The Income Tax Appellate Tribunal ( ITAT ), Delhi Bench, has recently, in an appeal filed before it, held that expenditure towards customer contracts and assembled workforce are “capital” in nature.
The aforesaid observation was made by the Delhi ITAT, when an appeal was preferred before it by the assessee, M/s. Genpact Services LLC, as against the order dated 15.02.2016, of the Commissioner of Income Tax (Appeals), New Delhi, pertaining to the assessment year 2010-11.
The grounds of the assessee’s appeal being the issues as to whether the expenditure incurred by the assessee for acquiring customer contracts and assembled workforce from M/s. Genpact India is revenue or capital in nature and secondly, and also as to whether the first appellate authority was justified in reducing the value of customer-related contracts and goodwill by tinkering with the value determined by the registered valuer, briefly, the facts relating to these issues were that the assessee was a non-resident corporate entity incorporated under the laws of Delaware, United State of America (USA), who was engaged in the business of providing Information Technology Enabled Services (ITES), such as data entry, conversion/processing data, business support, billing services.
For the assessment year under dispute, the assessee had filed its return originally on 12.10.2010 declaring a loss of Rs.3,89,17,092/, and thereafter, a revised return on 27.12.2011, declaring a loss of Rs.6,78,78,188/. However, in the course of the assessment proceedings, while examining the return of income filed by the assessee along with financial statements, the Assessing Officer noticed that in the year under consideration, the assessee had acquired third-party debt collection services as well as part of the analytical business of M/s. Genpact India as slump sale as a going concern on “as is where is basis” for a total consideration of Rs. 62,12,70,648/-.
Out of the same, an amount of Rs.39,96,70,372/ was found to be paid towards the acquisition of tangible assets, whereas, the balance amount of Rs.22,16,00,276/- represented payment made towards customer contracts, assembled workforce etc. Also, the Assessing Officer found that in the return of income, the assessee had claimed the amount of Rs.22.16,00,276/- as revenue/business expenditure.
Being of the view that such expenditure incurred has given enduring benefits to the assessee, the Assessing Officer called upon the assessee to show cause, as to why it should not be treated as capital expenditure. And, in response to the query raised by the Assessing Officer, the assessee furnished detailed submission stating that by incurring the expenditure, the assessee has not derived any enduring benefit, nor acquired any capital asset, and therefore it has to be allowed as revenue expenditure.
The Assessing Officer, however, being not convinced with the submissions of the assessee, he noticed that the assessee had recorded the payments in the books of account as intangible assets in terms of Accounting Standard -26 (AS-26). Thus, he observed that the accounting treatment given by the assessee itself presupposes that the expenditure incurred is capital in nature, while also referring to the note appended by the Auditor to the Audit Report, in this context.
Thus, ultimately, the Assessing Officer concluded that the expenditure incurred of Rs.22,16,00,276/- is in the nature of capital expenditure. And accordingly, he allowed depreciation at the rate of 25% on such expenses, while the balance amount of Rs.16,62,00,276/- was added back to the income of the assessee. And being aggrieved by this, the assessee contested the aforesaid disallowance before the Commissioner (Appeals).
While agreeing with the view of the Assessing Officer that the expenditure incurred was capital in nature, the Commissioner (Appeals), on verifying the break-up of the total consideration paid for acquiring the business from M/s. Genpact India found that the said consideration was based on a valuation made by an independent valuer, namely, Grant Thornton. And on examining the break-up, he found that the valuation of goodwill included the value of a trained and assembled workforce, amounting to Rs.2,91,63,000/-.
He also observed that the assessee had acquired the business on a slump sale as a going concern on “as is where is basis”, and that the business was acquired along with all assets and liabilities for a fixed consideration. Therefore, he was of the view that the consideration paid was for acquiring the business as a whole and thus, cannot be assigned to recruitment/training cost of employees that may have been imparted in the earlier years.
He observed that the employees were not bound to work with the assessee, as, no such contract exists with the assessee in that regard. Thus, he was of the view that the amount of Rs.2,91,63,000/- cannot be assigned to employees’ costs.
More so, when the employees have been assured of the same terms and conditions of services and emoluments as existed before, the agreement with the assessee and their services were deemed as continued, and in the aforesaid premises, he was of the view that the Assessing Officer had granted excess depreciation, thereby, resulting in under assessment of income. And, therefore, he issued a notice proposing to enhance the income.
Though, the assessee had filed detailed submission objecting to the proposed enhancement, the Commissioner (Appeals), however, rejected the submissions of the assessee, and observed that while valuing the intangible assets, which includes customer contracts, the Valuer has valued it for a period of 2 years and 4 months by taking the earnings before interest and taxed for 2010, 2011 and 2012 separately and thereafter discounted at the rate of 19.20%, which resulted in a value of customer contract at Rs.11,53,26,000/-. Further, the remaining life of customer contracts being further multiplied by an amortization tax benefit factor of 1.28%, resulting in the valuation of the customer contract at Rs.14,72,22,000/, thus, according to him, the assessee was claiming double benefit by first enhancing the present value of customer contract with the amount of likely tax benefit at the rate of 25%, on which further benefit in the form of depreciation allowance was also being claimed.
Stating that the value of customer contracts has been arbitrarily raised by Rs.3,18,96,000/-, he thus, reduced the value to Rs.11,53,26,000/- and further observed that while valuing the goodwill at Rs.7,43,78,276/-, the independent Valuer has included the value of assembled workforce amounting to Rs.2,91,63,000/-, which, according to the first appellate authority, cannot be included in the valuation of goodwill. And accordingly, he reduced the value of goodwill to that extent, thus, leaving the assessee aggrieved to prefer the instant appeal before the Delhi ITAT.
Hearing the opposing contentions of either side as presented by Advocates Sh. Tarandeep Singh, and Sh. Tarun Singh, on behalf of the assessee, as well as by Sh. Anand Kumar Kedia, the CIT (DR), along with Sh. Mrinal Kumar Das, Sr. DR, on the Revenue’s behalf, the Delhi ITAT observed:
“In sum and substance, by incurring the expenditure, the assessee has acquired a completely new business set up, which is nothing but an income generation tool. Therefore, in our view, the expenditure incurred is in the nature of capital expenditure. To that extent, we agree with the view expressed by the departmental authorities.”
“However, insofar as, the issue of enhancement of income by learned first appellate authority, we must observe, the assessee has paid the consideration for acquiring the business on the basis of value determined by an independent valuer. It is a fact that the assessee has paid the consideration as determined by the Valuer for acquiring the business. There is nothing on record to suggest that the payment claimed to have been made for acquiring the business is either non-genuine or doubtful. At least, no such view, either express or implied, can be found either in the observations of the Assessing or learned first appellate authority. Thus, when the payment made by the assessee is not disputed and is in terms of an agreement between two parties, learned Commissioner (Appeals) cannot arbitrarily and unitarily reduce a part of the payment made for computing depreciation”, ITAT Bench added.
“In any case of the matter, the consideration paid by the assessee is supported by the valuation report of an independent Valuer, who is an expert in the field. In case, learned first appellate authority had any doubt regarding the valuation report, he should have referred the valuation to an expert, instead assuming the role of Valuer himself and tinkering with the valuation of certain assets made in the valuation report, viz., customer and contract goodwill.”, ITAT Panel comprising of G.S Pannu, the President, along with Saktijit Dey, the Judicial Member further noted.
Thus, partly allowing the assessee’s appeal, the Delhi ITAT held:
“Thus, in our view, the action of learned Commissioner (Appeals) in reducing the value of customer contract and goodwill, as determined by the independent Valuer is wholly inappropriate, hence, unsustainable. Accordingly, we reverse the decision of learned Commissioner (Appeals) on the issue of valuation. Consequently, the computation of the Assessing Officer in allowing depreciation at 25% on the amount of Rs.22,16,276,000/- is upheld. Grounds are partly allowed.”
Subscribe Taxscan Premium to view the JudgmentSupport our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates
