The Commissioner Of Income Tax-1, ... vs M/S Khattri Perfumers[P]Ltd. ... on 20 August, 2013

[Cites 25, Cited by 1]

Allahabad High Court

The Commissioner Of Income Tax-1, ... vs M/S Khattri Perfumers[P]Ltd. ... on 20 August, 2013

All the appeals have been filed by the Department under Section 260A of the Income-Tax Act, 1961 against the consolidated judgment and order dated 28.02.2006, passed by the Income Tax Appellate Tribunal, Lucknow in I.T.A. Nos. 1076/A/96; 1760/A/96; and 1764/A/94, for the assessment years 1993-94; 1991-92; and 1992-93 respectively.

On 07.08.2006, a Coordinate Bench of this Court has admitted the appeals on the following substantial question of law:-

"Whether on the facts and in the circumstances of the case, the learned ITAT is, in law, justified in holding that assessee was entitled to deduction U/s 80HH and 80-I of the Income Tax Act, 1961 on consultancy charges even as the consultancy was given by its directors/ employees without involving any usage of the industrial undertaking and the company was eligible for royalty for that as per the agreement entered into by it?"

The brief facts of the case are that the assessee company is engaged in the manufacturing of wide range of products like industrial perfumes, chewing tobacco, synthetic essential oil etc. The assessee has entered into an agreement with Hindustan Lever Ltd. (for short, 'HLL') whereby assessee as the licensor had licensed the formula developed through its research and gave exclusive right to HLL to use the said formula in their products specially in liril soap. In addition to the consideration, the assessee has also received the royalty/consultancy charges from HLL under the heading for further research work. It is the claim of the assessee that along with its manufacturing activity, the assessee carried out the research and development activity side by side making use of the entire paraphernalia of the industrial undertaking. The assessee has claimed the exemption of the amount received as royalty/consultancy charges under Section 80HH and Section 80-I of the Act.

The Assessing Officer (AO) was of the view that the assessee was not entitled for deduction of receipt under any other head except the profit derived from an industrial undertaking. The CIT(A) was also of the view that the consultancy charges cannot be said to be profit earned and derived from the industrial unit. With regard to the consultancy charges, the CIT(A) observed that this payment has been received for the consultancy provided by the Directors/Employees of the assessee having technical knowledge and it had nothing to do with the industrial unit as such. So, the order of the AO was confirmed by the first appellate authority. However, the Tribunal has allowed the entire claim of the assessee pertaining to the consultancy charges by observing that it is an income derived from the industrial undertaking and is thus, eligible for deduction under Section 80HH and 80-I of the Act. Being aggrieved, the Department has filed the present appeals.

On the basis of aforesaid facts, Sri D.D. Chopra, learned counsel for the Department has relied on the order passed by the AO. He submits that as the assessee company has not been able to show as to how "Consultancy Charges can be said to have been derived from the Industrial Undertaking". A perusal of the Profit & Loss Account shows that the whole consideration has been shown as "sale". However, the assessee took the plea before the learned Tribunal that "consultancy" was provided not from the mind of any person but through the continuous activities of research and development making use of the same labour and machinery of the undertaking even as it had not shown as to how its "sale" had a direct nexus with the Industrial Undertaking. The CIT(A) in his appellate order dated 21.09.1994, had rightly upheld that payment received by the assessee company for the "consultancy" provided by the assessee company's employees/directors having technical knowledge and it has nothing to do with the industrial unit. For this purpose, he relied on the ratio laid down in the following cases :

(i) CIT vs. Cheekay Associates, 187 ITR 648 (Alld);

(ii) CIT vs. Sterling Foods, 213 ITR 851 (GOA);

(iii) CIT vs. N.C. Budharaj & Co., 215 ITR 447 (Ori); and

(iv)CIT vs. Lucky Mineral (P) Ltd., 226 ITR 253.

(v)Commissioner of Income-tax vs. Alpine Solvex Ltd., 276 ITR 92 (MP); and

(vi)Honda SIEL Power Products Ltd. vs. Commissioner of Income-tax, [2009] 318 ITR 309 (Del).

It is also a submission of the learned counsel for the Department that the Tribunal has not appreciated the facts in the correct perspective and wrongly interpreted the position of law, so it is liable to be quashed.

On the other hand, Sri Abhinav Mehrotra, learned counsel for the assessee has justified the impugned order passed by the Tribunal. He submits that the heading may be given as consultancy charges or royalty to the consideration, which was received by the assessee in its right perspective. He also submits that the assessee carries out two types of activities. One activity is by which it manufactures perfumery products generally which has an open market and which are sold to any consumer. These products are not tailor-made for specific consumer. Another activity carried out by the assessee is to manufacture specific products meant for specific consumer. The specific products which are meant for specific consumption being to be research and developed and these are not sold in the open market.

In the instant case, the consultancy provided was not from the mind of any person, but it was through the continuous activity of research and development marking use of the same labour and machinery of the undertaking. So, it has a direct nexus with the industrial undertaking and it was eligible for deduction under Section 80-HH & 80-I of the Act. For this purpose, he relied on the ratio laid down in the following cases:-

(i) Commissioner of Income-tax vs. Sterling Food, [1999] 237 ITR 579 (SC);

(ii) Mst. Sarju Bai vs. Commissioner of Income-tax, [1947] 15 ITR 137 (All);

(iii) National Organic Chemical Industrial Limited vs. Collector of Central Excise, Bombay, AIR 1997 SC 690;

(iv) Cambay Electrical Supply Co. Ltd., 113 ITR 84 (SC);

(v) Liberty India Ltd. vs. CIT, [2009] 183 Taxman 349 (SC);

(vi) Vellore Electric Corpn. Ltd. vs. CIT, [1997] 93 Taxman 401/227 ITR 557 (SC); and

(vii) CIT vs. Kothari Products Ltd., [2007] 295 ITR 223.

Learned counsel further submits that as per the agreement, which has been brought on records during the course of hearing it was claimed by the assessee that they have creative skills to develop perfumes on the basis of instructions given to them with regard to cost and other parameters and have manufacturing facilities to blend and supply the same to customers.

Further, in the agreement between assessee and HLL, the same was mentioned in Paras-3 & 4. On reproduction, Para 3 & 4 read as under:-

"3. Khattri will be briefed from time to time in respect of all perfume submissions (except in so far as where HLL decides to use only its inhouse or Concern facilities) for incorporation in 'Products' using their creative skills and undertake to respond to HLL's request for the same within agreed parameters. Khattri will further undertake to assist in modifying the perfumes as submitted by them and accepted by HLL in order to meet consumer preference and/or to overcome restrictions on sourcing the inputs either in terms of cost or availability.

4. HLL will enter into appropriate commercial arrangements with Khattri in respect of each perfume submission made by Khattri which is accepted and adopted by HLL for incorporation in "products". For accepted submissions, this could involve the opening of the formula by Khattri to HLL for captive blending by HLL (except in the case of speciality perfumery components created by Khattri) or could involve supply arrangements by Khattri without disclosing the furmulae but Khattri shall not be bound to disclose formulation of perfumes in all cases. The manner and mode of following either of these two options would be mutually discussed and agreed upon from time to time in case of every submission of Khattri which is accepted by HLL for incorporation in its "products". Similarly, the quantum of royalty payable to Khattri if the formulae are disclosed or the price and delivery schedules when it is a supply contract will be agreed from time to time."

Lastly, he made a request for dismissal of all the appeals.

After hearing both the parties and on perusal of the record, it appears that the assessee is engaged in the manufacturing of various types of perfumes including the perfumes as per the terms of the agreement entered into with HLL for which the assessee has received consideration. In addition, the assessee has received consultancy charges for continuous activity for research. The assessee has claimed that the consultancy charges are to be allowed as deduction under Section 80-HH & 80-I of the Act.

In order to adjudicate the question raised before us, it is appropriate to reproduce the provisions of Section 80-HH & 80-I of the Act read as under:-

80HH.-Deduction in respect of profits and gains from newly established industrial undertakings or hotel business in backward areas (1) Where the gross total income of an assessee includes any profits and gains derived from an industrial undertaking, or the business of a hotel, to which this section applies, there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction from such profits and gains of an amount equal to twenty per cent thereof.

(2) This section applies to any industrial undertaking which fulfils all the following conditions, namely:-

(i) it has begun or begins to manufacture or produce articles after the 31st day of December, 1970 [ but before the 1st day of April, 1990 ], in any backward area;

(ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence in any backward area:

Provided that this condition shall not apply in respect of any industrial undertaking which is formed as a result of the reestablishment, reconstruction or revival by the assessee of the business of any such industrial undertaking as is referred to in section 33B, in the circumstances and within the period specified in that section;

(iii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose in any backward area;

(iv) it employs ten or more workers in a manufacturing process carried on with the aid of power, or employs twenty or more workers in a manufacturing process carried on without the aid of power.

Explanation.- Where any machinery or plant or any part thereof previously used for any purpose in any backward area is transferred to a new business in that area or in any other backward area and the total value of the machinery or plant or part so transferred does not exceed twenty per cent of the total value of the machinery or plant used in the business, then, for the purposes of clause (iii) of this sub- section, the condition specified therein shall be deemed to have been fulfilled.

(3) This section applies to the business of any hotel, where all the following conditions are fulfilled, namely:-

(i) the business of the hotel has started or starts functioning after the 31st day of December, 1970 [ but before the 1st day of April, 1990 ], in any backward area;

(ii) the business of the hotel is not formed by the splitting up, or the reconstruction, of a business already in existence;

(iii) the hotel is for the time being approved for the purposes of this sub- section by the Central Government.

(4) The deduction specified in sub-section (1) shall be allowed in computing the total income in respect of each of the ten assessment years beginning with the assessment year relevant to the previous year in which the industrial undertaking begins to manufacture or produce articles or the business of the hotel starts functioning:

Provided that,-

(i) in the case of an industrial undertaking which has begun to manufacture or produce articles, and

(ii) in the case of the business of a hotel which has started functioning, after the 31st day of December, 1970 , but before the 1st day of April, 1973 , this sub-section shall have effect as if the reference to ten assessment years were a reference to ten assessment years as reduced by the number of assessment years which expired before the 1st day of April, 1974 .

(5) Where the assessee is a person other than a company or a co-operative society, the deduction under sub-section (1) shall not be admissible unless the accounts of the industrial undertaking or the business of the hotel for the previous year relevant to the assessment year for which the deduction is claimed have been audited by an accountant as defined in the Explanation below sub-section (2) of section 288 and the assessee furnishes, along with his return of income, the report of such audit in the prescribed form duly signed and verified by such accountant.

(6) Where any goods held for the purposes of the business of the industrial under- taking or the hotel are transferred to any other business carried on by the assessee, or where any goods held for the purposes of any other business carried on by the assessee are transferred to the business of the industrial under- taking or the hotel and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the business of the industrial undertaking or the hotel does not correspond to the market value of such goods as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of the industrial undertaking or the business of the hotel shall be computed as if the transfer, in either case, had been made at the market value of such goods as on that date:

Provided that where, in the opinion of the [ Assessing] Officer, the computation of the profits and gains of the industrial undertaking or the business of the hotel in the manner hereinbefore specified presents exceptional difficulties, the [ Assessing] Officer may compute such profits and gains on such reasonable basis as he may deem fit.

Explanation.- In this sub-section, "market value" in relation to any goods means the price that such goods would ordinarily fetch on sale in the open market.

(7) Where it appears to the [ Assessing] Officer that, owing to the close connection between the assessee carrying on the business of the industrial undertaking or the hotel to which this section applies and any other- person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in the business of the industrial undertaking or the hotel, the [ Assessing] Officer shall, in computing the profits and gains of the industrial undertaking or the hotel for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom.

(8) * * * (9) In a case where the assessee is entitled also to the deduction under [section 80-I or] section 80J in relation to the profits and gains of an industrial undertaking or the business of a hotel to which this section applies, effect shall first be given to the provisions of this section.

[(9A) Where a deduction in relation to the profits and gains of a small- scale industrial undertaking to which section 80HHA applies is claimed and allowed under that section for any assessment year, deduction in relation to such profits and gains shall not be allowed under this section for the same or any other assessment year.] (10) Nothing contained in this section shall apply in relation to any undertaking engaged in mining.

[11 For the purposes of this section," backward area" means such area as the Central Government may, having regard to the stage of development of that area, by notification 3 in the Official Gazette, specify in this behalf:

Provided that any notification under this sub- section may be issued so as to have retrospective effect to a date not earlier than the 1st day of April, 1983.] (Emphasis Added) 80-I.-Deduction in respect of profits and gains from industrial undertakings after a certain date, etc. (1) Where the gross total income of an assessee includes any profits and gains derived from an industrial undertaking or a ship or the business of a hotel [or the business of repairs to ocean-going vessels or other powered craft], to which this section applies, there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction from such profits and gains of an amount equal to twenty per cent thereof :

Provided that in the case of an assessee, being a company, the provisions of this sub-section shall have effect [in relation to profits and gains derived from an industrial undertaking or a ship or the business of a hotel] as if for the words "twenty per cent", the words "twenty-five per cent" had been substituted.

(Emphasis Added) In order to get the benefit under Section 80HH of the Act, it is necessary that the industrial unit be engaged in the manufacturing process with the aid of power and employees of ten or more workers and in case without aid of power the strength of worker should be twenty and more. Further, the said industrial unit be established without splitting or reconstruction of business or formed by the transfer of a new business of machinery or plant.

Further on perusal of the provisions of sub-section (1) of Section 80-I of the Act, the gross total income which includes any profits and gains "derived from such industrial undertaking" be allowed a deduction from such profits and gains of an amount equal to twenty per cent thereof. Thus, there is direct nexus between the profit and gains and industrial undertaking derived from an industrial undertaking.

The Hon'ble Apex Court in the case of National Organic Chemical Industrial Limited vs. Collector of Central Excise, Bombay (supra), while adjudicating, word "derived" has held that :

"The dictionaries state that the word 'derive' is usually follows by the word' from' and it means get or trace from a source, arise from, originate in, show the origin or formation of. It, therefore,, suggests that the root word is 'derived' and the suffix 'from' or 'by' or 'directly', etc., are indistinguishable and do not impinge on the interpretation at hand. In other words, there is no greater significance in the word 'from' following the word 'derived' other than the fact that it is the usual linguistic practice...."

Further, Hon'ble Apex Court in the case of National Organic Chemical Industries Ltd. (supra), observed in Paras-10 & 11, that -

"10. The dictionaries states that the words 'derive' is usually followed by the word 'from', and it means : get or trace from a source; arise from, originate in; show the origin or formation of.

11. The use of the words 'derived from' in item 11-AA(2) suggests that the original source of the product has to be found. Thus, as a matter of plain English, when it is said that one word is derived from another, often in another language, what is meant is that the source of that word is another word, often in another language. As an illustration, the word 'democracy' is derived from the Greek word 'demos' the people, and most dictionaries will so state. That is the ordinary meaning of the words 'derived from' and there is no reason to depart from that ordinary meaning here."

The Hon'ble Apex Court in the case of Commissioner of Income Tax vs. Sterling Foods (supra), while answering the question have held that for claiming the benefit of Section 80HH, the assessee had to establish that the profits and gains were derived from its industrial undertaking and the industrial undertaking itself had to be the source of the profit and the said industrial undertaking had directly to yield that profit. The Hon'ble Apex Court further held that the industrial undertaking had the direct source of that profit and not a means to earn any other profit.

Similarly, in the case of Commissioner of Income-tax vs. Alpine Solvex Ltd. (supra), the Hon'ble Apex Court observed that :

"The expression "derived from" used in Section 80HH and 80-I of the Income Tax Act, 1961, has a definite but narrow meaning and it cannot receive a flexible or wider concept. The assessee is entitled to claim deduction of the amount which it derives as direct profit by sale of manufactured goods in its newly set up industrial undertaking. Any indirect or incidental profit cannot be regarded as profit earned out of the main business activity".

In the case of Commissioner of Income-tax vs. Alpine Solvex Ltd., 276 ITR 92 (MP), it was observed that the assessee is entitled to claim deduction of the amount which it derives as direct profit by sale of manufactured goods in its newly set up industrial undertaking. Any indirect or incidental profit cannot be regarded as profit earned out of the main business activity. The amount received as consultancy had to be taxed as income earned from other sources as defined under Section 56(1) read with Section 14 (item F).

Further, in the case of Honda SIEL Power Products Ltd. vs. Commissioner of Income-tax, [2009] 318 ITR 309 (Del), it was observed that:-

"Both sections 80HH and 80-I of the Income-tax Act, 1961, use the expression "profit and gains derived from an industrial undertaking". The Supreme Court has drawn a distinction between the expression "derived from" and "attributable to" in Combay Electric Supply Industrial Co. Ltd., vs. CIT, [1978] 113 ITR 84. Only such business profits that have a direct nexus to the essential business activity of the assessee can qualify for deduction under Section 80HH of the Act. Inasmuch as both Sections 80HH and 80-I use the expression "profits and gains derived from an industrial undertaking", the burden is on the assessee to show that the income earned from an activity, the profits from which are claimed to qualify for deduction, has an immediate and direct nexus to the essential activity of the industrial undertaking."

Emphasis Added As stated hereinabove, there should be a direct nexus between the profits and gains and the industrial undertaking whereas in the instant case, the income derived from consultancy/profit so accrued from consultancy has no direct nexus but only an incidental and as such the Tribunal has erred in law in extending the benefit of the provisions of Section 80HH & 80-I of the Act to the profits and gains from consultancy business. The rulings laid down by the learned counsel for the respondent has no application in the facts and circumstances of the case.

It is undisputed that that the industry was established in the backward area and the appellant was enjoying the deduction under Section 80HH & 80-I of the Act.

From the record, it appears that Section 80HH of the Act defines that the income of an assessee includes any profit and gains derived from industrial undertaking from the business. Undoubtedly, the assessee was running the business in the manufacturing of the perfumes. As per the agreement between the assessee and HLL, the assessee was getting the consideration for supplying the perfume. For further research, the assessee can claim the benefit under Section 35 of the Act, which on reproduction read as under:-

"35.Expenditure on scientific research.-(1) In respect of expenditure on scientific research, the following deductions shall be allowed--

(i) any expenditure (not being in the nature of capital expenditure) laid out or expended on scientific research related to the business.

[Explanation.--Where any such expenditure has been laid out or expended before the commencement of the business (not being expenditure laid out or expended before the 1st day of April, 1973) on payment of any salary [as defined in Explanation 2 below sub-section (5) of section 40A] to an employee engaged in such scientific research or on the purchase of materials used in such scientific research, the aggregate of the expenditure so laid out or expended within the three years immediately preceding the commencement of the business shall, to the extent it is certified by the prescribed authority to have been laid out or expended on such scientific research, be deemed to have been laid out or expended in the previous year in which the business is commenced]"

The aims and objects of Section 80HH & 80-I of the Act are to establish the industry in the backward area. So that the area can be benefited. By claiming the deduction on research, backward area cannot be developed. The consultancy can be given from the chamber or locality, urban area like an Advocate, Doctors, C.A., and so on.

In the instant case, the consultancy has no nexus with the objects as mentioned in Section 80HH & 80-I of the Act. The case laws relied by the assessee are in the context of old Section of 80E/80I, in which the words were "profit attributable to" as distinct from the word "profit derived from" in the present Section of 80HH and 80-I of the Act.

It may be mentioned that the consultancy activity might be incidental of the business of the assessee but it has no direct nexus with the activity of the industrial undertaking which is the manufacturing unit of the products in the backward area. Hence, the consultancy charges cannot be held to be "derived from industrial undertaking".

It may further be mentioned that to obtain the benefit of section 80HH the assessee had to establish that the profits and gains were derived from its industrial undertaking and it was just not sufficient that a commercial connection was established between the profits earned and the industrial undertaking. The industrial undertaking itself had to be the source of the profit. The business of the industrial undertaking had directly to yield that profit. The industrial undertaking had the direct source of that profit and not a means to earn any other profits.

Needless to mention that only income that is derived from the manufacturing activity is eligible for deduction under Section 80HH & 80-I of the Act. The income which is eligible under Section 80HH & 80-I of the Act is dependent upon the receipt, as per the ratio laid down in the case of Commissioner of Income-tax vs. Alpine Solvex Ltd., [2005] 276 ITR 92 (MP) (supra).

In the instant case, the consultancy charges received from the HLL is a receipt. So, it is subject to tax and cannot be allowed for deduction under Section 80HH & 80-I of the Act. For the purpose of this section, the profit and gains of the new undertaking is not commercial profit but only such profit as are computed in the manner land down under the Act in pursuance of Section 80AB, as if each undertaking was a separate assessee. Even past losses cannot be set off as per the ratio laid down in the case of CIT vs. Loonkar Tools Pvt. Ltd., (1995) 213 ITR 721 (Raj). Deduction under Section 80HH will have to be calculated with reference to net profit only as per the ratio laid down in the case of CIT vs. Yenpeyes Rubber Pvt. Ltd., (1999) 239 ITR 734 (Mad).

In the light of above discussion and by considering the totality of the facts and circumstances of the case, we are of the view that the consultancy charges are not exempted under Section 80HH & 80-I of the Act. Hence, we set aside the impugned order and restore the order of the AO.

The answer to the substantial question of law is in favour of the revenue and against the assessee.

In the result, all the appeals filed by the appellant-Department are allowed.

Order Date : 20th August, 2013 Rakesh/-

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