TMI Blog1993 (8) TMI 126X X X X Extracts X X X X X X X X Extracts X X X X ..... essee-company, a copy of which is furnished in the paper-book No. I of the assessee. 16. The assessee put forth the following contentions and urged that the amount of Rs. 14,83,931 is allowable as expenditure (a) Explaining the nature of the expenditure, it is stated by the assessee-company in its letter dated 16-3-1992 addressed to the Assessing Officer as follows: "During the previous year relevant to the assessment year, the assessee has made certain payments for acquisition of know-how relating to the manufacture of Ammonium Nitrate for use in its business. The relevant agreements were entered into on the following dates: (i) UNDE, GmbH, dated 2-12-1987. (ii) NORSK HYDRO, dated 2-12-1987. (iii) ADOLOF PLINK SOHONE, dated 27-1-1988. (iv) UHDE INDIA LIMITED, dated 2-12-1987. (v) BHALLA SPECTRUM INDUSTRIES LIMITED. A statement showing the amounts paid during the relevant previous year and the receipts in respect thereof are enclosed. At the time of filing of original return, two amounts paid were inadvertently omitted to be claimed as a deduction and the same were included in the revised statement enclosed. The total amount paid shown in the enclosed statement tall ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nly. No doubt, it intended to diversify its business to manufacture Ammonium Nitrate and Nitric Acid. The new line of business cannot be considered as the same business of the assessee. For acquiring the project report for the new business, certain expenditure was claimed as revenue expenditure and it was not allowed for assessment year 1988-89. The new line of business had not gone into commercial production in the accounting year in question, and therefore, the new line of business cannot be considered as the business of the assessee till the assessee goes into commercial production of Ammonium Nitrate and Nitric Acid. The new line of business, viz., manufacture of Nitric Acid, etc., is distinct and different from the existing business of manufacture of soft drinks and aerated water. Thus, with this reasoning, he disallowed the claim of the assessee under section 35AB. 18. Having been aggrieved by the disallowance made by the Assessing Officer, the assessee came up in appeal before the CIT (Appeals). The same arguments, which were advanced before the Assessing Officer were reiterated before him. He also held that deduction under section 35AB would be admissible only if the expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business of the assessee. (3) It is not necessary that the know-how is actually used for the purpose of the business of the assessee. It is enough if it is capable of being used for the purposes of business of the assessee. That means actual working of the manufacturing unit, using the technical know-how purchased was not essential. The lump sum paid for acquisition of know-how has to be allowed in instalments beginning from the assessment year in which the said know-how is purchased and in five other subsequent assessment years. (4) The importance is being given to the purchase and not very much for use of it in business. More often than not, the use of know-how developed in Laboratories and Universities will take considerable time to be adopted for industrial use and adoption. In some cases, in order to put them to use, new machinery and new set up or factory may be required, which involves time. It was the intention of the Legislature to allow the deduction if only one condition is fulfilled. That is, the know-how is acquired for business purposes, and it was never the intention of the Legislature that it should also be put to use in business in the first year of purchase ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of several units is worked out by consolidated P L Account and balance sheet, if there is common management and administration, if the ultimate control of the manufacturing units is done by a common registered office, if there is complete inter-connection, inter-lacing and inter-dependence and dovetailing of different business activities, then there are a number of decisions which held that the activity of running multiple units constitute one and single business only. Thus, the question in this case is whether the assessee who has been manufacturing soft drinks deriving profits in that venture, as a measure of diversification of its activities, started setting up of a factory for manufacture of Ammonium Nitrate and Nitric Acid, is entitled to the deduction under section 35AB. Though the said factory has not yet started manufacture or business by virtue of the fact that the same assessee has been running the other unit of manufacturing soft drinks, etc., can it be considered to be carrying on the same business, or not. 22. In this connection, attention of this Tribunal is invited to the following decisions: (1) Coromandal Fertilizers Ltd.'s case (2) Prithvi Insurance Co. Ltd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f retrenchment compensation paid by the assessee upon the closure of one of its units, and the bad debts written off in the other two units were allowable deductions under section 37 and section 36(1)(vii), respectively. The factors or the basis of evidence which were duly taken into consideration in coming to the conclusion that several businesses which were noted above, constituted a single business are the following as per the head note of the decision at pages 66 and 67: "Held, that the board of directors of the assessee, which was a private company, was in overall control of all the five business activities which were owned and carried on by the assessee. There was a common fund from which the necessary capital and working funds were supplied to the various business activities. The ultimate gain or loss of the business was also worked out by a consolidated profit and loss account and balance sheet. The source of finance for running the various businesses was thus one and the same and there was consolidation of accounts for the purpose of ascertaining the ultimate working result of the business carried on by the assessee. Merely because there was a separate staff, which was n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the common funds of the assessee company. It is no doubt true that it is desired to manufacture Ammonium Nitrate in the factory set up in a village in Srikakulam District, whereas the unit manufacturing the soft drinks and aerated water was situated in Vizag. However, according to the decision quoted above, it is not a matter of any consequence and that factor does not run counter to inter-lacing inter-dependence, unity of control, management, etc. So also, the maintenance of different accounts or maintenance of different staff for two separate units cannot also have any significant consequence. 25. In Coromandal Fertilizers Ltd.'s case the facts which came up for consideration before the Tribunal are that the assessee initially incorporated in 1961 for manufacture and sale of fertilisers. In 1979, its objects clause was amended and the assessee was authorised to start a cement plant. The assessee raised capital from the financial institutions, several works of the plant were started in 1981 and the first batch of machinery arrived in January 1982. For assessment year 1982-83, assessee claimed deduction in respect of amounts spent towards interest and commitment charges paya ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see in connection with the setting up of the six new divisions were allowable as business expenditure. Following its own earlier decision in CIT v. Hindustan Machine Tools Ltd. (No. 1) [1989] 175 ITR 212 (Kar.) the High Court held that the Tribunal was correct in holding that the expenditure incurred by the assessee in connection with its new divisions was deductible as business expenditure. 27. Having regard to the facts and circumstances of the case, and also having regard to the innumerable decisions, we are of the opinion that the business of manufacture of soft drinks and aerated water, as well as the business of manufacture of Ammonium Nitrate and Nitric Acid should be considered as one and the same business carried on by the assessee. 28. It is further contended that the provisions of section 35AB were intended to give special deduction as special incentive to persons who are already in business. This provision was introduced under Finance Act, 1985. Memorandum explaining the provisions of the Finance Bill, 1985, and the relevant provision, namely section 35AB and it reads as follows: "44. It is proposed to insert a new section 35AB in the Income-tax Act to provide tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee, it should not be allowed as deduction. 30. The caution given by the Supreme Court while following its judgments and applying the ratio of the judgments to the cases arising before the lower authorities, is apt to be noted at this juncture. The said caution is administered in a recent decision of Supreme Court in CIT v. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 297: "It is not proper to regard a word, a clause or a sentence occurring in a judgment of the Supreme Court divorced from its context as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgment." It is further stated as follows: "It is neither desirable nor permissible to pick a word or a sentence from the judgment of the Supreme Court divorced from the context of the question under consideration and treat it to be the complete law declared by the Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before the court. A decision of the Supreme Court takes its colour from the questions involved in the case in which it is rendered and while applying the decis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nit manufacturing aerated water and soft drinks, the assessee is entitled to claim the deduction contemplated under section 35AB and thus, it is entitled to Rs. 14,55,556 as deduction. We reverse the orders of the lower authorities in this regard and direct the Assessing Officer to grant deduction of Rs. 14,55,556. 31. to 37. [These paras are not reproduced here as they involve minor issues.] 38. The last of the issues that remains for consideration is the deduction claimed under S. 80HHC. The amount of deduction claimed is Rs. 5,17,695. The assessee also claimed a sum of Rs. 2,24,679 towards service charges paid to V.B.C. Exports Ltd. as deduction. However, both the claims were denied by the Income-tax Officer. The brief facts with regard to the claim of the assessee under S. 80HHC may be stated as follows: (a) V.B.C. Exports Ltd. is a sister concern of the assessee and it is engaged in the processing as well as export of shrimps. The assessee claimed to have exported 47.1 metric tons of Shrimps worth Rs. 54.88 lakhs to several countries including Japan. The assessee entered into an agreement with V.B.C. Exports on 4-3-1989. Copy of the agreement is provided at page 1 of 2nd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Chief Controller of Imports and Exports dated 30-3-1988 was provided. It discloses that the assessee was given Importer-Exporter Code No. (IEC) 2688000195. At page 23 copy of the allotment of Exporter Code No. HV 000085 dated 8-3-1989 was assigned to the assessee at page 25 of the paper-book the provisional certificate as exporter was given to the assessee by the Marine Products Export Development Authority (MPEDA), dated 7-11-1991 was provided. The said authority certified Invoice No., its date, the quantity exported and the FOB value of the said consignments. Therefore, it is extracted: "To whomsoever it may concern--- M/s. V.B.C. Industries Ltd., A-4 Unit, Industrial Estate Visakhapatnam-530007 is a Registered Exporter with the Authority. The Registration Number assigned to them is 2022/MPEDA/REGN/VSRO/V-2/89, dated 5-7-1989. Prior to the issual of permanent Registration as an Exporter with the Authority, the party has exported 39,940 Kgs. of Frozen Shrimp worth Rs. 56.17 lakhs on the basis of ad hoc permits issued by the authority, the details of which is given below: 1. Invoice dated 10-3-1989 9120 Kgs. Rs. 20,88,121.48 2. Invoice dated 10-3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. 59,602.20 from the assessee-company. The Debit Note is dated 30-3-1989. At page 45 is the statement of exports made by the assessee-company during the years 1988-89 and 1989-90 as also 1990-91. This would show that whichever exports were made by the assessee-company for the financial years 1988-89 and 1989-90 were made only through its sister concern, M/s. VBC Exports Ltd. However, in the financial year 1990-91 all the exports were shown to have been made through others and not through VBC Exports. The C F Value as well as the FOB value of the exports made in the financial years of 1988-89 and 1989-90 were provided in a tabular form. For financial year 1988-89 with which we are concerned, the C F Value of exports was stated to be Rs. 57,70,600 and the FOB value of the exports was stated to be Rs. 56,16,986. Details of exports which the sister concern (VBC Exports) made during the financial years 1988-89, 1989-90 and 1990-91 were shown at page 49. In the financial years 1988-89 and 1989-90, VBC Exports Limited was shown to have made direct exports as well as exports made on behalf of others. The exports made for others were titled as 'route through exports' in the tabular form ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng to the Assessing Officer, since it has incurred losses during the year, there is no scope for the sister concern of the assessee to claim deduction under section 80HHC. Therefore, a colourable device of tax avoidance was evolved by the assessee with the help of its sister concern. The reasons for coming to the said conclusion were stated to be as under: 41. The terms and conditions contained in the agreement dated 4-3-1989 were not strictly adhered to by the parties to the agreement. Deviation from the terms and conditions were freely resorted to. According to clause 6 of the agreement, sister concern had the right to enjoyment of incentives like REP, duty draw back and the assessee was left only with the deduction which can be claimed under section 80HHC. According to clause 12 of the agreement the date from which it would come into force was left blank. Clause 14 of the agreement states that the agreement should terminate after exporting products worth Rs. 50 lakhs and on completion of connected formalities. No renewal of the agreement was contemplated. The assessee had in fact effected exports exceeding Rs. 50 lakhs in contravention of the agreement. However, the oral conte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n fact confirmed the order of the Assessing Officer. The reasons given by him at para 12 of his order are the following: (1) The agreement does not bring into existence a buyer/seller relationship between the assessee and the sister concern. (2) It does not specify the cost of the goods transacted. (3) As per articles (3) and (5) of the agreement the entire cost of export is borne by assessee's sister concern and the entire export proceeds also are to be appropriated by the sister concern. (4) In the process, the sister concern may earn some profits but if it incurs some loss, the assessee could not be careless. (5) The assessee was only aiming at getting recognition as export house and would of course get the benefit of deduction under section 80HHC. (6) The assessee did not take any risk of buying or selling. Its name only was to be used. For the benefit to be gained by it (recognition as Export House and 80HHC deduction) it agreed to pay service charges at 4%. He held that this is an unusual agreement and it cannot be termed as commercial arrangement since it had no scope for any commercial risk by any of the parties to it. For gaining benefit under section 80HHC, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as an export house and for getting benefits under section 80HHC, it had agreed to pay service charges to the VBCE at 4% FOB. According to the learned Commissioner of Income-tax (Appeals), the whole commercial risk of exporting marine products was on VBCE and at the same time it was divested of a legal benefit of deduction which it would have otherwise availed. He also opined that for getting the benefit of being recognised as export house besides getting benefits under section 80HHC, the assessee paid an unusual consideration that too to a sister concern. He also held that for depriving the Government of India part of its tax due, the assessee had entered into an arrangement for giving largesse to one of its sister concerns. He came to the conclusion that the arrangement was designed only for escaping tax liability on two counts by claiming deduction under section 80HHC and by claiming deduction for payment of service charges to VBCE. 46. After hearing both sides, we are unable to agree with the findings of the lower authorities that under the agreement the assessee did not stand to gain anything, and the assessee could not derive any commercial profit from the said agreement. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icate shall be determined on the basis of the Net Foreign Exchange Earnings (NFE earnings) from the exports actually made in the preceding three licensing years termed as the 'Base Period'. The earnings from (i) the exports of products specified in Appendix- 12, (ii) re-exports as defined in para-174(1) of this policy, (iii) 'Deemed Exports' as defined in Chapter (XVI), and (iv) exports from Free Trade/Export Processing Zone and 100% EOUs, shall not qualify for this purpose. (2) The eligibility will be considered subject to the following conditions: (a) The annual average NFE earnings in the prescribed base period should not be less than Rs. 2 crores in the case of Export Houses, and Rs. 10 crores in the case of Trading Houses." There are certain requirements to be fulfilled before being recognised as Export House status. They are: (1) The annual average Net Foreign Exchange (NFE) earnings during the preceding three licensing years should not be less than Rs. 2 crores; (2) However, NFE earnings in none of the preceding three years should be less than 25 per cent of the minimum average NFE earnings (25% of Rs. 2 crores comes to Rs. 50 lakhs). The assessee-company exporte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y given the right to claim indemnity from VBCE for such claims. On behalf of the assessee several other such instances where the sister concerns acted as agents for exports and where service charges were paid in between two to 5% for the agents helping the assessee in exports were furnished before the Commissioner of Income-tax (Appeals). Similar contracts entered into by the assessee with other concerns were furnished before the learned Commissioner (Appeals). At page 1 of the written arguments, the following is what is stated : "Among others, the assessee had entered into the following contracts, with agents other than the assessee's sister concern, for the export of goods (copies of agreements annexed):--- (a) Agreement with Pacific Export dated 11- 12-1985 - Import Entitlements to Processor, 80HHC benefit to the exporter; commission 2%. (b) Agreement with Chinar Exports dated 25-9-1984-Minimum turnover Rs. 20 lakhs, to be completed before 31-12-1984, Import Entitlements to processor, 80HHC benefit to Exporter and commission 2.75%. (c) Agreement with Shaw Wallace Limited dated 8-11-1989 - Import entitlements to exporter, Minimum Turnover Rs. 100 lakhs, to be completed be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iness (as computed under the head 'Profits and gains of business or profession'), the same proportion as the export turnover bears to the total turnover of the business carried on by the assessee." The Press Note of the CBDT dated 21-6-1983 now found at page 3232 of Sampath Iyengar's Law of Income-tax (8th Edition) is to the following effect : "4. Sub-section (3) of section 80HHC statutorily fixes the quantum of deduction on the basis of a proportion of the profits of business under the head 'Profits and Gains of Business or Profession' irrespective of what could strictly be described as 'profits derived from the export of goods or merchandise out of India'. The deduction is computed in the following manner: Profits of the Business x Export Turnover --------------- Total Turnover ......" Another criticism levelled against the arrangement between the assessee and VBCE was that the date of commencement of the agreement was not filled up in the agreement, and it is clear indicia to show that it is sham and not intended to be acted upon. We are of the opinion that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tract did not take place as contemplated by the terms of the contract. Under the terms of the contract, it was contended that Rs. 50 lakhs is the upper limit of the value of the exports and as soon as that target is reached, the agreement automatically comes to an end. However, in this case, the value of exports exceeded the maximum limit prescribed. However, in this year, the total value of the exports were stated to be of Rs. 57,70,669 which is much more than the exports contemplated under the agreement in question. The question is whether if some exports are made over and above the maximum prescribed under the contract, can it be said that the extra exports are to be governed by any terms whatsoever. There are terms called quantum meruit and quantum valebant under the Contract Act under which if services are rendered over and above maximum what is prescribed under the contract, the person who rendered the services is entitled to get reasonable rate for goods supplied or services rendered. In all such cases, it is no doubt true that there is no binding contract between the parties as to how much one is obliged to pay for the goods supplied or for the services rendered for the ext ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... early arose under section 70 of the Contract Act." 47. Therefore, what are the terms which apply for the extra services rendered by VBCE in exporting more than what is liable to be exported under the terms of the contract dated 4-3-1989 can easily be determined by applying the rule of Quantum Valebant as stated above and the fact that there was excess export than what is contemplated under the contract does not invalidate the contract in any way and also does not make the contract sham or make it only a colourable device to evade tax or one not intended to be acted upon, The next argument of the Revenue is that ratio of McDowell Co. Ltd.'s case applies and renders the agreement dated 4-3-1989 as sham and a colourable device to evade tax. Even in the case of McDowell Co. Ltd.'s the Supreme Court had held that tax planning may be legitimate provided it is within the frame work of the law. Canit be said that when the quantum of benefit derived by the assessee is of the order of Rs. 5,17,000 incurring an expenditure of about Rs. 2,24,679 towards service charges to a sister concern can be called tax avoidance measure, especially when similar agreements were cited before the learne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g Officer found that the assessee had entered into an agreement with a sister concern and since the sister concern had directly exported the goods contracted by the assessee this was only an arrangement to avoid tax payment and accordingly disallowed the deduction under section 80HHC. On appeal, the Commissioner (Appeals) upheld the disallowance. On second appeal, it was contended by the revenue that the deduction under section 80HHC was not available where there were no profits from export business. HELD In the instant case, the assessee had procured orders abroad for export of certain marine products and the sister concern was to arrange the export of the marine products in the name of the assessee. The RBI had allotted a code number to the assessee as an exporter and it was not in dispute that one of the objects of the assessee was to enter into the marine foods exports trade. The Marine Products Export Development Authority had also registered the assessee as an exporter. The shipping documents clearly indicated that the assessee was the exporter and the packing credit account was negotiated in the Bank of America in the name of the assessee. The telex message in regard ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come of the assessee. They further held that section 80HHC would be attracted even if there are no profits from export business and the assessee has merely qualified the export turnover. Even if the assessee has not earned any profit, in the export business, yet, if he has other business income which constitute the total income, then a deduction calculated on the basis of the formula given in the CBDT press note adverted to above had to be given, namely: Profits of the business x Export Turnover ----------------------------------------- Total Turnover Thus, it can be seen that even if the ultimate result of export business carried on by the assessee was loss, if only the assessee carries on other businesses and earns income, then, the assessee is entitled to deduction under section 80HHC as per the formula quoted above. 48. Learned Counsel for the assessee brought to our notice the decision of the Cochin Bench reported in Sea Pearl Industries v. ITO [1988] 26 ITD 380. In that case, the assessee's claim for deduction under section 80HHC was rejected by the Income-tax Officer, on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r. Even in such a case, the assessee only was recognised as real exporter entitled for the rebate under section 2(5) of the Finance Acts 1963 to 1967. Therefore, however minimum the role of the assessee may be in exporting goods, if ultimately it can be considered to be the exporter, then it would be entitled to get deduction under section 80HHC. So, the criticism that all the risks upto shipment were borne by sister concern M/s. VBCE and not by the assessee and on that ground the agreement dated 4-3-1989 should be held to be a tax avoidance device cannot be accepted. The learned counsel for the assessee further contended that if the transaction under the agreement dated 4-3-1989 is found as a legitimate transaction and it does not amount to a device then, the Supreme Court's decision in McDowell's case does not apply. It is so held by Madras High Court in another decision, namely, M.V. Valliappan v. ITO [1988] 170 ITR 238. In that case, in April 1979, a partial partition of certain assets of the assessee-Hindu Undivided Family was effected and an application under section 171(2) of the Income-tax Act, 1961 was made. The Income-tax Officer accepted the said partial partition on 28- ..... X X X X Extracts X X X X X X X X Extracts X X X X
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