Depreciation on Intangibles Acquired Through Demerger: ITAT Kolkata Upholds Tata Consumer Products' Claims for AY 2020-21

Background and Context

The Income Tax Appellate Tribunal, Kolkata, recently adjudicated a significant appeal filed by Tata Consumer Products Limited against an assessment order dated 27.06.2024 for Assessment Year 2020-21, framed under Section 143(3) read with Section 144C(13) of the Income Tax Act, 1961, following directions of the Dispute Resolution Panel (DRP) issued on 19.06.2024 under Section 144C(5) of the Act.

Three principal issues came up for consideration before the Tribunal:

  1. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules, 1962
  2. Disallowance of depreciation under Section 32 of the Act on goodwill, brands and distribution network acquired through a court-sanctioned demerger
  3. A deduction claimed under Section 80G

The Tribunal's ruling, particularly on the depreciation question, carries considerable precedential weight given the scale of the transaction and the number of judicial decisions engaged in the analysis.

The Demerger Transaction: Structure and Valuation

How the Business Undertaking Was Acquired

Under a scheme of demerger sanctioned by the National Company Law Tribunal (NCLT) on 08.01.2020, the consumer products business undertaking of Tata Chemicals Limited vested in Tata Consumer Products Limited as a going concern, effective 01.04.2019. As consideration for this acquisition, the assessee allotted 29,04,21,986 fully paid equity shares to the shareholders of Tata Chemicals Limited, carrying an aggregate fair value of ₹6,098.87 crore.

Both entities being listed companies, applicable provisions of the Companies Act and SEBI Regulations mandated that the transfer occur at fair value and that the share exchange ratio be determined on a fair basis. Two Chartered Accountant firms — one each appointed by the respective companies — independently arrived at the exchange ratio of 114 equity shares of the assessee for every 100 shares held in Tata Chemicals Limited, employing the discounted cash flow method and comparable company multiples. An independent Category-I Merchant Banker, M/s DSP Merrill Lynch Limited, certified the fairness of this exchange ratio.

Purchase Price Allocation

Ernst & Young Merchant Banking Services LLP prepared a purchase price allocation report dated 13.05.2020 under Indian Accounting Standard Ind AS 103. The report identified intangible assets — specifically three brands and a distribution network — that had not been recorded in Tata Chemicals Limited's books, assigning them a fair value of ₹2,459.01 crore. After deducting this figure and the value of net tangible assets from the total consideration of ₹6,098.87 crore, residual goodwill of ₹3,562.41 crore was recognised.

The assessee accordingly claimed:

  • Depreciation of ₹890.60 crore on goodwill
  • Depreciation of ₹614.76 crore on brands and distribution network

Neither the fact that these assets were absent from Tata Chemicals Limited's books, nor the valuations contained in the report dated 13.05.2020, were disputed by the Revenue.

Issue 1: Disallowance Under Section 14A Read with Rule 8D

Facts

During Financial Year 2019-20, the assessee earned dividend income of ₹19.36 crore, claimed as exempt under Section 10(34). On a voluntary basis, the assessee disallowed ₹62,16,000 under Section 14A as expenses attributable to the earning of exempt income, arrived at by apportioning a portion of employee costs. The Assessing Officer, without substantively engaging with this computation, applied Rule 8D(2)(ii) and computed a total disallowance of ₹9,44,16,000. After netting the voluntary disallowance, a further disallowance of ₹8,82,00,000 was proposed and ultimately confirmed in the final assessment order.

The DRP sustained this addition on the ground that the 2016 amendment to Rule 8D made mechanical application of the formula mandatory, removing any discretion from the Assessing Officer.

Tribunal's Analysis

The Tribunal examined the interplay between Section 14A(2) and Rule 8D. It noted that Section 14A(2) expressly conditions the Assessing Officer's recourse to the prescribed method upon his not being satisfied with the correctness of the assessee's claim. This statutory condition is mirrored in sub-rule (1) of Rule 8D, which remained untouched by the Income Tax (Fourteenth Amendment) Rules, 2016. That amendment substituted only sub-rule (2) — changing the computational formula — and omitted sub-rule (3). It did not, in any manner, displace the anterior requirement of recording cogent dissatisfaction with the assessee's computation.

The Tribunal observed that the Assessing Officer's recorded reasoning amounted to nothing more than an observation that the assessee's disallowance was "not satisfactory as provisions of Section 14A clearly provide for the rules/calculation." Rejecting an assessee's computation solely on the ground that it does not conform to the Rule 8D formula, without first examining the accounts and articulating reasons for dissatisfaction, does not constitute the satisfaction required by the statute.

Relying on:

  • The coordinate bench order in ITA No. 1869/KOL/2014 for AY 2009-10 (upheld by the Calcutta High Court, ITAT 327 of 2018, order dated 25.02.2019)
  • PCIT v. West Bengal Infrastructure Development Finance Corporation Ltd., (2022) 143 taxmann.com 135 (Calcutta High Court)