1. These are the cross-appeals filed by the assessee and the Revenue against the order dt. 6th March, 2003 passed by the CIT(A), New Delhi for asst. yr. 1999-2000.
2. The first ground of appeal in substance relates to the order confirming the disallowance of Rs. 37.82 crores out of total expenditure of Rs. 56.73 crores on account of royalty debited to the P&L a/c and claimed as allowable expenditure. Briefly stated facts are that during the year the assessee had made total payment of royalty of Rs. 56,73,24,000 on account of technical fee/royalty to the Societe de Products SA (SPN) and Nestec Ltd., Switzerland (Nestec) for 7 major categories of products. Nestec and SPN are subsidiary non-resident companies of Nestle, Switzerland. The AO observed that the assessee had claimed to have paid the royalty @ 3.5 per cent on domestic sales and 5 per cent on export sales net of taxes and by including the tax of 20 per cent and cess of 5 per cent, the payment of technical fee/royalty on domestic sale becomes 4.41 per cent and on export sale becomes 6.3 per cent. In respect of same payments the assessee had entered into 7 agreements starting from 4th Feb., 1992 to 29th Aug., 1998 as per product-wise details. The AO mentioned that copy of agreement given by the assessee would reflect that the company had paid for the following three services to be rendered by the two companies: 3. The AO asked the assessee to justify payment of royalty or technical fee giving details of exact services rendered by these non-resident companies in support of royalty/fee payment claimed within the provisions of Section 92, in view of the fact that SPN and Nestec are subsidiaries of Nestle, Switzerland holding substantial interest in appellant company. It was explained by the assessee that these agreements were duly approved by RBI or industrial policy resolution.
It was further observed by the AO that out of three major services claimed to have been rendered by licensor, only one service of granting of licenses to manufacture and sell its licensed products had been rendered by the SPN and Nestle. As regards the other two services, it was noted by the AO that the assessee was already manufacturing these products much before entering into the agreements and had not substantiated the specific services which had been rendered to the assessee company during the year under consideration. In view of these observations, the AO allowed only l/3rd of the total payment claimed by the assessee and 2/3rd of the payments were disallowed under Section 92 r/w Section 37(1) of the IT Act.
4. On appeal, the CIT(A), after having considered the submissions of the assessee observed that the assessee company was manufacturing various products for the last many years but the appellant had started paying royalty only after the industrial policy was framed. For the purpose of procuring technical know-how and assistance in the business of manufacture of its products the assessee had entered into different agreements with Nestec and SPN which are 100 per cent subsidiaries of Nestle S.A. From the order of the AO, it is clear that the various brands which were manufactured by the assessee are from 1973 to 1989 and only a few items have been introduced in the year 1995, 1997 and 1998. Thus, the assessee company was already having an access to facility of manufacturing as well as various scientific development and research of the parent company. Only during the liberalization era, the assessee started paying a hefty royalty to the parent company. The CIT(A) has further mentioned that the details of payment of royalty, total amount of royalty, tax and R&D net profit ratio and royalty to net profit were analysed by his predecessor as per his order dt. 21st Feb., 2002 in Appeal No. 3/2001-02 in the assessee's own case. The learned CIT(A) has extracted the details of payment of royalty as well as details of net profit ratio of various years at pp. 5 and 6 of the order and has, thus, observed that it is clear that in the earlier asst. yrs. 1989-90 to 1992-93 the payment of royalty to the net profit was a very small percentage ranging from 2.53 per cent to 4.48 per cent. From 1993-94 onwards the royalty percentage to net profit has gone very high which has reached to 78.37 per cent. In the asst. yr.
1997-98 it is 78.37 per cent but in the asst. yr. 1998 99 its 49.95 per cent and in the year under consideration i.e., 1999-2000 it is 43.46 per cent. Therefore, the moot question is whether the assessee company is paying royalty for commercial consideration or not and whether such huge payment is justified to the parent company on the basis of commercial expediency? Nestle SA is having 51 per cent share ratio in the company and the dividend is being paid for such investment. Any payment under Section 37 will be allowed only on the basis of commercial expediency of the company. He has further observed that in the case of Jaipur Electro (P) Ltd v. CIT it has been held that doctrine that the businessman as the best judge of business expediency does not affect the right, nay duty of the AO to know whether it was meant for business purposes and not for extraneous consideration. In the case of Siddho Mal & Sons v. CIT it has been held that such a point of view has to be prudent and reasonable point of view which is free from an apparent taint of excessiveness, collusiveness or colourable discretion. In view of these decisions, the payment will have to be examined from the point of view of commercial expediency and treating this company as an independent entity. It was the duty of AO to examine whether the payment of such royalty was for business purposes or for extraneous consideration. He has further observed that the automatic approval by RBI as well as Indian Industrial Policy does not debar the AO from examining the allowability of this expenditure under Section 37 of the Act or under Section 92 of the IT Act. It is undisputed fact that the assessee company was already having the know-how of manufacturing various products and was also having the benefit of scientific and technical development of the parent company. The assessee has accepted that there were thirteen products which were in manufacture even prior to signing up the agreements. Only six products were introduced after the signing of agreements. Thus in view of these facts it was to be examined by the AO that whether such huge payment of royalty was paid for commercial expediency of the company in the liberalized era. It is clear from the facts that the company started paying huge royalty siphoning off substantial amount of net profit to the parent company which holds 51 per cent share. Considering the services rendered by the parent company which were already existing in the case of most of the products, the amount paid was excessive and was for extraneous consideration other than wholly for business purposes. If the parent company would not have 51 per cent voting rights, the assessee company would never have agreed to pay 43.46 per cent of total profits (as per chart). This was not a new company where the manufacturing licence for the know-how was obtained on the payment of royalty. The products and the brand were already existing in the Indian market and in the ordinary course of business in such circumstances the assessee could not have paid such huge royalty for the existing products. Therefore, AO was justified in holding that the payment of royalty has been paid excessively for extraneous consideration. As the payment has been made to the non-resident company, the provisions of Section 92 of IT Act are also applicable as owing to the close connection between the assessee company and the non-resident company, the resident company had less than the ordinary profits. The conditions as laid down in Section 92 of the IT Act are fully satisfied in this case. He has further mentioned that the above facts were also examined by his predecessor in asst. yr.
1998-99 in Appeal No. 30/2001-02 vide order dt. 21st Feb., 2002 and he is in agreement with him for applicability of Section 92 of the IT Act and who on the issue decided that the payment of royalty is excessive considering the commercial business expediency. He has further mentioned that the reliance on the case of Kinetic Honda Motor Ltd. v.Jt. CIT (2001) 72 TTJ (Pune) 72 : (2001) 77 ITD 393 (Pune) is of no help as the facts are different in the present case. He has further mentioned that the case of Dy. CIT v. Nabulls Chemicals Ltd. relied upon by the assessee is also distinguishable from the assessee's case.
The CIT(A) has further mentioned that it is also to be ascertained as to how much excessive payment was made by the appellant within the meaning of Section 37 or Section 92 of the IT Act. From the reply of the assessee it is clear that 13 products were already existing with the appellant company prior to signing up of these agreements whereas 6 products were introduced post/after the signing up of these agreements and in case of new product (instant tea) the agreement was approved by Government of India. Thus, about 2/3 products were already existing with the assessee company prior to the signing of the agreements and the assessee company was already having know-how of manufacturing of these products and access to scientific development of these products as they were existing in Indian market. Therefore, 2/3rd of royalty payment in respect of these existing products was excessive, collusive and was beyond commercial expediency. Therefore, the disallowance of 2/3rd of royalty payment made by the AO has been confirmed by the CIT(A).
5. We have heard the parties and perused the record of the case. The similar issue came up for consideration before the Tribunal, 'D' Bench, New Delhi in assessee's own case for asst. yrs. 1997-98 and 1998-99 in ITA Nos. 4545/Del/2000 and 2239/Del/2002 [reported as Addl. CIT v.Nestle India Ltd. (2005) 94 TTJ (Del) 53-Ed.] wherein the Tribunal has held thus: 89. We have carefully considered the rival submissions. We see considerable force in the contention of the learned CIT-Departmental Representative that the appeal in relation to asst. yr. 1997-98 is by and large academic because there is no dispute between the assessee and Revenue as to the quantum of the assessed tax liability for asst. yr. 1997-98. However, during the course of assessment proceedings for asst. yr. 1997-98, the learned AO has examined the question of allowability of the assessee's payments to SPN at considerable length. The learned AO has given a harsh finding that the payments were part of a device followed by the party to siphon away the profits of the assessee company in the disguise of royalty payment and thereby reducing, among other things, the assessee company's tax incidence in India. We find that while completing the assessment for asst. yr. 1998-99, the AO has merely adopted the argument, reasoning and basis of disallowance as given in the assessment order for asst. yr. 1997-98. In spite of the assessment order for asst. yr. 1997-98 not finding favour with the learned CIT(A), the succeeding learned CIT'(A) has for asst. yr. 1998-99 sought to differ from his predecessor mainly on the basis of the findings and reasoning of the AO for asst. yr. 1997-98. The learned CIT(A) entertained, in addition to the report of the AO, a report also from the previous incumbent who was then working as Addl.
Director of IT (Inv.) on the ground that he was the officer who had framed the assessment order for asst. yr. 1997-98. We are, therefore, of the view that academic or non-academic the assessment order for asst. yr. 1997-98 has to be kept in view while deciding the assessee's appeal for asst. yr. 1998-99. Hence, now the matter for asst. yr. 1997-98 has travelled unto us, we may as well deal with Revenue's appeal for asst. yr. 1997-98, for whatever impact, our order in relation to that assessment year may have.
90. On perusal of the assessment order for asst. yr. 1997-98 that has formed the bedrock of the assessment order for asst. yr.
1998-99, we find that the learned AO has made part disallowance of the assessee's claim of deduction on account of agreements with SPN on the following grounds: (a) The assessee refrained from furnishing to the AO the full details as asked for and thus not allowing the AO to examine in depth the correctness or otherwise of the assessee's claim of deduction.
(b) The assessee not furnishing the material/evidence in relation to technical assistance actually received so as to justify the huge payment of Rs. 47 crores for asst. yr. 1997-98.
(c) The assessee not explaining as to on what basis the scale of remuneration was agreed upon in the agreements in question and whether any evaluation and analysis of this technical assistance was being made.
(d) Ptima facie, the quantum of royalty paid was excessive and unreasonable having regard to the amount of the assessee's business profit.
(e) The assessee was already well-established in the business, particularly coffee business, and therefore need not have made such large payment for technical assistance.
On this basis, the learned AO for asst. yr. 1997-98, contended that the payments in question were only part of a device to siphon away the profits of the Indian company thereby reducing the profit distributable in India and incidence of tax thereon. The learned CTT(A) for asst. yr. 1998-99 has also drawn the same conclusion that the payments in question were a colourable device on the part of the assessee and, therefore, hit by the judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. v. CTO .
However, we find that in the order of the learned CTI'(A) for asst.
yr. 1997-98, the emphasis is upon his inference that the payments in question were disproportionately high looking at the profits earned by the assessee and the assessee has not been accused of hiding from examination or not furnishing the information regarding technical assistance actually received.
91. As to the case of the AO that the assessee failed to establish the commercial expediency of payments in question by production of reliable information and evidence, on careful perusal of the assessment order for asst. yr. 1997-98, we find that the learned AC) has mainly alleged non-compliance to various requisitions made by way of order-sheet notings in the course of the assessment proceedings. So much so that in the assessment order for asst. yr.
1997-98, while the learned AO has reproduced verbatim his letter dt.
17th June. 1999 and order-sheet notings dt. 20th Sept., 1999, 6th Oct., 1999 and 29th Nov., 1999, the letter dt. 10th Dec, 1999 and order-sheet noting dt. 27th Dec, 1999, he has summarized the assessee's reply and the submissions in one single para 10 of the assessment order. The learned AO has charged the assessee also for not establishing the commercial expediency. During the course of hearing before us, while the learned CIT-Departmental Representative stoutly emphasized this allegation, the learned Counsel for the assessee, with equal vehemence, relied upon the voluminous evidence, material and record died/produced before the AO during the course of the assessment proceedings for asst. yr. 1997-98. We find that in the assessment order for the asst. yr. 1997-98, the learned AO has spelt out in para 22, various queries that according to him wore not complied with by the assessee. We have reproduced the same in para 6 of this order. The learned Counsel for the assesee has painstakingly taken us through the letters from the assessee and other evidence, material and record produced during the course of assessment proceedings for asst. yrs. 1997-98 and 1998-99 and the same have been enumerated by us from paras 37 to 65 of this order. On consideration, we find that by and large the assessee furnished almost entire information, material and evidence as was asked for by the AO. In addition, the assessee also furnished plenty of material giving the AO for asst. yrs. 1997-98 and 1998-99 a fair view of the kind, quality and significance of technical assistance received and being received by the assessee by virtue of the agreements in question. The assessee informed the learned AO that it could comply with his requisitions and substantiate its claim of deduction by making a full and comprehensive presentation of technical assistance more conveniently at the assessee's own premises where the relevant record was located. During the course of appeal before the learned CIT(A) for asst. yr. 1998-99 also, the assessee offered that he may visit the assessee's office premises and factories. However, these requests were not acceded to. We have, therefore, to see the material and evidence produced by the assessee keeping in view that the assessee was not granted the advantage of first-hand demonstration at the assessee's own premises where technical assistance was supposed to be rendered. We, therefore hold that the learned AO has been less than fair in his observations that the requisite details and supporting material, evidence and information were not furnished by the assessee. We see force in the contention of the assessee that while making such observation, the learned AO ignored and omitted to make a reference to voluminous material placed before him by the assessee. It is true that some of the information asked for was not furnished. The learned Counsel for the assessee has informed us that the same was either not in the possession of the assessee or did not exist. The assessee had certain reservation about furnishing the sensitive information regarding the product-wise profitability as the assessee was in highly competitive market of fast moving consumer goods. However, eventually, the assessee furnished even the data pertaining to product-wise profitability. The assessee did not furnish the particulars of profit and balance sheet, etc. of Nestec, SPN, Nestle SA of Switzerland because the same fell outside the assessee's obligation to supply. Ironically, according to the assessee, all this emphasis on working on profit of the assessee and service providers was irrelevant because the quantum of remuneration could neither be fixed nor adjudged on the yardstick of profit.
92. During the course of hearing before us, considerable arguments were made in relation to the applicability or otherwise of the provisions of Section 40A(2)(b)/ Section 92/art. 9 of DTAA, etc. For the purpose of his order, we do not wish to go into the finer technical points relating to these legal provisions. In our view, in the absence of any specific material, evidence or information, the entire exercise undertaken by the AO could have been tampered if due importance was attached by him to the fact that the RBI approvals had been granted in respect of each one of the nine agreements. We see ample authority for the submissions made by the assessee's counsel in this respect as enumerated by us in para 67 of this order. After consideration, we reject the contention that the adverse inference was correctly drawn against the assessee on account of alleged non-compliance to various requisitions of the AO during the course of the assessment proceedings for asst. yr.
1997-98.
93. We now address ourselves to the question whether the assessee has discharged the initial onus that lay upon him to substantiate its claim of deduction. We may state that irrespective of the question whether the provisions of Section 40A(2)(b) or Section 92 or Article 9 of DTAA could be invoked or not in this case, it is quite clear that the burden to prove under those special provisions is cast on the AO and not upon the assessee. At the same time under the provisions of Section 37(1), the primary burden to substantiate a claim of deduction of expenditure is on the assessee. According to the learned Counsel for the assessee, learned AO/learned CIT(A), if they entertained any doubt, should have accepted the assessee's offer to visit the assessee's factory and office premises. We do not understand as to why the request of the assessee could not be accepted. In our opinion, this request on the part of the assessee as quite reasonable on the facts and in the circumstances of the case. Be that as it may, from the detailed submissions of the learned Counsel for the assessee in this behalf during the course of a number of sittings on various dates which we have attempted to summarise from paras 41 to 64 of this order, we are satisfied that the assessee had successfully discharged the burden of proof which lay upon him under the provisions of Section 37(1) of the Act. We find that the assessee's case is well armed in this respect on account of approval also granted by the RBI to the agreements in question. At any rate from the facts stated and the evidence/material produced in the assessee's paper book, we are of the view that the technical assistance agreements in question were essential for the purpose of the business of the assessee during the assessment years before us. The assessee appears to have been highly benefited both in respect of profitability as well as growth of its business on account of close association and support from Nestle SA, Switzerland, internationally renowned and leading food processing company.
94. We now come to the question as to whether the quantum of remuneration as agreed upon in the agreements in question and actually paid during the course of the assessment years before us is justified on the facts and in the circumstances of the case. In other words, whether both the AO in the assessment order for asst.
yr. 1997-98 and the learned CIT(A) in the appellate order for asst.
yr. 1998-99 are justified in their conclusion that the assessee in collusion with parent company in Switzerland adopted a colourable device whereby the profits of Indian company were siphoned away to be aggrandized by the Swiss company. The learned AO has argued in the assessment order for asst. yr. 1997-98 that from the very fact that no evaluation and analysis of technical assistance had been made at the time of entering into agreements and subsequently to determine the impact of technical assistance on the business of the company, it was clear that these agreements had been entered into with the sole object of diverting profit of the assessee company. In this context, the learned AO even asked the assessee to produce a certificate from an independent technical agency that the payments were commensurate to actual services received. Besides, both the learned AO in the assessment proceedings for the asst. yr. 1997-98 and the learned CIT(A) in the order for the asst. yr. 1998-99 emphasised that the assessee was already well-established and well versed in the business of products in question, and was not new to the business of manufacture and sale of those products and, therefore, the assessee could not by any stretch of imagination be considered to need further technical assistance of the magnitude so as to part with a substantial chunk of its business profit.
95. The authorities below in their orders and the learned CTT-Departmental Representative in his arguments before us have relied upon certain charts indicating 78.37 per cent and 49.95 per cent of the profit had been paid off by the assessee company under the agreements in relation to the asst. yrs. 1997-98 and 1998-99 respectively. During the course of hearing before us, the learned Counsel for the assessee has attacked the very rationale of the exercise done in these charts by the income-tax authorities.
According to him, the quantum of remuneration could not, in any case, be linked with the profit. The profit as a derivative figure depending on various factors outside the direct and reasonable control of the technical assistance providers. Contracting for a fixed amount of royalty could be disastrous if the product did not click in the market. In the sale-linked agreement, the technical assistance providers interest in the success of the product was highest and ensured maximum assistance was received. Moreover, intangible benefit of technical assistance could not be gauged by the performance of the same year in which the investment in technology was made. The benefit could be gauged only over sufficiently long-term allowing the technical initiative to bear fruits. That part, the learned Counsel for the assessee pointed out that the working done by the Department was highly unreasonable inasmuch as the payments were compared with the prior of the company after payment of remuneration in question. The learned Counsel, therefore, furnished a separate chart to show that even on imperfect and irrational basis of comparison with the profit adopted by the assessing authority, the payments in question constituted only 34.89 per cent and 26.59 per cent of the profits for asst. yrs. 1997-98 and 1998-99 respectively. The learned Counsel further argued that the percentage was higher during asst. yrs. 1997-98 and 1998-99 because the net profit as percentage of turnover itself was lower in those assessment years. As to the question that no independent evaluation of the value and utility of technical services were carried out, the learned Counsel argued that such was never a practice in a case where highly specialized and restricted technology was imparted. Technology provided to the assessee by the parent company and its subsidiary had always been and was intended to always remain the property of the parent company and its subsidiaries. The assessee had been given a right to use only that technology for manufacture and sale of products under the parent company's brand name. The technology was highly sensitive and confidential and, therefore, in every agreement, the assessee was bound by confidentiality clause. In such circumstances, to invite an independent agency for evaluation and certification as desired by the AO was unthinkable. As to the basis on which the quantum of remuneration for technology assistance was fixed, the learned Counsel argued that at the time of entering into the agreement, it was not possible to predict accurately the amount of remuneration to be paid to technical assistance providers. That depended on the success of the product launched and actual working of the project in India and subject to several imponderables. It was for that reason that there was no specific working made at the time of entering into agreements in question and insistence of the learned AO on production of the same was not justified. The assessee as well as the technical assistance providers were in the line of business and had experience for a long time and based on their experience and perception, by mutual discussion, the rate of remuneration was fixed. It was not possible to physically demonstrate that intangible exercise. The fact of the matter was that the remuneration was fixed at a very reasonable rate in spite of the Government regulations having permitted payment of remuneration at much higher rate. The justification of remuneration paid was to be seen in the voluminous material and evidence filed by the assessee during the course of the assessment proceedings and the proceedings before us. It was totally inappropriate to test the reasonableness of the remuneration on the yardstick of profit of the year in which the payment was made. This issue required a long-term view to be taken. On careful consideration of the detailed submissions made by the assessee in this behalf and briefly enumerated by us in paras 37 to 65 of this order, we find ourselves in substantial agreement with the assessee.
In the first instance, the assessee only had license to use the technology and, therefore, the assessee could not have continued the manufacture of any Nestle brand product without the consent of the parent company. We do not subscribe to the argument of the learned CIT-Departmental Representative that as intellectual property rights were not recognized in India, the assessee could have snapped ties with the foreign company and carry on its business as before. We also find that the technical assistance provided by the parent company was all pervasive in the operations of the assessee company and permeated into almost every detail. The assessee company in India was reaping harvest of fine production technology evolved by the parent company over 125 years by virtue of presence in more than 70 countries. For continuing to arrest the benefit, it was essential for the assessee to have a perennial source of supply of all the technological innovation, advancement and upgrade. It would not be an exaggeration to say that in modern times, no businessman can afford to be oblivious of the fast moving technology related to his business on the ground of contentment with the knowledge and experience already gathered. The assessee did not contribute a single penny to R&D cost of Nestle SA stated to be over Rs. 2,000 crores per year. Nestle India received tested technology and, therefore, did not have to suffer loss of a failed technology or project. The assessee had access to all the required technology available with the parent company not only in respect of manufacturing but also in various other fields like quality control, personnel, staff management, marketing, storage and so on. The kind of technical assistance received by the assessee was of such nature as to sustain its position as number one manufacturer in India in respect of the products being manufactured by it. During the course of hearing before us the learned Counsel for the assessee has given several examples of major technological advancements that had taken place in the area of the assessee's products. He explained to us in detail the major changes that took place in the field of coffee manufacturing and state of art technology that allowed to capture the aroma of fresh coffee in the products of the assessee. The learned Counsel dwelt at length on the unique technology in relation to extraction process called MUCH process resulting into better finished product from the same coffee beans. He made reference to the changes in the manufacturing process of weaning foods that ensured bio availability of carbohydrates through the process of enzymation to provide higher nutrition in meals and enhanced digestibility. These were just a few examples from out of the many advancements and changes taking place every year. The learned Counsel pointed out that during the period under consideration, more products were launched by Nestle than in the immediately preceding two decades. He also emphasized with considerable justification that several thousand Indian shareholders of the assessee company tremendously benefited. An investor who purchased 100 shares in 1970 had grown into shareholding of 3,700 shares of the market value of Rs.19 lakhs after having received the dividend totalling to Rs. 2,66,653. The learned Counsel argued that these aspects were required to be appreciated rather than merely suspecting that the remuneration for technical assistance was nothing but a camouflage to siphon away and repatriate the profits of Indian operations. On careful consideration, we see considerable force and justification in these arguments of the assessee.
96. There is one more important aspect of the case. After all what is the material against the assessee in the orders of the authorities below. Apart from preparing same charts, no material or evidence has been brought on record by the authorities below to substantiate their allegations against the assessee. As we have pointed out that the assessee only had initial onus to substantiate its claim of deduction of expenditure as laid down under Section 37(1). The burden to prove that the claim of expenditure was a colourable device or a camouflage for diversion of profits rested upon the Revenue. In the order of the authorities below, no material has been brought on record except disbelieving the assessee's explanation and their subjective opinions. The burden of their order is that the assessee so arranged its course of business that it was left with a less than ordinary profit expected in the assessee's line of business. No one, however, has taken care to specify as to how much that ordinary profit was supposed to be and on what basis the same could be determined. It appears to us that the assessment order for asst. yr. 1997-98 and, the learned AO as well as the CIT(A) for the asst. yr. 1998-99 have argued without adequate material that the assessee might have taken the advantage of liberalization of industrial policy from the year 1991 in judicial proceedings, suspicion howsoever strong cannot take place of material/evidence. We, therefore, hold that the disallowance of the assessee's claim of deduction on account of remuneration paid for technical assistance is not called for in both the asst. yrs.
1997-98 and 1998-99. We direct accordingly.
6. Since the facts and circumstances of the instant case are identical to that for asst. yrs. 1997-98 and 1998-99, we, concurring with the above said decision of the Tribunal hold that the disallowance of royalty payments made by the AO and confirmed by the learned CIT(A) was not justified. We, therefore, direct to delete the same.
7. The second ground of appeal states that on the facts and in the circumstances of the case and in law the CIT(A) erred in holding that UPS which are attached to computers and form an integral part of the whole computer system cannot be categorized as computer, for the purpose of depreciation under Section 32 of the Act.
8. Briefly stated facts are that during the year the assessee had claimed depreciation on UPS @ 60 per cent treating it as part of computer. But the AO asked the AO to justify the higher claim of depreciation, as UPS is part of plant and machinery and not of computer. After going through the details of UPS submitted by the assessee, it was found by the AO that the UPS had been used for less than 180 days and by treating it as part of plant and machinery, the AO allowed depreciation @ 12.5 per cent on UPS and accordingly disallowed excess sum of Rs. 11,99,768. On appeal before the CIT(A), the assessee submitted that it had purchased a few UPS costing aggregate to Rs. 68,55,814. These UPS wore purchased for the purpose of running the computers uninterruptedly during the power cuts and avoid loss of data in the computer due to sudden frequent power cuts and voltage fluctuation. These UPS were connected to LAN, PCs, servers, routers, V.Sats, etc. and formed an integral part of the overall computer system.
Considering that they were in fact connected to computer system and were not used for any other purpose and further fact that the computer could not have functioned properly without support from UPS, Lhey were considered as integral part of computer and capitalised so and accordingly depreciation at the rate applicable to computer was claimed. However, the CIT(A) after having considered the submissions of the assessee has observed that UPS is an instrument which gives uninterrupted power supply to computer and it cannot be termed as computer by any stretch of imagination. The depreciation of 60 per cent is available only on computers and not on any other instrument connected to computer. Therefore, UPS cannot be categorized as computer and it is not eligible for higher depreciation. Therefore, the assessee who had claimed higher slab of depreciation i.e., 60 per cent on UPS claiming it as part of computer is not justified and the AO was justified in making the disallowance out of excess claim of depreciation.
9. Before us, the learned Counsel for the assessee has submitted that UPS purchased were connected to local area network (LAN), PCs, servers, routers, V-sats, etc. and thus formed an integral part of the overall computer systems. Considering the fact that the UPS were an integral part of computer system and were meant only for and could be used only as part of computer, therefore, the UPS is an integral part of computer. The learned Counsel for the assessee has further submitted that accordingly the assessee claimed the depreciation on the UPS at the rate of 60 per cent applicable to 'computers' as per Entry No. (2B) of Part IE of Appendix I to IT Rules, 1962, as applicable to the assessment year under consideration. The AO and the CIT(A) held that UPS is not part of computers. The lower authorities held that UPS was classified as general plant and machinery and allowed depreciation @ 12.5 per cent on the same. The learned Counsel has argued that according to the functional test, the principle followed by the Courts, it is required to be seen if an item is an apparatus with which the business is carried on; if yes, then the same is to be considered as 'plant'. On the basis of this principal, the following were held to be 'plant': (i) Sanitary and pipeline fittings in a hotel [CIT v. Taj Mahal Hotel ;CIT v. Kanodia Warehousing Corporation ]; (iii) Buildings specially built to conserve temperature and filtered air \R.C. Chemical Industries v. CIT .
10. Further, in the present case also, it will be appreciated, what is important is the function for which UPS were purchased and used. UPS were purchased and actually used in running the computer network only, as an integral part thereof. He has further pointed out that the UPS did not merely ensure uninterrupted power supply to computer network, but more importantly, also regulated the flow of power to avoid any kind of damage to the computer network due to fluctuation in power. The central unit of assessee's computer system is located at one place, which is connected to different locations spread all over India through satellite networking. The computers work in the live environment and sudden loss of power could bring the whole operations to a halt besides causing loss of valuable data in the mean time. UPS were essential and integral part of the computer network and must be classified as 'computer' only, given the functions for which it was actually used.
The learned Counsel further mentioned that the printer/scanner have been held as essential parts of computer and eligible for depreciation @ 60 per cent in the case of ITO v. Samiian Majumdar (2006) 101 TTJ (Kol) 501 : (2006) 98 ITD 119 (Kol). He has further argued that UPS has no other function but to assist the functioning of the computer. It cannot be used for another purpose. As, in the laptop, battery is an integral part, the same is the position of UPS. The learned Counsel for the assessee has further referred to 'a word definition from the Webopedia Computer Dictionary' of UPS which reads as under: Short for uninterruptible power supply, a power supply that includes a battery to maintain power in the event of power outage. Typically, a UPS keeps a computer running for several minutes after a power outage, enabling you to save data that is in RAM and shut down the computer gracefully. Many UPSs now offer a software component that enables you to automate back-up and shut down procedures in case there is a power failure while you are away from the computer.
There are two basic types of UPS systems; standby power systems (SPSs) and on-line UPS systems. An SPS monitors the power line and switches to battery power as soon as it detects a problem. The switch to battery, however, can require several milliseconds, during which time the computer is not receiving any power. Standby Power Systems are sometimes called line-interactive UPSs.
An on-line UPS avoids these momentary power lapses by constantly providing power from its own inverter, even when the power line is functioning properly. In general, on-line UPSs are much more expensive than SPSs.
11. Thus, he has submitted that the authorities below were not justified in not treating the UPS as an integral part of the computer and, as such, denying the higher depreciation @ 60 per cent on UPS.12. On the other hand, learned Departmental Representative has submitted that the UPS cannot be held to be part of the computer and hence, it cannot be considered as an integral part of the computer. In western countries UPS is not used as power supply is constant and regular. He has further argued that in case the UPS is an integral part of computer, then the air conditioners used in server room and power back-up would also form part of computer. Thus, he has submitted that UPS cannot be held to be an integral part of computer so as to entitle the assessee to claim higher depreciation @ 60 per cent. Thus, he has supported the order of the CIT(A).
13. We have heard the parties and perused the record of the case. The assessee is engaged in the business of manufacturing of various food products and beverages. During the year the assessee company had purchased UPS for a sum of Rs. 68,55,814 and claimed depreciation on UPS @ 60 per cent treating it as part of computer. However, the AO has treated the same as plant and machinery and allowed depreciation @ 12.5 per cent on UPS where as per Entry No. (2B) of Part III of old Appendix I of IT Rules (as applicable for asst. yrs. 1988-89 to 2002-03) depreciation on computer is fixed @ 60 per cent of WDV. The expression "computer" has not been defined in the Act. However, it has been defined by Section 2(1)(i) of the Information Technology Act, 2000. As per the said Act, "computer" means any electronic, magnet, optical or other high speed data processing device or system which performs logical, arithmetic and memory functions by manipulation of electronics or magnetic or optical impulses and include all input-output processing, storage, computer software or communication facilities which are connected or related to the computer in a computer system or computer network. It may be mentioned that there is no inbuilt system of power supply in the computer. Therefore, it works on electric power supply. The UPS, as defined by Webopedia Computer Dictionary, stands for uninterruptible power supply. The UPS keeps the computer running for several minutes after a power outage enabling to save data that is in RAM and shuts down the computer gracefully. Thus, the UPS mainly ensured uninterrupted power supply to computer network and also regulated the flow of power to avoid any kind of damage to the computer network. It is, thus, a source of alternative supply of power to the computer and applying the functional test also, it is a part of power supply system and not the computer system. The UPS is also not inbuilt in the computer as a battery in the laptop to make it an integral part of the computer system. It merely gives external aid to the computer system by ensuring the uninterrupted power supply in emergency and in regulating the flow of power. It is worthwhile to note here that the computer system can function independently without the UPS and even the UPS generally can be used to ensure uninterrupted power supply to other equipments besides computer. It is, thus, not the integral part of the computer system like printer and scanner, which being output devices of the computer system are its integral part and, thus, are included in the definition of a computer as given in Section 2(1)(i) of the Information Technology Act, 2000. It is also pertinent to note here that a higher rate of depreciation is provided on computers mainly because the technology used in the making of computer is rapidly developing and the same becomes obsolete very fast. Applying this criteria also, the UPS cannot be treated as a part of computer since the technology which goes into making UPS is not developing so rapidly to make it obsolete in the short span. Keeping in view all these relevant and material aspects, we find it difficult to accept the contention of the learned Counsel for the assessee that UPS is a part of computer and is entitled to a higher depreciation rate of 60 per cent and rejecting the same, we uphold the impugned order of the learned CIT(A) confirming the disallowance made by the AO by restricting the claim of the assessee for depreciation on UPS treating the same as plant and machinery. Ground No. 2 of the assesee's appeal is accordingly dismissed.
14. The third ground of appeal states that on the facts and in the circumstances of the case and in law the CIT(A) has erred in confirming the setting off of the losses of Rs. 7,72,636 incurred by the appellant in respect of business of export of 'traded goods' against the profit made by it from the business of export of manufactured goods for the purpose of allowing the deduction under Section 80HHC of the Act.
15. When the matter came up for hearing, the learned Counsel for the assessee fairly concedes that this issue is covered against the assessee by the decision of Hon'ble Supreme Court in the case of IPCA Laboratories Ltd. v. Dy. CIT . Therefore, this ground of appeal of the assessee is dismissed.
16. The fourth ground of appeal relates to the charging of interest under Section 234B of the Act. This ground being consequential in nature, the AO is directed to consider the same accordingly.
17. The first ground of appeal states that on the facts and in the circumstances of the case the CIT(A) has erred in directing the AO to exclude the excise duty from the total turnover while computing deduction under Section 80HHC. We find that this issue stands decided in favour of the assessee in assessee's own case by the Tribunal for asst. yr. 1998-99 and the Department's appeal filed before the Hon'ble jurisdictional High Court since has been dismissed vide order dt. 7th July, 2006 in ITA No. 1023/Del/2006. Therefore, this ground of appeal of the Revenue is dismissed.
18. The second ground of appeal states that on the facts and circumstances the CIT(A) has erred in allowing a relief of Rs. 52,43,18,000 on account of advertisement expenses.
19. Briefly stated facts are that the AO has observed that during the year under consideration the assessee had incurred advertisement expenses of Rs. 104,86,36,000. The advertisement and sale promotion expenses had been incurred for promotion of products manufactured by the assessee under license of M/s Nestec and M/s SPN. He has further observed that the assessee was manufacturing and marketing specific products in the brand names of Nestle and had been paying royalty/technical fee for using the licence to manufacture and sell the products. Though the benefits of advertisement/sale promotion expenses to the assessee's business cannot be ruled out but simultaneously it is resulting in establishment of brands and products of Nestle, SA a nonresident, substantially interested company in assessee's business.
On this basis, the AO has observed that it is clear that the provisions of Section 92 are squarely applicable to the assessee's advertisement expenses incurred for the purpose of establishment of products having Nestle's brand. The incurrence of advertisement expenses to the benefit of non-resident company is certainly resulting in less than ordinary profits to assessee company for which provisions of Section 92 are invoked and therefore, the AO disallowed 50 per cent of total expenditure incurred on advertisement and sales promotion and treated it as not wholly and exclusively for assessee's business and therefore, she disallowed Rs. 52,43,18,000. On appeal, the CIT(A) has held thus: 4.4 I have examined the reply of the appellant and facts of the case carefully. From the details furnished by the appellant before the AO it is clear that the appellant company, had made expenditure in respect of advertisement and sales promotion in respect of only with those products in which the Indian company is actually dealing in.
These expenses were incurred for advertisement in India only that too in respect with those products in which they are dealing in. The expenses are payments made to the third party in India that are not in anyway related to them either in the loose definition of Section 92 or strict definition of Section 40A(2). The expenditure has been incurred to promote sales in India in Indian territory. The AO has not brought out anything on record to justify the invoking of Section 92 of the IT Act. Neither any payment has been given for advertisement to Nestle SA nor there is any business dealing as far as advertisement expenses are concerned between Nestle SA and Nestle India Ltd. Therefore, the provisions of Section 92 are not applicable for the allowability of this expenditure. In the case of Wiltshire Brewery Ltd. v. Bruce 6 Tax Cases 399 (HL) cited by the appellant in which it is clearly mentioned that "where whole and exclusive purpose of expenditure is the purpose of expender's trade and the object which the expenditure serves is the same, the mere fact that to some extent the expenditure enures to a third party's benefit or that spender incidentally obtains some advantage in some character other than that of a trader, cannot in law defeat the effect of finding as to the whole and exclusive purpose. It was reiterated in the judgment of Supreme Court in the case of CLT v. Chandulal Keshavlal & Co. and Sassoon J. David &CLT and Eastern Investment Ltd. v. CIT (supra). From the facts submitted before me and before the AO, it is clear that the appellant company, has made expenditure on advertisement in respect of only those products which are sold by this company within the Indian territory. To be an allowable expenditure within the meaning of Section 37(1) the money paid out or away must be (a) paid out wholly and exclusively for the purpose of the business or profession and further (b) must not be (i) capital expenditure (ii) personal expense or (iii) an allowance of the character prescribed in Sections 30 to 36. In the appellant's case the AO has nowhere mentioned that the expenditure is capital in nature or personal in nature or covered in Sections 30 to 36 of IT Act. The payment has not been made to any person covered under Section 40A(2). The payment on advertisement has not been paid to any non-resident person mentioned in Section 92. The appellant has not spent any amount with the sole intention that only the brand name Nestle is to be advertised. The appellant has made expenditure only on advertisement of these products which are manufactured and sold in India to boost the sale and exclusively and wholly for business purposes. The appellant has also not incurred any expenditure outside Indian territory for any other products.
Therefore, in my opinion the expenditure has been incurred wholly and exclusively for business purposes and not for establishing brand name of Nestle SA. All the conditions which are prescribed under Section 37(1) are satisfied in the appellant's case and AO has not brought any material on record justifying the disallowance of part expenditure. The ad hoc disallowance of 50 per cent made by the AO is without any appreciation of facts or basis and not in accordance with legal position. Therefore, the disallowance of Rs. 52,43,18,000 made by the AO is hereby deleted. The appellant succeeds on this ground.
20. Before us, the learned Departmental Representative has submitted that the assessee has incurred the expenses on advertisement and sale promotion under various heads during the previous year. The advertisement expenses have been incurred by the assessee for the purpose of establishment of products having Nestle brand. Thus, the impugned expenses have resulted in benefit to Nestle SA, a non-resident. Therefore, the AO was justified to disallow 50 per cent of the total expenses incurred in advertisement by invoking the provisions of Section 92 of the Act. Thus, he has supported the order passed by the AO. On the other hand, the learned Counsel for the assessee has submitted that the assessee has incurred expenses in India on advertisement and sale promotion by advertisement over television channel, radio, cinema and other print media. The sale promotion activities includes incentives, trade give aways, consumer sampling, sponsorship, etc. The advertisement expenses have been incurred only in India and in respect of products sold by the assessee in India. No advertisement expenses have been incurred by the assessee outside India. The assessee only decides the extent of expenditure it needs to be incurred on advertisement to promote its own sale in the best interest of its business and Nestle SA has no say in this regard. The benefit arising from promotion of Nestle brand is to the account of assessee only. The extent of expenditure incurred wholly and exclusively for the business purpose of the assessee is allowable as revenue deduction. The learned Counsel for the assessee has submitted that though the benefit may have arisen to Nestle SA by the impugned expenditure, but it is well settled that an expenditure incurred for the purpose of assessee's business is allowable even if it results in an advantage to a third party. A reliance in this regard has been placed on the following decisions:Star India (P) Ltd. v. Addl. CIT 21. He has further argued that Section 92 has no application as the advertisement expenses have not been paid to Nestle or to any party in India who is related to Nestle SA. He has pointed out that there is no business dealing with Nestle SA in respect of advertisement expenses.
He has further submitted that as has been held by the Tribunal in assessee's own case for asst. yrs. 1997-98 and 1998-99, the AO is required to bring evidence on record to justify that the expenses has resulted in less than ordinary profits to the assessee for invoking the Section 92 of the Act. No such evidence has been brought on record by the AO. Thus, he has supported the order passed by the CIT(A).
22. We have heard the parties and perused the record of the case. The assessee is engaged in the business of manufacturing of various food products and beverages. The assessee is manufacturing various products under various brands owned by Nestle, Switzerland. During the year under consideration, the assessee has incurred advertisement and sales promotion expenses of Rs. 104,86,36,000. According to the AO, the benefit of advertisements/sales promotion expenses to the assessee's business cannot be ruled out but simultaneously it is resulting in establishing of brands and products of Nestle SA a non-resident, substantially interested company in assessee's business. However, it may be mentioned that the fact that assessee company had incurred expenditure on account of advertisement and sales promotion in respect of only those products in which India company is dealing in, has not been controverted by the Revenue. Thus, the expenditure has been incurred to promote sales in India. Therefore, these expenses were incurred wholly and exclusively for the purpose of business of the assessee. Further, payment for those expenses have been made to third parties in India who are not in anyway related the Nestle SA.Therefore, there is no justification on the part of AO to invoke the provisions of Section 92 of the Act in the matter. Therefore, we find ourselves in agreement with the view of CIT(A) that provisions of Section 92 are not applicable for the allowability of this expenditure.
The expenditure incurred by the assessee company on advertisement/sales promotion of some Nestle products in India may give rise to certain benefit to Nestle SA, but this cannot be a ground to disallow the claim of the assessee, once it is established that the expenditure in question has been incurred by the assessee for the purpose of business of the assessee inasmuch as the expenditure by the assessee on advertisement/sales promotion has direct nexus with the earning of income by the assessee. It may be mentioned that an identical issue had come up for consideration before Tribunal, Mumbai in the case of Star India (P) Ltd. v. Addl. CIT (supra) wherein it has been held that advertisement expenses incurred on promoting viewership of TV channel by the assessee engaged in procuring programmes for those channel was expenditure incurred wholly and exclusively for the purpose of its business and it could not be disallowed on the ground that it might have also benefited the assessee's principal. In view of what has been discussed above, we do not find any reason to interfere with the order of the CIT(A) passed in this regard. Hence, the same is upheld.23. In the result, the appeal filed by the assessee is partly allowed and that of the Revenue is dismissed.