1987-VIL-45-ITAT-DEL
Equivalent Citation: ITD 025, 136,
Income Tax Appellate Tribunal DELHI
Date: 13.10.1987
ROLLS ROYCE INDIA LTD.
Vs
INCOME-TAX OFFICER.
BENCH
Member(s) : CH. G. KRISHNAMURTHY., U. S. DHUSIA., ANAND PRAKASH.
JUDGMENT
Per Shri U. S. Dhusia, Judicial Member - The one issue referred to in grounds of appeal numbered 1 to 5 in this appeal filed by the appellant company (hereinafter referred to as the 'India Company') for assessment year 1982-83 is in respect of trading receipt of the appellant in the year in question. According to the appellant it was Rs. 2,13,237 representing his remuneration @ 5 per cent of the actual operating cost of Rs. 31,76,373 subject to adjustment incurred by the assessee for its principal Rolls Royce Limited, U. K. (hereinafter referred to as the 'English Company') in taxable territory. According to the IAC (Assessment) it was the sum of Rs. 31,76,373 remitted by the English Company towards the actual operating cost plus 5 per cent remuneration. According to the IAC (Asstt.) this sum constituted the taxable receipt of the appellant company. The appellant/Indian Company had returned an income of Rs. 2,13,237 as the income of the assessment year 1982-83. But the IAC (Asstt.) proceeding on the basis of taxable receipt of Rs. 31,76,373 raised it to Rs. 25,33,718.
2. The main controversy in this appeal is what was the trading or taxable receipt of the appellant company. The Indian Company claimed that it was only 5 per cent of the gross or total expenditure incurred by it on behalf of the English Company. The appellant company contended that it was doing liaison work for the English Company for which it got remunerated by the payment of additional 5 per cent of the actual operating cost incurred in connection with the liaison work. The IAC (Asstt.) ignoring the finding of the earlier years, held that his trading or taxable receipt was the full amount of remittance consisting of actual operating cost plus addition 5 per cent for remuneration due to the appellant company for services rendered by it to the English Company. According to the IAC (Asstt.) the agreement defined 'service fee' as 'shall mean the annual fee payable by Rolls Royce Ltd., the English Company to the Rolls Royce India Ltd., the Indian Company, calculated and payable in accordance with clause (5) hereof'. Clause (5) of the agreement executed on the 1st day of July, 1979 between the Indian Company and the English Company ran as under :
"Service Fee
Rolls-Royce shall pay annually to RR India the Service Fee as hereinafter provided :
(a) The Service Fee shall be calculated for each year of Account at a fixed rate of 105 per cent of the actual operating costs incurred during the year of account to which the service fee relates."
3. On a consideration of this clause the IAC (Asstt.) held that the trading receipt of the appellant company was 105 per cent of the actual operating cost incurred during the year of account to which the service relates. The appellant had objected to IAC (Asstt.) in respect of this approach by pointing out, inter alia, in its letter dated 31st October, 1984 as under :
"1. Disallowance under various sections of the Act can be made only out of expenses claimed to be allowable as business expenditure. It follows that no disallowance can be made in our case as no expenditure has been claimed to be allowable as business expenditure.
2. As will be seen from the Agreement dated1 July, 1979between ourselves and Rolls-Royce Limited, U. K., as clarified by the Memorandum dated20 May, 1980, we receive monies by way of advances and are accountable to Rolls-Royce Limited, U. K., in respect of such monies. At the point of time when we receive the said monies we are in the position of a trustee or a bailee and are under contractual obligation to spend the advances of the purpose for which the advances are received. In the case of Morley (Inspector of Taxes) v. Tattersall [1939] 7 ITR 316 (CA) even subsequent appropriation of monies belonging to others were held not to be a trading receipt. On the strength of that case, even if we were to appropriate any part of the advances received from Rolls-Royce Limited, U. K. without appending the same for the intended purposes, such appropriation would still not be 'income'. It could not be 'income' even under such circumstances, the advances received and actually spent cannot obviously be regarded as income or trading receipts. Since the advances cannot be regarded as income or trading receipts, the question of claiming expenses there-against cannot arise. Therefore, the further question which follows as a corollary, namely, what part of the expenses, if any, are disallowable under the provisions of the Act cannot also arise. The legal principle laid down in Tattersall's case has been followed in many Indian cases, a list of which is given below :
(i) Addl. CIT v. Netal Krishana Sahgals (P.) Ltd. [1983] 141 ITR 681 (Delhi).
(ii) Bengal & Assam Investors Ltd. v. CIT [1983] 142 ITR 156 (Cal.).
(iii) Lal Chand Gopal Das v. CIT [1963] 146 ITR 355 (All.).
(iv) CIT v. A. V. M. Ltd. [1984] 48 ITR 324 (Mad.).
3. Even if there were some instances where expenditure was first incurred by us and thereafter reimbursed by Rolls-Royce Limited, U. K., such reimbursement of expenses cannot also be regarded as income against which claim for expenses might arise. This principle is well settled by the decision of the House of Lords in Owen v. Pook (Inspector of Taxes) [1969] 74 ITR 147. The Calcutta High Court has also held likewise in CIT v. Dunlop Rubber Co. Ltd. [1983] 142 ITR 493. The point made in this regard in the earlier note is, however, not relevant as, in fact, there has not indeed been any reimbursement of revenue expenses during the relevant previous year. All revenue expenses incurred by us during the year ending31 December 1981were, in fact, met by us out of advances received from Rolls-Royce Limited, U. K."
The IAC (Asstt.) however, ruled out the objection as in his view subsequent memorandum cannot take away the true nature of the agreement made on1-7-1979. He, therefore, proceeded on the basis of gross remittance including the actual operating cost plus 5 per cent of the same as trading receipt of the appellant company for making the assessment. He scrutinized the expenses incurred of behalf of English company and by making several disallowances raised the total income to Rs. 25,33,718 as against the sum of Rs. 2,13,237 returned by the appellant company.
4. The commissioner (A) to whom the issue went in appeal preferred by the assessee-company, also relying on the definition of 'service fees' in the agreement dated1-7-1979, dittoed the finding of the IAC (Asstt.). He was also of the view that the memorandum could not affect a change in the nature of receipt as provided in clause (5) of the agreement dated1-7-1979. The appellant company having felt aggrieved has brought the issue in appeal before the Appellate Tribunal.
5. The learned counsel for the assessee-company, Mr. R. Ganesan, elaborately argued the issue as to the basis of assessment made by the IAC (Asstt.) by taking the actual operating cost, besides the remuneration of 5 per cent as the trading receipt of the assessee. According to him the English Company entered into an agreement with the Indian Company so that the letter did liaison work for it. He referred to the object in the preamble of the agreement dated 1-7-1979 which ran as under : "WHEREAS Rolls-Royce sells Engine products to airlines and other markets throughout the world using commercial information and marketing support derived from various sources; AND "WHEREAS Rolls-Royce has accepted and will accept service support obligations to customers and licensees of Engine products who are located within the Territory and to others of its customers whose aircraft regularly operate into the Territory; AND WHEREAS RR India, has been formed for the purpose of providing marketing support and a commercial information service relating to the Territory and for the purpose of co-ordinating the service support obligations on behalf of Rolls-Royce throughout the Territory."
6. The learned counsel for the assessee-company referred to the sole purpose of bringing into existence the appellant company as brought out in the preamble above. It was emphasised by him that the main object in bringing into existence the RR India, the appellant company, was only to sub-serve and fulfil the need of the English Company for ensuring market support and availing commercial information. The agreement defined the obligation of RR India in clause (2), reproduced below :
"Duties of RR India
RR India will carry out the following duties to such extent as Rolls-Royce may require from time to time :
(i) To obtain and report to Rolls-Royce on a regular basis such marketing information as in considered to be relevant to Rolls-Royce's interests.
(ii) To disseminate such marketing and commercial information relating to Rolls-Royce may require.
(iii) To provide administrative and secretarial assistance locally for the Service Representatives deployed in the Territory.
(iv) To provide a liaison service between Rolls-Royce and relevant department of the Government of India and other customers of Rolls-Royce in the Territory in all matters of supply of products and services.
(v) To monitor the effectiveness of Rolls-Royce's commercial advisers and to report regularly thereon.
(vi) To look after Rolls-Royce visitors inIndiaand arrangements for stay and itinerary."
7. The remuneration for services to be rendered was described as 'service fee' which was to mean annual fee payable by Rolls-Royce to RR India, calculated and payable in accordance with clause (5). Clause (5) read as under :
"(a) The service fee shall be calculated for each year of account at a fixed rate of 105 per cent of the actual operating costs incurred during the year of account to which the Service Fee relates.
(b) Payment of the Service Fee shall be made by way of advances payments by Rolls-Royce to RR India each AP with quarterly adjustments in manner following :
(i) Each of such advance payments shall be calculated at a fixed rate of 105 per cent of the Budgeted operating costs for the AP (period normally 4 weeks) to which the particular advance payment rates and shall be payable by Rolls-Royce to RR India at the beginning of each AP (or part thereof) commencing with effect from 1st June 1979.
(ii) Within ten weeks of the close of the last business day of AP3, AP6, AP9 and AP13 in each year of account RR India will submit to Rolls-Royce a statement showing the actual operating costs incurred up to the end of the said AP3, AP6, AP9 or AP13 (as the case may be) together with the total of advance payments made to date during that year of account.
(iii) Following verification of each such quarterly statement Rolls-Royce will calculate the amount by which the service fee has been overpaid or underpaid and Rolls-Royce or RR India (as the case may be) will promptly make an adjusting payment to rectify such overpayment or underpayment."
8. It was to be noted that the settlement was to be made by making advance payments as well as reimbursement of the expenditure incurred. To clarify and remove any doubt in respect of remuneration of the appellant company a memorandum agreement was made on20-5-1980which provided as under :
"AND WHEREAS it is deemed necessary and expedient to reiterate and clarify the position with regard to the remuneration payable under the formation Agreement by RR to RRI so as to put the same beyond any doubt :
NOW THIS MEMORANDUM WITNESSETH AS FOLLOWS :
It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in accordance with the Formation Agreement in respect of liaison services provided by RRI in the territories of India, Bangladesh, Nepal, Sri Lanka, and Bhutan is 5 per cent of the total expenses of RRI (including depreciation) incurred on behalf of RR in connection with the provision of the said services, the entire expenditure incurred on this account by RRI being reimbursed by RR and it has always been so intended between the parties hereto and always so understood."
In light of the aforesaid it was asserted by Mr. R. Ganesan, that there was no possibility of treating the 105 per cent of the expenditure-the actual operating cost plus 5 per cent of the remuneration as the taxable receipt of the appellant company. The learned counsel referred to a string of judicial pronouncements to support the aforesaid plea that the receipt of the company should be limited to only 5 per cent of the expenditure which was its remuneration and not the 105 per cent of the gross expenditure consisting of both actual operating cost and 5 per cent thereof as the remuneration which were fully reimbursed by the English Company.
9. Learned Departmental Representative on the other hand made out, inter alia, two pleas-Firstly, the judicial pronouncements did not apply to the facts of the case and secondly, the provision of clause (5) of the agreement provided for calculation of the service fee at 105 per cent of the actual operating cost during the year of account to which the service related. He countered the suggestions that the appellant company could be considered as mere agent or bailee of the English Company. He had his own reality and independent existence and did not depend upon the English Company for imparting to it substance and matter as will undoubtedly arise from a consideration of engagement of its personnel and office premises under agreements entered by it independent of the English Company. Therefore, the agreement should be take as one between two principals and not between the principal and his agent or bailee. According to the clauses there was no doubt that his receipt was 105 per cent and not 5 per cent.
10. Having considered the rival submissions made out by the revenue and the appellant company we are of the view that on a consideration of facts brought on record and the two agreements date 1st July, 1979 and 20th May, 1980, it is not possible to uphold the finding of the lower authorities and reject the plea of the appellant company as misconceived. Although Mr. Ganesan stoutly resisted the suggestion that the appellant company was an agent of the English Company in view of clause (4) of the agreement dated 1-7-1979, a consideration of the facts does not support the submission of Mr. R. Ganesan in this respect that the Indian company was not a creature of the design of the English Company and a subsidiary one brought into existence with the sole object of the sub serving to the need of its principal, the English Company. Clause (4) of the agreement read as under :
"RR India is not and shall not represent itself to be the agent of Rolls-Royce nor shall it enter into or purport to enter into any commitments or negotiations of whatsoever nature on behalf of Rolls-Royce in the territory or elsewhere or do any act or thing which might result in any person believing that RR India has authority to contract on behalf of Rolls-Royce."
In spite of this provision and the prohibition contained therein one cannot rebut the suggestion that the appellant company was a mere agent or a subsidiary creature, created out of the design of the English Company to fulfil and subserve the need of the latter. This conclusion is not defeated by a consideration of the fact that the two agreements-the one made on1-7-1979and the other on20-5-1980, were entered into by the two companies as principal to principal. Even a consideration of the engagement of the premises, occupies by the Indian Company and its personnel under contractual agreements between the Indian Company and the personnel cannot overshadow the paramount truth that the Indian Company as brought out on the preamble was created only to carry out the task appointed by the English Company. The English Company had brought the Indian Company into existence to sub-serve its need of a company doing liaison work inIndiaand surrounding countries for it. The Indian Company had no independent activity, no other business except and apart from the liaison work for the English Company. This conclusion is not only based on a consideration of the preamble but also the permission of the Reserve Bank ofIndiato allow the company to take a liaison office inIndia. The Reserve Bank ofIndiain its letter dated26-9-1979agreed to allow the Indian Company to establish a liaison office subject to the following stipulations :
"We advise that we are agreeable to your establishing a liaison office atNew Delhiinitially for a period of two years for the purpose of undertaking purely liaison activities as stated in the schedule to your above application. Please not that this permission has been granted subject to the following conditions :
(i) Except the proposed liaison work, the liaison office inIndiawill not undertake any other activity of a trading, commercial or industrial nature nor shall it enter into any business contracts in its own name without our prior permission.
(ii) No commission/fee will be charged or any other remuneration received by the liaison office inIndiafor the liaison activities services rendered inIndia.
(iii) The entire expenses of the liaison office inIndiawill be met exclusively out of the funds received from abroad through normal banking channels.
(iv) The liaison office inIndiashall not borrow or lend any money from/to any person inIndiawithout our prior permission.
(v) The liaison office in India shall not acquire, hold, transfer or dispose of (other than by way of lease for a period not exceeding five years) any immovable property in India without obtaining prior permission of the Reserve Bank of India under section 31 of the Foreign Exchange Regulation Act, 1973.
(vi) The liaison office inIndiawill furnish to us (in duplicate on a yearly basis) the following particulars/documents :
(a) A certificate from the auditors to the effect that during the year no income was earned by/or accrues to the liaison office inIndia."
11. It may be of interest to note that clause (6) of the Agreement made the English Company liable to bear the cost of setting up of an office inNew Delhifor the use of RR India. The clause read as under :
"All costs and expenses incurred by RR India (as authorised by Rolls-Royce prior to commitment either specifically or generally) in establishing a liaison office in New Delhi or otherwise in setting up operations shall be reimbursed by Rolls-Royce in full in Sterling in the UK as soon as practicable after such costs and expenses are incurred but in any event within eight weeks from the date they are incurred and notified to Rolls-Royce".
In this background of fact can it be reasonably maintained that the position of Indian company was any better than that of its agent or representative or a subsidiary. Clause (4) only disentitled the Indian Company to represent inIndiaas the agent of the English Company and bind and saddle the English company with liability under an agreement entered into by the Indian Company acting on its own and not under the authority and command of the English company. Clause (4) aimed at limiting the poser of the Indian Company to represent and to represent and saddle the English Company with liability. Otherwise it us not possible to think of it as an independent unit doing its business on its own irrespective of its agreement with the English Company. Its very existence as has been asserted by Mr. R. Ganesan was rooted in the need of the English Company to derive benefit from the liaison work inIndiaand surrounding countries performed by the Indian Company and we may add who would do no other trading or business. It could not under the inhibition placed by the permission accorded by the Reserve Bank ofIndiaundertake any liaison work for any one else. The English Company had not only undertaken to meet the full cost of expenditure incurred by the appellant company for carrying out its appointed task of doing the liaison work but also had met the cost of setting up a liaison office. No doubt, the Indian Company had engaged employees and the office premises under agreements entered into by it, but could a consideration arising from this aspect affect the finding that the Indian Company was a mere agent or a mere subordinate of the English Company which was created for the purpose of carrying out of the liaison work for the English Company. Considered in this light, could we not safely hold that the Indian Company being not an employee or an agent in name, was an agent in fact for the purpose of carrying out the appointed task of doing the liaison work of the English Company. Looked at in this background could we justify ourselves that the expenditure incurred by the Indian Company in doing the liaison work which the English Company met hundred per cent besides remunerating the Indian Company was the expenditure of the Indian Company and not of the English company which had borne the incidence of expenditure as well as that a remuneration paid to the Indian Company, for doing the liaison work. We may look at the issue from a different angle. Suppose the English Company was resident in the taxable territory could one hold that the expenditure debited by the English Company resident in India the expenditure debited by the English Company resident in India to its profit & loss account was to be considered the expenditure of the Indian Company and not that of the former. As the law stands the deduction for the said expenditure could not be claimed by both the companies. In the case of aratias the turnover is limited only to the commission they receive and not to the sales although it is they who purchase and sell on behalf of their principals. Exactly this is the situation in the present case. The appellant company undertakes expenditure on behalf of his principal although full cost of the operation to the last penny is met by the English Company either by advance payments or by subsequent payments made promptly or latest within a period of ten weeks. Therefore on a consideration of these facts it is not possible to hold that the IAC was justified in treating the remittances for operating cost as taxable receipt of the appellant company. In our consideration the IAC misdirected himself when he proceeded to arrive at the profit of the Indian Company by taking the remittances for the actual operating cost as the receipt of the Indian Company from which the expenditure incurred by it on behalf of the English Company was to be deducted to arrive at the taxable profit and not by limiting the taxable receipt to 5 per cent remuneration paid by the English Company to the Indian Company under the agreement. Need we emphasise that settlement prescribed under clause (5) was not only to make advance payments but also to clear up the liability for expenditure by reimbursement of the expenditure. The English Company reimbursed every penny of the expenditure incurred by the appellant company. No one on these facts could hold that the Indian Company, a mere agent, was liable for the profit resulting from the transactions entered into by the agents on behalf of the principal which the latter refrains from repudiating. There is no instance when the English Company repudiated the liability for undertaking the expenditure by the Indian Company. A consideration of the remuneration payable to the Indian Company also rules out the possibility of taking the Expenditure incurred by the Indian Company on behalf of the English Company as its own expenditure. If the Indian Company was incurring the expenditure on its own where was the need for the English Company to remunerate it ? On these facts was it open to Revenue to hold that the expenditure incurred by the Indian Company related to its own business for which it could be held liable against the receipts of 105 per cent of the actual operating cost including the 5 per cent remuneration from the English Company. No doubt the IAC (Asstt.) and the Commissioner (A) had depended upon clause (5) which prescribed the calculation of service fee as already indicated. This would call for a look at the two agreements one made on1-7-1979and the other memorandum made on20-5-1980. We have already in the foregoing paras reproduced the definition of the services fee and also the clause (5). We reproduce the relevant portion of the memorandum :
"... to reiterate and clarify the position with regard to the remuneration payable under the Formation Agreement by RR to RRI so as to put the same beyond any doubt."
We may again reproduce for the facility of appreciating the finding :
"NOW THIS MEMORANDUM WITNESSETH AS FOLLOWS :
It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in accordance with the Formation Agreement in respect of liaison services provided by RRI in the territories of India, Bangladesh, Nepal, Sri Lanka, and Bhutan is 5 per cent of the total expenses of RRI (including depreciation) incurred on behalf of RR in connection with the provision of the said services, the entire expenditure incurred on this account by RRI being reimbursed by RR, and it has always been so intended between the parties hereto and always to understood."
12. A consideration of clause (5) and the aforesaid explanation in memorandum made on20-5-1980does not leave any doubt that the remuneration of the Indian Company was 5 per cent of the total expenses and not the total cost of operation which was reimbursed by the English Company. This was the import of the two-is evident from the corresponding treatment of the remittances regarding the expenses in the account books of the Indian Company and we take it on the basis of the certificate of the English Company that similar treatment had been entered in the account of the English Company, as appears from the letter dated 10-10-1986, which runs as under :
"1. All expenditure incurred by Rolls-Royce India Limited, both inIndiaand in the U. K., is borne by Rolls-Royce plc and is charged to the profit and loss account in Rolls-Royce plc's books of account.
2. All monies advanced by Rolls-Royce plc to Rolls-Royce India Limited are for the purposes of defraying operational costs. Any unexpanded advances held by Rolls-Royce India Limited are refundable to Rolls-Royce plc and are recorded as recoverable from Rolls-Royce India Limited in the books of account of Rolls-Royce plc."
What is the true purport of the agreement is to be found out not only from interpretation of the terms but also the way in which the two parties to the agreement had understood the purport of the various stipulations of the agreement. It is the surest way to find out the true intention of the parties underlying the stipulations and provisions in the two agreements. It is not generally the case but there are occasions when the draftsman is not able to clothe the intention in suitable and proper language. Therefore, it becomes necessary to make out the true intention from the conduct and understanding of the parties as to what they had agreed to mean by from a certain stipulation inserted in the agreement. There is no room for doubt that taking into account the conduct and understanding of the two parties, only 5 per cent of the total expenses of RRI was to be adopted as the remuneration of the appellant Indian Company. They have accordingly treated the remittances in their respective accounts. They had no conflict in this respect-rather they were unanimous in claiming that the stipulations in the first agreement was limit the remuneration of the Indian Company to 5 per cent of the actual operating cost. This fact is manifest by their agreement to execute a memorandum dated20-5-1980to clarify the purport clause (5) of the original agreement made on1-7-1979. A point has been made by the lower authorities that the language of clause (5) being crystal clear there was no scope left for causing rectification by the memorandum. We are unable to appreciate this finding or the basis of this finding. It was not a statutory provision which the revenue authorities were called upon to interpret. It was a stipulation inserted in the agreement entered into by the two private parties. They being signatories to the agreement were the best judge and spokesmen of the true purport of clause (5). Such an approach as was relied on by the revenue authorities is possible only in respect of a statutory provision. There the rule prevails that if the purport of a provision was clear there was no need for explanation. In respect of a statutory provision it has been held that the provision of an explanation cannot change or override the express provision of a substantive law. But such a rule of interpretation does not prevails where is an agreed consensus in the parties to an agreement about the true purport of a provision in the original agreement.
13. We also cannot appreciate the proposition that the stipulation of an agreement cannot be altered by a subsequent agreement. We have not succeeded in finding any support for this proposition in law nor revenue could enlighten us about any support. Any one familiar with the Indian Contract Act knows that section 62 of the Indian Contract Act provides for addition, subtraction, alteration, waiver and rescission. Dutt in his Indian Contract Act has explained the scope of the section as under :
"It is competent to the parties to a contract at any time before breach of it by a new contract to add to, subtract from or vary the terms of it or altogether to waive and rescind it."
However, it was not a case of novation which we are faced with. It was a case of clarifying the intention of the parties which they felt was obscure in the language of clause (5). No offence could be possibly taken to the memorandum on the ground that it was an afterthought. It was not. Memorandum had been executed long before the IAC had started making the assessment for the year in issue overruling the finding of his predecessor incorporated in the assessment for the preceding year 1980-81.
14. Therefore, whatever way we took at the issue, whether from the object for realising which the appellant Indian Company had been created or from the nature of its duties or obligations imposed under the agreement or from the limitations placed on its authority to represent the English Company or by the limitations placed on the activity of the Indian Company by the agreement as well as the permission of the Reserve Bank of India to enable it to set up a liaison office in New Delhi or from the consideration that the cost of setting up of liaison office was met by the English Company in full or from the interpretation of the two agreements or from the understanding of the respective parties about the true purport of the relevant stipulations or from the conduct of the two parties to the agreement or from the treatment in their accounts we cannot but hold that the trading receipts of the appellant Indian Company could not be treated as 105 per cent of the operating cost instead of remuneration of 5 per cent of the gross operating cost as made out by the appellant company. We, therefore, hold the two lower authorities in error when they disregarded the plea of the assessee to treat the taxable receipts of the appellant as 105 per cent and not 5 per cent of the gross operating cost. We vacate orders and direct the IAC (Asstt.) to adopt the remuneration of the appellant company and proceed to make the assessment accordingly. As we are setting aside the assessment it is not necessary to record a finding on other grounds relating to disallowances. There is another reason why we are not adjudicating on other grounds. As we have held the expenditure from which disallowances are made, relate to the trading of the English Company, if any disallowances are to be made, they are to be made in the case of the English Company, if they are found liable, but not in the case of Indian Company, as they did not arise for consideration in its assessment. Besides the learned counsel for the assessee did not address the Board on these grounds. It was evident that these grounds were not pressed. Therefore, the appeal preferred on these grounds of appeal is dismissed.
15. In the result appeal preferred by the assessee is partly allowed.
Per Shri Anand Prakash, Accountant Member - As it has not been possible for me to agree with the reasoning and conclusion of my learned brother, I draw up a separate order putting forth my views on the controversy canvassed before us.
2. The assessee is a non-resident company being 100 per cent subsidiary of another non-resident company namely, Rolls-Royce (For the sake of convenience I will describe these companies as R. R. I. and R. R. respectively hereafter). It was incorporated on20-2-1979with numerous objects enumerated in the Memorandum of Association. Sub-clauses A to D of clause 3 appear to set out objects and sub-clauses E to X appear to enumerate the powers, which may be exercised in pursuance of the objects mentioned in sub clauses A to D. The said sub-clauses are extracted here below for ready reference as follows :
"(A) To carry on business as manufacturers, builders, designers, repairs and owners of aero-engines, motor cars and carriages, cabs, omnibuses, wagons, carts, cycles, ships, boats, and other marine vessels, aeroplanes, airships, and all other land, sea, or air carriages and conveyances, in whatsoever manner and by whatsoever powers the same may be propelled or driven, and to buy, sell, let out on hire, or act as factor or agent for the purchase or sale of, or otherwise deal in aero-engines, motor cars and motor vehicles and boats of every description, aeroplanes, airships, and every kind of aircraft and component parts, fittings and accessories of all kinds for the same, and all articles and things used in the manufacture, maintenance and working thereof.
(B) To carry on business as engineers, machinists, smiths, fitters, electricians, brass-founders, iron-founders, tube-makers, metalworkers, wiredrawers, rope-makers, rubber or rubber substitute manufacturers, oil-refiners, automobile store; garage and aerodrome keepers, storers, and suppliers of and dealers in petrol, paraffin, oils and other fluids, generators and distributors of electricity and suppliers of motive power of any description for all kinds of motor vehicles and boats.
(C) To make, construct, buy, hire, sell, repair, alter and deal in component parts and accessories of any of the manufacturers or products of the Company and apparatus, machinery, materials, and goods and articles of all kinds useful or necessary in carrying on the business of the Company, or in connection therewith.
(D) To carry on any other trade or business whatsoever which can, in the opinion of the Board of Directors, be advantageously carried on by the Company in connection with or as ancillary to any of the above business or the general business of the Company."
3.1 In pursuance, presumably, of clause 'D', the assessee-company entered into an agreement with RR on1-7-1979. The preamble of the agreement recited, inter alia, as follows :
"WHEREAS Rolls-Royce sells Engine Products to airlines and other markets throughout the world using commercial information and marketing support derived from various sources; AND WHEREAS Rolls-Royce has accepted and will accept Service Support Obligations to customers and Licensees of Engine Products who are located within the Territory and to others of its customers whose aircraft regularly operate into the Territory; AND WHEREAS RR India has been formed for the purpose of providing marketing support and a commercial information service relating to the Territory and for the purpose of co-ordinating the Service Support Obligations on behalf of Rolls-Royce throughout the Territory; NOW THEREFORE in consideration of the Service Fee payable hereunder it is HEREBY AGREED as follows :"
3.2 Clause 1 of the agreement defined certain terms some of which may be noted here as below :
(a) Service Support Obligations-shall mean obligations of Rolls Royce under contract or otherwise to provide technical and after sales service to customers and licensees of Engine Products.
(b) "Service Fee" shall mean the annual fee payable by Rolls Royce to RR India calculated and payable in accordance with Clause 5 hereof.
(c) "Actual Operating Costs" shall mean the total of revenue expenditure incurred by RR India in performing its obligations pursuant to this Agreement in theUK,Indiaand elsewhere.
(d) "Budgeted Operating Costs" shall mean the RR India budget forecast of Actual Operating Costs.
(e) "AP" shall mean a Rolls-Royce accounting period of normally four weeks..3.3 Clause 2 spelled out the duties of RRI and reads as below :
"2. Duties of RR India
RR India will carry out the following duties to such extent as Rolls-Royce may require from time to time (i) To obtain and report to Rolls-Royce on a regular basis such marketing information as is considered to be relevant to Rolls-Royce's interests.
(ii) To disseminate such marketing and commercial information relating to Rolls-Royce's products as Rolls-Royce may require.
(iii) To provide administrative and secretarial assistance locally for the Service Representatives deployed in the Territory.
(iv) To provide a liaison service between Rolls-Royce and relevant departments of the Government of India and other customers of Rolls-Royce in the Territory in all matters of supply of products and services.
(v) To monitor the effectiveness of Rolls-Royce's commercial advisers and report regularly thereon.
(vi) To look after Rolls-Royce visitors inIndiaand arrangements for stay and itinerary.
3.4 Clause 3 provided for the establishment of the offices of RRI and is extracted here as follows :
"Offices of RR India
(a) RR India shall as soon as practicable establishment a liaison office inNew Delhiand such other similar offices within the Territory as may from time to time be required by RR India for the purpose of carrying out its obligations under this agreement.
(b) RR India shall operate and maintain such offices within the Territory as may be necessary to fulfil its obligations under this Agreement and shall employ competent engineers and other suitably qualified personnel properly to carry out its duties under the provisions of this Agreement.
(c) Rolls-Royce and RR India may make appropriate arrangements in theUKfor such liaison staff as may be necessary to co-ordinate the activities of RR India with the activities and requirements of Rolls-Royce concerning its business interests in the Territory."
3.5 Clause 4 clarified that no agency relationship was sought to be established by this agreement in between RR and RRI and read as below :
"No Agency Relationship
RR India is not and shall not represent itself to be the agent of Rolls-Royce nor shall it enter into or purport to enter into any commitments or negotiations of whatsoever nature on behalf of Rolls-Royce in the Territory or elsewhere or do any act or thing which might result in any persons believing that RR India has authority to contract on behalf of Rolls- Royce."
3.6 Clause 5 spelled out the service fee and, as such, deserves to be extracted in full as below :
"Service Fee
Rolls-Royce shall pay annually to RR India the Service Fee as hereinafter provided :
(a) The Service Fee shall be calculated for each year of account at a fixed rate of 105 per cent of the Actual Operating Costs incurred during the Year of Account to which the Service Fee relates.
(b) Payment of the Service Fee shall be made by way of advance payments by Rolls-Royce to RR India each AP with quarterly adjustments in manner following :
(i) Each of such advance payments shall be calculated at a fixed rate of 105 per cent of the Budgeted Operating Costs for the AP to which the particular advance payments relates and shall be payable by Rolls-Royce to RR India at the beginning of each AP (or part thereof) commencing with effect from 1st June, 1979.
(ii) Within ten weeks of the close of that last business day of AP 3, AP 6, and AP 13 in each year of account RR India will submit to Rolls-Royce a statement showing the Actual Operating Costs incurred up to the end of the said AP 3, AP 6, AP 9, or AP 13 (as the case may be) together with the total of advance payments made to date during that Year of Account.
(iii) Following verifications of each such quarterly statement Rolls-Royce will calculate the amount by which the Service Fee has been overpaid or underpaid and Rolls-Royce or RR India (as the case may be) will promptly make an adjusting payment to rectify such overpayment or underpayment"
3.7 Clause 6 pertained to the reimbursement of initial setting up costs and read as follows :
"Setting up Costs
All costs and expenses incurred by RR India (as authorised by Rolls-Royce prior to commitment either specifically or generally) in establishing a liaison office in New Delhi or otherwise in setting up operations shall be reimbursed by Rolls-Royce in full in Sterling in the UK as soon as practicable after such costs and expenses are incurred but in any event within eight weeks from date they are incurred and notified to Rolls-Royce."
4. On20-5-1980, a supplemental agreement was entered into between RR and RRI which purported to "reiterate and clarify the position with regard to the remuneration payable under the Formation Agreement by RR to RRI so as to put the same beyond any doubt." The relevant part read as below :
"NOW THIS MEMORANDUM WITNESSETH AS FOLLOWS :
It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in accordance with the Formation Agreement in respect of liaison service provided by RRI in the territories of India, Bangladesh, Nepal, Sri Lanka, and Bhutan is 5 per cent of the total expenses of RRI (including depreciation) incurred on behalf of RR in connection with the provision of the said services, the entire expenditure incurred on this account by RRI being reimbursed by RR and it has always been so intended between the parties hereto and always so understood."
5. Immediately after the aforesaid agreement had been entered into, the assessee applied to the Reserve Bank ofIndiaon23-7-1979seeking permission to open an office here. Copy of the said application has not been placed on record but the gist thereof appears at page 188 of the paper book. The reply of the Reserve Bank ofIndiadated26-9-1979is on record. It reads, inter alia, as below :
"2. We advise that we are agreeable to your establishing a liaison office atNew Delhiinitially for a period of two years for the purpose of undertaking purely liaison activities as stated in the schedule to your above application. Please note that this permission has been granted subject to the following conditions :
(i) Except the proposed liaison work, the liaison office inIndiawill not undertake any other activity of a trading, commercial or industrial nature nor shall it enter into any business contracts in its own name without our prior permission.
(ii) No commission/fee will be charged or any other remuneration received by the liaison office inIndiafor the liaison activities/services rendered inIndia.
(iii) The entire expenses of the liaison office inIndiawill be met exclusively out of the funds received from abroad through normal banking channels.
(iv) The liaison office inIndiashall not borrow or lend any money from/to any person inIndiawithout our prior permission.
(v) The liaison office in India shall not acquire, hold, transfer or dispose of (other than by way of lease for a period not exceeding five years) any immovable property in India without obtaining prior permission of the Reserve Bank of India under section 31 of the Foreign Exchange Regulation Act, 1973.
(vi) The liaison office inIndiawill furnish to us (in duplicate on a yearly basis) the following particulars/documents :
(a) A certificate from the auditors to the effect that during the year no income was earned by/or accrued to the liaison office inIndia.
(b) Details of remittances received from abroad duly supported by bank certificates.
(c) Certified copy of the audited final accounts of the liaison office inIndia.
(d) Annual report of the work done by the liaison office in India, stating therein the detail of activities taken up/services rendered in India and also actual export/import, if any, effected during the period in respect of which the office had rendered liaison services.
3. We further advise that maintenance of an account in the name of your Head Office in the books of the liaison office inIndiawill require prior permission of the Reserve Bank."
6.1 In accordance with the above permission the assessee opened a liaison office inIndia, and for that purpose, it leased out suitable building and also engaged staff. Total expenditure incurred during the accounting period under consideration on the maintenance of the staff and the office and other related subjects inIndiais aggregated to Rs. 29,76,865. In terms of pound, this came to pound 1,71,281. The expenditure incurred by the company in the Head Office was pound 31,462. Thus, the aggregate expenditure incurred by the assessee-company during the accounting period under consideration was pound 202,743. The whole of it was reimbursed to it by RR.
6.2 Audited copies of the assessee-company have been placed on record. They appear at pages 14 to 22 of the paper book. The Profit and Loss Account appears at page 17 and so far as it is relevant for our purpose, it reads as below :
1981
Pound
"Turnover 1(a) 14,014
Profit before taxation 2 14,014
Taxation charge 4 8,462
------
Retained profit for the year. 5,552"
------
Copy of the account on the basis of which the figure of pound 14,014 has been worked out has not been placed on record. Some insight into the fact that there is such an account, whether called as trading account or otherwise, is had form Note 2 to the accounts which states, inter alia, as below :
"The Profit before taxation is stated after charging :.
1981 1980
Pound Pound
Depreciation 7,495 5,000
Audit fees and expenses 1,611 1,410
Directors' emoluments (Note 3) 55,131 32,623
------ ------
64,237 "
------ ------
From the above figures, it immediately follows that the assessee's income before deducting the above expenses was pound 78,251 (pound 14,014+pound 64,237). Where is that account in which these expenses were debited ? Apparently it has not been placed on record. One has similar insight into this fact from the computation of total income filed by the assessee, which reads as below :
Pound
"Profit as per Profit and Loss Account : 14,014
Deduct : Net surplus included therein arising
from adjustments on currency re-
alignments not representing actual
profit : 3,877
------
10,137
Add : Depreciation charged : 7,495
------
17,632
Converted to Indian currency @
Rs. 100=pound 5,782 3,04,946
Less : Depreciation : 91,709
--------
2,13,240"
6.3 The working of the net surplus on account of foreign exchange amount to pound 3,877 appears at page 28 of the paper book. It is seen therefrom that pound 3,877 was credited to the Profit and Loss Account of 1981 and as is seen from the computation above, the said sum is part of pound 14,014, the other sum being pound 10,137, being 5 per cent of pound 2,02,743 (i.e., the aggregate revenue expenditure incurred by the assessee-company). There is apparently an account where these two figures appear separately, but the same has not been placed on record. The assessee is claiming depreciation separately, and for this purpose is adding back the depreciation debited in accounts, i.e., pound 7,495, and then deducting that which is allowable under the Income-tax Act, 1961 separately. There is, again, apparently an account pound 7,495 has been debited. Copy of it should have, in all fairness, been filed by the assessee. In the absence of such copy their true state has but to be guessed, and the obvious guess is as follows :
Dr. Pound Cr. Pound
To Depreciation 7,495 By reimbursement of expenses
expenses incurred by the
assessee in carrying on
its business 2,02,743
To Audit fees and
expenses 1,611 By Service fee 10,137
To Directors'
emoluments 55,131 By Surplus arising from
adjustments on currency
re-alignments 3,877
To other expenses 1,38,506
To profit before
taxation 14,014
-------- --------
2,16,757 2,16,757
-------- --------
It is this profit of pound 14,014, with the Profit and Loss Account, as given to us, starts. An impression was sought to be given to us in the course of hearing of the appeal that the assessee's accounts start with the Profit & Loss Account itself, appearing at page 17. Obviously this is not the correct factual position. I am unable to understand and appreciate this action on the part of the assessee and its counsel. As substantial part of the assessee's argument was based on this factually incorrect assumption, the attempt at presenting a wrong picture of the accounts is, prima facie, regrettable.
7. Having noted the facts of the case, as above, let me note the submissions of the assessee. They were as below :
"(i) That the expenses in question were incurred by RRI on behalf of RR who reimbursed them to the assessee in full. The assessee got neither a farthing more nor a farthing less than the expenditure actually incurred by the assessee on behalf of RR.
(ii) That the assessee's only income was service commission computed at the rate of 5 per cent on the total expenses incurred and the assessee's accounts were made out on this basis. In support of it, reliance was placed on the copy of the P & L A/c filed at page 17 of the paper book and on the agreement dated 20-5-1986, which according to the assessee, clarified the position as above is beyond any shadow of doubt. Attention was also invited to the assessment orders for assessment years 1980-81 and 1981-82, in which the above submission of the assessee was accepted. According to the assessee, there was no justification to depart from these assessment orders, while framing the present assessment."
(2) That the monies, which the RR gave to RRI was in the nature of an 'advance', and the 'advance' did not bear the character of income. Reference was made to clause 5(b) of the Agreement dated1-7-1979in support of the above submission and to page 63 of the paper book containing account of RRI with Grindlays Bank, wherein the remittances from U. K. are deposited first and withdrawals are made subsequently from such deposits. The initial nature of receipts, thus, being not income, it could not be assessed as income. Reliance was placed on the following authorities in support of the above proposition :
1. Bengal & Assam Investors Ltd. v. CIT [1983] 142 ITR 156 (Cal.).
2. Morley (Inspector of Taxes) v. Tattersall [1939] 7 ITR 316 (CA).
3. CIT v. Sandersons and Morgans [1970] 75 ITR 433 (Cal.).
(3) (i) That whatever expenditure is incurred by RRI in India or in U. K. is for and on behalf of RR, and RR reimburses it to RRI, therefore, the expenditure is not revenue expenditure in the hands of the assessee, (ii) that even if it is the assessee's expenditure, only the net expenditure should be taken into account in its hands, and not the gross expenditure, and inasmuch as all that the assessee spent was reimbursed to it, the expenditure in.the assessee's hands was nil, and so nothing could be disallowed in the hands of the assessee in terms of sec. 40(c) (iii) or 40A (5) or rule 6D, etc. Reliance was placed on the judgment of the Hon'ble Calcutta High Court in the case of CIT v. Duncan Bros. & Co. Ltd. [1983] 140 ITR 335.
(4) That the monies received to reimburse the expenses incurred did not become income in the hands of the assessee. Reference was made to the ratio of CIT v. Dunlop Rubber Co. Ltd. [1983] 142 ITR 493 (Cal.), in support of the above proposition.
8. The Revenue opposed the above submissions, and the learned Departmental Representative submitted that the two companies were separate and independent entities, that both of them were doing their independent business, that their relations inter se, were business relations on principal to principal basis, that the RRI was not agent of RR, that clause 4 of the agreement dated 1-7-1979 made this position absolutely clear, that therefore, it will be wrong in law to say that RRI was acting as agent of RR and acting for and on behalf of it; that RRI was acting on its own to carry out its contractual duties listed in clause 2 of the Agreement, that the expenditure of RR was the income of RRI, that both of them were of revenue nature, that what was received under clause 5 of the Agreement was the service fee for rendering contractual services, that this fee was paid in advance, that the advance in question was of the service fee and not de hors that, therefore its nature was that of service fees, and not of loan or advance on account, that, even though Agreements dated 1-7-1979 and 20-5-1980 should be read together it has not to be forgotten that the latter agreement was not in substitution of the original agreement, but only in explanation and clarification of it, that it, in no way, affected or changed the character of the receipts of RRI from RR; they were trading receipts to begin with and they continued to be so even under the Agreement dated 20-5-1980, that the expenses incurred by RRI were its expenses, the employees were its employees and the leased premises were its, that the privity of contract existed between RRI and its employees and its lessor, that that RR had nothing to do with the employees or the lessor or within any other expenditure, for that matter, that the basic question to be asked in the present case was : Are the receipts in the course of business, and are they trading receipt ? Are the expenses incurred by the assessee in the course of its business, for carrying out its contractual obligations ? That the answers to the above questions were in the affirmative, that the amounts were received by the assessee in the normal course of its business and not as a bailee or as a trustee, that the expenses of the assessee were subject to the provisions of sections 30 to 43A and, therefore, the ITO had rightly made the disallowances u/s 40(A)(5) /40(c)(iii) /rule 6D, etc., that the facts of Duncan Bros. & Co. Ltd.'s case were all together different and bore no similarity to the facts of the present case, that the ratio of Dunlop Rubber Co. Ltd.'s case had also no application to the assessee's case, that there it was the ratio of V. S. S. V. Meenakshi Achi v. CIT [1966] 60 ITR 253 (SC) that fully governed the facts of the present case, that there too it was the case of reimbursement of the expenses of the assessee, and the receipts in question were held to be of revenue nature, that therefore, it would be wrong to hold that the entire receipts of RRI from RR, i.e., 105 per cent of the actual operating costs of RRI were not of revenue nature and that only part of them, i.e., 5 per cent were such.
9. In rejoinder, the learned counsel reiterated that both the agreements should be read together and that legal effect must be given to the transactions. Reliance was placed on CIT v. B. M. Kharwar [1969] 72 ITR 603 (SC).
10. I will begin with B. M. Kharwar's case. The ratio of that judgment, as extracted in the head note, is, inter alia, to the following effect :
"... It is now well-settled that the taxing authorities are not entitled, in determining whether a receipt is liable to be taxed to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as 'the substance of the matter'.... The taxing authority is entitled, and is indeed bound, to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the 'substance of the transaction'. This principle applies alike to cases in which the legal relation is recorded in a formal document, and to cases where it has to be gathered from evidence-oral and documentary-and conduct of the parties to the transaction."
In view of the above settled law, the true nature of relationship between the assessee and RR has to be determined after examining the documents and record and their conduct.
11.1 The first thing that strikes one on perusal of the facts of this case is the corporate character of both RR and RRI. May be that RR is the holding company and RRI is it subsidiary but, for that reason, their separate entities are not lost. RRI is an independent judicial entity, having its own Memorandum, assets and business machinery. It entered into agreement with RR on1-7-1979in pursuance of its own object clause and to pursue its own business, which, to begin with, consisted of providing marketing support and commercial information service to RR. The obligations, which it undertook, in terms of the said contract, are listed in clause 2 of the agreement, which has been extracted in extenso above. In brief, they included collecting of commercial intelligence marketing information in India and its neighbouring countries for Rolls-Royce and to disseminate such marketing information in the market, as RR may like to be consumed by the Indian and other markets, to provide Secretarial and administrative assistance to the Service Representatives of RR in India, to provide liaison service between RR and its customers or potential customers regarding supply of RR's products and servicing and to look after the visitors from RR to India and neighbouring countries, and to provide for their stay and travel facilities. To enable the RRI to discharge the above functions effectively, RRI was to set up its offices inIndiaand was to employ qualified staff. A liaison office was also to be kept in the U. K. to co-ordinate the activities of RRI with RR.
11.2 RR did not want RRI to act as its agent and to bind it or commit it in any manner in respect of its business transactions. It was merely to provide the services stipulated in clause 2 to RR. Lest somebody should misunderstand the position of RRI vis-a-vis RR, due to the closeness of their mutual dealings, RR put in a specific clause in the Agreement, being clause 4, which clarified, in terms, that RRI was not and "shall not" represent itself to be the agent of RR, nor shall it "enter into any commitments or negotiations of whatsoever nature on behalf of RR and will refrain from doing anything" which might result in any person believing that RRI has authority to contract on behalf of RR. The legal effect of this clause is that RR and RRI are dealing with each other as principal to principal and that RRI was not the agent of RR and it could not bind RR by any of its actions. It was to do its contracted jobs for RR as an independent principal, and not as its agent, or servant. All the jobs that RRI did were, no doubt, for the benefit of RR, but they we were not done by RRI for and on behalf of RR, as its agent, but in the course of carrying out its own obligations under the contract. The activities carried on by RRI were its own activities and they did not become the activities of RR, even though their sole object as per the Agreement was to sub-serve and cause benefit to RR. It is a vital distinction, and prima facie the parties, attached importance to it and so it has been written into the contract itself by the contracting parties, and it will be wrong to ignore it, while construing their true relationship.
11.3 To enable RRI to set up its office in India and to assemble its operational set up, RR was to reimburse the expense incurred by RRI "in full in sterling in the U. K. as soon as practicable after such costs and expenses are incurred...." (clause 6 of the Agreement). For the services to be rendered by RRI to RR, the latter was to give to the former "Service Fee". This term has been defined in clause 1 of the Agreement to "mean the annual fee payable by RR to RRI calculated and payable in accordance with clause 5 hereof". Sub-clause (a) of clause 5 provided the basis for calculating the service fee. According to it, "The service fee shall be calculated for each year of account at a fixed rate of 105 per cent of the Actual Operating Costs, incurred during the year of account to which the service fee relates". It is clear from the aforesaid wordings that the basis of calculation of service fee is the actual operating costs of RRI. If it is 100, the fee will be 105. In other words, the service fee was to be the amount which will compensate the RRI for all its actual operating costs cent per cent, and then leave it with a surplus of 5 per cent of the said cost. The agreement dated20-5-1980does not improve upon or alter the aforesaid implication of sub-clause (a). It also does not claim to do so. It is at pains to emphasise that it was only reiterating and clarifying the position, as already existed, vide sub clause (a). In the process, it divides the "service fee" into two parts, one being 100, i.e., actual operating cost which will be reimbursed in full to RRI, and the other being 5 per cent of the actual operating cost, and clarifies that the real and effective fee (i.e., surplus) of RRI will be 5 per cent of the actual operating cost. The clarificatory agreement is, however, at pains to emphasise that the expenses were of RRI (e.g., witness the language "5 per cent of the total expenses of RRI"), and goes on to say that the said expenses of RRI were incurred "on behalf of RR". The use of the phraseology "on behalf of" has, therefore, to be understood in the setting and context of the entire agreement, and inasmuch as clause 4 of the agreement makes it absolutely clear that RRI was not RR's agent dandy that both of them were working as independent principals, the said words will in my opinion mean for the benefit of and not "incurred as the agent of RR". The RR is paying to RRI a composite sum equal to 105 per cent of the actual operating cost. One may, therefore, say that imbedded in it is the reimbursement of the 100 per cent actual operating cost, plus 5 per cent over and above it. The clarification, therefore, does not improve or alter the nature of the agreement dated1-7-1979and, of the payment. It is the sum which as per contract has to be paid for the service rendered by RRI to RR. It is important to remember in this connection that the Agreement dated20-5-1980does not in any way refer to clause 4 of the agreement, which, therefore, retains its full operating efficacy. Definition of Service Fee has also not been changed. It continues to be "the annual fee payable by Rolls-Royce to RR India". Its "calculation" was left to clause 5 of the agreement. What is paid annually to RRI by RR is 105 per cent of the actual operating costs. The cost incurred is of RRI. Even the Agreement dated20-5-1980say so. The entire operations of RRI inIndiaare, no doubt, for the benefit of RR. One may, therefore, loosely say that RRI is acting inIndiaon behalf of RR, but there is clause 4 to remind one that "on behalf of" can never mean in the above context, "as agent of RR"; it can only mean for the benefit of RR.
11.4 It is possible that the contracting parties might have been advised that clarification as above was necessary to bring the reality into sharper focus, as the commercial profit of the assessee will be only 5 per cent but, as it did not purport to change the original agreement, and meant only "to reiterate and clarify the position" as it already existed, and as in fact also it did so, it will not in my opinion, be correct to say that the quality of the payment of 105 per cent visualized under the contract underwent any change as a result of the agreement dated 20-5-1980. Earlier also 105 per cent of the actual operating costs were to be paid; later also, the same amount is to be paid. Its bifurcation into two parts is only with a view to emphasise that the RRI's net surplus will be 5 per cent of actual operating cost, the remaining 100 per cent being just sufficient to make the both ends of RRI meet. It was so earlier also and the Agreement dated20-5-1980did not improve the situation.
11.5 Sub-clause (b) of clause 5 spells out the mode of payment of service fee. It is to be paid, not at the end of the year of accounting, but in advance for a period of four weeks at one time. As the actual will be known only at the end of the year of accounting, so a system had to be derived to calculate the advance to be paid. It was, therefore, stipulated that RRI shall prepare a budget forecast of its actual operating cost, and the advance shall be paid on its basis. The discrepancy between the budget and the actual shall be adjusted at quarterly rests. The actual operating cost has been defined for this purpose as "total of revenue expenditure incurred by RRI in performing its obligations" pursuant to this agreement. As will be clear from the portions intelicised above, actual operating cost meant
(i) revenue expenditure
(ii) incurred by RRI
(iii) in performing its obligations under the Agreement dated1-7-1979.
The expenditure incurred was thus of RRI, on its own behalf, to carry out its own obligations. The purpose of all this activity was no doubt to benefit RR, and in this sense the expenditure, though of RRI, was for the benefit of RR, but it was not on its behalf. It will in fact, be half truth to even say that the expenditure in question was only for the benefit of RR, it also benefited RRI. It enabled it to show its flag in the entire territory, to set up its reputation, goodwill, contacts, etc., in the territory and also to earn the surplus of 5 per cent of its operating cost. So to say that the expenditure was incurred by RRI on behalf of RR will be totally misleading, and to say that it was incurred for the benefit of RR will be only half the truth.
11.6 The mode of payment of Service Fee as above, i.e., in advance, did not change the character of the payments from that of service fee to an advance or loan. Sub-clause (b) of clause 5 is quite forthright on this point. It stipulates-"
"Payment of the service fee shall be made by way of advance payments..."
Advance payments were thus no "on account", but of service fee itself. The basis of payment was obviously "Pay as you earn". To term the payments as advance will in my opinion be travesty of facts. All the three cases, referred to in para 7.2 supra and relied upon by the assessee are irrelevant in view of the above factual situation.
11.7 The accounts of the assessee have also been maintained on the above basis, as noted above. All the receipts under clause 5 of the Agreement are credited to the Operating or Trading account and all the expenses incurred are debited to the said account. On ground also, it is the assessee which engages its employees, which hires out its accommodation, and pays salaries and rents, etc. The respective agreements for hiring the employees and leasing the accommodation have been admittedly entered into by the assessee on its own and not on behalf of RR. The offices set up inIndiaare of the assessee and so are the employees. It is, again, the assessee which approached the Reserve Bank ofIndiafor permission to set up its office inIndia, and the RBI accorded its permission to the assessee "to your establishing a liaison office atNew Delhi". (See page 187 of the paper book). In the face of these hard facts, it is impossible to accept the proposition that the expenses incurred by the assessee inIndiawere not its expenses. It paid salary to its directors and employees, it paid rents to its lessors, and it paid audit fee to its auditors. It is because of this, that the auditors of the company clarified in note 2 to their report that profit before taxation was stated after charging Depreciation, Audit fee and expenses, and Directors' remuneration aggregating to pound 64,237. If these were not the assessee's expenses, where was the question of deducting them from the assessee's gross receipts or giving an audit note to the above effect ? Even in its return, the assessee claimed depreciation. If it had been reimbursed to the assessee, being the expenditure of RR, where was the occasion of claiming it as a deduction from the assessee's income which as per the assessee's present stand was pound 10,137. Prima facie, the assessee has been keeping its accounts in which all the amounts received by it from RR (i.e., 105 per cent of actual operating costs) are being credited and all the expenses incurred by it are being debited. This is the true state of affairs and the assessee, being a company is obliged under the law to present its accounts in a manner which will represent its true state of affairs. The assessee cannot, in my opinion, be allowed to take a stand not in consonance with its true state of affairs as reflected in the accounts.
12. The claim of the assessee that it incurred no expenses because all that it incurred was reimbursed to it by RR would be negating the above reality. It not only incurred the expenses in question, but also debited them in its accounts. The position in this case is far different from that inDuncanBros. & Co. Ltd.'s case. There, the assessee was the Managing Agent of certain other companies. It had centralised the working and had common employees who worked both in the offices of the managed companies as well as in the office of the assessee. The assessee debited the salaries of the employees, who worked in the managed companies to its own account, in the first instance, but simultaneously debited the accounts of the managed company for the amounts which were payable by them for the services rendered by the employees to the managed companies and the net amount was finally debited to the P & L A/c and was claimed as an expenditure u/s 37(1). The ITO, however, proceeded on the footing that the gross salary paid to the employees was to be taken into account for the purpose of sec. 40(c)(iii) and the reimbursement of the salary being of the revenue nature was to be credited separately. On these facts, it was held by their lordships that the ITO's stand was wrong and that the gross amount before making adjustments could not be considered in considering the amount coming within the purview of section 40(c)(iii). The above facts have prima facie, no similarity with the facts of the present case. Here, the assessee's employees are not working on deputation, so to say with RR and RR is not paying anything to those employees for the services rendered by them to RR. The employees are rendering services to RRI and it is RRI, which is paying them. The employees have no direct/indirect relationship with RR or its work. RR is the client of RRI and RRI's employees discharge their duties to RRI, when they provide contracts-for services to RRI's client. There can, therefore, be no question of the reimbursement of the salary of the salary of the employees of RRI by RR, for the employees of RRI have not been deputed, to it for rendering services to it. RR pays to RRI for the services rendered, and merely because the compassion of such payment is related to the actual operating costs of RRI, the payment does not become ipso facto the re-imbursement of the costs. That may be the result of it, that may be the measure of it, but the true nature of the payment unalterably remains the quid pro quo for the rendering of the contracts-for service by RRI to RR. The ratio of Duncan Bros. does not, therefore, apply to the facts of the present case. There is in fact no similarity of facts in the two cases.
13. This being so, the expenditure of the assessee has to be subjected to scrutiny by the ITO, and if any expenditure comes within mischief of the restrictive sections like 40(c)(iii), 40A(5) or rule 6D, the same will apply to the assessee's case. The Income-tax Act, 1961 makes no distinction in this regard in a Resident and a Non-resident. The learned counsel of the assessee also did not put forward any arguments to show as to why the various restrictive provisions will not apply to the expenditure incurred by the assessee. The correctness of the computation of the disallowances was also not challenged by the assessee. There is, therefore, no case to interfere with the orders of the authorities below on this point.
14.1 Whether or not the amounts received by the assessee from RR in terms of clause 5 of the agreement (by virtue of which alone 100 + 5 per cent of the actual operating costs of the assessee are paid to it by RR) constitute trading receipts in the assessee's hands is strictly not germane to deciding g the issue as to whether or not the "actual operating costs" are "of the assessee" and whether to them the various provisions of the Income-tax Act mentioned by the assessee in ground Nos. (4) and (6) apply. The grounds raised by the assessee concern themselves only with the restriction of the expenditure by the ITO, and not with the nature of the receipt in the assessee's hands. Yet, as the issue was raised by the assessee's counsel and argued at length, I will deal with it.
14.2 That one of the components of the receipts, i.e., 5 per cent of the actual operating costs is of income nature is not disputed by the assessee. May it be noted, at this stage, that the payment is a composite one, calculated at 105 per cent of the budgeted operating costs, adjusted at the end of each quarter with the actual operating costs incurred till then and this mode of payment has not been touched by the Agreement dated20-5-1980. This entire payment is termed as "Service Fee" by the definition clause. Agreement dated 20-5-1980 clarifies that the above provision in the original agreement in fact meant that (i) the entire expenditure incurred in connection with the provision of the services stated in clause 2 of the agreement incurred by RRI will be reimbursed to it by RR, and (ii) that 5 per cent of the above will be paid in addition. Even according to the latter agreement the payment in questions for the services rendered by RRI to RR in terms of the Agreement dated1-7-1979and not de hors it. It is one of the businesses of the assessee to render such services. It is in the course of carrying on of such business, and the rendering so services that the payment is made by RR to RRI. This basic character of the payment cannot be camouflaged under any subtlety of legal drafting-it is the amount, which has been earned by RRI by dint of rendering of the services to RR in terms of clause 2 of the Agreement, and the amount so earned would be its trading receipt coming to it directly as a result of its carrying on its business. It is the endeavour of every businessman to earn so much as will reimburse it its costs and leave with it some surplus. This is what the assessee is also doing. The mode of the calculation of the quid pro quo with reference to its "actual operating costs" will not, in my opinion, change its basic character of its being a trading receipt.
14.3 The assessee had placed reliance on due up Dunlop Rubber Co. Ltd.'s case in support of the proposition that amounts received as reimbursement of expenditure were not revenue receipt. The decision in that case turned on its own peculiar facts, and it cannot be held to be laying done such a wide proposition as the assessee's learned counsel canvassed. The relevant facts as weighed with their Lordships of Calcutta High Court may be noted. The assessee, a non-resident English Company, which has a world-wide network of subsidiaries and associated companies, maintained in the U. K. extensive technical research establishments, which were known as service departments for his entire organization throughout the world. The assessee-company communicated the latest information, process and inventions relating to goods manufactured by them to its subsidiaries and associated companies on certain terms and conditions. Dunlop Rubber (I) Ltd. an Indian Company availed of the above facilities, and in lieu of it, paid certain amounts to the non-resident assesses. The question was whether the amounts so paid by the Indian Company to the assessee non-resident were revenue receipts in its hands. The assessee pleaded that the amount received by it from the Indian Company could not constitute income, as the payments were merely reimbursement of the expenditure, incurred in connection with the research work, and so the amounts could not be assessed in its hands and that the assessee-company incurred large expenditure but only a part of it was allocated to the various subsidiary companies in the world and what it received from the subsidiary companies was only a part of the expenses incurred by it and as such, there was no element of profits in them. The above plea of the assessee was found to be factually correct by the Tribunal, and so its appeal was allowed by it. On a reference to the Hon'ble High Court, the above view was confirmed by their Lordships, who observed, inter alia, as follows :
"It appears to us that the Tribunal was right in arriving at the view that it was the recoupment of expenses. The result of the research was for the benefit of all concerned including the head office and thus subsidiary concerns. It was for sharing of the expenses of the research which was utilized the subsidiaries as well as the Head Office organization that the payments were made... the very fact that the technical date were jointly obtained and the expenses were shared together indicates the tit would not be treated a income."
14.4. The above narration shows
(i) That the non-resident company was not doing the business of doing research work with a view to sell its results.
(ii) That it was an in house R & D effort and it was doing research jointly for itself and its subsidiaries, which all owned the fruits of research.
(iii) That subsidiaries shared all expenses of this joint effort and did not purchase the information.
(iv) That the expensed incurred by the non-resident were far more than it realized from its subsidiaries and there was no profit element in such realizations form the subsidiaries. In the context of these facts, it was held that the receipts were by way of recoupment of joint expenses incurred by teahouses on its won and the "subsidiaries" behalf and were not income.
14.5 It is not possible to record such a finding in the present case. There is on goutiness of as to on which joint expenses have been incurred by RR & RRI, which have been reimbursed by RR to RRI. Here, there is an agreement between RR & RRI in terms of which RRI renders services to RR, and the latter pays to RRI stipulated payments computed with reference to actual operating costs of RRI. The payment on the hands of RRI is thus clearly a trading receipt. There is nothing done jointly for which the other joint owner of the result of the joint effort might be reimbursing part of the cost. No assistance can, therefore, be derived by the assessee form the Dunlop Rubber Co. Ltd.'s case.
15. The assessee's case, in fact, stands neatly covered by the ration of the judgment of the Hon'ble Supreme Court in the case of V. S. S. V. Meenakhsi Achi. It has been categorically held by their lordships in the said case the receipt on account of the reimbursement of revenue expenditure is Revenue receipt. The contention of Mr. Vishwanath shastri before their lordships was : "The payments were made to the appellants to enable them to recoup the revenue expenditure incurred for running and maintaining the rubber plantation, and, therefore, the payments were revenue receipts". Their lordships accepted the above reasoning relying on Higgs. v. Wrightson [1944] 26 Tax Cases 73. This is what their lordships said at p. 260 :
"Having regard to the aforesaid facts, we must hold that the amounts from the fund earmarked for the appellants on the basis of the rubber produced by them were paid against expenditure incurred by them for maintaining the rubber plantation and producing the rubber. If so, it follows that the receipts by the assessee during the accounting year were revenue receipts."
In the present case also, the expenses in question have been incurred by assessee for carrying units business of rendering stipulated services to RR. Therefore, the reimbursement of such expenses even if this be the true nature of the payments, for argument sake will be revenue receipts.
16. The facts of Bengal Textiles Association v. CIT [1960] 39 ITR 723 (SC) are also (rather more) apposite. In that case, the Government of Bengal, in terms of an agreement with the assessee, agreed to pay every moth to the association the administrative expenses, incurred in the previous moth including establishment charges, office advertising, salaries and wages not exceeding Rs. 600,000 per year less the salary and expanses of the Liaison Officer. The question of determination was whether the reimbursement of the above expenses was trading receipt of the assessee. It was held by the Hon'ble Supreme Court that the payments were made by the Government to the assessee to assist it in carrying on its business and for the services it was rendering to the Government by doing so. They were not of a benevolent nature and constituted trading receipts. In the present case also, this is precisely what has happened. The payments have been made in the present case, as per the assessee's submission in the form of reimbursement of expenses (if this plea of the assessee be accepted for arguments sake) for rendering services in terms of the contract dated 1-7-1979 read with that dated 20-5-1980, and, therefore, they will even on this concessional hypothesis, constitute business receipts in terms of the ration of the above case.
17. In the end, I sum up the above discussion by holding-
"(i) That the assessee has a separate and independent entity form that of RR, and that the Agreement dated.1-7-1979 was entered into on principal to principal basis, and so there is no question of the assessee incurring its actual operating expenditure on behalf of RR as its agent. The assessee's expenditure is not RR's expenditure. It is its own expenditure.
(ii) That the above positions is reflected from the accounts kept by the assessee showing its true state of affairs in terms of its obligation under the respective company law.
(iii) That therefore, the various restrictive provisions of the Income-tax Act, 1961 (from sections 30 to 43A, including the relevant rules) apply to the assessee, and the assessee's counsel has put forward not single argument in support of the proposition that the above restrictive provision will not apply to it. iv) That the total receipts of the assessee form RR computed in terms of clause 5 of the Agreement dated1-7-1979read with that dated20-5-1980are business receipts."
18. In view of the above, I reject the assessee's appeal. I need not repeat that ground Nos. 7 to 13 were not pressed by the assessee and so they deserve to be rejected for non-prosecution thereof. As Per Beach-As it has not been possible for us to come to an agreed conclusion in the present appeal, we refer the following question for the valued opinion of the Hon'ble Third member :
"Whether, on the facts and in the circumstances of the case, the CIT (Appeals) was justified in holding that the entire receipts by RRI from RR (being 105 percent of the actual operating costs of RRI) minus expenses admissible under the Income-tax Act, 1961 were liable to income-tax ?"
THIRD MEMBER ORDER
Per Shri Ch G. Krishnamurthy, President - On a point of difference of opinion between the learned Members of the Tribunal who heard this appeal originally, their difference of opinion was formulated in the following words and was referred to the President for the nomination of the third Member to express his opinion on the point of difference of opinion :-"
Whether, on the facts and in the circumstances of the case, the CIT -(Appeals) was justified in holding that the entire receipts by RRI from RR (being 105 per cent of the actual operating cost of RRI) minus expenses admissible under the Income-tax Act, 1961, were liable to income-tax ?"
The matter has now come before me in may capacity as a Third Member and I shall proceed to recount the facts, the narration of arguments addressed to me both for and against the views expressed by the Members and then express my opinion. I shall take the facts from the order of the learned accountant Members, not that there is any difference in the facts narrated by both the Members but it is nor convenient to taken them form the order of the learned Accountant Member.
2. The assessee is a non-resident company being 100 per cent subsidiary of another non-resident company, namely, Rolls-Royce. For short, they will be referred to as RRI for the non-resident Indian Company and RR for the non-resident holding company. RRI was incorporated on 20th of February, 1979. In sub-clauses (A) to (D) of clause 3 of the Memorandum of Association the objects of the RRI were set out. They are :
(A) To carry on business as manufacturer, builders, designers repairers and owners of aero-engines, motor cars and carriages, cabs, omnibuses, wagons, carts, cycles, ships, boats, and other marine vessels, aeroplanes, airships, and all other land, sea or air carriages and conveyances, in whatsoever manner and by whatsoever powers the same may be propelled or driven, and to buy, sell, let out on hire, or act as factor or agent for the purchase or sale of, or otherwise deal in aero-engines, motor cars and motor vehicles and boats of every description, aeroplanes, airships, and every kind of aircraft and component parts, fittings and accessories of all kinds for the same, and all articles and things used in the manufacture, maintenance and working thereof.
(B) To carry on business as engineers, machinists, smiths, fitters, electricians, brass-founders, iron-founder, tube-makers, metal workers, wiredrawers. Rope-makers, rubber or rubber substitute manufacturers, oil-refiners, automobile store, and garage and aerodrome keepers, stores, and suppliers of and dealers in petrol, paraffin, oils and other fluids, generators and distributors of electricity and suppliers of motive powers of any description for all kinds of power vehicles and boats.
(C) To make, construct, buy, hire, sell, repair, alter and deal in component parts and accessories of any of the manufacturers or products of the Company and apparatus, machinery, materials, and goods and articles of all kinds use ful or necessary in carrying on the business of the Company, or in connection there with.
(D) To carry on another trade or business whatsoever which can, in the opinion of the Board of Directors, be advantageously carried on by the Company in connection with or as ancillary to any of the above businesses or the general business of the Company.
3. The RRI entered into an agreement with RR on1-7-1979for rendering of certain services by RRI to RR. The preamble of this agreement is an follows :
"WHEREAS Rolls-Royce sells Engine Products to airlines and other markets throughout the world using commercial information and marketing support derived from various sources. AND WHEREAS Roll-Royce has accepted and will accept Service Support Obligations to customers and Licensees of Engine Products who are located within the Territory and to others of the customers whose aircraft regularly operate into the Territory, AND WHEREAS Roll-Royce India has been formed for the purpose of proving marketing support and a commercial information service relating to the territory and for the purpose of co-ordinating the Service Support Obligations on behalf of Rolls-Royce throughout the Territory.
NOW THEREFORE in consideration of service Fee payable here under it is HEREBY AGREED as follows :"
4. Clause 1 of the agreement defined the terms agreed upon between RRI and RR. They are :
"(a) 'Service Support Obligations' shall mean obligations of Rolls-Royce under contract or otherwise to provide technical and after sales service to customers and licensees of Engine Products.
(b) 'Service Fee' shall mean the annual fee payable by Rolls-Royce to RR India calculated and payable in accordance with Cause 5 hereof.
(c) 'Actual Operating Costs' shall mean the total of revenue expenditure incurred by RR India in performing its obligations pursuant to this agreement in the UK Indian and elsewhere.
(d) 'Budgeted Operating Costs' shall mean the RR India budget fore case to Actual Operating Costs.
(e) 'AP' shall mean a Rolls-Royce accounting period of normally four weeks."
5. Clause 2 provided for the duties of the RRI as :
RR Indian will carry out the following duties to such extent as Roll-Royce may required from time to time :
(i) To obtain and report to Rolls-Royce on a regular basis such marketing information as is considered to be relevant to Rolls-Royce's interests.
(ii) To disseminate such marketing and commercial information relating to Rolls-Royce's products as Rolls-Royce may require.
(iii) To provide administrative and secretarial assistance locally for the service Representatives deployed in the Territory.
(iv) To provide a liaison service between Rolls-Royce and relevant departments of the Government of India and other customers of Rolls-Royce' in the territory in all matters of supply of products and services.
(v) To monitor the effectiveness of Rolls-Royce's commercial advisers and to report regularly thereon.
(vi) To look after Rolls-Royce visitors inIndiaand arrangements for stay and itinerary.
6. Clause 3 provided for the establishment of the offices of RRD as :
"Offices of RR India
(a) RR India shall as soon as practicable establish a liaison office in New Delhi and such other similar offices within the Territory as may from time to time be required by RR India for the purpose of carrying out its obligations under this agreement.
(b) RR India shall operate and maintain such offices within the Territory as may be necessary to fulfil its obligations under this agreement and shall employ competent engineers and other suitably qualified personnel properly to carry out its duties under the provisions of this Agreement.
(c) Rolls-Royce and RR India may make appropriate arrangements in theUKfor such liaison staff as may be necessary to coordinate the activities of RR India with the activities and requirements of Rolls-Royce concerning its business interests in the territory."
7. Then came clause 4 which clearly stipulated that this agreement should not be construed as having established a relationship of agency, as under :
"No Agency Relationship
RR India is not and shall not represent itself to be the agent of Rolls-Royce nor shall it enter into or purpose to enter into any commitments or negotiations of whatsoever nature on behalf of Rolls-Royce in the Territory or elsewhere or do any act or thing which might result in any persons believing that RR India has authority to contract on behalf of Rolls-Royce."
8. Then came the most important clause 5 for our present purpose, namely, the clause providing for the remuneration to be paid by RRI to RR.
"Service Fee
Rolls-Royce shall pay annually to RR India the service Fee as hereinafter provided :
(a) The service Fee shall be calculated for each year of account at fixed rate of 105 per cent of the actual Operating Costs incurred during the Year of account to which the Service Fee relates.
(b) Payment of the service Fee shall be made by way of advance payments by Rolls-Royce to RR India each AP with quarterly adjustments in following manner :
(i) Each of such advance payments shall be calculated at a fixed rate of 105 per cent of the Budgeted Operating Costs for the AP to which the particular advance payments relates and shall be payable by Rolls-Royce to RR India at the beginning of each AP (or part thereof) commencing with effect from 1st June, 1979.
(ii) Within ten weeks of the close of the last business day of AP 3, AP 6, AP 9 & AP 13 in each Year of Account RR India will submit to Rolls-Royce a statement showing the actual Operating Costs incurred up to the end of the said Ap 3, AP 6, AP 9, or AP 13 (as the case may be) together with the total of advance payments made to date during that year of Account.
(iii) Following verification of each such quarterly statement Rolls-Royce will calculate the amount by which the services Fees has been overpaid or underpaid and Rolls-Royce or RR India (as the case may be) will promptly make an adjusting payment to rectify such overpayment or under payment.".
9. Then by clause 6, it is provided that the expenditure incurred by RRI will be reimbursed to it in full by RR in the following terms :
"Setting-up Costs All costs and expenses incurred by RR India (as authorised by Rolls-Royce prior to commitment either specifically or generally) in establishing a liaison office in New Delhi or otherwise in setting up operations shall be reimbursed by Rolls-Royce in full in Sterling in the UK as soon as practicable after such costs and expenses are incurred but in any event within eight weeks form day they are incurred and notified to Rolls-Royce."
10. Another point to be noted, in this connection, is that on 20th of May, 1980 a supplementary agreement was entered into between RR and RRI, the purpose of which was stated to 'reiterate and clarify the position with regard to the remuneration payable under the formation agreement by RR and RRI so as to put the same beyond any doubt". This agreement provided in categorical terms that all the expenditure incurred by RRI would be reimbursed by RR. It was also points out in this supplementary agreement that reimbursement of expenditure incurred by RRI by RR was always the intention between the parties. It is, therefore, necessary to notice what was provided in this supplementary agreement and it is to the following effect :
"NOW THIS MEMORANDUM WITHNESSETH AS FOLLOWS :
It is hereby declared and reiterated that the remuneration payable by RR by way of service fee under and in accordance with the Formation Agreement in respect of liaison services provided by RRI in the territories of India, Bangladesh, Nepal, Sri Lanka, and Bhutan is 5 per cent of the total expenses of RRI (including depreciation) incurred on behalf of RR in connection with the provision of the said service, the entire expenditure incurred on this account by RRI being reimbursed by RR : and it has always been so intended between the parties hereto and always so understood."
11. On 23rd of July, 1979, the assessee-company, RRI applied to the Reserve Bank of India seeking permission to open an office in India, in reply to which the Reserve Bank of India by its letter dated 26th of September, 1979, granted permission laying down certain stipulations, namely, that permission to establish a liaison office in India for a initial period of two years would be granted if the office undertakes only the proposed liaison work and would not undertake any other activity of trading commercial or industrial nature, nor enter into any business contracts in its own name without the prior permission of the Reserve Bank of India; that it would charge no commission or fee or any other remuneration for the lesson activities rendered by RRI in India; that the entire expenses of the liaison office in India would be met exclusively out of the funds received from abroad through normal banking channels; that the liasion office in India should not borrow or lend any money from or to any person in India without prior permission. It also stipulated that the liaison office in India should not acquire, hold or dispose of any property in India without the prior permission of the Reserve Bank of India under section 31 of the Foreign Exchange Regulation Act, 1973; that the liaison office in India would furnish every year a certificate from the auditors to the effect that during the year no income was earned by or accruing to the liaison office in India, along with details of remittances received from abroad duly supported by the bank certificates. A certified copy of the audited final accounts by the liaison office in India and finally an annual report of the work bone by the liaison office in India stating therein the details of activities taken up, services rendered in India and also actual export and import, if any, effected during the period in respect of which the office had rendered liaison services should also the furnished. It also proposed that maintenance of account in the name of RR which was described in this letter as Head Office by the assessee, in the books of the liaison office inIndiawill be shown only after permission of the Reserve Bank ofIndiato do so.
12. After, thus, obtaining permission from the Reserve Bank ofIndia, of the assessee-company, RRI opened a liaison office inIndiaby taking a suitable building on lease. It also engaged the staff as per the requirements provided in clause 3 of the agreement. The assessee-company, RRI incurred in the accounting year a total expenditure of Rs. 29,76,865, on the maintenance of the staff and office inIndiato render services to RR as provided for in the agreement. In addition to the expenditure incurred inIndia, some other expenditure was also incurred in the head office of the RRI atLondon. The total amount of expenditure incurred by RRI expressed in terms of pound sterling came to pound 2,02,743 (pound 1,71,281 inIndiaand pound 31,462 at the head office outsideIndia). The whole of this expenditure was reimbursed to RRI by RR..13. The dispute in regard to the computation of the income of the RRI presented a piquant situation. The assessee-company states the its income was only the remuneration of 5 per cent of the actual operating cost and that amounted to only 2,37,237 in terms of Indian rupee and that alone constituted its income and nothing more. Whereas the IAC (Assessment) was of the opinion the entire amount remitted by RR towards the actual operating cost increased by remuneration of 5 per cent thereof constituted assessee's income and that had worked out to Rs. 31,76,373. After making certain allowances, the final income of the assessee was computed at Rs. 25,33,718 as against Rs. 2,13,237 returned. The main controversy was as to whether the reimbursement of expenditure to assessee-company, RRI by RR constituted the income of the assessee. Put it differently, whether expenditure by RRI in India for the don behalf of RR and got reimbursement thereof in full could there, in fact, or in law be regarded as the expenditure incurred by the assessee-company RRI. The revenue's point was that the expenditure incurred by RRI in India though on behalf of RR and though reimbursed by RR in full yet it constituted the expenditure of the assessee-company in India for the purpose of earning income and when that was the expenditure of the assessee-company in India, the allowance of expenditure to compute the income for the purpose of the Income-tax Act should be as per the provisions of the Income-tax Act and if the Income-tax act had placed any prohibits or restrictions on the allowance of that expenditure, those prohibitions or restrictions should be given full effect to, and only then the expenditure eligible to be allowed as permissible expenditure should be allowed. Since, the entire expenditure was reimbursed the amount received towards reimbursement was in the course of business carried on by the assessee-company and, therefore, constituted its trading receipt. Thus, the receipts including the commissions received and form those gross receipts, only the permissible expenditure under the Income-tax Act should be allowed and the balance should be taken as income. It is in this view of the interpretation of the Income-tax act, that the IAC (Asst.) computed the income of the assessee at Rs. 25,33,718, negativing the assessee's claim the expenditure incurred by it having been solely, entirely, for and on behalf of and at the behest of RR did not become the expenditure incurred by the assessee at all and, therefore, the question of treating remittances received by way of reimbursement of the expenditure to so incurred shout not and could not be regarded as trading receipts, much less, as income. Since, the assessee got only reimbursement of the expenditure incurred by it on behalf of RR there was an element of income in it. Since, the assessee did not claim any portion of that expenditure as allowable in compacting its income, the question of disallowing the expenditure would not arise nor the question of applying the provisions of the Income-tax Act would arise because the assessee, in so far as that expenditure and remittances received by way of reimbursement are concerned, was not carrying on any business. Even to meet the expenditure, the assessee-company RRI was receiving advances from RR, which is clear from the terms of agreement referred to above in clause 5. It was the amount received from RR by way of advance to meet the expenditure inIndiathat the RRI and met the cost of expenditure out of advance received. Thus, there was not even any investment made by RRI to meet the expenditure. Therefore, the expenditure incurred by RRI in India and the reimbursements received from RRI should both be excluded and only the commission received by RRI, which was measured at a particular percentage of the actual expenses incurred in India must be regarded as the income of the RRI, which was measured at a particular percentage of the actual expenses incurred in India must be regarded as the income of the RRI minus expenditure incurred by it on its own behalf to earn this commission. The actual cost incurred by RRI inIndiawas only a measure to arrive at the commission that accrued to RRI inIndiaand that should not be misunderstood that the reimbursement of the expenditure by RRI inIndiaconstituted its trading receipts.
14. This is the essence of the case of the assessee-company before the authorities below. The IAC (Asst.) for reasons recorded by him in his assessment order rejected the assessee's contentions and proceeded to compute the income as stated earlier. It may be noted here that the revenue accepted this position as explained by the assessee in respect of the earlier two assessment years but this was the only year where a departure was made to tax the remittances received by the assessee by way of reimbursement. The assessee having failed in appeal before the CIT (A) preferred a further appeal before the Income-tax Appellate Tribunal.
15. The learned Judicial Member expressed his assent to the view canvassed on behalf of the assessee by holding that only the commission received by the assessee-company constituted the income of the assessee and not the receipts received by way of reimbursement of expenditure. The learned Accountant Member expressed a dissent with the view expressed on behalf of the assessee and assented with the view of the revenue stating that the reimbursement of expenditure and the amount received by way of remittances constituted trading receipts of the assessee.
16. Before I go to the reasons that prevailed with my learned brothers to come to their respective conclusions, I may have to notice what prevailed with the CIT (A) in declining to accept the claim of the assessee. In paras 3.6 and 3.7 of his order, CIT (A) has mentioned as under :
"3.6 As such it is clear that the amount paid by Rolls-Royce U. K. was in the form of service fee. This Service fee was fixed at 105 per cent of the actual operating cost incurred during the year of account to which the Service fee related. In the circumstances, I am of the view that entire amount received from Rolls-Royce U. K. by the appellant has in the from of ordinary receipts of service fee received by any businessman or professional or company, etc., for the services rendered by him/it. Hence, entire receipt minus expenses admissible under the IT Act, 1961 were liable to income-tax.
3.7 I further agree with the IAC (Asst.) that memorandum dated29-5-1980cannot change the nature of receipt in the hands of the appellant. So far as the actual expenses are concerned, Rolls-Royce U. K. might be competent to verify the same for the purpose of calculation of Service fee. But that does not mean that each and every expenditure is exempt from Income-tax. As such entire amount received from Rolls-Royce U. K. by the appellant has to be treated as revenue receipt. As regards the expenses, these have to be scrutinised under the Income-tax act and such expenses as are not admissible under the Income-tax Act have to be disallowed. To this extent I completely agree with the IAC (Asst.)"
17. It will be seen from the above that the CIT (A) was under the genuine impression that the service fee fixed was 105 per cent of the actual operating costs incurred during the year of account and, therefore, the entire amount received from RR by the assessee-company RRI constituted receipt for service fees and, therefore, taxable, minus expenses admissible under the Income-tax act. Whether reference to 105 per cent as actual operating cost would lend support to the view taken by the assessee is a matter for deep thought. What is more, the CIT (A) held that the agreement entered into on 29-5-1980 had brought about a change in the nature of the receipt in the hands of the assessee end that change would not be permitted, and, therefore, the service fee by the assessee was at 105 per cent of the actual operating cost and, therefore, the expenses incurred by the assessee had to be scrutinized under the Income-tax Act and such expenses as are not admissible under the Income-tax Act had to be disallowed. Whether this view is right or wrong, as I have mentioned earlier, is the bone of contention, in this appeal.
18. The learned Judicial Member held that the view taken by the learned CIT (A) was incorrect. After referring to the relevant passages of the agreement, objects in memorandum of association and the arguments of the learned counsel for the assessee and the D. R. the learned Judicial Member held that the service fee received by the assessee was not 105 per cent of the actual operating cost incurred during the year of account but it was only 5 per cent. He held that RR had brought RRI into existence to subserve its needs of perform liaison work in India and surrounding countries to promote the sales of its manufactured goods; that the RRI had no independent existence or activity; that this fact was borne out not only by the preamble to the agreement but also by the permission granted by the Reserve Bank of India whereby the Reserve Bank of India had specifically restrained RRI form carrying on any business of whatever kind other than performing the liaison work as mentioned in the agreement, a copy of which was filed before it. He held that on a careful consideration of agreement entered into between RR and RRI, RR and agreed to reimburse the entire expenditure by RRI in carrying out the appointed tasks by RRI. He held that though clause 4 of the agreement between RRI and RR had prohibited RRI from acting as the agent of RR, having regard to the other clauses of the agreement and the purpose for which RRI was brought into existence, RRI was acting as de facto agent of RR thought not as de jure agent of RR. He, therefore, held that the expenditure incurred by RRI and reimbursed by RR was not at all the expenditure of RRI. The reference to 105 per cent of the actual cost incurred in the agreement must be understood in such a way, as to mean that what was to be paid to the RRI was only actual expenses incurred by it for which it received advance money from RR plus 5 per cent remuneration. Since, 105 per cent included reimbursement of expenditure to the full brim, that amount should not be regarded as receipt at all being only reimbursement of expenses. Placing reliance upon the agreement entered into on 20-5-1980, which was entered into with a view to reiterate and clarify the position was understood between RR and RRI, when the original agreement was entered into, the learned judicial Member held that this mater was put at rest beyond any doubt that the expenditure incurred by RRI in India was really the expenditure of RR and, therefore, the reimbursement of it did not constitute receipt in the hands of the assessee-company, RRI as a taxable receipt. He also placed reliance upon a certificate issued by RR on10-10-1986wherein RRI had certified that all expenditure incurred by RRI both inIndiaand in the U. K. was borne by RR and was charged with a profit and loss account in the books of account of RR. It also stated that the moneys advanced to RRI were for different purposes for defraying operational costs to be incurred by RRI inIndia. Any unexpended advance held by RRI was refundable to RR and was shown as such in the books of RRI. According to the learned Judicial Member, this certificate put beyond any shadow of doubt, the nature of the expenditure that was all spent by RRI. The learned Judicial Member finally held that it was not possible to agree with the view expressed by either the IAC (Asst.) or the CIT (A) that the intention of entering into an agreement on20-5-1980was to change a situation which did not exist at the time when the agreement was originally entered into on1-7-1979. The purport of agreement of20-5-1980was only to clarify the situation and to clear the doubts not to bring about a change as was supposed by he authorities. In this context, he mad reference to section 62 of the Indian Contract Act, which provided for addition, subtraction, alteration, waiver or a recession of an agreement before a contract was breached. He held that the agreement dated 20-5-1980 could not be taken as an so as to circumvent a situation created by the proceedings initiated by the IAC (A) because IAC (A) initiated proceedings for this assessment year long after the agreement was entered into on 20-5-1980 and the assessments for the earlier years were completed on the basis of these agreements. He, therefore, vacated the order passed by the IAC (Asst.) and directed him to take the remuneration of 5 per cent of the actual operating cost as the taxable receipt of the assessee-company and proceed to make the assessment accordingly. On other grounds no finding was recorded as assessment was set aside.
19. The learned Accountant Member, however, took a different stand. After exhaustively referring to the material placed on record, which was considered by the learned Judicial Member also he held that he assessee-company was trying to hide something from the department. By reconstructing the profit and loss account on the basis of figures available on record, he came out the conclusion that the assessee made an attempt at presenting a wrong picture of the accounts. According to the learned Accountant Member, RRI is an independent juridical entity having its own identity and the business machinery. It is not the agent of RR either factually or legally. Though RRI undertook all the jobs, they were not for and on behalf of RR as its agent but they were for the benefit of RR in the course of carrying out the obligations cast upon by RR on RRI. The activities carried on did not become the activities of RR even though their sole object was to subserve the cause of RR. This, according to him, was vital distinction. Closely relying upon clause 5 of the agreement, he held that since the service fee was to be calculated at a fixed rate of 105 per cent of the actual operating cost, it meant that if 100 rupees was spent, the fee that the assessee-company would be entitled to receive would be 105 per cent. That is to say, the service fee was so fixed as to compensate the assessee-company, RRI not only for its actual operating costs in their entirety but also leave it with a surplus of 5 per cent. The agreement of20-5-1980did neither improve upon nor later the aforesaid arrangement by remunerating the assessment-company. Again, dwelling on the agreement of20-5-1980, particularly the phrase used on behalf of RR", the learned Accountant member said that the phrase has to be understood in the setting and the context of the entire agreement and so constructed. It should be interpreted as meaning "for the benefit of RR" and not "incurred as the agent of RR". When the agreement provided for the payment of full expenditure incurred by RRI plus 5 per cent commission, the expenditure incurred by RRI became its own expenditure and the amount received by way of reimbursement became its receipt and while computing the income under the Indian Income-tax Act from the gross receipts of 105 per cent such expenditure as is allowable under the Income-tax Act only will have to be allowed and in this context, it is of no consequence to contend that whether the receipts were not 105 per cent nor the expenditure incurred by the assessee was not of its own. Thus, the agreement of20-5-1980, according to him, did not bring about any change in the method, manner and nature of remunerating the assessee-company. Since, the complexion of the arrangement had not changed, he did not agree with the view expressed by the revenue that agreement of20-5-1980had brought about a change in the complexion of the earlier agreement. Advance payments towards full reimbursement of expenditure, according to him, was only a convenient system devised to facilitate accounting and payments and that by itself did not advance the assessee's case. As the actual should be known only at the den of the year of accounting, this system had to be devised. Even so, the method and manner of remunerating the assessee-company had not undergone any change. He also drew support for his view that the expenditure incurred was that of RRI and not that of RR, from the use of the expression in the agreement "total of revenue expenditure incurred by RRI for performing its obligation". The "revenue expenditure incurred by RRI" according to the learned Accountant Member, meant that the expenditure was incurred by RRI as its own and not as that of RR, even though in the process, RR was amply benefited. It is only by incurring this expenditure that RRI was able to earn commission by 5 per cent. It would be, therefore, misleading to say that the expenditure was incurred by RRI on behalf of RR. Though the copy of the profit and loss account as prepared by the assessee-company was file before the Bench, the learned Accountant Member constructed a profit and loss account on the basis of figures furnished and arrived at the profits which was shown in the statement filed by the assessee and since, to the profit and loss account the entire remittances were credited, he drew support for his view that the entire receipts constituted the trading receipts of the assessee in the sense that 105 per cent in entirety became assessee's trading receipts. He also relied upon the fact that it was the assessee-company RRI which engaged the employees, hired out accommodation, set up office inIndiaand which approached the Reserve Bank of for permission to set up office inIndia. The Reserve Bank ofIndiagranted permission to the assessee-company to set up an office inIndiaand this according to him, is of paramount importance to support the view that the assessee-company was incurring the expenditure on its own and thereby carrying on business inIndia. On behalf of the assessee, reliance was placed upon the decision of the Calcutta High Court inDuncanBros. & Co. Ltd.'s case and another judgement of the Calcutta High Court in Dunlop Rubber Co. Ltd.'s case. By distinguishing both these decision, the learned Accountant Member held that the principle enunciated in those decisions did not at all apply to the facts of the case. Once the expenditure was incurred by the assessee, that expenditure had to be subjected to the scrutiny by the Income-tax Officer and if any expenditure came within the mischief of section 40C(3), 40(A) 5 or rule 6D, that has to be applied to this expenditure also irrespective of the fact whether the assessee-company was a resident or non-resident because the Income-tax Act did not make any distinction in so far as the application of these restrictive provision between a resident and a non-resident assessee is concerned. Finally, the learned Accountant Member, drew ample support for his vie from the ratio of the judgment of the Supreme Court in the case of V. S. S. V. Meenakshi Achi. The Supreme Court according to the learned Accountant Member, held in this case that receipt on account of the reimbursement of revenue expenditure is revenue receipt. He also relied upon another judgment of the Supreme Court in the case of Bengal Textiles Association.
20. Now, it is my task and endeavour to find out whose view is just, correct and according to law on the facts, if not close to it. I do not have to reproduce here the arguments addressed to me by both the learned counsel for the assessee and the departmental representative because they emphasised, reiterated their respective stands taken up before the authorities below as well as before my learned Brothers. My first task is to resolve the raging controversy as to how RRI rendered services to RR and in what capacity ? To answer this question, one has necessarily to go to the agreement, which is on pages 42 to 49 of the paper book. I have already extracted above the relevant clauses form the order of the learned Accountant Member. RR, whose registered office was at London was selling engine products to Ireland and other markets throughout the world using commercial information and marketing support derived from various sources. So, for RR on order to maintain its sales and to push them up further, it is of paramount importance to obtain commercial information and marketing support without which it would not be able to sell its engine products, which are of complex nature. Another aspect of paramount importance to RR is that under the sale agreement it entered into with its customers, it had accepted the service and support obligations to customers and to licensees of the engine products. RR had been specifically therefore thought of a source for perennial supply of information as part of its business activity. Thus RRI was incorporated for this specific purpose of providing marketing support and commercial information service relating to the territory, to which it is assigned and also for carrying out the service support obligations undertaken by RR in that territory. Thus, for RR to maintain and promote its sales, it has to have source from which it could obtain commercial information and provide marketing support as well as discharge its obligation of providing service support to customers and licensees. It is to perform these functions that RRI was conceived of, promoted and was brought into existence. That is why, if we have a look at the memorandum of association of RRI, it will be seen that of the total share capital of RRI of pound 50,000 divided into 50,000 shares of pound 1 each RR subscribed for 9,990 shares of pound 1 each and Alan Edward West had subscribed for the balance of 10 shares in his capacity as Chartered Secretary. This shows that RRI is a more or less 99.9 per cent owned subsidiary of RR but for the 10 shares held by the Chartered Secretary, there is no distinction between RR and RRI although for the purposes of Indian Companies Act, RR and RRI are two juridical entitles having perpetual succession. In conducting the business of RRI, it cannot have a say of its own other than submitting to the dictates of RR. One can even say by piercing the corporate veil of RR and that of RRI one would discover that RRI was nothing but the agent or benami of RR. That is not a question directly before me. Therefore, I would not like to go into this aspect except to take assistance and support from this fact to the view that I am going to take as to whom the expenditure incurred by RRI eventually belonged. This fact would lend support to the view that RRI though was given a legal independent existence was not factually independent. The entire control of it vested with RR. RRI was operating in theterritoryofIndia,Bangladesh,Sri LankaandBhutan, where RR had sold its products and incurred service support obligations, that is, to provide technical and after-sales service to customers. This is essentially highly technical service to be provided by RR under the agreement it entered into. For this purpose, RRI on which this responsibility was cast has to engage competent and technical qualified men. But when we look at the salaries paid to employees, RRI engaged two persons, both of whom were directed to be employed by RR. This is the information ascertained during the course of hearing before me because of the observation of the learned accountant Member that the employees of the assessee-company RRI were paid huge salaries and they were engaged by RRI. I do not have to refer to the duties that they include obtaining and reporting to RR on a regular basis the marketing information as is considered relevant to RR's interest, to provide administrative and secretarial assistance for the service representatives deployed in the territory assigned to RRI and to provide liaison service between RR and the relevant departments for the Government of India and other customers and to look after the visitors of RR in India by making arrangements for their stay and itinerary. Their duties are basically not for the benefit of RRI but for and on behalf of RR. For this purpose it had to establish of office inIndia. Even though RRI was empowered to employ competent engineers and other suitably qualified personnel to carry out its duties, the immediately next clause provided, which is clause 3(c) that RR and RRI should make appropriate arrangements in the U. K. for such liaison staff, as may be necessary to carry out the activities of RRI with the activities and requirements of RR. Clause 4 comes in, to specifically state, that no relationship of agency existed but this is more to avoid and circumvent the application of the provisions of F. E. R. A and perhaps, the Income-tax Act also but really not to say that RRI should not act as the agent of RR. What was prohibited under this clause 4 was entering into or purporting to enter into any commitment or negotiations of whatsoever nature on behalf of RR. This is to prevent RR from being dragged into any controversy or getting caught in the web of legal complexities of the countries assigned to RRI rather than prevent RRI from acting. A close look at the duties assigned to RRI under clause 2 and the restriction contained in clause 4 do suggest that there is some amount of mutual contradiction. It cannot provide a liaison office or provide service support obligations, if it did not represent RR. Just to collect information from the customers about the proper functioning and performance of goods sold and about further needs and transfer that information to RR, I do not see how RRI can obtain the information, which is sometimes of complicated and confidential nature without its holding out to be representative of RR. How can it act as representative unless it implies agency. There is one point which has to be borne in mind for resolving the issue involved in this case.
21. As I see, since RRI was put-up to perform the obligations that were otherwise to be performed by RR and at the same time obtained information, which has to be creditable and trustworthy and since both are one and the same except for difference of 10 shares RR has to meet and own the entire expenditure, to be incurred by RRI. Since, RRI has no independent existence and since, it has not been permitted by the Reserve Bank ofIndiato perform any other activities than to purely and simply acting as liaison office of RR, it has no purpose to incur any expenditure of the nature now incurred by RR. This background has to be borne in mind to decide this issue. RR having put up RRI as its shadow has to necessarily meet its expenditure and, therefore, it has to show the entire expenditure in its accounts and also provide resources to RRI to meet the expenditure by way of periodical advances depending upon the requirements as projected to it by way of budgets by RRI and RR. The agreements entered into on1-7-1979and clarificatory agreement entered into on20-5-1980have to be read and understood and appreciated in this background. So understood, I am of the view that the expenditure incurred by RRI cannot be said to be the expenditure incurred by it on its own behalf. The agreement of20-5-1980entered into with a view to provide clarification cannot be interpreted in a manner otherwise than as how the parties to it understood it. Therefore, in my opinion, it is not very appropriate to substitute the expression "on behalf of by" the expression as was brought to be done by the learned Accountant Member "for the benefit of". This is to say the least, would amount to rewriting the agreement between the parties. It is, no doubt, true that both the parties are two independent legal entities yet for the purposes of business that these entities were carrying on, they are one and the same within the meaning of the expression "same business" as enunciated by the Supreme Court in the case of Produce Exchange Corpn. Ltd. v. CIT [1970] 77 ITR 739. Judged from this angle there can be no doubt that RRI is not free to spend any money by way of expenditure. This is also brought out more clearly from a close reading of the agreement entered into between RRI and RR. The furnishing of budget, approval by RR, payment of advance to meet the expenditure by RR to RRI and clarification of the statements submitted by RRI to RR to ascertain over-payments or under payments and a provision for adjustment of payment to rectify such over or under-payments, all go to show that RRI is not free to incur expenditure as it likes. This position is borne out by sub-clause (b) sub-clauses (i), (ii), (iii) of clause 5 of the agreement, which provided for the payment of service fee. Now, sub-clause (b) very clearly pointed out that all costs and expenses incurred by RRI are to be authorised by RR but prior to commitment either specifically or generally in establishing a liasion office in New Delhi or otherwise in setting up operations. This reference to "otherwise in setting up operations" reinforces the inference, I am drawing, that RRI cannot incur any expenditure other than that authorised by RR either in establishing a liaison office or in setting up office later. This arrangement, in my opinion proves the statement made by RR that the expenditure incurred by it was not its own expenditure incurred by it for the purpose of its own business. Thus, RRI is only an agent of RR for the specific purpose of incurring expenditure on behalf of RR.
22. Before I go to the other aspects of the matter, I would like to deal here with the interpretation sought to be placed upon sub-clause (c) of clause 5 of the agreement whereunder the service fee of 105 per cent of the actual operating costs incurred, was provided. When the agreement provided that the service fee shall be 105 per cent of the actual operating costs, it did not, in my opinion, mean that RRI is receiving 105 per cent as its trading receipts. Of this 100 per cent cost was towards the reimbursement of expenses and the balance of 5 per cent was only towards service fee. The expression 105 per cent to the actual operating costs incurred is not like weighted receipt like the weighted deduction u/s 35 of the Income-tax Act. The same thing could have been expressed in a manner as to show that 100 per cent was to go towards expenses and the balance of 5 per cent only would be the service fee. Instead of mentioning that the actual expenditure incurred by RRI would be reimbursed in full, the agreement said in a manner of expression that the service fee would be 105 per cent of the actual operating costs. That the actual operating costs were going to be reimbursed to RRI becomes clear from the reading of sub-clause of clause 5. Sub-clause (ii) of sub-clause (b) of clause 5 provided that within 10 weeks of the close of the last business day, RRI will submit to RR a statement showing the actual operating costs incurred up to that day together with the total advance payments made up to that day. Thus, sub clause (iii) provided that following that verification, the RR will calculate the amount by which service fee has been over-paid or under-paid and make necessary adjustments. This clearly proves that the actual operating costs incurred by RRI inIndiais to be reimbursed. When the actual operating cost was reimbursed to it, the question would arises whether that constituted the income of the assessee. In my opinion, it does not constitute income. It is like a businessman 'A' carrying on business in Delhi asking his friend, another businessman 'B', let us say in Trivandrum, to buy for him rail-tickets or air-tickets and to make hotel arrangements and also for transport and agreeing to reimburse the expenses incurred later. The amount spent by businessman 'B' inTrivandrumwas fully reimbursed to him by the businessman 'A' atDelhi. For the businessman inTrivandrum, the receipt by way of reimbursement can neither be a trading receipt much less its income. Nor the expenditure incurred by him can be said to be expenditure incurred by him for the purpose of his business. In other words, the reimbursement received for the expenditure incurred for the purpose of business carried on by an assessee can it be said that reimbursement would be revenue receipt? This is what the Supreme Court held in V. S. S. V. Meenaishi Achi's case. In this case, the assessee owned 5/6 shares in an estate inMalaya. During the Second World War rubber estates inMalayawere destroyed or denuded. In order to encourage planting or re-planting of rubber trees, the Govt. of Malaya by an Ordinance constituted a Board to administer the funds accumulated in terms of the said Ordinance. The assessee received 5,962 Malayan dollars as re plantation cess from the said Board. The assessee claimed that the said amounts were capital receipts. The Income-tax Officer treated them as revenue receipts on the ground that the said payments were made to cover the re-plantation expenses of the assessee. The AAC on appeal held that the ITO's view was right because the assessee had a reasonable expectation of receiving the amounts from the Government in consideration of running a rubber estate business. The Tribunal also confirmed the view of the revenue. The High Court also affirmed the view of the Tribunal and when the matter came before the Supreme Court, the Supreme Court also confirmed the view of the revenue. The Supreme Court analysed the provisions of the Ordinance issued, under which the cess was collected and found that the cess was collected in terms of the rubber exported and the distribution has to be made among the planters in a manner as to provide them compensation for the expenditure incurred. It is not necessary for me to reproduce here all the clauses of the Ordinance there. The Supreme Court noticed that the finding of the Tribunal in that case was that those expenses were based upon the production and not the actual expenses shown as having been incurred by the assessee. The Tribunal has also found that it was not a reimbursement of expenditure outlaid. The Supreme Court approved this finding an held eventually that the amounts made out of the funds earmarked for the assessee on the basis of rubber produced by them were paid against the expenditure incurred by them for maintaining the rubber plantation and producing the rubber. It would, thus, be seen that the expenditure incurred by the assessee was her own expenditure and the reimbursement made not to the full extent but partly, was, held to be revenue receipt. Therefore, the primary fact to be established before a reimbursement of expenditure can be held to be a revenue receipt is whether the expenditure incurred was the assessee's own expenditure and whether it was incurred in the course of its business. If the expenditure incurred was in the course of its business, then the reimbursement would be his income. In the example, I have given above, the expenditure incurred by the businessman inTrivandrumis neither his expenditure nor incurred in the course of his business and, therefore, reimbursement of expenditure cannot be said to be a trading receipt. I am of the opinion that the Supreme Court decision relied upon by the learned Accountant Member may apply to a case where the expenditure was incurred by the assessee on its own in the course of its business but not to a case where the expenditure was incurred not on its own but on behalf of someone else. On the facts of this case, it cannot be said that RRI incurred expenditure on its own. It incurred the expenditure for and on behalf of and at the behest of RR. Neither RRI has a say in the planning of the expenditure on its own and then claim reimbursement. Everything is controlled and regulated by RR, by means of advance payments, pre-budgeting and prior approvals.
23. Another aspect that requires to be considered is whether the provisions of the Income-tax Act would apply to the expenditure incurred by the assessee in order that the aforesaid expenditure could be disallowed. Sections 30 to 43A of the Income-tax Act are the concerned provisions. Each of these provisions, to which I have made a close study, stipulates, that the expenditure must be incurred by the assessee or depreciation must be on the machinery owned by the assessee and used for the purpose of the assessee's business. Therefore, I do not wish to quote the provisions of sections 30 to 43A in extenso, suffice it to say that those provisions apply to an expenditure incurred by an assessee in carrying on its business. Therefore, the basic requirement for these sections to apply are that the expenditure must be incurred by the assessee on its own for the purpose of its business. Section 37, for example, opens with the words "any expenditure laid out or expended wholly or exclusively for the purpose of business or profession shall be allowed in computing the income chargeable under the head profits and gains of business or profession" (words not necessary for our present purpose are omitted). This shows that the expenditure must be incurred by the assessee first on its own. So, too is the provisions made by section 40 which puts a prohibition on the allowance of expenditure in computing the income chargeable under the head "Profits and gains of business or profession". Again, section 40A(2)(a) states that "Where the assessee incurs any expenditure in respect of which"-which again applies only when the assessee incurred an expenditure on its own and claimed it as a deduction in computing the income is only then the ITO's power to make a disallowance out of it will arise and the said basic jurisdictional fact to vest him with the power of disallowance is the incurring of the expenditure by the assessee and claiming it as a deduction. Here, the assessee claimed that it never incurred any expenditure on its own and never incurred any part of the expenditure as a deduction. It is the Income-tax Officer, who is forcing upon the assessee that some expenditure was incurred by him or must be deemed to have claimed some expenditure and, therefore, a portion of it would be disallowing by applying the restrictive provisions of the Income-tax Act all because the assessee-company received some reimbursement of the expenditure incurred. This, in my opinion, is not the correct appreciation of the situation. The correct appreciation of the situation is as was done by the ITO in the earlier assessment years 1980-81 and 1981-82. No departure should have been made from that view. So when the requirement of the Income-tax Act, namely, incurring of expenditure by the assessee and claiming the same a deduction was not fulfilled and without these two basic conditions being fulfilled, it is not permissible in my view to proceed to disallow the expenditure. When the reimbursement was not in respect of the expenditure incurred by the assessee on its own like in V. S. S. V. Meenakshi Achi's case, the same cannot be considered as revenue receipt. Unless, the receipt is considered as revenue receipt, the question of considering the expenditure for the purpose of disallowance can arise. I have already noticed that even the employees employed by RRI were not those employed by RRI at its own instance but those employed at the instance of RR. They were qualified people sent over by RR to RRI to render the services that RRI was obliged to do under the agreement, which again ensures for the benefit of RR. It is RR that is working through RRI in all this arrangement. Perhaps this fact should not be forgotten. The clarification provided by the agreement dated20-5-1980though had to be of no consequence by the learned Accountant Member with which I agree, does not also bring about any change in the understanding between RRI and RR in so far as the payment of service fee was concerned. It made explicit what was implicit in it, earlier. That explicit arrangement between the two entities is a clear pointer that RRI was not to incur any expenditure inIndiafor its own purpose except for the purpose of RR. If the purpose of expenditure inIndiawas not for the purpose of RR, RR need not agree to reimburse it. But one thing has to be noted here, namely, that the subsequent agreement on20th May, 1980clearly stated that what was to be paid to RRI by way of service fee was only 5 per cent of the total expenses of RRI incurred on behalf of RR. Thus, the incurring of expenditure is taken only as a measure for the purpose of calculating the 5 per cent of service fee. This being clear from the agreement of20th May, 1980and having found that this agreement was not a fictitious one but only clarificatory of the earlier agreement and did not bring any change, it should have been held that the fee of the assessee-RRI was only 5 per cent and not 105 per cent. Furthermore, the letter of 20th October, 1986 which was available on the record clearly provides that the expenditure incurred by RRI in India and in the U. K. is borne by RR and the moneys advance by RR were for the purpose of defraying operational costs. What is more important in this letter is the explanation that the unexpanded advance, if any, held by RRI were held in trust by RRI for and on behalf of RR and in this state of affairs it cannot be said that the expenditure incurred by RRI was on its own and not on behalf of RR.
24. The learned departmental representative did not advance any particular argument before me during the course of the hearing except to strongly defend the view taken by the learned Accountant Member. The learned Accountant Member proceeded on the assumption that expenditure incurred by RRI was its own and, therefore, the reimbursement of it was trading receipt and, therefore, when the income is to be computed for the purpose of the Income-tax Act, the entire 105 per cent should be taken as trading receipts and from that only such expenditure which could be allowed as a deduction under the Income-tax Act, be allowed. The basic postulate of the learned Accountant Member was that the expenditure incurred by RRI was its own expenditure. Here, I find it difficult to travel with him. I am inclined to agree with the view expressed by the learned Judicial Member. Though the revenue refused to treat the agreement of20th May, 1980as of any consequence in validity both the learned Members have proceeded on the assumption that the agreement of20th May, 1980was a valid agreement intended only to bring out explicit what was implicit in the agreement. I do not have to express any opinion on this agreement even though the learned D. R. had made a submission that this agreement must be looked as an afterthought.
25. In my opinion, the letter issued by the Reserve Bank ofIndiapermitting RRI to open a liaison office inIndiaimposing several restrictions also lends support to the view that I am taking that the expenditure incurred by RRI inIndiacould not be said to be its expenditure. The decision of the Calcutta High Court in Dunlop Rubber Co. Ltd.'s case lays down the rule that amount received by way of recoupment of expenditure incurred could not be regarded as income. When the Calcutta High Court laid down in V. S. S. V. Meenakshi Achi's case, that amount received towards incurring of expenditure was of revenue receipt. Apparently, it may seem that there is a conflict between these two decisions and the Supreme Court decision must overrule the Calcutta High Court decision and the Calcutta High Court decision must yield to the Supreme Court decision. But in my view there is no conflict between these two decisions. In the case of V. S. S. V. Meenakshi Achi, the asses see incurred some expenditure for the purpose of its own business and received some reimbursement from the Government by way of a help or subsidy or subvention, the amounts so received were rightly held to be revenue receipts. But in the case of Calcutta High Court, it was direct recoupment of expenses incurred under a prior arrangement. Recoupment of expenditure can be income in very exceptional case. If expenditure is incurred by an assessee and that expenditure is fully or partially reimbursed, the net addition to income is nil, for, in that case the reimbursement received will offset the expenditure leaving the income unaffected either by way of addition or diminution. But if the expenditure incurred is claimed and allowed as a deduction and reimbursement of such expenditure is excluded, then that will give a distorted picture of income because the receipts, which are clearly of income nature, are being excluded. The present case to my mind is not the one where expenditure was incurred by the assessee-RRI claiming it as expenditure but at the same time claiming the reimbursement to be excluded. The assessee is claiming that expenditure spent by it was not its own, nor incurred by it for its business purpose. The expenditure was that it was required to spend, and the reimbursement it got should, therefore, be excluded. This, I think is fair and justified. As rightly pointed out by the learned Judicial Member, the assessee-company RRI did not incur any expenditure in the true sense of the expression "incur" but it spent the money belonging to RR for the business purpose of RR, as its agent. Therefore, it was to hold out as an agent of RR. But the reservation in clause 4 of the agreement became necessary for, RR, did not want to entangle itself by the commitment, intended or unintended made or to be made RRI. This is not to be construed the RRI is not acting as agent of RR. As I pointed out earlier, there will be an apparent repugnancy in the agreement if RRI is read as not to act as an agent of RR. Therefore, in my opinion the ruling of the Supreme Court cannot be applied to the facts of this case but the ruling of the Calcutta High Court does seem to apply.
26. For these reasons I am in agreement with the view expressed by the learned Judicial Member. The matter will now be placed before the regular Bench to dispose of the appeal in accordance with the opinion of the majority.
27. Before I conclude I would like to draw sustenance for my view that that amount would only be called expenditure which an assessee incurs on a permanent basis and parts with the money irretrievably for this purpose of his business. If there is a prospect of recovery of money by reimbursement or the money is spent at the behest of someone else with a promise to reimburse it that would never be the expenditure contemplated for deduction under the Income-tax Act. This is amply borne out by a series of decisions and I would like to rely for my present purpose on one decision of the Orissa High Court in Sajowanlal Jaiswal v. CIT [1976] 103 ITR 706. Though for the purpose of section 40A (3) of the Income-tax Act, the word 'expenditure' used in section 40A (3) came up for interpretation in this case their Lordships of the Orissa High Court relying upon the meaning assigned to the word 'expenditure' in the dictionaries, because the word 'expenditure' was not defined in the Income-tax Act, held that the expenditure was such where money was spent irretrievably. This would show that the money spent by the assessee, in this case, was not for its own purposes.
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