Bombay High Court
Warner Lambert Co. Ltd. vs Commissioner Of Income-Tax on 12 June, 1998
Equivalent citations: [1998]234ITR516(BOM)
Author: A.Y. Sakhare
Bench: A.Y. Sakhare
JUDGMENT A.Y. Sakhare, J.
1. By this reference under Section 256(1) of the Income-tax Act, 1961 ("the Act" for short), the Income-tax Appellate Tribunal has referred the following questions of law for the opinion of this court at the instance of the assessee :
"(i) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that a charge was not created in respect of the preference dividend of Rs. 1,37,500 paid by Warner Hindustan Limited on the preference shares held by the assessee ?
(ii) Whether, on the facts and in the circumstances of the case, the Tribunal ought to have held that the dividend paid by Warner Hindustan Limited on the preference shares belonging to the assessee was diverted at source by an overriding title and, therefore, did not belong beneficially to the assessee and the same was not assessable to tax in the hands of the assessee ?
(iii) Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that the preference dividends were received by the assessee in its own right and thereafter used for certain purposes ?"
2. The assessee is a non-resident company. The assessment year under consideration is 1975-76. The previous year for the assessment year under consideration is calendar year December 31, 1974. The assessee's accounting system is mercantile.
3. The assessee is incorporated under the laws of the United States of America and is carrying on business of manufacturing pharmaceutical products in several countries. Initially, the assessee's business of manufacturing pharmaceutical products in India was carried on through Martin and Harris (I.) Ltd. In year 1963, a company in the name of Warner Hindustan Ltd., came to be incorporated in India (said company is hereinafter referred to as the Indian company for short). In the year 1967, the said company went into production. The assessee is holding 50 per cent. of the issued equity share capital and the entire preferential share capital of the Indian company. Till June, 1964, the Indian branch of the assessee carried on its manufacturing activity through other factories. Thereafter, the Indian company carried on the manufacturing activity with the help of outside factories till its own factory started production. On May 12, 1964, a collaboration agreement was entered into between the assessee and the Indian company. The collaboration agreement provided that the research activity of the Indian company was to be financed, inter alia, from dividend received against the preferential shares issued to the assessee. When the assessee was carrying on business of manufacturing with the help of other factories as mentioned earlier, funds belonging to the assessee were locked in India, due to the restrictions imposed by the Reserve Bank on the remittance of the profit earned by the assessee. Desai and Vakil were interested in promotion of the Indian company. The assessee by its letter dated March 29, 1963, addressed to Desai and Vakil, confirmed the mutual understanding of the general terms of collaboration with respect to the industrial licence granted to Desai and Vakil. As per the understanding a limited company was to be formed with its office in Bombay and plant in Hyderabad. The capital of the Indian company was to be Rs. 150 lakhs made up of Rs. 100 lakhs of equity shares and Rs. 50 lakhs of preference shares. The subscribed and paid-up equity capital was to be approximately Rs. 50 lakhs and the paid up preference capital was Rs. 20 lakhs. The assessee wanted to take 51 per cent. of the equity shares and was to make available foreign exchange of approximately Rs. 15 lakhs for the acquisition of equipment, machinery, etc., to be imported. Paragraph 6 of the letter dated March 29, 1963, reads as under ;
"Para 6 : It is further proposed that Warner Lambert will make available an additional amount of Rs. 20 lakhs, again subject to the approval of the Government of. India, of rupee funds accumulated in India and held to the credit of Warner Lambert in return for which preference shares bearing agreed rate of interest shall be issued to Warner Lambert. It is understood that such preference shares shall not be callable or repatriable for a period of ten years and Warner Lambert is prepared to agree, if required, that the interest payable thereon will not be asked to be remitted abroad, but will be used as a contribution to financing the research activities that are expected to be carried on by Warner Hindustan Limited." (emphasis* supplied).
4. Thus, the assessee of its own volition agreed to use the dividends receivable on the preference shares as contribution to finance the research activity of the Indian company. The assessee was to get royalty in consideration of the grant of right of manufacturing of products considered by the parties for production in India. Paragraph 11 of the aforesaid letter reads as under :
"Para 11 : It is Warner Lambert's policy to expand its research and . development activities not only in the United States, but to extend them also to major foreign countries. It is contemplated, therefore, that Warner Hindustan Ltd. will commence activity in the field of research and development not later than two years following the start-up date of its operations. Such activities, which are expected to be financed primarily out of the company's undistributed profits and the interest yielded by the preference shares proposed to be issued to Warner Lambert, will in part be conducted by the staff and on the premises of the company, but emphasis will be given, by means of a suitable grant or otherwise, to participation in research projects and co-operation with outside Government as well as non-Government research organisation in India."
5. Thus the assessee proposed to finance research activity out of the assessee's undistributed profits and the dividends yielded by the preferential shares. Reply sent by Desai and Vakil is not on record. On April 15, 1963, Desai and Vakil addressed a letter to the Ministry of Commerce, Government of India, explaining the mode of arrangement of the formation of the Indian company. In the said letter it was recorded by them that the dividends on preference share capital would be used fully for financing research activity, for which a special facility would be set up on the lines of the assessee's research laboratory in U. S. A. and other parts of the world. By letter dated August 9, 1963, the Deputy Secretary to the Government of India addressed to Desai and Vakil merely recorded the understanding that the investments of the assessee can be only 50 per cent. in the issued equity capital and the assessee being allowed to subscribe out of the blocked amount of Rs. 20 lakhs towards the preference capital of the Indian company. Thus the assessee and Desai and Vakil agreed between themselves that the preference shares shall not be callable or repatriable for a period of 10 years and the dividend will not be remitted abroad but will be used as a contribution for financing the research activity expected to be carried out by the Indian company, Thus the assessee of its own volition gave assurance about its intention not to repatriate the preferential capital or dividend accruing from it for some period in future. The letter of the Deputy Secretary to the Government of India records that the approval of the Government to the utilisation to the blocked amount was accorded on account of the assurances given by the assessee and Desai and Vakil.
6. During the assessment year, under consideration, the assessee received dividend of Rs. 1,37,500 against the preference shares held by it. Before the Income-tax Officer, the assessee-company claimed that an amount of Rs. 1,37,500 received by it as dividend against the preference shares cannot be taxed in its hands on the ground that the dividend in question has not been made available to it unconditionally. The Income-tax Officer did not accept the explanation of the assessee and the dividend received by it was taxed in its hands. The assessee challenged the order of the Income-tax Officer by filing an appeal before the Commissioner of Income-tax (Appeals), who by his order dated March 2, 1979, dismissed the appeal. The Commissioner of Income-tax (Appeals) in his order has observed that it is not free from doubt as to whether the dividend restriction ordinance is applicable to the preference dividend already declared and the assessee will not be entitled for the reliefs as prayed for. The assessee preferred an appeal before the Income-tax Appellate Tribunal. The Tribunal by following its own order dated January 18, 1973, in Income-tax Appeals Nos. 460 and 461 (Bom) of 1971-72 and I. T. A. No. 624 (Bom) of 1971-72 in the assessee's own case dismissed the appeal. The Tribunal in its earlier order dated January 18, 1973, came to the conclusion that dividend received by the assessee against the preference shares will have to be taxed in the hands of the assessee, that the Indian company has no exclusive right to the amounts of preference dividends and this is a case of receipt first by the assessee in its own right and using the amount for certain purposes. The Tribunal held that this is not a case of diversion of income by overriding title and as the income has accrued to the assessee it will have to be taxed in the assessee's hands. It appears that against the order passed by the Income-tax Tribunal dated January 18, 1973, in the appeals referred to above, references were made to this court under Section 256(1) of the Act. All these references were returned unanswered for non-compliance of the High Court 0. S, Rules.
7. The facts narrated above will show that the assessee is incorporated in the U.S.A. and is carrying on the business of manufacturing pharmaceu-ticals in several countries. Initially, its business in India was carried out by entrusting the manufacturing activity to certain factories in India and marketing the product through Martin and Harris India Ltd. The Indian company came to be incorporated in the year 1963 and went into production in 1967. The assessee holds 50 per cent. issued equity capital and the entire preferential capital in the Indian company. Till June, 1964, the Indian branch of the assessee manufactured pharmaceuticals through other factories. Thereafter, the Indian company carried out manufacturing activity with the help of outside factories till its own factory started production. When the assessee was carrying on the business of manufacturing with the help of other factories, due to the Reserve Bank restrictions on the remittance of the profits, approximately Rs. 31 lakhs were locked up in India. The correspondence exchanged between the assessee and Desai and Vakil shows that the assessee on its own agreed that it will not ask for remittance of the dividend payable on preferential shares and the same amount will be used as contribution to finance research activity in India to be carried out by the Indian company. A letter written by Desai and Vakil also confirms that the assessee has agreed that the dividend on the preference shares would be used only for financing the research activity of the Indian company. The said letter further records that the assessee would not ask for repatriation of the preferential share capital. In view of this proposal, the Government of India informed Desai and Vakil that the assessee is permitted to invest 50 per cent. in the equity capital, the assessee will not ask for repatriation of preferential shares for a period of 10 years and dividend accrued thereon will be used as the assessee's contribution for financing research activity of the Indian company. Thus the Government only gave approval to the utilisation of the blocked amount on the basis of the proposal given by the assessee and by Desai and Vakil.
8. The assessee's claim is based on the ground that the amount was not includible in the total income as under a contractual obligation for the disbursement of research and development expenditure it had been diverted at source by an overriding title.
9. Learned counsel appearing on behalf of the assessee contended that the preference dividends did not represent the assessee's income because of a charge or an overriding title thereto. As per learned counsel a charge was created in respect of preferential dividend paid by the Indian company, therefore, this income has not accrued to the assessee. He submitted that the dividend paid by the Indian company was diverted at source by an overriding title, therefore, this income did not belong beneficially to the assessee and consequently the same is not assessable in the hands of the assessee. He further submitted that the Tribunal committed an error in holding that the preference dividend was received by the assessee in its own right and used for certain research activity of the Indian company and, therefore, liable to be taxed in the hands of the assessee. In support of these submissions, learned counsel relied upon the following decisions :
(i) CIT v. C. N. Patuck [1969] 71 ITR 713 (Bom) ;
(ii) CIT v. Nariman B. Bharucha and Sons [1981] 130 ITR 863 (Bom);
(iii) Somaiya Orgeno-Chemicals Ltd. v. CIT [1995] 216 ITR 291 (Bom);
(iv) CIT v. M. D. Manohar Rao .
10. In reply learned counsel appearing on behalf of the Revenue contended that charge was not created in respect of the preferential dividend payable by the Indian company to the assessee, the dividend payable to the assessee on the preferential shares was not diverted at source by an overriding title and the Income-tax Tribunal was right in holding that the preferential dividend was received by the assessee in its own right, and thereafter, used for research activity carried out by the Indian company. Learned counsel further submitted that on the facts of the present case, the dividend was not diverted at source by an overriding title, hence, preferential dividend received by the assessee on the preferential shares is its own income and taxable accordingly. Learned counsel for the Revenue relied upon the following decisions in support of his submissions.
(i) CIT v. Sitaldas Tirathdas ;
(ii) Associated Power Co. Ltd. v. CIT ;
(iii) CIT v. V. G. Bhuta [1993] 203 ITR 249 (Bom) ;
(iv) Mrs. Meherbai N. Sethna v. CIT [1994] 209 ITR 453 (Bom) ;
(v) Colaba Central Co-operative Consumers' Wholesale and Retail Stores v. CIT [1998] 229 ITR 209 (Bom).
11. This court in the case of CIT v. C. N. Patuck [1969] 71 ITR 713, has held that a charge was created for payment of monthly sums in favour of the daughters of the assessee. This court was dealing with a case, where there was a compromise decree for dissolution of marriage between the assessee and his wife. In the said decree, the assessee took responsibility to pay monthly sums to his daughters. After the decree a tripartite agreement was entered into between the assessee, his daughters and the partners of the partnership firm in which the assessee was one of the partners, to pay a fixed sum to the daughters out of the assessee's share of profit in the partnership firm. As a result of the compromise decree in the suit for dissolution of marriage and in view of the tripartite agreement between the assessee, his daughters and the partners, this court came to the conclusion that the assessee created a charge in favour of his daughters and because of an overriding title, money paid to the daughters ceased to be the remuneration and/or profit of the assessee, hence, it could not be taxed in his hands. Thus on the facts of the said case, this court came to the conclusion that the income was diverted at source by an overriding title.
12. This court in the case of CIT v. Nariman B. Bharucha and Sons [1981] 130 ITR 863, on facts found that in a firm consisting of a father and two sons, the partnership deed provided for the sons continuing as partners but subject to giving a share in the profit to their mother after the death of the father. On the facts of the case, this court came to the conclusion that a charge was created over the partnership assets in respect of the payment made on the death of the father and the money payable to the mother was diverted at source by overriding title, Thus on the facts of the case this court came to the conclusion that a charge was created over the partnership assets, there is diversion at source by an overriding title, hence, the money diverted cannot be taxed in the hands of the assessee.
13. This court in the case of Somaiya Orgeno-Chemicals Ltd. v. CIT [1995] 216 ITR 291, considered the case of storage fund contribution under the statutory orders. The assessee before this court was a manufacturer of rectified spirit. The assessee transferred some amounts from sale proceeds of rectified spirit to the storage fund for molasses and alcohol account as required under the Ethyl Alcohol (Price Control) Amendment Order, 1971, issued in exercise of powers conferred by Section 18G of the Industries (Development and Regulation) Act, 1951. By considering the provisions of the Order of 1971, this court came to the conclusion that by the statutory provisions a charge was created on a portion of the income received by the assessee and that portion of income is diverted at source, therefore, it cannot be treated as income of the assessee. This court found that due to the statutory compulsion, the assessee made deposits in the funds for the storage of molasses and alcohol, there was absence of domain of the assessee over this amount and there was diversion of the money at source, consequently, the money cannot be taxed in the hands of the assessee.
14. The Andhra Pradesh High Court in the case of CIT v. M. D. Manohar Rao [1985] 155 ITR 696, considered the effect of an agreement for sale of land, which land was subsequently acquired by the Government and a subsequent agreement between the seller and the purchaser, agreeing therein that compensation receivable in excess of the price agreed upon will belong to the purchaser. In the case before the Andhra Pradesh High Court, the assessee was the owner of land who entered into an agreement of sale with a third party. After the agreement of sale, acquisition proceedings were initiated to acquire the said land. The parties entered into another agreement agreeing therein that the compensation in excess of the price agreed under the agreement would belong to the purchaser. On considering the facts of the case, the Andhra Pradesh High Court came to the conclusion that there was diversion by overriding title and the compensation received by the assessee cannot be taxed in the hands of the assessee.
15. The decisions referred to by the assessee of this court as well as of the Andhra Pradesh High Court are of no assistance to the assessee as in the present case, no charge is created in favour of the Indian company nor is there a diversion of income at source by overriding title. Dividend income is received by the assessee in its own right, thereafter it is transferred to the Indian company for research activity. Thus in law the said income is first received by the assessee, and then applied for the research activity of the Indian company, therefore, will have to be taxed in its hands.
16. The Supreme Court in the case of CIT v. Sitaldas Tirathdas [1961] 41 ITR 367 has observed that the true test for application of the rule of diversion of income by an overriding title is whether the amount sought to be deducted, in truth, never reached the assessee as his income. The nature of the obligation is the decisive fact. There is a difference between an amount which the person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible. But where the income is applied to discharge an obligation after such income reaches the assessee, in law the same consequence, does not follow, as the assessee is merely under an obligation to pay to another a portion of his own income. In this case, the Supreme Court at pages 374 and 375 has observed as under :
"In our opinion, the true test is whether the amount sought to be deducted in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible ; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable."
17. The Supreme Court in the case of Associated Power Co. Ltd. v. CIT [1996] 218 ITR 195, has held that the monies credited to the contingency reserve fund under the statutory provisions are monies belonging to the assessee and are not diverted by an overriding title. While considering the assessee's argument about diversion of income by overriding title due to the statutory provisions the Supreme Court at page 207 has observed as under :
"The application of the doctrine of diversion of income by reason of an overriding title is quite inapposite. The doctrine applies when, by reason of an overriding title or obligation, income is diverted and never reaches the person in whose hands it is sought to be assessed (see CIT v. Sitaldas Tirathdas [1961] 41 ITR 567 (SC). In the present case, the statute requires the electricity company to create certain reserves if its clear profit exceeds a reasonable return (Clause II, Sixth Schedule). Again, the contingencies reserve is to be created from existing reserves or from 'the revenues of the undertaking'. This clearly indicates that the monies which have to be put into the contingencies reserve reach the electricity company and are not diverted away from it."
18. This court in the case of CIT v. V. G. Bhuta [1993] 203 ITR 249, to which Dr. B. P. Saraf J. was a party, has considered the clause in a deed of partnership that on the death of a partner, the firm was not dissolved but the surviving partners were empowered to continue the partnership on payment to the widow of the deceased partners of :
(a) a share of profits of the deceased accrued to him up to his death,
(b) an amount equal to the share of the profits which would have accrued to him for a period of one year from the date of his death,
(c) the amount standing to the credit of the deceased in the books of account ; and
(d) the amount of the share of the deceased in the reserve fund with accumulated interest.
19. On consideration of the various decisions and tests laid down by the Supreme Court in CIT v. Sitaldas Tirathdas [1961] 41 ITR 367, this court came to the conclusion that this was not a case of diversion of income by overriding title but this was a case of application of income in fulfilling of a legal obligation after it has arisen or accrued to the surviving partners.
20. This court in the case of Mrs, Meherbai N. Sethna v. CIT [1994] 209 ITR 453, to which Dr, B. P. Saraf J. was a party, has considered the case of income earned out of India, where, there was restriction or prohibition in such country on its remittance to India. The assessee in the said case was an Indian national to whom certain amounts accrued in Ceylon. However, due to the restrictions imposed by the Ceylon Government, the said amount could not be brought in India. This court considered the restrictions on remittance and held that the objections of, the assessee to its inclusion in the total income on account of restrictions of the Ceylon Government on remittance of money to India, do not have any bearing on the computation of total income of the assessee. This court further observed that income accruing to the assessee outside India falls within the ambit of his total income.
21. This court in the case of Colaba Central Co-operative Consumers' Wholesale and Retail Stores Ltd. v. CIT [1998] 229 ITR 209, to which Dr. B. P. Saraf J. was a party, held that the obligation to apply certain amounts out of the income for a particular case cannot make a case of diversion of income by overriding title. In this case, the assessee was a co-operative society and the State Government contributed to the share capital of the assessee under an agreement. The amounts set apart by the assessee as a capital contribution redemption fund as per the stipulation in the agreement, was held to be income accrued to the assessee and that there was no diversion of income by overriding title. The agreement between the parties stipulated that the amounts should be invested with the Government and it should not be used for business of the co-operative society. This court held that the amount belonged to the assessee even though it was to be invested with the Government and there was no diversion by overriding title. This court at page 213 has observed as under ;
"Law is well-settled that the doctrine of diversion of income by reason of overriding title applies only in cases where the income never reaches the assessee as his income. The mere fact that the assessee has an obligation to apply a certain amount out of its income for a particular purpose cannot make it a case of diversion of income by overriding title. An obligation to apply the income accrued, arisen or received amounts merely to the apportionment of income and the income so applied is not deductible. There is a difference between an amount which a person is obliged to apply out of his income and an amount which, by the nature of the obligation, cannot be said to be a part of his income. Where by the obligation income is diverted before it reaches the assessee, it is deductible ; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. The obligation to apportion the income in a particular manner cannot be termed as diversion of income by overriding title."
22. Considering the decisions of the Supreme Court in the case of CIT v. Sitaldas Tirathdas [1961] 41 ITR 367, and in the case of Associated Power Co, Ltd. v. CIT [1996] 218 ITR 195 and of this court in the case of CIT v. V. G. Bhuta [1993] 203 ITR 249, in the case of Mrs. Meherbai N. Sethna v. CIT [1994] 209 ITR 453, and in the case of Colaba Central Co-operative Consumers' Wholesale and Retail Stores Ltd. v. CIT [1998] 229 ITR 209, it will have to be concluded that on the facts of the present case, the charge was not created in respect of preferential dividend receivable by the assessee from the Indian company. In our opinion, this is not a case of diversion of income at source by overriding title but the dividend was first received by the assessee in its own right, and thereafter applied for research activity of the Indian company. The letter written by the assessee to Desai and Vakil clearly shows that the assessee of its own volition agreed that the preferential dividend receivable by it will be used as contribution to financing the research activity of the Indian company.
23. In view of the proposal of the assessee, Desai and Vakil submitted a proposal to the Government and held discussions for grant of licence. Upon the proposal made and the assurances given, the Government of India granted licence to the Indian company on the condition that the assessee will utilise the preferential dividend for the research activity of the Indian company. Even though due to restrictions imposed by the Reserve Bank of India the assessee could not have remitted the amount out of India, for the purposes of the computation of total income the dividend income will have to be computed in the hands of the assessee. thus the assessee received the preferential dividend in its own right, and thereafter, the said money was used to finance research activity of the Indian company. The agreement between the assessee and the Indian company does not either expressly or by implication created a charge over the preferential dividend. The Indian company had no exclusive right on the amount of the preferential dividends. This is a case of receipt first by the assessee in its own right and then applying the amount for research activity of the Indian company. In these circumstances, the Income-tax Tribunal was right in holding that a charge was not created in respect of preferential dividend receivable by the assessee nor was there diversion of income at source by an overriding title. In our opinion, the preferential dividend received by the assessee is rightly included in the hands of the assessee for the purposes of computing tax under the Act.
24. We, therefore, answer all the three questions referred to us in the negative (sic), i.e., against the assessee and in favour of the Revenue.
25. This reference to stand disposed of accordingly with no order as to costs.