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TMI Blog2007 (10) TMI 322X X X X Extracts X X X X X X X X Extracts X X X X ..... ee/affiliates of the collaborator of the appellant was excessive and unreasonable and the action of the AO in invoking the provisions of Section 40A(2) and Section 92 of the Act was justified to the extent of such excess. 1.1.2. That the CIT(A) erred on facts and in law in holding that the appellant has failed to establish with supporting evidences that payment of commission @ 12.5 per cent was reasonable. 1.1.3. That the CIT(A) erred on facts and in law in not appreciating that the AO did not discharge the onus of bringing on record any comparable instance to show that the payment of export commission was excessive. 1.1.4. That the CIT(A) erred on facts and in law in holding that the AO could not bring any identical comparable case as the nature of services to be rendered for earning such commissions varies from case to case. 1.1.5. The CIT(A) erred on facts and in law in appreciating that in the facts and circumstances of the case the payment of export commission was commensurate with the business necessities of the appellant and was not excessive or unreasonable. 3224 /Del/2005: (Grounds of appeal of Revenue) 1. On the facts and in the circumstances of the case and in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l Development Corpn. Ltd. (GMDC) and Gujarat Alkalies & Chemicals Ltd. (GACL) to undertake manufacture of float glass in India. Guardian International Corpn., USA owns 50 per cent of the equity capital of the assessee company. The assessee was originally known only as GACL. Later on GACL became Gujarat Guardian Ltd. after change of name i.e. the assessee. 5. Original foreign collaboration agreement dt. 5th June, 1990 between GIC, MRL, and GACL contemplated the assessee entering into an export sales agreement whereby GIC or any of affiliate of GIC was to act as sole exclusive agent for the sale of float glass manufactured by the assessee in countries other than India. The commission payable to GIC or affiliate of GIC was agreed at 5 per cent of net FOB selling price. This was the maximum payment as per the prevailing law in force at that point of time. Even prior to the foreign collaboration agreement dt. 5th June, 1990 GACL had obtained letter of intent from the Ministry of Industry for establishing float glass plant in the State of Gujarat. The terms of approval contemplated that the assessee would export at least 25 per cent of the annual production. The assessee had imported ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xport realizations were less than the cost price. It was however, submitted that the price at which sales were made by the assessee was at the prevailing international prices and that there cannot be any link between the cost of production and payment of commission. According to the AO, the commission paid at 12.5 per cent was contributing to the cash loss of the assessee. The further case of the AO was that the change in the law permitting payment of commission from 5 per cent to 12.5 per cent without any permission of RBI also was another factor which was taken advantage by the assessee to pay commission at increased rate to offset the nonpayment of royalty due to conditions imposed by the financial institutions. 8. Apart from the above, the main case of the AO for disallowing the claim of the assessee for deduction of the commission expense was the inability of the assessee to substantiate the services rendered by GGE for which commission was paid. The findings of the AO in this regard were as follows: (a) The plea of the assessee in support of the claim for deduction of commission was that assessee did not have any sales office outside India nor any sales personnel to look a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the export market. Despite repeated requests to explain the reasons with supporting evidences, nothing was submitted or produced to justify huge differences. (k) That the payment to a person having substantial interest is not justified in view of the provisions of Sections 92 and 40A(2) of the Act. For the above reasons, the AO disallowed the claim for deduction of a commission. 9. Before CIT(A). The assessee contended as follows: (a)The plant of the assessee company commenced commercial production on 1st March, 1993. The domestic sales of float glass manufactured by the plant were not as anticipated leading to piling of inventory, thereby, increasing dependence on exports, apart from the export obligation which had to be fulfilled, in any case. The export sales agency agreement dt. 20 July, 1993 was signed between Guardian Glass Exports Ltd. (GGE), an affiliate of Guardian Industries Corp. which was nominated by Guardian International Corporation and the assessee company. In view of the increased involvement of Guardian in the promotion of exports, the said agreement provided for payment of commission at 12.5 per cent of the net FOB value of export, as against 5 per cent me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1994-95 43,24,72,033 4,79,91,164 1,04,491 -do- 1995-96 90,09,62,030 10,07,22,626 8,70,84,452 Disputed in appeal 1996-97 49,43,67,568 4,40,29,507 37,16,113 1997-98 32,77,74,975 2,91,11,445 4,97,576 1998-99 55,26,68,903 5,31,08,480 12,38,91,331 Total 2,80,56,70,692 28,52,52,778 21,62,34,387 It was submitted that there was no basis for the disallowance in the year under appeal, when there is no change in facts. (e) It was contended that Section 40A(2) of the Act clothes the AO with power to disallow deduction for any expenses claimed if the AO is of the opinion that the same is excessive having regard to the fair market value of such services and the legitimate needs of the business. The AO has not brought any material on record to show how Section 40A(2) was applicable to the present case. The provisions of Section 92 provide that where the business between a resident and a non-resident is so transacted that no profits or less than ordinary profits accrue to the resident, then, the AO may determine the amount of profits which may be deemed to have been derived from such business and include the same in the total income of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r cent agreed upon at the time of collaboration agreement to 12.5 per cent of the FOB value later is not supported by any strong arguments. The only reason given for enhancement of the commission from 5 per cent to 12.5 per cent was that the appellant has to depend on exports for disposal of the inventory that was piling up apart from carrying out exports to fulfill the export obligation imposed by Government while approving the collaboration agreement and undertaken under the EPCG scheme. At the time of collaboration agreement itself its foreign collaborator was aware of the export obligation imposed by the Government of India while approving the collaboration agreement. Moreover, there was hardly any profit arising out of the exports and the appellant was not able to recover even the cost price through exports. Under the circumstance enhancing the commission from 5 per cent to 12.5 per cent to the nominee/affiliates of its collaborator is unreasonable. The AO's reference to Section 40A(2) and Section 92 is, therefore, justified to the extent of disallowance of 6.5 (sic-7.5) per cent (i.e. difference between 5 per cent and 12.5 per cent) as the assessee has failed to establish ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lusive sales report (sic-agent) for soliciting Orders for the assessee's products in all the countries of the world except the Union of India. The assessee also agreed to pay 12-1/2 per cent of the invoice price of all the export sales of products sold outside India. The agreement was to be in force for a period of 5 years from 20th July, 1993 with option to renew for a period of further 5 years. 16. GGE have raised invoice for every month in respect of the export sales. Copies of this proforma invoice are available at pp. 92 to 102 of the assessee's paper book. At pp. 374 to 378 the assessee has given the list of customers to whom export sales were made during the previous year. The assessee has also listed communication between the assessee and the sales executives of the Guardian Group and the Orders procured by them. Guardian Industries Corporation, USA is amongst the top four float glass manufacturers in the world and it has 20 float glass plants in the various parts of the world and have wide marketing network having sales executives based in over 40 countries. The services rendered by GGE as part of the Guardian Industries Corporation, USA have already been enumerat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome of the existing manufacturers of sheet glass also converted part of their existing facilities for manufacture of float glass resulting in over capacity and excess supply. There was excess production capacity of about 40-50 per cent in comparison to the domestic demand. (iii) Low domestic demand--Float glass was originally sold at prices 15-20 per cent higher than sheet glass. Sales during the period February, 1993 to July, 1993 was only 43 per cent of the production while the balance remained in the inventory. The assessee had to depend on exports for disposal of the inventory that was piling up, apart from carrying out exports to fulfill the export obligation (i) imposed by Government while approving the collaboration agreement, and (ii) undertaken under the EPCG Scheme. The assessee being a new entrant in the field did not have any infrastructure or set up for procuring/facilitating export sales. The assessee solely relied on the Guardian Group for promotion of export. All the export Orders/contracts are procured by GGE. The emphasis on exports warranted a much larger role for Guardian in promotion of exports than envisaged at the time of signing the collaboration agreement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applying the provisions of Section 40A(2) has merely gone by the fact that the obligation for export existed even prior to the export sales agency commission agreement dt. 20th July, 1993 and even at this point of time there was piling up of inventory. The CIT (A) found that there was no profit arising out of exports and, therefore, there could be no circumstance necessitating enhancement of commission. For the above reasons the CIT(A) invoked the provisions of Section 40A(2) and Section 92 of the Act. We are of the view that the action of the CIT(A) in this regard cannot be sustained. Provisions of Section 40A(2) contemplate a disallowance subject to the condition that the Revenue establishes that the expenditure was excessive or unreasonable having regard to the fair market value of the goods and services or facilities for which the payment has been made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to the assessee therefrom. We do not find any evidence as to what is the fair market value of the services for which assessee paid commission. The percentage of 5 per cent agreed between the parties prior to 20th July, 199 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in law in not capitalizing training fees as part of plant and machinery, and allowing depreciation thereon, allegedly holding that the appellant failed to establish the nexus between such expenses and the assets. 21. We have already noticed that the assessee had a collaboration agreement with GIG, M/s GIC trained personnel of the assessee company in the operation and maintenance of float glass plant and also the manufacturing and marketing of float glass. The personnel of the assessee company underwent training at different locations between 21st Sept., 1991 and 16th Dec, 1992. This period was admittedly before the plant was set up. In September, 1995 that is the previous year relevant to asst. yr. 1996-97 the assessee received invoice from GIC in respect of amounts payable for imparting training prior to the period when the plant was set up. The amount payable was shown as a deferred revenue expenditure in the balance sheet for the financial year relevant to asst. yr. 1996-97. In the return of income for asst. yr. 1996-97, the entire sum was claimed as deduction as a revenue expenditure. The assessee claimed that because the invoice was received from GIC during the previous year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tructuring of debt. IDBI vide letter dt. 19th March, 1995 agreed to inter alia reduce the rate of interest on rupee loan to 15 per cent per annum, effective 1st April, 1995 upon payment of lump sum prepayment premium of Rs. 6 crores. The pre-payment premium of Rs. 8 crores was paid during the previous year relevant to the assessment year under consideration and debited to the P&L a/c. The same was claimed as business expenditure while computing the income of the assessee. The AO called upon the assessee to explain as to how the pre-payment premium is allowable deduction in its entirety during the asst. yr. 1996-97, more so in view of the decision of the Supreme Court in the case of Madras Industrial Investment Corporation Ltd. v. C.A.T. (1997) 139 CTR (SC) 555 : (1997) 225 ITR 802 (SC). In response thereto the assessee submitted that Section 36(1)(iii) of the Act allows deduction for interest paid on moneys borrowed for purposes of business. That "Interest" is defined in Section 2(28A) of the Act as under: Section 2(28A)--Interest' means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent value) of differential rate of interest that would have been due on the loan if no restructuring of the debt had taken place. In terms of Section 36(1)(iii) r/w Section 2(28A) of the Act prepayment charges being interest paid on moneys borrowed for purposes of business, are to be allowed deduction as revenue expenditure. The prepayment premium being revenue expenditure, is to be allowed deduction in the year of accrual thereof, since the Act does not recognize the concept of deferred revenue expenditure. 26. The decision of the Chennai Bench of the Tribunal in the case of 'Overseas Sanmar Financial Ltd. v. Jt. C.I.T. (2004) 87 T.T.J. (Che) 556 : (2003) 86 I.T.D. 602 (Chennai) also supports the plea of the assessee. Besides the above Section 43B (d) also permits claiming deduction on actual payment. Even on this basis the claim of the assessee deserves to be accepted. Ground No. 3 is accordingly allowed. 27. Ground No. 4 raised by the assessee reads as follows: 4. That on the facts and circumstances of the case the CIT (A) erred in not allowing/directing the AO to allow depreciation in terms of Section 32 of the Act. For the relevant previous year the return of income ..... X X X X Extracts X X X X X X X X Extracts X X X X
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