A) Assessee is engaged in the business of multimedia computer graphics and animation and had been running a software and training division. The software and training division was hived off to its sister concern ‘PCL’ for a consideration of Rs. 894.21 crores which included brand value of Rs. 544.21 crores and towards transferring of intellectual property rights in the software developed by the assessee and also towards non-compete fee.

In agreement it was mentioned as sale of intellectual property rights which were explained to be trade names, trade marks or service marks together with the goodwill associated therewith and also copyrights, trade secrets, confidential or proprietary information, computer programmes and all other sorts of intangible rights and properties. AO examined the accounts of the sister concern and observed that Rs. 626,08,80,282/- was accounted under ‘fixed assets’ towards goodwill on acquisition of the software division. Assessee did not offer any capital gains towards transfer of goodwill. Assessee contended that the sister concern had debited the consideration under the head ‘goodwill’, pending allocation of the excess consideration paid over depreciation value of the assets. But for this difference, as far as the assessee was concerned, there was no goodwill included in the transaction.

AO did not accept the claim of the assessee and held that the consideration also included a portion attributable to the transfer of goodwill of the software division of the assessee company. Even if it is impossible to ascertain in terms of money value of goodwill in view of its nebulous character and its uncertain nature, it is possible to value the goodwill by applying accounting standards at a certain multiple of the average profits of the past in the belief that if the business is continued in the same name and style, the same amount of profits would be earned in future as well and worked out the goodwill by working out the average of the profits of five years and taxed the sum as short term capital gains under the provisions of section 55(2)(a)(ii).

CIT observed that the quantum determined by the assessing authority was not correct. CIT found that the AO had adopted the value of goodwill at the average of the five years’ profit and no multiplier was applied to follow the accepted method of valuation of goodwill. Thus it was erroneous and prejudicial to the interests of the Revenue. CIT further held that the transferor company and the transferee company both were having a common chairman and CEO and they were all working in a closely related manner, there was no much relevance in attributing a sizeable amount of the consideration as non compete fee. There was no case of any competition between these units working under the same management with a common chairman and CEO. Thus, non compete fee was nothing but a colourful arrangement of the accounts to shadow over the reality of the transfer of goodwill. The alleged payment towards non compete fee, IPR on brand/brand value, etc. was a figment of a creative accounting with no relevance to real price. The amount relating to the sale consideration had been written off by the assessee and the value of shares had come down below Rs. 25/-. It means brand value was nothing but goodwill. Thus, the average profit of the assessee had to be multiplied by a reasonable factor to decide the fair value of goodwill and directed the AO to examine the whole issue afresh. AO had not at all considered the issue of ESOPs. Thus, CIT set aside this matter to AO to reexamine the issue.

Assessee filed an appeal against the order u/s 263 which was delayed by 1671 days. Assessee contended that the advice given to the assessee was that as the entire assessment order was set aside, no prejudice was caused to the assessee and the issues could be agitated in the consequential assessment as the outcome of the appeal which was pending before the CIT (A). By the time, AO passed a fresh assessment considering Rs. 126 crores as short term capital gain on goodwill. When this order was taken in appeal before the CIT (A), the impression given to the assessee was that as the assessment order was passed under the direction of the CIT, the CIT (A) might not interfere in the revised value of goodwill. Thus, the proper course of action was to file an appeal before the Tribunal against the revision order itself.

As per the directions of CIT, AO adopted the average profits of the assessee for the last three years and applied a multiplying factor of 3 years and finally determined the value of goodwill at Rs. 126.67 crores which was brought to tax as short term capital gain on sale of goodwill. CIT (A) dismissed the appeal of assessee following his order in preceding year.

B) AO treated the interest income as income from other sources and disallowed the benefit of section 10B. CIT (A) confirmed the order of AO. Assessee contended that the interest income received should be treated as business income and the interest paid should be set off against the same. The fixed deposit is made for margin money and as such interest from the same should be treated as business income.

C) AO treated the 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. as income from other sources, as against claimed by the assessee as business income. Assessee contended that those receipts were having clear nexus with the business carried on by the assessee.

D) AO treated the rent received by the assessee from staff as income from other sources against claimed by the assessee as business income.

After hearing both the parties, the ITAT held that,

A) ++ there is substance in the submissions made by the assessee. It is not the case that the assessee has not pursued the matter. Even in the original assessment, an addition was made in respect of goodwill. That issue was pending before the CIT (A) at that point of time. So there cannot be a case that the assessee has ever accepted the stand of the Revenue on the question of goodwill. As multiple proceedings were alive at that point of time, the assessee had in fact chosen to rely on one course of action that of regular appeal against the order of the AO and thereafter, if necessary, before the Tribunal. Delay in filing this appeal was caused for genuine reasons and not because of any callous or negligent attitude of the assessee. Accordingly, the delay is condoned;

++ as rightly pointed out by the CIT, the AO has not analysed the circumstances leading to the payment of non-compete fee by the sister concern to the assessee-company. 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 assessee-company and its sister concern are working in close relation with a lot of interlacing of activities and interlocking of finance. In these circumstances, as rightly pointed out by the CIT, the prominent question to be considered is whether there is any occasion at all to make out a case of paying non compete fee to the assessee-company. The question is, is there any justification for the sister concern for paying any non-compete fee to the assessee company? The assessee and is its sister concern may have their own explanations. But, the issue is that the assessing authority has not considered this aspect at all. Therefore, on this ground as well, the order passed by the assessing authority is erroneous ad prejudicial to the interests of the Revenue. Likewise, CIT has categorically held on the basis of examination of the terms of the sale agreement that the assessing authority has not examined important aspects such as the consideration paid for the transfer of intellectual property rights and also the deduction claimed by the assessee in respect of ESOP scheme. Thus, even though the AO has computed an amount attributable to goodwill even against the contentions raised by the assessee, the computation of goodwill made by the AO was not proper;

++ in the present case, there are no two views available before the AO to choose among them as a possible view. While doing the valuation of the goodwill, the Assessing Officer has adopted only the average profit for five years without any multiplier. The standard rule of valuation of goodwill is to apply a factor of multiplier. There are no two views on this point. If a multiplier is not necessary, it is the duty of the Assessing Officer to state in his order as to why the situation of the present case is different and a different rule should be applied. Therefore, the revision order passed by AO is just and proper;

++ the transferee company has treated a prominent portion of the consideration towards goodwill. The argument of the assessee that the transferee company has shown the amount towards goodwill only as an interim arrangement, pending appropriation of the consideration among properly classified heads, cannot be accepted in its entirety. Some portion of that amount may be attributed to other assets and rights acquired by the sister concern. 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 as well as its sister concern do have a common CEO and the companies are working under a common management. Thus, it is correct that 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. 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. Thus, the only conclusion that can be arrived is that the total consideration received by the assessee from its sister concern also included a payment towards goodwill as well. AO has adopted the average profit of the immediate past three years and multiplying factor of three years. Both the variables are extremely fair. Therefore, the value of goodwill is confirmed as Rs. 126.67 crores;

++ however, the capital gain cannot be held to be short-term capital gains. 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. Therefore, the Assessing Officer is not justified in treating the capital gains arising out of sale of goodwill as short-term capital gains;

B) ++ Section 10B provides for deduction of such profits and gains as are derived by a hundred percent export oriented undertaking from the export of articles or things or computer software. The interest received by the assessee on margin money deposits were not generated out of export activity. Therefore, the assessee is not entitled to treat the interest income as business income eligible for deduction under section 10B;

C) ++ incidental income arising from use of computers, insurance claims on damage to computers, etc. needs to be treated as operational income in the nature of business income. This is the case with the sale of scrap as well. Reimbursement of expenses incurred for agents abroad in fact reduces the cost in assessee’s hands and, therefore, resulting in overall increase in business income and thus, is to be treated as business income and eligible for deduction u/s 10B;

D) ++ the rent recovery made from the employees is not an independent income or a different source of income. The assessee is providing residential quarters to the employees against which a nominal rent is recovered from them. The recovery ultimately reduces the cost in the hands of the assessee. Therefore, the recovery is in the nature of business income. Thus, the lower authorities are not justified in treating it as income from other sources.

(See 2012-TIOL-733-ITAT-MAD)