The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has dismissed the Revenue’s appeal against deletion of a ₹3.80 crore penalty imposed under Section 271AA of the Income Tax Act, 1961, holding that goodwill recognised in the books pursuant to a court-approved demerger, without any actual purchase, sale or transfer of goodwill, could not be treated as an international transaction under Section 92B. 

The bench of Vimal Kumar (Judicial Member) and M. Balaganesh (Accountant Member) noted that the accounting treatment was revenue-neutral and that the assessee had a reasonable cause for not reporting the amount in Form 3CEB. 

The appellant/assessee was an Indian subsidiary of Top Victory Investment Ltd., Hong Kong, and was engaged in selling products manufactured by the TPV Group in the Indian market. For AY 2015-16, the company filed its income-tax return declaring a loss of approximately ₹10.31 crore.

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The assessment was subsequently completed under Section 144C read with Section 143(3) of the Act on February 7, 2019. During the assessment proceedings, the matter was referred to the Transfer Pricing Officer (TPO because the assessee had entered into international transactions aggregating to approximately ₹315.53 crore. 

The TPO noticed that the assessee had not reported an alleged international transaction relating to acquisition of goodwill of ₹190.06 crore in Form 3CEB. Based on this, penalty proceedings under Section 271AA were initiated.

The Assessing Officer ultimately imposed a penalty of ₹3,80,13,460, alleging failure to report the relevant international transaction. 

The assessee explained that the Indian Branch Office of Top Victory Investment Ltd. had been demerged into the assessee with effect from April 1, 2014, pursuant to a scheme approved by the Punjab and Haryana High Court on March 9, 2015.

Under the scheme, the assets and liabilities of the branch undertaking were transferred to the assessee at their written-down values as appearing in the books of the demerged undertaking. 

As a consequence of the accounting treatment required to give effect to the demerger, the assessee recognised goodwill of ₹1,90,06,73,197, representing the difference between the assets and liabilities of the demerged undertaking.

The assessee maintained that the goodwill was not acquired from the associated enterprise. Rather, it was merely an accounting entry arising from implementation of the demerger scheme.

The assessee further pointed out that there had been no goodwill recorded in the books of the erstwhile branch office itself. Therefore, according to the assessee, there could be no question of any purchase, transfer or acquisition of goodwill from the branch office. 

The Revenue argued before the ITAT that the CIT(A) had erred in holding that the goodwill did not constitute an international transaction.

According to the department, the recording of goodwill in the assessee’s books as a consequence of the demerger had a bearing on the assessee’s assets and therefore fell within the scope of Section 92B.

The Revenue also relied on the Supreme Court’s decision in Smifs Securities Ltd. v. CIT, under which goodwill has been recognised as falling within the expression “any other business or commercial right of a similar nature” in the context of intangible assets. 

The CIT(A), however, examined the financial statements of the demerged undertaking and found that no goodwill existed in the books of the erstwhile branch office as on March 31, 2014.

Accordingly, the appellate authority concluded that there had been no transfer of goodwill between the associated enterprises.

The ₹190 crore goodwill reflected in the assessee’s books represented the difference between the assets and liabilities of the demerged undertaking and was recognised pursuant to the accounting treatment applicable to the demerger. 

The CIT(A) therefore held that the accounting entry could not, by itself, be treated as an international transaction within the meaning of Section 92B.

The CIT(A) also relied upon the principle that the transfer-pricing machinery under Sections 92B to 92F presupposes the existence of an international transaction. Since there was no goodwill appearing in the books of the demerged undertaking, there was no acquisition of goodwill by the assessee from that undertaking. 

Another important factor considered by the appellate authorities was the absence of any revenue or tax impact.

The assessee had initially recognised goodwill of approximately ₹190 crore. A substantial portion, approximately ₹150 crore, was amortised through the Profit and Loss Account during the relevant year.

However, the amortisation charged to the Profit and Loss Account was added back while computing taxable income. Consequently, the accounting treatment did not result in a reduction of taxable income. 

The CIT(A) accordingly treated the accounting of goodwill as revenue-neutral.

The Tribunal specifically noted that out of the ₹190 crore goodwill, ₹150 crore was amortised through the P&L account and the corresponding amount was added back in the computation of income. 

The CIT(A) also found that the assessee had made complete disclosure of the relevant facts.

The scheme of arrangement and the accounting treatment were disclosed in the financial statements, including Note No. 31 to the accounts. The assessee had also furnished the relevant material to the accountant preparing Form 3CEB.

The appellate authority therefore concluded that the assessee had made a complete and bona fide disclosure of the underlying facts. 

The assessee also contended that the demerger itself was tax-neutral and did not result in any profit or loss or tax benefit. The CIT(A) recorded that the TPO and AO had accepted in their respective proceedings that the accounting of goodwill had no revenue impact. 

The Assessing Officer had relied upon the Supreme Court’s decision in Smifs Securities Ltd. v. CIT to treat goodwill as an intangible asset.

The CIT(A), however, distinguished that ruling, observing that the Supreme Court decision concerned the allowability of depreciation on goodwill under Section 32.

According to the CIT(A), that decision did not establish that the mere accounting recognition of goodwill arising from a demerger, without any transfer or acquisition of the asset, automatically constituted an international transaction under Section 92B. 

The CIT(A) identified an additional defect in the penalty proceedings.

It observed that the penalty notice issued under Section 274 read with Section 271AA did not specifically identify how the assessee had failed to report the relevant transaction. The notice was therefore found to be vague.

Importantly, the CIT(A) also noticed that the notice referred to Section 271(1)(c) at one point instead of Section 271AA, leading the appellate authority to characterise the notice as mechanical in nature. 

After considering the facts, the CIT(A) held that there was a bona fide difference of opinion between the assessee and the Assessing Officer on whether the goodwill entry amounted to an international transaction.

It therefore concluded that the assessee had demonstrated a reasonable cause for not reporting the amount in Form 3CEB.

Taking into account Sections 92B to 92E read with Section 273B, the CIT(A) deleted the entire penalty of ₹3,80,13,460 imposed under Section 271AA. 

The Delhi ITAT examined the findings of the CIT(A) and found no reason to interfere.

The Tribunal noted that the goodwill was recognised as a consequence of the demerger and that the underlying financial records showed that the demerged undertaking itself did not have goodwill on its books.

Thus, the Tribunal accepted the reasoning that the ₹190 crore entry was essentially an accounting recognition arising from the excess of liabilities over assets, rather than a transaction involving acquisition or transfer of goodwill between associated enterprises.

The Tribunal further emphasised the revenue-neutral nature of the accounting treatment and found the Revenue’s grounds to be without merit. 

Ultimately, the ITAT dismissed the Revenue’s appeal, thereby sustaining the deletion of the ₹3.80 crore penalty under Section 271AA.

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