The Hindu Business Line : Depreciation on intangibles

Gone are the days, where the assets of a company would typically include tangible assets (or so to say traditional assets) such as plant, building, furniture, office appliances, etc.

In the present day business environment, intangibles form an essential part of the assets of a company.

Intangible assets are identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset.

These intangibles can either be in the form of copyrights, patents, trademarks, goodwill, trade secrets, customer lists, marketing rights, franchises, etc. which either arises on acquisition or are internally generated.

Very often, in a typical mergers and acquisition deal, the prospective buyer, apart from considering other legal and commercial considerations, would also consider the tax cost in his deal, which plays a significant role in influencing/structuring a deal.

The prospective buyer would be keen not only to know as to what are the types of the assets that he would own post-merger, but will also like to factor-in the tax incidence in the form of tax depreciation that would be allowed to him on the assets acquired.

Scope of Section 32

Historically, Section 32 of the Income-Tax Act, 1961 enabled companies to claim depreciation only on the tangible assets such as building, machinery, plant or furniture.

However with the growing need for recognition of intangibles, and keeping pace with the business realities, the scope of Section 32 was widened by the Finance (No. 2) Act, 1998, whereby depreciation is now allowed also on intangible assets acquired on or after April 1, 1998.

However it is interesting to note that not all the intangibles qualify for depreciation. The legislature in its wisdom has identified few intangibles for depreciation.

As per Section 32(1)(ii), depreciation is allowed only in respect of knowhow, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after April 1, 1998.

Thus from the above it can be noted that the depreciation is not only allowed on knowhow, patents, copyrights, etc., but is also allowed on any other business or commercial rights which are of similar nature.

It is therefore important to understand as to which types of intangibles qualify for depreciation and which do not qualify. Recently, the Mumbai Tribunal in the R.G. Keswani vs ACIT (2009 308 ITR (AT) 271) case has held that goodwill acquired by an assessee does not come under the expression of any business or commercial rights of the nature similar to know-how, patents, copyrights, etc. and is therefore not eligible for depreciation.

The Ahmedabad Tribunal in the Bharatbhai J. Vyas (2005 97 ITD 248) case has also held that the amount paid for goodwill does not result into acquisition of any knowhow, patents, copyrights, trademarks, etc., as prescribed in this behalf and consequently, the assessee is not entitled to claim of depreciation on goodwill.

A similar view has been taken by the Delhi Tribunal in the Guruji Entertainment Network Ltd (2006 14 SOT 556) case.

Tenancy rights

The Mumbai Tribunal in the M. M. Nissim & Co. vs ACIT (2007 18 SOT 274) case has held that the tenancy rights acquired by the assessee cannot be equated with the licence provided under Section 32 so as to qualify it as an intangible asset eligible for depreciation.

Customer contracts

The Mumbai Tribunal in the Skyline Caterers (P) Ltd vs ITO (2008 20 SOT 266) case has held that the specific intangible assets are followed by the expression ‘any other business of commercial rights of similar nature’. In such situation, the rule of ejusdem generis would apply, by virtue of which the expression ’any other business or commercial rights of similar nature’ would include such rights which can be used as a tool to carry on the business.

Applying the above test, the Mumbai Tribunal allowed deprecation on payment made for acquiring rights under a contract.

Marketing rights

The Delhi Tribunal in the Sarabhai Zydus Animal Health Ltd (2007 TIOL-202-ITAT-DEL) case has held that marketing rights acquired by the appellant were intangible rights and hence eligible for depreciation.

Non-compete right

Recently, the Chennai Tribunal in the ITO vs Medicorp Technologies India Ltd (2009 TIOL-203-ITAT-MAD) case once again analysed the claim of depreciation in respect of intangible assets in the form of payment made for a non-compete right.

In that case, Medicorp Technologies India Ltd (‘taxpayer’) who was engaged in manufacture and distribution of bulk drugs/intermediaries, including exporting of these products to the US, Canada, Europe and Australia, acquired an export division of Medispan Ltd. The total consideration paid for this acquisition was Rs 5.33 crore, of which, Rs 3.33 crore was paid towards intangibles that inter alia included use of brand names as well as transfer and assignment of product registration, business agreements, dossiers and licenses including dossiers pending approval, etc.

Further, Rs 2 crore was paid towards compensation for acceptance of non-compete obligation in respective exports of bulk drugs, pharmaceuticals products and formulations. The taxpayer, in its income-tax return, claimed the payment of Rs 2 crore towards the non-compete obligation as deductible revenue expenditure. The tax payer also made an alternate claim before the tax authorities that depreciation be granted on the non-compete right.

On the above facts, the Chennai Tribunal held that non-compete right acquired by the tax payer is towards compensation in the export business and hence it is a business / commercial right and hence eligible for depreciation.

The Tribunal observed that the capability of an asset to have a market value, assignability, transferability or diminution in value are no more the ‘touch stones’ to test the admissibility for depreciation under Section 32. The holder of patents, copyrights or trademarks can sue the one who infringes them. Similarly, payer of non-compete fees can sue the person who violates the non-compete terms and conditions.

The Tribunal concluded by observing that if patents, copyrights and trademarks fulfils the conditions of ‘being an intangible asset’ then surely the non-compete right acquired by the taxpayer also fulfils that condition by way of a logical corollary.

The above are landmark decisions and the views expressed by the judicial authorities need to be kept in mind while structuring a business deal.

(The author is Director, Deloitte Haskins & Sells, Mumbai.)

More Stories on : Taxation | Courts/Legal Issues

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

Stories in this Section
Full Government at last

Transfer of capital asset

Tax signals crisscross broadcasting

Depreciation on intangibles

Validity of audit objections

Cash or work: What do people want?

I-T with a human face

Inflation misery