IN THE ITAT MUMBAI BENCH ‘J’
Deputy
Commissioner of Income-tax
v.
Lyka Labs
Ltd.
K.C. SINGHAL,
JUDICIAL MEMBER
AND D.K. SRIVASTAVA, ACCOUNTANT MEMBER
IT APPEAL
NOS. 8172 (MUM.) OF 2003 AND 40 (MUM.) OF 2004
[ASSESSMENT YEAR
1998-99]
NOVEMBER 23, 2007
I. Section 28(i) of
the Income-tax Act, 1961 - Business income - Chargeable as - Assessment year
1998-99 - Whether a receipt can be said to be capital receipt when it is
relatable to transfer of capital asset other than stock-in-trade and that
parting of capital asset must be in a sense that transferor cannot make any
gain out of same either for ever or for an enduring period - Held, yes -
Assessee had been in business of manufacturing of various drugs and
formulations and sale thereof as well as marketing of Nitro Glycerine
based formulations/products manufactured by a company ‘S’ - It had a huge
distribution network for marketing its own manufactured product as well as
products manufactured by other parties - In course of such business, it came to
possess certain marketing information relating to Nitro Glycerine
based formulations - A foreign company ‘U’ was also engaged in manufacture of
Nitro Glycerine based formulations and it intended to
market its products in India - To facilitate its marketing process, it entered
into an agreement with assessee to procure certain information relating to
Nitro Glycerine based formulations - During previous
year, assessee received certain amount from company ‘U’ on two accounts - (i) for transferring marketing information relating to
formulations made from bulk Nitro Glycerine for
period of three years, and (ii) for not competing with ‘U’ in promoting,
distributing and selling activities of such formulations for period of five
years - Consideration received was composite one and no apportionment was made
in respect of above activities - Assessee claimed deduction of said receipt on
ground that it was a capital receipt - Whether since assessee had simply parted
with information relating to marketing of Nitro Glycerine
formulations for a period of three years only without affecting its
trading/marketing structure, imparting of such information did not amount to
transfer of capital asset - Held, yes - Whether therefore, payment allocable to
such business of imparting of information amounted to revenue receipt
chargeable to tax - Held, yes - Whether payment relatable to non-compete
covenant amounted to capital receipt, inasmuch as there was a loss of source of
income to assessee from marketing of Nitro Glycerine
based products for a period of five years - Held, yes
II. Section 145 of the
Income-tax Act, 1961 - Method of accounting - Change of - Assessment year
1998-99 - Whether in view of amended provisions of section 145 effective from
1-4-1997, an assessee is permitted to follow either cash system of accounting
or mercantile system of accounting - Held, yes
FACTS-I
The assessee had been in the
business of manufacturing of various drugs and formulations and sale thereof as
well as marketing of Nitro Glycerine based
formulations/products [Angispan TR] manufactured by a
company ‘S’. It had a huge distribution network for marketing its own manufactured
product as well as products manufactured by other parties. In the course of
such business, it came to possess certain marketing information relating to
Nitro Glycerine based formulations. A foreign company
‘U’ was also engaged in the manufacture of Nitro Glycerine
based formulations, who intended to market its products in
On second appeal :
HELD-I
There is no hard and
fast rule to determine the character of the receipt. It would depend on the
facts of each case. The nomenclature given to the transaction by the parties is
also not relevant. The true nature of the transaction has to be ascertained
from covenants of the contract. A receipt can be said to be capital receipt
when it is relatable to the transfer of capital asset other than the
stock-in-trade. The capital asset may be a tangible one or an intangible one.
In the case of a tangible asset, the asset must be physically transferred from
one person to other person. Dispossession of the asset by the transferor is the
condition precedent. Such transfer may be once for all by way of sale or may be
for an enduring period. What would be the enduring period would depend on the
facts of each case. On the other hand, in the case of an intangible asset, the
possession may continue to remain with the transferor such as know-how,
expertise, invention, formulation, etc. The question arises as to when such an
asset can be said to be transferred so as to treat the consideration relating
to such an asset as capital receipt. Unless the transferor is restrained from
using such an intangible asset as well as a transferring it to other parties,
the consideration received cannot be treated as a capital receipt. Therefore,
there must be parting of asset for a price in the sense that the transferor
cannot make any gain out of the same transfer either for ever or for an
enduring period. [
In the instant case,
the assessee had simply parted with the information regarding its marketing
structure such as list of wholesellers, stockists and dealers of formulations; State-wise sales
figures of such formulations for the last 5 years; list of specialists, doctors,
cardiologists and institutions who recommend such formulations, promotional
materials and clinical data. Even after imparting such information to other
parties, it always remained with the assessee-company. The marketing structure
of the assessee remained intact. The only obligation of the assessee was that
it would not disclose such information to other parties for a period of three
years. Further, the assessee was not restrained from using this information for
marketing its own manufactured goods or goods manufactured by other companies.
Further, the assessee could provide such information to other parties after
three years. Therefore, the assessee had simply allowed the aforesaid
information to be used by ‘U’ for a period of three years. There was no parting
of the information either for ever or for an enduring period. Thus, neither the
assessee had parted with the information, nor its marketing structure had been
impaired. [
Therefore, the
imparting of information relating to marketing of Nitro Glycerine
formulation for a period of three years did not amount to transfer of the
capital asset and, on the contrary, it was a case where the assessee allowed
the company ‘U’ to use the information for a period of three years without
affecting its trading/marketing structure. Hence, the payment allocable to such
business of imparting information amounted to revenue receipt chargeable to
tax. [
Further, the assessee
was right in contending that payment relatable to non-compete covenant amounted
to capital receipt in view of Supreme Court decision in Gillanders Arbuthrot & Co.
Ltd. v. CIT [1963] 53 ITR 283 as well as various other decisions of
the Tribunal. There was no dispute that the assessee was marketing ‘Angispan TR’, a Nitro Glycerine
formulation for various years. ‘U’ wanted to enter into the market in respect
of its own formulation and, therefore, intended to avoid the competition.
Hence, there was a loss of source of income for a period of five years. Thus,
the receipt relatable to non-compete covenant was a capital receipt not
chargeable to tax. [
Since the payment
received was composite one and part of the same had been found to be revenue
receipt, the receipt had to be bifurcated and apportioned. In absence of any
material on the aspect of valuation, the matter was to be remitted to the file
of the Assessing Officer for adjudication of the issue of valuation of non-compete fee and then tax the amount relatable to the
imparting of the information relating to marketing of Nitro Glycerine
formulation. [
FACTS-II
The assessee was
consistently declaring income on account of interest on overdue sundry debtors
in the past after following mercantile system of accounting. In the relevant
previous year, it showed the interest income on accrual basis upto June, 1997 and, thereafter, on cash receipt basis. The
assessee, therefore, in the statement of accounts had shown a sum of Rs. 47,86,703 as interest income
on accrual basis and for the remaining period, such income was shown on receipt
basis. Thus, there was a loss of Rs. 1,70,22,528 on account of not showing interest income on
accrual basis in respect of three parties. The assessee in this regard
submitted before the Assessing Officer that the debtors had disputed the debit
notes which had remained unsettled and, therefore, as a prudent accounting
system, the income accrual was being switched over from mercantile system to
receipt basis. The Assessing Officer was not satisfied with the Explanation
of the assessee and, accordingly, made an addition of Rs.
1,70,22,528 to its income. On appeal, the Commissioner
(Appeals) took note of the amendment made to section 145 with effect from
1-4-1997 and applying the amended provisions held that the assessee could not
follow the different methods, i.e., mercantile system in respect of
interest paid and cash system in respect of interest received. He, therefore,
held that the interest income was chargeable to tax on accrual basis. He,
therefore, confirmed the action of the Assessing Officer.
On second appeal :
Held-II
Prior to the assessment
year 1997-98, the hybrid system of accounting was held to be permissible by the
Bombay High Court in CIT
v. Citibank N.A. [1994] 208 ITR 930/75 Taxman 433. In view of that judgment,
the assessee could follow mercantile system of accounting in respect of
interest liability and cash system of accounting in respect of interest income.
The Legislature perhaps found difficulty in accepting such system of
accounting, as it would depict the distorted picture of income of the assessee.
Accordingly, the Legislature made amendment by substituting the old provisions
of section 145. A bare reading of the amended provisions of section 145
effective from 1-4-1997 makes it clear that from the assessment year 1997-98,
an assessee is permitted to follow either the cash system of accounting or
mercantile system of accounting. No third method is permissible as per amended
provisions. Such amended provisions nullify the effect of the judgment of the
Editor’s
note
(1) Where
the assessee-company had given insterest free deposit
of Rs. 75 lakhs to its
Managing Director out of borrowed funds and claimed deduction of interest paid
on such borrowings submitting that assessee-company was to provide housing
accommodation to its Managing Director as per an agreement but as the Managing
Director had his own personal accommodation, the same was taken on rent by the
assessee-company and, in turn, was provided to the Managing Director as his
accommodation; as per the agreement on arranging of any other accommodation for
the Managing Director it was necessary for the assessee to keep the security deposit
with the landlord and, therefore, going by the market practice and considering
the locality, interest-free deposit was given to the Managing Director; and,
thus the said deposit was given wholly and exclusively for the purpose of
business, in view of Tribunal’s decision in assessee’s
case for the assessment years 1997-98 and 1999-2000, the entire interest paid
by the assessee on the aforesaid deposit was allowable as a deduction under
section 36(1)(iii).
(2) Where
the assessee had acquired a property for setting-up an administrative and
distribution office out of the borrowed funds and had capitalized the interest
paid on the borrowed funds and, further, while computing the income also
claimed deduction of the interest paid, the interest paid in question was
allowable as a deduction under section 36(1)(iii).
(3) Where
the Assessing Officer on ad hoc basis had disallowed expen-ses
of Rs. 2 lakhs out of
miscellaneous expenses of Rs. 5,35,969,
since no defect had been pointed out by the Assessing Officer in the account
books of the assessee and, on the contrary, the account books were duly
audited, the disallowance of expenses of Rs. 2 lakhs was not justified.
Case
review
Jayaprakash Mady v. ITO [2001] 79 ITD 1 (Bang.), Dy. CIT v. Chander
Mohan [2000] 242 ITR (AT) 1 (Chd.) (TM), Balkrishna V Doshi
v. ITO [1986] 15 ITD 262 (Ahd.); distinguished
a facts; Gillanders Arbuthnot
&
Cases
referred to
CIT v. B.C. Srinivasa
Setty [1981] 128 ITR 294/5 Taxman 1 (SC) (para 4), Gillanders Arbuthnot & Co. Ltd. v. CIT [1964] 53 ITR
283 (SC) (para 4), CIT v. Best & Co.
(P.) Ltd. [1966] 60 ITR 11 (SC) (para
4), CIT v. Saraswati Publicities
[1981] 132 ITR 207 (
Jayesh Dadia for the Appellant. Anil Mehta for
the Respondent.
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