ORDER
N.V. Vasudevan, J.M.
1. These are appeals by assessee and Revenue against Order dt. 26th April, 2005 of CIT (A)-X, New Delhi, relating to asst. yr. 1996-97.
2. Ground Nos. 1 to 1.5 in appeal of the assessee and grounds of appeal of the Revenue can be conveniently decided together. Ground Nos. 1 to 1.5 raised by the assessee read as follows:
1. That the CIT(A) erred on facts and in law in allowing payment of export commission only to the extent of 5 per cent of FOB value of exports as against 12.5 per cent invoking provisions of Section 40A(2) of the IT Act, even while observing that the foreign collaborator was instrumental for promotion of export sales achieved by the appellant.
1.1.1. That the CIT(A) erred on facts and in law in holding that increase in payment of export commission to 12.5 per cent from 5 per cent to nominee/affiliates of the collaborator of the appellant was excessive and unreasonable and the action of the AO in invoking the provisions of Section 40A(2) and Section 92 of the Act was justified to the extent of such excess.
1.1.2. That the CIT(A) erred on facts arid in law in holding that the appellant has failed to establish with supporting evidences that payment of commission @ 12.5 per cent was reasonable.
1.1.3. That the CIT(A) erred on facts and in law in not appreciating that the AO did not discharge the onus of bringing on record any comparable instance to show that the payment of export commission was excessive.
1.1.4. That the CIT(A) erred on facts and in law in holding that the AO could not bring any identical comparable case as the nature of services to be rendered for earning such commissions varies from case to case.
1.1.5. The CIT(A) erred on facts and in law in appreciating that in the facts and circumstances of the case the payment of export commission was commensurate with the business necessities of the appellant and was not excessive or unreasonable.
3224 /Del/2005: (Grounds of appeal of Revenue)
1. On the facts and in the circumstances of the case and in law, the CIT (A) has erred in restricting the export commission to 5 per cent as against disallowance made by the AO at 12.5 per cent without considering the reasonableness and commercial expediency for the outlay.
2. On the facts and in the circumstances of the case and in law, the CIT (A) has erred in admitting the additional evidence during the appellate proceedings disregarding the objection raised by the AO in the remand report that the assessee was provided several opportunities at the assessment stage to authenticate its claim of the expense claimed but failed to do so and, therefore, the additional evidence filed may not be accepted in view of Rule 46A(1). Furthermore, the CIT (A) has also erred in not complying with the provisions of Rule 46A(2) of IT Rules, 1962 and not passing a speaking Order.
The appellant craves leave to add, amend, alter or vary from the above grounds of appeal before or at the time of hearing.
3. The assessee is a company. It is engaged in the business of manufacture and sale of float glass and mirror glass. The assessee claimed deduction of a sum of Rs. 10, 07, 22,625 being commission paid to Guardian Glass Export Ltd. (GGE) @ 12.5 per cent of the export sales. The AO disallowed the claim for deduction on the ground that evidence of rendering service by the person to whom commission had been paid, had not been furnished by the assessee. Besides the above reasons, the AO also noticed that GGE was an associate company and that the exports were made at a loss and, therefore, there was no justification for payment of commission. According to the AO, the commission was paid only to compensate the foreign collaborator for loss of royalty. The CIT (A) allowed deduction of commission to the extent of 5 per cent of the net FOB value of exports and sustained the disallowance of the remaining sum. Aggrieved by the action of CIT (A) in not deleting the entire disallowance, the assessee is in appeal before the Tribunal. Aggrieved by the relief allowed by the CIT (A), the Revenue is in appeal before the Tribunal.
Before dealing with the rival contentions on behalf of the assessee and Revenue, it is necessary to give some more details as to why the AO made the disallowance.
4. The assessee was incorporated as a joint venture company between Guardian International Corporation, USA (GIC), Modi Rubber (I) Ltd., MRL, M/s Gujarat Mineral Development Corpn. Ltd. (GMDC) and Gujarat Alkalies & Chemicals Ltd. (GACL) to undertake manufacture of float glass in India. Guardian International Corpn., USA owns 50 per cent of the equity capital of the assessee company. The assessee was originally known only as GACL. Later on GACL became Gujarat Guardian Ltd. after change of name i.e. the assessee.
5. Original foreign collaboration agreement dt. 5th June, 1990 between GIC, MRL, and GACL contemplated the assessee entering into an export sales agreement whereby GIC or any of affiliate of GIC was to act as sole exclusive agent for the sale of float glass manufactured by the assessee in countries other than India. The commission payable to GIC or affiliate of GIC was agreed at 5 per cent of net FOB selling price. This was the maximum payment as per the prevailing law in force at that point of time.
Even prior to the foreign collaboration agreement dt. 5th June, 1990 GACL had obtained letter of intent from the Ministry of Industry for establishing float glass plant in the State of Gujarat. The terms of approval contemplated that the assessee would export at least 25 per cent of the annual production.
The assessee had imported capital goods under the Export Promotion Capital Goods (EPCG) Scheme. Such permission was accorded subject to the assessee agreeing to fulfil its export obligations as contemplated under the aforesaid scheme.
6. According to the assessee export sales had to be effected by the assessee in view of the aforesaid conditions.
The assessee entered into export sales agency agreement dt. 20th July, 1993 with GGE an associate of GIC under which the later was appointed as the sales agent of the assessee’s products in countries of the world other than India. The percentage of commission agreed was 12.5 per cent of the invoice price of all export sales of product sold through GGE. Consequent to change in the law 12.5 per cent commission was permissible at this point of time.
7. We have already noticed that there was a foreign collaboration agreement between GIC, MRL and GACL. Under this agreement and approvals to this agreement, assessee had to pay royalty to GIC at 3 per cent on internal sale and 4 per cent on export. The assessee had entered into a loan agreement with IDBI, IFCI, ICICI, LIC, GIC and UTI. In October, 1992, GIC gave an undertaking to tire financial institutions that it will not claim royalty during the repayment period of loan and interest to these financial institutions. It is not in dispute that from 1992 till 1999 the assessee did not pay any royalty to GIC in view of the above undertaking. This condition was waived by the financial institutions only in November, 1999.
The case of the AO was that because of this condition of financial institution regarding non-payment of royalty to GIC, the assessee and GIC devised a scheme by which sales agency agreement dt. 20th Sept., 1993 was entered into between the assessee and GGE whereby commission was increased to 12.5 per cent from 5 per cent and the motive was to ensure that GIC gets royalty camouflaged in the form of enhanced commission. According to the AO there was no necessity to enhance the commission income. In this regard the AO has also referred to the fact that the export realizations were much below even the cost of production. The plea of the assessee in this regard was that there was no domestic demand and the export sales were helping the assessee to recover fixed costs and minimizing losses and, therefore, the assessee preferred to sell the products by exporting them even though the export realizations were less than the cost price. It was however, submitted that the price at which sales were made by the assessee was at the prevailing international prices and that there cannot be any link between the cost of production and payment of commission. According to the AO, the commission paid at 12.5 per cent was contributing to the cash loss of the assessee. The further case of the AO was that the change in the law permitting payment of commission from 5 per cent to 12.5 per cent without any permission of RBI also was another factor which was taken advantage by the assessee to pay commission at increased rate to offset the nonpayment of royalty due to conditions imposed by the financial institutions.
8. Apart from the above, the main case of the AO for disallowing the claim of the assessee for deduction of the commission expense was the inability of the assessee to substantiate the services rendered by GGE for which commission was paid. The findings of the AO in this regard were as follows:
(a) The plea of the assessee in support of the claim for deduction of commission was that assessee did not have any sales office outside India nor any sales personnel to look after sales and that Guardian Group located across the world provides services including procuring export Orders, customer service, follow up etc.
(b) The AO called upon the assessee to furnish details of parties to whom exports were made through the services of intermediaries, complete documentary evidence like correspondence details of sales personnel of the export agent etc.
(c) The AO held that the assessee has given a general reply about services rendered which are normally rendered by any agent. That no evidence to identify the nature of services rendered by the agent with regard to the export business of the assessee was produced by the assessee.
(d) Export obligation of the assessee was not a new phenomenon and it existed even when the agreement to pay 5 per cent commission was in vogue.
(e) The assessee did not give any valid explanation for the upward revision of commission from 5 per cent to 12.5 per cent.
(f) The assessee failed to demonstrate that the percentage of commission charged was reasonable compared with international practice.
(g) The assessee had managed affairs in such a way that there is no tax incidence on payment to the joint venture partner. Had the assessee paid monies in the form of dividend or royalty, there would have been some tax collected by Indian authorities on such payment.
(h) The assessee failed to give calculation of cost per unit and the price of export sale per unit, so as to justify payment of 12.5 per cent commission.
(i) The assessee failed to establish the fact that the export sales were made by the assessee at prevailing international prices.
(j) Average sale price was of Rs. 7,655 per unit for the raw glass in the domestic market and Rs. 13,519 average per unit in the export market. For the mirror glass the average sale price per unit in the domestic market was Rs. 34,950 as against the average sale price in the export market of Rs. 23,728. The assessee’s major export consists of raw float glass of which the average sale prices in the domestic market (for three months January, 1996, February, 1996 and March, 1996) were Rs. 18,067, Rs. 19,368 and Rs. 19,299 respectively. However, the average sale prices in the export market were Rs. 14,038, Rs. 13,149 and Rs. 13,139, respectively, for the above period. Thus, there has been a tremendous difference in selling price of domestic as compared to the export market. Despite repeated requests to explain the reasons with supporting evidences, nothing was submitted or produced to justify huge differences.
(k) That the payment to a person having substantial interest is not justified in view of the provisions of Sections 92 and 40A(2) of the Act.
For the above reasons, the AO disallowed the claim for deduction of a commission.
9. Before CIT(A). The assessee contended as follows:
(a)The plant of the assessee company commenced commercial production on 1st March, 1993. The domestic sales of float glass manufactured by the plant were not as anticipated leading to piling of inventory, thereby, increasing dependence on exports, apart from the export obligation which had to be fulfilled, in any case. The export sales agency agreement dt. 20 July, 1993 was signed between Guardian Glass Exports Ltd. (GGE), an affiliate of Guardian Industries Corp. which was nominated by Guardian International Corporation and the assessee company. In view of the increased involvement of Guardian in the promotion of exports, the said agreement provided for payment of commission at 12.5 per cent of the net FOB value of export, as against 5 per cent mentioned in the collaboration agreement of 1990. The Guardian Group is amongst the top four float glass manufacturers in the world with 20 plants in various parts of the world and offices in several countries. The assessee company being a new entrant in the field and having no expertise in marketing of float glass in the overseas market, did not establish any office abroad nor recruited any employees to look after such marketing. The assessee solely relied on the Guardian Group for promotion of export.
(b) In the aforesaid factual background, the assessee pointed out that the commission paid to GGE was out of business necessity and was justified on grounds of commercial expediency and that the action of the AO in disallowing deduction for payment of export commission is based only on conjectures and surmises and is not sustainable both in law and on facts.
(c) That Guardian Group rendered, inter alia, the following services:
(i) regular contact with customers and responding to their enquiries;
(ii) procurement of Orders and assistance in establishing the letter of credits wherever required;
(iii) informing customers on Order status/delivery;
(iv) attending to customers complaints regarding breakage, quality, etc. and settlement of customers claims;
(v) follow up and payment responsibility in respect of exports on credit terms; and
(vi) regular customers” visits and providing other customer support services such as educating the customers about usage of glass, guidance on cutting of higher thickness glass, etc.
(d)The services rendered by Guardian are amply borne out from the sample copies of correspondence filed before AO which originate with the receipt of enquiry by the assessee company from Guardian salesmen are continued till the time that the goods are exported and payment received. The fact that commission has been paid to Guardian on the export of goods is highlighted in the GR forms submitted to the customs authorities and in the bank certificate of export and realisation. The commission paid by the assessee has been allowed as deduction in asst. yrs. 1994-95 and 1995-96. A chart showing FOB value of exports, the accrual of commission and payment thereof in different years was also as follows:
F.Y.
Export (FOB value)
Export commission as per P&L a/c
Actual remittance
Remarks
1993-94
9,74,25,183
1,02,88,556
Nil
Allowed by AO
1994-95
43,24,72,033
4,79,91,164
1,04,491
-do-
1995-96
90,09,62,030
10,07,22,626
8,70,84,452
Disputed in appeal
1996-97
49,43,67,568
4,40,29,507
37,16,113
1997-98
32,77,74,975
2,91,11,445
4,97,576
1998-99
55,26,68,903
5,31,08,480
12,38,91,331
Total :
2,80 56,70,692
28,52,52,778
21,62,34,387
It was submitted that there was no basis for the disallowance in the year under appeal, when there is no change in facts.
(e) It was contended that Section 40A(2) of the Act clothes the AO with power to disallow deduction for any expenses claimed if the AO is of the opinion that the same is excessive having regard to the fair market value of such services and the legitimate needs of the business. The AO has not brought any material on record to show how Section 40A(2) was applicable to the present case. The provisions of Section 92 provide that where the business between a resident and a non-resident is so transacted that no profits or less than ordinary profits accrue to the resident, then, the AO may determine the amount of profits which may be deemed to have been derived from such business and include the same in the total income of the resident. The provisions of Section 92 of the Act have no relevance to the allowance of claim of deduction of commission. The exports made by the assessee were to unrelated third parties and were not at a price lower than the prevailing international market prices. There is, therefore, no question of invoking provisions of Section 92 of the Act.
10. The assessee also explained as to why it had to effect exports sales and as to how such export sales contributed to recovery of fixed costs to the assessee. The assessee highlighted the fact that after payment of commission exports contributed Rs. 34.25 crores. The assessee also drew attention of CIT(A) to its letters dt. 4th March, 1999, and 11th March, 1999 wherein the reasons for revision of export commission was duly explained by the assessee.
11. Before the CIT(A), the assessee sought to file certain additional evidence in terms of Rule 46A(c) and (d) of the IT Rules. These documents are with reference to the plea of the assessee that there was slack demand for float glass in local market and with a view to recover fixed costs the assessee had to resort to export sales even at less than cost price., Certain documents regarding payment of royalty to GIC after financial year 1999-2000 and financial position of other glass manufacturers in India was also filed before CIT(A). These documents were duly confronted to the AO and his comments on the admissibility of these documents and their impact on the plea of the assessee before CIT(A) were also obtained.
12. On consideration of the above submissions the CIT(A) held as follows:
(a) Because of the export obligations under approval of foreign Collaboration agreement and EPCG scheme, there was necessity for export sales. A commission of 5 per cent was agreed to be paid to the foreign participant in the venture on export sales. To this extent payment of commission was justified.
(b) That the foreign promoter was instrumental for promotion of export sales achieved by the assessee. Therefore, services rendered were duly proved by the assessee.
(c) The fact that the price fetched on export sale was less than the cost was not a relevant factor so long as the price fetched was at the international market rate.
(d) Regarding the increase in commission from 5 per cent to 12.5 per cent the CIT (A) held as follows:
But for enhancing the commission from 5 per cent agreed upon at the time of collaboration agreement to 12.5 per cent of the FOB value later is not supported by any strong arguments. The only reason given for enhancement of the commission from 5 per cent to 12.5 per cent was that the appellant has to depend on exports for disposal of the inventory that was piling up apart from carrying out exports to fulfill the export obligation imposed by Government while approving the collaboration agreement and undertaken under the EPCG scheme. At the time of collaboration agreement itself its foreign collaborator was aware of the export obligation imposed by the Government of India while approving the collaboration agreement. Moreover, there was hardly any profit arising out of the exports and the appellant was not able to recover even the cost price through exports. Under the circumstance enhancing the commission from 5 per cent to 12.5 per cent to the nominee/affiliates of its collaborator is unreasonable. The AO’s reference to Section 40A(2) and Section 92 is, therefore, justified to the extent of disallowance of 6.5 (sic-7.5) per cent (i.e. difference between 5 per cent and 12.5 per cent) as the assessee has failed to establish with any supporting evidences that the payment of commission at 12.5 per cent is reasonable considering the facts of the appellant’s case. As far as payment of commission is concerned, the AO cannot bring any identical comparable case as in each case the nature of services to be rendered for earning such commission varies from case to case. Under the given facts and circumstances of the case, the AO is directed to allow commission to the extent of 5 per cent and disallow the balance amount in view of the provisions of Section 40A(2) and for the various reasons mentioned by the AO in his Order.
13. In this appeal before the Tribunal submissions as were made before CIT (A) were reiterated by the learned Counsel for assessee. The learned departmental Representative relied on Order of AO. In particular, the learned Departmental Representative highlighted the timing of the sales agency agreement in June, 1993 which, coincided with the condition by financial institutions regarding non-payment of royalty. She also highlighted facts with regard to existence of adverse conditions and necessity for export sales even prior to the signing of the sales agency agreement of 1993 and when commission of 5 per cent was thought justified between the assessee and GIC. It was submitted by her that the case of the AO is based on circumstantial evidence and should be restored. With regard to the action of AO in allowing commission in asst. yrs. 1993-94 and 1995-96, she submitted that principles of res judicata are not applicable in tax cases and, therefore, the AO was at liberty to embark upon such enquiry.
14. We have considered the rival submissions. The following points arise for consideration:
(a) Whether the assessee has established the fact that services were rendered by the agent justifying payment of commission?
(b) If the answer to the above point is in the affirmative, whether the Revenue was justified in restricting the allowance to 5 per cent as against 12.5 per cent claimed by the assessee?
(c) Whether the Revenue has established justifiability of the disallowance under the provisions of Section 40A(2) or Section 92 of the Act?
15. The evidence on record shows the following. The assessee entered |into an agreement with GGE dt. 20th July, 1993. This agreement is titled export sales agency agreement. The assessee appointed GGE as the assessee’s non-exclusive sales report (sic-agent) for soliciting Orders for the assessee’s products in all the countries of the world except the Union of India. The assessee also agreed to pay 12-1/2 per cent of the invoice price of all the export sales of products sold outside India. The agreement was to be in force for a period of 5 years from 20th July, 1993 with option to renew for a period of further 5 years.
16. GGE have raised invoice for every month in respect of the export sales. Copies of this proforma invoice are available at pp. 92 to 102 of the assessee’s paper book. At pp. 374 to 378 the assessee has given the list of customers to whom export sales were made during the previous year. The assessee has also listed communication between the assessee and the sales executives of the Guardian Group and the Orders procured by them. Guardian Industries Corporation, USA is amongst the top four float glass manufacturers in the world and it has 20 float glass plants in the various parts of the world and have wide marketing network having sales executives based in over 40 countries. The services rendered by GGE as part of the Guardian Industries Corporation, USA have already been enumerated in para 14 of this Order. At pp. 81 to 91 and 190 to 224 there are several correspondences between the assessee and the various sales agents of the Guardian Group across the world. These correspondences are in the form of emails. The assessee has also placed in the paper book evidence regarding export sales in the form of invoice, shipping bills, etc. There are two realisation certificates of export products. In this realisation certificate issued by the bank the payment of export commission is duly reflected. In the light of the above documentary evidence on record, we are of the view that there was sufficient evidence before the AO regarding services rendered by GGE for which export commission had been paid by the assessee. We, therefore, hold that the assessee has established that services were rendered by the agent justifying payment of commission.
On the question whether the CIT(A) was justified in restricting the disallowance to 5 per cent as against 12.5 per cent made by the AO, we notice that the assessee in its submissions before the AO had clearly explained the necessity for making export sales. These facts have already been narrated while discussing the basis of disallowance made by the AO.
17. The assessee has explained in its submissions before AO about the nature of the float glass industry as follows:
(i) Float glass manufacturing is a continuous process industry. Float glass furnaces are typically built for 10-12 years and operate 24 hours a day, 365 days a year. It takes about 3 weeks for the furnace to be put into normal operation and once in operation, it cannot be allowed to be cooled down. Any sudden cooling may result into major damage to furnace refractory and may even result in collapse of the furnace. Planned shutdown and restart of furnace takes 3 to 4 months.
? The furnace always contains glass in molten stage and hence gas consumption remains fixed. Also as per the agreement with GAIL for supply of gas, minimum payment is required to be made for the guaranteed quantity irrespective of usage.
? The float glass industry is very capital intensive in nature and, consequently, there is high level of fixed costs on account of high interest and depreciation costs.
(ii) Excess capacity in India–Subsequent to the setting up of the plant by the assessee, similar float glass plant was set up by Indo Asahi Sheet Glass Co. Ltd. Some of the existing manufacturers of sheet glass also converted part of their existing facilities for manufacture of float glass resulting in over capacity and excess supply. There was excess production capacity of about 40-50 per cent in comparison to the domestic demand.
(iii) Low domestic demand–Float glass was originally sold at prices 15-20 per cent higher than sheet glass. Sales during the period February, 1993 to July, 1993 was only 43 per cent of the production while the balance remained in the inventory. The assessee had to depend on exports for disposal of the inventory that was piling up, apart from carrying out exports to fulfill the export obligation (i) imposed by Government while approving the collaboration agreement, and (ii) undertaken under the EPCG Scheme. The assessee being a new entrant in the field did not have any infrastructure or set up for procuring/facilitating export sales. The assessee solely relied on the Guardian Group for promotion of export. All the export Orders/contracts are procured by GGE. The emphasis on exports warranted a much larger role for Guardian in promotion of exports than envisaged at the time of signing the collaboration agreement in 1990. Guardian, therefore, renegotiated export commission to 12.5 per cent of net FOB value of exports as against 5 per cent originally agreed, while signing the export sales agency agreement in 1993. The export commission paid was as per the limits prescribed by RBI.
(iv) Others: The exports made by the assessee even after reducing the export commission during the relevant previous year contributed Rs. 34.25 crores towards meeting the fixed cost. The assessee compared to other float glass manufacturers has the highest export sales, as borne out from the statistics for the financial year 1995-96. The assessee during the year under appeal sustained a loss of Rs. 0.01 crore only as against loss of Rs. 51.27 crores sustained by Float Glass India Ltd., another competing glass manufacturer with similar capacity. The lower loss for the assessee was due to higher exports to the tune of Rs. 90 crores as compared to Rs. 33 crores by Float Glass India Ltd. Net realisation/profit from export of glass/mirror of GGI, even after considering the payment of export commission, is higher than that of the industry. (The fact is also borne out from the enquiries conducted by the Transfer Pricing Officer in asst. yr. 2002-03). By carrying on the exports, the assessee saves Rs. 67 crores in customs duty and also Rs. 10 crores which would have been payable as interest in case the export obligation had not been met, thereby resulting in preventing financial loss of Rs. 10.77 crores.
18. The above submissions on behalf of the assessee have not been properly construed by the AO. We may also add here that once it is held that services have been rendered by the agent the quantum of commission that has to be paid is purely the discretion of the assessee and the Revenue cannot sit in judgment over the same. We, therefore, hold that there was no basis to restrict the claim of commission at 5 per cent as against 12.5 per cent claimed by the assessee.
19. The next issue that would arise for consideration is as to whether there was justification for invoking the provisions of Section 40A(2) or Section 92 of the Act. On this issue we find that the AO has merely made a passing reference to the provisions of Section 40A(2) and Section 92 of the Act without making any attempts as to how these provisions were attracted and as to on what basis the disallowance was being made. The CIT(A) in applying the provisions of Section 40A(2) has merely gone by the fact that the obligation for export existed even prior to the export sales agency commission agreement dt. 20th July, 1993 and even at this point of time there was piling up of inventory. The CIT (A) found that there was no profit arising out of exports and, therefore, there could be no circumstance necessitating enhancement of commission. For the above reasons the CIT(A) invoked the provisions of Section 40A(2) and Section 92 of the Act. We are of the view that the action of the CIT(A) in this regard cannot be sustained. Provisions of Section 40A(2) contemplate a disallowance subject to the condition that the Revenue establishes that the expenditure was excessive or unreasonable having regard to the fair market value of the goods and services or facilities for which the payment has been made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to the assessee therefrom. We do not find any evidence as to what is the fair market value of the services for which assessee paid commission. The percentage of 5 per cent agreed between the parties prior to 20th July, 1993 agreement cannot be said to be the fair market value. The CIT(A) has proceeded on the basis that the same was the evidence of fair market value. Even on the question of application of Section 92, we notice that the Transfer Pricing Officer in asst. yrs. 2002-03, 2003-04 and 2004-05 has accepted the percentage of commission paid by the assessee as one at arm’s length price. In these circumstances we are of the view that even provisions of Section 92 were not attracted. We, therefore, hold that there was no justification in restricting the allowance of commission at 5 per cent by invoking provisions of Section 40A(2) or Section 92 of the Act. We therefore allow the grounds of appeal of the assessee on this issue and dismiss the grounds of appeal of the Revenue on this issue. We may also add that the Revenue has raised an issue regarding violation of provisions of Rule 46A of the Rules. On this issue we find that the CIT(A) has afforded opportunity to the AO and there cannot be any complaint in this regard. The CIT(A) also has given a finding that the documents filed by the assessee were necessary to rebut the observations made by the AO against the assessee in the Order of assessment. The CIT(A) has also held that the assessee was prevented by sufficient cause from placing the additional evidence during the course of assessment proceedings. Therefore, the objections of the Revenue in this regard are without any basis.
20. Ground Nos. 2 to 2.5 raised by assessee read as follows:
2. the CIT(A) erred on facts and in law in confirming disallowance of deduction of Rs. 21,84,87,000 being amount of training fee paid to Guardian USA on the ground that the training fee was incurred during the setting up of business and was therefore, of the nature of pre-set up expenses.
2.1 the CIT(A) erred on facts and in law in not appreciating the fact that the liability for training fee had crystalised/become known for the first time in the assessment year under consideration only on receipt of invoice from Guardian Industries Corporation.
2.2 the CIT(A) erred on facts and in law in not appreciating that the claim of training expenses, even otherwise, was allowable in the year under consideration in terms of Section 40(a)(i) of the Act considering that the tax had been deducted/deposited in the relevant year.
2.3 Without prejudice that the CIT(A) erred on facts and in law in not capitalizing training fees as part of plant and machinery, and allowing depreciation thereon, allegedly holding that the appellant failed to establish the nexus between such expenses and the assets.
21. We have already noticed that the assessee had a collaboration agreement with GIG, M/s GIC trained personnel of the assessee company in the operation and maintenance of float glass plant and also the manufacturing and marketing of float glass. The personnel of the assessee company underwent training at different locations between 21st Sept., 1991 and 16th Dec, 1992. This period was admittedly before the plant was set up. In September, 1995 that is the previous year relevant to asst. yr. 1996-97 the assessee received invoice from GIC in respect of amounts payable for imparting training prior to the period when the plant was set up. The amount payable was shown as a deferred revenue expenditure in the balance sheet for the financial year relevant to asst. yr. 1996-97. In the return of income for asst. yr. 1996-97, the entire sum was claimed as deduction as a revenue expenditure. The assessee claimed that because the invoice was received from GIC during the previous year the liability crystallised only during the previous year. That the assessee deducted tax at source and deposited the same to the credit of the Central Government and, therefore, the deduction of the said sum as an expenditure should be allowed in view of the provisions of Section 40(a)(i) of the Act. The AO was of the view that since these expenses were prior to the setting up of the plant they were capital expenditures and were to be capitalized. Since the assessee failed to establish the nexus between the assets and the training fee, even capitalization of these expenses could not be permitted. On the question of the expenditure having crystallised during the previous year, the CIT(A) held that under the mercantile system which the assessee follows this item of expenditure could be considered only as expenditure during the period in which it was incurred and claim of the assessee for deduction by virtue of making payment relying on provisions of Section 40(a)(i) cannot be allowed. The CIT(A) upheld the Order of the AO. Hence, the aforesaid ground of appeal by the assessee before the Tribunal.
22. The learned Counsel for the assessee reiterated submissions as were made before the AO. We are of the view that the item of expenditure in Question was admittedly incurred prior to setting up of the plant and, therefore, they were to be capitalized as part of plant and machinery. The fact that the payment was made during the previous year or that tax at source is deducted during the previous year will not convert the capital expenditure into the revenue expenditure. The provisions of Section 40(a)(I) are provisions enabling Revenue to make disallowance. The assessee cannot seek to rely on those provisions when the item of expenditure was admittedly capital expenditure. We, however, direct that the training fee be capitalized as part of plant and machinery, depreciation be allowed thereon. Thus, the above grounds are partly allowed.
23. Ground No. 3 reads as follows:
3. The CIT(A) erred on facts and in law in confirming disallowance of deduction for lump sum prepayment premium paid to IDBI amounting to Rs. 8 crores in lieu of agreeing to reduce rate of interest on all outstanding rupee loans under Section 43B of the Act, instead in allowing deduction for only 1/10th thereof.
The assessee had made proposal to Industrial Development Bank of India (IDBI) for restructuring of debt. IDBI vide letter dt. 19th March, 1995 agreed to inter alia reduce the rate of interest on rupee loan to 15 per cent per annum, effective 1st April, 1995 upon payment of lump sum prepayment premium of Rs. 6 crores. The pre-payment premium of Rs. 8 crores was paid during the previous year relevant to the assessment year under consideration and debited to the P&L a/c. The same was claimed as business expenditure while computing the income of the assessee. The AO called upon the assessee to explain as to how the pre-payment premium is allowable deduction in its entirety during the asst. yr. 1996-97, more so in view of the decision of the Supreme Court in the case of Madras Industrial Investment Corporation Ltd. v. C.A.T. . In response thereto the assessee submitted that Section 36(1)(iii) of the Act allows deduction for interest paid on moneys borrowed for purposes of business. That “Interest” is defined in Section 2(28A) of the Act as under:
Section 2(28A)–Interest’ means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised.
Lump sum repayment premium paid by the assessee to IDBI is in lieu of IDBI agreeing to reduce the rate of interest on the rupee loan aggregating to Rs. 170.76 crores. The same, in other words, represents upfront payment (present value) of differential rate of interest that would have been due on the loan if no restructuring of the debt had taken place. Even under Section 43B(d) of the Act deduction of interest payable to any public financial institution only in the year in which such sum is actually paid is allowed, irrespective of the year in which the liability to pay such sum was incurred according to the method of accounting followed by the assessee. Since the payment of lump sum prepayment premium, which is in the nature of interest, has been made during the previous year relevant to the asst. yr. 1996-97, the same is clearly admissible deduction in terms of Section 43B(d) of the Act.
24. The AO, however, rejected the contention on behalf of the assessee and held that the expenditure was of a capital nature because it was made to reduce the rate of interest payable in future and the same would confer a benefit of enduring nature on the assessee. The AO has also referred to the decision of the Hon’ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd. v. C.I.T. (supra). On appeal by the assessee CIT(A) confirmed the Order of the AO. Hence, the aforesaid ground of appeal before the Tribunal.
25. We have heard the rival submissions. The assessee had made proposal to IDBI for restructuring of debt. IDBI vide letter dt 19th March, 1995 agreed to, inter alia, reduce the rate of interest on rupee loan to 15 per cent per annum, effective from 1st April, 1995 upon payment of lump sum prepayment premium of Rs. 8 crores. The AO has allowed deduction for Rs. 80 lacs being 1/10th of the prepayment premium of Rs. 8 crores during the year, applying the ratio of the Supreme Court decision in the case of Madras Industrial Corporation Ltd. v. CIT (supra). The prepayment premium paid by the assessee to IDBI is in lieu of IDBI agreeing to reduce the rate of interest on the rupee loans aggregating to Rs. 170.76 crores. The same, in other words, represents upfront payment (present value) of differential rate of interest that would have been due on the loan if no restructuring of the debt had taken place. In terms of Section 36(1)(iii) r/w Section 2(28A) of the Act prepayment charges being interest paid on moneys borrowed for purposes of business, are to be allowed deduction as revenue expenditure. The prepayment premium being revenue expenditure, is to be allowed deduction in the year of accrual thereof, since the Act does not recognize the concept of deferred revenue expenditure.
26. The decision of the Chennai Bench of the Tribunal in the case of ‘Overseas Sanmar Financial Ltd. v. Jt. C.I.T. (2004) 87 T.T.J. (Chennai) 556 : (2003) 86 I.T.D. 602 (Chennai) also supports the plea of the assessee. Besides the above Section 43B (d) also permits claiming deduction on actual payment. Even on this basis the claim of the assessee deserves to be actepted. Ground No. 3 is accordingly allowed.
27. Ground No. 4 raised by the assessee reads as follows:
4. That on the facts and circumstances of the case the CIT (A) erred in not allowing/directing the AO to allow depreciation in terms of Section 32 of the Act.
For the relevant previous year the return of income was filed by the assessee declaring nil income (after set off of brought forward business loss). The assessee did not claim allowance of depreciation under Section 32 of the Act. The return of income was assessed under Section 143(3) of the Act at nil income, without allowing depreciation. In the course of the hearing of the appeal for asst. yr. 1996-97 before the CIT(A)-X, the AO, vide letter dt. 28th March, 2000, requested that depreciation be allowed to the assessee even though the same was not claimed by the assessee in the return of income. In the course of appellate proceedings, the CIT (A)-X had made available a copy of letter dt. 28th March, 2000, received from the AO to the assessee for comments thereon. The assessee vide letter dt. 11th May, 2000, objected to the AO’s request for depreciation being thrust on the assessee in the absence of a claim made in that regard. Subsequently, however, vide letter dt. 28th Oct., 2003, the assessee withdrew the aforesaid objection to the grant of depreciation and accepted the contention of the AO for allowance of depreciation. The CIT (A) while disposing of the appeal for asst. yr. 1996-97, did not adjudicate on the request of the AO. The assessee filed application under Section 154 of the Act dt. 20th Oct., 2003 before the CIT(A) pointing out that the non-disposal of the request made by the AO constituted mistake apparent from record. The said application is pending disposal before the CIT (A). It is in the above circumstances that the aforesaid ground of appeal has been raised by the assessee.
28. We have heard the rival submissions. We are of the view that in the light of the admitted fact that in asst. yr. 1996-97 onwards depreciation has been allowed on the value of fixed assets. After considering the depreciation for asst. yr. 1996-97 as having been allowed, there is no reason why depreciation should not be allowed in the present assessment year. We direct that the depreciation claimed be allowed.
29. The assessee has filed an application for raising an additional ground of appeal. This additional ground of appeal sought to be raised by the assessee reads as follows:
That on the facts and circumstances of the case for the purpose of allowance of depreciation, the actual cost of assets should be adjusted, in terms of Section 43A of the Income-tax Act, 1961 (the Act’) taking into account the rate of exchange at the year-end, vis-a-vis, the rate of exchange prevailing at the time the asset was purchased/loan was obtained in foreign currency.
30. Since depreciation was not claimed and was directed to be allowed, while deciding ground No. 4, we are of the view that this additional ground sought to be raised does not rise out of the Order of the CIT(A). We, however, hold that the assessee will be at liberty to make this claim before the AO and the AO will adjudicate the same in accordance with law. With these observations the additional ground of assessee is dismissed.
In the result the appeal by the assessee is partly allowed, while the appeal by the Revenue is dismissed.