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TMI Blog1998 (2) TMI 158X X X X Extracts X X X X X X X X Extracts X X X X ..... d in holding that in view of the arts. (iii)(3) of the double taxation agreement withJapan, no disallowance can be made under r. 5D, s. 40A(3), s. 40A(12), s. 37(2A) and s. 43B of the IT Act. 3.1. Ground No. 1--relating to deletion of the addition of Rs. 2,19,15,387 being the valuation on account of work-in-progress in respect of equipment supply : The respondent company Mitsubishi Industries Ltd. (MHIL), which is a foreign company, incorporated inJapan, has entered into a contract with National Thermal Power Corporation (NTPC) to construct the Auriya Gas Base Combined Cycle Plant at Divyapur in U.P. This was the first year of company's business inIndia. On total receipts of Rs. 28,14,59,000 the assessee has claimed expenses at Rs. 36,58,91,000 returning a net loss of Rs. 8,44,32,000. The assessment was completed by the AO vide assessment order under s. 143(3) dt.30th Sept., 1991at taxable profit of Rs. 3,08,80,570. The AO had inter alia, made an addition in respect of work-in-progress (WIP) relating to equipment supply (ES) to the tune of Rs. 3,61,24,600. The AO has discussed the facts relating to the aforesaid addition in paras 23 and 24 of the assessment order. He has observed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... basis for estimating the value of equipment for which payments have been made but for which bills have not been raised such value would work out at Rs. 3,61,24,600 (Rs. 12,61,23,000 (-) 80 per cent of Rs. 11,24,98,000 = Rs. 3,61,24,600). Thus, the value of equipment for which payments have been made, for which bills have not been raised is estimated at Rs. 3,61,24,600 which will be reduced from the assessee's loss." 3.1. (i) The CIT(A) has discussed this point in para 4 to para 4.2 at pp. 9 to 11 of the order passed by him, relating to addition of Rs. 3,61,24,600 made on account of valuation of WIP in respect of ES and addition of Rs. 1,58,30,000 made in respect of valuation on account of WIP relating to inland transportation.Para4 and 4.1 deal with the first addition of Rs. 3,61,24,600. The said para 4 and 4.1 of the order of the CIT(A) are reproduced hereunder: "4. Grounds of appeal Nos. 4 and 5 relate to the additions of Rs. 3,61,24,600 and Rs. 1,58,30,000 being the valuation on account of WIP in respect of ES and Inland Transportation (IT). It is an admitted fact that the appellant company has not accounted for WIP in respect of the ES and IT. However, the appellant is dispu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll, therefore, get a relief of Rs. 2,19,15,387 on this account." 3.1. (ii) The learned senior Departmental Representative submitted that the assessee has admitted that the value of WIP relating to ES has not been taken into consideration while computing the taxable income of the year under consideration. This aspect was not contested on behalf of the assessee before the CIT(A). The assessee simply disputed the valuation of such WIP adopted by the AO. The assessee has also not preferred any appeal before the Tribunal in relation to an addition of Rs. 1,42,09,213 sustained by the CIT(A) out of the said addition of Rs. 3,61,24,600. Therefore, the question which is the subject-matter of consideration before the Tribunal relates only to the quantum of addition sustained by the CIT(A) to the extent of Rs. 2,19,15,387. He submitted that the CIT(A) while granting the aforesaid relief had taken into consideration the figures of the alleged net profit derived by the assessee in relation to ES in the execution of the said contract by considering the results not only of the year under consideration but also the figures pertaining to the subsequent years. It was pointed out by him that the sai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n should have been considered by the learned officer at 17.07 per cent. Without prejudice to this, the maximum gross margin can only be 1.25 per cent based on consideration of all sub-contractors including Texmaco. The learned officer thus erred in considering a margin of 20 per cent. Under cl. 3.10.6. of the contract, NTPC was required to make direct payments to sub-contractors to enable the sub-contractors to avail the deemed profit benefits. We have provided the break-up for costs and revenues between direct payments to sub-contractors and payments to MHIL in Annexure 4. As your honour will observe, revenues and costs for direct payments to sub-contractors are the same. The profit or loss, therefore, arises on the portion of work performed by MHIL. The percentage of gross profit to be applied can only be applied on the revenue related to work performed by MHIL. In Annexure 5 and 6, we have provided a computation of work in progress, depending on whether the profit margin is 17.07 per cent or 1.25 per cent. We request your honour to issue appropriate instructions to the learned officer to revalue the WIP as per the lower figures. 3.1. (iv) The learned lawyer further submitted th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,048,800 2,951,200 . Paharpur . 3,530,000 2,000,000 1,530,000 . Lloyd . 4,800,000 14,049,967 (9,249,967) . WorthingtonPump . . 1,339,250 (1,339,250) . West Coast Engg. . . 3,020,856 (3,020,856) . Berger . . 1,936,071 (1,936,071) . Peico Electricals . . 2,671,870 (2,671,870) . Triveni . 8,190,080 8,094,137 95,943 . Chemicals & Associates . . 2,408,196 (2,408,196) . Total excluding Texmaco . 141,674,858 165,859,037 (24,184,179) (17.07) Texmaco (Work performed in subsequent year) . 88,476,220 61,424,158 27,052,062 . Total . 230,151,078 227,283,195 2,867,883 1.25 3.1. (vii) The learned counsel further submitted that the written submissions dt.29th Nov., 1001along with the aforesaid charts were submitted before the CIT(A) on the date of hearing fixed before him on that date. He further submitted that the AO was not present before the CIT(A) on the said date of hearing. But he made a categorical statement at Bar that the said chart and the written submissions were telephonically communicated the AO on that day. It is therefore, incorrect on the part of the learned Senior Departmental Representative to state that the AO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ustained by the CIT(A). 3.1. (xii) The CIT(A) has granted the relief of Rs. 2,19,15,387 on this account by basing his decision on the chart submitted before him by the assessee showing that the gross margin in relation to such ES comes to only 1.25 per cent. The photocopy of the aforesaid chart has already been made a part of this order. A careful perusal of the said chart clearly indicates that the CIT(A) has accepted the gross profit rate of 1.25 per cent without application of mind and without examining the correctness of the said chart. Let us examine some of the items appearing in the said chart. For instance, the chart shows that cost incurred by the assessee in relation to ES include payments made to the following suppliers against which no revenues have been booked: Comparison of contracted revenues with cost--ES Name of the party Cost WorthingtonPump 13,39,250 West Coast Engg. 30,20,856 Berger 19,36,071 Peico Electricals 26,71,870 Chemicals & Associates 24,08,196 The aforesaid details shows that the assessee had claimed expenditure in relation to the payments made to these suppliers either directly or through NTPC but the invoices for such ES had not been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dered opinion that the order passed by the CIT(A) in relation to this ground should, be set aside and the matter should be restored back to the CIT(A) for deciding the same afresh after supplying a copy of the written submissions dt.29th Nov., 1991along with all the charts to the AO and after allowing the AO to submit his detailed comments thereon. The AO for giving his comments thereon will be at liberty to call for necessary details and documents from the assessee in this regard so that he could properly examine the correctness and relevance of such details relating to valuation of WIP in respect of ES. The CIT(A) will thereafter decide the aforesaid issue afresh in accordance with the provisions of law and after providing reasonable opportunity to both sides. It may also be worthwhile to add that so far as the addition sustained by the CIT(A) to the extent of Rs. 1,42,09,213 is concerned, the same has achieved finality as assessee has not filed any further appeal or cross-objection against the said confirmation of the part amount of the said addition. 3.2 Ground No. 2--Relating to deletion of the addition of Rs. 1,58,30,000 in respect of WIP relating to Inland transportation T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ." 3.2. (iii) The assessee has accepted the said addition partly sustained by the CIT(A) to the extent of Rs. 44,98,300 as no further appeal or cross-objection have been submitted by the assessee before the Tribunal. 3.2. (iv) The learned Senior Departmental Representative relied upon the reasons mentioned in the assessment order. He submitted that the CIT(A) has erred in reducing the said addition from Rs. 1,58,30,000 to only Rs. 44,98,300 by taking into consideration the net surplus in IT for the period upto31st March, 1991, when the project was completed. He has ignored the fact that a scrutiny in relation to transport expenses was necessary with a view to find out whether the credits or revenue of inland transportation had a direct nexus with the expenses for IT incurred by the assessee. The IT might have been incurred for the assessee for execution of erection portion of the contract, civil, structural and architectural portion of the contract and such expenses for IT could be charged from NTPC along with running bills of the contracts in question. It is not known whether revenue recognised in the IT covers reimbursement of all the IT expenses incurred by the assessee. Such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r consideration. The system of recognising revenue relating to IT also ought to have been examined keeping in view the relevant terms of contract the system of preparing invoices for IT, and all other relevant factors. The tax is leviable on income of the previous year relating to the assessment year under consideration. During the year under consideration, the assessee had incurred cost of Rs. 4,45,18,000 on IT. Out of this, the AO disallowed 92.05 lakhs separately vide paras 26 to 29 of the AO. That left a balance of Rs. 3,53,13,000 against which receipts accounted for in the year under consideration was only Rs. 1,94,83,000. The balance amount of Rs. 1,58,30,000 was part of the net cost, incurred by the assessee under the head IT relating to execution of the said contract. The amount in question which form part of the cost of execution of contract/WIP had to be recovered from NTPC in accordance with the system of billing in confirmity with the terms of the contract. The nature of cost incurred under the head "IT", the nature of revenue recognised under this head, the system of billing, the relevant terms and conditions of the contract, had to be carefully examined by the CIT(A) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the same in view of the judgment of Hon'ble Allahabad High Court in the case of CIT vs. Bazpur Co-operative Sugar Factory Ltd. (1982) 30 CTR (All) 266 : (1983) 142 ITR 1 (All). 3.3. (ii) the CIT(A) held that the bridge over river Yamuna was constructed by the assessee-company for the transportation of over-dimensional consignment to the work site without which the project could not have been completed. It is also clear from the certificate of the Uttar Pradesh Public Works Department that the bridge over river Yamuna and the bye-pass roads constructed for the said transportation were of temporary nature and were to be demolished after the necessary use. The CIT(A) considered the judgments of the Hon'ble Supreme Court in the case of Bombay Steam Navigation Co. (P) Ltd. vs. CIT (1965) 56 ITR 52 (SC), judgment in the case of Empire Jute Co. Ltd. vs. CIT (1980) 17 CTR (SC) 113 : (1980) 124 ITR 1 (SC) and judgment in the case of Bikaner Gypsum Ltd. vs. CIT (1990) 89 CTR (SC) 176 : (1991) 187 ITR 39 (SC). He further observed that the assessee had to incur expenditure on the construction of bye-pass road and temporary bridge on river Yamuna for the purposes of carrying on its business be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o Rs. 3,86,16,155 being 13.72 per cent of the gross receipts in respect of the Indian contract on the basis of the ratio of selling, general and administrative expenses recorded in the consolidated accounts of the company for the year ending 31st March, 1989. The assessee claimed that in view of art. III(3) of the DTA withJapan, the provisions of s. 44C are not applicable. The assessee placed reliance on the decision of the CIT(A),Bombay, dt.11th July, 1990in case of Nippon Kokan, K.K. The AO rejected the said contention and held that the matter would be governed by s. 44C of IT Act, 1961. The AO examined the assessee's claim with reference to terms and conditions prescribed in s. 44C and disallowed the entire claim of Rs. 3,86,16,155. 3.4. (ii) The CIT(A) examined the relevant art. III of DTA,Japan. He also considered the decision of Tribunal, Jaipur in the case of Degramont International involving consideration of a similar article contained in the corresponding DTA in that case. After considering the said decision, the learned CIT(A) gave the following findings in para 6.1 of the order passed by him: "6.1 The provision of art. III of agreement for avoidance of double taxation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t aside and that of the AO should be restored. 3.4. (iv) The learned counsel for the assessee submitted that the provisions of DTA will override the provisions contained in IT Act. He contended that there is no dispute about the fact that the assessee has a permanent establishment inIndia. The relevant DTA withJapancontained inter alia the following clause in art. III(3). "In determining the industrial or commercial profits of a permanent establishment, there shall be allowed as deductions all expenses wherever incurred, reasonably allocable to such permanent establishment, including executive and general administrative expenses so allocable." As regards reasonably allocable expenses attributable to the contract carried out by the assessee in India, the learned lawyer invited our attention towards the notes to the financial statements annexed with the auditors' report appearing at p. 67 if the paper-book, which is reproduced hereunder: "Head office overheads are allocated to the Auraiya GCCP contract in proportion to the world wide turnover of the company, as certified by the head office auditors inJapan." He thus, strongly supported the order of the CIT(A) and relied upon the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent is located, it has been so specifically provided in the DTA. In the present case, the learned lawyer contended that the relevant DTA pertaining to the year under consideration clearly provides in art. III(3) that in determining the industrial or commercial profits of a permanent establishment, there shall be allowed as deduction all expenses, wherever incurred reasonably allocable to such permanent establishment. This clearly shows that the entire expenditure incurred by the assessee which are attributable to the permanent establishment in India ought to have been allowed in full by the AO and the provisions of s. 40A(3), 40A(12), 37(2A), r. 6D providing for certain disallowances or limitations of allowable expenses will not apply. 3.5. (iii) We have carefully considered the submissions made by the learned representatives of the parties and have perused the orders of the learned Departmental authorities as well as other documents to which our attention was drawn during the course of hearing. 3.5. (iv) The CIT(A) while granting this relief has relied upon the art. III(3) of DTA with Japan and on s. 90(2) inserted by the Finance (No. 2) Act, 1991 with retrospective effect from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esident taxpayers--43. Tax treaties generally contain a provision to the effect that the laws of the two contracting States will govern the taxation of income in the respective States except when express provision to the contrary is made in the treaty. It may so happen that the tax treaty with a foreign country may contain a provision giving concessional treatment to any income as compared to the position under the Indian law existing at that point of time. However, the Indian law may subsequently be amended, reducing the incidence of tax to a level lower than what has been provided in the tax treaty. 43.1 Since the tax treaties are intended to grant tax relief and not put residents of a contracting country at a disadvantage vis-a-vis other taxpayers, s. 90 of the IT Act has been amended to clarify that any beneficial provision in the law will not be denied to a resident of a contracting country merely because the corresponding provision in the tax treaty is less beneficial." The provisions of s. 90(2) will, therefore, be applicable with retrospective effect to ensure that any beneficial provision in the IT law will not be denied to a resident of a foreign country, merely because ..... X X X X Extracts X X X X X X X X Extracts X X X X
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