A trademark is a distinctive sign that distinguishes the goods or services of a particular person or entity from those of others. Trademarks are valuable intangible assets that have an impact on brand reputation, customer loyalty, market share of a business etc. However, factors such as obsolescence, competition, dilution, infringement, or lack of maintenance lead to reduction in their value over time leading to depreciation of trademarks.
The questions that present themselves are: what is trademark depreciation and if a trademark can be claimed as an asset, then can it claim depreciation costs under tax law in India, and what are the implications?
Trademarks are one of the most important forms of intellectual property (IP) that protect the identity of a business in the market. Trademarks range from words, logos, slogans, shapes, colours, sounds, to any other distinctive signs that separate the goods or services of one person or entity from those of others. They help consumers to identify the products or services they utilise while simultaneously enabling the customers to differentiate between similar products. Trademark allows customers to identify themselves to their consumers and create a loyal customer base.
Trademarks are considered as intangible assets that have economic value for a business. This value – which can be referred to as the ‘Trademark Value’ of a product/service –is derived from the benefits that a trademark can generate for its owner.
A few indicators of these benefits could include increased sales, profitability, market share, brand recognition, customer satisfaction, and bargaining power. In addition, such valuation is further influenced by external factors such as market demand, consumer preferences, industry trends, legal environment, and socio-cultural dynamics.
However, no trademark is immune to time. Owing to various reasons, trademark decreases in value over time. The same, in economic terms, is known as depreciation. Trademark depreciation possesses the capability to spell detriment and impairment over the financial performance and competitive advantage of a business, while simultaneously leading to tax implications for the trademark owner. Therefore, it is important for businesses to understand whether they can claim their trademarks as assets to claim depreciation costs under tax law, and what the implications of the same could be.
How Does a Trademark Actually Depreciate?
A trademark depreciates due to various factors that affect its ability to generate benefits for its owner over time. These factors can be classified into two types: physical depreciation and economic depreciation.
Physical depreciation refers to the loss of value due to physical deterioration or damage to the trademark itself or its associated elements such as packaging, labels, or displays.
Physical depreciation can result from :
· natural wear and tear,
· theft, or
· natural disasters.
Physical depreciation can be measured by the cost of repairing or replacing the trademark or its associated elements.
Economic depreciation refers to the loss of value due to changes in the market conditions or consumer preferences that affect the demand and profitability of the trademarked goods or services.
Economic depreciation can result from :
· Obsolescence: The decline in value due to technological innovation or changing consumer tastes that make the trademarked goods or services outdated or less desirable. For example, a trademark for a video cassette may lose its value due to the live streaming platforms.
· Competition: The decline in value due to increased rivalry or entry of new competitors that offer similar or superior goods or services at lower prices or with better quality. For example, a trademark for a soft drink may lose its value due to the introduction of new brands or flavors by other producers.
· Dilution: The decline in value due to the loss of distinctiveness or reputation of the trademark caused by unauthorized or excessive use by others. For example, a trademark for a luxury brand may lose its value due to counterfeiting or imitation by other sellers.
· Infringement: The decline in value due to unauthorized use by others that creates confusion or deception among consumers about the source or quality of the goods or services. For example, a trademark for a fast moving consumer product may lose its value due to infringement by other sellers who use similar names or logos for their products.
· Lack of maintenance: The decline in value due to failure to renew or protect the trademark registration or enforce the trademark rights against infringers. For example, a trademark may lose its value if it is not renewed before expiry or if it is not defended against oppositions or cancellations.
Such economic depreciation can be simply measured by the present value of the future income or cash flows that can be attributed to the trademark.
Can a Trademark be Claimed as an Asset to Claim Depreciation Costs under Tax Law?
The answer to this question primarily depends on whether the trademark is registered or unregistered, owned or used, transferred, or retained, and amortized or not. To understand the same, a few points should be clarified first:
According to Section 2(14) of the Income Tax Act, 1961, [ITA] a ‘capital asset’ refers to property of any kind held by an Assessee whether connected with their business/profession except stock-in-trade etc. Further, according to Section 2(47) of the Income Tax Act (ITA), 1961, the ‘transfer of a capital asset’ includes sale, exchange, relinquishment, extinguishment, conversion, compulsory acquisition, gift, inheritance, distribution by company to shareholders on liquidation etc. Also, under Section 55(2)(a) of the ITA, the ‘cost of acquisition’ in relation to capital asset being goodwill/trademark/right to manufacture etc. essentially points to the purchase price paid by assessee.
A careful perusal of the above definitions deduces that notwithstanding any other variables, if a registered trademark is transferred by its owner to another person for a consideration, the same ought to, and shall be treated as a capital asset and will hence be subject to capital gains tax under Section 45 of ITA. This capital gain will be computed by deducting from sale the consideration received/receivable by assessee’s cost of acquisition and cost of improvement incurred by him. The rate and period of capital gains tax will depend on whether the transfer is long-term (more than 36 months) or short-term (less than 36 months).
Conversely, if an unregistered trademark is transferred by its owner to another for consideration, it will be treated as a business asset and would still be subject to business income tax under Section 28 of the Act. This business income will be computed by deducting from sale consideration received/receivable by assessee’s expenses incurred wholly and exclusively for business purpose. The rate and period of such tax will depend on whether the assessee is an individual, firm, company etc.
Also, if a registered or unregistered trademark is used by its owner for his own business purpose, it will not be subject to any tax under the ITA.
Any use resulting in depreciation in value of trademark due to any reason such as obsolescence, competition, dilution, infringement etc. is not allowed as deduction from income under ITA. This is because depreciation is allowed only on tangible assets such as buildings, machinery, plants, furniture etc.
However, the direct tax proposals in the recent Union Budget provide for allowing depreciation on intangible assets (which would now from a separate block of assets) at the rate of 25 per cent on written-down (that is, depreciated) value. This means that trademarks, along with other intangible assets such as know-how, patents, copyrights, licenses, franchises or any other business or commercial rights of a similar nature, being intangible assets acquired on or after the 1st day of April 1998, will be eligible for depreciation under Section 32 of ITA 1961. This will apply to both registered and unregistered trademarks, whether owned or used by the assessee.
While an interpretive reading of the provisions brings forth the desired conclusion, further corroboration now becomes pertinent. Fortunately, very recently, the High Court of Delhi, in the case of Pr. Commissioner of Income Tax - 1, Chandigarh v. M/S Kuantum Papers Ltd. [2019 SCC OnLine Del 12354], held very categorically that trademarks are part of intangible assets under the Act. Quoting the judgment of the Supreme Court in Commissioner of Income-Tax vs. Smifs Securities Ltd., [(2012) 348 ITR 302 (SC)] the Court determined that a careful perusal of Section 32(1)(ii) of the Act, read with clause (b) of Explanation 3 would show that trademarks are covered under the said provision.
Further analysing the definitions of ‘Mark’ and ‘Trademark’ under the Trademarks Act of 1999, the court observed that a trademark means a mark which is capable of being represented graphically and is capable of distinguishing the goods or services of one person from those of others, and may include the shape of goods, their packaging, and combination of colours. The expression “mark” …includes, among others, a „brand‟. Therefore, a conjoint reading of these Sections would clearly point in the direction that the expression “trademark” under Section 32(1)(ii) and in the appended Explanation i.e., Explanation 3(b) would clearly include brand names.
As such, the court deemed a brand to be a specie of a trademark.
The court, therefore, conclusively determined that the definition of assets…includes commercial rights of similar nature. Brand names certainly invest in the owner commercial rights, and therefore, will fall within the scope of intangible assets, which are amenable to deprecation under Section 32(1)(ii) of the Act.
While the Court perused and interpreted the relevant sections, they did not delve into the merits and demerits of considering a trademark as an intangible asset. As such, the consequent question would be – why should or should not a trademark come under the head of depreciation in tax law?
A trademark has herein been considered as an intangible asset that has a finite useful life and is subject to wear and tear like any other asset. Therefore, ideally it should be treated like any other depreciable asset for tax purposes. It is also an income-generating asset that contributes to the profitability and growth of a business. Essentially, it is an economic resource that reflects the market value and goodwill of a business. Therefore, it should be allowed to claim for depreciation as a legitimate business expense for tax purposes.
However, contrariwise, a trademark can also be considered as an intangible asset that has an indefinite useful life and is not subject to physical deterioration like other assets. It is only a unique identity that represents the brand name and reputation of a business. It is, at best, a legal right that confers exclusive use and protection to its owner. Therefore, it should not be adjusted for depreciation to show its true economic value for tax purposes.
What are the Positive and Negative Implications of Claiming or Not Claiming Depreciation Costs on Trademarks under Tax Law?
An attempt at creating an exhaustive list for such implications could turn counterproductive. However, for the sake of clarification, it comes to be of cardinal value to now qualitatively, assess the same. As such, a few positive implications of claiming depreciation costs on trademarks under tax law can be:
· Reduction in the taxable income and tax liability of the assessee, as depreciation is an allowable deduction from income.
· True reflection of the economic value and performance of the trademark, as depreciation is a measure of the loss of value over time.
· Incentivization of investment and innovation in intangible assets such as trademarks, as depreciation will provide a tax incentive for acquiring and developing such assets.
On the other hand, the negative implications of claiming depreciation costs on trademarks under tax law could be:
· Increase in the complexity and compliance burden of the assessee, as depreciation will require valuation and accounting of intangible assets such as trademarks.
· Reduction in capital gains and business income that can be realized from the transfer of trademarks, as depreciation will lower the cost of acquisition and cost of improvement of such assets.
· Uncertainty and disputes with the tax authorities, as depreciation will involve subjectivity and variability in the valuation and allocation of intangible assets such as trademarks.
It is important to analyse the above-stated factors. As such, a few positive implications of not claiming depreciation costs on trademarks under tax law are:
· Simplification of the compliance process of the assessee, as no depreciation will require no valuation and accounting of intangible assets such as trademarks.
· Increase in capital gains and business income that can be earned from the transfer of trademarks, as no depreciation will maintain the cost of acquisition and cost of improvement of such assets.
· Avoidance of uncertainty and conflicts with the tax authorities, as no depreciation will eliminate subjectivity and variability in the valuation and allocation of intangible assets such as trademarks.
The negative implications could include:
· Increase in taxable income and tax liability of the Assessee, as no depreciation will disallow any deduction from income for the loss of value over time.
· Distortion of the true economic value and performance of the trademark, as no depreciation will ignore the impact of obsolescence, competition, dilution, infringement etc. on its value.
· De-incentivization of investment and innovation in intangible assets such as trademarks, as no depreciation will provide no tax incentive for acquiring and developing such assets.
As the awareness regarding the importance of a Trademark grows, it has become necessary derive a position that will, in fact, stand the test of time in the changing and the growing market economy. As of now, trademarks are considered depreciating assets in the eyes of law.