Section 32(1) or not, the Mumbai Tribunal held that the principle of ejusdem generis would have to be duly applied in this regard.

On this subject, the Mumbai Tribunal further held that the meaning of the aforesaid principle is that words of a general nature following specific and particular words should be construed as limited to things which are of the same nature as those specified.

The general words take their colour from the specific words. Further, applying the aforesaid principle, the expression “any other business or commercial rights of similar nature” in clause (ii) to Section 32(1) would include such rights which can be used as a tool to carry on the business of the assessee-company.

Having regard to the above, the Mumbai Tribunal concluded that the rights acquired by the assessee-company under the agreement do satisfy the above criterion and hence, would fall within the scope of clause (ii) to Section 32(1).

These apart, the Mumbai Tribunal also held that the value allocable to the transfer of certain articles (that is, tangible assets which qualify for depreciation under clause (i) to Section 32(1)) would have to be imputed separately as their value is also incorporated within Rs 25 lakh, and the balance sum would be eligible for depreciation as per clause (ii) to Section 32(1).

On a concluding note, the Mumbai Tribunal also distinguished the decision of the Ahmadabad Tribunal in the Bharatbhai J Vyas vs ITO (97 ITD 248) case, wherein it has been held that sum paid to a retiring partner on account of goodwill is not eligible for depreciation, as goodwill simplicitor cannot be considered as an intangible asset in terms of clause (ii) to Section 32(1) of the I-T Act.

The reasoning provided by the Mumbai Tribunal for the same was that Baharatbhai’s case pertained to a vanilla transfer of goodwill (as opposed to transfer of rights under a contract in the facts of the case — even though the same has been represented under the head ‘goodwill’ in the balance-sheet of the assessee-company).

Thus, it is hoped that this ruling would lend requisite certainty on the issue of allowability of depreciation vis-À-vis various rights acquired under contracts in the course of business.

(The author is a Deputy Manager with Deloitte, Haskins & Sells, Mumbai.)

More Stories on : Accountancy | Income Tax | Courts/Legal Issues

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Banking with Singapore

Depreciation on rights acquired under contract

Intricacies of indivisible business

Ideas are like pizza dough

Short-selling does have a rationale

Powering a resurgent India

Fusion of energy economics with financial engineering

‘Inflation and growth’

Faculty shortage

Pay Commission recommendation

Welcome move

Undeserved largesse

Fall in small savings