Disallowed under garb of HO expenses if it doesn’t include executive or general admin expenses

IN THE ITAT MUMBAI BENCH ‘L’

John Wyeth & Brother Ltd.

versus

Assistant Commissioner of Income-tax, Circle 2(3)

IT APPEAL NOs. 6772 & 6773 (MUM.) OF 2002

[ASSESSMENT YEARS 1981-82 & 1982-83]

JULY 25, 2012

ORDER

Dinesh Kumar Agarwal, Judicial Member  

These two appeals preferred by the assessee are directed against the common order dtd. 30-9-2002 passed by the ld. CIT(A) for the assessment years 1981-82 and 1982-83. Since facts are identical and issue involved is common, both these appeals are disposed of by this common order for the sake of convenience.

2. Briefly stated facts of the case extracted from ITA No. 6772/Mum/2002 for A.Y. 1981-82 are that the assessee is a non-resident company, being only a branch of a foreign company with Head Office in U.K. Its business both in U.K. and in India is that of manufacturing pharmaceutical products. It has a separate and independent establishment for its branch business in India. The original assessment was completed on 16-11-1983 on an assessed income of Rs. 1,34,34,300/- as against the income returned of Rs. 69,10,646/-. The said assessment was subject matter of appeal before the ld. CIT(A) and thereafter before the Tribunal. The ITAT vide its consolidated order in ITA No. 6471 & 6908/Bom/1983, 3695 and 6911/Bom/1984 for assessment years 1980-81 and 1981-82 order dtd. 16-12-1992 on the issue of disallowance of laboratory expenses has observed and held vide para 8 as under:-

“8. The next dispute in revenue’s appeals for the two years is for laboratory expenses incurred outside India and attributable to Indian Branch and whether would be treated as head office expenses for the purposes of disallowance under s. 44C of the Act. We find that in the assessment year 1979-80, an identical point was sent back to the file of the assessing officer, by the Tribunal. For similar reasons and with similar directions, we set aside the orders of the departmental authorities on the point and sent back the matter to the assessing officer to examine the issue afresh after affording an opportunity of being heard to the assessee.”

Pursuant to the order of the Tribunal, the A.O. provided opportunity to the assessee and examined the issue of applicability or otherwise of section 44C of the Income Tax Act, 1961 (the Act) in respect of laboratory expenses. In response, the assessee filed certificate of overseas auditors M/s Arthur Andersen & Co., U.K. along with details of R&D expenses and apportionment of total laboratory expenses. However, the A.O. did not accept the assessee’s explanation. He observed that the entire R&D activities have been centralized under the Wyeth Laboratories in U.K., and the expenses are merely in the nature of general administrative and executive in nature, and hence the applicability of section 44C of the Act is inevitable. He further observed that since the R&D is centralized by the Head Office in U.K., it is also equally valid to conclude that the R&D matters are connected with executive and general administration. The A.O. while examining the issue even under the provisions of section 37(1) of the Act held that the entire claim of laboratory expenses are covered/restricted to the provision of section 44C of the Act and accordingly he disallowed the claim of the assessee Rs. 66,90,924/- and added the same to the total income of the assessee. The A.O. for the same reasons also disallowed similar expenses Rs. 68,25,014/- for the A.Y. 1982-83.

3. On appeal, the ld. CIT(A) vide his common order observed that it is well known that Arthur Andersen & Co. is a tainted tax audit company and its certificate cannot be taken for granted particularly when this certificate was also available before the Tribunal. He further observed that the R&D expenditure has been incurred by the Head Office in U.K. and accordingly a portion of the expenditure is allowable in computing the appellant’s income only if the result of the R&D has been utilized by the branch office in India. He further observed that it is not the case that the Indian branch has incurred any such expenditure on his own in the U.K. He further observed that the appellant has failed to produce the books of accounts, the relevant documents and particularly the evidence that this expenditure had not been allowed or proportionately disallowed in case of the parent company in U.K. Income Tax assessment and accordingly he upheld the disallowance made by the A.O. for both the assessment years.

4. Being aggrieved by the order of the ld. CIT(A) the assessee is in appeal before us challenging in the common grounds for the assessment years 1981-82 and 1982-83 the sustenance of disallowance of laboratory expenses Rs. 66,90,924/- in A.Y. 1981-82 and Rs. 68,25,014/- in A.Y. 1982-83.

5. At the time of hearing the ld. counsel for the assessee, at the outset, submits that the Tribunal in assessee’s own case in ITA Nos. 1916 (Bom) and 1917 (Bom) of 1980 for assessment years 1975-76 and 1976-77 order dtd. 12-4-1983 on the appeal filed by the Revenue while upholding the order of the ld. CIT(A) has held vide para 7 of the order as under:-

“7. Having heard the parties and after going through the details of the World expenses and the manner in which they have been apportioned as made in annexure ‘A’ and ‘B’ to the order of the Commissioner of Income-tax (Appeals) and other statements prepared by the assessee at our instance, we hold that the assessee’s claim for deduction was correctly accepted by the Commissioner of Income-tax (Appeals). As pointed out by the Inspecting Assistant Commissioners and the Commissioner of Income-tax (Appeals), the fact that no portion of the expenses under some of the heads is stated to have been exclusively incurred for the United Kingdom business is somewhat inconceivable. However, having regard to the fact that the assessee has itself not claimed any portion of the expenses under other heads and has claimed less than the proportionate expenses under other heads suggests that the assessee has while making the claim applied its mind fairly and reasonably. Apart form the fact that this system is being accepted by the Department in the past we find that the percentage of expenses to Indian sales and Indian income to Indian sales after making into account the Head Office expenses claimed as expenses pertaining to Indian income compares favourably if the same method is adopted to the World Sales, World expenses and World income or United Kingdom income. United Kingdom expenses and United Kingdom sales. In this view of the matter, we do not think that there is any material before us justifying interference with the order of the Commissioner of Income-tax (Appeals). As regards the introduction of section 44C in the Income-tax Act, 1961, with effect from 1.6.1976 we do not think that it is really necessary for us to make any comment as that section, admittedly, is not applicable to the proceedings in appeal.”

He further submits that the Tribunal for the assessment years 1980-81 and 1981-82, however, set aside the issue to the file of the A.O. following the Tribunal order for the A.Y. 1979-80. He further submits that against the order passed by the Tribunal for the assessment years 1980-81 and 1981-82, the Hon’ble jurisdictional High Court in John Wyeth & Bros. Ltd. v. CIT [2009] 312 ITR 86/174 Taxman 451 (Bom) has examined the issue of applicability of laboratory expenses in the light of the provisions of clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Act. Their Lordships while upholding the order of the Tribunal in remanding the matter to the file of the A.O. for disposal afresh held that if the assessee were to satisfy that the expenses incurred towards laboratory expenditure did not include any executive or general administration expenditure indicated in clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Act, the expenditure claimed would be allowable. In the light of the above, the ld. counsel for the assessee referred to the following certificate/statements:-

 1.  Certificate from Arthur Andersen & Co. re. Laboratory expenses – assessment year 1981-82 (page No. 21-24 of paper book).

 2.  Allocation Statement of London Overheads – assessment year 1981-82 (Page No. 25-27 of paper book).

 3.  Certificate from Arthur Andersen & Co. re. laboratory expenses – assessment year 1982-83 (Page No. 28-33 of paper book).

 4.  Allocation Statement of London Overheads – assessment year 1982-83 (page No. 34-36 of paper book).

 5.  Computation of tax for the assessment year years 1981-82 and 1982-83 (Page No. 37-43 of paper book).

In view of the above, the ld. counsel for the assessee submits that the apportionment of laboratory expenses based on the percentage of gross sales of the Indian Branch to total gross sales of Head Office – U.K. are equivalent to Indian Rupees 66,90,924/- for A.Y. 1981-82 and Rs. 68,25,014/- for A.Y. 1982-83 and did not include any expenditure under clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Act and, hence, the same are allowable as claimed by the assessee. The ld. counsel for the assessee further submits that the Hon’ble Supreme Court of the United States in the case of Arthur Andersen LLP v. United States 544 U.S. – (2005) has reversed the judgment of the Court of appeal vide opinion of the Court dtd. May 31, 2005, therefore, the observation of the ld. CIT(A) that Arthur Andersen & Co. is a tainted Tax Audit Company and its certificate cannot be taken for granted is not valid in law. He further submits that since the assessee has filed all the relevant details before the A.O. and ld. CIT(A), the ld. CIT(A) without examining the same was not justified in rejecting the claim of the assessee. The ld. counsel for the assessee has also placed reliance on the following cases :

  –  British Bank of Middle East v. Jt. CIT [2005] 4 SOT 122 (Mum)

  –  Cairn Energy India (P.) Ltd. v. Asstt. CIT [2009] 126 TTJ 226 (Chennai)

  –  Asstt. CIT v. Modicon Network (P.) Ltd. [2007] 14 SOT 204 (Delhi)

  –  CIT v. Dunlop Rubber Co. Ltd. [1983] 142 ITR 493/[1982] 10 Taxman 179 (Cal.)

  –  Bangalore International Airport Ltd. v. ITO (International Taxation) [2008] 307 ITR (AT) 295 (Bang.)

  –  Dy. DIT (International Taxation) v. Stock Engg. & Contractors B.V. [2009] 27 SOT 452 (Mum).

6. On the other hand the ld. D.R. while relying on the order of the A.O. and the ld. CIT(A) further submits that since the assessee has failed to produce the books of accounts and even to submit the annual accounts of the U.K. Company for the assessment years 1981-82 and 1982-83 and the relevant assessment order of the parent company, therefore, the ld. CIT(A) was fully justified in upholding the disallowance made by the A.O. He further submits that even as per the judgment of the Hon’ble jurisdictional High Court, the assessee is required to prove as to whether the expenses claimed by the assessee did or did not include any executive and general administration expenditure as indicated in clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Act and since the assessee has failed to produce the relevant documents in this regard, the A.O. was justified in rejecting the claim of the assessee. He, therefore, submits that the order passed by the A.O. and confirmed by the ld. CIT(A) be upheld.

7. We have carefully considered the submissions of the rival parties and perused the material available on record. We find that the facts are not in dispute inasmuch as it is also not in dispute that the Revenue upto the assessment years 1975-76 & 1976-77 has accepted apportionment of laboratory expenses based on the percentage of gross sales of the Indian Branch to total gross sales of Head Office in U.K. However, in the assessment years under consideration the A.O. disallowed the claim of the assessee on the ground that the expenses claimed by the assessee are merely in the nature of general administration and executive in nature, therefore, according to the provisions of section 44C of the Act the same are not allowable. On appeal the ld. CIT(A) while observing that the appellant has failed to produce the books of accounts and relevant documents and particularly the evidence that the said expenditure had not been allowed or proportionately disallowed in the case of parent company in U.K. Income Tax assessment, confirmed the disallowance made by the A.O.

8. Their Lordships in assessee’s own case in John Wyeth & Brother Ltd. (supra) has examined the provisions of section 44C of the Act in detail and observed and held as under (page 87 to 89):-

“The definition of “head office expenditure” given in Explanation (iv) to section 44C is once again reproduced hereunder.

“(iv) head office expenditure means executive and general administration expenditure incurred by the assessee outside India, including expenditure incurred in respect of

(a)  rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession.

(b)  salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary whether paid or allowed to any employee or other person employed in, or managing the affairs of, any office outside India.

(c)  travelling by any employee or other person employed in, or managing the affairs of, any office outside India ; and

(d)  such other matters connected with executive and general administration as may be prescribed.”

From the above definition it is clear that the head office expenditure means “executive and general administration expenditure”. The definition of head office expenditure also states that it includes expenditure incurred in respect of sub-clauses (a), (b), (c) and (d) under Explanation (iv). It, therefore, cannot be doubted that the expenditure on sub-clauses (a), (b), (c) and (d) has necessarily to be of the nature of executive and general administration expenditure. The contention of the advocate for the Revenue to the contrary is, therefore, rejected.

The Income-tax Circular No. 202, dated July 5, 1976, makes it extremely clear that section 44C was introduced in the Act because it was becoming very difficult to scrutinise and verify claims in respect of general and administrative expenses incurred by the foreign head offices in so far as such expenses were related to their business or profession in India, particularly in the absence of account books of the head office which are kept outside India. Foreign companies operating through branches in India some times tried to reduce the incidence of tax in India by inflating their claims in respect of the head office expenses.

We have noted the fact that the Assessing Officer has without calling for any documents pertaining to the laboratory expenses come to the conclusion that the laboratory expenses would fall under the category of “executive and general administration expenses” and, therefore, ceiling prescribed under section 44C would apply to such expenses. On the other hand, the Commissioner of Income-tax (Appeals) without any verification by merely relying on the assessee’s statement that the research and development expenditure claimed does not include the expenditure in the nature of rents, rates, taxes, salaries, etc., reached the conclusion that the laboratory expenditure was not connected with the general and administrative expenditure covered by clauses (a), (b), (c) and (d) of Explanation (iv) of section 44C. We are of the view that the Tribunal in the absence of any evidence has not reached a final conclusion whether laboratory expenses are covered under section 44C or not and has taken a very reasonable and rational view, namely, that the matter requires consideration as to whether the laboratory expenses include any of the expenditure mentioned in clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Income-tax Act, 1961. We see merit in the suggestion of the Tribunal that the establishment/supporting staff may exist in connection with maintaining of the laboratory and that could be the expenditure in the nature of that indicated in clauses (a) to (d) for such establishment/supporting staff. This is all the more required because as recorded by the Assessing Officer the assessee had in fact clubbed this expenditure with the head office expenditure in the computation of income filed with the return. We agree that an examination as to whether the expenses claimed did or did not include any executive and general administration expenditure as indicated in clauses (a) to (d) of Explanation (iv) to section 44C is required instead of accepting the assessee’s bare statement without an iota of evidence that such expenditure did not include the expenses set out in clauses (a) to (d) without any verification. If mere statement of the assessee is accepted without any verification as is done in the instant case by the Commissioner of Income-tax (Appeals), the object of introducing section 44C would get frustrated.

We are, therefore, of the view that the Tribunal is right in remanding the matter back to the file of the Commissioner of Income-tax (Appeals) for disposal afresh. We make it clear that the assessee would be free to show the expenses incurred towards laboratory expenditure and satisfy the Commissioner of Income-tax (Appeals) that they did not include any executive and general administration expenditure indicated in clauses (a) to (d) of Explanation (iv) to section 44C of the Income-tax Act, 1961. Needless to add that if the assessee succeeds in satisfying the Commissioner of Income-tax (Appeals) to the effect set out above, the expenditure claimed by it would be allowable.”

9. Keeping in mind the principle laid down by Their Lordships, we find that the assessee has filed auditors certificate dtd. 27-1-1984 and 25-1-1985 for the year ended on 31-10-1980 and 31-10-1981 respectively along with relevant details appearing at page 21 to 43 of the assessee’s paper book. The relevant paras of the certificate of the Chartered Accountant dtd. 27-11-1984 for the A.Y. 1981-82 read as under:-

“……We confirm that total laboratory expenses of Pound 2,792,275 were incurred by John Wyeth & Brother Limited and are incorporated in the statutory accounts of John Wyeth & Brother Limited at 31 October 1980 upon which our firm gave an unqualified audit report.

We also confirm that the detailed analysis of this expenditure as shown on Schedule 1 (document two above) is in agreement with the accounting records of the Company which formed the basis of the statutory accounts referred to in the preceding paragraph.

We confirm that laboratory expenses incurred directly by the Indian branch, Pound 13,803 is in agreement with the financial statements of the Indian branch as received by the Company in the United Kingdom and incorporated into the statutory accounts for the year ended 31 October 1980. We also confirm that an additional apportionment of pound 362,063 was made to the Indian branch. This apportionment is based on the percentage of gross sales of the Indian branch to total gross sales of John Wyeth & Brother Limited……..”

The relevant paras of the certificate of the Chartered Accountant dtd. 25-1-1985 for the A.Y. 1982-83 read as under:-

“……We confirm that total laboratory expenses of Pound 3,404,133 were incurred by John Wyeth & Brother Limited and are incorporated in the statutory accounts of John Wyeth & Brother Limited at 31 October 1981 upon which our firm gave an unqualified audit report.

We also confirm that the detailed analysis of this expenditure as shown on Schedule 1 (document two above) is in agreement with the accounting records of the Company which formed the basis of the statutory accounts referred to in the preceding paragraph.

We confirm that laboratory expenses incurred directly by the Indian branch, Pound 16,789 is in agreement with the financial statements of the Indian branch as received by the Company in the United Kingdom and incorporated into the statutory accounts for the year ended 31 October 1981. We also confirm that an additional apportionment of pound 417,693 was made to the Indian branch. This apportionment is based on the percentage of gross sales of the Indian branch to total gross sales of John Wyeth & Brother Limited……….”

The details of research and development expenses as per Schedule I (in Pounds) are as under:-

We further find that the assessee has also filed the details of apportionment of the expenses based on the percentage of gross sales of the Indian Branch to total gross sales by the U.K. Company which is as under:-

We further find that the assessee has also filed financial statements to show that the U.K. Company has shown executive or general administration expenditure as indicated in clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Act separately appearing at pages 25 to 27 for A.Y. 1981-82 and at pages 34-36 for A.Y. 1982-83 of the assessee’s paper book, therefore, the assessee has proved beyond doubt that the expenses claimed on the laboratory expenses did not include any executive or general administration expenses indicated in clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Act. Since all these details were already filed by the assessee before the A.O. and the ld. CIT(A) and the Revenue Authorities without examining the same or without pointing out any item of disallowable nature to show that the said item of expense did not pertain to laboratory expenses has disallowed the claim of the assessee on the ground that the said expenses are in the nature of general administration and executive in nature as provided u/s 44C of the Act.

10. In the absence of any contrary material placed on record by the Revenue to show that the laboratory expenses claimed by the assessee did include the expenses incurred on executive or general administration as indicated in clauses (a), (b), (c) and (d) of Explanation (iv) to section 44C of the Act, we are of the view that the ld. CIT(A) was not justified in sustaining the disallowance of laboratory expenses and accordingly we delete the addition of Rs. 66,90,924/-for A.Y. 1981-82 and Rs. 68,25,104/- for A.Y. 1982-83. The common grounds taken by the assessee are, therefore, allowed.

11. In the result, assessee’s appeals stand allowed.

NF