CIT(A) enhancing assessed income without notice:

CIT (A) can enhance income if assessee is made aware of proposal, formal notice not required - R & D expenditure for launching new car is revenue in nature - warranty is allowable expenditure : ITAT THERE are several issues in this appeal and the primary one is about admissibility of additional ground. CIT(A) enhancing assessed income without notice: The assessee raised an additional ground that the CIT(A) erred on facts and in law in enhancing the assessed income of the appellant alleging that the payment made on account of lump sum fee and royalty was neither revenue expenditure (as claimed by the appellant), nor capital expenditure (as treated by the assessing officer), without providing reasonable opportunity of being heard as provided in section 251(2) of the Act." The assessee submitted that it had filed returns of income for both the assessment years declaring therein loss of Rs.68,14,22, 302/- and Rs.93,03,99, 726/- for the assessment years 2001-2002 & 2002-2003 respectively. In the return of income filed for the asstt. year 2001- 2002, the assessee had claimed deduction of lump sum fee amounting to Rs.28,67,00, 000/- paid to M/s. Honda Motor Company Ltd; Japan ('HMCL') under a technical collaboration agreement ('TMC') and royalty of Rs.12,38,37, 000/- paid to HMCL @ 4% of the sale for the assessment year 2001-2002. Similar deduction amounting to Rs.29,20,07, 000/- towards instalment of lump sum fee and Rs.15,60,93, 000/-being royalty was claimed as deduction for the assessment year 2002-2003. The AO disallowed the claim of the assessee on the ground that the technical know-how received by the assessee related to setting up its plant and, therefore, the impugned expenditure was capital in nature. Similar reasoning was given by the AO for treating the royalty payments also as capital expenditure. When the matter was taken in appeals before the CIT(A), the CIT(A) held that the impugned expenditure was indeed diversion of income to the holding company. The action of the CIT(A) has resulted in enhancement of income. As per provisions of sub-section (2) of section 251 of the Act, the CIT(A) was under a statutory duty to issue a show cause notice to the assessee before enhancing the income. Since the CIT(A) failed to issue such notice, the assessee has contended that the action of the CIT(A) for enhancing the income is illegal, invalid and void ab initio. The assessee has contended that this is purely a legal issue for which relevant facts are already on record. The Tribunal admitted the additional ground and observed that the CIT (A) is under a statutory duty to issue a show cause notice and provide a reasonable opportunity to the assessee before enhancing such income, but observed that Since there is no statutory notice prescribed under the Act and the assessee has been allowed full opportunity before making enhancement of income, we are of the considered opinion that there is no illegality in the action of the CIT(A) before enhancing the income. The law only requires that assessee must be made aware of the proposed action of CIT(A) for enhancement of income and the explanation be obtained and considered. The entry made in the order sheet amounts to due compliance with the procedure. Thus, we are of the view that Ld. CIT(A) has complied with the procedure as laid down under the Act and the assessee was duly put to notice before making enhancement of income. Therefore, the orders of the CIT(A) are upheld on this point and the additional ground of appeal filed by the assessee is rejected for both the assessment years. The main appeal was on the following grounds that on the facts and circumstances of the case the CIT(A) erred 1. in upholding disallowance of technical know-how fee and royalty paid to Honda Motor Company Ltd; Japan (HMCL), on a different ground than that taken by the assessing officer, thereby enhancing the assessment. 2. in alleging that payment of technical know-how fee and royalty to HMCL is neither revenue expenditure, as claimed by the appellant, nor capital expenditure as held by the assessing officer, but diversion of profit in favour of HMCL. 3. in alleging that relevant Articles of Technical Collaboration Agreement (TCA) between appellant and HMCL, relating to payment of technical know-how fee and royalty to HMCL are void, in terms of Contract Act and permission granted by Reserve Bank of India. 4. in not appreciating that since appellant by virtue of TCA merely acquired a right to use the technical information and know-how, payment therefore in the nature of lump sum fee and royalty is revenue in nature and deductible business expenditure. 5. in not directing allowance of depreciation on the amount of lump sum fee and royalty, treating the same as capital expenditure. The facts In the returns of income filed for both the assessment years, the assessee had claimed deductions of Rs.28,27,00, 000/-and Rs.29,20,07, 000/- being lump sum amount of "Technical Guidance Fee" paid to M/s. IIMCL, Japan for the assessment years 2001-02 & 2002-03 under a Technical Collaboration Agreement (TCA'). In addition, the assessee also claimed deductions of Rs.12,38,27, 000/- and Rs.15,60,93, 000/- being royalty paid to the foreign company under the agreement for the assessment years 2001-02 & 2002-03 respectively. During the course of assessment proceedings, the AO called upon the assessee to justify its claim as revenue expenditure. The assessee submitted that it had entered into TCA with M/s. IIMCL, Japan, under which the assessee was granted an indivisible, non-transferable and exclusive right and license to use the know-how and technical information provided by M/s. HMCL. In consideration of right and license granted, the assessee company was required to pay a lump sum fee of US 30.5 million Dollars payable in 5 equal instalments beginning from the 3rd year after commencement of commercial production. The assessee furnished copy of the TCA. Relying on the two judgments of Supreme Court, the assessee contended that the impugned expenditure was allowable as revenue expenditure. Similarly, the assessee had explained that the assessee was also required to pay Royalty @ 4% of the net sale price of the manufactured products sold in India under TCA for a period 7 years. The assessee claimed that such payments were also in the nature of Revenue expenditure and hence allowable. However, the AO referred to the various clauses of TCA and observed that without such agreement, the assessee could not even start its business, let alone run it. He observed that the agreement was crucial for setting up and starting the business of the assessee and the technical know-how provided for the foreign collaborators included inputs for setting up its plant and manufacturing facilities. The restrictions placed on the use of license, technical knowhow, trademark etc. were simply by way of abundant precautions and legality as the affairs of the assessee-company were being supervised and monitored by the parent company i.e. HMCL, Japan. Thus, the AO observed that by incurring expenditure in the nature of technical guidance fee, the assessee had obtained an advantage of enduring benefit and, therefore, such expenditure was capital in nature. He further observed that the expenditure incurred on payment of Royalty was also for acquisition of technical know-how, license etc. and, therefore, by incurring such expenditure, the assessee has obtained benefit of enduring nature. In this view of the matter, the AO disallowed both the Royalty payments and lump sum technical guidance fee being capital expenditure for both the assessment years. Aggrieved, the assessee filed appeals against the assessment orders before the CIT(A) and not being very successful there, is now before the ITAT. The Tribunal observed, 1. it is obvious that the AO had disallowed the lump sum payment of technical fee and royalty on the ground that the impugned payments related to setting up of plant and manufacture of automobile goods and therefore, the expenditure was capital in nature. 2. The CIT(A) has not recorded any finding on the issue raised before him as to whether the impugned expenditure was capital in nature. However, he has held that the impugned payments represented diversion of profits to HMCL. And held that the CIT(A) was not justified in treating the payment of lump-sum technical fee and royalty as diversion of profit to HMCL, Japan. Accordingly, the Tribunal set aside the orders of the CIT(A) and allowed this ground of appeal of the assessee for both the assessment years. Was the expenditure capital or revenue in nature? The CIT(A) has not recorded any finding on the issue because he has taken a view that the impugned payments represented diversion of profits to a foreign company. This view has not been approved by the Bench. The Tribunal therefore remanded the matter to the CIT(A) Disallowance of research and development expenses on the ground that the same were capital in nature. The facts of the case are that the AO observed that the assessee had debited research and development expenses of Rs.69,37,000/ - to profit & loss account and claimed as revenue expenditure for the asstt. year 2001-2002. The AO observed that the expenses incurred were towards research and development prior to the launch of various new models of cars. These also included annual membership fee paid to Automotive Research Association of India amounting to Rs.7,50,000/ - and Rs.4,42,898/ -. The same was allowed as Revenue expenditure. However, the remaining expenditure of Rs.57,44,102/ was not allowed by the AO on the ground that such expenditure related to research and development and was, therefore, capital in nature. The CIT(A) was not impressed with the submissions of the assessee and upheld the disallowance on the ground that the assessee was not carrying out any research and development activities. The tribunal observed, It is clear that the assessee has explained the purpose of setting up of Technical and Research Center (TRC) and its functioning was also explained by the assessee during the course of proceedings before the authorities below. From the facts discussed above, it is obvious that one of the reasons given by the authorities below for making impugned disallowance was that it was the responsibility of the HMCL to provide technical assistance and guidance as per TCA. However, the assessee has explained the purpose of setting up of TRC for analyzing the problems being encountered during the manufacturing as well as failures in the field. The factum that assessee has incurred such expenditure for the purpose of assessee's business is not in doubt. Accordingly, the Tribunal set aside the orders of the CIT(A) and allowed the deduction of the impugned expenditure as revenue in nature. Since it has already allowed such expenditure as revenue in nature, the ground relating to the claim of depreciation has become redundant. Therefore, the same is dismissed as such. Expenditure for launch of new model of car: The next ground of appeal for the assessment year 2001-2002 is that the CIT(A) was not justified in sustaining the disallowance of Rs.63,07,099/ - being expenditure incurred by the assessee in connection with the launch of new model of car manufactured by the assessee. The facts of the case are that this expenditure was not charged to profit & loss account for the assessment year 2001-2002. However, in the computation of income, the assessee had claimed deduction of the same as revenue expenditure with a Note that impugned expenditure pertained to new model of car in the existing line of business. It was stated that the expenditure was charged to profit & loss account for the A.Y. 2002-2003. But the same was disallowed while computing income for the subsequent year because expenditure related to this asstt. year. The assessee also stated that by incurring such expenditure no new asset in the capital field had been created. The AO examined the details and found that the same was for travelling, training & seminar and sale promotion of the new model of the car. However, the AO disallowed the same on the ground that by incurring such expenditure, the assessee had obtained a benefit of enduring nature by way of establishing a new car model in the automobile market of India and he disallowed the same. The CIT(A) upheld this order. The tribunal observed, There is no doubt about the fact that the assessee is already engaged in the business of manufacture of cars and the production had commenced about three years before. The new model of the car relates to the same line of business which the assessee has been carrying on. The assessee has not set up a separate and independent unit to manufacture new model of the car. From the details of the expenses given, it is clear that the expenses related to travelling, training & seminar and advertisement, technical guidance fee etc. of the on going business. It is common knowledge and there is a cut throat competition in the automobile market and the assessee is required to bring new models in the market in order to retain/capture market. Therefore, the expenditure incurred by the assessee in respect of on going business is a revenue expenditure. This ground of appeal is allowed. Disallowance of custom duty on the drawings imported: The assessee deposited a sum of Rs.3,00,00,000/ - with the Custom Department in the earlier years towards Custom Duty on import of Drawing under the TCA with HMCL, Japan in response to the show cause notice issued by the Custom Authorities. The payment of Rs.3,00,00,000/ -was an advance. The assessee also filed an application with the Custom & Excise Settlement Commission after making said payment. Out of the payment of Rs.3 crore, the assessee admitted custom duty of Rs.1,16,63,000/ - and debited the expenses in the year under consideration. But in the revised computation, the assessee added back the Custom Duty of Rs.84,00,257/ - and claimed deduction of Rs.32,63,032/ -, the amount which was paid in the assessment year 1999-2000 and adjusted in the assessment year under consideration. The AO observed that the impugned amount was paid on 31.3.1999 under protest and, therefore, did not relate to the asstt. year under consideration. He also observed that the payment was not in revenue account. He also observed that provisional payment does not become an ascertained liability until the same has become final. He also observed that the show cause notice issued by the Custom Authorities was also for imposing the penalty for not making the payment. The assessee had submitted that the amount of Rs. 3,00,00,000/ - paid on 31.3.1999 as an advance was shown as loan and advance in the audited accounts in the financial year 31.3.199 and the claim was made before the CIT(A) under section 43B of the Act for the assessment year 1999-2000 which was not allowed by the CIT(A). This issue was pending before the ITAT. It was submitted that in case it was decided in favour of the assessee, the amount of Rs.32,63,032/ - would be required to be added back to the income of the asstt. year 2002-2003. However, the claim was not accepted by the AO on the ground that the same did not relate to the asstt. year under consideration. The CIT(A) observed that since the issue was subject matter of appeal before the ITAT for the assessment year 1999-2000, the disallowance is confirmed for statistical purposes. The Tribunal observed, It is obvious that the assessee had made the payment of the amount on 31.3.1999 as an advance and had claimed deduction for the asstt. year 1999-2000. The Revenue did not allow the same on the ground that the amount in question was advance only and had not become final. The assessee's appeal for the A.Y. 1999-2000 is pending with the Tribunal. In case, the matter is decided by the Tribunal in favour of the assessee by taking notice of the subsequent events that the liability had become final, the assessee would not be entitled to claim deduction for the same in the asstt. year under consideration. However, if the disallowance made is upheld by the Tribunal for the reason that the amount paid was only an advance and was not otherwise payable and hence not allowable u/s 43B, the assessee would be entitled to claim deduction in the asstt. year under reference because the liability had become final in the asstt. year under reference and the advance so paid would be adjusted in the asstt. year under reference. So the tribunal set aside the order of the CIT(A) and directed the AO to allow the claim of the assessee only if the said claim is not allowed for the asstt. year 1999-2000. Provision for warranty- disallowance: the Cars sold by the assessee are covered under warranty. The assessee made provisions of Rs.86,38,000/ - for warranty and claimed deduction of the same on the ground that the company was engaged in the business of manufacture and sale of highly competitive premium segment cars and the assessee was contractually bound to provide after sale services at various intervals and provide one year after-sale warranty for manufacturing defects and thereafter sale service to the customers. It was stated that the liability to provide free after-sale service accrues to the assessee as soon as the car is sold to the customer. However, the AO held that the same was not ascertained liability of the asstt. year under consideration. Accordingly, he disallowed the claim, which was upheld by the CIT(A) The Tribunal observed, There is no dispute about the fact that the cars sold to the customers are covered by warranty and after-sale services for repair and replacement for a period of one year. The assessee has been following the same method of accounting and has been making provisions for the same on the basis of actual expenses incurred in the past. It is a fact that in the past such expenses have been allowed by the Revenue. Even such claim of the assessee was allowed for the A.Y. 2001-2002. This is not the case of the Revenue that the provisions made far exceeded the actual expenses incurred. Thus, the various judgments support the view that the liability was incurred on the date when sales were made. Therefore, this was ascertained and accrued liability of the assessee and accordingly the same was allowable. The Tribunal set aside the order of the CIT(A) and deleted the impugned disallowance. This ground of appeal is allowed. Excise Duty refund: TheAO observed that in the balance-sheet, an amount of Rs.79,63,384 was shown as receivable. When the assessee was asked to explain, it submitted that such amount receivable included excise duty of the car sold to India Hotels at Rs.5,96,726/ - , excise duty of Rs.3,61,303/ - on sale of car to Ambassador Hotel. Rs.1,92,340/ - on sale of car to Leela Ventures and amount of Rs.48,76,196/ - being excise duty refund of sale of 43 Cars and export rebate of Rs.8165/-. It was explained by the assessee that the amount in question was refunded to the car buyers. However, the AO observed that the assessee failed to furnish any supporting evidence that the amount received was actually refunded to the car owners. He, therefore, made an addition of Rs.60,34,370/ -. The CIT (A) upheld the disallowance. The tribunal observed, it is obvious that the claim of the assessee was that it charged full excise duty at the time of sale of cars to the taxi operators and accounted for the same in its income and expenditure because at that time, the assessee did not know whether the car sold would be used as taxi or not. It is only when the car is registered as taxi, that the taxi operator approached the assessee to claim refund of the same. The assessee has also stated that on receipt of refund of Excise Duty from the Excise Authorities, the same was passed on to car owner. The main objection of the AO was that the assessee failed to furnish complete details along with supporting evidence about the excise duty charged, accounted for in the books of account recovered from the Excise Deptt. and disbursed to the car owners. Therefore, such claim was disallowed and upheld in appeal by the CIT(A). Now in case, the assessee has claimed refund of excise duty on behalf of others and on receipt the same has been passed down to the customers, no income accrues to the assessee and the claim of the assessee deserves to be allowed. However, considering the fact that these details were not furnished before the authorities below and the order of the CIT(A) has been set aside in regard to first-two grounds of appeal, it is fair and appropriate also to set aside the order of the CIT(A) on this point and restore the same to his file with a direction to redecide the same as per law and after allowing reasonable opportunity to both the parties. So this issue is remanded.