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TMI Blog2011 (8) TMI 485X X X X Extracts X X X X X X X X Extracts X X X X ..... n of the revenue in this regard. Applicability of provisions of section 40A(2) - Assessing Officer in the assessment year 1997-98 after recording that the shares of the assessee were held by six (6) entities goes on to observe that the assessee "became a subsidiary of Shaw Wallace Group of Companies" - There is no finding recorded by the Assessing Officer that SWCL had acquired substantial interest i.e., 20 per cent or more of the share capital with attending voting rights, whether directly or beneficially - If that is so, then the provisions of section 40A(2)(a) could not have got triggered - Further, CIT(A) records that six (6) individuals held ten (10) shares each in the assessee while, one gentleman by the name of Mr. Suraj P. Gupta held 8,61,610 shares who was neither an employee of the assessee and nor was any payment made to Mr. Suraj P. Gupta or his relative or to a company of which he was a Director - Held that:-payments had not been made to persons specified under section 40A(2)(b) and therefore, the provisions of section 40A(2) were not applicable. X X X X Extracts X X X X X X X X Extracts X X X X ..... e in the manufacture of IMFL products. The sample spirit shall be in accordance with the specifications and tolerances given in Appendix 'A'. 2.2 The UNIT shall procure spirit in such form as may be agreed to by Shaw Wallace in conformity with the sample, specifications and tolerances in such quantities as may be required for the purpose of utilizing the same for the manufacture of IMFL products. 2.3 Unless otherwise agreed in writing the 'spirit' shall mean manufactured and distilled out of raw materials molasses. 2.4, 2.5 and 2.7** ** ** 3. Manufacture/Bottling of IMFL 3.1 The UNIT hereby undertakes to manufacture different brands of IMFL, which Shaw Wallace may specify taking into account the market condition from time to time. 3.2** ** ** 3.3 Unless otherwise agreed to in writing the IMFL products shall be supplied and delivered to the purchasers in bottles sealed, labelled and packed in cartons. 3.4 and 3.5** ** ** 3.6 The packing material shall be as per the specifications of Shaw Wallace as regards size, shape, design, quality etc. Such packing materials shall also conform to the statutory regulations as may be laid down from time to time by the Excise and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts shall be sent to the UNIT along with the indents with full particulars of the type of products to be dispatched by the UNIT and the place, date and mode of such dispatch. 4.5** ** ** 5.** ** ** 6. Trade Marks and Marketing 6.1 The trade marks, brand names, design and the get up in which the IMFL products will be sold, supplied and delivered by the UNIT and in particular and not limited to those listed in APPENDIX 'C' hereto shall always be the sole property of Shaw Wallace or its associate or related companies as the case may be. 6.2 The UNIT hereby acknowledges and accepts that the UNIT never had nor has any right title or interest therein and shall not at any time claim any right whatsoever to the use of the labels, brand names, trade marks and or get up of the IMFL products belonging to Shaw Wallace or to the nominees associates of Shaw Wallace except under written permission from Shaw Wallace. 6.3 Shaw Wallace hereby authorizes the UNIT as a licensee, under a separate agreement to manufacture, process package and sell the IMFL products of various brands of Shaw Wallace as contained in the APPENDIX 'C' and such other brands as may be agreed upon from time to time f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aw Wallace and or any similar trademarks upon termination of this agreement for any reasons whatsoever in respect of the goods of Shaw Wallace or goods of the same description or any other goods.. 8.4** ** ** 9. and 10.** ** ** 11. Assigment The UNIT shall not assign subject or part with the rights and obligations under this Agreement which are personal to the UNIT provided however Shaw Wallace may at any time designate any of its subsidiary company to undertake the work under this Agreement and be the beneficiary of the terms and conditions of this agreement." [Emphasis supplied] 4. At this stage it may also be relevant to note that insofar as the provision for consideration payable under the said agreement is concerned, the details are largely provided in appendix 'D'. The relevant portion of appendix 'D' reads as follows : "Consideration 1. The prices at which Shaw Wallace will purchase IMFL products from the UNIT will be computed as under : (i) Actual cost of Sprit incurred by the UNIT as per Shaw Wallace's direction Plus (ii) Actual cost of Electricity and Water charges Plus (iii) Actual cost of Labour and other expenses which are incurred by the UNIT (wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of royalty paid to SWCL in consonance with the said agreement. The assessee submitted that the amount paid was expended wholly and exclusively for its own business and hence, the expenditure incurred deserved to be allowed fully. 7. The Assessing Officer, however, disagreed with the explanation rendered by the assessee as according to him, this was a case of 'transfer of income' having been undertaken by employing a device of setting up a separate entity. The Assessing Officer came to the conclusion that the day-to-day management and control of the assessee company lay with the Shaw Wallace Group. The fact that the Shaw Wallace Group held majority shares in the assessee was not even disclosed in the audit report or, notes to the accounts or even in the tax audit report, and that, this fact emerged only during the course of assessment. The Assessing Officer compared the bottling charges, which were received by another entity by the name of Balbir Distilleries Limited located at Solan, Himachal Pradesh from SWCL, with that, which were received by the assessee. According to the findings returned by the Assessing Officer, Balbir Distilleries Ltd., received towards bottling charges R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ned in the Explanation thereto. According to this if a company has 20 per cent of the voting power or more it is said to have a substantial interest. The Assessing Officer has already pointed out that the majority share holding is by the SW which has not been contravened. The ld. AR further submitted that the employees of SW have the controlling share holding. Therefore, the payment of royalty to SW is covered under section 40A(2) and it has to be seen whether the payment is excessive or unreasonable." 8.1 In conjunction with the above, the CIT(A) took note of the difference in bottling charges paid to Balbir Distilleries Ltd., as against that which was paid to the assessee. The CIT(A) sustained the findings of the Assessing Officer that this was a case of transfer pricing. Accordingly, he disallowed a sum of Rs. 24,70,929 out of the total sum claimed, i.e., Rs. 84,01,160 under section 40A(2) of the Income-tax Act. As regards the balance sum, i.e., Rs. 59,30,231 (84,01,160 - 24,70,929) he applied the provisions of section 35A of the Income-tax Act. Thus in consonance with the provisions of section 35A, the CIT(A) allowed 1/14th of the said amount, i.e., Rs. 4,23,588. Resultantly, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ded to it, purchase of raw materials, packing materials and in obtaining import permits, etc. 11. Insofar as the second aspect is concerned, i.e., whether the payments were hit under section 40A(2) of the Income-tax Act, the CIT(A) returned the following finding of fact while disagreeing with the view taken by the CIT(A)-XIV, New Delhi vide his order dated 20-2-2001 pertaining to assessment year 1997-98 :-- "The second issue relates to the applicability of provisions of section 40A(2). The equity capital of the appellant company as on 31-3-1997 was held by the following investment companies and individuals and number of shares held by them are indicated against their names : (i) Alaknanda Manufacturing and Finance Ltd. 5,18,800 (ii) Tribtis Investment Ltd. 4,50,000 (iii) Manaswar Wall Investment Ltd. 3,60,000 (iv) Canver Investment Ltd. 1,35,000 (v) Maharashtra Distilliaries Ltd. 87,930 (vi) Sh. Suraj P. Gupta 8,61,610 (vii) Six individuals holding shares 10 each 60 It may be noted that not a single share is not held by the Shaw Wallace & Co. Ltd….. 5.3 ….. In the instant case the payment has not been made to any director of the company or a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... diture does not arise though the appellant has given explanation for differential rate of payment of bottling charges to the Balbir Industries…." [Emphasis supplied] Assessment year 1999-2000 12. The Assessing Officer noticed a sum of Rs. 10,20,35,544 had been debited to the profit and loss account as payments made on account of royalty to SWCL. The Assessing Officer more or less adopted the view taken in the assessment year 1997-98 and came to the conclusion that the assessee had along with SWCL put in place the present arrangement only to transfer profits. The Assessing Officer in the net result allowed only 1/14th of the amount claimed; resultantly, a sum of Rs. 9,97,78,120 was disallowed. 12.1 Being aggrieved, the matter was carried in appeal by the assessee once again to the CIT(A). The CIT(A) in this assessment year agreed with the views taken by his predecessor in the assessment year 1997-98, while disagreeing with the view taken by his other predecessor in the assessment year 1998-99. The net result was that CIT(A) confirmed the disallowance of Rs. 9,97,78,120 as ordered by the Assessing Officer. 13. As noticed in the very first paragraph hereinabove, appeals wer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty of the provisions of section 40A(2) of the Income-tax Act was concerned, the Tribunal was of the view that the Assessing Officer had failed to bring any evidence on record that SWCL held majority shares in the assessee. In this connection the Tribunal also noticed that the revenue was obliged to show that SWCL either held 20 per cent or more of the shares (including right to receive dividend) or 20 per cent or more of the voting rights in the assessee. The Tribunal deprecated the approach adopted by the Assessing Officer, which according to it, was not backed by cogent findings that SWCL had a substantial interest in the assessee's business. The Tribunal after noticing the divergent views expressed by the CIT(A) in assessment year 1998-99 as against those taken in 1997-98 and 1999-2000, approved the view of the CIT(A) taken in assessment year 1998-99, including the reasoning given therein. 16. On the aspect of the difference in bottling charges paid to the assessee, as against those paid to one Balbir Distilleries Ltd., by SWCL; in paragraph 29, the Tribunal accepted the rationale provided by the assessee that at the time at which SWCL had entered into a bottling agreement with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dverse inference ought to be drawn against the assessee. To buttress her contention that the payments made for use of trademark and brand names were in the nature of capital expenditure, reliance was placed on the observations made by this court in CIT v. J.K. Synthetics Ltd. [2009] 309 ITR 371/176 Taxman 355 in paragraph 58 at page 414. 17.2 Insofar as the invocation of provisions of section 40A(2) was concerned, Ms. Rashmi Chopra submitted that the Assessing Officer had noticed in paragraph 2 of his order dated 27-3-2000, passed in respect of assessment year 1997-98, that shares in the assessee had been acquired by six (6) entities; and thus according to her the SWCL group had substantial interest in the assessee. She submitted that if this was so then the conclusion of the Tribunal that the provisions of section 40A(2)(b) were not attracted, is erroneous. 17.3 It may, however, be noted here that Ms. Rashmi Chopra did contend that the Assessing Officer had returned no finding as to the exact shareholding interest, and thereby, the extent of voting power acquired by SWCL in the assessee. She submitted that the Assessing Officer had admittedly only referred to the number of share ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re not attracted. On the other aspect as to whether the expenditure incurred by the assessee by way of royalty was excessive or unreasonable, having regard to the fair market value of the goods in issue, it was the learned counsel's say that in order to attract the provisions of the said section, the conditionalities provided therein had to be fulfilled. 19.1 Mr. Vohra submitted that ordinarily expenses incurred by the assessee in connection with his business or profession had to be allowed notwithstanding the alleged imprudence of such expenditure from the point of view of the Assessing Officer. The expenditure incurred was amenable for deduction under the provisions of section 37 of the Income-tax Act. The Assessing Officer if at all obtained jurisdiction to disallow a certain part of the expenditure on the ground that it was either excessive or unreasonable having regard to the fair market value of the goods, services or facilities in issue or by applying the test of legitimate needs of business or profession of the assessee or the benefit derived by or accruing therefrom to the assessee by virtue of the provisions of section 40A of the Income-tax Act. In order to trigger the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o ultimately disallow 13/14th part of the expenditure incurred, in the said assessment year, by taking recourse to section 35A of the Act. The CIT(A) in the said assessment year i.e., assessment year 1997-98 bifurcated the disallowance by invoking both the provisions, that is, section 40A(2)(a) and section 35A. The result was that the disallowances crystallized by the CIT(A) was higher than that which had been made by the Assessing Officer. 21. In the subsequent assessment years (i.e., 1998-99 and 1999-2000) the Assessing Officer and in assessment year 1999-2000 has ultimately disallowed a part of the expenditure by invoking the provisions of section 35A of the Income-tax Act; the only exception being the order of CIT(A) in assessment year 1998-99. Therefore, we would first like to deal with the revenue's stand that the expenditure had to be disallowed partially that is to the extent of 13/14th by taking recourse to section 35A. Sub-section (1) of section 35A requires broadly three (3) conditionalities to be fulfilled for it to be triggered :-- (i) the expenditure ought to have been incurred after 28-2-1966; (ii) the expenditure should be related to acquisition of patent right ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cture the product, in respect of, which "access" to knowledge was obtained during the subsistence of the licence. (f) whether any secret or process of manufacture was sold by the licensor to the licensee. Expenditure on obtaining access to such secret process would ordinarily be construed as capital in nature; (vi) the fact that assessee could use the technical knowledge obtained during the tenure of the license for the purposes of its business after the Agreement has expired, and in that sense, resulting in an enduring advantage, has been categorically rejected by the courts. The Courts have held that this by itself cannot be decisive because knowledge by itself may last for a long period even though due to rapid change of technology and huge strides made in the field of science, the knowledge may with passage of time become obsolete;" 22.2 The observation made in paragraph 58 at page 414 of the aforementioned judgment, on which reliance has been placed by the learned counsel for revenue seeks only to emphasise that the assessee in that case, had only acquired access to technology which was not related to any secret process or patent rights and thus in continuum it is mentione ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) entities goes on to observe that the assessee "became a subsidiary of Shaw Wallace Group of Companies". There is no finding recorded by the Assessing Officer that SWCL had acquired substantial interest i.e., 20 per cent or more of the share capital with attending voting rights, whether directly or beneficially. If that is so, then the provisions of section 40A(2)(a) could not have got triggered. It is noticed that the CIT(A) in the assessment year 1998-99 has returned a finding that there were five (5) limited companies apart from two (2) individuals who held shares in the assessee, but none of the entities adverted to, by the Assessing Officer, both in the assessment years 1997-98 and 1998-99 is SWCL. As a matter of fact, the CIT(A) in assessment year 1998-99 records that not a single share in the assessee is held by SWCL. The CIT(A) further records a finding of fact that, on a perusal of list of shareholders, it is clear that even the employees of SWCL did have ownership of a controlling share holding interest in the assessee. CIT(A) records that six (6) individuals held ten (10) shares each in the assessee while, one gentleman by the name of Mr. Suraj P. Gupta held 8,61,610 sh ..... X X X X Extracts X X X X X X X X Extracts X X X X
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