Income Tax Appellate Tribunal - Delhi
Hcl Infosystems Ltd. vs Deputy Commissioner Of Income Tax on 3 October, 2002
Equivalent citations: [2003]85ITD42(DELHI), (2003)81TTJ(DELHI)922
ORDER
V. Dongzathang, President
1. This appeal of the assessee is directed against the order of the CIT(A) for asst. yr. 1998-99.
2. The assessee, incorporated as HCL Limited, a public limited company, was engaged in the manufacture, distribution and sale of computers and services in India prior to 2nd April, 1991 It had developed a strong research and development team and most computer products being manufactured were designed in-house.
3. HP a company incorporated in the United States of America, is engaged in the design, engineering, manufacture, assembly and sale of certain types of computers, together with their, components and peripherals. It has substantial experience, expertise and reputation in its area of operations.
4. Hewlett-Packard India (P) Ltd. ("HPI"), a private limited company was incorporated in India and was engaged in manufacture of computers in India under licence from HP, ,
5. The assessee and a majority of its shareholders entered into a joint venture agreement with HP and HPI on 2nd April, 1991, as amended on 27th May, 1991, pursuant to which the parties, agreed to combine the respective computer manufacturing, marketing, servicing and sales activities in India of the assessee and HP1. In the JVA 26 per cent equity was held by HP through its wholly-owned subsidiary, Hewlett-Packard Delaware Capital Inc. ("HPDC") Under the joint venture agreement, the assessee was permitted to use the name "Hewlett Packard" and was thus renamed as HCL Hewlett-Packard Ltd ("HCL HP Ltd")
6. The joint venture agreement amongst these parties was ultimately terminated by an agreement, dt. 1st April, 1997, Para 2 of the said agreement, provides for payment of seventeen million dollars ( $ 1 7,000,000) as follows:
"HP shall pay to HCL HP as full compensation to HCL HP, its shareholders, creditors, and any other interested persons for the past and future loss of exclusivity with respect to HP computer products and elimination of noncompetition obligations referred to in Article 14.3 of the joint venture agreement the sum of seventeen million dollars ($ 17,000,000) as follows:
(a) On or before 3rd April, 1997, eight million dollars ( $ 8,000,000) (hereinafter referred to as the "First Installment") to HCL HP's designated bank outside of India,
(b) Upon the completion of the sale by HPDC of the shares in HCL HP offered to SAAAP pursuant to Article 1, nine million dollars ( $ 9,000,000) (hereinafter referred to as the "Final Installment") HP's obligations to pay installments under this article are expressly conditioned on SAAAP's being in full compliance with the terms of this agreement."
7. Para 143 of the joint venture agreement dt. 2nd April, 1991, provides as follows:
"The parties agree during the term of this agreement not to enter, either directly or indirectly, into any business in India which would be in competition with the company. For purposes of this paragraph, the manufacture, marketing, sale or support of laptop computers by HCL or its successor in India shall not be considered a breach of this provision so long as such activities occur prior to any similar activities undertaken by the company."
8. During the course of the assessment proceedings, it was submitted before the AO that the compensation of Rs 60.80 crores received from HP was in consideration of extinguishment of the following rights:
(a) the right to use the name HP,
(b) the license to manufacture HP products with exclusive use of HP technology,
(c) using of HP patents, trademarks, logos, technical know-how, technical skills, drawing specifications, blue prints, test procedures, etc and
(d) access to HP's worldwide strategies in marketing, product introduction support and business planning
9. It was further pleaded that all these rights constituted a bundle and formed capital asset representing the sources of the income of the assessee-company and that on disappearance of these rights, the income earning apparatus of the assessee got seriously impaired and the compensation was against such loss of the income earning apparatus and was, therefore, to be treated as a capital receipt. The assessee also relied on the decision of the Hon'ble Supreme Court in the case of Oberoi Hotel (P) Ltd v. CIT (1999) 236 ITR 903 (SC) in support-of its contention that the entire amount received by it by way of compensation from HP represented capital receipt not assessable to tax.
10. The AO, however, held that the rights and privileges to manufacture HP products under the joint venture agreement (hereinafter referred to as the "JVA") constitute a capital asset in terms of Section 2(14). Further he held that the extinguishment of this bundle of rights by termination of the JVA has resulted in transfer of an asset as per provisions of Section 2(47)(ii) of the IT Act. The AO also rejected the assessee-company's contention that this capital receipt is not taxable and held as under:' "The amendment to Finance Act, 1997 also very clearly states that if the extinguishment of a capital right to manufacture is for a consideration it will fall under Section 55. The assessee's case is, therefore, covered by the provisions of s, 45 r/w Section 55 of the IT Act, 1961. The intent of the legislature on this issue is very clear. Section 55(2)(ii) has been amended w.e.f. 1st April, 1998, in order to ensure payments such as these are brought to tax. Section 66(2)(ii) states that in such cases, the cost of acquisition, where the capital asset is a right to manufacture or produce any article or thing will be Nil."
The entire amount of Rs. 60,80,95,000 was brought to tax under Section 45 r/w Section 55 of the IT Act, 1961 as income from long-term capital gains.
11. Aggrieved by the said order, the assessee took up the matter in appeal before the CIT(A) and reiterated the same submissions as advanced before the AO The learned CIT(A), however, concurred with the findings of the AO and upheld the order observing as follows:
"2.7 I have carefully considered the matter. The right to manufacture HP products in India vested with the appellant-company under an exclusive licence granted by HP during the currency of the joint venture agreement. To my mind, the AO has correctly held that under the joint venture agreement the assessee-company had acquired a bundle of rights and privileges, which clearly and patently constitute a capital asset. Under these rights and privileges no other entity was entitled to manufacture HP products in India. Ownership of a property results in a bundle of rights. These rights include rights to possess, use, enjoy and dispose of a thing The central point, to my mind, is that a property need not have a tangible or physical existence. In this case, I find that the bundle of rights and privileges enjoyed by the appellant-company under the joint venture agreement with HP constitutes a capital asset and extinguishment of these rights has resulted in transfer of a capital asset. Under Section 2(14) a capital asset has been defined as property of any kind held by an assessee The bundle of rights and privileges acquired by the appellant-company under the joint venture agreement constitute a 'property'. In fact the decisions quoted above by the learned authorised representative strengthen the case of the Department that the compensation received in this case is in the nature of a capital receipt for transfer of a capital asset. The Hon'ble Supreme Court has in the case of Rustom Cavasee Cooper v. Union of India, AIR 1970 SC 564, held that the goodwill of a business is a capital asset, This has also been reaffirmed by the Hon'ble Supreme Court in the following cases:
(a) Devidas Vithaldas and Co. v. CIT (1972) 84 ITR 277 (SC);
(b) CIT v. B. C. Srinivasa Setty, (1981) 128 ITR 294 (SC).
Further, there has been an amendment to Section 55(2) by the Finance Act, 1987 w.e.f 1st April, 1988, to the effect that cost of acquisition of goodwill of a business will be nil. Even the cost of acquisition of a right to manufacture, produce or process any article or thing has been included in Section 55(2)(a) w.e.f. 1st April, 1998, i.e. for asst, yr. 1998-99. Therefore, keeping in view this amendment it is clear that the AO's action suffers from no infirmity, Accordingly, I have no hesitation in holding that the capital receipt of Rs 60,80,95,000 has been correctly brought to tax by the AO under Section 45 r/w Section 55 as income from capital gains. The submissions and contentions of the learned authorised representative on this issue do not hold water and carry no weight. The AO's finding rests on a sound footing and suffers from no infirmity. No relief is admissible on this ground."
12. The assessee is still aggrieved and has come up in appeal before the Tribunal. Shri S.K Tulsyan, adv. appeared with Shri Section Bandyopadhyay, adv. and Shri J.B. Sanghari, CA on behalf of the assessee The learned counsel of the assessee strongly objected to the conclusion drawn by the AO that on termination of the JVA, the main loss of the assessee was in respect of the right to manufacture HP products i.e., computers, its component and other accessories. According to him on proper reading of the JVA of 2nd April, 1991, it is seen that the parties desired to combine the respective computer manufacturing, marketing, servicing and sales activities in India of the assessee and HPI into one operation. Thus, apart from manufacturing, marketing, servicing and sales activities were also envisaged under the JVA.
13. It was further submitted that the main thrust of the termination agreement and the necessity to compensate the assessee-company lies against its loss of monopoly in the field of distribution of HP products and its agreement to allow HP to develop competing channels of distribution through its subsidiary HPI or otherwise. Thus it is seen that on termination of the JVA, the assessee had lost not simply the right to use HP brand name in the manufacture of products in India, but the exclusive right of distribution and sale of worldwide products of HP in a graded manner, It is, therefore, submitted that the finding of the AO that the main and in fact the only result of termination of the JVA was the extinguishment of the right to manufacture of computers by the assessee, is not tenable.
14. It was further submitted that on careful analysis of the different clauses of the termination agreement and especially of clause (J) thereof incorporating the aspect of compensation and explaining the purpose behind the payment of compensation, it would be quite evident that both HP and the assessee wanted to emphasise upon the aspect of the use of HP name and its patents, trademark, technical know-how etc. in an exclusive mariner and also introduction of competition in the distribution channels of HP products. It is, therefore, clear that the actual reason for the compensatory aspect are quite contrary to the view taken by the AO The loss of manufacturing right under HP brand name is just incidental to the entire episode, and the actual recorded reason behind the payment of compensation is loss of exclusivity and introduction of competition in the distribution channels of HP products.
15. The learned counsel of the assessee referred to the provisions of Clause (a) of sub-s. (2) of Section 55 so as to explain the nature of the right lost by the assessee in terms of right to manufacture, produce or process any article or thing etc. as provided in Sections 48 & 49. According to him the expression "manufacture, produce or process any article or thing", clearly shows that an article or thing in terms of its general specie is meant and not any particular or individual item of article or thing. It has got, therefore, to be concluded that the expression "any article or thing" used in different sections of the IT Act denote the whole specie of a particular article or thing and not some selected items thereof produced under a particular brand name, trade-mark etc. On this basis, it was submitted that the assessee never lost the right to manufacture computers as such which is the general specie but a particular brand i.e. HP computers and its products.
16. In support of the above interpretation, Shri S.K. Tulsyan, the learned counsel relied on the decision of the Hon'ble Rajasthan High Court in the case of CIT v. Laxmi An Studio (2001) 249 ITR 710 (Raj) where it was held that there is no further condition that the article or thing manufactured or produced by the assessee must be an article or thing which could be sold or bought in open market as a general commodity. The article or thing, which the particular assessee was producing was photographic films and related to the specific requirements of its customers. Acknowledging that in general, the expression "article or thing" should mean article or thing in its generality which can openly be sold or bought in the market. The Hon'ble Rajasthan High Court held in that case that even some particular articles or things produced for some specific purpose and not meant to be sold openly in the market would also be covered by the definition of "article or thing". Drawing inference from the above decision, it was argued that in a converse manner that if the assessee retains its right to manufacture that particular type of article or thing belonging to a general specie, i.e., HP computers then exclusion only of the HP brand thereof i.e., under a particular brand name, cannot give rise to the occasion of losing the right to manufacture the article or thing as such.
17. Reliance also was placed on the decision in the case of Pathange Poultry Farm v. CIT (1994) 210 ITR 668 (Kar) where it was held that such article or thing meant only general specie of the article or thing and not to any segregated variety thereof as held by the Hon'ble Supreme Court in the case of Scientific Engineering House (P) Ltd. v. CIT (1986) 157 ITR 86 (SC).
18. Reference also was made to the decision of the Hon'ble Calcutta High Court in the case of Apeejay (P) Ltd. vs CIT (1994) 206 ITR 367 (Cal) where it was held that the process of mixing up and blending of tea and selling the same in the market did not tantamount to manufacture or production of any article or thing in as much as what the assessee was producing was not "tea" as such, but a particular brand or variety of tea only.
19. In this particular case, the assessee was all along having the right to manufacture or produce computers, their component parts and accessories like software, etc., under its in-house technology. Although the assessee, after entering into the JVA with HP, started manufacture of HP brand name, that does not mean that it lost its right to manufacture computer under the earlier technology. This right continued even after termination of the JVA, Therefore, there was no relinquishment by the assessee or extinguishment of its right to manufacture or produce computers, its component parts and accessories. What the assessee has really lost under the termination agreement is not its-right to manufacture any article or thing but the right to use the brand name, patent, trademark and also technical know-how of HP in such manufacturing process. The loss of this particular type of right cannot be considered to be envisaged by a right to manufacture, produce or process any article or thing, as is mentioned in Clause (a) of sub-s. (2) of Section 55 of the IT Act, 1961. Hence it is pleaded that merely on account of loss of right to use a particular brand name in respect of manufacture of certain types of article or thing, there is no extinguishment of the general right to manufacture such article or thing and hence provisions of Section 55(2)(a)(ii) would not apply to the present case.
20. It was submitted that the assessee was already in the line of manufacture of computers, its component parts and accessories on the basis of its in-house technology. The termination agreement does not stop the assessee-company from manufacturing computers and its component parts, accessories and workstation systems. The assessee-company continues to be in the same business even now. In other words, the right to manufacture computer is not lost on account of the termination of the JVA. Therefore, the contention of the AO that the abovementioned compensation is for the loss of the right to manufacture is not correct. In the present case, the right to manufacture article or thing is the right to manufacture computer and accessories, which is still not extinguished. It is only the use of the HP technology and its brand name which is lost and not the right to manufacture computer itself. Therefore, the right to use the technology or the trademark or brand name cannot be equated with the right to manufacture computer as held by the AO and the CIT(A).
21 The learned counsel of the assessee further submitted that the above contentions of the assessee find support in the decision of the Calcutta Bench of the Tribunal in the case of ICI India Ltd v. Dy. CIT (2002) 75 TTJ (Cal) 932 : (2002) 81 ITD 348 (Cal). In that case a U.K. company granted to the assessee a license to use its trade-mark for which the assessee did not pay any cost to acquire such rights. Later on the U.K. company withdrew such license and paid compensation to the assessee, The Tribunal held that such compensation could not be charged to capital gains tax in the light of the decision of the Hon'ble Supreme Court in the case of CIT v. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC) which still holds good even after the amendment -of Section 55(2) and that no capital gains tax could be levied under Section 45 of the Act in respect of those capital assets for which no cost of acquisition is incurred by the assessee The learned counsel of the assessee, therefore, submitted that the case of the assessee is squarely" covered by the decision of the Tribunal referred to above and no capital gains is exigible to levy of capital gains tax. It is, therefore, submitted that the Tribunal may pass suitable order deleting the addition made by the AO and sustained by the CIT(A).
22. On the other hand, Shri B.D. Gupta, learned CIT Departmental Representative strongly supported the order of the learned CIT(A). According to him, the JVA dt. 2nd April, 1991, includes the following rights and privileges:
(a) the license to manufacture HP products with exclusive use of HP technology,
(b) the right to use the name HP,
(c) using of HP patents, trademarks, logos, technical know-how, technical skills, drawing specifications, blueprints, test procedures, etc.
d) access to HP's worldwide strategies in marketing, product introduction support and business planning.
At the core of the said agreement is the licence to manufacture computers, accessories and other peripherals with the exclusive use of HP technology. These rights mentioned above r/w para C of the termination agreement dt. 1st April, 1997, make it abundantly clear that the assessee-company which was made to be the exclusive manufacturer of HP computer products in India was given technical know-how etc. in order to enable the manufacture of HP products as per HP technology. If the assessee-company was to manufacture HP computer products as per the HP technology, it is obvious that it had to be supplied the technical know-how, patents, drawings, designs and blueprints, etc. Without the right to use such technical know-how, drawings and blueprints, etc., it would not be possible for the assessee-company to produce computer products as per the exclusive HP technology. Therefore, it is obvious that such rights to use the patents, technical know-how etc. are ancillary to the licence given for manufacturing HP products as per the exclusive HP technology. In other words, the above rights given for use of patents, technical know-how, drawings, blueprints etc. are all embedded in the expression "exclusive use of HP technology" Therefore, it cannot be said that the use of HP patents, "technical know-how etc., is a right distinct from the right to manufacture as per the agreement. Therefore, although the assessee acquired certain bundle of rights in terms of the JVA, the core of the said agreement is the right to manufacture HP products. Accordingly, on termination of the JVA, what the assessee lost was the right to manufacture HP products. The extinguishment of other rights of use of HP brand name, patents, technical know-how etc. was automatic on termination of the right to manufacture given to the assessee-company. So what the assessee lost on the termination of the said agreement was the right to manufacture HP products, other things being ancillary to this basic right. Therefore, the case of the assessee is covered within the meaning of transfer of a capital asset being a right to manufacture, whose cost of acquisition has duly been defined as "nil" in terms of the amendment introduced in s, 55(2)(a)(ii) by the Finance Act, 1997 w.e.f. 1st April, 1998.
23. With regard to the claim of the assessee that the manufacture, produce or process any article or thing used in Section 55(2)(a), it was submitted that such distinction drawn by the learned counsel of the assessee cannot be accepted. The reference to Section 32A(2A) and Section 80-I(2) to define the meaning of the expression "manufacture or production of any article or thing" have no application as the expression used therein was to restrict the benefit of those provisions to those industrial undertakings which manufacture articles or things other than those specified in the Eleventh Schedule. The question under consideration in this case is the right to manufacture computer products as per the HP technology and as to whether there was any extinguishment of this right to manufacture HP computer products. Therefore, the above distinction between the general specie and a particular item is not relevant.
24. The learned CIT (Departmental Representative) also submitted that the reliance of the learned counsel of the assessee on the decision of the Hon'ble Rajasthan High Court in the case of CIT v. Laxmi Art Studio (supra) is misplaced as the question for consideration in that case was whether manufacture or production of an article or thing is sufficient for grant of allowance under s, 32A. It was held that the marketability of the production of a product or sale as generic goods is not the requirement of Section 32A. This decision, therefore, does not advance the case of the assessee.
25. Similarly, the reliance on the case of Pathange Poultry Farm v. CIT (supra) was also held to be irrelevant as the question for consideration in that case was the interpretation of the word 'plant'.
26. With regard to the reliance in the case of Apeejay (P) Ltd. v. CIT (supra), it was submitted that the Hon'ble Calcutta High Court in that case held that the assessee was merely mixing up and blending the tea which did not involve manufacture of any article or thing. The input and the output of the assessee's business remained tea and, therefore, the thing produced by the assessee was tea and the end product sold by the assessee was also tea. The learned CIT, therefore, questioned how this helps the case of the assessee since the controversy in the present case was the question of manufacture of article or thing namely computer products.
27. The assessee in this case was engaged in the business of manufacture of computer products as per its in-house technology prior to entering in JVA with HP, USA After entering into the JVA, the assessee ceased to manufacture such in-house computer products and instead started the manufacture of computer products as per HP technology. What is under consideration is not the loss of right to manufacture of its in-house computer products but the loss of the right to manufacture computer products as per the HP technology. Admittedly, on termination of the JVA the assessee was required to give up the rights and privileges it derived under the JVA namely the right to manufacture the above mentioned HP computer products.
28. With regard to the claim that the assessee was having the right to manufacture computers and other accessories and, therefore, the right to manufacture computer remained with it and the loss was in regard to the use of the brand name the learned CIT (Departmental Representative) submitted that this issue is covered by the earlier submissions. The question for consideration here is not whether there was any relinquishment by the assesses or extinguishment of its rights to manufacture computer products as per the in-house technology, the question is whether there was extinguishment of the right to manufacture computer products as per the HP technology on the termination of the JVA. Since the assessee has lost the right to manufacture computer products and the right to use the brand name, patent etc. was automatic and ancillary to the loss of right to manufacture. It is not tenable that the assessee only lost the right to use a particular brand name in respect of manufacture of certain types of article or thing.
29. With regard to the claim that there being no cost for acquisition of the asset and no capital gains tax could be levied in the light of the decision of the Hon'ble Supreme Court in the case of CIT v. Srinivasa Setty (supra), it is submitted that this issue has been resolved by the amendment brought out by the Finance Act, 1997 w.e.f. 1st April, 1998. The same is reproduced hereinbelow:
"Instances have come to light where rights to manufacture, produce or process any article or thing have been extinguished for a consideration and claimed to be not taxable.
The Act, therefore, amended Sections 55(1) and 55(2) of the IT Act in order to bring extinguishment of such a right to manufacture, etc., within the ambit of capital gains tax. Capital gains tax would be leviable only where such an extinguishment or right to manufacture, etc., is for any consideration. Such receipts will be subjected to capital gains tax on the same basis as already adopted for taxing transfer of goodwill and tenancy rights. The cost of acquisition and cost of improvement will be determined in the same manner as for goodwill.
The amendment will take effect from 1st April, 1998, will accordingly, apply in relation to asst. yr. 1998-99 and subsequent years."
30. It is further submitted that it has been held in the case of J.C. Chandiok v. Dy. CIT (1999) 64 TTJ (Del)(SB) 1 : (1999) 238 ITR 89 (AT)(Del)(SB) that the amendment of Section 55(2)(a) w.e.f. 1st April, 1995, providing that the cost of acquisition of tenancy rights is to be taken as nil, indicates that the legislature took the character of tenancy rights as that of capital asset. The ratio of this judgement would be applicable to the facts of the instant case also. The introduction of the words "a right to manufacture, produce or process any article or thing" in Section 55(2) w.e.f. 1st April, 1998 clearly indicates that the legislature took the character of the above rights to manufacture as that of capital asset. The words "a trademark or brand name associated with a business" have been further introduced by the Finance Act, 2001 w.e.f. 1st April, 2002. These amendments are only clarificatory in nature, since a trademark or a brand name associated with a business were always included in the definition of a capital asset as Section 2(14) of the IT Act, defining "capital asset to mean property of any kind held by an assessee whether or not connected with his business or profession."
31. In view of the foregoing discussion, it is submitted as under:
--The right to manufacture HP computer products in India vested with the assessee-company under exclusive licence granted by HP during the currency of the JVA The other rights, viz., the use of HP brand name, patents, technical know-how etc. are ancillary to the above rights to manufacture HP products and are in fact embedded in the "right to manufacture".
--The right to manufacture is a capital asset under Section 2(14), which defines the capital asset as the property of any kind held by an assessee.
--On the termination of the JVA, there was an extinguishment of such right to manufacture resulting in transfer of above capital asset in terms of the provision of Section 2(47)(ii) of the IT Act.
--As per amendment to Section 55(2) by the Finance Act,1987 w.e.f. 1st April, 1998, the cost of acquisition of the above capital asset in the form of right to manufacture is to be taken as nil and the ratio of the Supreme Court's decision in the case of CIT v. Srinivasa Setty (supra) is inapplicable to the facts of the case.
--The transfer of the above capital asset gave rise to capital gains which has correctly been brought to tax under the head "capital gains". .
In view of the above, the learned CIT (Departmental Representative) submitted that the decision of the lower authorities in the case deserves to be upheld.
32. We have carefully considered the rival submissions in the light of the arguments advanced before us and the material placed on our record. There is no dispute about the facts and also the fact that the compensation in the present case is of a capital nature. The limited issue for our consideration is in regard to the nature of the capital receipt whether it is a compensation for surrendering a right to manufacture, produce or process any article or thing or simply a compensation for surrender of a right to use a trademark or brand name associated with a business as contemplated under Section 55(2)(a) of the Act for the purpose of computation of income from capital gains. The assessee alongwith Hewlett-Packard Company of USA and Hewlett-Packard India (P) Ltd. entered into a joint venture, vide Agreement dt. 2nd April, 1991, As seen in the preamble to the Agreement, HP is and for several years has been engaged inter alia in the design, engineering, manufacture, assembly and sale of certain types of computers together with their components and paripherals.
33. Similary, the assessee then HCL has been engaged in the manufacture, distribution and sale of computers and services in India and has been and continues to be the recipient of workstation computer technology from HP pursuant to its agreement with Apollo Computers Domain GmbH, a subsidiary of Apollo Computer Inc. It was also acting as exclusive representative of HP's computer products in India pursuant to earlier agreement dt. 24th Oct., 1990. Since the parties desire to combine the respective computer manufacturing, marketing, servicing and sales activities in India of HCL and HPI into one operation to be conducted by a company in India owned jointly by HP and the shareholders of HCL, the JVA was entered into,
34. On the basis of the agreement, a control group company was to be formed by the name of "HCL Hewlett-Packard Ltd." and "Hewlett-Packard" was to be used as part of the company's name with the express consent and permission of HP.
35. The parties agreed during the terms of this agreement not to enter, either directly or indirectly, into any business in India which would be in competition with the company. For purposes of this: paragraph, the manufacture, marketing, sale or support of laptop computers by HCL or its successor in India shall not be considered a breach of this provision so long as such activities occur prior to any similar activities undertaken by the company. It, however, strictly prohibited HCL and the control group not to compete, either directly or indirectly with and shall cause the company not to compete with HP, HPI or other HP affiliates in the manufacture, marketing, sale or service of computer peripherals offered for sale in India.
36. From the above terms of the agreement, it is seen that the parties under the JVA are companies who have been and are in the line of manufacture and sale of computer and its components. The main objective of the agreement is to pool their resources and capture the market in the field of manufacture and sale of computers and its components under the brand name of HP. The agreement does not prevent the assessee HCL or its successor in India to continue its activities as long as such activities occur prior to any similar activities undertaken by the company. In other words, the assessee could continue the activities that occurred prior to the agreement. It, however, cannot market any of its products in the name of HP or in competition thereof. The agreement was entered into in April, 1991 and the same was terminated by an agreement dated 1st day of April. 1997.
37. In the preamble to the termination agreement, a reference was made in regard to liberalization of foreign investment regulations, reductions in import duties and increased market access to international suppliers all having contributed to a changing business environment. It further stated that despite such changes, the assessee-company has achieved substantial growth in its traditional customer base of Indian companies while gaining valuable expertise and experience in the marketing and servicing of HP products. A reference was also made to the change in the competitive landscape significantly due to increased investment : and interest in India by HP's global competitors and also to HPI having become a wholly-owned subsidiary of HP with full access to HP's worldwide infrastructural and marketing support resources.
38. HP, therefore wished to offer for sale its entire share holding in HCL HP to the members of the control group and obtain the freedom to implement in India through HPI its worldwide sales, distribution and business models and discontinue manufacturing of HP computers and software in HCL HP under the licensing agreements. HP, therefore, agreed to pay as full compensation to the assessee-company, its shareholders, creditors and any other interested persons for the past and future loss of exclusivity with respect to HP computer products and elimination of non-competition, a sum of seventeen million dollars ($ 17,000,000). The issue, therefore, is to consider whether this payment is a compensation to the assessee for the loss of a right to manufacture, produce or process computers or it is a mere loss of right to use the trademark or brand name associated with HP computers.
39. On verification of the assets of the company at the time of JVA in 1991 as at the time of termination of the agreement in 1997, it is seen that there is no actual transfer of assets in the form of plant and machinery and other apparatus for the manufacture of computers. The schedule of fixed assets as on 1st April, 1997 given at p. 70 of the paper book shows that there was no transfer of plant and machinery including furniture, fixtures and office equipment to HP. Rather there was addition of Rs. 374.50 lacs in the plant and machinery and air conditioners which is claimed to be capitalization of computer in use by the assessee itself. There is also no evidence of any transfer of documentation in the form of drawings, designs, plans, processing data etc. The termination operates in situ and the assessee continues to manufacture computers and its components by using its own brand name w.e.f. the termination of the agreement.
40. From the above facts, it is evident that the assessee as well as the parties to the JVA have been manufacturing computers and the computers so manufactured during the period of JVA have been marketed under the trademark or brand name of HP computers. Even after the termination of the agreement the assessee continues to manufacture computers under its own brand name and the sale of computer by the year ended 31st March, 1997, was shown at Rs. 54,164.10 lacs and at Rs. 55,993.54 lacs as on 31st March, 1998. It will, therefore, be contrary to the facts on records to hold that the assessee surrendered the right to manufacture computers and for that it received compensation. As per the JVA referred to above, HP therefore wished to discontinue manufacture of HP computers and software in JVA with assessee and wanted to monopolize the production and marketing through HPI. The assessee, therefore, lost the right to market its computer products in the trademark or brand name of HP computers. The loss, therefore, suffered by the assessee is the loss of the right to use the brand name or trademark of HP computers.
40.1. On the basis of these findings of fact, we have to hold that the amount received by the assessee will not be assessable to tax during the relevant assessment year as the provisions of Section 55(2)(a) including "or a trademark or brand name associated with the business" in the definition of cost of acquisition was inserted w.e.f. 1st April, 2002 by the Finance Act, 2001. In the absence of this provision, the cost of acquisition cannot be determined and in the light of the principle laid down by the Hon'ble Supreme Court in the case of CIT v. B.C. Srinivasa Setty (supra), no capital gains tax could be levied under Section 45 of the Act in respect of this capital asset for which no cost of acquisition is incurred by the assessee. This view taken by us is in line with the decision of the Calcutta Bench of the Tribunal in the case of ICI India Ltd. v. Dy. CIT (supra). We, therefore, hold that the compensation received by the assessee in the instant case cannot be assessed to capital gains tax for the year under consideration as the amended definition of cost of acquisition is effective only from the asst. yr. 2002-03. The appeal on this ground is accordingly allowed.
41. The next ground is in regard to claim of depreciation on computers which was part of stock-in-trade of the assessee-company and which had been given on hire or use in-house capitalized during the year. The AO found that these computers were used and since the assessee has been claiming depreciation on all other items, the non-claiming of depreciation was due to losses in the earlier years. Since the assessee could not give proper reason for not claiming depreciation on these items he was of the view that the correct market value for capitalization should be arrived at by calculating allowable depreciation on the computers. Accordingly, applying the concept of written down value (hereinafter referred to as WDV), the opening WDV for this year is calculated by allowing the reduction in capital cost by providing for notional depreciation for the earlier years. Therefore, the capitalization value at Rs. 6,10,68,073 was reduced to Rs. 3,38,29,430. Depreciation of Rs. 1,03,00,811 was allowed on the said amounts of Rs. 3,38,29,430 as against Rs. 1,52,67,018 claimed by the assessee.
42. Aggrieved by the said order, the assessee took up the matter in appeal before the CIT(A). The learned CIT(A) held that the computer technology is progressing by leaps and bounds and is being rendered totally obsolete very quickly. The pace of evolution of this technology reduces the value of computer peripherals to ridiculous levels, sometimes within the span of one year or less. The Windows 95 or Windows 98 programmes now are totally obsolete and so is the case with all other peripherals. Keeping in view the facts and circumstances of this case, to his mind, the action of the AO in reducing the capitalization value from Rs 6,10,68,073 to Rs 3,38,29,430 cannot be faulted. Accordingly, he decided the issue against the assessee and confirmed the disallowance.
43. The assessee is still aggrieved and has come up in appeal before the Tribunal. At the hearing Shri S.K. Tulsyan, the learned counsel of the assessee submitted that the assets were all along treated as stock-in-trade prior to this assessment year and hence the cost incurred in acquiring these assets was never allowed in the assessment of any earlier years inasmuch as the said cost amount remained intact in the closing stock. During the year under consideration, the assets were converted from stock-in-trade to fixed assets, and depreciation was claimed thereon. Therefore, there was neither any scope nor any legal provision for reducing the cost of the assets by deducting notional depreciation which was not allowed in the earlier assessment years. Since the assessee rightly took the value of the assets at cost at the point of time of conversion of the same as fixed assets, the depreciation has to be allowed on the cost of the assets. It was further submitted that the decision of the Hon'ble Supreme Court in the case of CIT v. Mahendra Mills (2000) 243 ITR 56 (SC) will continue to apply till asst. yr. 2002-02 (sic) 2002-03 as Expln. 5 to Section 32 was inserted by the Finance Act, 2001 w.e.f. 1st April, 2002. Since depreciation has to be allowed on the actual cost, it is submitted that the claim of the assessee should be allowed without reducing the cost by deducting notional depreciation of the earlier years.
44. On the other hand, Shri B.D. Gupta, learned CIT (Departmental Representative) supported the order of the CIT(A). According to him the assets in question were undisputedly put to use from year to year by giving them out on hire or use in-house, The assets in question, therefore, were not only treated as fixed assets but were also all along put to use. Therefore, the claim of the assessee that the assets in question were stock-in-trade is not tenable on the facts and circumstances of the case. Since the assets were also put to use right from the year in which they were acquired, the assessee ought to have claimed depreciation thereon in order to arrive at the true business profits. The, nature of the entries passed in the books of account of the assessee by treating these assets as stock-in-trade are not conclusive. Having regard to these and also keeping in view the Expln. 5 inserted by the Finance Act.2001, it is submitted that the depreciation has been rightly allowed by the AO on the reduced WDV.
45. We have carefully considered the rival submissions. From the order of the AO and the CIT(A), it is seen that the actual conversion of the assets into fixed assets is not in dispute. The entitlement of depreciation on the fixed assets converted from the stock-in-trade by the assessee is also not disputed. The only question is at what value the cost of the assets should be fixed while converting it into fixed assets. It is a fact that the assessee has been using these assets either in-house or for hiring to other panics. It is also not denied that these assets were used in the earlier years. The claim of the assessee is that the actual cost should be treated as the cost for the purpose of depreciation as no depreciation had been allowed in the earlier years. The AO, however, felt that the non-claiming of depreciation would not amount to non-allowance of depreciation in view of the fact that the profit from the user of these assets have already been taken into account and, therefore, the depreciation should be presumed to have been granted. We are, however, not persuaded by any of the arguments, From the verification of the schedule of assets referred to above earlier at p. 70 of the paper book, it is seen that the value of plant and machinery and airconditioners as on 1st April, 1997 was shown at Rs. 2768,85 lakhs, Additions during the; year is shown at Rs. 374.50 lacs. This figure of addition is neither the cost of the assets of Rs. 6,10,68,073 nor the value determined by the AO at Rs. 3,38,29,430. The real test of actual cost will be the amount transferred by the assessee to the fixed assets as per its account. The actual transfer figure of this" stock-in-trade to the fixed assets in the schedule forming part of the accounts should be adopted as the cost of assets transferred to the fixed assets and depreciation should be allowed accordingly. The AO is accordingly directed to verify the actual amount of closing stock transferred to fixed assets for the purpose-of determining the allowable depreciation and allow the same thereon. In doing so full opportunity should be given to the assessee to substantiate the claim. The order on this point is accordingly set aside and restored to the file of the AO for fresh decision as indicated above.
46. The next ground is in regard to liability in respect of fluctuations in foreign currency loan received from HP. The assessee in this regard debited a sum of Rs 2,60,80,000 on account of the foreign exchange rate difference in the principal loan amount. The AO disallowed the claim observing as follows:
"Further, this debit of Rs 2,60,80,000 is on account of the exchange rate difference in the principal loan amount. It is apparent that increase in loan amount due to foreign exchange fluctuation is not an expenditure incurred for securing the loan, it is not an expenditure which can be stated to be incidental to business of the assessee. On the contrary, it is an expenditure related to indebtedness of the assessee and is therefore, not a business expenditure, as held by Calcutta High Court in Bestobell (India) Ltd. v. CIT (1979) 117 ITR 789 (Cal). The Calcutta High Court stated that "In the instant case it was not the contention of the assessee that it had . incurred the extra expenditure in order to secure the loan. The loan had already been obtained. It was at the point of repayment that the assessee has to provide an extra amount in Rupee by reason of the devaluation. Hence, it is not an expenditure incurred for securing the use of money for a certain period which could be treated as revenue expenditure."
47. Aggrieved by the said order, the assessee took up the matter in appeal before the CIT(A). The learned CIT(A) upheld the order observing as follows:
"4.2 I have carefully considered the matter. The ratio of the decision of the Hon'ble Tribunal, Delhi Bench in the case of Telemecanique and Controls (India) Ltd. v. by. CIT (supra) does not apply to the facts of this case, as in that case the exchange loss which had arisen on account of adverse fluctuation in exchange rate, was in respect of liability for payment for import of raw material, which expenditure was clearly on revenue account. The submissions and contentions of the learned authorised representative do not hold water. The liability has risen on capital account and not on revenue account, as has been correctly observed by the AO The learned authorised representative's reliance on the decision of the Hon'ble Delhi High Court in the case of Bharat Heavy Electricals is totally misplaced as in that case the liability had arisen on the purchase price of raw materials and as such was on revenue account. Even the ratio of the Hon'ble Supreme Court decision in the case of Sutlej Cotton Mills Ltd. v. CIT (1979) 116 ITR 1 (SC) does not apply to the facts of this case as the liability in this case is not on revenue account but on capital account. Therefore, as there is no merit in the appellant's case on this issue, I have no hesitation in confirming the disallowance of Rs 2,60,80,000. No relief on this count is admissible."
48. Shri S.K. Tulsyan, the learned counsel submitted that the reasons given by the AO are not tenable. The main ground was that the amount of excess claim on account of fluctuation in foreign exchange during the year has not been debited by the assessee to its books of account. According to him non-debiting of the amount under consideration in the books of assessee cannot be a ground for disallowance in view of the decision of the Hon'ble Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT (1971) 82 ITR 363 (SC) as also in the case of Sutlej Cotton Mitts Ltd. v. CJT (supra).
49. With regard to the issue regarding actual payment in respect of the liability having not been met during the year, it is submitted that the assessee has been maintaining its account under the mercantile system and, therefore, actual payment has got no relevance in the case of the assessee. Relying on the decision of the Hon'ble Supreme Court in the case of CIT v. Arvind Mills Ltd. (1992) 193 ITR 255 (SC), it is submitted that the question of actual payment of liability was not at all important and the liability should be considered to have accrued during the year.
50. Relying further on the decision referred to above and that of the Hon'ble Delhi High Court in the case of CJT v. Bharat Heavy Electricals Ltd. (1999) 239 ITR 756 (Del) and that of the Delhi Bench of the Tribunal in the case of Telemecanique and Controls (India) Ltd. v. Dy. CIT (1998) 60 TTJ (Del) 434 : (1997) 60 ITD 483 (Del), it is submitted that increase in the loan liability utilized for importing raw materials on account of adverse fluctuation in (sic) Mills Ltd. (supra) and that of the Hon'ble Delhi High Court in the case of BHEL (supra) and of the Tribunal in the case of Telemecanique & Controls (India) Ltd. (supra) are distinguishable and the ratio laid down by them have no application to the facts of the present case. Since the decision of the Hon'ble Calcutta High Court in the case of Vegetable Products Ltd; squarely covers the case of the assessee, it was submitted that the additional liability incurred at the point of repayment of loan and not at the point of securing the loan could not be allowable as revenue expenditure. It is, therefore, submitted that no interference is called for in this regard.
52. We have carefully considered the rival submissions in the light of the material on record. From the order of the AO and the CIT(A), it is seen that various reasons are given for disallowing the claim. It is also seen that the learned counsel of the assessee submitted various decisions which according to him covers the issue in favour of the assessee. The Special Bench of the Tribunal Delhi Bench in a recent decision in the case of Oil & Natural Gas Corpn. Ltd.'s case (ITA No 2472/Del/96 dt. 1st Aug., 2002) considered this issue and spelt out certain conditions for allowing the claim in this regard as follows:
(i) Whether the system of accounting followed by the assessee is mercantile system, which brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it is actually received;
(ii) Whether the same system is followed by the assessee from the very beginning and, if there was a change in the system, whether the change was bona fide;
(iii) Whether the assessee has given same treatment to the losses claimed to have accrued and to the gains that may accrue to it;
(iv) Whether there has been consistency and definiteness in making entries in the account books in respect of losses and gains;
(v) Whether the method adopted by the assessee for making entries in the books both in respect of losses and gains is as per nationally accepted accounting standards.
(vi) Whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reducing the incidence of taxation."
53. We. therefore, consider it fair and reasonable to set aside the order of the learned CIT(A) on this point and restore the matter to the file of the AO with a direction that he will re-examine the claim of the assessee in the light of the above observations and decide the same in accordance with law, after giving full opportunity to the assessee to substantiate the claim. The order on this point is also accordingly set aside for fresh decision as indicated above.
54. The next ground is in regard to claim of deduction under Section 80-IA. In this regard the claim of the assessee for deduction under Section 80-IA was disallowed in respect of the industrial unit at Pondicheri on the ground that the gross total income was negative. It is the limited submission of the learned counsel of the assessee that the AO failed to take into account the provisions of Clause (7) of Section 80-IA as it existed at the relevant time as follows:
"Notwithstanding anything contained in any other provision of this Act, the profits and gains of an eligible business to which the provisions of sub-s. (1) apply shall, for the purposes of determining the quantum of deduction under sub-s. (5) for the assessment year immediately succeeding the initial assessment year or any subsequent assessment year, be computed as if such eligible business were the only source of income of the assessee during the previous year relevant to the initial assessment year and to subsequent assessment year up to and including the assessment year for which the determination is to be made."
55 It is, therefore, submitted that the non obstante clause used in this particular sub-section takes it out of the operation of Section 80A and, therefore, the claim of deduction under Section 80-IA is to be made from the profits of the Pondicheri unit separately as a separate entity.
56. After hearing Shri B.D. Gupta, the learned CIT (Departmental Representative), we are of the view that this issue also should go back to the AO for reconsidering the issue in the light of the provisions of Section 80-IA r/w Sub-clause (7) referred to above. In doing so, reasonable opportunity should be given to the assessee to substantiate the claim.
57. With regard to ground No.5, it is seen that the AO made a disallowance of depreciation relating to the following units whose incomes are exempt under Section 10A:
Rs.
EHTP Noida:
6,30,891 STP Chennai 4,60,066 STP Calcutta 7,94,773 STP Noida 8.00.417 26.86.147 The disallowance was upheld by the learned CIT(A).
58. It is the limited claim of the learned counsel of the assessee that the amount has already been included by the assessee and, therefore, by making the said disallowance, there was a double disallowance of the same amount. It is, . therefore, submitted that the AO should be directed to rectify the same.
59. After hearing Shri B.D. Gupta the learned CIT (Departmental Representative), we are of the view that this issue should go back to the AO for checking whether the assessee has actually made the disallowance in the return and, therefore, by making this disallowance again, it becomes double disallowance. The AO will give full opportunity to the assessee to explain the matter and then decide the same in accordance with law. The order on this point is accordingly set aside for fresh decision.
60. The next ground is in regard to claim of deduction of Rs 76,94,880 under Section 10A. It is the grievance of the assessee that this issue has not been adjudicated upon by the learned CIT(A).
61. After hearing Shri B.D. Gupta, the learned CIT (Departmental Representative), we are of the view that it will meet the ends of justice if the order of the learned CIT(A) on this point is set aside and restored to his file for fresh decision in accordance with law, after giving reasonable opportunity to both the parties. The order on this point is accordingly set aside and restored to the file of the CIT(A) for fresh decision in accordance with law.
62. In the result, the appeal shall be treated as partly allowed.