THE issues before the Bench are - Whether when a part of the steep hike in lease rental is attributable to modernisation of plant ana machinery, even then such expenditure is revenue in nature; Whether the enhancement in lease rent, if any, which is attributable to normal appreciation, if any, in line with the lease rentals prevailing in the market constitutes revenue expenditure; Whether the enhancement in lease rent, which is attributable to the other party agreeing not to indulge in competition with the assessee within a radius less than 1000 kms from the said property, constitutes capital expenditure; Whether when the Directors of the assessee company are also trustees who steeply enhanced lease rental for the premises with plant and
machinery, such transactions between the related parties warrant invocation of provisions of Sec 40A(2) and Whether the Trust can be construed as an ''association of persons''. And the verdict partly goes in favour of the Revenue.
machinery, such transactions between the related parties warrant invocation of provisions of Sec 40A(2) and Whether the Trust can be construed as an ''association of persons''. And the verdict partly goes in favour of the Revenue.
Facts of the case
The assessee is engaged in the business of Katha and Cutch and had taken on lease a factory belonging to Mehta Charitable Prajnalay Trust, which also was engaged in the business of manufacturing of the same products. Shri Bishan Dass and Shri Raj Kumar, two of the trustees of the Trust were also the directors and shareholders of the Assessee Company. Three out of five directors of the assessee company were the sons of two trustees. Bulk of the shares of the assessee Company was held by the trustees of the Trust and their family members. Initially, the lease rent was fixed at Rs 25,000/- p.m., which was later increased first to be Rs 50,000/- p.m. and then to Rs 1,00,000/- p.m. As on 31.12.1991, the assessee was paying lease rental of Rs 1,00,000/- p.m. to the Trust, in respect of the factory taken on lease. The assessee entered into a fresh lease deed on 18.01.1992, whereby the lease rent was enhanced to Rs 6,75,000/- per month with effect from 01.01.1992.
The assessee, in its return of income for the assessment years 1992-93, claimed deductions for the lease rental which it had paid to the Trust. The AO was of the view that the assessee Company had acquired an asset of an enduring nature and accordingly disallowed the increased amount of rent on the ground that this payment was in the nature of capital expenses. In this regard, the AO invoked the provisions of Section 40A(2) of the Act. The CIT(A) confirmed the assessment order. He was also of the view that the unusual increase in the rent was primarily for the purpose of reducing the tax incidence on the profits earned by the assessee Company and not for a business consideration and therefore was not allowable. The Tribunal upheld the order of CIT (Appeals) and held that the enhanced lease rent amounting to Rs.17,25,000/- for the period from January to March, 1992 was a capital expenditure and therefore not allowable as a deductible expenditure.
For the Assessment Years 1994-95, 1995-96 and 1996-97, the disallowance made in the year 1992-93 was maintained by the AO in the AY 1993-94 onwards. The Tribunal, while deciding the appeals of the Revenue for the Assessment Years 1994-95 and 1995-96 and the appeal of the assessee for the Assessment Year 1996-97 vide order dated 25.2.2002, held that since the assessee did not have any enduring benefit by obtaining capital assets of the lessor against payment of monthly lease rent, the expenditure incurred by it was a revenue expenditure. The Tribunal however held that the provisions of Section 40A(2) of the Act had rightly been invoked, as there was a direct relationship between the trustees and directors of the assessee company. It was noted by the tribunal that the maximum share holding in the assessee company was owned by the trustees and their relatives as defined in Section 2(41) of the Act. The Tribunal however accepted the contention of the assessee that since the AO had not recorded a specific finding that the expenditure incurred by it was excessive or unreasonable having regard to (i) the market value of goods or services, (ii) the legitimate business needs, and (iii) benefits derived by the assessee thereforom, invocation of provisions of Section 40A(2) was not proper. The Tribunal held that the reasonableness of payment of lease rent should be examined afresh by the AO, in the light of the valuation report which the assessee had submitted before it and other evidence available on record. Similarly the disallowances were deleted by the Tribunal in the AYs 1993-94, 1997-98, 1998-99, 1999-2000 and held that the payment of lease rent to the trust was a revenue expenditure and that the provisions of Section 40A(2) of the Act were applicable. The Tribunal therefore directed that the matter should be restored to the AO for fresh consideration.
Entire disallowance was deleted by the Tribunal in respect of the Assessment Years 2000-01, 2001-02, 2002-03, 2003-04, 2004-05, 2005-06 and 2007-08 by following its earlier decisions.
On appeal by the Revenue, the High Court held that,
++ it would thus be seen that the lease rental was enhanced from Rs 1,00,000/- to Rs 6,75,000/- for the following reasons:-
(a) The Trust relinquishing its rights to purchase Khairwood in Himachal Pradesh;
(b) The Trust agreeing not to indulge in competition with the assessee in a radius of less than 1000 kms.
(c) The Trust having incurred expenditure in the year 1989-90 on modernization and improvement of the plant and machinery which it had leased to the assessee.
++ Yet another factor contributing to revision of lease money could be the normal appreciation in the lease rental, in line with the lease rent prevailing in the market;
++ there is no dispute that the normal lease rental in this case would be a revenue expenditure and not a capital expenditure, as the ownership of the property as well as the plant and machinery continued to vest in the trust and in any case the lease granted to the assessee company was neither a perpetual lease nor a lease for such a long term as would bring it at par with a perpetual lease;
++ there can be no dispute that enhancement of lease rental from Rs.1 lac p.m. to Rs.6,70,000/- p.m., to the extent it is attributable to the expenditure incurred by the trust in the year 1989-90 on modernization and improvement of the plant and machinery which the lessee had taken on lease, would be a revenue expenditure, since it would have the effect of enhancing the lease rent of the plant and machinery in the open market. How much of the enhancement in the lease rent is attributable to the moderation and improvement in the plant and machinery is a matter which the AO has to decide after giving an opportunity to the assessee, to lead evidence in this regard. In particular, the AO will have to ascertain what lease rent the modernized and improved plant and machinery would have fetched in the market, as on 1.1.1992, when the revised lease commenced and the rent which such plant and machinery would have fetched in the open market prior to its modernization and improvement in the year 1989-90;
++ even the expenditure on improvement and modernization of plant and machinery was carried out by the Trust and not by the assessee. On determination of lease, the modernized plant and machinery was to revert back to the Trust. Hence, the case of the assessee stands on a much stronger footing;
++ similarly, if there was any appreciation in the market in the lease rentals of such properties, the enhancement in the lease rent of the property to the extent it is attributable to such normal appreciation in the lease rentals prevailing in the market, would be revenue expenditure. Again, it would be for the AO to determine whether there was any such appreciation in lease rentals, and if so, to what extent;
++ one of the tests to determine whether the expenditure in question is revenue expenditure or a capital expenditure is to ascertain whether it had the effect of bringing in an advantage of an enduring benefit to the assessee. An enduring benefit does not mean permanent benefit but, at the same time, it certainly cannot be a short-term advantage and needs to last for a substantially long period, before it can qualify to be an advantage of an enduring nature. Moreover, even if an advantage brings about an enduring benefit that by itself would not be determinative in every case, because in certain cases even a revenue expenditure may bring about an advantage of an enduring nature to the assessee. What is important to see is as to whether the advantage which occurred to the assessee, was in the capital field or in the field of revenue. The whole matter has to be examined from the point of view of a prudent businessman, applying a commercial sense and taking business necessity and expediency into consideration. If the expenditure incurred by the assessee is so intrinsically connected to the conduct of his business as to become an essential component of his profit making process and is not incurred for acquisition of an asset or right of a permanent nature, the expenditure should ordinarily be regarded as revenue expenditure;
++ Right to purchase Khairwood – In the instant case, the Trust relinquished its rights to purchase khairwood in Himachal Pradesh by way of commercial dealing, as a consideration for enhancement of the lease rent by the assessee. The assessee company is engaged in manufacturing of Katha which is a necessary ingredient in pan and pan masalas. Katha is derived from the Khair tree, the central portion of which is used for this purpose. The central portion of the Khair tree is thus a raw material for the assessee company. It appears from the lease deed dated 18.01.1992 that not everyone can purchase Khair wood in Himachal Pradesh from the Government. It also appears that the Trust possessed rights to purchase Khair wood in the State and it were those rights which were relinquished in favour of the assessee, at the time of enhancement of the lease rent. This is not the case of the revenue that the Trust held ownership or even leasehold rights in the land on which Khair wood trees stood in the State of Himachal Pradesh and those leasehold rights were surrendered in favour of the assessee. This is also not the case of the revenue that certain specified trees or specified area having Khair trees on it had been allocated to the Trust and it had the right to cut and remove them at any time during a stated period of say 10, 20 or 30 years. Therefore, it is assumed that the Trust was not entitled either to any particular piece of land with Khair trees on it or to specified Khair trees with right in the further growth of those trees, for a substantially long period. Therefore, this case is not akin to a case of acquiring land with standing trees or the trees with right to cut them at any point of time, during a stated period. What we gathered during the course of arguments was that in the absence of right to purchase Khairwood from the Government, the assessee would have to purchase them from the open market and, therefore, relinquishment of the right of the Trust to purchase Khair tree resulted in better availability of material besides making it available to the assessee at a cheaper price, which, in turn, had the effect of increasing its profit. Therefore, it cannot be said that by obtaining relinquishment of the right to purchase Khair wood, the assessee had acquired the source of raw material itself. It only got a right to participate in the process of purchase of Khair wood from the Government in the State of Himachal Pradesh, which facilitated acquisition of raw material by it;
++ the right to purchase khair wood from the Government in the State of Himachal Pradesh is not superior to acquiring a quota which enables a person to obtain the raw material. If purchase of quota right of another person does not constitute capital expenditure, it is difficult to say that relinquishment of right to purchase khair wood in the State of Himachal Pradesh by the Trust, in favour of the assessee, would constitute capital expenditure;
++ the Turst did not have any right either in the land on which khair wood trees had grown nor did it have any right in specified khair wood trees. The limited right which the assessee acquired under the lease was the right to purchase khair wood trees from the Government in the State of Himachal Pradesh. The central portion of the khair wood being the raw material for manufacture of katha, the assessee company would have got a right only to purchase the raw material and not the source of raw material. Therefore, that part of the lease rent, which is attributable to the right to purchase Khair wood, in Himachal Pradesh would be a revenue expenditure and not a capital expenditure;
++ Elimination of Competition – As regards that part of the enhancement of the lease rental which is attributable to the trust agreeing not to compete with the assessee in manufacture and sale of katha and Cutch in a radius of less than 1000 kms from the premises which it had leased to the assessee, it is found upon a perusal of the lease deed that the trust was earning sufficient profits from these activities. It further shows that both the trust as well as the assessee felt that such direct competition was prejudicial to the interest of both the parties and therefore ought to be avoided. Admittedly, it is the trustees of the Trust and their family members who owned and controlled the assessee company. Shri Bishan Dass and Shri Raj Kumar, who were the directors and shareholders of the assessee company, were also the trustees of the Trust. Three out of five directors of the assessee company were the sons of the trustees. Bulk of the shares of the assessee Company were admittedly held by the trustees and their family members. Considering the fact that the Trust as well as the assessee Company were being controlled by the same set of persons and/or their family members, it can hardly be disputed that the assessee Company could have continued with the lease, so long as it was in the financial interest of the Company to continue with the arrangement it had with the Trust;
++ considering the close connection between the assessee and the trust, resulting in common control of both the entities, it is difficult to dispute that the benefits, which accrue to the assessee company on account of elimination of competition by the trust were certainly of an enduring nature. This also becomes evident from the fact that the lease deed between the trust and the assessee which came into force from 1.6.1978 continued for more than 22 years till it was finally determined vide letter dated 29.9.2000. Even the lease deed dated 18.1.1992 whereby the lease rent was enhanced from Rs.1 lac to Rs.6,70,000/- p.m. continued for more than 8 years which clearly indicates that despite termination clause contained in the lease deed, the parties to the deed contemplated a long term relationship, which, at the option of the Directors of the assessee company, who were also the trustees of the trust, could have continued for an indefinite period. Therefore, it is difficult to dispute that elimination of competition from Mehta Charitable Trust brought benefits of an enduring nature to the assessee company;
++ elimination of competition from the Trust brought benefit of an enduring nature to the assessee-company, in the field of capital and, therefore, increase in lease rent, to the extent it is attributable to this benefit, would be a capital expenditure;
++ the assessee contended that since elimination of competition from the Trust did not happen simultaneous with acquisition of Katha and Cutch business of the Trust, enhancement of lease rent, even to the extent it is attributable to elimination of competition from the Trust, would not constitute capital expenditure. In our view, this is not an absolute proposition of law that in order to constitute capital expenditure, the payment/compensation for elimination of competition should be coupled with acquisition of business of the rival and both the things should happen at the same time. In a given case, either the payment to eliminate competition may be post acquisition of business of the rival or elimination of competition may not be accompanied by acquisition of business of the rival. It is very much possible for a rival to agree not to compete in a given area, while continuing with the same business in other areas. In such a case, there would be no takeover of the business of the rival. In any case, as would be seen from the lease deeds executed between the assessee and Mehta Charitable Trust, that the Trust had leased whole of its production unit ‘Mahesh Udoyog’, which was a profit generating unit to the assessee and not only the building, but the plant and machinery was also leased to the assessee along with all benefits, etc. The lease continued for more than 22 years. A perusal of the schedule of fixed assets of ‘Mahesh Udoyog’, managed by the assessee, Shankar Trading Company, would show that the fixed assets which were leased to the assessee-company and were managed by it, included machinery, shed, laboratory equipments, truck, furniture & fixtures, electricity fittings, fans, cooler, typewriter, refrigerator, water geyser, scooter, car, cooling tower, generator, boiler, transformers, water pollution equipment, Photostat machine, etc. Even the liability towards gratuity of the employees of the Trust was taken over. The Trust had also relinquished its rights to purchase khairwood from the Government in favour of the assessee. This is not the case of the assessee that even after lease deed dated 18.01.1992, the Trust continued with the business of manufacture and trading of Katha and Cutch in areas beyond 1000 kilometres from the leased premises. Therefore, the business being carried by ‘Mahesh Udyog’ was practically taken over by the assessee-company for an indefinite period. The lease deed also shows that the lessee had approached the Trust that it should stop commercial dealings in Katha and Cutch and in lieu thereof it had agreed to compensate the Trust for the loss that would be caused to it by stopping such commercial dealings. Therefore, this was a case of takeover of the business, coupled with elimination of competition from the rival. It is also evident from a perusal of the lease deed dated 18.01.1992 that the previous lease deed executed between the parties was repealed simultaneous with the execution of the new lease deed on 18.01.1992. Therefore, technically speaking in this case, acquisition of assets of the trust and elimination of competition from the Trust took place simultaneously. In fact, the whole transaction between Trust and assessee was a composite transaction, without apportionment of lease rent into various components of the transaction. Therefore, from whatever point of view, we may examine, there is no escape from the conclusion that increase in lease rent, to the extent it was relatable to elimination of competition from the Trust, constitutes capital expenditure;
++ Applicability of Section 40A(2) of Act – The objective behind Section 40-A of the Act is to address evasion of tax under the cloak or guise of permissible deductions by checking payments made or benefits granted made to closely connected persons and entities ostensibly for the goods sold or services rendered by them. Admittedly, Mehta Charitable Prajnalay Trust is a charitable trust and by itself the Trust does not hold any share of the assessee-company. The Trust is not entitled to any profit out of the business being run by the assessee-company. Hence, the Trust does not have a substantial interest in the business of the assessee-company;
++ clause (v) of Section 40A (2)(b) of the Act brings only such companies, firms, HUFs or association of persons within its purview, directors/partners/members of which have a substantial interest in the business or profession of the assessee. The interest of the relatives of a director/partner/member of such company /firm /HUF /association of persons cannot be taken into consideration to ascertain whether the director/partner/member have substantial interest in the business of the assessee or not. The explanation provides that a person shall be deemed to have a substantial interest in a business if in a case where the business is carried on by a company, he, at any time, during the previous year, was the beneficial owner of shares carrying not less than 20% of the voting power. The Tribunal has not given any finding with respect to exact shareholding of the trustees in the assessee-company during the relevant previous years, and we have no material before us to indicate the exact shareholding of the trustees in the assessee-company during the years to which these appeals pertain;
++ Since Clause (v) of Section 40A (2) of the Income Tax Act refers to a company, firm, association of persons or Hindu Undivided Family and the Trust is not a company, firm or HUF. The only question which comes up for consideration is as to whether it is an association of persons within the meaning of clause (v) of Section 40A(2)(b) of the Income Tax Act? The term “association of persons” has not been defined in Income Tax Act, though it is mentioned in Section 2(31) of the Act which defines the expression “person” to include “an association of persons”. In CIT v. Indira Balakrishna: 1960 (39) ITR 546, the Supreme Court, while considering what constitutes an “association of persons”, observed that by “association” means “to join any common purpose or to join an action”. Therefore, association of persons would mean an association in which two or more persons join with a common purpose or for a common action. Though in view of the explanation inserted by Finance Act, 2002 w.e.f. 1.4.2002 to Section 2(31) such association need not be formed with the object of deriving income profit or gains, it is difficult to say that either the trustees or beneficiaries of a trust come altogether and form an association for a common purpose or to take a common action;
++ the beneficiaries do not set up a trust and the trustees derive their authority under the terms of the deed of the trust. Therefore neither the trustees nor the beneficiaries could be said to have come together for a common purpose. The beneficiaries merely enjoy the benefit of the trust whereas the function of the trustees is to administer the trust in terms of the provisions of the trust deed. The mere fact that the beneficiaries or the trustees are more than one, cannot lead to a conclusion that they constituted an association of persons. In the absence of element of volition on the part of either the trustees or beneficiaries by no stretch of imagination it cannot be considered to be an “association of persons”. Therefore, since Mehta Charitable Trust is not “association of persons” within the meaning of Section 40(A)(2) of Income-tax Act, the aforesaid provision is not attracted to the transaction which is the subject-matter of these appeals.
The assessee is engaged in the business of Katha and Cutch and had taken on lease a factory belonging to Mehta Charitable Prajnalay Trust, which also was engaged in the business of manufacturing of the same products. Shri Bishan Dass and Shri Raj Kumar, two of the trustees of the Trust were also the directors and shareholders of the Assessee Company. Three out of five directors of the assessee company were the sons of two trustees. Bulk of the shares of the assessee Company was held by the trustees of the Trust and their family members. Initially, the lease rent was fixed at Rs 25,000/- p.m., which was later increased first to be Rs 50,000/- p.m. and then to Rs 1,00,000/- p.m. As on 31.12.1991, the assessee was paying lease rental of Rs 1,00,000/- p.m. to the Trust, in respect of the factory taken on lease. The assessee entered into a fresh lease deed on 18.01.1992, whereby the lease rent was enhanced to Rs 6,75,000/- per month with effect from 01.01.1992.
The assessee, in its return of income for the assessment years 1992-93, claimed deductions for the lease rental which it had paid to the Trust. The AO was of the view that the assessee Company had acquired an asset of an enduring nature and accordingly disallowed the increased amount of rent on the ground that this payment was in the nature of capital expenses. In this regard, the AO invoked the provisions of Section 40A(2) of the Act. The CIT(A) confirmed the assessment order. He was also of the view that the unusual increase in the rent was primarily for the purpose of reducing the tax incidence on the profits earned by the assessee Company and not for a business consideration and therefore was not allowable. The Tribunal upheld the order of CIT (Appeals) and held that the enhanced lease rent amounting to Rs.17,25,000/- for the period from January to March, 1992 was a capital expenditure and therefore not allowable as a deductible expenditure.
For the Assessment Years 1994-95, 1995-96 and 1996-97, the disallowance made in the year 1992-93 was maintained by the AO in the AY 1993-94 onwards. The Tribunal, while deciding the appeals of the Revenue for the Assessment Years 1994-95 and 1995-96 and the appeal of the assessee for the Assessment Year 1996-97 vide order dated 25.2.2002, held that since the assessee did not have any enduring benefit by obtaining capital assets of the lessor against payment of monthly lease rent, the expenditure incurred by it was a revenue expenditure. The Tribunal however held that the provisions of Section 40A(2) of the Act had rightly been invoked, as there was a direct relationship between the trustees and directors of the assessee company. It was noted by the tribunal that the maximum share holding in the assessee company was owned by the trustees and their relatives as defined in Section 2(41) of the Act. The Tribunal however accepted the contention of the assessee that since the AO had not recorded a specific finding that the expenditure incurred by it was excessive or unreasonable having regard to (i) the market value of goods or services, (ii) the legitimate business needs, and (iii) benefits derived by the assessee thereforom, invocation of provisions of Section 40A(2) was not proper. The Tribunal held that the reasonableness of payment of lease rent should be examined afresh by the AO, in the light of the valuation report which the assessee had submitted before it and other evidence available on record. Similarly the disallowances were deleted by the Tribunal in the AYs 1993-94, 1997-98, 1998-99, 1999-2000 and held that the payment of lease rent to the trust was a revenue expenditure and that the provisions of Section 40A(2) of the Act were applicable. The Tribunal therefore directed that the matter should be restored to the AO for fresh consideration.
Entire disallowance was deleted by the Tribunal in respect of the Assessment Years 2000-01, 2001-02, 2002-03, 2003-04, 2004-05, 2005-06 and 2007-08 by following its earlier decisions.
On appeal by the Revenue, the High Court held that,
++ it would thus be seen that the lease rental was enhanced from Rs 1,00,000/- to Rs 6,75,000/- for the following reasons:-
(a) The Trust relinquishing its rights to purchase Khairwood in Himachal Pradesh;
(b) The Trust agreeing not to indulge in competition with the assessee in a radius of less than 1000 kms.
(c) The Trust having incurred expenditure in the year 1989-90 on modernization and improvement of the plant and machinery which it had leased to the assessee.
++ Yet another factor contributing to revision of lease money could be the normal appreciation in the lease rental, in line with the lease rent prevailing in the market;
++ there is no dispute that the normal lease rental in this case would be a revenue expenditure and not a capital expenditure, as the ownership of the property as well as the plant and machinery continued to vest in the trust and in any case the lease granted to the assessee company was neither a perpetual lease nor a lease for such a long term as would bring it at par with a perpetual lease;
++ there can be no dispute that enhancement of lease rental from Rs.1 lac p.m. to Rs.6,70,000/- p.m., to the extent it is attributable to the expenditure incurred by the trust in the year 1989-90 on modernization and improvement of the plant and machinery which the lessee had taken on lease, would be a revenue expenditure, since it would have the effect of enhancing the lease rent of the plant and machinery in the open market. How much of the enhancement in the lease rent is attributable to the moderation and improvement in the plant and machinery is a matter which the AO has to decide after giving an opportunity to the assessee, to lead evidence in this regard. In particular, the AO will have to ascertain what lease rent the modernized and improved plant and machinery would have fetched in the market, as on 1.1.1992, when the revised lease commenced and the rent which such plant and machinery would have fetched in the open market prior to its modernization and improvement in the year 1989-90;
++ even the expenditure on improvement and modernization of plant and machinery was carried out by the Trust and not by the assessee. On determination of lease, the modernized plant and machinery was to revert back to the Trust. Hence, the case of the assessee stands on a much stronger footing;
++ similarly, if there was any appreciation in the market in the lease rentals of such properties, the enhancement in the lease rent of the property to the extent it is attributable to such normal appreciation in the lease rentals prevailing in the market, would be revenue expenditure. Again, it would be for the AO to determine whether there was any such appreciation in lease rentals, and if so, to what extent;
++ one of the tests to determine whether the expenditure in question is revenue expenditure or a capital expenditure is to ascertain whether it had the effect of bringing in an advantage of an enduring benefit to the assessee. An enduring benefit does not mean permanent benefit but, at the same time, it certainly cannot be a short-term advantage and needs to last for a substantially long period, before it can qualify to be an advantage of an enduring nature. Moreover, even if an advantage brings about an enduring benefit that by itself would not be determinative in every case, because in certain cases even a revenue expenditure may bring about an advantage of an enduring nature to the assessee. What is important to see is as to whether the advantage which occurred to the assessee, was in the capital field or in the field of revenue. The whole matter has to be examined from the point of view of a prudent businessman, applying a commercial sense and taking business necessity and expediency into consideration. If the expenditure incurred by the assessee is so intrinsically connected to the conduct of his business as to become an essential component of his profit making process and is not incurred for acquisition of an asset or right of a permanent nature, the expenditure should ordinarily be regarded as revenue expenditure;
++ Right to purchase Khairwood – In the instant case, the Trust relinquished its rights to purchase khairwood in Himachal Pradesh by way of commercial dealing, as a consideration for enhancement of the lease rent by the assessee. The assessee company is engaged in manufacturing of Katha which is a necessary ingredient in pan and pan masalas. Katha is derived from the Khair tree, the central portion of which is used for this purpose. The central portion of the Khair tree is thus a raw material for the assessee company. It appears from the lease deed dated 18.01.1992 that not everyone can purchase Khair wood in Himachal Pradesh from the Government. It also appears that the Trust possessed rights to purchase Khair wood in the State and it were those rights which were relinquished in favour of the assessee, at the time of enhancement of the lease rent. This is not the case of the revenue that the Trust held ownership or even leasehold rights in the land on which Khair wood trees stood in the State of Himachal Pradesh and those leasehold rights were surrendered in favour of the assessee. This is also not the case of the revenue that certain specified trees or specified area having Khair trees on it had been allocated to the Trust and it had the right to cut and remove them at any time during a stated period of say 10, 20 or 30 years. Therefore, it is assumed that the Trust was not entitled either to any particular piece of land with Khair trees on it or to specified Khair trees with right in the further growth of those trees, for a substantially long period. Therefore, this case is not akin to a case of acquiring land with standing trees or the trees with right to cut them at any point of time, during a stated period. What we gathered during the course of arguments was that in the absence of right to purchase Khairwood from the Government, the assessee would have to purchase them from the open market and, therefore, relinquishment of the right of the Trust to purchase Khair tree resulted in better availability of material besides making it available to the assessee at a cheaper price, which, in turn, had the effect of increasing its profit. Therefore, it cannot be said that by obtaining relinquishment of the right to purchase Khair wood, the assessee had acquired the source of raw material itself. It only got a right to participate in the process of purchase of Khair wood from the Government in the State of Himachal Pradesh, which facilitated acquisition of raw material by it;
++ the right to purchase khair wood from the Government in the State of Himachal Pradesh is not superior to acquiring a quota which enables a person to obtain the raw material. If purchase of quota right of another person does not constitute capital expenditure, it is difficult to say that relinquishment of right to purchase khair wood in the State of Himachal Pradesh by the Trust, in favour of the assessee, would constitute capital expenditure;
++ the Turst did not have any right either in the land on which khair wood trees had grown nor did it have any right in specified khair wood trees. The limited right which the assessee acquired under the lease was the right to purchase khair wood trees from the Government in the State of Himachal Pradesh. The central portion of the khair wood being the raw material for manufacture of katha, the assessee company would have got a right only to purchase the raw material and not the source of raw material. Therefore, that part of the lease rent, which is attributable to the right to purchase Khair wood, in Himachal Pradesh would be a revenue expenditure and not a capital expenditure;
++ Elimination of Competition – As regards that part of the enhancement of the lease rental which is attributable to the trust agreeing not to compete with the assessee in manufacture and sale of katha and Cutch in a radius of less than 1000 kms from the premises which it had leased to the assessee, it is found upon a perusal of the lease deed that the trust was earning sufficient profits from these activities. It further shows that both the trust as well as the assessee felt that such direct competition was prejudicial to the interest of both the parties and therefore ought to be avoided. Admittedly, it is the trustees of the Trust and their family members who owned and controlled the assessee company. Shri Bishan Dass and Shri Raj Kumar, who were the directors and shareholders of the assessee company, were also the trustees of the Trust. Three out of five directors of the assessee company were the sons of the trustees. Bulk of the shares of the assessee Company were admittedly held by the trustees and their family members. Considering the fact that the Trust as well as the assessee Company were being controlled by the same set of persons and/or their family members, it can hardly be disputed that the assessee Company could have continued with the lease, so long as it was in the financial interest of the Company to continue with the arrangement it had with the Trust;
++ considering the close connection between the assessee and the trust, resulting in common control of both the entities, it is difficult to dispute that the benefits, which accrue to the assessee company on account of elimination of competition by the trust were certainly of an enduring nature. This also becomes evident from the fact that the lease deed between the trust and the assessee which came into force from 1.6.1978 continued for more than 22 years till it was finally determined vide letter dated 29.9.2000. Even the lease deed dated 18.1.1992 whereby the lease rent was enhanced from Rs.1 lac to Rs.6,70,000/- p.m. continued for more than 8 years which clearly indicates that despite termination clause contained in the lease deed, the parties to the deed contemplated a long term relationship, which, at the option of the Directors of the assessee company, who were also the trustees of the trust, could have continued for an indefinite period. Therefore, it is difficult to dispute that elimination of competition from Mehta Charitable Trust brought benefits of an enduring nature to the assessee company;
++ elimination of competition from the Trust brought benefit of an enduring nature to the assessee-company, in the field of capital and, therefore, increase in lease rent, to the extent it is attributable to this benefit, would be a capital expenditure;
++ the assessee contended that since elimination of competition from the Trust did not happen simultaneous with acquisition of Katha and Cutch business of the Trust, enhancement of lease rent, even to the extent it is attributable to elimination of competition from the Trust, would not constitute capital expenditure. In our view, this is not an absolute proposition of law that in order to constitute capital expenditure, the payment/compensation for elimination of competition should be coupled with acquisition of business of the rival and both the things should happen at the same time. In a given case, either the payment to eliminate competition may be post acquisition of business of the rival or elimination of competition may not be accompanied by acquisition of business of the rival. It is very much possible for a rival to agree not to compete in a given area, while continuing with the same business in other areas. In such a case, there would be no takeover of the business of the rival. In any case, as would be seen from the lease deeds executed between the assessee and Mehta Charitable Trust, that the Trust had leased whole of its production unit ‘Mahesh Udoyog’, which was a profit generating unit to the assessee and not only the building, but the plant and machinery was also leased to the assessee along with all benefits, etc. The lease continued for more than 22 years. A perusal of the schedule of fixed assets of ‘Mahesh Udoyog’, managed by the assessee, Shankar Trading Company, would show that the fixed assets which were leased to the assessee-company and were managed by it, included machinery, shed, laboratory equipments, truck, furniture & fixtures, electricity fittings, fans, cooler, typewriter, refrigerator, water geyser, scooter, car, cooling tower, generator, boiler, transformers, water pollution equipment, Photostat machine, etc. Even the liability towards gratuity of the employees of the Trust was taken over. The Trust had also relinquished its rights to purchase khairwood from the Government in favour of the assessee. This is not the case of the assessee that even after lease deed dated 18.01.1992, the Trust continued with the business of manufacture and trading of Katha and Cutch in areas beyond 1000 kilometres from the leased premises. Therefore, the business being carried by ‘Mahesh Udyog’ was practically taken over by the assessee-company for an indefinite period. The lease deed also shows that the lessee had approached the Trust that it should stop commercial dealings in Katha and Cutch and in lieu thereof it had agreed to compensate the Trust for the loss that would be caused to it by stopping such commercial dealings. Therefore, this was a case of takeover of the business, coupled with elimination of competition from the rival. It is also evident from a perusal of the lease deed dated 18.01.1992 that the previous lease deed executed between the parties was repealed simultaneous with the execution of the new lease deed on 18.01.1992. Therefore, technically speaking in this case, acquisition of assets of the trust and elimination of competition from the Trust took place simultaneously. In fact, the whole transaction between Trust and assessee was a composite transaction, without apportionment of lease rent into various components of the transaction. Therefore, from whatever point of view, we may examine, there is no escape from the conclusion that increase in lease rent, to the extent it was relatable to elimination of competition from the Trust, constitutes capital expenditure;
++ Applicability of Section 40A(2) of Act – The objective behind Section 40-A of the Act is to address evasion of tax under the cloak or guise of permissible deductions by checking payments made or benefits granted made to closely connected persons and entities ostensibly for the goods sold or services rendered by them. Admittedly, Mehta Charitable Prajnalay Trust is a charitable trust and by itself the Trust does not hold any share of the assessee-company. The Trust is not entitled to any profit out of the business being run by the assessee-company. Hence, the Trust does not have a substantial interest in the business of the assessee-company;
++ clause (v) of Section 40A (2)(b) of the Act brings only such companies, firms, HUFs or association of persons within its purview, directors/partners/members of which have a substantial interest in the business or profession of the assessee. The interest of the relatives of a director/partner/member of such company /firm /HUF /association of persons cannot be taken into consideration to ascertain whether the director/partner/member have substantial interest in the business of the assessee or not. The explanation provides that a person shall be deemed to have a substantial interest in a business if in a case where the business is carried on by a company, he, at any time, during the previous year, was the beneficial owner of shares carrying not less than 20% of the voting power. The Tribunal has not given any finding with respect to exact shareholding of the trustees in the assessee-company during the relevant previous years, and we have no material before us to indicate the exact shareholding of the trustees in the assessee-company during the years to which these appeals pertain;
++ Since Clause (v) of Section 40A (2) of the Income Tax Act refers to a company, firm, association of persons or Hindu Undivided Family and the Trust is not a company, firm or HUF. The only question which comes up for consideration is as to whether it is an association of persons within the meaning of clause (v) of Section 40A(2)(b) of the Income Tax Act? The term “association of persons” has not been defined in Income Tax Act, though it is mentioned in Section 2(31) of the Act which defines the expression “person” to include “an association of persons”. In CIT v. Indira Balakrishna: 1960 (39) ITR 546, the Supreme Court, while considering what constitutes an “association of persons”, observed that by “association” means “to join any common purpose or to join an action”. Therefore, association of persons would mean an association in which two or more persons join with a common purpose or for a common action. Though in view of the explanation inserted by Finance Act, 2002 w.e.f. 1.4.2002 to Section 2(31) such association need not be formed with the object of deriving income profit or gains, it is difficult to say that either the trustees or beneficiaries of a trust come altogether and form an association for a common purpose or to take a common action;
++ the beneficiaries do not set up a trust and the trustees derive their authority under the terms of the deed of the trust. Therefore neither the trustees nor the beneficiaries could be said to have come together for a common purpose. The beneficiaries merely enjoy the benefit of the trust whereas the function of the trustees is to administer the trust in terms of the provisions of the trust deed. The mere fact that the beneficiaries or the trustees are more than one, cannot lead to a conclusion that they constituted an association of persons. In the absence of element of volition on the part of either the trustees or beneficiaries by no stretch of imagination it cannot be considered to be an “association of persons”. Therefore, since Mehta Charitable Trust is not “association of persons” within the meaning of Section 40(A)(2) of Income-tax Act, the aforesaid provision is not attracted to the transaction which is the subject-matter of these appeals.
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