-1- IN THE HIGH COURT OF JUDICATURE AT BOMBAY O.O.C.J. Income Tax Reference No.6 of 1992 John Wyeth and Brother Ltd. Bombay ..Applicant vs. Commissioner of Income Tax Bombay City II, Bombay ..Respondent Mr.Poras Kaka with Mr.N.Doshi with Mr.Sameer Chitnis i/b M/s Crawford Bayley and Co. for applicant. Mr.Parag Vyas i/b Mr.P.S.Sahadevan for respondent. Judgment Reserved on: 26.8.2008 Judgment Delivered on: 23.9.2008 CORAM: Dr.S.RADHAKRISHNAN & CORAM: Dr.S.RADHAKRISHNAN & CORAM: Dr.S.RADHAKRISHNAN & S.J.KATHAWALLA JJ. S.J.KATHAWALLA JJ. S.J.KATHAWALLA JJ. 23rd September,2008 23rd September,2008 23rd September,2008 J U D G M E N T: (Per S.J.KATHAWALLA J.) J U D G M E N T: (Per S.J.KATHAWALLA J.) J U D G M E N T: (Per S.J.KATHAWALLA J.) 1. The Appellate Tribunal, Bombay Bench "B" has, at the instance of the applicant (assessee) by its statement of case dated 18th April, 1991 referred to this Court the following questions arising out of the order of the Tribunal dated 26th October, 1989 pertaining to Assessment Years 1977-78 and 1978-79. "1. Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the matter requires consideration as to whether the laboratory expenses claimed include any of the expenditure mentioned in clauses (a) to (d) of -2- Explanation (iv) to Section 44C of the Income Tax Act, 1961 even though in its general meaning "Head Office Expenditure" might not as such include the laboratory expenses? 2. Whether on the facts and in the circumstances of the case, the Tribunal ought to have held that laboratory expenses of Rs.12,72,330/- were allowable as a deduction in the computation of the assessee’s income? 2. The facts relevant for the purpose of deciding the present reference are as under: a) The assessee is a branch of a foreign company which has its Head Office in United Kingdom. The business of the assessee is that of manufacturing pharmaceutical products. The assessee has a separate and independent establishment in its branch in India including a Research Laboratory. The Head Office of the assessee also has a Research Laboratory at U.K. The issue involved herein pertains to the Laboratory expenditure incurred by the Head Office at U.K. b) Section 44C was inserted in the Income Tax Act, 1961 by Finance Act No.66 of 1976 with effect from 1st June 1976. By introduction of section 44C a ceiling has been put on the head office expenses in the case of non residents. This has been explained by Income Tax Circular No.202 dated 5th July, 1976 in the following terms. -3- "25.1: Non residents carrying on any business or profession in India through their branches are entitled to a deduction, in computing the taxable profits, in respect of general administrative expenses incurred by the foreign head offices in so far as such expenses can be related to their business or profession in India. It is extremely difficult to scrutinise and verify claims in respect of such expenses, particularly in the absence of account books of the head office which are kept outside India. Foreign companies operating through branches in India sometimes try to reduce the incidence of tax in India by inflating their claims in respect of head office expenses. With a view to getting over these difficulties, the Finance Act has inserted a new section 44C in the Income Tax Act laying down certain ceiling limits for the deduction of head office expenses in computing the taxable profits in the case of non resident tax-payers. Under this provision, the deduction in respect of head office expenses will be limited to - (i) an amount equal to 5 percent of the adjusted total income of the tax payer for the relevant year; or (ii) the annual average of the head office expenditure allowed during a base period of three previous years, namely, the previous years relevant to the assessment years 1974-75 to 1976-77; or (iii) the actual amount of head office expenditure attributable to the business in India; whichever is the least. In cases where the adjusted total income of the resident for the current year is a loss, the rate of 5 percent referred to at (i) above will be applied with reference to the average adjusted total income of the non resident "or the three previous years immediately preceding the relevant assessment year. 25.2: The term "head office expenditure", as defined for the purposes of this provision, means -4- executive and general administration expenditure incurred by the non resident tax payer outside India, including expenditure in respect of -- (a) rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession; (b) salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary, which are paid to any employee or other person employed in, or managing the affairs of, any office outside India; (c) travelling by any such employee or other person outside India; (d) such other matters connected with executive and general administration as may be prescribed by the Board. The expression "adjusted total income", "average adjusted total income" and "average head office expenditure" have been defined in the Explanation to the new section. 25.3: The aforesaid amendments have come into force with effect from 1st June, 1976 and will apply in relation to the assessment year 1977-78 and subsequent years. (Section 10(Part) of the Finance Act)." c) According to the assessee, prior to Assessment Years 1977-78 the assessee was claiming the laboratory expenses incurred in respect of the laboratory maintained at the head office in United Kingdom in proportion of Indian sales to world sales and was accepted and allowed by the Tax Authorities. d) Section 44C which came into effect from 1st June, 1976 became applicable for the period 1st July, 1976 to 30th -5- September, 1976 in respect of the Assessment Year 1977-78. However, the assessee has in the said assessment year 1977-78 as well as in the subsequent assessment year i.e. 1978-79 after already claiming head office expenses at 5% of the total income being expenses referred to under section 44C, have further claimed sums of Rs.12,72,330/- and Rs.27,95,207/- respectively being proportionate expenses incurred towards laboratory expenses at U.K. on the ground that these expenses are not covered by section 44C of the Act and the assessee is entitled to a deduction in respect of the entire amount claimed under section 37 of the Income Tax Act. The Assessing Officer did not accept the contention of the assessee viz. that the head office expenses as per section 44C means executive and general administration expenditure and that the laboratory expenses are not covered by section 44C of the Income Tax Act, 1961. The view of the Assessing Officer as set out in his order dated 30th December, 1980 for the Assessment Year 1978-79 is reproduced hereunder. "6..........The assessee may have incurred laboratory expenses and this would form part of the executive and general administration expenses incurred by the assessee outside India and it cannot be said that the laboratory expenses are not covered by Section 44C. There is no dispute that the expenditure had been incurred outside India. The assessee has in fact clubbed this expenditure under the head H.O. expenditure in the computation of income filed with the return. The purpose of sec.44C was to put a limit on the expenditure which -6- could not be otherwise verified in the course of assessment in India as explained in para 25.1 of C.B.D.T’s Circular No.202 dated 5th July, 1976. The expenditure is of the nature which falls under sec.44C of the Act and, therefore, restricted to the limits prescribed therein." e) Being aggrieved by the stand taken by the Assessing Officer, the assessee preferred Appeals before the Commissioner of Income Tax (Appeals). The assessee argued before the CIT(A) that section 44C very clearly defines "head office expenses" as executive and general administration expenses incurred by the assessee outside India and includes what is set out in sub-clauses (a), (b), (c) and (d) of the said section. It was argued that the assessee had given the most conservative claim which are in proportion of Indian sales to world sales and which percentage comes to only at 17.7% of the world sales. It was argued that even allocation of expenditure has been much less in India in the matter of laboratory expenditure and, therefore, the claim of the assessee ought to have been allowed without being challenged in respect of the arithmetical methods thereon. It was emphasised by the assessee that in principle the laboratory expenses are allowable even if the Board’s circular dated 5th July, 1976 is taken into account as it nowhere says that executive’s salaries referred to therein referred to the salaries of scientists employed in the laboratory. The -7- assessee, therefore, submitted before CIT(A) that the laboratory expenses are entirely allowable. f) The CIT(A) by his order dated 13th July, 1982 decided in favour of the assessee. The CIT(A) took the view that there is nothing to indicate in the Income Tax Circular dated 5th July, 1976 that the laboratory expenses which are spent on research and development are covered by the provisions of section 44C. CIT(A) also held that the expenditure covered by sec.44C is obviously of the administrative nature and refers to the rent, taxes, salaries, wages etc. which are in connection with executive and general administration. CIT(A) has recorded that the assessee has categorically stated before him that the research and development expenditure claimed does not include the expenditure of the nature as discussed above. CIT(A), therefore, took a view that the expenditure connected to laboratory expenses was not connected with the general and administrative expenditure covered by clauses (a), (b), (c) and (d) of explanation (iv) of section 44C. CIT(A), therefore, directed the Assessing Officer to allow the claim of the assessee and also clarified that the expenditure towards laboratory expenses would be in addition to 5% of the allowable expenses as per provisions of section 44C in respect of other -8- expenditure incurred. g) In the appeal filed by the Revenue before the Appellate Tribunal, the Tribunal by its order dated 26th October, 1989, after considering the orders passed by the Assessing Officer as well as CIT(A) and after hearing the submissions of the revenue as well as assessee found some force in the contention of the revenue that when the assessee is maintaining the laboratory outside India, it must be having an establishment of its own and/or supporting staff therefor and that the claim of expenditure must be on salary and other items enumerated in clauses (a) to (d) of explanation (iv) to section 44C included in the definition of "head office expenditure". The Tribunal has also noted the fact that the assessee’s statement that the laboratory expenses will not include any expenditure stated in the sub-clauses of the explanation appeared to have been accepted by the CIT (A) without verification and calling for the details of the laboratory expenses. The Tribunal, therefore, took a view that the matter required consideration as to whether the laboratory expenses include any of the expenditure mentioned in clauses (a), (b), (c) and (d) though in its general meaning "Head Office Expenditure" might not include the laboratory expenses. -9- h) The Tribunal in its original order dated 26th October, 1989 made the following observations/directions. "In the fresh disposal of the appeal, the CIT(A) may look into this aspect as to whether the payment was made with any specific purpose and decide the matter accordingly as to whether such specific payment would also be covered by the provisions of Sec.44C of the Act. If on verification he finds that the payment was not for a specific purpose of the assessee’s business in India, then, in our opinion, the order of the IAC (Assessment) considering the same as part of the Head Office expenditure is unassailable." Pursuant to the assessee’s Miscellaneous Application No.70/Bom/1990 the Appellate Tribunal by its order dated 14th November, 1990 expunged the above observations/directions. The Tribunal has, therefore, not reached any conclusion as to whether section 44C applies to laboratory expenses or not, but has come to a finding that the expenses claimed needs consideration/verification. The Tribunal has also categorically rejected the argument of Revenue that the -10- laboratory expenditure, if not part of head office expenditure covered by section 44C is not allowable at all. i) Since the assessee was aggrieved by the order of the Appellate Tribunal, at the instance of the assessee the Appellate Tribunal referred the questions set out in paragraph 1 above for the opinion of this Court under section 256(1) of the Income Tax Act, 1961. 3. We have heard the arguments advanced by the Advocates for the assessee as well as the revenue at some length. The Advocate for the assessee has reiterated what is argued by the assessee before the CIT(A) and the Tribunal and has strongly relied on the reasoning given by the CIT(A) in favour of the assessee. 4. The learned Advocate for the assessee has in support of his contention that section 44C applies only to executive and general administration expenditure and that laboratory expenses would not fall under the category of executive and general administration expenses, cited a decision in the case of Commissioner of Income Tax Vs. Emirates Commercial Bank Ltd. reported on 2003(262) ITR 55 (Bom). That was a case where the expenditure was -11- exclusively incurred for the branch office in India. There was a concurrent finding of fact recorded by the Commissioner (Appeals) as well as the Tribunal that the officer came from the head office at Abu-dhabi to Mumbai to attend to the work of Mumbai branch and in connection with that work the expense was incurred and that expense was initially incurred by the head office and was recovered by the head office from the branch in India by raising a debit note. It was, therefore, held that the expense was incurred for the branch office in India and, therefore, section 44C had no application. In view of the aforesaid facts, we are of the view that the said decision does not lend any assistance to the present case of the assessee. 5. The Advocate for the assessee has also cited before us a decision of ITAT, Bombay Bench (A) in American Bureau of Shipping Vs. Income Tax Officer reported in (1986) 19 ITD 793 and has laid strong emphasis on a portion of paragraph 11 of the said order which is reproduced hereunder. "11............As regards plan approval, engineering expenses of Rs.3,10,112/- we have gone through the details filed. These expenses were incurred for specific technical services of the nature of approval of the plan for ships being constructed in India, reviewing survey reports, covering ships being constructed at Indian shipyards, approval of designs, tonnage admeasurements and issuance of tonnage certificate -12- certificates, reviewing test reports etc. These expenses were incurred not only at head office in New York but also in other offices like London, Geneva, Hamburg. We, therefore, confirm the order of the Commissioner (Appeals) holding that these expenses were not head office expenses for the purpose of section 44C." In our view the aforesaid quoted portion, makes it amply clear that the assessee had filed the details of expenses which the Tribunal had gone through and thereupon came to the conclusion that the said expenses were not head office expenses for the purpose of section 44C. This decision in fact supports the decision of the Appellate Tribunal which forms the subject matter of the above reference. 6. The Advocate for the revenue has reiterated the arguments advanced before the Appellate Tribunal and have supported the reasoning given in the orders of the Assessing Officer as well as the Appellate Tribunal. The Advocate for the revenue has also contended, in our view wrongly, that the expenses set out in clauses (a), (b), (c) and (d) in Explanation (iv) to section 44C need not be in the nature of executive and general administration expenditure. 7. The definition of "head office expenditure" given in explanation (iv) to section 44C is once again reproduced hereunder. -13- "(iv) "head office expenditure" means executive and general administration expenditure incurred by the assessee outside India, including expenditure incurred in respect of - (a) rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession. (b) salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary whether paid or allowed to any employee or other person employed in, or managing the affairs of, any office outside India. (c) travelling by any employee or other person employed in, or managing the affairs of, any office outside India; and (d) such other matters connected with executive and general administration as may be prescribed." 8. From the above definition it is clear that the Head -14- Office Expenditure means "executive and general administration expenditure". The definition of Head Office expenditure also states that it includes expenditure incurred in respect of sub-clauses (a), (b), (c) and (d) under explanation (iv). It, therefore, cannot be doubted that the expenditure on sub-clauses (a), (b), (c) and (d) has necessarily to be of the nature of executive and general administration expenditure. The contention of the Advocate for the Revenue to the contrary is, therefore, rejected. 9. The Income Tax Circular No.202 dated 5th July, 1976 makes it extremely clear that section 44C was introduced in the Act because it was becoming very difficult to scrutinise and verify claims in respect of general and administrative expenses incurred by the foreign head offices in so far as such expenses were related to their business or profession in India, particularly in the absence of account books of the head office which are kept outside India. Foreign companies operating through branches in India some times tried to reduce the incidence of tax in India by inflating their claims in respect of the head office expenses. 10. We have noted the fact that the Assessing Officer has -15- without calling for any documents pertaining to the laboratory expenses come to the conclusion that the laboratory expenses would fall under the category of "executive and general administration expenses" and, therefore, ceiling prescribed under sec.44C would apply to such expenses. On the other hand, the CIT(A) without any verification by merely relying on the assessee’s statement that the research and development expenditure claimed does not include the expenditure in the nature of rents, rates, taxes, salaries etc. reached the conclusion that the laboratory expenditure was not connected with the general and administrative expenditure covered by clauses (a), (b), (c) and (d) of explanation (iv) of section 44C. We are of the view that the Tribunal in the absence of any evidence has not reached a final conclusion whether laboratory expenses are covered under section 44C or not and has taken a very reasonable and rational view namely that the matter requires consideration as to whether the laboratory expenses include any of the expenditure mentioned in clauses (a), (b), (c) and (d) of explanation (iv) to section 44C of Income Tax Act, 1961. We see merit in the suggestion of the Tribunal that the establishment/supporting staff may exist in connection with maintaining of the laboratory and that could be the expenditure in the nature of that indicated in clauses (a) -16- to (d) for such establishment/supporting staff. This is all the more required because as recorded by the Assessing Officer the assessee had in fact clubbed this expenditure with the head office expenditure in the computation of income filed with the return. We agree that an examination as to whether the expenses claimed did or did not include any executive and general administration expenditure as indicated in clauses (a) to (d) of section 44C is required instead of accepting the assessee’s bare statement without an iota of evidence that such expenditure did not include the expenses set out in clauses (a) to (d) without any verification. If mere statement of the assessee is accepted without any verification as is done in the instant case by CIT(A), the object of introducing section 44C would get frustrated. 11. We are, therefore, of the view that the Tribunal is right in remanding the matter back to the file of CIT(A) for disposal afresh. We make it clear that the assessee would be free to show the expenses incurred towards laboratory expenditure and satisfy the CIT(A) that they did not include any Executive and General Administration expenditure indicated in clauses (a) to (d) of the explanation (iv) to section 44C of the Income Tax Act, 1961. Needless to add that if the assessee succeeds in -17- satisfying the CIT(A) to the effect set out above, the expenditure claimed by it would be allowable. 12. In view of the above, we answer question no.1 in affirmative. As regards answer to question no.2 is concerned, if the assessee succeeds in satisfying the CIT(A) as set out above, the assessee would certainly be entitled to the said deduction. 13. The above reference is accordingly disposed of. (S.J.KATHAWALLA J.) (Dr.S.RADHAKRISHNAN J.) (S.J.KATHAWALLA J.) (Dr.S.RADHAKRISHNAN J.) (S.J.KATHAWALLA J.) (Dr.S.RADHAKRISHNAN J.) -18- 4. The learned Advocate for the assessee has in support -19- of his contention that section 44C applies only to executive and general administration expenditure and that laboratory expenses would not fall under the category of executive and general administration expenses, cited a decision in the case of Commissioner of Income Tax Vs. Emirates Commercial Bank Ltd. reported on 2003(262) ITR 55 (Bom). That was a case where the expenditure was exclusively incurred for the branch office in India. There was a concurrent finding of fact recorded by the Commissioner (Appeals) as well as the Tribunal that the officer came from the head office at Abu-dhabi to Mumbai to attend to the work of Mumbai branch and in connection with that work the expense was incurred and that expense was initially incurred by the head office and was recovered by the head office from the branch in India by raising a debit note. It was, therefore, held that the expense was incurred for the branch office in India and, therefore, section 44C had no application. In view of the aforesaid facts, we are of the view that the said decision does not lend any assistance to the present case of the assessee. 5. The Advocate for the assessee has also cited before us a decision of ITAT, Bombay Bench (A) in American Bureau of Shipping Vs. Income Tax Officer reported in (1986) 19 ITD -20- 793 and has laid strong emphasis on a portion of paragraph 11 of the said order which is reproduced hereunder. "11............As regards plan approval, engineering expenses of Rs.3,10,112/- we have gone through the details filed. These expenses were incurred for specific technical services of the nature of approval of the plan for ships being constructed in India, reviewing survey reports, covering ships being constructed at Indian shipyards, approval of designs, tonnage admeasurements and issuance of tonnage certificate certificates, reviewing test reports etc. These expenses were incurred not only at head office in New York but also in other offices like London, Geneva, Hamburg. We, therefore, confirm the order of the Commissioner (Appeals) holding that these expenses were not head office expenses for the purpose of section 44C." . In our view the aforesaid quoted portion, makes it amply clear that the assessee had filed the details of expenses which the Tribunal had gone through and thereupon came to the conclusion that the said expenses were not head office expenses for the purpose of section 44C. This decision in fact supports the decision of the Appellate Tribunal which forms the subject matter of the above reference.