2002 (7) TMI 790 - AT - Income Tax

Income tax issues on deductibility of write-offs, duties, leave provisions, TDS and computation of exempt income

Procedural signature defects in appeal memoranda are curable by subsequent ratification; appeals may be admitted where no jurisdictional defect exists. ... - ISSUES PRESENTED AND CONSIDERED 1. Whether an appeal memorandum signed by a person not statutorily specified under rules is a fatal defect or a curable defect under the Income-tax Act and rules. 2. Whether provisions for bad and doubtful debts / incremental provisions are deductible - interaction of s.36(1)(vii) (as amended), s.36(2) and s.37, and the extent to which aggregated/consolidated write-offs, segment summaries or provision entries satisfy statutory requirements. 3. Proper application of rule 6D disallowance and the trip-wise versus employee-wise computation; and allowance of travelling expenses of spouses of employees and related s.37(1) analysis. 4. Characterisation of entertainment, club and conference expenses; whether amounts attributable to employees are excluded from 'entertainment expenses' disallowance under s.37(2)/(2A) and relevant explanation. 5. Deductibility of excise and customs duties paid and held in Personal Ledger Account (PLA) - applicability of s.43B and whether amounts held as advance or included in stock valuation are allowable. 6. Whether customs duty included in valuation of closing stock may be separately allowed under s.43B; distinction between customs duty (part of cost) and excise duty (nature of payment). 7. Allowability of fees for increasing authorised share capital by amortisation under s.35D. 8. Whether taxes paid in a foreign country on foreign-sourced income are deductible under s.37(1) or barred by s.40(a)(ii). 9. Deductibility/timing of premium on redemption of debentures and treatment across assessment years. 10. Deductibility of provision for leave encashment computed under mandatory Accounting Standard AS-15 - whether past service component is allowable as deduction. 11. Allowability of advertisement/sales promotion/gift articles under s.37(3)/rule 6B and whether auditor's Form 3CD reporting triggers disallowance. 12. Deductibility of advance lease rent paid irrevocably for entire lease term - revenue or capital incidence and allowability under s.31. 13. Scope of exemption under s.10A - whether profit from sale of Special Import Licences (SIL) / import entitlements is 'profits and gains derived from' the eligible industrial undertaking. 14. Allocation of unallocated administrative overheads and interest among divisions, and whether such notional allocations can be made against profits of s.10A eligible units (interaction with s.14A, s.10A regime and authorities on stand-alone computation). 15. Whether foreign exchange fluctuation loss on foreign currency borrowings is revenue (allowable) or capital (disallowable), determined by actual utilization (working capital v. fixed capital). 16. Whether royalty provisions payable to non-residents are deductible where tax has not been deducted at source (interaction of s.195 and s.40(a)(i)). 17. Principles governing computation of Chapter VI-A benefits (ss.80-series and s.80O) - whether deductions are to be computed on gross receipts or on 'income as computed under the Act' applying s.80AB and related case law; and whether losses of non-priority businesses may be set off against profits of priority undertakings. 18. Procedural fairness in appellate enhancement - requirement of reasonable opportunity under s.251(2) before CIT(A) enhances amounts. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Admissibility of appeal where memorandum signed by non-statutory person Legal framework: Rule 47(1) read with r.45(2) and s.140 prescribe who may sign appeal/return; s.292B saves proceedings from invalidity for mistakes. Courts' inherent/civil powers (CPC authority) and ratification principles are relevant. Precedent treatment: Supreme Court decisions recognising curable procedural defects (Union Bank of India v. Naresh Kumar) were cited and applied; distinguishing criminal/prosecution precedents (Sri Keshab Chandra Mandal) where presumption is impermissible. Interpretation and reasoning: Tribunal held signature defect curable where assessee cures defect by subsequently filing memorandum signed by competent person and where substantive rights (right to appeal) would be defeated by strict technicality. Ratification or board-authorisation and s.292B support cure. Ratio vs. Obiter: Ratio - procedural defect in signing appeal memorandum is curable where cure occurs and no jurisdictional defect exists; reliance on controlling SC precedent is ratio. Conclusion: Appeal admitted; preliminary objection rejected. Issue 2 - Provision/write-off for bad and doubtful debts (s.36(1)(vii), s.36(2), s.37) Legal framework: s.36(1)(vii) allows deduction for bad debts written off in accounts; amendment (w.e.f.1-4-1989) substituted requirement to establish 'become a bad debt' by requirement of being 'written off as irrecoverable in accounts'; s.36(2) procedural/conditions; s.37 covers other business-expenditure. Precedent treatment: Gujarat HC (Vitthaldas) supports consolidated P&L debit being sufficient; Patidar Ginning & Pressing held that writing off in accounts suffices; earlier decisions required proving debt became bad but amendment changed test. Interpretation and reasoning: Tribunal reads amendment as shifting focus to objective satisfaction of assessee on write-off; assessee need not prove the debt became bad in that previous year. However where particulars/details absent, burden on assessee to furnish details; if claim not established, AO may disallow but may allow under s.37 if nature of write-off falls within business expenditure categories. Tribunal restored matters to AO for verification and allowed particular clearly evidenced write-off (1992-93 Rs.24,38,821). Ratio vs. Obiter: Ratio - post-amendment, write-off in accounts suffices for s.36(1)(vii) deduction (need not prove year of becoming bad); obligation to furnish details remains. Obiter - guidance on alternative claims under s.37. Conclusion: Specific written-off amounts with details allowed; other provisionary claims remitted to AO to examine under s.36 or as alternative under s.37 with directions on heads (short shipments, incentives, cancellations, employee advances, etc.). Issue 3 - Rule 6D disallowance; travelling expenses of spouses Legal framework: r.6D prescribes limits per trip; tax audit reporting; s.37(1) for business expenditure. Precedent treatment: Authorities require trip-wise disallowance; earlier Tribunal/Court decisions distinguished components like local conveyance/telephone. Interpretation and reasoning: Tribunal held trip-wise computation is correct; where AO made ad-hoc estimate, Tribunal adjusted (reduced) amounts where rule amendments changed per day limits (increase from Rs.150 to Rs.1,500). For spouses' foreign travel, Tribunal accepted that long-term deputation may justify spouse travel as business-related; expenses allowed under s.37(1) if bona fide and necessary. Ratio vs. Obiter: Ratio - r.6D disallowance should be applied trip-wise and local conveyance/telephone are not covered by r.6D. Spouses' travel can be allowable where connected to long-term business deputation. Conclusion: Specific reductions/modifications ordered; spouses' travel expenses allowed. Issue 4 - Entertainment, club and conference expenses Legal framework: s.37(1) revenue expenditure; s.37(2)/(2A) and Explanation 2 define 'entertainment expenses' and carve out tea/coffee provided to employees. Precedent treatment: Courts permit reasonable allocation if part of entertainment attributable to employees. Interpretation and reasoning: Tribunal accepted that consolidated audit figures require reasonable apportionment; where AO or CIT(A) attributed none to employees, Tribunal directed 50% to be treated as attributable to employees (not entertainment) unless AO had evidence. Conferences largely for staff - 50% allowed, balance treated as entertainment. Club membership similarly split 50/50. Ratio vs. Obiter: Ratio - where auditor gives consolidated entertainment figures, reasonable apportionment (here 50%) to employees acceptable absent particularized evidence to the contrary; conferences may be revenue if primarily for staff training. Conclusion: 50% of entertainment/club/conference expenses attributable to employees allowed; balance disallowed as entertainment. Issue 5 & 6 - Excise duty and customs duty & s.43B; duties in PLA and duties included in closing stock Legal framework: s.43B allows deduction of specified taxes/duties on actual payment irrespective of accounting method; valuation rules and s.145, and principles for valuation of closing stock (British Paints). Customs duty as part of cost of imported raw materials. Precedent treatment: Lakhanpal National Ltd. (Guj) and later authorities interpret s.43B as non-obstante permitting deduction on payment; but where duty forms part of cost/stock valuation (customs), AO may correct valuation. Interpretation and reasoning: Tribunal held excise duty actually paid and held in PLA (and less than duty payable on closing finished goods) deductible under s.43B despite mercantile accounting - s.43B overrides accounting method; cited Lakhanpal and other Tribunal decisions. However customs duty paid on imported raw materials forms part of cost and thus reflected in closing stock: cannot be separately allowed under s.43B (would require adjustment to stock valuation; method of accounting cannot override correct stock valuation under s.145). Similarly, customs duty included in closing inventory cannot be separately deducted. Ratio vs. Obiter: Ratio - excise duty actually paid is deductible under s.43B irrespective of accounting method; customs duty that forms part of stock cost cannot be separately allowed under s.43B where stock valuation properly includes it. Conclusion: Excise duty in PLA allowed under s.43B; customs duty held in PLA but forming cost of inventory not separately deductible; customs duty included in closing stock disallowance upheld. Issue 7 - Amortisation under s.35D for Registrar of Companies' fee for increasing authorised share capital Legal framework: s.35D allows amortisation of expenditure specified in s.35D(2) in limited situations (pre-commencement or extension/setting up new industrial unit). Interpretation and reasoning: Registrar fee for increase of authorised share capital is not a fee for registration of the company nor expenditure in connection with extension or new industrial unit; s.35D(2)(c)(iii) covers registration fees, not increase in authorised capital. Conclusion: Amortisation under s.35D refused. Issue 8 - Foreign taxes paid (U.S.) and s.40(a)(ii)/s.37 Legal framework: s.40(a)(ii) disallows 'any sum paid on account of any rate or tax levied on the profits or gains of any business' and s.37 allows business expenditure. Interpretation and reasoning: Taxes paid abroad on profits of business are taxes on income and not allowable as business expenditure under s.37(1); they fall within s.40(a)(ii) and are disallowed. Conclusion: Foreign income taxes not deductible. Issue 9 - Premium on redemption of debentures Legal framework & precedents: Supreme Court and High Court authority indicate premium on redemption is allowable in the year it becomes payable (year of redemption) or proportionately spread as per judicial guidance (refer Madras Industrial Investment Corpn.). Interpretation and reasoning: In absence of year-specific facts, Tribunal remitted to AO to allow claim proportionately from year of issue to year of redemption in line with apex authority. Conclusion: Matter restored to AO for proportionate allowance per controlling precedent. Issue 10 - Leave encashment provision under AS-15 and tax allowability Legal framework: Accounting Standard AS-15 requires accrual of retirement benefits; judicial authorities distinguish commercial/accounting standards and taxation but allow accrual where liability is present (Bharat Earth Movers). Precedent treatment: Supreme Court has recognised leave encashment provision as present liability (not contingent) in Bharat Earth Movers. Interpretation and reasoning: Tribunal accepted bona fide change from cash to accrual due to mandatory AS-15, recognized actuarial valuation, held entire accrued liability (including past service component) had crystallised and was deductible in the year of change because liability accrued in that previous year and change was bona fide to present true and fair view. Ratio vs. Obiter: Ratio - properly ascertained liability under AS-15 (accrued, actuarially valued) deductible even if past service component; change in accounting method bona fide and applicable to closing year. Conclusion: Full provision for leave encashment allowed. Issue 11 - Gifts/advertisement and rule 6B/s.37(3) Legal framework: s.37(3) r/w r.6B regulate advertisement/gift disallowances; Form 3CD reporting obligations. Interpretation and reasoning: Auditor's reporting in Form 3CD of articles >Rs.1,000 does not ipso facto mean those are 'advertisements' under r.6B; receipts in ordinary course (festival gifts, no logos, sales promotion samples) may be business expenditure wholly and exclusively for business. AO must examine nexus; cannot disallow merely because entries appear in audit report. Conclusion: Gifts in ordinary course allowed when no advertisement/logo and when incurred in course of business. Issue 12 - Advance lease rent paid irrevocably (11 years) - revenue allowability Legal framework & precedent: s.31 allows rent; authorities (HMT) allow prepayment as allowable where payment is non-refundable/irrevocable and relates to period. Interpretation and reasoning: Lease deed produced showed advance rent for entire term non-refundable/ non-adjustable; facts identical to HMT; CIT(A)'s limited remand time unlawful; Tribunal admitted lease deed and held payment was rent for lease period and allowable. Conclusion: Advance rent for whole lease allowed as deductible. Issue 13 - SIL / import entitlements and s.10A exemption Legal framework: s.10A exempts 'profits and gains derived by an undertaking to which this section applies' (EHTP/STP); Exim policy, structure of SIL entitlements. Precedent treatment: Sterling Foods (SC) on s.80HH distinguished on facts. Interpretation and reasoning: Tribunal held income from sale of SIL springs from export activity - the source is exports by eligible unit; statutory purpose of s.10A (promote foreign exchange) indicates export incentives integral to undertaking's profits. Distinguishes Sterling Foods and relies on commercial/functional nexus and earlier case law (Wheel & Rim). Dictionary and purposive interpretation support that SIL proceeds are 'derived from' the eligible undertaking. Ratio vs. Obiter: Ratio - proceeds from sale of import entitlements used because of export activity constitute profits 'derived from' the eligible industrial undertaking under s.10A. Conclusion: SIL sale proceeds included in s.10A exempt income. Issue 14 - Allocation of unallocated overheads/interest to s.10A units; s.14A considerations Legal framework: s.10A benefit computed on profits of eligible undertaking; s.14A bars deductions relating to exempt income; authorities require stand-alone computation for eligible units where separate books exist. Precedent treatment: Conflicting authorities; principles in Indian Bank, Maharashtra Sugar Mills, and Canara Workshop emphasise stand-alone treatment; statutory s.14A prohibits deduction relating to exempt income. Interpretation and reasoning: Tribunal examined accounts and found separate audited unit accounts maintained and no finding that unallocated interest was incurred for eligible units. Applied principle that where separate books exist, notional allocation is impermissible absent evidence. Also noted s.14A implications. Accordingly reversed CIT(A)'s ad hoc allocation. Conclusion: No notional allocation to reduce s.10A profits; eligible profits to be computed on unit-wise basis as per accounts. Issue 15 - Foreign exchange fluctuation loss on FC loans Legal framework/Accounting: AS-11 requires restatement; fiscal law distinguishes revenue v. capital loss by utilization (circulating v. fixed capital). Precedent treatment: Bombay HC (V.S. Dempo) and other authorities apply utilization test. Interpretation and reasoning: Tribunal held loss is revenue in nature where AO had found loan used as working capital; where loan funds were part working capital the exchange loss is trading loss; remanded in part but ultimately allowed as revenue loss per applied authorities. Conclusion: Exchange fluctuation loss allowable as business loss where loan utilized as working/circulating capital. Issue 16 - Royalties payable abroad and TDS (s.195)/s.40(a)(i) Legal framework: s.195 requires TDS on sums chargeable under Act paid to non-resident at time of credit/payment; s.40(a)(i) disallows deduction where tax not deducted as required. Interpretation and reasoning: Tribunal held that where royalty payment to non-resident is chargeable under Act and tax was not deducted as required, the proviso in s.40(a)(i) disallows deduction in that year; if tax subsequently deducted/paid, deduction may be claimed in year of deduction. Conclusion: Provision for royalty not deductible where tax required under Chapter XVII-B was not deducted; matter remitted where proof later produced. Issue 17 - Computation of Chapter VI-A benefits (s.80-series and s.80O) and whether deductions computed on gross receipts or net income (s.80AB) Legal framework: s.80O, s.80AB, scheme for deductions and statutory non-obstante clauses. Precedent treatment: Conflicting High Court/Tribunal decisions; Special Bench/Motilal Pesticides analysis; later Calcutta decisions; Dastur line of cases. Interpretation and reasoning: Tribunal concluded s.80AB applies - deductions under Chapter VI-A (including s.80O) must be computed on 'income ... as computed in accordance with the provisions of this Act' (i.e., after allowable deductions), but for s.80O the Tribunal directed reduction only of direct offshore expenses (travel/manpower) and not ad hoc estimates of domestic establishment costs; for other ss.80HH/80-IA/80HHC, Tribunal emphasised stand-alone computation and held losses of non-priority businesses cannot be set off against profits of priority undertakings following Canara Workshop and related authorities; also remitted certain disputed treatment to AO for fact-finding. Conclusion: Chapter VI-A deductions to be computed on income as per Act (s.80AB); s.80O deduction allowed after direct offshore costs only; losses of other businesses not to be set off against eligible unit profits. Issue 18 - Procedural fairness before CIT(A) enhancing assessments Legal framework: s.251(2) - CIT(A) shall not enhance without reasonable opportunity to show cause; principles of audi alteram partem. Interpretation and reasoning: Tribunal found CIT(A) failed to afford reasonable opportunity (short timeline, intervening holidays) and acted prematurely; on merits also enhancements were contrary to binding precedents (stand-alone computation); enhancement direction quashed. Conclusion: Enhancement vacated for procedural and substantive reasons; AO to follow Tribunal directions on merits.