Income tax - Whether compensation in form of standing charges received by assessee for remaining idle is eligible for deduction u/s 80IC - NO, rules Delhi HC

THE issue before the Bench is - Whether compensation in form of standing charges received by assessee for remaining idle is eligible for deduction u/s 80IC - Whether such charges can be said to have been derived from manufacturing of the undertaking. And the verdict goes against the assessee.

Facts of the case

For the AY 2007-08, the assessee had shown turnover of Rs.9,81,75,513/- in the return of income and net profit of Rs.86,95,402/-. After adjustment of brought forward unabsorbed depreciation of Rs.45,24,020/-, the balance income was set

off/reduced from the deduction claimed u/s 80IC of the Act. The assessee included Rs.1,05,09,877/- received as “standing charges” from Hindustan Lever Limited as a part of the total receipts of Rs.9,81,75,513/- on which deduction u/s 80IC was permissible. The AO, CIT (Appeals) and the Tribunal concurrently held that standing charges did not qualify for deduction u/s 80 IC as the said payment was not income or profit/gain derived from manufacturing or production of articles and things but payment made on account of failure of Hindustan Lever Limited to place purchase orders for the minimum stipulated/agreed quantity. The standing charges, as per settled laws, therefore, constituted compensation for remaining idle or reimbursement of certain expenses for the said reason. It was not a part of the sale price. The contention of the assessee was that the standing charges were nothing, but the sale consideration received from Hindustan Lever Limited and therefore, were profits/ income derived from manufacture or production of articles or things.

Having heard the matter on the issue, the High Court held that,

++ it is not disputed that for income to qualify for deduction under the said Section, the profit/ income earned should be derived from business of manufacture or production of article or thing, which is eligible for deduction;

++ the expression “derived from” in taxation laws means something which has direct or immediate nexus with the specified activity, which in the present case means manufacture or production of article or thing. Manufacture or production of article or thing should be the direct and proximate cause of the said receipt and not the indirect causation and reason for the said income. Mere second/ third connection is not sufficient; the manufacture/production should be the causa causaus. The expression “derived from” is a narrower expression than the words “attributable to” which includes direct as well as indirect receipts which may not have immediate or direct nexus with the specified activity. In the present case, in view of words “derived from”, we have to look at the immediate source which has generated or resulted in the said receipt/income. The immediate source will be the first degree source and not the second or the third degree source, which is a step removed from the specified activity;

++ Clause 12 onwards of Annexure 3 to the agreement dated 23rd June, 2004 deal with the standing charges. Standing Charges are payable where the Hindustan Lever Limited does not place orders for the minimum quantity as stipulated, i.e., the normative production possible. Standing charges are also payable where actual production exceeds the normative production possible and in such an event the standing charges are payable as enunciated in clause 13 of the Annexure 3 to the agreement, but this did not happen in the present case;

++ the standing charges were payable because Hindustan Lever Limited did not place purchase orders for the normative production possible. In other words, the assessee was not given purchase orders equal to the normative production possible. The assessee, therefore, did not produce or manufacture the products because of lack of orders or failure of Hindustan Lever Limited to place purchase orders for the possible normative production. Payment has been made for non-production and not because of unsold production, and therefore the failure to buy. In these circumstances, it is not possible to accept the contention of the assessee that the standing charges have been paid are towards the cost price of the products purchased by Hindustan Lever Limited from the assessee. It is not a part of the purchase/sale price. The standing charges, which have been paid are not towards the sale price but on account of the fact that Hindustan Lever Limited did not place the prescribed or the stipulated purchase orders for supply of products/articles. This had resulted in non-production and the charges which have been paid were to compensate the assessee for failure to produce and then market its products;

++ the standing charges are not charges payable for the supplies made or towards price of the products sold but for non/ under utilization or idle plant/machinery etc. due to lack of orders. The payment was for non-production/ manufacture;

++ the products or the articles supplied are goods. Excise duty, if not exempt, is payable in many cases on ad valorem basis. Similarly, sales tax, if not exempt, is also payable. The standing charges obviously do not form part of the supply made and are not treated as sale consideration or the price of the goods on which excise duty or the sales tax etc. would be or is payable. Keeping in view the nature and character of the standing charges, evidence and finding regarding nature and character of the manufacturing activity undertaken, it cannot be said that the said charges were paid for or towards sale consideration of the goods supplied. This is not a case where goods were produced but not purchased or supplied etc. The factual matrix as found does not support the claim of the appellant u/s 80IC of the Act. We add by way of caveat that in a given case, and depending upon the factual matrix/ evidence, charges similar to standing charges may represent cost/sale price or price for failure to purchase produced/ manufactured goods. In view of the aforesaid discussion, the question of law accordingly has to be answered in affirmative, i.e., against the assessee and in favour of the Revenue. The appeal is accordingly dismissed.