Income Tax Appellate Tribunal - Delhi
Ito vs Sylvania And Laxaman (P) Ltd. on 23 March, 2007
ORDER
R.C. Sharma, A.M.
1. This is an appeal filed by the assessee (sic-Revenue) against the order of Commissioner (Appeals) dated 1-12-2004 for the assessment year 2001-02, in the matter of order passed under Section 143(3) of the Income Tax Act, 1961, wherein following two grounds of appeal have been raised:
1. On the facts and in the circumstances of the case, the learned Commissioner (Appeals) erred in directing the assessing officer to treat the royalty income as business income and allow the expenditure as claimed by the assessee without appreciating the fact that the assessing officer clearly established in the assessment order that business was discontinued and as such the royalty income was to be treated as income from other sources.
2. On the facts and in the circumstances of the case, the learned Commissioner (Appeals) erred in directing the assessing officer to set off brought forward unabsorbed depreciation as per provisions of the Act by holding that there is no discontinuation of business.
2. Rival contentions have been heard and record perused. Brief facts of the case are that the assessee is a private limited company. It was engaged in the business of manufacture/sale of and deals in electrical goods. Its premises were temporarily sealed by the office of the District Collector, Tees Hazari, Delhi, vide order dated 26-8-1996. The manufacturing activity has been suspended since then from the said premises. During the year under consideration the assessee has received royalty under the "manufacturing and selling license agreements" with various parties. The assessing officer held the royalty income as "income from other sources" as against assessee's claim that it is business income and disallowed various expenditures claimed thereagainst.
3. In its order, the assessing officer observed that Section 28 of the Act states that income shall be chargeable to income-tax under the head profits and gains of business or profession which was carried out by the assessee at any time during the previous year. The assessee has stopped its manufacturing activity which was its core business activity way back in the year 1996 and there was no intention to restart the business. As on date the assessee has not started any of its manufacturing activity even after a gap of 8 years when the production came to a halt in June, 1996. The business of the assessee has stopped in June, 1996 and the exploitation of its assets could generate income which is chargeable under the head income from other sources. The assessing officer further stated that as per the terms of the agreements for earning the royalty income there is no risk of uncertainty, etc. presently to earn royalty income and instead a minimum royalty has been guaranteed thereof. There is no risk of losing the capital employed in the business, as no such capital is required to earn royalty income. As per memorandum of association, the main object of the company was to manufacture and deal in electrical consumer goods whereas the assessee has relied on Clause 36 of the memorandum which may be incidental to its main business activity.
4. With regard to allowability of expenditure claimed against this income, the assessing officer observed as under :
If for the time being it is presumed that the assessee is deriving business income from royalty during the previous year relevant to the assessment year under consideration, there is no justification for the assessee company to claim expenses Rs. 7,45,688, interest to employees Rs. 8,65,233, legal charges and payment of Rs. 2,62,326, MCD payments Rs. 7,78,167, union welfare expenses Rs. 60,000, interest Rs. 2,17,500, as these expenses relate to closed business i.e., manufacturing of electrical consumer goods, and accordingly could not be allowed thereof. As it has been held that in order to sustain a claim for deduction by way of business, expenditure must have been incurred for the purposes of business which was in existence in the year of account, the profits of which are under assessment. If during the relevant period, there was, in fact, no business no question of computation of its income after deduction of expenses can possibly arise. (S.P.V. Bank Ltd. v. CIT .
5. By the impugned order, Commissioner (Appeals) directed the assessing officer to treat royalty income as income from business and profession and to allow deduction of the expenditure claimed after having the following observations :
I have considered the submission of the learned counsel vis-a-vis the facts of the case. I had also gone through the various decisions relied upon by the assessing officer as also by the learned counsel to support their respective contentions. In this case, the first question to be decided is whether there was a closure or permanent discontinuance of the business carried on by the appellant in earlier years so as to deny allowance of expenditure pertaining to the said business.
The second question is whether the royalty income earned by the appellant during the year by exploitation of its commercial asset, viz., brand name/trademark/goodwill is business income or income from other sources. The appellant company was incorporated in 1962 and was engaged in the manufacturing and selling of all sorts of electrical consumer goods under the trademark/brand name Laxman Sylvania/Laxman. According to the appellant they were not only manufacturing the products on their own but also getting the goods manufactured by other concerns for the purpose of selling under their brand name. But of late in 1996 (in April 1996), its business premises have been sealed by the office of District Collector, Delhi, Tees Hazari and its manufacturing activities were temporarily suspended since then due to labour dispute. The learned counsel contended that the appellant has no intention to close down its business and the stoppage of manufacturing activity from its premises since 1996 was due to sealing of its factory by the aforesaid authority, which is beyond the control of the appellant. It is also contended that in order to keep its brand name alive/popular amongst the customers it leased out its brand name under "manufacturing and selling license agreements" to various parties under strict specification and quality control by the appellant. It is also contended that this arrangement is directly related to its core business activity of manufacturing and under no circumstance it can be said as unrelated to the business carried on by the appellant. There is nothing on record to rebut the argument of the learned counsel. The assessing officer has not brought on record any such surrounding circumstances/facts wherefrom one can infer that the appellant has either discontinued the existing business carried on by it or switched over to separate and distinct business independent of the one carried on by it. To support his conclusion of discontinuance of existing business, the assessing officer has merely stated that in para 2 of the settlement under Section 18(1) of the Industrial Disputes Act, 1947, it has been mentioned that in view of the peculiar circumstances and conditions existing as are there, it may not be viable to restart the operation in the factory. This would in no way indicate that the appellant wanted to discontinue the business carried on by it. No other reason has been given by the assessing officer that the business carried on by the appellant has been closed down. As is apparent from the facts narrated above, the suspension of manufacturing activity is forced by the court due to labour problem. It is not a case that the appellant had sold off its plant and machinery showing its clear intention that it is no longer interested in continuing the business carried on by it. Rather, the exploitation of the commercial assets during the suspension of manufacturing activity, that too because of court order of sealing the factory, speaks of the intention of the appellant to carry on its business of dealing in electrical goods. Since the appellant could not itself run its factory due to the above sealing by the Court, it exploited its commercial asset i.e. the brand name/trademark built-up by the appellant from the business carried on by it since 1962 through granting license to other parties under 'manufacturing and selling license agreement' with the intention of continuing and then reviving its manufacturing activity once the circumstances become conducive for the same. It may be noted that the company has been engaged in the business of manufacturing/dealing in various kinds of electrical goods for the past 30 years or so. It had installed plant and machinery and set up factory, etc., and had earned goodwill/brand name in the market. Suddenly in 1996, certain labour dispute arose due to which the appellant was compelled to suspend its manufacturing activity temporarily. Since it could not manufacture its own products from the factory premises but in order to earn some profit to meet the various establishment and other expenses during the suspension of manufacturing activity, it leased out its brand name/trademark earned during the past several years of its business to various parties under strict quality control and supervision by the appellant. It is very clear from these facts narrated above, that in this case there was only a temporary suspension of manufacturing activity. There was no discontinuance of the existing business by the appellant. In order to tide over the crises, the appellant exploited its goodwill/brand name through granting 'manufacturing and selling licenses' to other parties, which in my view cannot be considered as income from other sources. It is nothing but a different form of carrying on of the same business which the appellant is engaged in. There was never any act indicating that the assessee never intended to discontinue the business so as to deny the allowance of business expenditure claimed.
6. We have considered the rival contentions, carefully gone through the orders of the authorities below and also the materials placed on record. We found from the record that in the return of income filed for the relevant assessment year under consideration, the assessee had shown income from house property, profits and gains of business, unabsorbed depreciation allowance, brought forward unabsorbed business loss and investment allowance. The assessing officer held that assessee was not carrying any business as stipulated under Section 28 of the Act, on the plea that royalty income was earned by way of exploitation of intangible assets. He further held that even if royalty is taken as business income, there was no justification for claiming expenses on employees, advertisement expenses, interest to employees, legal charges, payment to MCD, union welfare expenses and payment towards interest. He has held that these expenses were not for the purposes of royalty. He has neither allowed set off of brought forward unabsorbed business loss/depreciation/investment allowance nor has he allowed carry forward of such unabsorbed amounts.
7. From the record, we found that assessee company was engaged in the manufacturing and selling of all sorts of electrical consumer goods of lighting, florescent tubes and other type of apparatus for light and fittings under the trademarks Laxman Sylvania/Laxman. It was getting the goods manufactured by other concerns for the purpose of selling under its brand name. However, due to a workmen/staff strike, the manufacturing activities were "temporarily suspended" in April 1996 and the office of District Collector, Delhi, Tees Hazari, in exercise of powers conferred on him under the provisions of Delhi Land Reforms Act, 1954, and Delhi Land revenue Act, 1954, sealed the office block, cost section, store room in the premises of the company. Further, as per the direction of the Hon'ble Justice vide his order dated 3-9-1996, status quo was to be maintained. During the year in question, assessee had earned income from royalty. This royalty is being earned under the "manufacturing and selling license agreements" with various parties viz., Kiran Lighting (P) Ltd., Laxman Marketing (P) Ltd., Orion Electrotech (P) Ltd. In terms of the said agreements, the assessee company has granted its trade names to be used by these licensees for the purpose of manufacturing and selling the products and the licensees pay royalty to it as envisaged in the agreements. The trademarks, viz., 'Laxman Sylvania' and 'Laxman' are the commercial assets of the company, which are being exploited by the assessee in one of the core activities i.e. marketing of lighting products. For this purpose, the assessee company was to continuously monitor market situation, ensure quality and specification of the products manufactured by the licensees and get involved in introduction of new products. The "manufacturing and selling license agreements" are an integral part of the core activities envisaged in the memorandum of association of the company. The temporary suspension of manufacturing and selling activity was due to circumstances beyond the control of the assessee. The business was not closed down. The manufacturing operation was suspended as the workers raised an industrial dispute and the factory was closed. There were numerous court cases due to which the assessee company had to suspend its normal manufacturing and selling operations. No evidence was brought on record by the assessing officer that the assessee had closed down the business with no intention to resume manufacturing and selling.
8. We also found that under the license agreements, the assessee company also provided know-how about the manufacturing, marketing and conduct of the business operation. The assessee company had not simply given the licensees permission to use the trademark and sitting back and enjoying the remuneration. It was actively involved in the conduct of the business of the licensees. The terms of agreement under Clauses 19, 20, 21 and 22 specifically provided for strict specification and quality control. The assessee had also employed its own personnel to visit the licensees and dealers' premises to check the quality of the products. The result of the inspection was also conveyed to the licensees so that performance can be improved. All these terms and acts of the assessee clearly show that royalty paid to the assessee was not passive income. We have considered the case law referred by the learned assessing officer and Commissioner (Appeals) in their respective orders and also deliberated on the case law cited by the learned Authorised Representative and departmental Representative during the course of hearing before us in the context of factual matrix of the case. In the case of CIT v. Vikram Cotton Mills Ltd. , the assessee company carried on business of textiles. It sustained huge losses. After its sustained huge losses, it closed the mill and let out the mill to creditors. The question was whether earning from letting out of plant and machinery was business income. The Supreme Court held that it was a possible conclusion that the assessee intended that there should be a temporary suspension of the business for the purpose of reconstruction of the company and for that matter there must be stoppage of the user of the machinery by the assessee. It was a temporary lease for 10 years or 19 years on renewal and after the expiry of the period, the property reverted back to the assessee. The court held that it is predominantly a matter of intention. It was held that the intention was not to go out of the business altogether as there was no act indicating that the assessee never intended to carry on the business. This judgment of the Supreme Court dated 15-12-1987 is subsequent to the case relied upon by the assessing officer in the case of CIT v. Jacobs . The facts of assessee's case are even better than those in the case of Vikram Cotton Mills Ltd. (supra). It had not sold or let out the factory and the machinery. It had all the intention of resuming the manufacturing and marketing operations, and it was only because of the exigencies of the situation, the assessee company turned to an indirect way of operation in the market through the licenses. All the activities during the year are indicative of intention that it was in the business and had no plan to abandon the core of the business. In Laxmi Narayan Board Mills (P) Ltd. v. CIT , the assessee found certain difficulties and the factory was leased to another concern. The lease was given for a period of nine years and six months. On expiry of the lease, the lessee did not vacate it and the assessee filed a civil suit against the lessee. The High Court held that the assessee had no intention to close the business as there is no evidence that the assessee had no intention of restarting the business. Therefore, there was no discontinuance of business. In the case of Mysore Electrical Industries Ltd. v. CIT , where the assessee entered into technical collaboration agreement on the basis of competence, it had acquired by engaging itself in the business of manufacturing and production of the goods, Karnataka High Court held that the income derived under such agreement was attributed to the know-how acquired by the assessee while carrying on the business, the income from supplying of technical know-how was held another way of exploitation of the business in which the assessee was engaged. Relying on the above decision, Bombay High Court in CIT v. West Coast Paper Mills Ltd. held that where the assessee agreed to give technical know-how and assistance which it had acquired in commissioning the successfully running its own pulp and paper plant, the income derived from it cannot but be held to be profits and gains of business attributable to the priority industries.
9. Thus, it is clear from the various pronouncements discussed above, as referred by learned Authorised Representative during the course of hearing, where the assessee had acquired technical know-how while carrying out its business and it comes to others under collaboration agreement, the income from licenses to use the know-how and technical assistance falls under the head "Income from business". In the instant case, the royalty income is to be treated as business income and should be held to be part and parcel of the same business in which at one time manufacturing and marketing operations were undertaken by the assessee. The manufacturing and marketing operations were suspended temporarily, to be resumed when conducive circumstances would emerge. The income by way of royalty is only by way of conducting the business in a different form. The core of the activities in the earlier format and the present format of the business remains the same.
10. With regard to disallowance of the expenditure, the assessing officer has disallowed the same solely on the ground that these expenses were not necessary for earning the royalty income. However, as per the details of expenses placed on record, keeping in view, the nature of the expenditure, we found that expenses were laid down for the purpose of the business. The litigation expenses are allowable as business expenditure in view of the decisions of Hon'ble Supreme Court in the cases of Shri Meenakshi Mills Ltd. v. CIT and Birla Cotton Spinning & Wvg. Mills Ltd. . Retrenchment compensation is also allowable expenditure. The assessing officer has disallowed the retrenchment compensation payable to the workers in pursuance to the settlement agreement signed by the management with the workers before the Delhi High Court. Such expenditures are intimately connected with the running of business. In Sassoon J. David & Co. (P) Ltd. v. CIT (SC), the Hon'ble Supreme Court examined the question whether terminal benefits on termination of employment can be allowed as business expenditure. The court held,-
It is too late in the day now, whatever may have been the position about two decades ago, to treat the expenditure incurred by a management in paying reasonable sums by way of gratuity, bonus, retrenchment compensation or compensation for termination of service as not business expenditure.
11. We also found that expenditures incurred on advertisement, payment to MCD, union welfare expenses, interest, etc. were connected with the business operation; necessary evidences for incurring the same were also furnished to substantiate that these were necessary for carrying on business operation. We, therefore, do not find any infirmity in the order of the Commissioner (Appeals) for directing to treat royalty income as income from business and to allow expenditure incurred during the year for the purpose of business. There is also no reason to decline setting off of brought forward unabsorbed depreciation as per provisions of Income Tax Act, insofar as business of assessee was continuing during the year under consideration.
12. In the result, the appeal of the revenue is dismissed.