1. We find it convenient to dispose of three appeals together. The assessee has come on appeal for the assessment year 1978-79. Both the assessee and the department are on appeal for the assessment year 1979-80. The assessee is a public limited company. It is a subsidiary of Pressure Cookers & Appliances Ltd. The accounting year in respect of the assessment year 1978-79 is the year ended 31-5-1977. The company had changed the accounting year to be in conformity with the accounting year of the holding company. Thus, for the assessment year 1979-80, the accounting year ended on 30-9-1978. The assessee has established a unit for fabricating/assembling cookers in semi-finished stages.
2. For the assessment year 1978-79, the two issues raised by the assessee are the computation of capital for the purpose of Section 80J of the Income-tax Act, 1961 ('the Act'). The assessee's contention is that borrowed capital should also be considered as capital employed.
This contention has to be rejected in view of the retrospective amendment of Section 80J. The second contention is the deduction claimed under Section 80HH of the Act. It is an admitted position that there is no gross total income for the assessment year in view of the past losses. So, the claim for deduction under Section 80HH is academic.
3. We will now take up the issues arising in the assessment year 1979-80. Here also, two issues have been raised by the company. The first issue is the computation of capital employed under Section 80J.For the reasons stated in the above para, the assessee's claim has to be rejected. That leaves with the issue of Section 80HH. The assessee-company has an industrial unit established in Hoshiarpur in Punjab. It is an admitted position that Hoshiarpur falls in a backward area and any new industrial undertaking established therein would be entitled to deduction under Section 80HH. During the accounting year concerned, the assessee had shown a profit of Rs. 3,21,050. Most of the profits are referable to the Hoshiarpur unit. In respect of these profits, the assessee claimed deduction under Section 80HH. The claim was rejected by the ITO mainly on the ground that the profits shown by the unit are inflated in order to get the deduction. He had invoked Sub-section (7) of Section 80HH. The ITO's opinion is that the business between the assessee and its holding company has been so arranged that the business transaction produces to the assessee more than ordinary profits which could be expected to arise in the business of industrial undertaking, He appears to have assumed that if the transcations are hit by Section 80HH, no deduction would be admissible.
4. The case made out by the ITO has to be understood in the background of certain facts. The business of the holding company of the assessee is manufacture and sale of pressure cookers. They had one unit at Thane, near Bombay. The fabrication, assembling, etc., up to the semifinished stage was undertaken by a registered firm styled 'Thakur Metal Industries (TMI)'. Originally, the holding company had a unit only in Thane. Later, they started a unit in Hoshiarpur. There also, the business was manufacture and sale of pressure cookers. When the assessee-company was put into commission, the fabrication and assembly work was given to the assessee-company. The ITO noticed that the rate charged by the TMI at Aodheri to the holding company was much lower than the rate charged by the assessee-company. He has given the comparative figures in the assessment year 1978-79. It would be seen therefrom that in respect of 4 litre cookers the assessee had charged Rs, 19.50 per unit, whereas TMI had charged only Rs. 13. There is a similar glaring difference in the other type of cookers, i.e., 5 litres, 6.5 litres, etc., manufactured by the holding company. It is on this account that he came to a finding that the provisions of Section 80HH(7) were attracted. According to him, the assessee-company by overcharging the holding company had successfully diverted part of the profits of the holding company accruing to it in the forward area to the assessee in the backward area. So, he held that the assessee would not be entitled to the deduction.
5. The Commissioner (Appeals) was satisfied that there was a close connection between the assessee-company and its holding company. The analysis of the bills also showed that the profits of the assessee had been jacked up. The assessee attempted to justify the higher rates charged by them by showing certain reasons but the Commissioner (Appeals) did not find them acceptable. He, however, held that the entire denial of exemption was not justified. He directed the ITO to determine the profits assuming the rates charged by the assessee to be at the same level as charged by the TMI.6. From the above finding, both the assessee and the department are on appeal before us. The departmental appeal appears to be misconceived.
The ground raised by them is that the Commissioner (Appeals) could not direct the ITO to allow an unabsorbed relief under Section 80HH to be carried forward since there is no such provision in the Act. A reading of the finding of the Commissioner (Appeals) shows that no such direction was given by him. What he has directed is that the deduction under Section 80HH allowable to the limited extent should be granted and if there is profit to absorb it, the balance should be considered for the purpose of deduction under Section 80J. This is a proper direction to be given. The statute provides that where the assessee is entitled to deduction under Section 80HH as well as under Section 80J, effect shall be given first to the provisions of Section 80HH and the deduction under Section 80J would be reduced to that extent. So, what is carried forward is really deduction under Section 80J. There is no dispute that the statute provides for carry forward of deduction under Section 80J.7. Shri B.K. Khare, appearing for the assessee-company, submitted that the premises under which the exemption is denied is wrong and there is no basis for holding that the business is so arranged that the transaction produces to the assessee more than ordinary profits. He pointed first that the business of the hoiding company expanded considerably. It was not possible for the TMI to attend to the entire work of the holding company. It was in the interest of the holding company that their dependence on an outsider was reduced. It was for this purpose that the holding company had floated the subsidiary company. In the initial stages any company going into production will have certain teething troubles. It is in the interest of the holding company to see that the subsidiary company comes out of the teething troubles. He then submitted thai it will be erroneous to apply the provisions of Section 80HH by considering only the transactions of one or two years, He submitted that whether the provisions of Section 80HH are attracted has to be seen by considering the transactions between them over a period of years. He then pointed out that although initially the rates were high, it has been progressively reduced. He pointed out that the rates referred to by the ITO were the rates effective from 12-5-1976. These rates were changed with effect from 12-6-1978. From that year onward, the charges were reduced to Rs. 15.70 per unit in respect of 4 litres and Rs. 16.5 in respect of 5 litres.
After the company had become a little more experienced, the rates were further reduced with effect from 23-7-1979. From that date onwards, Rs. 10.80 was charged in respect of 4 litres and Rs. 11.65 in respect of 5 litres. There was similar reduction in rates of other sizes also. He pointed out that the rate charged by the TMI had been Rs. 13 for 4 litres and Rs. 13.25 for 5 litres. These had been constant for all these years. These rates comparatively were higher even from the rates of the assessee with effect from 12-6-1978. He pointed out that there was one difference between the rates quoted by the TMI and the rates quoted by the assessee. The TMI were not supplying separators. So, from the rates quoted by the assessee, a proportion referable to the separators has to be deducted. This would also account for part of the difference in the rates.
8. Shri Khare then pointed out that the assessee-company was supplying only one-third of the requirements of the holding company. With reference to the balance sheets, he pointed out that the holding company had manufactured 4,43,391 units during the accounting year. The profits earned by the holding company was Rs. 90.83 lakhs. The assessee had only supplied 1,42,090 units which would come to roughly one-third of the production, i.e., out of the profits of Rs. 90.83 lakhs, at best, the profits attributable to the production of the assessee would be Rs. 30 lakhs. The profits of the assessee-company for the accounting year is Rs. 3.21 lakhs. Now, if the department's case is correct, the proportionate profit earned by the holding company should be much more than Rs. 30 lakhs. He pointed out that the share capital of the holding company was Rs, 82 lakhs and reserves about Rs. 54 lakhs. On these figures, it cannot be said that the profit of Rs. 90 lakhs was low. Nor can it be said that any of the profits of the holding company has been transferred to the assessee-company.
9 Shri Khare then referred to the assessment made in the hands of the holding company. It appears that the ITO held that the expenditure incurred by (he holding company in the payment of the charges to the assessee-company would be hit by Section 40A(2) of the Act. The addition made by him, however, had been deleted on appeal. Therefore, even Section 40A.(2) has not been found applicable. In this connection, he referred to the department's circular regarding applications of the provisions of Section 40A(2) wherein the officers have been cautioned to avoid hardships in bonafide cases. He submitted that the assessee's case was a bona fide case.
10. Coming to the legal principles involved in applying Section 80HH, Shri Khare submitted that the onus is on the department to show that the provisions were applicable. The department must show a motivation to increase abnormally the profits of the undertaking in the backward area. He pointed out that a mala fide intention must be shown. Now, Shri Khare pointed out that the holding company could have had their own unit at Hoshiarpur. Then they would have been entitled to all these benefits.
11. Shri K K. Tuli, the learned departmental representative, on the other hand, submitted that each assessment, being separate, it is enough if the ITO makes out a case that the charges received by the assessee from the holding company are abnormal. He submitted that the figures speak for themselves and the department's case is made out. He then submitted that the reasons given by the assessee are not relevant.
It may be that in the subsequent years the assessee, having become wiser, would have reduced the rates. That does not mean that in the year in which the rates were high, the provisions of Section 80HH cannot be applied.
12. We have considered the submissions and we are of the opinion that the assessee's case must be accepted. In arriving at a decision on this point, in the absence of any direct authority, it would be open for us to consider certain analogous provisions contained in the Indian Income-tax Act, 1922 ('the 1922 Act') and the Excess Profits Tax Act.
In the 1922 Act, Section 42(2) contained a similar provision. Where a person not ordinarily resident is carrying on business with a resident and it appears to the ITO that owing to the close connection between them the course of business is so arranged that it produces either no profits or less than ordinary profits, to the resident then the ITO could estimate the profit which the resident assessee could have earned from the transaction. This provision deals with a reduction in profit, whereas we are concerned with jacking up of profits. But the principles underlying therein are the same. It has been accepted by the Courts that the onus is on the department to bring the case within Section 42(2). There are a number of decisions under the Excess Profits Tax Act which also deal with transfer of legitimate profits from one unit to another. Section 10A of the Excess Profits Tax Act dealt with transactions designed to avoid or reduce the liability to excess profits tax. The provisions in substance are similar to Section 80HH(7). In the case of V.N.M. Arunachala Nadar v. CEPT  32 ITR 222 the Madras High Court had analysed that Section 1n the following manner: (1) The mere fact that a new business started at a time when by such starting there would be a reduction of liability is not by itself proof that it was started with the main object of avoiding excess profits tax. (2) The burden is on the department to prove that this was the main purpose with which the transaction was effected. (3) The relationship between the parties to the transaction is by itself not conclusive to prove that the motive in that transaction was avoidance of liability. (4) It is not sufficient if this was an incidental advantage which might have accrued to the assessee. It must be the main motive to compass which the transaction was brought out. We may mention that the above analysis of the section was approved by the Supreme Court when the matter came on appeal in V.N.M. Arunachala Nadar v. CEPT  44 ITR 352.
13. With the guidelines from the above cases, we will hold that the onus is on the department to prove that the profits of the assessee have been inflated. We would reproduce Sub-section (7) of Section 80HH below: Where it appears to the Income-tax Officer that, owing to the close connection between the assessee carrying on the business of the industrial undertaking or the hotel to which this section applies and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in the business of the industrial undertaking or the hotel, the Income-tax Officer shall, in computing the profits and gains of the industrial undertaking or the hotel for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom." It will be noticed that the key to understand the Section 1s the expression 'the course of business between them'. The Legislature was not satisfied with a mere use of synonyms like 'transactions' or 'dealings'. They had not even used a limited expression of 'business'.
They have used the expression 'course of business'. Now, a 'course of business' naturally presupposes a series of dealings. It cannot be contained with a period of 1 year. The course has to be considered over a longer period. We will, therefore, accept Shri Khare's submission that it is not correct to confine our attention merely to the rates charged by the assessee for the assessment year 1978-79 or even the assessment year 1979-80. At least a period of 2 to 3 years will have to be seen before one could give a clear rinding.
14. It will be noticed that the transactions referred to in the sub-section should result in more than ordinary profits to the assessee. Now, since the earlier part of the section refers to the transaction between two persons, it naturally follows that if the assessee had earned an inflated profit, the person having dealings with the assessee must have an inflated expenditure. It must be shown clearly that the profits of the person having dealings with him have been reduced and also the expenditure incurred by him is inflated. This is a clear inference from the section. Now, having stated that the transaction over a period has to be looked into, we should not also rest content with a mere finding that there is an excess charged by the assessee. As the Madras High Court has pointed out in V.N.M. Arunachala Nadar's case (supra), it is necessary to give a finding that the main motive for the transaction itself was to jack up the profits of the assessee. A mere incidental benefit is not sufficient. Now, since the question of motivation has been raised, it will be necessary for us to go into the whole issue of formation of the assessee-subsidiary company, the circumstances faced by the holding company, the inability of TMI to meet fully the demands of the assessee, etc. The motive of the holding company can be understood only if all these circumstances are looked into. Shri Khare has pointed out that the TMI was not able to supply fully their requirements. We have checked up the figures which are contained in a statement prepared by the assessee. This statement gives the units supplied by the TMI as well as the assessee.
The following table will give the figures of units supplied by both the parties:Year Thane Andheri TMI Hoshiarpur Total1 2 3 4 51976-77Production of cookers 2,33,584 58,647 31,508 3,23,7391977-18Production of cookers 1,87,185 1,14,173 1,42,033 4,43,391Percentage of increase onprevious year 20 per cent 95 per cent 35 per cent 37 per cent1978-79Production of cookers 1,88,968 94,683 1,76,611 4,60,262Percentage of increase onprevious year 1 per cent 17 per cent 24 per cent 42 per cent1979-80Production of cookers 1,90,440 1,04,600 2,25,562 5,20,602Percentage of increase onprevious year 1 per cent 10 per cent 28 per cent 13 per cent1980-81Production of cookers 2,06,155 1,30,684 2,64,654 6,01,493Percentage of increase onprevious year 8 per cent 25 per cent 17 per cent 16 per cent1981-82Production of cookers 2,31,039 1,27,735 3,20,747 6,79,521Percentage of increase on It will be noticed from the above figures that whereas the supplies made TMI had been constant at about 1.1 lakh to 1.3 lakh units, the supplies by the asscssee had increased from 1.42 units to 3.20 units, This clearly supports the case made by Shri Khare that the TMI was not able to supply the full requirements and the holding company had to depend more and more on the assessee. So, this could hardly be consistent with the theory of the department that the dominant motive was to transfer profits of the holding company to the assessee-company.
15. We are also satisfied that the assessee had considerably reduced the rates charged as soon as they had received some expertise in the business. Shri Khare had made a reference to these rates. The figures given below would bear out that the rates charged are very competitive PCA ENGINEERS LTDItem Effective 1st Percentage Effective 1st Percentage Effective 1st June, 1976 as of December, of change July, 1976, per letter change 1977 as per over per lettre dated letter dated previous dated letter 17-5-19)6 12-6-1978 Rates 23-7-1979 Rs. Rs. Rs.S.B. 4 Litres 18.33 15.70 (--) 14 per cent 10.80 5 Litres 18.83 16.50 (---) 13 per cent 11.656.5 Litres 24.78 21.60 (--) 13 per cent 13.70 8 Litres 31.12 24.80 (--) 20 per cent 15.85 The overall impression that one gets is that the holding company floated the subsidiary with the idea of having a unit under its own control which would do the necessary fabrication, etc. The motive was to come out of dependence on other units like the TMI who were in any case, unable to deliver the goods in literal sense. It is quite clear to us that the dominant motive was never to transfer profits. We are, therefore, satisfied that the assessee is entitled to Section 80HH deduction and the provisions of Subsection (7) are not attracted.
16. In the departmental appeal, one other ground requires disposal.
This is against the levy of interest under Section 215 of the Act. The assessee had filed a return showing an income of Rs. 3,14,655. After settirsg off losses of the earlier years, net loss of Rs. 98,200 was declared. The ITO after making certain disallowances, assessed the assessee at Rs. 4,24,550. He also directed charging of interest. On appeal, the Commissioner (Appeals) held that since the assessee was claiming that they were not assessable to advance income-tax, the levy of interest was appealable. He also gave a finding that the" liability had arisen on account of the controversial additions made in the assessments. He cancelled the levy of interest.
17. Against this finding, the department has come on appeal. The first submission made by Shri Tuli is that the levy of interest under Section 215 is not appealable at all. We are satisfied on the facts and circumstances of the case that the levy of interest is appealable. As we have pointed out, according to the assessee, there was no income for the year at all. There was only a loss. If that was so, the assessee was not at all assessable to advance income-tax. If they were not assessable to advance income-tax and interest is levied, then'the levy of such interest can be appealed against on the ground that the assessee denies liability to be assessed. With regard to the finding that no interest is leviable. We have to modify the Commissioner (Appeals)'s directions. The levy of interest is automatic if the advance income-tax payable by the assessee falls short of 75 per cent of the assessed tax. The ITO does not have to look for any other condition to be satisfied before the levy. We will, however, direct that the levy of interest has to be recalculated as per the final assessed figure after taking into account the past losses as well as the reductions given to the assessee in these appeals.
18. In the result, the departmental appeal for the year 1979-80 would stand partly allowed, whereas the assessee's appeals for 1978-79 and 1979-80 are partly allowed.