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2016 (3) TMI 461 - KARNATAKA HIGH COURT

2016 (3) TMI 461 - KARNATAKA HIGH COURT - [2017] 391 ITR 185 - Disallowance of Privilege fee paid u/s 40(a)(ii) or (iib) - sharing of revenue with the state - scope of any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains - Scope of any amount (A) paid by way of royalty, licence fee, service fee, privilege fee, service charge or any other fee or charge, by wha .....

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ich the petitioner and the State Government are avoiding payment of tax. In this regard, reliance is placed on Har Shankar [1975 (1) TMI 89 - SUPREME COURT] which is clear on this aspect and therefore, it was not open for the Assessing Officer to opine that privilege fee appears to be relatable to the profit earned and a large chunk of it is transferred to the State Government in the name of privilege fee. It is settled law that there is no illegality committed by the petitioner in paying such p .....

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e of the matter', are the words used by the Supreme Court in dealing with the privilege of the State Government to fix such a privilege fee. Therefore, it would aptly apply in the facts and circumstances of these cases insofar as the Assessing Officer having expressed an opinion of the State Government having exercised its power "unscientifically, illegally and irrationally". (sic) - Consequently, these petitions are allowed. The impugned assessments are set aside insofar as it treats the pr .....

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Government Adv ORDER Heard the learned counsel Shri A. Shankar appearing for the petitioner, the learned Advocate General Shri Madhusudhan R. Naik appearing for Respondents 3 and 4 and Shri Jeevan J. Neeralagi appearing for Respondents 1 and 2. These petitions are all heard and disposed of by this common order, as they are by the same petitioner. However, the challenge is to assessment orders for different years, as is detailed hereunder. 2. The petitioner is a company, a Government of Karnataka .....

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sessing Officer had also passed an assessment order under Section 143(3) of the Act for the assessment year 2011-12 and disallowed the Privilege fee of ₹ 695,14,70,000/- made disallowance under Section 14A of the Act in a sum of ₹ 19,20,039/-, disallowance of provision for ex-gratia ₹ 37,52,700/- and disallowance of expenditure on increase in share capital ₹ 4,85,000/-, by order dated 26.02.2014. Similarly, an assessment order was passed under Section 143(3) of the Act fo .....

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225/- and provision for exgratia ₹ 18,90,000/-. The total disallowance of privilege fee is as follows: Writ Petition Number Assessment Year Privilege Fee 12872/2013 2010-2011 Rs.570,14,37,000/- 14687/2014 2011-2012 Rs.695,14,70,000/- 15910/2015 2012-2013 Rs.829,41,58,944/- 17514/2015 2009-2010 Rs.479,36,60,000/- The Assessing Officer has disallowed the Privilege fee on the following grounds namely: i) The privilege fee paid is more than the surplus earned by the Company in the trade of liq .....

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. vi) The Government of Karnataka has varied the Privilege fee every year and there is no fixed rate. vii) The percentage of privilege fee is not known to the company in advance or at the beginning of the year and the payments made by the company are against the provisions of the Companies Act, 1956, The Income-tax Act, 1961 and Accounting Standards. viii) The Government order on levying the privilege fee is passed purposefully only at the fag end of the financial year. ix) The petitioner - Comp .....

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13. xiv) Amendment made in Section 24 of the Karnataka Excise Act, 1965 is illegal. 3. The learned counsel for the petitioner would contend that the several reasons assigned by the Assessing Officer in the Assessment orders pertaining to the above years would raise the following issues: i) Section 40(a)(iib) of the Income-tax Act disallows the privilege fee from the Assessment Year 2014-15 and subsequent years only and the amendment is prospective and not clarificatory. ii) The provisions of Sec .....

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ay of privilege fee or which is appropriated directly or indirectly from a State Government undertaking by a State Government. Consequently in view of the said provision, no disallowance can be made to the impugned assessment years 2009-2010, 2010-2011, 2011-2012 and 2012-2013, for the reason that the above provision is applicable only from the assessment year 2014-15 and subsequent years and it is applicable prospectively. This is supported by the Memorandum explaining the provisions of the fin .....

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ri vs. K.K.Sen, AAC [1965] 56 ITR 198 (SC). b) Ellerman Lines Limited vs. CIT, [1971] 82 ITD 913 (SC). c) CIT vs. Hero Cycles (Private) Limited, [1997] 94 Taxman 271/228 ITR 463(SC). d) State of Kerala and others vs. Kurian Abraham Private Limited and another, [2008] 303 ITR 284 (SC). Hence, the attempt to disallow the privilege fee in respect of the assessment years prior to 2014-15, is clearly without reference to any legal provision. The opinion expressed by the Assessing Officer is that the .....

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s concerned, there is no such indication and therefore, it can only be treated as prospective from a plain reading thereof and it cannot be construed as being clarificatory. In this regard, attention is drawn to the decision in Vatica Township supra. It is further contended that privilege fee is not any rate or tax levied. Disallowance was only when the payment was either rate or tax and when it is fee, cess, royalty, these further items have been brought in only by the Finance Act, 2013 with ef .....

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or profession or assessed as proportion or otherwise on the basis of any such profits or gains. It is also pointed out that several types of taxes have been allowed as business expenditure in computing the income. For instance, sales tax, entry tax, import duty, export duty, purchase tax, liability excise duty, etc. Royalty paid has always been allowed as allowable business expenditure. It is also pointed out that the revenue who has replaced several distributors who have been paying such fee w .....

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a shareholder of the company and therefore, was receiving privilege fee far in excess of what the shareholder would be entitled to, is also an observation which is irrelevant. It is also pointed out that even appropriation of income directly or indirectly is covered by the inserted provision of Section 40(a)(iib) of the Act. The petitioner would not be provided with Distributor Licence without payment of privilege fee to the Government. The State Government being a shareholder of the petitioner, .....

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such privilege fee on account of being a shareholder of the assessee. The State Government alone has the power to decide the quantum of the privilege fee. The notification issued by the State Government in exercise of powers conferred under Section 24 of the Karnataka Excise Act, 1965 read with Rule 8(4) of the Karnataka Excise (Sale of Indian & Foreign Liquors) Rules, 1968 is legitimate and in order. The State Government has fixed certain percentage on the purchase value of the Indian made .....

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f law. In this regard, reliance is placed on the decision in Hero Cycles (P) Ltd. vs. CIT 128 DTR 1 (SC). It is pointed out that if a certain amount is fixed at the beginning of the year, it would be impossible for the petitioner to make payments, as the extent of business is uncertain. The business model is also such that one can sell at only certain prices. How a price is fixed is left to the contracting parties and the Income Tax Department sitting in judgment as to the mode and the manner in .....

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nment determines the levy of fees as a percentage on the value of transactions of the petitioner company. The intention behind fixing the fee at the end of the year is to ensure that the petitioner is not saddled with losses and undue hardship, in view of the privilege fee being far in excess of the turnover. As for example, it is pointed out that if the privilege fee is fixed at ₹ 75 crore per month, it would be ₹ 900 crore for the entire year, in which event, the revenue would have .....

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x, is settled in the case of CIT vs. Chugandas and Co. 196 LV ITR 17 (SC). The dividends paid by the petitioner for the relevant assessment years, is as follows: Assessment Year Amount of Dividend 2010-2011 Rs.2.00 Crore 2011-2012 Rs.2.40 Crore 2012-2013 Rs.2.40 Crore 2009-2010 Rs.2.00 Crore It is then pointed out that if the payment of privilege fee, if it is treated as dividends, would lead to an absurdity. The percentage of dividend if relatable to the privilege fee, would be unheard of in th .....

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ofit for tax computation. The privilege fee is expenditure laid out or expended wholly and exclusively for the purpose of business and it is allowable as expenditure under Section 37(1) of the IT Act. It is levied on landed cost or purchase cost and not on profit. Therefore, it is contended that the levy of privilege fee is reasonable and allowable as business expenditure under Section 37(1) of the Act. Reliance is placed on the following judgments in support of the same: a) Sassoon J. David and .....

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the said legislation. If the Department was of the view that such legislation was irrational, unscientific and unreasonable, it is open for the Department to question it before the appropriate forum and the power of the State Government to bring about such amendment also cannot be questioned. In that, the amendments made to the Excise Act are in relation to Section 24 of the Excise Act, Rule 3 Clause (11), Rule 8 sub-rule (4), Rule 8 sub-rule (5) and Rule 8 subrule (13) of the Karnataka Excise .....

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nstitution of India and the Legislature of the State has exclusive powers to make laws for the State in respect of any of the matters enumerated in List-II in the Seventh Schedule as per the provisions of Article 246(3) of the Constitution of India. The fee or charges received by the Government for parting with its exclusive right to distribute as per the provisions of Section 24 of the Excise Act and 1968 Rules, is allowable expenditure as per the provisions of the IT Act. The Assessing Officer .....

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tion Details 2010-2011 No.AE 2 PES 2007 dated 18.03.2010 6.90% on the purchase price of liquor. 2011-2012 No.FD 26 EAA 2011 dated 24.03.2011 6.90% of purchase cost of liquor. 2012-2013 No.FD 26 EAA 2011 (1) dated 24.03.2012 6.90% on the purchase cost of Liquor for the period April, 2011 to June, 2011. No.FD 26 EAA 2011 (2) dated 24.03.2012 7.00% on the purchase cost of Liquor for the period July, 2011 to March, 2012. 2009-2010 No.FD 02 PES 2007 dated 25.03.2009 6.85% on the purchase cost. It is .....

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the State legislation and Central legislation and that the Central legislation would prevail in terms of Article 254 of the Constitution of India, is not tenable. It is not open for the Assessing Officer to raise constitutional issues in an assessment order and create a tax liability. It is on account of this extralegal authority exercised by the Assessing Officer that an alternative remedy of appeal insofar as the assessment orders was not found feasible and appropriate. Hence, the present pet .....

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determined by taking cognizance of the relatable statutory provisions of the Act. He contends that there is sufficient identification of the various types of income arising out of sources like business or profession. A plain reading of Section 37 of the IT Act would indicate that an expenditure to be allowed under this section should fit into the central theme of the section and the question was, of allowing or disallowing the deduction claimed as privilege fee in the present case on hand and th .....

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r otherwise of the said Act as sought to be contended. But, he has only proceeded to address the constitutional validity of the imposition of privilege fee and the determination of the taxable income of the petitioner - Company in relation to the provisions of the Act. The State Government has the exclusive right to pass legislation with regard to production manufacture, sale, etc., of intoxicating liquors and also the right to levy excise duty on the same. The disallowance of privilege fee does .....

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d through the network of about 50 licence holders in the State of Karnataka. In order to control the menace of tax evasion, the Government of Karnataka introduced the necessary legislative changes to ensure that the entire wholesale liquor distributors are canalized through the petitioner herein which was incorporated in the year 2003. The Government of Karnataka is admittedly the 100% shareholder of the petitioner. The petitioner has taken over the distribution business hitherto conducted by ab .....

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ion for privilege fee Amount of privilege fee paid and the date of decision of the government regarding the amount paid Method of calculation of privilege fee Income from sources other than liquor business for the year Taxable Income 2004-05 21.79 21.5 02.11.2004 Lump sum 3.89 0.29 2005-06 38.57 32.00 30.03.2005 Lump sum 10.07 6.57 2006-07 47.96 41.00 20.03.2006 Lump sum 10.08 6.96 2007-08 170.67 165.54 27.03.2007 5.15.% on IML sales value 14.82 5.13 2008-09 376.97 345.38 31.03.2008 6.00% on IML .....

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the taxable income of the petitioner has remained at very low figures. The main reason for such startling and alarming decrease is the payment of privilege fee by the petitioner to the State Government which, it is demonstrated, has increased from ₹ 21.5 crore to ₹ 695.15 crore during the corresponding period. It is also pointed out that the taxable income remained lower than the other income which consists of interest, dividend, etc., which again has been taken away by the State Go .....

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ed as 'privilege fee' and the State Government could lay its hands on the same without the same being brought to tax. Therefore, the interpretation of the provisions of the State Act relating to privilege fee and the claim of the petitioner that such fee is a first charge on profit preceding the charge of incometax, is certainly required to be discouraged, being repugnant and inoperative. In other words, in interpreting the provisions of the said Act, the provisions of imposition of priv .....

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cutta Gas Company (Proprietory) Ltd. vs. State of West Bengal and others AIR 1962 SC 1044 in this regard. 5. On a consideration of the above contentions and the facts and circumstances, it is not in dispute that the privilege fee which was paid by the petitioner to the State Government for the years 2004-05, 2005-06, 2006-07 was allowed as business expenditure. The respondents 1 and 2 have drawn inspiration from the 2013 amendment, whereby Clause (iib) of sub-clause (a) of Section 40 of the IT A .....

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ndment by insertion of subclause (iib) of clause (a) of Section 40 of the IT Act, the Assessing Officer feels fortified in his view on such amendment and it is also his opinion that it is merely clarificatory in nature and that such expenditure cannot be allowed as business expenditure and is liable to tax and the liability is with retrospective effect and hence is justified in seeking to disallow such expenditure over the years. On a further reasoning, it is sought to be demonstrated with refer .....

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t be construed as a fee at all and it is merely a device to evade tax. In this regard, as pointed out by the learned Advocate General Shri Madhusudan Naik, a Constitution Bench of the Supreme Court in the case of Har Shankar v. Deputy Excise and Taxation Commissioner AIR 1975 SC 1121, has expounded on the distinction between a 'tax' and 'fee' and the characteristics of these two as also excise duty, in the following words: 55. Since rights in regard to intoxicants belong to the S .....

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n business in the properties or rights belonging to the Government, nor can there be any infringement of Article 14 , if the Government tries to get the best available price for its valuable rights." Section 27 of the Act recognises the right of the Government to grant a lease of its right to 'manufacture, supply or sell intoxicants. Section 34 of the Act read with Section 59(d) empowers the Financial Commissioner to direct that a licence, permit or pass be granted under the Act on paym .....

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tutes the essence of the matter. Nor indeed does the label affixed to the price determine either the true nature of the charge levied by the Government or its right to levy the same. 56. The distinction which the Constitution makes for legislative purposes between a 'tax' and a 'fee' and the characteristic of these two as also of 'excise duty' are well-known. "A tax is a compulsory exaction of money by public authority for public purposes enforceable by law and is no .....

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ruswamy & Co. vs. State of Mysore, (1967) 1 SCR 548 = (AIR 1967 SC 1512). The amounts, charged to the licensees in the instant case are, evidently, neither in the nature of tax nor excise duty. But then, the 'Licence fee' which the State Government charged to the licensees through the medium of auctions or the 'Fixed fee' which it charged to the vendors of foreign liquor holding licences in Forms L-3, L-4 and L- 5 need bear no, quid pro quo to the services rendered to the lic .....

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SC 220) the impugned power having been exercised in respect of a centrally administrated area, the power was not fettered by legislative lists loses its relevance in the view we are taking. It is true that in that case it was permissible to the court to find, as in fact it did, that the fee imposed on the licences was, "more in the nature of a tax than a licence fee". As the authority which levied the fee had the power to exact a tax, the levy could be upheld as a tax, even if it coul .....

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any event, with the insertion of sub-clause (iib) in the Act, it would no longer be possible for the petitioner to claim that the said privilege fee is not taxable. The question as to whether the said provision can be applied with retrospective effect, is the only question that would remain for consideration. As rightly pointed out by Shri Shankar, a plain reading of the provision would not indicate that it is to be applied with retrospective effect. There are other provisions which were also a .....

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s follows: "12. Disallowance of certain fee, charge, etc. in the case of State Government Undertakings: 12.1 The provisions of Section 40 of the Income-tax Act, 1961 before its amendment by the Act, specifies the amounts which shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession". The non-deductible expense under the said section also includes statutory dues like fringe benefit tax, incometax, wealth-tax, etc. Dispute .....

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h income by way of surplus is not subject to tax. It is a settled law that State Government undertakings are separate legal entities than the State and are liable to income-tax. 12.2. In order to protect the tax base of State Government undertakings vis-a-vis exclusive levy of fee, charge, etc. or appropriation of amount by the State Governments from its undertakings, section 40 of the Income-tax Act has been amended to provide that any amount paid by way of fee, charge, etc., which is levied ex .....

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cent, of the paid-up equity share capital is held by the State Government; (iii) a company in which more than fifty per cent, of the paid-up equity share capital is held by the entity referred to in clause (i) or clause (ii) (whether singly or taken together); (iv) a company or corporation in which the State Government has the right to appoint the majority of the directors or to control the management or policy decisions, directly or indirectly, including by virtue of its shareholding or managem .....

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reads as follows: "Clause 7 of the Bill seeks to amend Section 40 of the Income-tax Act relating to amounts not deductible. The provisions of Section 40 specify the amounts which shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession". It is proposed to insert a new sub-clause (iib) in clause (a) of the aforesaid section so as to provide that any amount paid by way of royalty, licence fee, service fee, privilege fee, se .....

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his amendment will take effect from 1st April, 2014 and will, accordingly, apply in relation to the assessment year 2014-15 and subsequent assessment years." Therefore, it can safely be said that the privilege fee payable by the petitioner to the State Government would be taxable with effect from 1.4.2014 and not prior thereto. The unreasonableness of the privilege fee payable is also not a ground to hold that it is a device by which the petitioner and the State Government are avoiding paym .....

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