Coca Cola India (P) Ltd. Versus Deputy Commissioner of Income Tax (ITAT Pune)

Service charges (assessee’s appeal)

(i)      whether the services rendered benefited group companies.

(ii)     whether the expenses were incurred to take care of the TCCC brand image.

(iii)    whether rendering services to the bottlers could be a ground for making disallowance.

(iv)     whether disallowance of foreign travel expenses of the wives was justified.

Marketing expenses (assessee’s appeal)

(v)     whether disallowance could be made on ad hoc basis.

(vi)     whether expenditure on films/TV and brand buildings were capital expenditure.

(vii)    whether Rs. 31,19,919 deserved to be allowed as the payments were made by account payee cheques and it constituted a small fraction of the total expenditure of Rs. 73,79,03,469.

 Marketing expenses (Department’s appeal)

(viii)   whether the disallowance of prior period expenditure should have been Rs. 5,76,75,624 as claimed by the Department, instead of disallowance of Rs. 4,11,61,718 confirmed by CIT(A).

(ix)    whether the disallowance on account of differences/no reply should have been Rs. 1,89,99,955 as claimed by the Department instead of disallowance of Rs. 31,19,919 confirmed by the CIT(A).

The position in law, in relation to Section 37(1) of the Act, as emerging from the decisions of the Supreme Court, discussed in the above paras, can be summarized as under:

(i)      the expenses incurred should be ‘incidental’ to the carrying on of the business of the assessee.

(ii)     the expression “wholly and exclusively” used in Section 37(1) of the IT Act, 1961, does not mean ‘necessarily’.

(iii)    an expenditure incurred ‘voluntarily’ without any ‘necessity’, would be permissible for deduction under Section 37(1) if it was incurred for promoting the assessee’s business.

(iv)     the fact that somebody other than the assessee was also benefited by the expenditure, should not come in the way of an expenditure being allowed for deduction under Section 37(1).

(v)     the AO cannot justifiably claim to put himself in the armchair of the businessman to decide whether to incur an expenditure and how much to incur.

(vi)     the requirement of ‘commercial expediency’ has to be determined from the point of view of a prudent businessman and not from the point of view of the AO.

(vii)    the test is : existence of a ‘nexus’ between the expenditure and the ‘purpose of business’.(Para 18.8)

INCOME TAX APPELLATE TRIBUNAL- PUNE

Appeal No. 1257/Pn/2003; (Assessee’s appeal)

&

1269/Pn/2003; (Department’s appeal)

Coca Cola India (P) Ltd.

Versus

Deputy Commissioner of Income Tax

Date of Judgment: 30/6/2008

O   R   D   E   R

Ahmad Fareed, A.M.

1. The present proceedings in this case are a sequel to the directions given by the Bombay High Court in Writ Petn. No. 7459 of 2006, dt. 12th Feb., 2007.

Background

2. The cross-appeals, against the order of the CIT(A) dt. 14th Aug., 2003 for asst. yr. 1997-98, filed by the assessee and by the Department in ITA Nos. 1257/Pn/2003 and 1269/Pn/2003 respectively, were decided by Tribunal Pune, vide its order dt. 5th Oct., 2005. The miscellaneous applications filed by the assessee in Misc. Appln. No. 19/Pn/2006 and by the Department in Misc. Appln. No. 29/Pn/2007, in relation to the aforesaid order of the Tribunal dt. 5th Oct., 2005 were disposed of by the Tribunal vide its orders dt. 7th July, 2006 and 5th July, 2007 respectively.

3. The assessee then filed a Writ Petn. No. 7459 of 2006, before the Bombay High Court, challenging the orders of the Tribunal dt. 5th Oct., 2005 (supra) and dt. 7th July, 2006 (supra). While allowing the writ petition, in its order dt. 12th Feb., 2007, Coca Cola India (P) Ltd. v. ITAT and Ors. , the High Court held as under:

29. For all the aforesaid reasons, we set aside the impugned order passed by the Tribunal dt. 5th Oct., 2005, as well as the order passed on a miscellaneous application dt. 7th July, 2006, insofar as it pertains to the claim relating to service charges and marketing expenses and remit the case to the Tribunal for disposal of the appeal in accordance with law.

30. Accordingly, the writ petition succeeds. Rule is made absolute in terms of prayer Clause (a) with no order as to costs.

4. The Clause (a) of the assessee’s writ petition, referred to above, reads as under:

(a)        this Hon’ble Court may be pleased to issue a writ of certiorari or a writ in the nature of certiorari or any other appropriate writ, order or direction under Article 226 of the Constitution of India calling for the records of the petitioner’s case and after examining the legality and validity thereof quash and set aside the impugned orders dt. 5th Oct., 2005 (to the extent it deals with the deduction for service charges and marketing expenses) and 7th July, 2006 [Exhs. “E” and “K” passed by respondent No. 1 under Sections 254(1) and 254(2) of the Act respectively].

5. In order to comply with the directions given by the Bombay High Court (supra), the learned Authorised Representative of the assessee Shri S.E. Dastur, and the learned Departmental Representatives, Shri S.D. Kapila and Shri Pradeep Sharma, were heard on 16th Jan., 2008, 17th Jan., 2008, 18th Jan., 2008 and on 28th Jan., 2008.

Brief facts

6. The assessee company is a 100 per cent subsidiary of Coca Cola South Asia India Molding, Hongkong, which in turn is a subsidiary of Coca Cola South Asia Holding, Singapore. The ultimate holding company of the assessee is The Coca Cola Company, USA (TCCC for short), engaged in the manufacture of certain ‘beverage essence’ and ‘beverage bases’ used in the preparation of non-alcoholic beverages which are sold under the trademarks : “Coca Cola”, “Coke”, “Fanta” and “Sprite”. TCCC is the registered owner in India of the trademarks “Coca Cola”, “Coke”, “Fanta” and “Sprite”.

6.1 The assessee company had entered into an agreement with TCCC on 1st June, 1993 pursuant to which an ordinary gratuitous non-exclusive licence was granted to the assessee and accordingly the assessee had been manufacturing and selling non-alcoholic beverage bases, also known as ‘concentrates’, and beverages made out of such ‘concentrates’ (p. 17 of the assessee’s paper book, Vol. I).

6.2 The assessee company had also entered into a service agreement dt. 1st April, 1995 (p. 14 of the paper book, Vol. I), with Coca Cola India Inc. USA (CCI Inc. for short) which has its branch office in Delhi. The CCI Inc. is a subsidiary of Coca Cola Holdings India Inc. (USA) which in turn is the subsidiary of TCCC.

6.3 The assessee company sells ‘concentrate’ only to the bottlers authorized by TCCC. There were about 60 bottlers during the previous year relevant to 1997-98 and each one of them had entered into an agreement with TCCC. A sample of such an agreement is at p. 38 of the paper book Vol. III.

6.4 During the previous year relevant to 1997-98, the business activities of the assessee comprised of manufacturing of beverage bases (concentrates), and bottling of beverages. The return for asst. yr. 1997-98 was filed on 28th Nov., 1997 declaring loss of Rs. 46,74,77,640. A revised return was filed on 19th Dec., 1997 declaring loss of Rs. 46,62,27,370. In the assessment order passed by the AO under Section 143(3) on 31st March, 2000, the AO determined the loss at Rs. 12,52,40,834 after making disallowances/additions aggregating to Rs. 34,09,86,536, which included, inter alia, the impugned two items as under:

—————————————————-

Particulars                               (Rs.)

—————————————————-

Service charges                        10,80,04,482

—————————————————-

 Marketing expenses                  17,99,74,343

—————————————————-

 7. The assessee had claimed Rs. 46,35,12,031 under the head ‘Service charges’ out of which the AO made a disallowance of Rs. 10,80,04,482, computed in para 7(iii) of his order, as under:

 7.1 The CIT(A) confirmed the above disallowance made by the AO for the reasons summarized in paras 8.3.1 and 8.4 of his order as under:

8.3.1 As pointed out above, detailed enquiries were required to be made and in the process, statement on oath of Shri K.S. Nair, general manager of the appellant company was also recorded during the appellate proceedings for asst. yr. 1998-99 and a copy of the same is enclosed with the appellate order for asst. yr. 1998-99. Here it would suffice to point out that the minutes of the sales and operation meeting submitted by the appellant in the appellate proceedings for asst. yr. 1998-99 vide submission dt. 9th May, 2003 and the statement on oath as well as discussion with Mr. K.S. Nair during the appellate proceedings for asst. yr. 1998-99 reveal the following specific factors which are relevant for determining the allowability of service charges and the nature of services rendered by CCI Inc. to the appellant company:

 (i)         CCI Inc. has been rendering services not only to the appellant company but also to other group companies and entities in India insofar asst. yrs. 1997-98 and 1998-99 are concerned.

(ii)        CCI Inc. is looking after the India operation of TCCC and ‘India’ in the scheme of things of TCC includes Maldives.

(iii)       The very genesis of the CCI Inc. evidenced from the papers submitted to RBI was to provide technical and managerial assistance to the appellant company as well as to take care of the brand image of TCCC in India.

(iv)       The services, rendered by CCI Inc. to the bottlers licensed by TCCC could be classified into services which are for the purpose of the appellant company and the services which are for the purposes of the business of the bottlers/TCCC. While the services to the bottlers for purchase of concentrate etc. and activities relating to market research etc. could be classified as services for the purposes of the business of the company as it directly helps the appellant in planning its production as evidenced by minutes of sales and operation meetings (S&OP) submitted before me and also in manufacture resource planning styled as MRP-II Project by the appellant, the services rendered in quality upgradation of the bottlers, etc. are for the purpose of the bottlers as well TCCC brand-image. This aspect gets further proved by the recent episode of toxic residue in the soft drinks wherein the bottling companies were directly involved and therefore the cases have been filed before different Courts by the bottling unit M/s Hindustan Coca Cola Beverages Ltd. and not by the appellant. Merely because the bottlers are customers of the appellant, running their business or getting involved in their quality of product is not for the purposes of business of the appellant company but for purpose of the business of TCCC or the bottler. CCI Inc. provided such services to bottlers and rightly so as per the correspondence and approval from RBI, but these services do not have direct nexus with the business operations of the appellant. The decision of Hon’ble Supreme Court in the cases of Travancore Titanium Product Ltd. v. CIT Indian Aluminum Co. Ltd. v. CIT  provide relevant legal authority in this regard in the facts and circumstances of the nature of services rendered by CCI Inc. to the appellant and other entities in India.

(v)        There are expenses embedded in the service charges claimed by the appellant and embedded in the reimbursed cost of appellant to CCI Inc. which are not allowable in nature as per IT law. These include foreign travel expenses of wives of employees for their pleasure trips, capital expenditure on purchase of software, etc.

(vi)       There are expenses on various services directly provided to the appellant for supply of bases and concentrates of the beverages and various other aspects which have been discussed in detail in the appellate order for asst. yr. 1998-99.

8.4 In the light of these facts on record and after considering all these features, without prejudice to the stand that may be taken in later assessment years (as the facts are slightly different in different assessment years), the disallowance made by the AO out of the service charges which is of the order of less than 25 per cent of the total service charges claimed, is required to be upheld on this account. I am therefore not discussing the issue relating to the previous year expenses which has been discussed by the AO in the opening para of para 7(iv) of the assessment order. The material aspect is that part of the service for which service charges have been paid are not wholly and exclusively for the services of the business of the appellant company as discussed above and therefore suitable disallowance is required to be made and has rightly been made by the AO in last para of para 7(iv) of the assessment order which has also been quoted above. Ground No. 7 is therefore, decided against the appellant.

7.2 The Tribunal while restoring the above matter back to the file of the AO, observed in para 51 of its order as under:

51. …In this premise, we have no other alternative than to restore the matter back to the file of the AO for his fresh adjudication of the issue involved in this matter, so as to bring out the true and correct state of affairs in respect of the service charges claimed pertaining to and in the year under consideration. We may clarify that the issue as to whether the service charges paid by the assessee company to CCI Inc. are exclusively and wholly for the assessee’s business or for the benefit of some other entities or are allowable in nature may be independently examined on merit in each year having regard to the facts and circumstances of that year, and this order of ours restoring the matter to the AO for his fresh adjudication would not otherwise debar any appellate authority from taking any independent decision on the said issue on merit having regard to the facts in other years. The issue is being restored to the file of the AO as already clarified above first to ascertain and determine the actual amount pertaining to the year under appeal and then to adjudicate the question of allowability thereof as per law having regard to the facts and circumstances of the case relevant to the year under consideration and in the light of our discussion made above. The AO shall provide an opportunity of being heard to the assessee. The assessee shall produce and furnish all such relevant and necessary documents, details, particulars, information, books and other evidences which are necessary to support its claim.

8. The assessee had made another claim of Rs. 73,79,03,469, under the head ‘Marketing expenses’, out of which the AO disallowed Rs. 17,99,74,343, which was computed in paras 6(v) and 6(vi) of his order, as under:

 8.1 The CIT(A) restricted the above disallowance to Rs. 10 crores, described in para 7.17 of his order, as under:

7.17 In the light of these facts, the disallowance made under the head ‘Marketing expenses’ by the AO is sustained at Rs. 10 crores in this particular assessment year as the appellant was engaged in the manufacture of beverages in Ahmedabad and Pune as well. The above disallowance sustained at Rs. 10 crores is made up of four components viz.:

(i)         Rs. 4,42,81,637–because of external enquiries and as admitted by the appellant in view of its inability to give evidence in support of its claim.

(ii)        Rs. 2 crores–Ad hoc disallowance as the appellant has not been able to submit full and complete details during the assessment proceedings and appellate proceedings.

(iii)       On account of capital expenditure in the form of production of TV, cinema, radio and posters development; and

(iv)       Disallowance on account of whole expenditure on marketing expenses being partly towards building the equity and goodwill of TCCC brand, etc.

8.2 The Tribunal, while restoring this issue back to the file of the AO observed in paras 34 and 35 of its order (supra) as under:

34. …It is thus clear that the matter is to be re-examined and verified by the AO so as to bring out the true and correct state of affairs in respect of the assessee’s claim of deduction of Rs 73,79,03,461 on account of marketing expenses as these enquiries and cross-verifications can only be done after due examination and verification of the books of account of the assessee including all records, materials, evidences as well as information to be gathered from the respective parties to whom the payment has been made. This can be done only at the initial stage so that proper and detailed enquiry, examination and investigation can be carried out to decide the issue properly in accordance with the provisions of law contained in that behalf after giving adequate opportunity to the assessee to prove its case.

35. …Therefore, the issue as to whether the expenses claimed by the assessee are of capital in nature and have been incurred towards building the equity and goodwill of TCCC are to be properly examined and adjudicated upon after identifying and quantifying the same out of the expenses claimed in this particular year. The whole of the expenses claimed amounting to Rs. 73,79,03,469 are to be segregated first year-wise, and then the expenses pertaining or related to this year under consideration are to be examined in detail to determine and ascertain whether all the expenses related to the year under consideration has actually been paid out and expended wholly and exclusively for the assessee’s business, and whether any part of such expenditure are not allowable in computing the income of the assessee for the reason, that they are capital in nature and/or have been incurred towards building the equity and goodwill of TCCC brand, etc. or has been incurred for the benefit of any third party and for some other reason/s, if any. In these premises, we therefore, restore this issue to the file of the AO to decide the same de novo with a direction that he will determine and ascertain the expenditures pertaining to this year, examine various kinds of expenditure claimed by the assessee and decide the matter of admissibility of the expenditure as per law after giving an adequate and reasonable opportunity of being heard to the assessee, who shall be at liberty to furnish all such details, papers, documents, evidences, etc. in support of its claim. We order accordingly.

9. In its miscellaneous application dt. 3rd Feb., 2006, the assessee, inter alia, submitted in paras 19 and 27, that the Tribunal omitted to decide the ground Nos. 4 and 3 in the assessee’s appeal and the ground Nos. 1 and 2 in the Department’s appeal, relating to the disallowances out of ‘service charges’ and ‘marketing expenses’, raised before it, though the material already on record enabled it to decide the same, and that this constituted a mistake apparent from the record. In para 32 of its aforesaid petition the assessee requested as under:

32. For the aforesaid reasons, the applicant respectfully submits that the Hon’ble Tribunal may be pleased to:

(a)        recall its order dt. 5th Oct., 2005 and decide the appeals afresh after giving the parties an opportunity of hearing or;

(b)        pass such orders as may appear to the Hon’ble Tribunal to be necessary to rectify the mistakes apparent from the record as pointed out above so as to do justice to the applicant or;

(c)        in the alternative, clarify that its directions with regard to marketing expenditure do not exceed the disallowance of Rs. 17,99,74,343 and that its directions with regard to service charges do not exceed the disallowance of Rs. 10,80,04,482 made by the AO.

9.1 While disposing of the assessee’s miscellaneous application dt. 3rd Feb., 2006, the Tribunal held in paras 28 and 29 of its order dt. 7th July, 2006, as under:

28. In the light of our detailed discussion in our order, it is now very difficult to say that Tribunal’s failure to decide the matter on merits as against remanding the matter back to the AO could be said to be a mistake apparent from record at all. We, therefore, find no substance in this contention of the assessee on this issue also. However, as already held above, while remanding the matter back to the AO for fresh adjudication, the assessee cannot be put in a position worse than it would have been if the assessee had not filed the appeal. Therefore, we do hereby clarify that while deciding this issue afresh by the AO, the matter of disallowance shall be limited only to the sum of Rs. 17,99,74,343 which was the amount disputed before us by the assessee as well as by the Department.

29. Therefore, the alternative prayer made by the assessee in Sub-para (c) of para 32 of miscellaneous application stating that a clarification may be given to the effect that marketing expenses do not exceed the disallowance of Rs. 17,99,74,343 and service charges do not exceed disallowance of Rs. 10,80,04,482 is fit to be allowed and we do accordingly.

10. The Bombay High Court, while disposing of the Writ Petn. No. 7459 of 2006, filed by the assessee, set aside the orders passed by the Tribunal dt. 5th Oct., 2005 (supra) and dt. 7th July, 2006 (supra) and remitted the case back to the Tribunal for disposal of the appeal in accordance with law. The Court observed as under:

26. By the impugned order, the Tribunal has directed the AO to reconsider the entire claim of service charges and marketing expenses by first segregating the prior period expenses and thereafter determine the actual amount pertaining to the year under appeal and adjudicate as to whether the expenses incurred in the year in question have been incurred wholly and exclusively for the purpose of business. It is pertinent to note that in para 50 of its order, the Tribunal has given a categorical finding to the effect that out of the disallowance of service charges of Rs. 10,80,04.482 confirmed by the CIT(A), service charges amounting to Rs. 3,37,06,617 were incurred in the earlier year and that amount is not allowable in the year in question. Having quantified the claims which relate to earlier years, the Tribunal was not justified in remanding the matter to the AO to redetermine the service charges which are relatable to earlier years.

27. Similarly, whether service charges and marketing expenses were incurred wholly and exclusively for the purpose of business was not an issue raised in the appeal. The specific grounds raised in the appeal against the order of the CIT(A) were, whether the services rendered benefited group companies, whether the expenses were incurred to take care of the TCCC brand image, whether rendering service to the bottlers could be a ground for making disallowance, whether disallowance of foreign travel expenses of the wives was justified, whether disallowance of marketing expenses ought to have been enhanced as claimed by the Revenue, whether disallowance could be made on ad hoc basis and whether expenditure on films/TV and brand buildings were capital expenditure. The Tribunal ought to have adjudicated upon these issues and to decide any of these specific issues if it was found necessary, the Tribunal could have remanded the matter for reconsideration of those issues. As the Tribunal has not considered the specific issues raised in the appeal, it is difficult to sustain the remand order passed by the Tribunal.

28. …In these circumstances, the order passed by the Tribunal without considering the issues raised in the appeal and in remanding the case to the file of the AO for reconsideration of the entire claim relating to service charges and marketing expenses cannot be sustained.

 29. For all the aforesaid reasons, we set aside the impugned order passed by the Tribunal dt. 5th Oct., 2005, as well as the order passed on a miscellaneous application dt. 7th July, 2006, insofar as it pertains to the claim relating to service charges and marketing expenses and remit the case to the Tribunal for disposal of the appeal in accordance with law.

30. Accordingly, the writ petition succeeds. Rule is made absolute in terms of prayer Clause (a) with no order as to costs.

Specific issues/grounds

11. The Bombay High Court has directed us to decide the specific issues/grounds, mentioned in paras 23 and 27 of its order (supra), as under:

Service charges (assessee’s appeal)

(i)         whether the services rendered benefited group companies.

(ii)        whether the expenses were incurred to take care of the TCCC brand image.

(iii)       whether rendering services to the bottlers could be a ground for making disallowance.

(iv)       whether disallowance of foreign travel expenses of the wives was justified.

Marketing expenses (assessee’s appeal)

(v)        whether disallowance could be made on ad hoc basis.

(vi)       whether expenditure on films/TV and brand buildings were capital expenditure.

(vii)      whether Rs. 31,19,919 deserved to be allowed as the payments were made by account payee cheques and it constituted a small fraction of the total expenditure of Rs. 73,79,03,469.

 Marketing expenses (Department’s appeal)

(viii)     whether the disallowance of prior period expenditure should have been Rs. 5,76,75,624 as claimed by the Department, instead of disallowance of Rs. 4,11,61,718 confirmed by CIT(A).

(ix)       whether the disallowance on account of differences/no reply should have been Rs. 1,89,99,955 as claimed by the Department instead of disallowance of Rs. 31,19,919 confirmed by the CIT(A).

12. We now proceed to decide the aforesaid specific issues/grounds in the following paras.

13. The submissions made by both the parties during the hearing were summarized by the learned Authorised Representative and the learned Departmental Representatives, in written ‘notes’ filed on 18th/28^th Jan., 2008.

Arguments (service charges)

14. Shri S.E. Dastur, the learned Authorised Representative reiterated the arguments which were put forward on behalf of the assessee company before the AO, the CIT(A) and the Tribunal. He submitted that the assessee company benefited from the services rendered to it by CCI Inc., that any prudent businessman in the assessee’s position would have engaged the services of CCI Inc. to perform the specified functions, that assuming that the advise and help rendered by CCI Inc. benefited the bottlers by increasing the sale of the “Coca Cola” beverage, the assessee also directly benefited because this would result in a larger offtake of the ‘concentrate’ (which is the assessee’s stock-in-trade) by the bottlers that the purpose of the assessee engaging the services of CCI Inc. is to further its business and not of the bottler, that why would the assessee want to increase the business of unrelated third party bottlers, the activities of CCI Inc. resulting in building the “Coca Cola” brand benefit the assessee by increase of the consumption of the “Coca Cola” beverage, that the build-up of the brand results in immediate and direct benefit to the assessee, and the benefit, if any, to the US Coca Cola company (owner of the brand) is only an indirect benefit and expenditure is for the assessee’s direct benefit, that the fact that there was a benefit to a third party (bottlers or Coca Cola company, USA) was irrelevant as long as the assessee benefited from the expenditure, that in any event the test is that an expenditure is deductible if it incidentally benefits the assessee and not intimately or directly, though in the present case it is directly and intimately for its benefit.

14.1 Shri Dastur, the learned Authorised Representative, placed reliance upon and took us through each of the decisions in the following cases:

(i)         S.A. Builders Ltd. v. CIT(A) ;

(ii)        Indian Aluminium Co. Ltd. v. CIT :

(iii)       Star India (P) Ltd. v. Addl. CIT ;

(iv)       Campa Beverages (P) Ltd. v. IAC (1990) 34 ITD 241 (Del);

(v)        Nestle India Ltd. v. Dy. CIT (2007) 111 TTJ (Del) 489;

(vi)       CIT v. Sabena Detergents (P) Ltd. (2008) 214 CTR (Mad) 167 : (2007) 164 Taxman 17 (Mad);

(vii)      Tata Sons Ltd. v. CIT ;

(viii)     CIT v. Royal Calcutta Turf Club ;

(ix)       Govind Rubber Ltd. v. Dy. CIT (2004) 90 TTJ (Mumbai) 1068.

15. Shri S.D. Kapila, the learned Departmental Representative, submitted that TCCC, USA was engaged in the business of manufacture, distribution and sale of its products in India by systematically identifying and organizing a network of authorized contract bottlers, that it assured planned supply of concentrates to the bottlers by appointing a contract manufacturer-cum-supplier of concentrates who worked exclusively for it and to whom it sold essence which is the most vital and closely guarded ingredient of the concentrate, that for carrying on these activities including marketing and assisting bottlers in achieving a high degree of efficiency in production, quality and hygiene, TCCC utilized services of CCI Inc., the Indian branch for which payments were wholly made by Coca Cola India (P) Ltd., the assessee.

15.1 The assessee was an “authorized supplier” of concentrates under a license from TCCC for manufacturing and supplying concentrates to the ‘authorised bottlers’ of TCCC under strict instructions and plan of TCCC, which the latter continuously and systematically monitors and supervises, that the assessee is a captive contract manufacturer and supplier of concentrates, that it has limited manpower of about 50-60, which is wholly devoted to manufacture and supply of concentrates as per TCCC’s plan and arrangement with bottlers in India. It is the business of TCCC, as is evident from the combined reading of the ‘license agreement’, ‘bottlers agreement’ and ‘service agreement’, that the assessee is a mere one amongst many captive contract manufacturers of TCCC, that it has to exclusively supply it to the contracted bottlers of TCCC in India, Sri Lanka and Maldives.

15.2 He emphasized that the assessee had no power to appoint a bottler, nor can it supply concentrates to a bottler other than those appointed by TCCC, that it has to supply concentrates to a bottler as per the arrangement and plan between TCCC and the authorized bottler, that the assessee has to manufacture concentrates strictly under the instructions of TCCC, that its production is monitored and regulated by TCCC whose officers also visit its facilities (sic-factories) for instruction, compliance, etc., that the assessee must purchase essence from TCCC which is a vital and closely guarded proprietary of TCCC, that the price is fixed by TCCC which is not negotiable.

15.3 Shri Kapila pointed out that as per the service agreement, assessee “acts in India to promote and enhance the business of the company in the production and sale of its products”, that the “business of the company in the production and sale of its products clearly refers to business of TCCC in India, that admittedly, the assessee does not have any resource to promote the business of TCCC in India being exclusively engaged in manufacture and supply of concentrates to TCCC’s bottlers, that it is the branch office of CCI Inc., another subsidiary of TCCC, which does the work of assisting (1) the assessee in improving and planning production of concentrates; (2) identifying, assisting and planning the operation of bottlers of TCCC; (3) organizing schemes and material for publicity for marketing for TCCC, that the assessee pays out the entire expenditure, that it is the business expenditure of TCCC.

15.4 The service charges paid by the assessee to CCI Inc. are only partly for expenditure for the purpose of assessee’s business, that most of service charges and whole of publicity and marketing expenditure are clearly the business expenditure of TCCC which it does not reimburse to Coca Cola India (P) Ltd., that incidentally, it is about 60 per cent of gross revenue, that this is inverted logic which is not correct, that the assessee’s business is that of contract manufacturer-cum-supplier, that it is TCCC which is engaged in systematic business of contracting concentrates manufacturer (the assessee), supervisor-cum-consultant (CCI Inc.) and network of bottlers, that the assessee has no say in the pricing of essence which is a vital raw material for producing concentrates, that the assessee has also no say in fixation of price of concentrates to be sold to bottler and not in the pricing of beverages by the bottlers, that all these prices are fixed by TCCC and these prices are not negotiable, that the assessee has also no control over the bottlers, that it is not an independent seller of goods produced by it. Therefore, it is not a trader of its goods, that hence, the entire expenditure is the business expenditure of TCCC, that the settled law, therefore, is that expenditure on marketing and service charges is allowable in the hands of TCCC even if it incidentally benefits Coca Cola India (P) Ltd., that the payments made by the assessee are gratuitous and not for the purpose of its business, which is that of captive contract manufacturer-cum-supplier of TCCC.

15.5 He drew our attention and took us through the following three agreements:

 15.6 Shri Kapila, the learned Departmental Representative placed reliance upon and took us through the decisions in the following cases:

(i)         CIT v. Chandulal Keshavlal & Co. ;

(ii)        S.A. Builders Ltd. v. CIT(A) (supra).

16. The main question for consideration before us is whether, on the facts of this case, the expenses incurred by the assessee during the accounting year relevant to asst. yr. 1997-98 under the heads ‘Service charges’ and ‘Marketing expenses’, are deductible under Section 37(1) of the IT Act, 1961. The Section 37(1) reads as under:

Any expenditure (not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purpose of the business or profession shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’.

Legal position

17. Before proceeding further we consider it necessary to examine and discuss the legal position as laid down in the various decisions relied upon by both the parties.

18. It is seen that the CIT(A) in para 8.3.1.(v) of his order had placed reliance on the decisions of the Supreme Court in the cases of Travancore Titanium Product Ltd. v. CIT  and Indian Aluminium Co. Ltd. v. CIT (supra).

18.1 It was pointed out by Shri Dastur, the learned Authorised Representative, that the ratio laid down by the Supreme Court in the case of Travancore Titanium Product Ltd. (supra) was modified by a Larger Bench of five Judges of the Supreme Court in the case of Indian Aluminium Co. Ltd. (supra).

18.2 In the case of Travancore Titanium Product Ltd. (supra), the test adopted by the Supreme Court was that to be a permissible deduction, there must be a direct and intimate connection between the expenditure and the business’.

18.3 In the case of Indian Aluminium Co. Ltd. (supra), the above test was qualified by stating that if the expenditure laid out by the assessee was ‘incidental’ to the carrying on of his business, it should be allowed. In other words, the requirement of a ‘direct and intimate connection between the expenditure and business’ was substituted by ‘expenditure being incidental to the carrying on of business’.

18.4 It is seen that the expression ‘wholly and exclusively’ used in Section 37(1) of the IT Act, 1961 was the subject-matter of discussion by the Supreme Court in the case of Sassoon J. David & Co. (P) Ltd. v. CIT . In this case, the Court held that the expression “wholly and exclusively” used in Section 10(2)(xv) of the IT Act, 1922 [Section 37(1) of the IT Act, 1961] does not mean “necessarily”, that ordinarily it was for the assessee to decide whether any expenditure should be incurred in the course of his or its business, that such expenditure may be incurred ‘voluntarily’ and without any ‘necessity’ and if it is incurred for promoting the business and to earn profits, the assessee can claim deduction under Section 10(2)(xv) of the Act even though there was no compelling ‘necessity’ to incur such expenditure, that the fact that somebody other than the assessee was also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction under Section 10(2)(xv) of the Act, if it satisfied otherwise the tests laid down by law.

18.5 The legislative history of Section 37 of the IT Act, 1961 was mentioned by the Supreme Court in its order in the case of Sassoon J. David & Co. (P) Ltd. (supra) as under:

…It is relevant to refer at this stage to the legislative history of Section 37 of the IT Act, 1961, which corresponds to Section 10(2)(xv) of the Act. An attempt was made in the IT Bill of 1961 to lay down the ‘necessity’ of the expenditure as a condition for claiming deduction under Section 37. Section 37(1) in the Bill reads ‘any expenditure…laid out or expended wholly, necessarily and exclusively for the purposes of the business or profession shall be allowed….’ The introduction of the word ‘necessarily’ in the above section resulted in public protest. Consequently, when Section 37 was finally enacted into law, the word ‘necessarily’ came to be dropped. The fact that somebody other than the assessee is also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction under Section 10(2)(xv) of the Act if it satisfies otherwise the tests laid down by law.

18.6 Shri Dastur, the learned Authorised Representative pointed out in this regard that the crucial expression used in Section 37(1) was ‘purpose of business’, and in this connection, he drew our attention to the discussion at p. 624 of The Law and Practice of Income-tax (Eighth Edn.) by N.A. Palkhivala, which reads as under:

Purpose of business.-Before the corresponding section in the 1922 Act was amended in 1939, allowance was given in respect of any non-capital expenditure ‘incurred solely for the purpose of earning such profits or gains’. Under the present law the expenditure should be laid out ‘wholly and exclusively for the purposes of the business’. The two expressions are not synonymous; the latter is wider than the former. Expenditure may be for the purpose of the business although it may not be incurred for the purpose of earning the profits of the business. This is established by the decision of the Supreme Court.

Subba Rao, J., speaking for the Supreme Court, observed in CIT v. Malayalam Plantations Ltd., “The expression ‘for the purpose of the business’ is wider in scope than the expression ‘for the purpose of earning profits….

The law directs attention to the purpose for which, and not to the motive with which, the expenditure is incurred.

18.7 Both the parties referred to the recent decision of the Supreme Court, in relation to Section 37(1) of the Act, in the case of S.A. Builders Ltd. v. CIT(A) (supra). In this case the Court held as under:

 35. We agree with the view taken by the Delhi High Court in CIT v. Dalmia Cement (Bharat) Ltd.  that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize his profit. The IT authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own viewpoint but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister-concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits.

18.8 The position in law, in relation to Section 37(1) of the Act, as emerging from the decisions of the Supreme Court, discussed in the above paras, can be summarized as under:

(i)         the expenses incurred should be ‘incidental’ to the carrying on of the business of the assessee.

(ii)        the expression “wholly and exclusively” used in Section 37(1) of the IT Act, 1961, does not mean ‘necessarily’.

(iii)       an expenditure incurred ‘voluntarily’ without any ‘necessity’, would be permissible for deduction under Section 37(1) if it was incurred for promoting the assessee’s business.

(iv)       the fact that somebody other than the assessee was also benefited by the expenditure, should not come in the way of an expenditure being allowed for deduction under Section 37(1).

(v)        the AO cannot justifiably claim to put himself in the armchair of the businessman to decide whether to incur an expenditure and how much to incur.

(vi)       the requirement of ‘commercial expediency’ has to be determined from the point of view of a prudent businessman and not from the point of view of the AO.

(vii)      the test is : existence of a ‘nexus’ between the expenditure and the ‘purpose of business’.

19. We now proceed to examine the facts of the present case in the light of the legal position discussed in the above paras.

Discussion and conclusion (Service charges)

 20. The assessee had claimed Rs. 46,35,12,031 under the head ‘Service charges’ out of which the AO made a disallowance of Rs. 10,80,04,482, in para 7 (iii) of his order, as under:

 21. It is seen that the first/main reason given by the AO for disallowing Rs. 10,80,04,482 was that these expenses related to earlier year and not ‘related to this year’. In other words, according to the AO the balance of Rs. 35,55,07,549 related to the accounting year relevant to asst. yr. 1997-98, which he allowed. The other reason given by the AO, and without prejudice to the aforesaid first reason, was that the item-wise, date-wise details of payment, and evidence/details of services rendered by CCI Inc. to the assessee, were not furnished; but we find that on this reason/ground the AO made no disallowance. The entire disallowance made by the AO was for the reason that it did ‘not relate to this year’, as seen from the details given above.

22. The CIT(A) does not appear to have gone into the question as to whether part of the expenses claimed related to earlier year. He confirmed the disallowance made by the AO for three specific reasons; one, the services were rendered by CCI Inc. not only to the assessee but also to other group companies in India; two, the expenses were incurred to take care of the brand image of TCCC in India; and three, the services rendered to bottlers were for the purpose of the business of bottlers and for brand image of TCCC.

23. It is seen that the Tribunal in para 50 of its order dt. 5th Oct., 2005, had given a clear finding that Rs. 3,37,06,017 related to earlier years and had to be excluded. This finding of the Tribunal has been noted by the Bombay High Court in para 25 of its order (supra). Therefore, in the present proceeding, we have to confine ourselves to the disallowance of the balance of Rs. 7,42,98,465 only.

24. We find that TCCC, USA is a multinational company operating in more than 150 countries through its subsidiaries. The three agreements, mentioned above, are part of the ‘business model’ chosen by TCCC. The subsidiary companies like the CCI Inc. and the assessee are independent entities for the purpose of the IT Act, 1961. In such a situation, an expenditure incurred by one company may sometimes directly and/or indirectly benefit more than one group company. There will be inter se purchases and sales at rates carefully worked out after taking into consideration various factors. The Courts have laid down clear guidelines for determining the allowability of expenses incurred and claimed under Section 37(1) of the Act, as summarized above,

25. Shri Kapila, the learned Departmental Representative urged that in the case of Chandulal Keshavlal & Co. (supra) the Court had made an exception in respect of those cases where the expenditure was incurred to foster the business of another party. He vehemently argued saying that in the present case the services rendered by the CCI Inc. to the bottlers were for fostering the business of TCCC in India, and therefore the reimbursement of these expenses by the assessee could not be allowed in view of the decision of the Supreme Court in the case of Chandulal Keshavlal & Co. (supra). He drew our attention to the following observations of the apex Court:

Another fact that emerges from these cases is that if the expense is incurred for fostering the business of another only or was made by way of distribution of profits or was wholly gratuitous or for some improper or oblique purpose outside the course of business then the expense is not deductible….

25.1 In our opinion, the word ‘only’ appearing in the judgment of the Supreme Court, as reproduced above, is crucial and makes all the difference, in the context of the facts of the present case. The argument of the learned Departmental Representative would have been acceptable if it was demonstrated by the Department that the expenses were incurred by the assessee for services rendered to bottlers, manufacturing a beverage which was not made from the ‘concentrate’ manufactured by the assessee company.

26. In the present case, it is an admitted fact that the bottlers manufacture beverages from ‘concentrates’ purchased from the assessee company. An increase in the volume of business of the bottlers has a direct effect of increasing the volume of the business of the assessee. It can be nobody’s case that the volume of the business of the assessee company and of the bottlers was not intricately linked with each other, and that the services rendered by CCI Inc. to the bottlers did benefit the assessee by helping the bottlers to increase the volume of their business. Therefore, in respect of the expenses relating to the services rendered by CCI Inc. to the bottlers, it can be said that the necessary ‘nexus’ did exist between such expenses and the purpose of the business’ of the assessee.

27. Shri Kapila the learned Departmental Repesentative, reiterated that it was the TCCC which was doing business in India, and that the assessee was merely a captive contract manufacturer and supplier of concentrate.

27.1 Shri Dastur, the learned Authorised Representative, responded by saying that the learned Departmental Representative had made an altogether new case, that if what was contended by the learned Departmental Representative was accepted the entire expenditure claimed by the assessee would have to be disallowed, which even the AO had not done. He argued that it was not open to the Tribunal, at this stage, to consider all that the learned Departmental Representative had argued. He insisted that, in the present proceeding the Tribunal had-to confine itself to the directions given by the High Court.

28. Now, coming to the specific issues mentioned above, it is, no doubt, true that the services rendered by the CCI Inc. to the bottlers did benefit the business of the bottlers. It is also true that these services benefited TCCC-surely a group company, in enhancing its brand image in India. But it is equally true that these services benefited the assessee company. The services rendered by CCI Inc. helped the bottlers to increase the volume of their business which, in turn, resulted in increased purchases of ‘concentrates’ by the bottlers from the assessee. There is nothing on record to show that the decision on the part of the assessee company to incur these expenses was not based on ‘commercial expediency’.

28.1 In para 8.3.1 of his order, the CIT(A), while justifying a disallowance of 25 per cent of the expenses claimed under the head ‘Service charges’, inter alia, made a general and vague observation as under:

(v)        There are expenses embedded in the service charges claimed by the appellant and embedded in the reimbursed cost of appellant to CCI Inc. which are not allowable in nature as per IT law. These include foreign travel expenses of wives of employees for their pleasure trips, capital expenditure on purchase of software etc.

28.2 The CIT(A) has not given any detail. He merely says, “these include foreign travel expenses of wives of employees for their pleasure trips, capital expenditure on purchases of software etc.”. The observation is too general and vague to form a basis for any disallowance.

28.3 In view of the facts and circumstances discussed above, we are of the opinion that in respect of the impugned expenses incurred by the assessee under the head ‘Service charges’, the necessary ‘nexus’ between these expenses and the ‘purpose’ of the assessee’s business did exist, and therefore, the requirement of Section 37(1) can be said to have been fulfilled. The fact that the bottlers and TCCC-a group company were also benefited by these services is immaterial. The mandate of the Supreme Court, as noted in the above paras, is very clear. Therefore, on the facts of the case, we see no justification for the addition of Rs. 7,42,98,465 (Rs. 10,80,04,482 -3,37,06,017).

29. To conclude, the addition of Rs. 10,80,04,482 is reduced to Rs. 3,37,06,017. In other words, the assessee gets relief of Rs. 7,42,98,465. The ground No. 4 in the assessee’s appeal is partly allowed.

Arguments (Marketing expenses)

30. Shri S.E. Dastur, the learned Authorised Representative submitted that the ‘advertisement expenditure’ incurred by the assessee did benefit it, that the assessee, as a prudent businessman proceeded on the basis that the ‘advertisement expenditure’ would be for his benefit, as it would increase the purchase by the bottlers of the concentrate manufactured by him, that assuming that the ‘advertisement expenditure’ builds the “Coca Cola” brand, the assessee too gets immediate and direct benefit therefrom as opposed to the latent and deferred brand building benefit, if any, to TCCC, that even if the ‘advertisement expenditure’ results in a benefit to TCCC in the form of building the “Coca Cola” brand, it does not mean that the expenditure is not for the assessee’s benefit and not ‘wholly and exclusively’ for the purposes of the assessee’s business, that the advertisement expenses were factored into the price charged from the bottlers.

30.1 Shri Dastur placed reliance on the decisions in the following cases:

(i)         CIT v. Patel International Film Ltd. ;

(ii)        Dy. CIT v. Metro Shoes (P) Ltd. ;

(iii)       IAC v. Joshi Formulabs (P) Ltd. .

31. Shri S.D. Kapila, the learned Departmental Representative had put forward common arguments in respect of both the issues relating to ‘service charges’ and ‘marketing expenses’ as mentioned above.

Discussion and conclusion (Marketing expenses)

32. In the P&L a/c for asst. yr. 1997-98, the assessee had claimed Rs. 73,79,03,469 under the head ‘Marketing expenses’. In the assessment order passed under Section 143(3) on 31st March, 2000, the AO disallowed Rs. 17,99,74,373, computed in paras 6(v) and 6(vi), as under:

 33. The AO made the disallowance, mainly on three grounds; one, that there were differences in the amounts claimed by the assessee and the amounts confirmed by the payee-parties; two that there were claims that which were not confirmed by some of the parties by sending replies to the AO; and three, that there were expenses pertaining to earlier years. It is seen that in order to verify the assessee’s claim, the AO had written letters to only 56 parties and therefore, in respect of other parties to whom letters had not been written by him an estimated/ad hoc disallowance of Rs. 2,00,00,000 was made. The failure on the part of the assessee to file details has also been mentioned as one of the reasons.

34. The CIT(A) reduced the above addition of Rs. 17,99,74,343 to Rs. 10,00,00,000 computed as under:

 35. The order of CIT(A) was challenged by the assessee as well as by the Department. The specific issues/grounds, raised in these cross-appeals, in relation to ‘marketing expenses’, have been summarized above.

36. It is seen, from the details given above, that the major component forming part of Rs. 17,99,74,343 disallowed by the AO, was Rs. 9,97,41,327 representing expenses pertaining to earlier years. The CIT(A) examined the matter in detail and restricted the addition of Rs. 9,97,41,327 to Rs. 4,11,61,718 as per the chart enclosed with his order as Annex. (2). It appears that this chart was furnished by the assessee, during the appellate proceeding before the CIT(A), which he accepted as such after verification. In other words, the assessee accepted the disallowance of Rs. 4,11,61,718.

36.1 In the ground No. (1) filed in Form No. 36, the Department insisted on the figure of Rs. 9.97,41,327, but it appears that during the appellate proceeding before the Tribunal the learned Departmental Representative gave another figure of Rs. 5,76,75,624, as mentioned in para 32 of the order of the Tribunal (supra).

36.2 During the hearing before us. the learned Departmental Representative did not make any particular submission to support the figure of Rs. 5,76,75,624 in place of Rs. 4,11,61,718. Therefore, we see no reason to interfere with the order of the CIT(A) on this point, and the ground No. (1) in the Department’s appeal is accordingly rejected.

36.3 The other two components of Rs. 17,99,74,343 were Rs. 2,12,04,099 and Rs. 3,90,28,917; the former represented the difference between the amounts claimed by the assessee and the amounts confirmed by the payee-parties and the latter represented the claims which were not confirmed by some of the parties by sending replies to the AO. The CIT(A) reduced the addition of Rs. 6,02,33,016 (Rs. 2,12,04,099 + Rs. 3,90,28,917) to Rs. 31,19,919 as mentioned in Annex. (2) enclosed with his order.

36.4 Shri Kapila, the learned Departmental Representative did not make any particular submission as to why the CIT(A) went wrong in reducing the addition of Rs. 6,02,33,016 to Rs. 31,19,919.

36.5 Shri Dastur, the learned Authorised Representative, submitted that Rs. 31,19,919 constituted a small fraction (about 0.4 per cent) of the total expenditure of Rs. 73,79,03,469, that all the payments were made by account payee cheques, and that the concept of ‘materiality’, as applicable to all walks of life, had to be taken into consideration. He, however, admitted that, at this stage, the assessee could not give details. Admittedly, in respect of this amount of Rs. 31,19,919 the cases of difference/no reply could not be explained. It is seen that during the hearing before the Tribunal on the earlier occasion the assessee was agreeable to the confirmation of the disallowance of Rs. 31,19,919. This has been noted by the High Court in para 23 of its order (supra). Therefore, considering the facts and circumstances discussed above we are of the opinion that the order of the CIT(A), confirming the disallowance of Rs. 31,19,919 does not call for any interference.

 36.6 The last component of Rs. 17,99,74,343 was Rs. 2,00,00,000 added by the AO on estimate/ad hoc basis which was confirmed by the CIT(A). It is seen that in order to verify the assessee’s claim, the AO had written letters to only 56 parties and therefore, in respect of other parties to whom letters had not been written by the AO an estimated /ad hoc disallowance of Rs. 2,00,00,000 was made by the AO. The failure on the part of the assessee to file details has also been mentioned as one of the reasons. It was pointed out by the learned Authorised Representative that the assessee had furnished details before the AO in respect of the entire expenses of Rs. 73,79,03,468 vide letter dt. 27th Aug., 1999 as under:

 36.7 He stated that the Annexs. (2) and (3) appear to have escaped the notice of the AO.

36.8 In view of the facts and circumstances discussed above, we are of the opinion that the reasons given by the AO for making the ad hoc disallowance/addition of Rs. 2,00,00,000 have no merit. The CIT(A) too gave no cogent reason to agree with the AO and therefore, we see no justification for the disallowance. It is accordingly deleted.

36.9 It appears that the CIT(A) first decided the quantum of addition that he wanted to sustain and then he proceeded to give its break-up. It was for this reason that the last component of Rs. 10,00,00,000 that he decided to sustain was a balancing figure worked out at Rs. 3,37,18,000. The reason given by the CIT(A) for the last component which was a balancing figure was that it represented ‘capital expenditure in the form of production of TV, cinema, radio and posters development’. In our opinion, the reason given by the CIT(A) is too general and vague and is therefore unsustainable. One does not know what specific items of expenses the CIT(A) was talking about; which advertisements on TV/cinema/ radio he had in mind and, what was the basis for arriving at the balancing figure of Rs. 3,37,18,000. In view of these facts, we do not consider it necessary to go into the decisions relied upon by the learned Authorised Representative. The disallowance made by the CIT(A) is devoid of merit and is deleted.

37. To conclude, the addition of Rs. 10,00,00,000 sustained by the CIT(A), in respect of ‘marketing expenses’ is reduced to Rs. 4,42,81,637 (Rs. 4,11,61,718 + Rs. 31,19,919). In other words, the assessee gets relief of Rs. 5,37,18,863 (Rs. 2,00,00,000 + Rs. 3,37,18,863). The ground No. 3 in the assessee’s appeal is partly allowed, and the ground No. (2) in the Department’s appeal is rejected.

Decision

In the result, the decisions taken by us, in the above paras, are summarized as under:

Appeal No.	Ground No.	Result	Para
1257/Pn/2003; (Assessee’s appeal)	4	Partly allowed	29
	3	Partly allowed	37
1269/Pn/2003; (Department’s appeal)	1	Rejected	36.2
	2	Rejected	37

NF