Shaw Wallace & Co. Ltd. vs Asstt. Cit on 25 February, 2002

ORDER

Per R.P. Garg, Vice-President

These cross appeals are against the orders of the Commissioner (Appeals) for the assessment year 1994-95. For the sake of convenience, they are being disposed of by this common order.

2. The first ground raised in assessee’s appeal is that the Commissioner (Appeals) erred in holding the view that the separate assessment can be made under the provisions of section 143(3) of the Act in respect of an assessment year falling within the block period after the search is made under section 132 of the Act. In this case, the search and seizure action was taken on 27-8-1996 and the assessment was made by the assessing officer on 31-3-1997. A block assessment was also made covering this period by the assessing officer and the income assessed for this year was excluded from the block assessment and that view was upheld by the Calcutta High Court in the assessee’s own case reported in Dy. CIT v. Shaiv Wallace & Co. Ltd. (2001) 248 ITR 81 (Cal), wherein it was held that an assessment under section 143(3) can be made even where the assessee is to be assessed by way of block assessment for the block period. The ground is, accordingly, rejected.

2. The first ground raised in assessee’s appeal is that the Commissioner (Appeals) erred in holding the view that the separate assessment can be made under the provisions of section 143(3) of the Act in respect of an assessment year falling within the block period after the search is made under section 132 of the Act. In this case, the search and seizure action was taken on 27-8-1996 and the assessment was made by the assessing officer on 31-3-1997. A block assessment was also made covering this period by the assessing officer and the income assessed for this year was excluded from the block assessment and that view was upheld by the Calcutta High Court in the assessee’s own case reported in Dy. CIT v. Shaiv Wallace & Co. Ltd. (2001) 248 ITR 81 (Cal), wherein it was held that an assessment under section 143(3) can be made even where the assessee is to be assessed by way of block assessment for the block period. The ground is, accordingly, rejected.

2.1 On merits, the first dispute is for not allowing the non-competition fees of Rs. 10 crores (Sri G.R. Murarka Rs. 4 crores and Sri S.R. Gupta Rs. 6 crores). The assessee purchased two distilleries, viz., M/s. Pampasar Distillery Ltd. wherein Sri G.R. Murarka held 60 per cent shareholding and M/s. Central Distillery & Breweries wherein Sri S. R. Gupta together with his relatives were registered holders and exclusively entitled to the beneficial ownership of 1,86,109 equity shares of Rs. 10 each, which approximately fully paid-up equity share capital of Central Distillery & Breweries Ltd. As per the agreement, a sum of Rs. 10 crores was given to the promoter’s of the two Distilleries for the restrictive covenants not to compete with the assessee and as per the averments it was to facilitate its profits by eliminating competition from these two promoters. The assessing officer observed that there were limits to the price of shares of a company determined by market forces and in the instant case it was difficult. to imagine that such limits would not have been operative and the assessee was left with no option but to pay the cost of acquisition over and above the price paid for the acquisition of the shares of these two companies to their promoters. According to him, in order to claim the payments as allowable deduction, the transaction was given the colour of payments as non-competition fees. But, in fact, the real purpose of these payments was to compensate the promoters of the companies owning the two distilleries for the cost of the distilleries. He further observed that it was not the case of the assessee that the payments were made to any distillery owner or business rival and it was also not the case of the assessee that the persons who were paid the said amounts possessed special expertise and skills so as to threaten the business of the assessee. He further observed that the circumstances that these persons’ companies/distilleries did not produce any brand of liquor with national market presence does not support the case of the assessee as to the real purpose or motive of the said payments. He, therefore, held that the claim of the assessee for allowability of the claim of Rs. 10 crores as business expenditure is nothing but part of the cost of distilleries and added to the income of the assessee.

2.1 On merits, the first dispute is for not allowing the non-competition fees of Rs. 10 crores (Sri G.R. Murarka Rs. 4 crores and Sri S.R. Gupta Rs. 6 crores). The assessee purchased two distilleries, viz., M/s. Pampasar Distillery Ltd. wherein Sri G.R. Murarka held 60 per cent shareholding and M/s. Central Distillery & Breweries wherein Sri S. R. Gupta together with his relatives were registered holders and exclusively entitled to the beneficial ownership of 1,86,109 equity shares of Rs. 10 each, which approximately fully paid-up equity share capital of Central Distillery & Breweries Ltd. As per the agreement, a sum of Rs. 10 crores was given to the promoter’s of the two Distilleries for the restrictive covenants not to compete with the assessee and as per the averments it was to facilitate its profits by eliminating competition from these two promoters. The assessing officer observed that there were limits to the price of shares of a company determined by market forces and in the instant case it was difficult. to imagine that such limits would not have been operative and the assessee was left with no option but to pay the cost of acquisition over and above the price paid for the acquisition of the shares of these two companies to their promoters. According to him, in order to claim the payments as allowable deduction, the transaction was given the colour of payments as non-competition fees. But, in fact, the real purpose of these payments was to compensate the promoters of the companies owning the two distilleries for the cost of the distilleries. He further observed that it was not the case of the assessee that the payments were made to any distillery owner or business rival and it was also not the case of the assessee that the persons who were paid the said amounts possessed special expertise and skills so as to threaten the business of the assessee. He further observed that the circumstances that these persons’ companies/distilleries did not produce any brand of liquor with national market presence does not support the case of the assessee as to the real purpose or motive of the said payments. He, therefore, held that the claim of the assessee for allowability of the claim of Rs. 10 crores as business expenditure is nothing but part of the cost of distilleries and added to the income of the assessee.

3. Before the Commissioner (Appeals) it was submitted that agreement for non-competition fees was for 5 years and based on certain decisions, it was claimed that where the benefit is not of an enduring nature but is to exhaust in a short period, the expenditure is of a revenue nature; that the money paid to keep out a potential competition in business where the benefit is of an enduring nature, is an expenditure in the nature of capital. It was the claim of the assessee that where there is no certainty of the duration of the advantage and the same could be put to an end at any time, the expenditure would be revenue in nature. The Commissioner (Appeals) held that the payment cannot be taken as revenue expenditure because the agreements were, to run for a long duration of 10 years unfettered by any stipulation of termination. He further held that payment of non-competition fees could have some rationale if the competition was between equals producing the same commodity and that the promoters of the two distilleries taken over were no match for the assessee who had monopoly of manufacture and marketing of its own brand names. On these facts, he further held that there was no business necessity for making the non-competition fees of Rs. 10 crores. He, therefore, upheld the disallowance.

3. Before the Commissioner (Appeals) it was submitted that agreement for non-competition fees was for 5 years and based on certain decisions, it was claimed that where the benefit is not of an enduring nature but is to exhaust in a short period, the expenditure is of a revenue nature; that the money paid to keep out a potential competition in business where the benefit is of an enduring nature, is an expenditure in the nature of capital. It was the claim of the assessee that where there is no certainty of the duration of the advantage and the same could be put to an end at any time, the expenditure would be revenue in nature. The Commissioner (Appeals) held that the payment cannot be taken as revenue expenditure because the agreements were, to run for a long duration of 10 years unfettered by any stipulation of termination. He further held that payment of non-competition fees could have some rationale if the competition was between equals producing the same commodity and that the promoters of the two distilleries taken over were no match for the assessee who had monopoly of manufacture and marketing of its own brand names. On these facts, he further held that there was no business necessity for making the non-competition fees of Rs. 10 crores. He, therefore, upheld the disallowance.

4. The learned counsel of the assessee apart from relying upon the decisions referred to in the order of the Commissioner (Appeals), also placed reliance on the decision of the Supreme Court in the case of Empire Jute Co. Ltd. v. CIT (1980) 124 ITR 1 (SC) and decision of the Madras High Court in the case of CIT v. G.D. Naidu (1987) 165 ITR 63 (Mad) and submitted that the payment was made to ward off the competition and, therefore, an allowable deduction. The learned counsel of the revenue, on the other hand, submitted that the parties were not in a position to compete with the assessee; that the payments were made against the public policy, i.e. against free trade policy and that it was a capital expenditure in view of the Madhya Pradesh High Court decision in the case of CIT v. Sauser Liquor Traders (1996) 222 ITR 33 (MP), Madras High Court decision in the case of Chelpark Co. Ltd. v. CIT (1991) 191 ITR 249 (Mad), Calcutta High Court decision in the case of CIT v. Hindustan Pilkington Glass Works (1983) 139 ITR 581 (Cal) and Karnataka High Court decision in the case of CIT v. Bangalore Arrack Co. (1993) 201 ITR 25 (Karn). The decision of the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd. v. CIT (1998) 229 ITR 534 (SC) was also referred to. It was further submitted that the onus is on the assessee to prove that the expenditure was an allowable deduction and a reference in this connection was made to the decisions of the Madhya Pradesh High Court in the case of Sauser Liquor Traders (supra) and Bangalore Arrack Co.’s case (supra). Reference was also made to the decisions of the Supreme Court in the case of Lachminarayan Madan Lal v. CIT (1972) 86 ITR 439 (SC), Calcutta High Court in the case of Vishnu Agencies (P) Ltd. v. CIT (1979) 117 ITR 823 (Cal), Gujarat High Court in the case of CIT v. Shahibag Entrepreneurs (P) Ltd. (1995) 215 ITR 810 (Guj) and Gauhati High Court decision in the case of Assam Pesticides & Agro Chemicals v. CIT (1997) 227 ITR 846 (Gau).

4. The learned counsel of the assessee apart from relying upon the decisions referred to in the order of the Commissioner (Appeals), also placed reliance on the decision of the Supreme Court in the case of Empire Jute Co. Ltd. v. CIT (1980) 124 ITR 1 (SC) and decision of the Madras High Court in the case of CIT v. G.D. Naidu (1987) 165 ITR 63 (Mad) and submitted that the payment was made to ward off the competition and, therefore, an allowable deduction. The learned counsel of the revenue, on the other hand, submitted that the parties were not in a position to compete with the assessee; that the payments were made against the public policy, i.e. against free trade policy and that it was a capital expenditure in view of the Madhya Pradesh High Court decision in the case of CIT v. Sauser Liquor Traders (1996) 222 ITR 33 (MP), Madras High Court decision in the case of Chelpark Co. Ltd. v. CIT (1991) 191 ITR 249 (Mad), Calcutta High Court decision in the case of CIT v. Hindustan Pilkington Glass Works (1983) 139 ITR 581 (Cal) and Karnataka High Court decision in the case of CIT v. Bangalore Arrack Co. (1993) 201 ITR 25 (Karn). The decision of the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd. v. CIT (1998) 229 ITR 534 (SC) was also referred to. It was further submitted that the onus is on the assessee to prove that the expenditure was an allowable deduction and a reference in this connection was made to the decisions of the Madhya Pradesh High Court in the case of Sauser Liquor Traders (supra) and Bangalore Arrack Co.’s case (supra). Reference was also made to the decisions of the Supreme Court in the case of Lachminarayan Madan Lal v. CIT (1972) 86 ITR 439 (SC), Calcutta High Court in the case of Vishnu Agencies (P) Ltd. v. CIT (1979) 117 ITR 823 (Cal), Gujarat High Court in the case of CIT v. Shahibag Entrepreneurs (P) Ltd. (1995) 215 ITR 810 (Guj) and Gauhati High Court decision in the case of Assam Pesticides & Agro Chemicals v. CIT (1997) 227 ITR 846 (Gau).

5. We have heard the parties and considered their rival submissions. Admittedly, the payment of Rs. 10 crores was made to these persons for the alleged non-competition for a period of 10 years. It is stated to have been to ward off competition, Looking to the dominating position of the assessee in the market for liquor manufacturing, the assessing officer has held that it was nothing but a payment of cost price for the acquisition of distilleries, more so because of the fact that the parties to whom the payments were made were not in a position to compete with the assessee. But this aspect has not been dealt with by the Commissioner (Appeals) and he has rejected the claim of the assessee only on the ground that the payment was for an enduring benefit arid, therefore, cannot be allowed as a deduction. Our limited consideration in this case would, therefore, be whether it is a payment of an enduring nature which cannot be allowed as a revenue deduction. In the case of Empire Jute Co. Ltd. (supra), Their Lordships of the Supreme Court held that there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. Their Lordships further held that if the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. It is, therefore, held that the test of enduring benefit is not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case. It was further held that what is an outgoing ‘Of capital and what is an account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process and the question must be viewed in the larger context of business necessity or expediency. In this case, the payment was made for operating the looms for longer working hours and was primarily and essentially related to the operation or working of the looms which constituted the profit-making apparatus of the assessee and was an expenditure laid out as part of the process of profit earning. It was held to be an outlay of a business in order to carry in on and to earn a profit out of this expense as an expense of carrying it on; it was part of the cost of operating the profit-earning apparatus and was clearly in the nature of revenue expenditure.

5. We have heard the parties and considered their rival submissions. Admittedly, the payment of Rs. 10 crores was made to these persons for the alleged non-competition for a period of 10 years. It is stated to have been to ward off competition, Looking to the dominating position of the assessee in the market for liquor manufacturing, the assessing officer has held that it was nothing but a payment of cost price for the acquisition of distilleries, more so because of the fact that the parties to whom the payments were made were not in a position to compete with the assessee. But this aspect has not been dealt with by the Commissioner (Appeals) and he has rejected the claim of the assessee only on the ground that the payment was for an enduring benefit arid, therefore, cannot be allowed as a deduction. Our limited consideration in this case would, therefore, be whether it is a payment of an enduring nature which cannot be allowed as a revenue deduction. In the case of Empire Jute Co. Ltd. (supra), Their Lordships of the Supreme Court held that there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. Their Lordships further held that if the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. It is, therefore, held that the test of enduring benefit is not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case. It was further held that what is an outgoing ‘Of capital and what is an account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process and the question must be viewed in the larger context of business necessity or expediency. In this case, the payment was made for operating the looms for longer working hours and was primarily and essentially related to the operation or working of the looms which constituted the profit-making apparatus of the assessee and was an expenditure laid out as part of the process of profit earning. It was held to be an outlay of a business in order to carry in on and to earn a profit out of this expense as an expense of carrying it on; it was part of the cost of operating the profit-earning apparatus and was clearly in the nature of revenue expenditure.

5.1 In the case of G.D. Naidu (supra), the Madras High Court dealt with a case of partnership wherein the new partners took over the firm in stages and payment was made to the assessee and his son for not carrying on business for five years. The Tribunal held that compensation paid by the firm should be of three components, viz., (a) share in the assets, (b) share in the goodwill, and (c) share in the restricted covenant in terms of section 36(2) of the Partnership Act. The payments in respect of (a) and (b) would not be deductible in the hands of the firm because these were only payments to retiring partners but the contribution attributable to item (c) was deductible. The Tribunal also held that the amount received by the recipients was not liable to tax either as income or capital gains. The High Court distinguishing its earlier decision in the case of Blaze & Central (P) Ltd. v. CIT ( 1979) 120 ITR 33 held that no separate business of the old partners were acquired or any competition was eliminated by such acquisition. Since there was no acquisition of any business by payment of the amount referable to the restrictive covenant and there was no benefit of an enduring nature being acquired, the payment was held to be a revenue outgoing. In the case of G.D. Naidu (supra), the agreement was for five years. In a later case of Chelpark Co. Ltd. (supra), the Madras High Court dealt with a case of Managing Director of the assessee-company who constituted a partnership firm consisting of his wife and two daughters for the purpose of manufacture and sale of ink. In that case the assessee entered into an agreement with the said partnership under which the company paid a sum of Rs. 1 lakh as compensation to its erstwhile Managing Director on his undertaking to discontinue and not recommence at any time within a period of five years, the manufacture of writing ink and sale thereof or any other business similar or competitive to the business carried on by the company. Distinguishing the case of G.D. Naidu (supra), the court held that it was a case of payment for acquiring an enduring benefit in the sense that the partnership which was a potential competition to the assessee had vanished and that the ex-Mg. Director had left India and it was clear that the payment was made in order to ward off damaging competition from a potential competitor, resulting in the acquisition by the assessee of a right as well as protection to carry on its business activities as a whole for so long as the assessee carried on such business. Consequently, the payment by the assessee was held to be in the nature of capital expenditure and not revenue expenditure.

5.1 In the case of G.D. Naidu (supra), the Madras High Court dealt with a case of partnership wherein the new partners took over the firm in stages and payment was made to the assessee and his son for not carrying on business for five years. The Tribunal held that compensation paid by the firm should be of three components, viz., (a) share in the assets, (b) share in the goodwill, and (c) share in the restricted covenant in terms of section 36(2) of the Partnership Act. The payments in respect of (a) and (b) would not be deductible in the hands of the firm because these were only payments to retiring partners but the contribution attributable to item (c) was deductible. The Tribunal also held that the amount received by the recipients was not liable to tax either as income or capital gains. The High Court distinguishing its earlier decision in the case of Blaze & Central (P) Ltd. v. CIT ( 1979) 120 ITR 33 held that no separate business of the old partners were acquired or any competition was eliminated by such acquisition. Since there was no acquisition of any business by payment of the amount referable to the restrictive covenant and there was no benefit of an enduring nature being acquired, the payment was held to be a revenue outgoing. In the case of G.D. Naidu (supra), the agreement was for five years. In a later case of Chelpark Co. Ltd. (supra), the Madras High Court dealt with a case of Managing Director of the assessee-company who constituted a partnership firm consisting of his wife and two daughters for the purpose of manufacture and sale of ink. In that case the assessee entered into an agreement with the said partnership under which the company paid a sum of Rs. 1 lakh as compensation to its erstwhile Managing Director on his undertaking to discontinue and not recommence at any time within a period of five years, the manufacture of writing ink and sale thereof or any other business similar or competitive to the business carried on by the company. Distinguishing the case of G.D. Naidu (supra), the court held that it was a case of payment for acquiring an enduring benefit in the sense that the partnership which was a potential competition to the assessee had vanished and that the ex-Mg. Director had left India and it was clear that the payment was made in order to ward off damaging competition from a potential competitor, resulting in the acquisition by the assessee of a right as well as protection to carry on its business activities as a whole for so long as the assessee carried on such business. Consequently, the payment by the assessee was held to be in the nature of capital expenditure and not revenue expenditure.

5.2 The Calcutta High Court in the case of Hindustan Pilkington Glass Works (supra) dealt with a case of an assessee who entered into a tripartite agreement with two other concerns which produced the same type of commodity as was produced by the assessee and the object of the agreement was the elimination of competition in order to prevent possible annihilation of the business of the assessee. Here also the agreement was for five years, but it could be brought to an end earlier only if there was mutual consent. Under the terms of the agreement, one of the concerns agreed not to produce the particular commodity and in consideration thereof the other two concerns agreed to pay to it a stipulated sum every year. On these facts it was held by Their Lordships of the Calcutta High Court that the expenditure was incurred with the declared intention of preventing what the parties to the agreement described as annihilation from business. And the expenditure would, in all probability, secure a goodwill for the assessee in its field by sterilising the operation of a competitor for five years and in these circumstances, the profit-making apparatus of the assessee was thereby vastly improved and the expenditure was held to be accepted as capital nature. The decision of Supreme Court in the case of Empire Jute Co. Ltd. (supra) was also considered.

5.2 The Calcutta High Court in the case of Hindustan Pilkington Glass Works (supra) dealt with a case of an assessee who entered into a tripartite agreement with two other concerns which produced the same type of commodity as was produced by the assessee and the object of the agreement was the elimination of competition in order to prevent possible annihilation of the business of the assessee. Here also the agreement was for five years, but it could be brought to an end earlier only if there was mutual consent. Under the terms of the agreement, one of the concerns agreed not to produce the particular commodity and in consideration thereof the other two concerns agreed to pay to it a stipulated sum every year. On these facts it was held by Their Lordships of the Calcutta High Court that the expenditure was incurred with the declared intention of preventing what the parties to the agreement described as annihilation from business. And the expenditure would, in all probability, secure a goodwill for the assessee in its field by sterilising the operation of a competitor for five years and in these circumstances, the profit-making apparatus of the assessee was thereby vastly improved and the expenditure was held to be accepted as capital nature. The decision of Supreme Court in the case of Empire Jute Co. Ltd. (supra) was also considered.

5.3 In the case of Hindustan Pilkington Glass Works (supra), Karnataka High Court held that expenditure incurred in eliminating competition in bidding for right to vend arrack was opposed to public policy and also capital in nature and, therefore, not deductible. Their Lordships held

5.3 In the case of Hindustan Pilkington Glass Works (supra), Karnataka High Court held that expenditure incurred in eliminating competition in bidding for right to vend arrack was opposed to public policy and also capital in nature and, therefore, not deductible. Their Lordships held

“Held, that, on the admitted facts in the instant case, the assessee had purchased a rival bidder so that he would not come forward to participate in the public auction to vend arrack. This was contrary to the public interest as well as public welfare and, therefore, opposed to public policy. It could not be regarded as a valid payment for purposes of the Income Tax Act. Moreover expenditure was incurred in the instant case once and for all with a view to bring into existence the asset or the advantage of obtaining the privilege to vend liquor for one year. The entire business itself was of one year’s duration. The expenditure was, therefore, capital in nature. It was not deductible.”

5.4 In the case of Grover Soap (P.) Ltd. v. CIT (1996) 221 ITR 299 (MP) the Madhya Pradesh High Court held that payment made to ward off competition in business to a rival would constitute capital expenditure if the object of making that payment is to derive an advantage by eliminating the competition over some length of time. In this case the agreement was for 15 years. It was by following the decision of the Supreme Court in the case of CIT v. Coal Shipments (P) Ltd. (1971) 82 ITR 902 (SC).

5.4 In the case of Grover Soap (P.) Ltd. v. CIT (1996) 221 ITR 299 (MP) the Madhya Pradesh High Court held that payment made to ward off competition in business to a rival would constitute capital expenditure if the object of making that payment is to derive an advantage by eliminating the competition over some length of time. In this case the agreement was for 15 years. It was by following the decision of the Supreme Court in the case of CIT v. Coal Shipments (P) Ltd. (1971) 82 ITR 902 (SC).

5.5 The expenditure incurred in violation of a provision of the Act would not be an allowable deduction, as held by the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd. (supra) and as held by Karnataka High Court in the case of Bangalore Arrack Co. (supra), payment to ward off competition being against a public policy would riot be an allowable deduction.

5.5 The expenditure incurred in violation of a provision of the Act would not be an allowable deduction, as held by the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd. (supra) and as held by Karnataka High Court in the case of Bangalore Arrack Co. (supra), payment to ward off competition being against a public policy would riot be an allowable deduction.

6. In view of the above, the payment made by the assessee to Sri G.R. Murarka and Sri S.R. Gupta to ward off competition for the period of 10 years would be a payment for acquiring an enduring benefit which cannot be allowed as deduction in view of the latter decision of the Madras High Court in the case of Chelpark Co. Ltd. (supra), of Calcutta High Court in the case of Hindustan Pilkington Class Works (supra), of Madhya Pradesh High Court in the case of Sauser Liquor Traders (supra) and of Calcutta High Court decision in the case of Vishnu Agencies (P) Ltd. (supra) and, therefore, it cannot be allowed as a deduction. The disallowance is, accordingly, upheld.

6. In view of the above, the payment made by the assessee to Sri G.R. Murarka and Sri S.R. Gupta to ward off competition for the period of 10 years would be a payment for acquiring an enduring benefit which cannot be allowed as deduction in view of the latter decision of the Madras High Court in the case of Chelpark Co. Ltd. (supra), of Calcutta High Court in the case of Hindustan Pilkington Class Works (supra), of Madhya Pradesh High Court in the case of Sauser Liquor Traders (supra) and of Calcutta High Court decision in the case of Vishnu Agencies (P) Ltd. (supra) and, therefore, it cannot be allowed as a deduction. The disallowance is, accordingly, upheld.

7. The next dispute is against the disallowance of depreciation on the cost of electric meters and transformers purchased during the relevant previous year from Andhra Pradesh State Electricity Board (hereinafter referred to as the APSEB) and leased out to them. The assessee acquired certain meters worth Rs. 15,08,93,634 and transformers worth Rs. 4,91,06,482 and claimed depreciation at 100 per cent on the cost of the meters and Rs. 61,38,3 10 on power transformers. The assessing officer noticed that electric meters were originally purchased by APSEB during 1985 to 1989 and the written down value in their hands was nil. They were transferred to the assessee at the original cost of APSEB. There was no physical transfer of these assets to the assessee and, in fact, there was no possibility of their actual transfer as these meters were expected to be installed in the premises of hundreds or thousands consumers of APSEB. These assets were never got valued by the assessee nor by APSEB which gave an impression that the price paid was actually finance provided by the assessee to APSEB. There was no physical inspection of these assets by the assessee, nor was it ever possible being installed throughout the State of Andhra Pradesh. There was no possibility of the assessee recovering its dues from APSEB in case of payment default by sale of these assets. From the above facts and circumstances, the assessing officer held that real purpose of the payment. to APSEB was not towards the cost of acquisition of these assets but a purely financial deal wherein finance has been provided to APSEB in the garb of a leasing arrangement. He, therefore, disallowed the claim of the aggregate depreciation of Rs. 15,70,31,944.

7. The next dispute is against the disallowance of depreciation on the cost of electric meters and transformers purchased during the relevant previous year from Andhra Pradesh State Electricity Board (hereinafter referred to as the APSEB) and leased out to them. The assessee acquired certain meters worth Rs. 15,08,93,634 and transformers worth Rs. 4,91,06,482 and claimed depreciation at 100 per cent on the cost of the meters and Rs. 61,38,3 10 on power transformers. The assessing officer noticed that electric meters were originally purchased by APSEB during 1985 to 1989 and the written down value in their hands was nil. They were transferred to the assessee at the original cost of APSEB. There was no physical transfer of these assets to the assessee and, in fact, there was no possibility of their actual transfer as these meters were expected to be installed in the premises of hundreds or thousands consumers of APSEB. These assets were never got valued by the assessee nor by APSEB which gave an impression that the price paid was actually finance provided by the assessee to APSEB. There was no physical inspection of these assets by the assessee, nor was it ever possible being installed throughout the State of Andhra Pradesh. There was no possibility of the assessee recovering its dues from APSEB in case of payment default by sale of these assets. From the above facts and circumstances, the assessing officer held that real purpose of the payment. to APSEB was not towards the cost of acquisition of these assets but a purely financial deal wherein finance has been provided to APSEB in the garb of a leasing arrangement. He, therefore, disallowed the claim of the aggregate depreciation of Rs. 15,70,31,944.

8. The Commissioner (Appeals) upheld the disallowance. According to him, the reasoning given by the assessing officer stood unrebutted and what the assessing officer ultimately inferred was that both the transactions of purchase of assets by the assessee and leasing out the same to the seller of the assets where sham transactions with the intention of large scale tax avoidance by both the parties. He observed that amongst others, sham transactions may be presumed from the following circumstances :

8. The Commissioner (Appeals) upheld the disallowance. According to him, the reasoning given by the assessing officer stood unrebutted and what the assessing officer ultimately inferred was that both the transactions of purchase of assets by the assessee and leasing out the same to the seller of the assets where sham transactions with the intention of large scale tax avoidance by both the parties. He observed that amongst others, sham transactions may be presumed from the following circumstances :

“(a) Vendee purchasing assets even without taking care to value it; (b) Vendee purchasing assets without inspecting it; (c) vendor. remaining, in possession of the assets although possession is professedly transferred; (a) extent of avoidance of tax etc. It is an admitted fact in the present case that appellant did not take care to value the assets nor did he inspect it before purchase. it is also an admitted fact that assets continued to remain in the possession of APSEB. Over the same assets APSEB got 100 per cent depreciation in respect of meters and normal depreciation on transformers and appellant is now claiming identical depreciation resulting in huge tax avoidance. Only to curb this malpractice Explanation 4A to section 43(1) has been inserted with effect from 1-10-1996. From a perusal of the deeds of conveyance whereby APSEB transferred all rights etc. in equipments to appellant and agreements of lease of the same equipments by the lessor i.e., appellant to lessee i.e., APSEB, vide deed of conveyance dated 31-1-1994, 19 transformers & 694009 meters were transferred to appellant which were leased back to APSEB vide lease agreements dated 1-2-1991, 2-2-1994 & 3-2-1994, However, by lease agreement dated 21-3-1994, appellant leased out 6 transformers and 267500 meters to APSEB though appellant did not have any such asset as on 21-3-1994. There is a conveyance deed dated 21-3-1994 for transfer from APSEB of 6 transformers and 235467 meters but that conveyance deed was to come into effect only from 25-3-1994. Thus vide lease dated 21-3-1994, appellant leased out assets which it did not possess. Appellant’s undertaking that he is the absolute owner of the equipments in para 2 of page 3 of the lease deed was thus a false undertaking. This is an indication of the shamness of the whole transaction. Vide para 4 at page 6 of the lease deeds the lessee declared that the lessee had taken prior inspection of the equipments and that the lessee had obtained all consents, approvals, etc. as are necessary for/or in connection with the enforceability, validity and extension of the agreements. The very short duration between the deeds of conveyance and the lease agreements suggest that inspection of over 9 lakh meters, and obtaining consents, approvals etc. could not have been made by the lessee unless such job was undertaken long before the first transfer of the assets to appellant. Thus it is apparent that transfer of asset to appellant and subsequent leasing out of the assets again to APSEB were not isolated events that happened naturally but was part of a colourable device for tax avoidance conceived much earlier. Mc.Dowell’s case reported in 154 ITR 148 is about such colourable device and it is to be held that the transaction between appellant and APSEB were sham transactions and what was really done was advance of finance to APSEB in the garb of purchase of assets and subsequent leasing out of assets. As much has been admitted by the appellant when it made the alternate suggestion that in case benefit of depreciation is denied then capital component of the receipt of lease rent of the assets should not be taxed. This is an acceptable proposition as only interest accruing from advancement of loan can be taxed as a revenue receipt and not the capital component of repayment. In view of what has been discussed above, I have no hesitation in holding that payments made to APSEB was not towards cost of acquisition of meters and transformers but was for advancing finance to APSEB, that depreciation claimed on these assets to the tune of Rs. 15,70,31,944 is not allowable and that alternate proposition of the appellant for not taxing capital component of alleged lease rent is acceptable. The ground is disposed of as above.”

9. The learned counsel of the assessee submitted that the fact that no physical delivery is taken is not a ground for rejecting the claim of the assessee as the delivery was by agreement. As regards valuation and Nil W.D.V. in the hands of APSEB, he submitted that Explanation 3 is not invoked and the value is raised at cost plus tax to APSEB. Explanation 4A could be applicable in such cases that came into being with effect from 1-10-1966. which allows depreciation only on W.D.V. to the original owner. The alternate plea of the assessee is that the department has assessed the entire rental as income and if the depreciation is to be disallowed, it should have been assessed at the rental minus cost recovery included in such rental. The learned departmental Representative, on the other hand, supporting the orders of the revenue authorities submitted that in absence of physical delivery, the meters and transformers can only form the asset of the assessee and, consequently, no depreciation could be allowed thereon.

9. The learned counsel of the assessee submitted that the fact that no physical delivery is taken is not a ground for rejecting the claim of the assessee as the delivery was by agreement. As regards valuation and Nil W.D.V. in the hands of APSEB, he submitted that Explanation 3 is not invoked and the value is raised at cost plus tax to APSEB. Explanation 4A could be applicable in such cases that came into being with effect from 1-10-1966. which allows depreciation only on W.D.V. to the original owner. The alternate plea of the assessee is that the department has assessed the entire rental as income and if the depreciation is to be disallowed, it should have been assessed at the rental minus cost recovery included in such rental. The learned departmental Representative, on the other hand, supporting the orders of the revenue authorities submitted that in absence of physical delivery, the meters and transformers can only form the asset of the assessee and, consequently, no depreciation could be allowed thereon.

10. We have heard the parties and considered their rival submissions. A lease is an agreement whereby the lessor conveys to the lessee, in return for rent, the right to use an asset for an agreed period of time. Broadly speaking it is of two kindsa finance lease and an operating lease. A finance lease is a lease whereunder the present value of the minimum lease payments at the inception of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset. An operating lease is a lease other than a finance lease, viz., when it does not secure for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term. In the finance leasing, a new concept of sale and lease back was come into surface. In this system, the lessee is already having an asset and wants to leverage himself. The assets is first sold to the lessor and the lessee then takes back the assets on the lease from the lessor. Only the title moves and the assets does not actually and physically move. The finance is given in the form of sale price which along with interest is recovered back in the form of lease rental. In such like case where the lessee requires finance, he sells the old assets of very low or nil WDV at the price equivalent to the amount of finance he requires for his business matching the replacement value of the slow rate of technology in the country. He, therefore, takes these assets back without having parted with the possession either at the time of sale or taking it on lease. It is a paper exercise and the transaction is devoid of economic reality. The lessee who has a very low or nil WDV and could not have claimed depreciation at all for the use of the assets, can now claim the amount in the shape of lease rental for the use thereof. It is said that in view of the new provision of granting depreciation in regard to ‘block asset’, the sale consideration is reduced from the WDV and thereby the lessee’s charge of depreciation is reduced over the years which may be equivalent to the lease rental payment for the lease period. What benefit he actually got is the finance which is repaid in the form of lease rental over the period of lease.

10. We have heard the parties and considered their rival submissions. A lease is an agreement whereby the lessor conveys to the lessee, in return for rent, the right to use an asset for an agreed period of time. Broadly speaking it is of two kindsa finance lease and an operating lease. A finance lease is a lease whereunder the present value of the minimum lease payments at the inception of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset. An operating lease is a lease other than a finance lease, viz., when it does not secure for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term. In the finance leasing, a new concept of sale and lease back was come into surface. In this system, the lessee is already having an asset and wants to leverage himself. The assets is first sold to the lessor and the lessee then takes back the assets on the lease from the lessor. Only the title moves and the assets does not actually and physically move. The finance is given in the form of sale price which along with interest is recovered back in the form of lease rental. In such like case where the lessee requires finance, he sells the old assets of very low or nil WDV at the price equivalent to the amount of finance he requires for his business matching the replacement value of the slow rate of technology in the country. He, therefore, takes these assets back without having parted with the possession either at the time of sale or taking it on lease. It is a paper exercise and the transaction is devoid of economic reality. The lessee who has a very low or nil WDV and could not have claimed depreciation at all for the use of the assets, can now claim the amount in the shape of lease rental for the use thereof. It is said that in view of the new provision of granting depreciation in regard to ‘block asset’, the sale consideration is reduced from the WDV and thereby the lessee’s charge of depreciation is reduced over the years which may be equivalent to the lease rental payment for the lease period. What benefit he actually got is the finance which is repaid in the form of lease rental over the period of lease.

11. On the contrary, let us see the case of lessor like the assessee in this appeal. By taking the assets as acquired he claimed depreciation at the rate of 100 per cent of the enhanced value of assets being less than Rs. 10,000 each or at a high rate of depreciation applicable to that type of asset. Say, in this case Rs. 15,08,93,634 was claimed as depreciation in the case of electric meters which are entitled to depreciation at the rate of 100 per cent and Rs. 61,38,310 in respect of electric transformer which are entitled to high rate of depreciation. Excepting the execution of document of sale and agreements of leasing back, nothing actual has happened. The assets remained wherever they were. These were continued to be used without any disturbance or hindrance. Here also it is stated that the lessor has to offer the amount of lease rental as income over the period of lease. There is no tax avoidance or tax effect if the overall position of the entire period of lease is taken together. The money given by way of sale consideration is recovered back including interest in the shape of lease rental.

11. On the contrary, let us see the case of lessor like the assessee in this appeal. By taking the assets as acquired he claimed depreciation at the rate of 100 per cent of the enhanced value of assets being less than Rs. 10,000 each or at a high rate of depreciation applicable to that type of asset. Say, in this case Rs. 15,08,93,634 was claimed as depreciation in the case of electric meters which are entitled to depreciation at the rate of 100 per cent and Rs. 61,38,310 in respect of electric transformer which are entitled to high rate of depreciation. Excepting the execution of document of sale and agreements of leasing back, nothing actual has happened. The assets remained wherever they were. These were continued to be used without any disturbance or hindrance. Here also it is stated that the lessor has to offer the amount of lease rental as income over the period of lease. There is no tax avoidance or tax effect if the overall position of the entire period of lease is taken together. The money given by way of sale consideration is recovered back including interest in the shape of lease rental.

12. It is true that overall there might not be any advantage profit or gain or loss to either party but income is postponed by both the parties to subsequent years. That is all by mere executing some documents and nothing else. Let us explain this by way of an example

12. It is true that overall there might not be any advantage profit or gain or loss to either party but income is postponed by both the parties to subsequent years. That is all by mere executing some documents and nothing else. Let us explain this by way of an example

“‘B’ had an asset whose WDV is nil. It is revalued at Rs. 180. The asset is of the nature which entitled to 100 per cent depreciation. ‘B’ wants finance of Rs. 100 for 5 years. Normal rate of interest is 16 per cent. Instead of raising loan, he received the finance by selling the assets to ‘A’ who is a financier for Rs. 180 (Rs. 100 principal + Rs. 80 interest). Lease rental would be fixed at the rate of Rs. 36 per year. ‘B’ would receive the lease amount and interest in five years as under :

Particulars

Particulars

Particulars

B

B

B

A

A

A

 

Capital

Capital

Capital

Income

Income

Income

Capital

Capital

Capital

Income

Income

Income

Assets sold/purchased

Assets sold/purchased

180

180

180

180

Depreciation on sale items

Depreciation on sale items

(-) 180

(-) 180

Reduction of Depreciation on other assets

Reduction of Depreciation on other assets

180

180

Nil

Nil

Lease Rental – 1st year

Lease Rental – 1st year

(-) 36

(-) 36
 

36

36

2nd year

2nd year
 

(-) 36

(-) 36
 

36

36

3rd year

3rd year
 

(-) 36

(-) 36
 

36

36

4th year

4th year
 

(-) 36

(-) 36
 

36

36

5th year

5th year
 

(-) 36

(-) 36
 

36

36

 
 

Nil

Nil
 

Nil

Nil

13. As stated above, nothing physically has moved. The assets remained where they were. The lessor-assessee even did not know where these assets were and was not in a position even to identify at least in the case of electric meters. Transformers being voluminous in size might have been identified, but records say that the assessee had not even inspected any of the machine before purchasing and also leasing back to the lessee. Except financing, i.e., movement of money, no consequences flow from the transaction. Such type of transactions are known as one of a method of financing, though it is given a name of a ‘sale and a lease” on paper. Such transactions are to be regarded as sham or mere eye wash, viz., projected by acts done or documents executed by the parties which intended to give third parties or revenue authorities or court the appearance of creating between the parties legal rights and obligations which they intended to create. These types of transactions are, therefore, to be ignored in their apparent form. We may refer to the majority view of the Supreme Court decision in the case of Sundaram Finance Ltd. v. Stale of Kerala (1966) 17 STC 489 (SC) wherein after discussing various judgments of sale and hireback, the court held :

13. As stated above, nothing physically has moved. The assets remained where they were. The lessor-assessee even did not know where these assets were and was not in a position even to identify at least in the case of electric meters. Transformers being voluminous in size might have been identified, but records say that the assessee had not even inspected any of the machine before purchasing and also leasing back to the lessee. Except financing, i.e., movement of money, no consequences flow from the transaction. Such type of transactions are known as one of a method of financing, though it is given a name of a ‘sale and a lease” on paper. Such transactions are to be regarded as sham or mere eye wash, viz., projected by acts done or documents executed by the parties which intended to give third parties or revenue authorities or court the appearance of creating between the parties legal rights and obligations which they intended to create. These types of transactions are, therefore, to be ignored in their apparent form. We may refer to the majority view of the Supreme Court decision in the case of Sundaram Finance Ltd. v. Stale of Kerala (1966) 17 STC 489 (SC) wherein after discussing various judgments of sale and hireback, the court held :

“The appellants are carrying on the business of financiers; they are not dealing in motor vehicles. The motor-vehicle purchased by the customer is registered in the name of the customer and remains at all material times so registered in his name. In the letter taken from the customer under which the latter agrees to keep the vehicle insured, it is expressly recited that the vehicle has been given as security for the loan advanced by the appellants. As a security for repayment of the loan, the customer executes a promissory-note for the amount paid by the appellants to the dealer of the vehicle. The so-called “sale letter” is a formal document which is not made effective by registering the vehicle in the name of the appellants and even the insurance of the vehicle has to be effected as if the customer is the owner. Their right to seize the vehicle is merely a license to ensure compliance with the terms of the hire-purchase agreement. We are accordingly of the view that the intention of the appellants in obtaining the hire-purchase and the allied agreements was to secure the return of the loans advanced to their customers, and no real sale of the vehicle was intended by the customer to the appellants. The transactions were merely financing transactions.”

The court also cited the following observation of Lord Esher in the case of Re Watson :

“…. when the transaction is in truth merely a loan transaction, and the lender is to be repaid his loan and to have a security upon the goods, it will be unavailing to cloak the reality of the transaction by a sham purchase and hiring. It will be a question of fact in each case whether there is a real purchase and sale complete before the hiring agreement. If there be such a purchase and sale in fact and afterwards the goods are hired, the case is not within the Bills of Sale Act. The document itself must be looked at as part of the evidence; but it is only part, and the court must look at the other facts, and ascertain the actual truth of the case.”

14. It is well settled principle that it is the substance of the matter which should be looked into rather than the form or the nomenclature by which the parties call it for their own convenience. As held in the case of Mc. Dowell & Co. Ltd. v. CTO (1985) 154 ITR 148 – “the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax and whether the transaction is such that the judicial process may accord its approval to it”. From the table given above, it is apparent that by giving the loan transaction a cover of sale and lease back, no other economic consequences flow or affect the tax from one year to the other. This is also not approved by Their Lordships of the Supreme Court in the case of CIT v. British Paints India Ltd. (1991) 188 ITR 44 (SC). It was observed at page 56 – “Any system of accounting which excludes, for the valuation of the stock-in-trade, all costs other than the cost of raw materials for the goods -in-process and finished products, is likely to result in a distorted picture of the true state of the business for the purpose of computing the chargeable income. Such a system may produce a comparatively lower valuation of the opening stock and the closing stock, thus showing a comparatively low difference between the two. In a period of rising turnover and rising prices, the system adopted by the assessee, as found by the Tribunal, is apt diminish the assessment of the taxable profit of a year. The profit of one year is likely to be shifted to another year which is an incorrect method of computing profits and gains for the purpose of assessment. Each year being a self-contained unit and the taxes of a particular year being payable with reference to the income of that year, as computed in terms of the Act, the method adopted by the assessee has been found to be such that income properly be deduced therefrom. It is, therefore, not only the right but the duty of the assessing officer to act in exercise of his statutory power, as he has done in the instant case, for determining what, in his opinion, is the correct taxable income.”

14. It is well settled principle that it is the substance of the matter which should be looked into rather than the form or the nomenclature by which the parties call it for their own convenience. As held in the case of Mc. Dowell & Co. Ltd. v. CTO (1985) 154 ITR 148 – “the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax and whether the transaction is such that the judicial process may accord its approval to it”. From the table given above, it is apparent that by giving the loan transaction a cover of sale and lease back, no other economic consequences flow or affect the tax from one year to the other. This is also not approved by Their Lordships of the Supreme Court in the case of CIT v. British Paints India Ltd. (1991) 188 ITR 44 (SC). It was observed at page 56 – “Any system of accounting which excludes, for the valuation of the stock-in-trade, all costs other than the cost of raw materials for the goods -in-process and finished products, is likely to result in a distorted picture of the true state of the business for the purpose of computing the chargeable income. Such a system may produce a comparatively lower valuation of the opening stock and the closing stock, thus showing a comparatively low difference between the two. In a period of rising turnover and rising prices, the system adopted by the assessee, as found by the Tribunal, is apt diminish the assessment of the taxable profit of a year. The profit of one year is likely to be shifted to another year which is an incorrect method of computing profits and gains for the purpose of assessment. Each year being a self-contained unit and the taxes of a particular year being payable with reference to the income of that year, as computed in terms of the Act, the method adopted by the assessee has been found to be such that income properly be deduced therefrom. It is, therefore, not only the right but the duty of the assessing officer to act in exercise of his statutory power, as he has done in the instant case, for determining what, in his opinion, is the correct taxable income.”

15. Lease is a contract or bailment where returnability of goods is provided after a stipulated period. Without envisaging the return of goods it cannot be a proper bailment and hence not a valid lease. Returnability also necessitates identifying and, therefore, where the assets are not so identified or identifiable, there cannot be a valid lease. Though developed as a commercial device to alternate for traditional loans, leasing has found all over the world massive application as a device to exchange tax burdens. Virtually keeping the same rights over the asset as an owner, the capital allowances applying to asset ownership are transferred in a lease to the lessor. Mr. Bajoria submits that by executing the documents of sale, the lessee to the assets has passed to the assessee from the electricity board which creates ownership of the assessee. Money has actually been given by the assessee for the sale and in these circumstances it might be difficult to call it a sham transaction as economic interest of the parties are affected by passing on the money. As regards ownership, we may have reference to Delhi High Court decision in Goyal Cases (P.) Ltd. v. CIT (1997) 227 ITR 536 (Del) wherein it was observed as under :

15. Lease is a contract or bailment where returnability of goods is provided after a stipulated period. Without envisaging the return of goods it cannot be a proper bailment and hence not a valid lease. Returnability also necessitates identifying and, therefore, where the assets are not so identified or identifiable, there cannot be a valid lease. Though developed as a commercial device to alternate for traditional loans, leasing has found all over the world massive application as a device to exchange tax burdens. Virtually keeping the same rights over the asset as an owner, the capital allowances applying to asset ownership are transferred in a lease to the lessor. Mr. Bajoria submits that by executing the documents of sale, the lessee to the assets has passed to the assessee from the electricity board which creates ownership of the assessee. Money has actually been given by the assessee for the sale and in these circumstances it might be difficult to call it a sham transaction as economic interest of the parties are affected by passing on the money. As regards ownership, we may have reference to Delhi High Court decision in Goyal Cases (P.) Ltd. v. CIT (1997) 227 ITR 536 (Del) wherein it was observed as under :

“A was the manufacturer of the computers. It sold the computers to P, its selling agent. P, in its turn, sold the computers to the assessee. The assessee entered into an agreement of lease with A. The computers were given on lease by the assessee to A. A, in turn, sub-leased the computers to P and P again sub-leased the same computer to various parties of Calcutta. Having notice these facts the Tribunal had come to the conclusion that the entire transaction was so inter-woven that it gave a colour of a mere paper transaction without any actual transaction of sale, there was no material on record to establish that the title to the computers ever actually passed to the assessee. The Tribunal’s conclusion was based on facts and not on mere surmises. The Tribunal was right in denying depreciation to the assessee.”

16. Be that as it may, the question still remains that whether it was in reality a case of sale or lease back or it was only a case of loan transaction given the colour of the latter. See in this connection the Supreme Court decision in Sundaram Finance Ltd.’s case (supra) wherein it was field that in such like case the transaction in substance was a loan on security.

16. Be that as it may, the question still remains that whether it was in reality a case of sale or lease back or it was only a case of loan transaction given the colour of the latter. See in this connection the Supreme Court decision in Sundaram Finance Ltd.’s case (supra) wherein it was field that in such like case the transaction in substance was a loan on security.

17. What did the assessee do in this case? It financed the existing assets, i.e., electric meter of nil WDV and transformer having low WDV by purchasing it at the original cost plus taxes of the assets to the electricity company and that too without ascertaining the market price or marketability. If some default had taken place, the assessee was not in a position to take the assets back or even if he was in a position to take it, the assets had no marketability, they being installed in huge number of premises of consumers of electricity in West Bengal. No inspection of assets was done and it was impossible even; and the assessee solely relied upon the statement of the seller and the lessee about the quality, quantity, existence and the price without being sure of its sustained life or economic viability.

17. What did the assessee do in this case? It financed the existing assets, i.e., electric meter of nil WDV and transformer having low WDV by purchasing it at the original cost plus taxes of the assets to the electricity company and that too without ascertaining the market price or marketability. If some default had taken place, the assessee was not in a position to take the assets back or even if he was in a position to take it, the assets had no marketability, they being installed in huge number of premises of consumers of electricity in West Bengal. No inspection of assets was done and it was impossible even; and the assessee solely relied upon the statement of the seller and the lessee about the quality, quantity, existence and the price without being sure of its sustained life or economic viability.

18. Several transactions basic to the scheme were economically inserted to give a colour of sale and lease back which were only entitled to be physically active or make belief. An instrument may not be a magical talisman protecting its executants from payment of due tax. It has to be seen whether it was intended to have real effect as governing their rights and liabilities inter se or it was executed by way of pretence to escape or postpone the liability to tax without any intention that its provision showed in truth have effect as defining the rights of the parties as between themselves.

18. Several transactions basic to the scheme were economically inserted to give a colour of sale and lease back which were only entitled to be physically active or make belief. An instrument may not be a magical talisman protecting its executants from payment of due tax. It has to be seen whether it was intended to have real effect as governing their rights and liabilities inter se or it was executed by way of pretence to escape or postpone the liability to tax without any intention that its provision showed in truth have effect as defining the rights of the parties as between themselves.

19. In view of the above facts and circumstances and upon consideration of the terms and conditions of the agreements and the submissions of the parties, we are of the opinion that the transaction was a mere finance transaction and the assessee did not become the owner of the assets in reality and, therefore, not entitled to deduction for depreciation. As the lease rental received by the assessee in instalment consists of recoupment or the repayment of the finance provided by the assessee and interest thereon, the portion which relates to the recoupment of loan has to be excluded from the income of the assessee shown and declared from lease rentals and assessed by the assessing officer. We, therefore, uphold the direction of the Commissioner (Appeals) in disallowing the claim of depreciation and in accepting assessee’s claim to exclude the portion of the receipt of lease rents which consisted of repayment of the finance provided by the assessee.

19. In view of the above facts and circumstances and upon consideration of the terms and conditions of the agreements and the submissions of the parties, we are of the opinion that the transaction was a mere finance transaction and the assessee did not become the owner of the assets in reality and, therefore, not entitled to deduction for depreciation. As the lease rental received by the assessee in instalment consists of recoupment or the repayment of the finance provided by the assessee and interest thereon, the portion which relates to the recoupment of loan has to be excluded from the income of the assessee shown and declared from lease rentals and assessed by the assessing officer. We, therefore, uphold the direction of the Commissioner (Appeals) in disallowing the claim of depreciation and in accepting assessee’s claim to exclude the portion of the receipt of lease rents which consisted of repayment of the finance provided by the assessee.

20. The next ground in the assessee’s appeal and ground No. 1 in revenue’s appeal is against the disallowance/allowance of a portion of service charges paid to Peerless General Finance & Investment Co. Ltd. The assessee claimed a sum of Rs. 1,60,00,000 being paid to Peerless General Finance & Investment Co. Ltd. as service charges for the loan of Rs. 11.5 crores received by the assessee. As the loan was also obtained by the assessee from M/s. Peerless General Finance & Investment Co. Ltd. The assessing officer, therefore, held that question of paying any service charge to the very person/concern giving such loan does not arise as there is no service rendered so as to merit any separate payment. According to him, the real purpose of the payment was not as presented, but it was something else not disclosed. The real impact of the transaction, according to him, was the reduction of loan liability of the assessee. He, therefore, rejected the claim of the assessee.

20. The next ground in the assessee’s appeal and ground No. 1 in revenue’s appeal is against the disallowance/allowance of a portion of service charges paid to Peerless General Finance & Investment Co. Ltd. The assessee claimed a sum of Rs. 1,60,00,000 being paid to Peerless General Finance & Investment Co. Ltd. as service charges for the loan of Rs. 11.5 crores received by the assessee. As the loan was also obtained by the assessee from M/s. Peerless General Finance & Investment Co. Ltd. The assessing officer, therefore, held that question of paying any service charge to the very person/concern giving such loan does not arise as there is no service rendered so as to merit any separate payment. According to him, the real purpose of the payment was not as presented, but it was something else not disclosed. The real impact of the transaction, according to him, was the reduction of loan liability of the assessee. He, therefore, rejected the claim of the assessee.

21. Before the Commissioner (Appeals), the assessee submitted that the payment was made for the services rendered in connection with organising and arranging finance to the extent of Rs. 11.5 crores and the payment was allowable in view of the decisions in the cases of India Cements Ltd. v. CIT (1966) 60 ITR 52 (SC) and CIT v. Tumus Electric Corpn. Ltd. (1989) 179 ITR 219 (MP). The Commissioner (Appeals) on finding from the record a letter dated 12-8-1993 from Peerless General Finance & Investment Co. Ltd. to the assessee stipulated that since a loan of Rs. 1 crore was given to a concern in 1989 at the assessee’s request which had not been repaid till date, they were charging higher service charge from the assessee. He held that it contained a penalty component and observing that any expenditure incurred like stamps, registration fees, Lawyer’s fees for raising loans are allowable deduction, allowed the claim of 5 per cent to the assessee and disallowed the balance. He also observed that the service charges worked out to 14 per cent of the loan. Interest payment being 21 per cent and brokerage paid for syndicating the loan being about 5 per cent, the total cost of the loan to the assessee was around 40 per cent as against the real rate of interest being 20 to 24 per cent. The alternate claim was raised by the assessee before the Commissioner (Appeals) for deduction of 1/7th of Rs. 1,6 crores, but that point has not been accepted by the Commissioner (Appeals) because the expenditure has been allowed to the extent not considered excessive. Both the revenue and the assessee are in appeal.

21. Before the Commissioner (Appeals), the assessee submitted that the payment was made for the services rendered in connection with organising and arranging finance to the extent of Rs. 11.5 crores and the payment was allowable in view of the decisions in the cases of India Cements Ltd. v. CIT (1966) 60 ITR 52 (SC) and CIT v. Tumus Electric Corpn. Ltd. (1989) 179 ITR 219 (MP). The Commissioner (Appeals) on finding from the record a letter dated 12-8-1993 from Peerless General Finance & Investment Co. Ltd. to the assessee stipulated that since a loan of Rs. 1 crore was given to a concern in 1989 at the assessee’s request which had not been repaid till date, they were charging higher service charge from the assessee. He held that it contained a penalty component and observing that any expenditure incurred like stamps, registration fees, Lawyer’s fees for raising loans are allowable deduction, allowed the claim of 5 per cent to the assessee and disallowed the balance. He also observed that the service charges worked out to 14 per cent of the loan. Interest payment being 21 per cent and brokerage paid for syndicating the loan being about 5 per cent, the total cost of the loan to the assessee was around 40 per cent as against the real rate of interest being 20 to 24 per cent. The alternate claim was raised by the assessee before the Commissioner (Appeals) for deduction of 1/7th of Rs. 1,6 crores, but that point has not been accepted by the Commissioner (Appeals) because the expenditure has been allowed to the extent not considered excessive. Both the revenue and the assessee are in appeal.

22. We have the parties and considered their rival submissions. As observed by the Commissioner (Appeals), any expenditure incurred on raising loans are allowable expenditure in view of the two decisions referred to above. The service charges have been incurred by the assessee in connection with raising of the loan and this fact has not been disputed. The only dispute raised by the assessing officer is that it was paid to the same company which granted the loan and it amounted to receiving a lesser amount, i.e. gross loan as reduced by the said amount. The Commissioner (Appeals) restricted the allowance to 5 per cent by observing the rate in the above two cases, which is 296 in the first case and 1 per cent in the second case. In these circumstances, in our opinion, the Commissioner (Appeals) was not justified in restricting the claim on the ground of it being excessive. When the payment is related to raising of loan, the same cannot be disallowed on the ground that it was excessive unless the expenditure falls within the prohibitory category provided in section 40 of the Act, more so there being no close relation between the assessee- company and M/s. Peerless from whom the assessee has raised the loan. We, however, see force in the observation of the assessing officer that it was a case of receiving lesser amount for a liability and to pay higher amount over a period of 6 years and in these circumstances, in our opinion, in view of the Supreme Court decision in the case of Mangalam Finance the expenditure has the effect for the period of loan which is stated to be for seven years in the alternate contention of the assessee. We, therefore, direct that 1/7th of the expenditure on service charges be allowed to the assessee as against 5 per cent allowed by the Commissioner (Appeals).

22. We have the parties and considered their rival submissions. As observed by the Commissioner (Appeals), any expenditure incurred on raising loans are allowable expenditure in view of the two decisions referred to above. The service charges have been incurred by the assessee in connection with raising of the loan and this fact has not been disputed. The only dispute raised by the assessing officer is that it was paid to the same company which granted the loan and it amounted to receiving a lesser amount, i.e. gross loan as reduced by the said amount. The Commissioner (Appeals) restricted the allowance to 5 per cent by observing the rate in the above two cases, which is 296 in the first case and 1 per cent in the second case. In these circumstances, in our opinion, the Commissioner (Appeals) was not justified in restricting the claim on the ground of it being excessive. When the payment is related to raising of loan, the same cannot be disallowed on the ground that it was excessive unless the expenditure falls within the prohibitory category provided in section 40 of the Act, more so there being no close relation between the assessee- company and M/s. Peerless from whom the assessee has raised the loan. We, however, see force in the observation of the assessing officer that it was a case of receiving lesser amount for a liability and to pay higher amount over a period of 6 years and in these circumstances, in our opinion, in view of the Supreme Court decision in the case of Mangalam Finance the expenditure has the effect for the period of loan which is stated to be for seven years in the alternate contention of the assessee. We, therefore, direct that 1/7th of the expenditure on service charges be allowed to the assessee as against 5 per cent allowed by the Commissioner (Appeals).

23 to 32. [These paras are not reproduced here as they involve minor issues.]

23 to 32. [These paras are not reproduced here as they involve minor issues.]