PCIT Vs M/s. Chamundi Winery and Distillery (Karnataka High Court)
It is clear that the Courts and the Tax Authorities can look into the real purpose of the commercial arrangements and transactions to reach the truth and the transactions having the sole purpose of tax avoidance may be held to be having no effect on the actual tax liability of the tax payer.
Thus, we feel that there is no need of multiplying the authorities and some of which we have discussed above, we are fortified in our view that in the present case, the entire income from manufacture and sale of Liquor in the present case by CHAMUNDI was taxable in the hands of the Assessee CHAMUNDI and the application of income in the form of “distribution of surplus” from CHAMUNDI to DIAGEO was neither an “allowable expenditure” under Section 37 of the Act nor as a “trade loss” under Section 28/29 of the Act, and only after payment of income tax by CHAMUNDI on the entire profits earned from such business, such “distribution of surplus” could be made by CHAMUNDI to DIAGEO by way of application of income under the Agreement dated 30/10/2007.
We therefore, feel that upon the overall reading of the Agreement dated 30/10/2007 in para 17 defining DIAGEO INDIA’s entitlements before deducting entitlements of CHAMUNDI under Clause 16, the said Agreement in the correct perspective of applicability of Indian Tax laws on the income and profits of CHAMUNDI, ought to have provided for deduction of Income-tax payable on its profits and gains taxable in the hands of CHAMUNDI and thereafter from the net balance after deducting entitlements of CHAMUNDI under Clause 16, the balance surplus could only be taken as entitlement of DIAGEO INDIA Pvt.Ltd.
We further hold clearly and firmly that Book entries and Method of Accounting is not determinative and conclusive for deciding the computation of ‘taxable income’ in the hands of the Assessee though they may be relevant to be considered.
This is where we feel the tax avoidance effort has been made by the parties and we cannot uphold the same in the overall analysis of the facts and legal position applicable to the facts of the present case.
What we further feel is that the “diversion of income by transfer of overriding title at source” should normally have the support of the statutory requirements or some decretal binding character of Courts of law and even though the private contractual obligations can also bring about such “diversion of income at source” but in this last sphere of private contractual obligations, the Courts and the Income Tax Authorities have to examine such aspects carefully in comparison to the above two other categories of statutory requirements and the Court decrees and then examine the real purport and object of such private arrangements and Contracts.
Besides the issues of the legality of the Agreement, the real intention of the parties should be ascertained as to see whether such arrangements and contracts have been entered into to deflect and divert the applicability of Income-Tax laws on the Assessee who has really earned the “real income”, profits and gains under such Contract or whether such diversion is only an arrangement to suit the purposes of tax avoidance in such cases.
Therefore, we reiterate that it will depend upon the facts and circumstances of each and individual case whether in those circumstances, it would amount to a “diversion of income by overriding title at source” or an arrangement to serve the purposes of tax avoidance, as is the case before us.
With these observations and analysis, we are of the considered opinion that these Appeals filed by the Revenue deserve to be allowed and the substantial questions of law framed above deserve to be answered in favour of the Revenue and against the Assessee. We therefore proceed to answer the aforesaid questions in the following manner:-
[1] The substantial question No.1 is answered in favour of the Revenue and against the Assessee and we hold that the “distribution of surplus” by the Assessee CHAMUNDI WINERY AND DISTILLERY to DIAGEO INDIA PRIVATE LIMITED in pursuance of the Agreement dated 30/10/2007 was an “application of income” by the Assessee CHAMUNDI and the same was not an ‘allowable expenditure’ under Section 37 of the Income Tax Act of 1961.
[2] The substantial question No.2 is also answered in favour of the Revenue and against the Assessee and we hold that the terms and conditions of the Agreement dated 30/10/2007 between CHAMUNDI WINERY AND DISTILLERY and DIAGEO INDIA PRIVATE LIMITED did not amount to “diversion of income at source by overriding title” in favour of DIAGEO INDIA PRIVATE LIMITED because, the entire business under Excise licence in favour of the Respondent Assessee CHAMUNDI was in fact carried on by CHAMUNDI only and the profits and gains arising out of such business were liable to tax in the hands of the Assessee CHAMUNDI WINERY AND DISTILLERY.
[3] The substantial question No.3 is also answered in the following manner that the manner of accounting entries and the Method of Accounting in the Books of Accounts maintained by the Assessee CHAMUNDI WINERY AND DISTILLERY as well as DIAGEO INDIA PRIVATE LIMITED will not alter and determine the taxability and character of “real income” arising and accruing in the hands of the Assessee CHAMUNDI WINERY AND DISTILLERY in the present case and irrespective of any change of Method of Accounting, in all the Assessment Years in the present Appeals, the income from business of manufacture and sale of Liquor will be taxable in the hands of the Assessee CHAMUNDI WINERY AND DISTILLERY.
FULL TEXT OF THE HIGH COURT JUDGMENT / ORDER IS AS FOLLOWS:
1. The Revenue has filed these five Appeals under Section 260-A of the Income Tax Act, 1961 (‘Act’ for short) against the Respondent Assessee M/s. CHAMUNDI WINERY AND DISTILLERY, BANGALORE (hereinafter referred to as “CHAMUNDI” for short) for A.Y.2008-09 to 2012-13 raising the Substantial Questions of law, which we have re-framed.
2. The Tribunal as well as the first Appellate Authority, Commissioner of Income Tax (Appeals) decided in favour of the Respondent Assessee that the “Distributable Surplus” paid by the Respondent Assessee CHAMUNDI to DIAGEO INDIA PRIVATE LIMITED (hereinafter referred to as ‘DIAGEO’ for short), a subsidiary and Group Company of DIAGEO Plc, a United Kingdom based Liquor Conglomerate, was an allowable expenditure’ in the hands of the Respondent Assessee under Section 37 of the Act.
3. The following Substantial Questions of law do arise in the present set of appeals which we have reframed as below:-
[1] Whether the Tribunal was justified in holding that the Distributable Surplus paid by the Respondent Assessee M/s. CHAMUNDI WINERY AND DISTILLERY to DIAGEO INDIA PRIVATE LIMITED in pursuance of the Agreement dated 30/10/2007 between these two parties was not ‘application of income’, but an ‘allowable expenditure’ in the hands of the Respondent Assessee under Section 37 of the Act ?
[ii] Whether the terms and conditions of the Agreement dated 30/10/2007 between M/S. CHAMUNDI WINERY AND DISTILLERY and DIAGEO INDIA PRIVATE LIMITED amount to ‘Diversion of Income at source by over riding title’ in favour of DIAGEO INDIA PRIVATE LIMITED even though the Excise Licence under the provisions of the Karnataka Excise Act, 1965 during the relevant period was taken in the name of Respondent Assessee CHAMUNDI and therefore, such profits and gains from the said business of manufacture and sale of liquor by M/S. CHAMUNDI WINERY AND DISTILLERY was not assessable in its hands ?
[iii] Whether the method of Accounting or entries made in the Books of Accounts by the Respondent Assessee or maintaining the Bank Accounts under the close control and supervision of DIAGEO INDIA PRIVATE LIMITED will determine the taxability of business income in the hands of DIAGEO INDIA PRIVATE LIMITED who under the said Agreement dated 30/10/2007 supplied the Working Capital, Raw Materials and concentrates and right of user of Trade Marks and Brands to the Respondent Assessee on whether the income earned out of the said liquor business will still be taxable in the hands of the Respondent Assessee CHAMUNDI ?
4. The brief factual matrix of the case is as under:-
5. The Assessing Authority in the first instance in all these five Assessment Years, A.Y.2008-09 to 2012-13. disallowed the said “Distributable Surplus” paid by the Respondent Assessee CHAMUNDI to DIAGEO under Section 37 of the Act and also held that the said income earned out of manufacture and sale of liquor by the Respondent Assessee which held the Excise Licence from the State Government, which has the monopoly and exclusive privilege of carrying on the trade of liquor and gives only licences under the provisions of the Karnataka Excise Act to certain persons upon the terms and conditions stipulated in the Licence under the said Act and there is no ‘diversion of such income’ from the Respondent Assessee CHAMUNDI to DIAGEO by overriding title and the Respondent Assessee CHAMUNDI has to meet its Income-Tax obligations under the Act before applying the net income after tax in meeting its contractual obligations under the Agreement dated 30/10/2007 with DIAGEO.
6. The first Appellate Authority however, allowed the Appeal of the Assessee CHAMUNDI and the Revenue’s second Appeal before the Income Tax Appellate Tribunal also failed and hence, the Revenue has preferred these Appeals before this Court under Section 260-A of the Act, raising the substantial questions of Law.
7. The crux of the matter revolves round the Terms of the Conditions of the Agreement dated 30/10/2007 and therefore, a brief extraction of the relevant terms and conditions and its background are necessary to understand as the said Agreement has held the field throughout the aforesaid five Assessment Years. The DIAGEO is a Subsidiary and Group Company of DIAGEO Plc., a UK based Corporate entity and it owns several Trade Marks and Brands specified in the Schedule III of the said Agreement and the popular amongst them are SMIRNOFF (Vodka), VAT 69 (Scotch Whisky), CAPTAIN MORGAN (Rum), SMIRNOFF ORANGE TWIST (Vodka), SHARK TOOTH(Vodka) and HAIG GOLD LABEL (Scotch Whisky) and the Preamble of the said Agreement dated 30/10/2007 is quoted below:-
“WHEREAS:
A. DIAGEO INDIA is engaged inter alia in the manufacture and marketing of alcoholic beverages and is a subsidiary of Diageo Plc.
B. DIAGEO INDIA has valid and subsisting licence agreements with the respective Brand Owners of the Products listed in Schedule III to use the trade marks and reproduce the copyright works in India on the labels, caps of bottles, Packaging Materials and other support materials in respect of the Products to be manufactured and or bottled in India.
C. CHAMUNDI is engaged in the manufacture, bottling and labeling of alcoholic beverages and had expressed its desire of carrying out manufacturing of the Products at its Plant at 56, Chollapanahalli Village, B C Road, Hoskote Taluka, Bangalore Rural District.
D. CHAMUNDI has represented to DIAGEO INDIA that it has a fully operational Plant and has all requisite consents and facilities to manufacture the Products at the Plant.
E. CHAMUNDI has agreed to manufacture and sell the Products under control and supervision of DIAGEO INDIA for the period and subject to the terms and conditions hereinafter recorded.
F. The Parties acknowledge and confirm that each Party will undertake its responsibilities as clearly defined herein. Therefore, nothing in this arrangement shall be construed as either Party has representative rights for the other Party or one Party acts as an agent of the other Party or one Party grants any licence or right, for whatsoever, in favour of the other Party. Further, there should not be any claim or obligation of one Party on the other Party with respect to anything herein mentioned except for the specific claims provided hereunder.
G. The parties acknowledge that they will be independently responsible for their profits and losses, if any under this Agreement. CHAMUNDI is entitled to receive certain amount subject to fulfilling its obligations under this Agreement while DIAGEO INDIA would mainly undertake major risks and rewards under this Agreement. However, there is no intention to carry on any business in common or to earn income jointly. CHAMUNDI would carry out its obligations under the direction and supervision of DIAGEO INDIA as specified in this Agreement.
H. Each Party hereby acknowledges that it would continue to operate in its own capacity and the Agreement does not constitute a partnership or joint venture between the Parties.”
8. The said Agreement therefore, clearly rules out the Contract between the parties to be that of a Partnership, Agency or even a Quasi partnership because, the concept of mutuality is specifically negatived in the said Agreement.
9. The relevant Parties’ Obligations contained in para 3 of the said Agreement to the relevant extent are also quoted below for ready reference:-
“3. PARTIES’ OBLIGATIONS
3.1 CHAMUNDI shall primarily be responsible for providing manufacturing facility, raising purchase orders, supplying and delivering the Products as per Delivery Orders, completing excise formalities in relation to import of Raw Materials and despatches of the Products, obtaining necessary approval from the requisites authorities, raising necessary invoice in respect of sales effected, making Sales Tax/VAT payments, making payments of all other expenses relating to the manufacturing of the Products, as per the directions of DIAGEO INDIA.
3.2 DIAGEO INDIA shall procure orders for the Products from the distributors. DIAGEO INDIA shall submit to CHAMUNDI a Delivery Order for delivery of the Products by CHAMUNDI directly to the distributor as mentioned on Delivery Order. CHAMUNDI shall package the Products using the Packaging Materials purchased in accordance with DIAGEO INDIA’s instructions/specifications and regulations of the appropriate Governmental Authority. DIAGEO INDIA would take all the commercial decisions with regard to selling price of the Products and communicate to CHAMUNDI. CHAMUNDI shall supply and deliver the Products on the Date of Delivery by loading the Products on to the transport vehicles at the Plant and raise its invoice, at the selling price communicated by DIAGEO INDIA, on the distributors for the Products so delivered. It is expressly clarified and reiterated that CHAMUNDI is dispatching the Products at the direction of DIAGEO INDIA and CHAMUNDI undertakes not to dispatch the Products without written authorisation from DIAGEO INDIA.”
10. The responsibilities of DIAGEO to provide the Working Capital, Raw Materials and to take important commercial decisions about the quality, quantity, price, delivery schedule, etc. as given in para 7.1 with no right to CHAMUNDI WINERY AND DISTILLERY to use the Intellectual Property of DIAGEO are also quoted below for ready reference:-
“7. DIAGEO INDIA RESPOSIBILITIES
7.1 DIAGEO INDIA shall be responsible for:
(i) Providing working capital as outlined in Clause 15 below;
(ii) Identifying the suppliers for Raw Materials, Packaging Materials and commercial decisions as to quality, quantity, price, delivery schedule, etc.;
(iii) Identifying appropriate insurance company, type of insurance, quantum of insurance coverage, etc. and obtaining insurance in the name of CHAMUNDI with DIAGEO INDIA’s beneficial interest;
(iv) Procurement of sales order from the distributors;
(v) Appointment of sales force and other administration staff;
(vi) Carrying out marketing and sales promotion activities.
8. NO RIGHT TO USE INTELLECTUAL PROPERTY
8.1 CHAMUNDI acknowledges that the members of the Diageo Group which are listed as the brand owners of the Products in Schedule III are at the date of this Agreement the sole proprietors of the trade marks, copyright works and other intellectual property rights relating to their respective Products, and DIAGEO INDIA, being a member of the Diageo Group, is the authorised licensee and user of such trade marks, copyright works and other intellectual property rights in India. CHAMUNDI agrees that nothing in this Agreement shall give it any right, title, claim or interest in or to the trade marks, copyright works or any other intellectual property rights relating to the Products and there is no transfer by DIAGEO INDIA of any right whatsoever.”
11. Para 9 of the Agreement enjoins upon CHAMUNDI WINERY AND DISTILLERY to obtain all Licences and Consents required under the Statutes at its own cost and expenses.
Clause 9 is also quoted below for ready reference:-
“9. LICENSES AND CONSENTS CHAMUNDI shall, at its own cost and expense be responsible for all Consents necessary for the Manufacturing, storage and delivery of the Products and shall also renew and keep valid all such Consents at its own cost from time to time. CHAMUNDI shall also be responsible for the timely and full payment of annual licence fees as may be levied or imposed from time to time, by the Governmental Authorities under the relevant Karnataka State Excise Rules for manufacture of liquor products. CHAMUNDI shall prompt proof of all payments made in respect of Consents, including any annual licence fees.”
12. Para 15 of the Agreement makes DIAGEO responsible for providing Working Capital Finances for Operations envisaged in the said Agreement and the Bank Accounts to be operated by the persons duly authorised by the DIAGEO. The most important Clauses 16 and 17 providing for Distribution of Revenues between the two parties to the said Agreement are also quoted below for ready reference:-
“15. WORKING CAPITAL FINANCES
15.1 DIAGEO INDIA shall be responsible for providing working capital finance for operations envisaged in this Agreement and CHAMUNDI shall open a separate bank account(s) in CHAMUNDI’s name for the purpose of this Agreement. The bank account(s) shall be operated jointly by any two DIAGEO INDIA representatives as may be intimated to CHAMUNDI in writing. The bank account(s) will be used for working capital requirements of CHAMUNDI. DIAGEO INDIA shall ensure that sufficient funds are available in this account especially at the time of issuing cheques.
The said bank account(s) shall be used for:
(a) the payment for all Raw Materials and Packaging Materials purchased for the purposes of this Agreement as set out in Clause 4.1;
(b) the payment of excise duties, sales taxes and excise adhesive labels in relation to Products sold by CHAMUNDI;
(c) transportation costs in relation to Products despatched by CHAMUNDI in accordance with Clause 3.6;
(d) insurances required to be maintained by DIAGEO INDIA pursuant to Clause 5.2; and
(e) such other costs as DIAGEO INDIA may require to be paid from such account(s).
All monies received from the distributors in respect of Products, delivered and invoiced by CHAMUNDI or Raw Materials and Packaging Materials sold pursuant to Clause 3.10 or scrap sold pursuant to Clause 14.2 shall be paid into the accounts. DIAGEO INDIA shall be entitled to have transferred out to itself any surplus balance from time to time into these account(s).
15.2 CHAMUNDI shall not create any Encumbrances on any Raw Materials or Packaging Materials purchased with the working capital financed by DIAGEO INDIA. CHAMUNDI shall provide DIAGEO INDIA an annual certificate from its bankers to this effect.
15.3 In this regard, CHAMUNDI represents warrants and undertakes that:
a) the said bank account(s) shall not be operated by any persons other than nominated by DIAGEO INDIA.
b) No resolution will be passed changing the approved authorised signatories without DIAGEO INDIA’s prior approval in writing.
15.4 In this regard DIAGEO INDIA and the persons nominated by DIAGEO INDIA for the operations of the bank accounts shall be responsible for the conduct of the bank accounts including the violations under the Negotiable Instrument Act, 1881, if any.
16. CHAMUNDI ENTITLEMENTS
16.1 CHAMUNDI shall be entitled for a sum of Rs.45 per Case produced as a consideration for its manufacturing obligations under this Agreement.
16.2 The sums as mentioned in Clause 16.1 shall remain in force for the period upto 31st May, 2010 unless otherwise mutually agreed by the Parties.
16.3 DIAGEO INDIA guarantees the minimum volume of 15,000 cases per month for the Products.
17. DIAGEO INDIA’S ENTITLEMENTS
17.1 DIAGEO INDIA entitlements under this Agreement shall be calculated on the following basis:
a) Gross Sales (On the basis of sales invoices raised)
17.2 If CHAMUNDI is unable to produce and service the Delivery Orders, CHAMUNDI shall compensate DIAGEO INDIA for a sum equal to the Gross Contribution lost on account of such failure. For this purpose, “Gross Contribution” means the difference between the then current selling price of the Products and the cost of Raw Materials and Packaging Materials in relation to the quantity not delivered timeously by CHAMUNDI. It is agreed to between the Parties that the Gross Contribution is a pre-estimate of genuine liquidated damages and is not by way of penalty. Additionally, in the event the various state excise permits have to be sent for revalidation due to failure on the part of CHAMUNDI to deliver the Products in accordance with the permit, then CHAMUNDI shall be liable to compensate DIAGEO INDIA the cost of such revalidation. However, if due to Force Majeure or reasons attributable to DIAGEO INDIA (like delayed supply of raw or packing material) CHAMUNDI is unable to produce/service the orders, then CHAMUNDI would not be liable to compensate DIAGEO INDIA.
17.3 Compensation as per Clause 17.2 shall be paid by CHAMUNDI to DIAGEO INDIA within 30 days of intimation by DIAGEO INDIA to CHAMUNDI.
17.4 The statement of entitlements shall be computed on a financial year of April 1- March 31 basis each year with both the Parties signing off the statement as a proof of agreement and the account will be settled within three months from the close of that financial year.
17.5 CHAMUNDI shall:
a) Keep true and accurate records of all necessary for the computation of DIAGEO INDIA Entitlements and submit to DIAGEO INDIA every month a statement of computation of DIAGEO INDIA Entitlements;
b) Supply DIAGEO INDIA at the time of making such payments with a statement in writing showing the number of cases of the products sold by CHAMUNDI during the accounting period in respect of which such income has accrued;
c) Permit a representative/auditors of DIAGEO INDIA from time to time and at reasonable times to inspect at DIAGEO INDIA’s expenses the records referred above and for the purpose of verifying the accuracy of such reports to inspect any other pertinent records, documents or books of accounts kept by CHAMUNDI;
d) Prepare various reports and to submit the same within the stipulated time periods as required by DIAGEO INDIA from time to time;
e) Be responsible for engaging/ providing staff at their cost for providing the above information/reports and including maintenance of book of accounts related to DIAGEO INDIA operations.”
13. Clause 24 of the Agreement under the heading “Miscellaneous” inter alia provides for each Party to bear its own Income-Tax and other Tax liabilities. Clause 24.2 clearly stipulates that it is neither a Partnership nor a Joint Venture between the two Parties. Clause 24.3 allows DIAGEO to assign its benefits and burden under the said Agreement to any Third Party, however, CHAMUNDI WINERY AND DISTILLERY shall not assign either the benefit or the burden under the said Agreement to any Third Party without any prior consent of the DIAGEO.
14. The said relevant Clauses of the Agreement are also quoted below for ready reference:-
“24. MISCELLANEOUS
24.1 Costs & Expenses
a) Each Party agrees that it shall bear its own costs and expenses incurred by it in connection with any discussions, negotiations, investigations and due diligence undertaken in connection with the project, including costs and expenses associated with retention of financial, legal, tax and other professional advisers.
b) Each Party shall bear its own income tax and other tax liabilities. DIAGEO INDIA shall ensure that sufficient bank balance is maintained to discharge sales tax/VAT liability. However, should there be any tax liability incurred by CHAMUNDI as a direct result of DIAGEO INDIA failing to perform any of its obligations under this Agreement, DIAGEO INDIA shall be liable to the extent of such tax liability actually incurred by CHAMUDI, provided that CHAMUNDI establishes to the reasonable satisfaction of DIAGEO INDIA the actual amount paid by CHAMUNDI towards satisfaction of such tax liability.
24.2 No Partnership/Joint Venture
a) Nothing in this agreement shall be deemed to constitute CHAMUNDI as partner, or a joint venture or a legal representative of DIAGEO INDIA, or to create any fiduciary relationship between CHAMUNDI and DIAGEO INDIA. Both Parties acknowledge that they are personally and not jointly liable in respect of their obligations under the agreement.
24.3 Assignment
The benefit and burden under this Agreement shall be fully assignable and transferable by DIAGEO INDIA to any Third Party. However, CHAMUNDI shall not assign either the benefit or burden under the agreement to any Third Party without the prior written consent of DIAGEO INDIA.”
15. In the perspective of the aforesaid Agreement, it would be appropriate to first discuss the findings in brief of all the three Authorities below.
FINDINGS OF THE ASSESSING AUTHORITY:
16. For A.Y.2010-11, the Assessing Authority in the Assessment Order dated 31/03/2013 under Section 143(3) of the Act, held as under:-
“As evident from the above clause 3.1 the company M/s DIAGEO INDIA is holding M/s CHAMUNDI Winery and Distillery to carry out all activities of the business that include manufacture purchases, sales, dispatches approval from authorities and to make sale tax and VAT payments. By this it is very clear that the business carried out by the assessee firm is recognized in hands of the firm itself. The firm has complied to its statutory obligation by paying the excise duty to confirm its role as an assessee.
3.9 The firm M/s CHAMUNDI is the assessee for Sales tax/VAT purposes, then for all other purposes involving statutory obligation such as income-tax, the same firm is responsible. Initially the assessee during the course of assessment proceedings took a stand that the payment made to M/s Diageo was covered u/s.60 of the Income-tax Act, 1961. But it was brought to its notice that the nature of business as discussed in detail already does not permit any creation of charge by over riding title for diversion of income. The state excise department is the licensing authority to allow anybody to create a charge or indulge in liquor business. Hence the expenditure claimed is only an application of income and could not be allowed as deductible expense.
3.10 As evident from the above clause 15 of the said agreement the working capital finance was to be adequately made available by M/s Diageo. If this was the case the assessee could have booked finance charges or interest charges on the working capital and debit the same to the P & L account. Instead the assessee has transferred the profit of the business in the form of distributable surplus to the company M/s Diageo which is unacceptable since no parties can enter into an agreement to alienate their tax obligation from profit of the licensed and permitted business since tax is an integral part of the business.
3.11 In his submission vide para 2.1. assessee states that manufacturing operations, are supervised by personnel of brand owners, who are stationed in the distillery and if that were to be the case the assessee could have booked supervision charges in the P & L account. The Brands of the liquor manufacturer belonged to M/s Diageo, then the assessee could have booked royalty or technical knowhow fees. Since the excise Department granted the license to M/s CHAMUNDI Winery and Distillery and the entire business has been carried out duly by booking sales and purchases in its name and now to claim the business does not belong to it, is totally unacceptable. The surplus transferred is nothing but the profit of M/s CHAMUNDI and this firm is free to transfer the surplus after taxation but not before the charge to tax.
3.12 The Clause 17 of the agreement dated 30.10.2007 entered into by M/s CHAMUNDI and M/s Diageo to separate the element of profit from the business is not acceptable since tax is an integral part of business and the discretion to alienate statutory obligation is not available to these parties. Hence the stand of the firm M/s CHAMUNDI to run a licensed business but to take away the surplus or profit away without making itself liable to income-tax is wrong and unacceptable. At the same time there is no justification to allow the surplus to be transferred out of the business under the pretext of expenditure since this expenditure is not incurred by the assessee wholly and exclusively for the purpose of business.
4. Conclusion:
In view of the discussion made in the para 3, I hold that expenditure claim under the head distributable surplus is only an application of income of the assessee. As per the return of income, the amount of expenditure claimed under the head distributor’s surplus is of Rs.31,75,95,815/– and this claim is discussed above is disallowed. Hence an amount of Rs.31,75,95,815/- is brought to tax.
5 Penalty proceedings u/s.271(1)(c) for concealment of particulars of income is separately initiated.”
COMMISSIONER OF INCOME TAX (APPEALS):
17. The Commissioner of Income Tax (Appeals) however, allowed the Appeal of the Assessee with the following observations:-
“3.3 I have carefully considered the appellant’s submissions and also perused the assessment order. I find that a similar issue was involved in the appellant’s own case for the assessment year 2009-10 wherein the appellant had claimed deduction in respect of transfer of distributable surplus amounting to Rs.30,51,18,500/-. The AO, who had made the assessment for that assessment year, had disallowed the appellant’s claim for deduction of the amount as distributable surplus and treated the same as the appellant’s income. The appellant had filed an appeal against the said assessment order. My predecessor vide appellate order in ITA.No.795/W-4(3)/CIT(A)-II/11-12 dated 23/8/2012 had confirmed the AO’s action in treating the said amount as the appellant’s income and dismissed the appellant’s appeal. The appellant went in appeal to the Hon’ble ITAT, Bangalore against the said appellate order. By its order in ITA.No.1260/Bang/ 2012 dated 5/4/2013, the Hon’ble ITAT, Bangalore Bench ‘C’ allowed the appellant’s claim, holding that the distributable surplus cannot be considered as application of income but an expenditure incurred by the appellant in the course of its business and allowable u/s 37 of the Act. The relevant passages from the said decision are reproduced below: “
5.3.3 In this factual matrix of the matter, as discussed above, we are of the considered opinion that the example of theatre business cited by the learned counsel for the assessee is quite appropriate and applicable in understanding the true nature of the transactions entered into by the assessee and Diageo by virtue of Agreement dt.30.10.2007. From an application of the totality of the facts and circumstances of the case, we are of the view that the distributable surplus paid by the assessee in terms of clause 17 of the said Agreement is nothing but the amounts to which Diageo is entitled to receive over the expenses to be borne by them, leaving behind the real income to which the assessee is entitled to in accordance with the relevant clauses of the governing agreements and therefore cannot be disallowed on the ground that the same is to be considered as application of income. We hold that it is expenditure incurred in the course of business and therefore allowable under section 37 of the Act.
5.4 The above aspect of the matter can also be viewed from another angle. Though as per the Agreement dt. 30.10.2007, the assessee undertook to raise sale invoices in its name, it is not entitled to the said sale proceeds as the same is deposited in the designated bank account supervised and operated by authorized personnel of Diageo. The funds in the said bank account are required to be utilized for making various payments like purchase of raw materials, payment of Excise Duty and payment of bottling charges to the assessee in terms of the said agreement. Thus the surplus in terms of clause 17 of the said Agreement may either be a profit or a loss depending on the extent of sales and the expenses incurred in the business operation. Assuming that there is a loss that is incurred or arrived at in terms of the formula under the said agreement, Diageo will have already provided the working capital for running the operations and would not be entitled to any entitlement for that year. The assessee, however, cannot claim that the loss incurred in business will have to be set off against the bottling charges of Rs.45 per Case to which it is legitimately entitled under clause 16 of the said agreement. Thus, viewed from any angle, the distributable surplus, to which Diageo is entitled to as per the said agreement, cannot be considered as application of income. Rather, it is a case of expenditure incurred by the assessee in the course of its business which is allowable under section 37 of the Act. In this view of the matter, we hold that the addition/disallowance of the surplus transfer of Rs.30,51,18,500 is not sustainable in law and on facts of the case and accordingly delete the same….”
3.4 The facts in the appeal under consideration are similar in all respects to those in the appeal for the assessment year 2009-10. Respectfully following the decision of the Hon’ble ITAT, Bangalore Bench ‘C’ for the assessment year 2009-10 in the appellant’s own case, I hold that the distributable surplus amounting to Rs.31,75,95,820/- to which M/s DIAGEO INDIA Pvt. Ltd. is entitled as per the agreement dated 30/10/2007 cannot be considered as application of income by the appellant but constitutes expenditure incurred by it in the course of its business allowable u/s 37 of the Act. Accordingly, I delete the disallowance of Rs.31,75,95,820/- made by the AO.”
18. The second appeal filed by the Revenue before the learned Income Tax Appellate Tribunal (ITAT) also came to be dismissed on 26/08/2015 in favour of the Respondent Assessee with the following observations:-
“It is clear from the above grounds that Revenue is aggrieved on the CIT (A) placing reliance on Tribunal’s order in assessee’s own case for A.Y.2009-10. 02. Issue involved is a claim of Rs.31,75,95,820/- by the assessee as payment to M/s. DIAGEO INDIA Pvt.Ltd. Payment was effected by the assessee pursuance to an agreement under which assessee was manufacturing and bottling liquor under the brand names of the said company. As per the AO, it was only utlisation of surplus of the assessee since assessee was billing for the sales in its books of account and the turnover was accounted for by it in full. Similar disallowance was there for A.Y.2009-10 also. In the said year, assessee had moved in appeal before the CIT (A) against such disallowance which was allowed by CIT(A).
03. Aggrieved by the CIT (A)’s decision, Revenue had moved in appeal before this Tribunal and this Tribunal in ITA.1260/Bang/2012, dt.05.04.2013, for A.Y.2009-10 had held as under:
(para 5.3.3. & para 5.4 of ITAT order already quoted above as an extract in the Order of the CIT (Appeals) hence not quoted again)
Thus what we find is that CIT (A) had followed only the directions of the Tribunal for A.Y.2009-10. Fact-situation was the very same for the impugned assessment year also. We, therefore, do not find any merit in the appeal filed by the Revenue.
04. In the result, appeal of the Revenue stands dismissed.”
19. We have heard the learned counsels at length on both sides and have considered the large number of case laws cited by both the sides and before coming to the discussion thereon, the contentions of both the sides may be noted as below:-
CONTENTIONS OF THE APPELLANT – REVENUE:
20. The learned counsel for the appellant – Revenue, Mr. E.R. Indra Kumar, Senior Counsel appearing for Mr. E.I. Sanmathi made the following submissions:-
[I] That since the Respondent CHAMUNDI is doing the entire manufacturing and sale of Liquor under the exclusive Licence given to it by the State Excise Department under the provisions of the Karnataka Excise Act, 1965, even though with the Brands and Labels were issued by the DIAGEO and it also manufactures its own Brand OXYGEN (which is not a Brand of DIAGEO) under the same Excise Licence therefore, the entire business profits earned out of the said business activity of the manufacture and sale would be taxable as the real income of the Respondent Assessee CHAMUNDI and it is not assessable merely to the extent of Bottling charges of Rs: 45/- per Case received by it under the aforesaid Agreement dated 30/10/2007.
[II] The learned Senior Counsel for the Revenue submitted that the source of Business Income in the present case is Manufacture and Sale of Liquor which is a restricted business activity and DIAGEO does not hold any Excise Licence under the said Excise Act, 1965 and therefore by a mutual arrangement or Agreement between the parties, the income taxable in the hands of the Respondent Assessee CHAMUNDI could not be made over to the DIAGEO without being first brought to tax under the provisions of the Income Tax Act, 1961.
[III] The learned counsel for the Revenue submitted that for providing the Working Capital Finances by the DIAGEO and allowing the Respondent Assessee CHAMUNDI to use its Brands whatever could be payable as interest to the financier or as Royalty charges for using such Brands and Trade Marks could only to be allowed as business expenses in the hands of the Respondent Assessee CHAMUNDI, but the whole of the profit earned by CHAMUNDI during the relevant period from the liquor manufacture and sale under the Excise Licence could not be assessed in the hands of DIAGEO.
[IV] The learned counsel for the Revenue, Mr. Indra kumar has also submitted that there is no ‘Diversion of Income’ from CHAMUNDI to DIAGEO by overriding title in favour of DIAGEO and such private arrangements are nothing but Tax Avoidance and Tax Evasion tactics and the Respondent Assessee could not avoid its Income-Tax liability by claiming that it is only doing job work of Bottling of liquor manufactured for and on behalf of the DIAGEO and its entire profits belong to DIAGEO.
[V] He submitted that even though such profits or ‘distributable surplus’ paid by CHAMUNDI to DIAGEO might have been taxed in the hands of DIAGEO within India itself, subject to claim of expenses or deductions claimed in its own hands with which we are not concerned presently, it would not affect the taxable character of income in the hands of the Respondent Assessee CHAMUNDI and the same cannot be said to be double taxation.
[VI] The learned counsel for the Appellant Revenue submitted that the Respondent Assessee CHAMUNDI is neither the Agent of the DIAGEO nor a sub-Partner nor it is the case of assignment of any interest by a Partner in favour of another party, as is clear in the Agreement dated 30/10/2007 itself and therefore, the tax obligations of Respondent Assessee in respect of its income earned out of whole activity of manufacture and sale of liquor cannot be avoided and shifted on to DIAGEO.
[VII] He submitted under the provisions of the Karnataka Excise Act, the entire liquor manufactured by the licencee has to be sold exclusively to Karnataka State Beverage Corporation Limited (KSBCL) with which DIAGEO has no privity of Contract and only the Respondent Assessee CHAMUNDI is liable to sell the entire liquor manufactured by it to KSBCL and it receives all payments from KSBCL against such sale of liquor and therefore, the profits arising out of such sale have to be taxed as ‘real income’ of the Respondent Assessee, irrespective of the fact whether it is charging bottling charges to the extent of `45 per Case as per the said Agreement dated 30/10/2007 and over and above that, the entire surplus has to be made over to DIAGEO but which is nothing but ‘application of its income’ and which can be made only after meeting its own income tax liability in respect of the entire Business Profit for the year in question.
[VIII] He submitted that unless the Respondent Assessee cannot be said to have a right to receive such income before it reaches DIAGEO, and which is not the case here, the entire income is liable to be taxed in the hands of the Respondent Assessee and by a colourable device adopted by these two parties, the liability of payment of Income-Tax in the hands of the Respondent Assessee cannot be avoided.
[IX] Regarding the allowability of the said ‘distributable surplus’ paid by the Respondent Assessee CHAMUNDI0 to DIAGEO under Section 37 of the Act, the learned counsel for the Revenue submitted that there is no question of the same being allowed as an expenditure in the hands of the Respondent Assessee as it is not a business expenditure, but the ‘distributable surplus’ of the business which after payment of tax was required to be made over to the DIAGEO as per the terms of the contract and it is not a ‘business expenditure’ incurred by the Respondent Assessee CHAMUNDI to earn an income and therefore, Section 37 of the Act simply does not get attracted in the present case and therefore, the Tribunal clearly erred in allowing the same as a ‘business expenditure’ under Section 37 of the Act.
CONTENTIONS OF THE RESPONDENT – ASSESSEE:
21. On the other hand, Mr. A. Shankar, the learned counsel for the Respondent Assessee CHAMUNDI raised the following contentions before the Court.
[I] The learned counsel for the Respondent Assessee urged that the ‘real assessable income’ in the hands of the Assessee CHAMUNDI was only the bottling charges of Rs: 45 per Case and as per the Agreement dated 30/10/2007 and except the bottling charges, the Assessee was not entitled to receive anything in respect of the said manufacture and sale of liquor activity carried out by it wholly and exclusively for and on behalf of DIAGEO, who not only provided the Working Capital, Raw Materials, Brands and Trade Marks but also on day-to-day basis, all Receipts of sales by the DIAGEO as per the sale price were made over to DIAGEO and for meeting day-to-day operating expenses, every day, the funds was to be received from DIAGEO out of which, the Assessee CHAMUNDI could meet its operating costs and meet the day-to-day administrative expenses. The Bank Accounts were not only maintained, though in the name of Assessee CHAMUNDI but could be operated only by the authorized signatories as nominated by DIAGEO.
He therefore submitted that except the Excise Licence being in the name of the Assessee CHAMUNDI, the entire business activity was governed and controlled by DIAGEO under the said Business Agreement dated 30/10/2007 which is not only perfectly legal and a valid Agreement in the eye of law but has an over riding impact and therefore the entire income from the said manufacturing business belonged to DIAGEO and Respondent Assessee CHAMUNDI was only earning its Bottling charges for the job work of bottling at the rate of Rs: 45/- per Case and which income has been duly offered for taxation in the Income Tax Return filed by the Assessee with due payment of tax thereon.
[II] He also submitted that the surplus of the said business paid by the Assessee to DIAGEO has already been offered to taxation by DIAGEO and due tax is paid by it and therefore the same income cannot be doubly taxed in the hands of the Assessee CHAMUNDI also.
[III] Mr. Shankar further argued that the ‘distributable surplus’ of the said business which was closely monitored on day-to-day basis by DIAGEO, not only amounted to ‘diversion of income’ in favour of DIAGEO by overriding title at source and therefore, the said income could not be taxed in the hands of the Respondent Assessee and it is not a case of mere ‘application of income’ by the Assessee but a ‘diversion at source’ and therefore the Assessing Authority had erred in imposing tax in the hands of the Assessee on the entire gross receipts of such business other than mere bottling charges in the hands of the Respondent Assessee and the ITAT was right in holding in favour of the Respondent Assessee CHAMUNDI.
[IV] The learned counsel for the Respondent Assessee further argued that in the alternative, the entire ‘distributable surplus’ made over to DIAGEO should be allowed as ‘business expenditure’ in the hands of the Assessee because, in any case, the said amount was made over and paid to DIAGEO to meet the contractual obligations of the Assessee under the Agreement dated 30/10/2007 and Section 37 of the Act permits such general deduction of any business expenditure incurred by the Assessee in meeting its contractual obligations under a legal, valid and enforceable contract.
[V] Mr. Shankar though fairly submitted that Books of Accounts, method of Accounting and entries in Books do not determine and decide the fate of taxability of income in the hands of the Assessee, but in the present case, the day-to-day entries in the Books of Accounts maintained in the ordinary course of business by the Respondent Assessee clearly indicated that the Assessee in Clause 17 of the Agreement was only entitled to bottling charges of Rs: 45/- per Case and nothing more and therefore there was no occasion for the Assessing Authority to tax the entire income or rather gross receipts of the business in the hands of the Assessee.
[VI] Lastly, Mr. Shankar also submitted that as an alternative, the said ‘distributable surplus’ paid to DIAGEO should be allowed as a ‘trading loss’ under Sections 28/29 of the Act as the said money has not been retained by the Assessee nor it has accrued as savings to the Assessee and having lost that amount in favour of the DIAGEO, the same should be allowed as a Trading loss while computing the business profits in Chapter III and Sections 28/29 of the Act.
[VII] He relied upon several case laws in support of these contentions, which would be discussed at a later stage.
