Income Tax Appellate Tribunal - Mumbai
The Dy. Cit vs Lyka Labs Ltd. on 23 November, 2007
ORDER
K.C. Singhal, Judicial Member
1. These are the cross appeals by the assessee as well as Revenue pertaining to Assessment Year 1998-99 which have been heard together and are being disposed off by the common order for the sake of convenience.
Assessee's Appeal:
2. The first ground raised by the assessee in this appeal reads as under:
1. The learned CIT(A) erred in upholding the action of the Assessing Officer in considering the sum of Rs. 6 crores received from US Vitamins Ltd. in consideration of the transfer of marketing information and clinical data and allied rights and, agreeing to refrain from directly or indirectly competing with them, to be in the nature of a revenue receipt.
3. Briefly stated, the facts relating to the above issue are these. The assessee company is engaged in the business of manufacturing of bulk drugs and formulation of pharmaceutical products, which are sold both in domestic and export market. In addition, the assessee was also marketing a Nitro Glycerine based product named 'Angispan TR', manufactured by another company named 'Sidmak Laboratories India Ltd.' In the course of assessment proceedings, it was noticed by the Assessing Officer that there was a credit entry of Rs. 6 crores in the Profit & Loss A/c on account of receipt for transfer of marketing & clinical data and allied rights. In the computation of income filed along with the return of income, the assessee company claimed deduction in respect of the above receipt on the ground that it was a capital receipt not chargeable to tax. In the note No. 13 to the computation of total income, the assessee explained as under:
During the year the company has entered into agreement with US Vitamin Ltd. The company shall not compete with US Vitamin Ltd. directly or indirectly or through it affiliates in the promoting, distribution and selling activities of formulation made from the bulk drug nitro glycerine. The company has received consideration sum of Rs. 6 Crores towards non-compete fees. It is submitted that the consideration received in pursuance of agreement in restrict of trade is a capital receipt. Therefore, it is excluded from the total income. In this connection, the company relies on the decision of Gillandrs Arbuthnot & Co. Ltd. v. CIT 53 ITR 283 (SC).
The Assessing Officer, vide letter dated 23rd August, 2000, asked the assessee to substantiate the above claim and also file the copy of the agreement with US Vitamin Ltd. (USV). In response to the same, the assessee submitted the copy of the agreement and also the note for treating the receipt as capital receipt. On reading of the agreement, it was noted by the Assessing Officer that the consideration of Rs. 6 crores had been received on two accounts - (i) Transfer of marketing information and know-how; and (ii) Refraining to compete with USV directly or indirectly by not carrying on business of marketing of Nitro glycerine based product Angispan TR. After going through the agreement and the notes submitted by the assessee, the Assessing Officer took note of the following facts:
The assessee-company was engaged in the business of marketing products which is used for the treatment of cardiac disease through its marketing team comprising of nearly 300 medical representatives and 1000 stockist for the last 10 years. The assessee-company was a established player in the business of marketing the above product i.e. Angispan TR and had specialized knowledge and expertise which was necessary to market and distribute the product. The assessee-company had statewise database of users such as Doctors, Hospitals, Institutions, which recommended the above product. The assessee-company was in possession of certain clinical data, scientific details, clinical trials, carried on over a period0 of 8 years which had enabled them to develop substantial expertise and consumer information required for the distribution of the above product.
US Vitamins Ltd. i.e. USV is also engaged in the business of manufacturing, marketing and distributing various cardiac product and was desirous to expand its market so also the market share by expanding its activities in the field of nitro glycerine based formulation. The product Angispan TR, as stated above is also nitro glycerine based, Hence vide above agreement dated 20th January, 1998, the assessee-company under one time obligation disclosed the above scientific and marketing know-how, develop/generated in the course of business to the USV.
In addition to transfer of above know-how, Lyka was also restricted from making available/assigning the said information to a third party for a period of 3 years. Further for a period of 5 years Lyka or its affiliates are restricted from competing with USV in the sale and distribution of formulation made from nitro glycerine or having the same as its main ingredient.
4. The contention of the assessee before the Assessing Officer was that the above information and data was a self generated asset with no cost and therefore the amount received by the assessee for giving up such asset was in the nature of capital receipt not chargeable to tax. Reliance was placed on the Supreme Court judgment in the case of B.C. Srinivasa Shetty 128 ITR 294. It was also contended that there was non-compete Clause in the agreement and therefore the consideration for the same also amounted to capital receipt in view of the Supreme Court judgment in the case of Gillandrs Arbuthnot & Co. Ltd. v. CIT (supra) and in the case of CIT v. Best & Co. Pvt. Ltd. 60 ITR 11. Reliance was also placed on two judgments of Hon'ble Madras High Court in the case of CIT v. Saraswati Publicities 132 ITR 207 and G.D. Naidu and Ors. 165 ITR 63. It was also contended that the Board Circluar No. 763 dated 18th February, 1998 was not applicable since what the assessee had sold was marketing intormation and know-how and not the right to manufacture the product or process any article or thing which is covered by the circular.
5. According to the Assessing Officer, the amount received by the assessee constituted Revenue receipt for the reasons given hereafter:
(i) The agreement is not for one time complete transfer of the so-called marketing information and know-how since, imparting of such information and know-how was only for a period of 3 years. Similarly, non-compete Clause was only for a period of 5 years.
(ii) The trading structure of the assessee remained unaffected despite the above agreement since, the assessee continued to market the products manufactured by itself. The agreement related to only one item i.e. Angispan TR. The other items manufactured by the assessee were sold through the same trading infrastructure and the Turnover rather increased from 131.39 crores in the last year to 139.90 crores during this year. What the assessee had lost was the profit from the marketing of the above products for a short period of three to five years and not the source of income. Hence, the consideration received was a revenue receipt chargeable to tax and consequently could not be considered as capital receipt. Reliance was placed on the judgment of Hon'ble Bombay High Court in the case of CIT v. Ralliwolf Ltd. 143 ITR 720 wherein it was held that if the imparting of know-how is really in the nature of services rendered without anything more, then the receipt must be treated as Revenue receipt. However, if consideration is received for imparting know-how in association with the disposal of a capital asset then the receipt will be treated as capital receipt.
(iii) Since, in the present case, the supply of information was for a short period, it amounted to a licence to use the information and could not be considered as parting of any capital asset. Reliance was placed on the decision of the Bombay High Court in the case of CIT v. Gilbert & Barker Manufacturing Co., USA 111 ITR 529 for the proposition that if the supply of know-how is on the licence basis, then the receipt would be Revenue in nature.
(iv) That the definition of income in Section 2(24) of the I.T. Act (the Act) is an inclusive definition which would include any receipt which can properly be described as income. Reliance was placed on the Supreme Court judgment in the case of CIT v. G.R. Kartikeyan 201 ITR 866.
In view of the above reasons, it was held by him that the sum of Rs. 6 crores received by the asessee was Revenue receipt chargeable to tax. Accordingly, the addition was made.
6. The matter was carried in appeal before the learned CIT(A) before whom following submissions were made:
(i) that marketing information and knowledge developed by the assessee during the course of its engagements in the business, constituted a self generated asset. Therefore, the consideration received was a capital receipt not chargeable to tax;
(ii) even assuming that capital receipt is chargeable to tax Under Section 45 of the Act under the head 'Capital Gains', the capital gain cannot be computed in as much as no cost was incurred in acquiring such asset as it was a self generated asset and therefore no income can be brought to tax in view of the judgment of the Hon'ble Supreme Court in the case of B.C. Srinivasa Shetty (supra);
(iii) that the Section 55(2) of the Act was amended so as to tax various capital receipts i.e. receipts on account of goodwill of business, tenancy rights, loom hours, stage carriage permits and the right to manufacture produce or process any article or thing. The Legislature treated the cost of acquisition as Nil in respect of the above items and therefore the receipts in respect of the above items become chargeable to tax. However, no such amendment was made relating to the receipt on account of transfer of marketing information and knowledge and therefore the decision of the Supreme Court in the case of B.C. Srinivasa Shetty (supra) still applies. Consequently, no income can be taxed on the basis of the above judgment. That the Circular No. 763 dated 18.02.1998, is applicable only with reference to the right to manufacture produce or process any article or thing and therefore the said circular cannot be applied to the transfer of marketing information and knowledge.
(iv) In support of his submissions, the assessee further relied on various Tribunal decisions namely, Jayaprakash Mady v. ITO 79 ITD 1, DCIT v. Chander Mohan 242 ITR 1 AT (TM) and Bal Krishna V. Doshi v. ITO 15 ITD 262.
(v) Regarding non-compete Clause in the agreement it was submitted that any consideration received on account of non-compete Clause is to be considered as Capital receipts in view of the Supreme Court Judgment namely Gillandrs Arbuthnot & Co. Ltd. v. CIT (supra) and CIT v. Best & Co. Pvt. Ltd. (supra) as well as Madras High Court judgment namely CIT v. Saraswati Publicities and CIT v. G.D. Naidu and Ors. (supra). It was also submitted that the case law relied upon by the Assessing Officer were distinguishable on facts.
7. The learned CIT(A) was not satisfied with the submissions of the assessee. According to him, the word 'know-how' connotes a certain degree of expertise, special skill or invention which is peculiar to the person who possesses it. The act of marketing the product cannot, by any imagination, be called such special skill. It was also noted by the learned CIT(A) that assessee was not only selling Angispan TR manufactured by Sidmak Laboratories (India) Ltd., but was also marketing its own products. Further, as per the agreement, the assessee was not the sole selling agent as claimed by the assessee. In view of the same, the learned CIT(A) was of the view that the amount received could not be considered as a Capital receipt. It was also observed by him that marketing rights were acquired by the assessee in the normal course of business with the help of its markting staff and thus expenditure had been incurred in acquiring such rights. Consequently, it would be taxable under the head 'Capital Gain' even assuming it to be capital receipt. The addition made by the Assessing Officer was therefore upheld. Aggrieved by the same, the assessee is in appeal before the Tribunal.
8. The learned Counsel for the assessee has reiterated the stand of the assessee before the Assessing Officer as well as learned CIT(A) and therefore, the same need not be repeated. However, he has also relied on the decision of the Tribunal in the case of PL. Chemical Limited v. Assistant Commissioner of Income-tax 86 ITD 46 as well as the decision of Calcutta High Court in the case of Commissioner of Income-tax v. A.S. Wardekar 283 ITR 432. On the other hand, the learned D.R. has also reiterated the reasonings given by the Assessing Officer as well as learned CIT(A) and therefore, the same need not be repeated. However, it has been submitted by him that in the case of USV, the amount paid to the assessee has been held to be the Revenue expenditure by the Tribunal. The decision of the Tribunal in the case of USV is reported as 106 TTJ 535.
9. Rival submissions have been considered carefully in the light of material placed before us. The question for our consideration relates to the nature of receipt in the hands of the assessee i.e. whether capital or revenue. In order to appreciate the controversy, it would be appropriate to refer to the terms and conditions set out in the agreement between the assessee and USV. In our opinion, the entire agreement is relevant and therefore, the same is being reproduced below:
Agreement This Agreement made at Mumbai on 20th January, 1998 by and between LYKA Labs Limited, a Company incorporated under the Companies Act having its registered office at 4801/B & 4802/A, GIDC Industrial Estate, Ankleshwar, Gujarat 393 002 and administrative office at 77, Nehru Road, Vile Parle East, Mumbai 400 099 hereinafter referred to as 'LYKA' (which expression shall unless repugnant to the context or meaning thereof be deemed to include its successors and assigns) of the One Part; and Usv Limited, a Company incorporated under the Companies Act and having its registered office at B.S.b. Marg, Govandi, Mumbai 400 088 hereinafter referred to as "USV" (which expression shall unless repugnant to the context or meaning thereof be deemed to include its successors and assigns) of the Other Part.
Whereas A. LYKA has been engaged inter alia in the business of distributing and selling the formulations made from the bulk drug Nitroglycerine (hereinafter referred to as 'the Formulations'); and B. LYKA has invested substantial resources in generating certain market/product related information connected with marketing of the Formulations which is of vital importance to the marketing of the products to the doctors, institution etc. so as to answer queries related to the both bulk drug/formulations of Nitroglycerine and also to further educate the doctors in the new developments, side effects, contra indications, etc. of the Formulations; and C. LYKA is possessed of certain clinical data, scientific details, reports on clinical trials carried on by LYKA in the last few years and has also developed substantial expertise in ethical promotion of the formulation and is in the possession of valuable market information pertaining thereto; and D. USV is also engaged in the business of manufacturing, marketing and distributing inter alia various cardiac products and desires to expand its market, increase its market share and expand its activities in the filed of Nitroglycerine based Formulations; and E. At the request of USV and for the consideration mentioned herein, LYKA has agreed to provide to USV the aforesaid clinical data, scientific details, reports on clinical trials carried on by LYKA in the last few years, valuable market information more particularly set out in the Schedule hereunder written (hereinafter referred to as the Scientific and Marketing Know-how); and F. LYKA has represented that it is not restrained under any law or contract to disclose the aforesaid clinical data, scientific details, reports on clinical trials carried on by LYKA in the last past few yeas and the valuable market information.
Now This Agreement Withnessethand it is Hereby Agreed by And Between the Parties Hereto as Under:
1. On or before 28th February, 1998 LYKA shall supply and provide to USV clinical data, scientific details, reports on clinical trials carried on by LYKA in the past few years, valuable market information more particularly set out in the Schedule hereunder written (hereinafter referred to as the Scientific and Marketing Know-how).
2. In consideration of the obligations undertaken by LYKA, USV shall on or before the execution of this Agreement pay to LYKA a sum of Rs. 6,00,00,000/- (Rupees Six crores only) receipt whereof LYKA hereby acknowledges and accepts.
3. The obligations undertaken by LYKA hereunder shall not be assigned by LYKA to any third party without the prior written consent of USV.
4. LYKA undertakes not to disclose the data, details and the Scientific and Marketing know-how referred to herein to any third party for a period of at least three years from the date hereof.
5. LYKA shall not disclose to any third party any information pertaining to business of USV which comes in it possession in the course of discharging its obligations hereunder unless the same is in public domain.
6. With a view to enable USV to make full use of the Scientific and Marketing Know-how to be proved and supplied by LYKA to USV under this agreement, LYKA undertakes, if requested by USV, to assist USV for a consideration to be mutually agreed upon i. planning campaigns with doctors, cardiologists, institutions;
ii. conducting Continuous Medical Education (CMS) etc.;
iii. devising sampling strategies, promotional schemes for the Formulations;
iv. conducting market surveys;
v. training, medical representatives and other field force of USV engaged in the promotion of the formulation
7. USV undertakes to use the data, details and the Scientific and Marketing Know-how furnished by LYKA hereunder only for its own business and/or the business of its affiliates with respect to the business activities relating to the Formulations and shall not disclose or divulge the same to any other person without the prior written consent of LYKA.
8. For a period of 5 years from the date of this Agreement LYKA shall not compete with USV directly or indirectly or through its affiliates in the promoting, distribution and selling activities of Formulations made from the bulk drug Nitroglycerine i.e. Formulations whose major ingredient is the bulk drug Nitroglycerine.
Schedule referred to above Scientific and Marketing Know-how a. Clinical data, Scientific details and reports on clinical trails carried out by LYKA in respect of the Formulations based on the bulk drug Nitroglycerine.
b. Source of manufacture of Formulations from the bulk drug Nitroglycerine.
c. Break up of Statewise list of wholesalers, stockists and dealers of the Formulations.
d. Break up of Statewise sales of Formulations for last 5 years.
e. Break up of Statewise list of specialists, doctors, cardiologists and institutions as short listed by LYKA with respect to the Formulations referred to in the above Agreement.
f. Visual aid designs, copies of promotional material used.
Sd/-
(Mr. N.I. Gandhi for Lyka Labs Ltd.) Sd/-
(Mr. P.K. Tewari For USV Ltd.)
10. The perusal of the above agreement reveals the following facts and obligations:
1. that assessee had been in the business of distribution and selling the formulation made from the bulk drug Nitro Glycerine, apart from manufacturing of drugs manufactured by it.
2. in the course of its business, it acquired certain information relating to the formulation made from the bulk drug Nitro Glycerine.
3. the assessee agreed to provide certain marketing information relating to such formulation which are mentioned in the schedule to the agreement as well as not to compete with USV directly or indirectly in promoting, distribution and selling activities of such formulation against consideration of Rs. 6 crores.
4. the assessee undertook not to disclose such information to any third party for a period of three years from the date of agreement. The obligation regarding non-compete was for a period of five years.
11. Considering the agreement as a whole, it is found that consideration received by the assessee is on two accounts - (i) for transferring the marketing information relating to the formulation made from the bulk Nitro Glycerine and (ii) for not competing with USV in promoting, distributing and selling activities of such formulation for the period specified therein. The consideration received was composite one and no apportionment was made in respect of the above activities.
12. First we take up the issue relating to the transfer of information regarding Nitro Glycerine based formulation. There is no dispute that assessee had been in the business of manufacturing of various drugs and formulations and sale thereof as well as marketing of Nitro Glycerine based formulations known as 'Angispan TR' manufactured by Sidmak Laboratories India Ltd. Further, it had a huge distribution network for marketing its own manufactured product as well as product manufactured by other parties. In the course of such business, it came to possess certain marketing information relating to Nitro Glycerine based formulation. USV was manufacturer of Nitro Glycerine based formulation, who, intended to market its product in India. To facilitate its marketing process, it entered into an agreement with the assessee to procure certain information relating to Nitro Glycerine based formulations subject to the obligation of the assessee mentioned in the agreement. On these facts, the question is whether there is transfer of capital asset so as to treat the consideration as capital receipt.
13. In our opinion, there is no transfer of capital asset for the reasons given hereafter and therefore the consideration relatable to imparting of information by assessee cannot be considered as Capital receipt. There is no hard and fast rule to determine the character of the receipt. It would depend on the facts of each case. The nomenclature given to the transaction by the parties is also not relevant. The true nature of the transaction has to be ascertained from covenants of the contract National Cement Mines Ltd. 42 ITR 698 (SC). A receipt can be said to be capital when it is relatable to the transfer of capital asset other than the stock-in-trade. The Capital asset may be tangible or intangible. In the case of tangible asset, the asset must be physically transferred from one person to the other person. Dispossession of the asset from the transferor is the condition precedent. Such transfer may be once for all by way of sale or may be for an enduring period. What would be the enduring period would depend on the facts of each case. On the other hand, in the case of intangible asset, the possession may continue to remain with the transferor such as know-how, expertise, invention, formulation etc. The question arises as to when such asset can be said to be transferred so as to treat the consideration relating to such asset as capital receipt. In our opinion, unless the transferor is restrained to use such intangible asset as well as to transfer to other parties, the consideration received cannot be treated as Capital asset. For example, if an assessee has made an invention and the same is transferred to another party for consideration but reserves his right to sell the same to other parties or is not prohibited from selling to others, then it cannot be said that capital asset has been transferred since the possession of the same continues with the assessee transferor and the same can be sold\o as may persons as he wants. In such cases, the money is received without disposing of the intangible asset and therefore in our opinion, it would be a case of revenue receipt. On the other hand, if the assessee transfers such intangible asset once for all to the exclusion of others and the assessee is also prohibited to use the same, then it would be a case of transfer of capital asset and the consideration would ne a capital receipt. The dispossession of the asset in the manner mentioned above, in our opinion, is a condition precedent for constituting the receipt as Capital receipt. Reliance can be placed on the judgment of House of Lords in the case of Rolls Royce Ltd. v. Jellery 56 ITR 580 (HC). In that case, assessee possessed technical knowledge/know-how. The same were sold to various parties. The question arose whether consideration received by the assessee was capital or revenue receipt. The Court held that assessee was not parting with its asset but was trading in them. Hence the receipt was held to be revenue receipt. Reliance can also be placed on the judgment in the case of British Dye Stuffs Corporation (Black lay) Ltd. v. Inland Revenue Commission 12 Tax cases 586 wherein the test laid down was "Is the transaction in substance a parting by the assessee with part of its properties for a purchase price, or is it a method of trading by which the assessee acquires money as part of its profits and gains of that trade". Thus, as per both the decisions, there must be parting of asset for a price in the sense that the transferor cannot make any gain out of the same either for ever or for an enduring period.
14. Before adverting to the facts of the present case, it would also be useful to refer to the judgment of Supreme Court in the case of Chari & Chari Led 57 ITR 400 (SC) wherein it has been held that compensation paid for cancellation of a contract is normally a capital receipt but if such payment does not affect the trading or profit making structure of the assessee's business nor deprive him of the source of income, then it would be revenue receipt.
15. Now coming to the facts of the case, we find that assessee has simply parted with the information regarding its marketing structure such as list of wholesellers, stockists and dealers of formulations, state wise sales figures of such formulation for the last 5 years, list of specialists, doctors, cardiologists and institutions who recommend such formulation, promotional materials and clinical datas as is apparent from the schedule to the agreement. Even after imparting such information, it always remained with the assessee company. The marketing structure of the assessee remained intact. The only obligation of the assessee is that it shall not disclose such information to other parties for a period of 3 years. Further, the assessee is not restrained from using this information for marketing its own manufactured goods or goods manufactured by other companies. Further, the assessee can provide such information to other parties after 3 years. This shows that the assessee has simply allowed the aforesaid information to be used by the other party for a period of 3 years. There is no parting of the information either for ever or for an enduring period. Thus, considering the case laws mentioned by us, it has to be held that neither the assessee has parted with the information nor the marketing structure of the assessee has been impaired. Hence, the consideration relatable to this part of the agreement has to be held as revenue receipt.
16. The decisions relied upon by the learned Counsel for the assessee are quite distinguishable. In the case of Jaya Prakash Mady v. ITO 79 ITD 1, the know-how was sold by the assessee for all times to come for a lumpsum consideration and the assessee was not entitled to sell the same to others. Then, in that case, there was complete sale of know-how and assessee could not either use or sell to others while in the present case, the assessee had simply passed the information for a period of three years and the assessee was not prohibited to use the same in its own marketing business & further could transfer the same after 3 years. Hence, that decision is quite distinguishable.
17. The decision of the Tribunal in the case of Bal Krishna Doshi (supra) is not applicable since in that case the question was whether there was any cost for acquiring know-how. This decision would be applicable only when it is held that there is transfer of capital asset. Since in the present case, it has been held that there is no transfer of capital asset, that decision is inapplicable. For the similar reasons, the decision of the Tribunal in the case of Chander Mohan (supra) cannot be applied to the facts o the present case. Moreover, in that case, it was sale of Patent which is not the case before us.
18. In view of the above discussions, it is held that imparting of information relating to marketing of Nitro Glycerine formulation for a period of 3 years did not amount to transfer of capital asset and on the contrary it was a case where assessee allowed the other party to use the information for a period of 3 years without affecting the trading/marketing structure of the assessee. Hence, the payment allocable to such business of imparting of information amounted to revenue receipt chargeable to tax. The other contentions by the assessee's Counsel are therefore no more relevant. The order of the learned CIT(A) on this aspect of the issue is therefore upheld.
19. As far as other aspect of the issue is considered, we are in agreement with the contention of assessee's Counsel that payment relatable to non-compete covenant amounts to capital receipt in view of Supreme Court judgment in the case of Gillandrs Arbuthnot & Co. Ltd. v. CIT (supra) as well as various other decisions of the Tribunal. There is no dispute that assessee was marketing 'Angispan TR' a Nitro Glycerine formulation for various years. USV wanted to enter the market in respect of its own formulation and therefore intended to avoid the competition. Hence, there was a loss of source of income for a period of 5 years. Thus, in our opinion, the receipt was a capital receipt not chargeable to tax. The order of the learned CIT(A) is therefore set aside on this aspect of the issue.
20. Since the payment received is composite one and part of the same has been found to be revenue receipt, the receipt has to be bifurcated and apportioned. In the absence of any material on the aspect of valuation, we think it appropriate to remit the matter to the file of Assessing Officer for adjudication of the issue of valuation of non-compete fee and then tax the amount relatable to the imparting of the information relating to marketing of Nitro Glycerine formulation.
21. Ground No. 2 relates to addition of Rs. 1,70,22,528/- on account of interest on overdue sundry debtors.
22. Briefly stated the facts are that assessee was consistently declaring income on account of interest on overdue sundry debtors in the past after following mercantile system of accounting. In the year under consideration, the assessee decided to recognize the interest income on accrual basis upto June, 1997 and thereafter on receipt basis. The note was appended to the statement of accounts in this regard wherein, the sum of Rs. 47,86,703/- was shown as interest income on accrual basis and for the remaining period the interest income was to be shown on receipt basis. Thus, there was a loss of Rs. 1,70,22,528/- on account of not showing interest income on accrued basis in respect of three parties as under:
Antibiotics Stores Ltd. Rs. 1,07,98,248/-
Pharmawell Center Rs. 27,74,156/-
Krishna Sales Corporation Rs. 33,59,081/-
Miscellaneous Parties Rs. 91,043/-
------------------
Rs. 1,70,22,528/-
------------------
The explanation before the Assessing Officer was that the debtors had disputed the debit notes which had remained unsettled and therefore, as a prudent accounting system, the income was being switched over from mercantile system to receipt basis. However, the Assessing Officer was not satisfied with the explanation of the assessee since the income should have been declared on accrual basis as the assessee was following the mercantile system of accounting. Consequently, the addition of Rs. 1,70,22,528/- was made by the Assessing Officer.
23. The matter was carried in appeal before the learned CIT(A) before whom it was contended that choice of the system of accounting to be followed is with the assessee provided it is consistently followed. Further it was contended that change in the method of accounting is permissible if it is for the bonafide reasons. The reliance was placed on the Bombay High Court judgment in the case of Citibank N.A. 208 ITR 930 for the proposition that hybrid system of accounting can also be followed. Reliance was also placed on the Supreme Court Judgment in the case of UCO Bank 237 ITR 889 for the proposition that in case of sticky loans, the assessee is permitted to change the method of accounting from accrual to cash basis. Certain other decisions were also relied on, which are mentioned in the order of learned CIT(A).
24. The learned CIT(A) found that the income on accrual basis was not booked by the assessee since the concerned parties had not accepted the claims and therefore the method of accounting was changed from mercantile to receipt basis. It was also seen by the learned CIT(A) that objection of the Assessing Officer related to the- change in the method of accounting which was not consistent. It was also found by the learned CIT(A) that assessee was claiming deduction in respect of interest paid on accrual basis by following the mercantile system of accounting but the method was changed only in respect of interest income from Sundry Debtors. The learned CIT(A) also took note of the amendment made in Section 145 of the Act, which was effective from 1.4.1997 i.e. Assessment Year 1997-98. According to the amended provisions of Section 145, the assessee either could follow the mercantile system or receipt system and no other method was permissible. This amendment was brought to nullify the hybrid system of accounting. Therefore, applying the amended provisions, the learned CIT(A) held that assessee could not follow the different methods, i.e. mercantile system in respect of interest paid and cash system in respect of interest to be received. Therefore, the interest income was chargeable to tax on accrual basis since the assessee was following mercantile system of accounting for all other purposes. It was also observed by him that assessee can claim such income as bad debt in the subsequent years on account of non-recovery. Aggrieved by the same, the assessee is in appeal before the Tribunal.
25. Both the parties have been heard. The contention of the learned Counsel for the assessee remains the same as contended before the learned CIT(A). According to him, the sundry debtors had disputed the debit notes of interest issued by the assessee and therefore to avoid the practical difficulties the assessee switched over to cash system of accounting. Since the change in the method of accounting was bonafide and followed consistently, it was contended that addition was not justified. Reliance was also placed on the judgments cited before Ihe learned CIT(A). On the other hand, the learned D.R. has relied upon the order of learned CIT(A).
26. After hearing both the parities, we do not find merit in the ground raised by the assessee on this issue. The submissions made by the learned Counsel for the assessee were relevant only to the pre-amended provisions. There is no dispute that prior to Assessment Year 1997-98, the hybrid system of accounting was held to be permissible by the Hon'ble Bombay High Court in the case of Citibank N.A. (supra). In view of that judgment, the assessee could follow mercantile system of accounting in respect of interest liability and cash system of accounting in respect of interest income. The Legislature perhaps found difficulty in accepting such system of accounting as it would depict the distorted picture of income of the assessee. Accordingly, the Legislature made amendment by substituting the old provisions of Section 145. The amended provisions effective from 1.04.1997 i.e. from Assessment Year 1997-98 reads as under:
145(1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall, subject to he provisions of Sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.
(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.
(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in Sub-section (1) or accounting standards as notified under Sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in Section 144 A bare reading of the above provisions makes it clear that from the Assessment Year 1997-98, assessee was permitted to follow either the cash system of accounting or mercantile system of accounting. No third method is permissible as per amended provisions. Such amended provisions nullify the effect of the judgment of Hon'ble Bombay High Court in the case of Citibank N.A. (supra). The learned CIT(A) has found as a fact that assessee was claiming deduction on account of interest on the basis of mercantile system of accounting. Even otherwise, the assessee was following mercantile system of accounting in the past. Therefore, the switching over to cash system of accounting only in respect of interest income is not permissible in view of the amended provisions. Perhaps, one can contend successfully that assessee is permitted to change the method of accounting either from mercantile to cash system or vice-versa for bonafide reasons. But in our opinion, assessee cannot be permitted to contend that a part of income can be booked on mercantile basis while the other part of income on cash system of accounting. Therefore, considering the amended provisions of Section 145, we do not find any merit in the ground raised by the assessee on this issue. The order of the learned CIT(A) is therefore upheld on this issue.
27. Ground No. 3 raised by the assessee reads as under:
3. The learned CIT(A) erred in confirming the addition of Rs. 13,50,000/- being interest @ 18% on deposit of Rs. 45,00,000/- (out of total deposit of Rs. 75,00,000/-) being deposit kept with the director for providing him rent free accommodation as per the terms of his appointment.
Briefly stated the facts are that assessee had given interest free deposits of Rs. 75 lakhs to Mr. N.I. Gandhi, Managing Director of the Company. The Assessing Officer noticed that assessee had paid interest of Rs. 11.56 crores (approx.) on the borrowed funds. The assessee was asked why the interest relatable to the above deposit should not be allowed. The assessee vide letter dated 9.1.2001 submitted that as per the agreement with the Managing Director, it was obligatory for the assessee to provide the housing accommodation. Since the Managing Director had his personal accommodation at 3-C, Ridge Apartment, B.G. Kher Marg, Malabar hill, Mumbai-400 036, the same was taken on rent by the company and in turn it was provided to the Managing Director for his accommodation. A special Resolution was also passed by the General Body Meeting. It was also submitted that if the company had arranged for any other accommodation for the Managing Director, then it would have been necessary to keep the security deposit with the landlord and therefore going by the market practice and considering the locality, interest free deposit was given to the Managing Director. Thus, the said deposit was given wholly and exclusively for the purpose of business and consequently, the interest paid by the assessee was an allowable deduction Under Section 36(1)(iii) of the Act. On appeal, the learned CIT(A) following his earlier order for the Assessment Year 1997-98, confirmed the disallowance but on quantification it was held that the deposit to the extent of. Rs. 30 lakhs was reasonable and consequently the disallowance was rejected with reference to the balance amount of Rs. 45 lakhs. Still aggrieved, the assessee is in further appeal before the Tribunal.
28. After hearing both the parties, we find that this issue is now covered in favour of the assessee by the decision of the Tribunal in assessee's own case for the Assessment Year 1997-98 in ITA No. 1596/Mum/01. The said decision has been further followed by the Tribunal in assessee's own case pertaining to Assessment Year 1999-2000 copy of which is placed on record. Following the same, the issue is decided in favour of the assessee. Order of the learned CIT(A) is therefore modified and the entire disallowance sustained by him is deleted.
Departmental Appeal:
29. The first ground relates to the disallowance of interest of Rs. 3,07,589/-. Briefly stated the facts are that assessee had acquired the property at Marol against consideration of Rs. 61,68,688/- for setting up an administrative and distribution office out of the borrowed funds. The interest on borrowed funds amounted to Rs. 3,07,589/- which was capitalized. However while computing the income, the interest paid was claimed as deduction Under Section 36(1)(iii) of the Act. The Assessing Officer disallowed the same on the ground that such interest was capitalized by the assessee itself and therefore would form part of actual cost of the property. On appeal learned CIT(A) held, following his earlier order for the Assessment Year 1997-98, that claim of the assessee could not be disallowed merely because the expenditure was capitalized. If the expenditure is of revenue nature, then it was allowable deduction Under Section 36(1)(iii) of the Act. Aggrieved by the same, revenue is in appeal before the Tribunal. After hearing both the parties, we find that this issue is covered in favour the assessee by the Tribunal dated 22.1.2007 in the assessee's own case for Assessment Year 1997-98 wherein it has been held that interest payment was allowable deduction Under Section 36(1)(iii). Since the facts are identical, the said decision would apply to the present case. Following the same, the order of learned CIT(A) is upheld on this issue.
30. The next and the last issue relates to adhoc disallowance of Rs. 2,00,000/- out of miscellaneous expenses. This adhoc disallowance has been made by the Assessing Officer out of the total expenditure of Rs. 5,35,969/-. The learned CIT(A) has deleted the adhoc addition since no defect has been pointed out by the Assessing Officer, and on the contrary the books of accounts were duly audited. After hearing both the parties, we do not find any infirmity in the orders of learned CIT(A) on this issue.
31. In the result, the appeal of the assessee is partly allowed while the appeal of the revenue is dismissed.
Pronounced in the open Court on the 23rd November, 2007.