Income Tax Appellate Tribunal - Bangalore
M/S G. Corp Private Ltd.,, Bangalore vs Department Of Income Tax on 25 January, 1996
IN THE INCOME TAX APPELLATE TRIBUNAL
"B" BENCH : BANGALORE
BEFORE SHRI GEORGE GEORGE K., JUDICIAL MEMBER
AND SHRI A. MOHAN ALANKAMONY, ACCOUNTANT MEMBER
ITA No.465/Bang/2010
Assessment year : 2005-06
The Deputy Commissioner of
Income Tax,
Circle 11(3),
Bangalore. : APPELLANT
Vs.
M/s. G. Corp Private Ltd.,
No.21/19, Craig Park Layout,
Off M.G. Road,
Bangalore - 560 001. : RESPONDENT
Appellant by : Shri P.H. Naragundkar, Addl.CIT(DR)
Respondent by : Shri Cyrus Jal Bharucha, C.A.
ORDER
Per A. Mohan Alankamony, Accountant Member
This appeal of the Revenue is directed against the order of Ld. CIT (A) - I, Bangalore, in ITA No: 21/DC - 11(3)/ CIT (A)-I/ 07-08 dated:
22.1.2010 for the assessment year 2005-06 in the case of M/s. G. Corp Private Limited, Bangalore.
2. The Revenue raised five grounds in which ground Nos: 1, 4 and 5 being general and no specific issues involved, they have become ITA No.465/Bang/10 Page 2 of 17 non-consequential. In the remaining grounds, the crux of the lone issue is confined to-
"that the CIT (A) was not justified in deleting the addition of Rs.15 lakhs being corporate membership fee paid to Bangalore Club."
3. Briefly stated, the assessee - a Private Limited company and its nature of business being property development/real estate management
- during the year under dispute had claimed Rs.15 lakhs as revenue expenditure having paid to Bangalore Club as corporate membership fee. The AO was, however, of the view that the amounts paid to a club membership which was a payment once and for all, resulting in an enduring benefit to the assessee and, thus, treated the same as capital expenditure, brushing aside the assessee's strong reliance on the finding of the Hon'ble Bombay High Court reported in 195 ITR 682 (Bom), terming it as not on the facts and circumstances comparable to the case on hand.
4. Aggrieved, the assessee took up the issue with the CIT (A) for relief. The Ld. CIT (A), relying on the jurisdictional Tribunal's finding in the case of Infosys Technologies Ltd. v. JCIT reported in (2007) 109 TTJ 0631, favoured the assessee.
5. Disillusioned with the treatment of the issue by the CIT (A), the Revenue has come before us with the present appeal.
6. During the course of hearing, the brief submission of the Ld D.R was revolved around the fact that the first appellate authority has grossly erred in allowing the payment made to the Club as revenue expenditure without appreciating the fact that the payment gives rise to an ITA No.465/Bang/10 Page 3 of 17 enduring benefit to the assessee and was, therefore, in the nature of a capital expenditure.
6.1. On the other hand, the argument of the Ld. A R was that -
(i) the payment was made out of business expediency and enables the assessee to improve its business relations and prospects. Not only does it provide its executives/officers better contacts and associations with persons in good position, relating in favourable publicity for the assessee, but the Club provides a convenient place for holding meetings and discussions. The purpose behind the membership was to establish contacts which was in the long term interest of the assessee;
- the club forms a fertile ground for meetings, but, also constitute a relatively cheap place to entertain one's clients and customers;
- by incurring the expenditure, the assessee had not acquired any capital asset, nor was there any enduring benefit to the business, but, it was a normal expenditure incurred in the day- to-day running of the business;
(ii) the fee paid is non-refundable. Even if the assessee decides after a period of time that it does not want the membership, the money is not refundable and, thus, there was both accrual and payment during the year under consideration
(iii) relies on the following case laws -
(a) Otis elevator Company (India) Ltd. v. CIT 195 ITR 682 (Bom)
(b) Gujarat State Export Corporation Ltd. v. CIT 209 ITR 649 (Guj)
(c) CIT v. Sundaram Industries Ltd. 240 ITR 335 (Mad)
(d) JCIT v. M/s. Cabot India Ltd. in ITA NO:5043/Mum/2001 dt:25.7.2005 of the ITAT, Mumbai Bench 'H'
(e) DCIT v. Kodak India Ltd. in ITA NO.934/M/.07 dated:
16.2.2009 of the ITAT, Mumbai Bench 'A'
(f) Engineers India Ltd. 239 ITR (Del) 237
(iv) Neither the assessee has acquired any capital asset with respect to the payment made nor there is any enduring benefit accruing to the business of the assessee.
(v) There is no concept of deferred revenue expenditure defined in the income tax proceedings. Expenditure has to be either considered ITA No.465/Bang/10 Page 4 of 17 as revenue or capital in nature. Once the expenditure is held to be revenue, the same has to be fully allowed as held in the case of Travancore Rubber & Tea Co. Ltd. v. CIT (41 ITR 751) and CIT v. Kusum Products Ltd. (149 ITR 250).
(vi) To treat the expenditure incurred for obtaining corporate membership of a club as pre-paid expenses is incorrect in law
(vii) Courts in India have repeatedly held that the expenditure incurred on account of technical know-how fees is revenue in nature and fully allowable in the year in which it is incurred in spite of the fact that the relevant technical know-how agreements were entered into for a substantial period of time.
7. The Ld. AR, Mr. Cyrus Jal Bharucha agreed with the concept of prepaid expenses, however, restricted its application to expenditure in the nature of rent advance, insurance premium. Ld. AR agreed that the prepaid expenses are to be disclosed in the balance sheet on the asset side of the Balance Sheet and the portion of expenditure attributable to the relevant financial year is to be charged to the profit & loss account. Ld. AR cited the example of insurance premium to explain the concept of 'Prepaid Expenses'. He explained that the premium is paid over the period of the insurance policy and accounted as stated above. In case the insurance policy is terminated before the expiry of the term, then the premium paid for the next quarter is refunded to the policy holder. The standard fire and special perils policy clause (material damage) of the New India Assurance Co. Ltd. was quoted as an example, wherein the clause "General conditions" item No.5 it is stated that "this insurance may also at any time be terminated at the option of the company, on 15 day's notice to that effect being given to the insured, in which case the company shall be liable to repay on demand a rateable portion of the premium for the unexpired term ITA No.465/Bang/10 Page 5 of 17 from the date of the cancellation". Ld. AR further explained that similarly if rent is paid in advance and the lessee decides to terminate the lease, the rent paid for the unexpired period of the lease is refunded to the assessee. Ld. AR argued that the concept of Prepaid Expenses cannot be extended in the case of corporate membership because if the appellant decides to discontinue with the Corporate membership, the fees paid for the unexpired period of membership is not refunded. Therefore, the entire expenditure has to be considered as revenue expenditure in the year in which it is incurred.
8. On the other hand, ld. DR emphasized that the payment made for corporate membership is for a benefit of enduring nature and, therefore, the expenditure is purely a capital expenditure. At no stretch of imagination this lump sum payment of Rs.15 lakhs could be considered as revenue expenditure for the benefit derived out of this payment subsists over a period of 15 years. Ld. DR prayed for upholding the order of ld. AO.
9. We have duly considered the rival submissions and carefully perused the relevant records and also the aide memoir furnished by the Ld. A R during the course of hearing to drive home his point.
10. Let us first advert to analyze the provisions of the Act relevant to decide the issue. Section 28 of the Act is the charging section bringing under its fold the chargeability of income under the head 'profits or gains of business or profession'. Section 29 of the Act provides the manner in which the income under the head 'profits or gains of business or profession' is to be computed i.e., in accordance with sections 30 to 43D of the Act. ITA No.465/Bang/10 Page 6 of 17 Sections 30 to 36 provide exclusively for certain deductions in the nature of expenditure, allowance, rebate, reserves, etc. Section 37 provides for deduction of any expenditure incurred wholly and exclusively for the purpose of business or profession but not provided under sections 30 to 36 of the Act and which are not in the nature of capital expenditure, personal expenses or any expenditure prohibited by law. Thus, it is evident that any revenue expenditure expended wholly and exclusively for the purpose of business or profession barring certain expenditure specifically provided by the Act shall be allowed as deduction. Therefore, the moot question before us is to determine the nature of expenditure with regard to payments made for obtaining corporate membership in a club. At this stage it is very relevant for us to examine as to what revenue, capital and prepaid expenditure are.
10.1 Revenue expenditure : It is an expenditure incurred for the purpose of earning the income for the previous year. The benefits derived from this expense are exhausted during the previous year and does not overflow to the subsequent year. In certain cases the benefits derived from the expenses incurred during the previous year overflow to the subsequent years. For example, expenditure incurred on advertising and publicity, training and education to staff, sales promotion expense, etc. Definite period for which the benefits overflow cannot be determined. This kind of expenditure is termed as deferred revenue expenditure. There are no special treatments provided under the Act for deferred revenue expenditure. Therefore, due to the complexities involved in apportioning the relevant expense for the relevant previous year, the Courts have often ITA No.465/Bang/10 Page 7 of 17 held these kinds of expenses to be revenue in nature and the entire expenditure incurred during the previous year is allowed as deduction for the previous year, overlooking the principles of matching concept, perhaps also for the reason that these expenses are primarily incurred for deriving benefit during the previous year; as in the case of Advertisement and Publicity expenses, it is very essential to incur these expenses in order to earn revenue during the previous year, though benefits derived overflow for the subsequent years which are only consequential, and to what extent the benefits are derived in the subsequent years are not measurable. 10.2. Capital expenditure: It is an expenditure incurred for bringing into existence an asset or an advantage of enduring benefit. The word 'capital' refers to permanency. Hence, such expenditure revolves around to bring in a tangible or intangible asset. Such asset either delivers income or assists in earning income year after year.
10.3. Prepaid expenditure: It is an expenditure incurred for deriving a benefit or service for a predetermined period consisting of several previous years; however the entire expenditure is paid in a previous year. For example, (i) rent paid in advance say for five years, (ii) hire charges paid in advance say for 3 years, (iii) premium paid for securing warranty benefits say for 3 years, etc. Thus, a lump sum amount is determined and paid by an entity for the service to be obtained for a definite period of time. It is an advance payment made for the service to be rendered for the current previous year and also for later years. Therefore, it is appropriate not to charge the advance portion of payment made as revenue expenditure for ITA No.465/Bang/10 Page 8 of 17 the previous year. The advance portion has to be reflected in the balance sheet under the head 'current asset' and the portion pertaining to the relevant previous year has to be charged in the profit & loss account as revenue expenditure. In every previous year adjustments have to be made in order to give true and fair view of the balance sheet of the entity.
11. Now let us examine as to what corporate membership of Bangalore Club means. The extract of the Bangalore Club's recent-bye laws are reproduced herebelow for reference:
"Corporate Membership:
(a) A Public or Private Limited Company incorporated in India, Nationalised Banks, State Bank of India and its subsidiaries, Private Banks, Financial Institutions, Foreign Banks, Insurance Companies and Public Sector Undertakings having an office or factory in the State of Karnataka with a paid up capital of not less than Rs.10 Crores, or a wholly owned subsidiary Company incorporated in India of a holding Company incorporated overseas with a paid up capital of not less than US $ 10 million or its equivalent shall be eligible upon the proposal of a Permanent Member, duly seconded and accompanied by a Statement of Particulars relating to such Corporate Organisation, furnished by the Chief Executive thereof to be elected as a Corporate Member of the Club. Any such entity can opt for more than one Corporate Membership by being the last in the waiting list, if any, as on the date of registration of application provided there are no vacancies. Such Membership shall entitle the Corporate Member to nominate three of its full time directors / Senior Executives for use of the facilities provided by the Club.
Notwithstanding a nomination not being made, the Corporate Member shall be liable to effect immediate payment of the prescribed fees for the use of the facilities provided by the three of its full time directors / Senior Executives for use of the facilities provided by the Club. Notwithstanding a nomination not being made, the Corporate Member shall be liable to effect immediate payment of the prescribed fees for the use of the facilities of the Club by such nominees. Each of the Corporates nominees shall furnish a Certificate from their Auditor/s confirming that the intended nominee is a full time director / Senior Executive of the aforesaid Corporate Organisation holding the position stated in its nomination form. Such a certificate ITA No.465/Bang/10 Page 9 of 17 shall be submitted every year as on 31st march, in the absence thereof, the nominee/s will not be allowed use of the Club facilities.
The Club shall have authority to reject a nominee if it considers him/her unsuitable. The total number of Corporate Members shall at no time exceed One Hundred and Seventy Five.
(b) A Corporate Member shall ensure prompt payment of Club dues by its nominees and shall lose its membership in the event any or all of its nominees after being denoted a defaulter fails to pay their/his/her dues to the Club within the period prescribed in these Rules.
Provided that the Corporate Membership of such Company/Organisation shall stand automatically terminated upon the expiry of 10 years from the date of election, or earlier in the event of a change in status of the Company/Organisation, under which it ceases to exist by reason of its amalgamation with another organisation, its liquidation or otherwise and upon such termination all nominations of such Corporate Member shall ipso facto determine. Corporate Member may however, apply for re-election if they are eligible to do so and their said application for re-election shall be considered immediately, if they apply for such Membership not less than six months before the date on which their existing Membership ceases.
Transitory Provisions: The enhancement in the capital base and automatic clause under this category shall not affect the Membership of the existing Members in this category.
(c) Fee: Non-refundable Corporate Membership Fee - Rs.45 Lakhs + 10.30% of Service Tax.
12. Thus, on payment of the stipulated amount (in the appellant's case Rs.15 lakhs, however it is relevant to note that as on date any fresh applicants are charged by the Club Rs.45 lakhs, further certain other clubs charge twice the fold or more) and compliance of the other terms and conditions of the Club corporate membership is granted to Corporate. The corporate member is entitled to nominate a specified number of their ITA No.465/Bang/10 Page 10 of 17 directors or semi-executives for the use of the facilities provided by the club for a period of ten years. They do not have voting power or right for participation in the management of the club. It is only a right given for the usage of the club on compliance with the rules and regulations of the club. This right of usage is given for a period of ten years from the date on which the corporate membership is granted. Therefore it is apparent that the benefit derived out of the payment of Rs.15 lakhs in the instant case, according to the submission of ld. AR, falls for fifteen years, as a result only the relevant proportionate portion attributable to the previous year can be considered as revenue expenditure and the balance will be in the nature of prepaid expenditure. This aspect is very crucial in determining the income for the previous year of an assessee.
13. The following accounting concepts are very relevant for determining the correct and actual income earned during the previous year:
(i) Revenue recognition concept: In the case of rendering services revenue is recognized proportionately with the degree of completion of service. Diagonally revenue expenditure has also to be recognized proportionately with the degree of deriving the services.
(ii) Matching concepts: After having recognized the revenue receipts for a period, all the costs relating to that period should be identified and charged to that period in order to determine the net income of that period.
This is the essence of matching concept. To measure the income of a period, it is very essential to arrive at the expenditure of that period and after arriving at such expenditure, it should be taken off from the total ITA No.465/Bang/10 Page 11 of 17 income earned for the period. The net result will be the actual income of the period. The capital expenditure which brings into existence a capital asset cannot be fully charged to the profit & loss account in the year in which such expenditure is incurred because the benefit derived from the asset extends till the lifetime of the asset. The Act has recognized the concept of depreciation being a notional expenditure allowable under the Act with specific rates with respect to such expenditure incurred for acquiring assets. This concept of depreciation is aimed at for absorbing the cost of the asset rationally over a period of years to determine the correct income earned for the previous year. As per section 4 of the Act, income tax shall be charged for any assessment year at any rate or rates prescribed in respect of the total income of the previous year. Previous year is defined in the Act as the financial year immediately preceding the assessment year. Therefore, it is essential to determine the actual income of the previous year considering all factors for levy of tax. For arriving at the actual income of the previous year it is very important to identify the income earned during the previous year and the expense attributable to the earnings made for the previous year. Thus apportionment of revenue and expenditure to the concerned previous year plays a vital role. i.e., All receipts received for the previous year has to be classified as accrued for the previous year and advance receipts. Only the receipts accrued for the previous year has to be booked as revenue receipts for the previous year and the balance has to be carried forward for the subsequent years. A similar treatment has to be met out for the payments made for expenses. At times difficulty arises due to certain deferred revenue expenses which ITA No.465/Bang/10 Page 12 of 17 cannot be apportioned correctly over a period of previous years. However primarily these expenses are incurred for a previous year and therefore several courts have held that such expenses have to be written off in the year in which it is incurred. However when an expense is incurred for a definite period and where the benefits derived in each previous year are even, such expenditure has to be apportioned proportionately. Unless such expenses are apportioned, the correct income of the previous year cannot be determined. In some cases, the period for which payment is done may be too long say 25, 30 years etc. Difficulty may arise in such case to apportion such expenses for such a long period. With respect to the aspects of club membership, rev. author Dorphy D'Souza in his book on Indian Accounting Standards and GAAP Vol. 1, 6th Edn. Reprint in July 2009 page 778 has clarified as under:
Club Membership:
Non-refundable club membership deposit should be shown as an intangible asset and amortised over the period of membership. In the case of corporate life membership, amortisation may exceed 10 years as there is persuasive evidence that benefits would flow even beyond that period. However, it would be prudent and conservative not to extend their life beyond 10 years for the purpose of amortization considering AS 26.
14. It is very relevant to note clause 63 of AS 26 which holds as under:
Amortization period: The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is a rebuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use. Amortization should commence when the asset is available for use. The objects of AS26 are to prescribe the accounting ITA No.465/Bang/10 Page 13 of 17 treatment for intangible assets that are not dealt with specifically in other accounting standards. The statement requires an enterprise to recognise an intangible asset if certain criteria are met. The statement also specifies how to measure the carrying amount of intangible assets and requires certain disclosures about intangible assets. It also lays norms for amortisation of the assets.
15. From the nature of expense incurred and the benefits derived, club membership can be construed as an intangible asset. By following the guidelines of AS 26 it can be judiciously concluded that this expense has to be written off in proportion to the life term of the membership and if the life term extends beyond ten years, it should be restricted to ten years. With regard to the argument put forth by the Ld.AR that the club membership fees is not refundable if the appellant decided to cede the membership and therefore the entire amount has to be written off in the year in which the amount is paid; we hold that in such situation the appellant will be entitled to write off the entire balance amount shown as prepaid expense in the Balance sheet in the year in which such an event happens because only during that period the expenses crystallizes.
16. The recent introduction of Section14A in the Income Tax Act, Accounting Standards and GAAP in particular AS1 and AS26 has further strengthened these concepts. The principles of Accounting standards and GAAP are applicable for "general purpose financial statements" which are prepared solely for tax purpose or for the use of lenders. Further the adherence to Accounting Standards is mandatory for all companies ITA No.465/Bang/10 Page 14 of 17 commencing from 7th December, 2006. Section 642 of the Companies Act, 1956 read with section 2(11), 217(2AA) and 227(3)(d) mandates the compliance of Accounting Standards. Further section 115J of the Income- tax Act, 1961 makes it mandatory for every assessee being a company for the purpose of this section to prepare its profit & loss account, balance sheet, etc. in accordance with the relevant provisions of the Companies Act, 1956. The introduction of Section14A in the Income Tax w.e.f.1/4/2007 by Finance Act 2006 solidifies the concept of matching concept which provides that for the purpose of computing total income no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income. AS1 also recognise and give vital importance to this concept. Though the introduction of Section14A of the Act and amendments of the companies Act are recent developments not affecting the assessee's case as it falls in the assessment year 2005-06 compliance of AS1 and AS26 is very relevant because it is a tool or a methodology to determine the correct state of affairs of an enterprise. The Accounting standards are prescribed to establish rules relating to recognition, measurement, and disclosure to ensure that all enterprises follow a uniform and correct approach in preparing their financial statements in order to arrive at the accurate state of affairs. Further it is worthwhile to mention that Accounting Standard-1 has been notified by the Central Government in accordance with the powers conferred by section 145(2) of the Act to be mandatory for all assessees following mercantile system of accounting vide Notification No.9949[F.No.132/7/95-TPL dated 25.1.1996 wherein the accounting ITA No.465/Bang/10 Page 15 of 17 policies such as "prudence", "substance over form", "materiality" and concept of "accrual", "going concern" etc. are embedded, which are very relevant to decide the issue before us.
17. Now after determining the nature of asset, it is very essential to comply with the convention of materiality i.e., if the cost incurred on the asset is negligible or small in value though technically the expense has to be apportioned for the number of years of the life of the asset it has to be written off in the year in which the cost is incurred. As per this convention one must attach importance to material details and ignore insignificant details in the financial statements. Unnecessarily insignificant details should not be burdened in the financial statements. According to Indian Accounting Standards-1, materiality should govern the selection and application of accounting policies. By this concept In the case of the Corporate Club membership if the fee paid is insignificant comparing with the profit/loss or turnover of the assessee the same has to be written off in the same year.
18. Having briefly discussed with the Indian accounting standards, generally accepted accounting principles and concepts which are solely existent for presenting a true and fair disclosure of statement of affairs in business environments, let us examine the issue before us. In the case on hand, the gross income of the assessee is Rs.90,00,000. The assessee has claimed Rs.15 lakhs as expenses for obtaining corporate membership in the club thereby declaring a net income of Rs.75 lakhs in its return of income. It amounts to approx. 16.67% of the gross income of the assessee ITA No.465/Bang/10 Page 16 of 17 which is on a higher side thereby distorting the correct income of the assessee for the previous year. Following the matching concept, the materiality concept and Accounting Standard AS 26 in the assessee's case before us, the amount of Rs.15 lakhs claimed as expenses towards corporate membership for a period of 15 years has to be apportioned in ten years proportionately from the date of obtaining the membership. It is ordered accordingly. We have held so in this case keeping in view of the facts of the case. However, if the amount paid is negligible, it will be appropriate to write off the expense in the year in which such expense is incurred. We further make it clear that the expenditure incurred by way of fees for obtaining corporate membership in a club is revenue and prepaid in nature and has to be written off in the year in which it is incurred or to be apportioned for a period not exceeding ten years, as the case may be, following the principles laid down hereinabove.
19. We have considered all the case laws referred to by the assessee, however we find that in certain cases the category of membership were distinguishable and all these technical factors involved were not put forth for consideration.
20. We have also relied on the recent decision rendered in the case of Orchid Chemicals & Pharmaceuticals Ltd. v. ACIT [2011] 7 ITR (Trib) 601 (Chennai) wherein it is held that the non-compete fees paid for a period of four years has to be spread over for the period of four years and in the case of Techno Shares And Stocks Ltd. Vs. CIT [2010] 327 ITR 323 (SC) wherein it is held that Membership of Bombay Stock Exchange is an ITA No.465/Bang/10 Page 17 of 17 Intangible Asset and depreciation can be claimed thereon. In the instant case Corporate membership is held to be an Intangible asset however it is written off in ten years following the principles laid down in AS6 because the definite period for which the benefit derived is predetermined unlike in the case of membership in stock exchange where the membership ceases to be an asset only when the member commits a default.
21. We would also like to place on record our appreciation for the strenuous and elaborate arguments put forth by the Ld.DR. and the Ld.AR.
22. In the result the appeal of the Revenue is partly allowed as indicated above.
Pronounced in the open court on this 10th day of March, 2011.
Sd/- Sd/-
( GEORGE GEOREGE K. ) (A. MOHAN ALANKAMONY )
Judicial Member Accountant Member
Bangalore,
Dated, the 10th March, 2011.
Ds/-
Copy to:
1. Appellant 2. Respondent 3. CIT 4. CIT(A)
5. DR, ITAT, Bangalore. 6. Guard file (1+1)
By order
Assistant Registrar
ITAT, Bangalore.