Knowhow write-off: Comparing Sec. 32 and Sec.35AB of IT ACT 1961
The definition for Knowhow in the IT Act 1961 is “any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil well or other sources of mineral deposits (including the searching for, discovery or testing of deposits or the winning of access thereto.” Currently the act speaks of the amortization of Knowhow through two different provisions namely Sec.32 (depreciation of intangible assets) and Sec.35 AB (Amortization of Knowhow). Though neither of them is a non obstante provision, they are mutually exclusive benefits (i.e. both are not deductible simultaneously).
The rate of depreciation permissible under Appendix 1 to the IT Rules is 25% for Knowhow acquired on or after 1.4.1998 and on Written down value basis. But, two of the main conditions associated with depreciation claim under Sec.32 are 1) Ownership during the previous year and 2) Usage for the purpose of Business or Profession. As per Sec.35 AB where the assessee has paid in any previous year relevant to the assessment year commencing on or before the 1st day of April, 1998] any lump sum consideration for acquiring any know-how for use for the purposes of his business, one-sixth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year, and the balance amount shall be deducted in equal installments for each of the five immediately succeeding previous years.
The following is an attempt to capture the advantages and disadvantages of claiming deduction under these twin sections.
Sec.32 of the Income tax Act 1961:
1. The assessee can avail the benefit of carry forward of any depreciation loss arising in the current year and set it off indefinitely as Unabsorbed Depreciation Loss. (Sec.32 (2)).
2. There is no explicit word suggesting that the actual cost of the asset should have been actually paid during the previous year. In other words consideration is not necessary to have been paid. The word ‘paid’ is defined to be construed according to the method of accounting regularly employed by the assessee as per Sec.43 and Sec.32 leaves these terms to be determined by Sec.43. Needless to say if it is an accrual system of accounting, then capitalization based on the relevant agreement followed by a claim is possible.
1. The condition of usage during the previous year for the purpose of business poses the obstacle. Hence during a period of lockout the claim may not be tenable.
2. In case of an amalgamation, both the amalgamating as well as amalgamated company will have to satisfy certain conditions prescribed under Sec.72A of the act to claim the set off of the carried forward unabsorbed depreciation loss which interalia include continuance of business of the amalgamating company for a minimum period of 5 years by the amalgamated Company. It may be noted the unabsorbed depreciation is treated as current depreciation for the current assessment.
Sec.35AB of the Income tax act 1961
1. Unlike Sec.32 of this act there is no condition for actual usage during the previous year. The principal condition is that a lump sum amount towards Knowhow amount should have been paid during the previous year. It may be noted that unlike Sec.32 there is no reference for the term ‘paid’ as defined under Sec.43; hence we may consider the word paid to mean actual payment.
2. In case of an amalgamation, the amalgamated company is entitled to the same extent of deduction but for the residual period as it would have been allowable to the amalgamating company or the demerged company, as the case may be, had such amalgamation or demerger not taken place. This is allowed unconditionally.
1. The most serious disadvantage in making a claim under Sec.35 AB is that no carry forward of such unabsorbed expenditure may be allowed under the Act unlike as provided under Sec.32(2).
2. The assessee cannot skip amortization intermittently under this section once the process had already started. The words ‘five immediately succeeding previous years’ is a very clear indication.
The commonness in these two sections is that the benefits under either of them will be available only if the expenditure is of capital in nature. In other words, if it is revenue expenditure, the same is allowable under Sec.37 of the act. The same has been affirmed by Supreme Court in CIT v. Swaraj Engines Ltd. Civil Appeal No. 3347 of 2008 May 6, 2008. This expenditure is to be considered under Sec.32 or Sec.35AB as appropriate by the assessee while computing the Profits and gains of Business for the purpose of claiming exemption under Sec.10A and Sec.10B.