JUDGMENT
N. Kumar, J.
1. The Tribunal on an application filed by the Revenue has referred the following questions of law for our opinion under Section 256(1) of the IT Act, 1961 (for short hereinafter referred to as “the Act”):
1. Whether, on the facts and in the crrcumstances of the case, the Tribunal was right in holding that the expenses as claimed by the assessee constituted its genuine business expenses and that the same were allowable under Section 37(1) of the IT Act, 1961 ?
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the interest shown as payable to M/s McDowell & Co. was actually allowable ?
2. The facts which led to this reference are briefly stated as hereunder:
The respondent-assessee M/s Mysore Wine Products Ltd. is a company which is a wholly owned subsidiary of M/s Consolidated Investments Ltd., which in its turn, is again a wholly owned subsidiary of M/s United Breweries Ltd. M/s McDowell & Co. Ltd. and M/s MWP Ltd. are two more subsidiaries of M/s United Breweries Ltd. The assessee-company was incorporated on 30th March, 1961 and was carrying on the business of trading in liquor upto the period ending on 31st March, 1977. It applied to the State Government for a licence to produce Indian Made Foreign Liquor (IMFL) and it obtained the licence on 10th July, 1974 effective from 1st July, 1974. It also acquired assets like land, building and an orchard at Kumbalgodu. Up to the year ending on 31st March, 1976 they have incurred expenditure of Rs. 79,100 towards acquisition of land and Rs. 60,020 towards acquisition of machinery.
3. On 22nd Dec., 1978 the assessee applied to the Excise Commr. for transfer of the manufacturing licence by way of lease in favour of its sister-concern M/s MWP Ltd. When the said application for transfer was pending before the Government, the assessee entered into two different agreements simultaneously on 8th March, 1979 with another sister-concern, M/s McDowell & Co. Ltd. (hereinafter for short called as “McDowell”). Under one agreement the assessee was to take on hire basis certain plant and machinery belonging to McDowell for which they agreed to pay an amount of Rs. 3 lakhs per month commencing from 1st April, 1979 to 30th June, 1979 and Rs. 4 lakhs thereafter from 1st July, 1979 by way of hire charges. This agreement was to remain valid for a period of three years. Under another agreement entered into on the same day McDowell was to make available to the assessee its know-how and other technical advise in the line of manufacture of liquors and wines. The assessee was required to make a monthly payment of Rs. 4 lakhs to McDowell from 1st April, 1979 for this know-how and the said agreement was also for a period of three years. By an order dt. 15th June, 1979 in terms of the Government letter dt. 7th June, 1979 the Excise Commr. ordered for transfer of the licence from the assessee in favour of M/s MWP Ltd. Thereafter, on 25th July, 1979 the assessee entered into an agreement with M/s MWP Ltd. under which it leased its distillery licence to the ‘extent of operation of manufacturing and bottling of IMFL at its factory to M/s MWP Ltd. on payment of lease amount of Rs. 1,000 per month. Simultaneously, the assessee also transferred the plant and machinery taken by it on hire from M/s McDowell along with technical know-how and other information. The said contract is contained in exchange of letter between the parties. Under the said contract M/s MWP Ltd. had to pay an amount of Rs. 2 lakhs per month w.e.f. 1st Aug., 1979 for utilising the facilities offered by the assessee. However, no formal agreement was entered into between the parties.
4. The assessments of the assessee for the period from 1980-81, 1981-82 were completed earlier in which the Department disallowed the expenditure incurred by the assessee paid by way of hire charges and consideration for transfer of know-how by applying Section 40A(2) as the difference of amounts of payments made by the assessee to McDowell towards technical service fees and rent of plant and machinery and those received by the assessee in turn from M/s MWP Ltd. from user of the said assets and facilities. The said disallowances were confirmed by the CIT(A). When the matter was taken by the assessee to the Tribunal, the Tribunal by its order dt. 13th Feb., 1985 set aside the orders of the authorities below and restored the matter back to the ITO for fresh disposal in accordance with law. While remanding the matter the Tribunal directed that either the agreements with McDowell should be viewed in isolation or all the agreements namely the agreement of the assessee with McDowell for acquisition of know-how and machinery, the agreement with MWP Ltd., for sub-letting them and the agreement with McDowell and the assessee for acquiring the liquor manufactured at cost or below cost should be taken together as a single transaction to ascertain whether they involved any extra commercial consideration. It also held, because of the recitals in the agreement dt. 25th July, 1979 of the assessee with MWP Ltd. that the assessee had preferred an application dt. 22nd Dec., 1978 to the Excise Commr, for permission to lease out their distillery licence in favour of MWP Ltd. If this were so, the assessee had to explain why the assessee agreed with McDowell on 8th March, 1979 for purchase of know-how and lease of machinery in spite of the decision already taken to lease out their distillery licence. The Tribunal found that this matter had not been investigated by the authorities below and they should throw considerable light on the intention of the assessee and the real reasons why the tripartite transactions came into being. The closeness of the companies, the shares of which are ultimately field by United Breweries Ltd. do provoke this enquiry and without such an enquiry, it is not proper either to confirm or delete the disallowance.
5. After the aforesaid order of remand, the assessing authority made fresh assessments for two years by seeking directions of the IAC under Section 144B. This time, the disallowance of the expenditure incurred was on the ground that the same has not been incurred wholly and exclusively for the purpose of business of the assessee under Section 37(1) of the Act. The AO while disallowing the said expenditure held, the arrangements for giving higher amounts by the assessee to McDowell and at the same time charging much lower amounts from MWP Ltd. had resulted in considerable gain for the other two companies and especially for MWP Ltd. as compared to the assessee itself. Secondly it was held, the benefits had been transferred by the assessee to MWP Ltd. as the latter was an infant organisation. It was also held to boost up the affairs of M/s MWP Ltd. with a subscribed share capital of Rs. 790, this arrangement has been effected. Thirdly it was held that, the entire arrangements had been entered into for reducing the tax liability of the group as a whole and especially in the field of sales-tax liabilities. Therefore, it was held that, the aforesaid expenses incurred by the assessee were not wholly and exclusively for the purpose of business of the assessee and are not allowable under Section 37(1). Aggrieved by the said order of the AO, the assessee preferred an appeal to the CIT(A). The CIT considered the entire material on record and was of the view that the IAC/ITO had not at all taken into consideration the explanation offered by the assessee while passing the order. He held from the material on record that the ITO had not been able to show that the payments under the agreements with McDowell had in fact not been made for business purposes which appear on the face of the transactions. Secondly, he held once the business purpose is established, adequacy of consideration was not at all required to be taken into account. Thirdly it was held that, the transactions under consideration were neither colourable nor were shown to be even remotely for the purpose of reducing the tax liability of the assessee. Lastly he held that, McDowell had paid tax on the disallowed amount at the same rate of tax at which the assessee itself would have been liable to pay tax on the same. On an overall consideration of the material he held that the arrangement could not be considered as a sham transaction. Therefore, he deleted the disallowances for the two years.
6. The Revenue challenged the correctness of the order of the CIT by preferring an appeal. The Tribunal after re-examining the facts held that, the AO had wrongly mentioned that in the bargains MWP Ltd. had gained most i.e., at 25 times of the earlier years’ profit taking into consideration erroneously Rs. 1,120 lakhs in the year ended 31st March, 1982 as against the actual figure of Rs. 120 lakhs only. The evidence on record showed that McDowell had shown the entire payments in its own accounts as its trading receipts and it paid tax. The Department had not claimed that the payments were sham or bogus. The amounts received by the assessee was not very insignificant amounts as they received Rs. 16 lakhs, Rs. 75 lakhs and Rs. 96 lakhs for the three years respectively. Therefore, it held that the agreements with McDowell had in fact been entered into for genuine purpose of the assessee and hence expenses laid out for earning such business income are also to be considered as allowable in accordance with the provisions of Section 37(1). The material on record did not disclose that this arrangement resulted in reduction in tax liability of the three companies taken as a whole. It also took note of the fact that the fees were credited to the accounts of McDowell and not actually paid and considerable parts of interest were also constituted by interests accruing on unpaid balances of purchase prices of liquor, wine, etc., and, therefore, the amount paid by way of interest is also deductible. Accordingly, the appeal of the Revenue was dismissed by the Tribunal. In those circumstances, on an application filed by the Revenue, the Tribunal has referred, the aforesaid questions of law for our opinion.
7. Sri Inder Kumar, the learned standing counsel for the IT Department, assailing the correctness of the judgment of the Tribunal contended as under:
(1) The material on record clearly discloses when the assessee is paying a sum of Rs. 8 lakhs per month towards hire charges and if for the transfer of know-how by transferring the very same to MWP Ltd. the assessee is receiving only a sum of Rs. 2 lakhs which on the face of it will clearly go to show that the amount of Rs. 8 lakhs paid is not wholly and exclusively for the purpose of the assessee’s business.
(2) If the assessee had no intention of setting up the manufacturing activity after transferring the licence in favour of MWP Ltd., the two agreements entered into with McDowell for hiring the machinery and transfer of know-how for a consideration of Rs. 8 lakhs cannot be said to be laid out or expended wholly and exclusively for the purpose of the assessee’s business.
(3) The tripartite transaction entered into between the three sister-concerns did in no way benefit the assessee which is a condition precedent for allowing expenditure for the purpose of assessee’s business.
(4) There is no material placed on record to demonstrate that under this arrangement the assessee received liquor from MWP Ltd. at a price lower than the price at which they sold it to other customers. Therefore, he submits the assessing authority was justified in disallowing this expenditure which was based on material on record which has been wrongly interfered with by the first appellate authority as well as by the Tribunal and, therefore, this being purely a question of law, the answer to the questions has to be in favour of the Revenue and against the assessee.
8. Per contra, Sri Aravind Datar, the learned senior counsel appearing for the respondents submitted as under:
(1) On the first blush though the said statement appears to merit consideration, on a deeper analysis of the material on record, it is evident in the first place that there is no avoidance or reduction of the income-tax by any of the three firms to the Department.
(2) The transactions are real and not sham.
(3) As held by the assessing authority itself, the assessee was benefited to the large extent in the matter of payment of sales-tax. The other material on record clearly establishes under this arrangement the assessee was able to get the liquor manufactured by MWP Ltd. at a lower price and thereby earned higher profits thus benefiting the assessee.
(4) When the amount spent by way of payment towards hire charges and royalty is accounted for in the books of the assessee which in turn was reflected in the accounts of McDowell on which McDowell has undisputedly paid the tax to the Government, merely because these companies are sister-companies and what is received by way of hire charges by the assessee from MWP is less than the charges paid to McDowell no adverse inference as sought to be raised by the Revenue could be entertained.
(5) It is a case of commercial expediency. It is for the assessee to decide how he should conduct his affairs and if they have entered into a tripartite agreement in which each of the company is benefited and there is no avoidance of tax or reduction of tax, the transaction cannot be found fault with. In fact both the first appellate authority and the Tribunal on proper appreciation of the material on record having found that the expenditure incurred by the assessee is expended wholly and exclusively for the purpose of its business have rightly allowed the deduction by deleting the deletion made by the assessing authority.
(6) The question whether these expenses are expended wholly and exclusively for the purpose of business being purely a question of fact, when two fact finding authorities have concurrently held that the said expenses are expended for the purpose of business, the said finding is not liable to be interfered with.
(7) Similarly, both the authorities have not committed any error of law in arriving at the conclusions at which they have arrived at which is based on evidence on record and, therefore, no case for interference is made out.
9. Both the learned Counsel have relied on several judgments in support of their respective contentions.
10. In order to appreciate the rival contentions, it is necessary to notice the law on the point.
11. In the case of Swadeshi Cotton Mills Co. Ltd. v. CIT , the Supreme Court dealing with the question what constitutes expenditure under Section 10(2)(xv) of the old Act which is in pari materia with Section 37(1) of the present Act has observed that, the question as to whether an amount claimed as expenditure was laid out or expended wholly and exclusively for the purpose of such business, profession or vocation has to be decided on the facts and in the light of the circumstances of each case. The final conclusion on the admissibility of an allowance claimed is one of law. It is open to the assessee to contend that the decision arrived at by the IT authorities was based on no evidence at all. If the assessee satisfies the Court that the decision of the IT authorities is based on no evidence then the question at issue becomes one of law and the Court would be entitled to say that the decision of the ITO is defective in law. The ITO is entitled to examine the circumstances of each case to determine for himself whether the remuneration paid to the employee or any portion thereof was properly deducted under Section 10(2)(xv) of the IT Act.
12. The Supreme Court in the case of K. Ravindranathan Nair v. CIT (2000) 164 CTR (SC) 498 : (2001) 247 ITR 178 (SC) dealing with the scope of interference by the High Court regarding a finding of fact has held that, it is the Tribunal which is the final fact-finding authority. A decision of the Tribunal on the facts can be gone into by the High Court if a question has been referred to it which says that the finding of the Tribunal on the facts is perverse, in the sense that it is such as could not reasonably have been arrived at. on the material placed before the Tribunal. Unless and until a finding of fact reached by the Tribunal is canvassed before the High Court in the manner set out above, the High Court is obliged to proceed upon the findings of fact reached by the Tribunal and to give an answer in law to the question of law that is before it. The only jurisdiction of the High Court in a reference application is to answer the question of law that are placed before it. It is only when a finding of the Tribunal of fact is challenged as being perverse, in the sense set out above, that a question of law can be said to arise.
13. The Supreme Court in the case of CIT v. Chandulal Keshavlal & Co. dealing with business expenditure held that, if the expense is incurred for fostering the business of another only or was made by way of distribution of profits or was wholly gratuitous or for some improper or oblique purpose outside the course of business then the expense is not deductible. In deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may enure to the benefit of a third party. Another test is whether the transaction is properly entered into as a part of the assessee’s legitimate commercial undertaking in order to facilitate the carrying on of its business; and it is immaterial that a third party also benefits thereby. But in every case it is a question of fact whether the expenditure was expended wholly and exclusively for the purpose of the trade or business of the assessee.
14. A Constitution Bench of the Supreme Court in the case of McDowell & Co. Ltd. v. CTO held that, tax planning may be legitimate provided it is within the framework of the law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. The proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax and whether the transaction is such that the judicial process may accord its approval to it.
15. The aforesaid judgment was followed by the Supreme Court in the case of Union of India and Anr. v. Azadi Bachao Andolan and Anr. (2003) 184 CTR (SC) 450 : (2003) 263 ITR 706 (SC) where while considering the observations made by Justice Chinnappa Reddy it was observed that, “We are afraid that we are unable to read or comprehend the majority judgment in McDowell’s case (supra) as having endorsed this extreme view of Chinnappa Reddy, which, in our considered opinion, actually militates against the observations of the majority of the Judges which we have just extracted from the leading judgment of Ranganath Mishra, J. (as he then was).”
16. A Division Bench of the Madras High Court in the case of CIT v. Andhra Prabha (P) Ltd. has held that, so long as the payment had been made bona fide out of commercial considerations and so long as the allowance was not prohibited by any of the provisions of the Act, the payment could not be disallowed merely because the payment had been made to a sister-concern so to say.
17. In the light of the legal principles enunciated in the aforesaid decisions, what follows is the question as to whether an amount claimed as expenditure was laid out or expended wholly and exclusively for the purpose of such business, profession or vocation has to be decided on the facts and in the light of the circumstances of each case. In every case it is a question of fact. The ITO is entitled to examine the circumstances of each case to determine for himself whether the expenditure incurred falls under Section 37(1) of the Act as laid out wholly and exclusively for the purpose of such business. If the expenses so incurred is for fostering the business of another only or was made by way of distribution of profits or was wholly gratuitous or for some improper or oblique purpose outside the course of business or it is a colourable device to avoid the payment of tax by resorting to dubious methods or when the transaction is not real and is a device to avoid tax, then such expense is not deductible. However, if the payment or expenditure is incurred for the purpose of trade of the assessee it does not mean that the payment may enure to the benefit of another person and such a person is a sister-concern. If the transaction is properly entered into as a part of assessee’s legitimate commercial undertaking, in order to facilitate the carrying on its business, it is immaterial that a third party also benefits thereby and such amounts are deductible. In deciding whether a payment of money is deductible expenditure, one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading and prudence. If it is a case of tax planning, if it is within the framework of law, it is a legitimate expenditure incurred by the assessee. Therefore, what the Courts frown upon is whether the device adopted by the assessee is intended to avoid payment of tax and it is not real.
18. In the light of the aforesaid principles, now we have to examine the facts of this case. The relationship between the three companies is not in dispute As noticed by us, they are all sister-concerns. Admittedly, MWP Ltd. is not a dummy concern. In the very first year of its existence it has made profits to the extent of Rs. 33.07 lakhs during the asst. yr. 1980-81; Rs. 110.97 lakhs for the asst. yr, 1981-82 and Rs. 120,31 lakhs for the asst, yr. 1982-83. The agreement between the assessee and McDowell is not in dispute under which the assessee has to pay a sum of Rs. 8 lakhs to McDowell. The said payment is reflected in the books of the assessee. When the payments are not made, when it became outstanding, interest was liable to be paid on the said amount which is also reflected in the books of the assessee’s account. Though the charges of Rs. 8 lakhs was not actually paid to McDowell they have shown in their accounts the receipt of the said amount accrued and have paid income-tax. Even for the interest receivable, it is reflected in their books as paid which fact is not in dispute. The receipt of Rs. 2 lakhs from MWP by the assessee is not in dispute. The finding recorded by the AO shows in this tripartite agreement the assessee is benefited in the form of sales tax. The material on record also discloses as held by the first, appellate authority and the Tribunal, that MWP Ltd. supplied the assessee with the liquor manufactured by them at a lower price than which is sold to third parties. Moreover, 90 per cent of the production is supplied by MWP to the assessee out of which the assessee has made profit. It is also to be noticed if MWP had paid the additional Rs. 6 lakhs which was paid by the assessee to McDowell they would have incurred an additional expenditure of Rs. 72 lakhs each year in which event they would not have earned profit of Rs. 33.07 lakhs for 1980-81, Rs. 110.97 lakhs for 1981-82 and Rs, 120.31 lakhs for 1982-83. If they had made the said payment they were not liable to pay any tax at all and on the contrary they would have sustained the loss, which could have been carried over to the next financial year. In other words, if they had paid the money at the rate of Rs. 8 lakhs, they were not, liable to pay any tax for the asst. yrs. 1980-81 and 1981-82. The so-called avoidance of tax by the assessee in reality has no significance because the said amount is taxed in the hands of McDowell and thereby there is no evasion or avoidance of income-tax by these three sister-concerns, MWP has paid tax for the profits which they earned which is the direct result of non-payment of Rs. 6 lakhs to the assessee per month. Therefore, the appellate authority and the Tribunal have appreciated the material on record in the proper perspective and have recorded the aforesaid finding which is a finding of fact. Under those circumstances no error could be found in the findings recorded by the Tribunal and the first appellate authority.
19. The next question is whether the Tribunal was right in holding that the interest so payable to McDowell was actually allowable. The said interest was charged for the amounts which were legally due to McDowell which were not actually paid. Once the aforesaid amount was held to be genuine business expense under Section 37(1) for non-payment of the said payment within the stipulated time, the assessee is bound to pay the said amount. Therefore, this expenditure incurred towards payment of interest is also a genuine business income deductible under Section 37(1) of the Act. In this regard also, no error could be found in the findings recorded by the Tribunal.
20. In view of the above, we answer the reference in favour of the assessee and against the Revenue. Accordingly, this reference is answered.