2016 (10) TMI 357 - HC - Income Tax

Key ITAT Decisions: Revenue Expenditure, Commission, ESOP Trust, Section 14A, Foreign Exchange Fluctuation

Pr. Commissioner of Income Tax-06 Versus Nitrex Chemicals India Ltd.

The court upheld the ITAT's decisions on various issues, including classifying payments for trademark use and expertise as revenue expenditure, legitimacy ... Payment towards trade mark and use of expertise in the field of commerce, finance etc - capital or revenue expenditure - Held that:- This court is of the opinion that the finding with respect to tangible or non-tangible asset vesting in the assesee and whether it had or not any lasting or enduring advantage to it is more in the nature of a finding of fact. The findings are also that to use the Nitrex brand, payments were made and it was essential for the assessee to make such payments on account of nature of its business and on account of procuring knowledge for setting up the systems as well as other procedures. In the circumstances, we are of the opinion that no question of law arises on this aspect. Payments made by the assessee to its holding company Nitrex Chemicals India Ltd for the use of its trademark and for the purpose of obtaining expertise in commerce, finance, manufacturing etc. amounted to revenue expenditure instead. Excessive commission - Held that:- This issue is consistently ruled against the assessee, for all the five years. However, in both the CIT (A) and the ITAT, the revenue’s contentions were not accepted. Here, the assessee’s argument was that the commission could not be characterised as excessive because they were more customary in nature having regard to the historic relationship with M/S Asha export, its export agent. This court is of the opinion that such decisions as to the nature and quantum of commission may differ having regard to the uniqueness of each business and the relationship that it may possess with those associated with it. Unless, the revenue is able to pinpoint extraordinary features, it cannot scrutinize the commercial terms that a business takes into account in making a decision and contend that certain percentage or quantum of commission is “excessive”. Capital gains in respect of slump sale - Revenue’s contention here is that sum spent by the assessee at the time of transfer of its business undertaking to fund the ESOP Trust, cannot be characterized as permissible expenditure but rather has to be added back for the purposes of income calculations - Held that:- As is evident, the expression “expenditure incurred wholly and exclusively in connection with such transfers” is in plain terms sufficient to encompass the kind of expenditure with which this Court has to deal with in respect of determining the issue in question. ESOP was an essential term of employment for the assessee’s workforce; an ESOP Trust Fund had been created for this specific purpose. Upon the transfer of the assessee’s undertaking, the transferee disclaimed any responsibility to honor the ESOP conditions. As consequence, the funding of the ESOP became an integral part of the transfer itself.In these circumstances, the court is of the opinion that the mode of computation of capital gains had to necessarily take into consideration the ESOP funding through the trust fund by the Assessee at the stage of transfer.Therefore, the court holds that there is no infirmity in the findings of the ITAT. Disallowance under Section 14A - Held that:- We notice that the decision in the case of Maxopp Investment Ltd.Vs CIT, New Delhi (2011 (11) TMI 267 - Delhi High Court ) would apply in the circumstances. Equally for the last year i.e. year 2009-2010, the AO’s omission to record his satisfaction as to the permissibility of the deduction, which is the pre-condition for exercise of the power, persuaded us to hold that no question of law arise. Foreign exchange fluctuation - whether could be treated as capital losses rather than as revenue expenditure? - Held that:- We notice that this aspect was considered by the ITAT which observed that the ECB loan/advance was an old one and the treatment of the foreign exchange fluctuation especially in case of increase for all the previous years was taken to be on the revenue side. It is necessarily implied that the revenue accepted that the foreign exchange amounts amounted to income and proceeded to deal with it as such.This court is of the opinion that in view of the past revenue treatment, the revenue’s submissions by the appellant are unmerited. No question of law arises. Revenue appeal dismissed. Issues Involved:1. Classification of payments for trademark use and expertise as revenue or capital expenditure.2. Legitimacy of disallowance of excessive commission on exports.3. Deductibility of ESOP Trust funding from capital gains in a slump sale.4. Validity of disallowance under Section 14A.5. Treatment of foreign exchange fluctuation as capital or revenue loss.Detailed Analysis:1. Classification of Payments for Trademark Use and Expertise as Revenue or Capital Expenditure:The primary issue was whether payments made by the assessee to its holding company for the use of its trademark and expertise in commerce, finance, and manufacturing should be classified as capital or revenue expenditure. The Assessing Officer (AO) considered these expenditures as capital in nature due to their enduring benefits. However, the CIT (A) and ITAT treated them as revenue expenditure. The ITAT reasoned that the payments were for using the trademark and obtaining necessary expertise for smooth business operations, and no tangible or intangible asset with lasting benefits was acquired. The court upheld this view, stating that the findings were factual and no question of law arose.2. Legitimacy of Disallowance of Excessive Commission on Exports:The revenue argued that the commission paid by the assessee to its export agent was excessive. However, both the CIT (A) and ITAT rejected this contention, emphasizing that the commission was customary given the historic relationship with the export agent. The court noted that commercial decisions regarding commission payments are subjective and unless extraordinary features are pinpointed, the revenue cannot deem them excessive. Thus, no question of law arose on this issue.3. Deductibility of ESOP Trust Funding from Capital Gains in a Slump Sale:The revenue contested the deduction of Rs. 1,39,76,352 spent on funding the ESOP Trust from capital gains. The assessee argued that this expenditure was integral to the sale transaction. The ITAT found that the ESOP funding was a pre-condition for the business transfer and was essential for ensuring employee transition to the new company. The court agreed, stating that the expenditure was incurred wholly and exclusively in connection with the transfer, as per Section 48 of the Income Tax Act. Therefore, the court found no infirmity in the ITAT’s findings and ruled that no question of law arose.4. Validity of Disallowance under Section 14A:The revenue’s grievance regarding disallowance under Section 14A was limited to three assessment years. The court referred to the decision in Maxopp Investment Ltd. Vs CIT, New Delhi, and noted that the AO failed to record satisfaction regarding the permissibility of the deduction, which is a pre-condition for exercising the power. Consequently, the court held that no question of law arose on this aspect.5. Treatment of Foreign Exchange Fluctuation as Capital or Revenue Loss:For the assessment year 2009-2010, the AO disallowed the loss on foreign exchange fluctuation, treating it as a capital loss. The CIT (A) and ITAT disagreed, citing Section 43A and AS-11 (Accounting Standard), which mandate that such fluctuations be shown in the profit and loss account. The court observed that the revenue had previously treated foreign exchange fluctuations as revenue in nature. Given this consistent treatment, the court found the revenue’s submissions unmerited and ruled that no question of law arose.Conclusion:The court concluded that all questions of law were answered against the revenue and in favor of the assessee. Consequently, the appeal was dismissed as unmerited.