2006 (7) TMI 668 - AT - Income Tax

Accrual of commission income - Agency agreement with Satellite Television Asian Region Advertising Sales BV - non-resident company - change in the method of accounting from mercantile to cash system - Whether the commission income, as per the agreement, accrued when the advertisement solicited were telecast or when the sum was realized or collected from its clients - Deductibility of advertisement expenses - Difference of opinion between learned members - Whether, the commission income under the agreement dt. 31st May, 1994 accrued to the assessee when it was received by it from its clients as held by the JM or accrued at the time of acceptances of the solicited advertisement by the Principal though could be assessed in the year in which such advertisement was telecast as held by the AM ? Whether, the assessee is entitled to deduction of advertisement expenses amounting to ₹ 9,03,02,000 for asst. yr. 1998-99 and ₹ 9,38,05,000 for asst. yr. 1999-2000 under s. 37 of the IT Act, 1961? Third Member - HELD THAT - The learned JM in his proposed order further observed that as per settled legal position income accrues when an enforceable debt is created in favour of the assessee; in other words, when a right to receive income is acquired. For the aforesaid proposition, reliance was placed on the decision of the Hon'ble Supreme Court in the case of E.D. Sassoon Co. Ltd. Ors. 1979 (5) TMI 3 - SUPREME COURT . However, where right to receive is inchoate, it would accrue on the date when such right becomes absolute. In other words, if accrual of income depends on happening of any event or fulfilment of a condition, then income will accrue on happening of that event or fulfilment of the condition. The learned JM, in this connection, relied upon the decision of the Hon'ble Supreme Court in the case of CIT vs. Shri Goverdhan Ltd. 1968 (1) TMI 2 - SUPREME COURT . According to the learned JM, the assessee had no right to receive commission till the happening of such contingency as right to retain commission is dependant upon payment of invoice amount to the assessee. Once invoice amount was received by the assessee, the right to retain commission would accrue immediately irrespective of the remittance to the non-resident. Thus, payment by the clients was a condition precedent for accrual of income, which has been provided in the agreement to ensure the recovery of the amount. The learned JM also observed that effect of cl. 8 of the agreement was that assessee would never get any commission where invoice amount is not paid by the clients. The date of remittance to the Principal would be irrelevant and the claim of the assessee could not be rejected because date of accrual coincided with the date of payment. The learned JM accordingly held that orders of lower authorities were not sustainable. The learned JM observed that decision of Supreme Court in the case of Seth Pushalal Mansingkha (P) Ltd. vs. CIT (supra) does not help the assessee. The learned JM has reproduced the relevant observations of the apex Court at pp. 22 and 23 of his proposed order. The learned JM also rejected the contentions of the assessee that income cannot accrue to it unless income has accrued to the Principal. The learned JM also did not agree with the assessee that approval granted by the RBI to the assessee to remit amounts to its Principal had nothing to do with accrual of income. Reasons for aforesaid findings are given by the learned JM in paras 24 and 25 of his proposed order. It has been held by learned JM that decision of Supreme Court in the case of Morvi Industries Ltd. vs. CIT 1971 (10) TMI 5 - SUPREME COURT relied upon by learned Departmental Representative was in no way in conflict with the view, which was being taken in this case. The learned AM did not agree with the view taken by the learned JM. He first referred to the grounds of appeal raised by the assessee. He observed that assessee was obliged under law to follow mercantile system of accounting. The learned AM in his proposed order further noted that under the agreement dt. 31st May, 1994, the assessee had treated advertising commission as accrued at the time when time spots were aired and, therefore, change in system was sought to be made under the same agreement by giving new interpretation to cl. 8 of the agreement. According to the learned AM, change in accounting policy was aimed to reduce tax liability for the assessment years under consideration. The learned AM also observed that assessment in this case was to be made on the income as earned against traditional concept of actual receipt from right to receive. In the view of the learned AM, contractual obligations of the assessee comes to an end and once the client's requisition forwarded by the assessee is accepted by Principal, at this very point, assessee becomes eligible for its commission, i.e., a legally enforceable debt has been created in favour of assessee because the sale of time spots is completed, and the commission receivable by the assessee is also ascertainable on the basis of number of time spots sold at the rate accepted by the Principal and the client. Ascertainment or quantification of a debt will not affect accrual of income. Learned AM observed that the assessee had no contractual obligation to make efforts to realize amounts from clients as it would have caused implications and the assessee is not getting any money from Principal on this score. Thus, role of assessee under the agreement is limited to receive the amount paid by the clients. In nutshell, the assessee is under no obligation to realize the amount from the clients . After referring to certain other clauses, the learned AM refers to the more important cl. 8 providing for retention of commission by the assessee. In respect of above clauses, the learned AM has observed Thus cl. 8 does not, in any way, dilute the right of the assessee to receive the commission which has already accrued to the assessee upon its having solicited the advertisements for the Principal . The learned AM thereafter referred to the new agreement entered into between the assessee and its Principal w.e.f. 1st April, 1999 and the relevant clauses of the agreement have been reproduced. After perusal of different clauses, the learned AM observed that the above agreement materially altered and widened in the Representation Agreement than the agreement existing at the material time. The responsibility of collecting of advertisement revenue from clients has been specifically included in the scope of work and other duties in this regard like maintenance of records regarding amount due from clients, periodical reporting of the same to owner have also been included in the new agreement. No such responsibilities are listed in the agreement dt. 31st May, 1994. So it can be safely stated that the assessee was not liable for realization of amounts from clients and in substance the only role assigned to the assessee was to receive money from clients as per the instructions of the Principal. The learned AM in para 5.9 of his proposed order discussed in detail and was of the view that change made by the assessee in accounting policy relating to accrual of commission income was not justified and liable to be rejected. In subsequent para the learned AM discussed in detail how assessee was not justified in changing accounting policy relating to accrual of commission. Learned AM noted the activities of the assessee. He held that advertisement expenses incurred by the assessee were not incurred wholly and exclusively for the purpose of business. It was also not correct on the part of the assessee to claim that reasonableness of expenses could not be examined by the Revenue authorities. Assessee was also not justified in claiming that increase in business resulted on account of advertisements carried on by the assessee. There could be several factors like quality and contents of programmes and not advertisements, which are responsible for increase in business. The assessee was further not able to show that advertisement expenditure was incurred on account of any commercial expediency. On the basis of the decision of the Hon'ble Supreme Court in E.D. Sassoon J. David Co. (P) Ltd. 1979 (5) TMI 3 - SUPREME COURT the learned AM evolved the positive and negative steps to be applied to determine whether expenditure was incurred for the purpose of business and was admissible in law. On application of above tests, the learned AM held that expenditure incurred by the assessee was not deductible. It is nobody's case that assessee is following cash system of accounting. There is further no dispute that under the above system, income is liable to be taxed as soon as assessee has right to receive the income. Likewise expenditure under the system is to be allowed on the basis of liability to pay. Actual payment is not relevant. There is further agreement that aforesaid question has to be determined with reference to provisions of ss. 4 and 5 of the IT Act. According to the assessee, commission income under the agreement could accrue to the assessee as per cl. 8 of the agreement which provided that the agent (assessee) shall be entitled to retain 15 per cent of net invoice amount paid by clients as commission. So the case of the assessee as accepted by the learned JM in the proposed order is that income cannot accrue under the agreement unless assessee is in a position to exercise his right to retain 15 per cent of net invoice amount paid by assessee's Principal clients. The stand of the Revenue, as supported by proposed order of learned AM is that income would accrue to the assessee as soon as advertisements are solicited by the assessee for Principal. Both the parties agree that agreement between the assessee and its Principal is to be read as a whole to determine its legal implication. Having regard to terms and conditions of the agreement between the assessee and its Principal, it is difficult to agree with the observations quoted above. It is nowhere provided that assessee would be entitled to receive its commission even if advertisements solicited by the assessee are not telecast or amount is not realized by the assessee's Principal. There is no clause in the agreement which would indicate that commission would accrue to the assessee as soon as advertisements are solicited by the assessee. The learned AM or learned Departmental Representative during the course of hearing could not show me any provision or case law under which right to receive commission could be said to have accrued in favour of assessee as soon as advertisements are solicited/booked by the assessee. In the agreement there are further steps to be taken and advertisements solicited are required to be sent for approval by the Principal. The Principal under the agreement is not only to approve the advertisement solicited by the assessee but also to raise invoices within 30 days from the date on which advertisement is so telecast. The Principal has also to issue instructions to the client to make payment thereof to its agent (assessee). The assessee is further obliged to collect all the sums due to its Principal. It is not possible to ignore all the abovementioned clauses of the agreement and hold that assessee acquires right to receive income as soon as advertisements are solicited by the assessee and that other situations provided in the agreement relate only to future uncertainties, difficulties and delays and these would have no effect on the accrual of income. Other clauses cannot be understood to be relating to relinquishment of income after its accrual. Undisputedly s. 23A was attracted if aforesaid sum of ₹ 70,895, i.e., the share income of assessee-company from partnership was taken into account. The contention of the assessee was that meeting of board of directors to declare dividend was held on 17th May, 1951 and by that time books of account of the firm were not made up nor share of profit was known. Therefore, income of ₹ 70,895 had not accrued to the assessee. The share income accrues to the partner as soon as the previous year of the firm comes to a close. It is immaterial that exact amount of profit is not known on the close of the year (31st March in the cited case). Whenever the profit is worked out, it would be the profit as on 31st March and liable to be taken in assessment year immediately following the previous year. Therefore, having regard to the facts involved in Goverdhan Ltd. (supra), no support can be derived by the Revenue from the decision. I find that there is no dispute about the genuineness of the expenditure incurred by the assessee. There can further be no dispute that expenditure incurred by the assessee on advertisement made had direct nexus with earning of income by the assessee. It is possible that expenditure on advertisement might have also benefited the Principal of the assessee but on above ground, the expenditure incurred by the assessee could not be disallowed. The assessee clearly incurred expenses wholly and exclusively for purposes of its business and, therefore, was entitled to deduction of expenditure claimed in computing its income. The learned JM has given sound reasons for allowing expenditure in question. On facts of case, it is not possible for me to agree with learned AM on any of the reasons given by him to disallow the expenditure in question. Thus, I agree with the order proposed by the learned JM. The addition made for alleged accrual of income and disallowance of expenditure claimed on advertisement, in my opinion, is not justified. Majority Decision - The Hon'ble President, Tribunal, as Third Member, vide order dt. 13th July, 2006, has agreed with the view of the JM on both the points. Therefore, in accordance with the majority opinion, the issues arising out of the above points are decided in favour of the assessee by holding that'(i) commission would accrue to the assessee either on the date of receipt of commission, i.e., when the commission is collected by the assessee or on the date of payment by the clients directly to the Principal as the case may be; and (ii) assessee would be entitled to deduction in respect of advertisement expenses. In the result, the appeal of the assessee for asst. yr. 1997-98 is allowed while the appeals of the assessee for the asst. yrs. 1998-99 and 1999-2000 are partly allowed. On the other hand, the appeal of the Revenue for the asst. yr. 1999-2000 is dismissed and appeal for asst. yr. 1998-99 is partly allowed.

Summary

Issues Involved:
1. Date of accrual of commission income.
2. Disallowance u/s 43B of the Act.
3. Disallowance of advertisement expenses.
4. Disallowance of loss on account of bad debts.
5. Disallowance of depreciation on motor car.
6. Deduction u/s 80HHC of the Act.

Summary:

1. Date of Accrual of Commission Income:
The primary issue was whether the commission income accrued to the assessee when the advertisements were telecast or when the payment was received from clients. The assessee argued that commission income should be recognized upon receipt of payment from clients as per cl. 8 of the agreement. The AO and CIT(A) held that income accrued when advertisements were telecast. The Tribunal, considering the agreement and legal precedents, held that income accrued when payment was received from clients, aligning with the principle that a liability depending upon a contingency is not a debt until the contingency happens.

2. Disallowance u/s 43B of the Act:
The AO disallowed certain payments related to provident fund and other charges as they were made after the accounting year. The CIT(A) allowed partial relief. The Tribunal, referencing various decisions, held that payments made within the grace period or before the due date of filing the return should not be disallowed. The matter was remitted to the AO for verification of facts and re-adjudication.

3. Disallowance of Advertisement Expenses:
The AO disallowed advertisement expenses on the grounds that they were not incurred wholly and exclusively for the assessee's business. The CIT(A) allowed 20% of the expenses. The Tribunal held that the expenses were incurred for the purpose of the assessee's business, even if they also benefited the principal. The Tribunal deleted the disallowance, emphasizing that the necessity or benefit to a third party does not negate the business purpose of the expenditure.

4. Disallowance of Loss on Account of Bad Debts:
The AO disallowed the bad debt claim, stating that the conditions under s. 36(2) were not satisfied. The CIT(A) allowed partial relief. The Tribunal found that the matter was not examined properly and remitted the issue to the AO for fresh adjudication, considering the legal position with reference to ss. 36, 37, and 38 of the Act.

5. Disallowance of Depreciation on Motor Car:
The AO disallowed depreciation on a car acquired on hire-purchase basis, following a Special Bench decision. The CIT(A) allowed only the interest element. The Tribunal, referencing the Board's Circular and a Delhi High Court judgment, held that depreciation is allowable with reference to the cost element embedded in the hire-purchase payments made up to the end of the accounting year. The issue was remitted to the AO for verification and allowance of depreciation accordingly.

6. Deduction u/s 80HHC of the Act:
The assessee claimed deduction u/s 80HHC for films/TV serials produced and exported. The Tribunal admitted the ground, referencing a Supreme Court judgment, and remitted the matter to the AO to consider the claim after verification of the material.

Conclusion:
The Tribunal's decision favored the assessee on several grounds, including the date of accrual of commission income, advertisement expenses, and bad debts, while remitting certain issues back to the AO for further verification and adjudication.