Income Tax Appellate Tribunal - Hyderabad
Dr. Reddy Laboratories Limited, ... vs Assessee on 21 May, 2013
IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCH "B",
HYDERABAD
BEFORE SHRI B. RAMAKOTAIAH, ACCOUNTANT MEMBER AND
SHRI SAKTIJIT DEY, JUDICIAL MEMBER
ITA No. 1605/Hyd./10
Assessment Year : 2006-07
Dr. Reddy's Laboratories Addl. CIT
Limited Circle-1(2), 4th Floor
7-1-27, Ameerpet Aayakar Bhavan
Vs.
Hyderabad-500 016. Hyderabad.
PAN No.AAACD 7999 Q
(Appellant) (Respondent)
Assessee by : Shri Sampath Raghunathan
Revenue by : Shri D. Sudhakar Rao
Date of hearing : 21/05/2013
Date of Pronouncement : 08 / 08/2013
ORDER
PER B. RAMAKOTAIAH, AM:
This appeal by the assessee is against the orders of the AO under section 143(3) r.w.s. 144C(5) and 144C(13) of the Income tax Act, 1961 (the Act). The assessee filed return of income on 29.11.2006 declaring total income at nil after claiming deduction under Chapter-VI-A under normal provisions and Rs.204,62,90,909 as book profit under section 115JB. Subsequently, assessee filed revised return on 29.10.2007 declaring total income at nil and book profit at Rs.197,74,95,284. The return was selected for scrutiny and Assessing officer proposed a draft order under section 144C dated 23.12.2009. The assessee filed 2 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
objections under section 144C(2) before DRP on 29.01.2010. The DRP Hyderabad passed order under section 144C(5) on 30.09.2010 and AO finalized the assessment order on 01.11.2010. This order is the subject matter of present appeal.
2. The assessee raised 20 grounds in its appeal. Ground Nos. 1, 18, 19 & 20 are general in nature and does not require any adjudication. In the course of appellate proceedings the assessee has not pressed ground No.4 which is on claim of weighted deduction under section 35(2AB)of the Act.
2.1 We have heard the ld. Counsel and the ld. DR in detail and also perused the chart placed on record with reference to the grounds and submissions including the paper book relevant for considering the issues under appeal. Ld. DR relied on the facts as stated in orders and the findings of AO/DRP. Various grounds are decided as under :-
3. Ground No.2 and 17: These two grounds are as under :-
"Ground No.2 AO's order giving effect to Assessing Officer and ld. DRP order without considering the Revised Return filed by the assessee incorporating the merger of Perlecan Pharma Pvt. Ltd. with DR. Reddy's Laboratories Limited as per the order of Hon'ble High court of Andhra Pradesh is bad in law and lacks merits.
Ground No.17. AO and ld. DRP has erred in omitting to consider the revised return of income filed for the assessment year 2006-07 during the course of assessment proceedings consequent to the merger of its subsidiary M/s. Perlecan Pharma Private Limited with the assessee as per High Court Order."
3.1 The assessee having filed original return on 29.11.2006 and revised return on 29.10.2007, filed a second revised return on 24.12.2009. The reason for filing second revised return was to give effect to the merger order of the Andhra Pradesh High Court. Since the draft 3 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
assessment was served on the assessee on 31.12.2009 and assessment proceedings have not been concluded, the assessee filed objections before the DRP for considering the second revised return. Vide objection No.15 on page-47 (wrongly stated as page-51 by the assessee in the chart), the DRP did not agree with the assessee's contention stating that the AO has passed order under section 143(3) on 23.12.2009.
3.2 Before us referring to the objections filed by the assessee and the order of the DRP, the ld. Counsel submitted that the reasoning given by the DRP was not correct as a draft assessment order is not final assessment order and relied on the decision of the Hon'ble Delhi High Court in the case of Alpine Electronics Asia Pte. Ltd. Vs Director General of Income-tax (Del) (341 ITR 247)(Del.). It was further submitted that revised return had been filed on 24.12.2009 and relying on the principle laid down in the judgment given by the Hon'ble Allahabad High Court in the case of Dhampur Sugar Mills Ltd. Vs CIT (90 ITR 236)(All.), it was submitted that once a revised return has been filed the original return has to be taken as withdrawn. It was submitted that proceedings without considering the revised return are bad in law.
3.3 After considering the rival submissions, we are unable to agree with the contentions raised by the assessee for considering the second revised return filed on 24.12.2009. While admitting that the order of the DRP in rejecting the assessee's contention is not correct, in the sense that draft assessment order cannot be taken as final assessment order, the assessee's contention that second revised return should be considered as a valid revised return cannot be accepted. Eventhough, the reason for filing the second revised return is due to merger of Perlecan Pharma Pvt. Ltd. with the assessee company effective from 1st January 2006 vide order of Hon'ble High Court of Andhra Pradesh dated 4 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
07.07.2009 and a second revised return was prepared and filed giving effect to the said order, the provisions of Income tax Act does not permit the second revised return filed beyond the time limit provided to be treated as a valid return of income. Provisions of section 139(5) are as under :-
[(5) If any person, having furnished a return under sub-section (1), or in pursuance of a notice issued under sub-section (1) of section 142, discovers any omission or any wrong statement therein, he may furnish a revised return at any time before the expiry of one year from the end of the relevant assessment year or before the completion of the assessment, whichever is earlier :
Provided that where the return relates to the previous year relevant to the assessment year commencing on the 1st day of April, 1988, or any earlier assessment year, the reference to one year aforesaid shall be construed as a reference to two years from the end of the relevant assessment year.] ( Emphasis supplied) 3.4 As can be seen from the above provision of the Act, assessee has an option to furnish the revised return at any time before the expiry of one year from the end of the relevant assessment year or before completion of the assessment, whichever is earlier. Assessee's contention that the second revised return was filed before completion of the assessment may be technically correct, but that has to be filed before expiry of one year from the end of the relevant assessment year. In this case, as already stated earlier, assessee had filed original return of income on 29.11.2006 and another revised return on 29.10.2007. In case, the assessee has to file another revised return the same could have been filed on or before 31.03.2008, as per the provisions of section 139(5). The words "which ever is earlier" puts limitation on filing of revised return beyond one year from the end of assessment year. Thus, 5 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
the second revised return filed on 24.12.2009 was beyond the time limit prescribed under the Act. Therefore, since there is a limitation provided under section 139(5) which cannot be ignored, we have to hold that the second revised return filed was beyond the time limit prescribed. We cannot direct the AO or DRP to consider the same, when the law itself does not permit the same. Accordingly, the grounds raised by the assessee are rejected.
4. Ground No.3 is as follows :-
"3. AO and the ld. DRP has erred in considering capital gain on the sale of GOA Unit of the assessee as short term capital gain instead of long term capital gain."
4.1 This ground pertains to the issue whether capital gain arising on sale of Goa Unit of the assessee results in short term capital gain or long term capital gain.
4.2 Briefly stated, the assessee was having a manufacturing unit at Goa. During the year, the unit was sold to M/s Watson India Ltd. for a consideration of Rs.75.62 crores. The assessee filed the computation of capital gains in the original return as under :-
" Capital Gains in the Original Return of Income:
A) Sale of Lease hold Rights-at Goa
-Sale Consideration Rs.7,50,22,200
-Less: Cost of Acquisition Rs.1,60,60,688 5,89,61,512 B) Sale of Business and Commercial Right-At Goa
- Sale consideration Rs.10,42,82,630
-Less Cost of Acquisition --- 10,42,82,630"6 ITA No.1605/H/10
A.Y.06-07 DR. Reddy's Laboratories Ltd.
4.3 Subsequently, the assessee filed the capital gains in the revised return of income as under :-
"Capital Gains in the Revised Return of Income:
Gross sale consideration received Rs.75,61,88,546 Less: Net worth of the Unit Land Rs.1,60,60,688 WDV of Block of assets + Additions made during the year Rs.24,49,49,785 Rs.26,10,10,563 Long Tern Capital gains Rs.49,51,77,983"
4.3.1 The date of sale to M/s. Watson India Ltd. was Rs.29.10.2005 on which there is no dispute. There is also no dispute with reference to consideration received under capital gain working. The only dispute was with reference to date of setting up of the unit. According to the assessee, as assessee applied to Goa Industrial Development Corporation (GIDC) vide letter dated 28.10.2002 for allotment of plot, it contends that the capital gain is long term capital gain, as it sold after three years. However, the AO was of the opinion that it was only an application made to GIDC for granting lease of plot of land and eventhough a security deposit of Rs.2,05,660/- was paid on that date, the actual transaction resulted on 11.03.2003 on which date premium of Rs.1,76,28,000/- was paid and the assessee was given possession of land, on lease, from 10.04.2003 and further lease deed was registered on 31.07.2003. Eventhough, the factory was established subsequently, the AO considered that, even giving benefit of doubt to the assessee, the earliest date of acquisition can only be on 10.04.2003. Accordingly, invoking proviso to section 50B, the AO treated the same as short term capital gain as the date of sale transaction was within 36 months of setting up of the unit. The assessee reiterated the same 7 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
submissions before the DRP and relied on the decision of the Hon'ble Delhi High Court in the case of CIT vs. Hughes Escorts Communication Ltd. (311 ITR 253)(Del.), wherein the Hon'ble Court held that the setting up of business of the assessee company should be considered as the date when the assessee took the first step in the said business i.e. placed orders for purchase of VSAT equipments. Relying on the above principle it was the contention that the unit was set up when the assessee made application for the land to GIDC which is relevant. If calculated from that period the capital gains becomes long term capital gain. The DRP however relied on the date of manufacturing of commercial production which jointly is after the date of registering the barren land to the tax payer. Therefore, it did not agree with the contention that date of application has to be considered as date of setting up of unit.
4.4 Before us, the ld. Counsel, in addition to relying on the decision of Hon'ble Delhi High Court in the case of CIT vs. Hughes Escorts Communication Ltd. (311 ITR 253)(Del.) also relied on the co-ordinate Bench decision in the case of Dhoomketu Builders & Development (P.) Ltd. vs. Addl. CIT ITAT, Delhi 2011(11)TMI 193 and in the case of Jitendra Mohan vs. Income Tax Officer (2007) (11 SOT 594)(Del.). He also referred to the principles rendered by the Hon'ble Supreme Court in the case of Rustom Cavasjee Cooper vs. UOI (1970 AIR 564). The ld. DR relied on the orders of DRP.
4.5 We have considered the issue and examined the relevant facts and case law. In this case, the assessee made the application to GIDC on 28.10.2002 for allotment of plot in the industrial area being developed by GIDC. There is no dispute w.r.t. date of lease registration being 31st day of July, 2003. The recitals of the agreement are already extracted in the assessment order but suffice to say that the assessee paid an amount of 8 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
Rs.2,05,660/- as security deposit at the time of application and in pursuance, the assessee paid premium of Rs.1.76 crores on 11.03.2003 and possession was handed over on 10.04.2003. The period of 30 years lease starts from 10.04.2003, which can be extended to 95 years. This indicates that eventhough assessee made an offer for establishing a unit in GIDC, the offer was complete only when the same was accepted and this seems to have happened on 11.03.2003, when the assessee paid further amount of Rs.1.76 crores and possession was handed over on 10.04.2003. Eventhough lease deed was entered into on 31.07.2003, possession of vacant land was given on 10.04.2003 and period of 30 years of lease period starts from that day. Only after getting the possession, the assessee would have been in a position to establish a factory there and start manufacturing activity. Thus, it can be considered that a unit had been set up and ready to commence business only from the time GIDC allots the plot. In the case relied upon by the assessee CIT vs. Hughes Escorts Communications Ltd.(311 ITR 253)(Del.),the date of placing of purchase order for VSAT equipment was considered to be the date of set up of the company. In this case, it is not even the order for purchase of machinery or raw material but an application made to GIDC which, when gets accepted only can be considered as a valid one. In the case of Jitendra Mohan vs. Income Tax Officer (2007) (11 SOT 594)(Del.) the issue was with reference to period of holding u/s. 2(14). There the starting date for the counting the period of holding was considered as date of allotment i.e. 08.07.1994 and not before, therefore, this case law does not help assessee. Even in the case of Dhoomketu Builders & Development (P.) Ltd. vs. Addl. CIT ITAT, Delhi(supra) the issue was with reference to commencement of business and assessee's participation in the tender was considered as starting of one activity which enable the assessee to acquire the land for development. In that case, the assessee was in the real estate business and participation in the tender for 9 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
acquiring land was considered as commencement of business. Vide para- 7 of the order the Hon'ble Bench has considered the issue as under :-
"7. Section 2(13) provides the definition of expression 'Business" according to which business includes any trade, commerce, manufacture or any adventure or concern in the nature of trade, commerce or manufacture. The learned counsel for the assessee has referred a large number of decisions noticed above. Similarly, the Assessing Officer has made a reference to the decision of Hon'ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd.'s case (supra). In various authoritative pronouncement of Hon'ble Supreme Court and Hon'ble High Court, meaning and scope of expression, business has been propounded. It is not necessary to recite and recapitulate of those decisions but on the strength of them it would be suffice to say that word "business"
had a wide import and it means an activity carried on continuously and systematically by a person by the application of his labour and skill with a view to earn an income. Section 3 of the Income-tax Act, 1961 defines "previous year". Previous means the financial year immediately preceding the assessment year. The proviso appended to this section further contemplates that in case of a business newly set up in the said financial year, the previous year shall be the period beginning with the date of set up of the business. The expression "set up" has not been defined anywhere in the Act but it is understood in the common parlance and has been explained in a large number of decisions. According to the meaning expounded in the authoritative pronouncement, if an assessee is in a position to deliver the goods means that the business is set up. Actual delivery is immaterial. For example, if a person wants to carry on the business of transportation, the moment he purchased the vehicle for transporting the goods and arranged the space then it would indicate that business has been set up, it is immaterial whether he was able to actually transported the goods or not. In the case of Hughes Escorts Communications Ltd.'s case (supra), Hon'ble Delhi High Court has considered this expression and after referring the decision of Hon'ble Bombay High Court in the case of Western India Vegetable Products Ltd. v. CIT [1954] 26 ITR 151 has observed that Hon'ble Bombay High Court has drawn a distinction between the concept of commencement and setting up of a business. Hon'ble Delhi High Court has reproduced the observations of the Hon'ble Mumbai High Court which read as under:
10 ITA No.1605/H/10A.Y.06-07 DR. Reddy's Laboratories Ltd.
"The Bombay High Court, which was in this case dealing with the corresponding provision of the Indian Income-tax Act, 1922 then explained the distinction between the concepts of commencement and setting up of a business (pages 158 and 159):
"It seems to us, that the expression 'setting up' means, as is defined in the Oxford English Dictionary, 'to place on foot' or 'to establish', and in contradiction to 'commerce'. The distinction is this that when a business is established and is ready to commence business then it can be said of that business that it is set up. But before it is ready to commence business it is not set up. But there may be an interregnum, there may be an interval between a business which is set up and a business which is commenced and all expenses incurred after the setting up of the business and before the commencement of the business, all expenses during the interregnum, would be permissible deductions under sec. 10(2)."
(emphasis supplied) 4.6 Adverting to the present facts of the case, we find that assessee can be considered as setting up the business only from the time it got allotment of the land, if not ready to commence manufacturing activity, and not before. In this case, eventhough actual manufacturing activity started much later, the setting up of the business can be considered only when the assessee is in position to occupy land to start the unit in GOA, GIDC, as considered by authorities. The principles discussed above infact consider the setting up much later. But the authorities even gave a benefit in considering the date of taking possession of land while deciding the date of setup. Therefore, we are of the considered opinion that date of setting up of the business activity, as accepted by Assessing Officer and DRP as on 10.04.2003, does not require any modification, eventhough lease deed was entered into subsequently and unit was set up much later. In view of this, the gain can only be considered as short term capital gain, as decided by authorities. The ground is accordingly rejected.
11 ITA No.1605/H/10A.Y.06-07 DR. Reddy's Laboratories Ltd.
5. Ground No.4 is regarding weighted deduction available to the assessee u/s. 35(2AB) which was withdrawn.
6. Ground No.5 reads as under :-
"5. AO and the ld. DRP has erred in disallowing the expenditure incurred towards payment of interest to Department of Chemicals and Petrochemicals (DCP)."
6.1 Ground No.5 pertains to the issue of disallowance of expenditure incurred towards payment of interest to Department of Chemicals and Petrochemicals (DCP). Briefly stated, assessee has claimed a sum of Rs.28,49,85,605 as revenue expenditure being the amount paid to DCP. This amount was directly deducted in the computation of income. Assessee was asked to furnish the details of this expenditure. It is seen form the details that this amount was paid in pursuance of orders of National Pharmaceuticals Pricing Authority (NPPA) which is a government agency. It fixes the selling price of some drugs based on the DPCO (Drug Price Control Order) 1995 which is binding on all manufacturers of those controlled drugs. No manufacturer should sell at a price higher than what was fixed by NPPA. From the order, it is seen that the amount consists of two parts.
(a) The first part relates to the amount over charged on sale of Norfloxacin formulation. Assessee manufactures Norfloxacin formulation whose price of the drug was fixed by NPPA. NPPA has passed order on 14/7/2005 with a finding that assessee has overcharged the price in the sale of Norfloxacin. The order has computed the excess amount charged by the assessee at Rs.15,42,97,070 with a direction that such excess the amount be paid to the government.
(b) NPPA has passed another order dated 14/07/2005, whereby it has charged interest of Rs.13,06,87,515 for violation of norms notified by 12 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
Government of India in DPCO (Drug Price Control Price) 1995 by overcharging the sale price for Norfloxacin formulation.
6.2 Assessee has paid both the amounts and claimed both of them as expenditure.
6.3 Invoking the Explanation to section 37, the AO considered the claim of interest as penal in nature and accordingly disallowed the amount, wholly allowing overcharged amount paid to the DPCO. It was the contention of the assessee that NPPA vide its order dated 14.07.2005 asked to pay an amount of Rs.28,49,85,605/- towards recovering of excess price on sale of the product along with interest. Therefore, both the amounts are allowable as deduction. The assessee relied on the decision of the Hon'ble Allahabad High Court in the case of Kamlapat Motilal Vs CIT (104 ITR 783)(All.) on the proposition that if the principal is a permissible deduction, interest payable thereon would also be a permissible deduction. However, the DRP did not agree on the reason that interest was charged for violating the provisions of Central Act and therefore penal in nature. The assessee relied on the submissions before the DRP and also the decision of the co-ordinate Bench of the Tribunal in the case of A.P. Paper Mills Ltd. vs. ACIT in ITA No.872/Hyd./2006 for assessment year 2002-03.
6.4 We have considered the issue and examined the facts. There is no dispute to the fact that AO allowed the principal amount which was also determined vide Drug Pricing Control Order (DPCO). Assessee was directed to deposit total of Rs.28.49 crores. We are unable to understand the action of AO in allowing the principal amount u/s. 37(1) but disallowing the interest there on as penal in nature. As seen from the record, the assessee has collected more amount towards sale of Norfloxacin formulation and order was passed to pay the amount 13 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
collected in excess of the regulations. These transactions are contractual in nature and can not be considered as penal in nature. Eventhough the assessee relied on the decision of the Tribunal in the case of A.P. Paper Mills Ltd. vs. ACIT(supra),the issue dealt therein is not u/s.37(1) but u/s. 43B, therefore, the same is not applicable. This issue however was decided by the co-ordinate Bench( wherein The AM is a party) in the case of Glaxo Smithkline Pharmaceuticals Ltd. in ITA No.6158/Mum/2003 in Assessment Year: 1998-99 and ITA No.7125 & 7206/Mum/2003 in Assessment year: 1998-99 dated 12.06.2013, the issue has been discussed as under :
Assessee has raised the following additional grounds which are numbered as 9 and 10, which are allowed:
"Ground No.9 Betnelan Interest demand.
The Appellants submit that in view of the demand of interest raised by the Department of Chemicals and Petrochemicals pursuant to the letter/order dated 10th June, 1997 a sum of Rs..18,06,887 which represents the interest payable for the period 1.4.1997 to 31.3.1998 be allowed as a deduction.
Ground No.10. Betnelan demand.
The Appellants submit without prejudice to their contentions that they be allowed deduction for the demand in each of the AYs to which they pertain i.e. 1995-96 and 1996-97, the entire amount of Rs.1,20,42,318 be allowed in AY 1998-99 as the demand was raised vide letter/order dated 10.6.1997 of the Department of Chemicals and Petrochemicals".
10.1 Ground No.9 & 10 are the additional grounds raised in the course of present appellate proceedings vide letter dated 9.8.2007. The facts leading to the present issue are that during the previous year relevant to assessment year 1998-99, assessee received a demand dated 10th June, 1997 from the Department of Chemicals & Petrochemicals (DCP) amounting to Rs.1,90-,43,347/- towards overcharging of price in respect of the Appellant's product "Betnelan Tabs sold during the period January 1995 to July 1995. The demand was revised to Rs. 1,20,42,312/-. Interest of Rs. 84,29,619/- upto 31.12.1999 was charged on the demand at the rate of 15% per annum. Aggrieved by the DCP's order, assessee filed a Writ Petition bearing No. 1266 of 1999 before the Division Bench of 14 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
the Hon'ble High Court of Bombay. The Division Bench, vide order dated 16.2.2004 upheld the stand of the DCP. The DCP, subsequently by an order dated 17/18.5.2004, revised upwards the interest demand to Rs. 1,63,70,915/- (Total demand:Rs.2,84, 13,228/-). Assessee has filed a Special Leave Petition (CIVIL) No. 6518 of 2004 in the Supreme Court with prayer for interim relief challenging the order of the Division Bench of the Bombay High court. The same is pending before the Hon'ble Supreme Court for disposal.
10.2 Assessee is of the view that the liability pertaining to the above demand was allowable in each of the years to which the demand pertains. The year-wise break-up of the total demand of Rs.2,84,13,228/- (inclusive of interest) is given below:
Assessment Demand Interest
year Product demand (`.)
Betnelan (`)
1995-96 14,59,674 47,891
1996-97 1,05,82,638 18,06,887
1997-98 - 18,06,887
1998-99 - 18,06,887
1999-2000 18,06,887
2000-01 18,06,887
2001-02 18,06,887
2002-03 18,06,887
2003-04 18,06,887
2004-05 18,06,887
2005-06 65,901
Total 1,20,42,312 1,63,70,915
Assessee has not debited the aforesaid demand (including Interest) to the Profit & Loss Account. Assessee has also not paid the demand.
10.3 On this issue, it was fairly admitted that the issue is restored to the file of AO for fresh adjudication in view of the directions given in assessment year 1995-96 order dated 30.11.2011 wherein the Tribunal vide Para 3 & 4 restored the issue to the file of AO for de novo adjudication in accordance with the law. Consistent with the view taken therein, we direct AO to adjudicate the issue and consider the allowance of the above amount in accordance with the law and facts. The grounds are considered allowed for statistical purposes.
15 ITA No.1605/H/10A.Y.06-07 DR. Reddy's Laboratories Ltd.
Considering the orders of the co-ordinate bench on the issue and the fact that AO allowed principal amount as deduction u/s. 37(1), we see no reason to disallow the interest as penal in nature. This interest arises not as penalty but as compensatory amount. Therefore, we hold that interest is allowable. Ground No.5 is allowed.
7. Ground No.6 is as follows :
"AO and the ld. DRP has erred in disallowing the expenditure incurred by the assessee towards honouring of bank guarantee in respect of bank loan taken by Pathnet."
7.1 This ground pertains to disallowance of amount paid on discharge of bank guarantee issued for subsidiaries. The facts of the case are that assessee furnished a guarantee in connection with the borrowing by Pathnet from ICICI Bank. The assessee held 49% stake in the Pathnet. The assessee during the year had sold its stake in Pathnet and settled the guarantee of Rs.2,08,02,460/- issued for loan taken by the JV with the bank. The assessee wrote off the said amount in the books by debiting to the profit and loss account as the same was not recoverable from Pathnet.
7.2 Assessee contended that Pathnet was in the business of setting up of medical pathological laboratories. Assessee has given the corporate guarantee against the loan taken by the JV. The assessee has commercial interest in the JV and the loan amount paid by the assessee is in the commercial expediency of the business of assessee.
7.3 Regarding bad debts written off the ld. Assessing Officer in his order held as under :
16 ITA No.1605/H/10A.Y.06-07 DR. Reddy's Laboratories Ltd.
As per the provisions of section.36(2) of the Act, for the purpose of claiming bad debt such as deduction such debt should have been taken into account in computing the income of the assessee in the current previous or in an earlier previous year or should represent money lent in the ordinary course of the business of banking or money lending which is carried on by assessee.
In the instant case, the sum being claimed as bad debt never formed part of the receipts of assessee's business either in the previous year under consideration or in an earlier year. The assessee is neither a bank not is engaged in the business of lending money. The amount was paid to ICICI bank to settle the guarantee given to the loan availed by a related company. The amount represents capital loss and cannot be set of against business income. Given these facts, this claim of Rs.2,08,02,460/- as bad debt is not allowable. The same is therefore, disallowed and added back to assessee's income. The facts of the present case are different from the facts in the case law cited by assessee.
A somewhat identical issue was for consideration in the AY 2003-04 where the assessee wrote-off loan given to Compact Electric Ltd., 100% subsidiary of the assessee company during the course of the business to meet the requirements. The same was disallowed by AO which was upheld by CIT(A). This strengthens the finding that the above amount is not allowable as bad debt.
8. DRP confirmed the same stating that the same was in capital field.
8.1 It was submitted that Pathnet (an equity investee) secured a credit facility of Rs.250 million from ICICI Bank Ltd. to enhance the credit standing of Pathnet, on December14, 2001 the assessee issued a corporate guarantee amounting to Rs.122.5 million in favour of ICICI Bank. In July, 2005, the company was released by ICICI Bank from this guarantee obligation when its share of the outstanding loan amount, Rs.21.0 million (Rs.2.1 crores), was repaid. During the year ended March 31, 2006 the company sold its stake in Pathnet and settled the guarantee issued to ICICI bank by paying its share of the invoked guarantee by ICICI. The amount was paid and written off by the assessee to protect its credibility in business and claimed as allowable expenditure 17 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
under section 37(1) of the Act. The claim was based on the following judgments:
a) ACIT vs. M/s. W.S. Industries (India) Ltd.(2009-TIOL-783-ITAT-
MAD) where the ITAT has held that amount paid on discharge of corporate guarantee given to the subsidiary company is an allowable expenditure on the grounds of commercial expediency.
b) SA Builders vs. CIT (288 ITR 1)(SC) has observed the following on the principle of commercial expediency:
"The expression 'commercial expediency" is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as business expenditure it was incurred on grounds of commercial expediency."
c) Pfizer Pharmaceuticals (India)(P.) Ltd. vs. Dy. CIT 2010(12) TMI 242 (ITAT Mumbai).
8.2 We have considered the rival contentions. We are unable to decide the issue as facts are not completely brought on record. The loss on sale of investment in Pathnet was contested in ground no 14. But what was not on record was whether the bank guarantee was given at the time of investment in Pathnet or subsequently in the course of business by that concern. This fact has a bearing on the decision. In case assessee extended the guarantee at the time of investment itself the same can be considered as capital in nature as part of investment decision, the loss there on will be capital loss to be considered under the head Capital Gains. In case, the Guarantee was extended later after the investment as part of business under taken by subsidiary, the principles of Commercial expediency are to be considered. AO relied on the decision in AY 2003-04 by CIT(A) which was confirmed by ITAT in that year. But the facts in that case were that assessee advanced a loan directly to the subsidiary where as in this case it was not a direct loan but a guarantee given to Bank. So the facts are different. However, in the interest of justice, we restore the 18 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
matter to the file of AO to examine the above aspect and decide afresh, keeping in mind the principle laid down in the above cases relied on by assessee and order of ITAT in AY 2003-04. Assessee should be given an opportunity to support its contentions and place on record complete details. Ground is allowed for statistical purposes.
9. Ground No.7 is as follows:
"7. The AO and ld. DRP has erred in disallowing the claim of Rs.13,30,73,097/- made by the assessee in respect of the ESOP allotment."
9.1 During the FY 2005-06, assessee has charged an amount of Rs.13,30,73,097/- towards expenditure on the issue of shares under the Employees Stock Option Plan. In accordance with the Securities and Exchange Board of India guidelines, the excess of the market price of shares, at the date of grant of options under the employee stock option schemes, over the exercise price is treated as employee compensation and amortised over the vesting period. assessee claimed the said expenditure as allowable expenditure. The AO has disallowed the same contending that the expenditure is notional in nature.
9.2 It was submitted that the expenditure was incurred towards retaining the employees and hence is an allowable revenue expenditure. The same has been allowed in assessee's own case by CIT appeals for the assessment year 2004-05. The judgment of Hon'ble High Court of Madras in the case of M/s. PVP Industries (TC(A).No.1023 of 2005) was relied along with other ITAT bench orders where it has been decided that the ESOP charge made in books following SEBI directions is an allowable expenditure.
19 ITA No.1605/H/10A.Y.06-07 DR. Reddy's Laboratories Ltd.
9.3 After the hearing the case, the Special Bench of the ITATBangalore in the case of Boicon Ltd Vs DCIT held that ESOP discount (difference between market price and issue price) is a deductible expenditure at the time of vesting of the option. An adjustment has to be made if the market price is different at the time of exercise of the option. In that case also assessee framed an Employee Stock Option Plan (ESOP) pursuant to which it granted options to its employees to subscribe for shares at the face value of Rs. 10. As the market price of each share was Rs. 919, the assessee claimed that it had given a discount of Rs. 909 which was allowable as a deduction as 'employee compensation. Though the options vested equally over four years, the assessee claimed a larger amount in the first year than was available under the SEBI guidelines. The AO & CIT(A) rejected the claim on the ground that there was no "expenditure". On appeal to the Tribunal, the issue was referred to the Special Bench. HELD by the Special Bench:
(i) The difference (discount) between the market price of the shares and their issue price is "expenditure" in the hands of the assessee because it is a substitute to giving direct incentive in cash for availing the services of the employees. There is no difference between a case where the company issues shares to the public at market price and pays a part of the premium to the employees for their services and another where the shares are directly issued to employees at a reduced rate. In both situations, the employees stand compensated for their effort. By undertaking to issue shares at a discount, the company does not pay anything to its employees but incurs the obligation of issuing shares at a discounted price at a future date. This is nothing but "expenditure" u/s 37(1);
(ii) The liability cannot be regarded as being "contingent" in nature because the rendering of service for one year is sine qua non for becoming eligible to avail the benefit under the scheme. Once the service is rendered for one year, it becomes obligatory on the part of the company to honor its 20 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
commitment of allowing the vesting of 25% of the option. The liability is incurred at the end of the first year though it is discharged at the end of the fourth year when the options are exercised by the employees. The fact that some options may lapse due to non-exercise/ resignation etc does not make the entire liability contingent;
(iii) However, the obligation to issue shares at a discounted premium does not arise at the stage the options are granted. It arises at the stage that the options are vested in the employees. The amount deductible has to be determined based on the period and percentage of vesting under the ESOP scheme;
(iv) There is likely to be a difference in the quantum of discount at the stage of vesting of the stock options (when the deduction is allowable) and at the stage of exercise of the options. The difference has to be adjusted by making suitable northwards or southwards adjustment at the time of exercise of the option depending on the market price of the shares then prevailing. The fact that the SEBI Guidelines do not provide for the adjustment of discount at the time of exercise of options is irrelevant because accounting principles cannot affect the position under the Income- tax Act.
(v) On facts, the assessee's method of claiming a larger deduction in the first year defies logic. As the options vest equally over a period of four years, the deduction ought to be claimed in four equal installments on a straight line basis.
The decision in the case of Ranbaxy Laboratories 124 TTJ 771 (Delhi) was reversed and S.S.I. Ltd. v. DCIT 85 TTJ 1049 (Chennai) approved, PVP Ventures 211 Taxman 554 referred. The decision of Spray Engineering Devices Ltd 53 SOT 70 (Chd) was also approved. The above decisions referred by Special Bench was relied upon by assessee, therefore there is no need to refer them again. AO is directed to work out the deduction keeping mind the principle laid down by the Special bench 21 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
in the above referred case, after giving an opportunity to assessee. Ground is allowed for statistical purposes.
10. Ground No.8 is as follows:
"8. AO and ld. DRP has erred in disallowing payment of sales commission and legal and professional charges made to the non- resident u/s.40(a)(ia) on the ground that the assessee has failed to make an application before AO under section 195(2) of the Act."
10.1 During the current financial year, the assessee made payment to non-residents towards sales commission and Legal and professional charges on which the assessee did not withhold taxes on the reason that the same were not subject to the tax in India. AO has disallowed the expenditure stating that, the assessee has to compulsorily approach the AO under section 195(2) of the Act to obtain a nil 'Withholding tax' order if the assessee wishes to make the payment to non-resident without withholding taxes. It was submitted that the addition made by the AO/DRP is erroneous and the claim should be allowable based on the following rulings:
A) In assessee's own case in respect of assessment year 1997-98, the Hon'ble ITAT while dealing with the similar issue, after considering the decision of Transmission Corporation of AP Ltd. (1999) (239 ITR
587)(SC) held that the sales commission paid to foreign agents is not liable to tax in India, the question of withholding taxes on the same does not arise at all. The ITAT also held that in the assessment proceedings the AO has to necessarily come to a conclusion as to whether payments made to non-residents are liable to tax in India before making any disallowance under section 40(a)(i). The said 22 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
decision was again followed by the ITAT in assessee's own case in respect of assessment year 2000-01.
10.2 It was further submitted that In respect of the legal and professional charges paid to non-residents, the same being services performed outside India and payments received outside India, the same were not liable to tax as per the provisions of the Act and the relevant DTAA. The AO, however, without arriving at a definite finding as to whether the payments made to non-residents was in fact chargeable to tax in India and simply based on the ground that the assessee has not made an application under section 195(2) of the Act has jumped to the conclusion that the said payments are liable to be disallowed under section 40(a)(i). This is contrary to the decision of the ITAT in respect of assessee's own case as stated above.
10.3 In respect of Mexican entity, it was submitted that the expenditure was incurred towards conversion charges amounting to Rs.25,33,858/- for conversion of DL Acid into Naproxin. No provision to with hold taxes with reference to Business income pertaining to conversion/manufacturing activities as that entity does not have any PE in India.
10.4 We have considered the rival submissions and perused the orders of the authorities. As submitted by the assessee this issue was considered in favour of the assessee in assessee's own case for assessment year 1997-98 in ITA No.693/H/2000 wherein it was held as under :-
" 8. We have duly considered the rival contentions and the material on record. U/s 195 of the Act, an assessee is liable to deduct tax at source from the payments made to non residents, if such payments are chargeable to tax in India in the hands of the non residents. In the instant case, the revenue has heavily relied on two decisions one 23 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
of the Tribunal in the case of Cheminor Drugs and the other of the Supreme Court in the case of Transmission Corporation. In the case of Cheminor Drugs, the assessee had not deducted tax u/s 195 under similar circumstances and hence an order u/s 201 was passed raising demand against assessee at the said tax amount. It was, in the backdrop of S.201 proceedings, the Tribunal held that the provisions contained in s. 195 are urgent provisions against for collecting tax during the financial year itself. Therefore, the nature of enquiry and the nature of adjudication u/s 195(1.) is necessarily summary and generally peremptory in nature. The proceedings u/s 201, therefore, provides an opportunity to the assessee to show, that he is not liable to deduct tax and the only way to show it is either u/s 195(2), or by producing a certificate u/s 195(3), only to absolve the assessee of his liability. However, in the present case, we are dealing with the regular assessment of the assessee itself in which we are concerned with the deductibility of the expenditure u/s 40(a)(ia) of the Act. Under these proceedings, the assessing officer has to come to a definite finding whether commission paid to foreign agents was in fact chargeable to tax in India or not because of that finding depends the determination of the total income of the assessee. Accordingly in these proceedings the revenue cannot be heard saying that since the assessee has not deducted tax u/s 195(1), it will make the disallowance u/s 40(a)(ia) of the Act. To repeat, it has to come to a definite conclusion that the income was chargeable to tax in India.
9. Of course, the assessing officer has held that the income was chargeable to tax in India because the payment was received in India. It is on record that the assessee had purchased demand draft favouring the foreign agents and the same were sent by post. The drafts were sent by post by the assessee itself and not at the instance of the agents nor was there such stipulation in the agreements with the agents. Same set of circumstances were there in assessment year 1994-95 in which the Tribunal held that the postal authorities cannot be treated as the agent of the foreign payees. Thus, the payment is deemed to have been made directly to the agents abroad. If that be the case then the foreign agents are not liable to tax in India in the light of the circulars of the Board.
10. In the case of Transmission Corporation, the facts were that the assessee had entered into certain agreements with certain foreign parties for supply of equipments. Another set of contracts entered into were for assembling, erection, testing and commissioning of the equipment. Pursuant to these contracts, payments were made by the assessee to the foreign parties without deducting tax u/s 195 of the 24 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
Act. The contention of the assessee was that S. 195 would be applicable only where the payment to the non resident is wholly income chargeable to tax as it provides that any person responsible for paying to a non resident any sum chargeable under the provisions of this Act, shall, at the time of payment, deduct income tax thereon at the rates in force. In the time of payment, deduct income tax thereon at the rates in force. In other words, the contention was that when the payments made to the non resident were not entirely income, but a trading receipt, there is no question of deduction of income tax at the source as the section does not provide for it. To this contention, the Hon'ble Supreme Court answered that the assessee who made the payments to the non residents was under an obligation to deduct tax at source u/s 195 of the Act in respect of the sums paid to them under the contracts entered into. It further held that the obligation of the assessee to deduct tax u/s 195 is limited only to the appropriate proportion of income chargeable under the Act. Thus, it can, be seen that the said judgement in fact helps the assessee. The second question answered by the Hon'ble Supreme Court can be understood to mean that the obligation of the assessee to deduct tax u/s 195 is not there when the payment made to the non resident does not contain any proportion of income therein. In our view, right from the beginning, not only on the basis of the circulars of the Board, but also on the basis of the decision of the Tribunal in its own case, the assessee firmly believed that no part of the income paid to the foreign agent was taxable in India. Therefore, there was no question of deducting any tax at source on any exemption of the payment made to the non residents. Thus, the judgement in the case of Transmission Corporation does not advance the case of the department in the present appeal. Finally, it may be pertinent to note that Circular No.786 is dated 7.2.2000., i.e. the same has been issued after the judgement was rendered in the case of Transmission Corporation i.e. 17.8.1999. The facts in the assessee's case remain governed by the Board Circular and hence, in the final analysis, respectfully following the earlier order of the Tribunal in the assessee's own case, we uphold the order of the CIT(A) deleting the disallowance."
10.5 The same was relied upon before ITAT in ITA No.739/Hyd/07. While agreeing with the principles, the matter was restored to AO as revenue had raised additional grounds with reference to payments being illegal payments under food for oil programme (Volker Committee Report) in assessment year 2003-04. In this year, there are no such payments made under food for oil programme, therefore, the order of ITAT in 25 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
assessment year 2003-04 in setting aside the issue for fresh consideration does not apply to the facts this year. Therefore, the order for assessment year 1997-98 applies to the facts squarely. AO has not established that the amounts paid are taxable under Indian Income tax Act 1961. Prima facie, the payments were made for services rendered abroad and as seen from AO's order the assessee has deducted tax on the payments made in India/for services rendered in India. Further, as submitted the conversion charges paid to a Mexican Entity also can not be taxed in India as that amount was a business income and that entity does not have any PE in India. Moreover, there seems to be no proceedings initiated u/s.201 for recovery of taxes, eventhough assessee applied for a certificate u/s. 195. Considering the above facts and order of the co-ordinate Bench extracted above, we hold that the amount can not be disallowed in 40(a)(i) as was done by AO without establishing that the amounts are taxable in India. AO is directed to allow the amounts. The ground is allowed.
11. Ground No.9 reads as under :
"9. AO and the ld. DRP has erred in disallowing various payments as follows:
i) Business promotion expenditure Rs.8,25,910/-
ii) Gifts & compliments Rs.68,62,136/-
iii) Local Doctors meet expenses Rs.1,03,29,388/-
iv) Individual Doctor service Rs.8,84,41,258/-
the above expenditure have been disallowed erroneously by Assessing Officer on the ground that the same is not incurred wholly and exclusively for business."
11.1 This ground pertains to disallowance of various payments towards:
i) Business promotion expenditure: Rs. 8,25,910
ii) Gifts & compliments: Rs. 68,62,136
iii) Local Doctors meet expenses: Rs. 1,03,29,388 26 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
iv) Individual Doctor services: Rs. 8,84,41,258 During the year the assessee has incurred expenditure towards sales promotion which comprise of Business promotion expenditure, gifts and compliments, local doctors meet expenses, individual doctor service. It was submitted that the expenditure were incurred in the course of business and wholly and exclusively for the purpose of business. The AO/DRP disallowed the expenditure stating that the expenditure is not incurred in the course of the business of the assessee.
11.2 This issue was a recurring one having been considered by ITAT in assessment year 2003-04 in ITA No.655/Hyd/07 dated 29/10/2010 in AY 2003-04. Business promotion expenditure was stated to be payments to the Doctors, hospitals in cash amount and also like gifts. The contention of the assessee was that this expenditure was incurred wholly and exclusively for the purpose of business, whereas AO/DRP was of the opinion that the assessee can not explain said payments as related to business. Similar issue was examined by Assessing Officer and CIT(A) in assessment year 2003-04 in the above order (supra). ITAT also upheld the disallowance of these items vide para-39 of the order. Accordingly, the addition on this account stands confirmed. Likewise the expenditure of gifts and compliments and other expenditure of similar nature was also not allowed in the order of ITAT (supra). Respectfully following, we uphold the order of AO/DRP on various expenditures.
11.2 With regard to Local Doctor meet expenditure it was submitted that expenditure was incurred on doctors for provision of various gifts in individual capacity including gifts, tickets, sponsorship etc. It was contended that this was for business promotional expenses which are to be allowed as revenue expenditure. In assessment year 27 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
2003-04, this issue was set aside to the file of Assessing Officer for fresh consideration with the direction to assessee to substantiate the business expediency to incur this expenditure. Respectfully following the above, in this year also, we modify the order of AO/DRP to that effect and direct Assessing Officer to examine the nature of expenditure and whether the same can be allowed as incurred for the purpose of business. Accordingly, issue was set aside to the file of Assessing Officer to examine and decide afresh. To that extent, assessee's ground is allowed for statistical purposes.
11.3 Individual doctors services: On the reason that assessee incurred these expenses towards individual doctors and payment were made in cash or kind both travel expenses, sponsorship etc. the assessee was asked to justify the expenditure. The AO was of the view that doctor would not admit the benefit as a receipt and most of the expenditure was self vouched and are unverifiable in nature and disallowance made was to the extent of Rs.8,84,41,258/-. This issue was considered by ITAT in the order supra as under :
"42 The next is with regard to disallowance of individual doctor's meet expenses at Rs.3,20,97,763/-. This expenditure includes sponsorship of doctors' travel from states to attend the conference organized by the 3rd party to various parts of the country for which no details have been given. It also includes expenditure like sponsoring vacations doctors and his family and gifts including hospital equipments like laser machines etc. Since no satisfactory explanation was given by the assessee during the assessment proceedings, Assessing Officer disallowed the same. The CIT(A) set aside the issue to the file of Assessing Officer with a direction to 28 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
verify the nature of expenditure and disallow only that expenditure which are not incurred for the purpose of business. We do not find any infirmity in the direction of the CIT(A) and the assessee is directed to substantiate its claim before Assessing Officer. Accordingly this ground of the assessee is dismissed."
Since the issue was set aside by CIT(A) to the file of the Assessing Officer to verify the nature of expenditure and disallow only that expenditure which is not incurred for the purpose of business, we also modify the order of AO/DRP and direct the Assessing Officer to examine the nature of expenditure and consider disallowance of expenditure which is not incurred for the purpose of business. The issue is restored to the file of Assessing Officer.
11.4 The Circular issued by the Board in 5/2012 and code of ethics regulations 2002 issued by Medical Council of India was applicable from 2003-04 and for the relevant assessment year, the code of ethics is applicable and so expenditure incurred on the doctors can be considered as unethical. The Assessing Officer is also directed to examine this aspect also in addition to the directions given by the ITA No.655/Hyd./07 dated 29.10.2010. With these directions the ground is considered partly allowed for statistical purposes.
12. Ground 10 & 11 is as follows :
"10. The AO and the ld. DRP has erred in allocating a part of the head office expenditure against the profits of the units eligible for deduction u/s. 10B thereby reducing the deduction available to assessee.29 ITA No.1605/H/10
A.Y.06-07 DR. Reddy's Laboratories Ltd.
11. The AO and the ld. DRP has erred in allocating a part of the head office expenditure against the profits of the units eligible for deduction u/s. 80B thereby reducing the deduction available to assessee."
12.1 Regarding allocation of corporate overheads
i) On 10B-Generics 100% EOU Units
ii) On 10B Bulk drugs 100% EOU unit
iii) On 80IB Yanam Unit
iv) On 80IB Goa Unit While computing the total income, the assessee had computed deduction under section 10B, 80IB and 80IC without allocating overhead cost of corporate unit. It was the contention that the computation of deduction is based on the provisions laid down in the respective sections of 10B, 80IB and as per the Act it is the profit which is derived by an undertaking is eligible for deduction. The assessee considered the derived profit as net of "income derived" and "expenditure derived" out of the undertaking concerned. In other words it should be "income derived"
net- of "expenditure derived" but not "income derived" net-of expenditure attributable to.
12.2 It was reiterated that, as held by the apex court in cases like Sterlite Industries, the term used in the context of profits and gains is 'derived' and it is very narrow in application than 'attributable'. The profits that are direct in nexus to the industrial undertaking only need to be considered. In the present case the expenditure that is allocated is the expenditure in corporate office which cannot be related to any business. It has its own income like divided, interest etc and operations. The staff therein do not provide any direct service to any of the units eligible for deductions u/s lOB, 8OlB etc. In view of the forgoing explanation the services that may remotely and indirectly and, at the most, possibly, give some benefit to the units and the expenditure therein need not be 30 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
allocated and deducted. The similar observation was made in the AAR ruling in the case of M/s National Fertilizers Limited (A.A.R No.532 & 533 of 2001) interpreting the meaning of 'derived from' by Hon'ble Supreme Court in the case of CIT Vs Sterling Foods [237 ITR 579]. Further in a ruling by Hon'ble High Court of Delhi in the case of CIT Vs M/s S T Micro Electronics Pvt. Ltd [ITA No. 928/20101 it is observed that what was required to be apportioned was the common expenditure of the units and not the total expenses.
12.3 Without prejudice to the above 'derived' principle , the principle of "Nexus" is also required to be seen. It may be noted that in the context of Sec.14A, the Hon'ble High Court of Delhi in the case of CIT Vs. Wimco Seedlings Ltd. has pronounced, that..... the only expenditure which has been proved to have been incurred in relation to the earning of tax free income, can be disallowed while applying the section there is no authority conferred upon the Assessing Officer to deem or assume expenditure to have been incurred in relation to the "tax free income".
Common expenditure incurred at the head office cannot be broken up artificially to attribute or apportion a part thereof to the earning of the tax free income on the assumption that such part of the common expenditure was incurred in relation to the tax free income. It is submitted that this principle should squarely be applicable in our case too. Considering the principles laid in the above judgments, it was submitted that there cannot be any presumed allocation of over heads to the units whose income is tax free 12.4 Without prejudice to the above, it was further contended that, the A.O while computing the corporate Overhead, has considered corporate expenditure including finance charges, but has failed to consider interest income and gain on foreign exchange fluctuations which are also attributable to corporate activities only. Hence while computing corporate 31 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
Overhead allocable to the said units, he has to necessarily net-off the corporate income from the corporate expenditure and net only should be considered as corporate Overhead allocable.
12.5 We have considered the issue. This issue was discussed by ITAT in assessment year 2003-04 in assessee's own case from para 14 to para 18 onwards. The issue was set aside to the Assessing Officer observing as under:
"18. We have carefully gone through the order of the Tribunal in the case of Wipro GE Medical System Ltd. cited supra and wherein it was held that the assessee is rightly having allocated indirect expenses to the two units according to the wages and other expenses on the basis of sales for arriving respective profits of its two units. The Assessing Officer is directed to accept assessee's working in relation to deduction u/s.80IA. In view of the above judgment, in our opinion, in the absence of identifying the expenditure of the export division, there is no basis other than allocating the total indirect cost on the basis of turnover. Accordingly, we direct Assessing Officer to apportion the expenditure on the basis of turnover of various units. The issue is set aside to the file of Assessing Officer for fresh consideration."
12.6 Respectfully following the above, in this year also the matter is set aside to AO to re-examine the claim on similar lines. Accordingly, ground is allowed for statistical purposes.
13. Ground No.12 is as follows:
"12. AO and the ld. DRP erred in considering the payment made to get the existing customers contracts of Falcon assigned in favour of the assessee as capital expenditure instead of revenue expenditure as claimed by assessee."32 ITA No.1605/H/10
A.Y.06-07 DR. Reddy's Laboratories Ltd.
13.1 This ground is regarding Expenditure incurred towards customer contracts. During the FY 2005-06 the assessee acquired 100% share capital of Indutrias Quimicas Falcon de Mexico (hereinafter and before referred to as "Falcon) from Roche International Limited for a consideration of Rs. 232.02 crores. In addition to the purchase consideration, the assessee has paid a further sum of Rs.28.49,85,605 to Roche, whose affiliate was above referred company, to get the existing customer contracts of Falcon assigned In favour of the assessee and claimed the entire amount as allowable expenditure, eventhough the same was capitalized as intangible asset in the books of account.
13.2 The AO and the DRP disallowed the claim allowing depreciation on the same stating that the assessee got guaranteed sales not only for the year under consideration but also for future years also and hence capital in nature.
13.3 It was submitted that the A.O / DRP erred in treating the expenditure as capital and disallowing the assessee claim based on the following:
i) The facts as modified by the AO are not correct. The agreement no where states that by virtue of entering into agreement with Roche the assessee would be ensured guaranteed sales.
ii) It is respectfully submitted that the AO has totally misunderstood the arrangement. By virtue of the arrangement, the assessee only got an assignment of the existing customer contracts.
iii) The customers being independent parties and not privy to this agreement were not bound to continue purchasing from DRL Roche did not guarantee that the customer would continue to purchase from DRL 33 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
by inferring that the assessee has got guaranteed sales from the customers.
13.4. assessee relied on the case of Honda Siel Power Products Ltd. V CIT (2006) 167 Taxman 76 (ITAT Delhi) wherein it was held that if advantage consists of merely facilitating trading operations of assessee or enables management to conduct business more profitably or efficiently, expenditure would be on revenue account though the advantage may ensure for an indefinite period.
13.5 DRP discussed the terms of agreement and distinguished the cases relied on by assessee. We do not intend to extract the agreement here again. Suffice to say that the agreement is for Purchase and Sale of a Business. Preamble states the M/s Roach manages the business of Falcon and this business consist of number of third party agreements for supply of Naproxen and steroids manufactured under the Falcon business, termed as ' transferred business' in the agreement and assessee acquired the transferred business. Clause 2.1 clearly states that the agreement was for purchase and sale of Assets which are listed in (a) to (c). Terms also include that seller has to renegotiate contracts with third parties to the extent of transferred business. Assessee also treated the same as purchase of intangible assets in the books. All these indicate that what assessee purchased are intangible assets of transferred business and AO and DRP were correct in treating it as capital expenditure and allowing depreciation u/s 32 of the Act. We agree with the findings of authorities. Ground is rejected.
Ground No.13 is as follows:
"13. AO and the ld. DRP has erred in not allowing the amount paid as contribution towards the projects of ILS as revenue expenditure u/s. 37(1) of the Act."34 ITA No.1605/H/10
A.Y.06-07 DR. Reddy's Laboratories Ltd.
13.1 This ground pertains to disallowance of contribution paid to ILS. ILS is a research institution, engaged in research activities in the field of pharmaceuticals and is affiliated to Osmania University, Hyderabad. Since the assessee is also engaged in the business of manufacturing, research and development of pharmaceuticals, the assessee in its own business interest contributed a sum of Rs.3,41,18,538 to ILS and claimed deduction u/s 35AC and alternately u/s 37. The AO disallowed the contribution as the assessee was not able to produce the certificate required under the provisions of section 35AC of the Act.
13.2 It was submitted that though it is not allowable u/s 35AC, the said payment is allowable u/s 37 as the payment was made to an organization which is in similar line with assessee. Similar expenditure was allowed by CIT(A)-III and further confirmed by ITAT in our own case for the AY 2003-04.It further relied on the decision given in the case of Ranbaxy Laboratories Ltd vs. DCII (2009-TIOL-32-ITAT-DEL) (Delhi ITAT).
13.3 As seen from the record, the AO and DRP considered the claim only u/s 35AC. Since the same was not admissible, to that extent order of AO and DRP is sustained. The alternate claim u/s 37(1) was not made before revenue authorities. Therefore in the interest of justice we restore the claim u/s 37(1) to the file of AO to examine the same afresh, keeping in mind the order of ITAT in AY 2003-04 and other cases relied on by assessee. Assessee should be given an opportunity to substantiate the claim. The ground is considered allowed for statistical purposes.
Ground No.14 is as follows:
"14. The AO and the ld. DRP has erred in disallowing the loss incurred on transfer of investment in Pathnet, JV by treating the same as capital loss."
35 ITA No.1605/H/10A.Y.06-07 DR. Reddy's Laboratories Ltd.
14.1 It pertains to disallowance of loss incurred on transfer of investment in Pathnet India (Pvt.) Ltd. (a JV entity). Pathnet is in the business of setting up of medical pathological laboratories. The assessee had 49% stake in Pathnet.
14.2 During the year under consideration the assessee transferred its total stake in Pathnet. The assessee incurred loss of Rs. 4,90,00,000 on such transfer and debited the same to the profit and loss account of the year and claimed as allowable expenditure. The AO/DRP has considered the loss arising on transfer of shares as capital in nature and has disallowed the loss claimed as expenditure not allowable u/s 37.
14.3 It was submitted that the investment by the assessee in the Pathnet was a business investment. The assessee has treated Pathnet as a special purpose vehicle for entering into the business of pathological laboratories.
14.4 Without prejudice to above, assessee contends that as the loss has arisen due to transfer of assessees' investment in Pathnet and as the shares in Pathnet was held by the assessee prior to its transfer, the same should be as allowed as long term capital loss under the head "Capital Gains" assessee relied on the following decisions in support of claim:
1.CIT vs Amalgamation Pvt Ltd 226 ITR 188 (SC)
2. ACIT vs M/s WS Industries India Ltd [2009-TIOL -- 783-ITAT- MAD] 14.4 After considering the rival contentions, we are of the opinion that the authorities are justified in disallowing the same as capital loss and not as revenue loss to be set off under the head business. However, they are not correct in disallowing the same without considering the same under the head "Capital Gains or loss". Assessee no doubt treated the 36 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
same as investments and sale of investments resulted in loss. This should be considered as long term/ short term capital loss as the case may be and allowed set off or carried forward to be set off later as per provisions of Act. This was not done by authorities. Therefore, we allow the alternate claim of assessee and direct the AO to compute the same and allow benefit of set off as per the provisions of Act. Ground considered allowed to that extent.
Ground No.15 is as follows:
"15. The AO and the DRP has erred in disallowing the loss of Rs.8,50,98,956/- incurred in write off of investment in Aurantis considering the same as capital loss and not allowable u/s. 37 of the Act or not considering the same for set off or carry forward."
15.1 It pertains to disallowing the loss incurred in write off of investments in Aurantis Farmaceutica Ltd. Brazil considering the same as capital loss. The assessee made investment in Aurantis for the purpose of exploring the pharmaceutical business opportunities in Brazil. During the year Aurantis went into liquidation and assessee could not recover any amount against its investments in Aurantis. The loss charged to P&L a/c was claimed as allowable expenditure u/s 37 considering it to be a business investment and accordingly loss as business loss. A.O / DRP disallowed the same considering it to be capital in nature.
15.2 It was submitted that the investment by the assessee in the Aurantis was a business investment. The assessee has treated Aurantis as a special purpose vehicle for entering into the business of pathological laboratories. Without prejudice to above the assessee contends that as the loss has arisen due to transfer of assessees' investment in Pathnet and as the shares in Pathnet was held by the assessee prior to its 37 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
transfer, the same should be as allowed as long term capital loss under the head "Capital Gains".
15.3 This claim is similar to the claim made with reference to investment in Pathnet discussed in Ground no 14 above. For the reasons stated above, this should be considered as long term/ short term capital loss as the case may be and allowed set off or carried forward to be set off later as per provisions of Act. This was not done by authorities. Therefore, we allow the alternate claim of assessee and direct the AO to compute the same and allow benefit of set off as per the provisions of Act. Ground considered allowed to that extent.
Ground No.16 is as follows :
"16. The assessee respectfully objects to the adjustment of Rs.8,19,20,766/- proposed to be made by AO and ld. DRP by relying on the TPO's order dated 30 October 2009 In this regard the assessee wishes to submit its grounds of objection which are as follows:
i) AO and the ld. DRP/TPO made the adjustment ignoring the nature of transaction.
ii) AO and the ld. DRP/TPO erred in ignoring LIBOR as a benchmark for determining arm's length interest rate in international transaction.
iii)Without prejudice to the above the AO and the ld. DRP/TPO erred in ignoring principles of consistency by ignoring the rate of interest laid down by the CIT(A) in assessee's own case for the assessment year 2004-05, where in the Hon'ble CIT(A)held that the benchmark rate for determining the interest rate receivable should be the interest rate of risk free bank deposit."
16.1 It pertains to transfer pricing adjustment. During the FY 2005-06, assessee company has charged interest on advances provided to its 38 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
subsidiaries. It has been charging interest at a rate determined based on the LIBOR, prevalent in the market from time to time, in some cases and based on the mutually agreed rate in some other cases. The interest so charged by the assessee was Rs.3,62,12, 739/-
16.2 The learned AO / TPO has taken a view that the interest should have been charged at a rate determined based on the rate for corporate bonds as applicable to unrated companies which was claimed to be around 14% and accordingly considered the arms length interest as Rs.11,81,33,505/-, there by adding the differential amount of Rs. 8,19,20,766/- as adjustment u/s 92CA of Income Tax Act.
16.3 In this respect it was submitted that the entities to which the advances are given are wholly owned subsidiaries and are provided to support their working capital requirements. The company has been charging interest at a rate determined based on the LIBOR, prevalent in the market from time to time, in some cases and based on the mutually agreed rate in some other cases. Since they are our group entities, the loans given by the assessee company were risk free as these could have been repaid after a stipulated period. Hence, the unrated loan under BBB grade (which are with risk adjustment) adopted by TPO/A.O is factually not tenable. It was further submitted that the Commissioner of IT (Appeals) -- III, in assessee's own case for the AY 2004-05, has held the rate earned by company on the investments, in the form of bank deposits, should only be compared and allowed appeal partly for that year. It was further submitted that the ITAT Chennai bench in the case of M/s. Siva Industries & Holdings Ltd Vs ACIT (l.T.A No.2148/Mds/2010) decided that 'once the transaction between the assessee and the A.E is in foreign currency and the transaction is an international transaction, then the transaction would have to be looked upon by applying the commercial principles in regard to the international 39 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
transaction. If this is so, then the domestic PLR would have no applicability and the international rate fixed being LIBOR would come into play'. Similar observation is also made in the case of M/s Four Soft Limited Vs DCIT by Hyderabad bench of ITAT wide ITA No. 14951Hvd/2010.
16.4 This issue was contested by Revenue in ITA No.836/H/09 in assessment year 2004-05. In that year, the facts of the issue were that the assessee extended a loan of USD 3million to M/s. Dr. Reddy's Laboratories Inc. (DRI), a 100% subsidiary of the assessee at USA. DRI paid interest on this loan to the assessee @ LIBOR + 70 basis points on half yearly basis, which works out to approx. 2.7%. The amount of interest received during assessment year 2004-05 amounted to Rs.27,61,021/-. Since the aforesaid international transaction with associated enterprise was more than Rs.5 crores, the matter was referred to the TPO to determine the arm's length price. The TPO vide its order dated 21.12.2006 held that since there was no comparable available for such transactions, the issue has to be decided considering the purpose of the loan, debt market conditions, third party interest rate & the prevailing lending rate. The arm's length rate is the rate of interest charged or would have been charged in transaction with or between unrelated parties under similar circumstances. It was held that no independent parties would have given loans at such a low interest as was done by the taxpayer to its associated enterprise. It was observed by the TPO that all the lending public sector institutions in India were required to follow the prime lending rate (PLR) while fixing the rate of interest on the lending in Indian conditions. The prevailing PLR of 10.75% was accordingly adopted as the arm's length price of the interest receivable from the associated enterprise. The interest receivable at PLR of 10.75% was computed at Rs.1,43,54,690/- and accordingly the difference of Rs.1,15,93,669/- was adjusted u/s. 92 CA of the Act. Before the ld.
40 ITA No.1605/H/10A.Y.06-07 DR. Reddy's Laboratories Ltd.
CIT(A) the assessee submitted that as per interest norms LIBOR is considered to be "bench mark" for the charging of interest . Accordingly PLR is not a correct tool for calculating interest in the transaction with DRI,USA. On considering of the submission, the ld. CIT(A) re-worked out the interest on the basis of deposit @ 7% by stating as under :-
"10.3 On due consideration, I agree with the contention of the ld. AR that PLR cannot be adopted for determining the arm's length price of the interest receivable from the associated enterprise. PLR is the rate at which a bank charges interest to its borrowers. The appellant is not a bank or a lending institution. It is not in the business of regular lending, so as to consider & compare with a rate used by a lending institution. Hence, the comparison cannot be said to be between two identical or nearly identical properties. In fact, PLR is the rate at which the appellant could have borrowed the money. A basis for an income cannot be compared with a basis for expenditure. The rate charged by the appellant can be compared to an interest that it could have earned on an investment, say a bank deposit, which is also risk free. During the appeal proceedings, ld. AR was asked to furnish the average rate of interest of bank deposits. The appellant's letter dated 15.04.2009 furnished the required details showing that it had received interest on deposit made with banks & public companies at the rate varying from 5.95% to 7.43%, average coming to 7%.
10.4 At the same time and on the same logic, I agree with the contention of TPO that LIBOR can't be adopted as the basis to determine the ALP of interest charged by appellant from its AE. The "London Interbank Offered Rate" (LIBOR) is a daily 41 ITA No.1605/H/10 A.Y.06-07 DR. Reddy's Laboratories Ltd.
reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market). I also agree with the contention of the TPO that while determining the arm's length price, it is relevant to consider whether any independent party would have given loans to an unrelated party at the rate on which the loan was advanced by the appellant to its associated enterprise. It is a fact that the appellant company would not have given a loan to an unrelated party @ 2.7%. In fact, the appellant itself had charged interest @ 6% -6.5% from its other subsidiaries located in China, Brazil & South Africa in subsequent year i.e. AY 05-06."
16.3 It was held by ITAT in that year as under:
"After considering the rival submissions, we do not see any reason to interfere with the order of the CIT(A). We agree with the finding of the ld. CIT(A) that PLR can not be considered as a basis for arriving at rate at which assessee should have advanced the funds as international financial market works in a different way than the Indian market. There is also a basis of arriving at 7% by the CIT(A) based on the interest received on deposits made with banks and public companies. Therefore, considering the facts of the case, we do not see any reason to allow the Revenue contentions. Assessee also accepted the rate at 7% as it has not come in cross appeal on the same issue. Accordingly, we uphold the order of CIT (A). The ground is rejected.42 ITA No.1605/H/10
A.Y.06-07 DR. Reddy's Laboratories Ltd.
16.5 Since facts are same, following the findings in AY 2004-05 in assessee's own case, we direct the AO to modify the ALP adjustment on the basis of rate of interest received on deposits made with banks and public companies, for which assessee also has no objection. Thus the ground is allowed partly.
17. In the result, assessee appeal is allowed partly.
Order pronounced in the open court on 8th Aug., 2013.
Sd/- Sd/-
(SAKTIJIT DEY ) (B. RAMAKOTAIAH )
JUDICIAL MEMBER ACCOUNTANT MEMBER
Mumbai, Dated: 08/08/2013.
Jv.
Copy to: The Appellant
The Respondent
The CIT, Concerned, Mumbai
The CIT(A) Concerned, Mumbai
The DR " " Bench
True Copy
By Order
Dy/Asstt. Registrar, ITAT, Mumbai.
43 ITA No.1605/H/10
A.Y.06-07
DR. Reddy's Laboratories Ltd.
S.No Details Date Initial Designatio
. s n
1 Draft dictated on 10/07/,11/7,19/7/1 JM/AM
3
2 Draft Placed before 10/7, 11/7/, JM/AM
author 19/7/13
3 Draft proposed & JM/AM
placed before the
Second Member
4 Draft JM/AM
discussed/approve
d by Second
Member
5. Approved Draft Sr.PS/PS
comes to the
Sr.PS/PS
6. Kept for Sr.PS/PS
pronouncement on
7. File sent to the Sr.PS/PS
Bench Clerk
8 Date on which the
file goes to the
Head clerk
9 Date of Dispatch of
order
10. Draft dictation Yes
enclosed in file