ACIT 2(3), MUMBAI vs. STOVEC INDUSTRIES LTD, AHEMEDABAD

Order u/s.254(1)of the Income-tax Act,1961(Act) लेखा सद�य लेखा सद�य राजे�� राजे�� केकेकेके अनुसार अनुसार PER RAJENDRA, AM- लेखा लेखा सद�य सद�य राजे�� राजे�� अनुसार अनुसार Challenging the order dated 29.01.13 of CIT(A)-6, Mumbai the Assessing Officer (AO) and the assessee have filed the cross-appeals for the year under consideration.Assessee-company, engaged in the business of manufacturing of rotary screens etc.filed its return of income on 31. 10.2007,declaring income of Rs.5.52 crores. The AO completed the assessment on 18.12.09 u/s. 143(3)of the Act,determining income of the assessee at Rs.8,88,79,430/- .

2.The assessee has filed an application for admission of additional Ground of appeal and contended that the ground raised by it is legal in nature,that it did not require finding of facts.The Authorised Representiatve(AR)reiterated the same arguments before us,for admitting the additional ground.The Departmental Representiatve (DR) left the issue to the discretion of the Bench.We have gone

2812 & 2449/Mum/2013(07-08)StovecIndustries through the additional Ground of appeal and find that facts are not to be probed in to.Therefoer,we admit the said ground.

ITA/2812/M/2013: 3.First ground pertains to disallowance of Rs.2.5 crores under the head payment to sole selling agent.During the assessment proceedings,the AO found that the assessee had sold part of its assets of its PS Plate business to M/s.Technova Imaging Systems (I)Pvt.Ltd.(TISIPL),that a part of the same was utilised to pay M/s.ATE Marketing Pvt. Ltd.(AMPL) as a compensation for early termination of a long term agreement for various products including the product of PS Plate product, that the compensation amount was determined at Rs.2.05 crores,that it had claimed that same was an allowable expenditure,as it had been incurred in the normal course of business.The assessee relied upon the case of Motor Industries Company Ltd.(223 ITR 112).The AO held that the above-mentioned judgment was pronounced in the year 1996 and pertain to the assessment year 1978-79.He referred to the case of TI Diamond Chain Ltd.(274 ITR 59),wherein the compensation paid on termination of a selling agency was held to be a capital expenditure.Referring to the facts of the case under consideration,the AO observed that the agreement entered into by the assessee with AMPL was due to expire on 27.11.2007 i.e. almost after five months after the termination when it had run along for more than four years on the trot,that the agreement was terminated before that period in the same financial year, that the assessee had not explained as to why the agreement was terminated in its penultimate run and as to how it was commercially unviable to continue the agreement for further period in the very near future.He compared the profits of the assessee with the earlier years and held that it could not be said that the agreement with AMPL was unviable,that the payment in respect of a discontinued segment of business was not revenue specific and was not for running of the day-to-day affairs of the 2812 & 2449/Mum/2013(07-08)StovecIndustries business, that the compensation paid by the assessee,amounting to Rs.2.5 crores was a capital expenditure.

3.1.Aggrieved by the order of the AO, the assessee preferred an appeal before the First Appellate Authority(FAA).Before him,it was argued that the agree - ment was due to expire after 16 months and 27 days after the termination, that the agreement was terminated only for graphics division products which were running in loss and closedown by the assessee, that it had not acquired any enduring benefit or any income yielding asset, that the payment had to be allowed as revenue expenditure u/s.37 of the Act.He directed the assessee to file the details of date of termination of agreement between the assessee and the agent,the date of selling off of the graphic division,amount of commission paid in last five years and the common directors of the concerns.The assessee informed that the date of termination of agreement between the assessee and the agent and the date of selling off of the graphic division was 30.06.2006.The FAA was further informed that there were common directors in both the entities,that for the graphic division the assessee had paid commission of Rs.6.13 crores.After considering the available material,the FAA held that the compensation had been computed for the remaining period(16.9 months)on the basis of compensation paid for 43.1 months, that the compensation had been determined on the basis of actual sale done by the sole selling agent, that there was no logical or legal basis for the payment. With regard to the submission of the assessee that section 294A of the Companies Act permitted compensation for loss of office,the FAA held that the section in question prohibited payment of compensation,that the said section was not an enabling section to pay compensation rather it was a restrictive section to restrict payment of compensation not to exceed the remuneration which would have been earned for loss of office.He further held that payment of compensation for termination of agency of graphic division on 30.06.2006 coincided with the date of sale of 3

2812 & 2449/Mum/2013(07-08)StovecIndustries graphic division,that consideration received on sale of graphic division was a capital receipt, that the compensation paid for termination of agency was capital expenditure, that both the activities were interrelated and gave enduring benefit to the assessee,that directors of the assessee company and the agency company were common,that the expenditure incurred by the assessee was not wholly and exclusively for the purpose of the business considering the provisions of section 294A of the Companies Act.

3.2.During the course of hearing before us, the AR argued that assessee had entered into sole selling agency agreement in the year 1998, that agreement was to be lapsed on 27.11.2007,that in the agreement there was a clause for terminating the agreement, that the agreement was approved by the Central Government, that the compensation was paid as per provision of section 294A of the Companies Act, that expenditure was incurred wholly and exclusively for the purpose of business, that the assessee had hived off graphic division to third party, that it was a commercial decision and was taken in the common interest of business. He relied upon the cases of Ashok Leyland Ltd(86ITR549),Sales Magnesite(P.) Ltd (214 ITR 1),Life Insurance Corporation of India (119 ITR 900) and refer to the pages 110-114 and 122 of the paper book. The DR supported the order of the FAA.

3.3.We have heard the rival submissions and perused the material before us. We find that the assessee had entered into sole selling agreement with ATEMPL for sale of its products namely IMD products, Screen Division Products, Graphic Division Products,that the agreement was for a period of five years i.e. from 28.11.2002 to 27.11.2007, that as per the terms of the agreement the assessee was required to pay commission at a prescribed percentage of sales,that clause 11.4.3 of the agreement dealt with the termination of the agreement by the assessee,that as per the agreement in case of termination of agency ATEMPL

2812 & 2449/Mum/2013(07-08)StovecIndustries was entitled to get compensation as per the formula given in the agreement, that assessee terminated the agreement in respect of the Graphic Division Products with effect from 30.06.2006,that it had closed the business of graphic division, that it had incurred a loss of Rs. 98.2 lakhs from the graphic division, that it had sold the graphic division,that it was prohibited from carrying out dealing the same or similar products as that of graphic division,that it had paid compensa - tion in pursuance of the clause 11.4.3 of the agreement, that the compensation was paid as per the method prescribed under section 294A (a)to(e) of the Companies Acts.It is also a fact that sole selling agency agreement was approv - ed by the Central Government,that ATEMPL had offered the compensation received from the assessee in its return of income and thus taxes have been paid for the amount in question,the AO was not factually correct to hold that the agreement was due to expire in five months from the termination,that the agreement in respect of the sale of graphic division products was to expire on 27.11.2007 i.e. 16 months and 27 days after the termination and not five months as worked out by the AO. We find that the AO and the FAA have questioned the necessity of the payment. In our opinion it is the assessee who has to decide as to how much and as to when certain expenditure has to be incurred or not. The AO cannot sit in the proverbial ‘armchair’ of the assessee to decide the incurring of expenditure. It is the prerogative of the assessee to run the business in a particular manner. If the expenditure has been incurred,the AO cannot question the justification of incurring of the expenditure unless and until the said expenditure is incurred for the purposes prohibited by the law.The incurring of expenditure is not in doubt. The assessee took a decision,after selling the graphic division,to compensate the sole selling agent as per the agreement. It was a pure commercial decision and the AO had no business to question the intelligence of the assessee in that 2812 & 2449/Mum/2013(07-08)StovecIndustries regard.In the case of Dalmia Cement (Bharat) Ltd. (254 ITR 377) the Hon’ble Delhi High Court has held as under: “In applying the test of commercial expediency, for determining whether the expenditure was wholly and exclusively laid out for the purpose of the business the reasonableness of the expenditure has to be just from the point of view of the businessman and not the Revenue. The jurisdiction of the Revenue is confined to “deciding the reality of the expenditure”namely whether the amount claimed as deduction was factually expended or laid down and whether it was wholly and exclusively for the purpose of the business” The assessee was suffering losses in the graphic division and had sold the said division.Therefore,if it decided to pay compensation to its agent, in our opinion, it had not contravened the provisions of the Act or the Companies Act. Considering the above, we are of the opinion that the FAA was not justified in confirming the order of the AO. Therefore, reversing his order, we are deciding first effective ground of appeal in favour of the assessee.

4.Second ground of appeal is about confirming the order of the AO and considering the Long-Term Capital Gain(LTCG) on sale of goodwill amounting to Rs.10 lakhs as income from other sources.During the assessment proceed - ings,the AO found that assessee had received and amount of Rs.10 lakhs from TISIPL,that same was treated as capital receipt and was offered for taxation under the head LTCG.He observed that the amount in question was a consideration towards transfer of Goodwill,Marketing Information, Know-how and Approvals,that the agreement mentioned that the assessee was eligible for receipt of goodwill separately and Rs.10 lakh separately as non-compete fee. He held that intangible assets attracted depreciation at the rate of 25%, that there was no reduction in the value of the intangible assets owned by the assessee, that the records maintained by it were not able to justify that the receipt in question was for parting with goodwill only, that there was no evidence to prove that the receipt was for parting with Marketing Information Know-How and Approvals also, that the receipt was taxable as income from other sources.

2812 & 2449/Mum/2013(07-08)StovecIndustries 4.1.During the appellate proceedings, before the FAA,the assessee argued that the goodwill was a self generated asset, that in view of section 55 (2) (a) (i) of the Act,the cost of acquisition was nil, that the receipt of Rs.10 lakhs had to be taxed as capital gains and not under the head income from other sources. After considering the submission of the assessee and the assessment order, he held that Rs.10 lakhs received by the assessee was not for transfer of any asset- tangible or intangible,that the name of the graphic division was also not transferred by the assessee to TISIPL,that the amount in question was not received for transfer of goodwill, that the assessee had incorrectly given the nomenclatures goodwill to the receipt of Rs. 10 lakhs,that it was not clear as to why TISIPL had paid Rs.10 lakhs to the assessee,that on transfer of any asset owned by an assessee income is assessed under the head income from capital gain,that it was not able to specify as to which asset was transferred to TISIPL,that the AO was justified in assessing the receipt under the head income from other sources.

4.2.Before us,the AR stated that the assessee had sold the graphic division and had offered LTCG for the transaction in question.He referred to pg Nos.179, 159 of the PB and stated breakup of all assets were furnished to the AO during the assessment proceedings, that there was specific mention of goodwill, that the transaction was part of the agreement entered into by the assessee, that the AO had wrongly assessed it under the head income from other sources.DR relied upon the order of the AO and the FAA.

4.3.We have heard the rival submissions and perused the material before us. We find that the assessee had offered the receipt of Rs.10 lakhs, on transfer of goodwill, under the head LTCG, that the AO assessed the same as Income from Other Sources, that the assessee was carrying out business of manufacturing and 2812 & 2449/Mum/2013(07-08)StovecIndustries marketing Pre-Sensitised Offset Plates (PS Plates),that on 30.06.2006 it disposed off assets of the PS Plates for a total consideration of Rs.15.24 crores, that the breakup of the consideration included and amount of Rs.10 lakhs under the head Goodwill, Marketing Information, Know-How and Approvals. Section 55 (2) (a)(ii) of the Act deals with the cost of acquisition in respect of Goodwill of business or a right of manufacture, produce or process any article or thing right to carry on business.In our opinion, the assessee had rightly contended that assets under consideration were self-created/generated assets the cost of acquisi -tion was to be taken is nil and the assessee had rightly offered the entire sale consideration as LTCG.It is also a fact that the assessee had not claimed any depreciation under section 32 of the Act with regard to goodwill. Considering these facts, we are of the opinion that the amount in question was not assessable under the head income from other sources.Therefore,reversing the order of the FAA,we allow the second ground, raised by the assessee.

5.Last ground of appeal

, raised by the assessee is about VRS expenses, amounting to Rs.12.73 lakhs in respect of the contract employees.During the assessment proceedings,the AO had restricted the claim of deduction u/s. 35. DDA and made a disallowance of Rs.11.32 lakhs.He had held that assessee had made VRS payment to the employees that were not on its pay-roll and that Rs. 12.73 lakhs were paid as VRS to unspecified contract employees.

5.1.Aggrieved by the order of the AO,the assessee preferred an appeal before the FAA and made elaborate submissions.After considering the submission of the assessee and the assessment order,he held that the years of service was not at all relevant to decide the issue as to whether a person was an employee or not, that a large number of contract persons would be employed in various private companies and also by govern ment agencies on contract basis,that despite putting up many years of service such persons or workers are never 8

2812 & 2449/Mum/2013(07-08)StovecIndustries made permanent employees of the respective organisations,that in the VRS , adopted by the assessee, it was mentioned that scheme was applicable to the permanent employees of the company only, that neither the AO nor the assessee submitted the list and evidence of permanent employees. He directed the assessee to furnish the list and evidence of persons being permanent employees of the company. He also directed the AO to allow the deduction accordingly.

5.2.Before us, the AR stated that out of the total expenditure claimed under section 35DDA expenditure of Rs.12.73 lakhs only pertained to the contract employees,that the AO had not given effect of the order of the FAA till date. Alternatively, it was argued that if the amount was not to be allowed u/s. 35DDA,the same should be allowed u/s.37(1) of the Act, as the amount was spent for business purposes.The DR stated that the payment was for voluntary retirement scheme and it could not be allowed u/s.37 of the Act.

5.3.We find that the AO had restricted the claim of deduction u/s. 35 DDA to Rs.3.82 lakhs as against Rs.15.15 lakhs as claimed by the assessee and thus had made a disallowance of Rs.11.32 lakhs, that he had held that assessee had made VRS payment of Rs.43.87 lakhs to the employees that were not on its pay-roll, that Rs.12.73 lakhs were paid as VRS to unspecified contract employees. The FAA had observed that assessee had not filed any details in that regard and the AO had not called for further details before completing the assessment.It had claimed that payment of Rs.43.87 lakhs was made to the employees that were on its pay roll, that the AO had wrongly picked up only four employees while making the disallowance.We are of the opinion that the issue needs further verification.Therefore,in the interest of justice,we are restoring the issue to the file of AO for fresh adjudication.He is directed to afford a reasonable opportu - nity to the assessee and consider the material to be produced by it before taking final decision. 9

2812 & 2449/Mum/2013(07-08)StovecIndustries As far as the additional ground raised by the assessee is concerned we want to state that same has not been considered by the AO/FAA therefore, we are directing the AO to decide the same.Gr. No.3 and the additional Ground are decided in favour of the assessee in part. ITA/2449/Mum/2013: 6.In all the three grounds,raised by the AO, the main issue is the directions given by the FAA.The first ground of appeal is about the directions given by him to the AO to verify the list of the employees to be furnished by the assessee to find out the number of the permanent employees to the side the issue of VRS payment. According to the AO,with effect from 01/06/2001,the FAA could not set aside any issue to the file of the AO.

6.1.During the course of hearing before us, the DR stated that matter could be decided on merits.The AR contended that the FAA had not set aside any issue.While discussing the facts of the ground number three, raised by the assessee,we have narrated the facts. We find that the FAA directed the AO to make verification and only after that to allow the claim of the assessee.Thus,the final authority to decide the issue is AO.In our opinion,such direction cannot be equated with setting aside of an issue.The ground of appeal,raised by the AO, is devoid of any merits.We are surprised at how the CIT has approved the grounds and has authorised the AO to file the appeal.It is clear indication of non- application of mind on part of the departmental authorities.Such cases not only burden the DR.s,but also waste the precious judicial time of the Tribunal.We hope that in future the officers of the Department will be careful in filing the appeals.

6.2.Remaining two grounds are also about the directions given by the FAA to the AO to verify certain facts and pass necessary orders. As held in the earlier part of the order, we are of the opinion that it is not case of setting aside of any 10

2812 & 2449/Mum/2013(07-08)StovecIndustries issue to the file of the AO. The FAA has left the final decision in the hands of the AO and that also after verification.In our opinion,his order does not suffer from any legal infirmity.Therefore,confirming his orders we dismiss all the three grounds of appeal, raised by the AO.