Income Tax Appellate Tribunal - Mumbai
Mahindra & Mahindra Ltd, Mumbai vs Assessee on 10 April, 2012
IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI BENCHES "B" MUMBAI
BEFORE SHRI D. MANMOHAN, VICE PRESIDENT
AND
SHRI RAJENDRA, ACCOUNTANT MEMBER
ITA No. 8597/Mum/2010
Assessment Year 2006-07
Mahindra & Mahindra Limited, The Dy. Commissioner of
Mahindra Towers, Income Tax, 2(2),
Ground Floor,
Corporation Taxation, Worli Aayakar Bhavan,
Road No.13, Worli, M.K. Marg,
Vs. Mumbai - 400 020.
Mumbai - 400 018.
PAN: AAACM 3025E
(Appellant) (Respondent)
Assessee by : Shri H.P.Mahajani
Revenue by : Shri Pravin Varma
Date of hearing : 10.4.2012
Date of pronouncement : 06.06.2012
ITA No. 8597/Mum/2010
2
ORDER
PER RAJENDRA, A.M.
Following are the Grounds of Appeal preferred in the appeal filed challenging the Order dt. 26-10-2010 of the Assessing Officer (AO) i.e., DCIT Circle 2(2), Mumbai:
1. Expenditure debited to Profit and Loss Account Rs. 7,97,64,054/-
On the facts and in the circumstances of the case and in law, the Appellant contends that the DCIT erred in disallowing the following sums:
Sr .No Particulars Amount Amount
A Consultancy fees -- Automotive Division -- Worli Marketing 1,69,10,466
1 Due Diligence study in China 65,44,720
2 Legal expenses for acquisition of Euriss Motors. (Italy) 15,38,942
3 Deed of assignment with MIPL -- orient Law Firm 25,000
4 Memorandum fees -- Orient Law firm 5,000
5 Payment to Azb & Partners for Project Ganesh / International 87,96,804
Trucks
B Expenses incurred in connection with proposed acquisition of 3,48,12,788
Tractorul UTB S.A.Brasov -Romania.
(Break up of Expenses attatched)
C Expenses incurred for other acquisitions 2,35,65,648
1 Foreign travel expenditure 3,274,953
2 KPMG Fees provided -- Stokes 881,600
3 Fee For Technical Serv To Stokes Forgings WaIlsall 234,300
4 Prof Fess Flexion Review & Acquisition $ 896 39,684
5 Tds-Eur [email protected] & Tax Due Deligence 6,562
6 Prof.Chrgs. Due Diligence Of Stokes Group 71,48,331
ITA No. 8597/Mum/2010
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7 Stokes Forgings Matter-Legal Due Diligence 33,63,579
8 Advisory Fees-Plexion Technologies 22,68,603
9 Acturial Valuatn.-Pension On Stokes-Project Auto 10,24,400
10 Consultancy Services Acquisition Stokes Group 2,77,520
11 Consultancy Services : Acquisition Stokes Group 250,000
12 Consultancy Services : Acquisition Stokes Group 250,000
13 Consultancy Services : Acquisition Stokes Group 250,000
14 Acturial Valuatn.-Pension On Stokes-Project Auto 44,128
15 Consultancy Services : Acquisition Stokes Group 6,312
16 Consultancy Services : Acquisition Stokes Group 3,560
17 Consultancy Services : Acquisition Stokes Group 3,045
18 Advisory Fees-Plexion Technologies 680,581
19 Prof Chgs - Acquisition -Plexion Technologies 15,200
20 Prof Fess Flexion Review & Acquisition $ 896 39,684
21 Prof.Fees Due Diligince Revies-Chasecom Ltd 282,500
22 Project Alpha-Maspl-Amforge Aquisition Matter 604,500
23 Legal-Prof.Fees In Connection With Fii Opinion 60,000
24 Purchase Of Shares Of Temasek/Research 75,000
25 Legal Fees Drt Registrar Ii M.A. 101 Of 2004 3,500
26 Proff. Chgs At Govardhan Village Nashik 67,850
27 Legal Exps. For Aquiring Land At Nashik 67,100
28 Legal Prof Fees For MRV at Mahindra Industiral Park-Chennai 45,000
29 Prof Fees Consulting Project Forging Eur 13125.95 741,616
30 Prof Services Rendered For China Proj $3889.98 173,259
31 Prof Fees for acquisition of 98.6% shares/Invst 392,500
32 Profession Fee Paid 384,341
33 Environmental Report by Mouchel Parkmen 7755GBP 606,441
ITA No. 8597/Mum/2010
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D Expenditure in connection with issue of bonus shares
Stamp Duty on issue of Bonus Shares
E Expenditure on issue of FCCB 3,15,063
Bank charges-FCCB 122,179
FCCB Bonds -Adm Fee & Out Pkt Exps $ 4428 @ 43.56 192,884
F Bank charges -- Lead manager fees 30,00,000
TOTAL 7,97,64,054
treating the same as capital expenditure and also for the reason that these expenses were not incurred for the purposes of the business of the appellant:The DCIT ought to have upheld the Appellant's contention that the expenses were incurred wholly and exclusively for the purpose of business of the Appellant and therefore were allowable as deduction.Without prejudice to the above, the Appellant contends that the DCIT should have allowed depreciation thereon at the appropriate rate.
Without prejudice to the above, the Appellant contends that the DCIT should have allowed depreciation thereon at the appropriate rate.
2. Expenses in connection with development of engine Rs. 1,00,83,026/-
On the facts and in the circumstances of the case and in law the Appellant contends that the DCIT erred in not allowing deduction in respect of development expenses of Rs. 1,00,83,026/- incurred towards consultancy fees and other revenue expenses as revenue expenditure u/s 37(1) and instead allowing only depreciation thereon of Rs. 25,20,756 under section 32 of the Act treating same as capital expenditure.
Without prejudice to the generality of the above ground the DCIT ought to have allowed the above sum of Rs. 1,00,83,026 in its entirety under section 35 of the Act.
3. Development expenses - compact project for tractors Rs. 1,89,58,986/-
On the facts and in the circumstances of the case and in law the Appellant contends that the DCIT erred in not allowing deduction in respect of development expenses of Rs. 1,89,58,986/- incurred towards consultancy fees and other revenue expenses as revenue expenditure u/s 37 and instead allowing only depreciation thereon of Rs. 23,69,872/- under section 32 of the Act.
Without prejudice to the generality of the above ground the DCIT ought to have allowed the above sum of Rs.1,89,58,986 in its entirety under section 35 of the Act.
4. Premium payable on 'Foreign Currency Convertible Bonds'(FCCB) Rs. 5,39,94,814/-
ITA No. 8597/Mum/2010 5On the facts and in the circumstances of the case and in law the Appellant contends that the DCIT erred in disallowing prorate premium payable on FCCBs stating that the same cannot be treated as revenue expenditure allowable u/s 37(1) of the Income Tax Act, 1961.
5. Reversal of Premium payable on FCCBs- Rs. 8,43,76,582/-
On the facts and in the circumstances of the case and in law the Appellant contends that the DCIT erred in disallowing from taxable income, reversal of premium on Rs. 8,43,76,582/- incurred and claimed by the Appellant in earlier years. but disallowed in the assessment orders. passed for those years. The DCIT ought to have accepted the claim of appellant that since the premium was not allowed as deductible expenditure in the assessment of earlier years, reversal of such premium should not have been taxed-resulting into double taxation.
The Ld. DCIT erred in calling upon the appellant to withdraw its claim for deduction of the said expenditure in the said earlier assessment years. as a precondition for allowing the claim.
6. Unutilsed CENVAT credit on raw material - Rs. 25,18,342/-
On the facts and in the circumstances of the case and in law the DCIT erred in treating the incremental CENVAT credit balance of Rs. 25,18,342/- (`42,19,86,486/- as on 31.3.2006 as reduced by Rs. 41,94,68,144 as on 31.3.2005) as revenue income liable to tax be included in the income of the Appellant.
7. Octroi Incentive -- not taxable being capital receipt Rs.2050.92 lakhs On the facts and in the circumstances of the case and in law the DCIT erred in not accepting the contention of the Appellant that Octroi Incentive of Rs.2050.92 lakhs received during the year was in the nature of capital receipt and therefore was not liable to tax.
8. Special Pension -- Rs.48,87,957/-
On the facts and in the circumstances of the case and in law the DCIT erred in allowing deduction u/s 35DDA for only 1/5th (iRs.9,77,591) of the amount of provision made for liability of Rs.48,87,957/- on account of special pension based on the valuation provided by the Appellant rejecting the contention of the Appellant that the provisions of the said section were not applicable to the facts of the case and accordingly the entire amount of Rs.48,87,957 was allowable in the year under appeal.
9. Provision for Warranties -- Rs. 16, 19,08,000 On the facts and in the circumstances of the case and in law the Appellant contends that the D.C.I.T. erred in treating the provision for warranties made as at 3 103 2006 as inadmissible expenditure on the ground that this provision is in the nature of contingent liability and hence not an ascertained liability.
10. Provision for pending labour demand- Rs. 78,45,000/ ITA No. 8597/Mum/2010 6 On the facts and in the circumstances of the case and in law the Appellant contends that the D.C.I.T. erred in not allowing deduction of Rs.78,45,000/ being the provision, representing minimum liability, made by the Appellant towards pending labour demand totally disregarding the fact that the said liability was a certain liability though only the ultimate quantification of the liability was done at a later date.
11. Disallowance U/s. 40A(9) - Rs. 6,86,594 representing the actual expenses incurred and Rs.19,52,172/- being contribution to Mahindra Academy
a) On the facts and in the circumstances of the case and in law the Appellant contends that the D.C.I.T. erred in not granting deduction of Rs.6,86,594/-, being the actual expenditure incurred during the year on employee welfare
b) On the facts and in the circumstances of the case and in law the DCIT has also erred in disallowing u/s 40A(9) Rs.19,52,172 representing amount paid to Mahindra Academy. The Appellant contends that the school run by Mahindra Academy was for the benefit appellant's employees and also of other local residents and therefore, provisions of section 40A(9) are not applicable to such payment.
12. Expenses on Employees' stock Option -- Rs. 3,69,07,378/-
On the facts and in the circumstances of the case and in law the D,C,I.T erred in disallowing the deduction of Rs.3,69,07,378 claimed by the Appellant being the difference between the fair market value of the shares offered to employees on the date of the grant of option and the price at which they are offered to employees under the ESOP Scheme of the Appellant. The DCIT erred in treating the said expenditure being for increasing the share capital of the Appellant rejecting the contention of the Appellant that it was actually in the nature of staff cost.
13. Disallowance U/s. 14A -- Rs. 29.37 crores On the facts and in the circumstances of the case and in law the DCIT erred in disallowing an amount of Rs.29.37 crores under section 14A and thereby not accepting the contention of the Appellant that no expenditure was incurred in relation to exempt income earned by the Appellant during the relevant year so as to warrant disallowance u/s 14A.
14. Payments to Clubs - Rs.1,17,01,995/-
On the facts and in the circumstances of the case and in law The Appellant contends that the D.C.I.T. erred in disallowing as capital expenditure a sum of Rs.1,17,01,995/- being membership fees paid by the Appellant to various clubs, disregarding the fact that the said payments are in the nature of revenue expenditure and have been made wholly and exclusively for the purposes of business.
15. Adjustment u/s 92CA(3) to Arm's Length Price of international transaction -- adjustment of Rs.1,26,51,602/-.
On the facts and in the circumstances of the case and in law, the DCIT erred in adding a sum of Rs.1,26,51,602/- to the total income of the Appellant, being the amount of adjustment made ITA No. 8597/Mum/2010 7 in TPO's order u/s 92CA on account of the determination of Arm's Length Price (ALP) on international transactions with an Associated Enterprise. The addition be annulled.
16. Disallowance of capital loss on sale of R&D assets of Rs.1,85,21,865 On the facts and in the circumstances of the case and in law the DCIT erred in disallowing claim for deduction of capital loss on sale of R&D assets of Rs.1,85,2 1,865 and thereby not accepting the Appellant's contention that such loss was correctly claimed under the provisions of Act.
17. Consideration received on sale of LCV business in the form of non-compete covenant Rs.10,50,00.000 treated as business income On the facts and in the circumstances of the case and in law the Appellant contends that the DCIT erred in bringing to tax a sum of Rs.1050 lacs as income from business u/s 28(va) of the Act rejecting its contention that the said income by way of non-compete fees was taxable, at the highest, u/s 45 read with section 55 of the Act.In any event the DCIT has erred in adding to the income of the Appellant the said sum of iRs.1050 lacs when the same was already offered for tax under the head Capital Gains, and the DCIT has started the computation of assessed income from the amount of total income as per Return of Income, thereby resulting in the said income being inadvertently brought to tax twice.
18. Provision for price escalation I obsolescence Rs.4.59,70,000 On the facts and in the circumstances of the case and in law the Appellant contends that the DCIT erred in disallowing provision for price escalation and obsolescence in the amount of Rs.4,59,70,000 on the ground that the liability was in the nature of a contingent liability and there was no scientific basis for determining the same.
19. Disallowance under section 40a(ia) in respect of year end provisions Rs.4.25,52,623 On the facts and in the circumstances of the case and in law the DCIT erred in disallowing Rs.4,25,52,623 u/s 40a(ia) rejecting the contention of the Appellant that the provisions of the said section were not applicable to the facts of the case.
20. Disallowance of weighted deduction under section35(2AB) On the facts and in the circumstances of the case and in law the DCIT erred in not allowing weighted deduction u/s 35(2AB) with reference to expenditure of Rs.77,56,28,741 incurred on in-house Scientific Expenditure rejecting the contention of the Appellant that it was entitled to the said deduction with reference to such expenditure incurred at Nashik and Kandivali locations and also that non-receipt of form 3CL from DSIR was not determinative of the issue.
21. Disallowance of deduction under section 801C On the facts and in the circumstances of the case and in law the DCIT erred in not recording a finding that the Appellant had during the year set up an undertaking, profits derived from which would be eligible for deduction u/s 80-IC of the Act and in not quantifying the loss ITA No. 8597/Mum/2010 8 suffered by the said undertaking in the year under assessment.
22. Short Credit of TDS of Rs.185,57,211/-
On the facts and in the circumstances of the case and in law the DCIT erred in not allowing credit for TDS of Rs.1,85,57,211/-.
2.First Ground is about disallowance of Rs.7.97 Crores. While going through the audit report of the Appellant, Assessing Officer(AO) noticed that the Appellant had debited capital expenditure amounting to Rupees to 20.04 Crores to the profit and loss account. When inquired the Appellant submitted that out of Rupees Rs.20.04 Crores,Rs.12.07crores were added back to the comutation and the balance expenditure amounting to Rs.7.97Crores was claimed as revenue expenditure.
2.1.Before us, the Authorised representative (AR)submitted that expenditure incurred by the assessee-on account of i)consultancy fees, ii)proposed acquisition of Tractoral UTB SA,
iii)acquisition of various Indian and foreign entities iv)bank charges-was revenue in nature. Departmental representative (DR) submitted that in the Audit report filed along with the return of income expenditure related to acquisitions was treated as capital expenditure, that the Appellant did not offer any explanation before the AO when Appellant was directed o file reasons for not treating the said expenditure as revenue expenditure, that overseas acquisitions were not made by the assessee, but acquisitions were carried out by a Mauritius company, that profits of Mauritius company were not offered for taxation in India.
2.2.We have heard rival submissions and perused the material submitted It is found that Rs.1.69 Crores were paid as consultancy fees for acquisitions, Rs.3.48 Crores were spent for acquisition of a company in Romania and Rs.2.35 Crores were paid for other acquisitions. During the period under consideration the Appellant had acquired more than half a dozen Indian/foreign entities. Direct investment was made to acquire Mahindra International Ltd.,Stokes Group Ltd.,Plexion Technologies (India) Pvt.Ltd, and a unit of Amforge Industries. Indirect investment was also made to acquire Mahindra China Tractor Ltd. and Mahindra Europe SRL.These two acquisitions were made through a Mauritius company- Mahindra OveRs.eas Investment Company.Through Mahindra Holding & Finance Ltd. investment in Chasecom Ltd. Delaware,USA was also made. In this background issue remains to be decided is whether the expenditure incurred for acquisitions of overseas and Indian entities / making investment in foreign entities should be treated revenue or capital expenditure ?
2.3.It is a well-accepted legal preposition that no test of universal application can be laid down to determine the question whether an expenditure incurred by the assessee is revenue or capital. It depends on the overall facts and circumstances of each case.Such matters have to be decided from a practical view and on application of the proper principles of law. Courts are of the view that keeping in mind the ground realities of business, AO should consider the ITA No. 8597/Mum/2010 9 purpose of a particular expenditure. A few principles in this regard can be enumerated as under-
i).One of the guidelines for distinguishing revenue expenditure from capital expenditure is that if the expenditure is incurred for obtaining an advantage of enduring benefit it would be capital expenditure.But,the test of enduring benefit is not a certain or conclusive test and it is not be applied blindly and mechanically.In other words every advantage of enduring nature acquired by an assessee is not covered by the said concept. In a given case, the test of enduring benefit might break down.The idea of once for all payment and enduring benefit are not something akin to statutory conditions; nor are the notions of capital or revenue a judicial fetish.Concepts of capital/revenue expenditure are not eternal verities, but are flexible ones.
ii).What is material in this regard is to consider the type, nature and character of the advantage in a commercial sense on one hand and on the other to look in to the aim, intended object,effect of the expenditure and in the larger context of necessity and expediency.Legal rights secured in the process are also relevant in deciding the issue.
iii).If the expenditure is related to the carrying on or conduct of the business or is intrinsically connected with the running of a business the expenditure is to be regarded as revenue expenditure even though the advantage may endure for some indefinite future.
iv).A payment made with a view to obtain the benefit of technical assistance for running the assessee's business more efficiently so as to earn more profits and 'not by way of transfer of fruits of research once and for all',can be treated as an item of revenue expenditure
v).Expenditure incurred in connection with the profit earning apparatus would be revenue expenditure.
vi).Where the advantage is on the capital filed the expenditure would be treated a capital Expenditure. If the advantage leaves the fixed capital untouched, the expenditure would be on revenue account.
vii).Expenditure in the acquisition of a concern would be capital expenditure; expenditure in carrying on the concern would be revenue expenditure.
viii).An expenditure cannot be considered to be capital expenditure merely on the ground that the amount involved is large.The quantum of expenditure involved cannot alter the nature and character of the expenditure.
ix).The source or manner of the payment are of no consequence in deciding the issue.
x).The question whether a particular payment made by an assessee under the terms of an agreement forms a part of capital expenditure or revenue expenditure, would depend upon several factors., namely,whether the assessee obtained a completely new plan with a complete new process and completely new technology for manufacture of the product or the payment was made for the technical know-how which was for the betterment of the product in question ITA No. 8597/Mum/2010 10 which was already being produced; whether the improvisation made is part and parcel of the existing business or a new business was set up with the so-called technical know-how for which payments were made; whether on expiry of the period of agreement the assessee is required to give back the plans and designs which were obtained, but the assessee could manufacture the product in the factory that has been set up with the collaboration of the foreign firm; the cumulative effect on a construction of the various terms and conditions of the agreement; whether the assessee derived benefits coming to its capital for which the payment was made. If from the terms of the agreement between the parties it transpires that the purpose be the acquisition of an asset/a right of a permanent character was a pre-requisite to the commencement or continuance of the business, the expenditure would be a capital expenditure.
xi).If the amount spent was for the purpose of bringing into existence a new asset or obtaining a new advantage,then obviously such an expenditure would fall in the category of capital expenditure.
xii).If the amount is spent for preserving and maintaining the present asset in existence, it cannot be said that the expenditure so incurred is capital in nature
xiii).Where the object of incurring an expenditure is to effect a capital structure as a result of which certain incidental advantage flows, the expenditure will be of capital nature. Capital expenditure can be incurred after a company is floated or after it starts its business.
xiv).Ordinarily, the word capital expenditure refers to the expenditure which is of a permanent nature or for securing tangible or intangible property, corporeal or incorporeal right.
2.4.In the case under consideration the appellant had not produced copies of the acquisition agreements before any of the lower authorities. So, they had no occasion to decide as whether the transactions entered in to by the appellant were acquisition of a concern or carrying on of the concern ? In absence of the agreements we are also unable to apply the tests, referred at point x) of the preceding paragraph, in this regard.
2.4.a.But from the available records, in our opinion, it transpires that the expenditure incurred for acquisitions referred at para 2.2 of page 8 was not for preserving and maintaining the existing asset of the appellant,rather it was incurred for securing tangible or intangible property and corporeal /incorporeal rights of the acquired entities. Acquisition of a complete unit of Tractor Manufacturing unit from a Chinese Company, brought into existence a new asset and the appellant obtained new advantage.Same thing is applicable to the acquisitions of Europe SRL, Stokes Group and Plexion Technologies.Investment made in Chasecom Ltd.Delawar,Ltd.USA is of similar nature. Not only the advantage-flowed from such acquisition and investments-is in the capital field, but the expenditure has also affected the fixed capital of the appellant. We are of the opinion that the appellant obtained benefit of technical assistance of the acquired entities. In other words ,as the foreign / Indian entities lost their existence for ever after acquisition, so it can safely be held that the experience and research made by them became the property of the appellant and that after acquisition ITA No. 8597/Mum/2010 11 appellant was reaping the fruits of research 'once and for all'.Expenditure in question was not incurred in connection with the profit earning apparatus of the appellate-neither it was for carrying on or conduct of the business nor was it connected intrinsically with the running of a business the expenditure.
2.4.b. Law of burden of Proof expects that whenever a claim is made by an assessee, he has to support it with documentary, circumstantial and /or oral evidences. It was duty of the appellant to show that the acquisitions were apparatus to running the business and not a permanent source of income. But, the appellant chose not to bring these facts on record.
We find form the papers submitted by the appellant that business of the assessee is to manufacture Tractors, Jeeps, and Motor Vehicles and manufacturing of these items is the main source of its income.AR has submitted that Merger and Acquisition (M&A) is one of the objectives of the appellant as per the Memorandum Of Articles,but it does not mean that appellant is a venture-capitalist. Appellant has not produced any data to show that it was engaged in the business of M&A in the succeeding and previous years. of the assessment year under consideration and that income from such M&A operations was more than the income of manufacturing the motor vehicles etc. We are of the opinion that expenditure incurred by the appellant for successful or aborted acquisitions was capital in nature.While holding the acquisition expenditure as capital expenditure we have considered the type, nature and character of the advantage as well as the aim, intended object, effect of the expenditure in the larger context of necessity and expediency. Source /manner of the payment or quantum of expenditure are not at all the conclusive factors for deciding the issue under consideration. The issue has been decided after taking in to consideration the basic facts i.e. whether the expenditure was for running the business or not? We are of the opinion that expenditure amounting to Rs.7.97 Crores was spent for the purpose of bringing into existence a new asset /obtaining a new advantage. So, part A,B and C of the Ground No.1 are decided against the appellant.
However,allowing the alternate ground of the appellant, we hold that the said expenditure was part of investment.
2.5. Part D of Ground 1 is about stamp duty (Rs.11.6 lakhs) paid for issuing bonus shares. AR submitted that issue regarding stamp duty has already been decided by the Apex Court in the case of General Insurance Co.(286 ITR232).We find that Hon'ble SC has held that assesses do not acquire any benefit or advantage of enduring nature by incurring expenditure for stamp and registration for issue of bonus shares. Respectfully following the apex court we decide the issue regarding payment of stamp duty in favour of the Appellant.
2.6. Ground 1.E.deals with expenditure incurred for issue of Foreign Currency Convertible Bonds(FCCB).AR submitted that the same issue had arisen in the assessment year 1997-98 and that the tribunal vide its order dated 29.10.2009 ITA/ 7845/Mum/2004 had decided the matter in appellant's favourite. Respectfully following the said decision,we hold that the expenditure incurred with regard to FCCB is revenue in nature.
ITA No. 8597/Mum/2010 122.7.With regard to expenditure incurred for bank charges to the lead manager (Ground
1.F.)AR submitted that Hon'ble Supreme Court has decided the issue and has held that such expenditure is not capital. Following the matter of India Cement 60 ITR 52 we hold that money spent by the appellant amounting to Rupees 30 lakhs on account of lead manager charges is a revenue expenditure.
All the three items of expenditure ,discussed at paragraphs number 2.5,2.6. and 2.7,are of revenue nature.
Ground no.1 is partly allowed.
3.Next Ground is about expenditure of Rs.1.08 Crores incurred by the appellant in connection with development of Euro IV Compliant Engine. As per the appellant said expenditure was incurred for design,development and manufacturing of Cylinder head die casting tool set.Out of the total expenditure Rs.60.44lakhs were paid for consultancy and expenditure amounting to Rs.40.39 lakhs was incurred for procuring tools and spares in connection with the project. AO treated the said expenditure as capital. As per the AO payment was made to acquire technical know-how and technical know-how was covered by section 32(1)(ii) of the Act.He allowed depreciation on said know how at the rate of 25%.AO was of the opinion that the Intellectual Property including final product,design,data and specifications was to be the exclusive property of the assessee and that such acquisition was in nature of intangible assets in terms of section 32 of the Act.
3.1.AR submitted that the appellant company was already in business of manufacture of vehicles, that expenses were incurred in the course of carrying on of the same business though on up-gradation of engine to meet scientific norms of emission to make the vehicles more eco-friendly,that expenditure was deductible u/s. 37(1), that the appellant regularly introduced new models and upgraded existing products, that there was no increase in capacity,that no capital asset was acquired, that similar expenditure was held to be revenue in nature, in the case of Swaraj India Ltd. by the Hon'ble Supreme Court in 309 ITR 443,that the issue was covered in favour of the assessee(ITA/7845 and 8140/ Mum/2000 AY 1997-98, ITA /2523 and 3078/Mum/ 2005, AY1998-99). Alternatively, it was submitted that even if the said expenditure was held to be capital,it was allowable u/s.35(1) (iv)of the Act. Relying upon more than a dozen cases the AR submitted that expenditure incurred for up-gradation of the engine should be allowed as a revenue expenditure. DR strongly supported the order of the AO and submitted that the expenditure incurred was covered by the provisions of section 32, that section 37 or 35 were not applicable in the case under consideration.
3.2.Here,we would like to discuss cases referred to by the AR to arrive at a rational conclusion.
i)In the case of Sakthi Sugars Ltd.(45DTR 134) the assessee in its return of income claimed expenses relating to the expansion of the sugar units. The AO held that the assessee's business and installed capacity had gone up, that the business was expanded in a different state and that the assessee could not claim the expenses incurred on the installation of new factories as ITA No. 8597/Mum/2010 13 revenue expenditure. Accordingly, the same was treated as capital expenditure. The Hon'ble Madras High Court after discussing the facts of the case held as under-
"...in the instant case, the various kinds of expenditures disclose that all those expenditures were incurred in the relevant years. for the purpose of manufacture of sugar in the respective factories with a view to earn profits, and therefore they are nothing but revenue expenditure on the. In other words, applying the principles set out in the various decisions, the expenses were all expenses which were incurred by way of salaries, wages, bonus, provident fund contribution,welfare expenses, power, fuel and water, manufacturing expenses, rent for the office building etc.,and were incurred for the purpose of running of the business and it cannot be held to be by way of investment. In fact there was no dispute that whatever investments made for Baramba unit and Dhenkanal unit were capitalised and were never trained by way of revenue expenditure."
ii).Facts of the next case,Denso (I) Pvt. Ltd., reported at page number 140 of 318 ITR are that the company was engaged in the business of manufacturing auto Electric parts for which it was importing several components, and it incurred expenditure by setting up a cell for developing import substitute of those components. Towards this cell expenditure was incurred by the company and same was claimed under the head deferred revenue expenditure. The AO treated this expenditure is of a capital nature because, according to him benefit of the expenditure were available later. The Hon'ble Delhi High Court observed that the revenue had not disputed that the expenditure incurred towards salaries, wages, travelling expenses, etc., was revenue in nature that there was no enduring benefit from the expenditure,thatthe said expenditure was capital nature.Finally, the Hon'ble High Court held -" Merely because the benefit of the type of expenditure involved in this case is such a benefit, can also be available later, is not a good enough reason to treat the expenditure, which is otherwise of a revenue nature, as a capital expenditure.
iii).The facts of Essel Propack Ltd.case,decided by the Bombay High Court (325 ITR
185)were as under:
Under a collaboration agreement the assessee paid fees for non-exclusive license for 5 years for manufacturing of machines in India. The patents rights remained with the licensor. The assessing officer treated the said expenditure as capital. Deciding the case,filed by the revenue,the Hon'ble High Court observed- "...the assessee entered into an agreement with a company by the name of registered in Republic of Mauritius, under which the licence granted to the assessee are non-exclusive license, restricted to the territory of India to manufacture and use tube making machines and the tools and parts thereof with the right to register the licence. The licensor was a registered proprietor and beneficial owner of certain patents for manufacturing tube making machines. Under the terms of the agreement the assessee obtained a nonexclusive license for a term of 2 years between 1st September,1997 and 13st August ,1999. Under the agreement, the sole proprietary right in the patents vested with the licensor.... On behalf of the revenue it was sought to be submitted that the acquisition of Know-how under a license would fall within the ambit of section 32 of the income tax act, ITA No. 8597/Mum/2010 14 1961, as amended. On the finding of fact which has been arrived at by the CIT(A)and by the tribunal, it has emerged,from the record in the present case,that the assessee had as a matter of fact not acquired a proprietary interests, or ownership in respect of the subject matter of the licence either wholly or in part, so as to attract the provisions of section 32. Having regard to the factual position which has emerged before the court, which is to the effect that the assessee had obtained the benefit, purely on a non-exclusive basis, of a license confined to the territory of India, for a limited term and the proprietary rights in the patents, which formed the subject matter of the licence continued to vest in the licensor, the provisions of section 32, were not attracted in this case. Moreover, the finding, which has been arrived at in the present case is the agreement was entered into on 1st September 1997, which was prior to 1st appeal, 1998, on which date the amended provisions of section 32 were brought into force.... Thus, as a matter of fact, the tribunal found that the agreement was operative during the course of financial year 1997-98. Prior to the enforcement of the amended provisions of section 32."
iv).Next matter relied upon by the AR is of the High Court of Delhi. Facts of the T.E.I. Technologies (P) Ltd.(2008-TIOL-166-HC-DEL-IT) were as under:
The assessee paid certain amount to joint-venture partners as technical support fee to carry out manufacturing operations of electronic compound and. AO treated the amount paid as capital expenditure, instead of revenue expenditure on the ground that assessee received the benefit of enduring nature.The Hon'ble court was of the view that the assessee was given only technical support/assistance for manufacture of the said products, that there was no transfer of technology, knowledge, etc., that even if it was assumed that there was a benefit of enduring nature, not all enduring benefit could be classified as capital expenditure,that payments made were for services rendered in relation to process of manufacture. Dismissing the appeal filed by the revenue.The Hon'ble High Court held ... "The only services that were rendered to the assessee was in relation to the process of manufacture...... There can be no doubt that the assessee acquired technical know-how to enable it to manufacture the products and this was more in the nature of information,guidance or payment for consultancy."
v).In the matter of Escorts Auto Components Ltd.(323ITR11)the question before the Punjab and Haryana High Court was that whether the ITAT was right in law in holding the order of the CIT (A) in deleting the addition of Rs.72.6 lakhs on account of new project expenses holding the same to be of a revenue nature as against the admission of capital nature by assessee in its notes to an accounts,even though the assessee had identified Rs.72.64 diversification and expansion of new product range, including acquisition of machinery to add such expansion and the amount had been shown pending technical quantification under capital work in progress. CIT(A) as well as the ITAT decided the matter in favour of the assessee. Finalising the appeal filed by the Revenue Honb'le HC observed as under-
".... we are of the view that by no stretch of imagination the expenditure incurred by the assessee-respondent could be regarded as capital expenditure ......Moreover,finding of the Tribunal that the expenditure and/or for business purpose,has not been challenged,nor there ITA No. 8597/Mum/2010 15 is any challenge to the finding that no capital asset has come in to existence."Comparing the facts of the case with that of Denso (I) Pvt. Ltd. matter dismissed the appeal filed by Revenue
vi).The Hon'ble Supreme Court mentioned the facts of the next case,i.e.Swaraj,Engine Ltd.
(309ITR443) as under-
"M/s.Swaraj Engines Ltd (respondent herein) and are into an agreement or transfer of technology, know-how and trademark with Kirloskar oil engines Ltd, under which royalty was payable by it. The claim for deduction in respect of the said payment was made by the respondent. It is important to note that during the relevant assessment year 1995 - 96, the royalty was paid by the assessee as a percentage of net selling price of the licensed goods products.......
Two questions arise for determination in the civil appeal. Firstly, whether the question. Regarding applicability of section 35 AB of the income tax act, 1961,was ever raised by the AO in this case? The second question which arises for determination in this case is whether the expenditure incurred is revenue expenditure or whether it is an expenditure which is capital in nature and depending on the answer to the said question the applicability of section 35 AB of the income tax act needs to be considered."
The said matter was remanded back by the Hon'ble Supreme Court observing as under "On bare reading of the said question it is clear that applicability of section 35 AB in the context of royalty paid to Kirloskar as a percentage of the net sale price being revenue or capital in nature and depending on the answer to that question, the applicability of section 35AB for determination before the High Court. These that as it may, the said question needs to be decided, authoritatively by the High Court as it is an important question of law, particularly, after the insertion of section 35AB. Therefore, we are required to remit the matter to the High Court for fresh consideration in accordance with law. On the second question, we do not wish to express any opinion. It is for the High Court to decide, after construing the agreement between the parties, whether the expenditure is revenue or capital in nature....."
vii).In the case of Honda Cars India Ltd.(38 SOT471), one of the questions to be decided by the Tribunal was that whether the CIT (A) had erred in law and facts by allowing relief of Rs.27.78 Crores by taking lump-sum fees for technical guidance is revenue expenditure as against capital expenditure held by the AO. The tribunal observed as under-
"... it would be seen that the assessee obtained only the right to use,during the currency of the agreement,the technical know-how and information and the intellectual property rights relating to the manufacture of Honda cars and did not secure any ownership rights over them. We, therefore, hold that the payment of the lump-sum fees for technical know-how and the royalty is allowable as revenue expenditure."
viii).In the Engineering Innovation Ltd.matter (327ITR392)following substantial questions of law were before the Hon'ble High Court of Himachal Pradesh-
ITA No. 8597/Mum/2010 16"(i) whether,on the facts and in the circumstances of the case, the tribunal was right in holding that the definition of scientific research given in section 43(4) is not relevant to claim of expenditure u/s. 35?
(ii) whether,on the facts and in the circumstances of the case, the terminal was correct in holding that expenditure of a capital nature was admissible as deduction when the expenditure was not incurred for existing business?"
The Hon'ble High Court held that the activity of the assessee amounted to scientific research, and, therefore,the assessee was an titled to claim deduction u/s.s 35(1)(i)(iv).
ix).Gannon Norton Metal Diamond Die Ltd.(163ITR606) is about capital/revenue expenditure as well as about depreciation and development rebate. In this case appellant company entered into an agreement with a British company. The technical collaborator agreement provided for payment of Pound7,500 payable by 3 instalments for the know-how to be supplied by the die company and for the covenant contained in clause 5 of the agreement. The tribunal found that for the obligation to give technical assistance and collaboration for putting up the factory, no payment was envisaged under the agreement.The said findings of tribunal were not challenged before the court. The Hon'ble High Court observed-".....as far as the allowance of depreciation and development rebate is concerned, and with which aspect we are concerned in question number two our attention has been drawn to a few decisions in which, according to learned counsel for the assessee, it had been held that both depreciation and development rebate would be allowable to the assessee in the event of the payments being held to be a capital nature.A brief reference may be made to these decisions since in our view, no such claim is tenable under the facts of this particular case in question number two would be required to be answered against the assessee in the event of it being held that the answer to question number one required to be given would be one in favour of the revenue. In our opinion, it is not the settled legal position, and it cannot be that depreciation allowance or development rebate must be admissible on all items of capital expenditure..... In principle, it would seem to make no difference between a case where an existing company undertakes a totally new line of activity for which it has, to establish a new factory, and a case where for manufacturing a new product, a new company is constituted or formed. What we have to consider is whether the payment has been made for acquiring an asset of an enduring nature. If know-how has been acquired unrelated to see create or patented processes or the right to use the trade name or trademark than the acquirer of know- how sense that phrase was repeatedly used or emphasised would seem to acquire more asset of enduring nature is the know-how acquired relates to the setting up of the plant or machinery, then perhaps it may help to be held to be capital in nature, although we are not called upon to decide that question in present reference is the know-how acquired relates to process of manufacturing than the payment made for the same would have to be considered as an expenditure, since the acquirer does not obtain by the expenditure. Any asset of an enduring nature.... We are of the opinion that the payments made by the assessee in the instant case were fully allowable is revenue expenditure."
ITA No. 8597/Mum/2010 17x).In the case of Transweeigh (India) Ltd.decided by the ITAT,Mumbai,it was found by the AO that in the balance-sheet under the head fixed assets, research and development expenses to the tune of Rs.25.42 lakhs had been shown, which were claimed is revenue expenditure u/s. 35(1)of the Act in the computation of income for tax purposes,the AO also found that the main thrust of the development was on making off mixture-cum-dispenser for which the assessee had relevant know-how,in its possession, hence, there was no question of any further research and development. The AO also examined the technical cooperation agreement which revealed that said mixture was developed by virtue of engineering design provided by technical development, hence, development of prototype for the future sale of similar product did not tantamount to research and development.AO formed an opinion that assessee had rightly classified such expenses as of the nature of capital expenditure in its books of a/cs. AO also held that the assessee also did not meet the conditions of section 35(1) of the Act, as the assessee already had the expertise in the field and that the product was being developed as per the requirement of the customer.
The tribunal held-"We have considered the submissions made by both sides,material on record and orders of authorities below. It is noted that the assessee company is engaged in the business of manufacturing of capital goods i.e. plant and machinery to be employed by cement and steel companies and other companies engaged in infrastructure product. It is also noted that companies having technical Corporation for upgradation and improvement and development of new products.It is also noted that the company also customises its equipments based upon the specific request of particular customer to that effect. It has also been stated that research and development activities is a part of its business activities so as to remain competitive and qualitative in its line of business. We have also perused the nature of expenses which mainly comprise of salaries, travelling (including foreign travel), raw materials,consumables, hardware, etc. it is also noted that in-house research and development facilities have also been recognised by the government of India....... we would like to further state that research and allotment activities carried on by the assessee is resulted into product development, process development, indigenization, product support, and these activities have been carried on by the assessee in a continuous manner for years together, and no material has been brought on record by the revenue to controvert his claims of the assessee, hence, merely for the reason that assessee is having a technical Corporation or is developing various prototypes, these activities cannot be termed as not of the nature of scientific research.In this view of the matter,we hold that the expenditure claimed by the assessee is revenue is allowable u/s. 35(1) of the Act and a capital expenditure incurred by the assessee in this regard is allowable u/s. 31(iv) read with section 35(2) of the act."
xi).The facts placed on record in the case of Metalman Auto (Pvt.) Ltd.(78ITD357) showed that the assessee had debited expenditure amounting to Rs.5.48 lacs to the P&L account under the head R&D expenses.The assessee claimed the same as revenue expenditure.The AO noted that expenditure incurred on design and development of tools was a part and parcel of the plant and machinery being used to manufacture the components, that expenditure incurred on ITA No. 8597/Mum/2010 18 designing of these tools give the assessee benefit of enduring nature and that the expenditure was capital in nature. You allow depreciation at the rate of 33.3% on the expenditure incurred.
The tribunal decided as a matter in following words-
"...the facts placed on record show that the assessee had debited the expenditure to the profit and loss account and claim deduction of the same u/s. 37 of the act. The submissions of the assessee both before the AO and the CIT(A) was that the expenditure was allowable as revenue expenditure u/s. 37 of the act. The assessee has neither claimed deduction u/s. 35 AB , nor such plea was ever raised before the authorities below. The facts of the case, clearly show that the assessee was already in the business of manufacturing automobile components. The expenditure was incurred on the designs and development of tools to bring improvement in the components already manufactured by the assessee....... the assessee has carried out improvements in the items/components already manufactured by it. The assessee has neither set up a new unit, nor incurred such expenditure for manufacturing items not in the line of business of assessee.... In the case under consideration, there is no material on record to show that expenditure incurred by the assessee was for acquiring the technical know-how. It was incurred for obtaining and updating the mere use of the technical know-how and information, which was already available with the assessee. Therefore, the expenditure incurred by the assessee would not fall in the category of capital expenditure. The provisions of section 35 AB would be applicable only if the expenditure is held to be of that nature....... we hold that expenditure incurred by the assessee by way of consultancy charges and research and development expenses for modification of the existing automobile components does not relate to capital field. By incurring such expenditure, the assessee has only effected economy and efficiency in manufacturing the existing items. The expenditure does not relate to altogether a new business or for setting up a of business or expansion of the existing business. By incurring such expenditure. The assessee has only obtained business advantage is. Moreover, the benefit acquired by the assessee is not of enduring nature to put the impugned expenditure in the category of capital in nature. The assessee has not acquired any capital asset in the nature of exclusive user of technical information. It is in the nature of updating the existing information already available with the assessee. Therefore, the expenditure incurred by the assessee is off a revenue nature and is allowable u/s. 37 of the Act."
xii).Next case,Glaxo Smith Kline consumer Healthcare Ltd.,decided by the Chandigarh bench of the tribunal (ITA/379 and 534/Chd/2004 and 309 and 310/Chd/2005),is for assessment yeaRs. 1998-1999 to 2001-02.
In that case 1st issue with regard to the disallowance of Rs.3.21Crores made by the AO on the ground that the expenditure in question is capital in nature. Briefly stated, the facts were that the appellant incurred an expenditure of Rs.3.21 crores on promotional and trade marketing expenses in relation to the existing products Rs.1.57 crores and on product development expense for new products 1.63 crores which was claimed as a revenue expenditure u/s.37 (1) of the Act.According to the AO expenditure resulted in providing the assessee with ITA No. 8597/Mum/2010 19 information on consumers needs, taste and bounds, based on which the assessee would be able to decide on the constituent of the new product, its pricing its target market, etc.,which, in turn, would allow the assessee to build a product, brand and long-term strategy. CIT(A) upheld the disallowance made by the AO on the ground that the expense enable the assessee to introduce new products, which could be considered as venturing into a new line of business. He further observed that the expenses belong to capital field and were capital in nature.Tribunal decided the issue as under:
"A bare perusal of the details of the expenditure incurred by the assessee shows of fact positions that the expenditure is in relation to the business of the assessee. This aspect has also not been disputed by the revenue, as is evident from the orders of the lower authorities..... It is a trite law that what is relevant is to evaluate the purpose of the outgoing, and its intended object and effect and considered in the light of business realities..... In this background. We may peruse the expenses incurred by the assessee under the head promotional and trade marketing expenses. Such expenditure has been incurred on existing products of the assessee and include cost of presentation items, gifts, etc. The expenditure can be viewed as in actuality discount in kind allowed to the customers. and expenditure on advertisement of the existing products of the assessee. Clearly, the expenses incurred are of revenue nature. The expenses in question have merely facilitated the carrying on the business of the assessee more fruitfully....... in this case, although we are of the view that the said expenditure does not result in any enduring benefit to the assessee yet even if one is to concede to this argument of the revenue still ,it is not possible to deduce that the expenditure is capital in nature. This is for the reason that such enduring benefit is not in the capital field but is, in the revenue failed, thereby imbibing the said expenditure of a revenue expenditure...... now we may examine the expenditure under the head product development expenses. The details of the expenditure show that the same has been incurred for introducing and developing new products. The assessee is engaged in the business of manufacture and sale of food and healthcare products under a well known brand. The expenses include development expenses for new products, namely .......... Certainly such expenditure has the potential to improve the profitability of the assessee. However, the issue to, be considered is whether the expenditure seeks to enlarge the profit-yielding capacity or it increases the efficiency of the business. The suspect, in our considered opinion is to be decided in the light of the business realities, under which the assessee is operating......In our humble opinion , the expenditure in question has merely enable the assessee to remain competitive in the market and retail the customer preferences and/loyalty towards its brand of products. The said advantage certainly is not limited to the period under consideration, but spills over to the future also. So, however, this is not conclusive to hold that the expenditure in question is a capital expenditure...... in conclusion, we hold that. Having regard to the aforesaid discussion, the claim of the assessee for allowability of the impugned expenditure is revenue expenditure is justified."
xiii).In the matter of Munjal Showa Ltd.(2010-IT1-GJX-0411-DEL) revenue had placed following two questions is question of law before the Hon'ble High Court of Delhi-
ITA No. 8597/Mum/2010 20"2.1. Whether learned ITAT correct in low in holding that the expenditure incurred by the assessee on account of design and drawing fees are revenue expenditure instead of capital expenditure?
2.2 whether learned at ITAT erred in holding that the fees paid to the foreign technetium for imparting training to Indian technetium is an expenditure instead of capital expenditure?"
The assessee was engaged in the business of manufacture of shock absorbers used in automobile vehicles.It incurred expenses on travel and stay of foreign technical personnel of Showa Corporation, Japan and also on design and drying charges payable to show or Corporation.The assessee treated the same as deferred revenue expenditure in the accounts,but while filing the return it treated the expenses as revenue expenditure.
After going through the definitions of terms know-how and technical services the tribunal held that the assessee was merely granted license to manufacture the product is as per the drawings and designs provided by the licensor, that the drawings and designs merely enabled the assessee to manufacture the shock absorbers, that the amount paid by the assessee enabled it to facilitate the manufacturing process. But it did not acquire the proprietary rights, that the expenses were incurred were not capital in nature.
The Hon'ble High Court decided the matter in following manner-
"In the case at hand, the know-how was granted by the foreign company solely for the purpose of manufacture, assembly and sale of products during the term of contract and the licensee was to pay royalty to the licensor. The drawings and designs which were supplied by the licensor only enabled the assessee to manufacture the goods, namely, the shock absorbers. The assessee was required to change the design of such shock absorbers. from time to time for which new drawings and designs were required. For the aforesaid purpose, the training of the personnel of the assessee was imperative. If the agreement is read in entirety in a purposeful manner, there can be no trace of doubt that the know-how acquired relates to the process of manufacturing and for a tenure and the documents is, designs and specifications which have been supplied by the licensor are only for facilitating the set purpose of manufacturing.... In view of the aforesaid analysis,we do not perceive any merit in these appeals and, accordingly, they are dismissed....."
xiv).Last case relied upon by the AR was of Borosil Glass Works decided by the C Bench of ITAT Mumbai (3SOT940).In that matter issue relating to a disallowance of the expenditure on new product development, amounting to Rs.57.3Lacs was discussed. The assessee claimed said expenditure is a revenue ,whereas the AO treated it as capital. The matter was decided in favour of the assessee by the tribunal as under -
"We have considered the rival submissions and have perused the material placed on record. A perusal of the expenses indicates that the expenditure in question was incurred on salary, electricity, natural gas, etc., the mere fact that the expenditure which is otherwise revenue expenditure has been treated as deferred revenue expenditure in the books of the company ITA No. 8597/Mum/2010 21 cannot for that reason alone be disallowed in computing the total income.... We are of the opinion that the expenditure is allowable as an expenditure."
3.3.In view of the above discussion, we are of the opinion that all the cases relied upon by the AR are about capital/revenue expenditure. They deal with a situation is when a particular expenditure can be considered capital/revenue expenditure. Mandate of section 32 (1)(ii) has not been considered in these cases, except in the case of Essel Propack Ltd. In the cases referred to by the AR issue of depreciation u/s. 32 (1)(ii) verses the allowability of expenditure u/s. 37 of the Act was neither argued not decided. Even in the case of Essel Propack Ltd. it was held that provisions of section 32(1)(ii) were applicable from the A.Y.1998-99 and that the issue to be decided was for A.Y.1997-98. Clearly, the cases relied upon by the AR are of no help in resolving the issue under consideration.
3.3.a.We have perused the agreement entered into by the assessee with an Austrian company. The Austrian company agreed that it would carry out the complete design and development of tooling set. 'Design, Development and Supply Agreement' between the parties define a few terms. As per the definition 1(a) Design and development shall mean design, development and manufacturing of the cylinder head gravity die cast tooling set for making of cylinder head castings for prototypes and serial manufacturing and also includes establishment of the production process......
In paragraph 17 of the agreement under the head Intellectual property/title following terms have been mentioned-
1. It is agreed by HA (Austrian Co.) that in case during the term of this agreement HA obtains a license to or ownership of designs, data, drawings pertaining to this agreement, it shall sub- license or licence the same as the case may be, to M&M (Appellant.)
2. Subject to M & M performing its obligation under this agreement, the design, data, and drawings exclusively and specifically generate it/developed by HA pursuant to this agreement shall not be used by HA for any purpose other than the project.
3.HA shall not sell such design, data, and drawings to any 3rd party. HA will transfer finalised product design data and specifications in soft (electronic form) and tooling data to M & M with the shipment of permanent tooling and reserves the intellectual property thereof.
3.3.b.Here, it will be useful to peruse the provisions of Sec.32(1).
"Depreciation.--(1) In respect of depreciation of--
(i) buildings, machinery, plant or furniture being tangible assets ;
(ii) know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April, 1998,owned, wholly or partly, by the assessee and used for the purposes of the business or profession the following deductions shall be allowed--ITA No. 8597/Mum/2010 22
(i) in the case of assets of an undertaking engaged in generation or generation and distribution of power, such percentage on the actual cost thereof to the assessee as may be prescribed.
(ii) in the case of any block of assets, such percentage on the written down value thereof as may be prescribed: ......"
Clause (ii) introduced in section 32(1) with effect from April 1,1999, not only extends the benefit of section 32 to intangible assets, but also gives therein an inclusive definition of the intangible assets for this purpose. Sec.32(1)(ii) mentions that know-how,patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after April 1,1998 will be entitled for depreciation at a specified rate.
We are of the opinion that appellant had acquired Technical know how from the Austrian Company.Technical Know-how has been defined as the 'knowledge which would enable a company receiving such know-how to do the project'. If we take note of the definition of Technical know-how it becomes clear that expenditure incurred by the assessee has rightly been considered as Technical know-how by the AO.As per the agreement IPR were to remain with the appellant and the final product was to be the exclusive property of the assessee. In these circumstances his decision of allowing depreciation on intangible assets u/s.32 was as per provisions of law.
We are of the opinion that claim of the assessee that expenditure should be allowed u/s.35 also cannot be accepted. Expenditure incurred by the assessee was not for scientific research, it was for transfer of Technical know-how.
We are of the opinion that expenditure amounting to Rs.60.44 Lakhs was not revenue in nature.As per the details available appellant had incurred an expenditure of Rs.40.39 lakhs on tools and spares. We are of the opinion that said expenditure was revenue expenditure.
Ground no. 2 is partly allowed in favour of the assessee.
4.Next Ground is about development expenses,amounting to Rs.1.89 Crores, incurred for compact project for Tractors.In the books of account,the said payments, made to a UK company,were shown under the head 'deferred revenue expenditure to be amortised' over the specified period.As per the appellant out of the total expenditure Rs.1.20 Crores were spent on development of a new range of compact tractors. and Rs.69.37 lakhs were incurred in connection with such development. The appellant was of the opinion that the said expenditure should be allowed u/s.37 (1) of the Act or as an expenditure on scientific research u/s. 35. On the other hand, the AO was of the opinion that the expenditure was capital in nature is because it was for acquiring technical know-how,etc. 4.1.As the arguments, circumstances and facts of the appellant are same as that of the previous ground i.e. Ground no.2.,we are of the opinion that expenditure of Rs.69.37 lakhs ITA No. 8597/Mum/2010 23 was revenue in nature and that the AO has rightly invoked the provisions of Sec.32(1)(ii)with regard to balance amount i.e.Rs.1.20 Crores.
4.1.a.Here we would also like to mention that UK party had agreed to hand over IPrs to the assessee. Under the head 'rights' (para 10.1of the agreement)it was agreed -"All you intellectual property created or generated by either parties under this contract, and which are contained within the deliverables shall become the sole property of the client."
Assesse's appeal stands partly allowed.
5.Next ground of appeal is about disallowance of pro rata premium of Rs.5.39 crores payable on redemption of 'Foreign Currency Convertible Bonds'(FCCB).As per the AO the bonds were convertible into shares and, therefore, could not be construed as a borrowing, that they increased capital base of the company and that the expenditure incurred was capital in nature.
The AR submitted that FCCB were a form of borrowing that they were shown in the balance- sheet under loans that premium payable on redemption was cost of borrowing, that option of conversion of bonds into shares was only with the bond holders, that conversion was a subsequent event which did not change the initial character of the bonds of a debt, that in the event of redemption payment of premium was mandatory, that premium being a cost of borrowing was allowable on time,that premium was neither capital nor contingent in nature, that issue of FCCB had been held to be revenue in appellant is own case for the assessment year 1997-98 (ITA/7845/M/2004).DR supported the order of the AO.
In the matter of Crane software International Ltd. (ITA /741 and 742 Bangalore / 2010) issue of FCCB have been discussed as under -
"...the expenses were incurred in connection with the issue of FCCB. As the bonds were convertible, the assessing authority treated the bond proceeds as increased to capital. Accordingly, he treated the expenditure of Rs.6.63 crores. As capital in nature is, it was incurred for raising the capital of the assessee company. The said expenditure was disallowed.Assessee claimed the expenses is deductible as the expenses were incurred to raise loan finance. The assessing authority held that the bond holders at the option to convert the bonds to equity shares, and therefore, the collection of funds for the issue of bonds needs to be treated as to increase the capital and, therefore, the connected expenses would be capital in nature and hands disallowed. We agree with the view of the CIT (A)that the expenses are not capital in nature. As on 31.03.2006, the previous year ending for the assessment year 2006-07,thefunds collected by the assessee company through the issue of the foreign currency convertible bonds, were in the nature of liability. The assessee company was bound to discharge is the bonds new dates.The assessee was paying interest is to bond holders.It is clear that the bond finance was in the nature of loan finance. It becomes the capital of the company on leave in the bond holders. and exercise their option at the appropriate time in future. That conversion is only a future event, that may or may not happen, depending on the option exercised by the bond holders. Therefore, the possible equity character of the funds ITA No. 8597/Mum/2010 24 was contingent on the assessed whether bonds would be converted or not, in a future date. The nature of a present-day loan fund cannot be held equity fund on the basis of such contingency. As far as the nature of the funds for the assessment year 2006 - 07 is concerned, it was a liability in the nature of loan, that too interest-bearing loan. If the funds are dated as equity capital for the assessment year 2006 - 07 how the payment of bond interest would be justified in law, is law does not permit payment of interest on a company's equity capital."
In the case of Secure metres Ltd.(321 ITR 61)Hon'ble Rajasthan HC has held -
"Admittedly,the debentures,when a shoot is a loan, and, therefore, whether it is convertible, or nonconvertible, does not militate against the nature of the debenture, being loan, and, therefore, the expenditure incurred would be admissible as revenue expenditure."
Following the above decision of the Rajasthan High Court, the Hon'ble Karnataka High Court in the case of ITC Hotels Ltd.(334 ITR 109) held that even if the debenture is to be converted into a share at a later date,the expenditure so incurred for collection of debenture is to be treated as an expenditure of revenue nature.
5.1.Respectfully following the decisions of the above referred Hon'ble courts we hold that expenses incurred in connection with the issue of FCCB were revenue in nature.
5.2.Second part of the Ground 4 is about deduction for a right back during the year of excess provision of premium payable on FCCB of Rs.843.76 lakhs which was disallowed in the assessment for the assessment year 2005-06. AO was of the opinion that deduction was allowable only if the assessee accepted disallowance in the year under consideration. In this regard the appellant made following submission before the AO-
"Against the claim made in the assessment year 2005-06 of Rs.1303.52 lakhs, the bond holders. holding 64.73% have opted for conversion of the foreign currency convertible bonds into GDR's/shares of the company. Accordingly, is the amount of premium of Rs.873.76 lakhs is no longer payable in the same is offered to tax in the competition u/s.41(1) of the income tax act, 1961.,"
AO rejected the request made by the appellant for two reasons-first that the addition made in assessment year 2005-06 had not been accepted by the appellant and it had preferred an appeal against the same. Second argument of the AO was that claim should have been made in the original return or revised return should have been filed.
The AR submitted that since the entire provision was disallowed not allowing deduction for a write back would mean taxing the same income twice that was not permissible by law,that the AO might be directed accordingly that for that purpose it was not required to give up, claim in those years.In short AR submitted that the appellant should not be subjected to double taxation for the same amount.
5.3.We fully endorse the submission made by the AR. As no one is entitled to double deduction, so no one should suffer double taxation. We appreciate the concern of the AO ITA No. 8597/Mum/2010 25 that,if in appellate proceedings appellant claim of the appellant for assessment year 2005-06 as well as for the next assessment year,assessable amount will remain untaxed. Considering facts and circumstances of the case we direct that AO should tax it only in one assessment year and the appellant should make claim for the said amount for one assessment year only.
Ground no.4 is decided in favour of the appellant.
6.Next ground is about difference between opening and closing amount of unutilised cenvat credit amount to Rs.25.18 lakhs u/s.145A of the Act.The AO held that the assessee in the books of accounts had shown unutilised credit as an asset in the balance-sheet, which made it clear that income had accrued to the assessee in the form of cenvat credit on the raw material and on service tax.
6.1.The AR submitted that as per ICAI section 145A was profit neutral that when all the facts as required by that section were properly given to stocks, purchases and sales there was no impact on profits. Before us the AR, with the help of statistics,tried to demonstrate that in the method adopted by the appellant there was no element of income as far as Cenvat Credit was concerned. Referring to the guidelines issued by the ICAI,AR further submitted that in accordance with the guidelines and the provisions of the section 145-A of the Act the appellant had made necessary entries in the books of accounts, that figures submitted by the appellant were not considered in proper prespective.Pg.131-134 of the paper book were also referred to by him to support his submission. He relied upon cases of Hawkins cookers Ltd., (ITA number 505/mum/04 assessment years. 1999-00), Indo Nippon Chemicals co Ltd., Dai Ichi Karkaria Ltd.(156 CTR 172), Bharat Bijlee Ltd. (ITA number 6410/Mum/2008)and Dimple Drums and Barrels private Ltd(ITA number 3228/Mum/2010).
DR submitted that AO had decided the issue as per law, that income had accrued to the appellant and that same has been rightly taxed.
6.2.We find that the AO in his nine-page discussion (Page 35 to 44) has deliberated upon various issues with regard to Modvat credit. But ,it appears that he has not considered the data available on page number 131-134 of the paper book submitted during appellate proceedings.Even if he has considered the said data, he is not mentioned anything about it in the assessment order.We are of the opinion that, for arriving at a logical conclusion figures furnished by the assessee has to be considered and commented upon. In these circumstances, in the interest of justice we remit back the issue to the file of the AO. He is directed to give 'proper effect to stocks, purchases and sales' to arrive at a definite conclusion.
7.Ground no.7 pertains to Octroi subsidy received by the Appellant amounting to Rs.2050.92 lakhs. It was found by the AO that the appellant had claimed Rs.2050.92 lakhs as capital receipt not chargeable to tax.Although in computation of income the company had not reduced the amount of Octroi incentive from taxable income, yet it made a claim by way of letter filed with the signed copy of acknowledgement of return. Accordingly,the appellant claimed that Octroi incentives should be reduced while calculating taxable income.Vide his letter dated 27.10.2009 appellant made further submissions in this regard. After considering ITA No. 8597/Mum/2010 26 the submissions of the appellant,the AO held that the contention of the appellant was not acceptable for the reason that Octroi refund was revenue in nature, that said amount could not be construed as capital receipt, that following the decision of Goetze India AO had no authority to allow and direction without a revised return.
7.1.Before us, the AR submitted that issue was decided in favour of the appellant in AY 1996- 97 by the ITAT vide its order ITA No./3173/Mum/2001.He further submitted that the said incentives were received on the basis of packages scheme of incentives declared by the government of Maharashtra, that the main objective of the scheme, was to intensify and accelerate the process of dispersal of developed areas and for development of underdeveloped regions of the state, particularly farther away from the Bombay-Thane-Pune Belt. In other words,the scheme was meant to correct the regional imbalance in the industrial development of the State, the Octroi refund was only a measure or yardstick to determine the quantum of incentive and could not be construed as to mitigate operational cost of the business. He referred to various papers of the paper book in this regard to explain the provisions of the scheme.He relied upon the case of Reliance industries Ltd.(88ITD273) decided by the special bench of the Mumbai Tribunal. It was brought to our notice that decision of the special bench in the case of reliance industries was confirmed by the Hon'ble Bombay High Court.
DR supported the order of the AO. He further submitted that the Hon'ble Supreme Court had remitted back the matter of Reliance Industries Ltd.to the Hon'ble Mumbai High Court with regard to sales tax subsidy, that the issue of sales tax subsidy had not attained finality,that provisions of section 41 (1) and 43 (1), explanation 10 were applicable in the case under consideration, that in light of matter of Sahney Steel subsidy in question should be held revenue receipt.
7.2.We are aware that matter of Sales Tax Subsidy in the case of Reliance Industries has been restored back to the Hon'ble High Court of Bomby.We are also aware that in the matter of Wardex Pharmaceuticals P. Ltd Hon'ble High Court of Madras has held that Sales tax subsidy was revenue in nature (307ITR387) and that Hon'ble Gauhati High Court has held that transport subsidy was of revenue nature (332ITR91).But, we will not like to discuss these cases to decide the matter before us. We would like to deliberate upon facts of the case and principles propounded by the Hon'ble SC in this regard. In the case of Sahney Steel and Press Works Ltd.(228ITR253) it was held by the Apex Court that subsidies by way of refund of sales tax relief of electricity charges or water charges were given after commencement of production and hence they were operational subsidies, and were not capital subsidies. Hon'ble SC held :
"If payments in the nature of subsidy from public funds are made to the assessee to assist him in carrying on his trade or business, they are trade receipts. The character of the subsidy in the hands of the recipient-whether revenue or capital-will have to be determined, having regard to the purpose for which the subsidy is given. The source of the fund is quite immaterial. However, if the purpose is to help the assessee to set up its business or complete a project the monies must be treated as having been received for capital purposes. But if ITA No. 8597/Mum/2010 27 monies are given to the assessee for assisting him in carrying out the business operations and the money is given only after and conditional upon commencement of production, such subsidies must be treated as assistance for the purpose of the trade."
Similarly in the case of Ponni Sugars and Chemicals Ltd.(306ITR392),while explaining the decision of Sahney Steel, Hon'ble SC held as under :
"The character of the receipt of a subsidy in the hands of the assessee under a scheme has to be determined with respect to the purpose for which the subsidy is granted. In other words, one has to apply the purpose test. The point of time at which the subsidy is paid is not relevant. The source is immaterial. If the object of the subsidy is to enable the assessee to run the business more profitably then the receipt is on revenue account. On the other hand, if the object of the assistance under the subsidy scheme is to enable the assessee to set up a new unit or to expand an existing unit then the receipt of the subsidy would be on capital account............that the main eligibility condition in the schemes was that the incentive had to be utilized for repayment of loans taken by the assessee to set up new units or for substantial expansion of an existing unit. The subsidy received by the assessee was not in the course of a trade but was of a capital nature."
The appellant has extensively relied upon the case of Ponni sugars chemicals Ltd. in supporting the argument that the subsidy received was of capital nature. In the matter of Ponni Sugars, the benefit of the scheme had to be utilised only for the payment of term loans and the terms loans were granted to set up new units/expansion of existing units. Honourable Supreme Court, in paragraph 16-17 of the said order has observed as under :
"....In the present case also, the receipt of the subsidy was a capital in nature as the assessee was obliged to utilise the subsidy only for the payment of term loans undertaken by the assessee for setting up new units/expansion of existing business. Applying the about tests to the facts of the present case and keeping in mind the object behind the payment of the incentive subsidy we are satisfied that such payment received by the assessee under the scheme, was not in course of trade, but was off capital nature."
From the above it is clear that case of Ponni sugar was decided after applying tests to the facts of that case. In present case subsidy was not granted to repay term loans advanced for setting up new units/expansion of existing units only. Thus, in our opinion case of Ponni Sugar is of no help for the assessee.
7.3.As directed by the bench AR submitted the details of breakup of subsidy received by the appellant i.e. out of the total subsidy received how much related to revenue items and how much related to fixed assets. From the details filed by the appellant it transpires that for the period under consideration out of the total subsidy (19.7Crores)subsidy amounting to Rs.2.61Crores was referable to capital items, whereas subsidy of R.17.9crores was referable to revenue items. It is also found that subsidy was received for the period 01-09-1993 to 31- 08-1998. As per the appellant in the books of accounts,Octroi paid on said raw materials was accounted as a debit to the profit and loss account of the concerned years Government, by way of subsidy, paid back the Octroi to the assessee. Thus, part of the Octroi subsidy had the ITA No. 8597/Mum/2010 28 effect of reducing the costs for the purposes of determining the cost of production as well as for sales.
It is a known fact that Octroi is the charge collected by the local bodies on commodities or things entering their local limits.It is collected on capital goods as well as on raw material.As per admission of the assessee itself, subsidy amounting to Rs.17.3 Crores was in respect of revenue materials.We are of the humble opinion that if the principles of Sahney Steel and Ponni Sugar cases are applied to these facts,it becomes clear that subsidy received by the appellant to the extent of purchase of raw material is concerned it cannot be held a capital receipt.We have gone through the order passed by the Tribunal for the earlier assessment year. We find that the question of Octroi received for capital/revenue items was neither raised before the tribunal nor was it adjudicated upon.AR had relied heavily upon the case of SB in the case of Reliance Industries Ltd.It is sufficient to say that sales tax subsidy cannot be compared with the Octroi scheme in question.In our opinion,in the case before us, there is no dispute that the subsidies granted are revenue receipts and major portion of the subsidy was granted after setting up of the new industries and after commencement of production.
In these circumstances we decide Ground no.7 against the assessee.
8.In ground number 8 the appellant has raised the issue of special pension amounting to Rupees 48,87,957/-.As per the AO, on perusal of the computation of income filed, along with the return of income, it was noticed that the assessee had claimed special pension liability of Rs.48.87 lakhs.The AO found that in the books of accounts the assessee had amortised the expenses in 5 years, but in computation entire pension was claimed as an allowable expenditure.After considering the submissions of the appellant AO held as under:
"i)The decision of the Bombay High Court reported in 284 ITR 679 in assessee's own case pertains to AY1977 - 78. In the AY 1977 - 78, the provision of section 35DDA was not in the statute. The section 35DDA was not introduced when the Hon'ble High Court delivered the judgement and also the section was not applicable for AY1977 - 78. Therefore, the Hon'ble High Court did not have the occasion to consider the provisions of section 35 DDA of the Income tax act.
ii) the direction of special pension claims during the year is covered as per section 35 DDA which is evident from the plain reading of the section....."
8.1.AR submitted that the claim related to employees who had opted for the VRS. prior to 01. 04.2004.Since the claim was in respect of actualrial valuation of the pension liability (commuted and monthly), payable in future, payments could not be covered by the provisions of section 35 DDA, that at the relevant period section 35 DDA dealt with the expenditure at the time to voluntary retirement, that with effect from assessment year 2004-05,it referred to payment in connection with the voluntary retirement. DR supported the order of the AO.
8.2.We have gone through rival submissions. Before the introduction of section 35DDA, the legal dictum was very clear that the assessee could claim expenditure incurred on account of ITA No. 8597/Mum/2010 29 payment made for the VRS.It was also accepted legal position that payments to employees under the VRS. were in the nature of business expenditure and was deductible u/s. 37. Therefore, till the introduction of new provisions under section 35 DDA, the assessee could claim such expenditure as revenue expenditure. But, now assesses can claim deduction as per the new provisions.Section 35 DDA was introduced in the act with a specific purpose. After introduction also there were amendments in it.For the year under consideration section 35DDA,read as under -
35DDA. Amortisation of expenditure incurred under voluntary retirement scheme.-- (1)Where an assessee incurs any expenditure in any previous year by way of payment of any sum to an employee3in connection with retirement, in accordance with any scheme or schemes of voluntary retirement,one-fifth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year, and the balance shall be deducted in equal instalments for each of the four immediately succeeding previous years.(3.FA 2005, wef. 1-4-2004.) 8.3.Before us AR relied upon judgement of the Hon'ble Bombay High Court (248 ITR 679) decided in favour of the assessee. As discussed by the AO the said judgement pertains to assessment year 1977-78. As the provisions of section 35 DDA came into existence on the much later date,said judgement, in our opinion, is not applicable for the assessment year under consideration. Similar is the position of the judgement delivered by the Hon'ble Calcutta High Court in the case of National Insurance company of India (127 ITR 54).Secondly, if the submission of the AR-that amount involved with regard to employees retired before April,2004 were not covered by the provision-is accepted,even then from the material available it is not clear as whether the amount in question for the assessment year under consideration was for only the employees who retired before 1st April 2004, or it included the employees retired after the 1st,April 2004 ? The appellant had not furnished terms and conditions of the voluntary retirement schemes before the lower authorities or before us. Year-wise figures of the employees opting for the various voluntary retirement schemes were also not furnished. It is also not known as whether the schemes were part of composite voluntary retirement scheme is or they were stand-alone.
In the circumstances, we are of the opinion that it would be proper to remit back the matter to the file of the AO to decide the issue in light of the about discussion.
9.Next Ground of appeal is about the disallowance made by the AO on account of warranty liability.AO has discussed the issue as under:
"During the course of assessment proceedings, it was noticed that the assessee has claimed the provision for warranty at Rs.44,20,09,000/-. On the perusal of note 10 to the annual accounts, it is noticed that that the provision relates to warranty made in respect of certain ITA No. 8597/Mum/2010 30 products, the estimated cost of which accrued at the time of sale. The products are generally covered under a free warranty period ranging from one year to 3 years."
After considering the submissions of the assessee and directions of the DRP-II, Mumbai, the assessing officer held :
"The contention of the assessee has been verified and found to be incorrect due to the following reasons:
(i) The assessee has stated that it has adopted a scientific basis of the competition of the provision for the warranty based on the past years.' experiences. However, no submission has been made by the assessee regarding the method of the calculation of the same and the assessee has just relied on the decision of the Hon'ble CIT (A) in the earlier years in its favour. As per the directions of the Hon'ble DRP, the assessee has failed to establish as to how the provision for the warranty has been calculated by the assessee based on the scientific methods. As per the requirement is of the nature of the business is, the nature of the sales, the nature of the product manufactured and sold and historical trend and the number of the article is produced as directed by the DRP.
(ii)......... the provision for warranty is on 01. 04. 2005 was Rs.47.02 crores and the utilisation during the financial year 2005-06 is Rs.28.01, connotes and therefore, the difference between the provision made and that actual expenditure as being disallowed. In any case, the direction is being allowed to the assessee based on the actual amount spent. Thus as per the directions of Hon'ble DRP, assessee has failed to establish the scientific basis of the calculation of the provision for the warranty and therefore same cannot be allowed.
....... In view of the above, the provision made for warranty being contingent, cannot be allowed as expenditure for the year as per Hon'ble DRP's directions. However, during the year, the assessee has incurred the actual expenditure of Rs.28,01,01,000/-and the same is allowed as business expenditure. Therefore, the disallowance works out to Rs.16,19,08,000/- ........."
9.1.Before us AR submitted that on page number 53 of the order of the assessing officer methodology adopted for determining the warranty was available, that assessee was applying the scientific method for arriving at the figures of warranty. AR relied upon following cases in support of his contention-
ITA No. 8597/Mum/2010 31Rotrok Controls India Pvt.Ltd(314ITR62)Woodward Governor India Ltd (321 ITR 147) Luk India Ltd.(52DTR117), Nokia Siemens Networks India Ltd (202 Taxman 390), GE India Exports Private Ltd.(ITAT,Bangalore),Godrej Appliances Ltd.(ITAT, Mumbai) Ericsson Communications Pvt.Ltd(318ITR340),Himalaya Machinery (P.) Ltd.(334 ITR 64),Nagri Mills Ltd (33 ITR 681).He also relied upon the decisions pronounced in favour of the assessee, by the various branches of ITAT-Mumbai, for the assessment years. 1994-95,1996- 97,1997-98,1998-99.In the paper book filed by the assessee order for the assessment year 1994-95 was not available. In the assessment year 1996-97 and 1997-98 orders. for the assessment years. 1991-92 and 1995 -96 were followed. In the assessment year 1998-99 order for the assessment year 1997-98 was followed. Thus, it is clear that it was for the A.Y.1991- 92 that the claim made by the appellant was accepted by the tribunal for the first t time.
9.2.We would also like to reproduce the chart submitted by the appellant to the assessing officer during the assessment proceedings and it reads as under-
(Rs.in lakhs)
Division Provision for warranty Provision for warranty Incremental
made in the preceding year for the year i.e.A.Y. provision for
i.e. A.Y.2005-06 2006-07 warranty
Automotive div. 3293.74 4244.59 1558.30
Tractor division 1405.62 2061.60 36.37
Defence division 3.04 15.29 3.04
Total 4702.40 6321.48 1619.08
DR submitted that in light of the observation of the Hon'ble Supreme Court made while deciding the matter of Rotrok it could be said that assessee had not adopted a scientific basis, that in a group cases Mahindra Navy star(for AY 2007-08)assessee had admitted that provision for warranty was contingent in nature.
9.3.After hearing the rival submissions ,we would like to discuss the cases relied upon by the AR. In five cases relied upon by the AR principles, enumerated by Rotrok Controls India Pvt. Ltd.(Rotrok),have been followed or extensively quoted. Thus, Rotrok can be considered the touchstone for testing the merits of the case under consideration. So, before considering the facts and observations of the other cases, it would be appropriate that we refer to the case of Rotrok.
i).Rotrok Controls India Pvt. Ltd.-In this case the assessee sold valve actuators.At the time of sale the assessee provided a standard warranty whereby in the event of any actuator or part thereof becoming defective within 12 months from the date of commissioning or 18 months from the date of dispatch, whichever was earlier, it undertook to rectify or replace the defective part free of charge. Right from the assessment year 1983-84 the claim for allowance ITA No. 8597/Mum/2010 32 of this warranty had been allowed. For the assessment year 1991-92, it had made a provision for warranty of Rs.10,18,800 at the rate of 1.5% of the turnover. Since this provision exceeded the actual expenditure, the assessee reversed Rs.5,00,246 as reversal of excess provision, and claimed deduction of the net provision of Rs.5,18,554. But the AO disallowed the claim on the ground that it was merely a contingent liability. The High Court on appeal held that no obligation was cast on the date of sale and consequently there was no accrued liability. Reversing the decision of Hon'ble HC it was held by the Hon'ble SC that the valve actuators, manufactured by the assessee, were sophisticated goods and statistical data indicated that every year some of these were found defective ;that valve actuator being a sophisticated item no customer was prepared to buy a valve actuator without a warranty. Therefore,the warranty became an integral part of the sale price ; in other words, the warranty stood attached to the sale price of the product. In this case the warranty provisions had to be recognized because the assessee had a present obligation as a result of past events resulting in an outflow of resources and a reliable estimate could be made of the amount of the obligation. Therefore, the assessee had incurred a liability during the assessment year which was entitled to deduction under section 37 of the Income-tax Act, 1961.
It was further held - "The present value of a contingent liability, like the warranty expense, if properly ascertained and discounted on accrual basis can be an item of deduction under section 37. The principle of estimation of the contingent liability is not the normal rule. It would depend on the nature of the business, the nature of sales, the nature of the product manufactured and sold and the scientific method of accounting adopted by the assessee. It would also depend upon the historical trend and upon the number of articles produced.
A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when : (a) an enterprise has a present obligation as a result of a past event ; (b) it is probable that an outflow of resources will be required to settle the obligation, and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized.
The principle is that if the historical trend indicates that a large number of sophisticated goods were being manufactured in the past and the facts show that defects existed in some of the items manufactured and sold, then provision made for warranty in respect of such sophisticated goods would be entitled to deduction from the gross receipts under section 37."
Findings were summarised by the Hon'ble SC as under :
"What is a provision ? This is the question which needs to be answered. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when : (a) an enterprise has a present obligation as a result of a past event ;
(b) it is probable that an outflow of resources will be required to settle the obligation ; and
(c) a reliable estimate can be made of the amount of the obligation.If these conditions are not met, no provision can be recognized.ITA No. 8597/Mum/2010 33
Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events existing independently of the future conduct of the business of the enterprise that are recognized as provision. For a liability to qualify for recognition there must be not only present obligation but also the probability of an outflow of resources to settle that obligation. Where there are a number of obligations (e.g., product warranties or similar contracts) the probability that an outflow will be required in settlement, is determined by considering the said obligations as a whole. In this connection, it may be noted that in the case of a manufacture and sale of one single item, the provision for warranty could constitute a contingent liability not entitled to deduction under section 37 of the said Act. However, when there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise having no alternative to settling that obligation.
In the present case, the appellant has been manufacturing and selling valve actuators. They are in the business from the assessment yeaRs.1983-84onwards.Valve actuators are sophisticated goods. Over the years. the appellant has been manufacturing valve actuators in a large numbers. The statistical data indicates that every year some of these manufactured actuators are found to be defective. The statistical data over the years. also indicates that being sophisticated item no customer is prepared to buy valve actuator without a warranty. Therefore, the warranty became integral part of the sale price of the valve actuator(s). In other words, the warranty stood attached to the sale price of the product. These aspects are important. As stated above, obligations arising from past events have to be recognized as provisions. These past events are known as obligating events. In the present case, therefore, the warranty provision needs to be recognized because the appellant is an enterprise having a present obligation as a result of past events resulting in an outflow of resources. Lastly, a reliable estimate can be made of the amount of the obligation. In short, all the three conditions for recognition of a provision are satisfied in this case.
In this case, we are concerned with product warranties. To give an example of product warranties, a company dealing in computers gives a warranty for a period of 36 months from the date of supply. The said company considers. following options : (a) account for warranty expense in the year in which it is incurred ; (b) it makes a provision for warranty only when the customer makes a claim ; and (c) it provides for warranty at 2 per cent. of turnover of the company based on past experience (historical trend). The first option is unsustainable since it would tantamount to accounting for warranty expenses on cash basis, which is prohibited both under the Companies Act as well as by the Accounting Standards which require accrual concept to be followed. In the present case, the Department is insisting on the first option which, as stated above, is erroneous as it rules out the accrual concept. The second option is also inappropriate since it does not reflect the expected warranty costs in respect of revenue ITA No. 8597/Mum/2010 34 already recognized (accrued). In other words, it is not based on the matching concept. Under the matching concept,if revenue is recognized the cost incurred to earn that revenue including warranty costs has to be fully pro- vided for. When valve actuators are sold and the warranty costs are an integral part of that sale price then the appellant has to provide for such warranty costs in its account for the relevant year, otherwise the matching concept fails. In such a case the second option is also inappropriate. Under the circumstances, the third option is the most appropriate because it fulfils accrual concept as well as the matching concept. For determining an appropriate historical trend, it is important that the company has a proper accounting system for capturing the relationship between the nature of the sales,the warranty provisions made and the actual expenses incurred against it subsequently. Thus, the decision on the warranty provision should be based on past experience of the company. A detailed assessment of the warranty provisioning policy is required particularly if the experience suggests that warranty provisions are generally reversed if they remained unutilised at the end of the period prescribed in the warranty. Therefore, the company should scrutinise the historical trend of warranty provisions made and the actual expenses incurred against it. On this basis a sensible estimate should be made. The warranty provision for the products should be based on the estimate at the year end of future warranty expenses. Such estimates need reassessment every year. As one reaches close to the end of the warranty period, the probability that the warranty expenses will be incurred is considerably reduced and that should be reflected in the estimation amount. Whether this should be done through a pro rata reversal or otherwise would require assessment of historical trend. If warranty pro- visions are based on experience and historical trend(s) and if the working is robust then the question of reversal in the subsequent two years, in the above example,may not arise in a significant way.In our view,on the facts and circumstances of this case, provision for warranty is rightly made by the appellant-enterprise because it has incurred a present obligation as a result of past events. There is also an outflow of resources. A reliable estimate of the obligation was also possible.Therefore, the appellant has incurred a liability, on the facts and circumstances of this case, during the relevant assessment year which was entitled to deduction under section 37 of the 1961 Act.Therefore, all the three conditions for recognising a liability for the purposes of provisioning stands satisfied in this case. It is important to note that there are four important aspects of provisioning.They are- provisioning which relates to the present obligation, it arises out of obligating events, it involves outflow of resources and, lastly,it involves reliable estimation of obligation. Keeping in mind all the four aspects, we are of the view that the High Court should not to have interfered with the decision of the Tribunal in this case.
We may add a caveat. As stated above, the principle of estimation of the contingent liability is not the normal rule. As stated above, it would depend on the nature of business, the nature of sales,the nature of the product manufactured and sold and the scientific method of accounting being adopted by the assessee. It will also depend upon the historical trend. It would also depend upon the number of articles produced.As stated above, if it is a case of single item being produced then the principle of estimation of contingent liability on pro rata basis may not apply. However, in the present case, it is not ITA No. 8597/Mum/2010 35 so. In the present case, we have the situation of a large number of items being produced. They are sophisticated goods. They are supported by the historical trend, namely, defects being detected in some of the items. The data also indicates that the warranty cost(s) is embedded in the sale price. The data also indicates that the warranty is attached to the sale price.
....if the historical trend indicates that a large number of sophisticated goods were being manufactured in the past and in the past if the facts established show that defects existed in some of the items manufactured and sold then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deduction from the gross receipts under section 37 of the 1961 Act. It would all depend on the data systematically maintained by the assessee."
ii).Facts of Woodward Governor India Ltd.(321ITR147) were as under:
For the assessment year 2004-05, the assessee claimed warranty expenses on actual expense basis and provision for warranty expenses. In earlier years, the claim of warranty expenses was on payment basis, i.e., on actual basis. The assessee indicated that it had taken into account the sales of six months of the immediate previous year i.e. of October, 2002 to March, 2003, since the claims of warranty in respect thereof were to be settled in the current year itself. The AO disallowed the assessee's total claim for provision made for warranty treating it to be of a contingent nature. CIT(A)confirmed the finding of the AO .The Tribunal held that the working of the average rate of warranty expenses was rational and scientific and thus acceptable, but the rate had to be applied to the sales made during the current year only.The sales made during the period from October 2002 toMarch,2003 had been recognized in the previous year ended on March 31,2003 and the assessee had incurred actual warranty expenses in the current year with regard to the same. Moreover, the actual warranty expenses had already been allowed by the AO and thus there was no reason to make a provision for warranty expenses for the sales of the previous year.Consequently, the Tribunal reduced the provision by the sum pertaining to sales for the period from October, 2002 to March 31, 2003.
In the appeal filed by Revenue Hon'ble HC of Delhi held that there was no error in the impugned order of the Tribunal.
From the above, it is clear that Tribunal had adopted a principal, and the Hon'ble High Court endorsed, it.Figures were made available and the Tribunal reduced some figures pertaining to earlier period and then crystallised the liability.
iii).Ericssion Communications P. Ltd.(318ITR340) In this case the Hon'ble HC first referred to the issue before it in the appeal filed by Revenue as under -
"The common issue which arose in the appeals from the order of the Tribunal was "Whether the assessee/respondent was entitled to make a provision for warranty charges holding the ITA No. 8597/Mum/2010 36 same to be definite business liability allowable as deduction during the relevant assessment years."
The facts of the case were that the assessee was engaged in the business of installation / erection and setting up/commissioning of various telecommunications projects. In these projects executed by the assessee,the contracts in question provided for warranty clauses in favour of the customers which was the normal industry practice.By virtue of the inclusion of the warranty clauses in the contract,the assessee sought to make a provision for the anticipated costs of the assessee's liability under the warranties in respect of the projects executed by it. The amounts thereafter actually paid pursuant to the warranty clauses in the warranty period were subsequently met out of this provision. The assessee claimed that the expenses to be incurred by it during the warranty period of the project were provided for by a provision on the basis of technical evaluation carried out and the provision towards expenses is computed scientifically as a percentage of its total turnover on the basis of its worldwide experience with respect to such warranty clauses towards repairs and replacements.The assessee,thereafter,would make a reversal entry after actual payments against the warranty claims from the provision created in the preceding year, i.e., the balance amount except to the extent of actually paid during the warranty period is duly credited to the profit and loss account and offered for taxation u/s.41(1)of the Act. The business of the assessee commenced in the assessment year 1997-98 when the provision was first made.
After narrating the above facts Hon'ble HC stated as under :
"Counsel invited our attention to the assessment years 2004-05 and 2005-06 where provisions which were made during the year were Rs.90,412,453/- and Rs.95,279,000/-, respectively, and against which the actual payments were Rs.60,152,183/- and Rs.64,711, 000/-. Learned senior counsel contended that consequently in the subsequent years the claims of warranty, therefore, were a high percentage of the provision made. It was further contended that it is not as if a huge provision is made every year because there is a reversal in each subsequent year, i.e., although no doubt in each year provision is made as a percentage of turnover, in net effect, it is only the higher difference if there is a higher turnover, then there is a net additional provision inasmuch as the extent of provision made in the earlier year which is not paid of as warranty charges is to the extent of not utilised in payment of the warranty claims credited to the profit and loss account. Counsel, therefore, contended that it may appear that every year a huge figure is debited, however, that is in reality not the correct picture. Of course, we may note that even counsel for the Revenue does not dispute this position as, according to her, only the difference is being disallowed by the Assessing Officer .
In response to the arguments and the preliminary contention of the respondent, counsel for the appellant/Revenue has by referring to a chart made for the assessment years 1997-98, (which is the first year of operation of the company) to 2001-02 strenuously contended that the huge differences in the provisions made and the actual payment for warranty charges indicates, that there is no scientific basis for making of the provision and relying on various ITA No. 8597/Mum/2010 37 observations of the Supreme Court in Rotork Controls India P. Ltd. [2009] 314 ITR 62 it is urged that it is only a reliable estimate of a warranty amount which can be made as a provision. She further contended that the factual figures in the chart show that only a small portion of the warranty provision is utilised in the subsequent years. towards making payment of the warranty claims clearly showing that a sensible estimate has not been made. She referring to the chart further contended that the historical trend shows that the question of reversal in the subsequent years would not have arisen if the provision was made on a scientific basis."
Hon'ble HC found that the assessee was giving warranty for 12 months and provision was created at 2 % of project revenue and at 1% of trading income. Matter was decided by the Hon'ble HC in following words:
"We feel that,in the facts of the present case, the contentions of the respondent merits acceptance and the appeals are liable to be dismissed. This is because the entire stress of counsel for the Revenue on the aspect of the historical trend is not well founded inasmuch as the respondent-company commenced operation only in the year 1997-98 and in a period of 3 to 4 years it cannot be said that a " historical trend" emerges. It is not a matter of dispute that the respondent-assessee company is a multi-national company and carries out business throughout the world. The policy as prevalent for making a provision for warranty claims is universally applied by the assessee-company in various countries throughout the world where it carries on the business.Counsel for the respondent has placed reliance on its internal directives contained in its manual for the warranty provision.These policy directives with respect to the warranty provides in detail clauses and directions for warranties for supply contract ;for hardware ; spare parts and software and so on. The policy document further provides for warranty periods for different types of subjects and also deals with the requirement of financial terms for the warranty to be made. This is a nine page document and it is difficult for us to reproduce the same in the body of this order, however,it is quite clear that the policy and principles with respect to provisions for warranties which are made by the assessee-company is not simply an ad hoc method without any scientific basis. The scientific basis is consistently applied by the assessee-company for its business throughout the world".
We frame this question of law and in view of above discussion answer the said question of law as under : " The assessee-company is entitled to make a provision for the warranty charges holding the same to be a definite business liability allow- able as a deduction during the years under consideration, since the same is based on a scientific basis and a consistent policy applied by the assessee-company throughout the world including India and that consistent application of the same principle over the years would remove any advantage which, according to the Revenue, the assessee may have by deferring of its income to the extent of warranty provision to the next year."
iv).In Luk India (P) Ltd. question to be decided by the Hon'ble High Court of Madras was as under:
ITA No. 8597/Mum/2010 38"Whether the on the facts and in the circumstances of the case, the ITAT was right in holding that the provision for warranty was an allowable deduction, even though the provision had not been made on any scientific basis ensuring a fair degree of accuracy,thereby resulting in the deferment of revenue and the tax liability thereon?"
While going through the order of the Hon'ble High Court we noticed that in this case figures for 1997-2010 period were available to the Tribunal and that after analysing the data Tribunal decided the issue. In para 7 of the order Hon'ble High Court has held-"Having regard to the figures furnished and claim that a scientific approach was made, while making a provision for warranty claim, which was based on the average of the previous years' warranty settlements, it cannot be held that there was any error, much less an illegal error committed by the Tribunal while passing the impugned order. In fact, a cursory glance of the figures set out in the statement is in paragraphs 7 and 8 disclose that depending upon the trend of warranty settlement is over a period of time corresponding to the sales figures, the percentage of provisions made was not inconsistent and as rightly held by the tribunal, there was no arbitrary approach made by the assessee while making the provision for warranty claims. Therefore, looked at from any angle, we do not find any flaw in the order of the Tribunal in having decided to confirm the order of the CIT (A) for the relevant years."
After discussing the principles Rotrok in paragraph 5 of the order, the Hon'ble High Court , made following observations-
"The assessment years related to 1999-2000 to 2004 --2005. Before the tribunal, on behalf of the assessee, the provisions for warranty made in the books of accounts and the actual settlements of warranty claims for the assessment years 1997 - 1998 to 2009 - 2010 1 furnished and the same has been set out in paragraph 7. Similarly, the details of the year-wise sales and the percentage, at which the quantum of provision for warranty was worked out in each year by the assessee-company were also furnished. After referring to those figures furnished in form of statements and after considering the stand of the revenue as well as the assessee, the Tribunal has rendered its finding is under in paragraph 11.
"11. It is seen from the chart reproduced in paragraph (8) above that the multiplying factor was 3.99 in assessment year 2002 - 03 and that it came down to 0.67 in 2007-08. Since the basis of computation is the average of the immediately visiting the years actual settlements, the accumulated credit balance in the provision for warranty account will become self-limiting, as can be seen from the chart in paragraph (8) above.For the assessment year 2007-08, the sale was more than 3 times the sale for assessment year 2002-03, whereas the provision for warranty was about one half. Further, the genuineness of the figures of the actual settlements has not been doubted by the AO . In view of these facts, the method of computation adopted by the assessee cannot be said to be arbitrary, and therefore, we see no reason to interfere with the conclusions reached by the CIT (A)."
From the above discussion, it is clear that the working of liability in this case was based on a reasonable and scientific basis.Not only this,there was revaluation of the system of also.In the ITA No. 8597/Mum/2010 39 case under consideration the disallowance is not because the warranty liability was contingent or an unascertainable, but because no scientific method was followed to justify the claim amounting to Rs.44.2 Crores.
v).In the matter of Nokia Siemens Networks India Pvt.Ltd facts were that the AO had allowed the provision for warranty amounting to Rs.2.83 crores. But,the CIT in his revisional jurisdiction held that warranty provision was a contingent provision and it would not constitute expenditure. Aggrieved by the order of the CI, assessee preferred an appeal before the Tribunal. In the appeal, the Tribunal held that the provision for warranty was an allowable expenditure, and such provision was not a contingent expenditure. Hon'ble Karnataka High Court after citing paragraphs 10-12 of Rotrok held -
"In view of the declaration of the law by the apex Court which clearly applies to the facts of this case, no substantial question of law arises for consideration in this appeal."
From the about discussion, it is clear that in this case applicability of scientific method of liability was never discussed or decided.
vi).In the case of GE India Exports Private Ltd. AO held that warranty liabilities were contingent liabilities and held the same as non-allowable expenditure. While deciding the issue he did not refer to the principles propounded by Rotrok. But, during appellate proceedings Tribunal took notice of many a facts, one of which was the practice adopted by the assessee all over the globe. Secondly, facts and figures for various assessment years. were submitted by the assessee to The tribunal. After considering the figures the Tribunal reached at the following conclusion-
"Therefore, depending upon the period of warranty and the possible defects in the goods and also on the basis of past experience, the assessee will help to provide for warranty obligation. In the case before us, the assessee has been selling the goods with warranty and has been making a provision for warranty at 1% of eligible sales out of which every year. The assessee had to spend 30 to 40%. This method of making the provision of 1% of the eligible sales on the basis of the method followed by it, worldwide, cannot be said to be an ad hoc method or not on scientific basis. The Hon'ble Supreme Court in the case of Rotrok controls India Pvt. Ltd has considered the provision of warranty at length and has held that where a reliable estimate of an obligation is made, the provision of warranty is allowable. Similar view, have been expressed by the Hon'ble Delhi High Court, also in the case of Ericsson communication private Ltd. In our opinion, the decision of the Hon'ble Supreme Court and that of the Delhi High Court are very much applicable to the facts of the case before us and respectfully following the same, we allow this ground of appeal of the assessee."
Thus, in this case also figures were available to the Tribunal to hold that procedure adopted by the assessee was reasonable or not?
vii).In the case of Godrej Appliances Ltd. principles of Rotrok were neither referred to nor applied.In this matter, G Bench of the Tribunal ,has held as under -
ITA No. 8597/Mum/2010 40"We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that a similar issue was involved in the assessee's own case for the earlier years and the same has been decided by the Tribunal consistently in favour of the assessee. In one of such decisions rendered by the Tribunal vide its order dated 5 July, 2005 past and ITA number 334/mum/02, Tribunal note of the decision of its coordinate bench at Bangalore, passed in the case of Wipro GE medical Systems Ltd (81TT J455),where in it was held while deciding a similar issue that the warranty liabilities are in built in sale price,since all sales are with warranty liabilities.It was also held that the liability towards warranty is certain and the same accrues on the date of sale itself. It was also held that the ascertainment of such liability can be done with reasonable certainty on the basis of experience. Following this decision of Bangalore bench of ITAT in Wipro GE medical Systems Ltd, the Tribunal held in the case of the assessee for the assessment year 94-95 vide its order dated. 5. 7. 2005 that the learned in CIT (A) was right in deleting the disallowance made by the AO on account of assessee's claim for provision for free services under product warranties. The said decision rendered by the Tribunal for the assessment year 94-95 is being subsequently followed by the Tribunal and one of such orders passed by the Tribunal on the assessment year 2002-03 is being upheld by the Hon'ble Bombay High Court by dismissing the appeal of the Department by its order dated 29 July 2009."
viii).Nagari Mills Co. Ltd.
The question referred to the Hon'ble High Court was as under :
"Whether having regard to the provisions of section 10(2) read with section 10 (5) of the income tax act,the assessee company is entitled to a of Rs.1,80,000 on account of bonus for the year,1951 in computing the business profits for the assessment year 1952-53?"
We are of the opinion that the facts of the case under consideration are totally different from the facts of Nagari Mills Co.
9.4.In view of the above discussion we are of the opinion that warranty liability can be considered part of the sale and might be allowed in computing the taxable income.But, for claiming the allowance one has to furnish a fair,reasonable and scientific basis to the AO.To arrive at the conclusion that the assessee is following a reasonable and scientific method with regard to warranty liabilities,as directed by the Hon'ble Supreme Court in the matter of Rotrok,facts and figures of the earlier years are essential. Besides,AO should also consider as- what was the policy practised by the assessee in earlier years, what was the basis for calculating a certain percentage of sales for determining warranty liability, and what was the rate of reversals of liabilities in the earlier years .We find that in the case under consideration, the assessee did not provide material with regard to warranty liabilities(except a table found at pg.53 of the assessment order)to the AO or to the Redressal Penal during assessment/hearing proceedings. From the said chart(pg.53) any reasonable conclusion cannot be drawn,as desired by Rotrok.We find that the company has not scrutinised the 'historical trend' of warranty provisions made and compared it with the actual expenses incurred. Appellant has ITA No. 8597/Mum/2010 41 failed to prove that figures furnished by it are based on a 'sensible estimate' .We find that evidence of 'yearly reassessment of such estimates' were not produced. In other words appellant has not 'maintained data systematically'.In these circumstances, we are of the opinion that matter should be remitted back to the file of the AO to decide the matter, as per the guidelines discussed in the case of Rotrok. Assessee is directed to provide necessary figures to the AO to substantiate its claim.
As far as the earlier orders of the Tribunal are concerned we are of the view that at that point of time principles of Rotrok were not available, so matters were decided considering prevalent circumstances. Now, we have a light house in form of Rotrok to guide us, so it is advisable to be wiser and follow the path indicated by the Hon'ble SC.
10.Ground number 10 is about to the provision for pending labour demand amounting to Rupees 78.45 lakhs. As per the AO provision for labour demand was under negotiation at certain locations of the company and ultimate settlement was contingent on the conclusion of the negotiations. As per the AO in the annual general body meeting said liability was accepted as contingent in nature. Relying upon the case of Indian molasses Co. Pvt. Ltd he disallowed the said amount.
10.1.The AR submitted that tribunal had decided the issue in its favour for the assessment years. 1992-93 to 1996-1997.He also referred to the decision of the Hon'ble, High Court of Bombay in the case of United motors. DR supported the order of the AO.
From the records, it is clear that the issue in question has already been decided in favour of the assessee in earlier years. For the AY 1996-97 Mumbai Tribunal decided the issue of provision for pending labour demand as under :
"...that the deduction is allowable in respect of the estimated liability regarding incremental wages before the final agreement was entered in to." While deciding the said issue Tribunal relied upon the judgment of United Motors. and the appellate orders. for earlier years of the asssessee.
10.2.Respectfully following the orders of the earlier years in assessee's own case and the principles enumerated by the Hon'ble High Court of Bombay we decide the issue in favour of the assessee.
11.Ground number 11 pertains to disallowance made by the AO under section 40A (9) of the Act, amounting to Rs.26,38,766/-.On perusal of Annexure-XIV of the audit report, AO noticed that appellant had incurred expenditure of Rs.6,86,594/- and of Rs.19,52, 172/-,on account of contribution to employees' benefit fund and contribution to Mahindra Academy, Zaheerabad respectively. During the course of assessment proceedings, the appellant was asked to explain as to why the said expenses should not be disallowed as per the section 40A (9) of the act. After considering the submissions of the appellant AO disallowed the sum amounting to Rs.26.38 lakhs, because he was of the opinion that contribution was in violation of provisions of section 40A (9) of the Act.ITA No. 8597/Mum/2010 42
11.1.AR submitted that Rs.6.86 lakhs were transferred to welfare fund of the employees, that amount was not transferred to a separate entity, that Rs.6.86 lakhs did not represent any contribution but was the amount spent on employees' welfare activities ,that Rs.19.52 lakhs were incurred as a grant to Mahindra Academy. DR submitted that assessee himself had admitted that Rs.6.86 lakhs were transferred to a fund, that children of the locality were also studying in the school run by the Academy, that both the contributions were hit by section 40A(9).AR admitted that the issue about disallowance made u/s. 40A(9)was set aside by the Tribunal for the assessment years 1996-97,1997-98 and 1998-99.
11.2.After hearing rival submissions we are of the opinion that it will be useful to refer to a few matters dealing with Sec.40A(9).One of them was matter of Raasi Cement Ltd (275 ITR
579).Hon'ble AP HC in the case of framed following question law with regard to section 40(A)(9) of the Act :
"Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in holding that the contributions made by the applicant in M/s.Raasi Cement Executives Welfare Trust was not deductible in computing the income of the applicant ?
The brief facts of the said matter were that the assessee-company was engaged in the manufacture and generally to deal in all kinds of Portland cement, that the claim of the assessee pertained to the sum of Rs.1.5Crores which represented initial contributions made by it to Raasi Cement Employees' Welfare Trust and Raasi Cement Executives Welfare Trust, that expenditure debited to staff welfare expenses account was disallowed by the AO on the ground that the same was capital contribution in terms of Sec.40A (9)of the Act. The disallowance was confirmed by the first appellate authority. ITAT allowed the claim of the assessee for deduction regarding the contribution to Raasi Cement Employees' Welfare Trust, but in the case of Raasi Cement Executives Welfare Trust, the Tribunal rejected the claim of the assessee. Hon'ble HC decided the issue as under :
"By the said provision, only such deductions are to be allowed which are for the purposes and to the extent provided by or under clause (iv) or clause (v) of sub-section (1) of Sec.36 of the Act, or as required by or under any other law for the time being in force. There is no dispute that there is no law requiring the assessee to make such contributions or expend money on the said account. Perusal of clauses (iv) and (v) of Sec. 36(1) referred to in the afore-said sub-section (9) of Sec.40A of the Act would show that the deductions that are to be allowed to an employer are contributions towards a recognised provident fund or an approved superannuation fund or by way of contribution towards approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust.ITA No. 8597/Mum/2010 43
Admittedly, the payments in question do not fall either under clause (iv) or clause (v) of sub- section (1) of section 36 of the Act."
ii)In the case of Alfa Lavel (India) Education Trust issue regarding 40(A)(9) was dealt as under (286 ITR193(AT)(Mum) :
"Ground No.1 is against the findings of the learned Commissioner of Income-tax (Appeals) that the assessee was not entitled to deduct a sum of Rs.4.25 lakhs in computing the income, being a contribution made to Alfa Laval Education Trust, in view of the provisions contained in section 40A(9) of the Act. It was mentioned that he erred in not following the decision of the hon'ble Andhra Pradesh High Court in the case of CIT v. Vazir Sultan Tobacco Co. Ltd. [1988] 169 ITR 139, and that of the Commissioner of Income-tax (Appeals) in the assessee's own case for the assessment years 1987-88 to 1998-99. In the course of hearing before us, learned counsel for the assessee fairly conceded that this issue has been decided against the assessee in earlier years. by the Hon'ble Income-tax Appellate Tribunal, Mumbai Bench "F", Mumbai, in I. T. A. Nos. 3211 and 3212/Mum/2000 for the assessment years 1997-98 and 1998-99, a copy of which was placed in the paper book on pages 6 to 11. Paragraph 14 of the order deals with this issue, wherein it is mentioned that this very issue was considered by the Tribunal in the case of the assessee for the assessment year 1995-96. In that order it was held that the deduction is not permissible in view of the pro-vision contained in section 40A(9) of the Act and, consequently, the appeals of the Revenue for the assessment years 1997-98 and 1998-99 were allowed.
Respectfully following that decision, this ground is dismissed."
iii).Similarly,in the matter of National Dairy Development Board ITAT, Ahmedabad 310ITR325(AT-Abd) dealt the matter as under
"The Assessing Officer disallowed the claim of the assessee in view of the provisions of section 40A(9) of the Income-tax Act,1961 read with Circular No. 387 dated July 6, 1984 stating that deduction could not be allowed in respect of any sum paid as contribution to any fund. The Commissioner (Appeals) confirmed the addition observing that the expenses incurred by way of reimbursement to the employees' recreation club were not wholly and exclusively incurred for the purpose of business of the assessee.ITA No. 8597/Mum/2010 44
Held that the payments made by the assessee towards contribution to employees' recreation club were not of the nature specified under section 36(1)(iv) and (v) which were allowable under section 40A(9) of the Act. The Tribunal had upheld the disallowance of a similar claim of the assessee in its earlier case. Therefore the addition made by the Revenue authorities on account of contribution to the employees' recreation club was confirmed......We have heard the parties and considered the rival submissions. In our opinion the CIT(A) is right in disallowing the claim of the assessee. The provisions of section 40A(9) are very clear in providing that any payment or contribution made by an employer on behalf of the employees to any fund, trust, society, association or person etc. would not be an allowable expense except the payment made for expenses provided for under section 36(1)(iv) and (v). Admittedly the payments are not for expenses of the nature under section 36(1)(iv) and (v).It is also pointed out that disallowance of a similar claim of the asses-see was upheld by the Tribunal in ITA.No. 5051/Ahd/1994. We accordingly, uphold the said disallowance of expenses.
The addition made by the Revenue authorities on this account is confirmed."
11.3.In the earlier years matter was remanded back to the AO-it was not decided in favour of the appellant. After considering the facts and circumstances of the case as well as the legal position, we are of the opinion that issue in question in issue should be remitted back to the file of the AO,as it was referred in the earlier years.
Matter is set aside accordingly.
12.Next ground of appeal is about this allows of Rs.3,69,07,378/- claimed by the appellant as Employee Cost being the difference between the fair market value of the shares offered to the employees on the date of grant of option and prices at which they were offered to the employees.. Employees' Stock Option Scheme (ESOP) was dealt by the AO as under :
"As per the directions of the DRP-II, Mumbai, the expenses mentioned above are not being allowed as an expenditure because the expenditure has been incurred for increasing share capital of assessee company. The expenditure basically comprises the difference between market price and issue price employee stock option issue to the employees of the company. This issue will result into increase in the issued share capital of the company and, therefore, ITA No. 8597/Mum/2010 45 the expenses being the difference between the market price and issue price necessarily relate to increase in the share capital of the company."
12.1.The AR submitted that the expenditure incurred in respect of ESOPs was neither capital nor contingent nor notional in nature,that the difference was allowable as business expenditure, that there was no fresh issue of capital in the year under consideration, the shares were issued in 2002, the appellant wanted to reward its employees, that ESOP was compensation for services rendered, that it was welfare cost to the assessee, that same was chargeable to Fringe Benefit Tax under section 115 WB of the Act. He relied upon the case of S.S.I Ltd (85 TTJ 1049),Accenture services (P) Ltd, Oil & Natural Gas Corporation Ltd.(322 ITR180), Reliance Industries Ltd.(88 ITR 273).DR supported the order of the AO and submitted that expenditure incurred on ESOP was not allowable under section 37 of the Act.He relied upon the order of the Ranbaxy Laboratories (Delhi ITAT) and VIP Industries (Bombay ITAT).
12.2.After hearing the rival submissions we are of the opinion that the facts of case under consideration cannot be compared with the case of Reliance industries Ltd and ONGC Ltd.In the matter of Reliance industries question before the tribunal was sales tax subsidy.The question referred to the special bench for decision was as under-
"Whether, on the facts and circumstances of the case and in law passes the company is justified in its claim that the sales tax incentive allow to it during the previous year in terms of the relevant government order constitutes capital receipt and is not to be taken into account in computation of total income?"
Similarly,in the case of ONGC limited the question before the Hon'ble Supreme Court was about the additional liability arising on account of fluctuations in the rate of exchange in respect of loans taken for revenue purposes. Now, we would like to discuss the other 2 cases.In SSI Ltd.main question was about treatment to be given to ESOPs with regard to FBT and in the other matter. ESOPs of parent Company were allotted to the employees. Thus, all the four cases are distinguishable on facts from the case under consideration.
On the other hand, facts and circumstances of cases of Ranbaxy Laboratories, VIP Industries and PVR Ltd. are similar to the present case. In these cases all the arguments advanced by the ITA No. 8597/Mum/2010 46 AR of the assessee have been considered along with the case of SSI Ltd.We would like to mention the facts and ratios of the cases referred above.
i).ITAT,Mumbai-F,Bench in the case of VIP Industries (ITA No.7242,1004/Mum/08,AY 2005-06 and 2006-07) has discussed the question under consideration at length in following words -
"11. Ground No. 6 relates to the disallowance of Rs.66,24,877/- made by the A.O. and confirmed by the ld. CIT(A) on account of expenses claimed to be incurred by the assessee company on account of Employees Stock Option Scheme (ESOP).
12. During the year under consideration, the assessee company had allotted shares to its employees under the Employees Stock Option Scheme (ESOP). The said ESOP was granted on 22.11.2004 in respect of 8 lacs shares of the assessee company at Rs.30/- per share as against the market price of Rs.53.80/- per share. There was thus a price difference of Rs.23.80 per share which came a total of Rs.190.40 lacs in respect of 8 lacs shares given under ESOP. Out of this total amount, the assessee company had charged Rs. 66.25 lacs to its P&L account for the year under consideration and the balance amount of Rs.124.15 lacs claimed in the immediately succeeding year i.e. A.Y. 2006-07. In support of the claim made on this issue, reliance was placed on behalf of the assessee company before the A.O. on relevant SEBI Rules which specified that the difference between the market price and the price at which the option is exercised by the employees has to be debited in the P&L account as expenditure. It was contended that since there was no specific provisions contained in the Income Tax Act dealing with this issue, accounting practice suggested by the SEBI is required to be applied and adopted for tax purposes also. The matter was carried before the ld. CIT(A) ,but the submissions made on behalf of the assessee on this issue did not find favour with the ld. CIT(A) who confirmed the disallowance made by the A.O. on account of assessee's claim for deduction on account of ESOP expenditure."
After considering the submissions of the AR and DR and the rejoinder of the AO Tribunal decided the matter (in paragraphs 19-21) in following words -
"We have heard the arguments of both sides and also perused the relevant material on record. We have also carefully perused the case laws cited by the ld. Representatives of both the sides. In our opinion, the decision of Delhi Bench of ITAT in the case of Ranbaxy ITA No. 8597/Mum/2010 47 Laboratories Ltd. (supra) cited by the ld. D.R. is directly applicable in the present case and the same squarely covers the issue under consideration against the assessee and in favour of the Revenue. In the said case, the decision of Chennai Bench of ITAT in the case of SSI Ltd. (supra) heavily relied upon by the learned counsel for the assessee in the present case was also cited on behalf of the assessee. The same, however, was found by the Tribunal to be distinguishable on facts for the following reasons given in para 7.16 of its order:
" The decision of Tribunal, Chennai in the case of S.S.I. Ltd. (supra) relied upon by the learned counsel for the assessee is also distinguishable on facts. In the case the assessee claimed similar expenditure which was allowed by the Assessing Officer. The learned CIT in his revision jurisdiction under s. 263 held such expenditure as notional and contingent in nature. The Tribunal held that in view of SEBI guidelines which the assessee was required to follow, such expenditure are in the nature of ascertained liability and not contingent liability upon happening of certain events. Hence, it was held that the order was not erroneous so as to be validly revised under s. 263 of the Act. However, the Tribunal in the said case has not answered the issue whether the loss is notional in nature or not. The Tribunal has also not considered the decision of Hon'ble Supreme Court in the case of Eimco K.C.P. Ltd. (supra) and that of Delhi High Court in the case of Reinz Talbros (P) Ltd. (supra) which is a jurisdictional High Court for us. For all the reasons stated above we, therefore, hold that the expenses as claimed by the assessee are not allowable as such."
20. In the case of Ranbaxy Laboratories Ltd. (supra), shares were allotted by the assessee company to its employees under ESOP at price less than the market price and the resultant difference was claimed as expenditure relying, inter alia, on SEBI guidelines. The Tribunal, however, confirmed the disallowance made by the authorities below on account of the said expenditure after examining all the relevant aspects and after giving elaborate reasons as can be seen from the relevant portion of its order which is extracted from the held portion:
" The assessee was to issue shares of face value of Rs.10 /- by receiving a sum of Rs.595/- per share from its employees. Thus the assessee was entitled to receive Rs.585/- towards premium on issue of shares. The market price at Rs.738.95 per share would have resulted in realization of higher share premium. The assessee has not accounted for the difference between Rs.738.95 and Rs.10/- as its income during the year. Thus there is no loss of income held to be taxable. What is loss to the assessee is by way of short receipt of share premium amount ITA No. 8597/Mum/2010 48 and not by way of any expenditure or incurring any liability for such expenditure. By issuing shares at below market price, the same does not result into incurring any expenditure. By issuing shares at below market price, the same does not result into incurring any expenditure rather it results into short receipt of share premium which the assessee was otherwise entitled to. Though the guidelines of SEBI requires the assessee to account for short receipt of share premium as employees compensation expense, for claiming such expense as allowable, the assessee has to qualify that expenses are incurred and the same are wholly and exclusively for the purpose of business. By issuing shares at lesser that market price, the assessee cannot be said to have incurred any expenditure rather it amounts to short receipt of share premium. The receipt of share premium is not taxable and hence any short receipt of such premium will only be a notional loss and not actual loss for which no liability is incurred. SEBI guidelines are relevant for the purpose of accounting but are not conclusive for the purpose of allowing the same as expenditure. Therefore, such notional losses are not allowable under the Act. The assessee is not to defray or pay any liability under the claim. Therefore, such notional loss cannot be held to be allowable under the scheme of the Act.
What is allowable under s. 37 is any expenditure not being expenditure of the nature described in ss. 30 to 36 and not being in the nature of capital expenditure or personal expenditure of the assessee. Such expenditure should be wholly and exclusively for the purpose of business. Thus, the prerequisite is that the assessee should have incurred an expenditure. 'Expenditure' is what is 'paid out or away' and is something which has gone irretrievably. A benefit or income foregone cannot be considered as in expenditure. Since the assessee had not incurred any expenditure but has merely received lesser amount of share premium, the same does not amount to expenditure within the meaning os s. 37. Therefore, the claim of assessee is not allowable. - Eimco K.C.P. Ltd. Vs. CIT (2000) 159 CTR (SC) 137:(2000) 242 ITR 659 (SC) and CIT vs. Reinz Talbros (P) Ltd. (2001) 252 ITR 637 (Del) followed.
It is now settled law that entry or absence thereof in books of account is not conclusive either for treating the amount as income or allowability or otherwise of the expenditure. Thus, only on the basis of entry in the books of account the claim of expenditure is not allowable. The entry is made on the basis of recommendation of SEBI which is said to be mandatory for a listed company. The same may be relevant for the purpose of accounting but for allowability of expenditure under IT Act the direction of SEBI does not determine the alowability of ITA No. 8597/Mum/2010 49 expenditure. For the purpose of allowability of expenditure under IT Act the same has to be in consonance with the scheme of the Act. In the instant case the entry made in books of accounts as per direction of SEBI cannot be held to be conclusive for the purpose of allowing expenditure under s. 37. Unless the provision of s. 37 is complied with, the deduction is not permissible.- New India industries Ltd. Vs. asstt. CIT (2007) 112 TTJ (Del)(SB) 917 : (2008) 1 DTR (Del) (SB) (Trib) 247 and TVS Finance & services Ltd. Vs. jt. CIT (2009) 23 DTR (Mad) 33"
21. At the time of hearing before us, the ld. Counsel for the assessee has made an attempt to point out that certain aspects have not been considered by the tribunal while rendering its decision in the case of Ranbaxy Laboratories Ltd. (supra) on the similar issue. In our opinion, the said aspects pointed out by the ld. Counsel for the assessee, however, are not material enough to have any direct bearing on the well considered and well reasoned decision rendered by the Tribunal. As held by the Tribunal, any short receipt of share premium would only be a notional loss to the assessee and not an actual loss. As further held by the Tribunal, any benefit or income foregone by the assessee cannot be considered as an expenditure and since the assessee had not incurred any expenditure but had merely received lesser amount of premium, the same could not amount to expenditure within the meaning of section 37. In our opinion, the issue involved in the present case as well as all the material facts relevant thereto are thus similar to the case of Ranbaxy laboratories Ltd. (supra) and the decision rendered in the said case by the co-ordinate Bench of this Tribunal is squarely applicable in the present case. Even the decision of Hon'ble Supreme Court in the case of CIT vs. Infosys Technologies Ltd. (supra) cited by the ld. Counsel for the assessee was rendered in altogether different context and the same cannot be of any help to the assessee on the issue involved in the present case. Respectfully following the decision of the co-ordinate Bench of this Tribunal in the case of Ranbaxy Laboratories Ltd. (supra), we uphold the impugned order of the ld. CIT(A) confirming the disallowance made by the A.O. on account of ESOP expenses claimed by the assessee and dismiss ground No. 6 of the assessee's appeal."
ii).ITAT Delhi in the case of M/s PVR Ltd.(ITA No.1897/Del/2010- AY 2006-07) has again decided the issue against the assessee who had claimed that ESOPs expenditure was allowable. Matter has been discussed as under -
ITA No. 8597/Mum/2010 50"7. The ld. CIT(A) has erred on facts and in law in confirming the disallowance of loss/ expenditure debited to P&L a/c of Rs.70,08,183/- in respect of ESOP and ESPS schemes. The disallowance has been made by erroneously treating said expenditure/ loss as notional, as a capital expense and as a contingent liability.
8. That the said disallowance of Rs.70,08,183/- on account of ESOP and ESPS schemes as confirmed by the Ld. CIT(A) is based on erroneous facts and erroneous views and/ or non appreciation of the facts and law involved. The said claim is neither notional, is a revenue expense and does not constitute a contingent liability. The claim has been incurred and debited to P&L a/c as required under binding SEBI guidelines and is admissible in law and there is no provision under the Act against allowance of the same.
3.7. CIT(Appeals) upheld the disallowance on account of ESOP made by AO by following observations:
"I have carefully considered the submissions of the ld. AR and perused the assessment order passed by the AO. It is seen that the appellant has claimed the expenditure on account of ESOP on notional basis. On the ground that the scheme was approved by SEBI. Hon'ble Supreme Court in the case of Southern Technologies Ltd. vs. CIT 320 ITR 573 has held that the guideline of any regulatory authority cannot over ride the specific provisions of the Income tax Act. In order to claim a deduction admissible under I.T. Act, the appellant must show the specific provisions under which the same is allowable under I.T. Act. In view of the discussion and decision of Hon'ble ITAT, Delhi in the case of Ranbaxy Ltd. (supra), I hold that the AO was fully justified in making disallowance of Rs.70,08,183/- on account of ESOP. I, therefore, uphold the disallowance made by the AO."
13.8.Coming to the issue of ESOP and ESPS, facts have been mentioned above. Respectfully following coordinate Bench of ITAT Delhi judgment in the case of DCIT Vs. Ranbaxy Laboratories Ltd. (2009) 124 TTJ (Del) 771;and Mumbai ITAT judgment in the case of VIP Industry (supra), we hold that the provision made by assessee without actually paying them to the employees cannot be allowed as deduction. This ground of the assessee is dismissed."
12.3.As the case relied upon by the AR- S.S.I Ltd. - has been considered in the later judgments by different benches of the Tribunal, we are of the opinion that issue has to be decided against the assess. Respectfully following the above referred decisions of Ranbaxy ITA No. 8597/Mum/2010 51 Laboratories Ltd.,VIP Industry and PVR Ltd.(supra)we dismiss the ground under consideration.
13.Next ground of appeal is about disallowance made by the AO,u/s. 14 A of the Act, amounting to Rs.29.37 Crores. Pursuant to the directions of the DRP the AO enhanced the disallowance and also included entire personal cost of the company, interest on borrowed fund and entire miscellaneous expenses while calculating the disallowance.
13.1.AR submitted that AO should be directed to compute disallowance on the same basis as adopted for the assessment year 2007-08 pursuant to the directions of the DRP. As per the directions of the bench appellant submitted the comparative figures for the assessment year 2006-07 and 2007-08 (page number 363 to 371 of the paper book) in this regard.
AO is directed to recompute disallowance considering the materials submitted before us. In the interest of justice matter is being remitted back to the file of the AO.
14.Ground number 14 pertains to disallowance of Rs.1,17,01,995/- with regard to the entrance and membership fees of various clubs.As per the AO expenditure incurred for membership of clubs was a capital expenditure, because the appellant had enduring benefit from the said memberships.
14.1.Before us the AR submitted that issue was covered in favour of the assessee by the decision of the Bombay High Court in the case of Otis Elevators Company (India) Ltd.(195 ITR 682). He also relied upon the judgement of Hon'ble Gujarat High Court in the case of Gujarat State export Corporation Ltd (209 ITR649).AR further referred to the orders of the tribunal for the earlier assessment years (AYs.1996-97,1997-98,1998-99)decided in favour of the assessee along with the case of Bank of America Securities (I) Ltd (136 TTJ 441).DR supported the order of the AO and submitted that incurred expenditure was of capital nature. Here, we would like to mention that judgement delivered by the Hon'ble Bombay High Court in the case of Otis Elevators Company (India) Ltd is about section 40(a)(v),and not about capital/revenue expenditure.
14.2.After considering the rival submissions we are of the opinion that matter should be remitted back to the file of the AO.He is directed to consider the judgments of the Hon'ble High Courts of Gujarat and Kerala in the matters of Gujarat State export Corporation Ltd. and Framatone Connector Oen Ltd.while deciding the issue. He is also directed to peruse the ratio ITA No. 8597/Mum/2010 52 laid down by M/s. New India Extrusion decided by New India Extrusions (P) Limited v ACIT 10 Taxmann.com 165 in this regard .One of us was party to said order of the New India Extrusions.
Matter is set aside accordingly.
15.Next Ground is about adjustments made under section 92CA(3) of the act.In this regard decision of the AO is as under :
"The reference as the provisions contained under section 92CA (1) of the I.T.Act,1961, was made to Transfer Pricing Officer on 27.9.2007 for computation of arm length price in relation to the international transactions mentioned in the audit report in form number ....... the TPO, as per para 5 of his order made an adjustment of Rs.1,26,51,602/-."
The AO then referred to the directions issued by the DRP-II, Mumbai. DRP-II discussed the issue at length with regard to guarantees issued to the subsidiaries of the appellant within ambit of international transactions.The amount involved was Rs.29.18 lakhs. TPO had gathered information from SCB India. As per the bank rate 3% was applied by the TPO in this regard and guarantee fee of Rs.2.5 Lacs to the said amount.
15.1.The AR relied upon the decision in the case of Four Soft Ltd decided by the ITAT, Hyderabad in ITA No. 1495/Hyd/2010. It was held by the tribunal that corporate guaranty provided by the assessee company did not fall within the definition of international transactions. AR submitted that the decision of the Hyderabad Tribunal squarely applied to facts of the case under consideration.The DR submitted that Finance Bill 2012, had proposed to insert an explanation below section 92B of the act and that the said explanation would retrospective and effective from 1st,April 2002, that it would cover the transaction of guarantee, that the reliance of the assessee on the decision of Four Soft Ltd would become redundant once the Finance Bill 2012,was passed by the Parliament.
15.2.After hearing the rival submissions we feel that AO will have to follow the decision of ITAT Hyderabad or the amended provision of the Act in this regard. If the Finance Bill of 2012 is passed by the Parliament amending the provisions of section 92B, with effect from 1st,April 2002,he will have to ignore the decision of the ITAT Hyderabad. In case Section 92B is not amended with retrospective effect, he should grant relief to the appellant.
ITA No. 8597/Mum/2010 5315.3.The 2nd limb of the TPO's order is about reimbursement of expenses amounting to Rs.97, 32,802/-.AR submitted that a large number of H3 tractors exported to the USA had to be recalled due to some manufacturing defects.Pending rectification those tractors were stored at 2 locations. The appellant company reimbursed to the Distributor-AE-storage cost of US $ 118,680, insurance charges US$ 10,599 and property taxes of US $ 87,534 (property tax being payable with reference to the value of such recall tractors as on 31st December).
15.4.As per the AR rectifying the defects was the obligation of the appellant company, that re- shipping of the tractors to India for rectification did not make commercial sense. He further submitted that transaction in question was not an international transactions as envisaged by the transfer pricing legislation.DR submitted that payments made by the appellant were not covered by the agreement, that transfer pricing Officer had read aloud item number 5, 6, 7 and his order. He referred to the page number 18 of the agreement entered into between the appellant and the distributor, i.e., the US company. He submitted that as per the agreement (para 40)appellant company had to be reimbursed for certain expenses.
15.5.AO has followed the directions of DRP in this respect. The directions issued by the DRP about payments made to the US company are as under -
"The next issue for consideration is the transfer pricing adjustment of Rs.97, 32, 802/-on account of reimbursement of various expenses. It was stated by the assessee that H3 series of tractors. had to be recalled due to certain manufacturing defects. Those tractors. were, therefore, required to be stored at a separate location pending rectification of the defects for which USD 25,200 and USD93,480 were paid. Further insurance expenses for storage aggregated to USD 10,599. The inventory holding tax was also paid at USD 87, 534. It was stated that in the alternative, the assessee would have to incur huge expenses in bringing back the tractors. to India and to re-export the same to US, after rectification of the same. The expenses were reimbursed to Mahindra USA Inc. We have considered this issue. There is no dispute that the expenditure incurred was not covered under the warranty expenses or other expenses, as per the agreement between the assessee and the AE. These expenses were required to be borne by the AE who is a distributor acting in the course of its normal business activity. Under the warranty expenses, only cost relating to labour and spare parts were covered and the other costs which have been expended now, were not covered by any agreement of the assessee. It may also be pointed out ITA No. 8597/Mum/2010 54 that it is not an issue of a loss of business expenditure under section 37 of the I.T.Act on account of business expediency, but an issue of transfer pricing where the assessee is claiming expenditure of Rs.97,32,802/-from the Department,while this amount is being paid to the AE, meaning thereby that profits are being shifted outside India. The TPO has noted that the assessee had not provided any evidence of this practice, being adopted with unrelated parties inside or outside the country.The assessee is responsible only for the insurance of the products in the course of transit, which became a liability of the AE after it reached destination, as per the agreement. No evidence in the shape of expenditure has been divided to the TPO or in the DRP proceedings as to the documentations kept. The AE is responsible for payment of all local taxes as per the agreement.In view of the above, we are of the considered opinion that the TPO was more than magnanimous in charging only the reimbursement of expenditure and not charging any mark up on the services rendered by the assessee to the AE. The adjustment made by the TPO/AO is confirmed."
15.6.After considering the rival submissions we are of the opinion that the expenditure incurred by the appellant is not allowable. We have gone through the agreement dated 8 February 1999 between the appellant and the US company. Besides the Para number 40, relied upon by the DR,para 22 , also indicates that appellant had not to incur any expenditure in this regard. The perusal of both the paras will be useful,at this juncture.
Para 22-SALES AND SERVICES FACILITIES-
"Distributor shall be responsible to the seller for the proper representation of the products and shell maintain and shall cause to be maintained a place of business, sales room, parts department, and/or other facilities with suitable organisation and equipment in connection therewith, satisfactory to and in accordance with the policies of the seller. Distributor shall also use its best efforts to actively promote and develop sale and service of the said products throughout the territory, gave prompt and efficient service to its customers/buyers and confirmed in all respects to the policies recommended by the seller, from time to time."
Para 40. PAYMENT OF TAX "Distributor shall, as part of the expenses of its business, pay any tax duty, the or other charges that may be levied upon or against, or on account of such business or upon any product that has been delivered to a carrier for the distributor's account, or is in transit to the ITA No. 8597/Mum/2010 55 distributor, or that may be in the distributor's possession or in the territory for delivery to the distributor, and shall pay any taxes, duty, free or other charges that may be levied upon or against or incurred or paid by the seller on account of the manufacture or sale of any vehicle, part o or accessories delivered or to be delivered to the distributor and shall hold the seller harmless, there is from. In the event that the seller pays any such amounts, the distributor shall immediately reimburse the seller for the amounts so paid."
15.7.If both the paras are read together one thing becomes clear that it was not the responsibility of the appellant to make payments to the US company. As per the agreement, appellant had to be reimbursed for the payments made by it on behalf of the AE.
Ground number 15 is decided against the appellant.
16.Ground number 16 is about determination of loss amounting to Rs.1,85,21,865/- on transfer of capital assets used for R&D activities. The AO has discussed the issue as under :
"On perusal of the notes to the computation of income, it is noticed that the assessee has claimed loss of Rupees1,85,21,865/- on the R & D assets.The 100% deduction on such assets was allowed in the earlier assessment years. -in the ear the asset was put to use under section 35 (1) (iv) of the I T Act. Therefore, the assessee was asked to explain why the capital loss, claim should not be disallowed."
After considering the reply filed by the assessee AO held that the amount involved was covered under section 41 (3) of the Act.
16.1.Before us, the AR submitted that the appellant was entitled to loss to the extent of Rs.1,85, 21,865/-, that section 35 was an independent section, that income/loss related to section35 should be computed under the head capital gains. DR submitted that provisions of section 41(3) of the Act were applicable in this case, that amounts involved in this regard have to be dealt under the head Income from business.
16.2.From the facts available on the file, it transpires that the appellant was claiming deduction u/s.35 for revenue expenditure as well as capital expenditure incurred on R&D activity. Appellant company made a claim that whenever any capital asset held for R&D was transferred, the profit/loss has to be computed under section 48 of the Act. During the period under consideration, the company had sold capital assets having indexed cost of ITA No. 8597/Mum/2010 56 Rs.2,44,45,511/-for a consideration of Rs.59,23,646/-.As a result,it claimed long-term capital loss of Rs.1.85 Crores.
16.3.Undisputed fact is that the assessee had been allowed 100% depreciation on the assets used for R&D purposes in the first year itself,as per the provisions of the section 35.If he is allowed indexation for claiming capital loss,it will amount to double benefit. Generally double deductions/benefits are not allowable under the fiscal laws, until and unless special provisions exit in the statue. Hon'ble SC in the matter of Deepak Nitrite Ltd.( 199ITR43) has held-"There is a fundamental, though unwritten, axiom that no Legislature could have at all intended a double deduction in regard to the same business outgoing; and, if it is intended, it will be clearly expressed. In other words, in the absence of clear statutory indication to the contrary,the statute should not be read so as to permit an assessee two deductions." Secondly, section 35 is part of head 'Income from business,profession or vocation'-section 43 is part of the same heading. So,we are of the opinion that provisions of the head 'Capital Gains cannot be imported here to allow the assessee one more deduction.
Ground no 16 is decided against the appellant.
17.Next ground of appeal is about consideration received on sale of LCV business in form of non compete covenant. During the year under consideration, the assessee sold its rights in LCV business to a separate subsidy for the below mentioned consideration-
i) Intellectual property right 9.3 crores ii) Congeries of right 28.6 crores iii) Non-compete covenant 10.5 crores.
The assessee considered the entire sum received, including the amount of non compete covenant, as capital receipt.After obtaining explanation of the assessee the AO decided the issue as under :
"The submissions of the assessee have been carefully considered. However, the same is not acceptable, because section 55 of the I T Act, nowhere states that, non compete receipts are taxable as capital gains, on the contrary, section 28 (va) clearly provides that any amount received in cash or kind for not carrying out any activity in in relation to the business is to be treated as business income of the assessee. The assessee in its reply, has submitted that it has ITA No. 8597/Mum/2010 57 sold its entire LCV business, therefore, the payment received as non compete fee is not taxable as business income and light of proviso to section 28 (va) of the I T Act. However, proviso to section 28 of I-T act precludes the income which are covered under section 55 of the I T Act. Section 55 (2) of the I T Act, deals with the taxability of assets, being in nature of goodwill of business, or trademark or brand name associated with the business or a right to manufacture, produce or process any article or thing or right to carry on any business, tenancy rights, stage carriage permits or loom hors. .Herein, the phrase used by the statute is'right to carry on business' which is different than 'not carrying out any activity in relation to any business', which is the phrase used in section 28 (va). The phrase used in section 55, is an affirmative, and tantamounts to sale of the right of business to other party, which does not mean that the seller will not carry on the business. More importantly, the clause 6.1,of business transfer agreement', submitted by the assessee, it is mentions that the assessee' shall not directly or indirectly, including through an affiliate, either on its own account or in conjunction with or on behalf of any person'. The agreement also mentions that the assessee cannot even sell the part of LCV's. Thus, it is clear from the language used in the business. Transfer agreement that said payment of rubies 1050 lakhs, which is a separate consideration for not carrying out business shows that the above payment of Rupees were 1050 lakhs is payment taxable under section 28(va) of the I T Act, rather than section 55 of IT Act wherein only the consideration to the extent of the right to carry on business (and not the right not to carry on business) is taxable."
17.2.AR submitted that the assessee had sold the right to carry business and hence, section 55(2) would be applicable and not Section 28 as held by the AO. He referred to the non- compete agreement (page 220-231 of the PB) and further submitted that it was a capital receipt. He relied upon the case of Dr.B.V. Raju (ITA No. 1034/Hyd/2004).DR submitted that amount received by the assessee was in the nature of a revenue receipt ,that after the amendments to section 28 and 55 of the Act law had changed with regard to non-compete fees, that assessee had given up his right to continue his business and hence it was taxable under section 28(va).
17.3.We are of the opinion, that at this juncture, it will be useful to peruse the provisions of sections 28 and 55 because both the sections were argued extensively by the DR and the AR in favour and against the order of the AO.
ITA No. 8597/Mum/2010 5828. Profits and gains of business or profession.-The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession",-
**(va) any sum, whether received or receivable in cash or kind, under an agreement for-
(a) not carrying out any activity in relation to any business ; or
(b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services.
Provided that sub-clause (a) shall not apply to-
(i) any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head 'Capital gains' ;
** F.A. 2002, w.e.f. 1-4-2003.
Sec.55. ..... (2) For the purposes of sections 48 and 49, "cost of acquisition",-
(a) in relation to a capital asset, being goodwill of a business, *or a trade mark or brand name associated with a business or a right to manufacture, produce or process any article or thing **or right to carry on any business, tenancy rights, stage carriage permits or loom hours, --
(i) in the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price ; and
(ii) in any other case not being a case falling under sub-clauses (i) to (iv) of sub-section (1) of section 49, shall be taken to be nil ;
*F.A. 2001, w.e.f. 1-4-2002.
**F.A. 2002, w.e.f. 1-4-2003.
17.4.The undisputed fact is that the appellant received Rs.10.5 crores from its subsidiary is non-compete fee in view of its decision not to continue LCV business. Terms no.6. of the agreement (Pg.231 of the PB),relevant for deciding the issue, reads as under -
ITA No. 8597/Mum/2010 596.Non-competition-
" Non-compete. Subject to Article 6.2 below, on and from the closing Date, the Seller shall not, either directly or indirectly including through any Affiliate either on its own account or in conjunction with or one behalf of any person, carry on the business of manufacturing commercial trucks and buses with gross vehicle weight of three point five (3.5) tonnes and above, unless the Purchaser has consented to the same. The Seller shall not directly or indirectly or through its Affiliates sell trucks in the other parts of the world which compete with the Light Commercial Vehicles, unless the Purchaser has consented to the said sale on agreed terms and conditions"
In the background of above sections and the fact of the case we will try to analyse the issue in question.Prima facie ,both the sections appear more or less same, yet there is subtle difference between them. Section 28(va) starts with a negative direction, and it talks of carrying out of any activity in relation to any business. On the other hand, proviso to the said section and section 55(2) talk of a right to 'carry on' any business and they are not in negative terms. As per the accepted principles of jurisprudence we have to presume that the legislature has not used any unnecessary words while amending the above referred to sections. So, if after the verb 'carry' the Parliament has used out and on words in respective sections ,it has to be presumed that there must be valid reasons for it. Secondly, if section 28 envisages conditions in negative perspective, then it should also be accepted that transaction covered under the said section are definitely of peculiar nature, i.e. different from the transactions covered under section 55. Non-compete fee is an old concept of business -world and taxation laws. There used to be a lot of disputes in respect of treatment to be given to it. Parliament by introducing amendments to section 28 and 55 (with effect from 1.4.2003) try to put an end to the controversy.
17.5.1. In our humble opinion as per the amended provisions whenever any fee or compensation is received by an assessee for not indulging in business activities, that were being undertaken by him before entering into such agreement, provisions of section 28(va) come into play. If, terms and conditions of the agreement, in substance, prevents the assessee from an activity that he was doing earlier, than the resultant receipt becomes a revenue receipt. The basic conditions for invoking section 28 is a 'no' in the contract. As per the provisions of section 55 assessee having a right to carry on business, allows someone also to ITA No. 8597/Mum/2010 60 do the same thing, and in view of it,he receives fees or compensation. In those circumstances the receipt have to be held as capital. In the second situation a right to do business is shared and a right has always been considered a capital asset. So, logically, such transactions are covered by section 55 and a provision to section 28(va). If section 28 is about a negative transaction, then section 55 is about positive action.
17.5.2.In the case under consideration assessee has been specifically prevented from carrying on of business of manufacturing trucks etc.Amount received by the assess is for a negative convenat.From the terms and conditions of the agreement it does not transpire that the assessee had allowed its subsidiary to carry on business of LCV and in lieu of that the assesee received the said amount. Had it been so ,provisions of Sec.55(2) r.w. proviso to Sec. 28(va) would have been applicable.But,the fact is that assessee received Rs.10.5 Crores when it consented to not to the business of LCV. In our humble opinion, after the amendment such case are covered by section 28(va), not by section 55(2).Ratio of the judgement delivered by the Hon'ble Supreme Court in the case of Guffic Chem. P. Ltd.(332ITR602) also supports our view.In that case Apex Court had held that after1.4.2003 whenever an assessee is prevented from undertaking business activities, and he receives remuneration for such arrangement he is covered by section 28(va). In that matter Hon'ble SC had held:
"One more aspect needs to be highlighted. Payment received as non-competition fee under a negative covenant was always treated as a capital receipt till the assessment year 2003-04. It is only vide the Finance Act, 2002 with effect from April 1, 2003 that the said capital receipt is now made taxable (See section 28(va)). The Finance Act, 2002 itself indicates that during the relevant assessment year compensation received by the assessee under non-competition agreement was a capital receipt, not taxable under the 1961 Act. It became tax-able only with effect from April 1, 2003. .... In the present case, compensation received under the non- competition agreement became taxable as a capital receipt and not as a revenue receipt by specific legislative mandate vide section 28(va) and that too with effect from April 1, 2003. Hence, the said section 28(va) is amendatory and not clarificatory."
As far as case of Dr. Raju is concerned, it relates to assessment year 2001-02,as pointed out by the DR,and hence, not applicable for deciding the issue under consideration pertaining to assessment year .
ITA No. 8597/Mum/2010 61After this, we would like to discuss the case of Ramesh Tainwala. In this case, the assessee had agreed not to compete with the new entity as per the provisions of the agreement entered into by both the parties. Deciding the issue Mumbai Tribunal held as under :
"Agreement to refrain from carrying on competing business does not fall within any of the modes of transport is given in the definition of transfer under section 2 (47) of the act. If the agreement to refrain from indulging in competition is part and parcel of the agreement for transfer of a business and the transfer is it is not to indulge in competition, then it can be said that a right to carry on St or similar business was transferred along with the business is..... The provisions of section 28 would apply and, consequently, the receipt in question would be chargeable to tax as business income and not under the head capital gains."
17.6.In light of the above discussion we are of the opinion that the amount received by the appellant was of a revenue nature.
Ground number 17 is decided against the assessee.
Ground number 18 is about price escalation/obsolescence amounting to Rupees 4,59.75,000/-being contingent liability. AR did not press the said ground during the hearing, before us.AO is directed to exclude the said amount from taxation in the subsequent assessment years.We are of the opinion that amount in question is to be taxed in the year under consideration.
As a result, ground number 18 is dismissed.
19.Next ground of appeal is about addition made under section 40a(ia) in respect of year-end provision of Rs.4,25,52,623/-.AO on pages 104 (para23) has discussed the issue as under-
"It has been stated by auditors in note for clause 17(f) and auntie 7 (b) of form 3 CD audit report, that company is not detecting the TDS on year end provision as they are of the view that the liability of deducting TDS arises in subsequent year when Bill of the party is booked."
19.1.After considering the submissions made by the appellant AO held that same was not acceptable because expenses under consideration was liable to TDS and were squarely covered by the provisions of chapter XVIIB of the Act. He was of the view that once the ITA No. 8597/Mum/2010 62 assessee was debating the P&L account, it automatically was crediting the party account based on matching principle.
19.2.Before us ,AR submitted that amount in question was year-end accounting provision to book, expenditure incurred, but in respect of which there was no obligation to either pay or to deduct tax at source is because no income had accrued to the payee, that no order had been passed under section 201 of the act holding, the appellant to be an assessee in default. Therefore, no disallowance could be made under section 40a(ia). He referred to page number 265 of the paper-book that gives details of provision on which TDS was not paid. As per the AR bills for the said expenditure were not received during the year under consideration.
As per the AR, the appellant company would make year-end provisions based on services rendered by various lenders/professionals. These provisions represented cost of various activities carried out by the company during the relevant financial period. Since, the company was following the Mercantile system of accounting it was required to account for such expenses, even though the concerned parties had not submitted their bills or such bills were pending for approval based on the internal system. At that point of time, since bills from the contractors had not been raised though that was owed by the company in favour of any specific party. Such a debt would be owed only on receipt of the bills and after it had been passed following the procedure. Only at that point of time relationship of debtor and creditor was established and was also an obligation to pay that would amount within the agreed period of time. The obligation, to deduct tax at source from the account of a specific party arose only at the time the bill was passed not before that. Citing the example of audit fees the AR submitted that obligation to pay the fees to the statutory auditors arises only after they complete the statutory audit.He relied upon the decisions of GE India Technology Centre Private Ltd.(327 ITR 456) and Industrial Development Bank of India(107 ITD45) in this regard.DR submitted that work was already carried out for the assessee, that appellant should have deducted tax source. He further submitted that once the amount was debited to profit and loss account provisions of section 40(a)(ia) were applicable.
19.3.We find that the AO has not examined the issue about year-end payments.There is a difference between the payments that are made during the year and the payments made at the fag-end of the year.In our humble opinion in 2nd category of payments tax has been detected in the subsequent year when Bills are booked. In this regard we have also considered the ITA No. 8597/Mum/2010 63 amendment made to Sec.40(a)(ia) by the finance act,2008, with retrospective effect from 1.4.2005.We have also perused the case laws relied upon by the AR.Principles discussed in the said judgement is also support our view that provisions of tax deducted at source were not applicable in case consideration.
Ground number 19 is decided in favour of the assessee.
20.Next ground of appeal is about claim of weighted deduction under section 35 (2AB) on research and development workat Kandivali and Nashik Centre. The assessee during the year had claimed weighted deduction, amounting to Rs.116,34,43,112/-in respect of scientific research expenditure of Rs.77,56,28,741/-being at the rate of 150%. AO noticed that out of those total expenses,expense amounting to Rs.17,72,49,000/-was related to Kandivali unit of research and development and expenses amounting to Rs.59,83,80, 000/-was related to Nasik unit.During the assessment proceedings AO made the enquiry about claim of weighted deduction.
20.1.After considering the reply of the assessee and the direction is off DRP AO held that weighted deduction was not allowable to the assessee. In absence of the report in form number 3CL by the Department of Science and Industrial Research to the Director General (Exemption) as required by rule 6 (7A) of the Income-tax Rules,1962.AR submitted that R&D facility was approved by DSIR under section 35 (2AB), that accounts of R&D centre had been audited, that the report containing the details of R&D had been filed with the AO, that claim had been denied only in view of the failure on the part of DSIR to submit a report to the Director-general (Exemptions).He further submitted that AO had denied the weighted deduction in respect of Kandivali,because the approval from DSIR pertained only to Nashik unit and form 3CM did not mention name of Kandivali unit. He relied upon the cases of Meco Instruments Pvt. Ltd,Sandan Vikas India Ltd.(326ITR251)Claris Life sciences. Ltd(2008- TIOL-484-HC-AHM-IT). AR further submitted that AO may be directed that as and when permission comes from DSIR consequential relief should be granted in respect of Kandivali unit, that the assessee was not at fault for non-communication of permission of DSIR to Income tax authorities, that weighted deduction in respect of Nasik unit should not be denied to the assessee.
20.2.As per the information available from the records and the documents submitted by the assessee, it transpires that DSIR had granted recognition for both of the locations roads letter ITA No. 8597/Mum/2010 64 dated 23rd of March 2004. Thereafter, the appellant company applied for further approvals. In the subsequent certificate issued by the DSIR Kandivali unit was not mentioned.
20.3.After hearing rival submissions we are of the opinion that the appellant is entitled to claim weighted deduction,as far as Nasik unit is concerned. If DSIR has not rejected the application submitted by the appellant, it is entitled in presuming that the application has been accepted.Secondly,failure on part of DSIR to inform the Income tax authorities in time, cannot be the reason for denying weighted deduction to the appellant. AO should not have rejected the claim of the assessee on the ground that DSIR had not informed the Director- general (Exemptions) about the decision taken by the DSIR with regard to R&D carried out by the appellant. We are of the opinion that while deciding the issue related with benevolent provisions like 35 (2AB) a liberal and practical approach should be followed, so that it fulfils the objects with which said section was introduced.
Deduction under section 35(2AB) for Kandivili should be allowed by the AO as and when approval from DSIR is received and produced by the appellant. For this limited purpose matter is set aside accordingly.
Ground number 20 is decided in favour of the assessee.
21.Next ground is about direction under section 80-IC in respect of manufacturing unit at Haridwar.We find that DRP had given following direction to the AO in this regard - "The AO is directed to pass a speaking order, quantifying the loss suffered by the new unit at Haridwar, which is stated to have been set up during the year under consideration."
The AO has not quantified the losses suffered by the new unit at Haridwar, nor has passed a speaking order in this regard. Assessing officer is directed to quantify the loss for the year under consideration and to give a clear finding whether the unit was set up in January 2006 or not.
This ground is also decided in favour of the assessee.
22.Last ground of appeal is about failure of the AO to allow credits for TDS amounting to Rs.1,85,5,211/-.In the matter under consideration intimations under section 143 (1) was issued on 29 November 2007. As per the AR a letter requesting to give credit of Rs.1.85 Crores was ITA No. 8597/Mum/2010 65 submitted before the AO on 23 December 2009 i.e., before the draft order was sent to the DRP i.e.30.12.2009.
22.1.We are of the opinion that credit for TDS should be given for the year under consideration, even if same was filed before finalisation of assessment proceedings. Ground of appeal no. 22 is decided in favour of the assessee.
Appeal filed by the appellant is partly allowed.
Order pronounced in the open court on 6th June 2012.
Sd/- Sd/-
(D. MANMOHAN) (RAJENDRA)
VICE PRESIDENT ACCOUNTANT MEMBER
Mumbai,
Date 6th June, 2012
TNMM
Copy to:
1. Appellant
2. Respondent
3. The concerned CIT (A)
4. The concerned CIT
5. DR "B" Bench, ITAT, Mumbai
6. Guard File
(True copy)
By Order
Asst.Registrar,
Income Tax Appellate Tribunal,
Mumbai Benches, Mumbai