TMI Blog2005 (5) TMI 244X X X X Extracts X X X X X X X X Extracts X X X X ..... turnover. Learned CIT(A) following his order pertaining to assessment years 1995-96 to 1997-98 held that commission at the rate of 2 per cent is to be allowed. Whereas the assessee challenges disallowance of commission to the extent of 3 per cent, the revenue challenges the allowance of commission over and above that allowed by the Assessing Officer. 2.1 Similar issue arose before this Tribunal in assessee's appeal for assessment years 1995-96 to 1996-97. The Tribunal after elaborate consideration of the fact as well as argument and the results for the years, held as under:- "All these details have been extracted from the accounts of both the companies and are not in dispute also. From the above, it is clear that the assessee has been showing best results after the holding company has come into play. From the details found in the record it is clear that M/s. Givadaun Roure was responsible for introducing their clients to M/s. Hindustan Lever Ltd., M/s. Procter Gamble, M/s. Ponds etc., to substantiate the manifold increase in turnover of the assessee. The stand of that M/s. Givaduan Roure took over the shares of the assessee with an object of supporting the assessee and produc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for earlier years. The Tribunal, after considering the entire facts and circumstances of the case in para 7 of its order, held as under:- "From the details furnished in the aforesaid letter, it can be seen that from the assessment years 1991-92 to 1994-95 there is a steep increase in turnover and profit. This cannot be achieved without the technical advise from a qualified and experienced perfumers. It is the case of the assessee that both Shri Vijaya Kumar and Shri Nagendra are technically qualified and experienced perfumers having more than 15 years of experience in this field. The perfumery compounds and chemicals are specialised work. To manufacture aromatic products, it can be carried out only by the professionals in this line. A minor variance in the technique and formulae will directly affect the quality of products. Further procurement of raw materials is also the most essential factor to maintain quality of the product. The aforesaid Directors were in fact incharge of production as well as marketing. All these facts were not denied by the revenue. The only apprehension of the revenue is that the payment so made were excessive and unreasonable. To establish this factor, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was to pay a royalty at the rate of 5 per cent of the net sales value of the agreement products manufactured and sold by the assessee. The assessee was therefore liable to pay royalty to the extent of Rs. 2,74,88,099 for assessment year 1998-99. The assessee claimed Rs. 2,39,61,276 out of the said royalty, as for the balance sum, the tax was not deducted under section 195 and hence, in view of section 40(a)(i), the claim for the balance sum was not made. The Assessing Officer noted that GRIL is a fully owned subsidiary company of GRISA. GRIL owns 76 per cent of the share of the assessee company. Balance shares were held by erstwhile owner of the company viz. Shri Vijay Kumar and his nominees. For the year ended 31-3-2000, the entire share capital of assessee-company was held by GRIL and its nominees. The Assessing Officer held that though the assessee received know-how necessary for advancement of its business and though the assessee was benefited commercially, yet an entity which holds indirectly 76 per cent of the share of assessee-company, the transaction is not at an arms length. The Assessing Officer in this regard held as under:- "The argument that the assessee, M/s. GRIL a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y GRISA vide License executed on 1-11-1995 between the parties. A copy of the license agreement is filed in paper book. This agreement was put to RBI for approval and RBI vide its letter dated 22-9-1997 had approved with certain conditions to be fulfilled as provided therein. One of the conditions was that the royalty payment should not exceed 5 per cent of the domestic sales and 5 per cent of the export (net of taxes) for the period of 3 years. A copy of the said letter of the RBI is enclosed in paper book. In pursuance of this approval, the supplementary agreement was also made to define the effective date of the operation of the license on 30-9-1997. A copy of the said agreement is enclosed in paper book. Thus it may be appreciated that the agreement between the appellant-company and the GRISA was a genuine agreement which had been screened by the RBI which had given the approval and the RBI had also approved the payment of royalty not exceeding 5 per cent. In the circumstances, the payment of royalty at 5 per cent as made by the appellant could not be held to be unreasonable. Even if the parties fall in the susceptible category as contemplated under section 40A(2) of the Act, s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... paper book. It was also submitted that on account of the manufacturing activity of the flavours and fragrances by the appellant with the GRISA's expertise it could procure vast customers who were originally importing the flavours and fragrances from GRISA directly. The appellant submits that on account of this arrangement the turnover of the appellant had gone up substantially which is evident from the following:- ---------------------------------------------------- A. Yrs. Total turnover Net profit Royalty payment Rs. Rs. Rs. ---------------------------------------------------- 1997-98 29,89,10,716 3,59,97,182 - 1998-99 25,89,77,088 (2,24,86,874) 2,74,88,099 1999-2000 52,03,25,322 (3,37,80,173) 2,56,98,905 2000-01 61,28,58,230 1,82,04,990 3,04,87,912 ---------------------------------------------------- It may be noticed that assessment year 1997-98 was the first year after license was put to use. Once the business picked up the turnover had become double (assessment years 1999-2000 and 2000-01) and in 2000-01 in spite of royalty payment the appellant could derive profit. In fact prior to the license agr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l, firm, company, AOP, HUF, etc.) having a substantial interest (i.e. owning at lease 20 per cent voting rights on holding of equity shares) in the company or any person of which a director, partner or member has a substantial interest in the company or any relative of any such director or person. As GRISA is having no shareholding in the appellant-company, any of the conditions to invoke section 40A(2) of the Act are not satisfied. Consequently, GRISA is not in the susceptible character and the provisions of section 40A(2) are not attracted. In the absence of GRISA having any control in the appellant, not having shareholding in the appellant-company, the question of holding that the payment made to GRISA amounted to a payment to self was a wrong conclusion. The payment to GRISA being genuine and for obtaining the benefit by the appellant-company and the payment also being reasonable and approved by RBI, the disallowance as made by the assessing authority is unsustainable. He further submitted that when the transaction is at an arms length, the payment made cannot be disallowed. He submitted that for assessment year 2002-03, as per section 91 of the Income-tax Act, a transaction wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ese facts concerning the ownership of the assessee-company. The payment of royalty to GRISA is de fecto a payment to oneself for the reason that GRISA beneficiary owns 76 per cent shares of the assessee-company through its fully owned subsidiary GRIL. Hence, the payee of the royalty is none other than an entity which holds more than 76 per cent shares of the assessee-company. The transaction therefore is not one at arms length. The argument that the assessee, M/s. GRIL and M/s. GRISA are all different corporate entities is a tenuous one. It is an accepted judicial dictum that in order to see the real nature and substance of a commercial transaction for the purposes of taxation, one has to look at it after lifting the corporate veil. No doubt, the assessee and M/s. GRISA are two different corporate entities, but factually, GRISA is the real owner of the assessee-company. It is necessary to put into use one's expertise, knowledge, and other resources including money to make profit. In commercial terms, what one gets out of such investment including the investment of ones own know-how is the profit from business. If the profit of business are diverted by any other means, such as payme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... then (P.) Ltd. [1999] 236 ITR 416. This was a case relating to the applicability of Explanation 3 to section 43(1). The court found that revaluation of assets belonging to a firm taken over by the company which was a partner in the said firm was not bona fide. The court also observed, relying on the decision of the Apex Court in Sunil Sidharthbhai v. CIT [1985] 156 ITR 509 that the Assessing Officer is entitled to penetrate the veil covering a transaction to ascertain the truth. Even if two entities have been created legally, the bona fide nature of a transaction between two such legal entities can be critically examined to arrive at the trust of the matter wherein the court held "the High Court has power to disregard the corporate entity, if it is used for tax evasion or to circumvent tax obligation. Therefore, it could not be said that the Assessing Officer had acted unreasonably or arbitrarily in adopting Explanation 3 to section 43(1) and fixing the actual cost accordingly." The Court relied on the following observations of the Apex Court in CIT v. Sri Meenakshi Mills Ltd. [1967] 63 ITR 609: "It is true that from the juristic point of view, the point is a legal personalit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aps not so skilful, advisers, on the other side. Then again there is the 'sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it'. Last but not the least, is the ethics of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of the 'artful dodgers'." 4.6 Shri Bhatnagar also referred to a decision of ITAT, Pune Bench in Taparia Tools Ltd. v. Joint CIT [2002] 81 ITD 508. The head-note in the said case read as under:- "Tax planning - whether tax planning within framework of law is legitimate and it is only colourable devices and dubious methods that are to be discouraged - Held, yes, - Whether if result of normal transaction is tried to be achieved through a scheme, with only intention to avoid tax, then such scheme can be described as a colourable device even though such scheme may be within the framework of law - Held, yes." 4.7 He also referred to a decision of ITAT Mumbai in the case of Kantilal Manilal Co. v. Dy. CIT [2002] 77 TTJ (Mum.) 332. Hon'ble Tribunal held thus: "Answer to this contention of the assessee can be very well found in the observa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... device adopted to avoid payment of tax. Therefore, the Tribunal and the subordinate authorities were fully justified, taking into account several circumstances referred to by them in the orders impugned, to determine the nature of the new and sophisticated acumen adopted to avoid payment of tax legitimately due to the State. In a matter like this, we consider that it is the duty of this Court not to give judicial vindication to such an act of avoidance of payment of tax in the guise of sophisticated use of language as tax planning." 4.9 Lastly, he submitted that the Hon'ble Supreme Court's subsequent decision in case of Azadi Bachao Andolan, the earlier Supreme Court decision in case of McDowell Co. Ltd. cannot be applied to the facts of the appellant's case is concerned, it is pertinent to mention here that "the Supreme Court's decision in McDowell Co. Ltd.'s case was by a Full Bench of 5 judges. However, the Hon'ble Supreme Court's decision in the case of Azadi Bachao Andolan was by a Divisional Bench of 2 judges. Further, the Hon'ble Supreme Court decision in case of Azadi Bachao Andolan does not contradict or over rule its earlier decision in the case of McDowell Co. L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mercial way without bringing the relation in between. In such transaction, the consideration due and payable is paid, neither more nor less. The relationship of holding subsidiary, principal agent or any other relations is put aside and the transaction is termed solely on the basis of commercial consideration. A Managing Director of the Company, holding substantially the entire capital, is required to be remunerated for the services he has rendered, or the partners, though owning the entire business, are required to be remunerated as a working partner for the services rendered, or they are also required to be paid interest on the capital introduced. In all such cases, it cannot be said that by paying the remuneration or for rewarding for the services, the transaction is not done at an arms length. A transaction is said to be at an arms length when one is compensated for the benefit received. Conversely, if it is not so done, it can be considered as a transaction "hands in glove". In the present case, what the assessee did is precisely a transaction at an arms length. While paying for the technology received, the assessee has paid precisely the price payable for the same. Had it not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ant-company having reaped the benefit for obtaining the know-how is providing the fraction of the profit by way of royalty to the foreign company. By no stretch of imagination the agreement may be held to be colourable. The recent judgment of the Hon'ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706, the Supreme Court has observed as follows:- "We may also refer to the judgment of the Gujarat High Court in Banyan and Berry v. CIT [1996] 222 ITR 831 at 850 where referring to McDowell's case [1985] 154 ITR 148, the court observed: 'The court nowhere said that every action or inaction on the part of the tax payer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act; an inference which unfortunately, in our opinion, the Tribunal apparently appears to have drawn from the enunciation made in McDowell's case [1958] 154 ITR 148. The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell's decision leave us in no do ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th reference to the quantum, while the expression "exclusively" refers to the nature or the purpose of the activity in which the expenditure is incurred. In other words, the whole of the expenditure must have been wholly and exclusively incurred for business purposes, in order to qualify for allowance under section 37(1) of the Act. If there is a dual purpose, then, it is obvious that the expenditure would not qualify for allowance, for, it will cease to be wholly and exclusively laid out for business purposes [CIT v. T.S. Hajee Moose CO. [1985] 153 ITR 422, 429 (Mad.)J. The expression "wholly and exclusively" used in section 10(2)(xv) of the Income-tax Act, 1922, does not mean "necessarily". Ordinarily, it is for the assessee to decide whether any expenditure should be incurred in the course of his or its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits, the assessee can claim deduction under section 10(2)(xv) of the Act even though there was no compelling necessity to incur such expenditure. The fact that somebody other than the assessee is also benefited by the expenditure sh ..... X X X X Extracts X X X X X X X X Extracts X X X X
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