And Connected Matters v. M/S. Chamundi Winery And Distillery

IN THE HIGH COURT OF KARNATAKA, BENGALURU DATED THIS THE 25 DAY OF SEPTEMBER 2018 PRESENT THE HON'BLE Dr.JUSTICE VINEET KOTHARI AND THE HON’BLE Mrs.JUSTICE S.SUJATHA I.T.A.No.155/2016C/W I.T.A.No.458/2013, I.T.A.No.467/2015I.T.A.No.173/2017, I.T.A.No.172/2017 I.T.A.No.155/2016 Between: 1.The Pr. Commissioner of Income Tax C.R. Building, Queens Road Bangalore-560001. 2.The Income Tax Officer Ward-4(3), Bangalore. …Appellants (By Mr. E.R. Indrakumar, Sr. Counsel for Mr. E.I. Sanmathi, Advocate) And: M/s. Chamundi Winery and Distillery 1313, 9[th] Cross, 27[th] Main, 1[st] Phase J.P. Nagar, Bangalore-560 078 PAN; . …Respondent (By Mr. A. Shankar & Mr. M. Lava, Advocates) **** and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 2/137 This I.T.A. is filed under Section 260-A of Income Tax Act 1961, praying to: 1. Decide the question of law and/or such other questions of law as may be formulated by the Hon’ble Court as deemed fit. 2. Set aside the appellate order dated 26/08/2015 passed by the ITAT, ‘C’ Bench, Bengaluru, as sought for, in the respondent-assessee’s case, in Appeal proceedings in ITA No.908/Bang/2014 dated 26/08/2015 for A.Y. 2010-2011 & etc. I.T.A.No.458/2013 Between: 1.The Commissioner of Income-tax C.R. Building, Queens Road Bangalore. C.R. Building, Queens Road Bangalore. 2.The Income-Tax Officer Ward-4(3), C.R. Building Queens Road, Bangalore. Ward-4(3), C.R. Building Queens Road, Bangalore. …Appellants (By Mr. E.R. Indrakumar, Sr. Counsel for Mr. K.V. Aravind, Advocate) And: M/s. Chamundi Winery and Distillery No.1313, 9[th] Cross, 27[th] Main 1[st] Phase, J.P. Nagar Bangalore-560 078. …Respondent (By Mr. A. Shankar, Mr. M. Lava & Mr. K. Kiran Kumar, Advocates) **** This I.T.A. is filed under Section 260-A of Income Tax Act 1961, praying to: 1. formulate the substantial questions of law stated therein. 2. allow the appeal and set aside the and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 3/137 order passed by the ITAT, Bangalore in ITA No.1260/Bang/2012 dated 05/04/2013 and confirm the order of the Appellate Commissioner confirming the order passed by the Income Tax Officer, Ward-4(3), Bangalore. I.T.A.No.467/2015 Between: 1.Pr. Commissioner of Income Tax Central Revenue Buildings Central Revenue Buildings Queens Road, Bangalore-560 001. 2.The Income Tax Officer Ward-4(3), Bangalore. Ward-4(3), Bangalore. …Appellants (By Mr. E.R. Indrakumar, Sr. Counsel for Mr. E.I. Sanmathi, Advocate) And: M/s. Chamundi Winery and Distillery No.1313, 9[th] Cross, 27[th] Main 1[st] Phase, J.P. Nagar, Bangalore-560 078 PAN No.AAAEFC 5505C. …Respondent (By Mr. A. Shankar & Mr. M. Lava, Advocates) **** This I.T.A. is filed under Section 260-A of Income Tax Act 1961, praying to decide the foregoing question of law and/or such other questions of law as may be formulate by the Hon’ble Court as deemed fit and set aside the appellate order dated 17/04/2015 passed by the ITAT, ‘B’ Bench, Bangalore, in appeal proceedings in ITA No.1149/Bang/2014 for assessment year 2011-12, as sought for in this appeal and grant such other relief as deemed fit, in the interest of justice. **** Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 4/137 I.T.A.No.173/2017 Between: 1. The Pr. Commissioner of Income Tax(4) BMTC Complex, Kormangala Bangalore-560 001. BMTC Complex, Kormangala Bangalore-560 001. 2. The Income Tax Officer Ward-4(3)(3), Bangalore. Ward-4(3)(3), Bangalore. …Appellants Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 4/137 I.T.A.No.173/2017 Between: 1. The Pr. Commissioner of Income Tax(4) BMTC Complex, Kormangala Bangalore-560 001. BMTC Complex, Kormangala Bangalore-560 001. 2. The Income Tax Officer Ward-4(3)(3), Bangalore. Ward-4(3)(3), Bangalore. …Appellants (By Mr. E.R. Indrakumar, Sr. Counsel for Mr. E.I. Sanmathi, Advocate) And: M/s. Chamundi Winery and Distillery 1313, 9[th] Cross, 27[th] Main 1[st] Phase, J.P. Nagar, Bangalore-560 078 PAN No.AAEFC 3505C. …Respondent (By Mr. A. Shankar & Mr. M. Lava, Advocates) **** This I.T.A. is filed under Section 260-A of Income Tax Act 1961, praying to: 1. decide the question of law and/or such other questions of law as may be formulate by the Hon’ble Court as deemed fit. 2. set aside the appellate order dated 16/09/2016 passed by the ITAT, ‘C’ Bench, Bengaluru, as sought for, in the respondent-assessee’s case, in Appeal proceedings in ITA No.47/Bang/2016 for A.Y.2012-13 & etc. Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 5/137 I.T.A.No.172/2017 Between: 1. The Pr. Commissioner of Income Tax(4) BMTC Complex, Kormangala Bangalore-560 001. BMTC Complex, Kormangala Bangalore-560 001. 2. The Income Tax Officer Ward-4(3)(3), Bangalore. Ward-4(3)(3), Bangalore. …Appellants (By Mr. E.R. Indrakumar, Sr. Counsel for Mr. E.I. Sanmathi, Advocate) And: M/s. Chamundi Winery and Distillery 1313, 9[th] Cross, 27[th] Main 1[st] Phase, J.P. Nagar, Bangalore-560 078 PAN No.AAEFC 3505C. …Respondent (By Mr. A. Shankar & Mr. M. Lava, Advocates) **** This I.T.A. is filed under Section 260-A of Income Tax Act 1961, praying to: 1. decide the foregoing question of law and/or such other questions of law as may be formulate by the Hon’ble Court as deemed fit. 2. set aside the appellate order dated 16/09/2016 passed by the ITAT, ‘C’ Bench, Bengaluru, as sought for, in the respondent-assessee’s case, in Appeal proceedings in ITA No.46/Bang/2016 for A.Y.2008-09 & etc. These I.T.As. having been heard and reserved on 21-08-2018, coming on for Pronouncement of Judgment, this day, Dr Vineet Kothari, J, delivered the following: Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 6/137 J U D G M E N T Mr E.R. Indrakumar, Sr. Counsel for Mr. E.I. Sanmathi, Adv. for Appellants - RevenueMr. A. Shankar, Mr. M. Lava. & Mr. K. Kiran Kumar, Adv. for Respondent- Assessee 1. The Revenue has filed these five Appeals under Section 260-A of the Income Tax Act, 1961 (‘Act’ for short) against the Respondent Assessee m/S. CHAMUNDI WINERY AND DISTILLERY, BANGALORE (hereinafter referred to as “CHAMUNDI” for short) for A.Y.2008-09 to 2012-13 raising the Substantial Questions of law, which we have re-framed. 2. The Tribunal as well as the first Appellate Authority, Commissioner of Income Tax (Appeals) decided in favour of the Respondent Assessee that the “Distributable Surplus” paid by the Respondent Assessee CHAMUNDI to DIAGEO INDIA PRIVATE LIMITED (hereinafter referred to as ‘DIAGEO’ for short), a subsidiary and Group Company of DIAGEO Plc, a United Kingdom based Liquor Conglomerate, was an Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 7/137 ‘allowable expenditure’ in the hands of the Respondent Assessee under Section 37 of the Act. 3. The following Substantial Questions of law do arise in the present set of appeals which we have reframed as below:- 2. The Tribunal as well as the first Appellate Authority, Commissioner of Income Tax (Appeals) decided in favour of the Respondent Assessee that the “Distributable Surplus” paid by the Respondent Assessee CHAMUNDI to DIAGEO INDIA PRIVATE LIMITED (hereinafter referred to as ‘DIAGEO’ for short), a subsidiary and Group Company of DIAGEO Plc, a United Kingdom based Liquor Conglomerate, was an Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 7/137 ‘allowable expenditure’ in the hands of the Respondent Assessee under Section 37 of the Act. 3. The following Substantial Questions of law do arise in the present set of appeals which we have reframed as below:- [1] Whether the Tribunal was justified in holding that the Distributable Surplus paid by the Respondent Assessee M/s. CHAMUNDI WINERY AND DISTILLERY to DIAGEO INDIA PRIVATE LIMITED in pursuance of the Agreement dated 30/10/2007 between these two parties was not ‘application of income’, but an ‘allowable expenditure’ in the hands of the Respondent Assessee under Section 37 of the Act ? [ii] Whether the terms and conditions of the Agreement dated 30/10/2007 between M/S. CHAMUNDI WINERY AND DISTILLERY Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 8/137 and DIAGEO INDIA PRIVATE LIMITED amount to ‘Diversion of Income at source by over riding title’ in favour of DIAGEO INDIA PRIVATE LIMITED even though the Excise Licence under the provisions of the Karnataka Excise Act, 1965 during the relevant period was taken in the name of Respondent Assessee CHAMUNDIand therefore, such profits and gains from the said business of manufacture and sale of liquor by M/S. CHAMUNDI WINERY AND DISTILLERY was not assessable in its hands ? [iii] Whether the method of Accounting or entries made in the Books of Accounts by the Respondent Assessee or maintaining the Bank Accounts under the close control and supervision of DIAGEO INDIA PRIVATE Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 9/137 LIMITED will determine the taxability of business income in the hands of DIAGEO INDIA PRIVATE LIMITED who under the said Agreement dated 30/10/2007 supplied the Working Capital, Raw Materials and concentrates and right of user of Trade Marks and Brands to the Respondent Assessee on whether the income earned out of the said liquor business will still be taxable in the hands of the Respondent Assessee CHAMUNDI ? 4. The brief factual matrix of the case is as under:- 5. The Assessing Authority in the first instance in all these five Assessment Years, A.Y.2008-09 to 2012- 13, disallowed the said “Distributable Surplus” paid by the Respondent Assessee CHAMUNDI to DIAGEO under Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 10/137 Section 37 of the Act and also held that the said income earned out of manufacture and sale of liquor by the Respondent Assessee which held the Excise Licence from the State Government, which has the monopoly and exclusive privilege of carrying on the trade of liquor and gives only licences under the provisions of the Karnataka Excise Act to certain persons upon the terms and conditions stipulated in the Licence under the said Act and there is no ‘diversion of such income’ from the Respondent Assessee CHAMUNDI to DIAGEO by overriding title and the Respondent Assessee CHAMUNDI has to meet its Income-Tax obligations under the Act before applying the net income after tax in meeting its contractual obligations under the Agreement dated 30/10/2007 with DIAGEO. 6. The first Appellate Authority however, allowed the Appeal of the Assessee CHAMUNDI and the Revenue’s second Appeal before the Income Tax 6. The first Appellate Authority however, allowed the Appeal of the Assessee CHAMUNDI and the Revenue’s second Appeal before the Income Tax Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 11/137 Appellate Tribunal also failed and hence, the Revenue has preferred these Appeals before this Court under Section 260-A of the Act, raising the substantial questions of Law. 7. The crux of the matter revolves round the Terms of the Conditions of the Agreement dated 30/10/2007 and therefore, a brief extraction of the relevant terms and conditions and its background are necessary to understand as the said Agreement has held the field throughout the aforesaid five Assessment Years. The DIAGEO is a Subsidiary and Group Company of DIAGEO Plc., a UK based Corporate entity and it owns several Trade Marks and Brands specified in the Schedule III of the said Agreement and the popular amongst them are SMIRNOFF (Vodka), VAT 69 (Scotch Whisky), CAPTAIN MORGAN (Rum), SMIRNOFF ORANGE TWIST (Vodka), SHARK TOOTH(Vodka) and HAIG GOLD LABEL (Scotch Whisky) and the Preamble Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 12/137 of the said Agreement dated 30/10/2007 is quoted below:- “WHEREAS: A.DIAGEO INDIA is engaged inter alia in the manufacture and marketing of alcoholic beverages and is a subsidiary of Diageo Plc. [ B.DIAGEO INDIA has valid and subsisting licence agreements with the respective Brand Owners of the Products listed in Schedule III to use the trade marks and reproduce the copyright works in India on the labels, caps of bottles, Packaging Materials and other support materials in respect of the Products to be manufactured and or bottled in India. C.CHAMUNDI is engaged in the manufacture, bottling and labeling of alcoholic beverages and had expressed its desire of carrying out manufacturing of the Products at its Plant at 56, Chollapanahalli Village, B C Road, Hoskote Taluka, Bangalore Rural District. Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 13/137 D.CHAMUNDI has represented to DIAGEO INDIA that it has a fully operational Plant and has all requisite consents and facilities to manufacture the Products at the Plant. E.CHAMUNDIhas agreed to manufacture and sell the Products under control and supervision of DIAGEO INDIA for the period and subject to the terms and conditions hereinafter recorded. F.The Parties acknowledge and confirm that each Party will undertake its responsibilities as clearly defined herein. Therefore, nothing in this arrangement shall be construed as either Party has representative rights for the other Party or one Party acts as an agent of the other Party or one Party grants any licence or right, for whatsoever, in favour of the other Party. Further, there should not be any claim or obligation of one Party on the other Party with respect to anything herein mentioned except for the specific claims provided hereunder. Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 14/137 G.The parties acknowledge that they will be independently responsible for their profits and losses, if any under this Agreement. CHAMUNDI is entitled to receive certain amount subject to fulfilling its obligations under this Agreement while DIAGEO INDIAwould mainly undertake major risks and rewards under this Agreement. However, there is no intention to carry on any business in common or to earn income jointly. CHAMUNDI would carry out its obligations under the direction and supervision of DIAGEO INDIAas specified in this Agreement. Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 14/137 G.The parties acknowledge that they will be independently responsible for their profits and losses, if any under this Agreement. CHAMUNDI is entitled to receive certain amount subject to fulfilling its obligations under this Agreement while DIAGEO INDIAwould mainly undertake major risks and rewards under this Agreement. However, there is no intention to carry on any business in common or to earn income jointly. CHAMUNDI would carry out its obligations under the direction and supervision of DIAGEO INDIAas specified in this Agreement. H.Each Party hereby acknowledges that it would continue to operate in its own capacity and the Agreement does not constitute a partnership or joint venture between the Parties.” 8. The said Agreement therefore, clearly rules out the Contract between the parties to be that of a Partnership, Agency or even a Quasi partnership Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 15/137 because, the concept of mutuality is specifically negatived in the said Agreement. 9. The relevant Parties’ Obligations contained in para 3 of the said Agreement to the relevant extent are also quoted below for ready reference:- “3. PARTIES’ OBLIGATIONS 3.1CHAMUNDIshall primarily be responsible for providing manufacturing facility, raising purchase orders, supplying and delivering the Products as per Delivery Orders, completing excise formalities in relation to import of Raw Materials and despatches of the Products, obtaining necessary approval from the requisites authorities, raising necessary invoice in respect of sales effected, making Sales Tax/VAT payments, making payments of all other expenses relating to the manufacturing of the Products, as per the directions of DIAGEO INDIA. and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 16/137 3.2DIAGEO INDIA shall procure orders for the Products from the distributors. DIAGEO INDIAshall submit to CHAMUNDIa Delivery Order for delivery of the Products by CHAMUNDIdirectly to the distributor as mentioned on Delivery Order. CHAMUNDI shall package the Products using the Packaging Materials purchased in accordance with DIAGEO INDIA’s instructions/specifications and regulations of the appropriate Governmental Authority.DIAGEO INDIA would take all the commercial decisions with regard to selling price of the Products and communicate to CHAMUNDI. CHAMUNDI shall supply and deliver the Products on the Date of Delivery by loading the Products on to the transport vehicles at the Plant and raise its invoice, at the selling price communicated by DIAGEO INDIA, on the distributors for the Products so delivered. It is expressly clarified and Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 17/137 reiterated that CHAMUNDIis dispatching the Products at the direction of DIAGEO INDIA and CHAMUNDIundertakes not to dispatch the Products without written authorisation fromDIAGEO INDIA.” 10. The responsibilities of DIAGEO to provide the Working Capital, Raw Materials and to take important commercial decisions about the quality, quantity, price, delivery schedule, etc. as given in para 7.1 with no right to CHAMUNDI WINERY AND DISTILLERY to use the Intellectual Property of DIAGEO are also quoted below for ready reference:- “7. DIAGEO INDIA RESPOSIBILITIES 7.1 DIAGEO INDIA shall be responsible for: (i)Providing working capital as outlined in Clause 15 below; (ii)Identifying the suppliers for Raw Materials, Packaging Materials and commercial decisions as to quality, and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 18/137 quantity, price, delivery schedule, etc.; 10. The responsibilities of DIAGEO to provide the Working Capital, Raw Materials and to take important commercial decisions about the quality, quantity, price, delivery schedule, etc. as given in para 7.1 with no right to CHAMUNDI WINERY AND DISTILLERY to use the Intellectual Property of DIAGEO are also quoted below for ready reference:- “7. DIAGEO INDIA RESPOSIBILITIES 7.1 DIAGEO INDIA shall be responsible for: (i)Providing working capital as outlined in Clause 15 below; (ii)Identifying the suppliers for Raw Materials, Packaging Materials and commercial decisions as to quality, and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 18/137 quantity, price, delivery schedule, etc.; (iii)Identifying appropriate insurance company, type of insurance, quantum of insurance coverage, etc. and obtaining insurance in the name of CHAMUNDI with DIAGEO INDIA’s beneficial interest; (iv)Procurement of sales order from the distributors; (v)Appointment of sales force and other administration staff; (vi)Carrying out marketing and sales promotion activities. 8. NO RIGHT TO USE INTELLECTUAL PROPERTY 8.1 CHAMUNDIacknowledges that the members of the Diageo Group which are listed as the brand owners of the Products in Schedule III are at the date of this Agreement the sole proprietors of the trade marks, copyright works and other intellectual property rights relating to their respective Products, and DIAGEO INDIA, being a Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 19/137 member of the Diageo Group, is the authorised licensee and user of such trade marks, copyright works and other intellectual property rights in India.CHAMUNDI agrees that nothing in this Agreement shall give it any right, title, claim or interest in or to the trade marks, copyright works or any other intellectual property rights relating to the Products and there is no transfer by DIAGEO INDIA of any right whatsoever.” 11. Para 9 of the Agreement enjoins upon CHAMUNDI WINERY AND DISTILLERY to obtain all Licences and Consents required under the Statutes at its own cost and expenses. Clause 9 is also quoted below for ready reference:- “9. LICENSES AND CONSENTS CHAMUNDI shall, at its own cost and expense be responsible for all Consents necessary for the Manufacturing, storage and delivery of the Products and shall also renew and keep valid all such Consents at its own Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 20/137 cost from time to time. CHAMUNDI shall also be responsible for the timely and full payment of annual licence fees as may be levied or imposed from time to time, by the Governmental Authorities under the relevant Karnataka State Excise Rules for manufacture of liquor products. CHAMUNDIshall prompt proof of all payments made in respect of Consents, including any annual licence fees.” 12. Para 15 of the Agreement makes DIAGEO responsible for providing Working Capital Finances for Operations envisaged in the said Agreement and the Bank Accounts to be operated by the persons duly authorised by the DIAGEO. The most important Clauses 16 and 17 providing for Distribution of Revenues between the two parties to the said Agreement are also quoted below for ready reference:- “15. WORKING CAPITAL FINANCES 15.1DIAGEO INDIA shall be responsible for providing working capital finance for and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 21/137 12. Para 15 of the Agreement makes DIAGEO responsible for providing Working Capital Finances for Operations envisaged in the said Agreement and the Bank Accounts to be operated by the persons duly authorised by the DIAGEO. The most important Clauses 16 and 17 providing for Distribution of Revenues between the two parties to the said Agreement are also quoted below for ready reference:- “15. WORKING CAPITAL FINANCES 15.1DIAGEO INDIA shall be responsible for providing working capital finance for and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 21/137 operations envisaged in this Agreement and CHAMUNDI shall open a separate bank account(s) in CHAMUNDI’s name for the purpose of this Agreement. The bank account(s) shall be operated jointly by any two DIAGEO INDIA representatives as may be intimated to CHAMUNDI in writing. The bank account(s) will be used for working capital requirements of CHAMUNDI. DIAGEO INDIA shall ensure that sufficient funds are available in this account especially at the time of issuing cheques. The said bank account(s) shall be used for: (a)the payment for all Raw Materials and Packaging Materials purchased for the purposes of this Agreement as set out in Clause 4.1; (b)the payment of excise duties, sales taxes and excise adhesive labels in relation to Products sold byCHAMUNDI; and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 22/137 (c)transportation costs in relation to Products despatched by CHAMUNDI in accordance with Clause 3.6; (d)insurancesrequired to be maintained by DIAGEO INDIApursuant to Clause 5.2; and (e)such other costs as DIAGEO INDIAmay require to be paid from such account(s). All monies received from the distributors in respect of Products, delivered and invoiced by CHAMUNDI or Raw Materials and Packaging Materials sold pursuant to Clause 3.10 or scrap sold pursuant to Clause 14.2 shall be paid into the accounts. DIAGEO INDIAshall be entitled to have transferred out to itself any surplus balance from time to time into these account(s). 15.2 CHAMUNDI shall not create any Encumbrances on any Raw Materials or Packaging Materials purchased with the working capital financed by DIAGEO INDIA. and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 23/137 CHAMUNDI shall provide DIAGEO INDIA an annual certificate from its bankers to this effect. 15.3 In this regard, CHAMUNDI represents warrants and undertakes that: a) the said bank account(s) shall not be operated by any persons other than nominated by DIAGEO INDIA. b) No resolution will be passed changing the approved authorised signatories without DIAGEO INDIA’s prior approval in writing. 15.4 In this regard DIAGEO INDIA and the persons nominated by DIAGEO INDIA for the operations of the bank accounts shall be responsible for the conduct of the bank accounts including the violations under the Negotiable Instrument Act, 1881, if any. 16.CHAMUNDI ENTITLEMENTS 16.1CHAMUNDI shall be entitled for a sum of Rs.45 per Case produced as a consideration for its manufacturing obligations under this Agreement. and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 24/137 16.2The sums as mentioned in Clause 16.1 shall remain in force for the period upto 31[st]May, 2010 unless otherwise mutually agreed by the Parties. 31[st]May, 2010 unless otherwise mutually agreed by the Parties. 16.3DIAGEO INDIA guarantees the minimum volume of 15,000 cases per month for the Products. 17. DIAGEO INDIA’S ENTITLEMENTS 17.1 DIAGEO INDIA entitlements under this Agreement shall be calculated on the following basis: a) Gross Sales (On the basis of sales invoices raised)Agreement shall be calculated on the following basis: a) Gross Sales (On the basis of sales invoices raised) Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 24/137 16.2The sums as mentioned in Clause 16.1 shall remain in force for the period upto 31[st]May, 2010 unless otherwise mutually agreed by the Parties. 31[st]May, 2010 unless otherwise mutually agreed by the Parties. 16.3DIAGEO INDIA guarantees the minimum volume of 15,000 cases per month for the Products. 17. DIAGEO INDIA’S ENTITLEMENTS 17.1 DIAGEO INDIA entitlements under this Agreement shall be calculated on the following basis: a) Gross Sales (On the basis of sales invoices raised)Agreement shall be calculated on the following basis: a) Gross Sales (On the basis of sales invoices raised) Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 25/137 17.2 If CHAMUNDI is unable to produce and service the Delivery Orders, CHAMUNDIshall compensate DIAGEO INDIA for a sum equal to the Gross Contribution lost on account of such failure. For this purpose, “Gross Contribution” means the difference between the then current selling price of the Products and the cost of Raw Materials and Packaging Materials in relation to the quantity not delivered timeously by CHAMUNDI. It is agreed to between the Parties that the Gross Contribution is a pre-estimate of genuine liquidated damages and is not by way of penalty. Additionally, in the event the various state excise permits have to be sent for revalidation due to failure on the part of CHAMUNDI to deliver the Products in accordance with the permit, then CHAMUNDI shall be liable to compensate DIAGEO INDIA the cost of such revalidation. However, if due to Force Majeure or reasons attributable to and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 26/137 DIAGEO INDIA (like delayed supply of raw or packing material) CHAMUNDI is unable to produce/service the orders, then CHAMUNDI would not be liable to compensate DIAGEO INDIA. 17.3 Compensation as per Clause 17.2 shall be paid by CHAMUNDI to DIAGEO INDIA within 30 days of intimation by DIAGEO INDIA to CHAMUNDI. 17.4 The statement of entitlements shall be computed on a financial year of April 1-March 31 basis each year with both the Parties signing off the statement as a proof of agreement and the account will be settled within three months from the close of that financial year. computed on a financial year of April 1-March 31 basis each year with both the Parties signing off the statement as a proof of agreement and the account will be settled within three months from the close of that financial year. 17.5 CHAMUNDI shall: a)Keep true and accurate records of all necessary for the computation of DIAGEO INDIA Entitlements and submit to DIAGEO INDIA every month a statement of computation of DIAGEO INDIA Entitlements; and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 27/137 b)Supply DIAGEO INDIA at the time of making such payments with a statement in writing showing the number of cases of the products sold by CHAMUNDIduring the accounting period in respect of which such income has accrued; c)Permit a representative/auditors of DIAGEO INDIA from time to time and at reasonable times to inspect at DIAGEO INDIA’s expenses the records referred above and for the purpose of verifying the accuracy of such reports to inspect any other pertinent records, documents or books of accounts kept by CHAMUNDI; d)Prepare various reports and to submit the same within the stipulated time periods as required by DIAGEO INDIAfrom time to time; e)Be responsible for engaging/ providing staff at their cost for providing the above information/reports and including maintenance of book of and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 28/137 accounts related to DIAGEO INDIAoperations.” c)Permit a representative/auditors of DIAGEO INDIA from time to time and at reasonable times to inspect at DIAGEO INDIA’s expenses the records referred above and for the purpose of verifying the accuracy of such reports to inspect any other pertinent records, documents or books of accounts kept by CHAMUNDI; d)Prepare various reports and to submit the same within the stipulated time periods as required by DIAGEO INDIAfrom time to time; e)Be responsible for engaging/ providing staff at their cost for providing the above information/reports and including maintenance of book of and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 28/137 accounts related to DIAGEO INDIAoperations.” 13. Clause 24 of the Agreement under the heading “Miscellaneous” inter alia provides for each Party to bear its own Income-Tax and other Tax liabilities. Clause 24.2 clearly stipulates that it is neither a Partnership nor a Joint Venture between the two Parties. Clause 24.3 allows DIAGEO to assign its benefits and burden under the said Agreement to any Third Party, however, CHAMUNDI WINERY AND DISTILLERY shall not assign either the benefit or the burden under the said Agreement to any Third Party without any prior consent of the DIAGEO. 14. The said relevant Clauses of the Agreement are also quoted below for ready reference:- “24. MISCELLANEOUS 24.1 Costs & Expenses a) Each Party agrees that it shall bear its own costs and expenses incurred by it in connection with any discussions, Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 29/137 negotiations, investigations and due diligence undertaken in connection with the project, including costs and expenses associated with retention of financial, legal, tax and other professional advisers. b) Each Party shall bear its own income tax and other tax liabilities.DIAGEO INDIA shall ensure that sufficient bank balance is maintained to discharge sales tax/VAT liability. However, should there be any tax liability incurred by CHAMUNDI as a direct result of DIAGEO INDIA failing to perform any of its obligations under this Agreement, DIAGEO INDIA shall be liable to the extent of such tax liability actually incurred by CHAMUDI, provided that CHAMUNDI establishes to the reasonable satisfaction of DIAGEO INDIA the actual amount paid by CHAMUNDItowards satisfaction of such tax liability. 24.2 No Partnership/Joint Venture a) Nothing in this agreement shall be deemed to constitute CHAMUNDI as partner, or a joint venture or a legal representative of DIAGEO Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 30/137 INDIA, or to create any fiduciary relationship between CHAMUNDI and DIAGEO INDIA. Both Parties acknowledge that they are personally and not jointly liable in respect of their obligations under the agreement. [[24.3 Assignment The benefit and burden under this Agreement shall be fully assignable and transferable by DIAGEO INDIA to any Third Party. However, CHAMUNDI shall not assign either the benefit or burden under the agreement to any Third Party without the prior written consent of DIAGEO INDIA.” 15. In the perspective of the aforesaid Agreement, it would be appropriate to first discuss the findings in brief of all the three Authorities below. FINDINGS OF THE ASSESSING AUTHORITY: 16. For A.Y.2010-11, the Assessing Authority in the Assessment Order dated 31/03/2013 under Section143(3) of the Act, held as under:- “As evident from the above clause 3.1 the company M/s DIAGEO INDIA is holding M/s Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 31/137 15. In the perspective of the aforesaid Agreement, it would be appropriate to first discuss the findings in brief of all the three Authorities below. FINDINGS OF THE ASSESSING AUTHORITY: 16. For A.Y.2010-11, the Assessing Authority in the Assessment Order dated 31/03/2013 under Section143(3) of the Act, held as under:- “As evident from the above clause 3.1 the company M/s DIAGEO INDIA is holding M/s Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 31/137 CHAMUNDI Winery and Distillery to carry out all activities of the business that include manufacture purchases, sales, dispatches approval from authorities and to make sale tax and VAT payments. By this it is very clear that the business carried out by the assessee firm is recognized in hands of the firm itself. The firm has complied to its statutory obligation by paying the excise duty to confirm its role as an assessee. 3.9 The firm M/s CHAMUNDIis the assessee for Sales tax/VAT purposes, then for all other purposes involving statutory obligation such as income-tax, the same firm is responsible. Initially the assessee during the course of assessment proceedings took a stand that the payment made to M/s Diageo was covered u/s.60 of the Income-tax Act, 1961. But it was brought to its notice that the nature of business as discussed in detail already does not permit any creation of charge by over riding title for diversion of income. The state excise department is and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 32/137 the licensing authority to allow anybody to create a charge or indulge in liquor business. Hence the expenditure claimed is only an application of income and could not be allowed as deductible expense. 3.10 As evident from the above clause 15 of the said agreement the working capital finance was to be adequately made available by M/s Diageo. If this was the case the assessee could have booked finance charges or interest charges on the working capital and debit the same to the P & L account. Instead the assessee has transferred the profit of the business in the form of distributable surplus to the company M/s Diageo which is unacceptable since no parties can enter into an agreement to alienate their tax obligation from profit of the licensed and permitted business since tax is an integral part of the business. 3.11 In his submission vide para 2.1. assessee states that manufacturing operations, are supervised by personnel of Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 33/137 brand owners, who are stationed in the distillery and if that were to be the case the assessee could have booked supervision charges in the P & L account. The Brands of the liquor manufacturer belonged to M/s Diageo, then the assessee could have booked royalty or technical knowhow fees.Sincethe excise Department granted the license to M/s CHAMUNDI Winery and Distillery and the entire business has been carried out duly by booking sales and purchases in its name and now to claim the business does not belong to it, is totally unacceptable. The surplus transferred is nothing but the profit of M/s CHAMUNDI and this firm is free to transfer the surplus after taxation but not before the charge to tax. 3.12 The Clause 17 of the agreement dated 30.10.2007 entered into by M/s CHAMUNDIand M/s Diageo to separate the element of profit from the business is not acceptable since tax is an integral part of business and the discretion to alienate statutory Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 34/137 obligation is not available to these 3.12 The Clause 17 of the agreement dated 30.10.2007 entered into by M/s CHAMUNDIand M/s Diageo to separate the element of profit from the business is not acceptable since tax is an integral part of business and the discretion to alienate statutory Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 34/137 obligation is not available to these parties. Hence the stand of the firm M/s CHAMUNDI to run a licensed business but to take away the surplus or profit away without making itself liable to income-tax is wrong and unacceptable. At the same time there is no justification to allow the surplus to be transferred out of the business under the pretext of expenditure since this expenditure is not incurred by the assessee wholly and exclusively for the purpose of business. 4.Conclusion: In view of the discussion made in the para 3, I hold that expenditure claim under the head distributable surplus is only an application of income of the assessee. As per the return of income, the amount of expenditure claimed under the head distributor’s surplus is of Rs.31,75,95,815/- and this claim is discussed above is disallowed.Hence an amount of Rs.31,75,95,815/- is brought to tax. Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 35/137 5Penalty proceedings u/s.271(1)(c) for concealment of particulars of income is separately initiated.” COMMISSIONER OF INCOME TAX (APPEALS): 17. The Commissioner of Income Tax (Appeals) however, allowed the Appeal of the Assessee with the following observations:- “3.3 I have carefully considered the appellant’s submissions and also perused the assessment order. I find that a similar issue was involved in the appellant’s own case for the assessment year 2009-10 wherein the appellant had claimed deduction in respect of transfer of distributable surplus amounting to Rs.30,51,18,500/-. The AO, who had made the assessment for that assessment year, had disallowed the appellant’s claim for deduction of the amount as distributable surplus and treated the same as the appellant’s income. The appellant had filed an appeal against the said assessment order. My predecessor vide appellate order in ITA.No.795/W-4(3)/CIT(A)-II/11-12 dated Date of Judgment 25-09-2018 I.T.A.No.155/2016 and connected matters Vs. M/s. Chamundi Winery and Distillery The Pr. Commissioner of Income Tax & Ors. 36/137 23/8/2012 had confirmed the AO’s action in treating the said amount as the appellant’s income and dismissed the appellant’s appeal. The appellant went in appeal to the Hon’ble ITAT, Bangalore against the said appellate order. By its order in ITA.No.1260/Bang/ 2012 dated 5/4/2013, the Hon’ble ITAT, Bangalore Bench ‘C’ allowed the appellant’s claim, holding that the distributable surplus cannot be considered as application of income but an expenditure incurred by the appellant in the course of its business and allowable u/s 37 of the Act. The relevant passages from the said decision are reproduced below: “5.3.3 In this factual matrix of the matter, as discussed above, we are of the considered opinion that the example of theatre business cited by the learned counsel for the assessee is quite appropriate and applicable in understanding the true nature of the transactions entered into by the assessee and Diageo by virtue of and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 37/137 Agreement dt.30.10.2007. From an “5.3.3 In this factual matrix of the matter, as discussed above, we are of the considered opinion that the example of theatre business cited by the learned counsel for the assessee is quite appropriate and applicable in understanding the true nature of the transactions entered into by the assessee and Diageo by virtue of and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 37/137 Agreement dt.30.10.2007. From an application of the totality of the facts and circumstances of the case, we are of the view that the distributable surplus paid by the assessee in terms of clause 17 of the said Agreement is nothing but the amounts to which Diageo is entitled to receive over the expenses to be borne by them, leaving behind the real income to which the assessee is entitled to in accordance with the relevant clauses of the governing agreements and therefore cannot be disallowed on the ground that the same is to be considered as application of income. We hold that it is expenditure incurred in the course of business and therefore allowable under section 37 of the Act. 5.4 The above aspect of the matter can also be viewed from another angle. Though as per the Agreement dt.30.10.2007, the assessee undertook to raise sale invoices in and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Chamundi Winery and Distillery 38/137 its name, it is not entitled to the said sale proceeds as the same is deposited in the designated bank account supervised and operated by authorized personnel of Diageo. The funds in the said bank account are required to be utilized for making various payments like purchase of raw materials, payment of Excise Duty and payment of bottling charges to the assessee in terms of the said agreement. Thus the surplus in terms of clause 17 of the said Agreement may either be a profit or a loss depending on the extent of sales and the expenses incurred in the business operation. Assuming that there is a loss that is incurred or arrived at in terms of the formula under the said agreement, Diageo will have already provided the working capital for running the operations and would not be entitled to any entitlement for that year. The assessee, however, cannot claim that and connected matters The Pr. Commissioner of Income Tax & Ors. Vs. M/s. Ch