2024 (9) TMI 1439 - AT - Income Tax

AO's inadequate inquiry on Rs 340.45 crores expenditure upheld CIT's revision u/s 263 for erroneous revenue treatment

M/s. Mylan Laboratories Limited, Hyderaabad Versus Dy. Commissioner of Income Tax, Circle 5 (1), Hyderabad.

ITAT Hyderabad upheld CIT's revision u/s 263 regarding termination charges and liquidated damages. The tribunal found AO failed to conduct proper inquiry ... Revision u/s 263 by CIT - disallowing the amount paid on termination of agreement considering it as capital expenditure and disallowing amount paid on termination of License and supply agreement considering it as liquidated damage / penalty in nature and thereby disallowing the same u/s 37 - HELD THAT:- There is no dispute about the facts that the AO had missed to conducted enquiry in certain important aspect before allowing the expenditure as revenue expenditure to the assessee i.e. the AO did not verified the commercial expediency of the various agreement produced before him by the assessee i.e. he did not enquiry as to whether, the L&S agreement novated by SAL in favour of ASPL on 14.11.2011 were on some consideration or not., a) he did not enquiry whether there was any clause in such novated agreement to pay any termination charges or not, b) he did not enquiry why the title of the termination of the L & S agreement dated 31/10/2013 has been titled as “ Asset Purchase Agreement “where as the termination charges paid by the assessee has been claimed as revenue expenditure, c) he also did not enquiry actually who was liable to pay the termination fees, d) he did not make any inquiry, when a total consideration of Rs. 340.45 crores was to be receivable by ASPL from Mylon Ireland on account of L&D agreement, why only Rs. 273,05,47,600/- had been accounted for in the books of ASPL etc. Hence there was lacking on the part of the AO to make proper enquiry before allowing the expenditure as revenue. On going through the explanation 2 to section 263, which has been inserted w.e.f. 01/06/2015, it is abundantly clear that, if the AO failed to make proper inquiries or verification, then it shall be deemed that the order passed by the AO is erroneous so far as it is prejudicial to the interest of the revenue. Hence under such circumstances section 263 can be invoked. In our opinion, since the explanation has been made effective from a specific date , it will be applicable to the every order of AO, which has been passed by him w.e.f. 01/06/2015. As the impugned order of the Ld. AO has been passed on 31/01/2018, which is much latter than 01/06/2015, hence the explanation 2 to section 263 of the Act will be applicable on the order passed by the Ld. AO in the case of the assessee. Once the explanation 2 to section 263 of the Act being applicable on the order passed by the Ld. AO and there is lack of inquiry on the part of the Ld. AO(as discussed above), in our opinion the invocation of section 263 by the Ld. PCIT is justified and the claim of the assessee is not correct. Hence we dismiss these grounds of the Assessee. Disallowance of termination charges - From Assets Purchase Agreement, it is observed at the top of the page, the title of agreement itself shows that it is an assets purchase agreement. On the same page it has been mentioned that “ the seller shall cede their rights and obligations under the licence agreement and the supply agreement to the buyer pursuant to the terms of this agreement”. Whereas Section 2.1 at page number 114 talks about purchase of “all the right, title and interest of seller” by the buyer. Section 2.5 at page 114 and 115 talks about the purchase price to be paid in lieu of this assets purchase agreement. Section 3.3 at page number 118 talks about the transfer of assets in the agreement. Hence on the basis of such observation, it is abundantly clear that it was an agreement for purchase of assets and the amount paid under this agreement was on account of the purchase price of the said assets and was not in the nature of termination charges/fees . Hence, we are of the considered opinion that the charges of Rs. 340.45 crores paid by the ASPL to Pfizer are in the nature of capital expenditure and not in the nature of revenue expenditure. Hence we dismiss the ground no. 4 of the assessee. Disallowance of liquidated damages - There is no dispute about the facts that MLL was not interested to continue the L&D agreement with Fresenius and as per the business need of MLL, the assessee terminated the L&D agreement with Fresenius and was liable to pay the liquidated damages of Rs. 6.19 crores. It is also clear from the aforesaid portion of submission of the assessee, MLL was not interested to continue the L&D agreement with Fresenius and the ASPL had paid the liquidity damages of Rs. 6.19 crores to Fresenius to protect the business interest of MLL. The payment of liquidated damages made by the ASPL by no means related to the business needs of the assessee. As per section 37 of the Act, the expenditure which is incurred wholly and exclusively for the purpose of business, can only be allowed as business expenditure. Hence we are of the concerned opinion that the liquidated damages of Rs. 6.19 crores paid by the ASPL to Fresenius were not incurred wholly and exclusively for the purpose of business of the assessee and therefore can not be allowed as expenditure to the assessee u/s 37 of the Act. Decided against assessee. Issues Involved:1. Invocation of Section 263 by the Principal Commissioner of Income Tax (PCIT).2. Disallowance of termination charges of Rs. 340.45 crores paid to Pfizer.3. Disallowance of liquidated damages of Rs. 6.19 crores paid to Fresenius.Detailed Analysis:1. Invocation of Section 263 by the Principal Commissioner of Income Tax (PCIT):The assessee contended that the PCIT erred in invoking Section 263, arguing that the Assessing Officer (AO) had already made due inquiries and verifications. The assessee provided all requisite documents and explanations during the assessment proceedings, and the AO had taken a plausible view that the expenditures were revenue in nature. The assessee cited various case laws, including the Supreme Court's decision in Malabar Industrial Co. Limited v. CIT [2000] 243 ITR 83 (SC), to support their argument that an assessment order cannot be revised under Section 263 if the AO has adopted one of the possible views.The Department argued that the AO did not consider various factors to determine whether the expenditure was capital or revenue and did not clearly state who should claim the expenditure. The Department cited the Supreme Court's decision in Paville Projects Private Limited (2023) 453 ITR 447 (SC) to argue that an erroneous assessment resulting in a loss of revenue is prejudicial to the interest of the revenue.The Tribunal noted that there was a lack of inquiry by the AO on several important aspects and that the explanation 2 to Section 263, inserted w.e.f. 01/06/2015, was applicable. The Tribunal concluded that the invocation of Section 263 by the PCIT was justified due to the lack of proper inquiry by the AO.2. Disallowance of Termination Charges of Rs. 340.45 Crores Paid to Pfizer:The assessee argued that the termination charges paid to Pfizer were towards the termination of marketing and distribution rights and did not result in the transfer or creation of any new asset. The assessee contended that the termination of the agreement did not provide any new rights to ASPL and should be considered as revenue expenditure.The Department argued that the termination of the agreement was titled as an 'Asset Purchase Agreement' and that the amount paid was in the nature of capital expenditure. The Department also questioned how rights could be transferred to Mylan Ireland without acquiring any rights/assets.The Tribunal examined the 'Asset Purchase Agreement' and observed that it was indeed an agreement for the purchase of assets. The Tribunal concluded that the charges of Rs. 340.45 crores paid by ASPL to Pfizer were in the nature of capital expenditure and not revenue expenditure.3. Disallowance of Liquidated Damages of Rs. 6.19 Crores Paid to Fresenius:The assessee argued that the liquidated damages paid to Fresenius were revenue expenditures as they did not result in any benefit of enduring nature and were incurred for terminating the licensing and distribution agreement.The Department argued that the termination of the agreement was in the business interest of MLL, not ASPL, and thus the expenditure did not relate to the business needs of the assessee.The Tribunal noted that the termination of the agreement with Fresenius was to protect the business interest of MLL and not ASPL. The Tribunal concluded that the liquidated damages paid by ASPL to Fresenius were not incurred wholly and exclusively for the purpose of the assessee's business and thus could not be allowed as an expenditure under Section 37 of the Act.Summary:The Tribunal dismissed the appeal of the assessee, upholding the PCIT's invocation of Section 263 and the disallowance of both the termination charges paid to Pfizer and the liquidated damages paid to Fresenius. The Tribunal concluded that both expenditures were not allowable as revenue expenditures under the Income Tax Act.