M/S. INTERARCH BUILDING PRODUCTS PVT. LTD.,NEW DELHI vs. DCIT, NEW DELHI

The assessee also preferred additional ground as under: “That the deduction u/s. 80-IC of the IT Acct on the profits of the Pant Nagar unit and u/s. 80-IB of the IT Act on the Greater Noida unit, ought to have been allowed by the Assessing Officer on the profits derived from the respective units without allocating the indirect Head Office expenses.”

Before us it was submitted on behalf of the learned Counsel of the assessee that ground being legal in nature and not requiring investigation of fresh facts, therefore same might be admitted.

After hearing both the parties on the issue of admissibility of the additional ground, we have admitted the additional ground in view of decision of the Hon’ble Supreme Court in the case of NTPC Ltd Vs. CIT in 229 ITR 383 (SC), Wherein it is held that legal ground may admitted at any stage of appellate proceedings, if no investigation of fresh facts is required. 5. Briefly stated facts of the case are that the assessee company was engaged in the business of manufacturing of false ceiling, roof and wall cladding and Pre-engineered metal building. For the year under consideration, the assessee filed return of income on 30/11/2006 declaring total income of Rs.5,62,97,154/-. The return of income filed by the assessee was selected for scrutiny assessment and statutory notices under the Income-tax Act, 1961 (in short the Act) were issued and complied with. In the assessment completed under section 143(3) of the Act on 29/12/2008, the Ld. Assessing Officer made certain additions/disallowances and assessed total income at Rs.6,33,33,480/-. The appeal filed by the assessee against the assessment order was partly allowed by the Ld. first appellate authority i.e. Ld.CIT(A). Aggrieved with the finding of the Ld.CIT(A), the assessee is in appeal before the Tribunal, raising the grounds and additional ground as reproduced above. 6. Before us the parties appeared through videoconferencing facility. The assessee filed a paper book containing pages 1to 81. 7. At the outset, the Learned Counsel of the assessee submitted that assessee does not wish to press ground No. 2 of the appeal and therefore, said ground is dismissed as infructuous. 8. The ground No.1 of the appeal relates to disallowance in terms of section 14A of the Act. 9. The brief facts qua the issue in dispute are that the assessee earned dividend and tax-free income of Rs.1,30,39,655/-, which was claimed as exempted from tax. No disallowance for earning the said exempted income was offered by the assessee in the return of income filed. The Ld. Assessing Officer invoked Rule 8D of Income-tax Rules, 1962 (in short ‘the Rules’) and made disallowance of Rs.15,50,509/-, which consist of Rs.10,12,886/-out of interest debited in profit and loss account on the basis of average investment and assets ratio and Rs.5,37,723/- being administrative expenses at the rate of 0.5% of average investments. The Ld. CIT(A) deleted the disallowance of Rs.10,12,886/- on account of interest expenses, however sustained the disallowance of Rs.5,37,723/-on account of administrative expenses observing as under:

We have heard rival submission of the parties on the issue in dispute and perused the relevant material on record. We find that though the Ld. Assessing Officer made disallowance invoking Rule 8D of the ‘Rules’, however the Ld. CIT(A) did not follow the Rule 8D and he has sustained the disallowance under Section 14A of the Act on a reasonable basis. The disallowance towards interest expenses has already been deleted by him and towards administrative expenses he has made disallowance at the rate of 0.5% of average investment. Since the Ld. CIT(A) has not invoked the Rule 8D of the Rules, which is effective from assessment year 2008-09, the ground No. 1.2 of the appeal is rendered infructuous and accordingly, we dismiss the same. The ground No. 1.1 and 1.3 are regarding the disallowance of 0.5 percent of average investment sustained by the Ld. CIT(A). The issue in dispute before us is of identifying the expenses incurred by the assessee for earning exempt dividend income, out of the expenses debited in profit and loss account i.e. against taxable income. The assessee has without prejudice to ground No. 1.2 of the appeal has agreed for disallowance under Section 14A to the extent of disallowance sustained by the Ld. CIT(A) in Assessment Year 2005-06. The Ld. CIT(A) in assessment year 2005-06 has sustained 15% of the salary and remuneration of the personals engaged in the accounts Department of the company and 1% of the administrative expenses. The Ld. DR has argued before us submitted that this disallowance is purely in the ad-hoc manner, without any basis for the figure of 15% and 1%. The Ld. DR has also pointed out admission of the assessee of incurring expenses on ‘portfolio managers’ for activity of investment in mutual funds.

In our opinion, both, the disallowance opted by the assessee based on percentage of salary and administrative expenses as well as disallowance made by the Ld. CIT(A) in the year under consideration based on percentage of investment, are on estimate basis and we have to choose a disallowance which is more near to reality. As far as disallowance of 0.5% on investment eligible for yielding exempt income adopted by the Ld. CIT(A) is concerned, it is based on administrative expenses calculated as per Rule 8D(2)(iii) of Rules which is effective from assessment year 2008-09. As far as disallowance opted by the assessee is concerned, no basis has been furnished by the assessee to support estimate of disallowance. Further, the assessee has admitted in its submission before ld. CIT(A) of incurring expenses on ‘Portfolio Manager’ for the activity of investment in mutual fund and income from which has been claimed as exempt. But those expenses of portfolio managers are not included in disallowance opted by the assessee. In such circumstances, we feel it appropriate to uphold the disallowance of 0.5% of the investment sustained by the Ld. CIT(A). Accordingly, the ground Nos.1.1 and 1.3 of the appeal of the assessee are dismissed.

The ground No. 3.1, 3.2 and the additional ground relate to allocation of common/head office expenses to two units eligible for deduction under Section 80IB and 80IC of the Act respectively.

Facts in brief qua the issue in dispute are that during the year under consideration, the assessee was engaged in manufacturing from two units i.e. undertakings. One unit is located at ‘Greator Noida’ which is engaged in manufacturing for past many years, is eligible for deduction under section 80IB of the Act at the rate of 30% of the profit of the undertaking. In the year under consideration, the assessee started manufacturing from new unit installed at Pant Nagar, which is eligible for deduction u/s.80IC at the rate of 100 % (hundred percent) of the profit of the undertaking. In earlier years all the administrative or head office or finance expenses of the assessee company used to be debited to the ‘Greater Noida’ unit, while working out profit of the undertaking and there was no dispute of allocation of those expenses. In the year under consideration administrative and other expenses amounting to Rs.2,06,32,424/-, have been allocated by the assessee amongst two units, partly on the actual basis and remaining on the basis of respective sales from the units. Following this methodology, the assessee allocated Rs.1,84,26,578/-to ‘Greater Noida’ unit and Rs.22,05,846 to ‘Pant Nagar’ unit.

The Learned Assessing Officer was of the view that those expenses should be allocated purely on the basis of the sales ratio. He has noted in the assessment order that the Authorised Representative of the assessee, accepted this proposal and accordingly agreed for allocation of administrative and other expenses of Rs.2,06,32,424/- on the basis of sales ratio of the units. The Assessing Officer, accordingly determined allocation of Rs.1,33,07,893/-to the ‘Greater Noida’ unit and Rs.73,24,530/-to the ‘Pant Nagar’ unit. In order to give effect of this allocation, while computing profit of the undertaking, he reduced expenses of Rs.51,18,684/-from the Greater Noida unit and added same amount to the ‘Pantnagar’ unit. The Learned Assessing Officer, accordingly, reduced deduction of Rs.51,18,684/- claimed in ‘Pantnagar’ under 80IC of the Act and allowed further deduction at the rate of 30% to the ‘Greater Noida’ unit. The Ld. CIT(A) upheld the finding of the Assessing Officer observing as under: “9.3 Decision I have considered the submission of the appellant and observation of the Assessing Officer. It is seen that Pantnagar Unit is situated wherein the profit derived from such unit is 100% exempt. The Greater Noida Unit was in operation from last four years and the profit earned from this unit is entitled to get deduction u/s 80IB at the rate of 30%. The appellant claims that it is maintaining separate books of accounts and expenses are separately booked. It has drawn separate profit and loss account for both the units. The head office expenses have been bifurcated on sales basis ratio and other expenses have been booked on actual basis. In the assessment order, the Assessing Officer has bifurcated all the expenses on sale basis. The appellant has submitted that Unit wise accounts with the basis of allocation were submitted alongwith the return of Income. The method adopted by the Assessing Officer of allocating the expenses on the ratio of sales is not correct method. It is submitted by the appellant that Pantnagar Unit has worked only for 7-1/2 months whereas the Greater Noida Unit was in operation for last 4 four years.

The learned Counsel of the assessee submitted that the method of allocation of expenses on the basis of the turnover has not been provided statutorily. He submitted that expenses which are not related to manufacturing facility, are not related to profit derived from the respective manufacturing units. He submitted that in Section 80IB as well as Section 80IC, the expression used is “derived from” which means there should be immediate and first degree nexus between the earning of income and expenditure incurred. The Parliament, by using such expression, only intended to cover the sources not beyond the first degree. The learned Counsel relied on the decision of the Hon’ble Supreme Court in the case of Liberty India vs. CIT in 317 ITR 218, wherein the Hon’ble Supreme Court, while construing the provision of Section 80-IA/80-IB of IT Act, held that while working out the profits of the eligible units, the profits are to be computed as if such eligible business is the only source of income of the assessee and the devices adopted to reduce or inflate the profits of eligible business have to be rejected. He further submitted that in the following cases, it has also been consistently held that while working out the deductions u/s 80IB or any other similar provision, the head Office/research expenses are not directly related to the income earned by the assessee from industrial undertaking and accordingly the allocation of such head Office expenses should not be made to industrial unit while working out the profits of the industrial undertaking eligible for deduction u/s 80IB and 80IC of IT Act:

In view of the above arguments, the learned Counsel submitted that deduction u/s 80IB in respect of the profits of the ‘Greater Noida’ unit and profits u/s 80IC in respect of ‘Pant Nagar’ unit be worked out without allocating the ‘head office’ expenses because such expenses has no direct and first degree nexus with the profitability arising from the industrial activity of the respective units.

In support of original ground No. 3.1 and 3.2 the Ld. Counsel referred to pages 6 to 8 of the paperbook wherein detail of expenses directly related to the units are allocated on actual basis and remaining expenses are allocated on the basis of on sales ratio, reported in tabular form. The Learned Counsel submitted that expenses which could have been identified with the respective units should be allocated on actual basis and allocation on sales ratio should be made only where the common expenses or the head office expenses are not allocable on actual basis.

The Learned CIT DR on the other hand submitted that before the Ld.CIT(A) the assessee failed to substantiate allocation of expenses on actual basis. She referred to para-9.3 of the Learned CIT(A), wherein he has specifically mentioned that assessee could not bring any evidence before him to substantiate the arguments as how the expenses were allocated on actual basis. She further submitted that for balance expenses (other than distributed on actual basis), the assessee itself has allocated in the ratio of the sales of the unit. She submitted that when the assessee itself has allocated the expenses in the ratio of the sales, the grievance of the assessee is not justified. Regarding the additional ground, the Ld. DR submitted that the assessee has relied on ratio decidendi in the case of Zandhu pharmaceuticals Ltd (supra) and Hindustan Lever (supra), however, the facts of the cases relied upon by the assessee are totally different from the case of the assessee. The Learned DR relied on the decision of Hon’ble Supreme Court in the case of Commissioner of Income-tax Vs M/s Sun Engineering works P Ltd AIR 1993 SC 43 wherein it is held that while applying the decision to letter cases, the court must carefully try to ascertain the principal laid down by the decision of the Supreme Court and not to pick out words or sentences from the judgement divorced from the context of question under consideration by the court to support their reasoning.

She distinguished the case of ‘Zandhu pharmaceuticals Ltd. (supra)’ and submitted that in said case, expenses to be allocated were in the nature of the research expenses, which were in the nature of future earning of the company and not related to profits of the undertakings and therefore Hon’ble court is justified in declining to allocate the expenses towards manufacturing units. She submitted that in the case of ‘Hindustan Lever (supra)’ also the expenses to be allocated were not related to the profit of the undertakings and therefore ratio of the said case is also distinguishable.

We have heard rival submission of the parties on the issue in dispute and perused the relevant material on record. The issue before us is of the ‘allocation key’ for distribution of head office or common expenses of the assessee company relatable to the manufacturing undertakings, which are eligible for deduction at different rates. Had there been the same rate of the deduction in case of both the units, this issue would not have been arisen in the case of the assessee, but in old unit the assessee is eligible for deduction at the rate of 30% of the profit of the undertaking, whereas in the new unit the assessee is eligible for deduction of 100% (hundred percent) of the profit of the undertaking. According to the Ld. Assessing Officer, the assessee is shifting the expenses from unit where higher deduction is available, to the unit where lower deduction is available. The chart of allocation of common /head office expenses referred by the assessee is reproduced as under:

The Learned Counsel of the assessee in support of aboveground has relied on the decision of the Hon’ble Bombay High Court in the case of Zandu pharmaceutical works Ltd versus CIT reported in 259 CTR 253. In said case, the head office and other units of the assessee had their own separate research and development (R&D) departments, including laboratories. The R&D work was related to the development of new medicines and new formulae. The Hon’ble High Court has reproduced details of R&D work carried out by the head office, which was subject matter of dispute and observed that the income tax department failed to establish any co-relation or connection between the activities of the unit and said R&D work as under :- “6. The details of the R & D work in respect whereof the said expenditure of Rs.38,70,000 was incurred laboratory facilities.

The Hon’ble High Court has specifically observed that any of the unit had not benefited by the said R&D activity. The relevant finding of the Hon’ble High Court is reproduced as under:

The Hon’ble High Court has considered the decision of Hon’ble Supreme Court in the case of CIT Vs Sterling Foods (supra), which has been cited by the Ld. Counsel of the assessee before us also.

The Hon’ble High Court also concurred with the decision of Madras High Court in case of Bush Boake Allen (India) P Ltd (supra) wherein, it is held that unless the expenditure incurred on the R&D work relates to the undertaking/units in question, the same cannot be apportioned to it. The Learned Counsel of the assessee has before us also relied on the decision of Hon’ble Madras High Court in the case of bush Boake Allen India P Ltd (supra). The Hon’ble Bombay High Court in Zandhu pharmaceutical works Ltd (supra), rejected the argument of the Ld. Counsel of the Revenue that R&D activity would enure to the benefit of the units, observing as under: “17. The submissions proceeds on an erroneous basis and does not take into consideration the facts of the case at all. As we noted earlier, in the present case, the said R & D activities were in relation to the new drugs. There is nothing to indicate that in the event of the assessee deciding to commercially exploit the benefits of the R & D work, the products would be manufactured by the said units. The fallacy in the submissions proceeds on the hypothetical basis that the said products would be manufactured by each of the units or any one of them.

The fallacy also arises on account of an erroneous presumption that the benefit of any R & D activity can only be exploited by an enterprise utilizing the same in its manufacturing activities. That is not so. An enterprise can always assign the benefit thereof to a third party. It can always grant a licence in respect of any patent or design to a third party. In that event, the other units would not derive any benefit in respect thereof. The presumption of a nexus between the R & D activities and the units is not well founded.”

In the instant case before us, the assessee itself has identified part expenses debited under head office as related, directly to the units, which have been apportioned on actual basis and balance apportioned on the basis of sales turnover of the units. Therefore ratio in the case of Zandhu pharmaceutical works private limited (supra) where R&D expenditure of the head office have been held to be not related to the units and therefore not allocable to those units, cannot be applied in the facts of the instant case before us.

Similarly in the case of Hindustan Lever Ltd (supra) decided by the Income-tax Appellate Tribunal ( Mumbai Bench), also the assessee claimed that expenses of chairman, company secretary, public relations department on salary and wages and staff welfare expenses relating to financial controller and chief medical officer as they were in no way connected to the running of the units. The Ld. first appellate authority in said case accordingly directed not to allocate those expenses to the units for the purpose of deduction under section 80HH and 80I of the Act. The Tribunal did not find any infirmity in the said order and upheld the same.

Before us, facts are different and the assessee itself has admitted connection of the head office expenses with the units and accordingly has allocated said expenses partly an actual basis and partly on the issue of sales turnover. Thus ratio of the above case, also cannot be applicable over the facts of the case of the assessee.

The Hon’ble Bombay High Court in the case of CIT Vs Hindustan Unilever Ltd (supra), has followed the finding in the case of Zandhu pharmaceutical works Ltd (supra).

In view of the above, we do not find any force in the arguments of the Learned Counsel of the assessee raised in support of additional ground and accordingly, we dismiss the same. As far as regular grounds for allocating the common expenses/head office expenses is concerned, we find that in the return of income filed and the Assessing Officer, the assessee has allocated common expenses/head office expenses partly on the actual basis and balance on the basis of the sales turnover, whereas the Ld. Assessing Officer has allocated such expenses on the basis of the sales turnover of the units. The assessee failed to substantiate before the lower authorities as how the part of expenses have been allocated on actual basis. The Ld. CIT(A) has specifically recorded in para 9.3 of the impugned order that the assessee could not brought any evidence before him to substantiate arguments as how the expenses had been allocated an actual basis. Before us also the assessee has not supported any evidence as how the expenses have been allocated on actual basis except referring table of expenses on page 6 to 8 of paper book. In absence of any such evidences, the action of the Assessing Officer in allocating the expenses on sales turnover basis is upheld, which is one of the reasonable method for allocation of expenses among manufacturing units. In the case of EHPT India P. Ltd (supra), the taxpayer company was engaged in rendering of software services /software development services and apportioned common/head office expenses on the basis of headcount of the units. It was submitted by the assessee before the Ld. first appellate authority that there was no judicial precedents available as to what would be the best method of apportionment in the cases of software development units, but the turnover basis adopted by the Assessing Officer was more suited to the manufacturing concerns, whereas the headcount basis was appropriate for service industry. The Tribunal in said case upheld apportioning of indirect expenses on the basis of the headcount, which was also accepted by the Income-tax authorities in earlier years. In above case, the Hon’ble Delhi High Court upheld the finding of the Tribunal observing as under:

In the case of the assessee, being a manufacturing concern, the sales turnover is one of the best method for allocation of common/head office expenses amongst the units. We may note that the assessee itself has adopted the sales turnover for allocation of the common/head office expenses, which it could not allocate on actual basis. Therefore, in such circumstances, we reject the contention of the assessee and uphold the finding of the lower authorities for allocation of the common/head office expenses on the basis of sales turnover of the respective units. The ground Nos. 3.1 and 3.2 and the additional ground raised by the assessee are accordingly dismissed.

In the result, the appeal of the assessee is partly allowed.