(This post is authored by and published on behalf of Mathews P. George)
In M/s Hilton Roulunds Ltd v. Commissioner of Income Tax (2018), the Delhi High Court held that the expenditure incurred by the assessee for acquiring trademark was revenue expenditure and not capital expenditure. Accordingly, the expenditure is deductible under Section 37(1) of the Income Tax Act, 1961.
As per the first licensing agreement, the appellant had to pay running royalty at the rate of 1.8% of the net selling price from the date of commercial production of respective goods. The licence could be terminated by 12 months’ notice or by 30 days’ notice in case of breach of the terms of the agreement. The Agreement was for a period of 10 years. As per the second licensing agreement, which has overridden the first licensing agreement, a one-time royalty of Rs. 1 crore was payable towards the trademark licence. As per the terms, the Appellant enjoyed the exclusive right to use the mark for an indefinite time period.
The Assessing Officer, holding the expenditure to be of enduring nature, concluded that the expenditure was capital expenditure. The Commissioner of Income Tax (Appeals), reversed the finding of the Assessing Officer. The Department went in appeal and the ITAT concurred with the finding of AO.
The Delhi High Court reversed the ITAT’s finding and observed as follows: “When the benefit of the use of the mark has inured to the licensor i.e. HRL, the amount, that has been paid to HRL was a consideration for permission to use the mark, and not for acquiring ownership rights in the mark. The mark “HILTON” did not belong to the appellant. It also did not belong to either of its current promoters i.e. RF or IFU. It belonged to HRL which was one of the joint venture partners when the appellant was initially formed. The use of the mark “HILTON” thus, merely facilitated the appellant’s business in India. The question of law is answered in the negative, in favour of the Assessee and against the Revenue. It is directed that the payment of Rs. 1 crore be treated as revenue expenditure.”
[For distinction between capital expenditure and revenue expenditure, please click here. Please note that I do not intend to test the instant fact situation against all the factors distinguishing capital and revenue expenditure. On the other hand, I intend to test the given fact situation against some of the prominent factors only.]
Conceptually speaking, I am not convinced with the tenability of reasoning of HC. Ownership over an asset confers one with “a bundle of rights”. Licence, on the other hand, gives the licensee the right to exercise a particular right or set of rights agreed upon by the licensor. In determining whether the corresponding expenditure is capital or revenue in nature, the substance rather than the form of the expenditure must be examined. In the instant case, the expenditure is one-time in nature which is a characteristic associated with capital expenditure. As to draw an analogy, instead of buying a building for running my business, if I obtain lease / licence, the pertinent determining question should be whether that right (of indefinite time period for one-time payment) inter alia forms part of permanent platform on which the intended business is to be run? If yes, it should be capital expenditure.
Having the right to use a certain trademark for an indefinite time period improves the earning capability of the assessee (as the assessee can invest in brand building etc). On the other hand, if the licence period is pre-determined, the royalty payments at definite time intervals are necessary to ensure the ‘maintenance’ of earning capacity (by continuing to use the trademark). While the former is a characteristic associated with capital expenditure, the latter is a characteristic associated with revenue expenditure. In the instant case, the assessee can confidently invest in long term brand building as the licence period is indefinite and further, the royalty is one-time royalty payment. A permanent platform is built and further, the right to use that particular trademark is no longer a contingent right. It is a permanent right and therefore, no expenditure is required vis-à-vis ‘maintaining’ the right to use that trademark. Therefore, for the aforesaid reasons, I am inclined to perceive it as more a case of capital expenditure rather than revenue expenditure.
Finally, applying the canons of interpretation associated with taxation, an interpretation favouring tax avoidance is to be avoided. If the reasoning and conclusion of this judgment is accepted as tenable, then it paves the way for similar tax structuring schemes which may, arguably, contradict the intention of the legislature. Therefore, arguably, this judgment contradicts the mischief rule of interpretation as well.
Image from here