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Commissioner Of Income-Tax, Tamil Nadu-Ii v. Madras Rubber Factory Ltd.

Madras High Court

Jul 5, 1983

Judgment

Subsequent
References

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Summary of Judgment delivered by Ramanujam, J.

Factual and Procedural Background

This opinion arises from two questions of law referred to the Court by the Income-tax Appellate Tribunal under section 256(1) of the Income-tax Act, 1961. The Revenue referred the questions after adverse decisions at the Tribunal in two connected disputes involving the same assessee.

First dispute (royalty/technical fees): The assessee paid Rs. 4,79,481 as gross technical charges under a collaboration agreement dated 4 September 1961 to Mansfield Tyre & Rubber Company, U.S.A. The Assessing Officer (ITO) disallowed 25% of the gross royalty and technical charges; the AAC confirmed that disallowance. The Tribunal held that the entire royalty payment should be allowed as a deduction. The Revenue questioned this conclusion before the Court.

Second dispute (section 80J relief): The assessee held an industrial licence (September 1960) for tyre and tube manufacture at Thiruvottiyur and initially obtained the masticating process from third parties. In 1969 the assessee established a separate unit at Kottayam for producing masticated rubber and claimed relief under section 80J in respect of that unit. The ITO and the AAC held the Kottayam unit was not a “new industrial undertaking” (the AAC relying on a Calcutta High Court decision). The Tribunal, however, held that the Kottayam unit qualified as a new industrial undertaking under the test in a Gujarat High Court decision. The Revenue referred the legal question to this Court.

Legal Issues Presented

Whether the entire technical aid fees and royalty paid to the foreign collaborator under the agreement dated September 4, 1961, should be allowed as deduction and no portion of it should be disallowed as capital expenditure?
Whether the assessee was entitled to relief under section 80J(4)(i) in respect of the plant put up at Kottayam for manufacture of masticated rubber?

Arguments of the Parties

Assessee's Arguments

Regarding royalties/technical fees: The Tribunal allowed the entire royalty payment as a deduction; the assessee's position at earlier stages is aligned with allowing the payment as revenue expenditure (the text records the Tribunal's view in favour of the assessee).
Regarding section 80J relief for the Kottayam unit: The Kottayam unit was a self-contained, independent unit established at heavy capital cost to produce a commercial product (masticated rubber); it was a new venture that did not affect the original character of the Thiruvottiyur unit; the Thiruvottiyur unit was not intrinsically altered and continued to manufacture tyres and tubes as before; consequently, the Kottayam unit should be treated as a new industrial undertaking.

Revenue's Arguments

Regarding royalties/technical fees: The Revenue contested the Tribunal's allowance of the full royalty payment and raised the question whether a portion should be treated as capital expenditure (the Revenue sought the Court's determination on this point).
Regarding section 80J relief for the Kottayam unit: The Revenue contended that the Kottayam unit was only an expansion or enlargement of the existing industrial undertaking at Thiruvottiyur and was established to fulfil the needs of the existing undertaking; therefore it was an ancillary unit (or a reconstruction/extension) and not a “new industrial undertaking” eligible for s.80J relief. The Revenue relied on certain High Court decisions (Calcutta and Delhi) supporting this position.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
CIT v. Madras Rubber Factory Ltd., T.C. Nos. 774 & 775 of 1976, [1983] 144 ITR 678 (Mad)	Held that royalty and technical aid fees paid to a foreign collaborator under a collaboration agreement should be treated as revenue expenditure and thus wholly deductible.	The Court treated this decision as binding on the first question and followed it, answering the first question in the affirmative and against the Revenue.
Textile Machinery Corporation Ltd. v. CIT, [1977] 107 ITR 195 (Supreme Court)	Interpreted s.15C (corresponding to s.80J) and held that for a new undertaking to be treated as reconstruction of existing business there must be a transfer of assets from the old business; new plants and machinery and substantial investment do not necessarily make the new unit an integrated part of the old business.	The Court applied the Supreme Court's tests and reasoning to conclude that the Kottayam unit was not a reconstruction of the existing business and therefore qualified as a new industrial undertaking under s.80J.
Nagardas Bechardas & Brothers P. Ltd. v. CIT, [1976] 104 ITR 255 (Gujarat High Court)	Provided a test for determining whether a unit is a new industrial undertaking (as relied on by the Tribunal in this case).	The Tribunal had relied on this decision; the Court noted that the Supreme Court in Textile Machinery (supra) specifically approved this Gujarat High Court decision, and the Court found the Tribunal's reliance justified on the facts.
Commissioner Of Income-Tax v. Textile Machinery Corporation, [1971] 80 ITR 428 (Calcutta High Court)	Held (at that earlier stage) that producing goods for one's own use which were previously purchased externally amounted to reconstruction of existing business for the purposes of s.15C (this position was relied on by Revenue at earlier stages).	The Court recorded that the Supreme Court subsequently reversed the Calcutta High Court's approach in Textile Machinery Corporation Ltd. v. CIT (supra), and therefore the Calcutta High Court decision could not be used to deny s.80J relief in the present case.
The Commissioner Of Income-Tax, Delhi… v. Naya Sahitya, Delhi…, [1972] 84 ITR 567 (Delhi High Court)	Represented a line of authority relied upon by Revenue to support the view that certain new units could be treated as reconstructions / ancillary to existing business and thus not eligible for relief.	The Court noted that the Supreme Court's later decision in Textile Machinery Corporation Ltd. v. CIT (supra) specifically overruled the Delhi High Court decision relied upon by the Revenue; consequently, that authority could not support Revenue's claim here.
Commissioner Of Income-Tax v. Hindustan Motors Ltd., [1977] 107 ITR 164 (Calcutta High Court)	Mentioned as a decision which the Supreme Court approved when considering the scope of s.15C.	The Court recorded that the Supreme Court approved this decision in its discussion of s.15C and used that approval as part of the broader Supreme Court reasoning applied to the present facts.

Court's Reasoning and Analysis

The Court addressed each referred question in turn and applied binding or persuasive authority expressly cited in the opinion.

First question (royalty/technical fees)

The Court observed that the first question is controlled by an earlier decision of this Court (CIT v. Madras Rubber Factory Ltd., [1983] 144 ITR 678 (Mad)) rendered on September 17, 1982.
That decision held that royalty and technical aid fees paid to a foreign collaborator under a collaboration agreement are revenue expenditure and therefore the entire payment is deductible.
On that basis, without further dispute of the facts, the Court followed the earlier decision and answered the first question in the affirmative and against the Revenue.

Second question (eligibility for s.80J relief — Kottayam unit)

The Court set out the factual matrix: the assessee previously procured masticated rubber from third parties; in 1969 the assessee set up a separate Kottayam unit for masticating rubber, which was a self-contained independent unit with new plants and machinery, selling product both to the assessee and to outsiders; the Kottayam unit did not intrinsically affect operations at the Thiruvottiyur unit.
The Court explained the statutory and precedential context: section 80J corresponds to section 15C of the 1922 Act, and the Supreme Court's decision in Textile Machinery Corporation Ltd. v. CIT ([1977] 107 ITR 195) authoritatively interpreted the meaning of reconstruction and the test for a new industrial undertaking under that provision.
The Supreme Court held that reconstruction requires transfer of assets of the existing business to the new undertaking; that the mere production of goods formerly bought from outside does not automatically mean reconstruction; and that the establishment of new plants and machinery by substantial investment does not necessarily create an integrated unit of the old business.
The Court observed that the Tribunal had relied upon the Gujarat High Court test in Nagardas Bechardas & Brothers (supra), a decision which the Supreme Court had approved.
Applying those principles to the facts, the Court found no evidence that assets of the existing Thiruvottiyur undertaking were transferred to the Kottayam unit, and noted that the Kottayam unit was set up with new plants and machinery to produce masticated rubber. Although a substantial portion of production was used by the Thiruvottiyur unit, that did not convert the Kottayam unit into a reconstruction or an integrated part of the existing business.
Consequently, the Court concluded that the Kottayam unit qualified as a “new industrial undertaking” for the purposes of section 80J and that the Tribunal's decision in favour of the assessee was correct and in line with the Supreme Court authority.

Holding and Implications

HOLDINGS:

First question: The entire technical aid fees and royalty paid to the foreign collaborator under the agreement dated September 4, 1961, are to be allowed as a deduction — answered in the affirmative and against the Revenue (following CIT v. Madras Rubber Factory Ltd.).
Second question: The assessee was entitled to relief under section 80J(4)(i) in respect of the Kottayam unit for manufacture of masticated rubber because the unit qualified as a new industrial undertaking — answered in the affirmative and against the Revenue.

Direct consequences and orders:

The Revenue's references were answered in favour of the assessee on both questions.
The Revenue was ordered to pay costs to the assessee; counsel's fee was fixed at Rs. 500.

Implications: The Court's decision applied and followed existing precedent (including this Court's earlier decision on treatment of royalties and the Supreme Court's interpretation of the reconstruction test under the corresponding earlier provision). The opinion does not purport to announce a novel legal principle beyond the application of those precedents; its immediate effect is to resolve the two referred questions in favour of the assessee and against the Revenue.

Show all summary ...

The Judgment of the Court was delivered by

Ramanujam, J.:— At the instance of the Revenue, the following two questions of law have been referred to this court by the Income-tax Appellate Tribunal, under s. 256(1) of the I.T Act, 1961:

“1. Whether the entire technical aid fees and royalty paid to the foreign collaborator under the agreement dated September 4, 1961, should be allowed as deduction and no portion of it should be disallowed, as capital expenditure?

2. Whether the assessee was entitled to relief under section 80J(4)(i) in respect of the plant put up at Kottayam for manufacture of masticated rubber?”

2. The assessee in this Case has paid a sum of Rs. 4,79,481 being the gross amount of technical charges to the Mansfield Tyre & Rubber Company, U.S.A, in terms of the collaboration agreement dated September 4, 1961. The ITO disallowed 25 per cent, of the gross amount of the royalty and technical charges so paid and this was confirmed in appeal by the AAC.

3. The matter was taken to the Tribunal and the Tribunal held that the entire royalty payment made in terms of the collaboration agreement should be allowed as a deduction. Aggrieved by the decision of the Tribunal in that regard, the Revenue has raised the first question set out above.

4. The assessee was granted an industrial licence in September, 1960, to produce automobile tyres and tubes at its factory at Thiruvottiyur. The initial capacity was three lakhs of tyres and tubes. Masticating of rubber is one of the processes in the ultimate production of tyres and tubes. The assessee, however, was getting the said work done by third parties. However, in the year 1969, the assessee set up a unit at Kottayam for producing masticated rubber. The assessee claimed s. 80J relief in respect of its Kottayam unit which started work in the previous year relevant to the assessment year. The ITO held that the assessee is not entitled to the benefit of s. 80J as the Kottayam unit is not a “new industrial undertaking” as contemplated by that section. The assessee took the matter in appeal to the AAC, who also held that the Kottayam unit is only an ancillary to the already existing industrial undertaking of the assessee and, therefore, it is not entitled to the relief under s. 80J. In support of his conclusion, the AAC relied on the decision of the Calcutta High Court in CIT v. Textile Machinery Corporation, [1971] 80 ITR 428. The assessee took the matter in appeal to the Tribunal. Before the Tribunal, the assessee, relying on the decision of the Gujarat High Court in Nagardas Bechardas & Brothers P. Ltd. v. CIT, [1976] 104 ITR 255, contended that the Kottayam unit is a self-contained independent unit, set up at heavy capital cost, to produce a commercial product, that it is a new venture without affecting the original character of the Thiruvottiyur unit, that the Thiruvottiyur unit is not intrinsically altered to any extent and it continues to manufacture automobile tyres and tubes in the same way even after the establishment of the Kottayam unit and that, therefore, the Kottayam unit should be taken to be a new industrial undertaking. As against the said contentions, the Revenue contended that the Kottayam unit is only an expansion of the already existing industrial establishment at Thiruvottiyur and since the Kottayam unit had been established only to fulfil the needs of the existing industrial undertaking in the manufacture of tyres and tubes, Kottayam unit should be taken to be an ancillary to the Thiruvottiyur unit and that, therefore, the Kottayam unit is not entitled to the relief under s. 80J. In support of its submissions, the Revenue relied on the decision of the Calcutta High Court in CIT v. Textile Machinery Corporation, [1971] 80 ITR 428 and the decision of the Delhi High Court in The Commissioner Of Income-Tax, Delhi… v. Naya Sahitya, Delhi…, [1972] 84 ITR 567. The Tribunal, after due consideration of the rival contentions and the decisions cited in support of them, held that as per the test laid down by the Gujarat High Court in Nagardas Bechardas & Brothers P. Ltd. v. CIT, [1976] 104 ITR 255, the Kottayam unit will come under the expression “new industrial undertaking” as contemplated in s. 80J. Aggrieved by the said view of the Tribunal, the Revenue has raised the second question.

5. So far as the first question is concerned, it is seen that it is covered by a decision of this court, rendered on September 17, 1982, in T.C Nos. 774 and 775 of 1976, CIT v. Madras Rubber Factory Ltd., [1983] 144 ITR 678 (Mad), which is against the Revenue. In that case, this court has held that the royalty and the technical aid fees paid to the foreign collaborator under the collaboration agreement should be treated as revenue expenditure and, as such, the entire payment has to be deducted. Following the said decision, we have to answer the first question in the affirmative and against the Revenue.

6. Coming to the second question, it is seen that the assessee was previously procuring masticated rubber, which is a raw material for the manufacture of automobile tyres and tubes, from others without itself undertaking the process of masticating rubber in its factory at Thiruvottiyur. Subsequently, in the year 1969, the assessee started a new and separate venture for masticating rubber. This unit is found to be a self-contained, independent unit. This unit is engaged in the process of masticating rubber and sells the resultant product not only to the assessee-company, but also to outsiders. The Kottayam unit has not affected intrinsically or otherwise any of the operations in the existing unit at Thiruvottiyur. On these facts, we cannot agree with the contention of the Revenue that the establishment of the Kottayam unit is only an extension or enlargement of the activities of the old establishment at Kottayam or is a reconstruction of an existing establishment or business.

7. Section 80J of the 1961 Act corresponds to s. 15C of the 1922 Act. The scope of s. 15C came to be considered by the Supreme Court in Textile Machinery Corporation Ltd. v. CIT, [1977] 107 ITR 195. In that case, a heavy engineering concern manufacturing boilers, machinery parts, wagons, etc., set up two new units, a steel foundry division and a jute mill division. The steel foundry started manufacturing some castings which the concern was previously buying from the market, but the castings were mostly used by the other existing divisions of the assessee. Raw materials were supplied by the boiler division to the jute mill division and after machining and forging, the parts were given back by the jute mill division to the boiler division. Thus, the entire articles produced by the foundry and also the jute mill were utilised by the assessee concerned. The assessee claimed relief under s. 15C. The I.T authorities held that the two units were formed by reconstruction of the business already existing, within the meaning of s. 15C(2)(i). But, the Appellate Tribunal differed and held that the assessee was entitled to the relief under s. 15C because the two divisions were new industrial undertakings and that they were not formed by reconstruction of the existing business. On a reference, the Calcutta High Court held that producing one's own goods systematically used in the existing business instead of buying them from outside would only be a reconstruction of an existing business within the meaning of s. 15C(2)(i). On appeal, the Supreme Court reversed the decision of the Calcutta High Court, holding that the steel foundry and the jute mill were not formed by the reconstruction of the business already in existence within the meaning of s. 15C(2)(i) and that, therefore, the assessee was entitled to the exemption claimed. It was held that for the reconstruction of an existing business, there must be transfer of the assets of the existing business to the new industrial undertaking and the new activity launched by the assessee by establishing new plants and machinery by investing substantial funds may produce the same commodities of the old business or it may produce some other distinct marketable products which may feed the old business and still, the new undertaking cannot be said to bean integrated unit of the old business. The Supreme Court also held that for the purpose of s. 15C, the industrial units set up must be new in the sense that new plants and machinery are erected for producing either the same commodities or some distinct commodities and that in order to deny the benefit of s. 15C, the new undertaking must be formed by reconstruction of the old business. The Supreme Court, in that case, specifically approved the decision of the Gujarat High Court in Nagardas Bechardas & Brothers P. Ltd. v. CIT, [1976] 104 ITR 255 and of the Calcutta High Court in Commissioner Of Income-Tax v. Hindustan Motors Ltd., [1977] 107 ITR 164. As already seen, the Tribunal, in the instant case, had relied on the decision of the Gujarat High Court in Nagardas Bechardas & Brothers P. Ltd. v. CIT, [1976] 104 ITR 255. The Supreme Court has specifically overruled the decision of the Calcutta High Court in CIT v. Textile Machinery Corporation, [1971] 80 ITR 428, and the decision of the Delhi High Court in The Commissioner Of Income-Tax, Delhi… v. Naya Sahitya, Delhi…, [1972] 84 ITR 567, which have been specifically relied on by the Revenue before the Tribunal as also before us. On the facts of the present case, there is absolutely no evidence to indicate that any asset of the existing undertaking had been transferred to the new unit at Kottayam. It is also seen that the Kottayam unit was set up with new plants and machinery for producing masticated rubber. Though a substantial portion of the masticated rubber produced by the Kottayam unit is used up by the existing undertaking of the assessee-company, it cannot be said that the Kottayam unit was established in the process of reconstruction of the existing business or establishment. The decision of the Supreme Court referred to above, therefore, squarely applied to the facts of this case. The decision of the Tribunal in this case is quite in accord with the view expressed by the Supreme Court in the above case. Therefore, we, answer the second question in the affirmative and against the Revenue. The Revenue will pay costs to the assessee. Counsel's fee Rs. 500.