Income Tax Appellate Tribunal - Mumbai
Income-Tax Officer vs Emco Transformers Ltd. on 30 December, 1988
Equivalent citations: [1990]32ITD260(MUM)
ORDER
L.N. Aggarwal, Judicial Member
1. These two appeals have been filed by the revenue against the order of the CIT(A) dt. 1.2.85 for the assessment years 1980-81 and 1981-82. As some of the facts are common in both the appeals, they are disposed of by this single order for the sake of convenience.
2. Following grounds have been taken in the respective appeals:-
ITA 2771/BOM/85 (A.Y. 1980-81) (1) CIT(A) has erred in directing the ITO to allow provisions for guarantee liability of Rs. 3,64,311.
(2) CIT(A) has erred in allowing provisions for repairs of Rs. 1,64,372.
ITA 2772/BOM/85 (A.Y. 1981 -82) (1) CIT(A) has erred in allowing provisions for guarantee liability of Rs.2,11,157 (2) CIT(A) erred in applying provisions of Section 40(c) instead of Section 40(a)(5) in the case of directors correctly applied by the ITO.
(3) CIT(A) erred in allowing Rs. 28,999 as professional fees correctly disallowed by the ITO.
(4) CIT(A) erred in allowing set off of loss of Rs. 8,66,511.
3. Brief facts are that the company, in the assessment year 1980-81, was engaged in the manufacture of transformers and was supplying the same to various electricity boards. It had also given a warranty and undertaken the repair of manufacturing defects found out during the use of transformers by the electricity boards. With a view to enforce the warranty, the assessee had given a bank guarantee of the cost of 5% for this after-sales service and, consequently, had to incur certain expenditure for this after-sales service. Consequently, it made a provision in the balance-sheet to the extent of 1 % of the price of transformers which was likely to be incurred for the repair of the defective transformers found during their use by the electricity boards. It also claimed provision for repairs of Rs. 1,64,372 which it had incurred for repair of certain transformers, although in the assessment year 1981-82, but as the accounts for 1980-81 had not been closed, the said provision of the actual expenditure incurred in the subsequent year was claimed for this assessment year itself. Both the provisions were disallowed by the ITO but these were allowed by the CIT(A). Being aggrieved, the revenue has preferred appeals on both the issues.
4. In the assessment year 1981-82, besides this issue of provision for guarantee liability, there were certain other issues as well. During this year, one company, Emco Estar Capacitors, which was engaged in the manufacture of capacitors, which were required for the manufacture of the transformers by the assessee, was merged in the assessee company under the orders of the High Court dt. 14.4.81 as it was incurring losses. The assessee claimed set off of loss of the merged company amounting to Rs. 8,66,511 which was not allowed by the ITO but was allowed by the CIT(A). Being aggrieved, the revenue has come up in appeal on this issue.
5. Besides, revenue has also challenged the allowance of Rs. 28,999 as professional fees paid by the assessee to carry 'out amalgamation proceedings which were not allowed by the ITO but allowed by the CIT(A).
6. The revenue has also challenged the application of Section 40(c) instead of Section 40A(5) in the case of its director-employees.
ITA 2771 /BOM/85
7. In this appeal, the first issue pertains to the guarantee liability of Rs. 3,64,311, which was about 1% of the sale price of the transformers. The departmental representative stressed that this amount was a provision for contingent liability which was not allowable as a deduction while computing the net income of the assessee. For that, he relied on the decision of the Supreme Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66 in which it was held that the contingent liability could not be allowed while computing the net income.
On the other hand, the learned counsel for the assessee heavily relied on the order of the CIT(A) who has discussed this issue in his order.
8. We have heard the parties and have carefully perused the facts on record. In this case, although the learned counsel for the assessee had relied on the decision of the Tribunal (Pune Bench) in the case of ITO v. Wanson (India) Ltd. [1983] 5ITD 102, but we are of the opinion that that decision does not help the assessee. No doubt, in that case also, the provision made for guarantee and warranty of the industrial machines sold were allowed to be treated as an expenditure, but the facts in that case were a little different. In that case, the assessee had been making such provision for several previous years and its experience showed that the provision actually amounted to the amount required for actual expenditure and it was only in this assessment year in question that the said provision was disallowed by the ITO and, consequently, it was held by the Tribunal that although the liability was a contingent liability, yet on the basis of the experience in the earlier years, the estimate of provision was found to be normally correct
9. In the present case, however, the facts are absolutely different, i.e., the assessee had not been making provision for such expenditure in the earlier years and, for the first time, had claimed deduction for the provision in this year and which was not allowed by the ITO. In fact, in the present case, it is the decision of the Supreme Court in the case of Indian Molasses Co. (P.) Ltd. (supra) which applies with greater force in which their Lordships had held that for an amount to qualify for business expenditure, it should be towards liability actually existing at the time but not putting aside of money which might become expenditure on the happening of an event and, therefore, such putting aside of money could not be treated to be an expenditure. The Income-tax Law makes a distinction between actual liability in praesenti and the liability de futuro which, for the time being, is only contingent but it is only the former, i.e., the actual liability in praesenti, which is deductible and not the latter. The expenditure which becomes an expenditure on the happening of an event is not an expenditure in the eyes of the Income-tax Law. In the present case, no doubt, on the basis of the warranty and guarantee, there is a liability on the assessee to repair the transformers if found defective in, their use by the electricity boards, yet it is only a contingent liability and there may be circumstances when no liability might arise and there may be circumstances to the contrary that liability might arise even more than the provision made in the balance sheet. The learned counsel for the assessee pointed out that the companies like Ashok Leyland Ltd., Bharat Heavy Electricals Ltd. etc. had been making such provisions, but that contention does not help much the assessee as the circumstances of each case are different and they have to be looked into keeping in view the facts and evidence on record in each case. In the present case, the CIT(A) has mentioned in para 1 of his order that in the assessment year 1984-85, an excess provision of Rs. 3,44,913 was written back by the appellant and this fact itself shows that so far even the experience of the assessee has not crystallised to assess the approximate contingent liability which might arise subsequently and which could be considered for this assessment year. In fact, taking the principle enunciated by the Supreme Court in the case cited supra, we are of the opinion that contingent liability, which is not arising in praesenti and depends on several circumstances and will crystallise only on a future date, cannot be allowed as a business expenditure in the assessment year in question. We, therefore, hold that provision for contingent liability, which was not being made by the assessee in the earlier years and which is only a liability which is to accrue in future years, cannot be allowed as an expenditure. The same principle was also upheld by the Allahabad High Court in Addl. CIT v. U.P. State Agro Industrial Corporation. [1982] 153 ITR 597 in which certain receipts were not allowed to be deleted as income of the assessee on the ground that subsequently they might be required to return it to STC even though when finally in the subsequent years they had to return those receipts to the STC. The Allahabad High Court did not allow deletion of the said receipts from the income on the principle of contingency that in that assessment year, it had not crystallised or finalised though the amount had to be returned to the STC and unless it is crystallised or finalised, the said amount could not be allowed to be deducted merely on the basis of contingency. We, therefore, decide this issue in favour of the revenue and set aside the order of the CIT(A) on that score.
10. Another issue in this appeal pertains to disallowance of provision for repairs of Rs. 1,64,370 which had been reduced to Rs. 1,15,808 by the CIT(A). Admittedly, certain transformers were supplied by the assessee to the M.P. Electricity Board during the concerned financial year and the assessee was compelled to incur an estimated expenditure of Rs. 1,64,370 to get the same repaired on the basis of the guarantee and warranty furnished by the assessee and the said amount actually crystallised to Rs. 1,15,808, after the actual repairs were carried out The assessee had made a provision of Rs. 1,64,370 for the said repairs in this assessment year. Admittedly, this amount was neither spent in this assessment year nor the liability to repair the said transformers had accrued in this year. The complaint about the manufacturing defect in the alleged transformers were alleged to have been received in the subsequent year and this was why an estimated expenditure was claimed in this assessment year because the accounts of this year had not by then closed. The CIT(A) accepted the contention of the assessee and allowed the actual amount of expenditure incurred by the assessee for the repair of the transformers, although actually spent in the subsequent year.
11. As discussed in the finding of the earlier issue, this liability for repairs had not arisen in the assessment year under appeal but was only a contingent liability for the assessment year 1980-81 and had, in fact, accrued only in the subsequent year. Any expenditure can be allowed in the eyes of law only when either the liability has accrued in the assessment year or it has been actually carried out and the amount spent in a particular year which can be taken into consideration for the purpose of deduction as an expenditure while computing the net income. As admitted in the present assessment year 1980-81, the liability has neither risen nor the amount has been spent, we are of the opinion that the said provision for repairs cannot be allowed in this assessment year and the order passed by the CIT(A) on that score does not hold good. The issue is, therefore, decided in favour of the revenue.
In the result, the appeal for the assessment year 1980-81 filed by the revenue stands allowed.
ITA 2772/BOM/85
12. In this appeal, the first issue is identical as taken up by the revenue in the appeal 2771/BOM/85. This issue is, therefore, held accordingly and the order passed by the CIT(A) on that score is set aside as he had erred in allowing provision for guarantee liability of Rs. 2,11,157 which was nothing but a contingent liability and had not arisen in the year in question.
13. Next issue in this appeal pertains to the application of provision of Section 40(c) instead of Section 40A(5) in the case of director employees. The learned counsel for the assessee pointed out that this issue stood covered against the revenue by the decision of the Special Bench of the Tribunal in the case of Geoffrey Manners & Co. Ltd. v. ITO [1983] 3 SOT 40 (Bom.). In the said decision, the Special Bench had held that while computing the ceiling on salary and perquisites paid to the director employees, it is Section 40(c) and not Section 40A(5) which shall be applicable. In the present case the facts being identical, we do not find any reason to disagree with the finding of the Special Bench of the Tribunal on this issue. Therefore, respectfully following the same, we hold that the CIT(A) was right in applying provisions of Section 40(c)and not Section 40A(5)in the case of director employees while computing the ceiling on salary and perquisites. We, therefore, decide this issue in favour of the assessee and against the revenue.
14. In this appeal, the next issue pertains to the allowance of Rs. 28,999 as professional fees as revenue expenditure given to advocates in pursuing the proceedings for amalgamation of the two companies in the Hon'ble High Court, which was disallowed by the ITO. The departmental representative argued that by amalgamation of the two companies, there was an increase in the capital of the assessee company and, further, the amalgamation gave rise to a benefit of enduring nature to the assessee company and, thus, any amount spent towards amalgamation proceedings was nothing but a capital expenditure and should not be allowed as revenue expenditure.
15. On the other hand, the learned counsel for the assessee argued that this amalgamation was not for the purpose of increasing the capital or the assets of the assessee company but it was in the interest of the business of the company. Admittedly, the amalgamated company was engaged in a similar business, i.e., in manufacturing capacitors which were required for transformers. The said company was running at a loss and there was a chance of its closing down. Consequently, the assessee company would have been put at a disadvantage in procuring capacitors which was an important ingredient for the production of transformers and the assessee would have had to make efforts to find out an alternative. Therefore, in the interest of the business of the assessee company and to run efficiently its manufacturing process for transformers, it had to make efforts to amalgamate the said company with itself. In this way, the main interest was not augmenting of assets by the assessee but was to run its own establishment efficiently. Consequently, in view of the Madras High Court decisions in the cases of CIT v.Bush Boake Alien (India) Ltd.[l982] 135 ITR 306 and Addl. CIT v. W. A. Beardsell & Co. (P.) Ltd. [1981] 130 ITR 159, it should be allowed as a revenue expenditure.
16. We have heard the parties at length and have also perused the facts on record. We are of the opinion that the alleged expenditure should be allowed as a revenue expenditure. The Bombay High Court, in the case of Bombay Burmah Trading Corpn. Ltd. v. CIT [1984] 145 ITR 793 while considering various decisions of the Supreme Court and also considering the decisions of the Madras High Court (supra) had held that legal expenses in connection with issue of bonus shares was an allowable revenue expenditure and not in the nature of capital expenditure. The court had discussed at length that, in fact, the principle behind the revenue expenditure and capita! expenditure was that if the expenditure gave rise to a benefit of enduring and permanent nature, then it was to be treated as capital expenditure as, otherwise, it should be treated as a revenue expenditure. In the present case, when the amalgamated company was running at a loss and it was in the business interest of the assessee that it should continue to manufacture capacitors, which were important part in the manufacture of transformers by the assessee, that the assessee, moved by that interest in view, applied to the High Court for the amalgamation of the two companies and it is the details of expenses which related to charges for drafting the petitions to the High Court, notice charges, advertisement charges, valuation and other fees etc. which are nothing but a routine expenditure to achieve the object of amalgamation which was in the ultimate business interest of the assessee company. The CIT(A) had also relied on the decision of the Tribunal (Bombay Bench 'A') in the case of A.N.. & Co. Ltd. [IT Appeal No. 1406 (Bom.) of 1980] for assessment year 1976-77, reported in the Bombay Chartered Accountants Journal August 1981 issue p. 547, in which it was held that when the amalgamation of two companies was effected for running the business of the assessee company more economically, efficiently and for rationalisation of its administration, the legal fees paid to the chartered accountants in connection with the agreement was allowable as a revenue expenditure even though it resulted in some changes of the capital structure of the assessee company. In fact, this decision of the Bombay Bench of the Tribunal is based on practically identical facts and we do not find any reason to disagree with the said finding. Consequently, respectfully following the same and relying on the basic principle enunciated by the Bombay High Court in the case of Bombay Burmah Trading Corpn. Ltd. (supra), we are of the opinion that the CIT(A) was right in allowing Rs. 28,999 as professional fees and thereby as an expenditure of revenue nature. The issue is decided against the revenue.
17. The next issue is regarding the allowance of set off of loss of Rs. 8,66,511. The departmental representative argued that unabsorbed set off of loss was not allowable Under Section 72A as the said amalgamation had not been approved by the Government, as provided Under Section 72A.
On the other hand, the learned counsel for the assessee relied on the decision of the CIT(A) who has dealt with this issue in greater detail in para 5 of his order.
18. We have heard the parties at length and have considered the entire facts on record S/Shri Kanga and Palkhivala, in their 'Commentary on Income-tax Act while elaborating Section 72, have discussed it as follows:
The loss can be carried for ward and set off only against the profits of the assessee who incurred the loss. In other words, the person who incurred the loss alone has a right to carry forward the same and the successor in the business cannot claim to carry forward the loss incurred by the predecessor in the business. The only exceptional case is that of succession of inheritance (s.78(2)). The past loss of the company which merges into another under a scheme of amalgamation cannot be carried forward by the latter company.
19. The Calcutta High Court in the case of Indian lron & SteelCo. Ltd., In re [1941] 9 ITR 539 had held that the assessee company was not entitled to have the depreciation allowance on buildings, machinery etc. of the 'B' company acquired by it and nor entitled in law to carry forward the unabsorbed depreciation allowance of the acquired company. The same principle was followed by the said court in another case of Bengal Flour Mills Co. Ltd., In re [1941] 9 ITR 568 in which it was held that the income-tax authorities were correct in law in refusing to allow carry forward the sum of unabsorbed depreciation. The same principle was also upheld by the Hon'ble Privy Council in the case of Indian.Iron & Steel Co. Ltd. v. CIT [1943], zx11 ITR 328. In that case, the Hon'ble Privy Council held that where a business was transferred, the unabsorbed depreciation allowance and other losses of the previous owner could not be assigned to the successor so as to enable him to carry them forward and to set them off against his own profits. The decision of the Delhi Bench of the Tribunal in the case of Bharat Heavy Electricals Ltd. v. ITO [1983] 5ITD 361 relied on by the assessee, does not help much the assessee. The facts in that case were a little different In that case, both the amalgamated companies were Government of India Undertakings and their amalgamation had been approved by the Government in public interest Under Section 396 of the Companies Act on the basis of special powers vested in it. Consequently, it was held that the Central Government was aware of the fact that the loss of the HEL, whether on account of business or unabsorbed depreciation, should be treated as a part of the loss of the assessee. Full effect for it could be given only if its implication was given for the purpose of assessment under the I.T. Act also. What the assessee was claiming was not cany forward of unabsorbed loss or depreciation. It was claiming its own loss which had to be determined with reference to the order of amalgamation and, consequently, the same was held to be allowable.
20. Here, in the present case, the amalgamation order was not approved by the Central Government It was allowed by the High Court Under Section 394 of the Companies Act Thus, the facts of the present case are quite different than the facts of the case in Bharat Heavy Electricals Ltd. (supra). In fact, as the law stood, it had been enunciated by the Calcutta High Court and the same was also upheld by the Privy Council and also explained by the learned authors Kanga and Palkhivala in the commentary discussed above that such unabsorbed losses and depreciation could not be allowed to be carried forward while computing the income of the company in which the other company, whose losses and depreciation are desired to be carried forward, had merged. The Legislature, in its wisdom to clarify the position, enacted s.72A to be effective from 1.4.1978, inserted by the Finance Act No. 2 of 1977. This section provides as to how and under what circumstances the accumulated losses and unabsorbed depreciation of the amalgamating company shall be allowed to be carried forward. Thus, when a specific provision has been provided in the enactment itself, then it is this provision alone which shall govern such circumstances. Under this section, it has been provided that where there has been an amalgamation of a company owning an industrial undertaking with another company, and the Central Government, on recommendation of the specified authority, is satisfied that certain conditions provided in the section are fulfilled, then the Central Government may make a declaration to the effect and it is only thereafter that, notwithstanding anything contained in any other provisions of the Act, the accumulated losses and unabsorbed depreciation of the amalgamated company shall be deemed to be the loss or, as the case may be, allowance for depreciation of the amalgamated company for the previous year in which the amalgamation was effected. Admittedly, in the present case, the assessee had applied to the Central Government, but the Government of India, Ministry of Industry, by their order dt. 11th October, 1982, stated that the amalgamation did not satisfy the conditions enumerated in s. 72A(1). It clearly goes to suggest that the Central Government had not approved the amalgamation for the purpose of carrying forward of unabsorbed loss and depreciation of the amalgamated company.
21. In the Income-tax Act, 1961, besides Section 72A, there is no other specific provision under which such loss could be allowed to be carried forward or unabsorbed depreciation to be Carried forward, Section 32 or Section 72 provides carrying forward of the loss and unabsorbed depreciation only in cases when the assessee is the same. The person who incurs the loss alone has a right to carry forward the same and the successor in the business cannot claim to carry forward the loss incurred by the predecessor in the business. As the assessee here, after the amalgamation, has changed, carry forward of the loss or unabsorbed depreciation of the amalgamated company cannot be allowed a set off against the profits of the assessee company in which the amalgamated company has merged. We are, therefore, of the opinion that the order passed by the CIT( A) on that score was not correct in the eyes of the law and, therefore, we set it aside and restore the order passed by the ITO. The issue is, therefore, decided in favour of the revenue and against the assessee.
22. In the result -
(i) ITA 2771/BOM/85 is dismissed.
(ii) ITA 2772/BOM/85 stands partly allowed, as discussed above.