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TMI Blog2010 (9) TMI 900X X X X Extracts X X X X X X X X Extracts X X X X ..... disallowance of Rs. 3,12,57,152 paid on settlement of dispute which was incurred wholly and exclusively for the purpose of business. 1( b ) That the learned CIT(A)-V has erred both on facts and in law in upholding that the payment of Rs. 3,12,57,152 in pursuance of settlement of private business dispute between the appellant and Semco Inc. USA was not allowable under Explanation to section 37(1). 1( c ) That the learned CIT(A)-V has erred on fact in arbitrarily giving a finding that it is clear beyond doubt that there was an infringement of the US Patent Law by the assessee. 2. That the order passed by the learned CIT(A)-V is bad in law and against the facts of the case and therefore the disallowance of Rs. 3.12,57,152 may be deleted." 3. Relevant facts as borne out from the orders of the authorities below and the contentions of both the parties are summarized as under : In this case the assessee filed its return of income on 31-10-2005 declaring total income at Rs. 2,49,28,630. This return was processed under section 143(1) of the Act on 19-3-2006. Thereafter, the case was selected for scrutiny assessment. The Assessing Officer issued notice under section 143(2) on 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment of US$ 6,75,000. It was thus claim of the assessee that the payment was compensatory in nature to compensate the loss incurred by Semco as a result of selling the product covered by patent hold by Semco, to Venmar. The. assessee also filed certain documents along with its submissions. 3.3 The Assessing Officer then examined the assessee s explanation along with relevant documents filed by the assessee. From the document which includes letters dated 2-9-2004 and 3-9-2004 of the legal consultant of the assessee company, it was noticed by the Assessing Officer that the litigation was subsisted due to infringement of Semco s US Patent bearing No. 4769053 caused by the assessee company and its customers for manufacturing and marketing of the energy recovery wheel product, and Semco had already sued Venmar in the same Court for infringement of Semco s patent by selling the assessee company s product in their patented territory; and during that legal proceedings pending before the Court, Venmar acknowledged that the patent held by Semco was valid and enforceable and thus agreed not to sell products that would infringe the patent of Semco and accordingly compensated Semco for such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... llowed the payment of compensation paid by the assessee to settle the dispute and added the same to the assessee s total income. 4. Being aggrieved, the assessee preferred an appeal before the learned CIT(A). The facts as placed before the Assessing Officer were reiterated before the learned CIT(A). It was then submitted by the assessee before the learned CIT(A) that whatever allegation made by Semco were totally denied and disputed by the assessee and it then pursued the litigation for three years. However, keeping in view the cost of litigation and the advice given by its legal consultants, the assessee found it expedient and proper to make out of Court settlement and paid the amount equivalent to US$ 6,75,000 converted into Indian currency at Rs. 3,12,57,152. The assessee company argued before the learned CIT(A) that the settlement was not on account of any infringement of any law in as much as no Court of law held anything or given any finding against the assessee company. It was, therefore, contended that the assessee s case is not covered by Explanation to section 37(1) of the Act and therefore, the payment made in the course of carrying on assessee s business activity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der prohibiting a person from making payment of protection money but nonetheless the payment will be for a purpose prohibited by law and would not be allowable under section 37. Therefore, this argument regarding the necessity of an order from an authority or Court for making a disallowance under explanation to section 37(1) does not hold good. Another argument forwarded by the learned Authorised Representative that the payment was compensatory in nature. As it evident to this facts as discussed above, there was clear-cut infringement of the Patent Act and the out of Court settlement was in order to avoid the penal consequences of this infringement. It was therefore for a purpose which was prohibited by law. In light of these discussions, I, therefore, hold that the disallowance of Rs. 3,12,57,152 was correct and this ground is dismissed." Still aggrieved, the assessee is in appeal before us. 5. The learned counsel for the assessee Shri S.D. Kapila, advocate assisted by Shri R.R. Maurya, advocate, Shri Shailender Bajaj and Miss Charu Kapoor, chartered accountant, has drawn our attention to the orders of the authorities below and narrated the facts of the case and the backgrou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, therefore, of revenue in nature. 5.1 The learned counsel for the assessee further submitted that the assessee manufactures and sells energy saving wheels in India, which contain the alleged desiccant/component, and export to foreign companies was made ex-Indian ports and thus, it does not sell these goods either within or from USA or Canada. The assessee sells these goods only within India and also by way of exports from India. Since no patent of Semco is registered in India, there would be no violation of any patent laws in India. He further pointed out that the dealing with Venmar was made at arm s length on a principal to principal basis and the goods, were exported ex-Indian ports to Venmar and the assessee had no control over disposal of the goods by Venmar or any other importer after these goods left Indian ports. In this sense of the relation between the assessee and Venmar, the learned counsel for the assessee submitted that no question of inducing Venmar to violate patent law of USA could arise. 5.2 He further submitted that merely because Venmar has made settlement with Semco that by itself is not sufficient to conclude that the assessee has violated any patent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... There is absolutely no evidence to show that the assessee had any influence on Venmar or that it "induced" Venmar to sell its products, in USA or Canada where Semco allegedly held the ownership of the patent of the impugned component of the wheel . lKeeping in view the object of insertion of Explanation to section 37 and judicial, pronouncements under General Clauses Act and Contract Act, the terms offence and prohibited by law in force in India and prohibited by law of other countries . lThere is no infringement of patent law of USA and nor has it been held so by any Court in USA. The lower authorities have also not shown as to how US law would apply to any acts carried on by the assessee within the territories of India. lThere is clearly no infringement of any patent law in India. lBoth Assessing Officer and CIT have jumped to conclusion without referring to any provision of US, law or Indian law relating to infringement of patent. lIn absence of any violation of the provisions of Indian Patent Act, the payment under settlement with Semco does not fall within the meaning and scope of expression offence and prohibited by law used in Explanation to section 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itigation under any statute and not the nomenclature of the payment as given in the relevant statute to find out as to whether the payment is compensatory or penal in nature. He, therefore, submitted that merely because the payment was made to compensate the holder of the patent right for infringement of his patent would not mean that the payment was compensatory in nature and not as a penalty for the act which is prohibited under the law. He also relied upon the decision of Hon ble Supreme Court in the case of Prakash Cotton Mills (P.) Ltd. ( supra ), on which reliance was also placed by the learned counsel for the assessee. 6.1 The learned Departmental Representative further carried us to the various reasons and observations made by the Assessing Officer as well as by the CIT(A) in their respective orders while holding that the payment in question made by the assessee is not an allowable, expenditure as it is hit by the Explanation to section 37(1) of the Act. 7. Rival contentions of both the parties have been considered in the light of the factual matrix of the present case. We have carefully gone through the orders of the authorities below as well as various documen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is also not in doubt that before even insertion of Explanation to section 37(1) of the Act, the expenses incurred in connection with the violation of law etc. was not allowable. Explanation to section 37(1) is only inserted with a view to remove certain doubts about the allowability of payment on account of protection money, extortion, Hafta, bribes, etc. It is also well-settled that a distinction cannot be drawn between the expenses incurred in a civil litigation and expenses incurred in a criminal litigation. In both the cases, the test is whether the expenditure is incurred by the assessee in this character as a trader, in other words, whether the transaction in respect of which the proceedings are taken arose out of and is incidental to the assessee s business. Therefore, in this view of the matter, the contention of the learned counsel for the assessee that expenses incurred only in respect of payments on account of protection money, extortion, Hafta, bribes etc. are covered by Explanation to section 37(1) is not acceptable to us and is thus rejected. 11. It is well-settled that commission of offence or infraction of law cannot be said to be incidental to business. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omposite nature, that is, partly of compensatory nature and partly of penal nature, the authorities have to bifurcate the two components of the impost and give deduction of that component which is compensatory in nature and refuse to give deduction of that component which is penal in nature. Accordingly, in that case, the Hon ble Supreme Court remanded the case to the Tribunal for deciding the claims for deduction ( i ) of interest for delayed payment of sales-tax under the Bombay Sales-tax Act, 1959, ( ii ) of damages paid under the Employees State Insurance Act, 1948, for delayed payment of contribution, after examining the schemes of those Acts. In the present case we therefore, have to see as to whether the payment in question made by assessee is on account of any penalty for infraction of law, whether civil or criminal, or whether it is a payment incidental to the assessee s business. 12. Reverting to the facts of the present case, we find that the assessee had paid amount of Rs. 3,12,57,152 by way of settlement of dispute, arising from alleged violation of trademark/patent right held by one Semco, made out of the Court settlement. It is not in dispute that Semco Inc. USA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an run upto two million US dollars. Even if AIE/DRI were to eventually win the matter, the Courts do not normally award costs to a defendant in a patent litigation, particularly the US Attorney fees. We are aware that if the matter were to be taken to its logical conclusion AIE/DRI would end up spending a very huge sum of money. Keeping in view that AIE/DRI were already running at least sixty thousand US dollar towards the legal cost per month with no gains from the final outcome even if they win in the Court, it is considered prudent to settle the matter quickly with limited liability of US Six hundred and seventy-five thousand only rather than pursue litigation. Having considered the entire situation legally and from business point of view we believe that it is a perfectly sound business judgment to settle the matter with Semco rather than spend several times more in terms of legal cost, the outcome of which is entirely uncertain not to say the amount of professional time and energy that would be wasted. If you miss this opportunity to settle immediately, particularly keeping in mind, the imminent Court deadlines, you will end incurring huge legal cost, which would be sever ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e said agreement Semco had agreed to release, remise and forever discharge the assessee company and its agents, attorneys, consultants, officers, employees, representatives, heirs, successors and assigns and their customers from any and all claims, demands, or causes of action that arise out of or relate to the case that have been pending in the United States District Court for the Western District of Missouri, Jefferson City Division and any and all obligations, actions, causes of action, suits, debts, contracts, controversies, agreements, promises, damages, judgments, awards, executions, claims and demands whatsoever in law or in equity, and any and all claims for damages and attorneys fees and costs, based upon the violation of a federal State or other statute, regulation or law or arising out of any conduct, contract, employment, action, event or circumstance, under the law of any and all nations, whether known or unknown which occurred at any time upto and including the date of the execution of this agreement, except obligations created by this agreement, any associated licence agreement and/or by the consent judgment to be filed in accordance with that agreement. Similarly t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of any of the settling entities, or of Semco, or upon Court order, unless such terms are required to be disclosed in a legal proceeding, in which case the content and subject-matter of the agreement shall be disclosed only under an appropriate protective order, a confidentiality agreement or pursuant to an order of a Court of competent jurisdiction. 15. From the deed of settlement and the other surrounding circumstances, it seems to us that there is no finding by the Court by way of any judgment that the assessee has actually violated the provisions of any patent law enforceable in USA or Canada. The amount paid is neither a fine or a penalty for a proved offence nor an amount of compensation of an offence but is merely a sum in settlement of an action charging the assessee with infringement of patent right, and the guilt alleged upon the assessee was denied and not proved. In the present case, in the settlement agreement nothing is averted that the assessee company knowingly and willingly induced Venmar to sell the goods in USA in infringement of patent right held by Semco. The assessee has manufactured the goods in question in India, and the manufacturing and "selling goods ..... X X X X Extracts X X X X X X X X Extracts X X X X
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