Income Tax Appellate Tribunal - Delhi
Herbalife International India (P) Ltd. vs Assistant Commissioner Of Income Tax on 28 February, 2006
Equivalent citations: [2006]101ITD450(DELHI), (2006)103TTJ(DELHI)78
ORDER
1. This is an appeal by the assessee against the order dt. 25th Feb., 2005 of CIT(A)-XV, New Delhi, relating to the asst, yr. 2001-02.
2. The first two grounds of appeal of the assessee are general in nature and do not call for any specific adjudication. The grievance projected by the assessee in ground Nos. 3 to 3.13 is with regard to action of the Revenue authorities in disallowing an expenditure of Rs. 5.83 crores being administrative fee paid by the assessee to M/s Herbalife International of America Inc. The facts in this regard are as follows. The assessee carries on business of trading and marketing of herbal products for use in weight management, to improve nutrition and enhance personal care. The assessee was incorporated as a company in India with 100 per cent foreign equity participation, pursuant to an approval granted by the Ministry of Industry, Department of Industrial Policy & Promotion, Secretariat for Industrial Assistance. M/s Herbalife International, USA, was the foreign collaborator who obtained the approval for setting up the assessee-company in India. As per the approval of the Ministry of Industry, the assessee should manufacture herbal products on contract basis in India and should not import these items.
3. The products of the parent USA company are sold in 58 countries worldwide. Scientists, doctors and nutritionists have developed these products with personal wellness goals in mind. Through constant research and product testing, the products are claimed to meet the highest standards set for the industry. The parent company claims to have developed significant expertise developed over the years. The parent company desires that these standards should be achieved by the various subsidiaries throughout the world. The parent company, therefore, provides data processing services, record keeping, distributor/supervisor information and order and shipment processing, etc. The parent company also provides financial, marketing services. Besides the above direct services the parent company also renders some indirect administrative services. As already stated, similar services are rendered to several subsidiaries worldwide and the costs incurred in this regard are centralized costs, which is allocated to the overseas subsidiaries. The costs are allocated on a scientific basis.
4. The assessee entered into an Administrative Services Agreement dt. 10th Nov., 1999 with Herbalife International of America, Inc. (hereinafter called HIAI) a company formed in accordance with the laws of the State of California, United States of America. Under this agreement HIAI agreed to provide data processing services, accounting, financial and planning services, marketing services besides long-term financial planning for the assessee, analysis of prospects, etc. and to obtain approval for parent company products from Government and regulatory bodies. If necessary to assist in protecting the trademark, tradename, logo of the products. The assessee was to pay an administrative fee under this agreement. As already stated, these expenses are incurred by the assessee in USA not only for providing services to the assessee but also to its various other subsidiaries across the world by maintaining its centralized staff and other resources. The cost so incurred is apportioned and claimed from the assessee on a scientific basis. This agreement will hereinafter be referred to as "Administrative Service Agreement" (ASA for short).
5. As already noticed as per the approval of the Ministry of Industry, the assessee was not permitted to import the products, It could get the products manufactured on a contract basis in India. For such manufacture the assessee entered into an agreement called License and Technical Assistance Agreement with a company called M/s Herbalife International Inc. (hereinafter called HII), a company incorporated in United States of America, which was the owner of the incorporeal right relating to the process of manufacture of the various products. As owner of the technical know-how regarding manufacture, HII permitted the assessee as a licensee to manufacture the products. This agreement was also dt. 10th Nov., 1999,
6. This is the background of the assessee's nature of business. The assessee had claimed an expenditure of Rs. 5.83 crores as administrative fee paid during the year. This sum was paid by the assessee to M/s HIAI as consideration for the various services it provided to the assessee under the agreement dt. 10th Nov., 1999, the details of which have been mentioned at para 4 above. The break-up of this sum of Rs. 5.83 crores on the basis of the period to which it relates to is as follows:
1st January, 2000 to 31st December, 2000 10,00,000 US $
1st January, 2001 to 31st March, 2001 2,50,000 US $
______________
Total 12,50,000 US $
______________
12,50,000 US $ is equivalent to Rs. 5.33 crores.
7. It is pertinent to mention here that the previous year of the assessee relating to asst. yr. 2001-02 is the period from 1st April, 2000 to 31st March, 2001. M/s HIM follows the calendar year and the annual charges payable for calendar year 2000 was 10,00,000 US $.
8. As can be seen from the details of the administration fee claimed as deduction by the assessee, it includes fee for the period 1st Jan., 2000 to 31st March, 2000, which relates to the previous year relevant to asst. yr. 2000-01. According to the Revenue, since this item of expenditure relates to the period falling within the asst. yr. 2000-01, the same cannot be claimed as a deduction in asst. yr. 2001-02.
9. The plea of the assessee in this regard was that payment by the assessee to M/s HIM requires the permission of the RBI under the Foreign Exchange Regulation Act. Though the assessee had applied for grant of such permission on 24th March, 2000, the RBI granted permission only on 30th June, 2000, and has allowed the assessee to remit only 10,00,000 US $ as reimbursement of head-office expenses and has also directed that income-tax should be paid on the remittances as per the provisions of the IT Act, 1961. Since the payment was conditional on obtaining the RBI approval, the assessee pleaded that the expenditure in question cannot be deemed to have accrued to the assessee in law without such approval having been accorded and, therefore, the assessee treated the expenditure as having accrued only during the previous year relevant to asst. yr. 2001-02 when RBI granted approval on 30th June, 2000.
10. Another submission of the assessee in this regard was that by 31st March, 2000 when the accounting year for asst. yr. 2000-01 ended, the assessee did not receive the details regarding share of common expenses payable by it to HIM. The assessee pointed out that since the ASA commenced only from 11th Sept., 2000 (M/s HIM had waived ASA fee from 11th Sept., 2000 to 31st Dec, 2000) there was no past precedent available which enabled the assessee to make a provision on an estimate basis also. The assessee further pointed out that, an interim invoice was received by the assessee on 30th June, 2000 for US $ 333,333. The second interim invoice for US $ 333,333 was raised on 30th Sept., 2000 and the final invoice on 31st Dec, 2000 for the same amount. The last invoice duly supported with cost allocation sheets was actually received by 31st Jan., 2001 and the total amount payable to HIM towards administration fee amounted to US $ 1,015,240. In terms of the approval granted by the RBI only an amount of US $ 1 million were remitted and the balance US $ 15,240 were waived by HIAI. This, however, formed a prudent basis for accruing of such expenses for the first quarter of the year 2001, (i.e., January to March, 2001) in the assessee's books for the period ended 31st March, 2001.
11. As far as the expenditure pertaining to the period 1st Jan., 2001 to 31st March, 2001 is concerned, the plea of the assessee was firstly that since the bills upto 31st Dec, 2000 were received from M/s HIAI, there was a precedent on the basis of which it could reasonably estimate the expenditure under this head and it had estimated the same at 1/4th of the sum payable for a period of 12 months. The second plea of the assessee was that w.e.f. 1st June, 2000 Foreign Exchange Regulation Act, 1973 was replaced by Foreign Exchange Management Act, 1999 (FEMA for short) and under the new legislation payment such as the one made by the assessee, a resident of India to a nonresident like M/s HIAI was a payment on current account transactions and in terms of Section 5 of FEMA, foreign exchange could be drawn from an authorised dealer without a necessity for a permission from RBI as was the position earlier. The assessee thus pleaded that in view of these two facts the sum payable by the assessee to M/s HIAI could be ascertained and could, therefore, be said to have accrued and arisen to the assessee and, therefore, was an allowable expenditure.
12. Apart from this, disputes with regard to whether or not expenditure relating to period 1st Jan., 2000 to 31st March, 2000 can be said to have accrued or arisen as a liability in asst. yr. 2001-02 and the dispute as to whether expenditure for the period 1st Jan., 2001 to 31st March, 2001 can be said to have accrued or arisen as a liability for asst. yr. 2001-02, another major dispute which is applicable to the entire expenditure of Rs. 5.83 crores is to its allowability vis-a-vis the provisions of Section 40(a)(i) of the Act. The provisions of Section 40(a)(i) of the Act as it existed in asst. yr. 2001-02, reads as follows:
Section 40 : Notwithstanding anything to the contrary in Sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',-
(a) in the case of any assessee-
(i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable outside India, on which tax has not been paid or deducted under Chapter XVII-B:
Provided that where in respect of any such sum, tax has been paid or deducted under Chapter XVII-B in any subsequent year, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid or deducted.
Explanation : For the purposes of this sub-clause,-
(A) 'royalty' shall have the same meaning as in Expln. 2 to Clause (vi) of Sub-section (a) of Section 9;
(B) 'fees for technical services' shall have the same meaning as in Expln. 2 to Clause (vii) of Sub-section (1) of Section 9;
13. The sum paid or payable by the assessee as consideration under the ASA to M/s HIAI is payable outside India and, therefore, the aforesaid provisions are prima facie attracted. The question is whether the sum paid or payable by the assessee to M/s HIAI under the ASA can be said to be "fees for technical services" or "other sum", chargeable under the Act within the meaning of Section 40(a)(i) of the Act. It is not in dispute that the assessee did not deduct tax at the time of making payment or credit nor did it pay tax in respect of the consideration payable to M/s HIAI under the ASA.
14. In the assessment proceedings, the AO held that under the ASA, M/s HIAI provides data processing services, accounting services, marketing services, financial services as well as miscellaneous consultancy services and that as per the provisions of Section 9(1)(vii), income by way of fees for technical services payable by a person who is resident utilized within India are deemed to be income accruing or arising in India. The AO after making a reference to Expln. 2 to Section 9(1)(vii) of the Act, defining the term "fees for technical services" observed that it includes any consideration paid for rendering any managerial, technical and consultancy services and that the nature of services rendered by M/s HIAI to the assessee for which the sum was payable, fell within the definition referred to above. Since, there was a failure to deduct tax at source, the AO disallowed the claim for deduction of the sum of Rs. 5.83 crores, in view of the provisions of Section 40(a)(i).
15. The assessee raised a plea before the AO that the amount paid/payable to M/s HIAI were reimbursement of actual cost incurred by M/s HIAI on behalf of the assessee and, therefore, mere reimbursement of cost will not give rise to income in the hands of M/s HIAI which can be brought to tax in India in the hands of M/s HIAI. The assessee also pleaded that the nature of services were not such that the expenditure can be said to be payment of "fees for technical services".
16. The AO also held that the portion of the expenditure comprised in the sum of Rs. 5.83 crores which relates to the period from 1st Jan., 2000 to 31st March, 2000, is a prior period expense and cannot be allowed as a deduction. The AO refused to accept the plea of the assessee that due to non-receipt of bill from M/s HIAI before the end of the previous year relevant to asst. yr. 2000-01 and absence of RBI permission for payment, the liability cannot be said to have accrued to the assessee.
17. The AO also held that the liability for the period from 1st Jan., 2001 to 31st March, 2001 cannot be allowed as a deduction. According to AO though liability for this period can be said to have accrued to the assessee by the assessee's conduct in not making payment of this sum to M/s HIAI subsequently and not providing for such liability in future years, showed that this liability was a dead liability and that the payment has been given up by M/s HIAI.
18. Aggrieved by the order of the AO, the assessee preferred appeal before CIT(A). The CIT(A) confirmed the order of the AO holding that the payment by the assessee under ASA to M/s HIAI were in the nature of fee paid for technical services rendered and was taxable in India. On the plea of the assessee that the payment were mere reimbursement of expenses, the CIT(A) held as follows :
No doubt, on p. 4, para IIIA, the agreement uses the word 'reimburse' and goes on to say in para B-I that Herbalife USA shall determine the actual costs incurred for providing services, but later developments showed that the element of reimbursement was retracted by the actions (billing system) of the appellant-company and Herbalife USA. It is noticed that for the period 10th Nov., 1999 to 31st Dec, 1999, no bill was raised by Herbalife USA on the appellant-company for the so-called reimbursement of costs. For the 5 quarters from 1st Jan., 2000 to 31st March, 2001, Herbalife USA raised a fixed billing of US $ 2,50,000 per quarter. This makes it abundantly clear that there is no element of reimbursement of real costs involved but a fixed lump sum payment. It is also seen in Exhibit A para 6 at p. 4 that Herbalife USA is to provide consultation services. Exhibit A is an Annexure to the administrative services agreement. Further, this matter was considered by the RBI while granting permission for the remittance of 'Administrative Services Fees', and their communication dt. 30th June, 2000 addressed to the appellant-company has clearly stated that the approval is for payment of 'services fee' and that income-tax should be paid thereon as per the provisions of the IT Act.
In the light of the above discussion, it is clear that there is no point-to-point reimbursement of actual expenditure undertaken by Herbalife USA on behalf of the appellant. It is a moot point that in any technical service agreement, what is being paid by the user is partly the cost of the manpower deployed by the service provider, but that does not constitute an arrangement for reimbursement of costs or bills. If the argument of the appellant were to be accepted, then payments to law firms, chartered accountant firms, marketing consultants, etc. would all escape the provisions of Section 40(a)(i) by arguing that the payer is only reimbursing them for the various labour and skill components and no element of profit is embedded in the bills.
In the light of the above, I hold that the money paid to Herbalife USA was in the nature of technical fees and not reimbursement of costs. Accordingly, the arguments of the appellant are rejected and the disallowance made by the AO by invoking the provisions of Section 40(a)(i) is upheld. In view of the finding that the payment made to Herbalife USA is disallowed under Section 40(a)(i), the arguments of the appellant relating to inequitable/contrary treatment of the quarters January-March, 2000 and January-March, 2001, are not discussed.
19. Aggrieved by the order of CIT(A), the assessee is in appeal before the Tribunal. We have heard the submissions of the learned Counsel for the assessee and the learned Departmental Representative at length. The following main issue would arise for consideration on the ground of appeal raised by the assessee on this issue:
(A) whether the consideration paid or payable by the assessee to M/s HIAI under the ASA is chargeable to tax in the hands of M/s HIAI, in India ?
The answer to the aforesaid question would again depend on the answer to the following questions:
1. Whether the sum in question is a mere reimbursement of expense which would not give rise to income chargeable to tax ?
2. If the answer to the above question is in the negative, what is the nature of service rendered by M/s HIAI to the assessee ? Can it be said to be "fees for technical services" rendered by M/s HIAI to the assessee within the meaning of Section 9(1)(vii) Expln. 2 of the Act ?
3. If the services rendered by M/s HIAI are technical services as above, whether applying the source rule they can be said to have accrued or arisen in India rendering them taxable in India in the hands of M/s HIAI ?
4. If the answer to question No. 3 is in the affirmative, yet the sum in question cannot be brought to tax in view of the provisions of Article 12(4)(b) of the DTAA between India and USA. The sum in question will not be fees for included service and, therefore, not taxable in India in view of the provisions of Section 90(2) of the Act which lays down that in relation to an assessee to whom DTAA applies, the provisions of DTAA will override the provisions of the Act to the extent to which they are more beneficial to an assessee ?
5. Can the alternative plea of the Revenue raised for the first time before the Tribunal that provisions of Article 12(4)(a) will apply and consequently the sum in question can be said to be fees for included services be entertained ? If yes, is such a plea sustainable ?
6. Can the alternative plea of the assessee that in any event in view of the provisions of Article 26(3) of the DTAA between India and USA the provisions of Section 40(a)(i) of the Act cannot be applied in the instant case and consequently no disallowance can be made as has been done by the Revenue authorities.
(B) If the sum in question is held to be not chargeable to tax and not disallowable under Section 40(a)(i) of the Act, whether the disallowance of the said sum for the period from 1st Jan., 2000 to 31st March, 2000 can be disallowed as a prior period expense or can it be said that the liability accrued or arose to the assessee only in the previous year relevant to asst. yr. 2001-02 ?
(C) Whether the sum in question claimed as expenditure relating to the period 1st Jan., 2001 to 31st March, 2001 can be allowed as a deduction ?
20. At the outset, we take up for consideration the question whether in view of the provisions of Article 26(3) of the DTAA between India and USA, even assuming that the payment in question is not a reimbursement of expenses and even assuming that they were fees for included services within the meaning of Article 12(4) of the said DTAA between India and USA, whether the provisions of Section 40(a)(i) of the Act, cannot be applied in this case and consequently no disallowance can be made. A decision on this question, in our view, will obviate the necessity of deciding the other questions raised in point (A) above. We may at this stage itself mention that apart from the consequence of disallowance of expenditure for non-deduction of tax at source at the time of making payment to a non-resident, the assessee as a person responsible for making payment of any sum chargeable to tax to a non-resident is obliged to deduct tax at source under the provisions of Section 195 of the Act. On such failure the person responsible for deduction of tax at source is liable to pay the tax deductible together with interest from the date on which such tax is due to the date on which such tax is paid under the provisions of Section 201(1) and (1A) of the Act. In the present case the payment to M/s HIAI had been made by the assessee's office at Bangalore and, therefore, the officer having jurisdiction over the branch office at Bangalore had already initiated proceedings against the assessee under the provisions of Chapter XVII of the Act dealing with "collection and recovery of tax" and part B thereof dealing with deduction at source. The assessee has, in such proceedings, taken a plea that the payment in question is not chargeable to tax. In such proceedings, which is now pending disposal before the Tribunal Bangalore Benches, the questions arising in this appeal, other than the applicability of Article 26(3) of DTAA between India-USA, is subject-matter for consideration. If applicability of Article 26(3) of DTAA between India and USA in the context of Section 40(a)(i) is decided in favour of the assessee, the other questions can be decided in the appeal pending before the Tribunal Bangalore Benches, which we feel is an appropriate forum to decide as to whether the payment by assessee to M/s HIM is chargeable to tax in India in the hands of M/s HIAI and the assessee as a person responsible for making payment ought to have deducted tax at source.
21. We may also incidentally point out that Article 27 of the DTAA between India and USA contemplates a situation where a person considers that actions of one or both the Contracting States result or will result for in taxation not in accordance with the provisions of the DTAA, then he may, without prejudice to other remedies available to him under the local law, present his case to a competent authority of the Contracting State of which he is a resident or national. The assessee has made a reference under the mutual agreement procedure provided under Article 27 of India-USA DTAA.
22. Keeping in mind the aforesaid background of the case, we now proceed to decide the question of applicability of Article 26(3) of India-US DTAA. Article 26 of India-US DTAA deals with "Non-discrimination". Article 26(1) says that nationals of one Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is much more onerous, then it is on the nationals of that other Contracting State. Article 26(2) provides against discrimination in the context of a PE in the other Contracting State. Article 26(3) is a general clause providing for indirect discrimination against a non-resident, it reads thus:
Article 26(3) : Except where the provisions of para 1 of Article 19 (associated enterprises), para 7 of Article 11 (interest), or para 8 of Article 12 (royalties and fees for included services) apply, interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State, shall, for the purposes of determining the taxable profits of the first mentioned, resident, be deductible under the same conditions as if they had been paid to a resident of the first mentioned State.
The provisions of Section 40(a)(i) as it stood prior to its amendment by the Finance Act, 2003 w.e.f. 1st April, 2004 applied to payments by an assessee outside India to a non-resident only. After 1st April, 2004 the provisions apply equally to both resident and non-resident. In this appeal we are concerned with asst. yr. 2001-02 in which the provisions of Section 40(a)(i) as it existed prior to 1st April, 2004 alone are applicable. Admittedly, in the present case the exceptions set out in Article 26(3) are not attracted. Therefore, the payment by the assessee to M/s HIAI is of the nature contemplated by Article 26(3).
23. A question may arise for consideration is as to whether assessee who is a resident could take benefit under this clause, i.e., Article 26(3). A plain reading of Article 26(3) clearly suggests that the assessee can claim the benefit. In this regard it would be relevant to refer to the provisions of Section 90(2) of the Act, which reads as follows:
Section 90(2), Where the Central Government has entered into an agreement with the Government of any other country outside India under Sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation then in relation to the assessee to whom such agreement applies, the provisions of this Act, shall apply to the extent they are more beneficial to that assessee.
24. The payment in question by assessee to M/s HIAI attracts the provisions of the Indo-US DTAA. The payment in question if at all will be taxable in the hands of M/s HIAI in India only if it is a payment for included services within the meaning of Article 12(4) of the said DTAA and not taxable in India otherwise. The sum in question cannot be taxed as business income, since M/s HIAI admittedly does not have a PE in India. If the income is considered as having accrued or arisen to M/s HIAI in India, yet they can be taxed in India only if they are fees for included services. Even if the payment is considered as "fees for technical services" within the meaning of IT Act, 1961, yet they cannot be taxed because 'fees for technical services' and 'fees for included services' under India-US DTAA have different meaning and they are not one and the same. If the Revenue wants to tax the payment by assessee to M/s HIAI in the hands of M/s HIAI in India it has to bring its case within the ambit of Article 12(4) of the DTAA, i.e., fees for included services. The payment in question would, therefore, have to be judged in the context of the DTAA as to whether it is taxable in India or not.
25. We shall now revert to Article 26(3) of the DTAA which deals with non-discrimination. To illustrate as to what extent the non-discrimination clause would apply, we may make a reference to such clauses in the OECD Model of "Double Taxation Convention". Organisation for Economic Co-operation and Development ("OECD") is an organization, comprising of member countries, for economic co-operation. Its fiscal committee had taken up for consideration the study of questions relating to double taxation and of other fiscal questions of a similar technical nature. The committee after examining methods by which taxation can be used to promote improved allocation and use of economic resources, both domestically and internationally and after considering ways of increasing the effectiveness of taxation as a policy instrument for achieving Government objectives, have made a model Double Taxation Convention. The member countries generally use this model as a basis for negotiating Double Taxation Conventions. India is not a member of the OECD. We may at this stage set out the provisions of non-discrimination as contained in the OECD model. Article 24(4) of the OECD model is in pari mateha the same as that of Article 26(3) of the Indo-US DTAA and the same reads thus ;
Article 24(4) : Except where the provisions of para 1 of Article 9, para 6 of Article 11 or para 4 of Article 12, apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident, of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first mentioned State." [Other portion of Article 24(4) are not repeated as they are not relevant to the present issue], Mr. Philip Baker, Author of the book on "Double Taxation Conventions and International Tax Law", A manual on the OECD model tax convention on Income and on capital, 1992, Second Edn. at pp. 396 to 397 has the following to say on Article 24(4).
Article 24(4): Deduction of interest, royalties and other disbursements 24-18 Article 24(4) is not concerned with the discriminatory treatment of nationals, etc. of one State in the other Contracting State, but the treatment of enterprises of a Contracting State under the tax law of that State. Subject to the position where a special relationship exists between the enterprise and the recipient, interest, royalties and other disbursements paid to a resident of the other Contracting State should be deductible to the same extent that they would be deductible if paid to a resident of the same State. Thus this prevents the indirect discrimination which would arise if the sums were not deductible. A similar provision is included in the article relating to the deduction of debts owed to residents of the other Contracting State in determining the taxable capital of the enterprise.
At p. 411, the following commentaries are found on Article 24(4):
This paragraph is designed to end a particular form of discrimination resulting from the fact that in certain countries the deduction of interest, royalties and other disbursements allowed without restriction when the recipient is resident, is restricted or even prohibited when he is a non-resident. The same situation may also be found in the sphere of capital taxation, as regards debts contracted to a non-resident. It is however open to Contracting States to modify this provision in bilateral conventions to avoid its use for tax avoidance purposes,
26. As already observed by us the provisions of Section 40(a)(i) as it existed prior to its amendment by Finance Act, 2003, w.e.f. 1st April, 2004 provided for disallowance of payment made to a non-resident only where tax is not deducted at source on such payment at source. A similar payment to a resident does not result in disallowance in the event of non-deduction of tax at source. Thus a non-resident left with a choice of dealing with a resident or a nonresident in business would opt to deal with a resident rather than a nonresident owing to the provisions of Section 40(a)(i). To this extent the non-resident is discriminated. Article 26(3) of Indo-US DTAA seeks to provide against such discrimination and says that deduction should be allowed on the same condition as if the payment is made to a resident. Thus this clause in DTAA neutralizes the rigour of the provisions of Section 40(a)(i). By virtue of the provisions of Section 90(2) the law which is beneficial to the assessee to whom the DTAA applies, should be followed. We, therefore, hold that in view of Article 26(3) of Indo-US DTAA, the AO cannot seek to invoke the provisions of Section 40(a)(i) of the Act to disallow the claim of the assessee for deduction even on the assumption that the sum in question is chargeable to tax in India. We however make it clear that the question whether the sum is chargeable to tax is left open for adjudication by the appropriate forum in the appropriate proceedings already referred to in this order.
27. This takes us to question (B) framed by us, viz., if the sum in question is held to be not chargeable to tax and consequently not disallowable under Section 40(a)(i) of the Act whether the disallowance of the sum attributable for the period from 1st Jan., 2000 to 31st March, 2000 can be said to be prior period expenses or can it be said that the liability accrued or arose to the assessee only in the previous year relevant to asst. yr. 2001-02. As far as this question is concerned, the plea of the assessee has been that since the agreement with M/s HIAI is dt. 11th Sept., 2000 and since the period from 1st Jan., 2000 to 31st March, 2000 was the first period for which M/s HIAI raised a bill for services rendered to the assessee, it was not possible for them to even make an estimate of the expenditure and make a claim for deduction on a notional basis in asst. yr. 2000-01. The assessee also pointed out that M/s HIAI prepares its books of account on a calendar year basis and that only in June, 2000 it raised a bill on the assessee for the services it rendered to the assessee. The assessee further submitted that since the payments to M/s HIAI without the permission of the RBI was contrary to the provisions of FERA, 1973 or rules prescribed under the said Act, no expenditure can be said to have accrued or arisen to the assessee till such time RBI grants permission for remittances to M/s HIAI. The assessee pointed out that only on 30th June, 2000 the permission of RBI was received. The assessee, therefore, pointed out that the expenditure had accrued only in the previous year relevant to asst. yr. 2001-02.
27.1 The learned Counsel for the assessee reiterated the plea as was raised before the Revenue authorities. Reliance was placed by him on the following decisions for the proposition that where the particular act is prohibited under the provisions of any law without obtaining the approval of an authority then it cannot be said that until and unless such an approval is obtained, a payment which is dependent on such approval, can be said to have accrued as a liability. Nonsuch Tea Estate Ltd. v. CIT , CIT v. John Fowler (India) Ltd. , CIT v. Kirloskar Tractors Ltd. . The learned Departmental Representative on the other hand relied on the order of the Revenue authorities and also placed reliance on the decision of the Hon'ble Supreme Court in the case of Associated Cement Companies Ltd. v. Commr. of Customs 128 ELT 21 (SC) wherein the Hon'ble Supreme Court has held that the grant of permission by RBI for remittance in connection with import of drawings and designs cannot be construed and be held as decisive in the proceedings before the customs authorities under the Customs Act, 1962 where the question is whether they were goods chargeable to customs duty.
28. We have considered the rival submissions. It is not in dispute that as per the provisions of the FERA, 1973, the payment by the assessee to M/s HIAI could not be made by the assessee without obtaining the approval of the RBI. It is also not in dispute that the RBI granted approval for the remittances by the assessee to M/s HIAI only by its letter dt. 30th June, 2000. The Hon'ble Supreme Court in the case of Nonsuch Tea Estates Ltd. (supra) was concerned with the case where an assessee paid remuneration to managing agent which required the permission of the Central Government under the provisions of the Companies Act, 1956 for their appointment. The assessee was following the mercantile system of accounting. Though the remuneration paid by the assessee related to the period prior to the asst. yr. 1959-60 the assessee claimed the same as deductible expenditure in the asst. yr. 1959-60 on the ground that Central Government's approval was obtained only in the previous year relevant to asst. yr. 1959-60. The Hon'ble High Court did not agree with the plea of the assessee. The Hon'ble Supreme Court however reversed the decision of the Hon'ble High Court and held that the liability arose only when the approval was given by the Central Government for appointment of the managing agent. In the case of John Fowler India Ltd. (supra) the Hon'ble Bombay High Court has held that the liability towards royalty accrued only when the Government of India granted an approval to the agreement. The decision of the Hon'ble Supreme Court in the case of Associated Cement Companies Ltd. (supra) relied upon by the learned Departmental Representative is in a different context. In the said case the Court held that the purpose of grant of an approval by the RBI for remittance is from the viewpoint of the implications of Foreign Exchange outflow and that it had no impact on the adjudication under the Customs Act as to whether the payment for which permission was granted by the RBI was for rendering services or for import of goods. Considering the law laid down in the aforesaid judicial pronouncements, relied upon by the learned Counsel for the assessee, we are of the view that the claim of the assessee that the expenses for the period 1st Jan., 2000 to 31st March, 2000 accrued as a liability to the assessee only during the previous year and the action of the Revenue authorities holding that it is a prior period expenses cannot be sustained. The expenditure claimed for this period is, therefore, directed to be allowed as a deduction.
29. The next point that arises for consideration is as to whether the Revenue authorities were justified in disallowing the claim of the assessee for deduction in respect of fees paid to M/s HIAI for the period relating to 1st Jan., 2001 to 31st March, 2001. As far as the fee payable for this period is concerned, the reason given by the AO for making the disallowance was since the payment to M/s HIAI required the consent of the RBI and since there was no evidence to show that the assessee did apply for such permission to the RBI for the period subsequent to 31st Dec, 2000 it was evident that the assessee treated this liability as non-existent. The AO also noticed that even in subsequent years the assessee has not made any provisions for its liability on this account. The AO, therefore, disallowed the claim for the expenditure for the period relating to 1st Jan., 2001 to 31st March, 2001. As far as the expenditure for this period is concerned, there is no dispute that RBI permission was not required on or after 1st June, 2000 consequent to the repeal of FERA, 1973 and introduction of FEMA, 1999. Under FEMA, 1999, the payment in question by the assessee to M/s HIAI would fall in the category of current account transaction and, therefore, it did not call for any permission from RBI and the authorised dealers were permitted for making remittances in connection with current account transactions. In view of the above the payment for this period did not require the permission under any other law. Though the assessee did not receive any bill for this period from M/s HIAI it had made an estimate of the amount payable to M/s HIAI for this period on the basis of the bill that it had received from M/s HIAI for the period 1st Jan., 2000 to 31st Dec, 2000. This was a reasonable basis on which the assessee could claim a liability as having accrued. The Hon'ble Supreme Court in the case of Bharat Earth Movers v. CIT has stated the law m this regard as follows:
The law is settled : if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.
30. The liability of the assessee in the present case has, therefore, to be held as accrued and arisen during the previous year relevant to asst. yr. 2001-02 and, therefore, the claim made by the assessee for deduction deserves to be accepted. The AO is directed to allow the same.
31. We, therefore, hold that the claim of the assessee for deduction of the entire sum of Rs. 5,83,68,396 being administrative fee paid to M/s HIAI should be allowed as a deduction. The AO is directed to allow the deduction accordingly. The third ground of appeal of the assessee is allowed, to the extent and on the basis indicated above.
32. In ground Nos. 4 and 4.1 the assessee has challenged the action of the Revenue authorities in disallowing the claim for deduction of expenditure of a sum of Rs. 53,63,731 being expenditure incurred for improvements carried out in respect of premises taken on lease by the assessee. The reasons given by the Revenue authorities for making the disallowance was that the expenditure was of a capital nature. It is seen from the order of the AO as well as the order of the CIT(A) that none of them have considered the nature of expenses before concluding that they were of a capital nature. The details of the expenditure are as follows:
Details of leasehold improvements during the financial year 2000-01:
Date Particulars Amount Rs.
19.6.2000 Wood work, aluminium lock, 3,500.00
30.12.2000 wiring board 18,55,278.52
26.06.2000 Interior work 71,600.00
20.10.2000 Renovation work at Koramangala 60,000.00
Vinyl flooring, anodysed
31.05.2000 aluminium partitions 25,98,264.69
31.05.2000 Renovation work at Mumbai 4,92,469.91
31.08.2000 Electrical work at Mumbai 18,000.00
30.12.2000 Water proofing work 58,000.00
12.06.2000 Rectangle awning in two parts 17,700.00
14.08.2000 Wooden steps 1,08,331.12
05.09.2000 Interior work 27,066.50
31.10.2000 Meha designers 53,521.00
Sign palates, fixing of
flyer/drawers
Total : 53,63,731.74
33. It is noticed that in respect of the individual items of expenditure listed above, the assessee had furnished the details as well as copies of bills and the same are placed at pp. 140 to 186 of the assessee's paper book. On perusal of the various bills as well as the nature of expenses narrated above, it is clear that the expenditure did not create a benefit of an enduring nature to the assessee. These expenses have been incurred with the view to enable the assessee to carry on its business more effectively. The nature of expenses involved carrying out some alterations to the flooring, carrying out of some interior work, carrying out wooden panelling, wooden partition, installing false ceiling, installation of electrical fittings and wiring, etc. Perusal of the above, in our view, clearly shows that the expenditure in question cannot be considered as capital expenditure. After the insertion of Expln. I to Section 32 of the Act, even in respect of a leased premises if an assessee or lessee incurs capital expenditure, he can only claim depreciation. But as already stated, the expenditure in the present case is not of a capital nature, and, therefore, the disallowance made by the Revenue authorities cannot be sustained. A similar issue had come up for consideration in assessee's own case in the asst, yrs, 1999-2000 and 2000-01 in ITA Nos. 3098 and 2664/Del/20C4. This Tribunal on identical facts had held that the claim for deduction made by the assessee had to be allowed. The Tribunal held that these expenditure were necessary for day-to-day working of the assessee smoothly and it was necessary and was to facilitate the carrying on the business of the assessee. In view of the above the disallowance made by the Revenue authorities cannot be sustained, the same is directed to be deleted.
34. In the fifth ground of appeal the assessee has challenged the action of the Revenue authorities in disallowing a sum of Rs. 5,97,184 on account of foreign exchange fluctuation loss. In the grounds of appeal the assessee has however mentioned the figure at Rs. 73,17,184 which is a mistake as admitted by the learned Authorised Representative before us. As far as this issue is concerned, the total of the loss on foreign exchange fluctuation is given at p. 187 of assessee's paper book 1 which is as follows:
Summary of foreign exchange loss transactions during the year 2000-01 Rs.
On account of technical know-how fees $ 2 Million 67,20,000.00 Imports 8,06,243.03 Expenses on travel, communication costs etc, (55,584.90) Loan 3,01,674.29 Administration Fee (4,55,148.00)
35. It is not in dispute that the assessee has been consistently following a system of accounting for recording the exchange variation both when it is a loss as well as when there is a gain as on the last day of every financial year. It is also not in dispute that the foreign exchange fluctuation is not on capital account. According to the Revenue authorities the loss or gain for foreign exchange should be taken only at the time of remittance and only then there can be an accrual. This issue has been considered by the Special Bench of the Tribunal in the case of Oil & Natural Gas Corporation Ltd. v. Dy. CIT (2002) 77 TTJ (Del)(SB) 387 : (2002) 83 ITD 151 (Del)(SB). The said Bench has held that in the case where an assessee consistently follows a system of accounting by which the fluctuation in foreign exchange currency is duly accounted for at the end of the accounting year, the same cannot be said to be notional and it cannot be said that the assessee could claim the fluctuation loss or gain only in the year when the loan was actually repaid. The Tribunal held that the loss was not a notional loss and was to be allowed as deduction. The Tribunal also referred to the AS-2 of the Institute of Chartered Accountants of India (the assessee in the present case follows such an accounting standard). In view of the above the loss on account of foreign exchange claimed by the assessee deserves to be allowed. The 5th ground of appeal is accordingly allowed.
36. In the ground No. 6, the grievance of the assessee is against the action of the CIT(A) in confirming the view of the AO that the books of account, are unreliable and sustaining a lump sum (addition) of Rs. 5 crores on this count. The brief facts are as follows. The AO found that the assessee had claimed a deduction of Rs. 2,56,17,272 by way of debit to the P&L a/c on account, of obsolete/damaged inventory. During the course of assessment proceedings the AO show caused the assessee to submit the details and justify the write off. The assessee was further required to submit a reconciliation of each of the items written off vis-a-vis the opening stock, production, sale and closing stock. In response, the assessee submitted that the finished goods were written off as there was huge pile-up of inventory and the products had become unfit to be sold. However, the reconciliation of stocks did not tally inasmuch as the opening stock plus receipts less issues and write off did not tally with the closing stock. The quantitative reconciliation statement prepared by the assessee also differed from the quantitative figures of opening and closing stocks shown in the audited balance sheet and P&L a/c for the year under consideration. In this background the AO concluded as under:
I therefore, based on the findings above, hold that the manufacturing and trading accounts of the assessee are not correct and complete. Its opening and closing stocks are not tallying as per its own stock records. The production of each of the products is also not reflected correctly in the stock records, since only the balancing figure is taken. The sales in different statements submitted are varying and are not reliable. I, therefore, proceed to determine the trading income of the assessee to the best of my judgment. In the current year the assessee has debited manufacturing costs which is 28.8 per cent of its sales whereas in the preceding year the manufacturing costs was 19.6 per cent of the sales. The sharp increase in the cost of manufacture, coupled with the inability of the assessee to reconcile its production, sales, stock write off and the opening and closing stock, further lead me to believe that he assessee has not recorded its transactions fully and truly in its books of account. Even taking into account inflation, the slump in sales in the later part of the year, etc. the increase in the cost of production is found to be disproportionate. I, therefore, make a lump sum addition of Rs. 5 crores to the income of the assessee on account of its manufacturing and trading operations in view of the disproportionate increase in the manufacturing costs and the unreliable nature of the assessee's books.
37. Aggrieved with the aforesaid, the assessee carried the matter in appeal before the CIT(A) In appeal, the assessee contended that since the AO had taken up this issue at the fag end of the proceedings, the assessee did not have adequate time to properly explain the reconciliation statements filed before the AO, but nevertheless admitted that the discrepancies existed. At that stage, the assessee, in order to completely reconcile its stock statements, approached a firm of chartered accountants to carry out an independent exercise to ascertain the discrepancies, if any, in the stock position for the year under consideration. The report revealed discrepancies in the stock statements of the assessee with the profit for the year being understated by a sum of Rs. 72,36,139. The assessee submitted such report to the CIT(A) as additional evidence under Rule. 46 of the IT Rules. 1962. The assessee also submitted that the discrepancies were not such so as to merit rejection of the manufacturing and trading results of the assessee. However, the CIT(A) has declined to admit the additional evidence on the ground that the report was only an attempt to patch up the discrepancies noted by the AO in the records maintained by the assessee. The CIT(A) also sustained the addition made by the AO. The assessee is presently in appeal before us.
38. Before us, the learned Counsel for the assessee has assailed the decision of the CIT(A) in rejecting the prayer of the assessee for submission of additional evidence and not examining the same on merits. According to the learned Counsel the approach of the CIT(A) was not guided by principles of natural justice and fairplay. On merits, the learned Counsel explained that the discrepancies in the stock statements were primarily on account of use of different softwares in maintaining the inventory transaction and the financial books of account. The inventory taken on the basis of oracle software accounting system was compared with the stock statements and the discrepancies noticed were attempted to be reconciled by the firm of chartered accountants appointed for carrying out this exercise. The learned Counsel has vehemently submitted that the estimation made by the lower authorities was highly unjustified and the basis adopted was not justified, on facts. It was further submitted that the profit for the year, if at all, may be increased by an amount of Rs. 72,36,139 in terms of the report of an independent firm of chartered accountants.
39. The learned Departmental Representative has defended the orders of the lower authorities by placing reliance on the reasonings taken by them resulting in the addition based on an estimate basis.
40. We have considered the rival submissions. At the outset, we may state that insofar as the discrepancies in the rtock statements is concerned, the assessee itself does not seriously dispute that the same exist. The central explanation of the assessee for the difference is on account of the inventory software package which was introduced by the assessee in this year. Without going into the merits of the same, it is safe to deduce that the discrepancies are such so as to impact the profits declared by the assessee in its books of account. Thus, the unreliability of the manufacturing and trading results reflected in the assessee's P&L a/c attached with the return of income stands established and has been rightly ignored by the AO. Now, it brings us to the next stage, i.e., the efficacy of estimated addition of Rs. 5 crores made on this count. The AO has observed that in the year under consideration the manufacturing costs are 2,8.8 per cent of sales as against 19.6 per cent in the preceding year. Coupled with the unreliability of manufacturing and trading results the AO made an estimate of Rs. 5 crores. The assessee has explained that the major increase is on account of excise duty component which has increased from 0.65 per cent to 10.18 per cent and, therefore, the proportion of increase in manufacturing costs cannot be the yardstick to estimate the impact on the income. Similarly, the increase in the proportion of conversion costs, freight, etc. also cannot be the sole basis to estimate the impact of discrepancies on profits. We find that the assessee has ample force in its stand inasmuch as the turnover of the assessee in the preceding year was primarily of traded goods whereas in the current year the proportion of manufacturing goods has increased substantially. Nevertheless, it is inevitable that any process of estimation would involve an element of guesswork, but it is to be based, as far as possible, on the basis of material on record. In the instant case, we find that the entire dispute had arisen when the AO started the verification exercise of the write off of obsolete damaged stocks claimed by the assessee. The stocks record maintained was found to be unreliable for the same being unreconciled. In the entire exercise, there is no material or evidence that the assessee has carried out any sales outside the books of account. In our view, having regard to the facts and circumstances, in the interest of justice and to plug leakage of revenue, it would be appropriate if an addition of Rs. 3 crores be made to the income of the assessee to cover the impact on profits on account of unvenfiable discrepancies in stock records. The order of the CIT(A) is accordingly modified. The assessee partly succeeds on this count.
41. In the result, the appeal of the assessee is partly allowed.