1. This is a departmental appeal. The assessee is a limited company and derives income from vegetable oil, soap, etc.
In the facts and circumstances of the case the learned Commissioner (Appeals), Central-II, Calcutta, erred both in law and facts in deleting the addition of Rs. 7,39,528 in respect of addition towards export of machinery to P.T. Kusum Products, Indonesia and failed to appreciate the legal issue involved in Section 92 of the Income-tax Act, 1961 and as such the addition of Rs. 7,39,528 should be restored.
3. The assessee entered into an agreement on 13-3-1975 with Peter, Cremer, a company of West Germany, to establish a limited company in Indonesia. The name of the limited company which was to be floated in Indonesia was P.T. Kusum Products Ltd., Indonesia. The authorised and issued capital of the new company was U.S. $ 10,00,000 divided into 10,000 shares of $ 100 each. The assessee-company was to contribute 50 per cent of the capital of the new company. The RBI vide its letter dated 28-7-1975 permitted the assessee to contribute U.S. $ 5 lakhs by way of export of new and indigenous items of plants and machinery. The assessee was not allowed to contribute in money. The proposal to set up a joint venture unit in Indonesia was also approved by the Ministry of Commerce, Government of India, vide its letter dated 6-8-1976. The assessee-company accordingly, purchased machinery and equipment for Rs. 57,74,174 which were sold to the new company of Indonesia on F.O.B.value at Rs. 44,71,710 and earned freight in foreign currency at Rs. 5,62,935. Thus, the total sale to the assessee for machinery and equipment, exported to the new company in Indonesia, amounted to Rs. 50,34,645. The ITO invoked Section 92 of the Income-tax Act, 1961 and found that the profit earned on this transaction was not normal. He found that there was a recovery of Rs. 7,39,429. When the assessee was confronted with this position, the assessee urged that it earned the export incentive of Rs. 7,91,331 and thus, the assessee earned the surplus of Rs. 57,801. The ITO was not satisfied with the explanation of the assessee and stated that the export incentive earned by the assessee should not be taken up to cover up the profit on the transaction and he, therefore, added Rs. 7,39,528.
4. The assessee came in appeal and contended that the export of plant and machinery to the new company in Indonesia should not be viewed in isolation. The assessee was participating in the formation of the said concern and the collaboration agreement incorporated that the plant and machinery has to be exported in lieu of cash contribution to the share capital of the new company. It was also urged that all the terms of such scheme was known and approved by the Government of India and, hence, it cannot be said that the appellant has arranged the matter in such a way as to have nil or very little profit out of the transaction in question. The price of the plant and machinery in the international market was much less and as a matter of fact this was also pointed out by the other parties of the collaboration agreement. The letters written to the Indonesian company from the other collaborators pointing out that the price charged by the appellant for the plant and machinery was much higher than when considered with other international prices were also produced. The Commissioner (Appeals) was impressed with the above arguments of the assessee and he deleted the addition. While doing so, he observed as under in paragraph 13 of his order : 13. I have considered the arguments of the authorised representative and the details produced by him. I find that there is considerable force in his argument. The export of plant and machinery to this particular non-resident company was due to the fact that the Government of India had wanted that such machineries should be exported in lieu of cash contribution towards the share capital of the newly floated non-resident company. It is also seen that the Government of India was aware that such transaction would result in loss to the appellant-company and, accordingly, had allowed export subsidy and duty drawback which the ITO had completely ignored.
Considering all the circumstances I would hold that the addition of Rs. 7,39,528 cannot be upheld. This is, therefore, deleted.
5. Shri R.N. Bajoria, the senior departmental representative, referred to the order of the ITO as well as the Commissioner on this issue and Section 92 and urged that there was a loss on the transaction and the ITO has rightly invoked Section 92. The Commissioner (Appeals) was not justified in deleting the addition after considering the export incentives. Shri R.N. Bajoria relied in Mazagaon Dock Ltd. v. CIT/EPT  34 ITR 368 (SC).
6. Shri R.R. Bajoria, the counsel of the assessee, on the other hand, referred to Section 92 and urged that Section 92 is not applicable in the present case at all. The assessee was not dealing in plant and machinery. The assessee's business was a different one. The assessee was establishing a new company in Indonesia with others. The assessee was to contribute its capital of US $ 5 lakhs. The RBI did not permit the assessee to contribute in cash. The assessee was only permitted to export plant and machinery and equipment. Therefore, the plant and machinery and equipment were exported to Indonesia as capital of the assessee and not as a trader. Shri R.R. Bajoria further referring to the paper book urged that this fact is clear from the agreement dated 13-3-1975 and the letters issued by the RBI and the Ministry of Commerce, Government of India, by which they approved the scheme. The ITO was not justified in ignoring the export incentive which was directly related to the export of plant and machinery to the new company. The assessee-company would not have got the incentive of Rs. 7,91,331 unless it would have exported the plant and machinery to Indonesia. Therefore, if the export incentive is taken, the assessee earned Rs. 51,801 on this transaction. Accordingly, it was urged that the order of the Commissioner (Appeals) should be maintained.
7. Section 92 and Articles (3) and (4) with point Nos. 3.01,3.02,4.01, 4.02 and 4.03 are incorporated for considering the matter in issue : Section 92. Where a business is carried on between a resident and a non-resident and it appears to the Income-tax Officer that, owing to the close connection between them, the course of business is so arranged that the business transacted between them produces to the resident either no profits or less than the ordinary profits which might be expected to arise in that business, the Income-tax Officer shall determine the amount of profits which may reasonably be deemed to have been derived therefrom and include such amount in the total income of the resident.
3.01 The authorised and issued capital of the new company shall be US $ 10,00,000-divided into 10,000 shares of US $ 100 each.
3.02 The shares to be issued by the new company shall be registered equity shares.
4.01 The parties hereto shall subscribe and pay for, at par, the shares to be issued by the new company in the following ratio :(a) 'KPL' 50 per cent 4.02 On incorporation, 2,000 shares of US $ 100 each will be subscribed by the promoters on which 10 per cent shall be paid up initially. The promoters shall arrange for the subscription of the remaining capital of the company and the amount to be called up on the shares shall be determined by the promoters as and when required for the purpose of the company. The authorised capital of US $ 10,00,000-shall be fully paid up in accordance with the decisions of the Board of Commissioners but within two years from the date of incorporation of the company. Provided the capital has not been paid up as per decisions of the Board of Commissioners, an interest rate of two per cent (2%) per month will be charged by the company until the respective amount has been fully received. This interest will be applicable if payment is delayed beyond 21 days of call.
4.03 The payment for the shares subscribed and paid up shall be made either in cash or in kind as may be agreed by the promoters. The amount of shares money payable by KPL shall be exclusively in the form of machinery and plant and equipment coming in from India and for any other expenditure in connection therewith, for which KPL will submit proof.
Clause (v) of the letter of the RBI dated 28-7-1975 is also incorporated below : (v) Your contribution of US $ 5,00,000, i.e., approximate Rs. 37.50 lakhs towards equity share capital shall be by way of export of new and indigenous items of plant and machinery out of the list enclosed herewith ; 8. The facts of the case are that the assessee along with Peter Cremer of West Germany established a new limited company, P.T. Kusum Products in Indonesia. The authorised capital of the company was US $ 10,00,000.
There were three promoters-the assessee, the West German company and Teknik Umun P.T. of Indonesia. The share capital of the new company was US $ 10,00,000. The assessee-company, the West German company and the Indonesian company were to share 50 per cent, 30 per cent and 20 per cent, respectively, of the share capital. The assessee-company was, thus, to subscribe US $ 5,00,000 towards the capital of the new company which was going to be established in Indonesia. The RBI did not allow the assessee-company to drain out foreign exchange and vide its letter dated 28-7-1975, directed the assessee-company to invest the required capital by export of plant and machinery and equipment. This was also approved by the Ministry of Commerce, Government of India. Pursuant to the agreement dated 13-3-1975 and the approval of the RBI, the Ministry of Commerce, Government of India, the assessee participated in the new company by contributing its capital by way of exporting plant and machinery and equipment. The assessee was entitled for export incentive and moreover the prices of plant and machinery, it was reported, which were to be exported towards the capital of the assessee, quoted by the assessee, were high. The assessee took into consideration the export incentive which it was to get on the export of the plant and machinery and, accordingly, though the machineries were purchased for Rs. 57,74,174, it charged Rs 50.34,645 from the new company including freight. However, the assessee further received the export incentive of Rs. 7,91,331. Thus, the assessee contributed towards its capital in kind. The purpose of exporting machine to the new company in Indonesia was not to earn any profit and/or loss on the transaction. The only purpose of exporting the machinery was to contribute towards the capital as per agreement and as per the approval of the RBI, the Ministry of Commerce, Government of India.
9. The assessee earned the surplus of Rs. 51,801 on this transaction if the export incentive of Rs. 7,91,331 was added towards the sale proceeds of plant and machinery and equipment to the new company. The ITO invoked the provisions of Section 92. It would be relevant to consider whether on the facts and in the circumstances of the case, the ITO was justified to invoke Section 92. The section had been quoted above. The section is applicable where it is found by the ITO that in a business deal between a resident and a non-resident due to the close connection between the parties, the business is so arranged that the business did not result in any profit or less profit than the ordinary profit which might have been earned in the regular course of business and if so, the ITO will estimate the fair profit. If the ingredients of the above section are characterised, the following points may emerge : (iv) The profit earned by the assessee may not be fair due to the close relation.
So far as the first point is concerned, it was a transaction between a resident and a non-resident. But other ingredients of the section are not applicable on the facts of the case. There was no business transaction between the assessee and the non-resident company. The assessee did not export machines as a seller to a buyer. The assessee had contributed its share of capital in kind as permitted by the RBI and the Ministry of Commerce, Government of India. The question of profit and/or loss may not arise when one is contributing towards his capital. If it was not a business transaction with a motive to profit, the ITO was not competent, in such a situation, to consider whether there was a profit or the profit earned by the assessee was fair or not. The contribution of capital, in no circumstances, will result in profit. The ITO has not come to the conclusion that the transaction was underestimated or overestimated. The ITO has accepted that the assessee exported plant and machinery and equipment towards its capital participation in the capital of the new company. Therefore, the provisions of Section 92 were not correctly invoked by the ITO. Under the above circumstances, if the facts of the case along with the provisions of Section 92 are read, it is clear that the ITO was not justified in adding the additional income of Rs. 7,39,528 under Section 92. The Commissioner (Appeals) was, therefore, justified in deleting the same.