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Expenses incurred on royalty paid for use of technical know-how indispensable for carrying on business operations, qualify as revenue in nature: ITAT

2019-TIOL-1452-ITAT-DEL

IN THE INCOME TAX APPELLATE TRIBUNAL
BENCH ‘E’ NEW DELHI

ITA No.314/Del/2015
Assessment Year: 2009-10

M/s MAHLE FILTER SYSTEMS PVT LTD
1, SRI AUROBINDO MARG, NEW DELHI
PAN NO: AAACP5890Q

Vs

ADDITIONAL COMMISSIONER OF INCOME TAX
RANGE-6, CIRCLE 6(1), NEW DELHI

ITA No.6679/Del/2014
Assessment Year: 2009-10

DEPUTY COMMISSIONER OF INCOME TAX
CIRCLE – 6(1), NEW DELHI

Vs

M/s MAHLE FILTER SYSTEMS PVT LTD
1, SRI AUROBINDO MARG, NEW DELHI
PAN NO: AAACP5890Q

N K Billaiya, AM & Suchitra Kamble, JM

Date of Hearing: July 01, 2019
Date of Decision: July 04, 2019

Appellant Rep by: Shri Ajay Vohra, Sr. Adv. & Shri Anshul Sachar, Adv. & Shri Karan Jain, CA
Respondent Rep by: 
Ms Rinku Singh, Sr. DR

Income Tax – Sections 14A, 24, 37(1), 80IC

Keywords – Fringe Benefit – Income from house property – Leave & licence agreement – Rental income – Royalty payment

THE assessee incurred some expenses in the form of gift expenses paid to employees and declared income from rentals receipts by leasing out its factory premises. During the course of scrutiny assessment, the AO was of the opinion that the payment of gift cannot be said to be incurred wholly and exclusively for the purpose of business as per section 37(1). The AO found that the assessee had disclosed 50% as Fringe Benefit and accordingly, disallowed the balance 50% of the expenditure. The AO also taxed the rental receipts in income from other sources rather than income from house property. The assessee carried the matter before the CIT(A) but without any success.

Further, for the same relevant AY, the assessee as the transferor company amalgamated with one M/s Purolator India Ltd. being the transferee company. The scheme of amalgamation was approved by the Delhi High Court. The assessee had a manufacturing unit which was eligible for deduction u/s 80IC. After, the amalgamation, Subsequently, the name of assessee was changed to M/s Mahle Filter Systems [India] Ltd. For the relevant AY, the assessee claimed benefit u/s 80IC for such unit. The AO, however, considering the whole scheme as sham and colorable device to evade tax liability, disallowed the deduction. The CIT(A) deleted the disallowance.

On hearing the appeal, the Tribunal held that,

Whether the fact that rental income is accrued because of leave & licence agreement or lease agreement has any bearing in changing the colour of receipts in assessee’s hands from income from house property to income from other sources – NO: ITAT

++ on the issue of rental receipts taken as income from other sources, the factory building owned by the assessee was let out to one M/s Anand Engines Component Ltd., for which the assessee earned rental income. Whether there existed ‘leave and licence’ agreement and not ‘rental agreement‘ would not change the colour of receipts in the hands of the assessee. The undeniable fact is that the assessee has earned rental income from letting out its property and the same has to be taxed under the head ‘income from house property’ eligible for deduction as per the provisions of section 24. The AO to tax rental income under the head ‘income from house property’ as per provisions of law;

Whether once 50% of the tax liability is discharged upon gift & fringe benefit distributed to the employees, the AO cannot bring in to tax the rest of 50% of the balance expenditure – YES: ITAT

++ on the issue of disallowance of expenses distributed by the assessee to its employees, the AO has himself accepted 50% of the gift as eligible expenditure. Therefore, no reason to disallow balance 50%. Moreover, there is no dispute that the assessee has paid FBT @ 50%. It is a settled position of law that no disallowance can be made once expenses are exigble to FBT. Thus, the AO to delete the addition;

Whether the AO is vested with the power to brand a scheme of amalgamation approved by the jurisdictional high court as sham and colorable device to escape tax liabilities – NO: ITAT

++ on the issue of deletion of disallowance u/s 80IC, the Scheme of Amalgamation has been approved by the High Court of Delhi, by no stretch of imagination can be considered as a colorable device or a sham transaction. Provisions of section 80IA(12) is wrongly applied by the AO because it is applicable where any undertaking which is entitled to the deduction u/s 80IA is transferred before expiry of the period specified to another Indian company in a scheme of amalgamation or demerger. Whereas in the present case, the manufacturing unit continued to belong to the assessee and it is only M/s Mahle Filter systems [India] Ltd which amalgamated with the assessee M/s Purolator India Ltd and only the name has been changed to M/s Mahle Filter systems [India] Ltd. Accordingly, even consequent to the amalgamation, the unit was still owned and managed by the assessee in the same manner as it was managed prior to amalgamation. Considering the correct facts in true perspective, the revenue stand is dismissed;

Whether expenses incurred for making royalty payments for use of technical know-how which is indispensable with carrying on the day to day operations of business is revenue expenditure and does not merits disallowance as capital expenditure – YES: ITAT

++ on the issue of deletion of disallowance on account of royalty payments by the CIT(A), the payment of royalty in terms of agreement was for use of technical know-how and technical assistance, which was necessary to carry on and run the business from day to day. The CIT(A) was of the opinion that such expenditure is related to carry on business and is for efficient running of business for better profitability. Therefore, such expenditure is clearly allowable as revenue expenditure. Hence, the appeal of the Department stands dismissed.

Assessee’s appeal allowed/Revenue’s appeal disallowed

Cases followed:

Joint Investment Pvt Ltd. vs CIT – 2015-TIOL-574-HC-DEL-IT

Joint Investment Pvt. Ltd. vs CIT  2015-TIOL-295-HC-DEL-IT

Hero Motocorp in ITA No. 5130/DEL/2012 = 2012-TIOL-529-ITAT-DEL

BG Shirke Construction Technology [P] Ltd Vs. CIT – ITA No. 1430/PROVISIONS/2010, July 17, 2012

Case distinguished:

J.K. Synthetics Ltd – 2008-TIOL-671-HC-DEL-IT

ORDER

Per: N K Billaiya:

The above two captioned cross appeals by the assessee and revenue are preferred against the order of the Commissioner of Income Tax [Appeals] – IX, New Delhi dated 29.09.2014 pertaining to assessment year 2009-10. Since both these appeals were heard together and involve common issues, these are being disposed of by this common order for the sake of convenience and brevity.

ITA No. 314/DEL/2015 [Assessee’s Appeal]

2. Ground No. 1 relates to the disallowance of Rs. 88,577/- made u/s 14A of the Income-tax Act, 1961 [hereinafter referred to as ‘the Act’] read with Rule 8D of the Income tax Rules, 1962 [hereinafter referred to as ‘the Rules’].

2. At the very outset, the ld. AR stated that as per the ratio laid down by the Hon’ble Delhi High Court in 372 ITR 694 = 2015-TIOL-574-HC-DEL-IT, total disallowance u/s 14A of the Act cannot be more than the exempt income.

3. We find force in the contention of the ld. AR. Without going into the merits of the disallowance, we find that the assessee has disclosed exempt dividend income of Rs. 20,995/- u/s 10(33) of the Act. In the light of the decision of the Hon’ble Delhi High Court [supra], we direct the Assessing Officer to restrict the disallowance to the extent of exempt income of Rs. 20,995/-. Ground No. 1, with all its sub-grounds is partly allowed.

4. Ground No. 2 relates to the disallowance of expenses distributed by the assessee to its employees amounting to Rs. 1,57,074/-.

5. During the course of scrutiny assessment proceedings, the Assessing Officer noticed that the assessee has debited Rs. 3,14,148/- as gift. The Assessing Officer was of the opinion that the payment of gift cannot be said to be incurred wholly and exclusively for the purpose of business as per the provisions of section 37(1) of the Act. The Assessing Officer found that the assessee has disclosed 50% as Fringe Benefit and accordingly, disallowed the balance 50% of the expenditure.

6. The assessee carried the matter before the CIT(A) but without any success.

7. Before us, the ld. AR vehemently contended that since the assessee has paid Fringe Benefit Tax [FBT], therefore, expenditure cannot be disallowed. It is the say of the ld. AR that once a FBT has been paid, no disallowance can be made.

8. On the other hand, the ld. DR strongly supported the findings of the AO.

9. We have given a thoughtful consideration to the orders of the authorities below. The Assessing Officer, at para 11.1 of his order, has himself accepted that 50% of the gift as eligible expenditure and, therefore, we fail to understand why balance 50% has been disallowed. Moreover, there is no dispute that the assessee has paid FBT @ 50%. Now it is a settled position of law that no disallowance can be made once expenses are exigble to FBT. Our view is supported by the decision of the co-ordinate bench in the case of BG Shirke Construction Technology [P] Ltd Vs. CIT ITA No. 1430/PROVISIONS/2010 vide order dated 17/07/2012 wherein it has been held as under:

“As the CBDT explaining the provisions regarding the FBT makes it clear that FBT is levied on the expenses incurred by the employer irrespective of whether the same are incurred for official or personal purposes. Once FBT is levied on such expense it follow that the same are treated as fringe benefits treated by the assessee as employer to its employees and the same have to be properly allowed as expenses incurred wholly and exclusively for the purpose of business. Following the decision in the case of Hansraj Mathuradas (2012 (10) TMI 300, ITAT, Mumbai direct the AO delete the disallowance. Issues decides in favour of assessee.”

10. Respectfully following the same, we direct the Assessing Officer to delete the addition of Rs. 1,57,074/-.

11. Ground No. 3 relates to the treatment of ‘rental income’ as ‘income from other sources’.

12. While scrutinising the Return of Income, the Assessing Officer noticed that the assessee has disclosed rental receipts from its factory building at Gurgaon amounting to Rs. 47,26,510/- and after deducting 30% as per provisions of section 24 of the Act, income from house property has been disclosed at Rs. 33,08,557/-. The Assessing Officer found that the assessee has entered into a ‘Leave and License’ Agreement and not ‘Lease Rental’ Agreement. According to the Assessing Officer, ‘Lease Rental Agreement’ is different from ‘Leave and License Agreement’ and therefore, rental income received by the assessee cannot be treated as income from house property. Accordingly, the Assessing Officer taxed the entire receipts as income from other sources.

13. Aggrieved, the assessee carried the matter before the CIT(A), but without any success.

14. Before us, the ld. AR stated that by letting out its factory building at Gurgaon, the assessee has received rental income and the same has to be taxed under the head ‘income from house property’ eligible for deduction @ 30%.

15. On the other hand, the ld. DR supported the findings of the Assessing Officer and reiterated that ‘leave and licence agreement’ is not similar to ‘lease rental agreement’.

16. We have given a thoughtful consideration to the orders of the authorities below. There is no dispute that the factory building owned by the assessee was let out to M/s Anand Engines Component Ltd., for which the assessee earned rental income of Rs. 47.26 lakhs. Whether there existed ‘leave and licence’ agreement and not ‘rental agreement’ would not change the colour of receipts in the hands of the assessee. The undeniable fact is that the assessee has earned rental income from letting out its property and the same has to be taxed under the head ‘income from house property’ eligible for deduction as per the provisions of section 24 of the Act. We, accordingly, direct the Assessing Officer to tax rental income under the head ‘income from house property’ as per provisions of law. Ground No. 3 is, accordingly, allowed.

17. Ground No. 4 relates to MAT credit claimed amounting to Rs. 72,30,482/-.

18. We are of the considered opinion that MAT credit has to be allowed to the assessee as per the provisions of law and after considering the provisions and the assessment history of the assessee. We, accordingly, direct the Assessing Officer to allow MAT credit as per provisions of law after considering the provisions and the assessment history of the assessee. Ground No. 4 is allowed for statistical purposes.

19. As a result, the appeal filed by the assessee is partly allowed for statistical purposes.

ITA No. 6679/DEL/2014 [Revenue’s appeal]

20. Representatives of both the sides were heard at length, the case records carefully perused and with the assistance of the ld. Counsel, we have considered the documentary evidences brought on record in the form of Paper Book in light of Rule 18(6) of ITAT Rules. Judicial decisions relied upon were carefully perused.

21. First ground raised by the assessee relates to the deletion of disallowance of Rs. 2.96 crores u/s 80IC of the Act.

22. Elements of Ground No. 1 and Ground No. 4 have the same issue.

23. We are of the considered opinion that the Assessing Officer has not appreciated the underlying facts in issue in true perspective. Correct facts are that the manufacturing unit at Parwanoo, Himachal Pradesh was eligible for deduction u/s 80IC of the Act. The said undertaking belongs to M/s Purolotor India Ltd. The Assessing Officer proceeded by wrong assumption of facts that M/s Purolator India Ltd got amalgamated with M/s Mahle Filter Systems [India] Ltd whereas the fact of the matter is that Mahle Filter systems [India] Ltd was the transferor company and amalgamated with M/s Purolator India Ltd which was the transferee company by order of the Hon’ble High Court of Delhi in the matter of Scheme of Amalgamation of Company Petition No. 53/2008 connected with Company Application No. 172/2007. Subsequently, the name of M/s Purolator India Ltd was changed to M/s Mahle Filter Systems [India] Ltd.

24. According to the ld. DR, this is nothing but a sham transaction to take the benefit of section 80IC of the Act. We do not find any force in this contention of the ld. DR. The Scheme of Amalgamation has been approved by the Hon’ble High Court of Delhi and, therefore, by no stretch of imagination, the transaction of amalgamation can be considered as a colourable device or a sham transaction. There is no dispute that the manufacturing unit at Parwanoo was eligible for deduction u/s 80IC of the Act the same always belonged to the assessee, previously known as M/s Purolator India Ltd.

25. Provisions of section 80IA(12) of the Act have been wrongly applied by the Assessing Officer because the said provision is applicable where any undertaking which is entitled to the deduction u/s 80IA is transferred before expiry of the period specified therein to another India company in a scheme of amalgamation or demerger, whereas the facts of the case in hand show that the manufacturing unit at Parwanoo, HP continued to belong to the assessee and it is only M/s Mahle Filter systems [India] Ltd which amalgamated with the assessee M/s Purolator India Ltd and only the name has been changed to M/s Mahle Filter systems [India] Ltd. Accordingly, even consequent to the amalgamation, the unit at Parwanoo was still owned and managed by the assessee in the same manner as it was managed prior to amalgamation. Considering the correct facts in true perspective, we do not find any error or infirmity in the findings of the CIT(A). Ground Nos. 1 and 4 raised by the revenue stand dismissed.

26. Ground No. 2 relates to the deletion of disallowance of Rs. 64,23,771/- for the purpose of calculating deduction u/s 80IC of the Act.

27. During the course of scrutiny assessment proceedings, on perusal of the profit and loss account of the Purwanoo Unit, the Assessing Officer observed that the assessee has disclosed ‘Other Income’ of Rs. 64,23,771/- which consisted of rent receipts, interest receipts, scraps as well as discount received and foreign exchange gain. The Assessing Officer was of the firm belief that the expression ‘derived from’ in the language of section 80IC of the Act shows that the income must directly result from the eligible business and hence it should have a direct nexus with the eligible business. The Assessing Officer, accordingly, disallowed the claim of deduction u/s 80IC of the Act.

28. The assessee carried the matter before the CIT(A) and furnished the details of ‘Other income’ which read as under:

Interest on loans given to employeesRs. 1,78,000
Foreign exchange gainRs.19,94,070
Cash discount given to buyersRs. 21,09,398
Tooling incomeRs. 7,30,233
Sale of scarpRs. 7,56,631
Rental incomeRs. 6,10,800
Rent recovery from employees against rent expensesRs. 2,97,447
Other Income – Common Income Allocation(Rs. 2,50,689)
Interest received on fixed deposits – Common Income Allocation (netted off in Interest expenses)(Rs. 2,119)
TotalRs. 64,23,771

29. Out of the above, rental income and income on fixed deposits was offered to tax under the head ‘Income from other sources’. Other items of income are inevitably linked and have direct nexus to the industrial undertaking. Therefore, these incomes are eligible for benefit of deduction u/s 80IC of the Act. We, therefore, do not find any reason to interfere with the findings of the CIT(A). Ground No.2 is dismissed.

30. Ground No. 3 relates to the enhancement of deduction claimed u/s 80IC from Rs. 2,64,42,825/- to Rs. 2,96,26,413/-.

31. During the year under consideration, the assessee has transferred stock amounting to Rs. 25.55 crores at final selling price to the Head Office from where the goods were sold to retail customers. The cost incurred by the Head Office in the undertaking such sales were allocated to the Parwanoo unit. While scrutinising the return of income, the Assessing Officer was of the firm belief that the assessee has shifted the profit of the head office to the Parwanoo unit. Since the head office may have incurred such expenses in selling such goods, the Assessing Officer was of the opinion that the stock transfer price is required to be recomputed to derive correct profit from the undertaking as per provisions of section 80IC(7) r.w.s 80IA(10) of the Act. Accordingly, the Assessing Officer recomputed the profit derived from the Parwanoo unit at Rs. 8 crores and recomputed the deduction u/s 80IC of the Act.

32. Before the CIT(A), the assessee strongly contended that the finding of the Assessing Officer regarding net profit earned by the head office is on the basis of assumption that sale is accounted in the head office. It was explained that the head office is only facilitating the sales for respective units. It was further explained that he expenses incurred in the head office are allocated to three units based on their ratio of sale. The assessee also filed comparative analysis.

33. After considering the facts, detailed submissions and accounts, the CIT(A) was convinced that the Head office has allocated the expenses and, therefore, no addition is called for and deleted the disallowance made by the Assessing Officer.

34. The ld. DR repeated the finding of the Assessing Officer.

35. Per contra, ld. AR reiterated what has been stated before the lower authorities.

36. The allocation of expenditure can be understood from the following chart:

Mahle Filter Systems (India) Limited Certification under section 80-IC

Assessment Year 2009-2010

Mahle Filter Systems (India) Limited Certification under section 80-IC Assessment Year 2009-2010

Purolator India Limited Certification under section 80-1C Assessment Year 2009-2010

37. The above extracted charts are part of the annual audited accounts of the assessee. It can be seen from the above chart that the head office has allocated the expenditure to three units based on their ratio of sale. Therefore, the findings of the Assessing Officer are ill-founded. We, accordingly decline to interfere with the findings of the CIT(A). Accordingly, Ground No. 3 stands dismissed.

38. Ground No. 5 relates to the deletion of disallowance of Rs. 33,27,126/- on account of royalty payments.

39. The Assessing Officer noticed that the assessee has claimed royalty payment of Rs. 33,27,126/- to the following two persons of the Mahle Group:

Mahle Filter Systems GmbH, GermanyRs. 24,72,485/-
Mahle Filter Systems Japan CorporationRs. 7,61,586/-

The Assessing Officer was of the opinion that the above payments were clearly in the nature of capital expenditure as the assessee is deriving enduring benefits. The Assessing Officer proceeded by considering the relevant clauses of the agreement which are extracted at pages 33 to 35 of the assessment order. Drawing strong support from the decision of the Hon’ble High Court of Delhi in the case of J.K. Synthetics Ltd 309 ITR 371 = 2008-TIOL-671-HC-DEL-IT, the Assessing Officer concluded by holding that the entire royalty payments of Rs. 32,34,071 is capital in nature and not allowable as a revenue expenditure. The Assessing Officer capitalised the same and allowed depreciation @ 25% as intangible assets.

40. The assessee strongly agitated the matter before the CIT(A) and explained that it is engaged in the business of manufacturing and trading of automotive and industrial filters where technology is constantly changing and evolving and for which it entered into Technical Assistance Agreement with Mahle Filter Systems GmbH and Mahle Tennex Corp, Japan for obtaining know-how to manufacture automotive and industrial accessories, for which it paid royalty of Rs. 32,34,071/-. It was explained that pursuant to such agreement, the assessee only acquired limited rights to use the information for the purpose of production of the products in India. It was brought to the Notice of the CIT(A) that grant of license is non transferable and without the right to sublicense. Since the payment of royalty in terms of the agreement was for mere use of the technical know-how, and day to day technical assistance not resulting in any enduring benefit in capital field or acquisition or creation of capital asset, the same was consistently treated as revenue expenditure.

41. After considering the facts and detailed submissions of the assessee and after drawing support from various judicial decisions discussed by the CIT(A) in his appellate order, the CIT(A) was convinced that the payment of royalty in terms of agreement was for use of technical know-how and technical assistance, which was necessary to carry on and run the business from day to day. The CIT(A) was of the opinion that such expenditure is related to carry on business and is for efficient running of business for better profitability. Therefore, the same is clearly allowable as revenue expenditure.

42. Before us, the ld. DR read the relevant operative part of the assessment order.

43. On the other hand, the ld. AR reiterated what has been stated before the lower authorities.

44. We have given a thoughtful consideration to the orders of the authorities below. The undisputed fact is that by virtue of agreement with its AEs, the assessee has only acquired limited rights to use the information for the purpose of production of products in India. There is also no dispute that the assessee merely acquired a right to use technical information provided by the owners of the technical knowhow. The ownership/proprietary rights in the technical know-how continue to vest in lithe censor and the assessee is not authorised to transfer, assign or convey the know how/technical information to any third party and therefore, the assessee acquired a limited right to use and exploit the know-how. In our considered opinion, payment of royalty was for mere use of technical know-how, not resulting in any enduring benefit in the capital field, the same has to be allowed as revenue expenditure.

45. Similar view was considered by the Tribunal in the case of Hero Motocorp in ITA No. 5130/DEL/2012 = 2012-TIOL-529-ITAT-DEL. The relevant findings read as under:

“In the case of the assessee also, the collaboration agreement was for grant of technical assistance for setting up of the factory and also for the manufacture and sale of the product. But the assessee made separate payment for the technical assistance for setting up of the factory which was $5,00,000. This sum was treated as capital expenditure by the assessee itself. The annual payment for the royalty was based upon the percentage of sale of the motorcycles. Thus, the facts in the case of the assessee are distinguishable than the facts before the Hon’ble Apex Court. On the other hand, the facts of the assessee’s case are identical to the facts before the Hon’ble Jurisdictional High Court in the case of Climate Systems India Ltd. (supra) and Sharda Motor Industrial Ltd. (supra) and also the decision of ITAT in assessee’s own case cited supra. We, therefore, respectfully following the above decisions of Hon’ble Jurisdictional High Court, hold that the annual payment of royalty was a revenue expenditure. Accordingly, ground No.6 of the assessee’s appeal is allowed.”

46. This decision of the co-ordinate bench has been upheld by the Hon’ble High Court of Delhi in 372 ITR 481 2015-TIOL-295-HC-DEL-IT wherein the Hon’ble High Court has, in detail, considered the decision given in the case of J.K. Synthetics [supra]. Considering the facts of the case in totality, we do not find any reason to interfere with the findings of the CIT(A). However, depreciation allowed by the Assessing Officer has to be withdrawn since the impugned payment is being allowed as revenue expenditure. Ground No. 5 of the revenue stands dismissed.

47. In the result, the appeal of the assessee in ITA No. 314/DEL/2015 is partly allowed for statistical purposes and that of the Revenue in ITA No. 6679/DEL/2014 is dismissed.

(The order is pronounced in the open court on 04.07.2019)

(Paras are numbered as per the original text: Editor)

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