THE HON’BLE SRI JUSTICE GODA RAGHURAM AND THE HON’BLE SRI JUSTICE B.N. RAO NALLA I.T.T.A.No.2 of 2010 Dated: 30-12-2011 Between: VST Industriess Limited, having its registered office at 1-7-1063/1065, Azamabad, Hyderabad – 500 020, Andhra Pradessh, rep., by its constituted Attorney Mr. SanjayKhanna. --Appellant. And Assistant Commissioner of Income Tax, Circle –3(3) Hyderabad. --Respondent. THE HON’BLE SRI JUSTICE GODA RAGHURAM AND THE HON’BLE SRI JUSTICE B.N. RAO NALLA I.T.T.A.No.2 of 2010 JUDGMENT : (PER JUSTICE GODA RAGHURAM) Heard Sri S. Ganesh, learned senior advocate, instructed by Sri V. Padmanabhan and Sri J. Sivanesan for the appellant/assessee; and Sri B. Narasimha Sarma, learned standing counsel for Income Tax, for the Revenue. Tobacco Diversification and Investments Private Limited (TDIL) which was amalgamated with VST Distribution, Storage and Leasing Company Pvt. Ltd. (VSTDSL), initially filed this appeal. Pursuant to the order of this Court dated 27-04-2011 [permitting amendment of the cause-title in I.T.T.A.M.P.No.210 of 2011 - on amalgamation of VSTDSL with VST Industries Ltd (VST)] the appeal is continued by VST. TDIL a 100% subsidiary of VST, dealing in investments in shares and financial services, filed its return of income for the assessment year 1999-2000 disclosing a loss of Rs.22,69,876.00. The assessing officer completed the assessment on 28-03-2002 under Section 143(3) of the Income Tax Act, 1961 (the ‘Act’) determining an income of Rs,13,00,30,120/-. The CIT(A) confirmed the major additions made by the Revenue. In a further appeal by the assessee, the Tribunal by the order dated 30-09- 2003 set aside the assessment on the ground that facts of the case need to be ascertained after affording sufficient opportunity to the assessee and remanded the matter for assessment de novo. Re-assessment proceedings were taken up and the assessment completed on 30-03-2005, determining the income at Rs.12.91 crores. In the assessee’s appeal therefrom, the CIT(A) by the order dated 10-10-2005 confirmed the liability of Rs.52 crores in the hands of VST to be capital in nature and directed the assessing officer, while treating the amount of Rs.12 crores received in the form of ICICI Bonds and Securitised Debt due from Woodland as capital receipt; held that payment made by the assessee company to VST be also treated similarly, as capital expenditure. The CIT(A) disallowed the assessee’s claim that Rs.50 lakhs component of Rs.12.50 crores should be admitted as revenue expenditure and held that the receipt of Rs.12.00 crores as well as the payment of Rs.12.50 crores both be dealt as capital in nature. Aggrieved by the order of CIT(A), dated 10-10-2005, the Revenue preferred I.T.A.No.1233/Hyd/2005 and the assessee I.T.A.No.1234/Hyd/2005, before the ITAT. These two appeals were considered along with I.T.A.No.1279/Hyd/2005 which pertained to the assessment year 2000-2001 (not the subject matter of this appeal by the assessee). Background facts : (a) VST, the parent company of TDIL made investments in ITC group of companies and in M/s. Jayprakash Industries to the extent of Rs.52 crores during 1993 to 1996. Disputes having arisen regarding these investments were referred to arbitration. The award dated 20-04-1998 determined that ITC Classic Finance could issue a debt instrument acceptable to VST for Rs.52 crores payable not later than twelve years, in lieu of investments made by VST in various entities of the ITC Finance Group. (b) To effectuate the award an MOU was entered into on 05-05-1998. In terms of the award the ITC Classic Group was to issue debt instrument of Rs.52 crores payable/redeemable within a period of twelve years in exchange for investments of VST in the above entities; and upon discharging the liability of Rs.52 crores VST was to transfer the above investments to ITC Classic Finance; (c) As the ITC Finance Group was unable to issue any debt instrument acceptable to VST, ITC Agro Tech Finance (ITC-ATF) acting on its behalf and behalf of the ITC Finance Group made an alternative arrangement. (d) Accordingly, ITC-ATF, VST and VST Natural Products Ltd., entered into a tri-partite agreement on 19-05-1998 whereby ITC- ATF assigned the future liability of Rs.52 crores payable for a period of twelve years to VST. In consideration of undertaking such liability ITC-ATF issued a banker’s cheque for Rs.8 crores and transferred a securitized debt of Rs.4 crores owed to it by Woodlands Resorts Pvt. Ltd to VST-NPL. VST-NPL issued a demand promissory note for Rs.52 crores to VST. Under this agreement it was agreed between ITC-ATF and VST that VST would retain ownership of Rs.16,60,000/- equity shares of Jayprakash Industries valued at Rs.10 lakhs. VST-NPL purchased ICICI Security Bonds worth Rs.8 crores from the proceeds of the Banker’s cheque received from ITC-ATF; (e) In September, 1998, VST decided to obtain an undertaking/security for future liability of Rs.52 crores over twelve years from the assessee instead of VST-NPL. Consequently, after rescinding the earlier tri-partite agreement dated 19-05-1998 another tri-partite agreement was executed on 21-09-1998 between VST, TDIL and VST-NPL whereunder: (i) TDIL undertook the future liability of Rs.52 crores payable to VST not later than twelve years; (ii) issued a debt instrument for Rs.52 crores to VST; (iii) VST-NPL was relieved from the earlier future liability of Rs.52 crores, VST delivered to VST-NPL the cancelled demand promissory note, issued earlier; and (iv) in consideration of shifting the future liability of Rs.52 crores, VST-NPL delivered/transferred ICICI security bonds of Rs.8 crores and the securitized debt of Rs.4 crores due to it from Woodlands Resorts Pvt. Ltd., to TDIL. (f) During the year in question the assessee earned Rs.50 lakhs and Rs.33,62,055/- from the two assets transferred to it under the tri-partite agreement dated 21-09-1998. (g) On 30-03-1999, VST addressed a letter to TDIL proposing that in lieu of payment of Rs.52 crores over a period not later than twelve years, TDIL may immediately pay VST Rs.12.50 crores in full and final settlement of the entire TDIL obligations under the agreement dated 21-09-1998; and sought confirmation of TDIL to this proposal. This letter stated that the above proposal (by VST) is subject to necessary approvals as may be required. (h) In response to VST’s letter dated 30-03-1999 TDIL addressed VST a letter dated 31-03-1999 confirming that VST’s proposal is acceptable to it and it would make necessary arrangement to pay VST Rs.12.50 crores at the earliest by liquidating ICICI bonds and other investments held by it. This letter also classified that acceptance of VST’s proposal dated 30- 03-1999 is subject to necessary approval of the TDIL Board. By order dated 30-03-2005 the assessing officer rejected the appellant’s claim; that the settlement between VST and TDIL having taken place during the financial year 1998-99 (pursuant to VST’s proposal dated 30-03-1999 and its acceptance by TDIL by letter dated 31-03-1999) the consequence was setting off of the income of Rs.12 crores earned and the payment of Rs.12.50 corres resulting in a consequent loss of Rs.50 lakhs. The assessment order concluded that TDIL’s claim of discharge of its obligation arising out of the tripartite agreement dated 21-09-1998 by the assessee during the current year is not acceptable since : (a) The proposal by VST on 30-03-1999 and its acceptance by TDIL on 31-03-1999 was incomplete as these were subject to ratification by the Board of Directors of both the companies and such ratification occurred during the next financial year, i.e., on 08-05- 1999; (b) Though the assessee claimed to have accepted the proposal of discharging its obligation on liquidating the bonds/investments held by it during the financial year 1998-99, neither the sale of bonds/investments nor payment of the amounts to the holding company had taken place in the same year; (c) The ICICI bonds were sold on 03-05-1999 for Rs.8.5 crores and only after the sale of these bonds payments were made starting from June, 1999; (d) Though the assessee (TDIL) had shown VST as a creditor on 31-03-1999, VST the holding company did not reflect the effect of this acceptance of the assessee’s proposal in their accounts, by showing TDIL as a debtor for Rs.12.5 crores. The assessing authority concluded that no final settlement between VST and TDIL took place during financial year 1998-99 – relevant to the assessment year 1999-2000; consequently the expenditure of Rs.12.5 crores in the business of securitization of the assessee company or the loss claimed in this regard is unacceptable and Rs.12 crores earned in the form of ICICI bonds and securitized debt due from Woodlands is treated as income of the assessee and considered for the relevant assessment year. On appeal, the Commissioner (Appeals) held : (i) that the amount of Rs.12 crores is capital in nature both in form and substance; (ii) that the assessing officer construed it as a revenue receipt on the ground that the payment was not made to VST industries within the financial year but since the genuineness of the transaction was not doubted, the AO is in error in rejecting the very character of the settlement on the basis of the chronology i.e., that the appellants started paying only from June, 1999 onwards; (iii) that the nature of the transaction cannot undergo a change because a part of the chronology of events took place after the end of the previous year; and (iv) since the date of payments is only secondary to the matter in this respect, the A.O. is directed to treat Rs.12 crores as capital receipt. The appellate authority rejected the assessee’s contention that payment of Rs.12.50 crores to VST should be allowed as revenue expenditure, even if the receipt of Rs.12 crores is treated as capital in nature. Consequently, the assessing authority was directed to treat Rs.12 crores (received in the form of ICICI bonds and securitized debt due from Woodlands) as a capital receipt and the payment of Rs.12.50 crores made by the assessee to the VST also as capital expenditure. In its appeal before the Tribunal the Revenue claimed that the income earned by the assessee on securitisation ought to have been treated as a revenue receipt while the assessee in its appeal claimed that the settlement loss of Rs.50 lakhs was erroneously held to be capital in nature and the related income and expenditure having been routed through the profit and loss account, both should have been held to be revenue in character. The Tribunal concluded that since the assessee’s main business is securitisation of debt and in the course of this business the assessee has taken upon the liability of payment to VST of Rs.52 crores, for a consideration of Rs.12.50 crores and had been finally settled by the assessee paying Rs.12.50 crores as against the receipt of Rs.12 crores, the said receipt is an adventure in the nature of trade and the true character of the receipt is not a capital but a trading receipt. Similarly, payment of Rs.12.50 crores by the assessee to the VST cannot also be treated as capital expenditure. The Tribunal however held that the letter dated 30-03-1999 addressed by the VST to the assessee setting out the proposal being, subject to necessary approvals as may be required; and the acceptance of this proposal, by the letter of the assessee dated 31-03-1998 being also subject to necessary approval of the assessee’s board are only in the form of offer/proposal raised. There was no acceptance by the other party within the relevant financial year. Accordingly, the Tribunal concluded that in the assessment year under consideration no portion of Rs.12.50 crores could be treated as expenditure. In the result, the Revenue’s appeal on this aspect was allowed and the assessee’s appeal rejected. Sri Ganesh, learned senior counsel, contends that the Tribunal having held that the receipt of Rs.12 crores by the assessee is a revenue receipt and complementarily the expenditure of Rs.12.50 crores is also revenue in nature; erred in concluding that no portion of Rs.12.50 crores could be treated as expenditure since there was no acceptance of the VST’s proposals by the assessee’s Board during the financial year in question and therefore the liability did not accrue during the relevant year. Relying on the provisions of Section 196 of the Indian Contract Act, 1872 and the decisions in T.R. Bhavani Shankar Joshi and Anr. V. Gordhandas Jamnadas and Anr.[1]; Parmeshwari Prasad Gupta v. The Union of India [2] ; a n d Maharashtra State Mining Corporation v. Sunil S/o Pundikaro Pathak[3]. Sri Ganesh contended that despite the ratification of the VST proposal and its acceptance by the assessee by the relevant Boards of Directors on May 27, 1999 (the following financial year), the ratification relates back to the date of acceptance by the assesse of the VST’s proposal i.e., 31-03-1999. Section 196 of the Indian Contract Act enacts that when acts are done by one person on behalf of another but without his authority, the latter may elect to ratify such acts and if ratified the same effects would follow as if they had been performed by his authority. The Privy Council in T.R. Bhavani Shankar Joshi (supra) on analyses of the provisions of the Indian Contract Act spelt out the principle that ratification is in law equivalent to previous authority; it may be expressed or it may be effected impliedly by conduct. In Parmeshwari Prasad Gupta the Supreme Court concluded that the regularly constituted meeting of the Board of Directors could legitimately ratify the action of the chairman (terminating the services of an employee he was not legally authorised to terminate) and such ratification would relate back to the date of the act ratified and the services of the appellant must therefore be held to have been validly terminated, on December 17, 1953. In Maharashtra State Mining Corporation, the Supreme Court quoted with approval its earlier decision in Parmeshwari Prasad Gupta and the principle enunciated therein, that ratification would relate back to the date of the act ratified. In view of the provisions of Section 196 of the Contract Act and the binding precedents referred to supra the conclusion is compelling that despite ratification of the assessee’s acceptance of the VST’s propsoals dated 31-03-1999 only on 27-05-1999, by the resolution of the assessee’s Board, the ratification relates back to 31-03-1999 and operates during the assessment year in question. The conclusion to the contrary recorded by the Tribunal is erroneous and unsustainable. Consequently, the liability of the assessee to pay Rs.12.50 crores to M/s. VST Industries accrued on 31-03-1999 and constituted a deductible item of expenditure in respect of the accounting year ended 31-03-1999, relevant to the assessment year 1999-2000. As pointed out by the Supreme Court in Empire Jute Co. Ltd. v. Commissioner of Income-Tax[4], the fact whether a certain payment constituted income or capital receipt in the hands of the recipient is not material in determining whether the payment is revenue or capital disbursement qua the payer. As pointed by MACNAGHTEN J. in Racecourse Betting Control Board v. Wild[5] (an observation quoted with approval in Empire Jute Co. Ltd.): Payment may be a revenue payment from the point of view of the payer and a capital payment from the point of view of the receiver and vice versa. In the circumstances, and in the light of this principle the fact that M/s. VST had not reflected the effect of the assessee’s acceptance of its proposal in VST’s accounts by showing the assessee as a debtor for Rs.12.50 crores is not a relevant criterion for rejecting the assessee’s claim of this amount being a revenue expenditure during the assessment year in question. The assessing authority erroneously considered the VST accounts as one of the criteria for rejecting the assessee’s claim. The appellant alternatively contended before the Tribunal that since the value as on 31-03-1999 of the appellant’s liability to pay Rs.52 crores to M/s. VST after twelve years, was an allowable deduction from the revenue receipt of Rs.12 crores in order to assess the appellant’s correct and real income, the amount of Rs.12 crores being merely the appellant’s gross receipt could not have been treated as its net assessable income; and that this position flowing from accounting standard No.1 issued by the CBDT under Section 145 of the I.T. Act is mandatory and is to the effect that a provision must necessarily be made in the accounts for all known liabilities. The Tribunal did not at all advert to this alternative contention of the appellant. Be that as it may. In Calcutta Company Ltd. v. The Commissioner of Income-tax, West Bengal[6], the facts were that the appellant was in the business of land development and used to buy land to develop it and render it fit for building purposes and thereafter sell it in plots, for profit. The appellant maintained its accounts in the mercantile method. On facts though the appellant did not receive the whole of the price of Rs.43,692/- on the sale of plots, it entered this amount on the credit side of its accounts though only Rs.29,392/- was actually received in cash. On the debit side the appellant debited Rs.24,809/- in its accounts as expenditure for developments which were to be carried out on the plots which had been sold during the year. The ITO disallowed the claim for deduction of Rs.24,809/- as expenditure on the ground that expenses had not been actually incurred during the financial year in question and estimates were not real expenses which the company would have to incur in future. The Appellate Commissioner, the Tribunal and the High Court concurred. Allowing the appeal, the Supreme Court held that Rs.24,809/- which was to be incurred by the appellant was an accrued liability which according to the mercantile system of accounting constituted the estimated expenditure allowable as deduction. The Apex Court quoted with approval the following observation of LORD HERSCHELL in Russel v. Town and County Bank, Ltd.[7]: …It appears to me that that language implies that for the purpose of arriving at the balance of profits all that expenditure which is necessary for the purposes of earning the receipts must be deducted, otherwise you do not arrive at the balance of profits, indeed, otherwise you do not ascertain, and cannot ascertain, whether there is such a thing as profit or not. The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. That seems to me to be the meaning of the word “profits” in relation to any trade or business. Unless and until you have ascertained that there is such a balance, nothing exists to which the name “profits” can properly be applied. The Court also reiterated the observations of VENKATARAMA AIYAR, J. in Badridas Daga v. The Commissioner of Income-tax[8] : “The result is that when a claim is made for a deduction for which there is no specific provision in s. 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition against it, express or implied, in the Act.” I n J.K. Industries Ltd. and another v. Union of India and others.[9], the Supreme Court pointed out that “matching concept” or the principle that expenses should be matched with revenue so that tax is levied on the real income of the assessee is a basic principle of income tax law. The Court pointed out : …The paramount object of running a business is to earn profit. In order to ascertain the profit made by the business during a period, it is necessary that “revenues” of the period should be matched with the costs (expenses) of that period. In other words, income made by the business during a period can be measured only with the revenue earned during a period is compared with the expenditure incurred for earning that revenue. … As early as in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax, Bombay[10], the Court explained that income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Act; and that real profits can be ascertained only by making the permissible deductions. In the light of the principles following from the binding precedents aforesaid, the receipt of Rs.12 crores by the assessee, being directly associated with its normal business of securitization of debts is a revenue receipt and the liability of the assessee to pay VST the amount of Rs.12.50 crores (notwithstanding that the actual payment was made during the course of the subsequent financial year) was an accrued liability since the assessee was following the mercantile system of accounting and is liable as a deduction during the financial year 1998-99 relatable to the assessment year 1999-2000. On the above view of the matter the alternative contention by the assessee (addressed before the Tribunal as well but not considered) that even if the contractual liability of Rs.12.50 crores were not allowed as a deduction during the accounting year ended 31-03-1999, the present value as on 31-03-1999 and the liability of Rs.52 crores (payable after twelve years) must be allowed as a deduction against the revenue receipt of Rs.12 crores as assessed in the assessee’s hands in the said accounting year, need not be considered. Two other grounds were also pleaded by the assessee in this appeal, viz. : (a) that the Tribunal erred in holding that an amount of Rs.56.50 lakhs paid on settlement pursuant to the award of the arbitrator, was capital in nature; & (b) that the Tribunal erred in holding that the amount of Rs.7.50 lakhs paid as professional charges, was not a business expenditure and is a capital expenditure. However, Sri Ganesh, learned senior counsel for the assessee, at oral hearing has categorically stated that these grounds of challenge to the Order of the Tribunal impugned herein are eschewed and are not being pursued. Consequent on the above analyses in discussion, the appeal is allowed as above. No costs. _______________________ JUSTICE GODA RAGHURAM ______________________ JUSTICE B.N. RAO NALLA Date : -12-2011 Ndr/* THE HON’BLE SRI JUSTICE GODA RAGHURAM AND THE HON’BLE SRI JUSTICE B.N. RAO NALLA I.T.T.A.No.2 of 2010 (Order of the Division Bench delivered by Hon’ble Sri Justice Goda Raghuram) Date : -12-2011 Ndr/* [1] AIR 1943 PC 66 [2] AIR 1973 SC 2389 [3] AIR 2006 SC 1923 [4] 124 ITR page 1 [5] [1938] 22 TC 182 [6] [1959] 37 ITR 1 SC [7] (1888) 13 App. Cas. 418 [8] [1958] 34 ITR 10 (SC) [9] [2008] 297 ITR 176 (SC) [10] [1965] 57 ITR 521 (SC)