Per N.V. Vasudevan, Judicial Member.

ITA No. 3093/Del./2000 & ITA No. 2906/Del./2000 :

ITA 3093/Del./2000 is an appeal by the assessee, while ITA 2906/Del./2000 is an appeal by the Revenue and both these appeals are directed against the order dated 31-3-2000 of CIT(A), VII, New Delhi relating to assessment year 1996-97.

2. We shall first take up for consideration the appeal by the assessee viz., ITA 3093/Del./2000. The first ground of appeal reads as follows :

"1. That the CIT(A), erred on facts and in law confirming disallowance of expenditure on installation charges and management fee paid to HDFC in respect of assets taken on lease holding the same to be capital expenditure.

1.1 That the CIT(A), erred on facts and in law in holding that the assets were taken on lease on permanent basis resulting in enduring benefit to the assessee.

This ground of appeal can conveniently be decided together with ground No. 3 of the Grounds of appeal of the Revenue in ITA 2906/Del./2000, which reads as follows :

3. That on the facts and in the circumstances of the case, the learned CIT(A), has erred in deleting the disallowance of interest claimed as to leased assets which is capital expenditure in nature."

3. The facts and circumstances under which the aforesaid grounds of appeal arise are as follows. The assessee is a company, which is engaged in the business of manufacture of motorcycles and its accessories. The assessee had incurred an expenditure of Rs. 81,42,285 during the previous year. The details of these expenditures were as follows :

The assessee entered into a lease agreement dated 11-3-1986 with M/s. HDFC whereby the assessee took certain items of plant and machinery on lease. Copy of the lease deed is placed at pages 96 to 118 of assessee’s paper book. A sum of Rs. 10 lakhs was payable to HDFC as management fee for arranging the lease transaction. The payment of Rs. 10,00,000 as management fee to HDFC is one of the item of expenditure listed above. Similarly, certain items of machinery were also taken on lease from M/s. Hero Honda Finlease Ltd. A sum of Rs. 51,73,540 was paid as interest on leased assets. One of the terms of the agreement in both the lease agreements is a clause to the effect that in the event of the manufacturer of the plant and machinery demanding any advance for supply of machinery the finance company will pay the same and notwithstanding the fact that the lease of the machine will commence only in future, the lessee (viz., the assessee) will have to pay interest on the amount that is advanced by the finance company to the manufacturer of plant and machinery. It is such interest paid on such advances that is shown as interest on leased assets above. For erection of the machinery certain structures had to be erected and in that connection, the assessee had incurred expenditure, which is shown as Civil Work on Leased assets above.

4. In its books of account, the assessee considered the entire cost as listed above as a revenue expenditure but deferred claiming the entire sum as an expenditure relating to the previous year. According to the assessee the benefit of this expenditure would accrue to the assessee for a certain number of years and therefore the proportionate expenditure alone had been claimed in the books of account. A sum of Rs. 2,94,837 had been claimed as expenditure in the profit and loss account. However in the computation of income filed along with the return of income, the entire expenditure incurred was claimed as revenue expendi- ture.

5. The Assessing Officer was of the view that the expenditure was of a capital nature. He allowed only deduction of Rs. 2,94,837 debited in the profit and loss account and disallowed the claim for deduction of a sum of Rs. 78,47,447. Aggrieved by the order of the Assessing Officer, the assessee preferred appeal before CIT(A). Before CIT(A), the assessee contended as follows :

(a)That the action of the Assessing Officer in allowing portion of expenditure debited to the profit and loss account and refusing to allow part of the very same expenditure as capital expenditure was unwarranted.

(b)That the interest paid on leased assets represented interest on amount advanced to the supplier of machinery and the payment of such interest during the intervening period, i.e., period before commencement of lease and payment of lease charges was also in the nature of interest akin to payment of interest on funds borrowed for the purpose of business. Reliance was placed on the decision of the ITAT, Delhi Bench, in ITA No. 6201/Del./92 in the case of Modi Xerox Ltd., dated 31-3-1999 wherein proposition to the above effect has been laid down.

(c)That the civil work carried out by the assessee for carrying out installation of the lease assets does not result in any enduring advantage in the capital field since ownership of the asset never vests in the assessee and therefore such expenditure was of a revenue nature. Reliance was placed on the decision of the Hon’ble Gujarat High Court in the case of CIT v. Alembic Chemical Works Ltd. [1994] 206 ITR 170 ¹.

(d)That the management fee paid to HDFC being in the nature of lease rent does not result in any enduring benefit to the assessee and was allowable as revenue expenditure in connection with the business.

That entries in the books of account by the assessee by claiming only part of the expenditure as revenue expenditure and deferring the remaining expenditure and claiming it over a period of time is not conclusive when allowing deduction under the Income-tax Act. Reliance was placed on the decision of the Hon’ble Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 (SC) and Sutlej Cotton Mills Ltd. v. CIT [1979] 116 ITR 1 (SC).

6. The CIT(A) held :

(A) That the interest paid on advances to suppliers of machinery was akin to interest on funds borrowed for the purpose of business and was to be allowed as a deduction. The CIT(A) also found that later the assets were installed and the lease rentals were also paid by the assessee and allowed as a deduction. He therefore held that the interest on leased assets was also an allowable expenditure and directed the Assessing Officer to allow deduction of interest paid on leased assets. (b) With regard to civil work on leased assets, and (c) Management fee paid to HDFC, the CIT(A) held as follows :

(B) Installation charges :

1.From the details filed it was clear that technically it is highly specific machine. At the time the machine was leased, the assessee had monopoly of manufacturing four stroke engines. In other words the machine could not be taken back by the lessor and leased to anyone else. It was specifically manufactured for the assessee and assessee had taken it on lease on permanent basis, as per ground realities though on paper it was 5 years lease only.

2.It cannot be used by anyone else, i.e., it cannot be removed from the place where it was installed and leased to someone else.

3.The controlling power in both the companies, i.e., lessor and lessee is one Mr. Brij Mohan Munjal. So naturally the machine has been purchased specifically for the use of the lessee and forever i.e., till the life of the machine.

4.It has been leased initially for 5 years and lease period will be extended further again and again and so on. Lease is only a format given, the benefit is permanent. On these facts, it is clear that it is a benefit of enduring nature and installation charges have been incurred once for all. I hold that it is capital expense and see no reason to interfere.

(C) Management fees to HDFC

For the same reasons as discussed for disallowing expenditure on civil work the CIT(A) held that this payment has been made to acquire a benefit of enduring nature and the fee has to be treated as capital expense and found no reason to interfere with the action of the Assessing Officer.

7. Aggrieved by the order of the CIT(A) in confirming the order of the Assessing Officer, with regard to disallowance of expenditure on Civil work on leased assets and management fee paid to HDFC, the assessee is in appeal before us. Aggrieved by the order of the CIT(A) in directing the Assessing Officer to allow the claim for deduction of expenditure on leased assets, the Revenue is in appeal before us.

8. We have heard the rival submissions. As far as assessee’s ground of appeal is concerned, the learned counsel for the assessee reiterated submissions as was made before CIT(A) while the learned D.R. relied on the order of the revenue authorities. We are of the view that the order of the CIT(A) on this aspect cannot be sustained. The ownership of the assets which were installed for the purpose of assessee’s business and in connection with installation of which assets the civil work were carried out, did not vest with the assessee. The CIT(A) seems to have got carried away by the fact that the said item of machinery cannot be used by anyone else and therefore its lease though on paper was for a period of 5 years was in reality to be leased to the assessee permanently. This factor cannot divest ownership in the goods from the lessee to the lessor, viz., the assessee. The CIT(A) appeals seems to have drawn this conclusion on his observation that the controlling interest in both the companies viz., the assessee-company and M/s. Hero Honda Finlease Ltd. (the lessor company) were both held by one and the same person. The assessee and the lessor company were two different persons in the eye of law. Their relationship vis-a-vis the asset leased was that of a lessor and lessee and such relationship is clearly evidenced by the lease deed. There was no basis for the CIT(A) to draw his conclusions as has been done in his order. There is no evidence on record to justify the conclusion of the CIT(A) that the asset was likely to be in possession of the assessee for ever and permanently. The conclusion of the CIT(A) are based on conjectures. The Hon’ble Gujarat High Court in the case of Alembic Chemical s (supra) has held that where cable and other things are installed for the sake of not installing them as assets and were for the purpose of working of the computers which were taken on hire and which were capable of being removed by the lessor anytime after expiry of lease was held not to result in an advantage of an enduring nature and such expenditure was held to be allowable revenue expenditure. On the facts of the present case we are of the view the expenditure in question was not of a capital nature and was allowable as a deduction. The management fee paid to HDFC for arranging for the transaction of lease of machinery is duly evidenced by the agreement and was an allowable deduction being of a revenue nature. The machinery in question not being owned by the assessee, there was no basis to treat the expenditure as capital expenditure. The order of the revenue authorities is therefore not proper. We therefore direct the Assessing Officer, to allow the expenditure claimed towards civil work on leased assets and management fee paid to HDFC on leased assets. The ground of appeal of the assessee is allowed.

9. Regarding the ground of appeal of the Revenue, we are of the view that the order of the CIT(A) is just and proper and calls for no interference. The expenditure was of a revenue nature akin to interest on funds borrowed for the purpose of business. The borrowing was in respect of an asset, which was to be taken on lease, and the ownership of which was never contemplated as that of the assessee. There is no ground to interfere with the orders of the CIT(A).

10. One of the reason assigned by the Assessing Officer for making the impugned disallowance was the treatment given by the assessee in respect of this item of expenditure as a deferred revenue expenditure in its books of account. It is pertinent to ascertain as to whether such expenditure has been treated by the assessee as capital expenditure in its books of account. In this regard, we find that the assessee has treated the said expenditure as ‘deferred revenue expenditure’ considering the advantage of enduring nature that is likely to accrue to it in the sense the advantage which was going to last for a few years beyond the previous year. When any expenditure is treated as a ‘deferred revenue expenditure’, it presupposes that the concerned expenditure, creating benefit is in the Revenue field and is a revenue expenditure but considering its enduring benefits as well as the fact that it does not result in the creation of any new asset or advantage of enduring nature in the capital field, the same is required to be treated distinctly from capital expenditure. In any case, as held by the Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363, the allowability of a particular deduction depends on the provisions of law relating thereto and not on the basis of entries made in the books of account, which are not decisive or conclusive in this regard. We therefore find any basis for the conclusion drawn by the Assessing Officer in this regard.

11. Grounds 1 and 1.1 of the grounds appeal of the assessee is allowed while the 3rd ground of appeal of the Revenue is dismissed.

12. Grounds 2 and 2.1 of the grounds of appeal of the assessee reads as follows :

"2. That the CIT(A), erred on facts and in law in not adjudicat- ing upon the disallowance of investment allowance of Rs. 6,52,217 in respect of increase in value of assets on account of exchange rate fluctuation.

2.1 That without prejudice, that the CIT(A), erred on facts and in law in not directing to allow investment allowance on the increase in the actual cost of fixed assets on account of foreign exchange fluctuation to the extent the enhanced liability is actually paid."

13. The facts relevant for adjudication of this issue are as follows. The assessee was entitled to claim investment allowance in respect of assets purchased. The assets had been purchased on loans taken in foreign currency. The cost of the machinery on which the investment allowance was to be allowed was therefore subject to fluctuations depending on the fluctuation in the foreign exchange currency. The assessee had claimed investment allowance amounting to Rs. 6,52,217 at the rate of 20 per cent of foreign exchange fluctuations aggregating to Rs. 32,61,085 in respect of loans taken in foreign currency for acquisition of assets. The deduction on account of investment allowance was claimed in the return of income. There was no debit to the profit and loss account in respect of the deduction claimed. The amount of Rs. 32,61,085 comprised of actual payment of enhanced liability during the relevant previous year amounting to Rs. 29,76,979 and provision for the increase in actual cost on notional basis comprising of Rs. 2,84,108. The Assessing Officer disallowed the claim following orders of the earlier years on the ground that investment allowance was not admissible on the foreign exchange fluctuations on notional basis. The Assessing Officer added back the amount to the income of the appellant, without appreciating that the same had never been debited to the profit and loss account. The CIT(A), however, did not deal with the issue and instead only issued directions to the Assessing Officer, to rectify the order to the extent of the addition of the aforesaid amount made in the figure of net profit since the same had not been debited to the profit and loss account by the appellant. Though similar issue had arisen for consideration in assessee’s own case for assessment year 1990-91 in ITA No. 5772/Del./95 and this Tribunal had allowed the claim of the assessee, since the CIT(A) had not decided the issue, it would be proper to set aside the order of the CIT(A) on this issue and direct the CIT(A) to consider the issue afresh after affording assessee opportunity of being heard. Ground No. 2 is treated as allowed for statistical purposes while ground No. 2.1 is dismissed as not arising out of the order of the CIT(A) at present.

14. The 3rd ground of appeal of the assessee reads as follows :

"3. That the learned CIT(A), erred on facts and in law in confirming disallowance of deduction under section 35D of the Act of Rs. 9,000 in respect of fee paid to Registrar of Companies for increase in authorized capital holding that the same was not a pre-commencement expenditure covered by section 35D of the Act."

The facts and circumstances under which the aforesaid ground of appeal arises are as follows. The assessee had claimed deduction of Rs. 9,000 being 1/10th of the expenditure being fees paid to Registrar of Companies during the financial year 1994-95 towards increase of authorized share capital. In assessment year 1995-96, the claim for deduction under section 35D was allowed. In the present assessment year, the Assessing Officer disallowed the claim for deduction relying on the decision of the Hon’ble Delhi High Court in the case of Bharat Carbon Mfg. Co. Ltd. v. CIT [1981] 127 ITR 239 ¹ wherein it has been held that such expenditure was capital in nature. On appeal by the assessee, the CIT(A), held that the assessee did not fulfil the necessary conditions for allowing relief under section 35D. Aggrieved by the order of CIT(A), the assessee has raised the aforesaid ground of appeal. We have heard the rival submissions. The provisions of section 35D read as follows :

"35D. Amortisation of certain preliminary expenses.—(1) Where an assessee, being an Indian company or a person (other than a company) who is resident in India, incurs, after the 31st day of March, 1970, any expenditure specified in sub-section (2),—

(i)before the commencement of his business, or

(ii)after the commencement of his business in connection with the extension of his industrial undertaking or in connection with his setting up a new industrial unit,

the assessee shall, in accordance with and subject to the provi-sions of this section, be allowed a deduction of an amount equal to one-tenth of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the industrial undertaking is completed or the new industrial unit commences production or operation."

The assessee in the present case has neither incurred the expend-iture in question before commencement of his business nor has the expenditure been incurred in connection with extension of his industrial undertaking or in connection with his setting up a new industrial unit. The order of the CIT(A) is therefore confirmed and this ground of appeal of the assessee is dismissed.

15. The 4th ground of appeal of the assessee reads as follows :

"4. That the learned CIT(A), erred on facts and in law in confirming disallowance of Rs. 1,12,272 and Rs. 1,519 out of club subscription."

16. The assessee during the relevant previous year made payments to various clubs, the details of which are as follows :

"(a)Membership subscriptionRs. 1,12,272

(b)Corporate membership fee of Delhi Golf ClubRs. 1,519."

The Assessing Officer disallowed the claim of the assessee for deduction of these expenses holding that they were non-business expenditure. On appeal by the assessee the CIT(A) held that the expenditure were personal expenses of directors and the directors entertained their personal friends and relatives and also business associates. If some expenditure incurred by the Director to entertain the clients or business associates at clubs is reimbursed by the company or met by the company, the claim for deduction can be considered as business expenditure but not the membership subscription paid by the company. Aggrieved by the order of CIT(A), the assessee is in appeal before us. We have heard the rival submissions. The details of subscription paid is at page 130 of the assessee’s paper book. The description given in the said details reads as payment towards corporate membership. In the orders of the revenue authorities however there is a reference to the fact that it is individual membership of directors. Be that as it may. We find that several High Courts and various Benches of the Tribunal have taken a uniform view that such membership enables the directors and executives to socialize and develop contacts with various persons for promoting company’s business interests and was therefore to be considered as expenditure in connection with business. The decisions are as follows :

(a) Otis Elevator Co. (India) Ltd. v. Commissioner Of Income-Tax. [1992] 195 ITR 682 ¹ (Bom.)

(b) Gujarat State Export Corporation Limited v. Commissioner Of Income-Tax. [1994] 209 ITR 649² (Guj.)

(c) Commissioner Of Income-Tax v. Sundaram Industries Ltd. [1999] 240 ITR 335 (Mad.)

(d) Gujarat Petrosynthesis Ltd. v. Dy. CIT [2001] 76 ITD 257 (Ahd.)

(e) ITO v. Soya Production & Research Association [1985] 22 TTJ (Delhi) 594.

Respectfully following the ratio laid down in the aforesaid decisions referred to above, we direct the Assessing Officer to delete the addition made in this regard. The 4th ground of appeal of the assessee is allowed.

17. The 5th Ground of appeal of the assessee reads as follows :

"5. That the learned CIT(A), erred on facts and in law in confirming disallowance of foreign travelling expenses incurred on visit of Mrs. Santosh Munjal, wife of a Director, to South Africa holding the same to be a non-business expenditure."

18. The above ground of appeal can conveniently be decided together with ground No. 7 of the grounds of appeal of the Revenue in ITA No. 2906/Del./2000, which reads as follows :

"7. That on the facts and in the circumstances of the case, the learned CIT(A), has erred in restricting the disallowance of foreign travelling expenses of the wife of CMD though she was not employee of the assessee-company."

19. The facts and circumstances under which both the aforesaid grounds of appeal arise are as follows. The assessee had during the previous year incurred an expenditure of Rs. 30.55 lakhs on foreign travel expenses of directors. The Assessing Officer called for the details of foreign travel expenses. On scrutiny of the details filed in this regard, the Assessing Officer noticed that the foreign travel expenses also included expenditure in connection with foreign travel of Mrs. Santosh Munjal w/o Chairman & Managing Director, Mr. Brij Mohanlal Munjal who had travelled with the CMD on 21-6-1995 to Mauritius and on 22-7-1995 to South Africa. The Assessing Officer thereafter called upon the assessee to show-cause as to why the portion of the expenditure relating to foreign travel of Mrs. Santosh Munjal be not disallowed as she was neither an employee of the assessee nor was her travel abroad necessary for the business of the assessee. In reply, the assessee stated that to strengthen the business relations and in order to promote exports the CMD had undertaken the foreign travel along with his wife and that it is a common business practice for the wife to accompany the directors/executive on such visits. The Assessing Officer however disallowed an expenditure of Rs. 4,84,734 being proportionate expenditure incurred on the foreign travel of Mrs. Santosh Munjal. On appeal by the assessee before CIT(A), it was contended that the visit to Mauritius was on the invitation extended to the CMD and his wife by the Confederation of Indian Industry (CII) to head the delegation visiting Mauritius. It was further explained that the vehicles of the assessee were being exported to South Africa and there was a substantial fall in the exports in the past and the CMD had to visit South Africa to participate in poojas that were being performed there. It was also contended that the social custom abroad and in particular western countries was that the spouse accompanies the executive. The CIT(A) held as follows :

"For this visit the reason given is that the export sales were declining. First of all this point has not been substantiated with the help of facts and figures. Then the reason given defies logic. How will participation by the wife of Director in pooja ceremonies enhance the sales? And how did this help the business interests in South Africa has not been established before me ?

Regarding A.R’s reliance on the decision of J.K. Synthetics, the facts are clearly different. There the wishes of the employees had gone, not the Director. Though employee on paper, for all practical purposes Director is owner and not employee. A foreign visit of an employee accompanied by wife can be an incentive to an employee but not to Director. A Director is already motivated enough in terms of business and does not require company of wife to further motivate him. This would be true of an employee not employee Director. This expense is not allowed for business purpose. The Assessing Officer is directed accordingly."

20. Aggrieved by the order of CIT(A) upholding a part of the expenses disallowed the assessee is in appeal before us. Aggrieved by the order of CIT(A) in allowing partial relief the revenue is in appeal before us.

21. We have heard the rival submissions. The Special Bench of the ITAT, Bombay Bench in the case of Glaxo Laboratories (India) Ltd. v. Second ITO [1986] 18 ITD 226 held as follows :

"In the modern age, and more so in the Western countries, the senior executives are, as a matter of social custom, accompanied by their wives when they visit, though for business purposes, has necessarily some social aspects also."

The Hon’ble High Courts and Tribunals have expressed similar views in the following cases :

(a) CIT v. Apollo Tyres Ltd. [1999] 237 ITR 706 ¹ (Ker.)

(b) Commissioner Of Income-Tax v. Sundaram Clayton Ltd. [1999] 105 Taxman 545 (Mad.)

(c) ITO v. J.K. Synthetics Ltd. [1986] 18 ITD 490 (Delhi)

(d) ITO v. F.F. Ferguson & Co. [1986] 19 ITD 620 (Bom.)

22. In the present case, the visit to Mauritius at the invitation of the Confederation of Indian Industries, by the wife of the CMD along with the CMD was therefore to be considered as for business purpose and allowed as a deduction. The ground of appeal of the Revenue therefore deserves to be dismissed. As far as assessee’s appeal regarding foreign travel expenses of wife of CMD to South Africa is concerned, the visit apparently is to participate in poojas carried out at South Africa. There is no reference to any meeting with any foreign business associates. There is nothing to suggest any business necessity for undertaking these visits. The visit of the various outlets in South Africa is claimed to be a goodwill visit. The explanation given in our view was not sufficient to conclude that the visit by the wife of the CMD was necessary and consequently to that extent the expenditure is liable to be disallowed. In our view the order of the CIT(A) is just and proper and calls for no interference. The same is confirmed and the fifth ground of appeal of the assessee is dismissed.

23. Grounds 6, 6.1 and 6.2 of the grounds of appeal of the assessee reads as follows :

"6. That the learned CIT(A), erred on facts and in law in confirming the action of the Assessing Officer in allowing amortization of the technical know-how fee of Rs. 115.67 lakhs as per provisions of section 35AB of the Act as against revenue deduction claimed by the assessee.

6.1 That the learned CIT(A), erred on facts and in law in not appreciating that the provisions of section 35AB of the Act are not attracted in a case of payment of fee for mere use of technical know-how as opposed to the acquisition of technical know-how.

6.2 That the learned CIT(A), erred on facts and in observing that there is hardly any case for grievance of the assessee because in any case, the assessee will get the deduction of expenditure in six years and not in one year."

24. The assessee had during the previous year, paid net amount of Rs. 92.53 lakhs (Gross Rs. 115.66 lakhs minus Tax Deducted at Source of Rs. 23.13 lakhs) to Honda Motor Company Ltd., Japan, towards first instalment of technical know-how fee, which was claimed as deduction under section 37(1) of the Act. The Assessing Officer denied the claim for deduction holding that the expenditure was a capital expenditure. Alternatively, the Assessing Officer held that the expenditure would fall under the category of capital expenditure mentioned in section 35AB of the Act and that the assessee would be entitled to deduction of 1/6th of the expenditure. A deduction of Rs. 15.42 lakhs was allowed and the claim for deduction of the remaining sum was refused. On appeal by the assessee before the CIT(A), it was contended that the payment in question was made to the Japanese company under a technical collaboration agreement dated 2-6-1995 and that under the aforesaid agreement the assessee was granted only exclusive license to manufacture, assemble, sell and distribute the products and the parts and that there was no absolute transfer of the technology in favour of the assessee. That under the agreement the Japanese collaborator continues to remain the sole and exclusive owner of the know-how, technical information etc., and that the assessee was debarred from claiming any title to the said rights. That after termination of the agreement the assessee was prohibited from disclosing these information, processes and inventions during the currency and also after termination of this agreement. That even during the currency of the agreement, the assessee was obliged to keep secret and confidential information furnished by the Japanese collaborator and that the assessee was also prohibited from sub-licensing the know-how to any third party. It was contended that payment for licence to use the know-how was a revenue expenditure and reliance was placed on the decisions of the Hon’ble Supreme Court in the case of CIT v. CIBA of India Ltd. [1968] 69 ITR 692, Alembic Chemical Works Co. Ltd. v. CIT [1989] 177 ITR 377¹ . Further reliance was also placed on the decisions of the Hon’ble Delhi High Court in the case of Shriram Refrigeration Industries Ltd. v. Commissioner Of Income-Tax, Delhi-I [1981] 127 ITR 746² , Triveni Engg. Works Ltd. v. CIT [1982] 136 ITR 340 ³, Addl. CIT v. Shama Engine Valves Ltd. [1982] 138 ITR 216⁴ , CIT v. Bhai Sunder Dass & Sons (P.) Ltd. [1986] 158 ITR 115. It was further contended that insertion of the provisions of section 35AB allowed amortization of capital expenditure alone and that the said section makes a reference to acquisition of any know-how for use for the purpose of business. It was submitted that since the expenditure in question was only for limited use of the know-how without acquiring any right of ownership of the know-how it was neither capital expenditure nor was an expenditure incurred for acquisition of know-how and therefore the provisions of section 35AB never applied to the facts of the case. It was also contended that what was allowable as a deduction under section 37 as revenue expenditure was never sought to be superseded by the provisions of section 35AB of the Act. Reliance was placed on the decision of the ITAT, Calcutta Bench in the case of Wellman Incandescent India v. Dy. CIT [1995] 55 ITD 338 (Cal.). The CIT(A) however held that the expenditure was of a capital nature and fell within the parameters of section 35AB of the Act and that the assessee was entitled to claim only 1/6th of the expenditure as laid down therein. Aggrieved by the order of the CIT(A), the assessee is in appeal before us.

25. We have heard the rival submissions. The question for our consideration is as to whether the expenditure is a capital expenditure? Whether the expenditure would fall within the parameters of section 35AB of the Act and therefore the assessee would be entitled to only 1/6th of the expenditure as a deduction?

26. The terms of the agreement for use of technical know-how needs to be adverted to. A copy of agreement dated 2-6-1995 is placed at pages 149 to 184 of assessee’s paper book. The Japanese collaborator is referred to as the Licensor and the assessee as the Licensee under the aforesaid agreement. Article 2 of the agreement reads as follows :

"Grant of License : Subject to the terms and conditions herein contained, licensor hereby grants to licensee an indivisible and non-transferable exclusive right and licence, without the right to grant sub-licences, to manufacture, assemble, sell and distribute the products and the parts during the terms of this agreement within the territory under the Intellectual Property Rights and by using the Technical Information."

Under article 4 the licensor has agreed to provide technical information and guidance necessary for manufacture of products and parts by the licensee. Under article 17 it is clearly agreed that the know-how, technical information and any other public technical or business information shall remain the sole and exclusive property of the licensor and shall be held in trust and confidence for licensor by licensee and that the licensee shall not divulge or communicate information to any other person, that the information obtained will be kept secret and confidential. Under clause 18.5 it is specifically agreed that the licensee shall claim no title or property right whatsoever during the existence of the agreement and if the agreement is terminated the licensee shall not claim any right, title, property, interest or use whatsoever at all times after the life of the agreement as regards the use of the intellectual property rights, know-how, technical information or other information received under the agreement.

27. The above terms clearly show that the assessee was merely entitled to use the know-how for manufacture of motor cycles and its parts. The law is settled that expenditure incurred on payment for use of technical know- how for a limited duration as opposed to payment for acquisition thereof is allowable as deduction under section 37(1) of the Act. The consideration paid for acquiring any know-how for the purpose of the business was held to be capital expenditure, not allowable as deduction under section 37(1) of the Act. The consensus of judicial opinion was that expenditure for acquiring the technical know-how was different from expenditure incurred for obtaining the mere use of the technical know-how and information, which was allowable as revenue expenditure. We may refer only to three decisions of the Supreme Court on this point as laying down the law in this behalf. The first is the decision, in CIT v. CIBA of India Ltd. [1968] 69 ITR 692 (SC) where it was held that payments made for the right to have access to the technical knowledge and the fruits of continuing research and experience of a foreign company and to use its patents and trade marks were on revenue account. In Alembic Chemical Works Co. Ltd. v. CIT [1989] 177 ITR 377¹ , the Supreme Court again held that a lump sum consideration paid for obtaining technical know-how in order to achieve higher levels of production by better technology was allowable as revenue expenditure. The emphasis in all these cases was that if the payment is made for exclusive acquisition of the technical know-how or information the expenditure would be capital, but if the payment was made only to secure the use of the technical know-how or knowledge, it would be allowable as revenue expenditure. In the present case as we have already explained the assessee had only a mere right to use the know-how and did not acquire ownership of any know-how. The expenditure was, therefore, not a capital expenditure and was a revenue expenditure allowable under section 37(1).

28. The next question is whether the expenditure in question is covered by the provisions of section 35AB. If it is covered by the said provisions, the assessee would get deduction of 1/6th of the expenditure for each for six assessment years and he would be entitled to amortize the entire expenditure in 6 years. If the expenditure is outside the purview of section 35AB and was revenue expenditure in nature, the assessee would be entitled to claim the entire sum as deduction in one assessment year itself. Section 35AB was introduced into the Income-tax Act by the Finance Act, 1985 with effect from 1-4-1986. The section is as under :

"35AB. (1) Subject to the provisions of sub-section (2), where the assessee has paid in any previous year any lump sum consideration for acquiring any know-how for use for the purposes of his business, one-sixth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year, and the balance amount shall be deducted in equal instalments for each of the five immediately succeeding previous years.

(2) Where the know-how referred to in sub-section (1) is de- veloped in a laboratory, university or institution referred to in sub-section (2B) of section 32A, one-third of the said lump sum consideration paid in the previous year by the assessee shall be deducted in computing in profits and gains of the business for that year, and the balance amount shall be deducted in equal instalments for each of the two immediately succeeding previous years.

Explanation.—For the purposes of this section, ‘know-how’ means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil well or other sources of mineral deposits (including the searching for, discovery or testing of deposits or the winning of access thereto)."

29. To fall within the parameters of section 35AB, the assessee must have paid lump sum consideration for acquisition of any know-how for use for the purpose of business. The expression ‘Acquired’ used in section 35AB as we have already observed refers to a situation where the ownership is acquired by an assessee and not to a case of a mere right to use the technical know-how. The expression acquired means to become the full owner of the property with full and absolute right, title and interest. On a reading of the terms of the agreement it is clear that the assessee never became the owner of the know-how. Consequently, the provisions of section 35AB did not apply to the assessee. What was allowed by the provisions of section 35AB was an expenditure which was of capital nature and which was not allowable as a deduction under section 37(1) of the Act. The said provisions do not affect the right of an assessee to claim deduction of an expenditure which was legitimately allowable under section 37(1) of the Act. The learned counsel for the assessee has placed reliance on several judicial pronouncements of the Hon’ble Supreme Court/High Court and decisions of ITAT on this aspect. We do not wish to make a reference to all those decisions as those decisions lay down the principle relying on which we have set out in a nut shell the principle as stated above. We are therefore of the view that the disallowance of a part of the know-how fee paid by applying the provisions of section 35AB was not proper. The entire expenditure ought to be allowed as deduction. The relevant grounds of appeal of the assessee are allowed.

30. The 7th and 8th Grounds of appeal of the assessee reads as follows :

"7. That the learned CIT(A), erred on facts and in law in holding interest earned on temporary deposit of surplus funds of business, other than bill discounting and advances to employees as ‘income from other sources’ instead of ‘profits and gains from the business or profession’.

8. That the learned CIT(A), erred on facts and in law in confirming the action of the Assessing Officer in allowing deduction under section 80HHC of the Act at Rs. 1,61,46,627 as against Rs. 1,92,50,997 claimed by the assessee.

9. By excluding interest on temporary deposit of surplus funds of business, other than bill discounting and advances to employees from business profits.

(a)not treating custom duty benefit of Rs. 1,51,89,229 under advance licence scheme as a part of business profits.

(b)not excluding excise duty and sales tax amounting to Rs. 143 crores and Rs. 28 crores respectively from the total turnover, for the purpose of computing deduction under section 80HHC of the Act."

31. A decision on the 8th ground of appeal will also dispose ground No. 7. The facts with regard to ground No. 8 are as follows. The assessee was entitled to claim deduction under section 80HHC of the Act. While computing the deduction under section 80HHC of the Act the assessee had taken into consideration interest income of Rs. 1,64,78,854 as business income. This interest earned comprised of the following. Interest on inter- corporate deposits, Loans advanced to employees and Bill Discounting Charges. According to the Assessing Officer such interest income was to be assessed under the head ‘Income from other sources’ and not ‘Income from Business’. The Assessing Officer made a reference to the decision of the Hon’ble Supreme Court in the case of M/s. Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT [1997] 227 ITR 172¹0 (SC) in support of his conclusion wherein the Hon’ble Supreme Court has held that interest earned on short-term deposits will be treated as income from other sources. The assessee had during the relevant previous year availed rebate of customs duty for import of components against advance licence issued under the Import & Exports (Control) Act, 1947, used for manufacture of motor cycles amounting to Rs. 1,51,89,229. The aforesaid amount was also taken into account by the assessee for claiming deduction under section 80HHC as profits and gains of business. According to the assessee the said amount was covered under section 28(iiic) of the Act. According to the Assessing Officer it was only customs or excise duty repaid or repayable as drawback against expenditure under Customs & Central Excise Duty Drawback Rules, 1971, that is to be considered as income from business under section 28(iiic) of the Act. The benefit received by the assessee in the form of duty savings against advance licence according to the Assessing Officer was not income from business. The Assessing Officer also held that the assessee has not shown this benefit in the form of customs duty benefit as income. The Assessing Officer thus excluded this sum also while allowing benefit of section 80HHC to the assessee. The assessee while computing the deduction under section 80HHC had taken total turnover at Rs. 631.59 crores. This total turnover was taken net of excise and sale tax of Rs. 143 crores and 28 crores respectively. The Assessing Officer was of the view that these amounts will also form part of the turnover and added to the total turnover while allowing deduction under section 80HHC. As a result of the action of the Assessing Officer the deduction under section 80HHC was allowed only to the extent of Rs. 1,61,46,627 as against a sum of Rs. 1,92,50,997 claimed by the assessee.

32. Aggrieved by the order of the Assessing Officer, the assessee preferred appeal before CIT(A). Before CIT(A), the assessee contended that deployment of temporary surplus business funds in the form of ICDs was inextricably linked with the main business and arose out of the said business only. It was also contended that the impugned investment in ICDs was assessee’s current asset and was, therefore, to be considered as a business asset and any income arising out of business asset shall be considered as a business income. Reliance was placed on the following decisions:-

CIT v. AP Industrial Infrastructure Corpn. Ltd. [1989] 175 ITR 361¹1 (AP), Commissioner Of Income-Tax v. Tirupati Woollen Mills Ltd. [1992] 193 ITR 252 (Cal.), Commissioner Of Income-Tax v. Tamil Nadu Dairy Development Corporation Ltd. [1995] 216 ITR 535¹2 (Mad.).

33. As far as this plea of the assessee is concerned, the CIT(A) held that since the funds which were invested in ICDs were admittedly surplus funds which were lying idle, the earning of interest on such deployment of funds shall be considered as income from other sources. He also held that there was no business compulsion or business necessity for deployment of funds in ICDs. The CIT(A), therefore, considered the interest income earned on inter corporate deposit as income from other sources. With regard to the action of the Assessing Officer in not treating the Customs Duty benefit under Advance Licensing Scheme as part of business profits, it was contended by the assessee that the Duty Drawback as defined by the Customs and Central Excise Duties Drawback Rules, 1971 speak of rebate of duty chargeable on any imported material used in the manufacture of such goods and exported out of India. The assessee drew attention of the CIT(A) to the provisions of Advance Licensing Scheme notified by the Government and submitted that the Customs Duty benefit which the assessee gets under the Advance Licensing Scheme is akin to the Duty Drawback as defined in the Customs and Central Excise Duties Rules, 1971 and, therefore, the said income would fall within the ambit of section 28(iiic) of the Act and, therefore, the same should be considered as business income. The CIT(A) held that the rebate of duty under Advance Licensing Scheme cannot be equated with a Duty Drawback as envisaged under section 28(iiic) of the Act and, therefore, the same cannot be considered as business income. As far as the action of the Assessing Officer in not excluding Excise Duty and Sales Tax as part of the total turnover while computing deduction under section 80HHC of the Act is concerned, the assessee relied on the decision of the Calcutta Bench of the ITAT in the case of Chloride India Ltd. v. Dy. CIT [1995] 53 ITD 180 and of the Decision of the Pune Bench of the Tribunal in the case of Sudershan Chemical Industries Ltd. v. Dy. CIT [1997] 60 ITD 629 wherein it has been held by the Tribunal that the total turnover for the purpose of section 80HHC does not include statutory levies such as excess Sales Tax. The CIT(A), however, held that the expression ‘total turnover’ has not been defined under section 80HHC of the Act and, therefore, its meaning in common parlance should be considered. According to the CIT(A), the meaning of the words ‘total turnover’ in common parlance would denote gross receipt inclusive of Sales-tax and Customs Duty. Accordingly, the CIT(A) confirmed the order of the Assessing Officer.

34. Aggrieved by the order of the CIT(A) the assessee is in appeal before us. We have heard the rival submissions. The Ld. Counsel for the assessee reiterated his submissions as were made before the Assessing Officer. With regard to the interest income not having been considered as income from business the Ld. Counsel further relied on the decision of the Special Bench of the ITAT in the case of Rajeev Enterprises v. Assessing Officer [2003] 261 ITR AT 34 (Jp.). Further reliance was placed on the following decisions:—

CIT v. Nagpur Engg. Co. Ltd. [2000] 245 ITR 806 (Bom.), S. Damanjit Singh v. Asstt. CIT [2002] 121 Taxman 303 (Mag.) (Delhi - Trib.), Honda Siel Power Products Ltd. v. Dy. CIT [2001] 77 ITD 123 (Delhi), Dy. CIT v. Punjab State Electronics & Devp. Production Corpn. Ltd. [2002] 120 Taxman 119 (Mag.) (Chd. - Trib.), Shiva Shankar Granties (P.) Ltd. v. ITO [2002] 81 ITD 106 (Hyd.).

35. With regard to the Excise Duty benefit received under the Advance Licensing Scheme, the Ld. Counsel relied on the decision of the Ahmedabad Bench of the Tribunal in the case of Asstt. CIT v. Pratibha Syntex Ltd. [1999] 63 TTJ (Ahd.) 409¹3 wherein the Ahmedabad Bench of the ITAT while considering a case of claim under section 80HHC of the Act held that total benefit derived by an assessee on duty-free imports will form part of the profit by business under section 28(iiib) of the Act. The Tribunal found that under section 28(iiib) of the Act the expression ‘used’ was cash assistance received by an assessee by whatever name called and the expression ‘whatever name’ called was held to include any duty benefit derived by an assessee on dutyfree imports. On the basis of this decision it was submitted that the claim of the assessee should be considered under section 28(iiib) of the Act. With regard to the non-exclusion of the Excise Duty and Sales-tax, while computing the total turnover reliance was placed on the following decisions:-

CIT v. Sudarshan Chemicals Industries Ltd. [2000] 245 ITR 769¹4 (Bom.), CIT v. Wolkem (P.) Ltd. [2003] 259 ITR 430 ¹5 (Raj.), IFB Agro Industries Ltd. v. Dy. CIT [2002] 261 ITR (AT) 17 (Cal.) (SB), Avon Cycles Ltd. v. Asstt. CIT [1997] 59 TTJ (Chd.) 75¹6, Shri Dinesh Mills Ltd. v. Asstt. CIT [2000] 72 ITD 110 (Ahd. ‘A’), Ambika Cotton Mills Ltd. v. Asstt. CIT 72 TTJ 990 (Ahd.‘A’), CIT v. Bharat Earth Movers Ltd. [2004] 268 ITR 232 ⁴ (Kar.).

36. The Ld. DR relied on the orders of the Revenue Authorities. We have considered the rival submissions. As far as the interest on inter-corporate deposits is concerned, as rightly held by the CIT(A) it has not been shown to have any link with the business of the assessee. Admittedly, the funds were surplus funds which were temporarily invested to earn income. It was not the business of the assessee to invest monies and earn interest income. The decision relied upon by the Ld. Counsel for the assessee are not of any assistance in view of the decision of the Hon’ble Supreme Court in the case of Tuticorin Alkalies Chemicals & Fertilizers Ltd. (supra). Since the income in question has not been shown to have an inextricable links with the business of the assessee, the income has rightly been considered as income from other sources. Ground No. 7 of the assessee is, therefore, dismissed and part of ground No. 8 is also dismissed. As far as the Customs Duty benefit received by the assessee under the Advance Licensing Scheme is concerned, as rightly held by the CIT(A), the same would not fall within the ambit of section 28(iiic) of the Act, but as held by the Ahmedabad Bench of the ITAT in the case of Pratibha Syntex Ltd. (supra) the case of the assessee would fall within the parameters of section 28(iiib) of the Act. This would be a residuary clause as held by the ITAT and, therefore, any other reliefs given in any form to an exporter will fall within the said clause. Respectfully following the decision referred to above, we hold that the Excise Duty benefit should form part of the income from business of the assessee while computing deduction under section 80HHC of the Act. With regard to the Customs Duty and Sales-tax having been included as part of the total turnover while computing deduction under section 80HHC of the Act, the decision of the CIT(A) cannot be sustained, in view of the decision of the Hon’ble Bombay High Court in the case of Sudarshan Chemicals Industries Ltd. (supra), wherein the Hon’ble Bombay High Court has held that Excise Duty and Sales-tax should not be included in the total turnover while computing deduction under section 80HHC of the Act. In view of the above, the Excise Duty and Sales-tax is directed to be excluded from total turnover while computing deduction under section 80HHC of the Act. Ground No. 8 is partly allowed.

37. In the result, the appeal filed by assessee is partly allowed.

38. Now we shall take up for consideration the appeal by the Revenue i.e., ITA No. 2906/Del./2000. The first ground of appeal of the Revenue reads as follows:

"1. That on the facts and circumstances of the case, the learned CIT(A), has erred in allowing relief under section 80HH maintaining that the first year of manufacture of production is the first year of production of commercial manufacture though there is no distinction under section 80HH between commercial manufacturing or trial production."

39. The facts and circumstances giving rise to the aforesaid ground of appeal are as follows. The assessee was entitled to claim deduction under section 80HH of the IT Act. It claimed deduction under section 80HH of the IT Act of a sum of Rs. 7,07,83,477 in the present assessment year i.e. 1996-97. Under the provisions of section 80HH of the IT Act where the gross total in case of an assessee includes any profits and gains derived from an industrial undertaking which begins to manufacture or produce articles after 31-12-1970 but before 1-4-1990 in any backward area, a deduction from the total income of such assessee equal to 20% of the profits and gains is allowed. Sub-section (4) of section 80HH lays down the period during which the deduction is allowed under section 80HH and it lays down that the deduction is to be allowed for 10 assessment years beginning with the assessment year relevant to the previous year in which the industrial undertaking begins to manufacture or produce articles. The dispute in the present ground of appeal is to the year in which the industrial undertaking began to manufacture or produce articles. To appreciate the stand of the revenue and the assessee we may have to narrate the dispute in the case of the assessee for the assessment year 1986-87. The assessee is in the business of manufacture and sale of motor cycles on collaboration with M/s. Honda Motor Cycles of Japan. The assessee-company was incorporated on 19-1-1984 and closed its books on 30-4-1985. The assessment year 1986-87 was its first year of business. The assessee claimed deduction of certain expenses incurred w.e.f. 16-3-1985 to the end of the previous year on the ground that it had already set up its business during the previous year when trial production had commenced on 16-3-1985. The Assessing Officer disallowed the claim for deduction of these expenses on the ground that the business of the assessee had not commenced during the previous year relevant to assessment year 1986-87. On appeal by the assessee the learned CIT(A), held that the assessee had set up its business during the previous year relevant to assessment year 1986-87. On further appeal by the revenue before the ITAT, the order of the learned CIT(A), was confirmed. The revenue had contended in the said appeal before the ITAT that only 35 motor cycles had been manufactured on a trial basis as on 16-3-1985 and none of them were in saleable condition. Since commercial production of motor cycles commenced only on 27-5-1985 the expenditure cannot be allowed as deduction since business had not commenced. The ITAT however held that the business had been set up as on 16-3-1985 when trial production of 35 cycles were completed and that the expenditure incurred after such setting up of business was allowable as deduction not withstanding the fact that commercial production had not commenced.

40. Taking into consideration the findings of Tribunal for assessment year 1986-87, the Assessing Officer was of the view that the first year of production should be taken as having taken place in assessment year 1986-87 and therefore the period of 10 years referred to in section 80HH(4) ends with assessment year 1995-96 and therefore the assessee will not be entitled to deduction under section 80HH for the present assessment year viz., 1996-97.

41. According to the assessee the expression "beginning with the assessment year relevant to previous year in which the industrial undertaking begins to manufacture or produce articles" as used in section 80HH(4) refers to only manufacture of a final product and not manufacture of trial product. Since the final product was manufactured by the assessee only on 27-5-1985 the previous year relevant to assessment year 1987-88 the first year when deduction under section 80HH could be claimed is only assessment year 1987-88 and therefore the period of 10 years would end only with assessment year 1996-97, i.e., the assessment year in the present appeal and therefore the assessee was entitled to claim deduction under section 80HH in this year also. The assessee explained that the claim for deduction of revenue expenditure incurred after 16-3-1985 when trial production of 35 motor cycles had been completed in the assessment year 1986-87 was on the basis that the business was set up though the business had not commenced. The assessee pointed out the difference between ‘setting up’ of a business and ‘commencement’ of a business as explained by the Hon’ble Bombay High Court in the case of Western India Vegetable Products Ltd. v. CIT [1954] 26 ITR 151 (Bom.) as follows. In the case of a new business the accounting year commences on the date when the business is set up. A business is set up when it is established or set on foot. There may be a time gap between the setting up of a business and commencement of a business but under section 28 of the Act the chargeability of income to tax is in respect of a business which is being carried on and under section 29 only such chargeable income has to be computed in accordance with provisions of sections 30 to 43D of the IT Act. Expenditure incurred prior to setting up of a business is not to be allowed. Expenditure incurred after setting up of a business even though prior to commencement of business has to be allowed as deduction.

42. With the aforesaid background we shall now refer to the case made out by the Assessing Officer for rejecting the claim of the assessee for deduction under section 80HH of the IT Act. The Assessing Officer has made a reference to the stand of the assessee in assessment year 1986-87 and was of the view that having taken a stand that production had commenced in the previous year relevant to assessment year 1986-87 the assessee was changing its stand in assessment year 1996-97 by saying that commercial production had commenced only in assessment year 1987-88 and the period of 10 years has to be reckoned from that assessment year. He held that under section 80HH there was no concept like ‘commercial production’. He then made a reference to the Director’s report in the annual report of the assessee for 1984-85 which was relevant to assessment year 1986-87 wherein the Directors have informed the shareholders that the flag off ceremony of trial production of CD 100 Motor Cycles took place on 13-4-1985 and the commercial production of Motor Cycles commenced on 27-5-1985. According to the Assessing Officer the assessee did not choose to make a claim for deduction under section 80HH for assessment year 1986-87 because the assessee had incurred loss. Deduction under section 80HH would be available to an assessee even if trial production commenced and because there was a loss in assessment year 1986-87, the assessee did not claim deduction under section 80HH. The Assessing Officer also made a reference to the claim of the assessee for investment allowance as well as depreciation in assessment year 1986-87 and in his view this was sufficient to prove that production has started in the assessment year 1986-87 itself.

43. Aggrieved by the order of the Assessing Officer the assessee preferred appeal before the learned CIT(A). Before CIT(A), the assessee primarily contended that it was only when commercial production commenced the deduction under section 80HH can be claimed. The assessee relied on the decision of the Hon’ble Bombay High Court in the case of Commissioner Of Income-Tax, Poona v. Hindustan Antibiotics Ltd. [1974] 93 ITR 548 and the decision of the Hon’ble Madras High Court in the case of Addl. CIT v. Southern Structurals Ltd. [1977] 110 ITR 164 wherein while dealing with similar claim for deduction under analogous provisions of the IT Act, the courts have taken a view that it was only commercial production that was first year in which deduction was to be allowed and the period when only trial production is carried out shall not be reckoned as the first year of manufacture or production. The expression ‘manufacture or produce’ was held by the courts to mean only ‘commercial production’. The assessee thereafter relied on circumstantial and other evidence to show that commercial production had in fact commenced only in the previous year relevant to assessment year 1987-88. On such submissions, the learned CIT(A), held as follows :

(i)That in the previous year relevant to assessment year 1986-87, the assessee had only carried out trial production and not commercial production

(ii)That the claim of the assessee for deduction of revenue expenditure incurred by it after 16-3-1985 when trial production of 35 Motor Cycles was completed was on the basis of the distinction in law between ‘setting up of business’ and ‘commencement of business’ as explained in the case of Western India Vegetable Products Ltd. (supra). Since carrying out of trial production was setting up of business and the claim of the assessee was allowed.

(iii)That different yardstick applied when claiming a deduction under section 80HH and that only when commercial production commences the claim for deduction under section 80HH could be made. Since the assessee commenced commercial production only on 27-5-1985 the previous year relevant to assessment year 1987-88 under section 80HH could be acclaimed only in assessment year 1987-88. The learned CIT(A), relied on the decision of the Hon’ble Bombay and Madras High Courts in the case of M/s. Hindustan Antibiotics Ltd. (supra) and Southern Structurals Ltd. (supra) in this regard to come to the conclusion that the expression ‘manufacture or production’ used in section 80HHC has to be interpreted as ‘commercial production’ and not trial production.

(iv)The learned CIT(A), therefore concluded that the first year of manufacture or production was previous year relevant to assessment year 1987-88 and therefore the claim of the assessee for deduction under section 80HH for the assessment year 1996-97 was the 10th year and was therefore to be allowed.

44. Aggrieved by the order of the learned CIT(A), the revenue is in appeal before us. We have heard the rival submissions. The learned DR in his submissions reiterated the stand of the Assessing Officer. The learned counsel for the assessee again reiterated submissions as were made before the learned CIT(A). As can be seen from the ground of appeal of the revenue, what is challenged before us is not the finding of the learned CIT(A), that commercial production commenced only in previous year relevant to assessment year 1987-88 and that in the previous year relevant to assessment year 1986-87 only trial production had commenced. The only grievance of the revenue as projected in the ground of appeal is that first year of manufacture is not the first year of commercial manufacture or production since such a distinction is not contemplated by the provisions of the section 80HH of the IT Act.

45. The provisions of section 80HH insofar as it is relevant for a decision in the present case read as follows :

"80HH. Deduction in respect of profits and gains from newly established industrial undertakings or hotel business in backward areas. - (1) Where the gross total income of an assessee includes any profits and gains derived from an industrial undertaking, or the business of a hotel, to which this section applies, there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction from such profits and gains of an amount equal to twenty per cent thereof.

(2) This section applies to any industrial undertaking which fulfils all the following conditions, namely :—

(i)It has begun or begins to manufacture or produce articles after the 31st day of December, 1970 but before the 1st day of April, 1990 in any backward area;

(ii)it is not formed by the splitting up, or the reconstruction, of a business already in existence in any backward area :

Provided that this condition shall not apply in respect of any industrial undertaking which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such industrial undertaking as is referred to in section 33B, in the circumstances and within the period specified in that section;

(iii)it is not formed by the transfer to a new business of machinery or plant previously used for any purpose in any backward area;

(iv)it employs ten or more workers in a manufacturing process carried on with the aid of power, or employs twenty or more workers in a manufacturing process carried on without the aid of power.

Explanation - Where any machinery or plant or any part thereof previously used for any purpose in any backward area is transferred to a new business in that area or in any other backward area and the total value of the machinery or plant or part so transferred does not exceed twenty per cent of the total value of the machinery or plant used in the business, then, for the purposes of clause (iii) of this sub-section, the condition specified therein shall be deemed to have been fulfilled.

(4) The deduction specified in sub-section (1) shall be allowed in computing the total income in respect of each of the ten assessment years beginning with the assessment year relevant to the previous year, in which the industrial undertaking begins to manufacture or produce articles or the business of the hotel starts functioning :

Provided that,—

(i)in the case of an industrial undertaking which has begun to manufacture or produce articles, and

(ii)in the case of the business of a hotel which has started functioning,

after the 31st day of December, 1970, but before the 1st day of April, 1973, this sub-section shall have effect as if the reference to ten assessment years were a reference to ten assessment years as reduced by the number of assessment years which expired before the 1st day of April, 1974."

46. In the case of Commissioner Of Income-Tax, Poona v. Hindustan Antibiotics Ltd. [1974] 93 ITR 548, the question for consideration before the Hon’ble Bombay High Court arose in the context of section 15C of the Old Act, which reads as follows :

"15C. (1) Save as otherwise hereinafter provided, the tax shall not be payable by an assessee on so much of the profits or gains derived from any industrial undertaking to which this section applies as do not exceed six per cent per annum on the capital employed in the undertaking computed in accordance with such rules as may be made in this behalf by the Central Board of revenue.

(2) This section applies to any industrial undertaking which—

(i)is not formed by the splitting up, or the reconstruction of business already in existence or by the transfer to a new business of building, machinery or plant used in a business which was being carried on or before the 1st day of April, 1948;

(ii)has begun or begins to manufacture or produce articles in any part of the taxable territories at any time within a period of thirteen years from the 1st day of April, 1948, or such further period as the Central Government may, by notification in the Official Gazette, specify with reference to any particular industrial undertaking;

(iii)employs ten or more workers in a manufacturing process carried on with the aid of power, or employs twenty or more workers in a manufacturing process carried on without the aid of power :

Provided that the Central Government may, by notification in the Official Gazette, direct that the exemption conferred by this section shall not apply to any particular industrial undertaking. . . .

(6) The provisions of this section shall apply to the assessment for the financial year next following the previous year in which the assessee begins to manufacture or produce articles and for the four assessments immediately succeeding."

The assessee was a limited company, which on June 1, 1954, took over the project for manufacture of penicillin and other antibiotic products, which was initially started by the Government of India. The company commenced actual operations for manufacturing crude penicillin as from December 12, 1954. In the profit and loss account for the year ending March 31, 1955, it showed a closing stock of crude penicillin worth Rs. 16,727. The first samples of crude penicillin which were manufactured by the assessee-company on December 14, 1954, were required to be sent to USA and UK for obtaining certificates as to their qualities. The requisite certificates were received some time in June, 1955, and the assessee-company started manufacture of sterile penicillin from August, 1955, onwards. The Income-tax Officer, inter alia, took the view that it is not correct that the assessee-company’s actual manufacturing operations commenced with effect from August, 1955; that for the accounting year ending March 31, 1955 (the relevant year corresponding to assessment year 1955-56), the company in its profit and loss account showed a closing stock of crude penicillin worth Rs. 16,737. He took the view that the process of manufacture must certainly have commenced in the accounting year 1954-55, as the sales were effected in the accounting year 1955-56. Further, he took the view that the beginning of the manufacturing process was certainly in the accounting year 1954-55, as the balance-sheet and profit and loss accounts for the year ending March 31, 1955, showed that a substantial quantity of raw materials and stores were consumed, wages were paid and electricity charges were incurred.

In the appeal by the assessee, the Appellate Assistant Commissioner reversed the order of the Income-tax Officer and held that the assessee-company was entitled to exemption under section 15C of the Act for the assessment year 1960-61 also. On a further appeal by the revenue before the Tribunal, it was held that regular production of the end product commenced only in August, 1956, relevant to the assessment year 1956-57 and that mere production of crude penicillin, which until a final certificate as to quality was received may not be regarded as of any use, and cannot be regarded as the beginning of the manufacture or production of the article. On further appeal by the revenue, the Hon’ble Bombay High Court held as follows :

"The question that arises for consideration in this case depends upon the correct interpretation of the expression ‘has begun or begins to manufacture or produce articles’ used in section 15C(2)(ii). The first question that arises for consideration will be whether a trial production will be regarded as beginning to manufacture or produce articles. On behalf of the revenue, the counsel has not contended to that extent, but his submission, however, is that before a finished product is produced by the assessee-company it is necessary to produce some other product at an earlier stage, mere production of that material at an earlier stage will be sufficient to come to the conclusion that the assessee-company had begun or begins to manufacture or produce articles. Reliance was placed by him upon two facts which are not disputed, namely, that the assessee-company commenced production or manufacture of crude penicillin on December 14, 1954, and that in the profit and loss account for the period ending March 31, 1955, there was a closing stock of crude penicillin worth Rs. 16,727. The argument was that sterile penicillin, which is a final product saleable in the market can never be produced until first crude penicillin is produced or manufactured and if that be so, mere production or manufacture or crude penicillin will be regarded as beginning of manufacture or production of articles within the meaning of section 15C(2)(ii). The word ‘articles’ used in this expression has to be interpreted regard being had to the object with which this section was enacted. Undoubtedly, the object was to encourage establishment of new industrial undertakings and such object was sought to be achieved by granting an exemption from tax to the extent of 6 per cent per annum on the capital employed in the undertaking in the manner prescribed. If the object is to give exemption from tax, that presupposes that the real object is that the profits are capable of being earned by the company. If such be the object, then until the assessee-company reaches a stage where it is in a position to decide that a final product, which could ultimately be sold in the market, could be manufactured or produced by it, it will be idle formality to say that it had started manufacture or production of articles simply because trial products are prepared with a view to verify whether they can be ultimately used in the preparation or manufacture of the final products. It is undoubtedly true that commencement of operations for manufacture of crude penicillin took place on December 14, 1954, and there was some closing stock of crude penicillin at the end of March, 1955, but even the assessee-company itself did not know whether the crude penicillin manufactured or produced by it would at all be useful to them for the production or manufacture of sterile penicillin which is only a saleable product in the market. Facilities for testing crude penicillin are not available in this country and samples were required to be sent to U.S.A and U.K. with a view to find out its quality. It was only in the month of June, 1955, that a certificate as to the quality of the crude penicillin was received by the assessee-company and regular production was thereafter commenced only from and after August, 1955. If, on testing, the crude penicillin, which was sent for a certificate, was found useless it will be difficult to take the view that the assessee-company has begun to manufacture or produce articles, meaning thereby, articles which will ultimately be useful for manufacturing or producing finished products with the object of selling for which the assessee-company was incorporated. In our view, if regard be had to the object with which the section was enacted, then the word ‘articles’ in section 15C(2)(ii) can only be interpreted to mean articles which are definitely capable of being used by the assessee-company for manufacture or production of finished things which are to be ultimately sold by the company. Such a thing took place for the first time from and after August, 1955, and so the benefit of exemption under section 15C arose to the assessee-company for the first time in the assessment year 1956-57, for which the relevant accounting year ended on March 31, 1956.

The provisions of sub-section (6) lay down that they will apply to the assessment for the financial year next following the previous year in which the assessee begins to manufacture or produce articles and for the four assessments immediately succeeding. The first financial year in respect of which the benefit of the section is available being 1956-57, the company was entitled to claim exemption also for the assessment year 1960-61, as four years succeeding ended in that period."

47. In the case of Addl. CIT v. Southern Structurals Ltd. [1977] 110 ITR 164 (Mad.) facts were that the assessee entered into a contract with the Government of India, Ministry of Railways, to manufacture and deliver 250 railway wagons at a specified price. Being a new industrial undertaking, the assessee claimed relief under section 84 of the Income-tax Act, 1961. We may mention here that this section is identical to the provisions of section 15C of the old Act referred to in the decision of the Bombay High Court in the case of Hindusthan Antibiotics Ltd. (supra). The assessee was granted the relief under section 84 of the Income-tax Act up to the assessment year 1963-64. When the question of the availability of the relief to the assessee came up for consideration for the assessment year 1964-65, the Income-tax Officer took the view that the manufacture of railway wagons had begun in the calendar year 1958, relevant for the assessment year 1959-60, and that the last and final year of relief could only be 1963-64 and that, therefore, the assessee was not entitled to the relief for the assessment year 1964-65. Against this order of the Income-tax Officer, the assessee appealed to the Appellate Assistant Commissioner who upheld the finding of the Income-tax Officer and rejected the assessee’s claim for the relief. The assessee thereafter took the matter on appeal to the Appellate Tribunal. The Tribunal held that the assessee was eligible for the relief for the assessment year 1964-65 as the assessee could not be said to have begun manufacturing or producing railway wagons in any commercial sense in the calendar year 1958 relevant for the assessment year 1959-60. On further appeal by the Revenue the Court held as follows:

"There can be no dispute about the fact that the article that is relevant in the context of the present case is the wagon as such. Production of a proto-type is not production of an article as such, because if the Ministry of Railways had rejected the proto-type or had suggested substantial modifications thereto, then it would not have been possible for the assessee to go into production of the wagons in accordance with the proto-type already produced and the process of manufacture in accordance with the rectified type of wagon would take some further time. Therefore, the mere manufacture of proto-type would not be enough to show that the assessee had begun to manufacture or produce articles. The manufacture or production of articles must be in some commercial sense."

48. The principles laid down in the aforesaid decisions squarely apply to the provisions of section 80HH and therefore the CIT(A) was fully justified in holding that the first year in which the deduction under section 80HH was available is the year in which commercial production had commenced. The claim of the assessee in assessment year 1986-87 was allowed on the basis of principles laid down by the Hon’ble Bombay High Court in the case of Western India Vegetable Products Ltd. (supra). The first thing which one will have to bear in mind that there is a distinction between setting up of a business and the commencement of business. In Western India Vegetable Products Ltd. v. CIT [1954] 26 ITR 151 (Bom.), it has been held that under the Income-tax Act, what is relevant is the setting up of business and not the commencement of the business that is to be considered. The definition of the previous year as contained in section 3 of the Income-tax Act, 1961 reads as follows:

"3. ‘Previous year’ defined.

For the purposes of this Act, ‘previous year’ means the financial year immediately preceding the assessment year :

Provided that, in the case of a business or profession newly set up, or a sources of income newly coming into existence, in the said financial year, the previous year shall be the period beginning with the date of setting up of the business or profession or, as the case may be, the date on which the source of income newly comes into existence and ending with the said financial year."

49. It is on the basis of this definition that the Hon’ble Bombay High Court held that for the purpose of Indian Income-tax Act, it is the setting up of the business and not the commencement of the business that is to be considered. The Hon’ble High Court further held that when the business is established and ready to commence the business, then it cannot be said that business itself is set up but before it is ready to commence, it is not set up. It further held that there may be time gap in setting up of the business and commencement of the business and all the expenses incurred during that intervening period would be permis- sible deduction. It is on the basis of this principle that the deduction for revenue expenditure in assessment year 1986-87 had been allowed to the assessee in the present case. That will however have no bearing on the issue in the present assessment year which revolves around the question as to when commercial production commenced in the case of the Assessee. In view of the finding that commercial production commenced in the case of the assessee only in the assessment year 1987-88, the claim for deduction under section 80HH in assessment year 1996-97 was to be allowed.

50. The following facts would go to show that only the trial production had started on 16-3-1985 during the previous year relevant to the assessment year 1986-87. The commercial production began only on 27-5-1985, falling the assessment year 1987-88. The Director’s Report to the shareholders and notes to accounts forming part of the annual report for the financial year 1984-85 would go to show that the commercial production of Motor Cycles commenced only on 27-5-1985. A copy of the annual report for the year ending is placed at page Nos. 368 to 370 of the assessee’s paper book. At page 359, is the Director’s report to the shareholders wherein the above fact has been informed by the Directors to the shareholders. In the notes to the accounts to the said annual report there is a reference to raw materials and components consumed during the trial production as per note No. 4 of the notes to the accounts (360 paper book) in the note Nos. 10 to 12 of the notes to the accounts (370 of the paper book) the fact that the trial production commenced on 16-3-1985 and the fact that the commercial production did not commence as on 30-4-1985 (date of the balance sheet) is also mentioned therein. The expenditure incurred on the production during the period from March 1985 to 30-4-1985 has been shown as pre-operative and trial production expenditure allocated to fixed assets and capital work in progress. The auditors in their report to the shareholders (copy at page 361 attached to the paper book) have also reported to the shareholders that no commercial production has started as on 30-4-1985. A copy of the annual report for the year 1985-86 has also been filed before us. Copy of the same is at page Nos. 371 to 374 of the assessee’s paper book. In this annual report for the period ending 30-6-1985 it has been reported by the Director that the commercial production of the Motor Cycles began only from 1-5-1985 to 30-6-1986 (Page No. 372 of the assessee’s paper book). In the notes of accounts (at Page 392 of the assessee’s paper book) the fact that the commercial production began only on 27-5-1985 has been stated. In the year of assessment for the year 1986-87 the Assessing Officer has recorded the fact that the commercial production of the assessee began only on 27-5-1985. The first sale of Motor Cycles had taken place on 27-5-1985 and the sales tax return disclosing the sales made and the return to the excise authorities in RT-12 disclosing the production of the Motor Cycles was filed first time on 27-5-1985. The copy of the sales tax return for the month of June, 1985 is at pages 69 to 75 of the assessee’s paper book. Copy of the excise return for the month of March 1985 is at pages 76 to 83 of the assessee’s paper book. In the light of these documents, the findings of the learned CIT(A), that commercial production began only on 27-5-1985 is correct. In view of the above, the order of CIT(A) does not call for any interference and the same is confirmed and this ground of appeal of the Revenue is dismissed.

51. Ground No. 2 of the grounds of the appeal of the revenue reads as follows:

"2. That on the facts and in the circumstances of the case, the learned CIT(A), has erred in deleting the disallowance of provisions for warranty without appreciating the facts that it is not an incurred expenditure."

52. The Assessee company is in the business of manufacture and sale of Motor Cycles. For every Motor Cycle sold, the assessee provides warranty to the purchaser against any manufacturing defects in certain specific component of the Motor Cycle. The warranty so provided was for the following period,-

(a)On components of CD 100 series of Motor Cycles - 6 months

(b)On frame of Splendor model of Motor Cycles - 6 months

(c)On Engine components of Splendor model - 6 months

The assessee had claimed a sum of Rs. 28,70,416 as deduction on account of provisions of warranty, the assessee during the relevant previous year changed its method of accounting for warranty from cash to mercantile system. According to assessee this change in method of accounting became necessary in view of the amendments to provisions of section 209(3) of the Companies Act, 1956 whereby the assessee was required to follow the accrual system of accounting. The assessee also made a reference to the opinion of the Institute of Chartered Accountants of India, whereby they have opined that it was mandatory to provide warranty cost on accrual basis. According to the assessee, the change in method of accounting and the provisions made was based on the number of Motor Cycles sold in the particular year and the actual claims on Motor Cycles sold in the past. The provision was made on the basis of weighted average of the actual claim of the Motor Cycles in the past. The assessee also enclosed the basis of calculation of provisions for warranty. The Assessing Officer, however, was of the view, that the expenditure in question can be allowed only on actual accrual basis and since the purchaser of the Motor Cycle had not made the claim for rectification of defects, it cannot be said that the liability had accrued to the assessee. The Assessing Officer referred to several cases in this regard and disallowed the claim of deduction. Aggrieved by the order of the Assessing Officer, the assessee preferred an appeal before the learned CIT(A). Before the learned CIT(A), the assessee has contended as follows;

(a)That during the previous year, relevant to the assessment year 1996-97, the assessee changed its method of accounting in the matter of providing for claim on account of warranties on vehicles that it had sold from cash basis to mercantile basis.

(b)That a sum of Rs. 28,70,416 was set aside as provision for meeting claims on account of warranties and that this provision was worked out on the basis of weighted average of actual claims settled during the year.

(c)That the change in method of accounting was necessary because of the prescription by the ICAI to provide for warranty for actual basis and also on account of the mandate of the law (under the Companies Act) to follow the accrual system of accounting. The assessee had explained that as against the provision made during the previous year, the assessee had actually settled a sum of Rs. 51,23,558.

(d)That it had been following consistently a system of providing warranty claims, the details of which are as follows:

(e)That the changed method of accounting did reflect the true profits of the assessee inasmuch as all the cost of the warranty claims was included in the sales price, but the liability thereagainst was not claimed in the profit and loss account. That the method of accounting followed by the assessee was more scientific and based on actual claims for a specific period and that the Assessing Officer has not established that a better method would have been followed by the assessee.

53. The learned CIT(A), on consideration of the submission of the assessee, was of the view that the assessee was following the cash system of accounting in respect of the claim for warranties which was logical and realistic in determining the correct income. But such system of accounting could not be followed by the assessee, since as per the Companies Act, the assessee was statutorily required to follow mercantile system of accounting. He also was of the view, that even the hybrid system of accounting could not be followed by the assessee, because the law requires an assessee to either follow cash system of accounting or mercantile system of accounting. The learned CIT(A), thereafter considered the system of determining the provisions warranties as adopted by the assessee and was of the view that the provision is made by the assessee every year and the actual expenses incurred every year has also been debited in the profit and loss account. A similar provision has been made every year and there was consistency. He was of the view that the claim of the assessee deserves to be accepted. He, however, directed the Assessing Officer to verify that the provision is credited and also the actual expenses are debited and to ensure that the provision is not debited over and above the actuals. According to the CIT(A), the expenses in each year is not less than what has been provided for by the assessee and therefore he held that the claim of the assessee deserves to be allowed.

54. Aggrieved by the order of the learned CIT(A)’s order, the revenue is in appeal before us. We have heard the submissions of the learned DR who principally relied on the reasoning adopted by the Assessing Officer. The learned counsel for the assessee while relying on the order of the learned CIT(A) and the submissions made before the learned CIT(A), submitted that the claim of the assessee has been found to be consistent, scientific and logical and therefore, the same was rightly upheld by the learned CIT(A).

55. We have considered the rival submissions. The assessee follows the mercantile system of accounting. It is only the actual liability which accrues or arises during the previous year that can be considered as an expenditure deductible for income tax purposes. A liability which is dependent on fulfilment of a condition cannot be allowed as a deduction unless the dependent condition is fulfilled during the previous year. In the present case, it is noticed that the assessee when it sells its motorcycles manufactured by it, it confers on the purchasers the benefit of a warranty against defects appearing within the particular period. The assessee also undertakes to provide free maintenance including replacement of parts within a particular period from the date of sale of the motorcycle. It estimated its probable liability on account of free maintenance and replacement of parts during the warranty period and claimed the same as a deduction. According to the revenue authorities, the liability was contingent upon a defect appearing and being notified within the warranty period. Till such time there is no liability in law and therefore the claim for deduction on account of estimated liability cannot be allowed. The Hon’ble Supreme Court in the case of Bharat Earth Movers v. CIT [2000] 245 ITR 428 ¹ had an occasion to consider the claim for deduction on account of a contingent liability. The following principles were laid down by the Hon’ble Supreme Court:

"If a business liability has definitely arisen in accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible if these requirements are satisfied the liability is not as contingent one. The liability is in present though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain."

Similarly, in the case of Commissioner of England Revenue v. Mitshubishi Motors, New Zealand (supra) the Privy Council had an occasion to deal with a claim for deduction on account of anticipated liability under warranty. It was a case of a car manufacturer who had undertaken to repair defects appearing within one year of delivery or until the vehicle has been driven for 22,000 kms. whichever period is shorter. The assessee car manufacturer sought deduction of its anticipated liability under the warranty remaining unexpired at the end of the year in which the vehicles were sold. The Privy Council held as follows :—

"The tax payers liability under the warranty for each vehicle sold was contingent on a defect appearing and being notified to the dealer within the warranty period so that no liability was incurred by the tax payer until those conditions were satisfied, regard could be had to its estimation of warranty claims based on statistical information, which shows that as a matter of existing fact not future contingency 63 per cent. Of all vehicles sold by the tax payer contained defects likely to be manifested within the warranty, that since theoretical contingencies could be disregarded, the tax payer was in the year of sale under an accrued legal obligation to make payment under those warranties and, even though it might not be required to do so until the following year, it was definitely committed in the year of sale to that expenditure; and that, accordingly, in computing the profits or gains derived by the tax payer from its business in the year in which the vehicles were sold, the tax payer was entitled under section 104 to deduct from its total income and provision which it had made for the costs to its anticipated liabilities under outstanding warranties in respect of vehicles sold in that year."

56. Keeping in mind the principles laid down by the Hon’ble Supreme Court and also by the Hon’ble Privy Council, we shall now examine the facts of the present case. In the present case, the yearwise details of provision for warranty and actual payments for the subsequent year against it is as follows :—

The learned CIT(A), on an analysis of the method of making the provisions for warranty has held the actual expenses are being debited every year and a similar basis for making provisions is repeated every year. The system followed by the assessee is consistent. The expenses actually incurred for the previous year and provided for is not less than the actual expenses. Since the method of accounting is scientific and results in correct deter- mination of profits. We are of the view, that the order of the learned CIT(A), is just and proper and does not call for any interference and the same is therefore, confirmed. Hence, this ground of appeal of the revenue is dismissed.

57. The third ground of appeal has already been decided while deciding the first ground of appeal of the assessee for the reasons stated therein. Hence, this ground of the appeal of the revenue is dismissed.

58. The fourth ground of the appeal of the revenue reads as follows :

"4. That on the facts and in the circumstances of the case, the learned CIT(A), has erred in deleting the disallowance as to presentation of articles without considering the facts that the presentation of articles without considering the facts that the presentation articles are not in the nature of advertisement."

59. During the previous year, the assessee had incurred an expenditure of Rs. 25,93,750 on presentation of articles. Out of this amount, a sum of Rs. 21,93,750 was spent on refrigerators presented to the dealers for achieving target under the incentive scheme of the company. The remaining sum was incurred on articles presented to business associates in the usual course of business. The assessee also submitted that none of the articles presented carried the name, logo of the assessee and therefore, they could not be considered as having any advertisement value and consequently rule 6(B) also did not apply. According to the assessee, the aforesaid expenditure was incurred for the purpose of business to boost its sale and maintain its relationship with its business associates and was wholly and exclusively for the purpose of business of the company and was eligible for deduction under section 37(1) of the IT Act. The Assessing Officer, however, held that even though there is no logo printed or embossed on the articles presented, the same would always be presented with the visiting cards of the employees of the company. The Assessing Officer was therefore of the view that it had advertisement value and accordingly, disallowed a sum of Rs. 21,93,750 incurred as expenditure on presentation of refrigerator to dealers. On appeal by the assessee, the learned CIT(A), deleted the addition holding that the expenditure was only an incentive to the dealers to boost the sales of the company and the expenditure so incurred was wholly and exclusively for the purpose of business. Aggrieved by the order of the learned CIT(A), the revenue is in appeal before us.

60. We have heard the rival submissions of the learned DR who relied on the order of the Assessing Officer. The learned counsel for the assessee relied on the order of the learned CIT(A) and the submissions made before the learned CIT(A). We have considered the rival submissions there is no dispute in the present case that the articles in question had been presented to its dealers. Merely because refrigerators are presented along with the visiting cards will not make it an advertisement. The dealer knows about the assessee and its products and there is no occasion for the assessee to advertise its products to its own dealers. The expenditure was rightly considered by the learned CIT(A), to be an incentive to the dealers to boost its sale of the company and that it was wholly and exclusively related to the business of the assessee. The following case laws support the view taken by the learned CIT(A) :

Dy. CIT v. Bhagwandas Shobalal Jain [1997] 60 ITD 118 (Jab.)

Panama Industries & Laboratories v. IAC [1991] 38 ITD 80 (Bom.)

Asstt. CIT v. Hindustan Marketing & Advertising Co. Ltd. [1994] 49 TTJ (Delhi) 96

Avon Cycles Ltd. v. Asstt. CIT [1997] 59 TTJ (Chd.) 75¹

Aristocrat Marketing Ltd. v. Asstt. CIT [1996] 85 Taxman 236 (Bom.) (Mag.)

This ground of the revenue is therefore, dismissed.

61. The 5th ground of the revenue reads as follows :—

"5. That on the facts and in the circumstances of the case, the learned CIT(A), has erred in allowing relief of Rs. 1,34,191 in respect of R & D expenditure."

62. The assessee during the relevant previous year, incurred capital expenditure amounting to Rs. 79,12,181 on research and development and claimed the same as business expenditure under section 35(1)(iv) of the Act. The Assessing Officer, however, disallowed a part of the expenditure amounting to Rs. 1,34,191 on the basis that the same has not actually been paid during the year. The amount of Rs. 1,34,191 disallowed by the Assessing Officer had been paid in advance by the assessee to the extent of Rs. 1,23,691 during the financial year 1994-95, the balance amount of Rs. 11,500 was paid during the financial year 1997-98. The expenditure has been claimed as deduction in the relevant previous year on the plant and machinery being capitalized and used for scientific research during the relevant previous year. On appeal, the learned CIT(A), deleted the disallowance made by the Assessing Officer. Aggrieved by the order of the learned CIT(A), the revenue is in appeal before us. The learned DR relied on the order of the Assessing Officer. The learned counsel for the assessee relied on the order of the learned CIT(A). We have considered the rival submissions. Under the provisions of section 35, sub-sections (i) & (iv) it is not necessary that the assessee must have actually paid the amount expended as expenditure on scientific research before claiming deduction. The provision of section 35(2)(ia) of the IT Act, the requirement is that the assessee should have incurred capital expenditure after 31-3-1967. The assessee in the present case, follows the mercantile system of accounting and the liability in question had been incurred during the previous year, relevant to the assessment year 1996-97. In such circumstances, we find no ground to interfere with the order of the learned CIT(A), and the same is therefore, confirmed and this ground of the revenue is also dismissed.

63. The 6th ground of the revenue reads as follows :

"6. That on the facts and in the circumstances of the case, the learned CIT(A), has erred in deleting the disallowance under section 43B without granting opportunity to the Assessing Officer as per rule 46A of the IT Rules."

64. The assessee had collected Rs. 3,74,824 as Haryana General Sales Tax on work contracts given by the assessee-company. The said sum was outstanding as on 31-3-1996 but paid before the due date of filing the return. In the tax audit report the fact that payment has been made has been mentioned and proof of payment was also attached along with the return of income. The Assessing Officer ignoring the evidence on record, inadvertently disallowed the said amount by invoking the provisions of section 43B of the Act. The CIT(A) deleted the addition made by the Assessing Officer by holding that the necessary evidence for payment of sales tax before the due date for filing the return of income had been furnished along with the return of income. The revenue is aggrieved and has raised the present ground of appeal. We have heard the rival submissions. A perusal of the order of the learned CIT(A), shows that the assessee had filed before the learned CIT(A), necessary evidence to establish the fact that the sales tax had been paid before the due date for filing of the return of income had been duly disclosed in the tax audit report. Proof of payments had also been filed alongwith the return of income. In view of the above, the amount was allowable as deduction in view of the first proviso to section 43(B) of the IT Act. The learned CIT(A), was therefore, justified in allowing the same. The order of the learned CIT(A), is therefore, confirmed and this ground of the revenue is dismissed.

65. The 7th ground of appeal of the revenue has already been decided while deciding the connected ground of the appeal of the assessee. For the reasons stated therein, the 7th ground of the appeal of the revenue is dismissed.

66. In the result, the appeal filed by the revenue is partly allowed.

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