Facts of the case
- Assessee is engaged in the business of multimedia computer graphics and animation. Assessee’s software and training division was hived off to its sister concern M/s. Pentafour Communications Ltd.
- The consideration for the transaction was Rs. 894.21 crores. No amount was attributed towards goodwill. But amounts were attributed towards non compete fee, sale of brand name, sale of IPR, etc.
- In its computation of income, the assessee has not offered any capital gains towards transfer of goodwill.
- The accounts of the sister concern M/s. Pentafour Technologies Ltd. reflected Rs. 626,08,80,282 under the head ‘fixed assets’ towards goodwill on acquisition of the software division.
- AO observed that there is an element of goodwill included in the transfer price determined for the transaction.
- AO computed goodwill by taking average of the profits of five years from 1996 to 2000 which worked out at Rs. 31,74,40,000 and brought the same to tax as short-term capital gains under the provisions of section 55(2)(a)(ii) of the Act.
- The assessment order was revised on the above issue and direction was given to the AO to apply a proper multiplier to value the goodwill on accepted method of accountancy. The AO accordingly worked out the average profit of the latest three last years 1998, 1999 and 2000 to Rs. 4,222.33 lakhs. The multiplier of 3 was applied and ultimately the goodwill was valued at Rs. 126,67,00,000/-. and amount of Rs. 126,67,00,000/- treated as short-term capital gains.
Assessee’s contentions
- The sister concern debited the consideration under the head ‘goodwill’, pending allocation of the excess consideration paid over depreciation value of the assets.
- Goodwill can be brought to tax only if it is transferred and consideration paid for it. In the present case, the business as a whole was transferred, and the break up of the total consideration was clearly demarcated between fixed assets, current assets and investments, intellectual property rights and non compete fee. No amount was earmarked or received for “goodwill”.
Revenue’s Contentions
- The transferor company and transferee company both are having a common chairman and CEO and they are all working in a closely related manner, there is no much relevance in attributing a sizeable amount of the consideration as non compete fee.
- The amount attributed to non compete fee is nothing but a colourful arrangement of the accounts to shadow over the reality of the transfer of goodwill.
- Many of the components of the consideration have been termed by the assessee as non compete fee, IPR value, brand value, etc. to evade payment of capital gains tax on the transfer of the software division.
- All these figures were imaginary to re-engineer the balance-sheet of the assessee and group companies with no cash flow affected.
HELD:
- The locus standi of the parties to the transaction to fix an amount of non compete fee is to be appreciated in the light of the fact that the assessee and sister concern are under the common management of a common chairman and a common CEO.
- The accounts of the sister concern itself is a documentary evidence for the Revenue to come to a fair conclusion that the consideration definitely included consideration towards goodwill.
- The assessee has made an attempt to suppress the true colour of the payment towards the goodwill by stating that payments were made towards non compete fee, IPR on brand/brand value, etc
- There is no de facto situation which demands payment of non compete fee by the assessee’s sister concern to the assessee company. This is the same case with IPR on brand/brand value, etc. These are all, as rightly held by the Commissioner of Income-tax, a figment of a creative accounting, with no relevance to real state of affairs.
- It is to be seen that inspite of such a magnitude of the deal , the actual fund transmitted between the parties was only Rs. 58 crores. The assessee has written off amounts to the sale consideration thereby reducing the share value. In these circumstances the only conclusion that one may arrive at is that the total consideration received by the assessee from its sister concern also included a payment towards goodwill as well. Therefore, the factum of goodwill is confirmed.
- Valuation of goodwill by AO upheld and addition of Rs. 126,67,00,000/- as capital gains is confirmed.
- Capital gain cannot be held to be short-term capital gains. Section 50 does not automatically apply to an asset only because of the reason that the asset is a depreciable asset. The assessee was in the business for more than five years. The goodwill is a self generated asset and generates alongwith the commencement of the business, especially in the field of software technology. The capital gains of Rs. 126,67,00,000/- must be treated as long-term capital gains and taxed accordingly.
Other issues
- Interest income on margin money deposits were not generated out of export activity. To be treated as income from other sources and therefore, not eligible for deduction u/s 10B
- Amount received on renting out of computers, insurance claims on damage to computers, sale of scrap and reimbursement of expenses incurred for agents abroad, etc. to be treated as business income eligible profit for deduction under section 10B.
- Rent recovery made from the employees is not an independent income and is in the nature of business income eligible for deduction under section 10B