ITAT held that a right acquired by the taxpayer to convert advance given into equity shares falls under the definition of ‘Capital Assets’ as per Section 2(14) Income-tax Act,1961 (the Act). Accordingly, the compensation received for foregoing right to acquire equity shares is a transfer of ‘Capital Assets’ and is taxable as capital gain under the Act.
The Tribunal observed that the word ‘of any kind’ under the definition of ‘Capital Assets’ provided under Section 2(14) of the Act is of widest amplitude and therefore, any right which can be called property will be included within the definition of ‘Capital Assets’. Accordingly, the payment received towards the compensation for waiver of rights to receive the shares is taxable as capital gain.
FULL TEXT OF THE ABOVE JUDGMENT IS AS FOLLOWS:–
Income Tax Appellate Tribunal, Hyderabad
I.T.A. No. 765/Hyd/2011 – Assessment year: 2007- 08
Deputy Commissioner of Income-tax vs M/s. Natco Pharma Ltd.
I.T.A. No. 319/Hyd/2011 – Assessment year: 2007- 08
M/s. Natco Pharma Ltd. vs Deputy Commissioner of Income-tax
Date of pronouncement: 29.02.2012
PER CHANDRA POOJARI, A.M.
These are cross appeals by the assessee as well as the Revenue directed against the order of the CIT(A)-V dated 15.2.2011.
2. The brief facts of the case are that the assessee company is engaged in the business of manufacturing and sale of bulk drugs. For the assessment year under consideration, the assessee company filed its return of income on 31.10.2007 admitting a total income at Rs. 17,14,67,250/-. Thereafter, the assessee company filed revised return of income on 20.11.2008 revising its total income at Rs. 12,52,93,840/-. The books profit under section 115JB of the Act was admitted by the assessee company at Rs .39.53,57,880/-.
3. The Assessing Officer completed the assessment under section 143(3) of the Income-tax Act, 1961 determining the total income of the assessee company at Rs. 33,15,68,500/-. While completing the assessment, the assessing officer held that Rs. 10 crores received as compensation for foregoing right to acquire the shares of Krishnapatnam Port Co. Ltd., [KPCL] as short term capital gain instead of assessee’s claim that it is not taxable since the cost of acquisition of such right is to be taken notionally as ‘NIL’. The assessee company also claimed that right to acquire equity shares is not a capital asset as per section 2(47) of the Act and compensation received for waiver of such right is a capital receipt and the same is not taxable. The other issue being restricting the deduction under section 80IC of the Act to Rs.6,01,46,943/- as against the assessee company claim of Rs. 20,66,45,736 by referring to the provisions of section 80IA  of the Act. The assessing officer also made an addition of Rs. 1,32,78,739/- interest receivable on loan given to Natco Organics Limited.
4. Aggrieved by the order of the assessing officer, the assessee preferred an appeal before the first appellate authority. After elaborate discussion by the CIT [A], he held that the receipt of Rs. 10 crores, has to be assessed as income from other sources as per his discussions in para 5.5 to 5.8 of his order. With regard to the recalculation of deduction under section 80IC of the Act, he confirmed the action of the assessing officer and with regard to the addition made by the assessing office towards interest, he deleted the addition. Thus, the appeal of the assessee is partly allowed by the CIT [A]. Aggrieved further, both the assessee and department are in appeal before us.
5. The learned counsel for the assessee submitted that during the financial year relevant to the assessment year 2007- 08, the company received Rs. 10 Crores towards compensation for waiving the right to receive the equity shares which was admitted under the head “Other Income” in the profit and loss account. In the computation of income the assessee company claimed this receipt to be capital in nature. The assessee company promoted KPCL for establishing and developing a minor deep seaport at village Krishnapatnam in Nellore District. In order to implement the project and pending financial closure, the assessee company financed capital expenditure and also day to day revenue expenditure of the promoted company pursuant to agreement entered into on 9-6-1997. As per the agreement, the assessee company has a right to convert the advances given into equity shares of KPCL at a mutually agreed rate. The assessee company promoted the KPCL and entered into the above agreement with an object to implement the project, acquire equity stake and derive capital appreciation in the long run. No separate consideration has been paid for acquiring the right to receive equity shares. The loans advanced were to be converted into equity shares. The assessee company received Rs. 10 crores as compensation to waive the right to convert the advances into equity shares.
6. It is submitted that the compensation of Rs. 10 crore received for waiver of right to convert advances into equity shares is not a revenue receipt. The compensation amount has no character of a revenue receipt. The assessee company is not in the business of promoting and disposing off companies. If it was so, the compensation received would have been a revenue receipt. As could be seen from the agreement that the assessee company promoted and nurtures the company over a period of ten years spending substantial funds only with a view to successfully implement the project and acquire shares and reap capital appreciation and gain in the long run. By renouncing the right to convert its advances into share capital, the assessee company has forgone the capital appreciation and also source of recurring revenue by way of dividends. The learned counsel for the assessee relied on the decision of Apex Court in the case of Oberoi Hotels Private Limited reported in 236 ITR 903 wherein it was held that compensation received by an assessee for foregoing pre-emptive right to purchase or lease a property would be in the nature of capital receipt. He also relied on the decision of Apex Court in the case of Kettle well Ellen and Co. Ltd. Vs CIT. The amount of compensation of Rs. 10 crore has been received through cheque pursuant to the agreement dated 18.04.2006. The right to acquire equity shares in KPCL was waived for a consideration of Rs. 10 crore as per clause 5 of the agreement referred to above. Therefore, the lower authorities are not correct in treating the same as either short term capital gain or income from other sources.
7. On the other hand, the learned Departmental representative relied on the orders of the lower authorities.
8. We have considered the rival submissions and perused the material available on record. We find that the assessee company entered into an agreement with KPCL ON 9TH JUNE 1997 as per which the assessee would advance funds to KPCL to meet its expenses and in consideration for having met advanced funds, the assessee will have a right to convert its advances into equity shares of KPCL at a rate to be mutually between these two paties. We have perused the said agreement and we find that by virtue of this agreement entered into with KPCL on 9-6-1997, the assessee company has a right to convert its advances into equity shares of KPCL at a price to be mutually agreed upon. However, there was a tripartite agreement on 30-06-05 between assessee, KPCL and Shri V.C Nannapaneni by which the present assessee agreed to waive its right to convert the advance made by it to KPCL into equity shares of KPCL subject to receiving suitable compensation. The assessee through this triprtite agrement has received Rs. 26,19,72,872, which is reimburse of enitre advance and also received Rs. 11,60,82,000/- as interest on money advanced to KPCL which was paid by Mr. V.C. Nannapaneni on behalf of M/S KPCL. However, the issue relating to compensation payble to assessee to be decided on mutually agreeable terms, at a later point of time. The compensation for waiver of right to convert the shares has been agreed upon by Shri. Nannapaneni and the assessee company separately vide agreement dated 18-04-2006. As per this agreement dated 18-04-2006, the payment of Rs. 10 crores, is exclusively towards waiver of its rights to convert the advances made by assessee to KPCL into equity shares. We also find that the funding by the assessee company in Natco is primarily to acquire the shares in respect of funds advanced. Therefore, the total amount advanced to be treated as a consideration for acquiring the shares in KPCL. Therefore, the advances given to KPCL do fall under the definition of capital asset under section 2 of the Act as we find that the assessee company agreed to receive back its advances with interest and in addition to compensation for waiving the its right convert advance into shares. The assessee company admitted that it had received back the advances and interest thereon in the assessment year 2006- 07 and it cannot turn back and take a fresh stand that the compensation received is a capital receipt. Under section 2(14) of the Income Tax Act 1961, a capital asset means property of any kind held by an assessee, whether or not connected with his business or profession. The word ‘property’ used in s 2(14) is a word of the widest amplitude and the definition has reemphasized this by the use of the words ‘of any kind’. Any right which can be called property will be included in the definition of ‘capital asset’. An agreement for allotment of sale is capable of specific performance. It is also enforceable. Therefore, a right acquired by the assessee to convert the advance given to KPCL into allotment of shares is clearly property as contemplated by section 2(14) of the Act. The main contention of ld. Counsel of assessee is that even if the right acquired by the assessee for allotment shares can not be considered as a property within the meaning of section 2(14) still there was no transfer of that property by the assessee to attract the liability of capital gains tax. Under section 45, the liability is on any profits or gains arising from the transfer of capital assets effected in the previous year. According to the ld.Counsel for the assessee, there was no transfer of property effected in the previous year to give rise to capital gain liable to tax under the Act. Section 2(47) of the Act gives an inclusive definition of the capital gains as under:
2(47) Transfer in relation to a capital asset, includes:
i) The sale, exchange or relinquishment of the asset; or
ii) The extinguishment of any rights therein;
9. In the present case, the assessee gave up its right to get allotment of shares of KPCL and the relinquishment of an asset is a transfer u/s 2(47). There was yet another contention raised by the ld. AR relying on the decision of Supreme Court in the case of B.C. Sreenivasa Setty (128 ITR 294) that what is contemplated by section 48(ii) is an asset in the acquisition of which it is possible to envisage a cost and that none of the provision pertaining to the head ‘capital gains’ suggests that they include an asset in the acquisition of which no cost at all can be conceived. He also relied on the judgement of Supreme Court in the case of CIT vs. D.P. Sandu Bros., Chembur Pvt. Ltd. & Ors. [273 ITR 1 (SC)]. It was the contention of AR that, there was no cost of acquisition incurred by the assessee for obtaining the rights under the agreement cited earlier in this order and so there could be no capital gains assessable in that connection. We are not inclined to agree with the ld. Counsel that there was no cost incurred by the assessee for acquiring the right to get the allotment of shares in its favor. It was not as if the KPCL had unilaterally bestowed on the assessee, the right to allotment of shares in its favor. It is to be noted that at the time execution of the agreements dated 9th June 1997 the assesee and thereafter also assesee advanced money to KPCL to the tune of Rs.26, 19,72,872/-. That was a payments made in terms of the agreements. It was by paying this sum, that assessee acquired the right to get allotment of shares in its favour. When the assessee gave up that right or assigned it in favor of Mr. V.C. Nannapaneni , the assessee received Rs. 10 Crores and this amount is liable for capital gain taxes.
10. AR relied on following case laws:
i) Kalyani Exports & Investments (P) Ltd./Jannhavi Investments (P) Ltd./Rajgad Trading (P) Ltd. Vs. DCIT (78 ITD 95) (Pune) (TM)
ii) Nalinikant Ambalal Mody Vs. S.a.L. Narayan Row, CIT, Bombay City-I, 61 ITR 428 (SC)
11. The decisions relied upon by the learned counsel for the assessee distinguishable on facts of the present case. After considering the totality of facts and circumstances of the case, in our considered view, the entire amount of Rs. 10 crores received by the assessee company towards compensation for waiver of rights to receive the shares of KPCL is to be brought to tax as capital gain. This capital gain is to be computed as long term or short term as the case be on prorate basis depending upon the investments/advances as made by assessee. As we have held that the assesee is liable to capital gain tax on the relinquishment of right to allotment of shares, the other arguments of the ld. AR contesting the order of CIT(A) that the CIT(A) erred in sustaining the addition of Rs. 10 crores as income from other sources has became infractuous and dismissed accordingly. Similar is the position in respect of ground no. 3 of Revenue wherein the Revenue has the grievance with regard to treating the income as income from other sources instead of treating the same as short term capital gain.
12. The grounds raised by the assessee as well as Revenue on this issue are partly allowed.
13. Next issue relates to the restriction of deduction under section 801C of the Act to Rs. 6,01,46,943/- as against Rs. 20,66,45,736/-. The facts are that the assessee company has three units i.e., at Mekaguda, Kothur and Dehradun. The unit at Dehradun was set up in June, 2006 and during the current year deduction under section 801C was available. In Mekaguda, bulk drugs and active pharmaceuticals (APIs) are manufactured whereas in Kothur and Dehradun finished dosage of pharmaceutical formulations are made. The Assessing Officer observed that the total turnover of the Dehradun unit was Rs. 25,66,45,736/- and the net profit was Rs. 20,82,36,882/-. The net profit worked out to 81.14% of the turnover. For the other units excluding Dehradun unit the profit worked out to only 6% of the total sales. Even for the Kothur unit where exactly the same operations-were carried out as at Dehradun, the profit margin was much less and at Mekaguda, whereas the main work was done, there was actually a loss. Accordingly, the Assessing Officer recalculated the profits and the eligible deductions under section 801C of the Act. He made a detailed working at pages 12 and 13 of his order and found that the profits of Dehradun unit have been overstated or inflated. He held that the average gross profit ratio of Mekaguda and Dehradun units has to be adopted for the Dehradun unit also for the purpose of working out eligible deduction under section 801C of the Act. On appeal, the CIT [A] confirmed the action of the assessing officer in restricting the deduction under section 80IC of the Act.
14. The learned counsel for the assessee submitted that as per the provisions of Section 80-IA(8) of the Act which are applicable in view of provisions of Section 80IC (7) of the Act where any goods or services are transferred from other business to eligible business, the market value of such goods or services as on the date of transfer are to be considered for computation of income. Only where in the opinion of assessing officer the computation of profits and gains of the eligible business in the manner prescribed presents exceptional difficulties then a reasonable basis may be adopted. Whereas in the case under consideration, the assessing officer without narrating as to what exactly is the exceptional difficulty in computing the profits in the manner laid down in the provision has resorted to clubbing the incomes of the units at Mekaguda and Dehradun and resorted to arrive at a proportions at which profits of eligible business could be derived. The reasons given otherwise for such a method is that the assessee has inflated the income of the eligible business and deflating the income of non eligible unit. To come to this conclusion he relied on statements recorded from two of the technicians of the company who were produced before him on his direction. It is settled principle of law that whenever a statement is used against somebody it is required to provide copy of such statement and allow cross examination. Even when the witness is that of the assessee also, cross examination needs to be allowed when adverse inference is drawn from such statement. The statement could not have been used without providing an opportunity to the assessee. Therefore, it is submitted that this is purely a surmise and has no basis. The eligible unit earns higher income since the products marketed are cancer drugs and there are very few such drugs. If the assessing officer has to arrive at such conclusion he should have compared the income of non eligible unit with another comparable unit to hold that the income is deflated by claiming excess expenditure. He should prove as to what is the excess expenditure. Pharmaceutical industry as such is an industry where the expenditure will be very high. Without any comparison the assessing officer by just comparing with eligible unit with non eligible unit concluded that there is inflation of income and deflation of income. It is submitted that this is contrary to provisions of law and even on facts.
15. It is submitted that the assessing officer at best could have arrived at the market value of the goods transferred by adding reasonable percentage of profit of the unit that manufactured the same and should not have resorted to clubbing and arriving at the allowable deduction. It is prayed that the assessing officer be directed to arrive at the Market value and re-compute the profits eligible for deduction. Further he submitted that the AO shall consider the price of the goods which ordinarily fetch in the opern market. For this purpose he relied on the order of the Tribunal in the case of DCW Vs. Addl. CIT (37 SOT 322) (Mum).
16. On the other hand, the learned Departmental Representative submitted that sub-section (8) is applicable where any goods held for any other business of the assessee are transferred to the eligible business. In the case of the assessee, Active Pharmaceutical Ingredients (APIs) in the form of Imatinib Mesylate and Geftinib from Mekaguda unit are transferred to Dehradun unit purportedly at cost. In fact, they constitute the main raw material used at Dehradun for manufacture of finished dosage formulations of capsules / tablets. In fact, the total sales turnover of the Dehradun unit in the above formulations is Rs. 25,27,24,048/-. The entire materials of APIs are transferred from Mekaguda unit. The assessee cannot market the APIs produced at Mekaguda because of US FDA restrictions and has to convert them into dosage formulations before sale of the products. Thus, the whole activity of production of APIs to formulations is to be treated as an integrated activity of the assessee. It is the API which has been awarded patent and not the formulation. Therefore, the value attributable to APIs should be the major component of final value of the formulation. Since APIs have no comparable market products outside their company, its uniqueness and know-how gives it the value in the market. If it is a commonly manufactured item available with competitors, the value of API is reduced substantially. The manufacturing process involved at Dehradun is relatively very simple in that, it consists of only sifting, mixing, drying, lubrication, compression and coating of the products. The value of plant and machinery is another indicator of the extent of manufacturing that takes place at Dehradun. The total value of machinery used is of Rs. 57,03,202/-. It is apparent from the descriptions of the machinery, that the activity relating to value addition of the product is negligible at Dehradun as they are mostly useful for blending and mixing and compression into tablets and for packing. There is no much manufacturing activity involved in this process. The total of expenses other than raw material shown at Dehradun are Rs. 44,09,934/- which is not commensurate with the scale of operations required. The assessee himself has produced two expert staff who in their depositions stated that they were given annual salaries to the tune of Rs. 10 lakhs in total whereas the salaries debited in the Profit and Loss account are only Rs. 1,09,036/-. It is also stated by them that at least 20 to 30 employees were engaged in Dehradun. The salaries given to the above persons do not find a place in the Profit and Loss account of Dehradun unit. Therefore, it is apparent that the profits of Dehradun unit have been inflated purposefully.
17. Most of the raw material for the Dehradun is transferred from Mekaguda unit. Final product is being manufactured at Mekaguda unit, whereas, at Dehradun unit capsules are filled with the drug. The value addition is nominal at Dehradun unit and virtually the entire value addition takes place at Mekaguda unit. For the purpose of arriving at deduction under section 801C of the Act, the eligible profits should be worked out basing on the gross profit ratio at Mekaguda unit. Therefore, the lower authorities correctly restricted deduction under section 801C of the Act of Rs. 6,01,46,943/- as against the claim of the assessee for a sum of Rs. 20,69,69,445/-
18. We have considered the rival submissions and perused the materials available on record. We have also considered carefully the facts and circumstances of this case. We find that proviso to section 801A (8) of the Act clearly empowers the assessing officer to re-compute the eligible profits on a reasonable basis as he deems fit. The facts of the case are self-evident that it is unthinkable that the Dehradun unit would be giving such exceptional profits while the main unit at Mekaguda is showing less. The Assessing Officer has pointed out in the assessment order that the assessee has clearly deflated salary expenses, raw material expenses, etc. with respect to Dehradun to artificially inflate the profit. The statements recorded by the assessing officer from two employees of the assessee company clearly shows that expenses had not been booked in Dehradun but booked in other units to artificially shift profits into Dehradun unit. According to the Assessing Officer the formulations in Mekaguda unit cannot be sold in the market, it is obviously not practical for him to calculate the prices of inputs on the basis of market prices. In our opinion, it is most appropriate to consider the actual cost as per cost records maintained by the assesee and thereafter assessing office consider the profits on these transaction as compared to other industries in similar line or if there is no comparable, fix reasonable percentage of profit depending upon market condition prevailing in the similar line of industry. Accordingly, we set aside this issue to the file of assessing office to bring the comparable cases on record and redo the assessment on this issue.
19. The main ground raised by the Revenue is relates to the deletion of addition of Rs. 1,32,78,739/- by the CIT [A]. The assessee company had advanced certain loans to M/s Natco Organics Limited in the earlier years. Such advances up to assessment year 2007-08 amounted to Rs. 36,38,82,205/-. The assessee has not admitted any interest for the above advance. It was stated that the advance was given for business purpose of the assessee and that the issue has been decided in favor of the assessee by this Tribuanl. However, the total interest of Rs.5,96,29,676/- is stated to have been admitted in the assessment year 2008- 09. The assessee ought to have admitted interest of Rs. 1,32,78,739/- pertaining to the current assessment year which was not done. Therefore, the same is brought to tax and added back to the income of the assessee- Rs. 1,32,78,739/- by the assessing officer. On appeal, the CIT [A] deleted addition holding that the assessing officer does not have any reasons or basis to show that interest had been charged by the assessee company for the current year and had not been disclosed. Hence, the department is in appeal before us.
20. The learned counsel for the assessee submitted that the assessing officer made addition of Rs. 132.79 lakhs as interest not admitted on the amount, advanced to sister company Natco. It is submitted that when dis allowance of interest was made by the assessing officer for earlier assessment year, this tribunal has deleted such additions holding that these advances are from own funds and not from borrowed funds requiring dis allowance. The company itself during the financial year 2007- 08 has decided to charge interest on these advances and accordingly has admitted such interest income in the assessment year 2008- 09 to the tune of Rs. 596.30 lakhs which is the interest for all the years including the present assessment year. When such is the case, the assessing officer is of the opinion that such interest renting to this assessment year ought to have been admitted and accordingly has added. It is submitted that this opinion does not stand to reason and also is not in accordance with the provisions of law. Therefore, it is prayed that the addition deleted by the CIT[A] is to be confirmed. On the other hand, the learned Departmental Representative relied on the order of the assessing officer and the grounds of appeal.
21. We have examined carefully the facts and find that the addition made by the Assessing Officer does not have any basis. The issue is covered in favor of the assessee by the decision of this tribunal on the assessee’s own case in the earlier assessment year. Moreover, the CIT [A] is right in observing that the assessee is correct in saying that interest has to be charged from the date on which there is a resolution of the Board of the company stating that interest has to be charged. The Assessing Officer does not have any reasons or basis to show that interest had been charged by the assessee company for the current year and had not been disclosed. Accordingly, we do not see any infirmity in the order of the first appellate authority and the same is confirmed. The ground raised by the revenue on this issue is dismissed.
22. In the result, the assesee appeal as well as the Revenue appeal are partly allowed.
Order pronounced in the open Court on 29th February, 2012.