TMI Blog2003 (3) TMI 91X X X X Extracts X X X X X X X X Extracts X X X X ..... s envisaged in the Double Taxation Avoidance Agreements? - - - - - Dated:- 20-3-2003 - Judge(s) : R. K. ABICHANDANI., A. L. DAVE. JUDGMENT The judgment of the court was delivered by R.K. ABICHANDANI J.- This group of 32 matters has been argued together having regard to the nature of controversy and the common questions of law involved, which are as under: 1. Questions of law involved in these appeals: In Tax Appeal No. 273 of 2002: (1) Whether the usance interest paid by the assessee apart from the purchase price of the ship would fall within the scope of the definition of the term "interest" under section 2(28A) of the Income-tax Act, 1961? (2) Whether the Appellate Tribunal was right in law and on facts in deleting the disallowance under section 40(a)(i) of the Act for the failure on the part of the assessee to deduct tax at source from usance interest paid to a non-resident under section 195(1) of the Act? (3) Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes of the character of purchase price and therefore not liable to deduction at source under section 195(1) of the Act? (4) Whether the Appellate Tribu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax at source from usance interest paid to a non-resident under section 195(1) of the Act ? (3) Whether the Appellate Tribunal was right in law and on facts in holding that usance interest partakes of the character of purchase price and therefore not liable to deduction at source under section 195(1) of the Act? (4) Whether the Appellate Tribunal was right in law and on facts in holding that "usance interest" is not interest as envisaged in the double taxation avoidance agreement? (5) Whether the Appellate Tribunal was right in law and on facts in allowing the deduction under sections 80HH and 80-I to the assessee, holding that ship breaking activity gives rise to manufacturing and production of altogether a new article or thing? In Tax Appeals Nos. 128, 129, 195, 196, 197, 198, 199, 257, 258, 259, 300, 361, 380 of 2002 and Tax Appeals Nos. 22 and 23 of 2003: Whether the Appellate Tribunal was right in law and on facts in allowing the deduction under sections 80HH and 80-I to the assessee, holding that ship breaking activity gives rise to manufacturing and production of altogether a new article or thing? II. Brief facts: Tax Appeals Nos. 273 of 2002 and 196 of 2002 hav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... US $ 166.06 per long ton. The ship appears to have been manufactured in U.K. in 1969. Interest was stipulated to be paid at 7.25 per cent. from the date of notice of release for 180 days of usance period worked out on the purchase price of the ship. In both the cases the amounts were to be paid by means of irrevocable 180 days usance letter of credit (L.C.) as in all other cases. During the course of scrutiny proceedings, the Assessing Officer (Assistant Commissioner of Income-tax, Central Circle-1, Rajkot) observed that, as per the terms of the MOA, the assessee was making interest payment to the nonresident parties on account of credit facility availed of by it for the purchase of the ships. Therefore, he raised queries by letter dated January 2, 1998, inquiring as to whether tax was deducted at source on such interest payments and if it was not so deducted, then calling upon them to show as to why the provision of section 40(a)(i) of the Income-tax Act, 1961 ("the Act" for short), should not be invoked in the assessee's case and why the entire interest paid outside India should not be disallowed in the course of assessment. After considering the submissions made by the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ia and not to the non-resident seller was negatived. The Assessing Officer, therefore, by his order dated March 30, 1998 disallowed the expenditure of usance interest payment under the provisions of section 40(a)(i) of the said Act in respect of both the ships. In the same order, he considered the assessee's claim of deduction under sections 80HH and 80-I of Rs. 21,23,798 made on the ground that the assessee was an industrial undertaking engaged in the activity of manufacture. The Assessing Officer held that ship breaking would not constitute any manufacturing activity. Applying the ratio of the decision of the Supreme court in CIT v. N.C. Budharaja and Co. [1993] 204 ITR 412, it was held that ship breaking did not constitute any activity of manufacturing or production. The order of the Assistant Commissioner of Income-tax was challenged by the assessee before the Commissioner of Income-tax (Appeals)-VI, Ahmedabad, who while confirming the said order, held that the interest was payable by the assessee to the non-resident on debts incurred by deferring payment of purchase consideration in respect of the two ships for the purpose of its business carried on in India. It was held tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eement was entered into and although the purchase price of the ship and usance interest for 180 days from the date of the delivery/NOR were separately mentioned in the MOA, none the less it remained a single transaction of purchase and sale of the ship. Moreover, the buyer had to make payment of the total amount which was inclusive of interest by letter of credit. It was held that the interest amount though separately mentioned in the MOA was part of the same transaction and cannot be meted out a separate treatment from the main component, i.e., the purchase price. The Tribunal observed : "In other words, the point we are trying to drive home is that what governs a purchase transaction, will also govern the component thereof. It also needs to be appreciated that there is no right of pre-payment by the buyer to the seller, that is to say, irrespective of the point of time when the buyer makes payment within 180 days, the buyer shall have to pay the interest component as specified in the MOA". The Tribunal concluded that, by entering into the MOA, the buyer did not incur any debt in the sense of raising any loan or advance so as to be indebted to the sellers, and that it was a pure a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iability on the part of the residents making such payment by means of L.C. to deduct tax at source under section 195(1) of the Act. If at all according to them no tax was to be deducted, then the proper course was to follow the procedure laid down under section 195 itself, and there was no option on the part of the residents not to deduct tax from the interest which was payable to the non-residents at the time of making credit to their account or making payment by any mode including by letter of credit, whichever was earlier. It was submitted that the letter of credit was just an arrangement by which the price of the goods and interest on the late payment of the price over the period of 180 days was paid by the buyer to the seller in discharge of his contractual obligations. It was submitted that, interest is income which was chargeable to tax and the interest payable by the resident to the non-resident would be deemed to be arising in India under section 9(1)(v) of the Act irrespective of the manner in which it may have been paid or wherever it may have been paid. It was also argued that there were ample safeguards in sections 195 and 197 to prevent double taxation and requisite o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oint out that, in the context of the provisions of section 40(2) of the Indian Income-tax Act, 1922, the Supreme Court held that, under the said provision which was essentially a machinery and enabling section, the tax to be realized from a non-resident could be levied upon the agent in the same manner as it could have been levied upon and recovered from a non-resident. It was held that the Hapur firm being an agent could be held liable under sections 40(2) and 42(1) of the Act of 1922 as an assessee for income-tax on the profits made on the respondents' transactions at Hapur and was therefore entitled under the proviso to section 42(1) to retain the estimated amount of income-tax payable on the amount of the respondents' profits which, in that case, were deducted, retained and actually paid. The court held that if the Hapur firm rightly paid the tax on the profits, the respondents cannot be allowed to challenge the amount on the ground that his total world income was not taxable and he was entitled to his profits without deductions. That was a question which had to be agitated by the non-resident assessee at the time of his assessment. It was held that those persons who are bound ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of tax, or deduction of income-tax at any lower rate. On such determination, tax at the appropriate rate could be deducted at the source. If no such application is filed, income-tax on such sum is to be deducted and it is the statutory obligation of the person responsible for paying such "sum" to deduct tax thereon before making payment. (e) The decision of the Bombay High Court in CIT v. Vishnudayal Dwarkadas [1980] 123 ITR 140 was cited to point out that, in a case where under the agreement between the parties, the entire price, both for the moveable and immovable properties, agreed to be sold, was to be paid to the assessee by the vendor on May 1, 1958, and since the purchaser was unable to pay the same on that date, and paid it on the execution of the sale deed, on January 25, 1959, the sum of Rs. 15,083 was paid by way of interest, it was held that this amount was not part of the purchase price, but was a payment by way of interest and constituted a revenue receipt in the hands of the assessee. The court rejected the contention that the amount of interest was part and parcel of the sale price. (f) The Supreme Court, in Kesoram Industries and Cotton Mills Ltd. v. CWT [19 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an irrevocable letter of credit need not fear that he may have to bring an action to recover the price and be met with a specious counter claim that enables the buyer to get leave to defend and so keep him out of his money for the months or years that may pass before the action can be brought to trial. The seller can use the letter of credit to finance other business; it is, as has been said more than once, part of the lifeblood of commerce. The Court of Appeal cited with approval "a classic passage" of the judgment of Jenkins LJ in Malas (Trading as Hamzeh Malas and Sons) v. British Imex Industries Ltd. [1958] 1 All ER 262, at page 263, in which it was stated that the opening of a confirmed letter of credit constituted a bargain between the banker and the vendor of the goods, which imposed on the banker an absolute obligation to pay, irrespective of any dispute which there may be between the parties whether the goods are up to contract or not. It was held that an elaborate commercial system had been built up on the footing that the banker's confirmed credits are of that character, and, it would be wrong to interfere with that established practice. It has to be remembered that a ve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... point out that, in a case where the assessee claimed deduction of interest payment to a foreign banker from its business income, and it was contended that the interest payment was towards the amount lent outside India, and therefore, interest accrued outside India and was not taxable in India, the High Court held that the person who claims the benefit under the provisions of the Act, has to prove before the authorities that he is entitled to the benefit of deduction by placing proper and sufficient material to that effect. In the absence of any such materials, the authorities under the Act cannot grant any relief based on presumption. The court noticed that the Income-tax Officer had found from the profit and loss account of the assessee-company that the assessee had debited to its profit and loss account a sum of Rs. 3,17,805 being the interest amount which the assessee owed to the collecting foreign banker. The assessee had not produced any material to disprove its own entry or to show that the interest was not paid to a non-resident to take it out of the ambit of section 40(a)(i) of the Income-tax Act inasmuch as the said provision provided that the interest shall not be a deduc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... futuro or whether they were to become due to the promisee only on the respective dates when the instalments were payable. It was held that if on a proper construction of a contract it is found that the real agreement between the parties was to the effect that the whole amount was on the date of the bond a debt due but the creditor for the convenience of the debtor allowed it to be paid by instalments intimating that if default should be made in the payment of any instalment, he would withdraw the concession, then the stipulation as to the whole amount of the balance becoming payable would not be penal. (p) The decision of the Bombay High Court in Narsee Nagsee and Co. v. CIT [1959] 35 ITR 134, which was rendered in the context of the provisions of section 18(3A) and (3C) of the Indian Income-tax Act, 1922, was cited for the proposition that where the non-resident had indicated only the mode of payment by nominating an agent to whom the amount is to be paid, it was held that it was the responsibility of the assessee to the non-resident and that responsibility remained and therefore, the assessee was under a duty to deduct income-tax and super-tax under the said provisions and was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ush Doors and Furniture Co. (P.) Ltd. [1988] 70 STC 314; [1988] Supp. SCC 239; AIR 1988 SC 1164, was cited for the proposition that "manufacture" implies a change, but every change is not manufacture, yet every change of an article is the result of treatment, labour and manipulation. But something more was necessary and there must be transformation; a new and different article must emerge having a distinct name, character or use. (u) The decision of the Supreme Court in Lucky Minmat Pvt. Ltd. v. CIT [2000] 245 ITR 830, which was rendered in the context of the provisions of section 80HH of the said Act, was cited to point out that the Supreme Court held therein that the conversion into lime and lime dust or concrete by stone crushers could legitimately be considered to be a manufacturing process while the mere mining of lime stone and marble and cutting the same before it was sold in the market could not be so considered. (v) The decision in Divisional Deputy CST v. Bherhaghat Mineral Industries [2000] 246 ITR 230, the Supreme Court held that the crushing of dolomite lumps into chips and powder was not a process of manufacture that brings about a new commodity. IV. Contention ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... led, the seller could have no remedy against the buyer. It was argued that unpaid purchase price is not a debt and payment for unpaid purchase price was not a claim for a debt, but it remained a claim for unpaid purchase price. It was also submitted that the DTAA for Indonesia in 1989 and Philippines in 1980, respectively, included in the definition of interest, the words "including interest on deferred payment sales" after the words "debt claims" which shows that in other agreements where these words were not put into parenthesis, the idea was not to include interest on deferred payment sales within the meaning of the expression debt claims. It was submitted that the buyer had no option to pay the amount of purchase price earlier and that by itself showed that the interest amount payable along with the price at the end of the usance period of 180 days was a part and parcel of the price of the ship bought by the assessees. It was also argued that the customs authority would levy the duty on the value of the goods of import as may have been disclosed and the fact that the customs duty was charged on the purchase price of the ship and not on the interest amount considering the later ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the appropriate provisions in the letter of credit. (c) The decision of the Supreme Court in Tarapore and Co. v. Tractoroexport Moscow, AIR 1970 SC 891; [1970] 40 Comp Cas 447 (SC) was referred to for the same proposition that the letter of credit is independent of and unqualified by the contract of sale or underlying transaction, The court held that the autonomy of an irrevocable letter of credit is entitled to protection. As a rule, the courts refrain from interfering with that autonomy. (d) The decision in E.D. Sassoon and Co. Ltd. v. CIT [1954] 26 ITR 27 (SC), was cited for the proposition that a debt must have come into existence and a right must have been acquired to receive the payment. It was held that unless and until the assessee's contribution or parenthood is effective in bringing into existence a debt or a right to receive the payment or in other words a debitum in praesenti, solvendum in futuro, it cannot be said that any income has accrued to him. The Supreme Court held that income may accrue to an assessee without the actual receipt of the same. If the assessee acquires a right to receive the income, the income can be said to have accrued to him, though it ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... certained. It is a consideration paid either for the use of money or for forbearance from demanding it after it has fallen due. The court held that the Land Acquisition Act itself makes a clear distinction between the compensation payable for the land acquired and the interest payable on the compensation awarded. The court approvingly cited the observations of Lord Wright in Westminster Bank Ltd. v. Riches [1947] 15 ITR (Suppl.) 86; [1947] 28 TC 159 at page 189, which indicate that interest, whether it is statutory or contractual, represents the profit the creditor might have made if he had the use of the money or the loss he suffered because he had not that use. The Supreme Court held that it is something in addition to the capital amount, though it arises out of it. (g) In T.N.K. Govindaraju Chetty v. CIT [1967] 66 ITR 465, the Supreme Court held that the principle in Dr. Shamial Narula's case [1964] 53 ITR 151 that if the source of the obligation imposed by the statute to pay interest arises, because, the claimant is kept out of his money, the interest received is chargeable to tax as income, will apply if interest is payable, under the terms of an agreement, expressed or impl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AIR 1957 SC 743, which was rendered in the context of the provisions of section 30 of the Bengal Money Lenders Act, 1940, was cited to point out that the Supreme Court held that the purchasers could not claim any benefit under section 30 inasmuch as they were neither borrowers nor were they being made to pay in respect of a "loan" as those terms were defined in the Act; the fact that under the compromise decree, the moneys were payable in a number of instalments instead of at once would not show that the price had become a loan, nor was there anything to show that the parties had treated the purchase money as paid off in its entirety and the amount equivalent to the purchase money as being due by the purchasers to the vendor by way of a loan on which basis the transaction might in substance be a loan. Section 2(12) of that Act defined loan so as to mean an advance, whether of money or any kind, made on condition of repayment with interest and included any transaction which was in substance a loan. The Supreme Court observed that the case before it admittedly was not a case of an advance in kind, nor was it a case in which there was an actual advance of money. (l) The decision in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le D to the Income-tax Act, 1918. It was held that the interest awarded in that case truly constituted that part of the compensation discerned for which it is attributable to the fact that the claimant had been kept out of his due for a long period of time. The court held that the form of award in the case before it seemed to make it impossible to distinguish the character- of the so-called interest between November 4, 1981, and the date of the award, from its character between the date of the award and the date of payment. (o) The judgment of the High Court of Justice (King's Bench Division) in Wigmore (H.M. Inspector of Taxes) v. Thomas Summerson and Sons Ltd. [1925] 9 TC 577 was a case where a company sold a holding of 5 per cent. war-stock on the April 10, 1923. The sale was with interest rights, such stock not being dealt in "ex-interest" until May 1, 1923. An assessment to income-tax was made upon the vending company for the year 1923-24 in respect of the amount of interest deemed to have accrued on the stock in the period between the last payment of interest and the sale of the stock, it being contended that the price received by the company on sale of the stock included t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nciples. The Crown contended that the cherries formed part of the land and the purchase was a single operation resulting in the acquisition of a single capital asset. The Special Commissioner held that a deduction representing the costs of the cherries was permissible. The court held that no part of the purchase price of the land could be deducted for arriving at the profit from the sale of the crop. (r) The decision of the Andhra Pradesh High Court in CIT v. Visakhapatnam Port Trust [1983] 144 ITR 146 on which reliance was placed by the Tribunal was referred to for the proposition that, under article VIII of the Double Taxation Avoidance Agreement between the Federal Republic of Germany and India, interest would be assessable in India if it arises out of "indebtedness", and that an agreement to pay the balance of consideration due by the purchaser does not give rise to a loan. The court held that when the payment of interest is part and parcel of the agreement to pay the unpaid purchase money on a deferred payment basis, there is no indebtedness. If there is no agreement initially or by way of novation to treat the balance of sale consideration as paid off in full and no novatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... u Chetty's case [1967] 66 ITR 465. It, however, held where the interest is merely in name but constitutes part of the compensation or part of the damages, it is not "interest" chargeable to income-tax. As an integral part of such compensation, it may be either slumped up with the other elements in the gross sum or may be separately stated but treated as a part of the gross sum. On this, the court referred to Ballantine [1924] 8 TC 595 (C. Sess). It then proceeded to observe that mere description of the amount as interest which in fact is part of the compensation does not have the effect of altering the true character of the compensation and for this, it referred to Simpson's case [1929] 14 TC 580 (CA). After referring to the ratio of various decisions approvingly, the court observed that the same was the position with regard to unpaid purchase money coupled with a liability to pay interest along with each of the instalments. It was held that where as was the case before it, the parties entered into an agreement to accept a portion of the purchase money immediately and the balance to be paid in certain instalments along with interest on the instalment of purchase money, the agreemen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the provisions of clause (v) in section 9(1) of the Act by the Finance Act, 1976, with effect from June 1, 1976. (t) The decision of the Supreme Court in Central Bank of India v. Ravindra [2001] 107 Comp Cas 416; AIR 2001 SC 3095, was cited to point out that, in paragraph 37 of the judgment, the Supreme Court referred to the definition of "interest" in Black's Law Dictionary (7th edition), in which it was defined, inter alia, as the compensation fixed by the agreement or allowed by law for the use or detention of money, or for the loss of money by one who is entitled to its use; especially, the amount owed to a lender in return for the use of the borrowed money. The meaning of the word "interest" from Stroud's judicial Dictionary of Words and Phrases (5th edition) was also referred to and it was defined therein to mean, inter alia, compensation paid by the borrower to the lender for deprivation of the use of his money. The opinion of Lord Wright, in Riches v. Westminster Bank Ltd. [1947] 15 ITR (Suppl.) 86 was also referred to, as per which, the essence of interest was that it is a payment which becomes due because the creditor has not had his money at the due date. It may be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... goods or to claim the damages as on breach of warranty by the vendor and all these rights and obligations have got to be worked out inspite of the fact that the entries are made in the books of account by the vendor in accordance with the mercantile system of accounting adopted by him. The vendor could not say that he is under no further obligation to the purchaser and that the purchaser must pay the price of goods debited to him as a debit arising out of the book entry. It was held that the count in any action filed by the vendor against the purchaser would be a count for the price of goods sold and delivered and would not be a count on an assumpsit or for recovery of a debt due by the debtor to him. In the same judgment, the Supreme Court referring to the nature of the mercantile system of accounting, has held that the mercantile system brings into credit what is due, immediately becomes legally due and before it is actually received and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed. The profits or gains of the business which are thus credited are not realised but having accrued are treated as received th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... educt tax at source under section 18(3A) of the Act of 1922. The income-tax authorities disallowed the deduction under the proviso to section 10(2)(iii) of that Act on the ground that as the interest was chargeable under section 42 and was paid outside British India, the assessee could have deducted tax at source under section 18(3A). The court held that, in order to deprive the assessee of the deduction under section 10(2)(iii), it must be found that the persons who deposited moneys with the assessee and earned interest on the deposits knew as a part of the integral transaction of the deposit that the assessee would take this money to British India and utilize it for the purpose of earning income on it. It was held that since it was not established that there was any knowledge on the part of the lender that his deposit would be transferred to British India for the purposes of earning income on it, the interest earned by the depositors was not chargeable under the Indian Income-tax Act and there was no obligation upon the assessee to deduct tax under section 18(3A). The assessee was therefore entitled to the deduction under section 10(2)(iii) of the Act. (z) In CIT v. Cooper Engi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent sales agent could be taxed in India treating "B" to whom the sale price received on the sale in Japan was remitted wholly in India and who debited his commission account and credited the amount of commission payable to the Japanese company in his account book and later remitted the amount to the Japanese company, as a representative assessee, it was held that it could not be said that the making of entries in the books of "B" amounted to receipt, actual or constructive, by the non-resident sales agents as the amounts so credited in their favour were not at their disposal or control; they could not therefore be charged to tax on the basis of the receipt of income, actual or constructive, for the taxable territories. It was held that a credit balance, without more, only represents the debt and a mere book entry in the debtor's own books does not constitute payment which will secure a discharge from the debt. (z-3) The decision of the Calcutta High Court in CIT v. Davy Ashmore India Ltd. [1991] 190 ITR 626, which was rendered in the context of the provisions of sections 9 and 90 of the Act and the Double Taxation Avoidance Agreement between India and the U.K. was cited for the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t within the meaning of that sub-section so as to attract the income-tax at the maximum rate under section 24(12) of the Act. (z-7) The judgment of the Bombay High Court in Ship Scrap Traders v. CIT [2001] 251 ITR 806 was cited to show that the question whether the ship breaking activities in which the assessees were engaged amounted to manufacture or production activities for the purposes of deductions under sections 80HHA and 80-I of the Act was decided in favour of the assessees holding that they were entitled to claim deductions under these provisions. Relying upon the earlier decision of the court in CST v. Indian Metal Traders [1978] 41 STC 169 (Bom), in which it was held that scrap iron and steel which were obtained by the respondents by dismantling and breaking up of the ship must be regarded as a different commercial commodity from the ship itself, and hence, the activity would amount to manufacture, the court held that considering the peculiar nature of ship breaking activity, it gives rise to manufacture and production of altogether new commercial articles or things which were commercially identifiable in the commercial world as other than the ship and therefore, the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... manufacturing process and, therefore, the assessee was entitled to investment allowance as envisaged under section 32A of the Income-tax Act, 1961. (z-12) The decision of the Madras High Court in CIT v. Perfect Liners [1983] 142 ITR 654, which was rendered in the context of the provisions of section 33 of the Act, was cited to point out that it was held therein that the word "manufacture" was used in a wider sense. After the rough casting was polished, the product was a new product which was utilised as a component in internal combustion engines. It was held that the Tribunal having found that the component parts were essential parts for internal combustion engines, the grant of higher development rebate was justified. (z-13) The decision of the Supreme Court in CIT v. N.C. Budharaja and Co. [1993] 204 ITR 412, was cited for the proposition that the word "production" has a wider connotation than the word "manufacture". While every manufacture can be characterized as production, every production need not amount to manufacture. It was held that the word "production" or "produce", when used in juxtaposition with the word "manufacture" takes in bringing into existence new goods by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 118 held that the blocks and stones had different commercial names in common and commercial parlance and the dealer was a manufacturer entitled to avail of the benefit of the notification. (z-17) In Deputy CST v. K.M. Mohammad Ali [1993] 90 STC 174, the Supreme Court held that the lifeless meat was by any standard other goods different from goat and sheep for the purposes of purchase tax under section 5A of the Kerala General Sales Tax Act, 1963. The court followed its earlier decision in Deputy CST v. Ismail [1986] 62 STC 394 (SC). (z-18) In Ashirwad Ispat Udyog v. State Level Committee [1999] 112 STC 207, the Supreme Court held in the context of the provisions of section 2(j) and (12) of the Madhya Pradesh General Sales Tax Act, 1958, that when the appellants treated iron and steel scrap of considerable bulk by cutting it down by mechanical processes into pieces that might be conveniently utilized in rolling mills and foundries, such treatment making saleable goods fell within the wide definition of "manufacture" under section 20) of the said Act and the appellants were entitled to the relief granted to industrial units under the notification issued under section 12 of the Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e outside India and no tax was paid thereon, nor any deduction of tax made at source as required by Chapter XVII-B of the Act. The provision of section 40 of the Act, to the extent relevant, reads as follows: "40. Amounts not deductible.--Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head 'Profits and gains of business or profession',-- (a) in the case of any assessee- (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable outside India, on which tax has not been paid or deducted under Chapter XVII-B: Provided that where in respect of any such sum, tax has been paid or deducted under Chapter XVII-B in any subsequent year, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid or deducted. Thus, if interest expenditure in respect of which deduction in computing the income is claimed is payable outside India, such interest expenditure can be claimed only whe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a part of his "total income" in respect of which income-tax shall be charged for that year, as envisaged by section 4(1) of the Act. Section 4(2) specifically provides that, in respect of the income so chargeable under sub-section (1), income tax shall be deducted at source or paid in advance, where it is so deductible or payable under the provisions of the said Act. The provisions of section 9(1)(v)(b) read with section 5(2) and section 4(1)(2) leave no room for doubt that the income payable by way of interest by a resident to a non-resident (which is not payable for the purpose of carrying on the business of such resident outside India or for earning income from any source outside India) would be deemed to have accrued or arisen to such nonresident in India, and will be part of his total income that would be chargeable to income tax which shall be deducted at source or paid in advance when it is so de uctible at source or payable in advance under the provisions of the Act. If the controversy that the interest payable under the MOA to the non-resident by the assessee is not interest but a part of the price of the ship purchased by the resident is kept apart for the time-being an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was not a non-resident, and therefore, there was no obligation on the part of the assessee to deduct the tax at source. No such automatic shifting of responsibility in respect of interest payable to the non-resident under the MOA entailing duty to deduct tax at source and thereby shifting the obligation to deduct such tax to the bank which issued the letter of credit as a mode of payment of the amount by the assessee, is contemplated by section 195(1) of the Act. The amount was payable by the assessee as per the MOA and therefore, the liability to deduct the tax was that of the assessee while making payment through the letter of credit facility provided to the assessee by its bank. If a person responsible for paying to the non-resident the amount of interest chargeable under the Act considers that the whole sum would not be chargeable, he has to make an application to the Assessing Officer under section 195(2) of the Act. As held by the Supreme Court in Transmission Corporation's case [1999] 239 ITR 587, the provision of section 195 under which the payer should deduct income-tax on the amount paid to a non-resident is for a tentative deduction of income-tax thereon, subject to regu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... suing bank is to be discharged by it as a principal on the 180th day at the end of the usance period. It was contended that if the issuing bank fails to pay, the seller can have no remedy against the buyer. In short, the interest amount was paid by the buyer to the issuing bank and not to the foreign bank or the seller which means no interest income arose or accrued in India and the buyer was not obliged to deduct tax therefrom under section 195(1) of the Act. The contention was that the issuing bank was not acting as an agent of the buyer in effecting the payment under the L.C. and was acting as a principal. These contentions overlook the real nature of payment by a letter of credit which is one of the internationally recognized mode of payment through the banking medium for paying the consideration for purchase of goods. The letter of credit is a document issued by a bank as per instructions by a buyer of the goods, authorizing the seller to draw a specified sum of money under specified terms, usually receipt by the bank of certain documents, within a given time. In the present case, the MOA between the buyer and the seller stipulated that the payment was to be made by irrevocabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... commercial credit is addressed to the seller and states that, on the instructions of the buyer, the banker authorizes the seller to draw bills of exchange up to the stated amount, The opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods, which imposes upon the banker an obligation to pay on the basis of mercantile usage recognized all over the world. Irrevocable credit constitutes an independent contract between the issuing banker and the seller, and it is not qualified by or subject to the terms of the contract of sale or the contract between the issuing banker and the buyer. The autonomy of banks undertaking is usually upheld by the courts' reluctance to interfere with the banking arrangement except under the fraud rule or illegality of the letter of credit itself, which constitute exceptions to the autonomy doctrine. In order to avoid hard results from refusal to recognize contracts for the benefits of third parties as creating rights in the latter, English courts, as also American courts have been and are increasingly straining to get away from the exclusive bargain theory and the requirement of consideration. Dean Rosco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s on which they may be based and banks are in no way concerned with or bound by such contracts even if a reference whatsoever to such contract is included in the credit. Consequently, the undertaking of a bank to pay, accept and pay drafts or negotiate and/or fulfill any other obligation under the letter of credit is not subject to claims or defences by the applicant (buyer in the present case), resulting from his relationship with the issuing bank or the beneficiary (seller in the present case). Under article 9 of the U.C.P., an irrevocable letter of credit constitutes a definite undertaking of the issuing bank, provided stipulated documents are presented to the nominated bank or the issuing bank, and that the terms and conditions of the credit are complied with to pay, as provided by sub-clause (a) of article 9, on the maturity dates determinable in accordance with the stipulations of the credit, if the credit provides for deferred payment (as in the present case), or to pay as per the contingencies mentioned in other clauses. Under article 18(a)(b) of the U.C.P., banks utilizing the services of another bank for the purpose of "giving effect to the instructions of the applicant" ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such a case, when by reason of the dishonour of the drafts drawn by the seller on the letter of credit or the failure of the letter of credit, the condition on which the letter of credit was received by the seller is not fulfilled, the seller would be an "unpaid seller" within the meaning of section 45(1)(b) of the Indian Sale of Goods Act (similar to section 38(1)(b) of the U.K. Sale of Goods Act, 1979), and be entitled to claim the price from the buyer under section 55 of the Indian Act (similar to section 49 of the U.K. Act), and his remedies against the goods would revive. The issuing bank acts at the request and on the instructions of the buyer and thereby acts on behalf of the buyer to pay the seller the amount on presentation of the documents as per the stipulations in the letter of credit. It is only a banking arrangement to effect payment and has nothing to do with the statutory obligations of the buyer which continue to bind the buyer in respect of the income by way of interest and other sums that are deemed to accrue or arise in India in favour of the non-resident seller. The contention that the obligation of the buyer was taken over by the issuing banker when the let ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (1) and (2): "1. Price: U.S. $ 66.06 per long ton (excluding of interest for 180 days from the date of tendering NOR) of light displacement tunnage excluding permanent ballast, net L.D.T. being 18483.78 long tons excluding permanent ballast. Total price: US $ 30,69,416.51 (United States dollars three million sixty nine thousand four hundred sixteen and cents fifty one only) and interest for 180 days from the date of NOR 7.25 per cent. per annum, separate invoice and drafts to be prepared for the original price and for the interest amount. 2. The total amount with interest shall be payable: by means of 100 per cent confirmed irrevocable 180 days usance letter of credit with confirmation charges at seller's cost and acceptable to sellers through any nationalised Indian bank (hereinafter called the opening bank) to be established in favour of the sellers for the net amount by September 19, 1994." Thus, the original price of the ship fixed was US $ 30,69,416.51 (excluding interest). The interest for 180 days from the date of tendering the notice of readiness (NOR) was calculated at the rate of 7.25 per cent. on the said original price of the ship from the date of the NOR. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rest amount should be treated as part of the price is, therefore, clearly an afterthought of these buyers and cannot be countenanced being against their positive conduct and terms of the contract of sale. As per clause (2) of the MOA, the total amount with interest was payable by confirmed irrevocable 180 days usance letter of credit with confirmation charges at seller's costs and acceptable to sellers through any nationalised Indian bank, to be established in favour of the sellers for the net amount by September 19, 1994. The letter of credit was to be released to the sellers immediately after the notice of readiness had been given by the buyers and upon presentation to the negotiating bank of the documents mentioned in clause (3), which included signed commercial invoice certifying details of the vessel and the purchase price of US $ 30,69,416.51 and a signed invoice for the interest amount of US $ 1,09,742.15 for 180 days usance from the date of NOR, as was stipulated in the MOA dated July 14, 1994. In clause (6) of the MOA, it was stipulated that the vessel with everything belonging to "Her" shall be at seller's risk and expenses, until she is delivered to the buyer. If befor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... calculated from the date of the transfer of the property in the ship to the buyer till the end of the period of credit facility of 180 days given to the buyer for effecting the payment of the purchase price. When the price of the ship which became due on the property being transferred was to be paid under the contractual arrangement at the end of the usance period of 180 days and interest was calculated thereon, by the very nature of such contractual arrangement, both the principal amount and interest calculated for the credit period fixed were required to be paid together as per the usance letter of credit. When payment is made by negotiable instrument or by a letter of credit which is normally regarded as conditional payment, only the remedy of the seller to sue for price is suspended and not his right or claim to the price of the goods, which arises on the transfer of property in the goods. In England, statutory interest may be payable under the Late Payment of Commercial Debts (Interest) Act, 1998, on debt created by virtue of obligation to pay the whole or part of the contract price. Under section 1 of the Act, it is provided that it is an implied term in a contract to whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... considered the purchase price of the ship as payable on delivery after notice of release, and that is why the interest is computed at the rate agreed for the usance period of 180 days being the credit facility given to the buyer. Such contractual arrangement is perfectly valid and the parties have themselves stipulated payment of interest on the purchase price of the ship considering it to be a debt incurred by the buyer from the date of delivery when the risk passed to the buyer and with it, the property in the ship. Furthermore, as per the Accounting Standards, revenue from sale of goods is recognized when the seller transfers the goods to the buyer for consideration. Under the International Accounting Standard 18 relating to revenue recognition, revenue should be recognized in sale of goods when: (i) significant risks and rewards of ownership are transferred to the buyers, (ii) managerial involvement and control have passed, (iii) the amount of revenue can be measured thereby, and (iv) the costs of the transaction (including future costs) can be measured reliably. Interest revenue is recognized on a time proportionate basis using the effective interest rate. Accoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and interest amount was specifically worked out on the purchase price of the ship for the usance period. These are not cases where the total amount payable under the MOA included a mere estimate of interest loss made as an integral part of the purchase price on incremental basis. These are cases in which there exist conscious and deliberate stipulations of purchase price of the ship and the interest amount specifically calculated at the agreed rate for the period fixed. Thus, there is absolutely no scope for contending that the outstanding price of the ship was not a "debt incurred" within the meaning of section 2(28A) of the said Act or not a "debt claim" under the article concerning taxation of interest in the Double Taxation Avoidance Agreements, on the date of delivery or that the interest payable thereon under the contract was part of the purchase price or incremental price of the ship, as contended on behalf of the assessees. The observations of the Supreme Court in Keshav Mills Ltd.'s case [1953] 23 ITR 230, to the effect that the relationship of the vendor and the purchaser is not metamorphosed into that of creditor and vendor cannot be construed to mean that outstanding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... est" and provide in clauses (1) and (2) that interest arising in a contracting State and paid to a resident of the other contracting State may be taxed in that other State. However, such interest may also be taxed in the contracting State in which it arises, and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other contracting State, the tax so charged shall not exceed the percentage of the gross amount of the interest specified therein. The term "interest" as used in these articles of the said two agreements means "income from debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits." The relevant part of the said article concerning taxation on interest contained in the DTAAs reads as under "Article 11: Interest: 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Cont ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exclusive taxation of interest to one State, whether the State of the beneficiary's residence or the State of source was not sure of general approval. Therefore, article 11 of the Model Convention concerning the taxation of interest adopted a compromise solution providing that interest may be taxed in the State of residence but leaves to the State of source of income the right to impose a tax, if its laws so provide, it being implicit in this right that the State of source is free to give up all taxation on interest paid to non-residents. Its exercise of this right will however be limited by a ceiling which its tax cannot exceed. As per the OECD Commentary (para. 11C.06), the term "paid" in paragraph 1 of the article concerning taxation of interest has a very wide meaning "since the concept of payment means fulfilment of the obligation to put funds at the disposal of the creditor in the manner required by contract or by custom". Payment would therefore mean the fulfilment of the claim to receive interest in whatever form it may actually occur (see Klaus Vogel on Double Taxation Convention, third edition, at page 714). Thus, payment of interest by means of irrevocable letter of cr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m the date of delivery of the ship, was the amount that would aptly fall in the expression "debt claims of every kind". This was not a case where the vendor gave the goods to the buyers on credit at a lumpsum price to be paid in future in which the interest element could not be definitely identified, but it is a case where the price became outstanding under the MCA on the date of delivery and the interest was agreed to be paid on the debt that was incurred in the form of the unpaid purchase price that was treated as debt outstanding. The interest, in the present case, having regard to the nature of the contract and the intention of the parties reflected from their conduct of treating the purchase price and interest as separate for all purposes including payment of customs duty and accounts, has no element whatsoever of the selling price of the ship. The contention that the interest payable to the non-resident under the MOAs was part of the purchase price of the ship, therefore, fails both on facts and in law. The decision of the Andhra Pradesh High Court in CIT v. Visakhapatnam Port Trust [1983] 144 ITR 146, was rendered in the context of liability to pay tax on the basis of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asoned order of the Tribunal on the question whether ship breaking activity gives rise to manufacture and production of altogether different articles or things and hence, the applicant is entitled to deduction under sections 80HH and 80-I of the Act, which has been followed by it in other cognate matters, is contained in Tax Appeal No. 196 of 2001. The Tribunal followed the decision of the Bombay High Court in Ship Scrap Traders' case [2001] 251 ITR 806, holding that the ship breaking activity gives rise to manufacture and production of altogether new commercial articles or things which are commercially identifiable in the commercial world other than the ship, and therefore, the assessees should be held entitled to claim of deductions under sections 80HH and 80-I of the Act. The Bombay High Court distinguished its earlier judgment in CST v. Delhi Iron and Steel Co. Pvt. Ltd. [1995] 98 STC 202 in which it was held that no process of manufacture was involved when after purchase of an old ship, the assessee dismantled the same and sold the scrap material obtained from the dismantled ship. Even in Ship Scrap Traders's case [2001] 251 ITR 806 (Bom), an old ship was bought for the purpos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y should it not be considered as manufacture when by the reverse process of disassembling the automobile its parts are brought into existence. In short, both the "birth" and the "death" of a ship should be construed as manufacture or production activity. One of integration into a ship and the other of its disintegration into the articles that went into its making. The assessees have the advantage of making these arguments, because, the expression "manufacture and production" of articles or things is not defined for the purposes of sections 80HH or 80-I of the Act. The cases based upon sales tax, factory or excise laws where there is definition of "manufacture" or "manufacturing process" will have to be viewed in the context of and purposes underlying those laws and in the light of the definition of manufacture tailored to achieve those purposes. By the nature of its very setting, one has to construe the expression "manufacture or produce articles" in sub-section (2)(i) of section 80HH and the expression "manufactures or produces any article or thing not being any article or thing specified in the list in the Eleventh Schedule", appearing in section 80-I(2)(iii) in the context of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ship breaking is undoubtedly an industry in which there is great earning potential despite environmental hazards which have prompted the developed countries to shun it and forward their vessels for demolition to the countries where labour is cheap and concern for environment and health hazards is yet to gather its due momentum. The pollution aspects of ship breaking are enumerated in para. 2.13 of the Report of the Ferrous Scrap Committee of the Government of India published in August, 1997, which was referred to by learned counsel for the assessees during their arguments. Recently, criticism has been voiced in some rich OECD countries that ship owners assume no responsibility for the often very toxic substances long contained in their roughly 30 year old vessels. Instead, the owners sell the ship as pure steel to Asia and make a good profit on this, while fully aware that the unsuspecting people there will be directly exposed to the hazardous substance; fully aware, too, that the authorities there do not meet their obligations to protect their citizens, be it out of negligence or incapacity. (See "Ships for scrap steel and toxic wastes for Asia. The health and environment hazard ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... act on environment", relied upon by learned counsel for the assessees (excepts of which are in the compilation in Tax Appeal No. 196 of 2002) records in para. 02.05.02 that ship breaking consists essentially in the activities of preparation for breaking up (including mooring/beaching), breaking down to big blocks, small blocks and sections, with handling, hoisting, cutting and shipping equipment. The sequence of ship breaking activities generally followed in beaching methods is enumerated in para. 02.05.06, as under: "Different methods of dismantling large ships and for reclaiming metals from broken-up ships have been evolved over the years in various countries depending on the availability of berthing/beaching facilities with a view to achieve speed and ease of recovery......." "02.06 The shipbreaking process at Alang: The sequence of shipbreaking activities generally followed in beaching method are: * Ballast water, fuel oil and lubricants that can be pumped out are removed. * Super structure items like cabins, furnitures, life boats, loose cables, firefighting equipments, ladders, window panes and frames, doors, fittings, etc., are dismantled. * Stores and movable ge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... " Thus, there is nothing whatsoever in the process of ship breaking activity which can be termed as manufacture or production of any article or thing. The dismantled material was already existing as a component of the old ship. The process of extracting steel plates from it while dismantling the ship will not make such extraction of existing material an activity of manufacture or production of such material nor will the process of cutting extracted steel plates for convenient disposal be manufacture or production of such steel plates. Merely because ship breaking is considered as an industry, it would not be an industry engaged in manufacture or production of any article or thing. The benefit of the provisions of sections 80HH and 80-I is clearly not intended for such ship breaking activities which do not result in bringing into existence any new article or thing. The word "manufacture" in the context of sections 80HH and 80-I of the Act would mean making of articles or things. While dismantling the ship, steel plates are not made but only removed which is not the same thing as making steel plates. The word "production" in the context of these provisions would mean the action of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... produces chicks and that chicks are "articles or things". We are, therefore, of the opinion that the assessee is neither an industrial undertaking nor does the business of hatchery carried out by the assessee fall within the meaning of section 32A and section 80J of the Act." In the present case, the application of mechanical methods only removed the steel plates and other objects which were existing on the ships, which would not mean that the assessees produced those existing articles or things by the process of removing and cutting them. As held by the Supreme Court in CIT v. N.C. Budharaja and Co. [1993] 204 ITR 412, the word "production" or "produce" when used in juxtaposition with the word "manufacture" takes in bringing into existence new goods by a process which may or may not amount to manufacture. It was held that the principle of adopting a liberal interpretation which advances the purpose and object of beneficial provisions cannot be carried out to the extent of doing violence to the plain and simple language of the enactment. We are, therefore, unable to subscribe to the view that ship breaking is an activity which gives rise to manufacture and production of altog ..... X X X X Extracts X X X X X X X X Extracts X X X X
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