Income Tax Appellate Tribunal - Ahmedabad
India Gelatine & Chemicals Ltd., ... vs Department Of Income Tax on 31 March, 2004
IN THE INCOME TAX APPELLATE TRIBUNAL
AHMEDABAD BENCH "B" AHMEDABAD
Before S/Shri Bhavnesh Saini, Judicial Member, and
D.C. Agrawal, Accountant Member
ITA No.2040 & 2051/Ahd/2004
Assessment Year :2002-03
ACIT, Circle-4, V/s. India Gelatine &
Navjivan Trust Chemicals Ltd., 703-
Building, Off Ashram 704, Shilp, C.G. Road,
Road, Ahmedabad Ahmedabad
PAN No.AAACI3676F
India Gelatine & V/s. ACIT, Circle-4,
Chemicals Ltd. 703- Navjivan Trust
704, Shilp, C.G. Road, Building off Ashram
Ahmedabad Road, Ahmedabad
(Appellant) .. (Respondent)
Assessee by :- Shri Alok Johri, CIT-DR
Revenue by:- Shri J.P. Shah, Sr.AR
ORDER
Per D.C. Agrawal, Accountant Member:-
There are two cross-appeals - one filed by Revenue and other filed by assessee arising from the order of Ld. Commissioner of Income-tax (Appeals)-VIII, Ahmedabad dated 31-03-2004.
ITA No.2040/Ahd/2004 Asst. Year 2002-03 (Revenue's appeal)2. In Revenue's appeal following grounds are raised as under:-
"1. The Ld. CIT(A) has erred in law and as on facts on of the case in directing to delete an amount of Rs.3.38,000/- being the claim of depreciation on account of fluctuation in the rate of foreign exchange.
ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
2. The Ld. CIT(A) has erred in law and as on facts on of the case in directing to delete an amount ofRs.73,705/- out of disallowance made by the A.O from the expenditure on sales promotion expenses. The Ld. CIT(A) did not appreciate the fact that the said expenditure included expenditure on food and beverages to guest and also the expenses on presentation articles and gifts and that the disallowance made by the A.O at 20% of the total expenditure under this head is justified on the facts.
3. The Ld. CIT(A) has erred in law and as on facts on of the case in directing to include the excise duty and sales tax aggregating to Rs.72,45,365/- in the figure of total turnover for the purpose of deduction u/s.80HHC.
4. The Ld. CIT(A) has erred in law and as on facts on of the case in directing to include income by way of sale of empty bags, income by way of sale of C.B. Dust Sinews and income by way of sale of scrap and waste chemicals in the profits of the business for the purpose of deduction u/s.80HHC, disregarding the facts that these items of income are not derived by the industrial undertaking from the export business."
3. The facts of the case are that assessee-company is involved in the manufacture of "ossein" and "gelatine" from animal bones. The first issue in Revenue's appeal relates to deletion of sum of Rs.3.38 lakh being the depreciation on account of fluctuation in the rate of foreign exchange. The facts relating to this issue are that assessee-company had purchased plant and machinery. Its cost increased due to adverse fluctuation in exchange rate. The additional burden on this count amounted to Rs.3.38 lakh. The Assessing Officer had disallowed the claim following his order for assessment year 2001-02. The order of Ld. CIT(A) thereon was subject-matter of appeal before Tribunal. The Tribunal had allowed the claim of assessee for additional depreciation on increased cost due to adverse exchange rate fluctuation as under:-
2ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 "From the above it is clear that the increased liability which is on revenue account is not a notional or unascertained liability but actual liability and hence allowable in the year in which the increased liability arose due to exchange rate fluctuation. Similarly the increased liability which was utilized for acquisition of capital asset is to be added as cost of capital asset. It has also been clarified that amendment in section 43A by Finance Act, 2002 with effect from 1.4.2003 is prospective in nature. Therefore, in view of the authoritative pronouncement of the Hon'ble Supreme Court, the increased liability on account of working operation is allowable in the year in which the liability arose. The increased liability on account of foreign exchange loan which was utilized for acquisition of capital asset is to be added to the cost of assets for purpose of claiming depreciation in the year in which such increased liability arose. The same is to be held as ascertained or accrued liability and not notional or unascertained liability. Accordingly, the grounds raised by the assessee are allowed and that by the revenue are dismissed."
The issue is also covered by the decision of Hon'ble Bombay High Court in the case of CIT v. Sesa Goa India Ltd. (2006) 282 ITR 197 (Bom) and by the decision of Hon'ble jurisdictional High Court in the case of Garden Silk Mills Ltd. v. DCIT (1996) 222 ITR 27 (Guj). In that case also assessee had purchased machinery from a foreign country and it has taken loan to finance the machinery. The liability of repayment increased on account of fluctuation in the exchange rate. The assessee claimed depreciation on such increased cost which was allowed by the Hon'ble High Court.
4. As a result claim of assessee for depreciation is allowable. This ground of Revenue is accordingly rejected.
5. Next issue relates to disallowance out of sale promotion expenses. The Assessing Officer disallowed a sum of Rs.1,47,410/- out of sale promotion expenses. He had relied on the findings given in the 3 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 assessment order for the Asst. Year 2001-02. This order of Ld. Assessing Officer and order of Ld. CIT(A) thereon was considered by Tribunal. After considering the facts the Tribunal restricted the disallowance to 10% of total expenditure.
6. We have heard the parties. Following the order of Tribunal, we remit the matter back to the file of Assessing Officer for considering disallowance at 10% of the total expenses subject to the rider that such disallowance will not be more than the disallowance already made by the Assessing Officer. With this observation, this ground of Revenue's appeal is allowed but for statistical purposes.
7. The third issue relates to including excise duty and sales tax accrued amounting to Rs.72,15,365/- in the total turnover for the purpose of deduction u/s.80HHC.
8. We have heard the parties and in our considered view the issue is now fully covered by the decision of Hon'ble Supreme Court in the case of CIT v. Lakshmi Machine Works (2007) 290 ITR 667 (SC), wherein it is held that these two items have to be excluded from the turnover. Following above decision this issue is decided in accordingly. This ground of Revenue's appeal is accordingly disposed of.
9. Last issue relates to inclusion of income by way of sale of empty bags and scrap and waste in the profits of the business for the purpose of deduction u/s.80HHC.
10. We have heard the parties and perused the materials on record. This issue is now covered by the decision of Hon'ble Madras High Court 4 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 in the case of CIT v. Shiba Distillery Ltd. (2007) 293 ITR 108 (Mad), wherein it is held that scrap and waste material if not relatable to export business of the assessee, has to be excluded from the business profit for the purpose of calculation of deduction u/s.80HHC. Similarly, the same will not form part of the total turnover. Accordingly, this ground of Revenue's appeal is also decided in its favour. As a result, appeal filed by Revenue is partly allowed for statistical purposes.
ITA No.2051/Ahd/2004 Asst. Year 2002-03 (Assessee's appeal)11. In assessee's appeal detailed and argumentative grounds have been raised but the relief, claimed with respect to these grounds are as under :-
I. To delete addition of Rs.10,14,54,000/- being "capital compensation" treated as "Revenue Income"
II. To delete disallowance of Exchange Fluctuation Loss of Rs.50.64 lacs.
III. To recomputed income under the head "Profits & Gains of Business" for computation of relief u/s 80 HHC as certified by the Auditors & stated in grounds of appeal.
IV. To delete lumpsum disallowance of Rs.73,705/- out of Sales Promotion expenses.
V. To delete disallowance of rs.12,76,088/- as expenses incurred u/s 14A of the Act.
12. We will take up first, the second issue which relates to exchange fluctuation loss of Rs.50.64 lacs. The facts relating to this ground are that the assessee incurred an additional liability of Rs.50.64 on account of exchange rate fluctuation adverse to the assessee. The AO disallowed the claim following his order for Asst. Year 2000-01. That issue in that year 5 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 had travelled to the Tribunal which has allowed the claim. On the basis of above order, the ld. AR claimed that once the Tribunal has by following the decision of Hon. Supreme Court in CIT vs. Woodward Governor India (P) Ltd. (2009) 312 ITR 254 (SC) has allowed the claim treating it as additional liability of capital, or rather cost of the capital, then the claim of the assessee should have been allowed. He submitted that the Tribunal had, in that Asst. Year in the case of the assessee allowed the claim, as under :-
"From the above it is clear that the increased liability which is on revenue account is not a notional or unascertained liability but actual liability and hence allowable in the year in which the increased liability arose due to exchange rate fluctuation. Similarly the increased liability which was utilized for acquisition of capital asset is to be added as cost of capital asset. It has also been clarified that amendment in section 43A by Finance Act, 2002 w.e.f. 1.4.2003 is prospective in nature. Therefore, in view of the authoritative pronouncement of the Hon'ble Supreme Court, the increased liability on account of working operation is allowable in the year in which the liability arose. The increased liability on account of foreign exchange loan which was utilized for acquisition of capital asset is to be added to the cost of assets for purpose of claiming depreciation in the year in which such increased liability arose. The same is to be held as ascertained or accrued liability and not notional or unascertained liability. Accordingly, the grounds raised by the assessee are allowed and that by the revenue are dismissed."
The ld. AR also submitted that assessee had borrowed working capital from a foreign bank to the extent of Rs.7.35 crores as circulating capital for joint corporate objects. Once it is cost of the capital it should have been allowed as deduction.
13. The ld. DR on the other hand, supported the orders of authorities below.
6ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
14. After considering the rival submissions, we are of the considered view that claim has to be allowed. The Tribunal on similar circumstances and facts allowed the claim in Asst. Year 2000-01 and 2001-02 in the case referred to above by following the decision of Hon. Supreme Court in Woodward Governor India Ltd. (supra). Once loan is taken for revenue purposes then loss suffered by it on account of adverse exchange rate fluctuation has to be allowed as deduction u/s 37(1). Even Accounting Standard -11 provides that the difference due to foreign exchange fluctuation should be recognized as income or expenses unless it relates to fixed assets. The difference in foreign exchange rate in respect of foreign exchange liability by way of working capital or by way of trading transaction is either the revenue liability or revenue income for which necessary provision should be made. In mercantile system of accounting a Company is required to provide to such ascertained and accrued liability. Thus when it is undisputed fact that assessee had taken loan for circulating capital then an adverse exchange rate fluctuation creating further liability would go to revenue account. Accordingly the claim of assessee is allowed.
15. The second issue raised by the assessee in ground No.3 is general in nature. The ld. CIT(A) has directed the AO to recomputed the relief u/s 80HHC. No fault can be found with it as even after the order of the Tribunal AO is required to recompute such relief to give effect to the direction of the Tribunal with respect to the items constituting calculation of relief u/s 80HHC. Since this ground is general in nature it requires no specific adjudication. Hence it is rejected.
7ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
16. Ground No.4 relates to disallowance out of sales promotion expenses. Similar ground was raised in Revenue's appeal. While disposing of the same, we have held that once the Tribunal in Asst. Year 2000-01 and 2001-02 in the order referred to above has restricted the disallowance to 10% on total claim the AO is required to calculate such disallowance subject to overall limit of disallowances made by him in his Assessment Order as observed by us while disposing of Revenue's appeal. This ground is accordingly allowed but for statistical purposes.
17. Ground No.5 relates to disallowance u/s 14A. The facts relating to this issue are that assessee company claimed income of Rs.88,77,869/- as exempt u/s 10(33) of the I.T. Act., 1961.
18. After considering the reply of the assessee and his order for Asst. Year 2000-01 the AO worked out disallowable u/s 14A at Rs.12,76,089/- as under :-
A Total interest payment 7264572
B Total funds available 1068779664
C Cost of fund (taking both A/B 0/01
borrowed fund and own fund
together)
D Investment in Shares 148517246
E Cost of fund invested in shares (A/B) D 10099482
Sales 345863194
Other income 49354673
F Total Receipts 395217867
G Dividend being exempt 4575869
H Administrative and other 21609999
expenses
I Amount of disallowance (H*G)/F 266606
8
ITA Nos.2040 & 2051/Ahd/2004
Asst. Year 2002-03
Total disallowance u/s 14A E+1 1276089
The ld. CIT(A) confirmed the addition by following his decision for Asst. Year 2000-01. The matter had travelled to the Tribunal. In Asst. Year 2000-01. The Tribunal directed the AO to work out the disallowance as per section 14A following rule 8D. The directions of the Tribunal in this regard are as under :-
"29. Ground No.4 in appeal by the revenue for Asst. Year 2001-02 is against deletion of disallowance of interest expenses on proportionate basis by invoking provision of section 14A of the Act.
30. The computation of disallowance to be made by invoking section 14A has to be made in accordance with Rule 8D prescribed in this regard. Accordingly, for this purpose the matter is restored to the file of the AO. The AO shall compute the disallowance, if any, to be made in terms of Rule 8D as prescribed in this regard."
19. the ld. AR submitted that it has been held by Hon. Bombay High Court in Godrej and Boyce Mfg. Co. Ltd. vs. DCIT & Anr. (2010) 328 ITR 81 (Bom) that rule 8-D would be applicable w.e.f. Asst. Year 2008- 09 as it is not retrospective. Therefore, in Asst. Year 2002-03 rule 8-D cannot be invoked. But he fairly accepted the proposition as laid down in Godrej and Boyce Mfg. Co. Ltd. vs. DCIT & Anr. (supra) that reasonable amount of disallowance can be made which goes to earn exempt income. We accordingly restore the matter to the file of AO to give an opportunity to the assessee to present his views about what is the reasonable amount of disallowance. Disallowance as per rule -8D can also be reasonable unless any unreasonability is pointed out in the calculation so made. The AO, therefore, would consider reasonable amount of disallowance. Accordingly this issue is restored to the AO for 9 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 fresh adjudication in the light of decision of Hon. Bombay High Court in the case of Godrej and Boyce Mfg. Co. Ltd. vs. DCIT & Anr. (supra).
20. The main issue in this appeal is raised in ground No.1. It relates to treating a sum of Rs.10,14,54,000/- being compensation received by the assessee company from M/s Konica Gelatine Corporation, Japan, as revenue receipt by the AO as against claim of capital receipt by the assessee.
21. The facts relating to this issue as noted by the AO and the ld. CIT(A) are that the assessee company is involved in the manufacturing of "ossein" and "gelatine" from bones. M/s Konica Gelatine Corporation which was purchasing "ossein" from assessee company was a promoter of the assessee company. The "ossein" purchased by M/s Konica Gelatine was apparently used for manufacturing "gelatine" which was further used for manufacturing photographic films. The detailed facts from inception of the assessee company till the termination of agreement with Konca Gelatine which led to the award of compensation to the assessee company, are as under:-
Miranis were partners in M/s Khimji Vishram & Sons, Mumbai. This concern entered into collaboration with M/s Konica Gelatine Corporation and M/s Nichimen & Co., Japan, for manufacturing "ossein" in India. For this purpose they entered into a basic agreement and technical agreement both dated 29.08.1972. In pursuance of these agreements, assessee company namely India Gelatine & Chemicals Ltd. (IGCL) was set up to manufacture "ossein" in India. The basic agreement dated 29.8.1972 was to provide finance, administrative, technical and commercial conditions for running the company. The three partners namely - Konica Gelatine 10 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 Corporation, Michimen & Co. and the Miranis contributed share capital in the ratio of 1:2:3 being 60% of the total share capital. The balance 40% was left for general public to subscribe. The technical collaboration agreement of even date provided that technical know-how would be provided by Konica Gelatine Corporation and Michimen & Co. would arrange for sales of the product. Konica Gelatine Corporation was also made technical consultant to the assessee company. The two agreements provide code of conduct among the three partners and each was assigned specific objective and participation in equity and transfer of interest in future. Payment of fees for providing technical know-how was also prescribed which was to be paid by assessee company to Konica Gelatine Corporation. As per these agreements Konica Gelatine Corporation was made main purchaser of the "ossein" to be manufactured by assessee company. The arrangements continued and "ossein" manufactured by the assessee company was sold to M/s Konica Gelatine Corporation on priority basis. Subsequently, M/s Konica Gelatine Corpn. entered into technical collaboration agreement with the assessee company on 12.5.1995 for a period of 10 years ending on 11.5.2005 providing technical guidance, technology know-how for establishing gelatine manufacturing plant at Vapi. Separate payments for providing technical know-how/guidance were provided for in the said agreement. It seems that the gelatine manufactured at Vapi did not come up to the standard and, therefore, it was thought to shell off the projects. Konica Gelatine Corporation also found that it is unable to sell its product to the same extent as earlier. Hence it found difficult to continue to purchase "ossein"
from assessee company. Accordingly Konica Gelatine Corporation issued letters on 28.3.2001 & 26.6.2001 wherein Konica Gelatine Corporation expressed its intention to terminate the contract for purchase of "ossein" from the assessee company w.e.f. 1.2.2003. The termination agreement 11 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 was finally signed on 16.11.2001 by the assessee company. Under this agreement M/s Konica Gelatine Corporation paid US $ 2.1 million to the assessee company in full and final payment of loss, liabilities, expenses, claims and demands whatsoever arising under and in relation to the project documents. The project documents were defined in the termination agreement as consisting of two agreements of 1972 and technical agreement of 1995. The assessee had claimed that due to the structural damage to the project resulting from the termination agreement the compensation received is capital in nature. The termination agreement would have left possible closing of "ossein" plant and thus damage to the profit earning apparatus of the assessee company.
On the other hand, the claim of the Revenue is that the above receipt is revenue in nature as it is awarded against stoppage of purchases of "ossein" from the assessee company and that assessee company has not stopped manufacturing of "ossein" even after termination of agreement. In order to appreciate the arguments of the assessee and revenue we consider it appropriate to deal with the contents of the agreements in detail.
In 1972 a basic agreement and technical collaboration agreement were entered into between three parties who were as under :-
a) Konica Gelatine Corporation (KGC) (Technical Partner)
b) Nichimen Corporation Ltd., Japan (NCL) (Fin & Mar. Partner)
c) Miranis of India (Executive Partner) All the three partners contributed to the share capital: 10% by Konica Gelatine Corporation (known at that time as Takarazuka Gelatine 12 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 Manufacturing Co. Ltd.): 30% by M/s Nichimen & Co. and 24% by Miranis and balance 36% was left for being offered to the public. The three altogether floated the present assessee company i.e. India Gelatine Chemicals Ltd. to manufacture and deal in ossein and other allied chemicals. The role of each of the three parties to the agreement was assigned. Miranis would be solely responsible for the procurement of land, raw materials, utilities of personnel, appointment of project engineers and procurement of machinery equipment to implement business with TakaraZuka's assistance. The Miranis would also procure working capital for the assessee company. The role of Michimen was to provide knowledge and would undertake the trading of ossein. This part has bearing on this issue and hence it is quoted as under :-
Nichimen's role - Nichimen shall supply its knowledge and experience in regard to trading business and shall undertake the business of export of "ossein" under a 'Sales Agreement' to be concluded separately with IGCL, as well as the business of import of machinery and equipment supplied by Takarazuka from Japan to IGCL. Nichimen shall obtain Japanese Government's sanctions with regard to this Agreement.
22. The role of M/s Takarazuka was confined to providing technical assistance. Its role (i.e. the role of Konica Gelatine Corporation) as per basic agreement was as under :-
Takarazuka's role - Takarazuka shall be wholly responsible for supplying IGCL with technical assistance and for helping IGCL for its normal operation as per the separate technical collaboration agreement. Takarazuka shall take up ossein produced by IGCL when ossein is offered in priority at reasonable prices through Nichimen all the machinery and equipments which Takarazuka considers essential to be supplied from Japan. Takarazuka shall obtain Japanese Government's sanctions with regard to Agreement.13
ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 In respect of providing technical know-how assessee company would pay 5 million in Japanese yen to Takarazuka. Article 5 from basic agreement in this regard reads as under :-
Article-5: KNOW-HOW FEE The Company shall pay to Takarazuka as know-how fee, a sum of Five Million Japanese Yens simultaneously with the subscription of shares.
There were restrictions of transfer of shares by each party to the effect that for such transfer full agreement with other parties has to take place as the other remaining parties will have preemptive rights to purchase the same. Takarazuka was appointed technical consultant to the assessee company as per terms and conditions concluded with the two. It was further agreed that Takarazuka (now Konica Gelatine Corporation) would purchase "ossein" manufactured by assessee company on priority basis. Article 11 of basic agreement in this regard reads as under :-
Article-11: It is agreed that ossein produced by the company shall be taken up by Takarazuka to whom it shall be offered in priority at international prices. However, the Company shall not be precluded from selling ossein to any other countries. The international price here means the price obtainable by the other manufacturers of ossein in India in the international markets, on equivalent FOB terms in agreed foreign currencies, as determined from time to time. This will be subject to the policy and/or regulations of Government of India for the time being in force.
This basic agreement was thus executed on 29th August, 1972. On the same date, a technical collaboration agreement between Takarazuka and Miranis being one of the promoters of assessee company was executed. As per Article -1 thereof Takarazuka would provide appropriate advice in respect of following items :-
(3) Takarazuka shall give to IGCL appropriate advice on the following technical matter within the scope of technical collaboration terms stipulated in Glauses (2)(i), (ii) & (iii) above.14
ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
(i) Advice on selection and purchase of equipment and machinery.
(ii) Advice on installation of equipment and machinery including built-
in items.
(iii) Technical guidance during the testing and pre-operation run of the Plant.
(iv) Technical Training of IGCL Engineers and other personnel engaged in Plant operations.
(v) Sampling and testing operations for quality and yield from raw materials to finished products.
Takarazuka would send engineers and personnel for assistance to the assessee company for which separate payment was required to be made as salary by the assessee company. Article-6 also provide payment of know-how fees of 5 million Japanese yen as provided in basic agreement. Article -6 reads as under :-
Article-6: KNOW-HOW FEE IGCL shall pay to Takarazuka as Know-how fee, a sum of Five Million Japanese Yens simultaneously with the subscription of shares.
Article 9 provides for termination of agreement as under :-
Article-9: TERMINATION OF AGREEMENT 1) The term of validity of this AGREEMENT shall be five years from
the effective date as specified in Article-8. When any payment as specified in this AGREEMENT or in any portion thereof is not effected within 30 days beyond the specified period of payment, or if IGCL enters into bankruptcy proceedings or is unable to effect payment, TAKARAZUKA holds the legal rights to notify IGCL by registered mail 15 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 the cancellation of this AGREEMENT and in that event, TAKARAZUKA shall hold the right to claim from IGCL its immediate performance of all its obligations under this AGREEMENT and to claim from IGCL all the losses sustained from the consequences of such cancellation.
The above collaboration continued and assessee company continued to sell "ossein" to Takarazuka (Konica Gelatine Corporation)on priority basis. Thereafter in May, 1995 another technical collaboration agreement was executed between the assessee company and Konica Gelatine Corporation Ltd. (KGCL) for establishing a separate unit for manufacturing gelatine. KGCL would provide all technical assistance for production of "gelatine" as it was already engaged in this product for many years. This new plant was to be establish at Vapi, Gujarat employing KGCL's technology. The KGCL would have provided know- how and technology to the assessee company for setting up and running of this new plant. It was provided that gelatine so produced by IGCL could be exported, sold or used anywhere in the world. Such right was granted on the payment of fees. The Article-3 of this agreement in this regard reads as under :-
3.1 KGC hereby grants to IGCL subject to the payments of the fees agreed in this AGREEMENT, the exclusive right -
(a) to employ KGC's TECHNOLOGY in the design, construction, improvement and operation of the CONTRACT PLANT.
(b) To sell or use in India PRODUCTS so manufactured in the CONTRACT PLANT, and to export, sell or use the same in any other countryof the world. However, IGCL shall commence manufacture and sale of photographic grade of gelatine only at a future date after obtaining the prior written consent of KGC.
16ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
(c) To purchase, acquire, make or have made EQUIPMENT, apparatus, catalysts, chemicals and any other material necessary for the practice of KGC's TECHNOLOGY in the CONTRACT PLANT.
In consideration of providing technical know-how, selling rights and use of KGCL technology clause 9.1 of Article 9 provided payment of fees as under :
Article-9 : PRICE AND TERMS OF PAYMENT 9.1 In consideration of KGC transferring and selling its rights to and unto KGC TECHNOLOGY (including FEEP) in so far as they pertain to the territory of India only. IGCL shall pay to KGC a total sum of Japanese Yen 65,000,000 net of Indian income tax and tax (if any) to be borne by IGCL. The parties have agreed that the aforesaid sum is inclusive of the price attributable to designs and drawings pertaining to KGC TECHNOLOGY which is of Japanese Yen 32,50,000/-.
The fees for deputing technicians was separate.
Articles 12 & 13 are relevant for the purpose of deciding the role of termination of this agreement in working out the compensation paid to the assessee. These two articles read as under :-
Article-12 : TERM OF AGREEMENT Subject to any prior termination of this AGREEMENT as provided for hereinafter, the term of this AGREEMENT shall be for a periof of ten years from the EFFECTIVE DATE. The rights granted by KGC to IGCL under Articles 2 and 3 and the obligations undertaken by the parties under Articles 7 and 14 shall survive the expiry of the term of this AGREEMENT.17
ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
23. Thereafter vide agreement dated 16th November, 2001 assessee company and KGCL terminated the agreement to purchase "ossein" from IGCL and in pursuant to this agreement KGCL paid US $ of 21 lacs convertible to Rs.10,14,54,000/- which was claimed as capital receipt by the assessee.
Article-13 : TERMINATION
13. Each party shall have the right to terminate this Agreement by a notice in writing to operate on a date specified in the notice, if -
(i) the other party fails to observe any of the terms hereof to a material and significant extend and to remedy such failure (where it is capable of being remedied) within the period specified in the notice given to it by the aggrieved party calling for the remedy being a period of not less than 60 days.
(ii) The other party becomes insolvent or has a Receiver appointed of its assets or execution or distress levied is such as would materially affect the ability of that party to discharge its obligations under this Agreement.
(iii) As order is made a resolution is passed for winding up or liquidation of the other party except where in such an event is only for the purpose of amalgamation with another or reconstruction and the resultant company emerging is or agrees to be bound by the terms hereof.
13.2 No waiver of any antecedent deed and no grant of time and indulgence shall prejudice any subsequent right to terminate this Agreement.
24. Before the AO it was contended as under :-
● the so called termination has resulted in the damage to the profit earining apparatus, 18 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 ● It has lead to the sterilization (as termed by the assessee limbs are broken and it has become permanently handicapped baby) of the source of the income ● The receipt is capital in view of the loss of the infrastructure of the company (sic).
● Various cases have been cited selectively to buttress its claim as the capital receipt.
The AO, however, rejected the claim of compensation as capital receipt. He held that the profit making apparatus of the assessee company has not been compromised or harmed in any way. The assessee company can still continue its business with new buyers. The plant has not been closed down. The reasoning advanced by the ld. AO are -
(1) The termination of agreement for purchase has not resulted in any way closure of the manufacturing facilities. For the revenue slippage assessee has been compensated.
(2) Assessee company was free to supply entire spectrum of the product to other customers except that KGCL will enjoy priority purchase status.
(3) The basic agreement and technical agreement of 1972 were for technical support and guidance by KGCL for production of certain quality goods and for this separate payment of technical fees has been given. Though revenue stream of the assessee is affected but not its capacity to continue its business.19
ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 (4) Miranies and IGCL were active partners in manufacturing the products though it carried out certain risks. It is not the case that these two were only passive partners.
(5) No data like cash flow analysis, break even analysis, ratio analysis or any other basic data etc. is provided so as to show that there was loss to the capital part of the project. The assessee company has started new product mix and started looking for new customers. The production volume has been the same though sale realization has been affected.
25. When the matter travelled to the ld. CIT(A) he considered the reasoning of AO and accordingly confirmed the addition treating the compensation as revenue receipt. His reasons are summarised as under :-
(1) According to the ld. CIT(A) if compensation is paid for structural damage or damage to the infrastructure or damage to the income-earning apparatus, the receipt will be capital in nature whereas if compensation is received in lieu of loss of profit of the business it would be revenue receipt.
(2) As per notice given by KGCL dated 28.03.2001 to the assessee company the heading is termination of purchase of "ossein from you".
The second part of that letter clearly indicates that termination agreement dated 16.11.2001 spoke of only termination of purchases as under:-
"In view of discontinuation of procurement of gelatine from us and the likely closure of our business, we have no alternative but to terminate our contract for purchase of ossein from your company. Accordingly, we hereby serve you a formal notice for termination of purchase from you of ossein with your delivery of ossein to us in October this year. We have 20 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 endeavoured to provide this to you at the earliest possible opportunity and have provided you with termination notice of over 6 months, to allow you to identify alternative customers for purchase of ossein from you, and to thereby mitigate your losses, if any, arising from such termination."
According to the ld. CIT(A) this letter clearly states the intention of KGCL to terminate the contract for the purchase of "ossein". Similar letter was written on 26.6.2001 which also indicated that termination of agreement dated November, 2001 was for terminating the agreement for purchase of ossein. The ld. CIT(A) has referred to the contents of this letter as under :
"Dear Sirs, We refer to our letter of March 28, 2001 to you and the subsequent discussions on April 5, 2001, April 9, 2001 and May 21, 2001 regarding our decision to terminate the agreement for purchase of ossein from you. After due consideration of your request to extend concession and the circumstances, we hereby give you notice of our intention to terminate purchase of ossein from you as of January 31,2002 which means that we intend to accept delivery of ossein from you to us only until January 31, 2002.
As already communicated to you during our discussions mentioned above, we will use our best endeavours to provide you technical assistance at terms to be mutually agreed upon for manufacturing photographic gelatine. However, we cannot guarantee that you will become an able manufacturer of photographic gelatine which is satisfactory to potential customers in terms of quality and price.
Please treat this as our final notice for termination of the agreement for purchase of ossein from you."
(3) Even the termination of agreement dated 16.11.2001 showed the discontinuity of purchase of the product by KGCL from IGCL. This part of the agreement has been referred by ld. CIT(A) as under :-
21ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 "Pursuant to various negotiation from time to time, the parties have accepted the termination of the project documents in so far as it relates to the obligations of Konica on the terms of this Agreement and in consideration thereof and in consideration of discontinuing the purchase of the products by Konica from IGCL, Konica has agreed to make a voluntary payment of US$ 2,100,000 (United States Dollar two million one hundred thousand only) to IGCL (the "compensation")."
(4) Referring to these letters and termination of agreement as above, ld. CIT(A) held that compensation is paid for the loss which the assessee company would incur as a result of stoppage of purchase of "ossein" by KGCL from assessee company. The ld.CIT(A) also gave a finding that there is no indication in the notice, letter and termination agreement that compensation has been given for any structural damage or infrastructural damage or damage to income-earning apparatus.
(5) The basic agreement of 1972 provided that IGCL was not bound to sell "ossein" only to KGCL. The assessee company was not precluded from selling "ossein" to any other country.
The termination so made, resulted in loss to the business transaction but that does not mean a damage to the infrastructure of the assessee company or to the income earning apparatus. No material has been placed by the assessee to show that there was any structural damage or damage to the infrastructure. There is no decline in the output but there is only a decline in sales transactions and this by itself cannot lead to an inference that compensation so received is capital in nature.
26. Against this the ld. AR for the assessee submitted that -
22ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 (1) The termination of agreement should be read as a whole. It provided compensation for termination of basic agreement and technical agreement of 1972; (ii) for termination of agreement dated 12th May, 1995 which related to providing technical know-how; and (iii) for setting up gelatine plant.
(2) All the agreements namely Memorandum, basic agreement, technical collaboration agreement and agreement of 1995 were referred to as project documents which were finally terminated.
(3) In consideration of termination of project documents and in consideration of discontinuing the purchase of product by KGCL from IGCL, assessee was paid compensation. Therefore, it is incorrect on the part of the Revenue to say that compensation was only for termination of purchase from IGCL.
(4) By terminating the agreement and project documents there is a damage to the infrastructure. Gelatine plant was set up at the cost of Rs.45 crores in 1995-96 and it hardly attained commercial production by the end of 2001. The production reached only upto 30-50% of its capacity.
(5) Gelatine produced by Vapi plant was below the standard and not acceptable. Technical improvement in quality was still to be achieved. The profit making phase being photographic gelatine was still to be commenced.
(6) The quantity of ossein produced in 2000-01, sold and exported has gone down considerably i.e. from 3888 MT in 2000-01 to 2132 MT in 23 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 2001-02 and 580 MT in 2002-03. Thus percentage fall of "ossein production" is 45% in the year of termination and 85% in subsequent years. Volume of turnover has also gone down from Rs.60 crores to Rs.40 crores in 2002 and Rs.30 crores in 2003. The average operating profit has also gone down from Rs.4.4 crores in the last year ending 2001 to a loss of Rs.72 lacs and 2001-02 and a loss of Rs.170 lacs in 2002-03. The assessee company was not able to distribute dividend in 2001-02 and 2002-03. There is substantial closing stock lying with the factory. Thus mid-stream termination by a technical person would cause a structural damage to the plant and the very source of income has been sterilized.
(7) Thus there is a damage to the structure of the assessee company in the sense that there is a disassociation of KGCL a world-famous partner. It resulted into a loss of reputation. Through loss having been incurred the progress of the plant would be permanently crippled without technical guidance and support of KGCL.
In support of its argument that compensation received on termination of agreement dated November, 2001 was capital, ld. AR relied on following three judgments :-
1. Kettlewell & Co. Ltd. vs. CIT (Cal) 53 ITR 261 (SC)
2. PH Divecha vs. CIT 48 ITR 222 (SC)
3. Karamchand Thaper & Bros. (P) Ltd. vs. CIT 80 ITR 167 (SC) In addition to this, the ld. AR also referred to one more authority as under:-
(1) Inter Gold (India) (P) Ltd. vs. Jt. CIT (2010) 37 SOT 45 (Mumbai) 24 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
27. In response to above, the ld. DR submitted that as per agreement of 1972 Takarazuka (KGCL) is not indefinitely supplying technical know- how to the assessee company. The supply of technical know-how was limited to initial period of 5 years for which separate payment was made by IGCL. Further as per agreement of 1972 Takarazuka was to purchase only ossein and not gelatine. Even the letter being a notice for termination for purchase referred to "ossein" only and not gelatine. Once termination agreement of November, 2001 refers to purchase agreement then assessee company was to show what was the purchase agreement with Takarazuka or KGCL. If not then terms contained in basic agreement and technical collaboration agreement 1972 has to be considered as constituting purchase agreement which was terminated. Further ld. DR submitted that ossein plant and gelatine plants are different. Gelatine plant was being set up by virtue of agreement of 1995 and notice for termination was given only in respect of ossein. He submitted that assessee has not given any data how it has suffered structural damage. The basic working papers as to how the compensation has been calculated has not been given. The KGCL had only 10% holding whereas Nichimen had 30% holding in assessee company and it was required to market the products made by the assessee. This Nichimen is responsible for sale of ossein manyfactured by the assessee. By virtue of separate agreement called technical collaboration agreement Takarazuka (IGCL) had provided technical assistance and this technical assistance confined for 5 years only. It cannot be therefore said that by termination agreement there was any effect on technical collaboration between assessee company and KGCL. Even though termination agreement of November, 2001 refers to project documents which in turn refers to all the documents executed in 1972 and 1995 but agreement of 1995 related to manufacturing of gelatine through a separate plant at Vapi. In fact no notice of terminating the agreement of 25 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 1995 was given to the assessee company as stipulated in that agreement also. Therefore, it cannot be said that compensation paid by KGCL related to termination of agreement for gelatine plant at Vapi. In fact as per agreement of 1995 relating to set up of gelatine plant at Vapi, Gujarat technical support was to be provided upto 5 years by KGCL and thereafter for further technical support separate payment for engineers' visiting Vapi was to be made. The assessee company had already made the payments to KGCL for providing technical assistance for gelatine plant at Vapi and the period for which such technical assistance did not survive and had expired. Therefore, it cannot be said that compensation amount paid by KGCL included any part for termination of agreement relating to Vapi Plant. In fact without giving any notice to assessee company as stipulated in 1995 agreement KGCL could not terminate the agreements relating to Vapi Plant. Even if, terminated it will not be legally valid. Even otherwise major part of technical collaboration for Vapi plant was over before termination agreement of November, 2001. Even though term of 1995 agreement was for 10 years but various obligations contained therein are already over. Ld. DR submitted that letters/notices issued by KGCL to assessee company for termination of purchase agreements contained reference to purchase only. Even the letter from Rajni & Associates attorney for the assessee company mentions that erection, commissioning, production and trial were all over in last 30 years. In nut shell when all the letter issued by KGCL and letter of "Rajni Associates" is considered then project documents are confined to only purchase of "ossein" and, therefore, the compensation paid to the assessee company was for termination of purchase from assessee company.
28. The ld. DR submitted that even as per 1972 agreement KGCL or Takarazuka was not the sole purchaser of ossein from the assessee. They 26 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 refer only to the sale to Takarazuka/KGCL on priority basis. In other words assessee company was free to market its products in any other country which has been clearly specified in 1972 agreement. The ld. DR submits that if for the sake of argument it is held that some compensation was paid for termination of 1995 agreement then there was also stipulation of non compete fee. KGCL had clearly agreed not to compete with the assessee for sale of ossein after termination of its relationship with the assessee company. In other words KGCL would have charged non-compete fee from assessee company which is apparently adjusted against total compensation paid to the assessee company. Thus apparently there are three elements in the compensation -one which is major, is about termination of purchase of ossein from the assessee company for which KGCL would make payment to assessee company for loss of profit arising on sale of ossein to KGCL; secondly payment by KGCL to assessee company for withdrawing from Vapi plant; and thirdly payment by assessee to KGCL as non-compete fee. Since compensation paid was a net result and KGCL has terminated all the relation with the assessee company then "non-compete fee" element would neutralize any payment for withdrawing by KGCL from Vapi plant. What survives thereafter is only compensation for termination of purchases of "ossein" from assessee company. He further submitted that after KGCL withdrew from IGCL in relation to purchase of ossein from assessee company the rest of the production and manufacturing plant of the assessee company continued intact and, therefore, whatever is received by the assessee would be a revenue receipt. He referred to the decision of Hon. Supreme Court in CIT vs. Baijnath Gangadhar 86 ITR 19 (SC) and CIT vs. Manmaranji & Co. (1972) 86 ITR 29 (SC) for the proposition that where compensation is given for loss of earning it would be a revenue receipt. He then referred to the decision of Hon. M.P. High Court in Eastern Air Product (P)Ltd.
27ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 vs. CIT (2007) 290 ITR 562 for the proposition that where payment is made for compensating any short fall in purchase it would be revenue receipt. He also referred to the decision in CIT vs. Westend Co. (1996) 60 ITR 11 (SC) wherein it is held that compensation received towards loss of agency was a revenue receipt, as a loss of the agency is only a normal trading loss.
29. The ld. DR also submitted that as per 1995 agreement good-will of the assessee is intact. He is carrying on the business as usual though with the lower turnover. The termination agreement did not provide for any payment for structural damage. There was no compensation of loss of reputation or good-will. Therefore entire receipt by the assessee company as compensation is revenue receipt.
30. Ld. AR in rejoinder submitted that judgment of Hon. Supreme Court in Devecha's case was given by five judges of the Apex Court which will still hold the fields and judgments given by other Benches of the Apex Court subsequently cannot over-rule the judgment of Apex Court in Depacha's case. According to him in Devecha's case if monopoly contract has come to an end then it is a loss of enduring benefit, there is a damage to profit earning apparatus, a world famous organization has withdrawn which had severely affected the good-will and reputation of the assessee company and hence it has affected the carrying on of business in the same way and to the same extent as it was earlier done. In the present case 100% production goes to the KGCL hence it is a monopoly sale. Its withdrawal has ransacked the structure of the assessee company. The 1995 agreements are project document. It was for 10 years which are yet to expire and, therefore, on both the counts i.e. on account of structural damage to the assessee company and termination 28 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 of project document in respect of Vapi plant compensation received by it would be capital in nature. He submitted that the production of the assessee company has substantially fallen because of withdrawal of KGCL, as provided earlier.
31. We have considered the rival submissions and perused the material on record. The undisputed facts are that basic agreement and technical collaboration of 1972 provide the creation of assessee company for manufacturing ossein which would be purchased on priority basis by M/s Takarazuka (Konica Gelatine Corporation now), no time limit as such for continuation of this agreement was provided. For technical collaboration assessee company was to provide a total sum of 5 million Japanese yens.
Article-11 provided that ossein produced by the assessee company shall be taken up by Takarazuka on priority basis at international price and assessee company was not precluded from selling ossein to any other countries. The technical collaboration agreement provided that Takarazuka will give to IGCL necessary technical support and know- how for installation of equipment or machinery, technical guidance and providing the supporting technical staff in addition to sampling and testing operations for quality yield from raw material to finished goods. Takarazuka would send engineers for assisting assessee company for which separate payment would be provided by the assessee company. The terms of the two agreements were kept at 5 years. In the event of assessee company failing to make the payment as per the agreement within 30 days or IGCL enters into bankruptcy proceedings or unable to effect payment, Takarazuka will hold the legal right to cancel these agreements and in addition Takarazuka kept right to claim from assessee company its immediate performance of all obligations under these 29 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 agreements. Thus inspite of validity of agreement kept at 5 years the performance as per agreement continued till the termination of the agreement in the year 2001.
32. In addition to manufacturing of "ossein" and its sales to KGCL on priority basis the assessee company entered into another agreement with KGCL to establish a "genatine" manufacturing plant at Vapi, Gujarat for which separate agreement was executed in 1995. This agreement provided that "gelatine" so produced by the assessee company can be exported, sold or used anywhere in the world. Such right was granted on the payment of fees. The only rider put was that manufacturing and sale of photographic "gelatine" would commence at the future date after obtaining the prior written consent of KGCL. For the purpose of transfer and selling its rights in KGCL, the assessee company was required to pay to KGCL a total Japanese year of six crores fifty lacs which included price attributable to designs and drawing pertaining to KGCL technology whose price was estimated at Japanese yens 32,50,000. The fees for deputing technicians was separate. The terms of this agreement was for 10 years except the secrecy clause which would survive even thereafter.
Article -13 of 1995 agreement provides a right to both the parties to terminate this agreement by a notice in writing to operate on a date specified in the notice if any of the parties fail to observe any terms of the agreement or other party becomes insolvent or a party is in the process of winding up. The termination agreement dated November, 2001 executed between the assessee company IGCL, KGCL and Nichimen & Co. and Khimji Vishram & Sons (Miranis) provided by virtue of clause (F) the definition of project documents which were terminated by clause (G). The two clauses (F) & (G) in this regard are as follows:-
30ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 "(F) The Memorandum, the basic agreement, the Technical Collaboration agreement and the agreements dated May 12,1995 and October 15, 1998 executed between IGCL and Konica Shall, hereinafter, for the sake of brevity wherever the context so permits, be collectively referred to as the "Project Documents".
"(G) By its letters dated March 28, 2001 and June 26, 2001, Konica formally terminated the Project Documents and its contract to purchase the Product from IGCL."
Clause (I) provides that Konica has reduced the production capacity of photographic gelatine and desires to discontinue the purchase of products from IGCL. Clause (I) of this termination agreement states as under :-
"(I) For certain reasons, Konica has reduced the production capacity of photographic gelatine and therefore desires to discontinue the purchase of the products from IGCL with effect from February 1, 2002."
Clause (K) provides the payment of compensation relating to the obligation of Konica and for discontinuing the purchase of product of Konica. Clause (K) in this regard reads as under :-
"(K) Pursuant to various negotiation from time to time, the parties have accepted the termination of the Project Documents in so far as it relates to the obligations of Konica on the terms of this agreement and in consideration thereof and in consideration of discontinuing the purchase of the Products by Konia from IGCL, Konica has agreed to make a voluntary payment of US $ 2,100,000 (United States Dollar two million one hundred thousand only) to IGCL (the compensation)."
Clause 1.1 and 1.2 relate to providing release and discharge to Konika and its group company from all obligations and liabilities except secrecy clause contained in Article-8 of the basic agreement dated August 29,1972.
31ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 Clause 2.1 of Settlement Terms provides a payment of U.S. $ 2,100,000 as compensation to the assessee. Clause 2.1 (a) of the termination agreement reads as under :-
"2.1 The parties have agreed to the following terms (the Settlement Terms) -
(a) Upon validation of this Agreement which is automatically validated by satisfying Clause 7.2, Konica shall immediately pay IGCL an amount of US $ 2,100,000 (United States Dollars two million one hundred thousand only) to the Account of IGCL at SMBC Mumbai Branch by telegraphic transfer (the Compensation) in full and final settlement of all losses, liabilities, expenses, claims and demands whatsoever arising under or in relation to the Project Documents or in view of the termination of the Project Documents insofar as it relates to Konica or otherwise howsoever."
Clause 4 provided that Konica will not enter or participate in the business of manufacturing, marketing, sale, purchase and distribution of the product manufactured by the IGCL within territory of India. This non- competition clause reads as under :-
"4. NON-COMPETITION Konica agrees that for a period of three (3) years from the receipt of the Compensation by IGCL from Konica, it shall not, directly or indirectly, without the prior written consent of IGCL, enter or participate in the business of manufacture, marketing, sale, purchase and distribution of the product within the territory of India. For a period of three (3) years from the date of receipt of the Compensation by IGCL, Konica shall not in any manner, directly or indirectly, purchase and/or procure the Products from any third party within the territory of India. Konica acknowledges that the terms and conditions of this Agreement and the "non-objection" granted by IGCL is a composite, reasonable and sufficient consideration for undertaking the non-compete covenant under this Article, which has been arrived at after taking into account the commercial value of the covenant. Accordingly, no separate consideration is payable for this non-compete 32 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 covenant, and Konica admits and acknowledges the same and foreover releases and discharges IGCL from making any payment and/or paying any further consideration."
Thus from the termination agreement we notice that compensation was paid by Konica to IGCL in respect of three separate liabilities and obligations :-
(1) Obligation of Konica was to purchase ossein from assessee company which was stopped by KGCL on account of reduction in the production capacity of photographic gelatine and accordingly it desired to discontinue the purchase of the product from IGCL w.e.f. February 1, 2002.
(2) Discharging Konica from its obligation contained in an agreement of 1995 wherein gelatine manufactured by IGCL at Vapi plant would be purchased by KGCL.
(3) Konica is in obligation not to compete with IGCL in Indian territory in respect of manufacturing, marketing, sale and purchase and distribution of the product (ossein/gelatine) in India. This non-compete period was for three years.
The assessee company is apparently required to make the payment to Konica for this non-compete clause. However Clause-4 of Termination Agreement states that no separate consideration is payable for this non- compete covenant and it has released and discharged IGCL from making any payment or paying any further consideration. Thus where full compensation is determined after taking into account non-compete fee, then a clear inference is that total compensation paid by the KGCL to 33 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 assessee company is arrived at after adjusting any payment required to be made by assessee company to KGCL as non-compete fee. In any case no separate working how the compensation so paid has been worked out has been given to us in spite of our asking for it on the ground that the matter is old and such working papers may not be available.
The second part of the compensation as stated above related to discharge KGCL from its obligation towards -
(1) Guarantee given by KGCL for production of 166 kg per hour of the gelatine as provided in Article 6.1 of the agreement of 1995.
(2) Transfer and continuing transfer for running and improving the Vapi plant for the period of 10 years as provided in the agreement.
(3) Providing technical personal for improving and operation of the plant and other guarantees given as per article -6 of that agreement.
Now the question arises is whether the sum of US $ 2.1 million (equivalent to Indian Rs.10,14,54,000/-) is capital receipt in entirety or revenue receipt in entirety or a mixed capital-cum-revenue receipt. In this regard we refer to various authorities for coming to appropriate inferences.
(1) In PH Divecha vs. CIT (1963) 48 ITR 222 (SC), decided by five judges of the Hon. Supreme Court, it was held that compensation paid by Phillip Electrical Company to the assessee being a partner in the firm which had entered into an agreement with Phillip Electrical Co., and such 34 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 agreement was terminated, was held as capital receipt. The facts relating to that case are the assessee was conducting the business as a partner in the firm in electrical goods including electrical lamps. In 1938 it entered into an agreement with Phillip Electric Co. for the exclusive right to purchase and sale electrical lamps manufactured by Phillip Electrical Co. in certain areas of Indian territory. This arrangement continued for 16 years and thereafter Phillip Electrical Co. decided to take over the distribution of lamp in certain areas in which the firm of the assessee had a right. After serving a termination notice and after some deliberation with the partners it was agreed that a sum of Rs.20,000/- would be paid to Shri P.H. Divecha and other partners of the firm as three years remuneration. This amount was held as capital receipt in the hands of Shri PH Divecha for several reasons as under :-
(i) The agreement between the firm of PH Divecha and Phillip Electrical Company created a monopoly right of purchase and monopoly right of sale in the products of Phillip Electrical Co. in certain areas. It secured all the forms and advantage of an enduring nature and was not an ordinary trading agreement.
(ii) It could not be proved that amount payable to the partners represented the likely profits of the firm that would have arisen if the agreement is not terminated. Thus the compensation did not replace those profits.
(iii) The payment was not made for any service rendered by the partners. The payment was made for qualities of three partners who had built up a vast net work of sales organization of which Phillip Electrical Co. would obtain the benefit when it entered for selling by itself.35
ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
(iv) The payment was not related to any business done or loss to the profit and not to recompensate for services past or future.
(v) It did not bear the character of income or profit or gains chargeable to any income-tax. It was held by the Hon. Apex Court that to constitute income profit or gains there must be a source from which the particular receipt has arisen and a connection must exist between the receipt and the source. The relevant aspect is the nature of receipt in the hands of the persons who receive it, though the motive of the persons making the payment is also relevant. The largeness of amount or periodicity of payment is not decisive factor on this issue. Even the nomenclature is not decisive.
(2) In CIT vs. K K Roy (1967) 67 ITR 179 (Cal) Hon. Calcutta High Court held that a payment received on account of gratitude or valuable and legal services rendered by the assessee established a capital receipt. The facts in that case were that assessee was acting as a managing director of Airways India Ltd. The business of the company including Airways India Ltd. was acquired w.e.f. August 1, 1953. The Board of Directors of Airways India Ltd. recommended the payment of Rs.50,000/- to the assessee in view of the termination of assessee's association with that company due to scheme of nationalization. It was held that payment was for loss of employment and hence a capital receipt.
(3) In Indian Engg. & Commercial Corporation (P) Ltd. vs. CIT (1994) 205 ITR 001 (Bom) the assessee company had received a payment on termination of agreement to sale tractors of a Polish Company and it was held as revenue receipt. The facts in that case were that by agreement of 36 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 1958 assessee was appointed as sole distributor in India for certain types of wheeled tractors manufactured by Polish Company. The agreement provided that the assessee would be acting as sole distributor, act on its own account and orders would be issued and executed in its own name. However, selling price would be fixed by mutual consultation with Polish Company. The clause 15 of the agreement provided that period of the agreement would be 5 years but Polish Company retained the right to terminate the agreement by giving 45 days notice if any condition of the agreement are infringed but it also provided that termination of agreement would not affect in any respect, the fulfillment of contract between the parties in execution of the agreement. In other words the assessee would continue to sell tractors in its possession if agreement with the purchaser were executed prior to termination. The assessee purchased tractors from Polish Company but in between serious trouble developed on account of technical problems in the tractors. By mutual settlement distribution agreement was terminated and assessee received a sum of Rs.93,450/- in all. It was claimed as capital receipt. It was held by Hon. Bombay High Court that the sum received by the assessee company was in the course of its business and there was no damage to its profit making apparatus. Hon. Bombay High Court distinguished the decision of Hon. Supreme Court in PH Devicha's case (supra) and held that sum of Rs.93,450/- was a revenue receipt under the facts and circumstances of that case. The tractors were assessee's stock-in-trade and by arriving at the arrangement with the Polish Company assessee was able to dispose of the tractors.
(4) In the case of CIT vs. Automobile Products of India Ltd. (1983) 140 ITR 159 (Bom) assessee was carrying on the business in assembling cars which were subsequently discontinued in 1953. The licence given under Industrial Development Act was cancelled. In 1955 it obtained an 37 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 Industrial Licence to manufacture diesel engines in collaboration with a foreign company. One of the conditions of the agreement provided that assessee should have capacity to manufacture 3000 diesel engines. The agreement also provided that assessee would pay a royalty of 5% on selling prices of such engines or spare parts. Due to change in policy of the Government licences were granted to the Automobile Industry to manufacture both engines as well as tractors. Due to lack of manufacturing facilities of car the assessee could not secure such licence. Therefore, under an agreement with Premier Automobile Ltd. it transferred the undertaking of manufacturing of engines to that company. Thus assessee stopped its business and amounts so received from Premier Automobiles was held as capital receipt.
(5) In CIT vs. T.I. & M. Sales Ltd. (2003) 259 ITR 116 (Mad) the assessee was a distributor on principal to principal basis. There was termination of distribution. Under this agreement assessee was to transfer trained staff, dealership net work, brand image and other market infrastructure. Covenant in the agreement restricted the assessee from acting as distributor of stock of any other manufacturer for three years. The compensation so received even though payable in quarterly instalment was held as capital nature. It was held that amount paid to the assessee was compensation for impairment of profit making apparatus and for sterilization of very source of its income.
(6) In Eastern Air Products (P) Ltd. vs. CIT (2007) 290 ITR 562 (M.P.) it was held that when a payment is paid to compensate a person for cancellation of contract which does not affect the trading structure of its business nor cause a deprivation of what in substance is a source of income and is a normal incidence of its business, and then such 38 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 termination leaves him free to carry on his trade i.e. freed from the contract terminated, the receipt is revenue in nature. Where by the cancellation of an agency the trading structure of the assessee is impaired or such cancellation result in loss of what may be regarded as the source of income of the assessee, the payment made for cancellation agreement is normally a capital receipt. In that case assessee company carried on the business of manufacturing industrial gases. It entered into an agreement with Union Carbide India Ltd., Bhopal. The agreement was initially for 5 years with the option of further renewal. Union Carbide India Ltd.(UCIL) was to purchase a minimum quantity of gases per year worth Rs.20 lacs inclusive of sales-tax and duty and in the event of UCIL failing to take such quantity of gases in a year then UCIL would pay to the assessee a sum of money making to the assessee difference to Rs.20 lacs. The agreement was terminated by mutual consent w.e.f. February 5, 1985 after Bhopal Gas Tragedy, and the factory of UCIL was closed. However, another agreement entered into by the assessee with UCIL provided for supply of gases and supply being less the UCIL paid the differential to the assessee. The compensation so paid was treated as revenue receipt. After the Bhopal Gas Tragedy assessee has not claimed any amount as compensation for deprivation of its source of income and under debit note issued it had claimed the differential sum as revenue receipt.
(7) In Pary & Co. Ltd. vs. DCIT (2004) 269 ITR 177 (Mad) the assessee was one of the selling agents for a Company "HMM" manufacturing diverse items of food products and toiletries. HMM agreed to pay the assessee a sum of Rs.40 lacs in two instalments, one in consideration of premature termination of the selling agency relating to food products etc. and the other in consideration of the restricted covenant as contained in the relevant clause. The assessee received Rs.25 39 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 lacs in the year 1989 and Rs.15 lacs during 1989-90. The Tribunal allowed 20% of the total compensation as relating to restricted to covenant and thus out of Rs/40 lacs Rs.5 lacs represented capital receipt and balance Rs.35 lacs as revenue receipt. This view of the Tribunal was upheld by Hon. Madras High Court.
(8) In CIT vs. Ambadi Enterprises Ltd. (2004) 267 ITR 702 (Mad), the amount received on termination of the distributorship was held as capital receipt. It was held by Hon. Madras High Court that one test for ascertaining as to whether what was received was a capital receipt or a revenue receipt is to find out whether the termination is linked with profit making apparatus. If in pursuance of termination agreement the source of income is totally severed whereby the profit earning purposes could never be utilized by the assessee then compensation so received would be capital in nature. Hon. High Court had found that entire trained man power and customers were handed over to the other party of the agreement and, therefore, the payment received had an imprint of a capital receipt.
33. Thus from the above authorities, the principles already established can be summarised as under :-
(1) Where compensation is received for termination of distributorship if such distributorship is a source of income, then such compensation would be capital in nature.
(2) Where source of income is sterilized or comes to an end, the compensation so received would be capital in nature.40
ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 (3) Where assessee transfers its net work and all customers trained man power are handed over along with the area of sales, net work, under an agreement, and thus crippled or paralyzed one of the sources, then compensation so received would be capital in nature.
(4) Where assessee is continuing to remain in business, source of income is not paralyzed or does not come to an end and assessee is compensated for loss of profit on account of other party not purchasing goods as agreed earlier, then compensation so received would be revenue in nature. The distinction is whether assessee's source of income continues to survive or comes to an end. In PH Divecha's case (supra) the source of income of assessee came to an end inasmuch as the distributorship was taken over by Phillip Electrical Company and it started selling products at its own. When we apply above principles to the facts of the present case we find that -
(i) KGCL was continuing to purchase ossein from the assessee. It had stopped purchasing ossein on account of its being not able to sell gelatine manufactured by it from ossein. It allowed the assessee to operate in India in respect of ossein by not entering into Indian territory for sale of the product of the like manufactured by the assessee company. In other words KGCL allowed the assessee company to operate, manufacture and sale of ossein or even gelatine in India and for three years KGCL will not enter into Indian territory for manufacturing or marketing the two products. It clearly shows that KGCL did not have any intention to take over the 41 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 production or marketing of ossein or gelatine in India. It had in fact already agreed to allow the assessee company to sell gelatine anywhere in the world by virtue of its 1995 agreement. The termination agreement of 2001 only provided that KGCL would cease to provide technical support to assessee company for manufacturing and operation of gelatine plant at Vapi. Thus neither the ossein manufacturing plant nor gelatine manufacturing plant being the source of the income of the assessee company were impaired. The assessee was left at its own to manufacture and market its product namely ossein and gelatine. Since there was an obligation with KGCL to purchase ossein from assessee company and KGCL desired to forgo all these obligations, it paid compensation to the assessee. This will certainly be in the nature of revenue receipt.
(ii) The argument of the ld. AR that KGCL was its main purchaser and rather whole-sale purchaser of ossein and KGCL having withdrawn from its very such obligation, then its major source of income is impaired cannot be accepted because source of income is not KGCL but its ossein manufacturing plant. Therefore, the decision of Hon. Supreme Court in PH Divecha (supra) cannot be applied as in our considered view the source of income of the assessee is not impaired. It continues to produce ossein though it is finding it difficult to get new customers in place of KGCL but for that matter it cannot be said that source of income of the assessee company has been impaired or it is out of business because of termination of agreement or its manufacturing plant has been taken over or surrendered. Under the conditions where ossein is continued to be manufactured even after the termination of the agreement, the source of income remains intact. Therefore, the compensation paid by KGCL cannot be related to impairing of source of income. The notices issued by KGCL clearly reflected that it intended to stop purchasing ossein from 42 ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03 the assessee company. Whatever notices assessee company has produced before us and which have been issued by KGCL to assessee company related to intention of KGCL whereby KGCL did not desire to continue to purchase ossein from assessee company. In view of this, the compensation received by the assessee company from KGCL would be in lieu of stoppage of ossein purchases from assessee company and hence would be a revenue receipt. There are covenants in termination agreement according to which KGCL released itself from other obligations. One of these obligations was to provide technical support in respect of Vapi plant. However, no amount if any payable to IGCL has been worked out in respect of this part of compensation which was supposed to be paid by KGCL by assessee company. Similarly, the compensation, if any, to be paid by assessee company to KGCL on account of non-compete clause in the termination agreement has also not been worked out except stating in the relevant covenant that no separate working for such compensation has been made. In our considered view the compensation, if any, to be paid by KGCL for withdrawing itself from obligation in respect of Vapi Plant would apparently neutralize the compensation to be paid, if any, by assessee company to KGCL for non-compete covenant and therefore, what is actually paid is clearly the compensation for stopping purchase of ossein from assessee company. We have already observed above that it is a revenue receipt. As a result, we hold that sum of Rs.10,14,54,000/- is a revenue receipt and has been rightly taxed by the Revenue authorities. The appeal of the assessee in this regard is dismissed.
43ITA Nos.2040 & 2051/Ahd/2004 Asst. Year 2002-03
35. In the result, the appeal of the Revenue is partly allowed for statistical purposes and the appeal of the assessee is partly allowed for statistical purposes.
Order was pronounced in open Court on 29/04/11.
Sd/- Sd/-
(Bhavnesh Saini) (D.C. Agrawal)
Judicial Member Accountant Member
Ahmedabad,
Dated : 29/04/11.
Mahata/-
Copy of the Order forwarded to:-
1. The Assessee.
2. The Revenue.
3. The CIT(Appeals)-
4. The CIT concerns.
5. The DR, ITAT, Ahmedabad
6. Guard File.
BY ORDER,
Deputy/Asstt.Registrar
ITAT, Ahmedabad
1.Date of dictation 28/3/2011
2.Date on which the typed draft is placed before the Dictating 27/4/ 2011 Member................Other Member................
3.Date on which the approved draft comes to the Sr.P.S./P.S.............
4.Date on which the fair order is placed before the Dictating Member for pronouncement..............
5.Date on which the fair order comes back to the Sr.P.S./P.S...............
6.Date on which the file goes to the Bench Clerk...........
7.Date on which the file goes to the Head Clerk.............
8.The date on which the file goes to the Asstt. Registrar for signature on the order........................
9.Date of Despatch of the Order.................
44