KIRLOSKAR BROTHERS LIMITED,PUNE vs. DCIT, CIRCLE 11(1), PUNE

आदेश आदेश / ORDER आदेश आदेश

PER D. KARUNAKARA RAO, AM:

There are 2 appeals under consideration and both are filed by the assessee involving A.Yrs. 2002-03 and 2003-04 against the two different orders of the CIT(A) commonly dated 19-10-2012. In both these appeals, the facts relating to claim of expenses, disallowances, arguments, penalty provisions, explanations, the issues for adjudication raised in the grounds are identical. The core issue relates to the correctness of levy of penalty u/s.271(1)(c) of the Act qua the addition on account of expenditure for payment of transportation charges, aftersales fee etc. Assessee paid to the entities in Dubai and Jordan in connection with the export sales of the assessee. Relying on the Volcker Committee Report

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the AO disallowed the claim u/s.37(1) of the Act. CIT(A)/ITAT confirmed

the same on merits on the ground of discharge of onus. Therefore, AO

levied the penalty u/s.271(1)(c) of the Act and the CIT(A) confirmed the

same. Therefore, the assessee is in appeal before the Tribunal for both

the years.

For the A.Y. 2003-04, the validity of the reassessment proceedings

is the additional legal issue raised in particular for adjudication vide the

appeal ITA No.2612/PUN/2012.

proceedings before us, assessee filed concise grounds and the said

grounds for A.Y. 2002-03 are as under :

“Ground of appeal No.1: The Ld. AO erred in CIT(A) erred in confirming the levy of penalty amounting to Rs.32,00,000/-. Ground of appeal No.2 : The Ld. AO & CIT(A) erred in not considering the explanations and submission filed by the assessee and also erred in not appreciating the fact that the assessee had no malafide intentions and has disclosed all relevant facts.”

Manufacturer of Pneumatic Tools. In the re-assessment proceedings for

both the years, AO made additions of Rs.89,40,596/- and

Rs.1,57,09,142/- for the A.Y. 2002-03 and A.Y. 2003-04 respectively.

These amounts are paid by the assessee to M/s. Azhar Trading

Company, Dubai and M/s.Alia for Transportation and General Trading

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Company, Jordan for receipt of services in the A.Yrs. 2002-03 and 2003-

04 respectively. These payments are made to them towards availing the

logistic services like Transportation charges, Aftersales fee, Service

charges etc.

Further, Assessee’s name appeared in the list of the persons

enlisted in the Volcker Committee Report (in short ‘VCR’). Other names

appeared in the list of VCR includes the names of M/s. Air Pac Exports,

TIL Limited, Mohan Exports, Ajanta Pharma Ltd., Man Industries, M/s.

Exim Trade links India Pvt. Ltd., M/s.Godrej & Boyce Co. Ltd., Bajaj

International Pvt. Ltd., Reliance Industries Ltd., Cosmos International

and Mather and Platt Pumps Ltd. etc.

proceedings in both the assessment years under consideration, in

response to the AO’s queries on the genuineness of these payments and

the applicability of provisions of section 37(1) of the Act, assessee

responded by explaining that the payments to Azhar Trading Company,

Dubai was paid towards Inland Transportation fee and partly paid to

Kisloskar Middle East. When it comes to the payment to M/s. Alia and

General Trading Company, Jordan, the said payments were made for

transportation fees. These services are availed by the assessee in

connection with the export of the goods by the assessee and the said

payments were made to the above said persons in connection with the

export sales to Iraq. The total export sales for the A.Y. 2002-03 and

2003-04 to Iraq are Rs.8,35,21,002/- and Rs.16,78,78,707/-

respectively. In support, the assessee filed the Bills and Invoices. The

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Bank details in support of the genuineness of the payments to the said

parties are also furnished. It is the case of the assessee before the AO

that the said payments were for commercial expediency and therefore,

the payments are genuine. The payments were made through banking

channels. However, the AO rejected the same stating that the assessee

failed to discharge the onus in matters of genuineness of the services

rendered by them to the assessee. AO invoked the restrictive provisions

of the Explanation to section 37(1) of the Act and proposed for

disallowance in both the assessment years. Further, reference is made

by the AO to the contents of the VCR regarding the Kickbacks paid by

the assessee to Iraq Government. However, it is submitted by the

assessee that payments made by the assessee are only to the said

persons and not to the Iraq Government authorities/officials.

Eventually, the AO rejected the explanation of the assessee and

proceeded to make addition of the same in both the years. The penalties

u/s.271(1)(c) of the I.T. Act were levied in connection with the said

additions and the penalty in both the years are Rs.32,00,000/- and

Rs.60,00,000/- respectively.

proceedings in quantum appeals, the additions in both the years were

confirmed. While the CIT(A) relies on the applicability of the provisions of

Explanation 1 to section 37(1) of the Act, the Tribunal invoked the said

provisions and held that the assessee failed to discharge the onus in

matters of establishing the payments are made for the business purposes

and not as kickbacks to Iraq Government. Further, the Tribunal also

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referred to the UN Resolution-986 on one side and to the Volcker

Committee on the other. The Tribunal also referred to a letter from

Kirloskar Middle East (KMC) dated 02-01-2002 which contains certain

ambiguities while confirming the addition on its merits. Thus, the

quantum additions have attained finality against the assessee at the level

of ITAT.

years, the facts include that AO levied the penalty of Rs.32,00,000/-_for

A.Y. 2002-03 and Rs.60,00,000/- for the A.Y. 2003-04. In both the

assessment orders, the case of the AO is that the sum of Rs.89,40,596/-

and Rs.1,57,09,142/- were paid to Azhar Trading Company, Dubai and

M/s. Alia and also the assessee’s name is found in the list of records of

VCR. These payments constitute the kickbacks paid to the Iraq

Authorities in connection with the supply of portable centrifugal pumps

to Ministry of Irrigation, Government of Iraq, under the Oil for Food

Programme. In Para No. 5 of the penalty order, the AO referred to the

allegations of receipt of kickbacks by the Iraq Government from the

suppliers. On these allegations, United Nations appointed a commission

under the Chairmanship of Mr. Paul Volcker which submitted a report.

The committee finds that the Iraq Government charged fee, i.e. inland

transportation fees and also in the name of the aftersales fees at the rate

of 10% of sales. Apart from many others assessee’s name also appeared

in the list of said suppliers. On these facts, AO holds that said payments

of alleged kickbacks attract the provisions of the Explanation 1 to section

37(1) of the Act. In this regard, the assessee furnished written

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submissions which were extracted by the AO in Para 2 of the penalty

order. On considering the explanation, AO rejected the explanation of

the assessee and held the penalty is leviable for the allegation of

furnishing of inaccurate particulars of income without having reasonable

explanation. In the order, AO relies on the Supreme Court judgments in

the case of Union of India Vs. Dharmendra Textile Processors (306 ITR

277) and in the case of CIT Vs. Reliance Petro Products Ltd. (322 ITR

158) for levying the penalty of Rs.32 lakhs for the A.Y. 2002-03 and

another sum of Rs.60 lakhs for the A.Y. 2003-04 with identical reasons.

assessee made sales of Rs.16.79 crores (rounded off) to the Iraq

Government and the payment is made to M/s.Alia for transportation fees

and towards aftersales fees to the tune of Rs.1,57,09,142/-. Thus,

figuring the assessee’s name in the VCR on one side, the provisions of

Explanation 1 to section 37(1) of the Act are the dominant reasons for

levy of said penalties in both the assessment years. CIT(A) confirmed the

said penalty stating that the UN Security Council’s Resolution-986 is

legally binding on United Nations Organization.

assessee filed the present appeals before us with the grounds

summarized above.

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PROCEEDINGS BEFORE THE TRIBUNAL – DECISION

explained the above facts of the case and referred to various documents

from the paper books. Assessee filed the paper book before us in support

of the arguments that the penalty should be deleted on the ground of (A)

commercial expediency; (B) Non-binding nature of the UNO Resolution in

the absence of any domestic law in support of restricting the rights of

citizens of India in doing business with Iraq institutions; (C) debatability

of the issues on merits as well as law; (D) Deemed provisions – No

Penalty etc.

paragraphs of this order. The arguments of the Counsels on each of

these issues and the decision of the Tribunal in this regard are discussed

and given on each of the major arguments of the counsels in the

following paragraphs.

A. COMMERCIAL EXPEDIENCY

addition of disallowance of expenditure and submitted briefly that the

assessee exported “portable centrifugal pumps” (PCPs) to Iraq in the

assessment years under consideration. PCPs are useful for transfer of

fluids/water/liquids by use of centrifugal force. Accordingly, the

turnover in this regard in both the years are Rs.8,35,21,002/- and

Rs.16,78,78,707/- respectively. Exporting them is the business activity

of the assessee. In this regard, assessee made the payments to Azhar

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Trading Company, Dubai and Kirloskar Middle East FZE (in short ‘KME’)

to the tune of Rs.87,61,920/- and also Rs.1,78,676/- towards inland

transportation fees, aftersales service fee etc., Further, assessee paid

Rs.1,57,09,142/- to Alia and General Trading Company, Jordan towards

transportation fees/aftersales service. Such payments are not new in

this line of business.

Assessee paid Rs.1,78,676/- to (1) Azhar Trading Company, Dubai

for inland transportation fee, aftersales service fee etc., (2)

Rs.87,61,920/- to Kirloskar Middle East FZE, (3) Rs.1,57,09,142/- to

M/s. Alia and M/s. General Trading Company, Jordan for transportation

fees and aftersales service fee.

A. Further, it is the case of Ld. Counsel for the assessee that these

amounts were paid in connection with the export sales for facilitating

transport of goods to the end point and for rendering other services such

as aftersales as per the agreement. Making of such payments for said

services/fee is essential and therefore, incurring of the same constitutes

allowable “business expenses”. All these payments are not only borne

out of the accounted books of the assessee but also made involving

banking channels. Hence, these claims are allowable in view of the set

principles of commercial expediency. Assessee relies on various

decisions in this regard. CIT Vs. Walchand and Company Pvt. Ltd. 65

ITR 0381, Dr. G. G. Joshi V. CIT 209 ITR 0324 (Gujarat) are relevant for

the proposition that the allowance of payment by way of commission or

kickbacks is allowable although the same is against the good morality

and public policy. However, these decisions were delivered prior to the

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relevant amendment to section 37(1) of the Act w.e.f. 01-04-2015

introduced by the Finance No.2 Act, 1998 with retrospective effect. By

the said legislation, the new Explanation is inserted to section 37(1) of

the Act making certain expenditure “not deemed to be incurred” for

purposes of the business and hence disallowable u/s.37 of the Act. AO

is of the view that these payments by the assessee is meant for kickbacks

to Iraqi Authorities for allowing the exports to Iraq under “Oil and Food

Programme. VCR is relied heavily by the ITAT/CIT(A) & the AO.

B. According to said Explanation 1 to section 37(1) of the Act, any

expenditure incurred for any purpose which is (1) an offence or (2)

prohibited by law, is deemed disallowable ones despite their business

connection. This provision is for “not deeming” the business expenses as

not allowable ones. In this regard, Ld. AR for the assessee laboured a lot

to demonstrate that the payment for Transportation charges, Aftersales

service etc. do not constitute the one incurred for the purpose of

committing any offence or any purpose prohibited by any domestic law.

Further, Ld. AR argued that the payments were made to M/s. Alia, M/s.

Azhar Trading Company, Dubai, and General Trading Company, Jordan,

etc. for defined services. It is not for the assessee to monitor the money

outflow of those payees. The payees are free to appropriate their funds

in the manner they find it appropriate. Assessee is not the financial

Auditor/Mentor for these payees. Assessee’s responsibility stops with

the making of the payments to the payees for the services received by the

assessee. If the payees incurred any expenditure for kickback to Iraqi

authorities, it is for them to explain and face the penal provisions as

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applicable to them in their country. Thus, the Explanation 1 of the

section 37(7) of the Act does not apply to the transactions held between

the payees and the Iraqi Authorities and they apply to ones between the

assessee and the payees only. So far as the assessee’s payment is

concerned, the same are incurred by the assessee for its business

purposes and not for the purposes of committing an offence and any

purposes prohibited under Indian Laws. As per Ld. AR, if the said

expenditure is not incurred, the assessee could not have recorded the

export turnover of Rs.8,35,21,002/- and Rs.16,78,78,707/- in the

assessment years under consideration. Referring to the order of the

Tribunal on the disallowances, Ld. Counsel submitted that the addition

was confirmed due to discrepancy in a letter between the assessee and

the foreign entity.

C. Further, Ld. Counsel submitted that amongst number of cases

appeared in the VCR, the assessee’s case is a solitary exception to the

rule that in no case the additions are sustained on merits. Therefore, in

many those cases, there is no issue of penalties u/s.271(1)(c) of the Act.

In other cases, the penalty stands deleted by the Tribunal. In this

regard, Ld. Counsel filed a note on the list of cases where similar

additions are deleted and penalty was also deleted on the ground of other

decisions/judgment. Thus, according to Ld. Counsel, the payments are

made in view of the commercial expediency. Assessee never paid the

kickbacks to the Iraqi Authorities; all the facts are disclosed in the books

of the assessee etc. Therefore, it is not a fit case for levy of penalty

u/s.271(1)(c) of the Act. Ld. Counsel also submits that the assessment

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and penalty proceedings are two different proceedings and therefore, the

confirming of the additions by the CIT/ITAT should not influence the

confirming of the penalty.

D. Per Contra, Ld. DR for the Revenue rely heavily on the orders of

the AO/CIT(A). Particularly, Ld. DR rely on the finding of the Tribunal on

the merits of the addition made u/s.37(1) of the Act. It is the case of the

Revenue and Ld. DR that the assessee failed to evidence the rendering of

transport/aftersales service. Ld. DR relied on the failure of the assessee

in discharging the onus. Ld. DR rely heavily on the finding of the

Tribunal on this failure of the assessee.

business expenditure qua the commercial expediency. Further, we find

this issue involves not deeming such business expenditure as not

allowable u/s.37(1) of the Act. We find that there is no dispute on facts,

i.e. (a) export of sales to Iraqi; (b) making the payments to aforesaid

parties in Dubai and Jordan; (c) accounting these transactions in the

books of account of the assessee etc. The issue of Revenue is that the

said payments are made for the purpose of paying to Iraqi Authorities by

way of kickbacks. Further, it is also a fact that the payments were paid

to parties in Dubai and Jordan and not paid as kickbacks to Iraqi

Authorities. The payments were made only to the aforesaid parties. It is

also a fact that the name of the assessee appeared in the VCR along with

many other names from India. We also find similar disallowance stand

allowed in favour of the assessee except in this case of the assessee. In

other words, similar expenses are not deemed as incurred for business

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purposes in those cases. The assessee’s solitary case is a case where the

additions are confirmed and therefore, case is that the assessee is an

exception to the rule where the expenses are “not deemed’ so. Not

deeming so happened in this case on technicalities relating to failure of

assessee to discharge the onus and failure to file evidences or filing some

irrelevant and messy evidences, a letter between the assessee and KME,

etc., It is not the case that the AO is in possession of some incriminating

evidences to prove that the services are not rendered by the said

Dubai/Jordan entities or assessee paid kickbacks to Iraqi Authorities.

Therefore, similar payments are found to be allowable business expenses

incurred for business purposes. While this being the finding of the

Tribunal in many other cases and, only in this case, the Tribunal held

otherwise on technicalities. The confirming of addition is mainly due to

the failure of the assessee in discharge of onus and non demonstration of

onus in matters of rendering of services by the said Dubai/Jordan

entities. Thus, on similar facts, there are divergent views of the Tribunal

of various benches. Thus, there exists a debate on if the said

expenditure should be either “not deemed” as ones covered by the

provisions of Explanation of section 37(1) of the Act or not. Further, it is

a settled legal proposition that the penalty is not leviable u/s.271(1)(c) of

the Act when the issue suffer from the dispute or debate. We hold

accordingly.

B. BINDING NATURE OF THE INTERNATIONAL TREATIES / CONVENTIONS / AGREEMENTS – UNSUPPORTED ENACTMENTS OF INDIAN PARLIAMENT

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A. Whether the UN Resolution-986 restricting the rights of citizens

has binding effect on the assessee? In this regard, AO and the CIT(A)

mentioned and relied heavily on the UN Council’s Resolution-986 and

submitted the same are binding on the Revenue. UN established OIP

Programme called “Oil-for-Food Programme” in 1995 allowing the Iraq to

sell their oil for Food and other humanitarian needs of its citizens.

Under this programme, assessee along with many Indian exporters

exported Portable Centrifugal Pumps to Iraq. However, there are various

allegations of abuse of the said OIP programme and payment of

kickbacks (commission) by various entities to the Iraqi Authorities by

way of transportation fees, aftersales service charges etc. United Nations

instituted an enquiry commission under the Chairmanship of Shri

Volcker. He submitted a report called “VCR”. The VCR contains various

Indian exporters names and assessee is one of them. All these exporters

are said to be the parties to the said alleged kickbacks. In these cases of

exporters, the allowability of the expenses was the common issue. In few

cases, AOs invoked the amended provisions of Explanation to section

37(1) of the Act and held that the said payments made by assessee are

routed to the Iraq authority by way of kickbacks. This is merely an

allegation and there is no finding of fact by any judicial forum. In this

context, referring to the UN Resolutions, terming these allegations as

unsustainable ones, Ld. Counsel submitted that the assessee never

made any payment for the kickbacks. Ld. Counsel for the assessee

submitted that no international agreements/conventions/treaties/UN

Resolution-986 etc. are not binding on the citizens of India unless the

said resolutions of UNO/agreements/conventions/treaties obtain the

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status of domestic Acts duly passed by the Indian Parliament with due

process of legislation in India. In this regard and to support his

argument, Ld. Counsel for the assessee relies heavily on the Supreme

Court judgment in the case of Maganbhai Ishwarbai Patel etc. Vs. UOI

and others AIR 1969 SC 783

B. Relying heavily on the said judgment of Supreme Court in the case

of Maganbhai Ishwarbai Patel etc. Vs. Union of India and others (supra),

Ld. Counsel argued that the said resolutions /agreements /conventions

/treaties are applicable to the Indian citizens so long as they do not have

any adverse impact on the rights of the citizens of India. He mentioned

that there is a requirement of converting such resolutions /agreements

/conventions/treaties into a law, the moment the rights of the citizens

are infringed by such international treaties/resolutions etc. Relying on

the said judgment of Apex Court, Ld. Counsel for the assessee submitted

that the said judgment was not available to ITAT/CIT(A)/AO at the time

when the quantum appeals were heard and finalized by the Tribunal.

Had this judgment been brought to the notice of the Tribunal, the

outcome of the proceeding on merits might have been different.

C. UN Resolution-986 has the adverse effect on the right of

business of the assessee : Mentioning about the rights of doing export

business of the assessee and notwithstanding the decision of the

Tribunal against the assessee on the quantum proceedings, when it

comes to the penalty proceedings, the said Apex Court judgment and its

ratio decidendi becomes extremely relevant. Further, as per Ld. Counsel,

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the violation by the assessee to the UN Council’s Resolution- 986 does

not become an offence or violation of any law as no Indian Law classifies

such payments to parties at Dubai/Jordan or Iraq as an offence or

otherwise. Consequently, the provisions of Explanation 1 to section 37(1)

of the Act is not validly invoked by the AO. The ratio of said Apex court

judgment in the case of Maganbhai Ishwarbai Patel Vs. UOI and others

(supra) does not allot the UN Resolution-986 as equivalent of Indian

Laws. Further, relying on the jurisdictional High Court judgment in the

case of Karan Dileep Nevatia Vs. The UOI in Writ Petition No.7852/2008

(page 392 of the paper book) and the judgment of Hon’ble Karnataka

High Court in the case of Civil Rights Vigilance Committee, SLSRC

College of Law, Bangalore Vs. UIO and others (Page 392 of paper book

No.4), Ld. Counsel for the assessee submitted that the positive

commitment to International accords of Government ignites legislative

action at home but does not automatically make the covenant an

enforceable part of corpus juris of India.

Relying on these judgments, Ld. Counsel summed up by stating

that assessee did not commit any offence or executed any activity

prohibited under law of India in matters of export sales or making

payments to M/s. Azhar Trading Company, Dubai, M/s. Alia and General

Trading Company, Jordan, etc.

D. Further, Ld. Counsel submitted that the payments made by the

assessee for Transportation and other logistical services are not for the

purpose of kickbacks to the Iraqi authorities. Therefore, the same is not

against any Indian Public Policy as the assessee never incurred

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kickbacks directly. Referring to VCR, Ld. Counsel submitted that the

VCR is merely an opinion of a committee and it never passed the test of

legal scrutiny. Therefore, the same is wrongly treated by AO/CIT(A) as

sacrosanct and made an unsustainable additions. So far as the assessee

is concerned, it is the case of making payment for business contingency

and how the said payment is appropriated is not for the assessee to

monitor. Further, Ld. Counsel submitted that in making the said

payments, there is no intention in furnishing any inaccurate particulars

of income as alleged by the AO and the CIT(A). Therefore, it is the case of

the assessee that the cited purpose of an offence or purposes of

committing any act prohibited by law mentioned in the explanation 1 to

section 37(1) of the Act are not done in the hands of the assessee.

Therefore, as per Ld. Counsel, the said provisions are wrongly invoked by

the authorities for levying the penalty. No domestic law was ever violated

by the assessee in making the said payments to M/s. Azhar Trading

Company, Dubai, M/s. Alia and General Trading Company, Jordan,

KME, etc as the case may be. The UN Council’s Resolution-986 is

neither the law of the land nor it does not infringe the rights of the Indian

businessman.

UN Resolution-986 and therefore, it has binding effect on the citizens of

India. Further, Ld. DR fairly submitted that the said judgment of

Supreme Court did not exist in the past and mentioned that the facts of

said judgment are distinguishable.

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ratio of Hon’ble Supreme Court’s judgment in the case Maganbhai

Ishwarlal Patel (supra), Karan Dileep Nevatia etc. The ratio of judgment

of Supreme Court in the case of Maganbhai Ishwarlal Patel (supra) is

extracted as under :

“77. The effect of an international treaty on the rights of citizens of the States concerned in the agreement is stated in Oppenheim's International Law, 8th Edn., at p. 40 thus

"Such treaties as affect private rights and, generally, as require for their enforcement by English courts a modification of common law or of a statute must receive parliamentary assent through an enabling Act of Parliament. To that extent binding treaties which are part of International Law do not form part of the law of the land unless expressly made so by the legislature."

and at p. 924 it is stated :

The binding force of a treaty concerns in principle the contracting States only, and not their subjects. As International Law is prim- arily a law between States only and exclusively, treaties can normally have effect upon States only. This rule can, as has been pointed out by the Permanent Court of International Justice, be altered by the express or implied terms of the treaty, in which case its provisions become self-executory. Otherwise, if treaties contain provisions with regard to rights and duties of the subjects of the contracting States, their courts, officials, and the like, these States must take steps as are necessary according to their Municipal Law, to make these provisions binding upon their subjects, courts, officials, and the like."

In Wade and Phillips' Constitutional Law, 7th Edn., :It is stated at p. 274 :

" At first sight the treaty-making power appears to conflict with the constitutional principle that the Queen by prerogative cannot alter the law of the land, but the provisions of a treaty duly ratified do not by virtue of the treaty alone have the force of municipal law. The assent of Parliament must be obtained and the necessary legislation passed before a court of law can enforce the treaty, should it conflict with the existing law."

On p. 275 it is stated that "treaties which, for their execution and application in the United Kingdom, require some addition to, or alteration of, the existing law" are treaties which involve legislation. The statement made by Sir Robert Phillimore, Judge of the Admiralty Court in The Parlement Belge(1)-(though the ultimate decision was revised by the Court of Appeal in another point [vide (1880) 5 P. D. 197] in dealing with the effect of a "Convention regulating Communications,by Post" signed and ratified in 1876 which purported to confer upon Belgian mail streamers. immunity of foreign warships is appropriate :

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"If the Crown had power without the authority of parliament by this treaty to order that the Parlement Belge should be entitled to all the privileges of a ship of war, then the warrant, which is prayed for against her as a wrong- doer on account of the collision, cannot issue, and the right of the subject, but for this order unquestionable, to recover damages for the injuries done to him by her is extinguished.

This is a use of the treaty-making prerogative of the Crown which I believe to be without precedent, and in principle contrary to the laws of the Constitution."

"It will be essential to keep in mind the distinction between (1) the formation, and (2) the performance, of the obligations constituted by a treaty, using that word as comprising any agreement between two or more sovereign States. Within the British Empire there is a well-established rule that the making of a treaty is an executive act, while the performance of its obligations, if they entail alteration of the existing domestic law, requires legislative action. Unlike some other countries, the, stipulations of a treaty duly ratified do not within the Empire, by virtue of the treaty alone, have the force of law. If the national executive, the Government of the day, decide to incur the obligations of a treaty which involve alteration of law they have to run the risk of obtaining the assent of Parliament to the necessary statute or statutes.....Parliament, no, doubt, .... has a constitutional control over the executive : but it cannot be disputed that the creation of the obligation.-. undertaken in treaties and the assent to their form and quality are the function of the executive alone. Once they are created, while they bind the State as against the other contracting parties, Parliament may refuse to perform them and so leave the State in default."

These observations are valid in the context of our constitutional set up. By Art. 73, subject to the provisions of the Constitution, the executive power of the Union extends to the matters with respect to which the Parliament has power to make laws. Our Constitution makes no- provision making legislation a condition of the entry into an international treaty in times either of war or peace. The executive power of the Union is vested in the, President and is exercisable in accordance with the Constitution. The executive is qua the State competent to represent the State in all matters international and may by agreement, convention or treaties incur obligations which in international law are binding upon the State. But the- obligations arising under the agreement or treaties are not by their own force binding upon Indian nationals. The power to legislate in respect of treaties lies

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with the Parliament under Entries 10 and 14 of List I of the Seventh Schedule. But making of law under that authority is necessary when the treaty or agreement operates to restrict the rights of citizens or others or modifies the laws of the State. If the rights of the citizens or others which are justiciable are not affected, no legislative measure is needed to give effect to the agreement or treaty.

……………..

Considering the said judgment, on one side and the UN

Resolution-986 on the other, we find that there is need for domestic

legislation for restricting the business rights of the citizens in India.

14.1 The Hon’ble Supreme Court pronounced the judgment in the

context of ceding of part of land qua the order of International Tribunal.

The above said judgment of Supreme Court in the case of Maganbhai

Ishwarbhai Patel etc (supra) is categorical in pronouncing that no order

of an International Court effect adversely the rights of the citizens in

20 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

India. In this regard, we proceed to examine if the UN Resolution-986

has the capability of infringing the rights of Indians. As per the said UN

Resolution-986, the Indian, along with other member countries abroad,

are allowed to export to Iraq only under Oil-for-Food programme and not

otherwise. As such, no domestic enactment exist to support the same.

From this point of view, the effect of UN Resolution-986 infringes on the

rights of citizens. Such resolution, being in the nature of executive

order do not have the power of taking away the rights of the Indian

citizens. As such UN Resolution-986 cannot decide if an Indian citizen

can export his goods to Iraqi or not either under Oil-for-Food programme

or otherwise.

From this view point, we are of the view that the failure of the

assessee in not complying with the UN Resolution-986 do not constitute

an “offence” for the purpose of Explanation 1 to section 37(1) of the Act.

Thus, for the purpose of levy of penalty u/s.271(1)(c) of the Act in respect

of the payments for transport charges, aftersales fees to M/s. Azhar

Trading Company, Dubai, M/s. Alia and General Trading Company,

Jordan, KME etc., the penalty is not sustainable. The payments do not

constitute for the purpose of committing an offence or the same is

prohibited by any law. We order accordingly. When there is no

restrictive provisions, assessee is free to export his goods to any country

including Iraq. Therefore, no international treaty or UN Resolution-986

can take away that right of the Indian businessman.

21 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

C. WHEN THE ISSUES ARE DEBATABLE – NO PENALTY IS LEVIABLE

Company, Dubai, M/s. Alia and General Trading Company, Jordan, KME

etc. towards transportation/aftersales services etc. u/s.37(1) of the Act

attracted attention of the various benches of the Tribunal on one side

and the Calcutta High Court on the other side. The same is relevant in

the context of UN Council Resolution-986 qua the ‘Oil-for-Food

Programme. The allegation of kickbacks to the Iraq Government was

examined by the said High Court/Tribunals. In large number of cases

mentioned above, the expenditure claimed by the assessee on accounts

of transportation charges and aftersales services fee were found allowable

u/s.37(1) of the Act. The only difference in this case is with reference to

messy letter dated 01-02-2012 of KME which created negative opinion

against the assessee. The said letter may be sufficient evidence to make

addition but not for levy of penalty. According to Ld. Counsel for the

assessee, if the said letter is ignored, the facts of the present case is

exactly similar and therefore, the additions are unsustainable. The

Tribunal deleted similar addition in the other group cases of the

assessee, i.e. Kirloskar Oil Engines Ltd.. Therefore, the penalty is not

leviable in view of the above referred series of decisions tabulated above.

D. DEBATABILITY

Regarding the debatability, Ld. Counsel for the assessee submitted

that the assessee’s case is the only one case, where the additions are

confirmed on merits. In all other cases, assessee was found eligible for

22 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

claim of expenses and which were allowed. Therefore, on this issue of

claim of expenditure, there is variance, i.e. (1) same assessee never

claimed such expenditure as allowable expenditure at all; (2) others like

CIT Vs. Rajarani Exports Pvt. Ltd. (361 ITR 152 (Cal.) (DCIT Vs.Rajrani

Exports Pvt. Ltd.17 ITR (Trib.) 239 (Kol.) case claimed and were allowed

too; (3) assessee claimed as allowable but disallowed by the AO and

confirmed by the Tribunal in the present case. Thus, there is huge

amount of debate on the nature of allowability of the claim that the

payments made to M/s. Azhar Trading Company, Dubai, M/s. Alia and

General Trading Company, Jordan, KME. In such case, the issue is

debatable and therefore, penalty should not be levied.

E. LIST OF THE LEGAL PRECEDENTS ON THE SIMILAR PAYMENTS MADE TO SIMILAR PARTIES ABROAD AMDN MENTIONED THE DIVERGENT FINDINGS BY VARIOUS BENCHES OF THE TRIBUNAL

16.A. Ld. Counsel for the assessee mentioning the divergent findings by

various Benches of the Tribunal submitted that, in the following cases,

the payments were made to M/s. Azhar Trading Company, Dubai, M/s.

Alia and General Trading Company, Jordan, KME etc. and the said

payments were found allowable u/s.37(1) of the Act. Consequently,

penalties do not survive.

B. To start with, Ld. Counsel mentioned that in the case of Kirloskar

Oil Engineers Ltd. in ITA No.1170/PN/2011, the Pune Bench of the

Tribunal considered the payments are genuine and held allowable

u/s.37(1) of the Act. Referring to the order of the Mumbai Bench of the

Tribunal in the case of M/s.Exim Trade Links India Pvt. Ltd. in ITA

23 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

No.4266/Mum/2009, Ld. Counsel submitted that the payments was

found allowable. Therefore, the question of levy of penalty does not

arise. Various other cases, where the allegation of Kickbacks made to

Iraq Government is there, were found allowable by various benches of the

Tribunal/High Court.

C. Further, there is debate on if the payments made by the assessee

are for kickbacks at all in the present case and allowable u/s.37(1) of the

Act or not. He submitted that the Tribunal confirmed the addition in the

present case for failure to discharge of onus by the assessee and not

because of any adverse and direct evidences against the assessee in

matters of rendering of services. As such, there is no direct evidence in

support of payment of the kickback to Iraqi Authorities. Further, there is

debate on the sacredness of the VCR and their findings and they were

never scrutinized legally in forms of law. Therefore, assessee ought to

win on the issue of penalty on the ground of debatability. There are

catena of binding judgments for the legal proposition that the penalty

u/s.271(1)(c) of the Act are not sustainable when the issue is not free

from the debate. We order accordingly.

F. EXPLANATION 1 TO SECTION 37(1) –DEEMED PROVISIONS – NO PENALTY IS LEVIABLE

attention to the Explanation 1 to section 37(1) of the Act argued that the

Explanation 1 merely constitutes deemed provisions and the same may

be appropriate so far as the disallowance of expenditure is concerned.

24 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

However, when it comes to the levy of penalties u/s.271(1)(c) of the Act is

concerned, the penalties linked to the deemed income are not validly

levied. Relying on the various decisions in this regard, Ld. Counsel for

the assessee submitted that the penalties are required to be deleted since

the same are deemed to have been incurred for the purpose of business

or profession. Assessee also relied on various decisions in this regard.

PENALTY – CONCLUSION OF THE TRIBUNAL

arguments of Ld. DR as well as Ld. Counsel for the assessee on each of

the issues, i.e. (1) Commercial Expediency; (2) Binding nature of the

International Treaties/Conventions/Agreements; (3) Applicability of

Judgment of Supreme Court in the case of Maganbhai Ishwarbhai Patel

etc Vs. Union of India and others; (4) Debatability of the issues; (5) Legal

precedents on the similar payments made to similar parties abroad; and

(6)Deemed Explanation 1 to section 37(1) of the Act etc.,

We have also analysed facts of the issue on one side and the

provisions of section 37(1) and the Explanation (1) wherever applicable

and find the Explanation (1) does not permit deduction or allowance out

of the business expenses if certain expenses are not to be deemed to have

been incurred for business purposes. We have held that the said

Explanation is a deeming provision in the context of business

expenditure only. The language in the Explanation is negatively worded

for not deeming certain business expenses as not allowable or deductible

business expenditure u/s.37(1) of the Act. Further, in the context of

25 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

commercial expediency, we have analysed the expenditure incurred is for

transportation charges, aftersales service fee etc. which are obviously

business and allowable expenditure but for the deeming provisions of the

Explanation. Whether such expenditure falls under the category of

expenditure not to be deemed as incurred for business purposed within

the meaning of said Explanation (1), we observed that there is no

evidence on records to indicate that the assessee paid the kickbacks

directly to the Iraqi Authorities. Therefore, in the penalty proceedings,

the payments made by the assessee needs to be considered for the

transportation charges, aftersales service fee in the context of export of

the portable centrifugal pumps for use in Iraq under Oil-for-Food

Program of United Nations Organisation. Such claims are allowed in

favour of the assessee in large number of cases mentioned above.

Further, we have analysed the series of decisions and various types in it

and held, barring the instant case of the assessee, in all other cases, the

expenditure was found allowable u/s.37(1) of the Act on similar facts.

Further, we have dealt that the principle of debatability on various

counts connected to the claim of the assessee. On merits of the claims,

there are divergent decisions in favour and against allowing the claim of

deduction. Further also, the decision of Hon’ble Supreme Court in the

case of Maganbhai Ishwarbhai Patel etc. Vs. Union of India and others

(supra) was analysed and found the same is relevant for the proposition

that, wherever the rights of the citizens are restricted by way of

Treaties/Conventions/Agreements etc. like the case of UN Resolution-

986, there is a requirement of domestic law ratifying the said restrictions

of the UN Resolution. In the absence of any domestic law passed by the

26 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

Indian Parliament, such resolution cannot create an offence in the

context of Explanation (1) to section 37(1) of the Act and against the

assessee.

Therefore, the allegation of committing the offence by the assessee,

ignoring the fact of making payment by the assessee to the said entities

and not to the Iraqi Authorities, is unsustainable legally. The said

judgment of Hon’ble Supreme Court is very categoric in this regard.

Further, this is a case where AO merely relied on VCR which is not a

legal document duly scrutinised by any legal forum. Mere existence of

assessee’s name in the list of Indian entities appended to the VCR,

cannot be accepted as sacrosanct in these penalty proceedings. The

matters relating to income-tax has to be decided based on the income-tax

law and not based on the VCR of UN Resolution. The above findings are

borne out of the judgment/order in the case of CIT Rajarani Exports Pvt.

Ltd. (supra). This judgment is relevant for the proposition that, no

illegality in making payment of commission when there is no evidence to

show the transaction relating to the payment of commission is not

genuine or the payment is excessive or unreasonable. Relevant extract of

the findings of the Tribunal in the case of DCIT Vs. Rajrani Exports Pvt.

Ltd. (supra) are reproduced here below :

“15. The assessee has made payment for commission and has been rendered services in consideration of the same. As a matter of fact, it is not even revenue’s case that no services have been rendered at all. The fact that services have been rendered by a party other than the agent to whom commission is paid is wholly immaterial so far as deductibility in the hands of the assessee is concerned. 16. As for the position that the payment was highly excessive vis -à-vis the local costs, even if that be so, that aspect of the matter does not affect the deductibility in the hands of the assessee either. The assessee is concerned with commercial expediency of the said payment and not with

27 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

what are the actual costs incurred in rendering the services for which the payment is made. As we have seen earlier in this order, from the extracts of the Volker Committee report itself, it was absolutely necessary for the assessee to make the impugned payments and, in any event, the commercial expediency of these payments has not even been called into question by the Assessing Officer. The case of the revenue is confined to invoking the Explanation to Section 37(1). 17. The objections to the said commission payments do not, therefore , are not therefore sustainable in law, so far as deductibility under section 37(1) is concerned.”

The Revenue challenged the findings of the Tribunal before the

Hon’ble Calcutta High Court. The Hon’ble High Court confirmed the

findings of the Tribunal and held that where the assessee paid

commission on exports through banking channel in pursuance of an

agreement approved by Govt. of India and the United Nations, same

could not be disallowed in absence of evidence of its illegality.

Relying on the said judgment, the Mumbai Bench of the Tribunal

in the case of M/s.Man Industries India Ltd. in ACIT in ITA

No.6695/Mum/2014 decided on 12-02-2017 deleted the penalty

u/s.271(1)(c) of the Act read with Explanation 1 thereto considering the

similarity of facts as well as the above legal proposition. Para No.6 of the

order of Tribunal is relevant. For the sake of completeness, we proceed

to extract the same below :

“6. The decision of the Tribunal has upheld by the Hon’ble Calcutta High Court by dismissing the appeal of the revenue by holding that there was no infirmity in the order of appellate authority and therefore the payment of commission should not be disallowed. By applying the same analogy to the present case, we hold that the penalty cannot be imposed merely on the basis that the assessee has not filed any appeal against the quantum addition and more so when the tribunal decision upholding the claim of the assessee to claim the payments of charges to Iraqi regime as admissible which stands upheld by the jurisdictional high court. The penalty proceedings are independent proceedings which are to be decided on the basis of merits of each case. In the present case, the Calcutta

28 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

Bench of the Tribunal has already decided that the payment made on account of transportation charges as admissible which cannot be disallowed on the basis of Volcker Committee report and hence penalty on such disallowance which is wrong and against the spirit of the Act cannot be sustained. Accordingly, we set aside the order of ld. CIT(A) and direct the AO to delete the penalty.”

Therefore, it is a case where debatability exists both on facts as

well as on law. On law, the debate is whether the expenditure is

allowable or not; and, on legal front, the debate is whether the payments

made by the intermediaries to the Iraq Authorities constitutes an offence

committed by the assessee or not. Amidst all these debatabilities, we are

of the opinion that the levy of penalty in both the assessment years is

unsustainable.

made a contention that the additions u/s.37(1) of the Act becomes

unsustainable due to likely favourable finding on the invalidity of

reassessment proceedings. In our view, adjudication of this issue

becomes an academic exercise in view of the deletion of penalty by us on

the ground of debatability. Accordingly, relevant grounds are dismissed

as academic.

Order pronounced on 19th day of September, 2018.

Sd/- Sd/- (िवकास अव�थी िवकास अव�थी िवकास अव�थी /VIKAS AWASTHY) (डी िवकास अव�थी डी डी. क�णाकरा राव डी क�णाकरा राव क�णाकरा राव/D. KARUNAKARA RAO) क�णाकरा राव �याियक सद�य/JUDICIAL MEMBER लेखा सद�य �याियक सद�य लेखा सद�य/ACCOUNTANT MEMBER �याियक सद�य �याियक सद�य लेखा सद�य लेखा सद�य पुणे / Pune; �दनांक / Dated : 19th September, 2018. Satish

29 ITA Nos. 2611 & 2612/PUN/2012 Kirloskar Brothers Limited

आदेश क� आदेश क� �ितिलिप अ�ेिषत आदेश क� आदेश क� �ितिलिप अ�ेिषत �ितिलिप अ�ेिषत / Copy of the Order forwarded to : �ितिलिप अ�ेिषत

अपीलाथ� / The Appellant. 1. ��यथ� / The Respondent. 2. 3. The CIT(Appeals)-1, Pune. 4. The Pr. CIT-1, Pune. िवभागीय �ितिनिध, आयकर अपीलीय अिधकरण, “बी बी बी” ब�च, बी 5. पुणे / DR, ITAT, “B” Bench, Pune. गाड� फ़ाइल / Guard File. 6.

आदेशानुसार / BY ORDER, // True Copy // Senior Private Secretary आयकर अपीलीय अिधकरण, पुणे / ITAT, Pune