PCIT Vs Dishman Pharmaceuticals And Chemicals Ltd (Gujarat High Court)
Conclusion: Once the prior period income was held to be taxable, the prior period expenditure also should be allowed to be set off and assessee was not obliged in law to indicate any direct or indirect nexus between the prior period income and prior period expenditure.
Held: AO found that assessee credited net period income i.e. prior period income minus prior period expenses. AO took the view that during the year under consideration the “prior period income” was taxable, but the “prior period expenses” were not allowable. In such circumstances, AO made addition in respect of the “prior period income” and denied the set off of the prior period expenses against such prior period income. It was held once the prior period income was held to be taxable, the prior period expenditure also should be allowed to be set off and assessee was not obliged in law to indicate any direct or indirect nexus between the prior period income and prior period expenditure.
FULL TEXT OF THE HIGH COURT ORDER /JUDGEMENT
1. This Tax Appeal under Section 260A of the Income Tax Act, 1961 (for short, “the Act, 1961”) is at the instance of the Revenue and is directed against the order passed by the Income Tax Appellate Tribunal, Ahmedabad ‘D’ Bench, Ahmedabad dated 23rd May 2018 in the ITA No.773Ahd2011 for the assessment year 200607.
2. The Revenue has proposed the following questions of law:
“[A] Whether the Appellate Tribunal has erred in law and on facts directing to add only net income after setting off prior period expenditure without appreciating that assessee has been unable to prove expenditure was incurred for earning the particular receipts offered under the head prior period income?
[B] Whether the Appellate Tribunal has erred in law and on facts in deleting the disallowance made u/s. 40(a)(i) of the Act amounting to Rs.1,12,01,869/ without appreciating that assessee had not filed any application u/s. 195 for nondeduction of TDS?
[C] Whether the Appellate Tribunal has erred in law and on facts in directing the assessing officer to exclude unrealised export from the total turnover, without appreciating that the formula adopted by the Appellate Tribunal would render the entire scheme of things nonworkable in as much as the assessee would become entitled to Section 10B deduction even in respect of turnover for which sales proceeds was not realised?
[D] Whether the Appellate Tribunal has erred in law and on facts in directing the assessing officer to consider other income as being eligible for deduction under Section 10B of the Act?”
3. It appears from the materials on record that the return of income for the AY 200607 was filed by the assessee on 31st December 2006 declaring a total income of Rs.9,55,84,979/. A report under Section 92(E) of the Act relating to the international transaction in form No.3CB was also filed. The return was processed under Section 143(1) of the Act, 1961. Notice under Section 143(2) of the Act was issued on 18th December 2007 and was duly served on the assessee.
4. Essentially, the following four issues came up before the Assessing Officer:
(i) Prior period expenditure and prior period income.
(ii) Disallowance made under Section 40(a)(i) of the Act.
(iii) Section 10(B) deduction in respect of the turn over for which the sales proceeds were not realized.
(iv) The other income as being eligible for deduction under Section 10(B) of the Act.
> FIRST QUESTION OF LAW:
5. The Assessing Officer as regards prior period expenditures held as under:
“5.3 While making the alternate plea, the assessee has itself conceded the requirement of taxing at least the prior period Income in excess of the expenditure. No dispute remains about this. Further, no proof was submitted regarding the crystallization of the expenditure in the current year. No bills, no vouchers, no reasoning for lack of provisioning for the expenses in the earlier year were submitted. The accounts are generally finalized after a sufficiently long period of time to make adequate \ provisions for all expenses. Hence, this general statement regarding crystallization is not acceptable.
5.4 Once it is held that the prior period expense cannot be allowed, it has to be considered whether the prior period income can be set off against it.
The treatment of the income would not be the same as the expense. While the expenditure is disallowable as not pertaining to the current year, the income has to be included in total income on the principle taxability on acctual or receipt. Since the same was not taxed in the earlier year on the basis of accrual, the same has to be taxed on the basis of receipt. Since a different set of rules applied to them, they cannot be netted.
5.5 In view thereof the claim for netting of prior period expenditure is denied, and set off of prior period income against prior period expenditure is not accepted. Hence a addition of Rs.46,50,648/is made, being prior period income not offered for tax in this year or earlier years. As the assessee has not debited the prior period expenses in the profits offered for tax, no deduction is done to the income now computed. Penalty u/s. 271(1)(c) is separately initiated for furnishing inaccurate particulars of income.
6. Thus, the Assessing Officer found that the assessee credited Rs.3,39,534. being net period income i.e. prior period income of Rs.46,50,648/ minus the period expenses of Rs.43,11,114/. The Assessing Officer took the view that during the year under consideration the “prior period income” was taxable, but the “prior period expenses” were not allowable. In such circumstances, the Assessing Officer made addition of Rs.46,50,648/ in respect of the “prior period income” and denied the set off of the prior period expenses against such prior period income. The Assessing Officer denied the set off on the basis that a different set of rules applied to such income and expenses.
7. The CIT(A), in the appeal preferred by the assessee, confirmed the addition on the basis that the prior period expenses cannot be adjusted against the prior period income in the absence of any corelation or nexus. The observations of the CIT(A) are as follows:
“3.5 I have considered the facts of the case, assessment order and appellant’s submission. Appellant did not account for complete prior period income on the ground that these are adjusted against prior period expenses. The details and nature of prior period income is not given therefore it cannot be said that prior period income is related to prior period expenses. In absence of any correlation, prior period expenses cannot be adjusted against prior period income. In any case any income accrued or received by the appellant is taxable unless the same is already taxed in earlier year. It is not in dispute that prior period income is not taxed in earlier year therefore the same has to be offered for tax during the year. Since there is no correlation of this income with prior period expenses, the same cannot be set off against this. Accordingly, I agree with the assessing officer that no adjustment of prior period expenses is permissible against prior period incomes which are taxable in this year. This ground is therefore rejected.”
8. In further appeal before the Tribunal, the ITAT held that the income was being assessed at the entity level. All the expenditure debited under the different heads cannot be decided qua a specific receipt. The ITAT took the view that once the assessee offers prior period income, then the expenditure incurred under the different heads should be given set off against that income and only the net income should be added.
9. The observations of the ITAT in the aforesaid context are as follows:
“We have duly considered rival contentions. We find that income of the assessee is being assessed at entity level. All the expenditure debited under different heads cannot be decided qua a specific receipt. Once the assessee has been offering income of prior period as an entity, then its prior period expenditure cannot be disallowed simply by observing that it is not ascertainable whether this expenditure was incurred for earning a particular receipts offered under the prior period income. To our mind, if an assessee is offering prior period income, then the expenditure which was incurred under different heads ought to be set off against that income. Therefore, we are of the view that net differential amount of Rs.3,39,534/ought to be assessed as income of the assessee. We allow both these grounds of appeal statistical purpose and direct the AO to allow set off prior period expenditure against prior period income and only net income is to be added to the total income of the assessee.”
10. Mr. Manish Bhatt, the learned senior standing counsel appearing for the Revenue vehemently submitted that the decision of the Appellate Tribunal as regards the prior period expenditure is erroneous. Mr. Bhatt pointed out that it was noticed by the Assessing Officer, in the course of the assessment proceedings, that the assessee had credited an amount of Rs.3,39,534/ below the PBT net figure. The assessee accepted that the same pertained to the earlier years and having regard to the volume of the business, it had likely to have debit and credit pertaining to the earlier years. Mr. Bhatt submitted that there is no proof or evidence relating to the crystallization of the expenditure in the current year. According to Mr. Bhatt, once the Assessing Officer came to the conclusion that prior period expenditure cannot be allowed, then the same could not have been given set off against the prior period income. While the expenditure was disallowable as not pertaining to the year in question, the income should have been included in the total income of taxability on accrual or receipt.
11. On the other hand, Mr. Tushar Hemani, the learned counsel appearing for the assessee submitted that the only reason assigned by the assessee and the CIT(A) to confirm the addition is that the prior period income and the expenditure do not have any nexus, or in other words, any correlation, and therefore, the set off was declined. According to Mr. Hemani, there is no legal obligation to demonstrate any nexus to claim the business expenditure. Mr. Hemani placed reliance on Sections 37(1) and 57 of the Act, 1961. According to Mr. Hemani, the ITAT committed no error much less an error of law in taking the view that once the prior period was taken into account, the expenses should also be accepted.
> CONCEPT OF “PRIOR PERIOD” AND ITS ACCOUNTING TREATMENTS:
12. As per Section 209 of the Companies Act, 1956, every company is required to prepare and maintain its books of accounts, following the double entry system and the accrual method. At the end of the accounting year / financial year, the financial statements are prepared which furnishes the financial information relating to the financial position. As per Section 211 of the Companies Act, 1956, every company while preparing its profit and loss account and balancesheet has to comply with the Accounting Standards recommended by the Institute of Chartered Accountants of India constituted under the Chartered Accountants Act 1949 (38 of 1949), or the Accounting Standards prescribed by the Central Government in consultation with the National Advisory Committee on the Accounting Standards established under subsection (1) of section 210A of the Companies Act, 2013]. The Accounting Standard 5 “net profit or Loss for the period, prior period Items and changes in the accounting policies”, deals with the issue of prior period items. Vide Para 4.3, it defines the prior period the items as items of income or expenses which arise in the current period as a result of the errors or omissions in the preparation of the financial statements of one or more prior periods. The same read as follows:
“4.3 Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.”
The para 15 of the Accounting Standard indicates that the nature and amount of prior period items, should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived. Para 16 of the standard, restricts itself to those items of income or expenses which arise in the current period as a result of the errors or omissions in the preparation of the financial statements of one or more prior periods. Some of the examples of prior period items are as under :
Error in calculation in providing expenditure or income.
Omission to account for income or expenditure.
Non-provision of travelling expenses for travel already undertaken.
Non-provision for salary already due in earlier year.
Applying incorrect rate of depreciation.
Treating operating lease as finance lease.
Capitalisation of borrowing cost on working capital.
13. Section 37(1) of the Act is as follows:
“37. General (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 a [x x] and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession“.
Hence, the only requirement under Section 37 of the Act is that the expenses (not capital or personal) should be incurred for the purposes of the business or profession. There is no need to demonstrate that a certain expense relates to a particular income in order to claim such expense. Moreover, if the Legislature intended to have such a condition, it would have worded the section accordingly as was done in Section 57(iii) of the Act.
14. Section 57 of the Act is as follows:
“57. Deductions The income chargeable under the head “Income from other sources” shall be computed after making the following deductions, namely
*** *** ***
(iii) any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income.”
15. We are of the view that once the prior period income is held to be taxable, the prior period expenditure also should be allowed to be set off.
16. In the aforesaid context, we may refer to and rely upon a decision of the Delhi High Court in the case of Commissioner of Incometax, Delhi vs. Shri Ram Honda Power Equip [2007] 158 Taxman 474 (Delhi). We quote the following observations:
“25.5 The underlying principle of netting appears to logically get attracted as no prudent businessman would allow taxation of the interest income de hors the expenditure incurred for earning such income. The words ‘included any such profits’ following the words receipts by way of interest, commission, brokerage etc., is a clear pointer to the fact that only net interest would be includable in arriving at the business profit.
25.6 Once business income has been determined by applying accounting standards as well as the provisions contained in the Act, the assessed would be permitted to, in terms of Section 37 of the Act, claim as deduction, expenditure laid out for the purposes of earning such business income.
25.7 Support for this proposition is to be found from Circular No. 621 dated 19.12.1991 of the CBDT.
“32.10 The existing formula often gives a distorted figure of export profits when receipts like interest, commission, etc., which do not have element of turnover are included in the profit and loss account.
32.11 It has, therefore, been clarified that “profits of the business” for the purpose of Section 80HHC will not include receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature. As some expenditure might be incurred in earning these incomes, which in the generality of cases is part of common expenses, ad hoc 10 per cent deduction from such incomes is provided to account for these expenses.””
17. Mr. Hemani, the learned counsel placed reliance on the decision of this Court in the case of Principal Commissioner of Income Tax1 vs. Adani Gas Ltd [Tax Appeal No.900 of 2016 decided on 11th January 2017] wherein two questions fell for consideration of this Court. Those are as under;
“A. Whether the Appellate Tribunal has erred in law and in facts in deleting the disallowance of Rs. 10,28,028/ being the preliminary expenditure under Section 35 D of the Act ?
B. Whether the Appellate Tribunal has erred in facts and circumstances in directing the AO to set off prior period expenditure of Rs. 15,25,746/without considering the merit of the issue?”
This Court held as under:
“3.0. So far as proposed question no.A is concerned, it is with respect to deletion of disallowance of Rs. 10,28,028/ being preliminary expenditure under Section 35 D of the Act. The learned Tribunal has dealt with the same in para 4 and considering the fact that the very expenditure stand accepted in the preceding assessment year and therefore, thereafter it will not be open for the department in the subsequent year to disallow the preliminary expenditure under Section 35 D of the Act, the learned Tribunal has deleted the disallowance of Rs. 10.,28,028/ being preliminary expenditure under Section 35 D of the Income Tax Act. It is not in dispute that in the preceding assessment year, very expenditure stand accepted. The issue is squarely covered against the revenue in light of the decision of the Honble Supreme Court in the case of Shasun Chemicals & Drugs Ltd vs. Commissioner of Income Tax II, Chennai reported in (2016) 243 Taxman 47/73 taxguru.in 293(SC). In the said decision also, the issue was with respect to claim under Section 35 D of the Act and it was found that expenses claimed by the assessee for first two assessments years were allowed by the Assessing Officer, the Assessing Officer in the subsequent assessment year could not have disallowed the same. Under the circumstances, no error has been committed by the learned Tribunal in deleting the disallowance of preliminary expenditure under Section 35 D of the Act. We are in complete agreement with the view taken by the learned Tribunal. Under the circumstances, question No.1 A is answered against the revenue and in favour of assessee.”
“5.0. The aforesaid issue is also as such concluded by the decision of the Division Bench of this Court in the case of Associate Company of the very assessee i.e. in the case of Principal Commissioner of Income Tax1 vs. Adani Enterprises Ltd in Tax Appeal No. 566 of 2016. Even the said issue is also directly covered by the decision of the Delhi High Court in the case of CIT vs. Exxon Mobil Lubricant Pvt Ltd reorted in 328 ITR 17. No error has been committed by the learned Tribunal in accepting the alternative plea and directing the AO to set off prior period of expenditure of Rs. 15,25,746/. The learned Tribunal has directed the Assessing Officer to set off assessees prior period of expenditure and income as per the law. Therefore, necessary consequence shall follow. Under the circumstances, we see no reason to interfere with the impugned judgment and order passed by the learned Tribunal. Question B is also held against the revenue and in favour of assessee. No substantial question of law arise in the present appeal. Hence, present appeal deserves to be dismissed and is accordingly dismissed.”
18. Mr. Hemani also placed reliance on the decision of this Court in the case of Principal Commissioner of Income TaxI vs. Adani Enterprises Ltd [Tax Appeal No.566 of 2016 decided on 20th July 2016] wherein one of the questions was as under:
“(A) Whether on the facts and in the circumstances of the case and in law, the Tribunal was right in deleting the disallowance of Prior Period expenditure of Rs.67,88,591/?”
The Court, ultimately, held as under:
“2. Main question is sum of Rs.67.88 lacs(rounded off) which the Assessing Officer and CIT(Appeals) disallowed treating the expenditure as a prior period expenditure. The Tribunal reversed the findings of the Revenue authorities primarily on two grounds. Firstly, that the assessee being a company was charged uniformly for all years and would therefore, have no revenue implication of whether the expenditure was recognised in this assessment year or earlier year. The second ground was that in any case, the Revenue had recognised the prior period income. If that be so, according to the Tribunal, it would be unfair not to recognise the expenditure also of the prior period.
3. Having heard learned counsel for the parties and having perused the documents on record, we see no reason to interfere. Firstly, the expenditure of Rs.67.88 lacs is a fraction of the total income of the assessee company declared at Rs.105.88 crores. Further, even the Revenue does not dispute that the company would be taxed at the same rate in the present assessment year or during earlier year. It is also not disputed that prior period income was declared by the assessee during the current year which is also accepted by the Revenue. No question of law therefore, arises.”
19. In the aforesaid context, Mr. Hemani submitted that even otherwise, there is no loss to the Revenue as the respondent being a corporate entity, the rate of tax has remained the same and on this count also, the set off is to be allowed. Mr. Hemani placed reliance on a decision of the Supreme Court in the case of CIT vs. Excel Industries [2013] 358 ITR 295(SC), wherein the following has been observed:
“32. Thirdly, the real question concerning us is the year in which the assessee is required to pay tax. There is no dispute that in the subsequent accounting year, the assessee did make imports and did derive benefits under the advance licence and the duty entitlement pass book and paid tax thereon. Therefore, it is not as if the Revenue has been deprived of any tax. We are told that the rate of tax remained the same in the present assessment year as well as in the subsequent assessment year. Therefore, the disptue raised by the Revenue is entirely academic or at best may have a minor tax effect. There was, therefore, no need for the Revenue to continue with this litigation when it was quite clear that not only was it fruitless (on merits) but also that it may not have added anything much to the public coffers.”
20. This Court in PCIT vs. Adani Enterprises Ltd [Tax Appeals Nos.566 of 2016 and 573 of 2016 decided on 20th July 2016] has taken such a stance while allowing the set off of the prior period expenses against the prior period income.
21. This Court in PCIT vs. Adani Gas Ltd [Tax Appeal No.900 of 2016 decided on 11th January 2017] allowed the set off by following the decision of the Delhi High Court in CIT vs. Exxon Mobile Lubricant Pvt Ltd [(2010) 8 taxguru.in 249 (Delhi). It was held that if the AO had not excluded the prior period income while working out the current year taxable income, there was no reason to disallow only a part of the prior period adjustment.
22. This Court in PCIT vs. Adani Enterprises [Tax Appeal NO.566 of 2016 decided on 20th July 2016] noted that the prior period income was declared by the assessee in the current year and accepted by the Revenue. Hence, this Court declined to interfere with the order of the ITAT holding that it would be unfair not to recognise the prior period income. It further took into account the fact that the company would be taxed at the same rate in the present assessment year or during the earlier year.
23. This Court in PCIT vs. Adani Enterprises Ltd [Tax Appeal no.573 of 2016 decided on 20th July 2016] followed its order in the Tax Appeal no.566 of 2016 dated 20th July 2016 to dismiss the Tax Appeal.
24. Thus, in view of the aforesaid discussion, we are of the view that the ITAT committed no error in holding that once the prior period income is held to be taxable, the prior period expenditure also should be allowed to be set off and the assessee is not obliged in law to indicate any direct or indirect nexus between the prior period income and prior period expenditure.
> SECOND QUESTION OF LAW:
25. The Assessing Officer made disallowance of Rs.1,12,01,869/under Section 40(a)(i) on account of the non-deduction of TDS under Section 195 while remitting such payments to the non-residents. The break up of the same is as under:
Professional service expenditure : Rs.6,70,674/-
Reimbursement of administrative services : Rs.81,02,625/
Reimbursement of insurance and foreign travel expenses: Rs.24,28,570/
26. The assessee submitted before the Assessing Officer that the payees were not liable to pay taxes in India as the services were rendered outside India. However, the Assessing Officer relied upon a decision of the High Court of Karnataka in the CIT (International Taxation) vs. Samsung Electronics Co. Ltd [2010] 320 ITR 209 (Karnataka) to make the disallowance on the basis that no application was filed under Section 195(2) of the Act. The said disallowance came to be affirmed by the CIT(A) as well on the basis of the aforesaid decision of the High Court of Karnataka. The ITAT noted that the decision relied upon by the lower authorities in the case of Samsung Electronics 320 ITR 209 had been reversed by the Supreme court in the GE India Technology 327 ITR 456 by holding that the TDS has to be deducted under Section 195 of the Act only if the element of income is involved. The ITAT held that the Assessing Officer had failed to bring on record any material to indicate that the recipient is taxable in India. The ITAT also held that the reimbursement of expenses did not involve any income element, and therefore, the TDS was not required to be deducted. The only reason for the Assessing Officer and the CIT(A) to make the disallowance was the decision of the Karnataka High Court in Samsung Electronics. The said decision has now been reversed by the Supreme Court of India in GE India Technology (supra) wherein it was held that an assessee paying any sum to a nonresident is not liable to deduct tax if the sum is not chargeable to tax under the Act, as the expression in Section 195(1) of the Act is “chargeable under the provisions of the Act.”
27. The decision in GE India (supra) has been followed by this Court in PCIT vs. Nova Technology Pvt Ltd [Tax Appeal NO.290 of 2018 decided on 9th April 2018]. It was held therein that the payment does not enter the tax liability of the payee under the Act. Section 195 would not apply. The fundamental principle of deducting tax at source in connection with the payment only where the sum is chargeable to tax under the Act continues to hold the field even after the retrospective insertion of Explanation 2 to subsection (1) of Section 195 of the Act.
28. Thus, where the payment is in the nature of reimbursement, there is no element of income involved, and therefore, no tax is required to be deducted at source. Having regard to the settled position, the assessee was not liable to deduct the tax at source on such payments and hence, the ITAT committed no error in answering the second question as proposed by the Revenue in favour of the assessee.
> THIRD QUESTION OF LAW:
29. The Assessing Officer, while working the eligible profit for deduction under Section 10B of the Act, held that the “unrealized export turnover” is to be excluded from the “export turnover”, but refrained from excluding the same from the “total turnover”. The said action was confirmed by the CIT(A) on the basis that there is no provision to reduce the same from the total turnover the profit on the unrealised turnover would get unintended deduction and that the decisions relied on by the assessee pertained to the sales tax, excise duty etc. The ITAT held that if an item does not fall in the export turnover, then it has to be excluded from the total turnover also for computing deduction admissible under Section 10B of the Act. Mr. Hemani submitted that as per Section 10B(4) of the Act, the formula for determining the “profits derived from export of articles or things or computers software” i.e. the amount of deduction is:
Export Turnover x profits of the business of the undertaking
Total Turnover
Hence, for the purpose of parity, if “unrealized export turnover” is excluded from “export turnover” (numerator), then the same must be excluded from “total turnover” (denominator).
The aforesaid issue is now settled by the decisions of the Supreme Court. In CIT vs. HCL Technologies Ltd [2018] 404 ITR 719 (SC), it was held as follows:
“19. In the instant case, if the deductions on freight, telecommunication and insurance attributable to the delivery of computer software under Section 1OA of the IT Act are allowed only in Export Turnover but not from the Total Turnover then, it would give rise to inadvertent, unlawful, meaningless and illogical result which would cause grave injustice to the Respondent which could have never been the intention of the legislature.”
In PCIT vs. Tesco Hindusthan Service Centre Ltd. [2018] 257 Taxman 92 (SC), the Supreme Court dismissed the SLP against the decision of the High Court of Karnataka holding that while computing deduction under Section 10A of the Act, if the export turnover in numerator is arrived at after excluding certain expenses, the said expenses should also be excluded from the total turnover in denominator.
30. Thus, the third question, as proposed by the Revenue being no longer res integra, cannot be termed as a substantial question of law.
Comments are closed.