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Facts
The assessee, M/s B. N. Exports, appealed against the order of the CIT(A) which confirmed additions made by the AO. The additions related to profit on sale of samples and a non-compete fee paid to a sister concern. The assessee's business involved manufacturing, trading, and export of various items.
Held
The Tribunal held that the disallowance of expenses incurred on sending free samples should be restored to the AO for fresh adjudication, and allowed the ground for statistical purposes. Regarding the non-compete fee, the Tribunal found the disallowance to be not tenable and allowed the ground in favor of the assessee. The appeal was partly allowed.
Key Issues
1. Whether the disallowance of expenses incurred on sending free samples is justified. 2. Whether the addition on account of speculated profit on sale of samples is sustainable. 3. Whether the disallowance of non-compete fee paid to a sister concern is valid.
Sections Cited
143(1), 143(2), 142(1), 250, 250(6)
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Income Tax Appellate Tribunal, MUMBAI BENCH “J”, MUMBAI
Before: MS. PADMAVATHY S & SHRI RAJ KUMAR CHAUHAN
O R D E R PER RAJ KUMAR CHAUHAN (J.M.): 1. This appeal is filed by the appellant/assessee against the order of Learned Commissioner of Income Tax (Appeals) – 31, MumbaI [hereinafter referred to as the “CIT(A)”], passed under section 250 of the Income Tax Act, 1961 [hereinafter referred to as “the Act”] dated 18.11.2009 for the A.Y.
2006-07 wherein the Ld. CIT(A) confirmed the additions made by AO of Rs. 15,72,058/- on account of profit on sale of sample to the foreign buyers by the assessee and further addition made of Rs. 6 lakhs on account of non compete fee paid to M/s. Deepal Corporation, a sister concern of the assessee.
The brief facts of the case are that, the assessee is engaged in the business of manufacturing, trading and export or hair accessories, scarves, pareos, kitanga, bandana, garments, etc. The return of income for AY 2006- 07 was filed on 30.10.2016 declaring total income of Rs. 1,67,27,105/-. The return was process u/s 143(1) of the Act and the notice was issued u/s 143(2) of the Act on 03.10.07. The statutory notice u/s 142(1) was also issued to the assessee. In response, the assessee has filed necessary documents and given its submissions. Thereafter, AO has made 3 additions. The first addition of Rs. 31,68,785/- was disallowance which was claimed as deduction on account of payment of keyman insurance premium of the partners of assessee‟s firm. The said addition was made on the ground that assessee has not been able to prove the keyman status of the partners and that the insurance cover taken does not commensurate with the profit sharing ratio and the capital contribution of the concerned partners. The Page | 2 second addition of Rs. 15,72,058/- was made on account of profit on sale of samples. The third addition of Rs. 6 lakhs made on account on non compete fee paid to M/s Deepal Corporation.
3. The said order of the AO was challenged by assessee before the Ld. CIT(A) who vide impugned order set aside the first addition on relying upon the order of Coordinate Bench of ITAT in for AY 2004-05 dated 29.01.2009 and decided in favour of the assessee. Ld. CIT(A) has dismissed the other grounds raised by the assessee.
Aggrieved by the said order, the assessee challenged the impugned order before the Tribunal in the present appeal and the Ld. Predecessors presiding the Tribunal had dismissed the appeal of the assessee vide order dated 18.08.2011 by observing as under:-
Considering the facts narrated above and keeping in mind the provisions of Rule 19(2) of the Appellate Tribunal Rules as considered by the Tribunal in the case of CIT vs. Multiplan (India) P. Ltd. 38 ITD 320 (Del.) and by Hon'ble Madhya Pradesh High Court in the case of late Tukojirao Holkar 223 ITR 480 (M.P.), this appeal of the assessee is treated as unadmitted and dismissed for non prosecution. The assessee, if so advised, shall be free to move the Tribunal explaining the reasons for non compliance and for recalling of this order and if the Bench is so satisfied, then this order may be recalled.
In respect of recalling the ITAT order dated 18.08.2011 passed in Misc. Application dated 11.09.2017 wherein the Coordinate Bench has allowed the application of assessee and recalled the order dated 18.08.2011 and the appeal was ordered to be fixed for hearing.
The assessee in the preferred appeal before us raised the following grounds:-
1. On facts and in the circumstances of the case and in law the order passed by the learned CIT(A), so far as confirming various additions, is arbitrary unjustified and bad in law.
2. On facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the disallowance of Rs. 13,40,386 being expenses incurred on free sampling.
3. On facts and in the circumstances of case and in law, the learned CIT(A) erred in confirming the addition of Rs.8,66,026 made on account of alleged speculation profit on alleged sale of samples.
4. On facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the disallowances of Rs.6,00,000 being compensation paid to a firm for not competing with the assessee.
5. The assessee craves leave to add, delete, alter/modify the above grounds of appeal before or at the time of hearing.
We have heard Ld. AR and Ld. DR and carefully examined the record. Ground no. 1 is the general ground which needs no specific adjudication, accordingly dismissed. Ground No. 2 pertains to disallowance of Rs. 13,40,386/- being expenses incurred on sending free samples to various buyers. This issue has been dealt by the Ld. AO in para no. 5 to 5.3 in its order extracted below:-
“5. Free Sample expenses :
The perusal of the records reveal that assessee has debited Rs.20,46,418/- as Sample charges in the Purchase account and shown a receipt of Rs.7,06,032/ under the head Sample (export) Account. On this account alone, assessee was suffered a net loss of Rs. 13,40,386/-.
As assessee itself is showing-receipt on account of sample sale, assessee was asked to furnish the details of sample purchases and sales made during the year.. Vide reply dt. 25/11/2008 assessee filed certain documents relating to purchase of fabric for sample purposes, processing charges bills and finally export to M/s. N.V. Agegra Mode Accessories, SA, Belgium. The perusal of all bills show that samples are prepared as per requirement of foreign buyer. Each job work order bears the export order No. etc., etc., confirming that garments are prepared on specific order. The sample is exported through the export invoice dated 5/12/2005. It is important to note that against the purchase cost of around Rs. 50,000/-, export invoice is for US$ 2055.24 equivalent to Rs.93,718/- meaning that assessee earned å profit of Rs. 40/718% on the sale of samples in this particular instance.
5.1 Assessee was further asked to explain the reasons for clearing a bill of Ra346386/200 the sales of samples when it has earned a profit as discussed above on sale of samples to M/s. NV Agora, Mode Accessories, SA, Belgium. Vide reply dated 5/12/2008, assessee claimed that in cases where assessee is doubtful of, the quantum of business from the prospective customers, samples are sent at profit and in case where due to past experience and in anticipation of high order size, samples are sent free of cost.
5.2 The reply of the assessee is quite general and vague. It doesn't discharge the onus of proof. During the course of assessment proceedings assessee filed the copies of earlier letters and addresses to overseas clients relating to the sending of free of cost samples. The examination of these documents, show that these copies of letters don't bear any sign of acknowledgement by foreign buyer any sign of dispatch (If sent through post) or any proof of sending goods through courier etc. In absence of these evidences, claim of the assessee that it had sent free samples to the foreign buyer is not acceptable. The assessee failed to prove that samples were sent to the foreign buyers and that too free of cost.
The only evidence which shows goods were sent, is the transaction on which assessee has earned a profit of 76.82% (in relation to purchases).
5.3. Keeping in view the above facts, claim of loss of Rs.13,40,386/- on sale of samples is hereby rejected and added back to the income of the assessee. Further, as discussed above assessee has earned a profit of 76.82% on the sale sample to M/s NV Agora Mode Accessories, SA, Belgium the profit on sale of samples is determined by applying G.P. ratio of @ 76.82, which comes to Rs.15,72,058/- (Rs.20,46,418 X 76.82%).”
On appeal, Ld. CIT(A) while dismissing this ground has observed that the assessee has debited its purchase account of sample charges of Rs. 20,46,418/- against which it has shown receipt/sample sales of Rs. 7,06,032/- and accordingly claimed a net loss of Rs. 13,40,386/- for the relevant assessment year. The assessee could not substantiate its submission by furnishing necessary documentary evidences, except for submitting copies of letters and addresses of overseas clients relating to sending of free samples and the AO observed that relevant letters do not bear any sign of acknowledgment and proof of sending goods through courier.
Ld. AR in this regard brought to our notice para no. 4.1 of the order of Ld CIT(A) wherein the assessee submitted that “The assessee had incurred a total amount of Rs. 20,46,418/- towards the preparation of samples which are in the normal course of business, sent to the parties for their approval and based on their approval, ordered lots are prepared. In case if the parties are new or the samples are not approved, the cost of the said samples are normally remitted to the assessee but if the samples are approved than no cost is compensated to the assessee. During the relevant financial year out of total expenses incurred on sampling an amount of Page | 7 Rs. 7,06,032/- was realized and the balance was claimed as incurred on free sampling. During the course of assessment proceedings, the assessee had filed the relevant evidences showing purchase of fabric meant for sampling, processing charges bills etc and the same has been admitted by the learned AO in his order itself. There is no finding so as to disprove or controvert the contention of the assessee. The learned AO has further confirmed that some of the samples were sent on 5.12.2005 to one party at Belgium. The AO has also admitted that the assessee had filed the copies of letters addressed to the overseas client relating to the sending of free of cost samples. The learned AO has neither controverted this fact nor doubted the existence of these parties nor alleged any fabrication of the said communication thereby admitting the facts in its totality. Further, the said addition has been made on the reasoning that the letters does not bear any sign of acknowledgement by foreign buyers. The assessee says that these are the letters sent by the assessee and therefore the same will not bear the signatures of foreign buyers. The mention by the AO that the samples were not sent to the foreign buyers is nothing but a case of suspicion and therefore the entire addition is based on conjecture and surmises and without any substance and therefore deserve to be deleted.
Non application of find is further evident from the fact that the learned AO did not only disallowed this expenditure but further went ahead making hypothetical addition of Rs. 8,66,026/- as alleged speculative profit on entire Rs. 20,46,418/-. In view of the fact that the entire expenditure was supported by proper documentation with further evidence showing communication with and the identification of the parties and without there being an evidence that the alleged sale price is received by the assessee, the addition is arbitrary based on conjecture and surmises and therefore be deleted.” Ld. AR further brought to our notice page no. 1 to 13 of the paper book wherein the DHL Express Courier has sent the receipt of the bills.
On the other hand, Ld. DR relied on para 4.2 of the order of Ld. CIT(A) and submitted that the matter may be restored to the file of AO for fresh adjudication of this ground because Ld. AR has referred to fresh evidence in support of his arguments which has not been brought to the notice of Ld. AO and has not been considered by him while passing the assessment order.
We have heard the rival submissions and perused the material placed on record. It is evident that the assessee had filed the copies of letters addressed to the overseas client relating to the sending of free of cost samples and the AO has neither controverted this fact nor doubted the existence of these parties nor alleged any fabrication of the said communication thereby admitting the facts in its totality. The said addition has been made on the reasoning that the letters does not bear any sign of acknowledgement by foreign buyers and the assessee says that these are the letters sent by the assessee and therefore the same will not bear the signatures of foreign buyers, but the Ld. AO held that the samples were not sent to the foreign buyers and it is nothing but a case of suspicion. In that regard, we notice that the Ld. AR referred page 1, 2, 6, 8, 9 to 12 of the paper book to show that there are copies of courier bills as proof of sending samples to the foreign buyers and the same are not considered by the Ld. AO. It is also submitted by Ld. AR that the documents submitted were not considered as the books of accounts were not rejected by the Ld. AO. There seems to be no contradiction of these facts and submissions of the Ld. AR by the revenue. In view of this, we are of the considered opinion that the issue regarding sending of samples by the foreign buyers be restored to the file of AO for fresh adjudication of this issue. Accordingly the addition of Rs. 13,40,386/- is set aside and the ground no. 2 is hereby allowed for statistical purpose.
Ground no. 3 pertains to addition of Rs. 8,66,026/- on account of alleged speculation profit on alleged sale of samples. Ld. AO observed that assessee has earned a profit of 76.82% on the sale sample to M/s NV Agora Mode Accessories, SA, Belgium and the profit on sale of samples is determined by applying G.P. ratio of @ 76.82, which comes to Rs. 15,72,058/- (Rs.20,46,418 X 76.82%). Ld. CIT(A) in para 4 of its order observed that AO has estimated profit based on the sample sales made to Belgium @ 76.82% amounting to Rs. 15,72,058/- on this account and the assessee has shown receipts of Rs. 7,06,232/- on this account, the balance of Rs. 8,66,026/- was added on this account. In response, the assessee regarding addition of Rs. 8,66,026/- as speculation of profit on sale of samples submitted that the arbitrariness of this addition is evident from the order itself. The claim of Rs. 13,40,386/- has resulted into an addition of Rs.22.06,412/-(13,40.386+8,66,026). The assessee further submitted that it is not clear as to from where the G.P. @ 76.82% and the sale of Rs.15,72,088 was picked up by the AO. The assessee has himself reduced Page | 11 the sampling expenses from the entire expenditure on free sampling and net expenses were claimed as expenditure. Ld. CIT(A) while dealing the said addition has observed that assessee has not shown the documentary evidence and in absence of these evidences, claim of the assessee that it has sent free samples to the foreign buyer is not acceptable and the assessee has failed to prove the samples were sent to the foreign buyers and that too free of cost. Therefore, the Ld. CIT(A) has confirmed the profit on sale of samples determined by applying G.P. ratio @ 76.82% which comes to Rs. 15,72,058/-.
The Ld. AR submitted on behalf of the assessee that without any basis the Ld. AO has estimated the profit on sale of samples and its confirmation by Ld. CIT(A) is not justifiable and accordingly requested for deletion of the said addition.
On the other hand, Ld. DR relied on the orders of AO as well as Ld. CIT(A) and submitted that Ld. CIT(A) has rightly confirmed the addition made by AO because the assessee has failed to furnish necessary documentary evidences in support of its contentions that the samples sent were free of cost.
We have considered the rival submissions with respect to addition on account of speculation of profit on the sale of samples by the assessee and also examined the impugned order as well as assessment order and the reasons if any given by the Ld. Lower Authorities in support of this addition. On perusal of the assessment order as well as Ld. CIT(A)‟s order, we have noticed that in para 5.3 of the assessment order, no reason has been assigned for these addition on speculation basis because it is simply stated that since the assessee has earned 76.82% on sale sample to M/s N. V. Agora Mode Accessories, SA, Belgium, the profit of sale of sample is determined G.P ratio @ 76.82, which comes to 15,72,058/- (Rs. 20,46,418 x 76.82%).
The Ld. CIT(A) while deciding the said issue in para no. 4 has observed “Besides, the AO has estimated based on the sample sales made to Belgium as discussed above, @ 76.82% amounting to Rs. 15,72,058/- on this account (para 5.3 of the assessment order). Since the appellant has shown receipts of Rs. 7,06,232/- on this account, the balance of Rs. 8,66,026/- was added on this account.” The Ld. CIT(A) has further observed in para no. 4.2 “However. From the details examined by the AO in relation to such samples sent to Belgium, the AO has brought on record, which is not disputed by the appellant. In this particular consignment of sample sales, the appellant has earned a net margin of 76.82% on purchases. Since, the appellant has failed to furnish any evidence in support of its claim of loss due to free sap-les as discussed above and further it has failed to furnish necessary documentary evidences, in support of its contentions that the samples sent are free of cost, I find that the AO is fully justified in disallowing the said claim of loss and further estimating the profit on such sales based on the reliable evidences available in its own case, as discussed above. Since the claim of loss is of the appellant, I find that it is the responsibility of the appellant to substantiate its claim by fürnishing necessary documentary evidences. Accordingly, on account of the above, the rejection of the loss as well as estimation of profit on sale of sample is confirmed. This ground of appeal is therefore dismissed.”
17. As per section 250(6) of the Act, the Commissioner (Appeals) while disposing of the appeal shall state the points of determination, the decision thereon and the reasons for such decision. On perusal of the reasons given by the AO as well as Ld. CIT(A) as extracted above, we have noticed that the truthful disclosure of profit earned by assessee by sending sample to one party has been made basis of making addition as speculated profit with respect to the sample sent to the other parties allegedly free of cost as is being claimed by assessee and no reasons has been given by the lower authorities for such speculated profits which are being disputed by the assessee and the issue with respect to sending samples free of cost has already been restored to the file of the AO. Therefore, we are of the considered opinion that the addition on account of speculated profits on samples sent free of cost (as claimed by the assessee) are not legally justified in absence of any reasons for such additions and the Ld. Lower authorities were required to give reasons for such addition. Accordingly, the addition of Rs. 8,66,026/- as speculation of profit is deleted. The ground no. 3 is accordingly allowed.
18. Ground No. 4 pertains to disallowance of Rs. 6 lakhs being compensation paid to a firm for not competing with the assessee. From the record, the AO observed that during the year, the assessee has paid Rs. 6 lakhs as non compete fee to one of its group concerns M/s Deepal Corporation and when asked about „Non Compete Fee‟ from the assessee, the assessee filed a copy of memorandum of association, which extracted as under:-
[i] Both the parties i.e. M/s. B.N. Exports and M/s. Deepal Corporation are operating from same address of Mehta House, B-42, Veera Industrial Estate, Off New Link Road, Andheri (West).
[ii] The firm M/s. B.N. Exports have total six partners and M/s. Deepal Corporation has four partners. The examination of documents show that three partners namely Shri Rajesh B. Mehta, Mrs. Kashmira R. Mehta and Mr. Kaushal Rajesh Mehta are common partners.
[iii] Both the parties are engaged in similar nature of business of manufacture, exporter, Importer and dealer of readymade garments, imitation jewellery, Handicraft items or other Apparels madeups, fabrics etc.
[iv] M/s. Deepal Corporation, is already engaged in the business of export of fabrics and garments.
[v] Why assessee has paid non compete fee to sister /group concern, when such sister concern is not engaged in the export activity of common items at all.
[vi] It’s not a case, where business of export activity is taken over by M/s. B. N. Exports from M/s Deepal Corporation.
On appeal, Ld. CIT(A) while dismissing this ground has observed in para no. 5, 5.1 and 5.2 of its order as under:-
5. The fourth ground is regarding disallowance of non compete fees paid to its sister concern M/s. Deepal Corporation of Rs.6,00,000/ during the relevant assessment year. As per the brief facts relating to this issue, the AO has observed that the appellant has paid a sum of Rs.6 lakhs as non compete fees to one of its group concerns M/s. Deepal Corporation this regard, the appellant has filed a copy of memorandum of Association arrived at between the two interested parties. On examination of the same, the AO has observed that both the parties are operating from the same address, the substantial share holding in the concerned parties are held by the common three partners viz.; Shri. Rajesh V. Mehta, Mrs. Kashmira R. Mehta and Mr. Kaushal R. Mehta, engaged in the same Page | 16
line of business, memorandum of association is dated 10.09.2005 but it restricts M/s. Deepal Corporation from engaging in export activity for the period 01.04.2005 to 31.03.2006 and it is not a case, where business of export activity of M/s. Deepal Corporation is taken over by the appellant firm. Therefore, on account of these findings, the AO has disallowed the entire expenditure claimed by the appellant for the relevant assessment year.
5.1 In appeal, the AR, has argued that M/s. Deepal Corporation was engaged in the identical business and had agreed to stop its exports and pass over its exports orders to the appellant firm in consideration to the non compete fees as discussed above. However, he has not disputed the other facts brought on record by the AO as discussed above. However, according to the AR, both the concerns are different from each other although certain partners are common. According to the AR, the non-competence fees was paid in the best interest of the appellant firm as the price competition etc has been wiped off and the business can be smoothly run. Secondly, according to the AR, due to the payment of non competition fees, the exports of the appellant has increased or at least not affected and therefore resulted into better profit and sustainability. On account of the above, the AR has argued that the non competence fees were paid for business purposes and the same deserve to be deleted. According to the AR, it is a settled position of law that the AO cannot direct the appellant as to what expenses are required to be incurred and what not. He has further submitted that the AO has not alleged that these expenses are not for business purposes or they are of personal nature or of capital nature. Therefore, it was submitted that the entire addition made on this account should be deleted. 5.2. I have carefully considered the assessment order and the above mentioned submissions and arguments of the AR. The various facts brought on record by the AO based on the memorandum of association executed for this purpose by the related parties are not disputed by the AR. He has also not disputed that the governing provisions of memorandum is affected for the period 01.04.2005 to Page | 17
31.03.2006 whereas the same was executed only as on 10.09.2005. It is also not disputed that the major holding in both the concerns are of the common three partners, as mentioned above. Both the parties are engaged in the same line of business for the last number of years.) The appellant has failed to furnish any details or evidence that the expenditure incurred is for business purposes and not affected by the extraneous considerations. Moreover, from the facts brought on record as discussed above, the payment to a related party in which the common partners are having majority of share holding and a lump sum payment as non- compete fees to be paid, is decided after six month of the commencement of business, and is not fully explained by the AR. The appellant has failed to furnish any documentary evidence to establish that the expenditure made is for business purposes. No details or working of the payment of expenditure is furnished by the appellant during the assessment as well as in appeal. Moreover, the returned income in case of M/s. Deepal Corporation for the relevant assessment year is Nil whereas in case of the appellant it is for Rs.1,67,27,105/ Therefore, apparently it appears that the expenditure claimed is due to extraneous to reduce its tax liability since both the concerns are controlled by the same group of persons. Even otherwise, the AR has failed to bring on record any material to establish that there was any competition between the two closely related concerns which are owned by the common partners. Even if there is any such competition due in the fact that both the concerns are owned by the common parterres, I find no merits in the arguments of the AR that the expenditure claimed has any business expediency, rather it appears from the facts of the case that the same is claimed to reduce their tax liability in case of the appellant firm where it is taxed at its maximum marginal rate where as in case of their other concern the taxable income is nil. Therefore, in view of these specific facts, as discussed above I find that the AO is fully justified in making the disallowance. The same is therefore confirmed. This ground of appeal is therefore dismissed.
20. From the perusal of the facts pertaining to the impugned issue, the reason for making the disallowance is that the assessee is trying to reduce the profit by booking expenses to the sister concerns. However, we notice that Ld. CIT(A) himself has recorded the fact that M/s Deepal Corporation has not booked any income and that the assessee has recorded an income of Rs. 1.67 Crore. Therefore, in over view there is merit in the submission that the said non-compete fee is paid since M/s Deepal Corporation has stopped its export business which is being passed on to the assessee. It is accepted principle that the revenue cannot step into the shoes of a businessman to say that the expenditure incurred is not required or how much should be incurred. In assessee‟s case, considering the amount of non-compete fee paid as compared to the total profits declared by the assessee, in our view, revenue is not correct in holding that it is booked to reduce profits without bringing any concrete evidence to that effect. The assessee is not denying the fact that there are common partners, but as stated that M/s Deepal Corporation has given up export business in favour of the assessee for which it is paid compensation. This factual position is substantiated by the finding of the Ld. CIT(A) himself. In view of this discussion, we are of the considered view that the reason for making the disallowance is not tenable.
Accordingly, we direct the AO to delete the disallowance on that account. The ground no. 4 is allowed in favour of the assessee.
In the result, the appeal is accordingly partly allowed for statistical purposes in the above terms.