THE issue before the bench is - Whether entitlement to set off brought forward losses can be denied to an entity consequent to the reduction in its beneficial shareholding, by invoking Section 79, where the voting power of such entity together with its wholly owned subsidiary continues to be 51%. NO is the answer.
Facts of the case
The assessee is engaged in the manufacture and sale of storage batteries. During the concerned year, the assessee was granted the technical know-how and non-exclusive license under an agreement with M/s AMCO Batteries Ltd (ABL), to manufacture and sell Pocket Plate Nicad Batteries on payment of lumpsum consideration of Rs.5.00 crores for the licence and right to use the technology. For the A.Y 2003-04, the assessee filed its return declaring NIL income after setting off losses brought forward from earlier years. The said return was processed u/s 143(1). Subsequently, the case of assessee was taken up for scrutiny and assessment u/s 143(3) was completed and the income for the said year was determined at Rs.1,34,03,589/-. This was done so, primarily because the deduction u/s 35AB as claimed by the assessee, was disallowed and the lease rentals paid were also disallowed. The assessment order also disallowed the setting off of losses of the previous years by invoking Section 79. Similarly, for the earlier four A.Ys 1999-2000, 2000-01, 2001-02 and 2002-03, the case of assessee was reopened u/s 147/148 and the benefit granted in such years u/s 35AB was disallowed, except for A.Y 1998-99 because of limitation.
On appeal, the CIT(A) partly allowed the claim of assessee and granted benefit of deduction u/s 35AB. However, no entitlement to set-off of brought forward losses was granted, considering the change in beneficial holding of 51% or more, as provided u/s 79. On further appeal, the ITAT partly allowed the appeal of assessee by allowing the benefit of set-off of brought forward losses, but did not give the benefit of lease rentals paid by the assessee.
Having heard the parties, the High Court held that,
Set off of brought forward losses
++ the question that arises for consideration is, whether the assessee would be entitled to carry forward and set-off of business losses even though, as per the Revenue, the voting power of the assessee had been reduced below 51% of the shareholding, and consequently voting power of the assessee company had reduced to less than 51%. Admittedly, upto A.Y 2000-01, all the shares of the assessee company were held by the ABL. In the A.Y 2001-02, the holding of ABL was reduced to 55% and the remaining 45% shares were transferred to a subsidiary of ABL, namely AMCO Properties and Investments Ltd (APIL). In the A.Y 2002-03, ABL further transferred 49% of its remaining 55% shares to Tractors and Farm Equipments Ltd (TAFE) and consequently ABL retained only 6% shares and its subsidiary APIL held 45% shares and the remaining 49% shares were with TAFE. Similar shareholding continued for the A.Y 2003-04. It is noted that Section 79 provides that where there is a change in shareholding of a Company, no loss incurred in any year prior to the previous year shall be carried forward and set-off against the income of the previous year, unless on the last day of the previous year the shares of the Company carrying not less than 51% of the voting power were beneficially held by persons who beneficially held shares of the Company carrying not less than 51% of the voting power on the last day of the year or years in which the loss was incurred. In the instant case, the Tribunal after considering submissions of both the parties, held that 51% of the voting power was beneficially held with the ABL during the A.Ys 2002-03 and 2003-04 also, and would thus be entitled to carry forward and set-off of business losses for the previous years;
++ the fact that ABL is the holding Company of APIL, which is the wholly owned subsidiary of ABL and that Board of Directors of APIL are controlled by ABL, is not disputed. The submission of the counsel for assessee that the shareholding pattern is distinct from voting power of a Company, has force. Section 79 specifies that "not less than 51% of the voting power were beneficially held by persons who beneficially held shares of the Company carrying not less than 51% of the voting power." Since the ABL was having complete control over the APIL, which is the wholly owned subsidiary of ABL, in our view, even though the shareholding of ABL may have reduced to 6% in the year in question, yet by virtue of being the holding Company, owning 100% shares of APIL, the voting power of ABL cannot be said to have been reduced to less than 51%, because together, both the companies had the voting power of 51% which was controlled by ABL. The purpose of Section 79 would be that benefit of carry forward and set-off of business losses for previous years of a company should not be misused by any new owner, who may purchase the shares of the Company, only to get the benefit of set-off of business losses of the previous years, which may bear profits in the subsequent years after the new owner takes over the Company. For such purpose, it is provided under the said Section that 51% of the voting power which was beneficially held by a person or persons should continue to be held, then only such benefit could be given to the Company. As it is observed, though ABL may not have continued to hold 51% shares, but Section 79 speaks of 51% voting power, which ABL continued to have even after transfer of 49% shares to TAFE, as it controlled the voting power of APIL, and together, ABL had 51% voting power. Meaning thereby, the control of the company remained with ABL as the change in shareholding did not result in reduction of its voting power to less than 51%. In the present case, though there may have been change in the shareholding in the A.Y 2002-03, yet, there was no change of control of the Company, as the control remained with the ABL as the voting power of ABL, along with its subsidiary Company APIL, remained at 51%. Since in the present case, the control over the Company, with 51% voting power, remained with ABL and, as such the provisions of Section 79 would not be attracted. Accordingly, this court confirms the finding of the Tribunal in this regard;
Deduction u/s 35AB
++ the next question relates to the entitlement of the assessee for grant of deduction u/s 35AB, in respect of payment of Rs.5 Crores for transfer of technical know-how, for which the payment was not made strictly as per the instalments provided in the agreement. It is seen that prior to 1st April, 1998, know-how was not a depreciable asset. But after the said date, because of amendment u/s 32, know-how is now a depreciable asset. For the purpose of this case, it may be noted that know-how was acquired on 1st March, 1998, and hence the assessee would not be entitled to benefit of depreciation. The corresponding amendment was brought in Section 35AB, wherein it was provided that the benefit of the said Section, which was with regard to expenditure on know-how, would be only when the assessee has paid for the know-how, prior to 1st April, 1998. In the present case, there is no dispute about the fact that know-how was acquired on 1st March, 1998. It is also not disputed that payment for acquiring such know-how was made only in instalments after 1st April, 1998. The question now would be as to whether the benefit of Section 35AB would be available to the assessee, which provides that if the assessee has, prior to 01.04.1998, paid any lumpsum consideration for acquiring the know-how, then 1/6th of the amount so paid shall be deducted in computing the profits and gains of the business for that year and the balance amount shall be deducted in equal instalments for each of the five immediately succeeding years. For this, we have to analyze what would the word "paid" mean in the context of the present case. Section 43(2) clearly defines the term "paid" to mean as 'actually paid' or 'incurred'. 'Actually paid' would be as per the cash system of accounting, and 'incurred' would be for the mercantile system of accounting. Admittedly, the assessee was following the mercantile system of accounting. The crucial word thus would be "incurred";
++ it is seen that the payment, in the present case, had been deferred to such dates as provided in the agreement. Section 43B itself contemplates certain deductions to be given only on 'actual payment', even in case where mercantile system of accounting is followed. Such is not the case for Section 35AB, where "paid" has to be considered in terms of the definition provided u/s 43(2), which provides for actually paid or incurred the liability to pay. The moment there is liability to pay, which in our opinion, would be on the date of transfer of the technical know-how, the provisions of Section 35AB would be attracted. In the present case, for the A.Y 1998-99, such benefit was given and has not been withdrawn. However, for the subsequent four A.Ys, the cases have been re-opened, and the benefit which was granted by accepting the return u/s 143(1) has been withdrawn; and for the A.Y 2003-04 the same was denied by the AO itself. In the case of Keshav Mills, the Apex Court has held that the mercantile system of accounting treats profits or gains as arising or accruing at the date of the transaction notwithstanding the fact that they are not received or deemed to be received and under that system, book profits are assessed as liable to tax. In our view, the ratio of the decision would go in favour of the assessee and not the Revenue, as the moment a legal liability to pay arises, and before the actual disbursement is made, the assessee has incurred the liability to pay the amount, which, in the present case, would be on the date of transfer of know-how, which was on 1st March, 1998. The observations made by the Apex Court in the case of Morvi Industries would also go in favour of the assessee and not the Revenue, as the Apex court has observed therein that where accounts are kept on mercantile basis, the profits or gains are credited though they are not actually realised, and the entries thus made really show nothing more than an accrual or arising of the said profits at the material time. The same is the position with regard to debits made. As such, accrual of income would be different from receipt of income and the moment the income accrues, the party gets the vested right to claim such amount and conversely the moment the liability to pay arises, such liability is incurred by the assessee;
++ in the present case, the assessee, following the mercantile system of accounting, had in its books of account shown the amount of Rs.5 crores as liable to be paid, or as liability to pay on the date on which it acquired the technical know-how, which was 1st March, 1998, as the legal liability had been incurred even before it was actually disbursed. Further, the issue of 'lumpsum consideration' u/s 35AB was considered by the Jharkand High Court in the case of Tata Yodogawa Ltd. vs CIT, wherein it was held that "the word "lumpsum" as used before the word "consideration" u/s 35AB only exclude periodical or turnover based payments like royalty etc., and in one time payment for the know-how would fall within the expression "lumpsum" and if it is fixed and specified in the agreement, although it may be payable in instalments". This court is also of the opinion that the expression "lumpsum consideration" used in Section 35AB, in the facts of the present case, would only mean that the liability to pay the entire amount or "lumpsum consideration" had occurred on the date of the agreement and transfer of know-how, even though the payment may not have been made in lumpsum, but deferred over a period of time. In the present case, there is a finding that though the payment of the consideration under the agreement was to take place by installments, it would still constitute a lump sum consideration since the amount was fixed and was not variable on the basis of other unforeseen eventualities. The assessee had evidently incurred the liability to pay the entire amount under the agreement. In that view of the matter the finding of the CIT(A) that the assessee would be entitled to a deduction of one-sixth of the entire amount in respect of which the assessee had incurred a liability in the previous year relevant to the A.Y in question is correct. In the facts of the present case and in light of the law laid down in the aforesaid case, we are of the opinion, that the assessee would be entitled to claim deduction in accordance with Section 35AB in respect of sum of Rs.5 Crores for transfer of technical know-how, even though the amount was payable and paid in instalments on subsequent dates.