ACIT 25(1), MUMBAI vs. G SHOES EXPORTS, MUMBAI

3.2 Continuing further, a plant or machine (or any capital asset for that matter), therefore, cannot be regarded as setup or established or, put differently, ready to be commenced, unless the same is commissioned and ready to function, i.e., for its intended use. Where it is the first plant, set up for manufacturing a particular good, to produce which constitutes the business of the assessee, the same (business) itself cannot be treated as set-up or established unless the plant is ready to commence production. Reference in this context may be made to the decision in CIT vs. Ramaraju Surgical Cotton Mills Ltd. [1967] 63 ITR 0478 (SC), where the question arose if the unit was set up (by a particular date). It would be so, it was explained, only where it is ready to discharge the functions for which it was set up. And that the operations for establishment of the unit cannot be equated with the establishment or the setting up of the unit itself. The said processes are preparatory in nature. In its words: ‘A unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up. It is only when the unit has been put into such a shape that it can start functioning as a business or a manufacturing organisation that it can be said that the unit has been set up.’ Operations for the establishment of a unit, from the very nature of that expression used in the proviso to section 5(1)(xxi), can only signify steps that have to be taken to establish the unit. The word "set up" in the principal clause to section 5(1)(xxi) is equivalent to the word "established", but operations for establishment cannot be equated with the establishment of the unit itself or its setting up. The applicability of the proviso has, therefore, to be decided by finding out when the company commenced operations for establishment of the unit, which operations must be antecedent to the actual date on which the unit is held to have been set up for purposes of the principal clause.’ The Hon’ble Court, in so deciding, referred to and applied the principle laid down in Western India Vegetables Products Ltd. vs. CIT [1954] 26 ITR 151 (Bom), 6 & 6209/M/2014 (A.Y. 2010-11) G. Shoes Exports thereby approving it. The question was finally answered by it in the negative in-as- much as the manufacture of absorbent cotton wool, for which the unit was being set up, could not take place or be produced. Similarly, in CIT vs. Industrial Solvents and Chemicals Pvt. Ltd. [1979] 119 ITR 608 (Bom), the business of the assessee-company was held to be set up only on the receipt of the power connection and not earlier on the purchase of raw material or even the installation of the machinery subsequently. A business is thus set up or established only when it is ready to be commenced, all antecedent processes being preparatory in nature. Now, if the business has not commenced, how could the machinery be said to have been used for its purposes, so that in such a case even a ‘ready to use’ state of the machinery also may not be sufficient.

The second issue arising in the instant case is the assessment of short-term capital gain (STCG) on the sale of the old Windmill; the said sale (at Rs.322.84 lacs)

We have heard the parties, and perused the material on record. We are principally in agreement with the first appellate authority that it is the status of the block, positive or negative - STCG resulting in the latter case, as at the end of the year, which is to be seen in-as-much as the depreciation is to be computed only at the year-end, and on the value of the block thereat (refer s. 43(6)). This in fact is plain from the bare language of s.50, reproduced as under, whereunder the ‘surplus’ arising on the transfer of a depreciable asset forming part of a block of assets is deemed as a capital gain arising on the transfer of a short term capital asset, i.e., STCG, by definition, also prescribing the manner of its computation: ‘Special provision for computation of capital gains in case of depreciable assets. 50. Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act or under the Indian Income-tax Act, 1922 (11 of 1922), the provisions of sections 48 and 49 shall be subject to the following modifications :— (1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely :— (i) expenditure incurred wholly and exclusively in connection with such transfer or transfers; 13 & 6209/M/2014 (A.Y. 2010-11) G. Shoes Exports (ii) the written down value of the block of assets at the beginning of the previous year; and (iii) the actual cost of any asset falling within the block of assets acquired during the previous year, such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets; (2) where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.’ So, however, a particular machinery (asset) can be a part of the block of assets only where it satisfies the condition of depreciation for the relevant year. Until then it is only an acquisition of an asset which may or may not enter the block of assets, which, by definition, is a group of assets for which the same rate of depreciation is provided per the Income-tax Rules, 1962 (‘the Rules’ hereinafter) (s. 2(11)). This is apparent from the clear language of section 32(1) (refer paragraph 3 of this order) in- as-much as only assets – tangible or intangible, owned and used, would stand to form part of any particular block of assets. Rule 5(1) of the Rules, reading as under, further clarifies this aspect as only those block of assets, as used for the purpose of business at any time during the year, are eligible for depreciation thereon u/s. 32(1) r/w s. 43(6) of the Act: ‘Depreciation. 5. (1) Subject to the provisions of sub-rule (2), the allowance under clause (ii) of sub- section (1) of section 32 in respect of depreciation of any block of assets shall be calculated at the percentages specified in the second column of the Table in Appendix I to these rules on the written down value of such block of assets as are used for the purposes of the business or profession of the assessee at any time during the previous year.’ The fore-going is the only harmonious interpretation on a conjoint reading of the different provisions noted above. Not so reading the same would tantamount to 14 & 6209/M/2014 (A.Y. 2010-11) G. Shoes Exports allowing depreciation, which is to be allowed on satisfaction of the precedent condition of the user, on the assets acquired during the year independent of their user, defeating thereby s. 32(1), as explained, with reference to the decisions by the Hon'ble jurisdictional High Court, per the preceding part of this order. It would be incongruent and internally inconsistent to state that while an asset qualifies to form part of a block of assets, depreciation thereon is not exigible on account of its non-user. We have already adjudicated on the eligibility of the new Windmill, purchased on 31.3.2010, for depreciation, deciding against it in view of its’ non-user (refer paras 3 & 4 of this order). The same would, therefore, not enter the block of assets as at the relevant year-end, and its correct representation in the final accounts (as at the year- end) is as (part of) ‘capital work-in-progress’. The WDV of the relevant block (i.e., comprised of Windmills) would therefore stand to be computed without including the same, with consequential effect on the computation of STCG u/s.

The said provision, we may further add, is by way of a legal fiction, which however is limited to the computation of the gain arising on the transfer of depreciable assets, i.e., modifies the computational provisions of ss. 48 & 49 only. The character of the gain, nevertheless, and even as explained in CIT vs. Ace Builders (P) Ltd. [2006] 281 ITR 210 (Bom), would remain the same. As such, where the capital asset (old Windmill) transferred is beyond the minimum holding period prescribed in its respect (thirty six months), the same would be a long term capital gain, subject to tax u/s. 112 of the Act. We decide accordingly. This decides Gd. (iii) of the Revenue’s – which has taxed the gain as STCG, appeal partly in its favour.

Gd. (iv) of the Revenue’s appeal concerns the disallowance of commission allowed to foreign agents (Rs.16,01,833/-) in-as-much as tax was not deducted thereon at source. The assessee’s case is that services, which are not technical in nature, were rendered by the sale agents abroad. No part of them were rendered in India and are de hors any business connection in India. The A.O., while admitting that the services were rendered by the assessee’s Italy based sale agents outside India, was 15 & 6209/M/2014 (A.Y. 2010-11) G. Shoes Exports of the view that the right to receive, which the words ‘accrue’ or ‘arise’ signify, arose in India in-as-much as the supply (purchase) orders were executed in India. Reliance stands placed by him on the decision by the Authority for Advance Rulings (AAR) dated 22.2.2012 in SKF Boilers and Driers Pvt. Ltd. [2012] 343 ITR 385, reproducing there-from, and which in turn also drawn on its decision in Rajive Malhotra, In re (AAR No. 671 of 2005, reported at [2006] 284 ITR 564 (AAR)). The ld. CIT(A) allowed the assessee’s claim on the basis that the payment under reference is covered by the CBDT Circular No. 786 dated 7.2.2000, and that its withdrawal per Circular No. 7 of 2009 (dated 22.10.2009) could not be given a retrospective effect. Reliance for this proposition is placed on number of decisions by the tribunal, as in the case of CIT (Dy.) vs. Sanjiv Gupta [2011] 135 TTJ 641 (Luck).

We have heard the parties, and perused the material on record. As explained in CIT vs. R. D. Aggarwal & Co. [1965] 56 ITR 20 (SC), which stands referred to in CIT vs. Toshoku Ltd. [1980] 125 ITR 525 (SC), and continues to govern the field, business connection involves the relationship between the business carried on by a non-resident (outside taxable territories), which yields profits or gains, and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits and gains. It predicates an element of continuity, and postulates a real and intimate relation between the trading activity carried on outside the taxable territories and the trading activity within the territories, the relation between the two contributing to the earning of income by the non-resident in his trading activity – the Agents in the present case. The matter is, thus, principally and primarily factual. This is also what the Board Circular 23 (supra) explains, i.e., whether the non-resident has a business connection in India, from which income, profits or gains can be said to arise within the meaning of section 9 has to be determined in the facts of each case. This is also what it states in substance, which will not get whittled down when in the latter part, by way of an illustration, it states that for a foreign agent operating in his own country, no part of his income can be said 16 & 6209/M/2014 (A.Y. 2010-11) G. Shoes Exports to arise in India – a proposition on which there could be no dispute in principle, and which is what the Hon’ble Apex Court has endorsed in Toshoku Ltd. (supra). This cannot, and by no means, is meant to or could substitute a factual determination of whether there is any business connection which would only be upon examining the scope and activities in the taxable territory (India) and the relation with that carried in the territory outside India from which income is earned. A Circular cannot, and it would be presumptuous to think otherwise, decide whether there is in the facts and circumstances of the case, a business connection, i.e., a relation between the trading activity in the taxable and the non-taxable territories, and any income arises to the non-residents on account of that relationship, as the law is, and stands explained. That is, the said Circular is in conformity with the law. Reference in this context may also be made to the decision in the case of Elve Corporation (in ITA Nos. 4108 & 6279/Mum/2012 dated 20.11.2015). In the facts of the case, the commission is for soliciting sale orders. No part of the said activity is stated as carried out in India, where there is admittedly no permanent establishment (PE) of the non-resident agents. The income is by way of commission per se, so that no part of it can be said to be taxable in India, as clarified by the Apex Court in Toshoku Ltd. (supra). The reliance by the Revenue on the decision in Rajive Malhotra (supra) is misplaced. In the facts of that case, the commission was in respect of participation in a show in India, which was facilitated by the agent by booking orders by non-resident Exhibitors. The sales in the instant case, on the supply of goods in pursuance to the purchase order booked by the agents, and for which therefore commission is allowed to them, takes place outside India. The decision in the case of GE India Technology Centre (P) Ltd. vs. CIT [2010] 327 ITR 456 (SC) would, accordingly, clearly apply in the facts of the case, so that the provisions of section 195 of the Act and, consequently, of section 40(a)(i), are inapplicable. We decide accordingly, and the assessee succeeds.

Before us, on a question by the Bench as to why the supplies having been made through sale agents, and even otherwise as a matter of business practice, were the defect not pointed out or identified on their receipt and only much later. In fact, communicating the damaged/defective state of the goods immediately would ordinarily be the first thing that a buyer would do on receipt of a consignment. This becomes imperative as the goods supplied were presumably in okay condition, conforming to the design and quality standards. Further, what are those defects, or how were the grounds damaged, etc. which continue to remain unspecified? Did the assessee pursue the insurance claim or any other agency involved in shipment, etc., on account of delinquency on whose part the damage had occurred? On these and such like queries; it being apparently odd and queer that claims for damaged goods are received on a regular basis, much later to the supply of goods, and accepted as such, i.e., without proper verification, particularly considering that the assessee is represented by sale agents who could ensure that the goods supplied are thoroughly examined on delivery, so as to verify and vet the claim for damaged goods and, further, no preventive measure taken, the ld. counsel conceded that the claim is in fact for reduction in the amount receivable (on sale). The supplies being already made, the 18 & 6209/M/2014 (A.Y. 2010-11) G. Shoes Exports assessee, in view of the continuity of trade, which is profitable, accepts the same. This is a normal feature of trade with Italy. The buyers being in a dominant position, i.e., in trading terms, the claims are accepted, which stands also explained before the ld. CIT(A). The ld. DR would on this submit that this materially alters the nature of the assessee’s claim qua which there is no finding in the matter by the ld. CIT(A).

We have heard the parties, and perused the material on record. We agree that the candid declaration before us materially alters the nature of the assessee’s claim, so that the Revenue’s stance would also be required to be revised. It is unfortunate that the assessee comes out with the facts at a much later stage and not before the Revenue, particularly before the assessing authority. Be that as it may, the same, in view thereof, is to be regarded as a trade discount allowed by the assessee to its foreign buyers. Under the circumstances, we only consider it proper that the matter is restored to the file of the A.O. to examine the assessee’s claim – which is to be looked at from a businessman’s point of view, in light of the facts admitted before us, and who shall decide the same in accordance with the law, be it u/s. 37(1) or u/s. 36(1)(vi), issuing definite findings of fact. We decide accordingly.

Gds. (vii) and (viii) are general in nature, warranting no adjudication.

In the result, the Revenue’s appeal is partly allowed.

Vide Gd. 1 of its appeal, the assessee claims depreciation at 80%, i.e., the rate exigible on Windmill, on the following expenditure, being components of its cost, viz. (a) development rights for restoration, paid to the State Government of Andhra Pradesh; (b) Erection and commissioning expenditure; and (c) Transportation expenditure, as against at 15% allowed to it. For each of the expenses, the assessee claims its’ case to be covered by a decision by the tribunal, quoting its citation per the relevant ground itself.

Gd. 2 of the assessee’s appeal is in respect of the foreign travel expenditure of Priya Kejriwal, wife of Shri Sahil Kejriwal, partner in the assessee- firm. The claim is made on the basis of her having accompanied her husband on foreign travel, actively assisting him thereon. The same stands denied by the Revenue on the ground that the claim is totally unevidenced. There is, in fact, no evidence of her, who is neither a partner nor an employee in the assessee-firm, being involved in the day-to-day work of the organization. The only inference that follows under the circumstances is that she was simply accompanying her husband on foreign travel/s. Before us, it was explained by the ld. AR that as sellers, the representatives of the assessee-firm have to carry large sample bags from buyer to buyer, and for which otherwise physical assistance, at a cost, would be required. Secondly, Priya Kejriwal, being also a member of the family, involved in its business, participates in ensuing discussions with the buyers, so that the expenditure ought to be allowed.