A Change in the Law of Depreciation

A recent decision of the Bombay High Court in CIT v. M/s Techno Shares & Stocks Ltd. seems to have greatly narrowed down the scope of depreciation under the Income Tax Act. Although the issue before the Court was only whether depreciation can be granted on a Bombay Stock Exchange Membership Card, the rationale of the decision is likely to have significant implications for the law of depreciation.

Prior to the 1998 Finance Act, depreciation was allowed only in respect of tangible assets, specifically ‘buildings, machinery, plant or furniture’. By an amendment in 1998, a list of intangible assets was added to the provision. Now, depreciation can also be allowed in respect of ‘know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial right of similar nature’. The issue before the Court in Techno Shares & Stocks was whether the membership card amounted to a ‘license’ or ‘any other business of commercial interest of a similar nature’. The assessee contended that the BSE card is a ‘licence’ which permits or entitles a person to carry on the business of trading in shares on the floor of the Stock Exchange. In any event, given that the card was essential for the assessee to trade carry on the share broker business, it would be considered a ‘business or commercial interest’.

The Court, however, rejected these contentions, holding that the membership card was neither a license, nor a ‘business or commercial interest’ for the purposes of the provision. It began its analysis by observing that the Act allowed depreciation only in respect of the specific items enumerated in the provision, and reading ‘license’ broadly would go against this legislative intent. On this basis, the Court sought to narrow down the term ‘license’ using the doctrine of noscitur a sociis and ejusdem generis, basically suggesting that the term should be interpreted in the context in which it is used, and should take colour from the language of the provision. The Court observed that the types of assets preceding ‘license’ were all related to intellectual property rights. On this basis, the Court concluded that the terms ‘license’, and ‘any other business or commercial right’ also had to be in relation to intellectual property rights. On this reasoning, the Court refused to allow depreciation on the membership card.

While much can be said in favour of decision, especially when it comes to the implications of giving ‘license’ a wide interpretation. However, for two reasons, the decision seems to be at odds with the rationale of the provision.

First, the notes on clauses of the 1998 amendment stated- “It is proposed to widen the scope of this section so as to provide that depreciation will also be allowed where intangible assets are owned wholly or partly by the assessee and are used by such assessee for the purposes of his business or profession. Intangible assets, such as know-how, patent rights, copyrights, trademarks, licences, franchises or any other business or commercial rights of the assessee will form a separate block of assets”. This clearly suggests that the legislative intent was not to narrow the class of intangible assets in respect of which depreciation is allowed to purely intellectual property rights. It was only because intellectual property rights are the most common form of intangible assets that they form a majority of the items listed in the provision.

Secondly, previous decisions on this issue, although all decided by tribunals, also seem to differ from the rationale of the Court. Admittedly, the jurisprudence on the issue is divided, and there have been decisions which have applied noscitur a sociis and ejusdem generis to exclude certain types of leases and goodwill from the scope of the provision [R.G. Keswani v. ACIT, [2009] 116 ITD 133(Mum); M.M. Nissim v. ACIT]. However, neither of these two cases proceeded on the basis that the provision was restricted only to assets related to intellectual property rights. Further, there are a couple of decisions of the Chennai Tribunal which have held non-compete fees to be covered by the phrase ‘any business or commercial right’ [ACIT v. Real Image Tech Pvt. Ltd.; ITO v. Medicorp Technologies India Ltd.]. Further, a decision of the Bombay tribunal in Skyline Caterers v. ITO, [2008] 306 ITR 369 (Mum), has used the test that “rights which can be used as a tool to carry on the business” are covered under the provision. This shows that the judicial opinion is far from unanimous in the interpretation of the provision, and that no other Court has sought to restrict the scope of the provision to right related only to intellectual property rights.

Given this conflict of jurisprudence on this issue, and the far-reaching implications of the decision of the Bombay High Court, the outcome of a possible appeal or subsequent decisions on the provision will be eagerly awaited.