1. These two appeals by the assessee are directed against two separate orders of the learned CIT(A) dt. 8th March, 2002 and 22nd March, 2002 for asst. yrs. 1996-97 and 1997-98 respectively. For the sake of convenience, the two appeals are disposed of together by this combined order. The appeal for asst. yr. 1997-98 is taken up first for consideration.
The only ground raised in this appeal is against the disallowance of Rs. 1,06,43,227. The assessee company is engaged in the manufacture of various packaging systems catering to the requirements of various industrial units and other traders in India. It has entered into a manufacturing license agreement with Signode Corporation, USA. It had declared a total income of Rs. 60,44,800 for the year under consideration. In the course of assessment proceedings, it was noticed that the assessee had claimed deduction of Rs. 1,06,43,227 as market development and analysis group expenses in the computation of income. In the books of account this expenditure was treated as deferred revenue expenditure and was written off over a period of four years. Considering the nature of expenditure, the AO invoked the provisions of Section 35D of the Act. The AO was of the view that this expenditure was always treated as deferred revenue expenditure in the books of account because its benefits were long-term and of enduring nature. Therefore, to debit the entire expenditure in one year would give a distorted picture of the profits of the company. The main contention of the assessee was that the entire expenditure was claimed as deductible on the ground that it was wholly and exclusively laid out for the purpose of the business. It was also emphasized that there was common management, unity of control interconnection, interlacing, interdependence and dovetailing of one activity into the other. It was stated that no new business was set up and the expenditure was for the ongoing activities of the assessee. The AO observed that Section 35D was applicable to a going concern also and not necessarily to a new concern for conducting market survey prior to the commencement of the business. He was of the definite opinion that the expenditure incurred was on market survey and hence Section 35D was applicable.
Accordingly, he computed the deduction as per the said provision which amounted to Rs. 17,05,103.
3. Elaborate submissions were made before the CIT(A) over and above those made before the AO. It was stated that the entire expenditure comprised of expenses like salary and wages, travelling and conveyance, vehicles running and maintenance, miscellaneous office expenses etc. It was stated that the AO had disallowed the expenditure under an erroneous belief that the assessee had opened a new line of business/product. However, it was categorically stated that no new business has been set up during the relevant previous year as alleged by the AO. At the same time, in the later part of its submissions, it was stated that the assessee did set up new units for manufacturing new packaging material and improved the existing process of manufacturing some of the products already been manufactured by it. The CIT(A) took note of this contradictory stand taken by the assessee and concurring with the view taken by the AO, confirmed the disallowance.
4. Before us, the learned Counsel for the assessee submitted that the assessee has a marketing division which as part of its ongoing activity explores markets for new products, new dealers, new branch etc.
Referring to the observations of the AO in para 6.5 of his order, it was stated that it was factually wrong to mention that the assessee had opened a new line of business and that this new unit was yet to commence commercial production. Our attention was drawn to p. 88 of the paper book in which the information regarding goods manufactured by the assessee was given for the year under consideration as well as for the immediate preceding year. It was specifically pointed out that by comparing the information of the two years, it was evident that no new product was added to the list of products already being manufactured by the assessee. If at all there was a new product, it was the Edge Board the production of which was only 70,000 meters which was too insignificant. Taking us through the details of the expenses, it was submitted that all the expenses were in connection with the existing products and therefore were of revenue nature. Referring to Section 35D, it was argued that the said provision contemplates substantial expansion. In the case of the assessee there was no preparation either of any feasibility report or project report. It was submitted that the AO had specifically picked up Sub-clause (iii) of Clause (a) of Sub-section (2) of Section 35D which referred to expenses incurred for conducting market survey or any other survey without considering the facts in the case of the assessee. It was also pointed out that merely because it was treated as deferred revenue expenditure in the books of account, the same does not become capital expenditure. Reliance was placed on the decision of the Hyderabad Bench of the Tribunal in the case of Amar Raja Batteries Ltd. v. Asstt. CIT (2004) 85 TTJ (Hyd) 20 : (2004) 91 ITD 280 (Hyd) and also on the decision of the Delhi Bench of the Tribunal in the case of Jt. CIT v. Modi Olivetti Ltd. (2004) 84 TTJ 1038 (Del). Alternatively, it was contended that if Section 35D was held to be applicable, then at the most expenses attributable to the manufacture of Edge Board may be disallowed which amounted to Rs. 13,57,947.
5. The learned Departmental Representative submitted that the onus was on the assessee to prove that the expenditure was not incurred for setting up a new unit. In this connection, he specifically referred to the observations of the CIT(A) in para 17 of his order where a finding was given that the assessee did set up new units for manufacturing new packaging material/products.
6. We have duly considered the rival contentions and the material on record. The Revenue has invoked the provisions of Section 35D and has made the disallowance on the basis of the provisions of Section 35D(2)(a)(iii) of the Act. The said Sub-clause (iii) refers to expenditure incurred for conducting market survey or any other survey for the business of the assessee. Sub-section (2)(a) in which this sub-clause is contained is with reference to the expenditure referred to in Sub-section (1) of Section 35D. Section 35D(1) provides for a spread over of the expenses over ten assessment years with regard to certain preliminary expenses. For such amortization, the provision contemplates either of the two situations. The first situation is where expenditure is incurred before the commencement of business. In the present, case, we are not concerned with this situation. The second situation is where the assessee incurs the expenditure after the commencement of business in connection with the extension of its industrial undertaking or in connection with the setting up of a new industrial unit. Since the assessee has commenced its business long back and has incurred the impugned expenditure after the commencement of its business, we have to appreciate the facts in the light of this situation. This second situation further visualises either of the two situations. One is, the expenditure is incurred in connection with the extension of its industrial undertaking. Let us examine whether the assessee's case falls within this situation. The expression used is "extension" and not "expansion". The former connotes that the assessee has extended its operations from the present activity to another activity. On the other hand, the latter indicates that the assessee has merely expanded its present operations. The expansion is generally meant to be the expansion of its present installed capacities. The capacity may be expanded either at the same location or at a different location. But the legislature has not used the word "expansion" and that is with a purpose. If there is merely an expansion, then it may not be necessary for the assessee to incur the type of expenditure envisaged in Section 35D. On the other hand, if there is extension or where altogether a new industrial unit is set up, such extension or setting up of a new unit may be preceded with the preparation of a feasibility report or a project report or conducting market survey and so on. These preliminary expenses are envisaged in Section 35D for the reason that the extension or setting up of a new unit presupposes that the assessee is entering into altogether a new line of activity or is setting up an undertaking which is independent of the present undertaking. With this background, let us consider the facts of the present case.
7. The assessee company is in manufacture of state of art packaging systems. It manufactures several products like steel strapping, sealing tools, industrial packaging machines, stretch wrapping and packing systems, paper conversion products etc. It is not unknown to anyone that the market gets flooded with new innovative products everyday. It is also not uncommon that the manufacturers of such products always try to package them in a sophisticated way to attract customers. Secondly, automation in every activity is the order of the day and hence new machines are also being evolved to hasten the process of packaging with efficiency and efficacy. The assessee therefore has to keep on innovating new products and improving the existing products to cope up with the expanding market and consumerism. For this it requires dedicated department which keeps on conducting surveys of various types. It is in connection with this department that the assessee has incurred various expenses. As mentioned by the assessee, this department has been treated as a separate cost centre and hence its expenses are shown separately. To cope up with its expanding activities and production, the assessee has to install new plants or new machinery. Installing such new plants or machinery is sometimes loosely referred to as setting up a new unit. The contention of the assessee before the CIT(A) that it has set up new units was in this context and not in the context in which it is envisaged in Section 35D. Therefore, there is no gainsaying that the assessee has put up new industrial unit and hence the expenditure in connection therewith should be amortised under Section 35D. In the two Tribunal decisions, the assessee had launched altogether a new product and had incurred huge advertisement expenditure. In both the cases, the expenditure was treated as deferred revenue expenditure by the assessee in its books of account. The assessee had claimed the entire expenditure in the return of income as revenue expenditure. The Tribunal allowed the entire expenditure by observing that by its very nature, deferred revenue expenditure presupposed that the expenditure was in revenue field. It was also observed that though the expenses may have enduring benefit, no estimate can be made about the period for which the assessee may be benefited. Therefore, on these grounds, the Tribunal allowed the expenditure. The assessee's case in the present appeal is on a much better footing insofar as that the assessee has not launched any new product worth its name. The production of Edge Board which is a new product introduced during the year is too insignificant to be considered. Thus, considering the overall facts of the case, we do not see any reason to apply the provisions of Section 35D. The AO is directed to allow full deduction of the expenditure as claimed by the assessee.
The first ground in this appeal is against Rs. 1,00,00,000 being the amount written off in respect of inter-corporate deposit (ICD) due from Shaw Wallace & Company Ltd. (Shaw Wallace for short). It was noticed that the assessee had placed Rs. 1 crore as ICD with Shaw Wallace. On maturity, Shaw Wallace could not repay the amount and the assessee filed proceedings for recovery in Calcutta High Court.
In the opinion of the assessee since the amount was irrecoverable, it wrote off the amount in the books of account and claimed deduction thereof as bad debt. The AO was of the view that this amount was never taken into account in computing the income at any point of time before such write off. Secondly, it was more in the nature of investment and hence had the said amount been recovered, the assessee would not have credited it to its P&L a/c. Thirdly, according to the AO, it was a capital loss and not a debt of revenue nature. Thus, according to the AO, since the conditions for claiming deduction under Section 36(1)(vii) were not fulfilled, he disallowed the claim of the-assessee.
9. Almost the same contentions were made before the CIT(A). In addition, it was contended that alternatively the same may be allowed as a trading loss under Section 28 of the Act. It was also stated that during the previous year relevant to the asst. yr. 2001-02, the assessee had received Rs, 1,85,56,082 from Shaw Wallace in full and final settlement of the amount outstanding. The entire amount was credited to the P&L a/c. The argument was that if the addition is sustained in this year, the same should be reduced from the income of asst. yr. 2001-02. On the basis of this submission, the CIT(A) concluded that when the entire amount along with interest has been recovered in subsequent year, the same is wrongly claimed as bad debt in the year under consideration. Thus, concurring with the stand taken by the AO, the CIT(A) confirmed the addition by observing that the debt was not of revenue nature and that it had been taken into account in computing the income of earlier previous year.
10. After narrating the facts as mentioned above, the learned Counsel for the assessee submitted that after one rollover for further period of ninety days, Shaw Wallace had issued cheque to the assessee which had bounced. Therefore, the debt became due on 9th July, 1995 because it was legally recoverable. As regards Revenue's contention that it was never taken into account for computing the income of any earlier previous year, the learned Counsel referred to the wordings of Section 36(1)(vii) of the Act. In particular, he drew our attention to the expression "...any bad debt or part thereof..." and laid emphasis on the words "part thereof". The argument was that interest of about Rs. 21 lacs had accrued on the said ICD which also the assessee could not recover. Therefore, the accrued interest became a part of the debt due which was offered for taxation. When once it was treated as income, it being a part of the entire debt due, the condition of Section 36(1)(vii) stood fulfilled. Alternatively, it was contended that it was a loss incidental to business and hence was allowable under Sections 28 and 29 of the Act. For his propositions, the learned Counsel relied on the judgment of the Calcutta High Court in the case of Turner Morrison & Co. Ltd. v. CIT (2001) 165 CTR (Cal) 451 : (2000) 245 ITR 724 (Cal) and on the decision of the Bangalore Bench of the Tribunal in the case of K. Raheja Development Corpn. v. Asstt. CIT 11. The learned Departmental Representative submitted that the nature of debt and other facts in the present case are different from the cited cases and hence those cases have no relevance here. It was submitted that there was no business relationship between the assessee and Shaw Wallace but merely surplus funds were parked by the assessee with Shaw Wallace, He placed full reliance on the conclusion drawn by the CIT(A).
12. We have duly considered the rival contentions and the material on record. The facts are not in dispute. Recently, Supreme Court had the occasion to explain the meaning of the expression "commercial expediency". It was explained that it is a term of wide import and includes such expenditure for which there may not be any legal obligation but is incurred for the purpose of the business. It referred to its earlier judgment in the case of Madhav Prasad Jatia v. CIT (1979) 10 CTR (SC) 375 : (1979) 118 ITR 200 (SC) where the borrowed amount was donated to a college with a view to commemorate the memory of the assessee's deceased husband after whom the college was to be named. It was held that if the borrowed amount was donated for some sentimental or personal reasons then it could not be said that it was for commercial expediency. In the present case, it is not the case of the Department that the ICD placed with Shaw Wallace was for some personal reasons. Inter-corporate deposits are quite common and corporate houses accommodate each other on short-term basis on grounds of commercial expediency. Today, if the assessee accommodated Shaw Wallace, tomorrow, it could be Shaw Wallace accommodating the assessee.
Moreover, it is also not uncommon that at certain points of time, companies may have surplus funds awaiting fruitful deployment. Pending such deployment, they park their funds to earn interest. Earning of interest on surplus funds is also on grounds of commercial expediency as such income would ultimately augment the working capital of the assessee. Therefore, placing of ICDs is in the usual course of business and a company doing so need not be in money lending business. If placing of ICDs is in the normal course of business, the loss arising therefrom cannot be anything else but arising in the usual course of business. It was the judgment of the assessee that the debt due from Shaw Wallace has become irrecoverable. It was not without any reason that the assessee judged the debt to have become bad and irrecoverable.
The ICD was initially for 90 days. At the end of this period, it was rolled over again for another 90 days. At the end of the second period of 90 days, Shaw Wallace issued a cheque which it could not honour. If these are not good enough reasons to consider a debt as irrecoverable, what else is required. It is further interesting to note that the interest of Rs. 21,05,278 accrued on this very ICD is also claimed as a bad debt and the AO has allowed the same. Therefore, considering the facts of the case, the claim of the assessee for deduction of Rs. 1 crore is allowed.
13. Second ground in the appeal is against the addition of Rs. 28,02,328 being interest payable by Shaw Wallace in respect of the aforesaid ICD. The contention of the learned Counsel was that when the principal was written off, the interest thereon was quite notional and illusory. On the one hand, the AO was allowing interest as bad debt and at the same time he was adding it as notional income on the same ICD.The contentions of the learned Departmental Representative were the same as they were in respect of the first ground above. For reasons mentioned by us in ground No. 1, we delete the addition of Rs. 28,02,328.
14. Third ground in the appeal is against the disallowance of Rs. 1,26,95,765 as bad debt due from Glen View Plastic Systems (P) Ltd. (Glen View for short). The assessee had advanced a sum of Rs. 3,12,31,754 to Glen View which is its sister concern over a period of five years. The amount was purportedly shown to have been given towards advance for material supply. The assessee obtains its requirement of PP Strap of various sizes from Glen View. However, the AO made the observation that the supply was not commensurate with the advances given. During the year under consideration, the assessee came to the conclusion that Glen View may not be in a position to supply the material and hence wrote off the advances standing to the debit of Glen View. The AO was of the view that existence of Glen View was entirely dependent on the assessee as the latter had given on lease to it the factory and plant and had also provided funds to it. The AO was also of the view that the advances given were of capital nature and that to write off these advances was premeditated and make-belief arrangement.
Therefore, again, the AO referred to the provisions of Section 36(1)(vii) of the Act and observed that the amount given to Glen View never formed part of the assessee's income in earlier years.
Accordingly, he rejected the claim of the assessee. The CIT(A) confirmed the disallowance for the same reasons.
15. The submission of the learned Counsel was that Glen View was the subsidiary of the assessee and that the assessee was dependent on it for its business as it had to supply straps also to its customers along with packaging machinery. The total amount which was written off was inclusive of not only advances but also lease rentals for the machinery which were leased by the assessee and commission for carrying out marketing activities on its behalf. Therefore, reiterating the arguments given in connection with ground No. 1, it was stated that a part of the debt comprising of lease rentals and commission did form part of the income of the assessee in the earlier years and hence it satisfied the condition laid down in Section 36(1)(vii) of the Act.
16. The contention of the learned Departmental Representative was that an advance given for supply of raw material cannot be considered as a debt and all the more a bad debt. The submission that commission and lease rent were also included in the outstanding balance was a new fact according to the learned Departmental Representative which was never put before the lower authorities. Therefore, it was pleaded that the addition was justified.
17. We have duly considered the rival contentions and the material on record. Of course, the fact that the outstanding balance due from Glen View includes commission and lease rent does not find a mention in the order of the AO as well as the CIT(A). However, papers placed in the paper book at pp. 65 to 70 do reveal this fact and these papers were certainly before the lower authorities as the certificate appended to the paper book indicates. Therefore, it cannot be said to be a new fact brought on record. The assessee may have leased factory and plant to Glen View but that fact does not have any bearing on the claim of the assessee. The assessee is equally dependent on Glen View for its business. The financial position of the Glen View must not have been healthy, and hence, had the assessee not advanced any money to Glen View, the assessee would have been the sufferer for want of supplies of straps. Thus, to serve the needs of its own business, the assessee had to keep on pumping funds to Glen View. This is nothing but pure commercial expediency which has been discussed in detail in respect of ground No. 1. In fact, the case of the assessee here is much stronger than what it was in ground No. 1. Further, the balance does include lease rent and commission due from Glen View which was offered for taxation in the earlier years. Therefore, the condition laid down in Section 36(1)(vii) is also fulfilled. Accordingly, in the light of this discussion and in the light of the reasons given in respect of ground No. 1, we delete the disallowance of Rs. 1,26,95,765.
18. Fourth ground in the appeal is against the disallowance of Rs. 69,16,756 as bad debt on account of unrealized benefit under advance license scheme. The assessee was entitled to advance licenses for import of raw material pursuant to the import and export policy of the Government of India. Against these licenses the assessee could import raw material free of customs duty. At the same time, it was required to fulfill its export obligations. So far as accounting aspect is concerned, on receipt of advance license, the assessee used to credit its P&L a/c with the value of the license, it being a notional benefit obtained by it. As and when the raw material was imported, the customs duty payable on it was adjusted against the said notional benefit.
Subsequently, due to the change in the duty structure of the items being imported by the assessee, the benefit obtained by way of advance license was no longer required. Accordingly, the unused balances on account of these advance licenses were written during the year under consideration. The contention of the assessee was that since the notional benefits obtained by the assessee in earlier years were offered for taxation in those years, the unused balances which are no longer required are written off and hence the same be allowed as deduction. However, the AO observed that the so-called notional benefit offered for taxation in the earlier years was eyewash insofar as that the assessee used to debit the P&L a/c also at the same time by way of customs duty anticipated to be payable by it in future. Thus, in effect, nothing was offered for taxation in earlier years as claimed by the assessee. He also observed that spending in the sense of paying out of money is the primary meaning of expenditure. In the instant case, there is no actual paying out or no actual liability incurred, but everything being notional, no deduction can be allowed. Accordingly, the claim of Rs. 69,16,756 was disallowed. The CIT(A) confirmed the disallowance on the basis of the reasons given by the AO in his order.
19. The learned Counsel explained the system of advance licenses and submitted that the assessee used to account for the benefit obtained by it notionally. The balance lying to the credit of license benefit account was adjusted whenever raw material was imported. Subsequently, on account of change in the duty structure, it became more prudent to obtain the raw material locally rather than importing it. Therefore, the unused balance lying in the license benefit account has been written off. With regard to the AO's contention that if at all it was a debit, it was not due from anyone; it was contended that in a way, it can be said to be due from the Government. With regard to the AO's contention that it was not an expenditure, it was argued that it was a benefit which was credited in the books notionally but was no longer receivable now and hence, its write off is justified and should be allowed. The learned Departmental Representative submitted that this issue may be set aside to verify whether the notional benefit was offered for tax in earlier years or not.
20. On due consideration of the matter, we do not see any legal or accounting infirmity in the write off effected by the assessee. The AO is not right in observing that the assessee used to debit the P&L a/c with the anticipated amount of duty payable by it in future. That cannot be the case and in fact is not the case also. The amount credited to license benefit account will get adjusted only on actual import of raw material by the amount of the duty which the assessee saved on account of advance license. Thus, though the entries are notional in the sense that there is in reality no inflow or outflow of money, yet it is a benefit derived by the assessee and hence the same was rightly credited to the P&L a/c. Similarly, the benefit so derived and credited in the books got adjusted either on import of raw material or in the event of changes in the duty structure, it can be seen that unless these transactions, though notional, are recorded, the true profit or loss of the assessee cannot be determined. The benefit obtained in the earlier years which is lying as credit balance in the license benefit account has been written off by the assessee as it is no longer required. Again, if the unrequired balance is allowed to remain in the books, the accounts of the assessee will not reflect a true and fair view of the state of affairs of the business. Thus, in whatever way it may be described, be it a bad debt or benefit no longer required or balance due from Government, the fact remains that it is a legitimate write off effected by the assessee and hence we direct the AO to delete the addition. We do not accept the suggestion of the learned Departmental Representative to set aside the issue for the reason mentioned by him because it is not disputed even by the AO himself that the notional benefit derived by the assessee was in fact credited to the P&L a/c.
21. Fifth ground in the appeal is against excluding from business profits 90 per cent of gross interest and not net interest for the purpose of computing deduction under Section 80HHC of the Act. While computing the deduction under Section 80HHC, the AO reduced from the business profits 90 per cent of interest amounting to Rs. 41,75,358.
Before the CIT(A), it was contended by the assessee that the AO had taken 90 per cent of interest recovered and not 90 per cent of the net interest income. The CIT(A) observed that the assessee itself had taken 90 per cent of Rs. 41,75,358 and the same figure had been taken by the AO. Therefore, he held that there was no discrepancy in the computation made by the AO. The learned Counsel has relied on the judgment of the Delhi High Court in the case of CIT v. Shri Ram Honda Power Equip (2007) 207 CTR (Del) 689 : (2007)-TIOL-38-HC-DEL-IT, dt. 12th Jan., 2007. There have been differences of opinion on this issue not only amongst some of the Benches of the Tribunal but also amongst some of the High Courts. However, by and large, most of the Benches have been following the decision of the Special Bench in the case of Lalsons Enterprises v. Dy. CIT (2004) 82 TTJ (Del)(SB) 1048 : (2004) 89 ITD 25 (Del)(SB). The said decision of the Special Bench has since been upheld by the Delhi High Court in the case of Shri Ram Honda (supra) holding that 90 per cent of the net interest should be excluded from business profits under Clause (baa) of the Explanation to Section 80HHC. Of course, we are conscious of two contrary judgments, one by the Madras High Court in CIT v. Chinnapandi (2006) 201 CTR (Mad) 13 : (2006) 282 ITR 389 (Mad) and the other by the Punjab & Haryana High Court in the case of Rani Pahwal v. CIT (2003) 185 CTR (P&H) 333 : (2004) 268 ITR 220 (P&H). Both these judgments have been considered at length by the Delhi High Court. Considering all the judgments, we are inclined to follow the judgment of the Delhi High Court as it is well established that between two views expressed, the one which is favourable to the assessee should be accepted. Therefore, respectfully following the same we direct the AO to exclude 90 per cent of net interest from the business profits. With regard to the observation of the CIT(A) that the AO has taken the same amount of interest as was taken by the assessee, we may only add that if the assessee has taken gross amount on some mistaken belief, it should not be prevented from taking the net amount because afterall correct income has to be determined in accordance with law. Therefore, this ground of the assessee is upheld.22. Last ground in the appeal relates to the disallowance in respect of expenditure on food and beverages and expenses in connection with the maintenance of a transit house. In view of the judgment of the Supreme Court in the case of Britannia Industries Limited v. CIT (2005) 198 CTR (SC) 313 : (2005) 278 ITR 546 (SC), the learned Counsel fairly conceded that this issue has to be decided in favour of the Department.
Accordingly, the assessee's ground is rejected.
23. In the result, the appeal of the assessee for asst. year 1996-97 (ITA No. 560/Hyd/2002) is allowed and the one for asst. year 1997-98 (ITA No. 566/Hyd/2002) is partly allowed.