1. Both these appeals by the assessee relate to the assessment year 1975-76. IT Appeal No. 927 is directed against the Commissioner's order under Section 263 of the Income-tax Act, 1961 ('the Act') setting aside the ITO's assessment order passed under Section 143(3)/144B of the Act on 12-9-1978, and IT Appeal No. 1723 is directed against the Commissioner's order under Section 154 of the Act passed on 22-3-1980, by which the learned Commissioner rectified a mistake apparent from the record which had occurred in his order under Section 263. Both the appeals have been heard together and are being disposed of by this common order for the sake of convenience.
2. The assessee in this case is a private limited company which was registered on 6-2-1946. It had income from supply of high speed rotary presses imported directly from USA or, by acting as commission agent of foreign manufacturers. Due to foreign exchange difficulty, the assessee-company started manufacture and sale of a sophisticated foreign printing machine, high speed automatic letter press, mercedes super, in collaboration with a Dutch firm. Thereafter, in 1973 the assessee-company decided to develop another two types of printing machines-one web-effect and the other sheet-fed-effect-in view of the growing demand for these machines in India. Till then, these machines had not been manufactured in India. To achieve this purpose, there were two ways, one was to collaborate with some foreign concern and the second was to import a prototype new machine from abroad and then, after understanding the technique and mechanism, to develop its own machine. The company obtained approval and necessary licences from the Government of India and imported one web-effect machine from USA at a cost of Rs. 5,82,910 in June 1974. After considerable study, analysis and research on the prototype, by the end of 1975, the assessee developed its own web-effect in the name of 'Orient web-effect' and the first machine was sold in 1976. The assessee also imported in April 1974, one rapids machine from West Germany for Rs. 2,38,972. Total expenditure on the import of the two machines was Rs. 8,20,962 and the assessee claimed the same as a deduction under Section 35 of the Act, on the ground that it was expenditure incurred on scientific research connected with the assessee's business of manufacture and sale of printing machinery. The ITO allowed deduction for Rs. 5,82,010 but did not allow deduction for the other amount, i.e., Rs. 2,38,972. In appeal, the learned Commissioner (Appeals), however, allowed deduction for Rs. 2,38,972 also, by his order passed on 19-2-1980.
3. In connection with the claim under Section 35 mentioned above, full details were given of the activity relating to scientific research, which had been carried out by the assessee, in the various letters to the ITO. These letters are at pages 4 to 7, 10 to 19, 20 to 23 and 24 to 28 of the assessee's paper book. We would reproduce below the relevant extracts from the letter written to the ITO which is at pages 4 to 7 of the paper book and also from the assessee's letter dated 12-1-1978 which is at pages 10 to 19 of the paper book: In the instant case, the import of machinery was obtained with a view to help the assessee-company not only to make identical or improved parts of the machinery and the machinery, but also to check the quality of each item vis-a-vis the imported machinery as well as its performance. Each part of the machine was renewed and its specifications and quality of material tested and examined so as to enable the company to obtain requisite quality of material and to confer to the specification. But for the work done by the research and development cell of the company by working on these machines, it would not have been possible for us to manufacture the said machinery except through foreign collaboration. It is not merely copying of the machinery as that would not be warranted and permissible under the patent rights of the manufacturers. The company had to find ways and means to show a variance from the original in such a manner so as to avoid infringement of the principal manufacturers' rights. This enabled us to avoid the heavy cost of collaboration.
(6) After the Cosa Community Press was chosen for adoption, a deep study was made together with sketches, etc., of alternate changes/adjustments needed to meet the above requirements. On the basis of these sketches, detailed drawings were prepared at the factory from the prototype machine received in June 1974. A final study was made of the prototype machine and the alterations proposed in the drawings as well as of the raw materials to be used, and the further alterations that may be needed to make use of the indigenous talent and indigenous material needed for finally evolving the indigenous machine.
(7) Development to suit the Indian market - The major hurdle in making the components was the fact that the original machine made in America was manufactured in inch specifications as per American standards. This was unsuitable. Hence, the design introduced by us was appropriately altered as per the metric system con forming to ISI standards.
Considering the material placed before him the ITO came to the conclusion that the assessee had done considerable research in connection with the manufacture of its own web-effect machine and on that view he allowed deduction for Rs. 5,82,010 under Section 35 of the 1922 Act. With regard to the amount of Rs. 2,38,972, he however took a different view, after taking the approval of the IAC under Section 144B of the Act, which was that the said machiney, i.e., rapids machine, had not, in fact, been utilised for the purpose of scientific research, inasmuch as the project was eventually dropped.
4. The learned Commissioner, however, felt that the assessment order of the ITO was erroneous and also prejudicial to the revenue, inasmuch as deduction under Section 35 in respect of expenditure on scientific research claimed at Rs. 5,82,010 had been wrongly allowed by the ITO and accordingly proceedings under Section 263 were initiated. In response to the show cause notice, written submissions were made before the Commissioner (Appeals) by the assessee-company's letter dated 2-11-1979. This letter is at pages 101 to 128 of the assessee's paper book. Full details were given in this letter, of the nature of expenditure which had been incurred and it was also stated that all these details had been supplied to the ITO who duly considered these and came to a correct conclusion after applying his mind to the facts.
It was pointed out that there was nothing wrong in the order of the ITO and, therefore, the learned Commissioner could have no jurisdiction under Section 263. In this context, it was also stated that the order of the ITO had been passed after obtaining the IAC's approval under Section 144B and since under Section 263, the Commissioner could deal with the orders passed by the ITO only, such an order which the ITO passed with the IAC's approval under Section 144B cannot be the subject-matter of Commissioner's action under Section 263. It was also pointed out that against the ITO's assessment order, appeal had already been filed to the Commissioner (Appeals), and thus, the assessment order, having become the subject-matter of appeal before the Commissioner (Appeals), it could not be interfered with by the learned Commissioner.
5. The learned Commissioner considered the various submissions made on the assessee's behalf. It was felt that mere purchase of a prototype machine could not be treated as an activity of the nature of scientific research and the expenditure incurred on the purchase of the machine was not expenditure on scientific research. The learned Commissioner felt that in such a situation, the proper course for the ITO was to have the opinion of the competent authority through CBDT, in terms of Section 35(3), which the ITO had not done and as such the order passed by him was erroneous and also prejudicial to the revenue. In support of the view that in such circumstances the order of the ITO can be held to be erroneous and also prejudicial to the revenue, the learned Commissioner cited the Supreme Court decision in the cases of Rampyari Devi Saraogi v. CIT [1968] 67 ITR 84 and Tarn Devi Aggarwal v. CIT [1973] 88 ITR 323. Dealing with the argument of the learned, counsel that the assessment order having been passed under Section 143(3) read with Section 144B, it could not be the subject-matter of Section 263, the learned Commissioner observed that even if the order was passed after reference to the IAC under Section 144B, the final order which the ITO passed under Section 143(3) was the order of the ITO and it could be dealt with by the Commissioner under Section 263. In any case, the expenditure in question having been allowed by the ITO himself, it did not receive the consideration of the IAC under Section 144B and, therefore, it could not be said that on this issue, the order of the ITO had merged into that of the IAC. Relying upon the Supreme Court decision in the case of Gojar Bros. v. Ratanlal AIR 1974 SC 1380, the learned Commissioner held that there was no question of a merger of the ITO's order in the order of the 1AC. Regarding filing of appeal against the assessment, to the Commissioner (Appeals), the learned Commissioner took the same view, namely, there could be no merger of the ITO's order into the order of the appellate authority, on an issue which did not become the subject-matter of appeal and, for that, reference was made to the Supreme Court decision in the case of CIT v. Amritlal Bhogilal & Co. [1958] 34 ITR 130. The learned Commissioner ."accordingly proceeded to deal with the issue and held that the ITO's order allowing deduction for Rs. 5,82,010 was erroneous and also prejudicial to the revenue and hence the entire assessment was set aside to be made de novo. Later on the learned Commissioner passed an order under Section 154, by which it was made clear that the setting aside of the assessment was for the limited purpose of fresh disposal the assessee's claim for deduction of Rs. 5,82,010.
6. Against the learned Commissioner's orders under Section 263 and under Section 154, the assessee has come up in appeal. The various issues arising in this case have been argued before us, at length, by both the learned counsels. We do not consider it necessary to state their respective arguments since these are practically the same as were raised before the learned Commissioner in the course of the proceedings.
7. One of the issues which has been raised on the assessee's behalf is that the learned Commissioner had no jurisdiction under Section 263, since the appeal before the Commissioner (Appeals) had already been disposed of by order dated 19-5-1980, on which date the ITO's order merged completely into the order of the learned Commissioner (Appeals).
Dealing with this issue in para 10 of his order, the learned Commissioner held, following the Supreme Court decision in Amritlal Bhogilal & Co.'s case (supra), that an order under Section 263 could be passed by the Commissioner while an appeal was pending before the appellate authority. The correct position, as stated, however, was that before the Commissioner passed the order under Section 263 on 21-1-1980, the appeal had already been disposed of by the learned Commissioner (Appeals) vide order dated 19-2 1980 and, therefore, the question actually was whether there was complete merger of the ITO's order into the order of the Commissioner (Appeals) so that the Commissioner's jurisdiction ceased to exist or whether the merger was only partial so that the Commissioner could deal with that part of the assessment order passed by the ITO which remained undisturbed.
8. A vital issue thus arises for our consideration and it is, whether the learned Commissioner had jurisdiction under Section 263 with reference to the assessment order of the ITO. Against the assessment order, appeal had been filed by the assessee and before the learned Commissioner passed the order under Section 263, the appeal had been disposed of by the learned Commissioner (Appeals). The contention of the assessee is that immediately on the passing of the appellate order, the ITO's order of assessment merged completely into that of the appellate order and, therefore, it ceased to exist and hence the learned Commissioner had no jurisdiction under Section 263 with reference to the assessment order of the ITO. In support of this view, reference has been made to the Bombay High Court decision in CIT v.Tejaji Farasram Kharawala [1953] 23 ITR 412 and the decision of the Allahabad High Court in J.K. Synthetics Ltd. v. Addl. CIT [1916] 105 ITR 344. As against that the revenue's contention is that only that part of the ITO's assessment order merges into the appellate order which actually had been made the subject-matter of appeal in the grounds of appeal specifically raised by the assessee before the appellate authority and in respect of the other portion of the assessment order which had not merged into the appellate order, it was open to the learned Commissioner to pass an order under Section 263, if that portion of the order was erroneous and also prejudicial to the revenue. For this proposition reliance has been placed on the Gujarat High Court decision in the case of Karsandas Bhagwandas Patel v. G.V.Shah, ITO [1975] 98 ITR 255.
9. Section 263 provides in clear terms that if any order passed by the ITO is erroneous, insofar as it is prejudicial to the interest of the revenue, the Commissioner can pass such orders thereon, as the circumstances of the case justify, including an order enhancing or modifying the assessment or cancelling the assessment and directing a fresh assessment. Thus it is only the order passed by the ITO which can be the subject-matter of review by the Commissioner under Section 263 provided the order is erroneous and also prejudicial to the interest of the revenue. In a case where before the learned Commissioner passes order under Section 263, the appellate authority has already passed the order in appeal, a question arises whether the ITO's order merges completely into the order of the appellate authority so that the learned Commissioner ceases to have power under Section 263, to modify the ITO's order in the manner contemplated in that provision or, whether merger of the ITO's order into that of the order of the appellate authority is only partial so that the Commissioner can modify under Section 263 that part of the ITO's order which does not merge into the order of the learned Commissioner (Appeals). This issue, as would be seen from the immediately preceding case, came up for consideration before different High Courts in the light of Section 263/264 and also Section 154. There has been differences of opinion on this issue. On the one hand there is a decision of the Gujarat High Court in Karsandas Bhagwandas Patel's case (supra), holding that the merger of the ITO's order into that of the appellate authority's order is only partial, i.e., merger is to the extent the ITO's order has been actually made the subject-matter of appeal on the various grounds specifically raised in appeal. On the other hand, there are the decisions of the Bombay High Court in the case of Tejaji Farasmm Kharawala (supra) and the Allahabad High Court in the case of J.K.Synthetics Ltd. (supra) wherein, the view taken up was that, even if the appeal filed before the appellate authority does not cover the entire order of the AAC, on the passing of the appellate order, the entire order of assessment merges with the order of the AAC or the Commissioner (Appeals). This being the position, the issue was taken up for consideration by a Special Bench of the Tribunal, Bombay in the case of Dwarkadas & Co. (P.) Ltd. v. ITO [1982] 1 ITD 303. The Tribunal held, following the aforesaid Bombay and Allahabad High Courts' decisions, that the entire order of the ITO merges into that of the AAC or the Commissioner (Appeals), and after the passing of such appellate order the ITO's order ceases to exist and hence the Commissioner has no jurisdiction under Section 263 to interfere with the assessment order of the ITO. We reproduce below the relevant extracts from the said Tribunal's order: 12. Again, the Bombay High Court in the case of Blue Star (supra) and the Gujarat High Court in the case of Karsandas (supra), were considering the powers of various authorities for rectifying their orders. Since all these authorities had identical powers, the question had arisen about the extent of power of each authority.
This naturally raised the question of limitation inter se. Apart from the fact that the provisions considered in those decisions were of Section 35 of the 1922 Act and/or Section 154 of the 1961 Act, which, to our mind, are certainly not identical with those of Section 33B of the 1922 Act and Section 263 of the 1961 Act, it may be noted that even the insertion of Sub-section (1A) in Section 154 in 1964 which makes the legal position abundantly clear was not brought to the notice of their Lordships in those decisions.
Therefore, it is not possible to read something contrary to or explaining the decisions of the Bombay High Court in Tejaji's case (supra) and the Supreme Court decision in Amritlal Bhogilal's case (supra), in those cases.
16. Having regard to the above discussion, we do not find any material to hold that the proposition laid down by the Bombay High Court's decision in Tejaji's case (supra) has been overruled directly or by implication by the Bombay High Court in Sakseria's case (supra) or by the Supreme Court. The concepts of orders in the two sections materially differ and in our view all the decisions cited before us are reconciliable and correct on their own facts.
Accordingly, we further hold that for the purpose of jurisdiction under Section 263, the order of the ITO merges in that of the AAC not only to the extent to which the AAC has, as a matter of fact, dealt with but also to the extent to which he had power to look into with a view to enhance within the limits prescribed by the Supreme Court in its decision in the case of Motilal Chamaria's case (supra). In that view of the matter, we have to hold that the Commissioner had no jurisdiction under Section 263 to revise the order of assessment, as, after the order of the AAC, the order of assessment had ceased to exist.
10. Apart from the Bombay and Allahabad High Courts decisions referred to above, which were considered by the Special Bench of the Tribunal, Bombay, other decisions which came up later, taking the same view are the Karnataka High Court decision in Mysore Tobacco Co. Ltd. v. CIT [1981] 128 ITR 655 and the Madhya Pradesh High Court decision in CIT v.Narpat Singh Malkhan Singh [1981] 128 ITR 77. We may also add in this context that the Hon'ble Calcutta High Court in the case of Singho Mica Mining Co. Ltd. v. CIT [1978] 111 ITR 231 and the Madras High Court in CIT v. City Palayacot Co. [1980] 122 ITR 430, clarified that where the ITO did not levy interest under Section 217 at the time of making the assessment, the question of merger with the order of the learned AAC or the Commissioner (Appeals) did not arise, as the ITO had failed to levy the interest and no appeal having been provided under the Act, the appellate authority, by itself, also could not go into it. Hence, the Commissioner could modify the order under Section 263, with regard to non-levy of the interest under Section 217.
11. Respectfully, following the view taken by the Special Bench of the Tribunal, Bombay and the other later decisions afore-mentioned, we hold that the ITO's assessment order in the present case merged into the order of the learned AAC/Commissioner (Appeals) and, therefore, the learned Commissioner ceased to have jurisdiction under Section 263 with reference to the ITO's assessment order.
12. In this context, the argument was raised for the revenue that the Commissioner did have jurisdiction under Section 263, on the date when the proceedings were initiated since, the appeal before the Commissioner (Appeals) was pending on that date and the jurisdiction once acquired validity could not be divested. We do not find any merit in this plea. We are not concerned here with the divesting of the jurisdiction of the Commissioner, by virtue of any amendment in the law. It is, in fact, a case of jurisdiction ceasing to exist automatically, because the order of the ITO did not subsist on the date on which the Commissioner passed the order under Section 263.
13. Another plea which requires our consideration is whether the ITO's order under Section 143(3) read with Section 144B could be dealt with by the Commissioner under Section 263. The argument of the assessee's counsel is that where an assessment order is made after obtaining the IAC's direction under Section 144B, the order passed is that of the IAC and not that of the ITO and, therefore, Section 263 cannot apply. We are unable to accept this plea for several reasons. Firstly, while acting under Section 144B, the learned IAC does not review the entire order of the ITO, in the same way as the learned AAC can do while disposing of an appeal. Secondly, the jurisdiction of the IAC is not as unlimited as is that of the appellate authority. In fact the IAC's jurisdiction under Section 144B is confined only to those additions prejudicial to the assessee, which the ITO proposes to make. Thirdly, the order which is passed by the ITO after obtaining the IAC's directions, is the order of the ITO and not that of the IAC. In any case, the question of allowance under Section 35 of Rs. 5,82,010 did not receive the consideration of the IAC at all since the ITO himself had allowed the deduction.
14. Taking up the merits of the issue, we feel that the learned Commissioner was not justified in holding that the ITO's order was erroneous and also prejudicial to the revenue. As already stated, in several letters written to the ITO, the assessee had given full details of scientific research activity which had eventually resulted in the development of the assessee's own web-effect machinery. It was not as if the assessee had merely copied the prototype. If the assessee had done so, it would have been an infringement of the patent law. However, the prototype, based on the specifications of USA, did not suit Indian conditions and, therefore, it had to be suitably modified. After dismantling the machine, and a detailed study and research by the assessee-company's own Research and Development cell, a new machine was evolved which was suitable for Indian conditions. This being the factual position, we hold that the learned Commissioner proceeded on the incorrect basis that the assessee had merely copied the prototype and, therefore, no scientific research was involved.
15. The order of the ITO was not erroneous. The assessee had placed sufficient material before him in support of his claim. The ITO did apply his mind to the assessee's claim, inasmuch as he allowed deduction for a part of it, i.e., for Rs. 5,82,010, while the other part, i.e., Rs. 2,38,972, was disallowed after obtaining directions from the learned IAC under Section 144B. It could not, therefore, he said that the ITO had not applied his mind to the issue or that he had not properly considered the material which had been placed before him.
16. Before closing we might say a few words about the scope of Section 35(3) also. A plain reading of this provision would show that the ITO is required to make reference to the prescribed authority only if a controversy arises. But, if there is no controversy and the ITO accepts the claim of the assessee under Section 35, the question of reference to the competent authority does not arise. This is the view which had been taken by their Lordships of the Allahabad High Court in the case of J.K. Synthetics Ltd. (supra). According to their Lordships, the learned Commissioner has no locus standi at all in the matter of application under Section 35(3). We could have understood the setting aside of the assessment for the ITO's failure to resort to Section 35(3), if the ITO had allowed the claim without proper application of mind or without considering full facts. But, as in this case, if the ITO has before him the full facts and on application of mind, he comes to the proper conclusion that the claim under Section 35 was admissible, the question of reference under Section 35(3) would not arise and also there would be no justification for the setting aside of the assessment by the Commissioner, directing that the ITO could dispose of the issue afresh after taking the approval of the competent authority. In our view, therefore, the learned Commissioner was not justified in setting aside the order of the ITO. Hence, we cancel the Commissioner's order under Section 263.
17. Taking up the appeal again under Section 154, if we had sustained the Commissioner's order under Section 263, we would have held that the learned Commissioner's action under Section 154 was proper since he did rectify a mistake which was apparent from the record. But as we have cancelled the order under Section 263, the order under Section 154, which flows from it, must also be cancelled. We, accordingly, cancel this order also.