THE issues before the Bench are - Whether voluntary and unconditional grant received by the assessee for protecting image and goodwill of the holding company is taxable as business receipt – Whether the claim of depreciation is mandatory in nature; Whether software development product expenses is allowable as revenue expenditure u/s. 37(1); Whether the assessee is entitled to prepare a separate profit and loss account for the purpose of section 115JA of the Act, so far as it is in accordance with provisions of part II & Part II of Schedule VI of the Companies Act 1956 and Whether transfer made to debenture redemption reserve can be said to be a provision for ascertained liability and hence could not be added back while computing the book profit u/s 115JA. And the verdict goes against the Revenue.
Facts of the case
A) Unconditional grant
- The Assessee is a company engaged in the business of manufacture of pharmaceutical formulations and bulk drugs. During the previous year a company by name Boehringer Mannheim India Ltd. (BMIL) got amalgamated with the Assessee as per the scheme of amalgamation approved by the Bombay High Court. As per the scheme the appointed date was 1.4.1996. The effective date for amalgamation was 24.7.97. BMIL had received a payment of Rs. 29.26 crores from Boeheringer Mannheim GmbH, Germany (BMG) in November, 1996. This amount was credited to the capital reserve in the books of the assessee company. As per note forming part of the accounts, an unconditional grant of Rs.2926.17 lakhs received by the erstwhile BMIL after the appointed date from Boeheringer Mannheim GmbH, Germany had been credited to the Capital Reserve. After the merger, certain non-recurring expenses aggregating to Rs.18.61 crores are determined by the new management as pertaining to the period prior of the effective take-over of the company by the new management or were on account of the Comsat incident and accordingly an equivalent amount was drawn from Capital Grant Reserve during the year and reduced from Other expenses.In a note appended to the computation of income, the aforesaid amount received from BMG was claimed by the Assessee to be a capital receipt and therefore, not offered for taxation. The note further mentioned the fact that certain non-recurring expenses aggregating to Rs.1860.84 lakhs were incurred by BMIL are deductible expenditure u/s. 37(1) of the Act.
In the course of assessment proceedings, the Assessee reiterated that the receipt from BMG was a capital receipt not chargeable to tax. The Assessee claimed that the receipt in question is an unconditional grant in appreciation of the efforts and actions taken by the erstwhile BMIL to establish, protect and enhance the goodwill and image of BMG in India. The Assessee further claimed that in the last couple of years BMIL has been making persistent losses, consequent upon which the net worth of that company had eroded considerably. Since BMG had an approximately 64% holding in BMIL, the goodwill and image of BMG in India was also likely to be affected. The Assessee submitted that the payment by the German company BMG had to be viewed in the foregoing context. It was claimed by the Assessee that BMG made the aforesaid payment out of benevolence or compassion, it was a payment made without any legal obligations on its part to do so and that BMIL had no legal right to receive the same from BMG. It was claimed that the amount received was an unconditional grant from BMG which does not relate to any particular source of income or any specific reimbursement of expenditure. It was payment made by BMG, being a substantial stakeholder in BMIL, to rectify the erosion in the net worth of one of its subsidiaries. The Assessee in this regard relied on the juridical decisions wherein the proposition that payment to subsidiary to rectify erosion in net worth is a capital receipt not chargeable to tax has been laid down.
The AO however was of the view that the payment in question though was an unconditional grant without any legal obligation on the part of BMG and without any legal right vesting with BMIL to receive the payment was not conclusive that the same is not chargeable to tax. He held that the amount in question was received by virtue of business connection and therefore taxable and further was of the view that the character of the receipt has to be viewed from the point of the recipient and not the giver. The AO further held that Assessee’s statement that BMIL has been making persistent losses and as a 64% stakeholder BMG wanted to reimburse the losses was also factually incorrect.
According to the AO, the payment was not connected at all to repairing the erosion in the net worth of BMIL. The payment has been made in order to promote the image of the BMG group. The AO was of the view that the only test for deciding the taxability of the amount was to see whether the receipt arose out of the assessee’s business. In this regard the AO referred to the fact that BMG and its associates held 64% of the share capital in BMIL. BMIL was using the brand image of BMG, making use of the technical know-how of the parent company and was also acting as the marketing agent for BMG for sale of diagnostic products, Bio chemicals and Bio catalysts. In the month of August, 1996, a contaminated batch of “Comsat Forte” formulated at the factory of BMIL was released in the market causing severe illness in many cases and 3 deaths. The food and drug administration directed BMIL to withdraw four batches of “Comsat Forte” and also cancelled the license for manufacture and sale of products out of Thane plant. The incident caused adverse publicity for the BMG group. The above payment was paid to BMIL in lieu of the services rendered by BMIL in terms of protecting and promoting the interests of BMG. The AO held that the receipt arises out of the business activity of the assessee. It was clear that the payment was not made to improve the net worth of BMIL and was not in any way connected with the capital structure of BMIL. Accordingly, the receipt was held to be part of the profits and gains of the business carried on by the assessee. The CIT(A) allowed the appeal of the Assessee.
B) Depreciation - The assessee also claimed depreciation on the assets taken over as part of the merger. The AO noticed from the schedule of depreciation furnished by the assessee that depreciation was being claimed on the WDV without adjusting for depreciation allowable for A.Y.s 1995-96 & 1996-97 in the hands of erstwhile BMIL. The erstwhile BMIL did not opt to claim depreciation for the assessment years 1995-96 & 1996-97 although assets have been used in the business carried on by BMIL during those years. The AO was of the view that depreciation is not available to the assessee on the WDV without taking into consideration the allowable depreciation on the use of the assets during the assessment year 1995-96 & 1996-97 by BMIL. Depreciation charge being in the nature of a deduction for wear and tear of the assets, it was mandatory that depreciation is charged to arrive at the correct income for any given year. Accordingly, the WDV in respect of the assets belonging to erstwhile BMIL was adjusted (by reduction of the WDV) for the foregone depreciation for A.Y’s 1995-96 & 1996-97. The CIT(A) held that depreciation on the WDV as claimed by the Assessee on the assets in question should be allowed.
C) Software development product expenses - During the previous year relevant to A.Y. 1997-98 the assessee incurred as expenditure of Rs. 32.90 lacs for acquiring and implementing software programme known as known as ERP package MFG Pro-version 7.4 f. The assessee claimed it to be a revenue expenditure whereas A.O treated it as capital expenditure resulting in enduring benefit to the assessee. The A.O also observed that the recent amendment made in the I.T.Act providing for one time exception with regard to expenditure towards Y2K compliance makes it clear that the intention of law is to treat software expenditure to be capital in nature. The assesse contended before CIT(A) that because of very high degree of obsolescence of computer software it cannot be said that anybody gets enduring benefit by acquiring the software programme. The Assessee relied on print-out taken from the official web site of QAD, the original developers of MFG Pro software, in which it was clearly mentioned that MFG Provision 7.4 is currently in a retirement phase and urges its customers to upgrade this software in view of the fact that this version of the software is no longer being sold and it can be provided limited standard support on a best effort basis. It was submitted that the assessee company had to migrate from version 7.4 of the ERP software MFG Pro to version 9.1 (eB version) within a span of 4 years. The CIT(A) was of the view that expenditure incurred for acquiring and implementing the software programme cannot be treated as capital expenditure. The A.O was accordingly directed to allow deduction of Rs.32.90 lacs in computing the total income.
D) Book profit u/s 115JA - For AY 97- 98, the assessee prepared different set of P&L account for computing the book profit u/s 115J by excluding the loss of the BDD of SPCL between the appointed date and the effective date. According to the AO, doing so was not in accordance with the provisions of Sec.115JA of the Act.
It was submitted by the assessee that the accounting effect of withdrawal from the General Reserve for crediting it to the Profit & Loss account was achieved by the Assessee by reducing losses amounting to Rs.570.30 lacs directly from the General Reserve account which otherwise would have been debited to the company’s published profit and loss account. The Assessee explained that this was done to give effect to the specific provision for the Scheme of Arrangement whereby BDD of SPCL was taken over by the Assessee. The Assessee thus claimed that the book profits for the purpose of calculation of MAT should be Rs.3932.11 lacs as shown in the computation of income.
The AO rejected the claim of the Assessee that the accounting effect of withdrawal from the general reserve for crediting it to the P&L A/c. has been achieved by reducing the losses directly from the general reserve account as factually incorrect. He held that the losses of BDD of SPCL between the appointed date and effective date have not been recognized in the corporate accounts. Such losses have been set off against the revaluation reserve created during the take over of the BDD from SPCL. He held that revaluation reserve created was a mere book entry and withdrawal from the said reserve for crediting it to the P&L Account does not arise for consideration at all.
In computing the book profit the assessee also reduced from profit as per Profit and Loss Account an amount shown as transfer to reserve in the Profit and Loss Appropriation Account. It was the claim of the Assessee that this sum was transferred to the Reserve Account to meet liability on account of redemption of debentures issued by the Assessee. The AO was of the view that the amount set aside for redeeming the debentures is after all repayment of loan and therefore it is a reserve as per part II and III of Schedule VI of Companies Act. He further held that as per explanation to section 115 JA (2), the book profit has to be adjusted by increasing the net profit by “the amounts carried to any reserves by whatever name called”. Accordingly, the book profit was recomputed by disallowing the amount transferred to debenture redemption reserve.
On appeal by the Revenue, the ITAT held that,
A) ++ Unconditional grant - It is not a payment to enable BMIL to recoup its losses nor is it a payment which did not have business consideration for making such payments. The fact that it was voluntary or that it was an unconditional payment, will not make it a capital receipt not chargeable to tax. The stand of the Assessee before the Revenue authorities that BMIL was in losses and the payment in question was made to recoup such losses is contrary to the material on record. There was holding and subsidiary company relationship between BMIL and BMG besides business relationship viz., BMIL was using the brand image of BMG, making use of the technical know-how of the parent company and was also acting as the marketing agent for BMG for sale of diagnostic products, BIO chemicals and Bio catalysts. It is only because of such relationship and also in the light of the help rendered by BMIL in terms of protecting and promoting the interests of BMG in the wake of COMSAT incident, the payment in question was made by BMG and was therefore a payment connected with the business of BMIL and was liable to be taxed u/s.28(i) read with Sec.2(24) of the Act;
B) ++ depreciation - The Supreme Court in CIT Vs. Mahendra Mills (2002-TIOL-597-SC-IT) has laid down that the assessee is entitled to exercise his option even through the filing of revised return and that option cannot be denied to him nor can depreciation be thrust on the assessee against his willingness. It was held that until a claim is made for allowing deductions of the nature covered under s. 32 along with necessary particulars, there would hardly be any occasion for the ITO to ‘allow’ any ‘claim’. Two conditions – the making of a claim and the furnishing of particulars – have to be read as cumulative conditions. If either of the two conditions are not fulfilled the AO cannot force the depreciation allowance on the assessee. It further follows logically that in the absence of a claim by the assessee the allowance cannot be thrust upon him even if the particulars are available to the AO. Therefore, the mere fact that the assessee did not make a claim for depreciation places a fetter upon the powers of the AO to allow depreciation;
C) ++ software development product expenses - the nature of the software and the purpose that the software will serve in the business of the assessee are important criteria laid down by the Special Bench of ITAT to decide whether expenditure on purchase of computer software is capital or revenue expenditure. Therefore, the nature of the software and its role in business of the assessee have to be considered. Therefore, it would be appropriate to set aside the order of the CIT(A) on this issue and remand the same to the AO for fresh consideration in the light of the principles laid down by the Special Bench in the case of Amway India Enterprises;
D) ++ Book profit u/s 115JA - the P&L Account prepared by the assessee for the purpose of 115JA of the Act has been duly certified by the Chartered Accountant. There is no complaint that the same is not in accordance with provisions of part II & Part II of Schedule VI of the Companies Act 1956. As rightly pointed out by the assessee the only restriction in 115JA(2) is regarding the depreciation which has to be in conformity with the method adopted under Companies Act. There is however, departure in section 115JB(2) of the Act which provides that the accounting policies and accounting standards adopted while preparing P&L Account for section 115JB of the Act should correspond to the one adopted for the purpose of Companies Act 1956. In that view of the matter, the order of the CIT(A) has to be upheld;
++ the amount in respect of debenture redemption reserve cannot be said to be a reserve but was only a provision. The liability for which such provision was made was an ascertained or known liability and, therefore, amount was to be reduced from the profit as per P&L Account prepared in accordance with provisions of Company Act 1956 to arrive at the book profits under section 115JA of the Act.
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