Income Tax Appellate Tribunal - Hyderabad
Sanvita Biotechnologies Private ... vs Deputy Commissioner Of Income Tax ... on 5 October, 2021
IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCHES "B": HYDERABAD
(THROUGH VIRTUAL CONFERENCE)
BEFORE SHRI SATBEER SINGH GODARA, JUDICIAL MEMBER
AND
SHRI LAXMI PRASAD SAHU, ACCOUNTANT MEMBER
ITA No. 283/H/2021
Assessment Year: 2017-18
Sanvitha Biotechnologies Vs. Dy. Commissioner of
Pvt. Ltd., Hyderabad. Income-tax, Central
Circle - 2(3), Hyderabad.
PAN - AAQCS 4165F
(Appellant) (Respondent)
Assessee by: Shri P. Murali Mohana Rao
Revenue by: Shri Y.V.S.T. Sai
Date of hearing: 24/09/2021
Date of pronouncement: 05/10/2021
ORDER
PER L.P. SAHU, A.M.:
This appeal filed by the Assessee is directed against CIT(A) - 12 Hyderabad's order dated 30/04/2021 for AY 2017-18 involving proceedings u/s 143(3) of the Income Tax Act, 1961 ; in short "the Act.
2. The assessee has raised 19 grounds of appeal, o ut of which ground No. 2 regarding the addition of Rs. 22,50,00,000/- and ground No. 3 is relating to the addition :- 2 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
of Rs. 42,52,628/-. The remaining grounds are argumentative in nature, hence, need no adjudication.
3. Briefly the facts of the case are that the assessee company is engaged in Manufacturing of drugs & pharmaceuticals. Search and Seizure operation u /s.132 of the Income Tax Act, 1961 was conducted in the case of M/s.Vivimid Labs Limited and its group concern on 09 -11- 2016 by the DDIT(lnv.), Unit-1(2), Hyderabad. In connection with search & seizure operation in Vivirnid labs, a survey operation u/s.133A of the Income Tax Act, 1961 were conducted on 09-11-2016 in the case of assessee. Accordingly, this case had been selected for compulsory scrutiny. The assessee company had filed its return of income u/s.139(1) of the Income Tax Act on 28-10-2017 declaring total income of Rs.2,02,870/- admitted income under 115JB at Rs.2,78,636/-. Accordingly, notices u/s.143(2) and 142(1) were issued by the Assessing Officer.
3.1 After examining the material on record and the information furnished, assessment was completed by the Assessing Officer u/s.143(3) of the Income Tax Act, 1961, making the following additions j disallowances:
1. Business income u/s.28(i) of the IT Act -
Rs. 22,50,00,000/-
2. of capital expenditure - Rs. 42,52,628/-
:- 3 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
4. When the assessee preferred an appeal before the CIT(A), the CIT(A) confirmed the order of AO.
5. Aggrieved by the order of CIT(A), the assessee is in appeal before the ITAT.
6. As regards the issue of addition of Rs. 22,50, 00,000/- towards business income u/s.28(i) of the IT Act, the AO observed that from Financial statements for the year ending 31.03.2017, the assessee company had shown an amount of Rs.22,50,OO,OOO/· as 'Long term Deposit from Associates' (Ref. No.22 of Note to Accounts) which was classified under Unsecured Loans.
6.1 In the said Note 22 of the financial statements it is stated as under:
"The Company M/s Sanvita Bio Technologies Private Limited has entered Marketing Agreement for sale of its products with Boehringerlngelheim India Private Limited, in order to market and sell all of the animal health products thot it is manufacturing (or ) will manufacture in the future with global partner (Boenringerlnselheim India private Limited) with conditions as mentioned in the agreement. For the assignment of global exclusive distribution rights for its products, the company has received an amount of Rs.22.50 crores from the BI which is non refundable. The agreement is effective from 01.04.2016 for a term of 15 years."
:- 4 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
6.2. In view of fore-going facts, the AO issued a show cause notice on 21.12.2019 proposing for treating the amount of Rs.22.50 crores as business receipts as under:
"As seen from the Note No. 3 to 1·lotes to Financial Statements it is observed that under the head unsecured loans, under the sub-head "Long Term Deposits from Associates (Ref. No. 22 of Notes to accounts)" an amount of Rs, 22,50,00,000/ - has been received.
Further, Note no. 22 of Notes to Accounts states that the assessee company has entered Marketing Agreement for sale of its products with Boehringerlngel Heim India Pvt. Ltd., in order to market and sell all of the animal health products that it \5 manufacturing or will manufacture in the future with global partner (Boehringeringel Heim India Pvt. Ltd.) with conditions as mentioned in the agreement for the assignment of global exclusive distribution rights for its products, the company has received an amount of ns. 22.50 Crores from BI which is non-refundable.
In this scenario you are requested to show -cause why the nonrefundable receipt of RS. 22.50 Crores shall not be brought under the tax as business receipt."
6.3. In response, the assessee filed a detailed reply requesting for not to make any addition on this count. The assessee company had filed copy of agreement dt.01.04.2016 entered into with the Boehringerlngel Heim India Pvt. Ltd. which is placed on record , :- 5 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
6.4 After considering the contentions of the assessee and considering the agreement submitted by the assessee, the AO observed that the same was not acceptable. In this connection, he referred to the Article - 4 - 'Consideration Prices' of the said agreement, which states as under:
"4.1. For the agreement of global exclusive distribution rights to DISTRIBUTOR and/or a D1STRlBUTOR affiliate to any and all products which MANUFACTURER produces/will produce and holds/will hold a Marketing Authorization, DISTRIBUTOR shall pay to manufacturer Rs. 22,50,00,000/-."
6.5. Further the assessee had replied that the assessee is foregoing its rights in respect of trademark, fixing of price of the product, and to have incurred expenditure towards package, export transport and other related expenditure. Further it was stated that this corresponds to period of 15 years and further renewal period of 5 years, in this process, the assessee will incur huge losses for a long period. To compensate these losses, it has received an amount of Rs.22.50 Cr. from the 'distributor'.
6.6 Rejecting the above contention of the assessee, the AO observed that the assessee Company had received this money in the process of business transaction and it was surprising explanation from the assessee that in future it will incur losses and to compensate the future losses it ha d received this money. The AO opined that this was a :- 6 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
colorable devise used by the assessee to evade the tax on this receipt, as no prudent business concern will compensate the future losses of another business concern i.e. assessee company. Further, he observed that the receipt is pertaining to the rights of distribution and ought to have been admitted as business receipt. The claim of the assessee that the receipt of Rs. 22,50,00,000/- as 'unsecured loan' by the assessee company cannot be accepted.
6.7. In view of the above observations, the AO treated the amount of Rs.22,50,00,000/- as business income under 28(i) of the Income tax Ac and accordingly, the same was brought to tax as taxable income for the Asst. year 2017 -18.
7. Before the CIT(A), the assessee filed written submissions, which were extracted by the CIT(A) in his order at pages 6 & 7, the gist of which was mentioned by the CIT(A) is as under:
5.3.1 ................. In the written submissions, the AR sated that M/s. BIIPL has entered into an agreement and has paid Rs. 22.50 crores for the assignment of global exclusive distribution rights to market and sell the products produced by the appellant and will have marketing authorization for a period of 15 years from 01.04.2016 extendable by another 5 years. The AR has cited paras of the agreement to show that the appellant has to lose substantial amount for 15 years and to compensate the same, the distributor paid Rs. 22.50 crores as non-refundable advance which cannot be :- 7 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
considered as income for the current assessment year. It was also stated that the appellant has not started its production as on 01.04.2016 and even as on today} the duration of period of 15 years will commence into implication as per the conditions of the agreement Since the amount is in respect of future liability in the form of incurring costs for rendering the said services} it was argued that the amount could not partake the character of income until when the assessee would render the said services in future. Therefore, it was submitted that the receipt of advance cannot be treated as income in the hands of the appellant.
8. After considering the submissions of the assessee, the CIT(A) observed that the AO had considered the facts on the record and gave an opportunity to the assessee to explain the same by way of show cause notice which was in turn replied by the assessee and these facts were considered by the AO on merits. Therefore, it is not correct to state that the AO has not appreciated the facts of the case and has not considered the submissions made by the assessee. He, therefore, upheld the addition made by the AO by observing as under:
"5.3.12 To sum up, the appellant received Rs. 22.50 crores for assigning the territory distribution rights exclusively to M/s. BllPl for an initial period of 15 years extendable by another 5 years. The consideration is non-refundable. This was received as the appellant has exercised its business right of appointing distributor in the territories across the globe and appointed Mis. BllPl who in turn has paid the consideration for purchasing the distributor rights. This amount received is not linked to the pricing of the product or to compensate future losses. There are separate clauses in the :- 8 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
agreement as to how the cost of the product is reimbursed by the distributor and the profit margin is shared between them. There are no trademarks foregone by the appellant as no trademarks were listed in the agreement. It is seen from the appellant's website that the appellant company has developed vaccine for Foot & Mouth disease in animals and the distributor being a globally reputed pharmaceutical company in Animal Health care products intended to lock in the marketing rights of these products by purchasing them for a hefty non-refundable consideration which it did so. There is no dispute that the compensation has arisen on account of exploitation of business rights and the same is taxable as business income u/s. 28(i) of the LT. Act. On seeing an opportunity in appellant's products, the Distributor has secured the exclusive global distribution rights even though, the products are yet to be manufactured. Business is a bundle of various business I commercial rights and exploitation of these rights gives rise to business income. It is not mandatory that business income will arise only after the commencement of production. Though the income arising on account of sale of products is definitely business income, the sale or exploitation of other business rights such as distribution rights, intellectual property rights, etc. is also business income. There can be many streams of business income and there is no essential condition that the business income will arise only after the sale of products. By reading down the clauses in the agreement, if was held that the amount of Rs. 22.5 crores was not received to compensate the future liability in the form of incurring costs for rendering said services. The amount is not received as an advance or long term deposit or is an unsecured loan as wrongly accounted for by the appellant. This amount is received exclusively for assigning the global distribution rights to Mis. BIIPL. This is a taxable business income. Therefore, I agree with the AO that the sum of Rs. 22.50 crores is a taxable business income and :- 9 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
all the grounds of the appellant pertaining to this issue are dismissed."
9. Before us, the ld. AR of the assessee reiterated the submissions made before the revenue authorities and contended that the AO gave erroneous treatment to the amount of Rs. 22,50,00,000/- as business income u/s 28(i) of the Act. He submitted that the appellant company desires to market and sell all of the Animal Health Products which it manufactures or that it will manufacture in future in the territory and seeking to align with a global distribution partner, it has entered marketing agreement on 01-04-2016 with M/s. BOEHRINGER Ingelheim India Pvt. t.td., Mumbai which was effected w.e.f. 01-04-2016. According to the agreement, the above distributed company M/s. Boehringerlngelheim India Pvt. ltd.., has paid Rs. 22,50,00,000/- to the appellant for the assignment of Global Exclusive Distribution Rights to it and/ or it affiliated to any and all products which the appellant produces/ will produce and holds/will hold a Marketing Authorization for a period of 15 years from 01-04-2016. The above amount of Rs 22,50,00,000/- was paid to the appellant as non refundable for fulfilling the conditions as laid down in the said agreement by the appellant.
9.1 He submitted that for fulfilling the clauses in the agreement as well as also the other clauses in the said :- 10 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
agreement, of the distributor viz., M/s BOEHRINGER ingelheim India Pvt. ltd, Mumbai, the Manufacturing company, viz., the appellant has to lose substantial amounts for 15 Years from the date of agreement made on 01 -04- 2016, or from date of starting its manufacturing of the said products and to compensate the same, t he distributor has paid the amount of Rs.22.50 Crores as non refundable advance, which thus, it cannot be considered as income for this assessment year 2017-18 in the hands of the appellant.
9.2 He submitted that the assessee company has to bear the losses as noted below in view of the said agreement, which thus, the distributor has paid the above advance of Rs. 22,50,00,000 to the assessee:
"(I) That the sole consideration payable by distributor to manufacturer for granting distribution rights to the products manufactured! will manufacture;
[ii) loss towards trade mark(s) and trade dress;
(iii) loss towards use of trade mark(s) and trade dress by the distributor even after the termination of this agreement;
(iv) Loss towards usage of its own name and its own account by the distributor when sold the products by the distributor to its sub - distributors;
(v) Loss towards providing free of charge and to an adequate extent, with all available technical information in the English Language relating to the products including scientific publications, etc., to the distributor by the appellant;
:- 11 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
(vi) loss towards providing through the appellant's specialists training to distributor and it's sub- distributor's personnel regarding scientific information of the products and the field of application and use;
{vii) Loss towards shipment of product, including any transportation and insurance expenses incurred in connection therewith that ultimately is agreed or found to be a non - conforming product;
(viii) The manufacturing of products, the amount given by the Distributor is only on unsecured loan and after starting of manufacturing of the products, the above amount has to be considered as an expenditure, and no income element is available in any assessment year as pointed out by the AO;
9.3 He submitted that it is not out of place to submit that without appreciating that the amount is an advance receipt which would be assessable as income only in the subsequent years, when the services are rendered by the appellant, whereas the AO has made the addition during this assessment year, wherein the non-refundable was given. He submitted that the sole ground for the AO to take a divergent view was that the contract with M/s. Boehringerlngelheim India Pvt Ltd. did not specify the accounting treatment. According to the AR, the AO completely erred in this regard because the accounting treatment and the Income Tax liability of a person depends on the nature of his business and objects. Further , no part of the advance can accrue in the present assessment year as :- 12 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
the assessee is yet to render the services in this behalf. The amount is received with a view to incur expenditure in future. Since, the amount is in respect of a future liability in the form of incurring costs for rendering the said services, the amount could not partake of character of income until it was earned and could be said to be earned only when the assessee would render the said services in future, He pointed out that this fact that the assessee is under an obligation to render services in the future has not been disputed by the AO considering the fact that the amount of advance is received towards future services for which costs are to be incurred in future and the same is non -refundable, no addition need to made during this year. Moreover, the receipt in advance amount do not come within the provisions of sec 4 & 5 and they cannot be treated as income in the hands of the appellant.
9.4 He submitted that the financial statements of the company are prepared in accordance with the Indian General Accepted Accounting Principles (GAAP) under the Historical Cost Convention on the accrual basis except for certain financial instruments which are measured at Fair Values. GAAP comprises mandatory accounting standards as prescribed u/s 133 of the Companies Act, 2013 read with relevant rules issued there under. The accounting policies adopted in the preparation of the Financial Statements ar e consistent with those followed in the previous year.
:- 13 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
9.5 In view of the above submissions, the ld. AR finally submitted that the addition made of Rs. 22,50,00.000/- is not justified, is bad-in-law and is against to the Principles of Natural Justice.
9.6 He relied on various decisions, which are placed in the paper book including the following cases:
1. Siddheshwar Sahakari Sakhar Karkhana Ltd., 139 taxman 434 (SC) Relying on the above judgment, he submitted that issue of share in lieu of deposit received is as good as refund and cannot be treated as non-refundable.
2. Shooraji Vallabhdas & co., 46 ITR 144 (SC) Relying on the above judgment, he submitted that as per section 5 of the Act, income shall not be taxable in the hands of assessee unless it accrues and becomes dues to the assessee.
3. CIT Vs. Lok Housing Construction Ltd., 70 Taxmann
2.
10. On the other hand, ld. DR besides relying on the orders of revenue authorities, submitted that the claim of the assessee that the receipt of Rs. 22.50 crores as 'unsecured loan' by the assessee cannot accepted as the receipt is pertaining to the rights of distribution and ought :- 14 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
to have been admitted as business receipt, which the AO has rightly treated as business income u/s 28(i) of the Act.
11. We have considered the rival submissions and perused the material on record as well as gone through the orders of revenue authorities. The crux of the issue to be decided by us is whether the receipt of Rs. 22.50 crores received by the assessee as advance can be treated as business receipt u/s 28(i) of the Act or not ?. The provisions of section 28(i) read as under:
"28. Profits and gains of business or profession 1 The following income shall be chargeable to income - tax under the head" Profits and gains of business or profession",-
(i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year;"
11.1 As per the above section, it is clear that the assessee has not undertaken any business activity and he has received only advance for setting off of losses for future years, which commence w.e.f. 01/04/2016, but, no commercial activity has been started, which is clear from the audited financial statements. Therefore, the agreement in this regard for treating it as a revenue income cannot arise. On perusal of the agreement, which is placed at page nos. 23 to 56 of the paper book, the agreement will be in force when the commercial activity will start . Accordingly, :- 15 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
we observe that the advance received of Rs. 22.50 crores is not a revenue in nature for the year under consideration. The relevant part of the agreement in this regard is as under:
"Article 4 - Consideration/Prices:
4.1 For the assignment of global exclusive distribution rights to Distributor and/or a distributor affiliate to any and all products which manufacturer produces/will produce and holds/will a marketing authorization, distributor shall pay to manufacturer Rs.
22,50,00,000/- (in words Rupees Twenty two crores fifty thousand only) 4.2 The parties agree that the transfer price shall be 50% of distributor's net selling price of a product as defined in Annex A until 31 Dec 2023. From 1 Jan 2024 to 31 Dec 2027 the transfer price shall be 30% of distributor's net selling price as defined in Annex A. From 1 st Jan 2028 the transfer will be 40% of distributor's net selling price as defined in Annex A. Manufacturer grants distributor the right at any time until the end of the initial contract term (15 years) to acquire up to 25% of the shares (equity) of the manufacturer at a price agreed upon by way of fair valuation.
4.2.1 The parties have the common understanding that the transfer price is targeted to be at or above. Full costs of goods of a particular product plus 30%.
If price negotiation pursuant to...new purchase price for any of the products by the end of December in any marketing year, the new transfer price shall be calculated by sharing the applicable produ ct margin at a ratio of 60% for the distributor and 40% for the manufacturer.
:- 16 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
4.2.3 The transfer price is the sole consideration payable by distributor to manufacturer for the products and the granted distribution rights and no additional payment for the supply of the products will be made by distributor.
4.2.4 Payments of the transfer price to manufacturer shall be in Indian Rupees (INR)."
11.2 In support of our conclusion, we rely on the following judgments, on which reliance placed by the assessee.
11.3 In the case of Siddheshwar Sahakari Sakhar Karkhana Ltd., (supra), on which reliance placed by the assessee, the Hon'ble Supreme Court held as under:
"The purchase and payment of price of sugarcane was undoubtedly part of trading operations of the assessee. It was in the course of such trading operations that the assessee realized the amounts (treated as deposits) with regularity and utilized the money so received in its business. To the extent the full payment was not made to the farmers, the assessee saved the raw material cost as well. [Para 19] However, it needs to be clarified that the line of inquiry, in order to determine the true nature and character of the receipts, does not stop at ascertaining the mere fact whether the realization was in the course of trading operations. The moment it is found that certain amounts were deducted by the assessee out of the price payable to its members who supplied the raw material, the conclusion does not necessarily follow that all such realizations get impressed with the character of revenue receipts, giving rise to taxable income in the hands of the assessee. It is not any and every receipt linked to the trading activity that acquires the quality :- 17 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
of revenue receipt. The Tribunal or the Court should go further and delve into the true nature, character and purpose of the realizations. If the amounts are meant to be held as deposits liable to be returned to the depositor at a specified point of time or on the happening of specified contingencies which are by no means uncertain or are otherwise treated as members' money-the depository having no unfettered dominion over the said funds, then, it is difficult to characterize them as the income of the assessee. [Para 21] On an analysis of the relevant bye-laws regarding sugarcane price and non-refundable deposits, the following salient features were discernible:
1. The price of sugarcane was fixed every year by the Board of Directors, on a consideration of relevant factors.
2. However, so long as the share capital contributions of the State Government and/or the loans taken on capital account from IFCI and other Central Financial Institutions remained outstanding, the price as fixed by the State Government was liable to be paid by the society.
3. Every year the society shall collect from the members supplying sugarcane a non-refundable deposit at the minimum rate of Re. 1 per ton. In fixing the rate, the into account the liabilities towards the loan due to IFCI and other loans borrowed for capital expenditure and the repayment of time deposits received from the members.
4.. The Society was to continue to collect the deposits so long as it held Government share capital and other loans (on capital account) were outstanding. However, the deposits collected by the Society shall not exceed three times the shares held by the members.
:- 18 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
5. The rate of interest on the deposits collected shall not exceed 12 per cent.
6. The non-refundable deposit shall not be refunded to the members till the Government share capital and term loans taken from IFCI, etc., towards capital expenditure were repaid fully. On such repayment, the Management of the Society might convert such deposits into shares.
7. The amount of deposits collected shall be utilized for the repayment of term loans taken for the purpose of capital expenditure.
8. The amount collected as deposit could be transferred to the name of any other member on an application submitted in that behalf
9. On ceasing to be a member for whatsoever reason, the non-refundable deposit standing to his credit might be transferred to any other member's account subject to the approval of the Board of Directors or could be refunded to such member or his legal-heirs with the approval of the Board of Directors, but, such refund could only be granted after the lapse of one year, that too after considering the financial position of the society. [Para 26] Although the use of the expression 'deposit' did not conclude the issue, there were intrinsic indications in the bye-laws that the expression has been used to mean just what it says. These were : (a) conversion of the deposit into additional shares; (b) transferability/heritability; (c) refundability; and (d) payment of interest on the deposit. The first three features were no doubt dependent upon occurrence of certain contingencies or hedged in by certain limitations. But the deposited amount was not denuded of its character of 'deposit' for that reason alone. [Para 27] :- 19 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
The conversion of deposits into shares was as good as refund. Such conversion into additional shares was, however, postponed till the repayment of loans towards capital expenditure and the repayment of Government share capital. In other words, till such time, the member/depositor had no immediate right to demand the payment. Nevertheless, the obligation to repay stood annexed to the deposited amount at the time it was received by the assessee subject of course to the occurrence of the contingency specified in the bye -laws itself It could not be said, as had been said by the High Court, that "under the bye-laws, no event or contingency had been contemplated" under which the members could demand the repayment of the deposit. Nor could it be said that even after the happening of the event specified in the bye-laws, the right to demand repayment becomes illusory in view of the discretion reserved to the Board of Directors of the Society. [Para 28] Once the loans of the description mentioned in the bye - laws which were outstanding on the date the deposit was made were repaid, the Board of Directors of Society was bound to convert the deposit amount into shares. The discretion was always coupled with a duty; the discretion could not be used to circumvent the obligation cast under the law or contract governing the parties. On the occurrence of the specified event, namely, the repayment of the loans referred /0 in the bye-law and the Government share capital, the member/depositor could clutch at a legally enforceable right to demand repayment, might be, in the form of conversion into additional shares. [Para 28] Thus, the retention of the deposited money with the Society in order to utilize the same for repayment of term loans, etc., did not denude the amount of its character of 'deposit' carrying with it the obligation to repay. Nor was it necessary, that the separate identity of the deposited amounts should be kept up. The :- 20 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
absence of the right to secure repayment on demand was again not inconsistent with the receipt being a deposit. Liability to return need not be immediate and unconditional, following a demand by the depositor Even if such liability gets crystallized on the happening of a specified contingency, it is still a liability which could be legally enforced by the depositor The existence of such liability is an antithesis to the idea of ownership of the money by the Society. [Para 29] The contention of the revenue that the possibility of return of the deposit (by way of conversion into shares) depended on uncertain events and the repayment remained to be a remote possibility could not be accepted. True, the obligation to refund the deposit by way of conversion into shares would arise only on the occurrence of the contingencies specified in the bye - laws. But, it was wrong to assume that the events giving rise to refund were uncertain. The repayment of loans taken for capital expenditure and the share capital of the Government were the two specified events which were by no means uncertain, though the time of repayment was indefinite. On the occurrence of the said two events, the right to demand refund would accru e to the depositor. The obligation which had been in inchoate form ripened itself into a complete obligation on the occurring of specified events stipulated in the bye-laws. Such an obligation may be contingent in nature ~l initially but the right to enforce the obligation inheres in the depositor from the beginning. The existence of other features such as transferability of the deposit to another member and the provision for refund of the deposited amount to the member in case of cessation of membership or to his legal heirs in case of death. were important indicators against the treatment of the deposited amount as the money belonging to the Society. The payment of interest from year to year at a specified rate was another important factor that supported the conclusion of the disputed sum being a deposit. Such payment of interest was only :- 21 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
consistent with the fact that the deposited amount still belonged to the member. The fact that the deposited amounts were credited to individual accounts of the members was a corroborative circumstance to indicate that deposits belonged to the members. [Para 33] Further, the manner of user of the deposit was limited by the bye-laws. Which provided that the amount of deposits shall be utilized jar the repayment of term loans taken for the capital expenditure from the banks and financial institutions.
The fact that depositor could seek transfer of the deposit to another member by filing an application for that purpose again highlights the fact that the power of disposal of the deposit lies with the member. The obligation to convert the deposits into shares subsequent to the repayment of certain types of loans coupled with the right given to the member to seek transfer of the amount lying to his credit and the obligation to refund the deposit to the depositor on cessation of his membership or to his legal heirs in case of death subject of course to certain restrictions, were all pointers that the assessee could exercise dominion over the deposits only in a limited sphere. On a consideration of the bye-laws as a whole, it was difficult to hold that either the assessee or the depositor would exercise complete dominion over the deposited amounts. If so, it was not possible to countenance the plea that the title to the deposits would throughout remain in the hands of the Society and the depositor had no stake or interest therein, once it reached the assessee's hands. [Para 35] The Tribunal expressed the view that the whole idea was to increase the capital base of the assessee in a phased manner by retaining some portion of the money payable to cane-growers, while at the same time compensating the depositors by way of interest.
:- 22 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
However, the High Court was not inclined to accept the finding of the Tribunal.
Meeting the financial commitments of the Society may be one of the purposes for which the deposits were collected but that was not all. The augmentation of the share capital which might be in the overall interest of the members as well as the Society was an equally important purpose which could not be overlooked. At any rate, the view taken by the Tribunal appeared to be a reasonable view and the High Court need not have disturbed that finding. [Para 36] REFUNDABLE DEPOSITS As regards refundable deposits, though those were deducted from the cane price, they were pure and simple fixed deposits repayable on the expiry of a definite period of time with interest. The restrictions and conditions governing the non-refundable deposits were not incorporated in bye-laws. These 'deposits' were akin to the transaction of loan. They were clearly liable to be excluded from taxable income. [Para 40] The contended by the revenue that the members had no option but to agree for deduction on pre-obtained terms and there could not be in law a contract creating deposit could not be accepted. A person by becoming the member of a Co-operative Society volunteers to abide by the bye-laws of the Society, the real object of which is to provide for internal management of the Society including rendering assistance to the members. There is an authority for the proposition that the bye - laws of the Co-operative Society constitute a contract between the society represented by its managing body and its constituents. That apart, the mere fact that the contract has to be entered into in conformity with and subject to restrictions imposed by law does not per se impinge on the consensual element in the contract.
[Para 41]
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M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
CONCLUSION For the aforesaid reasons it was concluded that the non-refundable and refundable deposits could not be treated as the income of the assessee-society. Therefore, appeals filed by the assessees were allowed. [Para 41J OTHER FUNDS As regards the Chief Minister's Relief Fund, Late YB. Chavan Memorial Fund and Hutment Fund, the assessee had merely acted as an agent in collecting the amounts and remitting the same to the Government/Trustees. In truth and in substance, the money collected by the assessee was not reaching the assessee as part of its income, but the collection was made for and on behalf of the person to whom it is payable'. It had no manner of right or title over the said monies. The amount collected towards Hutment Fund stands on no different footing. It was meant to be handed over to Collector for the purpose of providing shelter to landless poor inhabitants within the area of operation of the sugar factory. Therefore, the conclusion reached by the Tribunal and the High Court that those receip ts should not be treated as income of the assessee was justified. [Para 44 J As far as Sugar Cane Development Fund was concerned, the Circular dated 18-8-1986 in which certain directive principles had been laid down to regulate the expenditure to be incurred out of the Cane Development Fund. The items specified in the directive principles were (1) green manuring,' (2) lift irrigation schemes; (3) distribution of cane seeds,' and (4) construction of new wells or deepening of old wells. The sugar fact07Y is required to make sure that any project which they want to undertake out of the Cane Development Fund is technically and financially sound and to send the proposals in advance to the Directorate of Sugar for :- 24 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
requisite sanction. The projects will directly b enefit the members and augment t he sugarcane production which will incidentally help the Society in its manufacturing operations. The beneficiaries under the scheme were no other than the members of the Cooperative Society concerned and the advantage of enhanced production of sugarcane will ultimately be felt by Society itself. Unlike the Area Development Fund, the monies out of Cane Development Fund would not be spent for purposes unconnected with the growth and functioning of the sugar factory. The Tribunal was inclined to view it as a 'compulsory levy' on the depositors collected by the Government through the agency of sugar factory. That approach was wholly unsustainable and was in the realm of surmise. No scope was found for the application of the principle of diversion of income at source in the case of collections made towards the Cane Development Fund. The amounts realized on that account undoubtedly reached the assessee as its income and was utilized by the assessee for the benefit of itself and its members. The supervisory role of the Directorate of Sugar to ensure that the amount was properly utilized to promote the objectives with which the Fund was formed, did not make a material difference to the quality and character of the receipt. Thus, the deductions made out of cane price towards the Cane Development Fund should be treated as income of the assessee. [Para 48J CONCLUSION Therefore, the appeal of the Commissioner of Income - tax partly in respect of the amounts collected by the respondent-societies towards the Cane Development Fund and was allowed, the amount collected towards the Cane Development Fund would be treated as the income of the assessees and any claim for deduction would be entertained and decided by the Tribunal.
[Para 49J
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M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
In the ultimate analysis, the assessee's appeals were allowed and the Commissioner's appeals were partly allowed to the extent indicated above."
11.4 Considering the totality of the facts and circumstances of the case, we find substance in the submissions made by the ld. AR of the assessee and accordingly, we direct the AO to delete the addition made on this count. Thus, the grounds raised by the assessee on this issue are allowed.
12. As regards ground No. 14 relating to the addition of Rs. 42,52,628/-, the AO observed that from the Profit and loss account, total amount of Rs.42,51,628/- was claimed as expenditure for the year under consideration. He further observed that, from the financials, the assessee company had not carried out any business during the financial year under consideration. He also found that the Company had not provided any depreciation during the year, as the project is still in work in progress stage. He, therefore, issued a show cause notice proposing disallowance of the expenditure so claimed as under:
"In your submissions, you hove stated that depreciation is not provided since the project is still in wor k in Progress stage and operations are not yet started. Further, you have shown only income from other sources of Rs. 45,31,264 being interest from ban k. You have not shown any income from business operations. However, you have claimed expenditure of Rs. 42,52,628/ "
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Since, you have stated that the Project is still in Work in Progress stage, you should have capitalized the expenditure of Rs. 42,52,628/- without bringing the same into P&L. account. in view of the same, you are requested to show cause why Rs. 42,52,628/- shall not be disallowed as business operations were not commenced."
12.1 In response, the assessee company filed a reply and requested for dropping of proceedings initiated.
12.2. As the assessee itself had categorically stated that it had not carried out any business during the year under consideration in the financial statements and also the fact that the project is still under work-in-progress, which is ought to have capitalized, the AO held that the expenditure of Rs.41,52,628/- so claimed was not eligible for deduction as expenditure for the Asst. year 2017-18 and accordingly, the expenditure of Rs.42,52,628/- was disallowed and added to the total income.
13. Before the CIT(A), the assessee claimed that these expenses were eligible for deduction u/s 37(1) of the Act. It was also mentioned that the expenditure incurred were in the nature of administrative expenses and payment of salaries which was incurred for the purpose of business and therefore is an allowable expenditure.
:- 27 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
14. After considering the submissions of the assessee, the CIT(A) confirmed the addition by observing as under:
6.3.2 I have considered the submissions of the appellant as well as the facts mentioned in the assessment orde r.
There is no dispute that the appellant has not commenced commercial production and the project is still in work-in-progress stage. There is no depreciation claimed by the appellant as the fixed assets are not put to use or ready to be put to use. There is no business income on account of sale of products offered in the P&L A/c. except interest from bank. These facts dearly show that the appellant has not set up his business yet and is still in pre-commencement period. Therefore, the expenses though of revenue nature are to be capitalized to the capital work-in-progress Ale. till the time period of actual commencement of business. The Proviso to Section 3 of the I.T. Act refers to the date of setting up of business and the previous year would commence only thereafter. The assessee has not produced any evidence to prove that it has actually set up its business. The Hon1ble Supreme Court in CWT Vs. Rama Raju surgical Cotton Mills ltd. [1967] 63 ITR 478 (SC) ruled that a unit cannot be said to have been set up unless it is ready to discharge the functions for which it is being set-up. The installation of machineries, purchase of land, etc. were merely operations for setting up of business and business would be set-up on culmination of these operations. Similar view was taken by the Madras High Court in CIT vs. Electron India (241 ITR 1661 [20011 and Delhi High Court in CIT vs, Samsung India Electronics ltd. [2013] [356 ITR 354] [Delhi]. Therefore, the AO is right in holding that these expenses are to be capitalized till the setting up of the business and commencement of operations. In view of the same, Ground Nos. 10 to 14 raised by the appellant on this issue are DISMISSED."
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15. Before us, the ld. AR of the assessee submitted that the expenditure was incurred for the purpose of business, and it is allowable as business expenditure if it is incurred on the ground of commercial expediency. He submitted that the assessee company has incurred the expenditure towards smooth running of business and the same should have been allowed as business expenditure. He contended that since the assessee company is satisfied all the conditions of section 37 of the Act, the disallowance made by the AO is against the principles of natural justice. He also submitted that the case law relied upon by the authorities below are distinguishable on facts to the case of the assessee. He relied on the following judgments:
1. Amrutha Power Projects P. Ltd., ITA No. 1944/H/2017 (ITAT, Hyd.)
2. E funds International India, 162 Taxman 1 (Delhi HC)
16. On the other hand, the ld. DR relied on the orders of revenue authorities and submitted that the asses see has not yet set up its business and is still in pre-commencement period and, therefore, the expenses though of revenue nature are to be capitalized to the capital work in progress account till the time period of actual commencement of business. He submitted that the proviso to section 3 of the Act refers to the date of setting up of business and the previous year would commence only thereafter. He :- 29 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
contended that the assessee has not produced any evidence to prove that it has actually incurred towards set up of its business. He, therefore, submitted that the addit ion made by the revenue authorities is correct and the same may be confirmed.
17. We have considered the rival submissions and perused the material on record as well as gone through the orders of revenue authorities. The ld. CIT(A) has alleged that the assessee has not set-up its business and still is in pre-commencement period, therefore, the expenditure should be capitalized. We observe that there may be time gap between the setting up of business and commencement of business, as the setting up of business involves many activities, viz., registration of the organization, obtaining license, selection/ purchase of land, installation of plant and machinery, construction activities, R&D activities, market research activities and employee recruitments, compliance with the govt. departments, etc. During this period, the company has to incur some expenditure which may be either in capital in nature or may be in revenue in nature. The revenue expenditure is allowed u/s 37 in the previous year in which it has been incurred. The Section 3 of the Income Tax Act, which defines "previous year", in the context of first year of business operation, states that the same previous year shall start from date of "setting up" of business. Accordingly, date of setting up assumes :- 30 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
importance because expenses prior to setting up of business will not be covered under section 37 of IT Act. This is however subject to section 35D of IT Act wherein specifically provision has been made by legislature for allowance of preliminary expenses. It has to be borne in mind that there is a distinction between setting up of a business and commencement of a business. The Bombay High Court in Western India Vegetables Products Ltd. v. CIT [1954] 26 ITR 151 has examined the concept and noticed the difference between commencement and setting up of a business by observing:-
"The important question that has got to be considered is from which date are the expenses of this business to be considered permissible deductions and for that purpose the relevant section defines the previous year as ?and for the purpose of a business the previous year begins from the date of setting up of the business".
Therefore, it is only after the business is set up that the previous year of that business commences and in that previous year the expenses incurred in the business can be claimed as permissible deductions. Any expenses incurred prior to setting up a business would obviously not be permissible deductions because those expen ses would be incurred at a point of time when the previous years of the business would not have commenced." 17.1 The Gujarat High Court in a subsequent judgment in the case of CIT, Gujarat v. M/s. Saurashtra Cement and Chemical Industries Ltd. (1973) 91 ITR 170 (Guj.), has held a business is said to have commenced as soon as an essential activity of that business is started. On the :- 31 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
question of setting up, the following observations are relevant:-
"...A business activity consists of three stages: the first stage relates to the activity necessary for the purpose of acquiring the raw material and establishment of plant and machinery and the second activity comprises the processing and manufacturing by using the raw material and the plants and machinery set up for the purpose and the third category consisted of the marketing thereof. The first in point of time lays the foundation for the second activity and the second activity when completed lays the foundation for the third activity. Therefore, the expenditure incurred for carrying on any of these activities including the first activity is also deductible in computing the profits and gains of the assessee for the relevant year when the activity is undertaken."
17.2 In Sarabhai Management Corporation Ltd. v. CIT, [1976] 102 ITR 25, the Gujarat High Court took the same view and held that the business commences with the first activity for acquiring by purchase or otherwise, immovable property. There may be an interval between the setting up of the business and the commencement of the business. All expenses incurred during that interval are also permissible for deduction.
17.3 The Delhi High Court, in case of Carrefour WC & C India Private Ltd. v. Deputy Commissioner Of Income Tax (September 2014) made the following observations on setting up:-
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"The present assessee i.e. Carrefour was engaged and incorporated for carrying on trading activities in different commodities. The word 'trade' even though not defined in the Act is used to denote operations of a commercial character by which a trader provides to customer for reward, some kind of goods or services. In other words, when the trader start providing such goods and services, the business is said to have commenced but the same may not hold good for set up of a business, which is a stage before the commencement.
To set up a business, the following activities become relevant:-
'Preparation of a business plan; establishment of a business premises; research into the likely markets or profitability of the business; acquiring assets for use in the business; registration as an entity and under the local laws etc.' The said list of activities are not exhaustive and facts of each case need to be considered. Indeed purchase of goods would amount to commencement of business, but before the said a ct, spade work and efforts to commence have to be undertaken. A trader before actual purchase would possibly interact and negotiate with manufacturers, landlords, conduct due diligence to identify prospective customers, spread awareness etc. These are all integral part and parcel of the business of a trader. The said activities continue even post first sale/purchase. When first steps are taken by a trader, the business is set up, commencement of purchase and then sales is post set up."
17.4 The ITAT Mumbai in case of Reliance Gems and Jewels Ltd. v. DCIT on October 28, 2015 held that "A business is 'set up' the moment employees are recruited for the purpose of the business. All expenditure incurred thereafter is allowable as a deduction u/s 37(1) even if the business has not :- 33 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
commenced. Setting up of business is different from commencement of business and the expenditures are allowable on setting up of business. The assessee has recruited employees for the purpose of its business and about 16 employees are for the job of quality assurance. The assessee is in the business of Merchandising of diamonds/gold/jewelry. Undisputedly, this line of business requires expertise that has proficiency in understanding the carats of diamonds and related jewelry, without such recruitment, it would be a futile exercise to commence the business. In our considered opinion, upon recruitment of employees, the factum that expenditure under the different heads was incurred is indicative that business was set up."
17.5 From the aforesaid cases, it is clear that it is only after the business is set up that the expenses incurred in the business can be claimed as permissible deduction under Section 37 of IT Act. For commencement of a business, there must be some income generating asset or income earning structure. In the case on hand, the assessee is incurring capital expenditure and till date of FY ending, the assessee has not commenced its commercial operations. On going through the revenue account, the assessee has debited the expenditure as under:
1. Staff salaries - Rs. 11,43,505
2. Staff Welfare expenses - Rs. 39,307 :- 34 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
3. Factory Maintenance - Rs. 3,41,256
4. Repairs & Maintenance - Rs. 2,45,167
5. R&D Expenses - Rs. 11,45,214
6. Transportation expenses- Rs. 1,06,300
7. Auditors Fees - Rs. 28,750
8. Administrative expenses (As per Note No. 14) - Rs. 11,55,395
9. Bank charges (as per Note No. 16) - Rs. 47,734 Total Rs. 42,52,628 =========== 17.6 From the above details of expenditure, it is clear that at Sl.No. 3, 4 & 5 are in the nature of capital expenditure .
As per the balance sheet filed by the assessee, the assessee is incurring capital expenditure, therefore, factory maintenance and repair & maintenance expenditure do not arise. The assessee failed to establish that expenditures incurred under Sl. No. 3, 4 & 5 are not directly relating to the installation of the project. The assessee has incurred R&D expenditure earlier, which has been capitalized and, therefore, this expenditure cannot be treated as r evenue expenditure since the assessee has not yet started commercial production. In view of the above observations and considering the totality of the facts of the case, this :- 35 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
ground of the assessee is partly allowed. Thus, the assessee gets a relief of Rs. 25,20,991/-.
18. In the result, appeal of the assessee is partly allowed in above terms.
Pronounced in the open court on 5 th October, 2021.
Sd/- Sd/-
(S.S. GODARA) (L. P. SAHU)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Hyderabad, Dated: 5 th October, 2021.
kv
Copy to :
1 M/s Sanvita Biotechnologies Pvt. Ltd.,
C/o P. Murali & Co., CAs, 6-3-655/2/3, 1 st Floor, Somajiguda, Hyderabad - 82 2 DCIT, Central Circle - 2(3), Hyderabad. 3 CIT(A) - 12, Hyderabad 4 Pr. CIT (Central), Hyderabad 5 ITAT, DR, Hyderabad.
6 Guard File.
S.No. Details Date
1 Draft dictated on
2 Draft placed before author
Draft proposed & placed before the Second 3 Member 4 Draft discussed/approved by Second Member 5 Approved Draft comes to the Sr. PS/PS 6 Kept for pronouncement 7 File sent to Bench Clerk :- 36 -: ITA No. 283/Hyd/2021 M/s Sanvita B iotechnologies Pvt. Ltd ., Hyd.
8 Date on which the file goes to Head Clerk 9 Date on which file goes to A.R. 10 Date of Dispatch of order