Income Tax Appellate Tribunal - Bangalore
Hewlett Packard India Software ... vs Assessee on 27 March, 2012
IN THE INCOME TAX APPELLATE TRIBUNAL
BANGALORE BENCH 'B
'B'
BEFORE SHRI N. BARATH
BARATHVAJA SANKAR, VICE-
VICE-PRESIDENT
and
SHRI GEORGE GEORGE K, JUDICIAL MEMBER
ITA No.814(Bang)/2010
(Assessment year: 2002-03)
M/s.Hewlett-Packard India Software Operation
Pvt.Ltd
Survey No.192, Whitefield Road,
Mahadevapura,
Bangalore-560048. ... Appellant
PAN:AAACH
PAN:AAACH 7164B
Vs.
Asst. Commissioner of Income-tax,
Circle 11(3),
Bangalore. ... Respondent
Appellant by: Shri Pradhan Dass, C.A.
Respondent by : Shri Farahat Hussain Qureshi, CIT-II.
Date of hearing: 27-03-2012
Date of pronouncement: 24-05-2012
O R D E R
Per N. BARATHVAJA SANKAR, VP:
VP:
This is an appeal preferred by the assessee-M/s. Hewlett-
Packard India Software Operation Pvt. Ltd., Bangalore, for the assessment year 2002-03 against the appellate order dated 15-03-2010 of the CIT(A)-I, Bangalore.
2. The assessee has raised as many as 17 grounds of appeal concerning only three issues viz.,
i) Disallowance of payments made to IIT Chennai.
ITA 814(Bang)/2010 Page 2 of 14
ii) Disallowance of provision for employee loyalty bonus
iii) Taxability of amount received by the assessee from M/s.Verifone India Pvt. Ltd.
I. PAYMENT TO IIT, CHENNAI:
3. The assessee is a company in the business of software development. Facts in relation to the first issue are : During the course of assessment proceedings, the AO noticed that the assessee has made a claim for deduction of a sum of `20,27,678/- u/s 37(1) of the Income-tax Act, 1961 [hereinafter referred to as "the Act"]. In response to notice, the assessee replied that the assessee had made donations of `20,27,678/- to IIT, Chennai. The AO held that the assessee did not derive any benefit for having incurred the expenditure and hence, disallowed the same.
3.1 Being aggrieved, the assessee carried the matter on appeal to the first appellate authority. The first appellate authority held that the IIT, Chennai is a fully Central Government owned organization and the donation being doubtful, obtained remand report from the AO. In the remand report from the AO it is stated that it is not a case of donation at all and the amount is spent for construction of a building and purchase of computer for IIT, Chennai. He, therefore, held that the expenditure is neither in the nature of donation nor in the nature of revenue. Therefore, he confirmed the disallowance made by the AO. Being aggrieved, the assessee is on further appeal before us.
3.2 Learned AR of the assessee has filed a paper book of 49 pages consisting of the following:
ITA 814(Bang)/2010 Page 3 of 14 1 Submissions before ACIT dt.10-2-2005.
2. Confirmation letter from IIT, Madras on receipt of assets.
3. Submissions before CIT(A) dt.20-2-2006.
4. Memorandum of Understanding between IIT Madras and HP.
5. Alliance Agreement between IIT Madras and HP.
6. Bonus policy - Loyalty Benefit Program of HP.
7. Break up of child education/wedding Asst provisions for March 2002.
8. Break up of disbursement of above mentioned provision.
9. Agreement with Verifone India Pvt. Ltd.
Learned AR of the assessee submitted that the assessee indeed derived benefit on revenue account as is evident from the MOU entered by the assessee with IIT, Chennai. He relied on the decision of the Rajasthan High Court in the case of ACIT vs. Rajasthan Spinning & Weaving Mills Ltd. (2003) 274 ITR 465)(Raj). He also relied on the decision of the Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. vs. CIT (1980) 124 ITR 1 (SC) for the proposition that if the expenditure did not result in enduring benefit in the nature of capital field, it must be allowed as deduction. He further submitted that the revenue authorities do not have any right to question the businessmen prudence on incurring expenditure for the purpose of business. For this proposition, he relied on the decision of the Apex Court in the case of S.A.Builders (288 ITR 1 (SC) and the decision of the jurisdictional High Court in the case of MICO Ltd. (163 Taxman 510)(Kar). He ITA 814(Bang)/2010 Page 4 of 14 further submitted that the expenditure based on commercial expediency must be allowed as deduction. He concluded his arguments by submitting that the expenditure incurred for the purpose of business must be allowed as deduction u/s 37 since it did not result in any enduring benefit to the assessee.
3.3 Per contra, learned DR submitted as under:
In September 2001 HP the assessee entered into a MOU and the Framework Alliance Agreement (FAA) with IIT, Chennai. A study of the MOU and FAA reveals the following:
a) The association of assessee with IIT, Chennai was for conducting research and creating technology that would bring benefits of Information and computing technologies to the populations of countries with developing economies and developing markets. The focus of FAA is on e creation of technologies suitable for the requirements of developing markets.
b) The assessee decided to provide funding amounting to USD 50,000 per year for a minimum period of two years commencing from September 2001 under a FAA.
c) The MOU describes the effort of the parties prior to the effective date of FAA.
d) The assessee would set up a lab at IIT, Chennai so that employees of HP would work jointly with the faculty and research staff of IIT.
e) Clause 7 of the MOU states that some of the IP will belong to HP and some would belong to both the assessee and IIT, Chennai.
It is clear from the above that the funding by the assessee is not in the nature of donations. The funding has been given for construction of a building block and for purchase and installation of ITA 814(Bang)/2010 Page 5 of 14 computers. Further the MOU makes it clear that the first payment of USD 50,000 was made on 7th Oct.2002 which does not pertain to the assessment year 2002-03. Further the funding would have generated intellectual property which would have been used by the assessee in its products and services and therefore the funding has resulted in generation of assets. The assessee has derived enduring benefit from the above transactions and expenditure has been incurred keeping in mind the long term benefits. Hence, it cannot be treated as revenue expenditure. The argument of the assessee that if the expenditure was held to be not allowable u/s 37, then the same is fully deductible u/s 35 cannot be accepted since R&D was not carried out at the premises of the assessee.
4. We have heard rival submissions and considered the facts and materials on record. It is noticed that the assessee would set up a laboratory at IIT, Chennai so that its employees would work jointly with the faculty and research staff of IIT. Unless the assessee has made this arrangement by making payment for construction of laboratory and purchase of computers, employees of the assessee would have been denied the benefit of working with IIT faculty. Hence, in our view, it is a payment made due to commercial expediency. The Apex Court, in the case of S.A.Builders vs. CIT(A) & another (2007)(288 ITR 1)(SC) has held that the phrase 'for the purpose of business' appearing in sec.37 includes expenditure voluntarily incurred for commercial expediency and it is immaterial if a third party also benefits thereby. Applying the above analogy to the present facts of the case, even though the assessee would have voluntarily made this ITA 814(Bang)/2010 Page 6 of 14 payment to IIT, Chennai, it was due to commercial expediency only.
4.1. The decision of the Rajasthan High Court in the case of Addl. CIT vs. Rajasthan Spinning & Weaving Mills Ltd.(2005)(274 ITR 465)(Raj) also is on the same lines. In that case, the assessee made contribution to the fund set up for export promotion of products which was also the business of the assessee. Hence, the Court found that there was direct nexus to the advancement of assessee's business and thus held that such contribution was for the purpose of assessee's business and was allowable u/s 37 of the IT Act.
4.2. In the case of Empire Jute Co. Ltd. Vs. CIT (1980)(124 ITR 1)(SC) it has been held as under:
"There may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case.
What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, ITA 814(Bang)/2010 Page 7 of 14 employed or exhausted in the process. The question must be viewed in the larger context of business necessity or expediency."
4.3. In view of the above discussion, we are of the view that the expenditure incurred by the assessee is not of enduring nature but of revenue nature and the same has been incurred due to commercial expediency of the assessee's business. Hence, we direct the AO to allow the claim of the assessee of `20,27,678/- being payment made to IIT, Chennai. This ground of appeal of the assessee is allowed.
II. PROVISION FOR EMPLOYEE-LOYALTY BONUS:
5. Brief facts in relation to the second issue viz., Disallowance of provision for employee loyalty bonus are as follows: The assessee had a scheme for its employees under which an employee is entitled to claim certain sums from the company upon completion of three years of service. The AO noted from the break-up of the provision for employees' benefits appearing in schedule J of the balance sheet of the assessee as on 31-3-2002 that provision was made for a sum of `30,77,954/- during the year. Hence, the AO concluded that the sum of `30,77,954/- is only a provision and accordingly added back to the income of the assessee.
6. The assessee carried the matter on appeal to the CIT(A). The CIT(A), observing that the expenditure has not been incurred in the relevant assessment year and is still a mere provision and ITA 814(Bang)/2010 Page 8 of 14 not an ascertained liability, upheld the disallowance. Being aggrieved, the assessee is in further appeal before us.
7. The learned AR of the assessee submitted that:
(i) The liability accrued on the completion of three years of service of an employee. However, the liability to pay arises only when the employee opts for the payout. Hence, the provision created on such basis is liable to be paid.
(ii) Moreover, the AO failed to appreciate the submission of the assessee that the liability has been settled in the subsequent year. However, based on mercantile system, the same IS accounted for on accrual basis. Thus, the AO erred in denying the non-incurrence of expenditure in the relevant year.
(iii) The assessee has, vide his submissions dated 20-2-2006 provided the CIT(A) a copy of the Loyalty Bonus Scheme. Thereby, the CIT(A)'s contention that no evidence as to the scientific basis of computation, is invalid.
(iv) It is to be noted that the provision was duly disbursed in the subsequent year (refer page No.39-41 of the paper book).
(v) In the instant case, the liability to pay loyalty bonus crystallizes when the employees' exercise their option under the scheme and is payable over three months in instalments from the year of exercising the option.
(vi) The CIT(A) and the AO failed to consider the ratio of the decision of the Apex Court in the case of Bharat Earth Movers v.
CIT (2000)(245 ITR 428)(SC) wherein it has been clearly held if the liability incurred in present but discharged in future is an expenditure allowed as deduction in the year in which the liability crystallizes, if the assessee follows the mercantile system of accounting.
8. On the other hand, learned DR submitted that:
(i) The assessee has made a provision for employees' benefits of `30,77,954/- in its P&L Account. The AO disallowed the same on the ground that the expenditure is merely a provision.
ITA 814(Bang)/2010 Page 9 of 14
(ii) It is the contention of the assessee that the provision was made on account of a scheme under which an employee is entitled to claim a loyalty bonus from the assessee therefore stated that the liability to pay bonus accrued at the time when the concerned employees completed three years of service.
(iii) In the assessment order the AO has clearly established that the sum of `30,77,954/- is in the nature of a provision and accordingly added back to the income of the assessee.
(iv) In the material submitted before the CIT(A) the assessee never established whether the expenditure was actually incurred during the previous year relevant to the assessment year 2002-03. The assessee has only estimated that it may have to incur such expenditure and accordingly made a provision. The assessee also has not submitted the details of the employees for whom such provision was made. Hence, the submission of the assessee is not acceptable.
(v) The assessee has relied on several case laws, one among which is Wipro GE Medical Systems Ltd. Vs. ACIT(ITA Nos.322 to 328/Bang/2001). The Karnataka High Court has also passed an order on the departmental against the order of the ITAT in the above case and it is in assessee's favour. However, the department has preferred SLP against the decision of the Karnataka High Court in the above case. Hence, the reliance of the assessee on the above case law is not acceptable.
(vi) The assessee has made an alternative claim that deduction should be allowed to the as on payment basis in the financial year during which payments would be made to its employees. This claim may be acceptable only after the verification of the payments made to the employees' during the financial year. Hence, the ITAT is requested accordingly.
9. We have heard rival contentions and considered the facts and materials on record. There is no dispute about the fact that there was a scheme called "Loyalty Bonus Scheme". According to ITA 814(Bang)/2010 Page 10 of 14 that Scheme, the liability accrued on the completion of three years of service of an employee and the liability to pay arises only when the employees opt for the pay out. It is also to be noted that the assessee had settled the liability in the subsequent year on the employees' opting out for pay out. The assessee is following mercantile system of accounting and hence according to the system of accounting followed by the assessee this liability has to be accounted for on accrual basis. In our opinion, as and when the employee completes three years of service the liability to pay loyalty bonus accrues to the assessee. Hence, the assessee has created provision for the sum (according to mercantile system of accounting) and cleared the liability in the subsequent year when the employees opted for paying out. The Apex Court in the case of Bharat Earth Movers v. CIT (2000)(245 ITR 428) has held as under:
"If a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain."
In view of the above decision of the Apex Court, in the facts and circumstances of the present case before us, the liability to pay loyalty bonus to the employees, for whom provision has been made by the assessee in the accounts, is the liability in praesenti though it will be discharged at a future date. Thus it is not a contingent liability and is an ascertained liability. Once it is an ascertained ITA 814(Bang)/2010 Page 11 of 14 liability and provision has been made in the accounts of the assessee who follows the mercantile system of accounting, the claim of the assessee has to be allowed in view of the decision of the Apex Court cited supra. Hence, we are not allowing this claim of the assessee. Thus this issue is decided in favour of the assessee.
III. AMOUNT RECEIVED FROM M/S. VERIFONE INDIA (P) LTD.:
10. Brief facts in so far as third issue viz. taxability of amount received by the assessee from M/s.Verifone India Pvt. Ltd. are: The assessee offered a sum of sum of `10,42,17,030/- as income from other sources. This income had arisen to the assessee on account of the compensation of `12,20,00,000/- received by it for recruiting certain employees by way of transfer from another company M/s.Verifone. Against this compensation received, the assessee had claimed the cost of the recruitment amounting to `1,77,82,970/- as deduction u/s 57 and offered the balance of `10,42,17,030/- as income from other sources. In the revised return filed on 31-10-2004 the income from other sources has not been offered to tax. The reason for not offering this amount as income from other sources is that the amount received is not in the nature of income. The AO held that the receipt is not a receipt arising from the business or the exercise of a profession or occupation as the assessee is not in the business of profession of providing employment to employees of companies which are wound up. He held that the receipt of the sum of `12,20,00,000/- was in the nature of casual and non-recurring receipt. Being ITA 814(Bang)/2010 Page 12 of 14 aggrieved, the assessee carried the matter on appeal to the CIT(A). The CIT(A) obtained a remand report from the AO and upon consideration of the same concluded that the AO was justified in treating such receipt as income from other sources. Being aggrieved, the assessee is in second appeal before us.
11. Learned AR of the assessee submitted that the original return has no bearing on the assessment once valid revised return has been filed. He submitted that the receipt does not constitute an income since it is a mere windfall gain and it does not have a definite source with regularity or a return for labour, skill or capital. In support of the proposition that revised return substitutes original return, learned AR has relied on the decisions of the Hon'ble Karnataka High Court in the case of CIT vs. Mangalore Chemicals and Fertilizers Ltd. (1991) 191 ITR 156 (Kar) and CCIT vs. Machine Tool Corporation of India Ltd. (1993) 201 ITR 101(Kar). He relied on the decision of the Hon'ble Supreme Court in the case of Parimisetti Seetharamamma vs. CIT (1965) (57 ITR 532)(SC) wherein it has been held that the Act does not provide that whatever is received by a person must be regarded as income liable to tax and in all cases in which a receipt is sought to be taxed as income, the burden lies upon the department to prove that it is within the taxing provision. He also relied on the decision of the Supreme Court in the case of Universal Radiators vs. CIT (1993) 201 ITR 800(SC) wherein it is held that if the assessee has received any sum by an extraordinary set of fortuitous circumstances, then such sum profit cannot be charged to tax.
ITA 814(Bang)/2010 Page 13 of 14 Learned Departmental Representative, on the other hand, submitted that as per clause 5 of the Agreement between the assessee and M/s.Verifone, compensation received by the assessee from M/s.Verifone is subject to tax and the consideration to be paid by M/s.Verifone to the assessee for taking over the past service liabilities in respect of the transferred employees will also include the tax element. He submitted that the transaction resulted in taxable income in the hands of the assessee and the consideration would also include the tax element. He has relied on the letter dt.15-7-2002 from M/s.Verifone to the assessee giving the break-up of the sum of `12.2 crores. He supported the orders of the AO as well as the CIT(A) in taxing the income as income from other sources.
12. We have heard rival contentions and considered the facts and material on record. This is an issue of addition of `12,20,00,000/-. In other words, this issue results in huge addition of around 12 crores. We find from the record that for confirming such huge addition, the CIT(A) has not passed a speaking order though he concurred with the AO. We find from the appellate order that the CIT(A) has simply mentioned that the assessee has relied on case-laws, the facts of which are different from the instant case. However, in our considered opinion, the first appellate authority ought to have discussed about the case- laws relied upon and given his reasons as to how they are not applicable to the present facts and circumstances. This is most required for the reason that the next appellate authority has to see ITA 814(Bang)/2010 Page 14 of 14 whether the first appellate authority has applied his mind properly or not. Hence, we deem it fit and proper to restore this issue back to the file of the first appellate authority with a direction to pass a speaking order on this issue after discussing as to how the case- laws relied upon by the assessee are not applicable. While doing so, the first appellate authority may also take into account the case-laws relied upon before us by the counsel (narrated in para.11 of the order). Needless to say the assessee should be given sufficient opportunity of hearing to put forth its submissions. The assessee also is hereby directed to co-operate with the first appellate authority by promptly appearing before him and producing the necessary details as would be required by him. Thus this issue is restored to the file of the CIT(A).
13. In the result, the assessee's appeal is partly allowed for statistical purposes.
Order pronounced in the open court on 24th May, 2012.
Sd/- sd/-
(George George K) (N.Barathvaja Sankar)
JUDICIAL MEMBER VICE-
VICE-PRESIDENT
Eks
Copy to :
1. Appellant
2. Respondent
3. CIT(A) concerned
4. CIT
5. DR, ITAT, Bangalore
6. Guard file
By Order
Senior Private Secretary,
ITAT, Bangalore.