Ita/1064/2008 Of The Commissioner Of Income Tax v. M/S. Motor Industries Co Ltd

IN THE HIGH COURT OF KARNATAKA AT BANGALORE DATED THIS THE 31st DAY OF OCTOBER 2014 PRESENT THE HON'BLE MR. JUSTICE N. KUMAR AND THE HON’BLE MR. JUSTICE B. MANOHAR ITA No.1064 OF 2OO8 BETWEEN; 1.)The Commissioner of Income-Tax,LTU, JSS Towers, 100 Ft. Ring Road,LTU, JSS Towers, 100 Ft. Ring Road, Banashankari 3[!-]stage, Bangalore-560 O8o. oOThe Asst. Commissioner of Income-Tax, Circle-12(1), C.R. Building, Queens Road, Bangalore _ APPKRLLANTS) (By Sri.K.V. Aravind, Advocate) AND: M/s.Motor Industries Co. Ltd.,(Bosch Limited), Hosur Road,|Adugodi, Bangalore-30. RBSPONDENT (By Sriyuths. S.E. Dastur and Percy Pardiwala,senior Advocates for M/s.King and Partridge)senior Advocates for M/s.King and Partridge) o This appeal is filed under Section 260-A of I.T. Act,1961 arising out of Order dated 12.6.2008 and Corrigendum|dated 18.88.2008 passed in ITA.No.3835/BNG/2005, for thassessment year 2000-01 to formulate the substantial|questions of law stated therein and to allow the appeal and|set aside the order passed by the ITAT, Bangalore in ITA.No.339/ BNG/ 2005, dated 12.06.2008 and Corrigendum dated|18.08.2008 and confirm the order of the Appellate.Commissioner and confirm the order passed by the AssistantCommissioner of India Tax, Circle-12(1), Bangalore. N. KUMAR, J.delivered the following:- | This appeal coming on for admission this day, | JU DGMENT The revenue has preferred this appeal against the|order passed by the Tribunal granting relief in favour of theASSESSEE. iaThe revenue has raised the following substantial questions of law for consideration by this Court:- “1.Whether the Tribunal was correct inreversing the finding of the Assessing Officer thatthe assessee had valued the work in progress atmaterialCOST.(closingStock)contrarytoAccounting Standard-?as|opinedbythe assessee’s Statutory Auditor that profit before taxand profit after tax are understated by the 3 assessee by Rs.137 million (Rs.48.1 crores) andRs.87 million (Rs.31.1 crores) which was broughtto tax? D2 Whether the Tribunal twas correct inholding that once the valuation of closing stock ischanged, the corresponding opening stock also)has to be changed by ignoring the judgment ofthis Hon'ble Court in CIT .vs. Corporation BankLtd., 174 ITR 616? 3.|Whether the Tribunal was correct inholdingthatExpensesincurred|towardsprofessionalchargesPress|announcements|Statutory fees etc., incurred towards buying backthe assessee’s Shares from its share holders isan allowable deduction?| 4 |Whether the Tribunal was correct inholding that the proceeds from sale of rawmaterial, stores etc. should be excluded from thetotal turnover for the purpose of computation ofdeduction under Section SOHHC of the Act byfollowing the view of its earlier order? 5.|Whether the Tribunal was correct insetting aside the finding of the lower authority v thatthe.interest.componentfor|allowingdeduction under Section SOHHC should beicomputed as per Explanation te. at 90% tosection SOHHC of the Act by following the view ofits earliwer order?” 3.The assessee is a public limited company|manufacturing fuel injection pumps, spark plugs andautomotive products. The assessee has been following themethod of valuation of work-in-progress at material cost andof finished goods at prime cost (i.e. direct material + direct|labour) from its inception consistently. The statutoryauditor in his report qualifying the final accounts of theassessee for the year ending 31.3.2000 has stated in para(d)as under:- “As Stated in Note 3, the company hasdetermined.theCOST.ofwork-in-progressconsidering material cost only and in the case offinished goods, material cost and direct labourforthe purpose of valuation. This practice is contraryto Accounting Standard 2, which requires cost of 3.The assessee is a public limited company|manufacturing fuel injection pumps, spark plugs andautomotive products. The assessee has been following themethod of valuation of work-in-progress at material cost andof finished goods at prime cost (i.e. direct material + direct|labour) from its inception consistently. The statutoryauditor in his report qualifying the final accounts of theassessee for the year ending 31.3.2000 has stated in para(d)as under:- “As Stated in Note 3, the company hasdetermined.theCOST.ofwork-in-progressconsidering material cost only and in the case offinished goods, material cost and direct labourforthe purpose of valuation. This practice is contraryto Accounting Standard 2, which requires cost of both work-in-progress and finished goods to bedetermined considering material cost, directlabour and appropriate overheads, includingduties. Asa result, inventories, current liabilities|and provisions are understated by Rs./64million,Rs. 53millionandRs.220million|respectively while loans and advances are,overstated by Rs.93 million. Consequently, profitbefore tax and profit after tax are understated byRs.137 million and Rs.87 million respectively.” 4The assessing authority after hearing the|assessee held that the assessee’s method of valuation oftinventory comes under Situation 2 mentioned in theaccounting standards and it is not in accordance with theAccounting principles, the accounting standards, CompaniesAct and Income Tax Act. The profit admitted by the assesseeis not true profit, but distorted profit. The cost of unsoldgoods has been neutralized completely by incorrect valuationof stock. Thereby, cost of unsold goods has been added tothe cost of goods sold, resulting in suppressed profits. The|profits of the business arrived by the assessee by this 6 method of valuation of inventory is not acceptable as it is notreflection of the true profits arising from current sale ofgoods. Therefore, the assessing authority proceeded todetermine the correct profits of the assessee for the currentyear. He gave the benefit of current closing stock in thesubsequent year, and held that correct profits from unsoldgoods as in the current year is assessable. He has alsorejected the contention of the appellant that if the closingstock were to be revalued according to AS2, then the openingstock should also be revalued on uniform basis and finallythe accounting policy of the assessee with regard tovaluation of inventory was rejected. He proceeded to assessthe income to the best of his judgment, based on thematerial gathered during the course of hearings. Aftercomputation of the correct consumption of material, hecomputed the correct and true profits and the additionalprofit of Rs.48,26,21,428/- arising from current year’s saleswas brought to tax. E 5DuringtherelevantyCa lrtheaSSeSSeCeformulated a proposal to buy back equity shares fromexisting share holders on a proportionate basis and througha tender. In this connection, the company had incurredCXDPCIISCtowardsprofessionalcharges,PIess|announcements and statutory fees amounting to total ofRs.27,82,411/- and an expenditure by way of professionalfees of Rs.6,01,250/- as a consequence thereof. TheaSSe€@SSEclaimedtheentireexpenditureasTEVENUEexpenditure on the ground that it was incurred exclusivelyfor the purpose of the business. However, the assessingauthority rejected the said claim on the ground that the saidexpenditure is incurred in connection with restructuring ofshare capital and with a view to improve return on equityover a period of time and this is an enduring benefit soughtto be achieved from buy back of shares. Therefore, totalexpenditure of Rs.33,83,661/- incurred directly in relation toand in consequence to buy back is treated as capitalexpenditure and was disallowed. | 8 6.The assessing authority included in the total|turnover, sale of raw material, scrap. etc for the purpose ofcomputation of deduction under Section 80HHC. Similarly,the interest component for allowing deduction under SectionSOHHC was also included in the total turnover. 8 6.The assessing authority included in the total|turnover, sale of raw material, scrap. etc for the purpose ofcomputation of deduction under Section 80HHC. Similarly,the interest component for allowing deduction under SectionSOHHC was also included in the total turnover. TT.Agegerieved by this order, the assessee preferrean appeal to the Commissioner of Income-Tax (Appeals) whodismissed the appeal confirming the findings of the appellateauthority. Aggrieved by the said order, the assesseepreferred an appeal to the Tribunal. The Tribunal by theimpugned order held that though the assessing authoritywas justified in changing the valuation of closing stock, hewas not justified in refusing to change the valuation ofopening stock. It held that at the instance of the assessingauthority, the closing stock is changed. Consequently, todetermine the profits, valuation of the opening stock alsoshould be changed. As regards the expenditure incurred inconnection with the buy back scheme was held be in the < nature of revenue expenditure following the judgment of theApex Court. In respect of the benefit under Section 80HHC,the orders of the authorities were set aside following the view|taken in the assessee’s case itself in the earlier years.Agegrieved by this order, the revenue is in appeal. 3S.Substantial questions of law 1 and 2:‘The| basis for the assessing authority to change the closing stock|was the auditor’s report where it was stated that thecompany has determined the cost of work in progress|considering the material cost only and in the case of finishedgoods, material cost and direct labour for the purpose otfvaluation. This practice is contrary to Accounting Standard|2, which requires cost of both work-in-progress and finished|goods to be determined considering material cost, direct|labour and appropriate overheads, including duties. As a|result, inventories, current liabilities and provisions are|understated by Rs.587 million, Rs.42 million and Rs.170|million respectively while loans and advances are overstated| 10 by Rs.64 million. All the three authorities are of the view|that the practice adopted by the assessee is contrary to theAccounting Standard 2 as stated by the auditor’s report. It|is in that context, the assessee contended in the alternativethat in case the method of valuation of closing stock ischanged by the assessing authority then the opening stockalso has to be revalued on the same basis which argumenthas been accepted by the Tribunal and the relief is grantedto the assessee. QOThe learned counsel for the revenue assailing|these findings contends relying on several judgments ofvarious High Courts that there is no obligation to change thevaluation in the opening stock because valuation of closingstock is changed. In support of his contention, he relied onjudgment of the Madras High Court in the case of|CommissionerofIncomeTax|CarborandumUniversal Limited [149 ITR 758]where at Paragraph 1o it|has been held as under:-. 11 “Further, even though the change of|the method has resulted in a detriment tothe Revenue in the year in question, sincethe method is to be followed consistentlyyear after year in future, this apparentdetriment to the Revenue will get adjustedand disappear. Therefore, in view of thefindings of the Tribunal that the change ofthe method is bona fide and is intended tobe followed in future, year after year, thechange has to be accepted by the Revenue,notwithstanding the fact that during theassessmenr year which is the first yearwhen the change of method is. broughtabout it has resulted in a prejudice ordetriment to the Revenue. So long as themethodOf|valuationadoptedbytheaSSCSSCEgetsrecognitionfromthepracticingaccountants|andcommercialworld for valuation of stock-in-trade, theadoptionOf|thatmethodCAanNoObe|questioned by the Revenue unless theadoption of that method ts found to be notbona fide or restricted for a particularyear.” 12 10..The Bombay High Court in the case of|Metmould Corporation .vs. Commissioner of Income Tax| [202 ITR 789]‘has held as under:-. 12 10..The Bombay High Court in the case of|Metmould Corporation .vs. Commissioner of Income Tax| [202 ITR 789]‘has held as under:-. “Thus, the value of the closing stockof the preceding year must be the value ofthe opening stock of the next year. Thechange, therefore, has to be effected byadopting the new method for valuing theclosing stock which will, in its turn, become|the value of the opening stock of the nextyear. If, instead, a procedure is adoptedfor|changing the value of the opening stock, itwil lead to a chain reaction of changes inthe sense that the closing value of the stockof the year preceding will also have tochange and correspondingly the value ofthe opening stock of that year and so on.” | 11.)This Court in the case oftCommissioner of Income Tax .vs. Corporation Bank Limited [174 ITR 616]held as under:-. 13 7On the application of the principleslaid down by the Supreme Court in the leadingcase of Chainrup Sampatram .vs. CIT (supra), twoprinciples appear to be well settled, t.e., that theassessee is entitled to value, the closing stockeither at cost price or market value, whichever tslower, and that the closing stock must be thevalue of the opening stock in the succeeding year. |It is thus clear that irrespective of the basisadopted for valuation in the earlier years, theassessee had the option to charge the method ofvaluation of the closing stock at cost or marketprice, whichever is lower, at any time, providedthe change was bona fide and followed regularlythereafter. The contention of the Revenue is that in|order to reflect the true profits, change in themethod of valuation of stock should be applied toboth opening stock as well as closing stock and itis not open to the assessee to apply new methodto the closing stock alone without reference toopening stock. The value of the closing stock inthe previous year must be the value of openingStock in the succeeding year and, therefore, if the| argument of the Revenue is accepted, therecannot be change in the valuation at all.However, the effect of the ruling in Chainrupsampatram~vDS,CIT|(1953)D4|ITR481(SC):TC2R. 124 is that there is no rule that theopening stock and closing stock of the sameaccounting year must necessarily be valued onone and the same basis. It is permissible,therefore, for the assessee to adopt either marketvalue or at cost price to value the closing stock aslong as such change in the method of valuation isadopted bonafide and is thereafter continuedyear to year. In a year where the opening stockvalue adopted is in one method and closing stockis another, there is bound to be some anomaly inthe year of change, but that will get ironed outand absorbed in course of time as the newmethod of valuation of stock is going to be appliedon a permanent basis thereafter in later years. Iderive support for this view from CIT .uvs.Carborandum Universal Ltd. (1984) 39 CTR (Mad)272: (1984) 149 ITR 759 (Mad); TC2R.3566 andBritish Paints India Ltd. .vs. CIT (1978) 111 ITR53 (Cal): TC2R.122.” 12.)The Apex Court in the case of)VKJ Builders & Contractors (P) Limited .vs. Commisstoner of Income Tax [318 ITR 204]|at Paragraph 4 has held as under:- “Tt1Sthe.fundamentalprincipleofaccountancy that the figure of the closing stock ofthe earlier year has to form the opening stock ofthe next accounting year. In the present case, wefind that after the alleged suppression of thework-in-progressCameTo|be|detected,|Cmdeclaration was filed under the KVSS on thebasis of the order passed by the AO on 27[th]| Feb.,1998 which declaration was accepted by thedesignated authority (presumably after obtainingthe report from the AO). In the circumstances, theAO ought not to have rejected the application ofthe assessee under S. 154.” 13..In the booklet called “Valuation of Stock and|Work-In-Progress-NormallyAcceptedAccountingPrinciples”- brought out by Indian Merchants’ ChamberEconomic Research & Training Foundation and written by 16 ohri G.P. Kapadia, at Page 4, there is discussion about thechange from one valid basis to another valid basis. 13..In the booklet called “Valuation of Stock and|Work-In-Progress-NormallyAcceptedAccountingPrinciples”- brought out by Indian Merchants’ ChamberEconomic Research & Training Foundation and written by 16 ohri G.P. Kapadia, at Page 4, there is discussion about thechange from one valid basis to another valid basis. 14..Relying on these judgments it was contended|that though the assessee is at liberty to change the valuationin the closing stock, it does not follow that the valuation ofthe opening stock also requires to be corrected. All thesejudgments are cases where the assessee has changed the|valuation of the closing stock. The department has acceptedit as it was a bonafide one. Therefore, the said closing stock|has become the opening stock for the subsequent year.Where a change from one valid basis to another valid basisisaccepted, certain consequences normally follow. The|opening stock of the basis year of change is- valued on the|same basis as the closing stock. Whether the change is to a|higher level or to a lower level, the revenue normally does notseek to revise the valuation of the earlier years. It neither|seeks to raise additional assessments, nor does it admit.relief under the ‘error or mistake’ provisions. It is not| possible to define with precision what amounts to a changeof basis. It is a convenience, both to the tax-payer and to theRevenue, not to regard every change in the method ofvaluation as a change of basis. In particular, the Revenueencourages the view that changes which involve no morethan a greater degree of accuracy, or a refinement, shouldnot be treated as a change of basis, whether the changeresults in a higher or a lower valuation. In such cases thenew valuation is applied at the end of the year withoutamendment of the opening valuation. This principle isaccepted by all the Courts and therefore in the aforesaidjudgments it was held there is no need to change or amendthe opening valuation. If such a change in the closingvaluation is not bonafide, the revenue is under no obligationto accept it. They could insist on the valuation without thechange. 15.|But the question now is whether such a changeis on account of assessing officer not accepting the valuation 18 given by the assessee. As in this case, if the valuation madeby the assessee is not in accordance with the accountingstandards 2 and it requires to be brought in conformity with|the same then is it necessary to correct the valuation of theopening stock. It is in this context, reliance is placed on thejudgment of the Bombay High Court in the case of|Commisstoner of Income Tax, Bombay .vs. AhmedabadNew Cotton Mills Co.,/ wherein it has been held as under:-. “Now what is common ground is that at any)rate the stock at the end of the year 1925 wasundervalued in the company’s. return. Thecompany says it was also undervalued at thebeginning of the year. That has not been strictlyproved, but the whole case depends upon it, andtherefore for the purposes of the present case wepropose to assume that this is the case. Nowwhat the Commissioner has done itis this. He hasrectified the value of the stock at the end of theyear by substituting the true value of the stock as|at that date, but he has declined to make thecorrespondent alteration as regards the stock at the opening of the year. He says that that oughtnot to be done becquse under q well-knownprinciple of accountancy the opening value mustbe taken at precisely the same figure as theclosing value for the previous year, viz., 31[sf]December, 1924, and that tf anything to thecontrary is done you would get into greatdifficulties, and would also open the door tofrauds on the public revenue. * 16.|The Privy Council affirming the view of the|Bombay High Court in the aforesaid case has in the case ofCommissioner of Income-Tax, Bombay Presidency .uvusAhmedabad New Cotton Mills Co. Ltd., reported in AIR|J9O3O PC 1526held as under:-. the opening of the year. He says that that oughtnot to be done becquse under q well-knownprinciple of accountancy the opening value mustbe taken at precisely the same figure as theclosing value for the previous year, viz., 31[sf]December, 1924, and that tf anything to thecontrary is done you would get into greatdifficulties, and would also open the door tofrauds on the public revenue. * 16.|The Privy Council affirming the view of the|Bombay High Court in the aforesaid case has in the case ofCommissioner of Income-Tax, Bombay Presidency .uvusAhmedabad New Cotton Mills Co. Ltd., reported in AIR|J9O3O PC 1526held as under:-. “If the method of altering both valuations isnot adopted it is perfectly plain that the profitwhich its brought forward is not the real one. Itmay be more or it may be less, but it has norelation to the true profit if the stock its valued onone basis when it goes out without consideringthe value of the stock when it comes in. When,therefore, there is undervaluation at one end, the effect is to cause both a smaller debit in respect ofthe stock introduced into the next account andalarger sum for profits realized by the sale, changein market values being immediately reflected inthe price obtained for the goods that sold, in thesecircumtances to contend that there should beundervaluation at one end and not at the other isto raise an argument which their Lordships“a cannot accept 17.)The Calcutta High Court in the case of|Commissioner of Income Tax .vs. Bengal Jute Mills Co.Ltd. (1992) 107 CTR 0034‘at paragraph 5 held as under:- “section 4 of the IT Act, imposes a charge|on the total income of the previous year of everyperson. If any income has escaped assessmentin an earlier previous year, then the ITO mayreopen the assessmentfor the purpose of bringinginto tax the income that has escaped assessment.The escapment may be due to undervaluation ofStock in the earlier years. But because theincome|oftheearlieryearhasescapedassessment is not ground for assessing thecurrent year’s profit at a distorted figure. The general rule of accountancy is that the value ofthe closing stock of a year becomes the value ofthe opening stock of the next year. But in a caselike this where the ITO has made an allegation ofundervaluation and has valued the closing stockat the market rate rejecting the assessee’svaluation, then to arrive at the correct figure ofprofit, the ITO must also value the opening stockin a similar fasion. If the assessee’s method ofvaluation of the opening stock is accepted and atthe same time that method is_ rejected forvaluation of the closing stock, then a _ highldistorted figure of profit will emerge. This will bebeyond the scope of the charging section.” 18.|The Apex Court in the case of|ChainrupSampatram .vs. Commissioner of Income-Tax, WestBengal [(1953) 24 ITR 481]‘stated as under:-. “The true purpose of crediting the value of|unsold stock is to balance the cost of those goodsentered on the other side of the account at thetime of their purchase, so that the cancelling outof the entries relating to the same stock from both|sides of the account would leave only the oo transactions on which there hque been actualsales in the course of the year showing the profitor loss actually realized on the year’s trading.” 18.|The Apex Court in the case of|ChainrupSampatram .vs. Commissioner of Income-Tax, WestBengal [(1953) 24 ITR 481]‘stated as under:-. “The true purpose of crediting the value of|unsold stock is to balance the cost of those goodsentered on the other side of the account at thetime of their purchase, so that the cancelling outof the entries relating to the same stock from both|sides of the account would leave only the oo transactions on which there hque been actualsales in the course of the year showing the profitor loss actually realized on the year’s trading.” 19.|From the aforesaid judgments, it is clear thatthe method of valuation may change in two circumstances.The assessee may change the method of valuation of theclosing stock though the opening stock was valued in adifferent method. If the change is bonafide and is acceptedby the revenue then the question of changing the openingstock would not arise. If such a change is not bonafide, it |will be open to the Revenue not to accept such a change invaluation and assess without such valuation. Once the saidchange in the valuation is accepted by the Revenue, theconsequence is the value of the closing stock in the previousyear would become value of the opening stock in thesucceeding year. In a year where the opening stock valueadopted is one method and closing stock is another, there isbound to be some anomaly in the year of change, but thatwill get ironed out and absorbed in course of time as the new O3 method of valuation of stock is going to be applied on apermanent basis thereafter in coming years. 2Q,But if the assessing authority rejects the|assessee’s valuation of the closing stock then to arrive at thecorrect figure of profit, the assessing authority should valuethe opening stock in a similar fashion. If the assessee’smethod of valuation of the opening stock is accepted and atthe same time his valuation of the closing stock is rejectedthen a highly distorted figure of profit will be arrived at. Thiswill be the scope of charging section. Section 4 of theIncome Tax Act, which is the charging Section, reads asunder:- “4(1) Where any Central Act enacts that|income-tax shall be charged for any assessmentyear at any rate or rates, income-tax at that rateor those rates shall be charged for that year inaccordance with, and subject to the provisions(including provisions for the levy of additionalincome-tax) of, this Act in respect of the totalincome of the previous year of every person: Provided|that where by virtue of anyprovision of this Act income-tax is to be charged in|respect of the income of a period other than theprevious year, income-tax shall be chargedaccordingly. (2) In respect of income chargeable under sub-section (1), income-tax shall be deducted at thesource or paid in advance, where it is sodeductible or payable under any provision of thisAct.” As is clear from the charging Section, the income tax shall becharged for the year in respect of total income of theprevious year of the very person. Therefore, if the basis forarriving at the valuation at the end of year is changed by theassessing authority without correspondingly changing thevaluation of the opening stock then it results in chargingincome on a distorted figure which is not permissible in law.Therefore, when the assessee changes the valuation of theclosing stock, there is no necessity to change the openingstock. But when the assessing authority changes the closingstock it becomes obligatory that the opening stock valuation has to be correspondingly changed on the basis of which thevaluation of the closing stock is changed in order to arrive atcorrect figure of tax which is chargeable as tax under Section4 of the Act. Therefore, the order passed by the Tribunalholding that the opening stock should also be revaluedcannot be found fault with. Accordingly, the substantialquestions of law 1 and 2 framed are answered in favour ofthe assessee and against the revenue. D1 «Substantial question No.3The facts are not has to be correspondingly changed on the basis of which thevaluation of the closing stock is changed in order to arrive atcorrect figure of tax which is chargeable as tax under Section4 of the Act. Therefore, the order passed by the Tribunalholding that the opening stock should also be revaluedcannot be found fault with. Accordingly, the substantialquestions of law 1 and 2 framed are answered in favour ofthe assessee and against the revenue. D1 «Substantial question No.3The facts are not in dispute. The assessee formulated the proposal to buyback equity shares from existing share holders on aproportionate basis and through a tender. The sum ofRs.33,83,661 /-Wa SIncurredaS|expendituretowards professional charges, press announcements and statutoryfees etc. Now the question is whether this expenditure iscapital in nature or revenue in nature. It was contended bythe revenue that as this expenditure was incurred to buyback equity shares it has resulted in expansion of the capital 22 base and is of enduring nature. Therefore, the expenditureis capital in nature and is not allowable as deduction. Insupport of this contention, reliance was placed on thejudgment of|Brooke Bond India Ltd. .vs. Commissioner ofIncome Tax [225 ITR 798(SC)/wherein it has been held as”under:- “It is no doubt true that before the AAC as|well as before the Tribunal it was submitted onbehalf of the assessee that increase in the capitalwas to meet the need for working funds for theassessee-company. But the statement of casesent by the Tribunal does not indicate that afinding was recorded to the effect that theexpansion of the capital was undertaken by theassessee in order to meet the need for moreworking funds for the assessee. We, therefore,cannot proceed on the basis that the expansion ofthe capital was undertaken by the assessee forthe purpose of meeting the need for workingfunds for the assessee to carry on its business. —Though the increase in the capital results inexpansion of the capital base of the company andincidentally that would help in the business of the company and may also help in the profit-making,the expenses incurred in that connection stillretain the character of a capital expenditure sincethe.expenditure1Sdirectly relatedTO theexpansion of the capital base of the company. Onthe facts and in the circumstances of the case, theTribunal was right in sustaining the disallowanceof Rs.13,99,305/- being expenses incurred inconnection with the issue offresh lot of shares.” | DO|Countering the said argument, it was contendedby the assessee that the aforesaid judgment was renderedwith reference to a case where issue otf fresh lot of shareswhich resulted in the expansion of the capital and therefore,it was rightly treated as the capital expenditure. But in the|instant case, the effect of buy back of shares resulted inshrinking of the capital. Therefore, there is no expansion ofthe capital structure of the company and as such thatexpenditure is revenue in nature. In support of thiscontention, reliance was placed on the judgment of the ApexCourt in|Commisstoner of Income-Tax .vs. General IS Insurance Corporation |(2006)286 ITR 232(SC)' where it was held as under:- “The capital base of the company prior to orafter the issuance of bonus shares remains.unchanged. Issuance of bonus shares does not result inany inflow of fresh funds or increase in thecapital employed, the capital employed remains.the same. Issuance of bonus’ shares bycapitalization of reserves is merely a reallocationof the company’s funds. — As observed earlier, the issue of bonus shares|bycapitalizationofTeECSeCTV1Smerely Cmreallocation of company’s funds. There is noinflow of fresh funds or increase in the capitalemployed, which remains the same. If that be so, |then it cannot be held that the company has.acquired a benefit or advance of enduring nature.The total funds available with the company will)remain the same and the issue of bonus shareswil not result in any change in the capitalStructure of the company. Issue of bonus shares. Pr Issuance of bonus shares does not result inany inflow of fresh funds or increase in thecapital employed, the capital employed remains.the same. Issuance of bonus’ shares bycapitalization of reserves is merely a reallocationof the company’s funds. — As observed earlier, the issue of bonus shares|bycapitalizationofTeECSeCTV1Smerely Cmreallocation of company’s funds. There is noinflow of fresh funds or increase in the capitalemployed, which remains the same. If that be so, |then it cannot be held that the company has.acquired a benefit or advance of enduring nature.The total funds available with the company will)remain the same and the issue of bonus shareswil not result in any change in the capitalStructure of the company. Issue of bonus shares. Pr does not result in the expansion of capital base ofthe company.” 23.The Apex Court in the case of|CIT .vs. DalmiaInvestment Company Limited /[(1964) 52 ITR 56| held asunder:- D4 “,... In other words, by the issue of bonuShares pro rata, which ranked pari passu withthe existing shares, the market price was exactlyhalved, and divided between the old and the'bonus shares. This will ordinarily be the case butnot when the shares do not rank pari passu andwe Shall deal with that case separately. Whenthe shares rank pari passu the result may beStated by saying that what the shareholder heldas a whole rupee coin is held by him, after theissue of bonus shares, in two 50 NP. Coins. Thetotal value remains the same, but the evidence ofthat value is not in one certificate but in two.” Following those judgments, the Delhi High Court in the case oftCommissioner of Income Tax .vus. Selan Exploration Technology Ltd. (2010) 199 TAXMAN 1has held at paragraphs 10 and 11 as under:- “10.It1Sclear|fromthe aforesaidjudgments that a fine distinction is made by theSupreme Court in classifying the expenditureunder two categories: (a) When the expenseincurred relates to the issue of fresh shares,which leads to an inflow of fresh funds into thecompany, such expenditure is to be treated ascapital expenditure, (bJ)On the other hand, whereno such flow of funds or increase in the capitalemployed, the expenditure incurred would berevenue expenditure, as in such a case thecompany would not acquire benefit or addition ofenduring nature. 11. In the present case, consultancy fee foradvisory services was paid by the assesseecompany for buyback of shares. Instead ofincrease in the share capital, it was going toresult in the decrease in funds with the buybackof the shares. In these circumstances, theTribunaly rightly held that the assessee had notacquired the benefit or addition of enduring nature because after the buyback, benefit oraddition of enduring nature would not arise ascapital employed had, in fact, gone down. Theexpenditure incurred had not resulted intobringing into existence any asset. Therefore, itwas rightly held to be an expense of revenuenature. ~ 5.In this context, it is equally useful to refer to section 7/(A) of the Companies Act in particular Section//A(7) which reads as under:- “71A(7)Where a company buy-back its ownsecurities, it shall extinguish and physicallydestroy the securities so brought-back withinseven days of the last date of completion of buy-back.” similarly Section 77AA reads as under:- “1(AA.Transfer of certain sums to capitalredemption reserve account.-Where a companypurchases its own shares out of free reserves,then a sum equal to the nominal value of theShare so purchased shall be transferred to the 39 capital redemption reserve account referred to inclause(d) of the proviso to sub-section(1) of section|80 and details of such transfer shall be disclosedin the balance sheet”. 5.In this context, it is equally useful to refer to section 7/(A) of the Companies Act in particular Section//A(7) which reads as under:- “71A(7)Where a company buy-back its ownsecurities, it shall extinguish and physicallydestroy the securities so brought-back withinseven days of the last date of completion of buy-back.” similarly Section 77AA reads as under:- “1(AA.Transfer of certain sums to capitalredemption reserve account.-Where a companypurchases its own shares out of free reserves,then a sum equal to the nominal value of theShare so purchased shall be transferred to the 39 capital redemption reserve account referred to inclause(d) of the proviso to sub-section(1) of section|80 and details of such transfer shall be disclosedin the balance sheet”. From the aforesaid Sections, it is clear that if the companypurchases its own shares out of free reserves then the sumequal to the nominal value of the share so purchased shallbe transferred to the Capital Redemption Reserve Accountand after the company buys back its own security, it shallextinguish and physically destroy the securities within sevendays after the completion of buy-back. 26.The increase in the capital results in expansionof the capital base of the company and incidentally thatwould help in the business of the company and may alsohelp in the profit-making. The expenses incurred in thatconnection still retain the character of a capital expendituresince the expenditure is directly related to the expansion ofthe capital base of the company. Issue of bonus shares doesnot result in the expansion of capital base of the company. 33 It does not lead to any inflow of fresh funds into thecompany. The capital structure is not expanded. On thecontrary the consequence of such buy-back of shares is thecapital base of the company gets reduced and the capitalstructure will go down. It is not of an enduring effect so as |to bring the expenditure incurred in this regard as capitalexpenditure. Where there is no flow of funds or increase inthe capital employed, the expenditure incurred would berevenue expenditure. Therefore, rightly the Tribunal heldthat it is in the nature of revenue expenditure and allowedthe same. OT.Insofar as substantial questions of law 4 and 5are concerned, in the assessee’s case itself, in ITA.No.734/07decided on 1.8.2014, the said substantial questions havebeen answered in favour of the assessee and against therevenue. Following the said judgment, those two questionsare answered in favour of assessee and against the revenue. �� ������!�����"�!�,�� ,�!�%�� �'�+��-�� �������% 5���!���� ������%;;�%/����##�!-� ,/5'�����%;;�%/����-�������-����%!��������>�%!�����!��+ �#������ L%/>:$�� �)-,������� �)-,�������