This appeal is preferred by the Revenue against the order of the CIT(A) pertaining to the asst. yr. 1989-90.
2. In ground No. 1 the order of the CIT(A) is assailed on the ground that the CIT(A) has erred in deleting the disallowance of royalty payment of Rs. 3,92,685 to an associate company holding that the associate company and the assessee-company are different entitles in the eyes of law even when it was accepted that the assessee-company is controlled by the directors of the associate company.
3. The facts relating to the issue are that the assessee has been in the business of making rivets of different metals since long and as per an agreement dt. 18th February, 1986, between the assessee and its associate concern, Precision Gears (P) Ltd., Bombay, the assessee obtained right to manufacture blister packing machines for which the associate concern had originally obtained a licence from West Germany under an agreement dt. 26th February, 1973. The associate concern was entitled to sub-licence the know-how so obtained and accordingly the assessee-company was allowed to manufacture the packing machines and the assessee was required to pay a royalty of 5 per cent. of ex-factory price. During the course of assessment it was observed by the AO that originally the assessee was fully held company of the associate company but subsequently some of the shares of the assessee-company were transferred in the names of directors of the associate company. Most of the directors of the assessee-company are also stated to be directors/managing directors of the associate company. The managing director of the assessee-company is also a director in the associate company. After relying upon the orders of the excise authorities in which it was held that both the companies are one and the same entity, the AO came to the conclusion that the assessee-company was under the full control of the associate company and the payment of royalty is not for any business needs of the assessee and, therefore, the whole of the payment was disallowed by him. Though the AO has considered this payment under S. 35AB of the Act but he disallowed the entire payment under S. 40A(2)(b) of the Act and for the reasons he held that no disallowance under S. 30AB is called for. Against the assessment order, an appeal was filed before the CIT(A) who deleted the addition after holding that both these companies are separate legal entities and the assessee-company had made the payment of royalties at the market rate to its associate company.
4. The learned Departmental Representative, Mrs. Swati Patil, has strenuously argued that both these companies are controlled by same management and if one of the companies obtained a technical know-how after making the payment of royalty to a foreign company, with the permission to sub-licence of the same technical know-how, the said technical know-how can be used by the sister concern and the settled royalty can be debited in the P&L a/c of the sister concern, but there is no justification for making the payment of royalty at a higher rate by one sister concern to another sister concern. She has invited our attention to the list of directors in both the companies which are placed at pp. 16 and 18 of the compilation of the assessee and as per the list Shri P. C. Rao and Anil Rao are the common directors in both the companies, but as per the details of share-holdings it is quite evident that out of the total shares i.e. 5,000 shares, 4,700 shares were owned by the Bombay company and its directors in their own name along with their family members. As such, only 300 shares out of 5,000 shares were owned by the outsiders not related to the directors of the Bombay company. As such, the assessee-company is fully controlled for all practical purposes by the Bombay company. Moreover, nomenclature of both the companies is the same i.e. processing Gears Private Limited.
In these circumstances, it is quite unfair that the sister concern will make the payment of royalty for using the technical know-how at a higher rate. It is nothing but the transfer of profits from one company to another company. The learned Departmental Representative further argued that at the most the assessee-company is liable to pay the actual royalty amount which was settled between the Bombay company and the foreign company. Besides, she strongly relied on the observations of the AO.5. The learned counsel for the assessee, Shri M. C. Mehta, on the other hand, strenuously argued that whatever royalty was paid by the assessee-company to the Bombay company, it was paid on the market rate.
Both the companies are two independent juristic entity and are being assessed to tax separately though some of the directors are common in both the companies. The assessee-company is managed and controlled by the director, namely, H. V. Konde whereas the Bombay company is controlled by Raos family. There is no legal embargo that one company cannot obtain technical know-how on payment of royalty from the other company whereas some of the directors are common. He further argued that while making the addition the AO has relied on the order of the collector of excise, which was passed on 6th March, 1989, under the Excise Act on different footings. Both these companies are entirely separate companies having their own constituents and registered with the Registrar of Companies separately. Since no set-off of business loss of one company is allowable against the profit of the other company under the principles of accountancy and as per the IT Act, there is no justification in disallowing the royalties paid by one company to other company on account of technical know-how obtained by the assessee-company. Out of the total shares of the assessee-company only 2,000 shares were owned by the Bombay company. As such, the Bombay company was not on dictating terms to the assessee-company. It was also argued that S. 35AB is not at all applicable in the instant case as there was no lump sum payment of royalty. However, S. 40A(2)(b) is also not applicable as no payment was made to that company which falls under the purview of S. 40A(2)(b) of the Act. If at all this section is applicable, the payment was made at the market rate which is not disallowable and as such the payment against royalties is not disallowable.
(i) Distributors (Baroda) (P) Ltd. vs. Union of India (1985) 155 ITR 120 (SC) and 7. We have heard the rival submissions of the parties and carefully perused the orders of the authorities below and the documents placed on record. It is obvious from record that the assessee-company and the Bombay company are the sister concerns and the Bombay company i.e.
Precision Gears (P) Ltd., Bombay, acquired the technical know-how for the manufacture of blister packing machines from Hassis Verpakung AG, West Germany (hereinafter called foreign company) under an agreement dt. 26th November, 1973, against the payment of certain royalty with a right to sub-licence the said technical know-how to any other party or parties in India and from the Bombay company the assessee has obtained the said technical know-how against a royalty @ 5 per cent. of the ex-factory value of the machines so sold. From a perusal of the list of directors of the assessee-company, we find that its director, P. C. Rao and Anil Rao are also directors in the Bombay company and from the shareholdings of the company, it is quite obvious that out of the total 5,000 shares, 2,000 shares were owned by the Bombay company and other 2,700 shares were owned by the directors and their family members of the Bombay company. Only 300 shares out of 5,000 shares of the assessee-company were owned by Konde family. Keeping in view these facts, it is abundantly clear that the assessee-company is fully controlled by the Bombay company as the Bombay company and their directors are substantially interested in the assessee-company. In these circumstances, we do not hesitate in holding that both these companies are sister concerns and are closely related with each other.
The lease agreement whereby the Bombay company acquired the technical know-how is not placed before us so we are unable to deduce at what rate of royalty the Bombay company acquired the technical know-how from the foreign company. However, the assessee-company has obtained the same technical know-how from the Bombay company against a royalty at 5 per cent. of the ex-factory sale value of the machines so sold. Though the assessees main plank of argument is that the assessee-company has paid the royalty to the Bombay company at a market rate and as such the payment is not hit by S. 40A(2)(b) but no evidence is placed to this effect that what was the market rate of royalty for this technical know-how. Even there is nothing on record to evince as to whether the Bombay company has ever sub-licenced the said technical know-how to any other company in India. In these circumstances, we are unable to accept the argument of the assessee that the royalty was paid at the market rate to the Bombay company.
8. While it is abundantly clear that both the companies are sister concerns and the assessee-company is fully controlled by the Bombay company for all practical purposes, there was no justification in charging the royalty at a higher rate from the assessee-company by the Bombay company. When the management is the same, the technical know-how obtained by the Bombay company can very well be used by the assessee-company to improve its quality. At the most the assessee-company should be liable to pay the original rate of royalty which was settled between the Bombay company and the foreign company.
There is nothing on record to evince that the Bombay company was under any obligation to charge higher rate of royalty while sub-licensing its technical know-how obtained from the foreign company, to any company in India or even to its sister concern. Though both these companies are separate juristic entities for legal purposes but they are being controlled by the same management for all practical purposes. So, it cannot be called that the loss in one company will not affect the other company. Ultimately the management controlling both the companies is being affected by the profit and loss of both the companies. If the contention of the assessee is accepted, and the payment of royalty at higher rate is allowed, it would amount to transfer of profit of one company to the other company which is not permissible under the law.
The assessee can incur only those expenses which are necessary for business exigencies. It cannot be allowed to claim those expenses under the garb of business expenditure which are not permissible under the law. These entire payments made by the assessee-company are hit by S.40A(2)(b) of the Act. Since there is nothing on record regarding the market rate of royalty of technical know-how, the assessee can only be allowed to pay the royalty at the same rate which was settled between the Bombay company and the foreign company. The original technical know-how agreement executed between the Bombay company and the foreign company is not placed before us and as such we are unable to ascertain the actual rate of royalty paid by the Bombay company to the assessee.
We, therefore, restore the matter to the file of the AO with the direction to allow the payment of royalty to the assessee at the rate which was settled between the Bombay Company and the foreign company for the said technical know-how. The order of the CIT(A) is hereby set aside.
9. Ground No. 2 relates to the direction to the AO not to deduct the amount of capital subsidy received from the cost of assets while allowing depreciation and investment allowance under the IT Act. During the course of hearing it was urged that the issue is covered by the judgment of the apex Court in the case of CIT vs. P.J. Chemicals (1994) 210 ITR 830 (SC), in favour of the assessee.
10. Since this issue is squarely covered by the judgment of the apex Court, we decide this issue in favour of the assessee.