ITTA/2/2010 of Tobacco Diversification and Investments Private Limited Vs Assistant Commissioner of Income Tax on 30 December 2011

THE HON’BLE SRI JUSTICE GODA RAGHURAM

AND

THE HON’BLE SRI JUSTICE B.N. RAO NALLA

I.T.T.A.No.2of 2010--Dated: 30122011

Between:

VST Industriess Limited, having its registered office at 1-7-1063/1065, Azamabad, Hyderabad – 500 020,Andhra Pradessh, rep., by its constituted Attorney Mr.SanjayKhanna.

And

--Appellant.

Assistant Commissioner of Income Tax,Circle –3(3)Hyderabad.

--Respondent.

THE HON’BLE SRI JUSTICE GODA RAGHURAMAND

I.T.T.A.No.2of 2010

JUDGMENT: (PERJUSTICE GODA RAGHURAM)

Heard Sri S. Ganesh, learned senior advocate, instructed bySri V. Padmanabhan and Sri J. Sivanesan for theappellant/assessee; and Sri B. Narasimha Sarma, learned standing counsel for Income Tax, for the Revenue.

Tobacco Diversification and Investments Private Limited(TDIL) which was amalgamated with VST Distribution, Storage andLeasing Company Pvt. Ltd. (VSTDSL), initially filed this appeal. Pursuant to the order of this Court dated 27-04-2011 [permittingamendment of the cause-title in I.T.T.A.M.P.No.210 of 2011 - on amalgamation of VSTDSL with VST Industries Ltd (VST)] theappeal is continued by VST.

TDIL a 100% subsidiary of VST, dealing in investments inshares and financial services, filed its return of income for theassessment year 1999-2000 disclosing a loss of Rs.22,69,876.00. The assessing officer completed the assessment on 28-03-2002under Section 143(3) of the Income Tax Act, 1961 (the ‘Act’)determining an income of Rs,13,00,30,120/-. The CIT(A)confirmed the major additions made by the Revenue. In a furtherappeal by the assessee, the Tribunal by the order dated 30-09-2003 set aside the assessment on the ground that facts of thecase need to be ascertained after affording sufficient opportunityto the assessee and remanded the matter for assessment de novo.

Re-assessment proceedings were taken up and theassessment completed on 30-03-2005, determining the income atRs.12.91 crores. In the assessee’s appeal therefrom, the CIT(A)by the order dated 10-10-2005 confirmed the liability of Rs.52crores in the hands of VST to be capital in nature and directed theassessing officer, while treating the amount of Rs.12 croresreceived in the form of ICICI Bonds and Securitised Debt due fromWoodland as capital receipt; held that payment made by theassessee company to VST be also treated similarly, as capitalexpenditure. The CIT(A) disallowed the assessee’s claim that Rs.50 lakhs component of Rs.12.50 crores should be admitted asrevenue expenditure and held that the receipt of Rs.12.00 croresas well as the payment of Rs.12.50 crores both be dealt as capitalin nature.

Aggrieved by the order of CIT(A), dated 10-10-2005, theRevenue preferred I.T.A.No.1233/Hyd/2005 and the assesseeI.T.A.No.1234/Hyd/2005, before the ITAT. These two appealswere considered along with I.T.A.No.1279/Hyd/2005 whichpertained to the assessment year 2000-2001 (not the subjectmatter of this appeal by the assessee).Background facts:

(a) VST, the parent company of TDIL made investments in ITCgroup of companies and in M/s. Jayprakash Industries to theextent of Rs.52 crores during 1993 to 1996. Disputes havingarisen regarding these investments were referred to arbitration. The award dated 20-04-1998 determined that ITC Classic Financecould issue a debt instrument acceptable to VST for Rs.52 crorespayable not later than twelve years, in lieu of investments made byVST in various entities of the ITC Finance Group.

(b) To effectuate the award an MOU was entered into on 05-05-1998. In terms of the award the ITC Classic Group was toissue debt instrument of Rs.52 crores payable/redeemable within aperiod of twelve years in exchange for investments of VST in theabove entities; and upon discharging the liability of Rs.52 croresVST was to transfer the above investments to ITC ClassicFinance;

(c) As the ITC Finance Group was unable to issue any debtinstrument acceptable to VST, ITC Agro Tech Finance (ITC-ATF)acting on its behalf and behalf of the ITC Finance Group made an alternative arrangement.

(d) Accordingly, ITC-ATF, VST and VST Natural Products Ltd.,entered into a tri-partite agreement on 19-05-1998 whereby ITC-ATF assigned the future liability of Rs.52 crores payable for aperiod of twelve years to VST. In consideration of undertakingsuch liability ITC-ATF issued a banker’s cheque for Rs.8 croresand transferred a securitized debt of Rs.4 crores owed to it byWoodlands Resorts Pvt. Ltd to VST-NPL. VST-NPL issued ademand promissory note for Rs.52 crores to VST. Under thisagreement it was agreed between ITC-ATF and VST that VSTwould retain ownership of Rs.16,60,000/- equity shares ofJayprakash Industries valued at Rs.10 lakhs. VST-NPLpurchased ICICI Security Bonds worth Rs.8 crores from theproceeds of the Banker’s cheque received from ITC-ATF; (e) In September, 1998, VST decided to obtain anundertaking/security for future liability of Rs.52 crores over twelveyears from the assessee instead of VST-NPL. Consequently,after rescinding the earlier tri-partite agreement dated 19-05-1998another tri-partite agreement was executed on 21-09-1998between VST, TDIL and VST-NPL whereunder:

(i) TDIL undertook the future liability of Rs.52 crorespayable to VST not later than twelve years;payable to VST not later than twelve years;

(ii) issued a debt instrument for Rs.52 crores to VST;

(iii) VST-NPL was relieved from the earlier future liabilityof Rs.52 crores, VST delivered to VST-NPL thecancelled demand promissory note, issued earlier;andof Rs.52 crores, VST delivered to VST-NPL thecancelled demand promissory note, issued earlier;and

(iv) in consideration of shifting the future liability ofRs.52 crores, VST-NPL delivered/transferred ICICIsecurity bonds of Rs.8 crores and the securitizeddebt of Rs.4 crores due to it from Woodlands ResortsPvt. Ltd., to TDIL.

(f) During the year in question the assessee earned Rs.50lakhs and Rs.33,62,055/- from the two assets transferred to itunder the tri-partite agreement dated 21-09-1998.

(g) On 30-03-1999, VST addressed a letter to TDIL proposingthat in lieu of payment of Rs.52 crores over a period not later thantwelve years, TDIL may immediately pay VST Rs.12.50 crores infull and final settlement of the entire TDIL obligations under theagreement dated 21-09-1998; and sought confirmation of TDIL tothis proposal. This letter stated that the above proposal (by VST)is subject to necessary approvals as may be required.

(h) In response to VST’s letter dated 30-03-1999 TDILaddressed VST a letter dated 31-03-1999 confirming that VST’sproposal is acceptable to it and it would make necessaryarrangement to pay VST Rs.12.50 crores at the earliest byliquidating ICICI bonds and other investments held by it. Thisletter also classified that acceptance of VST’s proposal dated 30-03-1999 is subject to necessary approval of the TDIL Board.

By order dated 30-03-2005 the assessing officer rejectedthe appellant’s claim; that the settlement between VST and TDILhaving taken place during the financial year 1998-99 (pursuant toVST’s proposal dated 30-03-1999 and its acceptance by TDIL byletter dated 31-03-1999) the consequence was setting off of theincome of Rs.12 crores earned and the payment of Rs.12.50

corres resulting in a consequent loss of Rs.50 lakhs. Theassessment order concluded that TDIL’s claim of discharge of itsobligation arising out of the tripartite agreement dated 21-09-1998by the assessee during the current year is not acceptable since :

(a)

The proposal by VST on 30-03-1999 and itsacceptance by TDIL on 31-03-1999 was incompleteas these were subject to ratification by the Board ofDirectors of both the companies and such ratificationoccurred during the next financial year, i.e., on 08-05-1999;as these were subject to ratification by the Board ofDirectors of both the companies and such ratificationoccurred during the next financial year, i.e., on 08-05-1999; (b) Though the assessee claimed to have accepted theproposal of discharging its obligation on liquidatingthe bonds/investments held by it during the financialyear 1998-99, neither the sale of bonds/investmentsnor payment of the amounts to the holding companyhad taken place in the same year;proposal of discharging its obligation on liquidatingthe bonds/investments held by it during the financialyear 1998-99, neither the sale of bonds/investmentsnor payment of the amounts to the holding companyhad taken place in the same year;

(c) The ICICI bonds were sold on 03-05-1999 for Rs.8.5crores and only after the sale of these bondspayments were made starting from June, 1999;crores and only after the sale of these bondspayments were made starting from June, 1999; (d) Though the assessee (TDIL) had shown VST as acreditor on 31-03-1999, VST the holding company didnot reflect the effect of this acceptance of theassessee’s proposal in their accounts, by showingTDIL as a debtor for Rs.12.5 crores.creditor on 31-03-1999, VST the holding company didnot reflect the effect of this acceptance of theassessee’s proposal in their accounts, by showingTDIL as a debtor for Rs.12.5 crores.

The assessing authority concluded that no final settlementbetween VST and TDIL took place during financial year 1998-99 –relevant to the assessment year 1999-2000; consequently the expenditure of Rs.12.5 crores in the business of securitization ofthe assessee company or the loss claimed in this regard isunacceptable and Rs.12 crores earned in the form of ICICI bondsand securitized debt due from Woodlands is treated as income ofthe assessee and considered for the relevant assessment year.

On appeal, the Commissioner (Appeals) held : (i) that theamount of Rs.12 crores is capital in nature both in form andsubstance; (ii) that the assessing officer construed it as arevenue receipt on the ground that the payment was not made toVST industries within the financial year but since the genuinenessof the transaction was not doubted, the AO is in error in rejectingthe very character of the settlement on the basis of the chronologyi.e., that the appellants started paying only from June, 1999onwards; (iii) that the nature of the transaction cannot undergo achange because a part of the chronology of events took place afterthe end of the previous year; and (iv) since the date of paymentsis only secondary to the matter in this respect, the A.O. is directedto treat Rs.12 crores as capital receipt. The appellate authorityrejected the assessee’s contention that payment of Rs.12.50crores to VST should be allowed as revenue expenditure, even ifthe receipt of Rs.12 crores is treated as capital in nature. Consequently, the assessing authority was directed to treat Rs.12crores (received in the form of ICICI bonds and securitized debtdue from Woodlands) as a capital receipt and the payment ofRs.12.50 crores made by the assessee to the VST also as capitalexpenditure.

In its appeal before the Tribunal the Revenue claimed thatthe income earned by the assessee on securitisation ought tohave been treated as a revenue receipt while the assessee in its appeal claimed that the settlement loss of Rs.50 lakhs waserroneously held to be capital in nature and the related income andexpenditure having been routed through the profit and lossaccount, both should have been held to be revenue in character.

The Tribunal concluded that since the assessee’s mainbusiness is securitisation of debt and in the course of thisbusiness the assessee has taken upon the liability of payment toVST of Rs.52 crores, for a consideration of Rs.12.50 crores andhad been finally settled by the assessee paying Rs.12.50 croresas against the receipt of Rs.12 crores, the said receipt is anadventure in the nature of trade and the true character of thereceipt is not a capital but a trading receipt. Similarly, payment ofRs.12.50 crores by the assessee to the VST cannot also betreated as capital expenditure. The Tribunal however held that theletter dated 30-03-1999 addressed by the VST to the assesseesetting out the proposal being, subject to necessary approvals asmay be required; and the acceptance of this proposal, by the letterof the assessee dated 31-03-1998 being also subject to necessaryapproval of the assessee’s board are only in the form ofoffer/proposal raised. There was no acceptance by the other partywithin the relevant financial year.Accordingly, the Tribunalconcluded that in the assessment year under consideration noportion of Rs.12.50 crores could be treated as expenditure. In theresult, the Revenue’s appeal on this aspect was allowed and theassessee’s appeal rejected.

Sri Ganesh, learned senior counsel, contends that theTribunal having held that the receipt of Rs.12 crores by theassessee is a revenue receipt and complementarily theexpenditure of Rs.12.50 crores is also revenue in nature; erred in concluding that no portion of Rs.12.50 crores could be treated asexpenditure since there was no acceptance of the VST’s proposalsby the assessee’s Board during the financial year in question andtherefore the liability did not accrue during the relevant year.

Relying on the provisions of Section 196 of the IndianContract Act, 1872 and the decisions in T.R. Bhavani Shankar Joshiand Anr. V. Gordhandas Jamnadas and Anr.[[1]];Parmeshwari Prasad[2]Gupta v. The Union of India;a n d Maharashtra State MiningCorporation v. Sunil S/o Pundikaro Pathak[[3]]. Sri Ganesh contendedthat despite the ratification of the VST proposal and its acceptanceby the assessee by the relevant Boards of Directors on May 27,1999 (the following financial year), the ratification relates back tothe date of acceptance by the assesse of the VST’s proposal i.e.,31-03-1999.

Section 196 of the Indian Contract Act enacts that whenacts are done by one person on behalf of another but without hisauthority, the latter may elect to ratify such acts and if ratified thesame effects would follow as if they had been performed by hisauthority.

The Privy Council in T.R. Bhavani Shankar Joshi(supra) onanalyses of the provisions of the Indian Contract Act spelt out theprinciple that ratification is in law equivalent to previous authority;it may be expressed or it may be effected impliedly by conduct.

In Parmeshwari Prasad Guptathe Supreme Court concludedthat the regularly constituted meeting of the Board of Directorscould legitimately ratify the action of the chairman (terminating theservices of an employee he was not legally authorised toterminate) and such ratification would relate back to the date of the act ratified and the services of the appellant must therefore beheld to have been validly terminated, on December 17, 1953.

In Maharashtra State Mining Corporation, the Supreme Courtquoted with approval its earlier decision in Parmeshwari PrasadGuptaand the principle enunciated therein, that ratification wouldrelate back to the date of the act ratified.

Ratio decidendi

In view of the provisions of Section 196 of the Contract Act and the binding precedents referred to supra the conclusion iscompelling that despite ratification of the assessee’s acceptanceof the VST’s propsoals dated 31-03-1999 only on 27-05-1999, bythe resolution of the assessee’s Board, the ratification relatesback to 31-03-1999 and operates during the assessment year inquestion. The conclusion to the contrary recorded by the Tribunalis erroneous and unsustainable.

Consequently, the liability of the assessee to pay Rs.12.50crores to M/s. VST Industries accrued on 31-03-1999 andconstituted a deductible item of expenditure in respect of theaccounting year ended 31-03-1999, relevant to the assessmentyear 1999-2000.

As pointed out by the Supreme Court in Empire Jute Co. Ltd.v. Commissioner of Income-Tax[[4]], the fact whether a certainpayment constituted income or capital receipt in the hands of therecipient is not material in determining whether the payment isrevenue or capital disbursement quathe payer. As pointed byMACNAGHTEN J. in Racecourse Betting Control Board v. Wild[[5]](an observation quoted with approval in Empire Jute Co. Ltd.):Payment may be a revenue payment from the point of view of the payer anda capital payment from the point of view of the receiver and vice versa. In the circumstances, and in the light of this principle the fact thatM/s. VST had not reflected the effect of the assessee’sacceptance of its proposal in VST’s accounts by showing theassessee as a debtor for Rs.12.50 crores is not a relevantcriterion for rejecting the assessee’s claim of this amount being arevenue expenditure during the assessment year in question. Theassessing authority erroneously considered the VST accounts asone of the criteria for rejecting the assessee’s claim.

The appellant alternatively contended before the Tribunalthat since the value as on 31-03-1999 of the appellant’s liability topay Rs.52 crores to M/s. VST after twelve years, was an allowablededuction from the revenue receipt of Rs.12 crores in order toassess the appellant’s correct and real income, the amount ofRs.12 crores being merely the appellant’s gross receipt could nothave been treated as its net assessable income; and that thisposition flowing from accounting standard No.1 issued by theCBDT under Section 145 of the I.T. Act is mandatory and is to theeffect that a provision must necessarily be made in the accountsfor all known liabilities. The Tribunal did not at all advert to thisalternative contention of the appellant. Be that as it may.

In Calcutta Company Ltd. v. The Commissioner of Income-tax, West Bengal[[6]], the facts were that the appellant was in thebusiness of land development and used to buy land to develop itand render it fit for building purposes and thereafter sell it in plots,for profit. The appellant maintained its accounts in the mercantilemethod. On facts though the appellant did not receive the whole ofthe price of Rs.43,692/- on the sale of plots, it entered this amounton the credit side of its accounts though only Rs.29,392/- wasactually received in cash. On the debit side the appellant debited

Rs.24,809/- in its accounts as expenditure for developments whichwere to be carried out on the plots which had been sold during theyear. The ITO disallowed the claim for deduction of Rs.24,809/-as expenditure on the ground that expenses had not been actuallyincurred during the financial year in question and estimates werenot real expenses which the company would have to incur infuture. The Appellate Commissioner, the Tribunal and the HighCourt concurred. Allowing the appeal, the Supreme Court heldthat Rs.24,809/- which was to be incurred by the appellant was anaccrued liability which according to the mercantile system ofaccounting constituted the estimated expenditure allowable asdeduction. The Apex Court quoted with approval the followingobservation of LORD HERSCHELL in Russel v. Town and CountyBank, Ltd.[[7]]:

…It appears to me that that language implies that for thepurpose of arriving at the balance of profits all that expenditure whichis necessary for the purposes of earning the receipts must bededucted, otherwise you do not arrive at the balance of profits,indeed, otherwise you do not ascertain, and cannot ascertain,whether there is such a thing as profit or not. The profit of a trade orbusiness is the surplus by which the receipts from the trade orbusiness exceed the expenditure necessary for the purpose ofearning those receipts. That seems to me to be the meaning of theword “profits” in relation to any trade or business. Unless and untilyou have ascertained that there is such a balance, nothing exists towhich the name “profits” can properly be applied.

The Court also reiterated the observations of VENKATARAMA AIYAR, J. in Badridas Daga v. The Commissioner of Income-tax[[8]]:

“The result is that when a claim is made for a deduction forwhich there is no specific provision in s. 10(2), whether it isadmissible or not will depend on whether, having regard to acceptedcommercial practice and trading principles, it can be said to arise outof the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of coursethere is no prohibition against it, express or implied, in the Act.”

I n J.K. Industries Ltd. and another v. Union of India and others.[[9]], the Supreme Court pointed out that “matching concept” orthe principle that expenses should be matched with revenue sothat tax is levied on the real income of the assessee is a basicprinciple of income tax law. The Court pointed out :

…The paramount object of running a business is to earnprofit. In order to ascertain the profit made by the business during aperiod, it is necessary that “revenues” of the period should bematched with the costs (expenses) of that period. In other words,income made by the business during a period can be measured onlywith the revenue earned during a period is compared with theexpenditure incurred for earning that revenue. …

As early as in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax, Bombay[[10]], the Court explained that income-tax is atax on the real income, i.e., the profits arrived at on commercialprinciples subject to the provisions of the Act; and that real profitscan be ascertained only by making the permissible deductions.

In the light of the principles following from the bindingprecedents aforesaid, the receipt of Rs.12 crores by theassessee, being directly associated with its normal business ofsecuritization of debts is a revenue receipt and the liability of theassessee to pay VST the amount of Rs.12.50 crores(notwithstanding that the actual payment was made during thecourse of the subsequent financial year) was an accrued liabilitysince the assessee was following the mercantile system ofaccounting and is liable as a deduction during the financial year1998-99 relatable to the assessment year 1999-2000.

On the above view of the matter the alternative contention by the assessee (addressed before the Tribunal as well but notconsidered) that even if the contractual liability of Rs.12.50 croreswere not allowed as a deduction during the accounting year ended31-03-1999, the present value as on 31-03-1999 and the liability ofRs.52 crores (payable after twelve years) must be allowed as adeduction against the revenue receipt of Rs.12 crores asassessed in the assessee’s hands in the said accounting year,need not be considered.

Two other grounds were also pleaded by the assessee inthis appeal, viz. :

(a) that the Tribunal erred in holding that an amount ofRs.56.50 lakhs paid on settlement pursuant to the award ofthe arbitrator, was capital in nature; &

(b) that the Tribunal erred in holding that the amount ofRs.7.50 lakhs paid as professional charges, was not abusiness expenditure and is a capital expenditure.

However, Sri Ganesh, learned senior counsel for theassessee, at oral hearing has categorically stated that thesegrounds of challenge to the Order of the Tribunal impugnedherein are eschewed and are not being pursued.

Consequent on the above analyses in discussion, theappeal is allowed as above. No costs.

_______________________

JUSTICE GODARAGHURAM

______________________

JUSTICE B.N. RAO

Date : -12-2011Ndr/*

NALLA

THE HON’BLE SRI JUSTICE GODA RAGHURAMAND

I.T.T.A.No.2of 2010(Order of the Division Bench delivered by Hon’ble Sri Justice Goda Raghuram)

Ndr/*

[1]AIR 1943 PC 66[2]AIR 1973 SC 2389[3]AIR 2006 SC 1923[4]124 ITR page 1[5][1938] 22 TC 182[6][1959] 37 ITR 1 SC[7](1888) 13 App. Cas. 418[8][1958] 34 ITR 10 (SC)[9][2008] 297 ITR 176 (SC)[10][1965] 57 ITR 521 (SC)

Date : -12-2011