TaxTMI 
TaxTMI 
2004 (7) TMI 652
X X X X Extracts X X X X
X X X X Extracts X X X X
....ied, illegal and unwarranted. The expenses debited to the P&L a/c pertain to the. relevant previous year only. Therefore, the addition of ₹ 3,19,553 deserves to be deleted in total. 2. That on the facts and in the circumstances of the case and in law, the disallowance of ₹ 91,320 on account of repair and maintenance is illegal, unwarranted and unjustified. The expenditure incurred on levelling of factory land, etc., is revenue in nature and is allowable in full. Therefore, on the grounds taken and basis adopted and in law, the disallowance of ₹ 91,320 is fully unjustified and deserves to be deleted in total." ITA No. 101 : Ground raised by the Revenue for asst. yr. 1999-2000 is as under : "On the facts and in the circumstances of the case, the learned CIT(A) erred in deleting the addition of ₹ 1,73,440 made on account of deferred revenue expenditure." ITA No. 3304 : Ground raised by the assessee for asst. yr. 1997-98 is as under : "That the disallowance of royalty amounting to ₹ 79,77,572 is totally wrong, illegal and unjustified. During the year under consideration, the appellant has paid royalty to Shaw Wallace & Co. Ltd. ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....isallowance drawing baseless, irrelevant and untenable conclusions without judiciously appreciating the facts of the case and the position of law." 2. The assessee, M/s Shaw Wallace Distilleries Ltd., is the successor of erstwhile assessee, M/s VRV Breweries & Bottling Industries Ltd., consequent to the merger of the latter with the former company. 3. M/s VRV Breweries & Bottling Industries Ltd. was a public limited company incorporated under the Companies Act, 1956. It entered into an agreement with the Shaw Wallace on 6th July, 1996, for manufacture of Indian made foreign liquor (IMFL) products of brands owned by Shaw Wallace and their associate. The aforesaid agreement was entered into as there was lack of demand of products manufactured by VRV Breweries and to open new and prospective channel for future of the company. In terms of the above agreement VRV Breweries agreed to manufacture and sell IMFL products of various brands owned by Shaw Wallace & Co. Ltd. (SWC). SWC agreed to provide various support services including controlling quality of spirit, purchase of raw material and packing material, quality control, obtaining of import permit, etc. In addition to said supp....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t provided its brand names, samples, formula in the manufacture of IMFL, process of manufacture, provision of brand labels, arrangement for supply of raw material and sales through its chain of customers without which the assessee could not have remained in the business. Thus, royalty was paid for all the services rendered by SWC and was calculated on the basis of formula specified in the agreement. 8. The assessee argued that without the agreement with SWC, assessee could not have survived. It was accordingly claimed that royalty was wholly and exclusively expended for the purpose of business and had direct nexus to the business needs of the assessee. Complete details of working of royalty payable to the said SWC were placed on record. A photocopy of a similar agreement entered into by SWC with Balbir Distilleries Ltd. was also placed on record for a ready reference. The AO disallowed 13/14th of the deduction of royalty with the following observations : "3.1 The contention of the assesses cannot be accepted. Market practice can only be established if payment of royalty is made to a company where majority shareholders of that company are not group companies of Shaw Wallace &....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ing charges receivable by the assessee-company in 1996. This further proves that intention is transfer of profit. It is obvious from the above that royalty payment is highly excessive and unjustified. 3.2 The copy of agreement dt. 6th July, 1996, has been perused. The assessee has acquired the right to manufacture and sell the brands of Shaw Wallace group. It has got the right to use the trademark, brand names, design and the get-up of Shaw Wallace products. By paying these consideration which are capital in nature, Shaw Wallace has authorised assessee under a separate agreement to manufacture, process, package and sell the IMFL products of various brands of Shaw Wallace. Inspite of repeated asking, the Authorised Representative has not produced a copy of the agreement mentioned in para 6.3 and also in Appen. 'C'. It is also important to mention here that assessee had pressed for claim under Section 37. However, Section 37 only deals with those expenditures which are not of the nature described in Sections 32 to 36 and also not in the nature of capital expenditure. In this case, the know-how, recent formula not being disclosed by the assessee as discussed above, designs an....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the assessee ensures any expenditure in respect of which payment has been made to any person referred to in Clause (b) of this sub-section and the AO is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of goods, services or facilities or the legitimate needs of the business or profession of the assessee, or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction. Assessee's case was taken to be covered under Clause (iv) of Sub-section (b) where a company having a substantial interest in the business or profession of the assessee is covered for this purpose. AO had already pointed out that majority share holding is by the Shaw Wallace which was not controverted before him. The employees of the Shaw Wallace were having controlling share holding. It was accordingly held that payment of royalty made to Shaw Wallace was covered under Section 40A(2) of IT Act. (2) In this connection, reference was made to a similar agreement with another company M/s Balbir Distilleries, the bottling charges were paid at ₹....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ied upon by the appellant is also applicable in the facts and circumstances of the case. Further, the expenditure has been incurred not only for use of trademark but also providing various other services like support for control quality of spirit, purchase of raw materials, packing materials, quality control, obtaining of import permits, obtaining verification certificate from excise authorities, financial and technical support, sale and marketing support, collection of sales proceeds, support for packing credits and payment of sales-tax, etc. Since expenditure has been incurred for the purpose of business and is revenue in character, the provisions of Section 35A will not be applicable. I respectfully defer with the findings of my learned colleague that the provisions of Section 35A are applicable to the case of appellant." In asst. yr. 1998-99, the CIT(A)-XX was of the opinion that the order of CIT(A)-IV was based on the finding that M/s VRV Breweries and M/s Shaw Wallace were group concerns. He held that : "I would like to mention here that the CIT(A)-XIV, New Delhi, had made reference to finding of the AO that the majority share holding is by the Shaw Wallace which ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....it cannot be denied that in case the group of companies of Shaw Wallace is a member have close business and commercial links, such a connection establishes a close business nexus between the parties. 13. The AO had also held that assessee had adopted a device to transfer profit and there was no commercial expediency or necessity for paying royalty to SWC. However, on appeal, the learned CIT(A) in order for asst. yr. 1998-99, held that shares are neither held by Shaw Wallace nor by the employees of Shaw Wallace and payment was not made to employees of Shaw Wallace. It was accordingly held that provisions of Section 40A(2) were not applicable. 14. The learned CIT(A) deciding the appeal of the assessee for asst. yr. 1999-2000 did not agree with above view. He referred to letter dt. 11th June, 2002, of the assessee wherein the assessee-company had informed that it stood transferred and merged with Maharashtra Distillery Ltd., w.e.f. 1st July, 2000, which was having business connection with M/s Shaw Wallace. The merger scheme of above company was approved by Hon'ble High Court of Bombay vide their order dt. 26th March, 2003. Thus, entire undertaking along with properties and asset....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... CIT(A) which went against them. We have heard submissions of both the parties. The learned counsel for the assessee has drawn our attention to the agreement between the parties, i.e., assessee and Shaw Wallace & Co. He argued that Section 40A(2)(b) had no application in this case. The AO loosely described two companies as group companies without stating what he means by group companies. It is also not stated as to where does the concept of group company figure in the IT Act. 19. In the instant case only Clauses (iv) to (vi) of Section 40A(2) of the Act may, if at all apply since Clauses (i) to (iii) deal with payments made by an individual assessee or payment made to an individual (as discussed infra). 20. Insofar as payment to a company is concerned, the relevant portions of Clauses (iv) to (vi) of Section 40A(2) of the Act read as under : "(b) The persons referred to in Clause (a) are the following, namely : (iv) a company..............having a substantial interest in the business or profession of the assessee or...........; (v) a company.............of which a director..............has a substantial interest in the business or profession of the assessee; or......... ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....of Section 40A(2) is not attracted; --Clause (ii) applies if payment is made to any director of a company or any relative of such director; Since payment was made to SWC, a company, not an individual, being a director or relative of director, Clause (ii) of Section 40A(2) is not attracted. --Clause (iii) applies to payment made to an individual having substantial interest in the assessee or any relative of such individual; Since payment was made to SWC, a company, not an individual, being a person holding substantial interest, Clause (iii) of Section 40A(2) is not attracted. It was emphatically stated before the AO and the CIT(A) in the aforesaid years that VRV and SWC are not related persons in terms of Section 40A(2)(b) of the Act. This is also evident from the (sic) of shareholders of VRV and the list of directors of VRV and SWC during the relevant years. In asst. yr. 1997-98, the CIT(A) however held that the assessee's case is covered by Clause (iv) of Sub-section (b) where a company having a substantial interest in the business or profession of the assessee is covered for this purpose. The relevant observations of the CIT(A) read as under (refer para 4 p. 2 of the or....
X X X X Extracts X X X X
X X X X Extracts X X X X
....incorrect understanding of the covenants and the facts of the assessees. 21. As regards application of provision of Section 35A, the assessee submitted that royalty paid to SWC was a revenue deduction. He further argued that under the agreement SWC was also to offer rebate/discount to customers and amount of allocated charges were adjusted against the gross royalty paid by the assessee to SWC. Consequently, SWC received only net royalty for rendering various services as enumerated below. (i) Controlling quality of spirit : SWC was required to supply to VRV sample of the spirit to be used in the manufacture of IMFL products (refer Clause 2.1). (ii) Purchase of raw materials : SWC was required to specify all raw materials required for the manufacture, distillation and bottling of the IMFL products and in certain cases arrange procurement thereof (refer Clauses 3.2 to 3.4). (iii) Purchase of packing materials : SWC was required to provide samples for purchase of packing materials and approve purchase of packing materials (refer Clauses 3.6 and 3.7). (iv) Quality control : SWC was required to check/control the quality of IMFL products (refer Clause 5). To facilitate the same, SWC ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....xpenditure on acquisition of patent rights or copyrights which was otherwise capital in nature. The term "acquisition" refers to absolute proprietary rights in the patent or purchase of copyright as opposed to obtaining mere permission or right to use as can be inferred from the meaning of the term "acquire" as explained in various dictionaries (Annex. 1 to this proposition). 22. The royalty paid was a revenue deduction and the provision of Section 35A had not been applied to such payment. The learned counsel relied upon commentary of learned authors Kanga and Palkhiwala, 8th Edition, Vol. 1, wherein the learned author have opined that right to use patent or copyrights and payment made therefor is a revenue expenditure under Section 37 of the Act. Section 35A deals with expenditure, i.e., price paid for purchase of copyright or patent rights. 23. The learned counsel further relied upon the following decisions : The Supreme Court in the case of Charanjit Lal v. Union of India AIR 1951 SC 41 explained the term acquisition as follows : 'It cannot be disputed that acquisition means and implies the acquiring of the entire title of the expropriated owner, what....
X X X X Extracts X X X X
X X X X Extracts X X X X
....held that the assessee did not under the agreement become entitled exclusively even for the period of the agreement, to the patents and trademarks of the Swiss company, it had merely access to the technical knowledge and experience in the pharmaceutical field which the Swiss company commanded. The assessee was on that account a mere licensee for a limited period of the technical knowledge of the Swiss company with the right to use the patents and trademarks of that company. The assessee acquired under the agreement merely the right to draw, for the purpose of carrying on its business as a manufacturer and dealer of pharmaceutical products, upon the technical knowledge available with the Swiss company did not part with any asset of its business, nor did the assessee acquire any asset or advantage of an enduring nature for the benefit of its business. In the said case, the Court held that the expenditure incurred for use of technical know-how was allowable as revenue deduction under Section 37(1) of the Act, not being a capital expenditure. The learned counsel for the assessee relied upon several other decisions including the decision of Indore Bench in the case of Etcher Motors Lt....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... assessee in having quality control, help in acquiring import permits and in obtaining certificate from excise authorities. Besides the above, SWC was to advise the assessee as to marketing arrangement for sale of IMFL products manufactured by the assessee. Financial support was also required to be provided by SWC. It is clear from the agreement that royalty was paid for carrying on day-to-day business activities of the assessee. It was payment for carrying on, enhance and promote assessee's production (business). It was to add efficiency to the business. The assessee has furnished sale figures on record to show that after the agreement assessee's sales took a quantum jump. Its profitability increased. The cases relied upon on behalf of the assessee are clearly attracted and payment made was royalty for use of technical know-how and experience of Shaw Wallace & Co. The assessee did not acquire any benefit of enduring nature which could be termed as a capital asset. 27. Neither the AO nor the learned CIT(A) in his order has brought any material on record to show that any asset of capital nature was acquired by the assessee. An adverse inference has been drawn against the as....
X X X X Extracts X X X X
X X X X Extracts X X X X
..... As already noted, under Clause (b) of Section 40A(2), definition of related party is given and that is exhaustive. The Revenue authorities have to establish the case within the relationship enumerated in the list. No attempt was made by them to show that the case is covered by relationship indicated in the provision. The decision of Hon'ble Supreme Court in the case of Mahindra Engineering and Chemical Products Ltd. v. Union of India (supra) supports the view that we are taking above. 29. The assessee has also shown that case of M/s Balbir Distilleries Ltd. was not comparable, bottling charges paid to that company were paid under totally different circumstances. The differences were highlighted by the assessee as under : "It is pointed out that the agreement with Balbir Industries was executed in the year 1995 and the agreement with the appellant was executed in the year 1996. The agreement being of commercial nature could contain different conditions for different parties. At the time of agreement with M/s Balbir Industries, Shaw Wallace was not having any bottling facilities in north India. It had to establish its presence and, therefore, it paid higher bottling cha....
X X X X Extracts X X X X
X X X X Extracts X X X X
....s to advertisement. The assessee cannot take the logic that the benefit of these expenses was to be availed in the future years also and accordingly the same has been deferred. This is not correct because the assessee has incurred the expenses in a previous year and were allowable in the same year itself. Also, in a number of case law, it has been held that it is not necessary that the benefit of expenditure should be limited to previous year in which it is incurred and accordingly it should be claimed in the year in which it has been incurred on accrual basis. [Mysore Spinning and Manufacturing Co. Ltd. v. CIT (1966) 61 ITR 572 (Bom) and CIT v. Mysore Spinning and Manufacturing (1970) 78 ITR 4 (SC)]. Therefore, the submission of the assessee on this issue is also not acceptable'." This issue has been discussed at length in the earlier years. I find the CIT(A) for 1997-98 on this issue has held as under : "The third ground of appeal is against the disallowance of ₹ 1,73,440 on account of deferred revenue expenditure written off during the year. The AO disallowed it saying that there is no question of allowance of deferred revenue expenditure under the IT Act. ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....diture is crystallised during the year. The disallowance of ₹ 3,19,553 consists of five items. The first item of ₹ 2,55,536 relates to rate difference on mono-cartons. The appellant purchased mono-cartons from Rainbow Distilleries (P) Ltd. on 10th Dec., 1996. As there was dispute as to the price of mono-cartons purchased, the appellant-company did not pass any evidence in its books of account on 10th Dec., 1996. Subsequently, at the end of financial year entry was passed only for Rs, 2,35,396 towards purchase of mono-cartons. The bill of ₹ 4,90,932 raised by the Rainbow Distilleries (P) Ltd. was not fully charged to the books of account because of the dispute. The dispute was finally resolved during the financial year 1997-98 relevant to the asst. yr. 1998-99 and the appellant passed entry for difference price, i.e., ₹ 2,55,536 (Rs. 4,90,932 minus ₹ 2,35,396) on 27th Dec., 1997. The appellant placed reliance on the decisions of Allahabad High Court in the case of Sir Shadi Lal Sugar and General Mills Ltd. v. CIT (1992) 64 Taxman 597 (All) and in the case of CIT v. Oriental Motor Co. (P) Ltd. I have considered the facts of the case. The appellant has no....