Section 47A(3) can be invoked only if benefit u/s 47 is claimed-High Court upheld deletion of royalty paid on takeover

Section 47A(3) can be invoked only if benefit u/s 47 is claimed. High Court uphelds deletion of payment of brand name royalty to proprietor on takeover.

ABCAUS Case Law Citation:
ABCAUS 2218 (2018) (02) HC

The Challenge/Grievance:
The case law involves the appeal filed by the Income Tax Department (Revenue) against the order of the Income Tax Appellate Tribunal (ITAT/Tribunal) in deleting the addition made of royalty paid for the use of the brand name and payment for copyright holding bith the payments to be revenue expenditure.

Important Case Laws Cited/relied upon by the parties:
CIT Vs. IAEC (Pumps) Ltd., 232 ITR 316

Brief Facts of the Case:
The respondent assessee was a private limited company. One of the directors of the company was carrying out business as sole proprietor in a firm’s name . The assessee company entered into an agreement to take over the business of the proprietory concern of the director.

The agreement was signed by the same person as proprietor of the selling concern and as a director of the assessee i.e. the purchaser.

The said directors had invented a technology and had a registered copyright in respect of the name of his proprietorship firm. As per the terms of the agreement,the director  permitted the assessee company to use the intellectual property vested in him, viz. his copyright name but he had not assigned the same to the assessee company.

Section 47A(3) can be invoked only if benefit u/s 47 is claimed.

The said director was entitled to receive royalty of 2% of the gross revenue receipts under the relevant business after two years of the closing date. The transfer of assets etc. of the sole proprietorship firm was against a monetary consideration and the director also acquired shareholding in the assessee company.

During the relevant assessment year, the assessee paid royalty for the use of the brand name to the said director. In the return of income the assessee company treated the amount of royalty paid as a business expenditure. Also, the company has claimed the payment of licence fee paid to another company as Revenue expenditure.

The case was taken up in scrutiny. The Assessing Officer (AO) sought an explanation from the assessee on various issues, including royalty and the licence fee paid. The assessee filed a reply. The AO was not satisfied with the reply filed. The Assessing Officer (AO) finalised the assessment u/s 143(3) of the Income Tax Act, 1961 (the Act) by inter alia made making addition on account of royalty paid to the assessee’s director. Further the payment of licence fee paid was treated as capital expenditure.

The CIT (Appeals) upheld the said additions.

Contentions made on behalf of the Petitioner Revenue:
The Revenue contended that since the director who was also the sole proprietor of the firm was being paid royalty, therefore, there was a violation of clause (xiv) of section 47, as consideration, apart from allotment of shares, was paid to him. The sole proprietor has admittedly received consideration in cash which included payment of royalty for the use of the brandname. Moreover he had admittedly not received shares as consideration for the same. Thus, it was contended that section 47 has no application to the case.

It was submitted that in view of the payment made, sub-section (3) of section 47A should be invoked and the said consideration would be deemed profit and gain of the assessee company.

Observations made by the High Court:
Regarding the ground that the agreement was only a colorable devise to reduce the tax liability of the company in which the Director was the sole beneficiary, the Hon’ble High Court noted that it, in the assessee’s own case decided this issue by holding that the Revenue had erred in considering that the assessee had entered into an agreement with himself by ignoring that the assessee company was a separate legal juristic entity.

The Hon’ble High Court noted that while section 45 deals with tax on capital gains, section 47 excludes certain transfers from the purview of Section 45 being not regarded as transfers for the purpose of section 45.

The clause (xiv) of section 47 deals with transfers where a proprietary concern is succeeded by a company in the business carried on by it, as a result of which the sole proprietary concern sells or otherwise transfers the capital assets to the company. The proviso to clause (xiv) provides three conditions. Proviso (c) provides that the sole proprietor has not received directly or indirectly any consideration, except by way of allotment of shares in the company.

The Hon’ble High Court also noted that Section 47A lays down the conditions, which if violated, would result in withdrawal of exemption as provided under section 47. Sub-section (3) of section 47A deals with violation of clause (xiii) or proviso to clause (xiv) of section 47. The result of violation would be that the amount of profits or gains arising from the transfer will be treated as deemed profits and gains of the successor company chargeable to tax in the previous year in the hands of the company.

The Hon’ble High Court opined that the issue raised had no foundation to stand. There were no findings that the provisions of section 47 were invoked for claiming exemption from capital gains while making transfers from the sole proprietary concern to the assessee company. The applicability of section 47A would arise only if it is established that section 47 was pressed into service. In absence thereof, the deeming provision of sub-section (3) of section 47A cannot be invoked.

The Hon’ble High Court noted that as per the agreement, it was evident that the sole proprietor/director had received a consideration for the use of the brand name. This itself showed that exemption of section 47 was not available. However, the appellant Revenue did not contend or establish that the assessee availed the benefit of Section 47.

Regardingt he issue of ITAT treating the copyright expense as a revenue expense, the Hon’ble High Court observed that the Tribunal on appreciating the agreement rightly came to the conclusion that only a license to use the copyright was granted to the assessee company. The assessee company had not acquired the copyright. In such circumstances, the license fee paid is a revenue expenditure. In this regard, the Tribunal rightly followed the decision of the Supreme Court. The assessee company did not own the copyright. It was only granted a license to use the same. Such a case would not be covered under section 32.

Decision/ Conclusion/Held:
The questions were answered in favour of the assessee and against the Revenue.

Section 47A(3) can be invoked only if benefit u/s 47 is claimed.

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