| SooperKanoon Citation | sooperkanoon.com/66109 |
| Court | Income Tax Appellate Tribunal ITAT Madras |
| Decided On | Jan-29-1993 |
| Judge | S Kannan, S A Reddy |
| Reported in | (1993)46ITD387(Mad.) |
| Appellant | E.i.D. Parry (India) Ltd. |
| Respondent | Dy. Commissioner of Income-tax |
2. The assessee is a multi-product company, having such diverse profit centres as Fertiliser Division, Sugar Division, Ceramic Division, etc.
It has also a number of subsidiaries such as Parry & Co. Ltd., etc.
Previously it was adopting the year ending on June 30 every year as its year of account. Thus, the year of account ending on 30-6-1987 was the previous year relating to the assessment year 1988-89. For the assessment 1989-90 (which is now before us), however, the previous year of the assessee ended on 31-3-1989. It. would appear that the year of account was changed to comply with the provisions of the Income-tax Act.
3. In the course of the examination of accounts, the assessing officer found, as was made clear in the Note No. 9 of Notes on Accounts contained in Schedule 15 to Accounts as on 31-3-1989, that during the relevant year of account, the assessee had switched over to "Factory Direct Cost Method" from "Full Factory Cost Method" which the assessee was hitherto following. The Note also made it clear that as a result of the said change in the method of valuation of closing stock and work-in-progress, the profits for the year of account ending on 31-3-1989 stood reduced by Rs. 340.98 lakhs.
4. The Assessing Officer refused to recognise the aforesaid change in the method of valuation. In this regard, she was impelled by the following considerations : (i) No explanation was forthcoming as to the reasons for the change in the method of valuation.
(ii) As respects the Fertilisers Division, it was only in the immediately preceding year of account that the assessee changed the method of valuation of closing stock. As has been held by the Madras High Court in the case of CIT v. Carborundum Universal Ltd. [1984] 149 ITR 759, the assessee has "right for a one time change in the method of valuation to be followed consistently thereafter. As a one time measure the assessee (had) chosen to change the method of valuation last year only in respect of fertilisers.... Therefore, the change in the method of valuation of other products cannot be resorted to this year.
Consistent with the line taken by her, she added a sum of Rs. 340.98 lakhs to the income returned by the assessee.
5. Predictably, the said issue was one of the subject-matters of appeal before the C.I.T. (A). Following points were made before the C.I.T. (A) in this regard : (i) 'Direct cost' method adopted by the assessee is a well-recognised method approved by the Institute of Chartered Accountants of India as well as International Accounting Standards.
(ii) For a fact, the Madras case of Carborandum Universal Ltd.'s case (supra) supports the assessee's case.
(iii) The Assessing Officer was not correct in stating that there was a change in the method of valuation in the previous year relevant to the assessment year 1988-89 because, in that year of account, 'standard cost' was adopted in place of actual cost in respect of certain fertiliser products and plant protection chemicals. There was no change in the method of valuation of closing stock in the strict sense of the term. Such a change had taken place only during the previous year relevant to the assessment year 1989-90.
6. On a consideration of the issue, the C.I.T. (A) declined to interfere in the matter observing : ....it is clear that it reduced the value of its closing stock on the basis of the judgment of the Madras High Court. No other reason for the change in the matter of valuation was mentioned by the appellant. The appellant was allowed to make a change in the valuation method in its Fertiliser Section in the proceedings for the assessment year 1988-89. The difference in the value on account of that change was Rs. 2.28 lakhs. By again making a change in the method of valuation of closing stock this year, the appellant has resorted to methods which are against the principles of 'consistency' laid down in Section 145 of the Income-tax Act. Such a change is not approved.
In this regard, the C.I.T. (A) purported to follow the ruling of the Supreme Court in the case of CIT v. British Paints India Ltd. [1991] 188 ITR 44. He also took the line that the Madras case of Carborandum Universal Ltd.'s base (supra) was not applicable to the facts of the case.
7. Shri Ramamani, the learned, counsel for the assessee took us through the facts and circumstances of the case and contended that 'direct cost' method of valuation of closing stock is one of the recognised methods. For a fact, the jurisdictional High Court has also approved that method in the case of Carborandum Universal Ltd. (supra). What is more, the Department's S.L.P. against the said judgment was dismissed by the Supreme Court. -See 187 ITR (St.) 38.
8. Secondly, the Supreme Court case of British Paints India Ltd.'s case (supra) cannot avail the Department because there, even while adopting 'direct cost' method, the assessee had left out of reckoning certain costs, such as direct labour, fuel, etc. It was in that context that the Supreme Court ruled that any system of accounting which excludes, for the valuation of stock-in-trade, all costs other than the cost of raw materials for the goods-in-process and finished products, it likely to result in a distorted picture of the true state of the business for the purpose of deducing the assessee's chargeable income.
In the case before us, however, the assessee had strictly followed the well-recognised 'direct cost' method.
In this regard, Shri Ramamani referred to and relied upon the following cases also : 9. The next limb of Shri Ramamani's argument was that in the year of account ending on 30-6-1987, production was suspended for sometime in the Fertilisers and Plant protection chemicals units owing to labour trouble. It was, therefore, that the assessee could not collect all the data necessary to adopt the total cost method which it was following earlier. As the assessee had to publish its accounts within the time stipulated under the Companies Act, the assessee adopted 'standard cost' instead of 'total cost' in respect of the said Divisions. The lower authorities were not justified in interpreting the said method which the assessee had perforce to follow, as meaning that the assessee had changed the entire method of valuation of closing stock and work-in-progress in that previous year. That there was no wholesale change in the method of valuation of closing stock and work-in-progress will be clear from the fact that the method adopted by the assessee in valuating the closing stock and work-in-progress relating to the said Division resulted in a nominal difference of Rs. 2 lakhs only. In view of the foregoing, therefore, contended Shri Ramamani, nothing turns on what happened in the previous year ending on 30-6-1987.
10. Finally, said Shri Ramamani, there was no mala fide intention on the part of the assessee when it decided to switch over to 'direct cost' method. After all, the assessee is a well-established going concern earning substantial income each year. Since the value of the closing stock as on 31-3-1989 will automatically be the value of the opening stock as on 1-4-1989, there is no avoiding or evading tax.
11. In view of the foregoing, therefore, contended Shri Ramamani, the assessee is entitled to succeed on this issue.
12. On his part, Shri Bose, the learned Departmental Representative, strongly supported the impugned orders of the lower authorities.
(i) The assessee has not given any reason for switchingover to 'direct cost' method.
(ii) The assessee has not taken the previous approval of the Assessing Officer for the switchover.
(iii) The rejection by the Supreme Court of the Department's S.L.P. in the case of Carborandum Universal Ltd. (supra) is neither here nor there. For a fact, the Supreme Court ruling in the case of British Paints Indi. Ltd. (supra) fully supports the Department's case.
(iv) The assessee had in the previous year ending on 30-6-1987 switched over to 'standard cost' method of valuing the closing stock in respect of the Fertiliser Unit. It is well-settled that after effecting a change in the method of valuation of closing stock, the assessee is obligated to regularly follow that method. The assessee cannot, therefore, be permitted to change the method of accounting once again.
(v) The orders of the Tribunal referred to an relied upon by Shri Ramamani cannot avail the assessee, because there the decisions turned on the peculiar facts of those cases. Thus, in the case of Modi Rubber Ltd. (supra), the method of valuation of closing stock came up for consideration in the very first year of assessment of the assessee. Properly viewed, that was really not a case of change in the method of accounting.
The decision of the Tribunal in the case of Orissa Cement Ltd. (supra) cannot also avail the assessee. There, even while professing to follow 'direct cost' method of valuing the closing stock, the assessee had omitted to take into account two components thereof.
The Tribunal ordered that the said two components be taken into account.
(vi) The switchover to the 'direct cost' method has resulted in the current year's profits being understated by Rs. 340.98 lakhs. The switchover cannot be accepted, because it goes counter to the well-known principle that for purposes of assessment, the true profit of each year must be ascertained.
The fact that all that happens is that the tax payable is deferred is neither here nor there. In this regard, Shri Bose drew our pointed attention to pages 53 and 56 of the report of British Paints India Ltd. 's case (supra) containing observations to the effect that the method of valuation of closing stock which produces such distortions should not be accepted.
14. In view of the foregoing, therefore, contended Shri Bose, the impugned orders of the lower authorities do not invite any interference on this issue.
15. In his reply, Shri Ramamani contended first that it was wrong to say that the assessee did not explain why it was switching over to 'direct cost' method. In any event, the basic question for consideration is whether 'direct cost' method is one that enables the Assessing Officer to deduce the true profits of the assessee. The answer to this question is 'Yes'. In this regard, Shri Ramamani highlighted the fact that in the case of Carborandum Universal Ltd. (supra), the Madras High Court has approved the method. What is more, the Supreme Court has nowhere ruled to the contrary.
Secondly, the Income-tax Act does not contain any provision which obligates the assessee to obtain the prior approval of the Assessing Officer for effecting a change in the method of accounting.
Thirdly, reiterated Shri Ramamani, the bona fides of the assessee before us could not be doubted.
16. We have looked into the facts of the case, we have considered the rival submissions.
It is a matter of record that all along the assessee was following 'total cost' method for valuing works in progress and the closing stock of the products manufactured by it. During the previous year relevant to the assessment year 1989-90 which is now before us, the assessee switched over to 'direct cost' method. In the context of the switchover, the assessee had explained its stand to the Assessing Officer through its letters dated March, 18, 1992 and March 30, 1992.
In support of the switchover, it had made two basic points before the Assessing Officer, namely, (i) 'direct cost' method is based on sound Accounting Principles and is one of the methods recognised by the Institute of Chartered Accountants of India as also International Accounting Standards; and (ii) in the Madras case of Carborandum Universal Ltd. (supra) that method was also approved by the High Court. But the said explanations did not interest the Assessing Officer who decided the issue against the assessee.
17. Before the C.I.T. (A) also the assessee explained its stand through its letter dated July 30, 1992. In that letter, it was shown that 'direct cost' method was applied only to the products manufactured by it and not to 'purchased items'. The letter also gave the break-up of the aggregate figure of Rs. 340.98 lakhs referred to above. The items of costs which had been taken into account for purposes of applying 'direct cost' method were also detailed. And as before the Assessing Officer, so before the C.I.T. (A), the Madras case of Carborandum Universal Ltd. case (supra) was referred to and relied upon. The C.I.T.(A) too was not impressed by the said arguments.
18. As pointed out earlier, two basic considerations weighed with the lower authorities in rejecting the assessee's claim. The first was that no reason was given by the assessee for the switchover to 'direct cost' method. And the second was that only in the immediately preceding previous year the assessee had changed the method of valuation of closing stock in respect of certain of its products.
19. As we see it, none of the aforesaid two considerations is decisive of the matter. We know of no justification, in authority and in law, for the proposition that the assessee should give reasons for the switchover. Even assuming that the assessee was obligated to give reasons for the switchover, the assessee had given sufficient reasons therefore. The first reason was that 'direct cost' method was a recognised method of valuing closing stock.
Secondly, the method was approved by the jurisdictional High Court in the case of Carborandum Universal Ltd. [supra). As we see it, the aforesaid two reasons are reasonable.
In H.D. Ostime v. Duple Motor Bodies Ltd. [1961] 2 All ER 167 (HL), the assessee was valuing work-in-progress for income-tax purposes by applying 'direct cost' method. The Revenue sought to value the work-in-progress by applying 'on cost' method. The House of Lords held first that 'direct cost' method is more accurate as a method of computation than 'on cost' method; and secondly, that as the assessee was following 'direct cost' method consistently over a period of years, the Revenue was not justified in disregarding that method and in adopting 'on cost' method, especially when great uncertainty was attached to the latter method.
It is of interest to note that in Carborandum Universal Ltd.'s case (supra), the Madras High Court referred to the said English case and held that 'the adoption of "direct cost" method by the assessee cannot be questioned by the Revenue as it has been found by the Tribunal that the adoption of this method is bona fide and is a permanent arrangment.' The Court went on to observe : So long as the method of valuation adopted by the assessee gets recognition from the practising accountants and the commercial world for valuation of stock-in-trade, the adoption of that method cannot be questioned by the Revenue unless the adoption of that method is found to be not bona fide or restricted for a particular year.
20. The position that emerges is that when 'direct cost' method has been recognised as being more accurate as a method of computation and when the said method had been approved by the jurisdictional High Court, a switch over to that method cannot be regarded as being bereft of reasons.
21. The second consideration which weighed with the lower authorities in rejecting the assessee's claim was that the assessee had changed the method of accounting in the immediately preceding previous year. As we see it, the lower authorities have misdirected themselves as to facts.
What had happened in the previous year relevant to the assessment year 1988-89 was that, owing to labour trouble, the assessee was unable to ascertain the total cost of certain fertiliser products and plant protection chemicals. Anxious as it was to beat the statutory deadline in matters relating to finalisation of accounts, the assessee had perforce to adopt standard cost in respect of the aforesaid products.
This was nothing but pis aller which was restricted to a few items of its products. We are, therefore, unable to view this as a change in the method of valuation of work-in-progress and closing stock. Such a change actually took place only in the previous year relevant to the assessment year 1989-90, which is now before us. It should, therefore, follow that the assessee's claim cannot be rejected on the spacious but unsound ground that it had effected a change in the method of valuation of closing stock only in the immediately preceding previous year. We hold accordingly.
22. The assessee's case, as we see it, is clearly covered, in favour of the assessee, by the decision of the jurisdictional High Court in the case of Carborandum Universal Ltd. (supra). Normally, the matter should have rested there. Even so, as the Departmental Representative had strenuously urged a couple of points, it is necessary to deal with them now.
23. The basic point made by Shri Bose was that the decision of the Supreme Court in the case of British Paints India Ltd. (supra) supported the Department's case. We are unable to agree. In that case, the assessee had valued the goods-in-progress and finished products exclusively at cost of raw materials and totally excluding overhead expenditure. The justification for this practice, which was consistently being followed by the assessee, was that the goods being paints have limited storage life and that if they are not quickly disposed of, they are liable to lose their market value. The said contentions did not find favour with the Supreme Court. After noticing the House of Lords case of Duple Motor Bodies Ltd. (supra), the Supreme Court observed : In the present case, what the assessee contends for is neither the "direct cost" method nor any other method which takes into account the actual or even part of the cost involved in the manufacture of the goods in process and finished products. What it contends for is valuation of the raw material without taking into account any portion of the cost of manufacture. No decision has been brought to our notice in support of such a contention.
It will thus be clear that the decision in the aforesaid case before the Supreme Court turned on the peculiar facts of that case.
24. An interesting point was made by Mr. Bose and that was that the switchover to "direct cost" method, resulting as it did in the current year's profit being understated by Rs. 340.98 lakhs, cannot be accepted, because it goes counter to the well-known principle that for purposes of assessment, the true profits of each year must be ascertained.
There is no gainsaying the facts that the endeavour and duty of the Assessing Officer is to deduce the true profits of each year of account on the basis of well-recognised method of accounting including the method of valuation of work-in-progress and closing stock. True, again, the switchover from one method of accounting to another method of accounting, or from one method of valuing closing stock to another, might entail the reduction of one year's income and increase in the immediately succeeding year of account and the consequential deferring of liability to that extent. If one were to go only on the basis of such deferment of tax liability, one would never permit a change in the method of accounting or the method of valuing closing stock. The position in law, however, is that deferment of tax liability comes into focus only in the cases where the switch over is to a unrecognised method or is mala fide. When we talk of recognised method, we mean that the method is recognised as one that conduces to the proper deducing of the true profits of the assessee. Therefore, in cases where the switchover is to a recognised method in the above sense, then the deferment of tax liability becomes immaterial, particularly in view of the fact that after switching over to the new method, the assessee is obligated to follow it thereafter.
This aspect of the matter came up for consideration in the Madras case of Carborandum Universal Ltd. (supra). In that case, the assessee had switched over to 'direct cost' method of valuing work-in-progress and closing stock, with the result that the profit of the relevant previous year stock understated by Rs. 17,80,329. The Assessing Officer refused to countenance the switch over. On his part, the AAC accepted the assessee's contention that the switchover to 'direct cost' method was bona fide. He, however, gave a direction to the Assessing Officer "to work out the value of the opening stock as on September 1, 1969, also at direct cost or market price basis, whichever is lower and recompute the profits." The Department objected to the AAC's finding that the switchover to the 'direct cost' method was bona fide; and the assessee was aggrieved by the AAC's direction relating to the recomputation of the value of the opening stock. The Tribunal upheld the order of the AAC, because it was satisfied that the change in the method of valuation had been adopted by the assessee bona fide; that the method of valuation was to be adopted in future year after year and not only for the particular assessment year; and that, therefore, the change in the method of valuation of closing stock could be accepted. The Tribunal also upheld the contention of the assessee that it is entitled to adopt 'direct cost' method only for the closing stock. In that regard, it was impelled by the consideration that since the switch over to 'direct cost' method was bona fide, the deferment of tax liability was immaterial. The above findings of the Tribunal were also upheld by the Madras High Court.
If, on the contrary, the switchover is to a method which is not recognised or a method which no method at all, then the assessee cannot be heard to say that the deferment of tax liability is not material, because in the long run, thing will get evened out. The said situation is exemplified by the House of Lords case of B.S.C. Footwear Ltd. v.Ridgway (Inspector of Taxes) [1972] 83 ITR 269 and the Supreme Court case of British Paints India Ltd. (supra). In the case of B.S.C.Footwear Ltd. (supra), the House of Lords found that the stock valuation made by the assessees were incorrect and as a sequel produced some distortion of the assessment of taxable profits for a given year of account. In the case of British Paints India Ltd. [supra) also, the incorrect method followed by the assessee produced a distorted picture of the true state of the business for the purpose of computing the chargeable income. It was, therefore, that the Supreme Court held that the method adopted by the assessee was such that its income could not be properly deduced therefrom and that, consequently, the Assessing Officer was justified in determining what in his opinion, was the correct taxable income of the assessee.
25. The position may be summarised as follows: If in the facts and circumstances of a given case, the change in the method of accounting or in the method of valuing closing stock is bona fide, then the fact that such a change entails the reduction in or a postponment of the assessee's tax liability, per se, is not a relevant criterion. If the change was bona fide, then it will have to be accepted, even though it may have the effect of reducing or postponing the assessee's tax liability. If, on the contrary, the change over is not bona fide, the ITO can refuse to recognise the change on that ground alone. For a fact, in such cases, it is not necessary for the Assessing Officer to advert to the incidental reduction in or the postponement of the assessee's tax liability. In the case before us, the switchover to 'direct cost' method is bonajide. We, therefore, hold that the incidental deferment of the assessee's tax liability is immaterial.
26. Yet another point was made by Shri Bose and that was that the assessee did not take the prior approval of the Assessing Officer to switch over to 'direct cost' method. As rightly pointed by Shri Ramamani, unlike in cases relating to change of previous year, there is no statutory requirement that the prior approval of the Assessing Officer must be obtained for making a change in the method of accounting or in the method of valuing the closing stock. The aforesaid obvious proposition apart, there is the basic legal mandate that the Assessing Officer should deduce the true profits of the assessee relating to a particular previous year. Given this legal mandate, what is necessary is that the new method followed by the assessee must be such that it enables the Assessing Officer to deduce the true profits of the assessee. In the case before us, we have already held that the switchover to 'direct cost' method was bona fide, that is to say, 'direct cost' method is one that is more accurate as the method of computation than the 'total cost' method. In the circumstances, therefore, we reject the arguments of Shri Bose on this point.
27. In view of the foregoing, therefore, we delete the impugned addition of Rs. 340.98 lakhs made by the Assessing Officer.
28. Dare House Investments Ltd. is a wholly owned subsidiary of the assessee-company. As in the past, so in the previous year relevant to the assessment year 1989-90, which is now before us, the assessee had advanced certain sums to the said subsidiary and charged interest at 6 per cent thereon. The Assessing Officer found that the assessee had in fact advanced the said sums to the said subsidiary from out of money borrowed by it from banks' at much a higher rate of interest (17.5%).
The Assessing Officer found that in the process, the assessee-company had paid the banks an aggregate sum of Rs. 65,65,645 as and by way of interest over and above the aggregate sum of Rs. 38,08,940 being the interest which the assessee had collected from the subsidiary.
According to the Assessing Officer, the said differential amount was not laid out wholly and exclusively for the purposes of the business of the assessee.
29. In support of the contention that the lower authorities were not justified in making the impugned addition, Shri Ramamani, the learned counsel for the assessee, made two points. The first point was that the sum in question was expended wholly and exclusively for the purposes of the assessee's business. The assessee is a selling agent for the products of Coromandel Fertilisers Ltd. - a company promoted by the assessee, that apart from the equity shares of Coromandel Fertilisers which the assessee had initially acquired qua promoter, the assessee considered it desirable to acquire more shares of the said company and this was done through the instrumentality of its wholly-owned subsidiary, namely, Dare House Investments Ltd. The sums necessary for acquiring the shares of the said company was found by the assessee-company and made over to the said subsidiary. As a result of the acquisition of extra shares, the assessee-company came to hold about 17% of the equity of Coromandel Fertilisers Ltd. Such a substantial shareholding naturally meant that the assessee-company acquired more clout in its dealings with Coromandel Fertilisers Ltd., in general and in matters relating to the selling agency in particular.
True, the shares were not acquired directly by the assessee-company but by Dare House Investments Ltd. But considering the fact that the said company is a wholly-owned subsidiary of the assessee-company, the acquisition of extra shares conduced to the business interests of the assessee particularly as respects the selling agency. It should, therefore, follow that the outlay in question was clearly for business purposes. In this regard, he referred to and relied upon the decision of the I.T.A.T. Madras Bench 'B' in the case of Durametallic (India) Ltd. v. IAC [1991] 38 ITD 211.
30. The second point urged by Shri Ramamani was that if regard be had to the fact that the profits of the assessee-company were in the neighbourhood of Rs. 21 crores, it will readily be seen that the profits were more than sufficient to cover entirely the aggregate sum of Rs. 6 crores advanced by the assessee to its wholly-owned subsidiary.
31. In view of the foregoing, therefore, contended Shri Ramamani, the assessee is entitled to succeed.
32. On his part, Shri, Bose strenuously contended that the impugned disallowance did not invite any interference. Relying on the Mysore case of CIT v. United Breweries [1973] 89 ITR 17 he contended that unless the functional test laid down by the Mysore High Court in that case was satisfied, the assessee cannot succeed. For purposes of assessment to income-tax, a holding company and its subsidiaries are separate and distinct entities. Consequently, unless the assessee before us (the holding-company) exercised functional control over Dare House Investments Ltd. (the subsidiary), the assessee cannot succeed in its claim. In this case, no evidence was forthcoming of such functional control. He, therefore, contended that assessee's claim is fit to be rejected.
33. We have looked into the facts of the case; we have heard the rival submissions. As we see it, the decision in the Mysore case turned on the facts of that case. No doubt, in that case also, the question that arose for consideration was whether the interest paid by United Breweries on money borrowed by United Breweries at interest and advanced to its subsidiaries free of interest would be revenue deductible. The Tribunal held that the assessee was entitled to succeed on the ground that the holding company was an agent of its subsidiaries. It was in that context that the Mysore High Court observed: In deciding whether a subsidiary company is an agent of the parent company the true test is whether there is in addition to capitalist control, functional control by the parent over its subsidiary. If the parent company did exercise functional control over its subsidiary, the existence of such subsidiary company as a separate legal entity would not prevent the business of the subsidiary being treated as that of the parent company.
Apart from the obvious fact that the assessee's claim was allowed by the Tribunal invoking the principle of agency, there is the further significant point that in the Mysore case it was not proved that the outlay in question was for the business purposes of the holding company. This, as we see it, was one of the reasons why the Mysore High Court held that part of the capital borrowed by United Breweries and advanced by it to its subsidiaries free of interest was not borrowed for purposes of its own business and that consequently, the interest on such borrowing was not an admissible deduction under Section 36(1)(iii).
34. The facts of the case before us, however, are different. Here, the assessee-company had promoted Coromandel Fertilisers Ltd. and qua promoter, it had initially taken some equity shares. Subsequently, with a view to increasing its shareholding, it purchased more shares through its wholly-owned subsidiary; and, in the process, came to hold a large chunk of equity shares of Coromandel Fertilisers Ltd. Such a large shareholding, as rightly pointed out by Shri Ramamani, confers on the assessee greater bargaining power particularly as respects the selling agancy. By reason of the large shareholding, the assessee-company will not only be in a position to ensure that the selling agency is not unilaterally withdrawn by M/s. Coromandel Fertilisers Ltd. but also to get favourable terms in matters of selling agency commission etc.
Viewed thus, the differential amount in question is clearly an outlay for business purposes. In coming to this conclusion, we have been guided by the Supreme Court ruling in the case of CIT v. Delhi Safe Deposit Co. Ltd. [1982] 133 ITR 756. In view of the foregoing, therefore, we delete the impugned addition of Rs. 65,65,645.
Before taking leave of this issue, we may add that in the case before us, the differential sum in question definitely conduces to the business interests of the assessee both in the short and long runs. It is significant to note that the details of the investments made by Dare House Investments Ltd. (which were filed at our instance) revealed that out of the total investments of Rs. 10.66 crores as on 31-3-1989, Rs. 10.48 crores represented the investment in 23,95,900 equity shares of Rs. 10 each of Coromandel Fertilisers Ltd. The significance of this fact, as we see it is that instead of itself acquiring such a large shareholding in Coromandel Fertilisers Ltd., the assessee had acquired the shares through its wholly owned subsidiary.
In the Mysore case, however, there was no evidence to show that the diversion by United Breweries's case (supra) of the money borrowed by it to its subsidiaries directly benefited it in any fashion.
35. During the relevant previous year, the assessee had naturally paid excise duty on the products manufactured by it in the Ceramics division. For purposes of valuing the closing stock of ceramic products, the assessee had naturally taken into account, inter alia, the excise duty attributable to such stock. Relying on the provisions of Section 43B of the Act, the assessee set up a claim that it was entitled to a deduction in a sum of Rs. 6,67,708, being the excise duty component of the value of the closing stock, subject of course to suitable adjustment being made in a sum of Rs. 80,007 being the excise duty component of the opening stock. The assessee was unsuccessful both before the Assessing Officer and the first appellate authority.
36. We find the said issue stands covered, against the assessee, by the decision of the I.T.A.T. Madras Bench 'B' in the case of Southern Asbestos Cement Ltd. v. Dy. CIT [1991] 38 ITD 449. We, therefore, decline to interfere in the matter and dismiss the related grounds.
Issue No. 4 - Interest received in advance from IDBI on Capital Gains Bond 37. During the relevant previous year, the assessee-company sold shares of SAE (India) Ltd. for a sum of Rs. 416 lakhs and invested the sale proceeds in 3 Year IDBI Capital Bonds with a view to getting the benefit of exemption under Section 54E(1) of the Act. The Bonds, it is common ground, have been notified for purposes of Section 54E(1) of the Act.
Under the 3 Year IDBI Capital Bonds Scheme, interest is payable at 9% per annum. The holder of the Bonds has two options for receiving interests: (a) Under Half-Yearly option, interest will be paid on April 1, October 1 every year the last interest payment being made for the period from April 1, October 1 to the date of maturity of the Bonds.
(b) Under the Discounted Value option, interest for the entire three year period will be discounted to the acceptance date [Please see paragraph 19(b) below) at 9% per annum and paid soon after realisation of cheque/demand draft. For every Rs. 1,000 of face value Rs. 235 will be payable as discounted interest.
The assessee, it is common ground, opted for the alternative at (b) above and received an aggregate sum of Rs. 97,76,000 as and by way of interest. It is common ground that the said aggregate amount was received during the previous year relevant to the assessment year 1989-90, which is now before us.
In its books of accounts, the assessee credited to Interest A/c a sum of Rs. 5,35,671 only, the balance Rs. 92,40,329 being taken to current liabilities. The assessee's case was that it was following mercantile system of accounting and that consequently, the aggregate sum of Rs. 92,40,329 could properly be brought to tax only in the subsequent assessment years as detailed below : The said argument did not find favour with the Assessing Officer who brought to charge the sum in the assessment for the assessment year 1989-90. The line taken by the Assessing Officer, to quote her was: "The interest on capital gains bond is payable half yearly calculated at 9% per annum for 3 years. Instead of receiving the interest on accrual basis half-yearly every year, the assessee opted to receive the present value of half-yearly interest for 3 years in the first year itself. In view of the option exercised by the assessee the interest does not accrue half yearly every year but receivable in the first year itself at a discounted value. Instead of receiving the interest on yearly basis the assessee exercised the option of receiving the interest in lumpsum in the first year itself at a reduced value. Hence either on accrual basis or on due basis or on receipt basis the present value of interest received is chargeable to tax in this year.
The C.I.T. (A) declined to interfere in the matter. In this regard, he was impelled by two considerations basically namely, first that the option exercised by the assessee under Rule 11(b) of the 3 Year IDBI Capital Bonds Scheme, was irrevocable and secondly, that by virtue of the option exercised by it, the assessee became entitled to the discounted interest immediately. To quote the C.I.T. (A) : 'This is a case where the reduced amount of interest had accrued as soon as the option under Rule 11 (b) was exercised by the appellant. Even if the appellant had not received the interest amount during the previous year after excercising 'discounted value option', the interest amount of Rs. 92,40,329 would have been includible on accrual basis.
38. Shri Ramamani, the learned counsel for the assessee, contended first that as the assessee was following mercantile system of accounting, the aggregate interest amount of Rs. 92,40,329, relating as it did to a three year period, needed to be spread over the ensuing three assessment years.
Secondly, relying on the provisions of Section 54E(2), Shri Ramamani contended that this was not a case of irreversible receipt of interest, because if the assessee failed to hold the Bonds for 3 years, it would not be entitled to the entire amount of interest.
At this juncture, the Bench made two points: First the Bonds in question are not transferable, assignable or negotiable. Therefore, it could not be argued that this was not a case of irreversible receipt of interest. Secondly, even if it is assumed that the Bondk are transferable, the position will not improve because the consequence of such transfer would be that the assessee would lose the benefit of exemption under Section 54E(1) of the Act. This was an entirely different matter.
39. Thereupon, Shri Ramamani fairly agreed with the aforesaid proposition and contended that because the assessee was following mercantile system of accounting, the assessee was entitled to the benefit of spread over. In this regard, certain extracts from "Compendium of Guidance Notes", Vol. II (Second Edition), issued by the Institute of Chartered Accountants of India, New Delhi (the extracts are available on pages 24 and 25 of the Paper Book-I filed on behalf of the assessee), were relied on.
40. On his part, Shri Bose, the learned Departmental Representative, strongly supported the impugned order of the C.I.T. (A).
41. We have looked into the facts of the case, we have considered the rival submissions.
The 3-Year IDBI Capital Bonds, which have been notified for the purposes of Section 54E(1) of the Act, provides the assessee with the protective umbrella of Section 54E(1). The Bonds in question are not transferable, assignable or negotiable. The subscriber has the option either to receive interest at the rate of 9% per annum at the stipulated half-yearly intervals, or to receive the present discounted value of the interest that is payable to him at the stipulated half-yearly intervals. In the case before us, the assessee exercised the discounted value option and received interest on that basis.
42. The question that arises for consideration is whether the aggregate sum of Rs. 92,40,329 is chargeable to tax in the assessment for the assessment year 1989-90, as it was received during the relevant previous year or whether the amount will have to be spread over the ensuing three assessment years as claimed by the assessee.
The assessee's case is that it is following mercantile system of accounting and that consequently it is entitled to the spread over. It must, at once be pointed out that mercantile system of accounting can be relevant only; to determine the point of time at which tax liability is attracted and it cannot, be relied upon to determine the range of taxable income or the ambit of taxation. In this regard, the following observations of the jurisdictional High Court in the case of CIT v.Motor Credit Co. (P.) Ltd. [1981] 127 ITR 572 (Mad.) are apposite : In the mercantile system of accounting credit entries are made in respect of amounts as soon as they became legally due and even before they are actually received and similarly the expenditure for which legal liability has been incurred, are immediately debited even before the amounts in question are actually disbursed. The point of time at which tax liability is attracted depends upon the system of accounting regularly employed by the assessee and in the case of mercantile system of accounting, liability to tax is attracted as soon as the income accrued. Regular mode of accounting only determines the mode of computing taxable income and the point of time at which the tax liability is attracted. It cannot determine or affect the range of taxable income or the ambit of taxation.
43. Under the scheme of the Income-tax Act, 1961, income-tax is imposed upon a person in respect of his total income computed in accordance with and subjected to the provisions of the Act. (Section 4). Section 5 of the Act, which deals with the scope of total income, defines the gamut of total income. And under that section, the ambit of taxation varies with the factor of residence in the previous year. The principle underlying this section is to make the chargeability of income depend upon the situs of accrual or receipt of income.
In the case of a resident, the total income of any previous year includes all income from whatever source derived which- (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arise or is deemed to accrue or arise to him in India during such year ; or In other words, a resident is chargeable to tax in respect of income accruing or arising or received, or deemed to accrue or arise or to be received in India; as also in respect of income which accrues or arises and is received outside India.
It is well-settled that the term "accrual" of income signifies the assessee's right to receive income. It is only after the right to receive a particular income arises that a person can receive it.
Conceptually speaking, therefore, receipt of income cannot precede the accrual of income. The receipt of income will normally come after the accrual of income. Of course, in some cases, both accrual and receipt of income may be simultaneous.
Once the first step of identifying the items of income that had accrued or arisen or received has been taken, there arises the need to determine the point of time at which lax liability is attracted and it is here that the system of accounting followed by the assessee is relevant. If the assessee of following mercantile system of accounting, then the point of time of accrual of income will be taken into account for purpose of computing his taxable income. If, on the contrary, cash system of accounting is followed, then the time of receipt of income would be the deciding factor.
44. In the case before us, the assessee had invested Rs. 416 lakhs in 3-Year IDBI Capital Bonds carrying interest at 9% per annum. The scheme gives the investors two options. They may either opt for receiving interest at half-yearly intervals and on the stipulated dates; or again, they may opt for receiving the present discounted value of the future payments. The scheme itself has quantified the discounted interest payable on Bond of face value of Rs. 1,000 at Rs. 235.
As we see it, by exercising the option to receive the present discounted value of the interest payable in future, the assessee has secured for itself the right to receive the discounted value here and now. This right accrued or arose during the relevant year of account.
The discounted interest was also received during the relevant previous year. It would, therefore, follow that the aggregate sum of Rs. 92,40,329 was rightly brought to charge in the hands of the assessee for the assessment year 1989-90.
As for the extracts from the Compendium (referred to supra), on which reliance has been placed by the assessee: Para 3.9 is too general to be of any use here. Para 3.10 obviously deals with debt securities issued at a discount/premium. It cannot, therefore, avail the assessee. Para 3.12 also cannot avail the assessee, because it is general in nature.
In any event, none of the extracts deal directly with the issue before us.
45. In this regard, we may usefully highlight the following observations of the House of Lords in the case of B.S.C. Footwear Ltd. (supra).
There is no doubt that the method of computing profits according to commercial accountancy practice holds some validity. But the computation must not conflict with the principles of the I.T. Act.
We have shown how under the scheme of the Act, a resident person is chargeable to tax on accrual or receipt basis, accrual connoting the right of the person to receive a particular sum. In the case before us, by exercising the option to receive discounted interest, the assessee secured for itself to receive interest here and now. Not only the said right arose during the relevant previous year; the amount of discounted interest was also received during the relevant year of account. It should, therefore, follow that the sum in question was rightly brought to charge in the assessment for the assessment year 1989-90.
46. In view of the foregoing, therefore, we decline to interfere in the matter and dismiss the related grounds.
47. During the relevant year of account, the assessee-company received a sum of Rs. 7 lakhs from Amphetronix Ltd. for termination of Selling Agreement. Though in its books of accounts, the assessee has shown the said receipt as income, yet in the course of the assessment proceedings a claim was set up to the effect that the said receipt was on capital account. The Assessing Officer negatived the assessee's claim, relying on the provisions of Section 28(ii)(c) of the Act.
48. Before us, it was contended on behalf of the appellant that the receipt in question was on capital account, particularly in view of the fact that it arose out of a termination agreement contaning restrictive covenant. To a query in this regard from the Bench, Shri Ramamani fairly conceded that the compensation occasioned by the cancellation of a selling agreement would go to fill the hole in the profits, of the assessee-company. Even so relying on the Supreme Court case of CIT v.Best & Co. (P.) Ltd. [1966] 60 ITR 11, Shri Ramamani contended that since the termination agreement contained a restrictive clause, the compensation received would have to be apportioned between capital and revenue on a reasonable basis.
49. On his part, Shri Bose, the learned Departmental Representative, relying on the Supreme Court case of CTT v. Bombay Burmah Trading Corporation [1986] 161 ITR 386 contended that this was not a case of sterilisation of rights and that consequently, the impugned orders of the lower authorities did not invite any interference on this issue.
50. We have looked into the facts of the case. We have considered the rival submissions.
On 18-4-1986, an agreement was entered into between the assessee and one Amphetronix Ltd. The said agreement was t be in force for a period of five years from April 2, 1986. The parties to he agreement expressly agreed that the basis of all transactions between the said Amphetronix Ltd. and the assessee-company shall be on Principal to Principal basis.
Under the agreement, Amphetronix Ltd. was to sell its products to the assessee-company which will sell them at prices determined from time to time by them. There is nothing in the agreement which would constitute or deemed to constitute either party as the agent of the other. The assessee-company was to retail the products. Under the agreement, the assessee-company was entitled to trade discount on the purchases made by it at 10% of the sale of the products.
The said Selling Agreement was terminated by and through an agreement dated July 20, 1987. After stating that Amphetronix Ltd. was satisfied that it would be in its commercial interest to take over the distribution and sale of the products in question, the agreement went on to state that the earlier selling agreement would stand terminated with effect from July 1, 1987. The assessee-company irrevocably and unconditionally agreed and undertook that upto June 30, 1990, it would not accept or engage itself in any selling agreement/arrangement of any products of any other Indian manufacturer which are similar to or which compete with the products of Amphetronix. For the termination of the agreement, the assessee-company was to receive an aggregate sum of Rs. 20 lakhs as detailed below : 51. Now, the Selling Agreement in question was entered into by the assessee in the ordinary course of its business. As pointed out earlier, the transactions under the agreement, it was the intention of the parties to the agreement, were to be conducted on Principal to Principal basis. Under the agreement, Amphetronix Ltd. was to sell its products to the assessee-company on wholesale basis, the assessee-company being free to retail them at the prices to be fixed by the assessee-company. The agreement in question thus is one that was entered into by the assessee in the normal course of its business. It is a matter of record that the assessee has entered into similar selling agreements with other parties also. Thus, as we saw earlier, it entered into a selling agreement with Coromandel Fertilisers Ltd. What is more, that selling activity formed a minor part of the entire business of the assessee. Therefore, when the Selling Agreement was terminated, it was not as though the trading structure of the assessee's business was affected thus paralysing the very source of its income. After the termination of the selling agency, the assessee was free to carry on and did in fact carry on, its other manufacturing and business activities. Since the trading structure of the assessee-company was not in any way impaired, it should be held that the compensation received by the assessee-company from Arnphetronix Ltd. just went to fill the hole in the profits of the assessee. Thus viewed, the receipt was very much on revenue account.
52. But it is contended by Shri Ramamani that the termination agreement contained a restrictive covenant and that consequently, the compensation received or receivable by the assessee must be apportioned between capital and revenue. In this regard, reliance is placed on the Supreme Court case of Best & Co. (P.) Ltd. (supra).
53. As we see it, the Supreme Court case of Best & Co. (P.) Ltd. (supra) cannot avail the assessee. The distinguishing feature of the case before the Supreme Court was that the transaction between the assessee therein and Imperial Chemical Industries (Exports) Ltd., Glasgow was one that was entered into at arms length. In the case before us, however, Amphetronix Ltd., it is matter of record, is a subsidiary of the assessee-company. This being the case, simply because a restrictive clause is included in the termination agreement, it cannot follow that part of the compensation received by the assessee was on capital account. For a fact, considering the fact that the assessee is a Holding Company holding more than 50% of the shares of Arnphetronix Ltd., the question of the assessee-company retailing the products of other competitors just does not arise.
For the same reason the Madras case of CIT v. Saraswathi Publicities [1981] 132 ITR 207 cannot avail the assessee. In the Madras case also, the transactions were at arms length. What was more, there, the business involved was the business of distribution and exhibition of advertisement films - a field, by its very nature competition-ridden.
54. In view of the foregoing, therefore, we decline to interfere in the matter and dismiss the related ground.
55. In the course of the assessment proceedings the assessee set up a claim to the effect that an aggregate expenditure of Rs. 1,90,709 under the head 'Repairs & Maintenance expenditure' and 'Depreciation' on guest house should be allowed. Reliance in this regard was placed on the Bombay case of CITv. Chase Bright Steels Ltd. (No. 1) [1989] 177 ITR 124 in which it had been held that items of expenditure allowable under Sections 30 and 31 of the Act cannot be brought within the pale of Section 37(3) of the Act. The Assessing Officer rejected the assessee's claim. The C.I.T. (A) declined to interfere in the matter.
Even though depreciation is allowed under Section 32 and not under Section 37(1) of the Act, we have, as rightly pointed out by the learned Departmental Representative, Section 37(4)(ii) which in terms lays down that no depreciation allowance will be allowed on any building used as guest house/any assets in a guest house in relation to the assessment year 1971-72 and onwards. We, therefore, decline to interfere in the matter in so far as it relates to depreciation on guest house.
57. As regards the sum of Rs. 1,30,024, the basis on which the said amount came to be computed was not readily available during the hearing. For a fact, the details of guest house expenses filed by the assessee at our instance do not also show how the said sum of Rs. 1,30,024 came to be worked out. In the circumstances, therefore, we remit this aspect of the matter to the Assessing Officer for fresh consideration and decision. We further direct the Assessing Officer to exclude from the pale of Section 37(3) items of expenditure which are allowed not under Section 37(0 but under other sections.