Income Tax Appellate Tribunal - Mumbai
Ion Exchange (I) Ltd., Mumbai vs Assessee
IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI `F' BENCH
BEFORE SHRI R.V.EASWAR (PRESIDENT) &
SHRI T.R.SOOD, ACCOUNTANT MEMBER
I.T.A.NO.4190/Mum/2005 - A.Y 1999-2000
Ion Exchange (India) Ltd., Vs. The Income Tax Officer,
Tiecicon House, Ward 6(3)(1),
Dr. E. Moses Road, Mahalaxmi, Mumbai
Mumbai 400 011.
PAN: AAACI 1726 L
(Appellant) (Respondent)
Appellant by : Shri R. Murlidhar.
Respondent by : Shri A.P.Singh [CIT-DR]
ORDER
Per T.R.SOOD, AM:
In this appeal various grounds have been raised out of which ground No.1 was not pressed and, therefore, same is dismissed as not pressed. The other grounds are as under:
2. Compensation received upon termination of Joint Venture Co.:
(a) The learned CIT[A] has erred in law and on facts in upholding the decision of the ITO by treating the sum of US$ 89,322,047/-
received from M/s W.R.Grace & Co., USA towards compensation for premature termination of the technical collaboration agreement with your appellant as revenue receipt instead of as a capital receipt.
(b) The CIT[A] ought to have appreciated the fact that your appellants were entitled to receive technical assistance from US company which was inter alia, an apparatus to carry on your appellants business. In the light of the termination of joint venture agreement, your appellants were deprived to obtain the technical assistance/collaboration due from the US Company and, therefore, your appellants were put to an irreparable loss of profit making apparatus.
2
(c) The CIT[A] has erred in law and on facts in upholding the decision of the ITO that in order to compensate for the loss of profit making apparatus, the said US company agreed to compensate your appellants company with an amount of US$ 2.25 million amounting to `.89,322,047/- and the same is connected with loss of income or profits by virtue of loss standing charges and fees and therefore the receipt would assume the form of a revenue receipt and not capital receipt.
(d) The CIT[A] has erred in law and on facts by not appreciating the fact that the receipt of US$ 2.25 million was not towards past and/or future loss of profits as the Joint Venture never made profits. Consequently, the CIT[A] should have appreciated that the question of compensating the loss of profits cannot arise.
(e) The CIT[A] ought to have held that the compensation received from M/s W.R.Grace & Co., is capital in nature and is not a source of income by any stretch of imagination. Moreover, the CIT[A] should have held that in the absence of any be considered as income subject to tax under the ITA
(f) Without prejudice, the CIT[A] should have also taken note of the amendment to the Income Tax Act, 1961 whereby insertion of sec.28[va] by the Finance Act, 2002, it was proposed to include w.e.f. 1-4-2003 that any sum whether received or receivable in cash or in kind, under an agreement either (a) for not carrying out any activity in relation to any business or (b) not sharing any know how, patent copyright, trademark, license, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision of services, shall be considered to be forming part of profits and gains of business or profession.
(g) Therefore, the CIT[A] ought to have considered that the intention of the legislature was not tax the amount of compensation received from M/s W.R.Grace & Co., till March 31, 2003. The CIT[A] should have appreciated the fact that such receipts were taxable effective April 01, 2003 only and not before.
3. Scaling down of Depreciation claimed.
(a). The learned CIT[A] has erred in law and on facts in upholding the decision of the ITO in arbitrarily estimating the cost of land and deduction the same from the cost of floors purchased by your appellants for the purposes of arriving at eligible depreciation on the asset purchased without verifying whether the cost of asset included cost of land.
(b) While scaling down the depreciation claim, the CIT[A] has totally derecognized the fact that your appellants do not have any ownership interest in the land beneath the building in which your 3 appellants have acquired the different floors. The CIT[A] ought not to have upheld the decision of the ITO to make such arbitrary and unwarranted disallowance by mechanically estimating the cost of land at 80% of the cost of the floors purchased.
4. Deduction under section 80IA:
(a) The learned CIT[A] has erred in law and on facts in upholding the decision of the ITO in reducing the deduction under Section 80IA from `.3,52,23,939/- as claimed by your appellants to `.2,93,87,280/-.
(b) Whilst restricting the 80IA claim, the CIT[A] has not taken cognizance of the fact that your appellants have been consistently following the method of allocating overheads on a "percentage of time spent basis" for the purpose of deduction under section 80IA.
Additionally, the ITO has made certain unwarranted allocations of overheads having no bearing on the profits of eligible units.
(c) The CIT[A] ought to have taken cognizance of the decisions rendered by the Income-tax Appellate Tribunal in your appellants' own case for preceding proceedings for the above mentioned year.
5. Disallowance of interest free advances to subsidiary companies.
(a) The learned CIT[A] has erred in law and on facts in not appreciating the fact that your appellants had sufficient generated by their business and consequently they were capable of investing in the shares of its subsidiaries and to advance interest free loans out of its own source or internal accruals.
(b) The learned CIT[A] has erred in law and on facts in partially upholding the presumption of the ITO that your appellants had borne interest on funds borrowed by it, which do not appear to have been deployed for the purposes of their business but utilized for lending to your appellant's group companies and subsidiaries and made an estimated disallowance in the assessment order.
6. Disallowance of interest expenditure on investment for Controlling interest:
(a) The learned CIT[A] has erred in law and on facts in partially upholding the decision of the ITO in disallowing part of expenditure incurred on interest attributing the same towards a diversion of interest bearing funds for investment in shares of subsidiaries & other cos.
(b) The CIT[A] ought to have appreciated the cash follow statement given to the ITO which evidences investments and internal accruals available with your appellants.4
2. Ground No.2: Brief facts relating to the issue are that the assessee is engaged in the business of manufacturing and selling water treatment chemicals, equipments etc. The assessee company i.e. Ion Exchange (India) Limited (for short IEI) entered into a joint venture agreement with M/s. W. R. Grace & Company of USA (for short WRG) on 16th September 1994 and the joint venture was to be known as M/s. Dearborn Ion Exchange (India) Limited (for short DIEI). WRG was interested to establish a joint venture company to provide and supply water treatment services, encompassing consultancy services to industries in India and supply speciality products utilized in advanced technology developed by WRG. The business to be carried on by the joint venture has been set out at Article 2.4 of the joint venture agreement and the main business is said to be supply of services, products and support equipments in India as well as some other countries. It was provided in this joint venture agreement that the assessee company shall supply various products from its manufacturing unit and the manufacturing unit was to be made available to joint venture for some exclusive time also for which joint venture would pay some standing charges. The assessee company was also required to assist the joint venture in management and administration areas for which again the joint venture agreed to reimburse the assessee company with pre define charges. Grace also agreed to transfer some 5 technical know how to the joint venture for development of the new products. In this joint venture Grace was to hold 51% share holding whereas assessee was to keep its holdings at 49%. WRG sold its business in June 1996 to M/s BETZ Laboratory Inc. USA who were highly active competitors and which had affected the business of joint venture DIEI. Subsequently, WRG terminated the joint venture agreement w.e.f. 31-3-1997. The assessee company launched certain proceedings against WRG for recovery of compensation for termination of the joint venture agreement before the International Chamber of Commerce by way of an arbitration and ultimately the matter was settled between the parties through a Settlement Agreement dated 31- 3-1998 by which WRG agreed to pay al sum of US$ 2.25 millions equivalent to `.8,93,22,047/-. This amount was credited to profit & loss account as revenue receipt and in the statement of income this amount was shown as extra ordinary item of compensation and included in the income returned by the assessee. Later on, a letter dated 19-2-2002 was submitted to AO through which it was requested to treat this amount of compensation as capital receipt. Through this letter it was mainly stated that to be an assessable income the item must fulfill the basic condition that it should fall under one of the heads of income. It was claimed that an amount received by an assessee as compensation for loss of profit making apparatus is a capital receipt 6 and, therefore, same is not taxable and for this reliance was placed on the decision of the Hon'ble Bombay High Court in the case of CIT vs. Khushalbhai Patel & Sons [118 ITR 656].
3. AO considered the whole issue at pages 14 to 33 of his order in which various clauses of the joint venture agreement as well as settlement agreement have been considered and ultimately it was concluded by him as under:
"Having regard to what has been elaborately discussed above, it emerges, that, the assessee company was already in the business of manufacturing speciality chemicals with the assistance of foreign technical know-how received from Dearborn Inc. USA much before the J.V.C. could take birth the compensation of `.89,322,047/- has come in handy to the assessee company to fortify its existing structure and facilities for enhancing its profitability of the assessee company. In view the above, it would be just and reasonable for the revenue to draw an inference, that, the assessee company has been compensated for loss of profits or income vis-à-vis the standing charges and other fees receivable by it, had the business of the J.V.Company continued to be carried on in the same vein as was done pursuant to the formation of J.V.Company vide J.V.Agreement. Moreover, as elaborately discussed above, the assessee company was precluded from the manufacture and making of certain profits, equipments and services during the currency of the business of the J.V.Company and which also provided expressly in relevant agreements, that, the assessee company was free to revert to the said W.T.C. business with the help of technologies and non-exclusive trade mark licenses, as meriting mention in the terms and conditions appurtenant to the settlement agreement. It is also a fact, that, the set up of the organisation for initiation and proliferation of business of the J.V.Company was solely the responsibility of the assessee company as per the terms and conditions of the J.V.Agreement. Viewed from this perspective, it is beyond comprehension as to how it has now been claimed by the assessee company, that, the compensation was sought from the foreign collaborator on account of expenditure for re- establishing the business of the J.V.Company pursuant to its acquisition by the assessee company. In this regard, it is stated, that the argument of the assessee company appears to be specious, however, so, it gets weakened in the facts of circumstantial evidences emanating from the recitals laid down in the J.V.Agreement, supplementary agreements for the termination of the J.V.Company.7
In conclusion, the revenue is therefore inclined to hold, that, the compensation received by the assessee company to the extent of US$ 2.25 million amounting to `.89,322,047/- [net of expenses relating there to and aggregating `.7,803,453/-] can directly be connected with the loss of income or profits by virtue of loss of standing charges and fees, which, the assessee company was in enjoyment of, during the currency of business of the J.V.Company. In the light of this stand adopted by the revenue, it is further stated, that, such a receipt would assume the form and substance of revenue receipt and not capital receipt as vehemently contended on behalf of the assessee company. However, no material change or alteration to the net profits declared by the assessee company as per Profit & Loss A/c is required to be affected, as the said amount of `.89,322,047/- stands credited to the Profit & Loss A/c already."
4. Before the CIT[A] various submissions were made which have been summarized by him at pages 9 & 10 of his order which are as under:
a) During the previous year relevant to this Assessment Year the appellant received a sum of US $ 2.25 million from W.R.Grace & Co., USA towards compensation for premature termination of the technical collaboration agreement with the appellant.
b) It is submitted that the appellants were entitled to receive technical assistance from the US Company which was inter alia, an apparatus to carry on the appellant business. In the light of the termination agreement, the appellant was not entitled to obtain the technical assistance/collaboration with the US Company and, thus, the appellants were put to an irreparable loss of capital apparatus.
c) In order to compensate for the loss of such capital apparatus, the said US company agreed to compensate the appellant with an amount of US$ 2.25 million. In turn, the appellants credited the same into profit & loss account for the year ended March 31, 1999. Incidentally, the appellants did not through oversight, reduce this amount/receipt while calculating the total income subject to tax under the ITA for this previous year.8
d) The ITO has, for reasons stated in his order at page 33, stated that the compensation received by the appellant to the extent of US$ 2.25 million amounting to `.8,93,22,-47/- is connected with loss of income or profits by virtue of loss of standing charges and fees and therefore, the receipt would assume the form of a revenue receipt and not capital receipt.
e) We are submitting herewith a copy of the relevant documents for your perusal. Please note, that these documents were submitted to the ITO under letter dt. 25-2-2002 in order to enable him to come to a logical conclusion.
f) In doing so the ITO has overlooked the following fundamental facts that the • Said JV company was making only looses and thus, loss to profits cannot arise.
• Services were rendered not only by the appellant but also by the said W. R. Grace & Co., USA as well, and therefore, one need not compensate the order on this count.
• The claim was purely for loss of capital asset, viz. Technology assistance additional capital expenditure to be incurred by the appellant.
5. The ld. CIT[A] after considering these submissions observed that the assessee company entered into the joint venture agreement with WRG in the normal course of the business only for distribution of certain items. Many items were excluded from the scope of this joint venture agreement which could still be dealt with by the assessee company. Further assessee company had also entered into- (i) Manufacturing Agreement (ii) General and Administrative Services Agreement and (iii) Laboratory Facility & Service Agreement with the joint venture for which the assessee company received separate 9 consideration in the form of standing charges and management fees etc. It was further observed that assessee company went on receiving technology from WRG because in terms of Settlement Agreement WRG had agreed to supply new technical know-how and an agreement was also entered into in this respect. Therefore, Assessee Company was not deprived of any capital asset or profit making apparatus as the company continued to manufacture and sale the same products and even received technology from WRG even after termination of the joint venture agreement. The ld. CIT[A] also placed reliance on the following decisions:
a) CIT vs. West End Company Pvt. Ltd. 60 ITR 11 (S.C)
b) Bombay Burma Trading Corpn. Ltd. vs. CIT 81 ITR 777 (Bom)
c) Blue Star Ltd. vs. CIT 217 ITR 514 (Bom) On the basis of above observations and case law Ld. CIT[A] held that compensation was of the revenue nature and accordingly confirmed the action of the AO.
6. Before us Ld.counsel of the assessee carried us through assessment order as well as various pages of the Joint Venture Agreement and Supplementary Agreements and Settlement Agreement entered into with WRG for manufacturing, general administrative services agreement, laboratory facilities and service agreement etc. He emphasized before us that WRG is a foreign company and wanted to expand its business in India in the field of water treatment equipments 10 as well as chemicals. Since the assessee company was already in this business, therefore, a Joint Venture known as DIEI was created whereby WRG took 51% stakes and assessee company took 49% stakes. The main business of the joint venture was to look into the capability of WRG in industrial water treatment plant with the capability of IEI i.e. the assessee company to treat water via a whole range of processes and combine the same to provide the Indian market with the specialized total water management capability. The joint venture was to operate not only in India but in some other countries i.e. Pakistan, Kenya, Uganda, Nigeria, Malaysia, Indonesia, Thailand, Philippine, Mauritius and Maldives. The joint venture was to take technology in respect of some items from WRG which were to be manufactured by the assessee company only on special terms and conditions by which the manufacturing facility was to remain dedicated for some portion of time for manufacturing products to be sold through the joint venture. For this the joint venture was required to pay assessee company in addition to the price of products some standing charges. Similarly, for management and administrative help assessee company was to receive certain fee. He emphasized that an apparatus was created through which certain rights were created for both the parties i.e. the assessee and WRG. Once this arrangement was terminated then assessee's right came to an end and the compensation received was accordingly to be 11 treated as capital receipt. He then referred to pages 24 & 25 of the assessment order wherein it has been clearly admitted that the termination agreement is a case of loss of source of income. He also referred to pages 8 to 12 of the CIT(A)'s order and argued that the observation that the joint venture was entered into a normal course of business is not correct because a foreign company i.e. WRG which was in similar business wanted to enter Indian market along with an organization which was in the similar field and since the assessee was in the similar field special kind of effort was made to boost the business by combining the capabilities of both the organizations by creating a new set up.
7. He then referred to the decision of Hon'ble Supreme Court in the case of Oberoi Hotels Pvt. Ltd. Vs. CIT 236 ITR 903. In that case the assessee company was operating and managing various hotels belonging to the assessee as well as others. An agreement was entered into with Singapore Company whereby the assessee company was to operate the hotel known as Hotel Oberoi Imperial for which the assessee company was to receive certain fee called management fee which was calculated on the basis of gross operating profits. The agreement was for 10 years and could be renewed for further term of ten years. There was also a covenant which gave the assessee a right to exercise an option of purchasing the hotel in case its owner decided 12 to transfer the same during the currency of the agreement. Later on the hotel went into some problems and a Supplementary Agreement was executed whereby the assessee company waived its right of purchase. For this some compensation was received which was ultimately held by the Hon'ble Supreme Court to be a capital receipt. The Ld.counsel of the assessee submitted that this clearly shows that if a right is given up by a businessman because of any reasons then any compensation received in respect of giving of that right has to be treated as capital receipt. He then referred to the decision of the Hon'ble Bombay High Court in the case of CIT vs. Kantilal Shah [118 ITR 648]. In that case assessee had agreed to finance a firm against which the firm had agreed to pay 25% of the profits to the assessee. Later on when this agreement was cancelled the assessee was paid for the premature termination of the agreement a compensation of Rs.50,000/- which was held to be a capital receipt. In this case another decision of the Hon'ble Bombay High Court in the case of CIT vs. Khushalbhai Patel & Sons [118 ITR 656], which has been published as appendix, was followed. In that case also the assessee which was a registered firm entered into an agreement with Western India Oil Distributing Co. Ltd. and agreed to give some finance for import of certain products. Against this finance, assessee company was to receive certain interest as well as commission on the value of imports. 13 Because of certain reasons, the agreement was terminated and ultimately compensation and/or demurrages to the extent of Rs.3 lakhs were paid in five equal installments. On taxability of the same, the Hon'ble High Court held that this was a receipt on capital account. He then referred to the decision of the Delhi Bench of the Tribunal in the case of Ms.Payal Kapur vs. ACIT [98 ITD 19], wherein members of one Jain group entered into a joint venture agreement with Gillette group of USA to pool their resources whereby to carry on the business of manufacturing and marketing of writing instruments and stationery products in India. Later on, Gillette group wanted to sell its shareholdings in the joint venture to another company and ultimately the Jain group agreed for the same through consent terms for which some compensation was received by the Jain group. A question arose whether the said compensation was taxable. The Tribunal held that it was a case of structure of foundation on which the joint venture was to be built and accordingly such structure was a capital asset and the compensation received was capital receipt not liable to tax. The Ld.counsel of the assessee argued that in the case of the assessee also the structure or foundation was created through joint venture through which some business was to be conducted and when that agreement had been terminated then the decision of the Tribunal in the case of Ms.Payal Kapur vs. ACIT [supra] will be clearly applicable. 14
8. On the other hand, Ld.DR also referred to the orders of the lower authorities and pointed out that AO has noted that assessee has credited the amount of compensation to the profit & loss account and even offered the same for taxation. Later on, some how or the other the assessee changed its stand and wrote a letter to the AO to treat this compensation as capital receipt. He also referred to the various pages of the joint venture agreement and submitted that reading of the same would show that the joint venture agreement was mainly entered into for selling of products which were to be manufactured by the assessee. In other words, it was purely a distribution agreement and there are no capital assets in this joint venture. He pointed out that after entering into the joint venture agreement the assessee company ceased to conduct its own marketing distribution activity for certain items and many items remained outside the distribution agreement which has been provided at annexure 'F' of the joint venture agreement. This means the assessee company was even selling and distribution some of the products even after the joint venture agreement. The assessee continued to produce the goods and even for the joint venture the assessee was to manufacture and supply various products for which a separate manufacturing agreement was entered into between the assessee and the joint venture. Therefore, nothing has come to an end by termination of the joint venture 15 agreement because assessee continued to manufacture the goods and selling the same. In other words, assessee was conducting its business in a particular method, i.e. manufacturing and selling of water treatment products and the method was changed by entering into the joint venture and the change was that the selling and distribution activity was to be looked after by the joint venture but after termination of this joint venture agreement the assessee again reverted back to the same method of doing its business i.e. manufacturing and selling of water treatment products on its own.
9. He submitted that there is no force in the submission that assessee has lost a source of income when the joint venture has been closed and in this respect he referred to page 24 of the assessment order and pointed out that as far as the joint venture is concerned, in all the four years in which the joint venture existed, it suffered losses. It was only that the assessee who was earning certain charges in the form of standing charges, general and administrative charges and R&D fees from the joint venture which means that though the joint venture was suffering losses, the assessee was still earning from the joint venture. He then referred to the Settlement Agreement and pointed out that even after termination of the joint venture WRG agreed to continue to supply the technology through different agreements and by termination of the joint venture agreement the assessee has become 16 the gainer because assessee could expand its business. He particularly referred to Article 3 of the Settlement Agreement and pointed out that payment of US$ 2.25 million was a lump-sum payment and WRG was relieved from all liabilities which clearly show that money was in lieu of standing charges which means that it has to be concluded as revenue receipt only.
10. He then contended that the case law cited by the Ld.counsel of the assessee is based on different facts and are totally distinguishable. For example, the decision of the Delhi Tribunal in the case of Ms.Payal Kapur vs. ACIT [supra], wherein the Jain group entered into the joint venture with Gillette group of USA the sources were pooled to carry on the business of manufacturing and marketing of writing instruments, which means some fixed assets were created because manufacturing cannot be done without such fixed assets, whereas in the case before us no assets have been created in the joint venture. Similarly, in the case of Oberoi Hotels Pvt. Ltd. Vs. CIT [supra] assessee had two rights, namely, (a) right to receive fees for operating the hotel and (b) right to purchase the hotel. Since assessee lost these two rights, the compensation received was held to be of capital nature. Whereas in the case before us, assessee has not lost anything because it continued to manufacture the products even after entering into the joint venture agreement. During the tenure of joint venture agreement 17 assessee was selling the products through the joint venture and after the termination of the joint venture agreement these products are still being sold by assessee itself. Therefore, assessee has not lost anything.
11. He then referred to the decisions relied upon by the Ld.counsel of the assessee in the case of CIT vs. Kantilala Shah & Another [supra] and submitted that in that case the compensation received by the lady was held to be on account of capital receipt because the lady never carried on any business, whereas in the case before us, the assessee was already in same business i.e. of manufacturing and selling of water treatment equipments and products.
12. He then relied to the decision of the Hon'ble Supreme Court in the case of Gillander Arbuthnot And Co. Ltd. 53 ITR 283. In this case assessee was having various agencies for distribution of different products and when one of the agencies was terminated and some compensation was received, same was held to be of revenue nature by observing that cancellation of the contract of agency did not affect the profit making structure of the assessee. Similar view was taken by the Hon'ble Bombay High Court in the case of Blue Star Ltd. Vs. CIT 217 ITR 514.
13. In the rejoinder, the ld. Counsel referred to the decision of the Hon'ble Bombay High Court in the case of CIT vs. Kantilal Shah [supra] 18 and pointed out that in this case the ratio of another Bombay High Court decision in the case of CIT vs. Khushalbhai Patel & Sons was followed wherein the assessee was already in business. He particularly referred to page 668 of the report wherein the argument of the revenue was rejected that it was a case of routine termination of the agreement. Therefore, it cannot be said that in the case of CIT vs. Kantilal Shah [supra] the compensation was held to be capital in nature merely because the lady who received the compensation had never carried on any business. Moreover, the test seems to be whether the agreement was terminated in routine fashion or in special circumstances. He again referred to the decision of the Tribunal in the case of Ms.Payal Kapur vs. ACIT [supra] and submitted that in that case on the basis of facts it was observed that when resources were pooled and an altogether exclusive structure or apparatus was created in which both parties had certain rights. In the case before us also through the joint venture a particular structure was created through which assessee also had certain rights. Moreover, this agreement was not terminated on routine basis and, therefore, the decision of the Hon'ble Bombay High Court in the case of CIT vs. Khushalbhai Patel & Sons [supra] is clearly applicable.
14. We have considered the rival submissions carefully in the light of the material on record as well as the judgments cited by both the 19 parties. We have also perused the paper book filed on behalf of the assessee carefully. We find that the assessee company is engaged in the business of manufacturing and selling of water treatment equipments and chemicals. A joint venture agreement was entered into by the assessee company with WRG of USA. The recital clauses which are on page 3 of the Joint Venture Agreement and page 17 of the paper book reads as under:
"WHEREAS GRACE is, inter alia, engaged in the water treatment business on a world wide basis;
WHEREAS GRACE has developed advanced water treatment chemicals technology, and wishes to engaged in the business of providing water treatment consultancy services and marketing speciality products in connection therewith in the Indian subcontinent; WHEREAS IEI is, inter alia, engaged in the business of manufacturing and selling water treatment chemicals in the Indian subcontinent and in certain other regions and is desirous of enhancing its business; WHEREAS GRACE with IEI desire to establish a joint venture company to provide and supply water treatment services, encompassing consultancy services to industries in India and supply of speciality products, utilizing advanced technology developed by GRACE;
WHEREAS GRACE and IEI desire to set out their agreement as regards the production, management and operation of the said joint venture company;
WHEREAS it is the understanding between GRACE and IEI that their rights and obligations in regard to their business relationship in the said joint venture company shall be interpreted, acted upon and governed in accordance with the terms and conditions of this AGREEMENT and in the spirit hereof."
The above clearly shows that both the organizations were in the business of water treatment equipments and chemicals etc., and WRG had developed an advanced water treatment chemical technology and was looking for engaging in the business of providing water consultancy services in the Indian sub continent. In fact, as pointed 20 out by the Ld.DR, the basic purpose as recited in clause-3 above was to enhance the business of both the organizations. Article 2.4 narrates the business of the joint venture which is basically to set up selling and distribution agreement in water treatment services and products. Various products were to be obtained from the assessee company itself for which manufacturing agreement was also entered into between DIEI and the assessee company i.e. IEI and it was agreed that manufacturing facilities at Patancheru or any other location will be available to DIEI. This means that even after the promotion of the joint venture, the manufacturing activity of the assessee company continued. Clause 2.4.3 of the Joint Venture Agreement reads as under:
2.4.3: Water Treatment Chemical Marketing and Distribution Activities of IEI IEI is engaged, inter alia, in marketing, distribution, supply and provision of Water Treatment Chemicals, Support Equipment and Services. Upon establishment of the JV Company, IEI will cease its activities of marketing, distribution, supply and provision of Water Treatment Chemicals, Support Equipment and Services provides always that nothing contained herein shall prevent IEI from continuing on undertaking the activities as are set out in Exhibit F hereto.
Upon the establishment of the JV Company, and EIE ceasing its marketing and distribution activities, as aforesaid, the JV Company will hereafter exclusively carry on the WATER TREATMENT CHEMCIAL marketing and distribution activities which had earlier been carried on by IEI.
The above shows that upon establishment of the joint venture, the assessee company ceased to do its marketing and distribution business 21 except for the exhibit 'F' listed in the agreement. Exhibit 'F' reads as under:
Products Polyelectrolyte as sold by Polyelectrolyte India Ltd.
Process chemicals for the sugar industry.
Basic chemicals and water quality and microbiological test kits except to Water Treatment Chemical and Pulp and Paper mill process water applications (providing that the pulp and paper process activities are introduced to DEARBORN IEI).
All water treatment process equipment supply including specification, design, manufacture, commissioning and associated marketing and equipment servicing.
Zero-B Ion Exchange resins All other activities not in competition with the agreed activities of the JV.
Support Equipment All information and know-how associated with the specification, sourcing, operation and maintenance of the equipment listed below which support the addition, control, use and monitoring of the products above.
Physical and chemical sensors Dosing pumps and activators Controllers.
This means that as far as the assessee company is concerned, it has changed its strategy of selling and distributing its products on its own through the joint venture. Some of the products and services were to sold through joint venture and some products as mentioned in 22 Annexure 'F' were to be sold directly by the assessee company. Thus, it is a simple case of change in the method of business.
15. The termination of the Joint Venture Agreement came in because in 1996 WRG sold its water treatment process and chemical business along with the technology rights TO Betz Laboratory Inc. USA who was competitor of the DIEI. Once that business was sold by WRG, the assessee company took steps against WRG and went on to file arbitration proceedings in the International Chamber of Commerce. Ultimately, a settlement was reached between the parties through which WRG gave its share for a nominal consideration to the assessee. Article 3 of the Supplementary Agreement provides for the consideration and reads as under:
Article 3 - Consideration In accordance with the terms, provisions and conditions of this Agreement, the Parties agree that in consideration of the termination of the JV Agreement and the mutual covenants and agreements herein contained, the sufficiency of which is hereby acknowledged.
1. Grace shall pay to IEI the total sum of US$ 2.25 million (United States Dollars Two Million Two Hundred and Fifty Thousand);
2. Grace shall convey to IEI all of Grace's interest in and to JVC;
3. Grace shall grant JVC certain limited, non-exclusive licenses for certain trademarks and Technology;
4. Grace will be released from all its liability, if any, including but not limited to any liability under Grace's guarantee to HSBC under the line of credit extended by HSBC to the JVC, and Grace shall receive from HSBC both a letter evidencing the release and the original guarantee documents;
5. The JV Agreement, the Grace Trademark License Agreement, the Corporate Name and Logo License Agreement and the Old Technical Know - how License Agreement shall be terminated and 23
6. IEI and JVC shall release and discharge Grace and the Released Parties of and from any and all liabilities and obligations arising out of or relating to the JVC, the JV Agreement, the Ancillary Agreements or otherwise from the relationship between the Parties and shall indemnify and hold Grace and the Released Parties harmless against any Damages (as defined herein).
The above clearly shows that WRG was relieved from all the liabilities of joint venture and the compensation received was a lump-sum amount. Further as per clause-3 WRG also agreed even for grant of certificate, non exclusive license and trade markets and technology. This means that assessee company even after termination of the joint venture agreement was still entitled to receive technology from WRG.
16. It is also to be noted that AO has extracted the financial results of the joint venture as well as amounts received by the assessee company. The summary is as under:
1. Amounts received by the assessee from joint venture:
Particulars Amounts received by the assessee
company from the joint venture
General and administrative charges 1995-96 `.4,522,738/-
1996-97 `.4,678,487
1997-98 `.5,298,808/-
R&D fees 1995-97 `.1,180,685/-
1996-98 `.1,229,621/-
1997-98 `.1,384,702/-
Management fees 1995-98 `.28,908,670/-
1996-99 `.39,796,503/-
1997-98 `.43,435,040/-
TOTAL 1995-99 `.34,622,093/-
1996-100 `.45,704,611/-
1997-98 `.50,118,550/-
2. Performance of joint venture :
24
Business Loss A.Y 1995-96 `. 860,189/-
A.Y 1996-97 `.9,664,668/-
A.Y 1997-98 `.15,619,041
A.Y 1998-99 `.20,220,403/-
The above clearly shows that the joint venture never made any profits.
17. On the basis of the above analysis, it can be easily concluded that first of all the formation of joint venture is only a change in method of doing the business by the assessee company and this is so-
1) Because the assessee instead of selling the products itself wanted to sell the same through the joint venture with the help of the WRG.
2) No new source of income has been created. The source of income remains the same i.e. manufacturing and selling of water treatment equipments and chemicals etc.
3) Even during the existence of the joint venture, the assessee company kept on manufacturing the goods which were supplied even to the joint venture for which it received the prices to be determined in accordance with the agreement as well as some standing charges, general and administrative charges and R&D fee for providing administrative services and laboratory services to the joint venture.
4) The assessee company also continued to sell some of the products as provided in exhibit 'F' which we have reproduced above and which was outside the scope of the joint venture.
5) The joint venture never made any profits.
6) Even after termination of the Joint Venture Agreement, the assessee company reverted back to its original position and kept on manufacturing various products and started selling these products on its own.
25
7) Even the advantage of technology which was available through the Joint Venture Agreement, was still available even after termination of the joint venture agreement; and lastly
8) The Joint Venture Agreement was terminated because WRG has sold its business to a competitor.
Thus, no separate source or apparatus for earning a separate income was created through the joint venture. It was a simple case of doing the business in a particular way and the whole business was carried on even after the termination of the Joint Venture Agreement.
18. Now let us deal with the legal propositions. The first decision relied on by the Ld.counsel of the assessee is in the case of Oberoi Hotels Pvt. Ltd. Vs. CIT [supra]. In this case, the assessee company was engaged in the business of operating, managing and administering various hotels belonging to the others for a fee. The assessee company had entered into an agreement with the Singapore company in 1970 through which assessee company agreed to operate the hotel known as Hotel Oberoi Imperial for which certain fee called 'management fee' which was to be calculated on the basis of gross operating profit was to be received. The agreement was to run for a period of 10 years which could be renewed for further two terms of ten years. There was also a clause in the said agreement by which assessee had a right to exercise an option of purchasing the hotel in case its owners desired to transfer the same during the currency of the agreement. In 1975 a Supplementary Agreement was executed by which the assessee 26 company agreed with the receiver who had been appointed for the property by which the assessee company waived its right of purchasing the hotel. For this, assessee company received some compensation. A question arose whether this compensation was taxable or not. In the head-note the following observations have been made by the Hon'ble Court:
"It may be broadly stated that what is received for loss of capital is a capital receipt: what is received as profit in a trading transaction is taxable income. But the difficulty arises in ascertaining whether what is received in a given case is compensation for loss of source of income, or profit in a trading transaction. Where on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leave him free to carry on his trade (freed from the contract terminated) the receipt is revenue : Where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee's income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt."
On the basis of the above principles, the Hon'ble Court held that the compensation was a capital receipt. The reasoning given is at page 907 of the report which reads as under:
"Applying the aforesaid test laid down by this Court in the present case, in our view the Tribunal was right in arriving at a conclusion that it was a capital receipt. The reason is that as provided in art. XVIII of the first agreement assessee was having an option or right or lien, if owner desired to transfer the hotel or lease or part of the hotel to any other person, the same was required to be offered first to the assessee (operator) or its nominee. This right to exercise its option was given up by a supplementary agreement which was executed in September, 1975, between the Receiver and assessee. It was agreed that Receiver would be at liberty to sell or otherwise dispose of the said property at such price and on such terms as he may deem fit and was not under any obligation requiring the purchaser thereof to enter into any agreement with the operator (assessee) for the purpose of 27 operating and managing the hotel or otherwise and in its return, agreed consideration was as stated above in cl. X. On the basis of the said agreement the assessee has received the amount in question. The amount was received because the assessee had given up its right to purchase and or to operate the property. Further, it is loss of source of income to the assessee and that right is determined for consideration. Obviously, therefore, it is capital receipt and not a revenue receipt."
Thus, from the above it is clear that this compensation was held to be of capital nature because the assessee company had waived its right to purchase the hotel and the new purchaser was not under any obligation to enter into any agreement with the operator i.e. the assessee for operating and managing of the hotel, which means the assessee had lost the source of income. In this case itself the Hon'ble Supreme Court has quoted with approval the following paragraph from the decision of the court in the case of Gillander Arbuthnot And Co. Ltd. [supra] which reads as under:
"Where, on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue : where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee's income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt."
Thus the above decision is clearly distinguishable because in that case the assessee had lost a source of its income whereas in the case before us we have already found that no new source of income came into existence for the assessee by entering into a joint venture 28 agreement and since even after the termination of the joint venture the assessee continued its business of manufacturing and selling of water treatment equipments and chemicals etc., and, therefore, there is no loss of any source of income.
19. The next decision relied on by the Ld.counsel of the assessee is the decision of Hon'ble Bombay High Court in the case of CIT vs. Kantilal Shah & Another [supra]. In that case assessee had agreed to finance a manufacturing firm upto an extent of Rs.1 lakh for a period of six years for which assessee was to receive 25% share from the profits of the firm. Some payments were received as profits, but later on certain differences arose and the agreement was terminated and the assessee was paid a sum of Rs.50,000/-. A question arose whether the sum of Rs.50,000/- is taxable or not. The Hon'ble High Court held as under:
"Held, that in this case the assessee was a lady who had no income from business and only had income from other sources. She had not entered into such agreement previously. The financing agreement possessed the unusual feature that the assessee was entitled to 25 per cent of the profits earned by the firm, which resulted in her securing profits of Rs. 45,243 in the first year as against the obligation to advance a loan up to the limit of Rs.1,00,000 only. This arrangement was one which is extremely beneficial to the assessee and onerous to the firm. It is impossible upon these facts to hold that this agreement was a contract or arrangement in the course of the regular business of the assessee; and, if that is so, it must follow that the termination was tantamount to a termination or premature determination of a capital asset and any amount paid for such premature determination must be regarded as a capital receipt:
Decision of the Bombay High Court in CIT vs. Khushalbhai Patel & Sons [1979] 118 ITR 656 (infra) applied.
The Tribunal was, therefore, correct in holding that the sum of `.50,000 received by the assessee from the firm was a capital receipt."29
Thus, it is clear that the compensation amount was held to be of capital nature because the assessee lady never had any income from business which is not the case before us. The assessee had business of manufacturing and selling of water treatment equipments and chemicals which was there before the joint venture agreement and remained there after the termination of the joint venture agreement.
20. The Ld.counsel of the assessee had tried to emphasise that in the above case the compensation amount was held to be of capital nature not only because the lady never had a business but also because of the principle laid down in the case of CIT vs. Khushalbhai Patel & Sons [supra] wherein, according to him, it was observed that if an agreement was terminated in an extra ordinary situation, then it would be a case of capital receipt. This decision is also reported in 118 ITR as appendix to the decision in the case of CIT vs. Kantilal Shah [supra]. In that case the facts of the case were as under:
"The facts leading to this question may be stated : The question relates to the asst. yr. 1957-58, the corresponding previous year being Samvat year 2012. The assessee is a registered firm constituted under a deed of partnership dated 9th April, 1954. Under the partnership deed, the business of the partnership was that of exporters, importers and commission agents and such other business or venture or ventures as might from time to time be determined by the partners. The assessee-firm entered into two finance agreements with the Western India Oil Distributing Co. Ltd. (hereinafter referred to as "the company"), one dated 29th August, 1953, and the other dt. 11th January, 1955. The former finance agreement related to the finance that was to be made available by the assessee-firm to the company in respect of the business of the company in imports of petrol, kerosene oil and other petroleum products in Bombay, while the latter agreement related to the finance that was to be made 30 available by the assessee-firm at Bombay in respect of the company's business of importing petrol, kerosene oil and other petroleum products in Madras. Under these two agreements, the assessee-firm agreed to finance the company such sum or sums of money as the company from time to time required for importing the aforesaid commodities either in Bombay or in Madras on certain terms and conditions set out in the aforesaid respective agreements. On 12th January, 1955, the first agreement dated 29th August, 1953, was varied to certain extent and the altered terms under which finance was agreed to be made available by the assessee-firm to the company were recorded in the said agreement. In substance, the assessee-firm was to finance the company any such sum or sums of money as the company required for importing the aforesaid products either in Bombay or in Madras not exceeding at any time in the aggregate a sum of Rs. 10,00,000. The company was to import in Bombay as well as in Madras the said goods from such sources of supply and on such terms and conditions as were to be agreed upon between the assessee-firm and the company, and the company was not to enter into any contract for import of the said goods without the consent in writing of the assessee-firm. In consideration of the services to be rendered by the assessee-firm to the company, the company was not only to pay interest to the assessee but it was also to pay on the goods imported during the continuance of the agreement, whether the company took or did not take any finance from the assessee-firm, commission at certain rates specified in the agreements and the agreements were to be in force for a period of 10 years from the date of execution and if any consignment was to remain outstanding on the date of expiration the same was to be included for determining the company's liability to the assessee-firm. In addition, even after the expiry of the period of the agreements, the company also agreed to pay to the assessee-firm so long as the company continued to carry on the said business of importing petrol, kerosene oil and petroleum products, commission at a lesser rate specified therein. The Bombay agreement dated 29th August, 1953, as varied by the further agreement dated 12th Jan., 1955, as well as the Madras agreement dated 11th Jan., 1955, were worked between the parties for about three or four years. The assessee-firm received interest amounting to Rs. 42,401 in S.Y. 2010 (assessment year 1955-
56), Rs. 1,07,957 in S.Y. 2011 (assessment year 1956-57) and Rs.
1,01,180 in S.Y. 2012 (assessment yr. 1957-58). The assessee-firm also received commission amounting to Rs.90,011 in the first year, Rs. 2,05,032 in the second year and Rs. 33,324 in the third year. It appears that in the meantime some differences and difficulties arose between the assessee-firm and the company, and the company informed the assessee-firm that the provisions of the agreements between them were illegal as offending against law and particularly the provisions of the Bombay Money-lenders Act and Usurious Loans Act and it would be prepared to pay only interest at the rate of 9 per cent per annum being the maximum rate of interest as provided under the Moneylenders Act, on the amount advanced by the assessee-firm from time to time. The assessee did not accept the suggestions of the 31 company and, therefore, the company filed a suit in this Court, being Suit No. 87 of 1956, for certain reliefs. The assessee-firm filed a written statement in the suit and a counter-claim against the company. Ultimately, a consent decree dated 21st of June, 1956, came to be passed whereunder the company agreed to pay to the assessee-firm as and by way of compensation and/or damages for termination of the agreements, a sum of Rs. 3,00,000 by five equal installments of Rs.60,000 each ; the first of such instalments was paid on 31st December, 1956, and the subsequent instalments on 31st of December of each succeeding year and it is with reference to this amount of Rs. 3,00,000, which was receivable by the assessee-firm from the company, that the question arose in assessment proceedings before the taxing authorities as well as before the Tribunal, as to whether the said amount represented a capital receipt or revenue receipt."
On the above facts the Hon'ble Bombay High Court referred to the observations of the Hon'ble Supreme Court in the case of CIT vs. Raibahadur Jairam Valaji 35 ITR 148 and the observations are at page 662 which are as under:
" The question whether a receipt is capital or income has frequently come up for determination before the Courts. Various rules have been enunciated as furnishing a key to the solution of the question, but as often observed by the highest authorities, it is not possible to lay down any single test as infallible or any single criterion as decisive in the determination of the question, which must ultimately depend on the facts of the particular case, and the authorities bearing on the question are valuable only as indicating the matters that have to be taken into account in reaching a decision. Vide Van den Berghs Ltd. vs. Clark (1935) 3 ITR (Eng Cas) 17 (HL). That, however, is not to say that the question is one of fact, for, as observed in Davies (H.M. Inspector of Taxes) vs. Shell Company of China Ltd. (1952) 22 ITR (Supp) 1, ' these questions between capital and income, trading profit or no trading profit, are questions which, though they may depend no doubt to a very great extent on the particular facts of each case, do involve a conclusion of law to be drawn from those facts ' ."
After pointing out that there was a difference between a payment made as compensation for termination of an agency contract and an amount paid as solarium for the cancellation of a contract entered into by a businessman in the ordinary course of business, the Supreme Court went on to indicate what that difference was like and on this question the relevant part of the head note runs as follows :
"There is a difference between a payment made as compensation for the termination of an agency contract and an amount paid as solarium for the cancellation of a contract entered into by a businessman in the ordinary course of business. In an agency 32 contract the actual business consists in the dealings between the principal and his customers, and the work of the agent is only to bring about that business. What he does is not the business itself but something which is intimately and directly linked up with it. The agency may, therefore, be viewed as the apparatus which leads to the business rather than the business itself. Considered in this light the agency right can be held to be of the nature of a capital asset invested in business. But this cannot be said of a contract entered into in the ordinary course of business. Such a contract is part of the business itself, not anything outside it as is the agency, and any receipt on account of such a contract can only be a trading receipt.
Because compensation paid on the cancellation of a trading contract differs in character from compensation paid for the cancellation of an agency contract, it should not be understood that the latter must always, and as a matter of law, be held to be a capital receipt. An agency contract which has the character of a capital asset in the hands of one person may assume the character of a trading receipt in the hands of another as, for example, when the agent is found to make a trade of acquiring agencies and dealing with them. Therefore, when the question arises whether the payment of compensation for the termination of an agency is a capital or a revenue receipt, it would have to be considered whether the agency was in the nature of a capital asset in the hands of the agent, or whether it was only part of his stock-in-trade.
Generally, payments made in settlement of rights under a trading contract are trading receipts and are assessable to revenue. But where a person who is carrying on business is prevented from doing so by external authority in exercise of a paramount power and is awarded compensation therefore, whether the receipt is a capital receipt or a revenue receipt will depend upon whether it is compensation for injury inflicted on a capital asset or on stock-in- trade."
On the basis of the above observations, the Hon'ble Court analysed the facts and observed that the assessee firm had not entered into with financing arrangement in the ordinary course of business because the assessee firm was mainly engaged in the business of export of cloth on commission. Thus, the observation that the agreement was entered into an extra ordinary situation and was terminated in an extra ordinary situation was in this context. This means that in that case the assessee was doing something different i.e. export of cloth and had 33 entered into an altogether different arrangement that of financing a different firm. Therefore, this case is clearly distinguishable. As observed repeatedly above, in the case before us, the assessee company was engaged in the business of manufacturing and selling of water treatment equipments and chemicals before entering into the joint venture and continued to do the same even after termination of the joint venture.
21. Coming to the last decision relied on by the Ld.counsel of the assessee is the Tribunal decision in the case of Ms.Payal Kapur vs. ACIT [supra]. In that case one Jain group entered into a joint venture agreement with Gillette Inc. of USA to carry on the business of manufacturing and marketing of writing instruments. Thus, a joint venture was entered into for pooling of sources by which a manufacturing facility was to be created, whereas in the case before us the assessee company entered into the joint venture for doing the business of selling and distribution of products to enhance the business along with WRG. No fixed assets have been created and it is only a case of at best change in the method of doing the business. Therefore, in our opinion, the principles laid down in the case of Ms.Payal Kapur vs. ACIT [supra] cannot be applied to the case before us.
22. The Ld.DR, had relied on the decision of Gillander Arbuthnot And Co. Ltd. 53 ITR 283. In that case the assessee company was 34 carrying on the business on diverse lines besides acting as managing agent. The assessee company was also having sole agency for distribution of explosives manufactured by Imperial Chemical Industries (Export) Ltd. This agency was terminated and compensation was paid to the assessee. A question arose whether this sum was taxable or not and the Hon'ble Apex Court held as under:
Held, that, having regard to the vast array of business done by the appellant as agents, the acquisition of agencies was in the normal course of business and determination of individual agencies, a normal incident, not affecting or impairing the trading structure. The amounts received by the appellant for the cancellation of the explosives agency therefore did not represent the price paid for the loss of a capital asset: they were of the nature of income. There is no immutable principle that compensation received on cancellation of an agency must always be regarded as capital.
Compensation paid for agreeing to refrain from carrying on competitive business in the commodities in respect of the agency terminated, or for loss of goodwill, is prima facie of the nature of capital receipt." .
In this case the Hon'ble Supreme Court at page 289 quoted with approval the following paragraph from the decision of Kettlewell Bullpen and Co. vs. CIT which we have already reproduced while dealing with the decision of Oberoi Hotels Ltd. [supra]:
"On an analysis of these cases which fall on two sides of the dividing line, a satisfactory measure of consistency in principle is disclosed. Where, on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue : where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee's income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt."35
Thus, it is clear from the above decision that if the receipt of compensation for cancellation of a contract does not affect the trading structure of business of the assessee nor deprive him of what in substance is his source of income and termination of contract being a normal understanding, then such compensation has to be treated as revenue receipt. In the case before us, the assessee has not been deprived of his business and, in fact, as observed repeatedly the same business continued before the joint venture and after the termination of the joint venture.
23. In view of the above discussion, we are of the view, that the compensation received by the assessee company has been rightly treated by the lower authorities as revenue receipt and accordingly we confirm the order of the CIT[A].
24. Ground No.3: After hearing both the parties, we find that during the assessment proceedings AO noticed that assessee has acquired certain premises located at Tiecicon House Bombay and further acquired office premises at Corporate Park, Bombay. AO observed that the issue regarding depreciation on these office premises was examined in appeal for A.Y 1997-98 and 1998-99 as these premises were acquired in earlier years and after detailed examination held that depreciation in respect of the entire value of these assets could not be claimed as value attributable to land which 36 was comprised in these superstructures had to be reduced before allowing depreciation on the basis of decision of the Hon'ble Supreme Court in the case of Alps Theater 65 ITR 377. Accordingly, depreciation in respect of land comprising in these structures was not allowed.
25. On appeal, the Ld. CIT(A) confirmed the action of the AO following the decision of the earlier year.
26. The Ld.counsel of the assessee fairly conceded that the issue is covered against the assessee by the order of the Tribunal in assessee's own case in I.T.A.No.2133/Mum/2002 for the A.Y 1997-98 [copy of the order filed].
27. On the other hand, Ld.DR relied on the orders of the lower authorities.
28. After considering the rival submissions carefully, we find that an identical issue came up for consideration before the Tribunal in I.T.A.No.2133/M/02 for A.Y 1997-98 and the same was discussed at paras-15 to 19 of the order. Para-19 of the order reads as under:
"19. Having heard the rival submissions and from a careful perusal of the record we find force in the contention of the revenue inasmuch as cost of flat always varies from one place to other. No doubt, in a c- operative society a member may not get the absolute right in a common land, but he has the right to use the common land/facilities of the society. It is also an undisputed fact that the super structure cannot be raised without owning a land meaning thereby the cost of constructive flats always has two components, one is cost of land and the other is cost of super structure. We also find force in the contention of the revenue that the cost of land is a major factor in determining the cost of flat. The cost of super structure may remain the same, but cost of land varies from place to place. Since the assessee has acquired the commercial premises at a prime location, the major portion of cost of acquisition pertains to the cost of land.37
Keeping in view these facts in mind, we do not find any unreasonableness in the estimation of cost of super structure adopted by the lower authorities. We, therefore, find no infirmity in the order of the CIT(A) and confirm the same. Accordingly the assessee fails."
Following the above order, we decide the issue against the assessee.
29. Ground No.4: After hearing both the parties, we find that during assessment proceedings AO noticed that assessee had claimed deduction u/s.80I for the industrial undertakings at Ankleshwar 2, Ankleshwar 3 and Goa 1 and Goa 2. It was further noticed that common overhead expenses were allocated to these units on a fixed percentage basis and it was stated that it was done in accordance with the manpower utilization effected in respect of work done in these unites. However, after detailed examination it was noticed that assessee could not explain the allocation satisfactorily and, therefore, AO allocated the overhead expenses to the eligible units on the basis of the turnover.
30. On appeal, ld. CIT(A) confirmed the action of the AO on the basis of the decision for the earlier years.
31. Before us, Ld.counsel of the assessee fairly conceded that this issue is also covered against the assessee by the order of the Tribunal for A.Y 1997-98 in I.T.A.No.2133/M/02.
32. On the other hand, Ld.DR, relied on the orders of the lower authorities.
38
33. We have considered the rival submissions carefully and find that this issue has been considered by the Tribunal in I.T.A.No.2133/Mum/02 vide paras 25 and 26 of the order. Para-26 of the order reads as under:
"26. Now the assessee has preferred appeal before the Tribunal. During the course of hearing, the learned counsel for the assessee has invited our attention to the order of the Tribunal in assessee's case for the assessment year 1992-93 in which identical issue was examined by the Tribunal and dismissed the appeal of the revenue while accepting the apportionment of overhead expenses adopted by the assessee. The learned counsel for the assessee has filed a copy of the Tribunal's order for the assessment year 1992-93 for our perusal. From this perusal we find that the Tribunal has disposed of the issue in few lines after following its order in assessee's case in revenue's appeal in I.T.A.No.5278/Bom/1992 rendered on 17-02- 2001. Since nothing is clear from this order of the Tribunal as to what issue was raised in the appeal and how the Tribunal has adjudicated it, we direct the assessee to file a copy of the order of the Tribunal in I.T.A.No.5278/Bom/1992 within a week. The assessee has filed the copy of the order in I.T.A.No.5178/Bom/92 which was rendered on 17- 07-2001 and from perusal of this order of the Tribunal, we find that the Tribunal has decided the issue of claim of deduction u/s.80HH following its order for assessment year 1986-87. So far as issue of deduction u/s.80IA is concerned the Tribunal has restored the matter to the file of the assessing officer with the direction to examine whether the aforesaid units prescribed the specified conditions. The assessee has also filed the copy of the CIT(A)'s order for assessment years 1985-86 and 1986-87 after conclusion of the hearing though not directed to file the same, but from its perusal we find that this issue was never examined by the lower authorities in detail. The issue was disposed of summarily in earlier years. In these circumstances, we are of the view that in this assessment year, the issue was examined by the lower authorities in detail and from a careful perusal of the orders of the lower authorities we find that the method adopted by the assessee firm allocating the overhead expenses amongst the eligible and non eligible units is not proper. It has been repeatedly held by the Apex Court or various High Courts that whenever overhead expenditures or indirect expenditures are required to be allocated amongst so many units, the proper way is to allocate on turnover basis and this method was followed by the revenue. We, therefore, do not find any infirmity in the method adopted by the revenue. Accordingly we confirm the order of the CIT(A)."
Following the above order, we decide this issue against the assessee. 39
34. Ground No.5: After hearing both the parties, we find that during the assessment proceedings AO noticed that assessee had borrowed certain funds and paid interest but the funds had been utilized for lending the same to group companies. The details of which are as under:
Name of the company Amount
1. M/s. Ion Exchange Demag Pvt. Ltd. ` .4, 509,975/-
2. M/s. Ion Exchange Enviro Farms Ltd. `. 447,882/-
`. 4,957,857/-
On query it was explained that assessee company was having large funds of its own and such funds have been given as interest free loans and, therefore, interest could not be disallowed. However, AO did not agree with this submission because, according to him, the funds of the assessee were pool of resources comprising of heterogeneous mixture of own funds as well as borrowings and it is difficult to identify the interest to be disallowed. Then he worked out the disallowance as under:
Therefore, in order to be fair and equitable in computing the rate of interest suffered for the borrowings by the assessee company and in view of the complexity of the nature of funds flowing into the common pool of resources of the assessee company, it is presumed that, the funds for investments/interest free advances have been partly out of borrowings and partly out of assessee's own funds. In this regard, it is observed, that, the company's peak borrowings during the year stand at Rs.67,094,275/- as derived above. The interest cost factor borne by the assessee company is reflected at Rs.87,398,254/-. On these variables, the interest rate works out to 13.03%. having regard to the proportion, that, the assessee's own funds bears to the peak borrowings during the previous year, the reasonable rate of interest that, can be presumed to have been suffered for non business purposes works out to 40 67,094,275 x 13.03 = 6.912% 1,264,654,546.
As per this method of computation, the average of interest works out to 6.912%.
In view of the above, the interest burden of the assessee company borne by it and attributable to those borrowed funds which in turn have been advanced to the subsidiaries as above stated is computed as under:
Total advances = `.4,957,857/-
Rate of interest as discussed above. = 6.912%
Interest disallowed on the above = 4,957,857 x 6.912
100
= `.3,42,687/-
Accordingly, the above amount of Rs.342,687/- is disallowed on the rationale, that, there was diversion of interest bearing funds for non business purposes. Hence a sum of Rs.342,687/- is included in the total income of the assessee.
35. On appeal, the action of the AO was confirmed by the ld. CIT(A).
36. Before us, Ld.counsel of the assessee reiterated the submissions made before the lower authorities. He further submitted that recently the Hon'ble Bombay High Court in the case of CIT vs. Reliance Utilities and Power Co. Ltd. 313 ITR 340 has considered this issue wherein it was observed that if both interest free and interest bearing funds were available then a presumption would arise that the investment would be out of these interest free funds. He fairly conceded that this aspect has to be re-examined and, therefore, the case may go back to the AO for re-examination of the issue in the light of the High Court decision in the case of Reliance Utilities and Power Ltd. [supra]. 41
37. On the other hand, the Ld.DR, relied on the orders of the lower authorities.
38. After considering the rival submissions, we find that the Hon'ble Bombay High Court in the case of Reliance Utilities and Power Ltd. has held as under:
"Held, dismissing the appeal, that if there were funds available both interest-free and overdraft and/or loans taken, then a presumption would arise that investments would be out of the interest free funds generated or available with the company, if the interest-free funds were sufficient to meet the investments. In this case this presumption was established considering the finding of fact by the Commissioner (Appeals) and the Tribunal. The interest was deductible."
Therefore, we set aside the order of the ld. CIT(A) and remand the matter back to the file of the AO with a direction to decide this issue in the light of the decision of the Hon'ble Bombay High Court. [supra].
39. Ground No.6: After hearing both the parties, we find that the AO further noted that assessee had made certain investments in various subsidiary companies as discussed in para-6 of his order. He further noted that in some companies more than 50% stakes were held by the assessee company and, therefore, the money has been invested to clearly gain controlling the stakes in those companies. He also observed that since assessee company had also borrowed the funds therefore interest could not be allowed on investments in subsidiary companies particularly in view of the introduction of section 14A where any expenditure incurred to earn exempt income was required to be disallowed. He also relied on the decision of the Hon'ble 42 Bombay High Court in the case of CIT vs. Amritaben R. Shah [238 ITR 777].
40. Ld. CIT[A] principally confirmed the addition, but he was of the view that while working out the actual interest only proportionate of funds deployed for such investment should be considered and ultimately he confirmed only the proportionate disallowance which has been worked out by following para:
"Accordingly, the action of the AO in disallowing interest in the above investment is required to be confirmed in principle. However, in respect of the actual working, I have already held that the proportionate view is required to be taken and similarly, the loan which has been utilised for specific purpose are required to be ignored as the same cannot be used for the investment. I have already given the working of the average rate of capital employed in the business while deciding Gr.No.1 wherein average rate has been taken at 2.76%. Accordingly, the interest expenditure on investment on controlling interest on subsidiary company amounting to Rs.9,04,29,960/- is worked out to be Rs.24,95,867/-. Similarly, the interest expenditure on investment made in other companies amounting to Rs.10,03,13,820/- is worked out at Rs.27,68,661/-. Accordingly, the disallowance made by the AO on the above two issues is scaled down to the figures computed by me. The above ground of appeal is considered as partly allowed."
41. Before us, Ld. counsel of the assessee submitted that investments in subsidiary company and other companies were made for commercial expediency and, therefore, interest could not have been disallowed and in this regard he relied on the decision of the Hon'ble Supreme Court in the case of S. A. Builders vs. CIT [288 ITR 1]. He also submitted that the decision relied on by the lower authorities in the case of CIT vs. Amritaben R. Shah [supra] is totally distinguishable. That decision was rendered u/s.57(iii) and therefore 43 same could not be applied here. In any case, the investments are old investments and no disallowance could have been made in this regard.
42. On the other hand, ld. DR referred to page-9 of the assessment order and submitted that AO has clearly invoked the provisions of sec.14A and since investments have been made out of interest bearing funds in the shares which would yield only exempted income, therefore, disallowance should be upheld u/s.14A.
43. In the rejoinder, Ld. counsel of the assessee submitted that sec.14A cannot be invoked because assessee also had interest free funds. He again referred to the decision of the Hon'ble Supreme Court in the case of CIT vs. Reliance Utilities Power Ltd. [supra] wherein it was held that when interest free funds and interest bearing funds both are available, then presumption is that only interest free funds have been invested for making loans etc. and, therefore, assessee clearly had interest free funds and thus disallowance is not called for.
44. We have considered the rival submissions carefully and find that the AO has basically invoked sec.14A. It has already been held by the Hon'ble Bombay High Court in the case of Godrej & Boyce (43 DTR
171) that sec.14A is applicable to all heads of income. Further, the Special Bench of the Tribunal in the case of Chem Investment Ltd. vs. ITO [121 ITD 318] has held that even if no income is there from shares, the interest is to be disallowed. However, at the same time the 44 Hon'ble High Court in the case of Godrej & Boyce [supra] has further held that Rule 8D is not of retrospective nature and, therefore, only reasonable disallowance can be made. Therefore, in the interest of justice we set aside the order of the ld. CIT[A] and remit the matter back to the file of the AO for re-examination of the issue in the light of the recent decision of the Hon'ble Bombay High Court in the case of Godrej & Boyce.
45. In the result, assessee's appeal is partly allowed.
Order pronounced in the open Court on this 13th day of October, 2010.
Sd/- Sd/-
(R.V.EASWAR) (T.R.SOOD)
President Accountant Member
Mumbai:13th October, 2010.
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