FIBRES & FABRICS INTERNATIONAL P LTD,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX,CIRCEL-11(3), BANGALORE

Per INTURI RAMA RAO, AM :

This is an appeal filed by the assessee-company, directed against the order of the learned Commissioner of Income-tax (Appeals)-I [‘CIT(A)’], Bangalore, dated 1/8/2014 for the assessment year 2005-06.

ITA No.1352/Bang/2014 Page 2 of 37 “Based on the facts and circumstances of the case, Fibres and Fabrics International Private Limited [the Appellant"] respectfully prefers an appeal under Section 253 of the Income-tax Act. 1961 ['the Act"], against the Order ("impugned order") passed by the Commissioner of Income- tax (Appeals)-I, Bangalore ["learned CIT(A)"] dated 01 August 2014 (received on 09 October 2014), on the following grounds, which may kindly be considered without prejudice to one another Ground 1: Order contrary to law, facts and is violative of principles of natural justice 1.1 The impugned order is grossly without jurisdiction, unjust, unlawful and bad in law, as the same is contrary to the express provisions of the Act and facts. as also the law as laid down by Hon'ble Court(s). Further impugned order reached wrong conclusions without affording complete opportunity to the Appellant to meet all the new objections/ grounds stated therein. Ground 2: Initiation of reassessment proceedings is without jurisdiction, illegal and untenable 2.1 The impugned order erred in upholding the validity of reassessment proceedings and failed to appreciate that proceedings initiated under Section 147 of the Act are invalid, unlawful and grossly without jurisdiction, as preconditions prescribed in law were not satisfied 2.2 The impugned order proceeds on unsubstantiated presumptions while completely ignoring correct and relevant facts on record to erroneously uphold the exercise of jurisdiction under Section 147 of the Act by wrongly relying on the decision not applicable to the facts of the case. 2.3 The learned CIT(A) has failed to appreciate that 'reason to believe' is a sine qua non for initiating the reassessment proceedings under Section 147 of the Act, that the reasons as recorded at the time of initiation of proceedings are sacrosanct and that it is impermissible to subsequently complete/ alter/ modify/ improve the same.

ITA No.1352/Bang/2014 Page 3 of 37 2.4 The learned CIT(A) has failed to appreciate that reassessment on mere 'change of opinion' and complete absence of any new 'tangible material' is not permissible in law. 2.5 The learned CIT(A) has erred in routinely and wrongly relying on court decision(s) involving completely different factual background to uphold invocation of jurisdiction under Section 147 of the Act. Without prejudice to above Ground 3: Disallowance of commission on sales 3.1 The learned CIT(A) has erred in upholding the disallowance of the Appellants claim for deduction of routine business expenditure amounting to Rs.16.21,45,504 paid towards sales commission, totally disregarding the submissions/ evidence on record, proceeding purely on conjectures and surmises, without citing any valid reasons basis. 3.2 The learned CIT(A) has erred in not considering the additional evidence, which is not only essential for deciding the dispute as per orders relied on by the learned Assessing Officer (learned AO"), but also goes to the very basis of the dispute and which positively establishes the service received. 3.3 The learned CIT(A) has erred in accepting the disallowance of the Appellant's valid business expenditure without citing any valid basis and/ or on irrelevant and vague considerations. The CIT(A) has erred in routinely accepting the allegation of the learned AO that there was no proper documentary evidence while failing to even consider the material produced on record and citing extraneous and irrelevant reasons. Ground 4: Disallowance of depreciation on "Goodwill" 4.1 Without prejudice to the Appellant's contention that if the disallowance of expenditure towards sales commission is deleted on merits or exercise of jurisdiction under Section 147 of the Act is held to be invalid, the disallowance of depreciation on Goodwill requires to be deleted, the learned CIT(A) has erred in not

ITA No.1352/Bang/2014 Page 4 of 37 appreciating that the Appellant's claim of depreciation on "Goodwill" amounting to Rs 6,56,25,000 is as per provisions of Section 32(1)(ii) of the Act is therefore, fully justified in law. 4.2 The learned CIT(A) has erred in not following Court decisions including that of the Honble Supreme Court of India in the case of CIT v. SMIFS Securities Ltd. 348 ITR 302 and the decision of the Hon'ble Delhi High Court in the case of CIT v. Hindustan Coca Cola Beverages (P) Ltd. 331 ITR 192. 4.3 The learned CIT(A) has erred in lightly disregarding various submissions filed by the Appellant during the course of appellate proceedings and in upholding the disallowance by wrongly and mechanically relying on decision in orders relating to subsequent years without citing any valid reasons. Further, the Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal, at any time before, or at the time of hearing of the appeal.”

ITA No.1352/Bang/2014 Page 5 of 37 4. A survey was conducted in the business premises of the assessee-company on 5/11/2009. Assessments for assessment years 2006-07 and 2007-08 were completed post survey operations. Based on survey, the Assessing Officer [AO] issued notice u/s 148 dated 12/3/2010 proposing to re-assess the total income for the assessment year 2005-06. After receipt of notice u/s 148, the assessee-company requested the AO to furnish reasons recorded for issue of notice u/s 148 vide letter dated 19/3/2010. In the mean while, the assessee-company filed writ petition before the Hon’ble High Court of Karnataka challenging the validity of the survey proceedings. During the course of writ proceedings before the Hon’ble High Court, the AO was directed to furnish the reasons. The AO complied with the directions of the Hon’ble High Court and furnished the reasons and the writ petition was withdrawn. The reasons recorded by the AO for issuing notice u/s 148 are as under: “The assessee filed return of income for the A. Y. 2005-06 on 31.10.2005 declaring an income of Rs. 28,94,18,182/-Assessment in this case was completed u/s 143(3) on 31.12.2008 determining a total income of Rs. 31,04,68,3881-. In this case a survey u/s 133A was conducted on 5. 11.2009 and during the course of survey, along with other issues, expenses debited to the P&L A/c were verified and it was found that the assessee has incurred huge expenses in the nature of Info Tracking and Delivery schedule which is paid to a foreign company namely M/s South Elegant Limited, Hong Kong as per the Service Agreement entered into between the assessee company and M/s South Elegant Limited dated 1.7.2002. During the course of post survey proceedings statement of the Managing Director of the company Shri Anupam Kothari was

ITA No.1352/Bang/2014 Page 6 of 37 recorded and was asked to substantiate this agreement and payments made in pursuance to this agreement and it is found that the reply of the Managing Director to most of the queries were evasive in nature and surprisingly, to quote a few, he could not substantiate with whom from South Elegant he had interacted or even to say where this deal was entered into and when. Surprisingly this agreement was cancelled on 26.10.2005 though it was made for a period up to 2012 and the so called termination is done again through a three line letter and huge sum running into tens of crores rupees has been paid by the assessee company towards termination fee. The genuineness of this Info Trekking and Delivery schedule expenditure was not proved by the assessee to the satisfaction of the Assessing Officer and even the assessee could not prove the legality of this document as the document in question was on a plain sheet of paper, neither registered nor notarized or either witnessed by any person or even does not have the name of the authorized person as such. Furthermore the assessee company could not prove beyond doubt the necessity of such expenditure as this kind of expenditure is unknown in this line of trade. Accordingly in the order passed u/ s 143(3) for A. Y. 2006- 07 the expenses debited under this head of Rs.10,68,71,384/ - was disallowed and added to the returned income. Similar nature of expenditure has been debited by the assessee company for the financial year 2003-04, 2004-05 also. On verification of records of the assessee for the A. Y. 2005-06 it was found that similar expenses has been paid by the assessee in the name of Commission - Sales amounting to Rs. 16,93,91,847/- and these commission payments have been paid to M/ s South Elegant Limited, Hong Kong and M/ s Gryters of Netherland along with others. As this issue was not examined in the original assessment proceeding and has come to light on account of survey u/ s 133A, I have reason to believe that income chargeable to tax has escaped assessment within the meaning of section 147 of the Income-tax Act, 1961 for the A. Y. 2005- 06"

ITA No.1352/Bang/2014 Page 7 of 37 assessment year 2005-06 may be treated as the return in response to notice u/s 148. The assessee-company objected to the re-assessment proceedings before the AO on the ground that the re-assessment proceedings are merely prompted by mere change of opinion. The objections have been turned down by the AO and he proceeded with making of fresh assessment order.

ITA No.1352/Bang/2014 Page 8 of 37 the assessee company get orders. The transactions are all entered in the assessee's books. The payments to the parties are through banking channel. The turnover for the year under assessment is close to Rs. 166,17,14,885/- and the same was capable of being achieved only on account of the support given by the agents of the assessee company in sending the timely information and support to ensure that orders are placed to the assessee company. The assessee company has paid the Commissioner to South Elegant Limited of Hong Kong and this party has not come to India to the best of their recollection. The customers visit G- Star International B.V. Netherlands and visit the assessee's factory at the instance of the above agent. Copies of invoices raised by the above party has also been filed along with the copies of letters of agreement with them. Documents such as ledger extracts as appearing in the books of the assessee company towards these expenses are also filed. It is claimed that the payments are made through authorised dealers and they are routed through the bank accounts. It has been mentioned that the rate of these charges are not unique and it depends upon the multiple factors like customers, season, product design etc., It has been clearly stated that no TDS is made as the services rendered is for procuring orders from oversea customers and hence the services are not rendered in India and the services are done entirely outside India and no part of the same requires TDS. The obligation of the agents is to identify customers abroad and send their full market report on the potential customers for their requirement world wide. The agents have procured orders from the assessee's various customers and also ensure payments have come to the assessee in time. That as per the Board's Circular No.786 dated 07.02.2007 where non resident operates outside the country no part of income arises in India and further as the payment is remitted directly abroad it is paid to agents directly. Hence it is claimed that the provisions of Sec. 195 are not applicable. That the payment where effected to the parties are wholly and exclusively for the assessee's business activities and all necessary documents to substantiate and in support of payment filed. ”

ITA No.1352/Bang/2014 Page 9 of 37

“During the relevant year, it is seen from the relevant ledger extract filed that the entire payments of Rs. 16,93,91,847/- are to South Elegant Ltd., of Hong Kong and Gruyters Agenturen B.V.. The various terms of agreement with the South Elegant Limited gave rise to a doubt as to the genuineness of the very document. The discreet enquiries caused revealed that the South Elegant of Hong Kong is likely to be a non existent concern. Further, without accepting and for a while it is assumed that there existed a concern by said name at Hong Kong, from the explanation given by the assessee company in its various replies whether the said concern had necessary infrastructure or expertise or man power to render the required services as per the agreement in Italy is again a mute point. A survey was undertaken in the business premises of the assessee company as the assessee had made huge payments under "Commission / delivery tracking charges" to this foreign company during the financial years 2003-04 to 2005-06 and other payments. During the course of Survey on 5.11.2009, a statement on oath of Shri. V. Sreedhar, General Manager (Fin) of the company was recorded confronting him about the details of the above payment, genuineness thereof and the business relevance of the expenditure. Later, the said points were confronted to Mr. Anuparn Kothari, Managing director of the company who also could not satisfactorily explain the various aspects. The Managing Director of the company (Mr. Anupam Kothari) has been living in Italy / Monte Carlo since last 10 years and the major dealings of the company including the export of finished garments and import of fabric etc., are with Italian based companies though in a few cases the sales / purchases have been made from Netherland based companies also. Keeping this in view and the unsatisfactory reply forthcoming from the General Manager (Fin) and the Managing Director of the company, I hold that it is highly unlikely as to why the assessee company will pay such huge amount to non resident company at Hong Kong. I hold that the payment made to Gruyters Agenturen B.V and South Elegant of Hong Kong is not genuine payment which is wholly and exclusively necessary for earning the business income of the assessee company. Further, the expenditure in the nature of tracking delivery charges have not been seen in any other similar export cases. ……………..

ITA No.1352/Bang/2014 Page 10 of 37 The assessee had no other valid proof except the proof of transfer of money through banking channels which does not render the payment the attributes of genuineness. The contract was not legal being executed on plain paper and the authorized signatories and witnesses are being identifiable for examination the claim of the assessee that the payment was on the basis of contract is itself doubtful, The relationship between the payer and payee was not a live one because inspite of agreement between the parties, the payee SEL never visited the premises of appellant in India and such type of non living non-existent relationship itself gives a hunch that the payment is not genuine and the contract is only a window dressing to cover the non- genuine payment. Further even if the payment is through banks it does not prove the payment is for business purposes and cannot be allowed u/s 37(1) of the I.T.Act. Further the assessee while crediting the account of the non-resident South Elegant Limited, never filed any application u/s 195(2) of the IT Act and therefore the entire sum is to be added u/s 40(a)(i). The fact is also that survey u/s 133A was conducted in the business premises of the assessee on 5.11.2009, in which no original agreement dated 1.7.2002 could be found which itself could be held as an evidence that payment were for some other purpose and had not been on the basis of alleged contract or scheme of arrangement. This stand of revenue is further streghthened by the statement recorded u/s 131 from Mr. Kothari, CMD who expressed his ignorance about the existence of any such contract. Mr. Kothari is the CMD who is an all knowing person having full control over the activities of the appellant even if sitting in Italy coming to India for a few days having the knowledge of all tit bits of the company for which he is being paid a huge salary. If such a person says in clear terms that he does not remember about any agreement between SEL and the assessee, it has to be held that no agreement ever existed and the payments are not genuine. Further more even if it is agreed that there is a payment, it is necessary to examine whether the payee was capable of doing such business as to make it eligible to receive such payment. During the course of assessment proceeding the AR was asked to furnish proof as to confirm that such company own manpower, machineries and technology to provide the tracing services but no proof was furnished. It is not out of place to mention here that on the similar issue an addition of Rs.10,68,71,384/- was made for the AY 2006-07 and against this order assessee preferred appeal

ITA No.1352/Bang/2014 Page 11 of 37 and this ground of appeal was dismissed by the CIT(A) vide ITA No. 63 & 97/DC 11(3)/A-1/09-10 dated 11.8.2010 holding that: - the agreement in question is on a plain sheet of paper, not enforceable in the court of law and cannot be held as a contract at all. - the assessee has not produced any documentary evidence in support of the claim that a company by name South Elegant Limited by filing copies of incorporation certificate, commencement of business certificates, Memorandum and Articles of Association, exact location of the place of business, nature of its activity, financial statement, the audit ports etc. etc. either at assessment stage or at the stage of appeal though the onus of proving the genuineness of transaction was with the assessee. - No evidence in support of the claim is produced as to South Elegant Limited had enough manpower, machineries and technology to provide the tracking services. For the above reasons, the claim of the assessee for the expenditure of Rs.16,93,91,847/- representing 49- Sales" is disallowed and added to the total income.”

The AO disallowed depreciation on goodwill of Rs.26,25,00,000/- thus completing the re-assessment by way of order dated 27/12/2010.

ITA No.1352/Bang/2014 Page 12 of 37 claim was accepted in the original assessment, that would not preclude the AO from reopening the assessment. The CIT(A) also upheld the disallowance of commission expenditure of Rs.15,93,91,842/- citing that the outstanding amount of commission payable is much more than the commission paid. Therefore, this would create doubt as to genuineness of the commission expenditure. He also disallowed depreciation on goodwill on the ground that it had not acquired any rights of commercial nature.

ITA No.1352/Bang/2014 Page 13 of 37 further submitted that based on the reasons recorded, re- assessment proceedings cannot be upheld, as the reasons recorded only lead to a suspicion and not to reasons to believe. In support of this proposition, he relied on the decisions of the Hon’ble Apex Court in the Sheonath (supra) and ITO vs. Lakhmani Mewal Das (103 ITR 437). On merits of disallowance of commission expenditure, learned counsel for assessee submitted that the following material was produced before the AO during the course of the original assessment proceedings in support of the claim for deduction of commission expenditure:

(i) copy of the agreement (ii) audited financial statement (iii) invoices raised and (iv) proof of payment through banking channel,

He controverted the allegation of the AO that discreet enquiry revealed non-existence of the service provider. He further submitted that the agreement copy with service provider was produced before the department during the course of TDS proceedings. Therefore, according to him, there was no basis for the AO to disallow the commission expenditure. On the issue of allowance of depreciation on goodwill, learned counsel for assessee submitted that the claim of depreciation on goodwill has to be allowed in view of the judgment of the Hon’ble Supreme Court in the case of CIT vs. Smifs Securities Ltd. (348

ITA No.1352/Bang/2014 Page 14 of 37 ITR 302) wherein it was held that goodwill is an intangible asset entitled to depreciation.

1) Ess Ess Kay Engg. Co. Pvt. Ltd. Vs CIT [2002] 124 taxmann.com 491 (SC) 2) Raymond Wollen Mills Ltd. Vs ITO [1999] 236 taxmann.com 34 (SC) 3) Kalyanji Mayji & Co. Vs CIT [1976] 102 ITR 287 (SC) 4) Rinku Chakraborthy Vs CIT [2012] 20 taxmann.com 609 (Kar.) 5) B S Shantharaju Vs CIT [2014] 48 taxmann.com 375 (Kar.) 6) CIT Vs Popular Vehicles & Services Ltd. [2010] 191 taxmann 333 (Ker.) 7) CIT Vs MAA Communication Bozell Ltd. [2014] 43 taxmann.com 160 (Kar.) 8) Powerdeal Energy Systems India Pvt. Ltd. Vs Asst. CIT [2015] 127 taxmann.com 454 (Bom.)

ITA No.1352/Bang/2014 Page 15 of 37 9) Innovative Foods Ltd. Vs Union of India [2013] 37taxmann.com 463 (Ker.) 10) CIT Vs National Tyres & Rubber Co. of India Ltd. [2011]] 5 taxmann.com 3 (Ker.) 11) Smt. Jyothi Devi Vs ITO (ITA No. 1352/B/2014) (ITAT, Bang.)

ITA No.1352/Bang/2014 Page 16 of 37 Delivery schedule, which is said to be paid to foreign companies viz., M/s.South Elegant Ltd., Hong Kong as per agreement entered into between assessee-company and M/s.South Elegant Ltd., on 1/7/2002. Subsequent to the survey operations, when the statement was recorded from the managing director of the assessee-company Shri Anupam Kothari, he failed to substantiate the agreement and payments made pursuant to this agreement. According to the AO, the answers to the queries were evasive and the genuineness of the expenditure was not proved by the assessee to the satisfaction of the AO. It was further stated by the AO that during the course of assessment proceedings for the assessment year 2005-06, the assessee-company could not establish or prove beyond doubt the necessity of such expenditure. Therefore, the AO inferred that the expenditure claimed for the assessment year 2005-06 is not allowable as genuine expenditure and issued notice u/s 148 of the Act. It is trite law that the validity of re-assessment proceeding has to be examined on the touchstones of the reasons recorded by the AO. From the reasons so recorded, we have to find out whether the AO was justified in forming a belief that income got escaped assessment from tax. The existence of the reasons to believe that income escaped assessment to tax is a condition precedent for exercise of jurisdiction of re- assessment. It is settled principle of law by a catena of decisions that the reasons believed must not be based on

ITA No.1352/Bang/2014 Page 17 of 37 surmises, conjectures or occasioned by change in opinion but must be based on some tangible and credible material based on which a reasonable belief could be formed that income of assessee has escaped assessment. It is equally settled law that the provisions of sec.147 require the AO to have a reason to believe and not a reason to suspect. The another important requirement of law is that AO should not form opinion or reason to believe that income escaped assessment must not be the same material which had been considered at the time of original assessment, as it would amount to review of the assessment order, which is not permissible under law. Keeping in view the above principles in mind, we shall now adjudicate the issue on hand.

a) the expenditure incurred on info tracking and delivery was huge; b) during the course of survey proceedings, the Managing Director of the assessee-company gave evasive replies concerning this transaction/agreement. c) The agreement was subsequently cancelled on 26/10/2005 and termination fee was paid. d) The assessee-company could not prove beyond doubt the necessity of such expenditure.

ITA No.1352/Bang/2014 Page 18 of 37 e) The addition was made on similar item during the assessment proceedings for the assessment year 2006- 07. f) This issue was not examined during the course of original assessment proceedings for the assessment year 2005- 06.

(a) The AO noticed that the expenditure incurred on info tracking and delivery, was huge. This is only an opinion or view and this cannot be treated as a tangible material which would have enabled the AO to form a belief that income escaped assessment. It is settled law that an opinion cannot be a basis for reopening the assessment.

The Hon’ble Supreme Court had an occasion to deal with the validity of the re-assessment proceedings in a case where the re-assessment was based on the report of a District Valuation Officer. The Hon'ble Supreme Court held that the opinion cannot be a basis for re-assessment proceedings and it has to be based on the facts [ACIT vs. Dhariya Construction Co. (328 ITR 515)]. Therefore, this reason, as recorded by the AO, cannot form the basis for the reason to believe that income escaped assessment.

ITA No.1352/Bang/2014 Page 19 of 37 (b) and (c): On perusal of the queries posed to the Managing Director (MD) of the assessee-company, during the course of survey proceedings, we find that the AO was trying to find out from the MD about the existence and authenticity of the agreement. The MD had not denied having paid this money to M/s.South Elegant Co., but could not produce the agreement before the AO. Whether these facts would have enabled the AO to form a belief that income escaped assessment? In this context, we may state that it is not necessary under law that every contract must be in writing and there can be equally binding contract between the parties on the basis of oral agreement unless there is a law which requires the agreement in writing [Tarsem Singh vs. Sukhminder Singh reported in AIR 1998 SC 1400].

It is also not an essential condition that an agreement in writing should be the basis for the allowance of an expenditure on commission payment. Therefore, nothing emerges out of the questionnaire/answers given by the MD of the assessee- company to show that the expenditure is not allowable. Therefore, this part of reasons recorded by the AO would not have enabled the AO to form a belief that income escaped assessment.

(d) The other reason assigned by the AO for assuming jurisdiction u/s 147 of the Act is that the assessee-company had not proved the necessity of incurring of such expenditure. It is

ITA No.1352/Bang/2014 Page 20 of 37 well settled that the AO cannot question the necessity of the expenditure for the purpose of considering the allowability of such expenditure. Please refer to the decision of Hon’ble Supreme Court in the case of Eastern Investment Ltd. v. CIT 20 ITR 1. The above principle was reiterated and followed by the Hon’ble Delhi High Court in the case of CIT vs. EKL Appliances Ltd.(345 ITR 241) wherein it was held as follows:

“19. ……….It has been held by our courts that it is not for the revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur. We may refer to a few of these authorities to elucidate the point. In Eastern Investment Ltd. v. CIT [1951] 20 ITR 1 (SC), it was held by the Supreme Court that "there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of the Income Tax Act". It was further held in this case that "it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned". InCIT v. Walchand & Co. (P.) Ltd. [1967] 65 ITR 381 (SC), it was held by the Supreme Court that in applying the test of commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. It was further observed that the rule that expenditure can only be justified if there is corresponding increase in the profits was erroneous. It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand [1938] 6 ITR 636 (HL) that "expenditure in the course of the trade which is unremunerative is none the less a proper deduction if wholly and exclusively made for the purposes of trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense". The question whether an expenditure can be allowed as a deduction only if it has resulted in any income or profits came to be considered by the Supreme Court again in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 (SC), and it was observed as under: -

ITA No.1352/Bang/2014 Page 21 of 37 "We fail to appreciate how expenditure which is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by way of expenditure must be debited irrespective of whether there is receipt of income or not. That is the plain requirement of proper accounting and the interpretation of Section 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income." It is noteworthy that the above observations were made in the context of Section 57(iii) of the Act where the language is somewhat narrower than the language employed in Section 37(1) of the Act. This fact is recognised in the judgment itself. The fact that the language employed in Section 37(1) of the Act is broader than Section 57(iii) of the Act makes the position stronger. 20. In the case of Sassoon J. David & Co. (P.) Ltd. v. CIT[1979] 118 ITR 261 / 1 Taxman 485 (SC), the Supreme Court referred to the legislative history and noted that when the Income Tax Bill of 1961 was introduced, Section 37(1) required that the expenditure should have been incurred "wholly, necessarily and exclusively" for the purposes of business in order to merit deduction. Pursuant to public protest, the word "necessarily" was omitted from the section. 21. The position emerging from the above decisions is that it is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. ……….”

Having regard to the above settled principles of law, this cannot be a basis to form a belief ‘income escaped assessment’

ITA No.1352/Bang/2014 Page 22 of 37 (e) One of the six reasons given by the AO to assume jurisdiction u/s 147, is that this item of expenditure came to be disallowed in the assessment proceedings for assessment year 2006-07. On perusal of assessment order for assessment year 2006-07, which was filed during the course of hearing of the appeal, it is noticed that addition on account of this expenditure was made by the AO on account of failure of the assessee- company to adduce evidence in support of the services rendered by recipients of commission payment. The appeal filed by the assessee-company before the ld.CIT(A) was dismissed. On further appeal before the Hon’ble Tribunal, prayer of the assessee-company for admission of additional evidence in support of services rendered by the foreign agents came to be accepted by the Tribunal and the matter was restored to the file of the AO for fresh adjudication. The relevant paras viz paras 5.10 to 5.12 of the assessment order for assessment year 2006- 07 are reproduced below:

“5.10 The assessee company is engaged in manufacturing and exporting of denim based garments. At the outset, the assessee has produced the original service agreement document, dated 1st July 2002, for verification. The copy of the said service agreement, claimed to have been made on 01.07.2002, between the assessee company and the South Elegant Ltd., Hong Kong, as supplied by the assessee company reflect the certain important aspects as discussed in para 4.10 of this order, but for clarity mentioned again as under: i. It is a document typed on plain paper running to five pages whereas any document which has financial implication is always done on a stamp paper. This is in contrary to normal practice adopted globally.

ITA No.1352/Bang/2014 Page 23 of 37 ii. It is not a registered or notorised document. Any document to have legality needs to be notorised which is not the case here. iii. It is mentioned as Service Agreement made on 1st July 2002. iv. The place where this agreement is made is not known which is in fact a mandatory requirement. v. The authority before whom or the law under which this agreement is made is not known, which is contrary to legal requirement. vi. It do not bear any stamp, endorsement etc., of any authority or atleast the notory before whom it could have been made. This is contrary to a normal practice adopted in any legal document. vii. It do not contain the details of the names and addresses of the authorissed signatories. viii. It do not contain the names and addresses of the witnesses and the date on which the witnesses have affixed their signature. ix. There is a clause in the agreement which mentions that the agreement shall be governed by the laws of Hong Kong and that each party submits to the non exclusive jurisdiction of Hong Kong Courts which is not very much clear with regard to enforcement of the terms of the agreement. x. The recital para is cryptic and it is simple containing only two brief clauses mentioning (a) that SEL is a sourcing agent for orders and that it has to provide services on information and tracking of deliveries schedules and (b) that in consideration of the said services the assessee has agreed to enter into the said agreement. xi. Duration of the agreement has been mentioned as 10 years with automatic renewal for one more year after the period of 10 years. xii. The termination clause is little peculiar. It is one sided. It provides heavy penalty only to the assessee company. It mentions that the termination of contract before 01.07.2012 by the assessee company will result in payment to SEL three times the last calendar years

ITA No.1352/Bang/2014 Page 24 of 37 commission which is at the outset unreasonable considering the automatic renewal clause available only for a period of one year after 01.07.2012. xiii. It is seen from the letter dated 18.10.2005 that the compensation payable for the termination of the agreement has been calculated with reference to the commission payments of the calendar year 2004 which is maximum since the agreement is entered. xiv. When there is a separate letter of arrangement dated 01.04.2005 for payment of charges for "Info & Tracking of Delivery Schedule" to the concerned non residents the need for such an separate agreement on 01.07.2002 with SEL alone and its cancellation within a short period of less than three years is not clearly explained and this gives rise to doubt as to the genuineness of the agreement and existence of the said party. 5.12 All the above unusual aspects of the case gave rise to a doubt as to the genuineness of the very document. The discreet enquiries caused revealed that the South Elegant of Hong Kong is likely to be a nonexistent concern. Further, without accepting and for a while it is assumed that there existed a concern by said name at Hong Kong, from the explanation given by the assessee company in its various replies whether the said concern had necessary infrastructure or expertise or man power to render the required services as per the agreement in Italy is again a mute point. A survey was undertaken in the business premises of the assessee company as the assessee had made huge payments under "delivery tracking charges" to foreign companies during the financial years 2003-04 to 2005-06 and a lump sum payment of Rs. 18.35 crores was made under the head "termination fees" during the financial year 2005-06. During the course or Survey, a statement on oath of Shri. M. Sreedhar, General Manager (Operation) of the company was recorded confronting him about the details of the above payment, genuineness thereof and the business relevance of the expenditure. Later, the said points were confronted to Mr. Anupam Kothari, Managing Director of the company who also could not satisfactorily explain the various aspects. The Managing Director of the company (Mr. Anupam Kothari) has been living in Italy/Monte Carlo since last 10 years and the major dealings of the company including the export of finished garments and import of fabric etc., are with Italian based companies though in a few cases the sales /purchases have been made from Netherland based

ITA No.1352/Bang/2014 Page 25 of 37 companies also. Keeping this in view and the unsatisfactory reply forthcoming from the General Manager (Operation) and the Managing Director of the company, I hold that it is highly unlikely as to why the assessee company will pay such huge amount to Hong Kong based companies where from the companies apparently have no dealings. Under these circumstances, I hold that the payment of "termination fee" made to South Elegant of Hong Kong is not genuine payment and it is not wholly and exclusively incurred for earning the business income of the assessee company. Apart from this, I hold that payment of whopping "termination fees" of Rs.18,35,79,000/- to Hong Kong based company is highly unreasonable. Further, the expenditure in the nature of tracking delivery charges have not been seen in any other similar export cases.”

(i) Without going into the correctness or otherwise of the above observations made in the assessment order for the assessment year 2006-07, we are of the opinion that the addition was made by the AO only on account of failure of the assessee to substantiate that actual services were rendered by the commission agents, not on the basis of discovery of new tangible material suggesting that no services were rendered by the recipients of the commission payment. AO proceeded to make addition only by inferences drawn, this is very clear from the perusal of the assessment order, as extracted above.

(ii) The Hon’ble Supreme Court in the case of Ess Ess Kay Engg. Co.(P) Ltd. Vs. CIT (247 ITR 818) and Phool Chand Bajrang Lal vs. ITO (203 ITR 456) held that information obtained in the subsequent assessment proceedings could lead to a belief that income chargeable to tax had escaped

ITA No.1352/Bang/2014 Page 26 of 37 assessment even though the transaction in question had been examined during the course of original assessment proceedings. This ratio was followed by the Hon’ble Bombay High Court in the case of Multiscreeen Media P. Ltd. vs. Union of India (324 ITR 54). As mentioned supra, no new tangible material was brought by the AO in the present case. Therefore, the ratio laid down in those cases is not applicable to the facts of the present case.

(iii) The decision in the case of Multiscreeen Media P. Ltd (supra) was considered subsequently by the same High Court in the cases of NYK Line (India) Ltd. Vs. DCIT (346 ITR 361) and CIT vs. Srusti Diam (57 Taxmann.com 392)(232 Taxman 127) and held that in the absence of fresh tangible material in the subsequent assessment proceeding, the subsequent assessment order cannot be basis for reopening the earlier assessment order.

(iv) The facts in that case are that during the course of original assessment proceedings for assessment year 2004-05, the AO had called upon the assessee to give details of labour charges which were made available along with the details of the quantum of work done, TDS amount and bills etc., and the AO accepted the claim of the assessee for deduction of labour charges. Subsequently, on the basis of information in the subsequent year, AO believed that the deduction on account of labour charges had been excessively claimed and therefore, reopened the assessment. On appeal before the CIT(A), the

ITA No.1352/Bang/2014 Page 27 of 37 claim was allowed by holding that the reopening proceedings on account of excessive claim of labour charges were unsustainable. On further appeal to the Tribunal, order of the CIT(A) was sustained. The revenue carried the matter to the Hon’ble High Court where the Hon’ble High Court held that the claim for deduction of labour charges was the subject matter of enquiry during the regular course of assessment proceedings. The AO considered the available material on records and formed an opinion that the claim is allowable. In the absence of any fresh tangible information or material obtained in the subsequent assessment year warranting reopening of assessment, the re-assessment proceedings were declared to be unsustainable. The Hon’ble High Court held as follows:

“8. We find that the impugned order of the Tribunal has while upholding the order of CIT(A) observed that the Respondent-Assessee had in its balance sheet indicated details regarding outstanding labour charges. In the regular assessment proceedings, the Assessing Officer had specifically by a letter dated 30th August, 2006 called upon the Respondent-Assessee to give details of the labour charges. The Respondent-Assessee's in its reply by letter dated 13th September, 2006 (referred in the order of CIT(A) made available details of labour charges along with the quantum of work done by each of the labour contractor, the TDS amount on the labour charges and the sample bills. It is only after Assessing Officer was satisfied with the claim of labour charges that he accepted the claim of the Respondent-Assessee in regular assessment proceedings. In the following Assessment Year i.e. A. Y. 2005-06, the labour charges has been disallowed to the extent the same were found bogus. This conclusion/opinion formed by the Assessing Officer in the subsequent Assessment Year which is treated as tangible material by the Revenue to re- open the proceedings. There can be no manner of doubt that material obtained during the assessment proceedings for

ITA No.1352/Bang/2014 Page 28 of 37 another year can form the basis of re-opening of an assessment. However, the re-opening of an assessment cannot be on the basis of a material which has already been considered during the regular assessment proceedings by the Assessing Officer. The decision relied upon by the Revenue in the matter of Multiscreen Media (supra) was considered by this Court in its subsequent decision in NYK Line (India) Ltd. v. Dy. CIT [2012] 346 ITR 361/211 Taxman 185 (Mag.)/28 taxmann.com 229 wherein the at para 18 the following observations is made:— "18:- Consequently and in this background the mere fact that the Assessing Officer for the assessment year 2007-08 had come to a different conclusion would not justify the reopening of the assessment for the assessment year 2006-07. In order to establish that the reopening of the assessment for the assessment year 2006-07 is not a mere change of opinion, the Revenue must demonstrate before the court that during the course of the assessment proceedings for the subsequent year, i.e. the assessment year 2007-08 some new information or material had been brought on record which was not available when the assessment order was passed for the assessment year 2006-07. That indeed is not the case of the Revenue. All material which was relevant to the determination was available when the assessment was completed for the assessment year 2006-07. Consequently, the mere formation of another view in the course of assessment proceedings for the assessment year 2007-08 would not justify the Revenue in reopening the assessment for the assessment year 2006-07 though the reopening of the assessment has taken place within a period of four years. The power to reopen assessments is structured by law. The guiding principles which have been laid down by the Supreme Court in Kelvinator [2010] 320 ITR 561 (SC) must be fulfilled. In the present case, there was no tangible material, no new information and no fresh material which came before the Revenue in the course of assessment for the assessment year 2007-08 which can justify the reopening of the assessment for the assessment year 2006-07." (Emphasis supplied) 9. The facts of the present case are similar to NYK Line (India) Ltd. (supra). The view in the following Assessment Year that the labour charges paid were excessive is not

ITA No.1352/Bang/2014 Page 29 of 37 tangible material but opinion/view on the material available for the next year. In this case, the labour charges paid by the Respondent for Assessment Year 2004-05 was subject matter of enquiry during the regular assessment proceedings. This enquiry was in the context of the fact that there were outstanding labour charges payable as was evidenced from the Respondent-Assessee's balance sheet filed along with return of income. A detailed enquiry was made into the labour charges and the same was responded by relating it to the quantum of work done. Thus, in the present facts, the Assessing Officer has considered the material available on record and formed an opinion holding that the labour charges have to be allowed. No further tangible material has been obtained in the following Assessment Year, warranting a re-opening of assessment.” The ratio of the above decision is that the subsequent assessment order can be basis for re-opening of the earlier assessment order only in the event fresh tangible information was brought on record in the subsequent assessment years contrary to the material already on record in the earlier assessment year.

(v) The facts of the present case are similar to the above cases dealt by the Hon’ble High Court of Bombay. Therefore, in the absence of any fresh tangible information brought on record in the assessment year 2006-07, the re-assessment proceedings are vitiated by change of opinion. Even the Hon'ble Supreme Court in the case of CIT vs. Kelvinator of India Ltd., (320 ITR 561) emphasized that the reasons to believe must be based on fresh tangible material, not on the change of opinion. The relevant observation is as under:

“6. On going through the changes, quoted above, made to section 147 of the Act, we find that, prior to the Direct Tax

ITA No.1352/Bang/2014 Page 30 of 37 Laws (Amendment) Act, 1987, reopening could be done under the above two conditions and fulfilment of the said conditions alone conferred jurisdiction on the Assessing Officer to make a back assessment, but in section 147 of the Act (with effect from 1st April, 1989), they are given a go- by and only one condition has remained, viz., that where the Assessing Officer has reason to believe that income has escaped assessment, confers jurisdiction to reopen the assessment. Therefore, post-1st April, 1989, power to reopen is much wider. However, one needs to give a schematic interpretation to the words " reason to believe" failing which, we are afraid, section 147 would give arbitrary powers to the Assessing Officer to reopen assessments on the basis of " mere change of opinion", which cannot be per se reason to reopen. We must also keep in mind the conceptual difference between power to review and power to reassess. The Assessing Officer has no power to review; he has the power to reassess. But reassessment has to be based on fulfilment of certain preconditions and if the concept of "change of opinion" is removed, as contended on behalf of the Department, then, in the garb of reopening the assessment, review would take place. One must treat the concept of "change of opinion" as an in-built test to check abuse of power by the Assessing Officer. Hence, after 1st April, 1989, the Assessing Officer has power to reopen, provided there is "tangible material" to come to the conclusion that there is escapement of income from assessment. Reasons must have a live link with the formation of the belief. Our view gets support from the changes made to section 147 of the Act, as quoted hereinabove. Under the Direct Tax Laws (Amendment) Act, 1987, Parliament not only deleted the words "reason to believe" but also inserted the word "opinion" in section 147 of the Act. However, on receipt of representations from the companies against omission of the words "reason to believe", Parliament reintroduced the said expression and deleted the word "opinion" on the ground that it would vest arbitrary powers in the Assessing Officer.” Therefore, any re-assessment proceedings initiated on the basis of very same material which was before AO, without any tangible material, amounts to change of opinion. The Hon'ble Supreme Court in the case of Phool Chand Bajrang Lal v. ITO (203 ITR 456) explained the tangible material as under:

ITA No.1352/Bang/2014 Page 31 of 37 "Acquiring fresh information, specific in nature and reliable in character, relating to the concluded assessment which goes to expose the falsity of the statement made by the assessee at the time of original assessment is different from drawing a fresh inference from the same facts and material which was available with the ITO at the time of original assessment proceedings. The two situations are distinct and different. ……..”

(vi) Again, the Hon'ble Supreme Court, in the case of Ram Bai vs. CIT (236 ITR 696), reiterated the above position that in absence of any fresh tangible material, subsequent assessment cannot be the basis for reopening the assessment for earlier assessment year.

(vii) In the instant case, AO had drawn fresh inference on the same set of facts which were available with AO. AO had not referred to any fresh material or information which led him to believe that income escaped assessment. Therefore, the assessment order for assessment year 2006-07, in the instant case, cannot be the basis to form a belief that income escaped assessment for assessment year in question.

(f) The last reason assigned by the AO to form a belief that income escaped assessment is that the issue of claim for allowance of commission expenditure was not examined by AO during the course of original assessment proceedings.

(i) Now, in this background, the facts of the present case have to be evaluated. The claim for allowing commission payment is very clear both from perusal of profit and loss

ITA No.1352/Bang/2014 Page 32 of 37 account as well as the details filed by the assessee before the AO during the course of original assessment proceedings. It cannot be said that the AO is not aware of the claim at the time of original assessment proceeding, as he himself called for details of expenditure incurred on this commission payment. It is only after perusing the information filed, he chose not to make any addition on this item. Therefore, applying the ratio of the decision of the Hon’ble Bombay High Court in the case of Idea Cellular Ltd. vs. DCIT (301 ITR 407) it cannot be said that AO had not applied his mind on this issue, wherein it was held as follows: “9. It was also sought to be contended that since the Assessing Officer had not expressed any opinion regarding this matter in his original assessment order, it could not be said that there was any change of opinion in this case. In our view, once all the material was before the Assessing Officer and he chose not to deal with the several contentions raised by the petitioner in his final assessment order, it cannot be said that he had no applied his mind when all material was placed by the petitioner before him.”

(ii) It is also settled law that once the return is picked up for scrutiny and the assessment was framed u/s 143(3) of the Act, and the accounts of the assessee were subjected to detailed examination by the AO, it amounts to disclosure of full and true material facts which are necessary for assessment proceedings.

(iii) The Hon’ble Supreme Court, in the case of Calcutta Discount Co. Ltd. Vs. ITO (41 ITR 191), held that once the

ITA No.1352/Bang/2014 Page 33 of 37 assessee discharges the onus of disclosing all primary facts, it is for the AO to draw inferences from the facts and determine the liability of the assessee, observing as under:

“It is for him to decide what inferences of facts can be reasonably drawn and what legal inferences have ultimately to be drawn. It is not for somebody else – far less the assessee – to tell the assessing authority what inferences, whether of facts or law, should be drawn. Indeed, when it is remembered that people often differ as regards what inferences should be drawn from given facts, it will be meaningless to demand that the assessee must disclose what inferences – whether of facts or law – he would draw from the primary facts.”

The above decision was subsequently referred by the Hon'ble Supreme Court in the case of CIT vs. Burlop Dealers Ltd. AIR 1971 SC 635 and held that if the assessee disclosed primary facts relevant to assessment, he is under no obligation to instruct the ITO about the inference, which the ITO may draw from those facts. This position was again reiterated by Hon'ble Supreme Court in subsequent decision in the case of ITO vs. Madnani Engineering Works Ltd. (118 ITR 1).

(iv) In the case of CIT v. Kelvinator of India Ltd (256 ITR 1)(Del), the Hon’ble Delhi High Court, observed that an order that has been purportedly passed without application of mind could not itself confer jurisdiction upon the AO to reopen the proceeding “without anything further” as that would amount to “giving a premium to an authority exercising quasi-judicial function to take benefit of its own wrong”.

ITA No.1352/Bang/2014 Page 34 of 37 (v) In CIT v. Usha International Ltd (348 ITR 485) (Del), Full Bench of the Hon’ble Delhi High Court observed that there can be cases where an AO may not raise any written query but still the Assessing Officer in the first round/original proceedings may have examined the subject matter because the aspect or question may be too apparent and obvious. (vi) In Swarovski India Pvt. Ltd. v. DCIT(368 ITR 601) (Del), it was held that the escapement of income by itself is not sufficient for reopening the assessment in a case covered by the first proviso to Section 147 of the said Act and unless and until there was failure on the part of the assessee to disclose fully and truly all the material facts necessary for assessment. It was insisted that the reasons for reopening of the assessment should specifically indicate which material fact was not disclosed by the Assessee in the course of the original assessment under Section 143(3) of the Act failing which there should not be any reopening of the assessment. (vii) In Oracle Systems Corporation v Asst. DIT (235 Taxman 337) the Hon’ble Delhi High Court reiterated the settled legal position that once a regular assessment is completed in terms of Section 143(3), a presumption can be raised that such an order was passed by the AO on a proper application of mind. (viii) To the same effect is the decision of the Full Bench of the Hon’ble Delhi High Court in the case of CIT vs. Usha International Ltd. (348 ITR 485). Therefore, in light of this

ITA No.1352/Bang/2014 Page 35 of 37 settled legal position, it cannot be said that the AO had not examined this issue during the course of original assessment proceedings. (ix) Even assuming that the AO had not examined the aspect of actual service rendered by recipients of commission payments, this can be attributed to the failure of the AO. It is settled principle of law that re-assessment proceedings cannot be initiated for failure of the AO at the time of original assessment proceedings. (x) Even otherwise, AO is a quasi-judicial authority, which is expected to exercise statutory functions on objective criteria, cannot act on the dictates of any superior authority or on any instructions that may be issued by an authority that may have an administrative control over the AO. It is only at the sole discretion of the assessing authority, an enquiry/investigation can be started on any issue during the course of assessment proceedings. It is for the AO, whether to have an enquiry at all or not? It is for the AO where to start the enquiry and end the enquiry. It is not expected of AO to embark upon an endless enquiry on any issue. In the instant case, the AO, after considering the material produced on record, had chosen not to make any enquiry into this aspect of claim. This can be, at the most, an erroneous order which cannot confer jurisdiction of re- assessment on the AO.

ITA No.1352/Bang/2014 Page 36 of 37 (xi) In the case of Anirudhsinhji Jadega v. State of Gujarat (1995) 5 SCC 302, the Hon'ble Supreme Court held that once a discretion is vested with a certain authority, he alone should exercise that discretion vested under the statute and if he acts in accordance with “the direction or any compliance with some higher authorities instruction” it would be a case of failure to exercise discretion altogether. (xii) Therefore, this reason also cannot be basis for forming a belief that income escaped assessment.

ITA No.1352/Bang/2014 Page 37 of 37 satisfaction of this condition renders all the proceedings initiated u/s 147 null and void. Therefore, we have no hesitation to hold that the re-assessment proceedings initiated by AO are illegal and cannot be sustained in law.

Order pronounced in the open court on this 10th day of February, 2016 sd/- sd/- (VIJAY PAL RAO) (INTURI RAMA RAO) JUDICIAL MEMBER ACCOUNTANT MEMBER Place : Bangalore D a t e d : 10/02/2016 srinivasulu, sps Copy to : 1 Appellant 2 Respondent 3 CIT(A)-II Bangalore 4 CIT 5 DR, ITAT, Bangalore. 6 Guard file By order Assistant Registrar Income-tax Appellate Tribunal Bangalore