ORDER
N.V. Vasudevan, J.M.
1. ITA No. 2823/Del/2004 is an appeal by the assessee against the order dt. 5th March, 2004 of learned CIT(A)-XV, New Delhi, relating to the asst. yr. 2000-01. ITA No. 819/Del/2005 is an appeal by the assessee against the order dt. 25th Jan., 2005 of learned CIT(A)-XV, New Delhi, relating to the asst. yr. 2001-02.
2. Common issues are involved in both these appeals and were heard together. We deem it convenient to pass this common order.
3. The first issue that arises for consideration in both these appeals is with regard to the disallowance made by the AO out of administrative expenses paid by the assessee to M/s Smithkline Beachem Consumer Hair (sic-Health) Care Ltd. (SBCH). The grievance of the assessee in this regard is projected in ground No. 1 to 1.9 in ITA No. 2823/Del/2004 and in ground Nos. 1 to 1.20 in ITA No. 819/Del/2005. The facts and circumstances giving rise to the aforesaid ground of appeal are as follows. The assessee is a company engaged in the business of manufacture and sale of various products viz., Eno, Crocin, Aquafresh toothbrush, etc. The assessee had incurred expenditure under the head administrative expenses paid to SBCH. In the previous year relevant to asst. yr. 2000-01, the assessee had claimed a sum of Rs. 22,97,46,564. In the previous year relevant to asst. yr. 2001-02, the expenditure claimed was Rs. 27,59,36,430. The assessee did not have any organisation or infrastructure to carry on the business activities. The assessee availed the services of SBCH for managing its business in the fields of inter alia, marketing, selling, distribution and administration. Originally under agreement dt. 18th Jan., 1996 and supplemental agreement dt. 26th April, 1996, it was agreed that the assessee would reimburse SBCH for the services rendered at cost + 5 per cent. The basis of billing as provided under these agreements were as follows :
(i) All marketing expenditure (including advertisement and promotion) incurred by SBCH for assessee’s products/brands which can be directly allocated to assessee would be so allocated for which assessee shall fully reimburse SBCH.
(ii) All distribution expenses such as freight charges for transporting assessee’s products to SBCH’s various depots/godowns, cost of insurance policies, cost of lease rentals for godowns hired exclusively for dealing with assessee’s products, brands, etc., which can be directly allocated to assessee’s line of business would be debited to assessee.
(iii) Other selling, distribution and marketing expenses incurred by SBCH which cannot be directly allocated to assessee’s business would be” determined by SBCH on a fair and reasonable basis by applying the formula of percentage to sales on total consumer sales and would be debited to assessee at cost + 5 per cent of cost basis.
(iv) The same principle of cost + 5 per cent would be applied by SBCH while determining the administrative expenses to be debited to assessee-company.
(v) A list of expenditure heads to be considered for cross charge was also part of the agreement.
4. SBCH is a multi-product, multi-unit company. It was not possible to separately ascertain the cost incurred for providing the aforesaid services to the assessee. Accordingly, a rule of thumb approach was evolved to ascertain the cost by allocating the expenses in the ratio of turnover of the assessee to the aggregate of the combined turnover of SBCH and the assessee. On that basis, SBCH recovered a sum of Rs. 2.30 crores as cross charge for the services rendered by SBCH to the assessee during the previous year relevant to the asst. yr. 1997-98.
5. Later on the assessee and SBCH felt that this method of allocation of expenses was not scientific. It was, therefore, felt necessary to appoint an independent professional firm of repute to carry out an exercise to determine an appropriate formula for segregation and allocation of expenses incurred by SBCH in providing services to assessee. It was also agreed that on the basis of the formula suggested by the independent professional firm, SBCH would raise debit notes on the assessee w.e.f. 1st Jan., 1997 for recovery of cross charge. In terms of the decision so taken, M/s Price Water House and Co. (PWC), a firm of chartered accountants, was appointed to conduct a study and suggest a suitable formula for recovery of cross charge between the SBCH and the assessee. M/s PWC gave a report dt. 20th Sept., 1997 determining the basis for the allocation of costs in respect of the services provided by SBCH. It is on the basis of such suggestion of PWC that the administrative expenses claimed by the assessee have been arrived at.
6. In the asst. yrs. 1998-99 and 1999-2000, the assessee had claimed deduction under the head ‘administrative expenses’ on the basis of allocation of the costs as suggested by PWC. The AO and the CIT(A) in those years, have held that the method followed by the assessee prior to the report of the PWC, was a sound method and accordingly, administrative expenses on the basis of the method followed earlier, was allowed. In asst. yrs. 2000-01 and 2001-02, the AO allowed administrative expenses only 7 per cent of the sales of the assessee and disallowed the claim for deduction of the remaining expenses. The order of the AO was confirmed by the CIT(A) and hence the present appeals by the assessee.
7. We have heard the submissions of the learned Counsel for the assessee as well as the learned Departmental Representative. As far as asst. yr. 2000-01 is concerned, it was brought to our notice by the learned Counsel for the assessee that the Tribunal in assessee’s own case for the asst. yrs. 1998-99 and 1999-2000 had considered similar issue and have ultimately concluded that the disallowances made by the AO was not sustainable and the allocation of administrative costs on the basis of the formula suggested by PWC was to be accepted. The operative portion of the order of the Tribunal in IT A Nos. 2099/Del/2002 and 421/Del/2003 and 2645/Del/2002 and 1316/Del/2003 for the asst. yrs. 1998-99 and 1999-2000 reads as follows :
“Rival submissions of the parties have been considered carefully in the light of materials placed before us, as well as the case law referred to. The question before our consideration is whether the lower authorities were justified in disallowing the expenses incurred in marketing of its products. Admittedly, the assessee-company does not have any infrastructure of its own and, therefore, it had entered into an agreement with SBCH under which SBCH was required to provide the entire network for marketing the assessee’s products. It was felt by both the parties that reimbursement of expenditure coupled with commission on sale were not adequate to cover the entire expenditure and, therefore, it was decided to ascertain the suitable criteria for reimbursement of the expenses incurred by SBCH. Accordingly, PWC was appointed to make an in-depth study to find a suitable criteria in respect of the expenditure incurred by SBCH. It is on this basis PWC made the study and prepared a report along with the formula under which suitable payments were to be made by the assessee to SBCH regarding the marketing of assessee’s products. In our opinion, this was a bona fide exercise made by the parties. Under such circumstances, the question is whether the AO could reject such report and determine the expenditure which the assessee ought to have paid to SBCH. At this stage, it would be appropriate to refer to the judgment of Hon’ble Supreme Court in the case of CIT v. Walchand and Co. (P) Ltd. (1967) 65 TTR 381 (SC) wherein it was held as under :
‘In applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out for the purpose of the business, reasonableness of the expenditure has to be adjudged from the point of view of the businessman and not of the Revenue.
It is open to the Tribunal to come to a conclusion either that the alleged payment is not real or that it is not incurred by the assessee in the character of a trader or that it is not laid out wholly and exclusively for the purpose of the business of the assessee and to disallow it. But it is not the function of the Tribunal to determine the remuneration which in their view should be paid to an employee of the assessee.
An employer in fixing the remuneration of his employees is entitled to consider the extent of his business, the nature of the duties to be performed, and the special aptitude of the employee, future prospects of extension by the business and a host of other related circumstances. It is erroneous to think that increased remuneration can only be justified if there is a corresponding increase in the profits of the employer.
The aforesaid principle was reiterated and applied by the Hon’ble Supreme Court in the following cases:
1. J.K. Woollen Manufacturers v. CIT
2. Aluminium Corpn. of India v. CYT
In view of the above settled legal position, it is clear that allowability of the expenditure is to be seen from the point of view of the businessman and the IT Department cannot substitute its own figures. As already stated, the assessee had no infrastructure whatsoever for marketing its products. Therefore, it was for the assessee to decide how the goods were to be sold in the market. The expenditure was incurred on the basis of the report of a leading firm of chartered accountants. Therefore, in our opinion, it cannot be said that the expenditure incurred was unreasonable. Further, there is no provision to disallow any expenditure on the ground that such expenditure is excessive or unreasonable unless the case of the assessee falls within the scope of Section 40A(2). It is not the case of the Department that provisions of Section 40A(2) are attracted in the present case. There is no material on record to show that such provisions could be attracted. On the contrary, the CIT(A) has rejected the case of the assessee by stating that it would make no difference even if Section 40A(2) was not applicable to the facts of the present case. Therefore even on this ground, the amount incurred by the assessee could not be disallowed. Further, it is not the case of the Revenue that such expenditure was not incurred wholly and exclusively for the purpose of business. Therefore, considering from any angle, we are of the view that no disallowance was warranted by the AO on this ground.”
8. It was also further submitted by the learned Counsel for the assessee that the further appeal of the Revenue to the High Court against the order of the Tribunal for the asst. yrs. 1998-99 and 1999-2000 has also been dismissed. A copy of the order of the Tribunal is placed at page Nos. 17 to 34 of assessee’s paper book. A copy of the order of Hon’ble High Court has also been filed before us. In view of the above, we are of the view that the disallowance made for the asst. yr. 2000-01 was not called for. The basis on which the disallowance was made by the AO and confirmed by the CIT(A) in the asst. yr. 2000-01 is identical to the basis adopted by the Revenue authorities in asst. yrs. 1998-99 and 1999-2000. Respectfully following the decision referred to above, we hold that the disallowance made by the AO and sustained by the CIT(A) for asst. yr. 2000-01 deserves to be deleted and the same is directed to be deleted.
9. As far as the asst. yr. 2001-02 is concerned, the facts are slightly different. In this assessment year, the AO made the disallowance out of administrative expenses by making a reference to the disallowance made in the earlier years. However, the CIT(A) had sustained the order of the AO by distinguishing the facts as prevailing in the asst. yr. 2001-02 from those prevailing in the asst. yrs. 1998-99 to 2000-01. The order of the Tribunal for asst. yrs. 1998-99 and 1999-2000 was also filed before the CIT(A) in the course of proceedings for asst. yr. 2001-02 and it was contended on behalf of the assessee that judicial proprietary demanded that the CIT(A) should follow the decision of the Tribunal. The CIT(A), however, rendered a finding that the facts prevailing in asst. yr. 2001-02 were different from the other years. Before the CIT(A), the AO filed a remand report in which he had raised certain issues which were as follows:
(a) that PWC report was based on the information provided by SBCH and that PWC had not independently verified the information from records. It was, therefore, suggested that the report of PWC was not to be given full credence.
(b) that PWC report was valid only for three years and did not cover the financial year 2000-01.
(c) the AO also found fault with the plea of the assessee that the level of effort required for the products of the assessee would be much higher than those products of SBCH because the assessee’s products were new. In this regard, the AO pointed out that SBCH was concentrating on malt products in which it had 62 per cent market share and, 75 per cent of its turnover in this product category was contributed by Horlicks. In this regard, the AO also brought out certain information from the website of SBCH. The AO thus contended that SBCH was deploying its extra manpower and resources towards maintaining its high market share in the highly competitive malt products market. The AO also submitted that the products of the assessee like Eno, Turns and Crocin were popular products and did not require any extraordinary efforts for promotion. The AO also pointed out that SBCH had acquired Maltova and Viva and was marketing them and, therefore, extra efforts were required in the financial year 2000-01.
(d) the AO also pointed out that the formula suggested by PWC based on “level of effort” would be subjective and not measurable in mathematical terms. The AO has also pointed out on the disproportionate allocation of conversion charges, selling expenditure and distribution expenses and marketing expenses.
(e) even if the provisions of Section 40A(2) did not strictly apply to the facts of the case, there was no denial that a close connection between the SBCH and the assessee did exist and therefore the dealings between them could not be considered as one which has taken place at arm’s length.
10. The assessee in reply to the remand report of the AO contended that the issue was fully covered by the earlier decision of the Tribunal. The assessee also contended that the report of the PWC, a reputed independent consultant, cannot be disregarded. The assessee also pointed out that marketing of health drinks such as Horlicks and marketing of pharma products (being products of the assessee) marketed by SBCH on behalf of the assessee required disproportionately more efforts. The plea as already made before the Revenue authorities in the earlier assessment years regarding the merits of the allocation of costs as made by PWC was also reiterated.
11. On consideration of the rival submissions, the CIT(A) came to the conclusion that the decisions of the Tribunal in the earlier years were not final and that the principle of ‘res judicata’ did not apply to income-tax proceedings. The CIT(A) also made a reference to the fact that as against the decision of the Tribunal, the Revenue has gone in appeal before the Hon’ble High Court. We may mention here that, as already observed by us, the appeal of the Revenue has already been rejected by the Hon’ble High Court. The other findings and reasons given by the CIT(A) were as follows:
(a) That the facts in the present assessment year were different and, therefore, required fresh consideration.
(b) That the report of the PWC was not valid for the asst. yr. 2000-01. The fact that they were reputed firm of chartered accountants was not relevant and their report cannot be accepted at its face value.
(c) SBCH and the assessee company are part of the same group and owned by the same mother-company. As per the chart submitted by the assessee, SB plc UK owns 100 per cent (via its subsidiaries) of Smith Kline Beacham International (Luxemburg), which in turn owns 100 per cent of Smithkline Beacham Portlouis Ltd. (Mauritius), which in turn owns all shares (55,99,998) of SBAP (the assessee), except 2 shares which are owned by SB plc UK. On the other side, SB plc UK owns 100 per cent shares of Horlicks Ltd. UK which in turn owns 40 per cent shares of SBCH (India) (balance 60 per cent are with Indian public, financial institutions, banks, etc.). According to the CIT(A) though there was a long chain of links between the mother-company and the assessee-company, the chain stands out as being continuous and strong. There is no stated reason for this structure being chain linked through Luxemburg and Mauritius. Through this long chain of links, while technically the assessee would not attract the provisions of Section 40A, but yet it is clear that SBCH and SBAP have common management control, despite their having separate legal corporate status. The assessee-company has no employees and all its affairs including day-today management are undertaken by the employees of SBCH. That the same mother-company. SB plc UK exerts managerial control over both SBAP and SBCH. The assessee was truly only a technical/legal entity which for all practical purposes an adjunct of SBCH as far as management control is concerned. The CIT(A), therefore held that the assessee and SBCH would not have dealt at arm’s length principle.
(d) that the formula suggested by PWC was not reflective of a true measure of the fee to be paid by the assessee and that the same cannot be validly applied for taxation and even for accounting purposes.
(e) it was true that the Revenue cannot sit in judgment over the quantum of expenditure incurred by the assessee but was certainly entitled to go into the reasonableness of the expenditure with a view to ascertain whether it was in connection of the business of the assessee or not.
For the aforesaid reasons, the CIT(A) upheld the order of the AO. Hence, the present appeal by the assessee.
12. We have heard the rival submissions. The learned Counsel for the assessee at the outset submitted that the decision of the Tribunal for the asst. yrs. 1998-99 and 1999-2000 should hold good for the present assessment year also. According to him, none of the factors which were held to be distinguishing facts as compared to the asst. yrs. 1998-99 to 2000-01, by the CIT(A) are correct. With regard to the finding of the CIT(A) that because of changed circumstances and facts in asst. yr. 2001-02, the earlier orders of Tribunal will not operate as res judicata, the learned Counsel for the assessee submitted that the basis of allocation of expenses by PWC between the assessee and SBCH was based on a scientific method capable of taking care of all situations and, therefore, the decision of the Tribunal in the earlier years should equally apply to the present asst. yr. 2001-02 also. He brought to our notice that the principal objection of the AO was that the level of effort required for promotion of assessee’s product was presumed to be greater than that required for promoting products of SBCH and, distribution of expenses on this presumption was not correct. According to the AO, the SBCH had during the previous year relevant to asst. yr. 2000-01, with a view to strengthen its share of nutrition drinks market, sought to acquire some brands of nutrition drinks from existing market players and even the managing director of SBCH had expressed the policy of SBCH to acquire brands in nutrition drinks segment if they come across a good opportunity. In keeping with this policy, SBCH had also acquired brands of Maltova and Viva from Jagajit Industries, who held about 8 per cent market share in February, 2000. SBCH held about 70 per cent market share of nutrition drinks market. According to the AO, because of this policy, there was a need to deploy extra manpower and resources to maintain its market share in the nutrition drinks market. According to the AO, the products of the assessee like Eno, Tums and Crocin did not require any special efforts as they were already popular products in the market. The learned Counsel for the assessee submitted that this presumption of the AO was fundamentally not correct. In this regard, he submitted that the products Crocin, Turns, Eno and toothbrush Aquafresh, were acquired by the assessee from third parties and were relaunched as products of the assessee. The efforts required for sustaining these products in the market in the initial years required higher level of marketing and selling efforts. The learned Counsel for the assessee also pointed out the higher sales of these products during the previous year compared to earlier years.
13. With regard to acquiring of a market share in the malt drinks (nutrition drink) market and consequent purchase of Viva and Maltova brands by SBCH, the learned Counsel for the assessee pointed out that these brands were primarily acquired only to kill competition in the market for the assessee’s brand of Horlicks and, therefore, there was no special effort, and expenditure necessary to keep up the market share in these two brands. In this regard, he drew our attention to p. 189 of assessee’s paper book where sales of Viva and Maltova have declined from Rs. 3,900.40 lakhs and 3,317.50 lakhs for financial year 1997-98 to Rs. 1,368.70 lakhs and 2,546.90 lakhs for financial year 2003-04.
14. It was further submitted by the learned Counsel for the assessee that there was no motive to divert income and, therefore, the approach of the Revenue authorities was not correct. In this regard, the learned Counsel for the assessee submitted that SBCH was showing the entire reimbursement as its receipts. He also brought to our notice that even the Revenue has accepted this fact in an affidavit filed before the Hon’ble Delhi High Court. A copy of the affidavit is placed at pp. 324 to 326 of assessee’s paper book.
15. With regard to the finding of the CIT(A) that the assessee and SBCH were not operating at arm’s length, the learned Counsel for the assessee submitted that it was not the case of the Revenue that the parties were related in the manner contemplated under Section 40A(2)(b) and, therefore, to conclude that the dealings between the assessee and SBCH were not at arm’s length cannot be sustained.
16. The learned Departmental Representative relied on the order of the CIT(A). In particular it was submitted by him that even the assessee went back on the method of sharing of expenses suggested by PWC. The assessee paid much more than what was payable as per the report of PWC. Reference was made to the letter of SBCH in this regard, a copy of which is placed at p. 74 of assessee’s paper book. The learned Departmental Representative also took us through the various findings of the CIT(A) with regard to change in facts and circumstances in the present assessment year compared to the earlier years. It was further submitted by him that the assessee was a licencee entitled to use the brand name “Horlicks” and had granted a sub-license to SBCH, for which it received royalty from SBCH. According to the learned Departmental Representative, if this royalty income is excluded from the income of the assessee, then the assessee would be incurring a loss. The learned Departmental Representative, therefore, submitted that expenses were deliberately shown high in the case of the assessee to offset the royalty income and vice versa by SBCH. According to the learned Departmental Representative, the Revenue was entitled to go into the quantum of expenditure with a view to find out if the same was wholly and exclusively for the purpose of the business of the assessee.
17. In reply, the learned Counsel for the assessee submitted that in the initial year, the assessee did not have enough profits, which phenomenon is common in this line of business. According to him, the increase in royalty income was commensurate with the increase in administration expenses of the assessee and hence, it cannot be said that but for the royalty income, the assessee would suffer a loss. With regard to the contention that the assessee went back on the method of allocation, the learned Counsel for the assessee submitted that the same was on mutual agreement between. the parties and on a consideration of the realities of the situation and keeping in view the broad principle of apportionment of cost as suggested by PWC.
18. We have considered the rival submissions. The basis of allocation of expenses as suggested by PWC is as follows:
–All expenses are divided into three categories, i.e., allocable expenses, assignable expenses determined, and assignable expenses undetermined. The expenses and their basis of allocation is discussed as below.
–Allocable expenses, includes those expenses which can be identified to the user of services at the time they are incurred.
–Assignable expenses determined, includes those expenses, which can be charged to a business unit on the basis of an objective unit of measurement. A list of these expenses and the basis of distribution has been elaborated earlier (See for example, bank charges have been rightly allocated in the ratio of collections made for the appellant as compared to SBCH, whereas freight is allocated based on transporter’s bills).
–Assignable expenses undetermined, includes those expenses which can neither be allocated specifically to any particular business nor can be distributed on the basis of an objective unit of measurement. For these expenses, the report has recommended charge based on the effort of human resources involved in the operations of the appellant rather than as a percentage of sales.
The nature of expenses included in the category of assignable expenses undetermined relates to selling, marketing, exports, finance, information resources, human resources, legal managing director’s office and consists mainly costs associated with human resources, i.e., salaries, bonus, staff welfare, etc. The same has been allocated in the ratio of the human resources that would have been employed by the appellant to carry these activities to the human resources actually employed by these business processes, which includes mainly employee costs.
The factor for charging the payment based on the level of efforts which would go into managing the operations of the assessee are given in the report as under :
SBAP Equivalent (b)
Factor for charge = ___________________
(per business process) SBCH (a)
SBCH(a) SBAP(b) Basis for Allocation
Works 360 — SBAP utilizes the works of SBCH for
the manufacture of Eno and the basis for charging
the same has been suggested separately in s. V
below. Accordingly, no works costs has been
considered.
Selling 206 70 In view of the new brands being launched by
SBAP and the promotion of the new acquisitions
the level of efforts required to sell SBAP
products are far more than that required in case
of SBCH food products as they already have a
dominant market presence. The selling activities
carried out for two companies are combined as
There are no resources, which are dedicated to any
particular brand. The SBAP equivalent represent
the level of efforts required to support SBAP
products.
Distribution 22 08 Maintaining a countrywide distribution network for
SBAP would require a certain minimum level
of resources. We consider that for the current level
of SBAP activities these many resources
are required.
Marketing 16 09 As per discussions, the number indicated represents
people directly identifiable with SBAP brands.
Exports 01 -- SBAP has no exports and accordingly, no resources
have been considered towards this
Horlicks 11 11 All costs related to SDI are separately identifiable
Expansion/S and are charged to SBAP and have accordingly been
DI considered as allocable expenditure.
Finance 49 16 No identified resources exists for the SBAP
activities and SBAP utilizes the resources at all
Information 11 04 the four regional offices and head office.
Resources We consider that these level of resources are needed
for the current level of SBAP operations.
Human 16 -- This activity is utilized by all the processes
Resources equally and hence its costs are charged in the ratio
of resources required for SBAP operations to total
organizational resources available with
SBCH (see below). The staff training costs are also
allocated on the same basis.
Legal 10 03 No identified resource exists for Purchases
the SBAP activities and it utilizes SBCH resources
for its requirements. We consider that these level of
resources are needed for the current level of SBAP
operations.
MD office 04 02 SBAP has no whole-time directors and all the
directors of SBCH are also managing its day-today
operations. Also, all the directors and MD office
provide equal importance to both the company's
operations and we consider that there should be
equal allocation of costs.
19. The above basis of allocation of expenses has already been found by the Tribunal to be acceptable and correct method in asst. yrs. 1998-99 and 1999-2000. One of the distinguishing feature in asst. yr. 2001-02 pointed out by the CIT(A), is the fact that PWC’s report was valid only for three years and the period of 3 years ended with asst. yr. 2000-01. This in our view was not a proper approach. As can be seen from the basis of allocation it takes into account the level of effort required for each item of activity and, therefore, the same would be valid even for asst. yr. 2001-02. The further reasoning of the CIT(A) has been that in a rapidly changing environment and product mix, the level of effort factor would not be a correct method of quantification of expenditure. As to what was the change in environment or product mix has not been spelt out by the CIT(A). The AO in his remand report filed before the CIT(A) has laid much emphasis on the fact that SBCH had acquired Viva and Maltova brands and promotion of these brands would involve huge expenditure. This is again a surmise of the AO. The assessee had demonstrated before us that acquisition of Maltova and Viva brands was only to kill competition and for no other purpose. A higher level of effort factor had been assigned to the promotion of assessee’s products keeping in view the fact that it was comparatively a new company, that assessee’s products were such that it needed more aggressive marketing and that SBCH being a company with huge turnover, economies of scale would operate in their favour. All these factors were very much present in the earlier years also. The conclusion of CIT(A) that ‘level of effort’ factor cannot be validly applied for taxation or even accounting purposes, in our view, is without any basis. The finding that the assessee and SBCH were not working at arm’s length is again not sustainable and in any event not a relevant consideration to disallow expenditure. The Revenue if it wants to disallow an expenditure on the ground that it is excessive or unreasonable having regard to FMV of the goods, services or facilities for which the payment is made and the legitimate needs of the business of an assessee or the benefit derived or accruing to an assessee has to establish that the person to whom the payment is made is a person falling within the provisions of Section 40A(2)(b). Admittedly, SBCH, the recipient, is not a person falling within the ambit of provisions of Section 40A(2)(b) of the Act. Therefore, the finding with regard to the dealings between assessee and SBCH not being at arm’s length is neither correct nor sustainable and was irrelevant while sustaining disallowance made by the AO.
20. The fact that the recipient viz., SBCH had duly shown the sums received from the assessee as its receipts is also not in dispute. In such circumstances, we are of the view that disallowance of expenses was not warranted. The allegation against the assessee that the charges paid by the assessee to SBCH was excessive is without any basis. We, therefore, conclude that none of the reasons assigned by the CIT(A) to conclude that the decision of the Tribunal for asst. yrs. 1998-99 and 1999-2000 is not applicable to the facts as it existed in asst. yr. 2001-02 can be sustained and, therefore, the said decision of Tribunal will apply to this assessment year i.e., the asst. yr. 2001-02 also. Respectfully following the order of the Tribunal, we direct that the disallowance of expenses made by the AO and sustained by the CIT(A) should be deleted and same is directed to be deleted. Grounds 1 to 1.20 in asst. yr. 2001-02 are allowed.
21. In ground Nos. 1.21 to 1.23 in ITA No. 819/Del/2005, the assessee has challenged the order of the CIT(A) whereby he upheld the disallowance of deduction of Rs. 67,75,476 being the difference of excise duty paid on closing stock and embedded in the opening stock and claimed as deduction under Section 43B of the Act holding that the same results in artificially bringing down tax liability. The facts in this regard are as follows. The assessee has consistently been claiming deduction in respect of excise duty of closing stock on payment basis, as per provisions of Section 43B of the Act. In the relevant previous year, the assessee claimed deduction of a sum of Rs. 1,76,68,848 being the difference of excise duty on opening stock (closing stock of the preceding year) of Rs. 2,95,61,634 and excise duty paid on closing stock of Rs. 4,74,30,482. The AO while completing the assessment made disallowance of the aforesaid deduction claimed under Section 43B of the Act alleging that the same resulted in deduction for the said amount twice, once as charged in the P and L a/c and again in the computation of income.
22. On appeal by the assessee, the CIT(A) confirmed the order of the AO observing as follows :
“Coming to the next ground of appeal relating to excise duty in closing stock, I find that the facts of the case are not at issue between Revenue and the appellant. The appellant had paid the excise duty to the excise authorities during the year under consideration. Thus, the amount paid had been debited to the P and L a/c as a normal expense. Further, the appellant has taken the figure of excise duty that is contained in the value of closing stock and has once again debited it to P and L a/c at the end of the year. By a simple reference to book-keeping and to the tax law, it is clear that the same amount cannot be charged to the profits of the company twice as this would neither be permissible as per tax laws as it would artificially bring down the taxable income, nor would it be an acceptable accounting practice because any system of accounting would allow the amount to be debited only once. Section 43B has no role to play in the issue at hand because it deals with a specific circumstance where excise duty has not been paid in the year the liability arises, and that it would not be allowed as a deduction on accrual basis.
In the light of the above discussion, I hold that excise duty contained in the closing stock is not a debitable expense for a second time at the end of the financial year and the argument of the appellant is rejected.”
23. The learned Counsel for the assessee reiterated submissions as were made before the Revenue authorities. The learned Counsel for the assessee placed reliance on the following decisions in support of his claim for deduction in respect of excise duty embedded in of closing stock :
(a) Lakhanpal National Ltd. v. ITO
(b) CIT v. Cadila Chemicals (P) Ltd.
(c) Decision of the Special Bench of the Tribunal in the case of Indian Communication Network (P) Ltd. v. IAC (1994) 48 TTJ (Del)(SB) 604 : (1994) 206 ITR 96 (Del)(SB)(AT)
(d) CIT v. Bharat Petroleum Corporation Ltd. (2001) 252 ITR 43 (Bom)
(e) Berger Paints India Ltd. v. CIT
We have heard the rival submissions. Section 43B of the Act provides a departure from the method of accounting followed by an assessee to allow deduction of statutory liability in the year of payment notwithstanding that liability in respect thereof may have accrued in another year. In other words, the provisions of Section 43B of the Act override the method of accounting consistently followed by assessee and mandate the deduction of statutory liabilities to be allowed in the year of payment thereof. The aforesaid proposition was accepted by the Gujarat High Court in the case of Lakhanpal National Ltd. v. ITO (supra). The relevant paras of the judgment of their Lordships are extracted below :
“…Under the mercantile method of accounting, as stated earlier, the moment the liability is incurred, it would be an admissible deduction. What Section 43B of the Act states is that irrespective of the fact that the liability is already incurred, that would be an admissible deduction only when the actual amount in that regard is paid. Therefore, it is clear that in the year 1983, when the goods including the raw material were imported and the finished goods lying at various depots were manufactured in the year 1983 (including the one under the closing stock), the liability to pay import duty and excise duty on the said goods was incurred by the petitioner-assessee. When that is so, it is also clear that the deduction of the said excise duty and import duty even on the closing stock was allowable in the accounting year 1983, but because of the specific language of Section 43B of the Act which has an overriding effect, it could not have been claimed by way of deduction unless payment thereof was made and here, in this case, it is not the case of the respondent that the payment of the said duty is not made and, therefore, it is not allowable. Therefore, the submissions of Mr. Shelat that deduction in respect of the amounts which are not allowable under commercial principles are claimed as deductions merely because they are paid, cannot be accepted.
The last fact of Mr. Shelat’s argument is that the expenditure of paying import and excise duty in respect of the closing stock does not pertain to the goods sold in the year. This argument runs counter to the mercantile method of accounting as well as to the specific language of Section 43B of the Act. It is not disputed that the said goods in the closing stock were either imported or manufactured in the accounting year 1983 and as per the principles of the mercantile method of accounting, the sum incurred by way of import duty as well as excise duty would be a permissible deduction in the year 1983, and particularly when the payment thereof is made under Section 43B of the Act. Under the circumstances, we do not find any merit in any of the contentions raised by Mr. Shelat, and for the same reasons we accept the contentions raised by Mr. J.P. Shah, appearing for the petitioner-assessee”.
In the case before the Gujarat High Court, the assessee had debited the entire amount of customs/excise duty paid and claimed deduction from the value of closing stock from the element of customs duty/excise duty included therein in order that full deduction could be availed under Section 43B for the customs duty/excise duty paid during the year.
The aforesaid view of the Gujarat High Court had been consistently followed by the Bombay High Court in the case of BPCL (supra) and also by the Hon’ble Supreme Court in the case of Berger Paints (supra). In the present case, the assessee has made a claim for deduction which was in conformity with a view accepted by the Hon’ble Gujarat High Court in the case of Lakhanpal National Ltd. (supra). The AO had placed reliance on the decision of the Hon’ble Supreme Court in the case of Berger Paints (supra) wherein it had held that excise duty was to be included in the valuation of closing stock of finished goods. The AO has overlooked the fact that by including the excise duty in the valuation of the closing stock, deduction for the said duty is not allowed to that extent as required under Section 43B of the Act. The disallowance made by the AO and confirmed by the CIT(A) cannot be sustained and is, therefore, directed to be deleted. Ground Nos. 1.21 to 1.23 in ITA No. 819/Del/2005 are allowed.
24. The next issue that arises for consideration in both these appeals is against the order of the CIT(A) sustaining disallowance to the extent of 4/5th on consumer product research expenses holding that such expenditure would result in long-term benefit to the assessee. The grievance is projected in ground Nos. 2 to 2.1 in ITA No. 2823/Del/2004 and in ground Nos. 2 to 2.2 in ITA No. 819/Del/2005. The facts which are relevant for adjudication of this ground of appeal are as follows. In the asst. yr. 2000-01, the assessee had claimed a sum of Rs. 54.80 crores on account of advertising and marketing expenses. Out of this, a sum of Rs. 87,66,623 was expenditure under the head consumer product research. The AO was of the view that from the nature of expenditure, it was apparent that it related to decision-making for long-term planning, since it relates to T.P. research to assess the effectiveness of the advertisements aired, retailer audit and household panel researches to assess brand presence and such other methods to keep track on brands presence marking, etc., formulate future strategies. He was of the view that this expenditure ought not to have been clubbed under the head advertisement and publicity. Since the expenditure resulted in an enduring benefit to the assessee, the AO was of the view, that only 1/5th expenditure should be allowed as deduction and the balance should be carried forward and allowed in the following four years in equal instalments. The AO also made a reference to the decision of the Supreme Court in the case of Madras Industrial Investment Corporation Ltd. v. CIT wherein the concept of deferred revenue expenditure had been accepted by the Hon’ble Supreme Court.
25. On appeal by the assessee, the CIT(A) confirmed the order of the AO.
26. For similar reasons only l/5th of the expenditure claimed under the head consumer product research of Rs. 2,85,36,594 was allowed as deduction by the AO in the asst. yr. 2001-02 which was confirmed by the CIT(A).
27. It is not in dispute before us that similar issue had come before the Tribunal in assessee’s own case for the asst. yrs. 1998-99, 1999-2000 in ITA No. 2645/Del/2002 and ITA No. 1316/Del/2003, the Tribunal had set aside the orders of the Revenue authorities on the issue and restored the matter to the file of the AO for fresh adjudication. The Tribunal expressed its opinion that the Revenue authorities had made the disallowance without making any. reference to the nature and impact of the expenditure incurred by the assessee vis-a-vis the running of the existing business and in the context of Section 37 of the Act. The Tribunal, therefore, directed the AO to ascertain the nature and impact of the expenditure incurred by the assessee and thereafter decide the issue in accordance with the decisions rendered by the Hon’ble Supreme Court as well as various High Courts on this issue.
28. Respectfully following the decision of the Tribunal referred to above, we set aside the additions made by the Revenue authorities in both the assessment years and direct the AO to decide these issues afresh in the light of the directions given by the Tribunal for the asst. yrs. 1998-99 and 1999-2000. The relevant grounds of appeals of the assessee are treated as allowed for statistical purposes.
29. The next issue for consideration is the disallowance of research and product development expenses of Rs. 8,46,182 by the Revenue authorities on the ground that the said expenditure resulted in a long-term advantage to the assessee and was, therefore, of the nature of capital expenditure. The grievance of the assessee on this issue is projected in ground Nos. 3.1 and 3.2 in ITA 2823/Del/2004. On identical issue, the Tribunal in assessee’s own case for asst. yrs. 1998-99 and 1999-2000 has set aside the order of Revenue authorities and remanded the same for fresh consideration by the AO. The basis on which the disallowance was made being the same as in asst. yrs. 1998-99 and 1999-2000, we deem it proper to set aside the order of the Revenue authorities and remand the issue to the AO for fresh consideration in the light of the directions given by the Tribunal for asst. yrs. 1998-99 and 1999-2000. The grounds of appeal are treated as allowed for statistical purposes.
30. The next issue for consideration in ITA No. 819/Del/2005 is with regard to the allocation of administrative expenses while computing deduction under Section 80HHC of the Act. The grievance of the assessee is projected in ground Nos. 3 and 4.1 in ITA 819/Del/2005 and ground Nos. 4 and 4.1 in ITA No. 2823/Del/2004. The AO while computing deduction under Section 80HHC of the Act, in respect of export of trading goods allocated the entire administrative expenses in the ratio of export turnover of such goods to the total turnover to determine indirect costs attributable to export of such goods.
31. On appeal by the assessee, the CIT(A) confirmed the order of the AO. Hence, the present grounds of appeal in both the appeals before the Tribunal.
32. We have heard the rival submissions. Clauses (b) and (c) of Sub-section (3) of Section 80HHC of the Act provide for determination of profit derived from export of trading goods as under :
“(b) Where the export out of India is of trading goods, the profits derived from such export shall be the export turnover in respect of such trading goods as reduced by the direct costs and indirect costs attributable to such exports;
(c) where the export out of India is of goods or merchandise manufactured or processed by the appellant and of trading goods, the profit derived from such export shall,–(ii) in respect of trading goods, be the export turnover in respect of such trading goods as reduced by the direct and indirect costs attributable to export of such trading goods.”
Profit from the export of trading goods is to be determined by reducing from the export turnover of such trading goods, direct cost and indirect costs attributable to such export. The terms direct cost and indirect cost have been defined in Clause. (d) and Clause (e) of Explanation below Section 80HHC(3) of the Act as under :
“(d) ‘direct costs’ means costs directly attributable to the trading goods exported out of India including the purchase price of such goods.”
“(e) ‘Indirect costs’ means costs, not being direct costs, allocated in the ratio of the export turnover in respect of trading goods to the total turnover.”
From a harmonious reading of definition of ‘indirect cost’ in Expln. (e) below Sub-section (3) of Section 80HHC and Clause (b) of that section it would be appreciated that only indirect cost attributable to the export is to be reduced for computing deduction from export of trading goods. Explanation (e) to Sub-section (3) of Section 80HHC cannot override the provision of Clause (b) of Section 80HHC(3).
The Special Bench of Tribunal in Surendra Engineering Corpn. v. Asstt. CIT (2003) 78 TTJ (Mumbai)(SB) 347 : (2003) 86 ITD 121 (Mumbai)(SB) held that indirect costs which are not attributable to export turnover of trading goods should not be taken into consideration. It is clear from the aforesaid order of the Tribunal that for the purpose of computing deduction under Section 80HHC, indirect costs related to the export of trading goods is to be apportioned and not all costs other than direct costs have to be prorated to arrive at the indirect costs that have to be reduced. It is only those costs which have some relation to the export of trading goods that need to be allocated. The AO is, therefore, directed to recompute the deduction under Section 80HHC of the Act in respect of trading goods by excluding from the indirect expenses, such expenses not related to the export of trading goods.
33. The next issue for consideration is with regard to the grievance of the assessee against the action of the Revenue authorities in excluding royalty income on sale of Horlicks by applying the provisions of Sub-clause (1) of Clause (baa) of Explanation to Section 80HHC of the Act. The grievance of the assessee is projected in ground Nos. 4.2 and 4.3 in ITA No. 819/Del/2005 and ground Nos. 4.2 and 4.3 in ITA No. 2823/Del/2004.
34. The assessee is a licensee for manufacture and marketing of Horlicks in India. The assessee entered into a sub-licensing agreement with SBCH, whereby SBCH was granted license to manufacture Horlicks. SBCH was to pay royalty of 5 per cent of net sales of Horlicks to the assessee. While computing deduction under Section 80HHC of the Act the AO excluded 90 per cent of the royalty income by applying the provisions of Clause (baa) (sic-of Explanation) to section 80HHC of the Act. According to the AO, the royalty income was of the nature referred to in Sub-clause (1) of Clause (baa) of Explanation to Section 80HHC. The CIT(A) confirmed the order of the AO. Hence the present appeal before the Tribunal.
35. We have considered the submissions of the learned Counsel for the assessee and the learned Departmental Representative. “Profits of the business” has been defined in Expln. (baa) of Section 80HHC of the Act, which reads as under :
“(baa) ‘profits of business’ means the profits of the business as computed under the head ‘Profits and gains of business or profession’ as reduced by–
(1) ninety per cent of any sum referred to in Clauses. (iiia), (iiib) and (iiic) of Section 28 or of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits; and….”
In view of the said Explanation for computing “profits of the business”, 90 per cent of receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature has to be reduced from the income computed under the head ‘profits and gains of business or profession’.
From a reading of the aforesaid provisions, it is clear that royalty income is not income of the nature of brokerage, commission, interest, rent or charges. The royalty income is clearly in the nature of profits and gains of business. The royalty income is not receipt of a similar nature as that of brokerage, commission, etc. The expression “of any other receipt of a similar nature” occurring in Clause (1) of Expln. (baa) has to be construed ejusdem generis with the words appearing immediately preceding that expression. The plea of the assessee also finds support from the decision of the Hon’ble Bombay High Court in the case of CIT v. Bangalore Clothing Co. and the Delhi Bench of the Tribunal in the case of Smt. Sujatha Grover v. Dy. CIT (2002) 74 TTJ (Del) 347. The action of the Revenue authorities in excluding 90 per cent of royalty income cannot, therefore, be sustained. The AO is, therefore, directed to recompute the income under Section 80HHC by considering the royalty income as profits of the business.
36. The only other surviving ground in ITA 819/Del/2005 is the charging of interest under Section 234D of the Act. The provisions of Section 234D read as follows :
“Section 234D: Interest on excess refund–(1) Subject to the other provisions of this Act, where any refund is granted to the assessee under Sub-section (1) of Section 143, and–
(a) no refund is due on regular assessment; or
(b) the amount refunded under Sub-section(1) of Section 143 exceeds the amount refundable on regular assessment, the assessee shall be liable to pay simple interest at the rate of two-third per cent on the whole or the excess amount so refunded, for every month or part of a month comprised in the period from the date of grant of refund to the date of such regular assessment.”
The above provision came into effect from 1st June, 2003. The plea of the assessee was that the refund ought to have been granted on or after 1st June, 2003 for applicability of the provisions of Section 234D. Since refund was allowed to the assessee prior to 1st June, 2003, i.e., on 22nd Feb., 2002 when the return of income of assessee was processed under Section 143(1) of the Act, provisions of Section 234D would not apply. The CIT(A), however, held that the section was a procedural section and would apply to all pending assessment cases. Since the order of assessment under Section. 143(3) in the case of the assessee was passed on or after 1st June, 2003, the CIT(A) upheld the action of the AO in charging interest under Section 234D.
37. The learned Counsel for assessee submitted that the provisions of Section 234D do not apply to assessment year in question especially when the amount of refund had been granted earlier to 1st June, 2003. The learned Departmental Representative submitted charging of interest under Section 234D is compensatory and the provisions of Section 234D are clarificatory and, therefore, applicable retrospectively. According to the learned Departmental Representative, the provisions being purely procedural and machinery provisions can be applied to pending assessment proceedings.
38. In our view, the law dealing with imposition of interest is substantive and not procedural law and, therefore, interest under Section 234D cannot be charged in respect of assessment years prior to coming into force of these provisions. The levy of interest under Section 234D is, therefore, directed to be deleted. The 5th ground of appeal of the assessee is allowed.
39. In the result, both the appeals are partly allowed.
