The Commissioner Of Income Tax, Central-I, Chennai v. M/S Associated Electrical Agencies, Chennai

IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED: 08/12/2003 CORAM THE HON'BLE MR.JUSTICE R.JAYASIMHA BABUandTHE HON'BLE MR.JUSTICE S.R.SINGHARAVELU T.C.No.249 of 1998 and T.C.No.277 of 1998 The Commissioner of Income Tax,Central-I,Chennai. ..Applicant -Vs- M/s Associated Electrical Agencies,Chennai. ..Respondentin T.C.No.249/98 M/s (Hydrabad),Chennai. ..Respondentin T.C.No.277/98 Tax Case reference under Sec.256 (2) of the Income-tax Act, 1961,against the order of the Income-tax Appellate Tribunal, 'C' Bench, Madras,dated 30.1.1997, made in R.A.Nos.273 & 274/Mds/97 in ITA Nos.128 &129/Mds/1996. !For Applicant : Mrs.Pushya Sitaraman,Sr. Standing Counselfor I.T. Department. ^For respondent : Mr.V.Ramachandran,Senior Counselfor Mr.Devendiran :JUDGMENT (Delivered by R.JAYASIMHA BABU, J.) The assessment year is 1992-93. The questions referred to us forconsideration are:- "1. Whether on the facts and in the circumstances of the case, theAppellate Tribunal was right in law and had valid material in coming to theconclusion that the advertisement expenses claimed to have been shared by theassessee with M/s Dynavision Ltd. and the difference in purchase price claimed by the assessee are in the nature of a contractual obligation and are,accordingly, allowable as expenditure incurred by the assessee for theAssessment year 1992-93? 2. Whether on the facts and in the circumstances of the case andhaving regard to the Supreme Court's decision in the case of Mc Dowell & Co.Ltd. (154 ITR 148) the Appellate Tribunal was right in law in failing toappreciate that the expenditure claimed by the assessee was only a device toavoid tax on income earned by the assessee?" 3. The two assessees are agents of a company Dynavision ( hereinafter referred to as 'the company'), which manufactured television sets. Accordingto the assessees, 70 per cent of the production of that company was marketedthrough them. The company was promoted by persons whose relatives arepartners in the two assessee firms. However, the majority of the shares inthat company are not held by those promoters. Substantial part is held by thepublic sector companies and a large part by private shareholders, and about26% by the promoters. The managing Director of the company belongs to thepromoters group. Several officers of the State Government are on the Board ofthis Company. 3. The two assessees are agents of a company Dynavision ( hereinafter referred to as 'the company'), which manufactured television sets. Accordingto the assessees, 70 per cent of the production of that company was marketedthrough them. The company was promoted by persons whose relatives arepartners in the two assessee firms. However, the majority of the shares inthat company are not held by those promoters. Substantial part is held by thepublic sector companies and a large part by private shareholders, and about26% by the promoters. The managing Director of the company belongs to thepromoters group. Several officers of the State Government are on the Board ofthis Company. 4. For the assessment year 1992-93, when the returns filed by theseassessee were taken up for scrutiny, the assessing officer noticed certainamounts having been shown as credited to the account of the company. Pursuantto enquiries made by the assessing officer, the assessees produced a letterdated 20.3.1992 received by them from the said company and addressed to one ofthe assessees with a copy thereof marked to the other. That letter is signedby the Managing Director of the company. The caption of that letter is"Sharing of marketing expenses and revision of price for the year 1991-92".That letter, after referring to some earlier communications stated to havebeen sent to the assessees, records the fact that the television market was ina recessionary trend; that sales and margins were under great strain and thatthe assessees had appreciated that it would not be appropriate to cut down theadvertising and marketing expenses in view of the competition getting tougherin the declining market and, accordingly, the assessees had agreed, havingregard to the past mutual benefits that they had obtained from the compan y,to share the financial strain that the company was facing. The manner inwhich that strain was to be shared as set out in that letter was that theassessee Associated Electrical Agencies would share 25% of the advertisementexpenses, the assessee Apex Agency (Hydrabad) 25% and the company itselfmeeting the balance 50%. The travelling and conveyance expenses incurred bythe marketing staff was also to be shared in the ratio of 30% each by the twoassessees and the balance 40% by the company. The salaries paid to themarketing staff were to be met out of the contribution agreed to be made bythe two assessees in the sum of Rs.2,37,500/- p. m. each. 5. The letter also records the agreement said to have been reachedearlier with the assessees that the assessees would pay an additional price ofRs.50/- per set for 14" Black & White TV sets and Rs.175/- for 20" black andWhite TV sets. The assessees, in addition to placing reliance on that letterand asserting that what was stated in that letter was indeed the record of an agreement which had been reached earlier and had been accepted by the twoassessees, also relied on the fact that they had made debit entries on31.3.1992 for the sums which corresponded to the sharing arrangement set outin that letter. 6. As the assessees followed mercantile system of accounting, theyhad claimed the amounts shown in their books of entry as having been creditedto the account of the company in accordance with the contents of that letterof 20.3.1992, as expenditure for that year. 7. The assessees had also produced before the assessing officer the debit notes issued by the company on 30.4.1992 for these sums. The sums incase of the assessee, Associated Electrical Agencies, are Rs.72,28,025/-towards marketing expenses and Rs.45,11,700/- towards the difference in pricefor the TV sets. In the case of Apex Agencies (Hydrabad), the sums areRs.72,28,025/- towards marketing expenses and Rs.22,74,075/- towards thedifference in price for the TV sets. 6. As the assessees followed mercantile system of accounting, theyhad claimed the amounts shown in their books of entry as having been creditedto the account of the company in accordance with the contents of that letterof 20.3.1992, as expenditure for that year. 7. The assessees had also produced before the assessing officer the debit notes issued by the company on 30.4.1992 for these sums. The sums incase of the assessee, Associated Electrical Agencies, are Rs.72,28,025/-towards marketing expenses and Rs.45,11,700/- towards the difference in pricefor the TV sets. In the case of Apex Agencies (Hydrabad), the sums areRs.72,28,025/- towards marketing expenses and Rs.22,74,075/- towards thedifference in price for the TV sets. 8. The assessing officer, while accepting that the assessees maintained theirbooks on mercantile system was, nevertheless, of the view that this was apost-accounting exercise undertaken solely for the purpose of reducing thetaxable profit of the assessees and that the letter, dated 20.3.1992, issuedby the company was not capable of being regarded as an agreement under whichan enforceable liability was cast on the assessees. He, therefore, disallowedthe sums, as a consequence of which, the taxable profit of the assessees wentup substantially. On appeal, the Commissioner upheld the view of theassessing officer. 9. On further appeal to the Tribunal, the Tribunal after noticing the fact that of the six directors of the Company, three did not belong to thepromoter group; that the Chairman of the company was an officer belonging tothe Indian Administrative Service; that the pattern of share holding in thecompany among the Tamil Nadu Industrial Development Corporation (TIDCO), thegroup of P.Obul Reddy, the promoters, and the public was 26:26:48; that thecomposition of the two assessee firms, which included the promoter P.ObulReddy in one firm in his individual capacity and in the other asrepresentative of HUF, one of the firms also having the Managing Director ofthe Company as a partner in his capacity as the Manager of HUF, held thatdespite the intimate linkage between the Managing Director and one of theDirectors and the two firms in which they were also partners eitherindividually or as representing the HUF, the other partners being the membersof their family, the agreement recorded in the company's letter, dated 20.3.92, followed by the firms making credit entries in favour of the companyin their books could not be regarded as unreal transaction or one undertakensolely for the purpose of reducing the taxable profit of the two assessees. 10. The Tribunal also took note of the fact that the production andsales volume of the company had steadily gone down and that the company'sfinances were poor and held that the arrangement which was recorded in thatletter of 20.3.1992 was one which was meant to equitably distribute a part ofthe burden borne by the company among the company and the two distributors. The bulck of the business run by the two assessees was only in relation to theproduct manufactured by the company and the two assessees, therefore, had avital interest in the continued functioning of that company. 10. The Tribunal also took note of the fact that the production andsales volume of the company had steadily gone down and that the company'sfinances were poor and held that the arrangement which was recorded in thatletter of 20.3.1992 was one which was meant to equitably distribute a part ofthe burden borne by the company among the company and the two distributors. The bulck of the business run by the two assessees was only in relation to theproduct manufactured by the company and the two assessees, therefore, had avital interest in the continued functioning of that company. 11. The Tribunal ultimately held that on applying the test as towhether the expenditure had been incurred wholly or partly or exclusively forthe purpose of the assessee's business it was necessary to find out as towhether the assessees were acting reasonably in the interest of their ownbusiness. The Tribunal accepted the assessees' case that they were indeedacting in the interest of the business, as their business was primarily thatof acting as agents for the sale of the products manufactured by the company,and by agreeing to share any sum of the expenditure which was necessary forthe company to incur for promoting the products manufactured by it andmarketed by the assessees they were in effect advancing the cause of their ownbusiness. It also accepted the assessees' claim that the expenditure incurredwas commercially expedient for the assessees. It also accepted the assessees'case that the expenditure in fact had been incurred as necessary entries hadbeen made in the books of account. 12. The Tribunal also took note of the fact that these amounts hadbeen shown in the books of account of the company and that there had been nodisallowance of expenditure by the assessing officer. The Tribunal concludedwith the finding that the expenses as claimed by the assessees were allowableas they were incurred indirectly to facilitate the carrying on of the businessor to preserve their existing source of income with a view to safeguarding thebusiness and also increasing their profits in future. 13. It was submitted before us by the learned counsel for the Revenuethat what has been done by the assessees is merely a paper exercise with aview to reduce their own tax burden and they have merely taken advantage ofthe fact that the company was engaged in the production of a product, which itwas not possible to market with the same degree of ease as was being doneearlier on account of technological changes and more entrants having enteredthe market. It was submitted that when the assessees found at the end of theyear that they had substantial profit which would attract a large taxliability, one of the partners who also happened to be the Managing Directorof the company had sent a letter in the name of the company and even the debitnotes sent by the company were only sent after the end of the accounting yearand that there was in fact no liability at all on the assessees and there wascertainly no need what ever for them to make payment of these sums to thecompany about which payment also admittedly there was no proof. 14. For the assessees it was submitted by the learned Senior Counselthat the business of the assessees was closely linked with that of thecompany; and that there was nothing surprising in the two assessees agreeingto bear a part of the expenditure which was required to be incurred and hadbeen incurred to promote the sale of the product with a view to expand themarket and the sale, as the bulk of the sales effected by these two assesseeswere only the television sets manufactured by the company. It was stressed bylearned counsel that these assessees would not stand to gain in any manner byparting with their valuable funds to the company when there was no prospect of 14. For the assessees it was submitted by the learned Senior Counselthat the business of the assessees was closely linked with that of thecompany; and that there was nothing surprising in the two assessees agreeingto bear a part of the expenditure which was required to be incurred and hadbeen incurred to promote the sale of the product with a view to expand themarket and the sale, as the bulk of the sales effected by these two assesseeswere only the television sets manufactured by the company. It was stressed bylearned counsel that these assessees would not stand to gain in any manner byparting with their valuable funds to the company when there was no prospect of that money coming back to them so as to result in a benefit consequent totheir having to pay tax in a lesser sum. The company to which the payment wasmade being a public company, 48% of it's shares being held by the public andthe Government corporation holding 26%, no business man, it was submitted, ifhe is prudent, would part with his money to a company 74% of whose shares wasin the hands of others, unless such payment was regarded by him as beingcommercially expedient. 15. Learned counsel also placed before us a statement showing the payments made by the assessees to the company in the subsequent year at theend of which it was the company which owed monies to the assessees although atthe commencement of the year the assessees owed a substantial sum to thecompany. 16. The reasons given by the Tribunal for taking the view that it didcannot be said to be arbitrary or irrational, having regard to the factsavailable on record. It was not the case of the Revenue that any part of themonies agreed to be paid by the assessees to the company and for which sumscredit had been given in the books of the assessees have subsequently comeback to the assessees in any other manner. While it is no doubt true thatthere was no legal compulsion on the assessee to agree to pay the sums whichare mentioned in the letter of the Managing Director of the company, there wasalso no legal bar to their agreeing to pay higher price for supplies alreadyreceived if they felt that it was in their long term interest to pay such ahigher price. It was also open to them to agree to bear a part of theadvertising and marketing costs as those costs were incurred with a view toenlarge the market and to improve the sales. Sales effected of the company'sproduct resulted in benefits to the assessees as they were the selling agentsfor the company. 17. This is not a case where the company to which credit was given bythe assessees was completely owned or controlled by the partners of theassessee firms although there is clearly a linkage between the two, inasmuchas two of the directors are partners in these firms and the other partners aretheir relatives. There is no material to show that any part of the amountsshown to have been credited to the company under this arrangement subsequentlycame back to these firms. 18. In the statement setting out the particulars of payments made bythe assessees to the company as also the amounts that were due to the companyduring the subsequent year which statement was filed before us reference ismade to credit notes. Learned counsel for the assessees raised doubts as towhat those credit notes represent. It is not necessary for us to go into thedetails of the accounts of the subsequent year as those questions would arisein the assessment for the subsequent year. What is evident from the figuresnow placed before us is that payment appears to have been made of the amountsfor which the credit was given in favour of the company on 31.3.1992 in termsof the contents of the letter of 20.3.1992. 19. Payments made, having regard to the commercial expediency, neednot necessarily have their origin in contractual obligations. If the 19. Payments made, having regard to the commercial expediency, neednot necessarily have their origin in contractual obligations. If the assessee, which carries on a business finds that it is commercially expedientto incur certain expenditure directly or indirectly, it would be open to suchan assessee to do so notwithstanding the fact that a formal deed does notprecede the incurring of such expenditure. While the company in this case mayhave had difficulty in compelling the assessee to make payments solely on thebasis of that letter of 20 .3.1992, once the assessees accepted and acted inaccordance with what was set out in that letter, the assessees cannot befaulted for having agreed to something which had been set out as a record of aprior agreement, in a letter written to them by the company. 19. Having regard to all these facts, the Tribunal cannot be said tohave erred in the view that it took. The question referred are answered infavour of the assessees and against the Revenue. Index: YesWebsite: Yes To 1.The Assistant Registrar,Income Tax Appellate Tribunal,Rajaji Bhavan,III Floor, Besant Nagar,Madras-90. (with records) (5 copies) 2.The Secretary,Central Board of Revenue,New Delhi. (3 copies) 3.The Commissioner of Income Tax,Central-I,Madras. 4.The Commissioner of Income-tax,(Appeals)-I, Madras. 5.The Addl. Commissioner of Income-tax,Central R-Ii, Madras. 6.The Asst. Commissioner of Income-tax,Central Circle-Ii (1, Madras. Dev/ �