Depreciation on Intangible Assets

A year ago (almost to the date), we had discussed the decision of the Bombay High Court in CIT v. Techno Shares, observing that it appeared at odds with section 32 of the Income Tax Act. Last week, the Supreme Court overruled the Bombay High Court. However, while the conclusion arrived at by the Court seems appropriate on the facts of the case, it is slightly disappointing that the basis on which the Bombay High Court had arrived at its conclusion has gone unaddressed by the Apex Court.

The issue which fell for the Court’s consideration was whether deprecation could be allowed on the membership card of a member of the Bombay Stock Exchange. The Indian law on depreciation is governed by section 32 of the Income Tax Act, the relevant part of which provides for depreciation ‘know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial right of similar nature’. Thus, the Court was asked whether the membership card could be said to be a ‘license’ or a ‘business or commercial right of a similar nature’.

The Bombay High Court, in deciding this issue had held that the card was neither a license nor a business or commercial right covered by the provision. The rationale adopted by the Court was that, applying the principle of noscitur a sociis and ejusdem generis (broadly meaning words in a statute should take colour from their context), the overriding requirement for allowing depreciation on intangibles under section 32 was that they be related to intellectual property rights [“IPR”]. Since the membership card had no relation to any IPR, the Bombay High Court refused to allow depreciation.

The Supreme Court however, has arrived at a different conclusion. The Court examined in detail the provision and the Rules and Bye-Laws of the Bombay Stock Exchange, to come to the conclusion that it is a business/commercial right, and that its terms make it clear that this right is in the form of a license. The Court observes that membership of the stock exchange enables a person to trade on the floor of the exchange, to participate in trading sessions and to access the market. This “right to participate in the market has an economic and money value. It is an expense incurred by the assessee which satisfies the test of being a ‘licence’ or ‘any other business or commercial right of similar nature’ in terms of Section 32(1)(ii)” (¶ 19).

Thus, the Court concluded that membership granted business/commercial rights in the nature of a license, and hence was clearly covered by the scope of the provision. However, in so doing, the Court does not explicitly express its view the reasoning adopted by the Bombay High Court- in its reading into the provision an IPR requirement, and in its reading ‘license’ narrowly. Obviously, by allowing depreciation on the membership card, the Court has impliedly rejected the argument on an IPR requirement being read into section 32. However, the reading down of ‘license’, which was also an important part of the Bombay High Court’s reasoning, has not got special attention from the Apex Court. In fact, the Court seems to be at pains to emphasise that the decision is not applicable beyond the specific confines of the facts at hand. In the words of the Court,

We hold that the said right of membership is a “business or commercial right” which gives a non-defaulting continuing member a right to access the Exchange and to participate therein and in that sense it is a licence or akin to licence in terms of Section 32(1)(ii) of the 1961 Act. That, such a right vests in the Exchange only on default/demise in terms of the Rules and Bye-laws of BSE, as they stood at the relevant time. Our judgment should not be understood to mean that every business or commercial right would constitute a “licence” or a “franchise” in terms of Section 32(1)(ii) of the 1961 Act. [emphasis supplied]

In sum, the Court has impliedly dismissed the IPR requirement read in by the Bombay High Court, while leaving the field open for further curbs being read into the interpretation of ‘any other business or commercial right of similar nature’.

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  • The SC judgment has, in effect, overruled the Bombay High Court judgment. Thus I dont think that the HC judgment is of any more concern (eventhough the SC judgment did not expressly address the interpretation of 'licence'). The interpretation adopted by the HC is unfortunate (for instance, did the court mean that the franchises should also have a character akin to IP??)

    The SC judgment has impliedly put forward a three step analysis of S. 32:

    1.Determine whether the intangible property falls under know-how / patents / copyrights / trademarks / licenses / franchises. If not, step 2

    2.a) Determine whether there exists a permission granted by a competent authority to exercise a certain privilege that, without such authorization, would constitute an illegal act (which is essentially what a licence means) or

    b) Determine whether there exists a special privilege to do certain things that is conferred on an individual or a corporation and which does not belong to public of common right (which is essentially what a franchisee means)
    If 2(a) or (b) is satisfied, step 3

    3.Determine whether the right under step 2 is business or commercial in nature

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