This is an appeal filed by the Revenue against the order of CIT(A)-V, Pune dated 19.02.2010 relating to assessment year 2005-06 passed under section 143(3) of the Income-tax Act, 1961.
2. The appeal of the Revenue was earlier dismissed by the Tribunal vide order dated 29th March, 2011 due to absence of proper service of notice upon the assessee. The Revenue moved Miscellaneous Application in MA No.123/PN/2013 pursuant to which the Tribunal recalled its earlier order for fresh adjudication on merits, hence this appeal.
3. The Revenue has raised the following grounds of appeal
“1. “Whether on the facts and circumstances of the case, and in law, the Ld. CIT(A) was justified in deleting the disallowance of Rs. 1,01,09,779/- made by the AO on account of depreciation on plant & machinery purchased from the sister concerns when the AO had clearly established that the said purchase of plant & machinery was hit by the provisions of Explanation 3 to Sec 43(1) of the I.T. Act 1961
2. "Whether on the facts and circumstances of the case, and in law, the Ld. CIT(A) was justified in deleting the disallowance of Rs. 13,23,750/- made by the AO on account of depreciation on technical know-how acquired from the sister concerns when the AO had clearly established that the said acquisition of technical know- how was hit by the provisions of Explanation 3 to Sec 43(1) of the I. T. Act 1961?"
3. "Whether on the facts and circumstances of the case, and in law, the Ld. CIT(A) was justified in deleting the disallowance of Rs. 43,86,417/- made by the AO, on account of payment made by the assessee to its sister concern viz. M/s Kinetic Engg. Ltd. for acquisition of tool room?"
4. "Whether on the facts and circumstances of the case, and in law, the Ld. CIT(A) was justified in deleting the disallowance of Rs. 43,86,417/-, when the transaction in question, for which the said payment has been made, appears to be a non-genuine and sham transaction?"
5. The order of the Ld. CIT(A) may be vacated and that of the AO be restored.
6. The appellant craves leave to add, amend or alter any of the above grounds of appeal.”
4. The grounds of appeal No.1 & 2 relates to question of applicability of Explanation 3 to section 43(1) of the Act on the given set of facts. The relevant facts concerning the issue are as follows.
4.1 During the relevant year, the assessee has purchased plant & machinery for its tool room division from sister concerns, namely, M/s Kinetic Engineering Ltd. (M/s KEL) and M/s Kinetic Motor Ltd. (M/s KML) for an aggregate consideration of Rs. 9,34,68,813/-. Moreover, the assessee has also acquired technical know-how for its aforesaid tool room division from M/s KEL for a consideration of Rs. 1,10,20,000/-. The details of purchase of plant & machinery and acquisition of technical know-how are as under :-
| Sr.No. |
Name of the entity |
Nature of transaction |
Amount (Rs.) |
1 |
M/s Kinetic Engg. Ltd |
Purchase of capital goods |
7,78,35,813/- |
2 |
Kinetic Motor Co. Ltd. |
Purchase of capital goods |
1,56,33,000/- |
3 |
M/s Kinetic Engg. Ltd |
Technical know-how fees |
1,10,20,000/- |
4.2 It is an admitted fact that assets acquired are second hand and has been used by the supplier before its sale to the assessee. The Ld. Assessing Officer also proceeded on the basis that the Written Down Value (WDV) of the capital goods in the books of the supplier/transferor is NIL for tax purposes.
4.3 The Assessing Officer questioned the transfer of capital goods by the sister concerns after availing the full tax benefits by way of depreciation allowance at substantial considerations as noted above. He observed that in the instant case the primary motive of transfer/sale of capital goods, etc. by the sister concerns to the assessee is to structure the transaction with a view to minimize the tax liability of the entire Kinetic Group as a whole. To support these contentions, the Assessing Officer observed that both the related concerns, namely, M/s KEL and M/s KML are having substantial accumulated losses. Therefore, the transactions have been structured in a manner so that taxable profits of the assessee are reduced by availing depreciation allowance again. Also, considering the huge losses available to the aforesaid two related transferor concerns, no tax liability will arise in their hands, even if extra profits are shown in the relevant years. In the light of aforesaid observations, the Assessing Officer invoked the provisions of Explanation 3 to section 43(1) of the Act. The Assessing Officer observed that the assets purchased from M/s KEL were the assets in respect of which the seller company had been claiming depreciation consequent to which the WDV in their hands had been reduced to Rs.NIL. The Assessing Officer concluded that in view of the provisions of Explanation 3 to section 43(1) of the Act, the WDV of the assets purchased by the assessee from M/s KEL and also from M/s KML are adopted at Rs.NIL. Therefore, the Assessing Officer denied the claim of depreciation of Rs. 1,01,09,779/- on the assets purchased from M/s KEL and M/s KML. Likewise, for the similar reasons, cost of acquisition of technical know-how acquired from M/s KEL was also treated at Rs.NIL by the Assessing Officer. Accordingly, the depreciation claimed of Rs. 13,23,750/- on the technical know-how was also disallowed and added back to the total income of the assessee.
5. Aggrieved by the order of the Assessing Officer, the assessee preferred appeal before the CIT(A).
6. Before the CIT(A), the assessee submitted that in response to rapidly expanding automotive market and also considering global requirements, the assessee decided to venture into manufacture of moulds, dies and tools as a backward integration to its capital machine building activity and to position itself as a total solution provider. It was further submitted by the assessee that Greenfield project would have taken a much longer time and therefore, it was decided that the existing ready facilities of M/s KEL be purchased by the assessee. Further, since it was a new line of activity, the assessee parallely entered into a technical know-how agreement whereby drawings & designs of moulds & dies, testing procedures & quality control specifications were made available to the assessee to execute the order in hand. It was also contended by the assessee that the company has obtained Valuation Report from an approved valuer and has adopted the prices as per the said report for the purposes of aforesaid transactions. The assessee further contended that while in the case of M/s KEL, the WDV was Rs. 47,58,848/- yet the Assessing Officer has wrongly adopted NIL value without assigning any reasons. The CIT(A) after appreciation of facts and law observed that Explanation 3 to section 43(1) of the Act can be applied only if the Assessing Officer is of the view that the fair market value of the assets has been inflated to claim excess depreciation. In the instant case, where the fair market value has been certified by the registered valuer and the Assessing Officer has not appointed its own valuer for valuation of the disputed assets, the Valuation Report submitted by the assessee ought to have been accepted. The CIT(A) concluded that the Assessing Officer was not justified in mechanically adopting the value of the assets as NIL where the machinery and know-how so acquired by the assessee has generated sales to the tune of Rs. 132.93 crores and therefore must have commanded some price in the market. He accordingly deleted the disallowance of depreciation made by the Assessing Officer on this score.
7. The Revenue is in appeal against the aforesaid deletion of disallowance of depreciation as per Ground Nos.1 & 2 of its appeal.
8. Before us, the Ld. Departmental Representative for the Revenue relied upon the order of the Assessing Officer and contended that the transactions have been carried out primarily with a view to save on the tax liability. The second hand assets have been purchased where the full/substantial tax benefits were already availed by the seller companies who happen to be sister concerns. The assessee has once again sought to claim depreciation on the impugned assets. He, therefore, pleaded for restoration of the order of the Assessing Officer.
9. Per contra, the Ld. Authorized Representative for the assessee observed that the observations of the CIT(A) are clear and self-evident. The parties to the transactions are widely held companies listed on the stock exchanges and are subjected to strict corporate governance. The acquisition of the tool room facilities from these parties was a strict business decision as a measure of backward integration to its existing business. The technical know-how agreement was entered to secure drawings & designs of moulds & dies and other testing procedures & quality control specifications to facilitate the assessee to execute the order. The Ld. Authorized Representative for the assessee further observed that the sales of the tool room division for the financial year 2004-05 amounting to Rs. 132.39 lakhs which increased upto Rs. 540.58 lakhs for the financial year 2006-07, the profits derived from which has been duly subjected to tax. Therefore, it cannot be the case of the Revenue that the transaction of the impugned acquisition of capital goods and know-how are non-existent and sham. He finally contended that Explanation 3 to section 43(1) of the Act is not applicable to the facts of the case at all. He observed that aforesaid Explanation 3 is triggered only in cases where two conditions exists. Firstly, the main purpose of transfer of such assets was reduction of tax liability by claiming depreciation with reference to enhance cost. In the instant case, the main purpose is clearly demonstrated to be on account of commercially expediency i.e. backward integration of the existing plan, which has resulted in substantial commercial advantage to the assessee. Secondly, the Explanation only enables the Assessing Officer to ignore the excess of actual cost as determined by him and does not entitle him to adopt the value of the assets at NIL as done by the Assessing Officer in the instant case. He, thereafter, contended that the valuation for the purpose of acquisition of the assets is supported by Valuation Report, which has not been contradicted by the Revenue. He, therefore, pleaded that Explanation 3 is not attracted at all and therefore no interference with the order of the CIT(A) is called for. The Ld. AR relied on the decision of the Tribunal in the case of Chitra Publicity Company (P) Ltd. vs. ACIT reported in (2009) 32 DTR 227 (TM) (Copy in file) and Unimed Technologies Ltd. vs. DCIT reported in (2000) 73 ITD 150 (Ahd) to support the case of the assessee.
10. We have carefully considered the rival submissions and the orders of the authorities below. The entire dispute revolves around the applicability of Explanation 3 to section 43(1) of the Act in the facts of the case. The WDV of the assets acquired from M/s KEL is NIL while the WDV of the assets acquired from M/s KML in the hand of the transferor was at Rs. 47,58,848/-. The assessee asserted that the main object of acquisition of the assets and technical know-how was to promote the business by way of backward integration of the existing facility, which has resulted in commercial profits. These facts have not been disputed by the Revenue.
11. In order to appreciate the Explanation 3 to section 43(1) of the Act, the relevant clause is reproduced as under“43. In sections 28 to 41 and in this section, unless the context otherwise requires-
(1) “actual cost” means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority:
Explanation 3.-Where, before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and the [Assessing] Officer is satisfied that the main purpose of the transfer of such assets, directly or indirectly to the assessee, was the reduction of a liability to income-tax (by claiming depreciation with reference to an enhanced cost), the actual cost to the assessee shall be such an amount as the [Assessing] Officer may, with the previous approval of the [Joint Commissioner], determine having regard to all the circumstances of the case.”
12. From a bare reading it is evident that the impugned Explanation has three ingredients (i) the assets acquired should be second hand asset; (ii) the main purpose of transaction should be to reduce the tax liability by claiming depreciation with reference to enhanced costs; and, (iii) the Assessing Officer may displace the actual cost of the Assessee and determine for himself the adjusted actual cost in the event of second eventuality. Hence, the Assessing Officer is entitled to determine the actual cost of the assets acquired at arm's length value or real value or worth of the assets notwithstanding the amount paid by the assessee for the acquisition of impugned assets. Nonetheless, the Assessing Officer is to be satisfied that main purpose of the transfer of such assets was the reduction of liability to income tax by claiming depreciation with reference to enhanced cost. The Burden to determine the replaced or adjusted actual cost in accordance with law is on the Assessing Officer and not on the assessee. The Assessing Officer has to show that he has gathered relevant material and determine actual cost after application of mind. Once, it is established that the main purpose was to circumvent the income-tax liability, the Assessing Officer will be entitled to substitute the purchase price adopted by the assessee with the adjusted actual cost or the real cost referable to such assets. Therefore, in terms of Explanation 3 to section 43(1) of the Act, if the Assessing Officer holds that the primary object of such acquisition is reduction of tax liability and is of the view that the fair market value of the assets has been inflated to claim depreciation then he can substitute the fair market value as per cost estimated by him with the approval of the superior authority.
13. We find that firstly, the Assessing Officer could not discharge its onus that the main objective of the transfer of assets was reduction of the tax liability. On the other hand, the Assessee has been able to demonstrate that the objective of such acquisition in question was with a view to augment its business capabilities by way of backward integration of existing facilities. The stand of the Assessee that the impugned assets and technical know-how so acquired were a commercial and outright business decision for backward integration of the existing manufacturing facilities, which has explicitly resulted in commercial gains remains undisputed. Some subservient and incidental tax benefits arising from such transactions by itself is not sufficient to hold against an assessee. The phraseology of the Explanation is plain and simple. It is the “main purpose” and not secondary purpose or some incidental benefits arising from such transaction which can trigger Explanation 3 to S. 43(1). Once the overwhelming commercial advantage from the transaction is displayed, which is done in the instant case, the other considerations fade into insignificance. Thus, while the assessee has clearly demonstrated its bona-fide, the Revenue could not contradict any averment of the assessee.
14. Secondly, having arrived at the finding that the main purpose is taken advantage from such acquisition, the second obligation cast on the revenue is to determine the fair value of the assets and replace it with the cost of acquisition of the Assessee and as a sequel to it, allow depreciation allowance on the adjusted actual cost. Hence, as per the scheme of the Act, the depreciation can not be disallowed in toto but is allowable on the actual cost as determined by the Assessing Officer. The learned Assessing Officer has adopted NIL value of the cost of acquisition and denied the depreciation completely only on the premise that depreciation has been already availed by the previous owner. This action is totally contrary to the plain language of the Explanation and is thus vitiated in law. There is no material in possession of the Assessing Officer to enable him to displace the cost of acquisition declared by the Assessee. Further, the WDV of assets in the case of M/s KEL was Rs. 47,58,848/-, which was taken at NIL by Assessing Officer. There is no rationale for such action. The Assessee on the other hand has supported the valuation of the assets by the Valuation Report of the Registered Valuer and in absence of onus being discharged by the Assessing Officer, the applicability of Explanation 3 to section 43(1) of the Act by the Assessing Officer is not justifiable in the facts of the case. The assessee is entitled to claim of depreciation on the acquisition of assets and technical know-how, we uphold the order of the CIT(A).
15. In the result, the Ground Nos.1 and 2 of the Revenue’s appeal are dismissed.
16. Grounds of Appeal Nos.3 and 4 relates to disallowance of Rs. 43,86,417/- made by the Assessing Officer on account of payment made by the assessee to its sister concern, namely, M/s Kinetic Engineering Ltd. (M/s KEL) for expenses concerning tool room acquired.
17. The relevant facts concerning the issue are that the Assessee by way of revised return, inter-alia, claimed expenditure of Rs. 43,86,417/- on the basis of debit notes raised by M/s KEL after finalization of accounts for the relevant year. The claim of expenditure was made by the assessee on the ground that the expenditure flows from the acquisition of its tool room division from M/s KEL. It is the case of the assessee that after the purchase of tool room division of M/s KEL, production and sales were effected during the relevant previous year as a going concern. The expenses in question are in the nature of salaries of the tool room employees and other relevant expenses. These expenses pertained to the period of January to March 2005 i.e. after the tool room was acquired by the assessee. Since the expenses were initially booked in the books of M/s KEL, the same was transferred to the assessee by raising debit notes for re-imbursement of such expenses.
18. In the course of hearing, the Ld. Departmental Representative for the Revenue submitted that it is not clear as to why the expenses were not claimed in the original return and claimed only by way of revised return. It is further not clear whether these debit notes were available before the Assessing Officer for necessary enquiry or not.
19. The Ld. Authorized Representative for the assessee submitted that the debit notes are dated 30th September, 2005 i.e. after the finalization of account pertaining to the relevant assessment year and therefore the claim has been made by way of filing the revised return to take cognizance of the legitimate expenses incurred by M/s KEL on behalf of the assessee.
20. On consideration of the facts in totality, we remit the issue back to the file of the Assessing Officer to decide the claim of assessee after affording proper opportunity of hearing to the assessee. The issue is accordingly set-aside to the Assessing Officer for re-consideration in accordance with facts and law.
21. In the result, the Ground of Appeal Nos.3 and 4 of the Revenue’s appeal are allowed for statistical purposes.
22. Resultantly, the appeal of the Revenue is partly allowed.