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From the Courts »
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M/s Continental Carriers Vs. Commissioner Of Income Tax, New Delhi
April, 26th 2016
       IN THE HIGH COURT OF DELHI AT NEW DELHI
%                                    Judgment delivered on: 26.04.2016

+                         ITA 264/2002

M/S CONTINENTAL CARRIERS                      ..... Appellant
                 Through: Mr Piyush Kaushik, Advocate.

                          versus

COMMISSIONER OF INCOME TAX,
NEW DELHI                                      ..... Respondent
                 Through: Mr Dileep Shivpuri, Senior Standing
                 Counsel with Mr Sanjay Kumar, Junior
                 Standing Counsel.
                                   AND

+                         ITA 415/2004

M/S CONTINENTAL CARRIERS                      ..... Appellant
                 Through: Mr Piyush Kaushik, Advocate.

                          versus

COMMISSIONER OF INCOME TAX,
NEW DELHI                                      ..... Respondent
                 Through: Mr Dileep Shivpuri, Senior Standing
                 Counsel with Mr Sanjay Kumar, Junior
                 Standing Counsel.

CORAM:
JUSTICE S.MURALIDHAR
JUSTICE VIBHU BAKHRU

                             JUDGMENT

VIBHU BAKHRU, J




ITA 264/2002 & 415/2004                                      Page 1 of 19
1.      The present appeals have been preferred by M/s Continental

Carriers (hereafter `the Assessee') under Section 260A of the Income Tax

Act, 1961 (hereafter `the Act') impugning orders dated 24 th April, 2002

and 10th February, 2004 passed by the Income Tax Appellate Tribunal

(hereafter `ITAT') in ITA Nos. 5890/Del/1996 and 4169/Del/2000

respectively. Whereas ITA No. 5890/Del/1996 was preferred by the

Assessee against an order dated 23rd September, 1996 passed by the

Commissioner of Income Tax Act (Appeals) [ hereafter `CIT(A)'] for

Assessment Year (AY) 1993-94, ITA 4169/Del/2000 was filed by the

Revenue against an order dated 31st July, 2000 passed by CIT(A) for AY

1997-98.


2.      The controversy involved in both the appeals relates to the method

of computing the income received or brought into India in convertible

foreign exchange for the purposes of deduction under Section 80-O of the

Act.


3.      The Assessee is a partnership firm and involved in the business of

clearing and forwarding of goods for import and export, in India. It is

asserted that in 1988, the Assessee commenced a new business activity

which resulted in Assessee earning income by way of commission from

certain foreign enterprises. It is not disputed that the commission earned


ITA 264/2002 & 415/2004                                         Page 2 of 19
from foreign enterprises was brought into India in convertible foreign

exchange and was eligible for deduction under Section 80-O of the Act.


4.      During the Previous Years relevant to AYs 1993-94 and 1997-98,

the    Assessee           earned   Rs.1,56,10,111/-   and     Rs.4,19,66,477/-     as

commission in foreign currency respectively.                The Assessee filed its

return of income for AY 1993-94 on 28th October, 1993, inter alia,

claiming a deduction of Rs.78,05,005/-, being 50% of the gross

commission from foreign enterprises, under Section 80-O of the Act. The

return filed by the Assessee was picked up for scrutiny. During the

assessment proceedings, the Assessee claimed that it was entitled to

deduction of 50% of the gross commission from foreign enterprises under

Section 80-O of the Act.              However, without prejudice to the said

contention, the Assessee also computed its net income from foreign

enterprises at Rs.1,30,12,924/- and claimed 50% of the said income - that

is, Rs.65,06,462 - as an allowable deduction under Section 80-O of the

Act. The question whether the Assessee is entitled to deduction under

Section 80-O on the gross foreign income or the net foreign income is no

longer in dispute and it is common ground that the Assessee would be

entitled to 50% of the eligible net income earned in convertible foreign




ITA 264/2002 & 415/2004                                                  Page 3 of 19
exchange (hereafter referred to as 'the Foreign Income') as a deduction

under Section 80-O of the Act.


5.      The Assessee computed the Foreign Income at Rs.1,30,12,924/- in

the following manner: the Assessee first computed the average profit

margin on its domestic receipts for the AYs 1978-79 to 1987-88 - a

period of 10 years during which the Assessee did not have any

commission from foreign enterprise - at 11.5%.         Accordingly, the

Assessee computed the net profits attributable to domestic receipts at

Rs.26,92,496/- (being 11.5% of Rs.2,34,13,012/-). The Assessee then

deducted the net profits from domestic receipts from the consolidated net

profit of Rs. 1,57,05,421/- as per its Profit and Loss Account to compute

its Foreign Income as Rs. 1,30,12,925/-.


6.      The AO rejected the Assessee's method of computing the Foreign

Income for deduction under Section 80-O of the Act and determined the

Foreign Income by applying the Assessee's profit margin on its

consolidated income.      In other words, the AO applied the ratio of

assessed income to gross receipts on the commission received and

computed the deduction under Section 80-O at Rs.32,57,779/- for AY

1993-94.







ITA 264/2002 & 415/2004                                        Page 4 of 19
7.       For the AY 1997-98, the Assessee filed its return claiming a

deduction of a sum of Rs.2,00,98,400/- under Section 80-O of the Act.

The Assessee had computed the aforesaid deduction by deducting 80% of

the expenses relating to postage, telegram, telephone and fax etc. and

10% of the expenses relating to salaries from the gross commission

received from foreign enterprises to compute its Foreign Income. 50% of

the Foreign Income so computed was claimed as deduction under Section

80-O of the Act.          The AO rejected the aforesaid computation and

computed the deduction under Section 80-O by applying the same

formula as adopted by the AO while computing the deduction under

Section 80-O for AY 1993-94. Since the total receipts disclosed by the

Assessee for AY 1997-98 was Rs. 7,19,42,363/-, out of which

commission from foreign enterprises amounted to Rs.4,19,66,477/- and

the total expenses were assessed at Rs. 3,16,25,140/-; the AO computed

the deduction under Section 80-O of the Act as under:


He computed the expenses attributable to foreign income at

Rs.1,84,48,041/- on a proportionate basis to the gross income of the

Assessee [(Rs. 3,16,25,140 /7,19,42,363) x 4,19,66,477/-]. He then

calculated the Foreign Income at Rs. 2,34,18,436/- by deducting the

expenses attributable to receipts from foreign enterprises from those



ITA 264/2002 & 415/2004                                        Page 5 of 19
receipts [4,19,66,477/- - 1,84,48,041/- = 2,34,18,436/-]. Accordingly, he

computed the deduction under Section 80-O of the Act, being 50% of the

Foreign Income, at 1,17,59,217/- [50% of 2,34,18,436/-]


8.      The Assessee appealed against the respective assessment orders for

AYs 1993-94 and 1997-98 before the CIT(A). By an order dated 23rd

September, 1996, the CIT(A) rejected the Assessee's challenge to the

quantum of deduction under Section 80-O of the Act as computed by the

AO for AY 1993-94 and upheld the AO's conclusion that the average rate

of net profit for a period of 10 years provided no basis for determining the

Foreign Income. The CIT(A) concurred with the AO that since, the

Assessee had not maintained separate books of accounts, the most

scientific method for determining Foreign Income would be by allocating

expenses between the domestic income and income from foreign

enterprises on a proportionate basis.


9.      However, for AY 1995-96, the CIT(A) accepted the methodology

of computing Foreign Income as was canvassed by the Assessee, in the

alternative, for AY 1993-94. The CIT(A) accepted that the average profit

margin for income other than Foreign Income was 11.5% and, thus,

average expenses for domestic business was 88.5% of the gross domestic

income. On this basis, the domestic expenditure was calculated at


ITA 264/2002 & 415/2004                                           Page 6 of 19
Rs.3,01,55,138/- [being 88.5% of 3,40,73,602/-]. The balance expenses

being Rs.1,04,27,180/- (that is, after deducting Rs.3,01,55,138/- from the

total expenses of Rs.4,05,82,318/-) were held to be attributable to earning

commission from foreign enterprises in convertible foreign exchange.

Accordingly, the Foreign Income for AY 1995-96 was computed at Rs.

1,61,50,615/- (that is, gross foreign commission of Rs.2,65,77,795/- less

Rs.1,04,27,180/-). This method was also accepted by the CIT(A) for AY

1996-97.


10.     The CIT(A), by an order dated 31st July, 2000 followed the earlier

decisions for AYs 1995-96 and 1996-97 and, computed the deduction

under Section 80-O of the Act at Rs.1,84,34,998/- for AY 1997-98.


11.     Aggrieved by the order dated 23rd September, 1996 passed by the

CIT(A) for AY 1993-94, the Assessee preferred an appeal before the

ITAT. The Revenue, on the other hand, appealed against the CIT(A)'s

order dated 31st July, 2000 for AY 1997-98. By an order dated 24th April,

2002, the ITAT rejected the Assessee's plea that only 11.5% of domestic

receipts could be considered as expenditure allocable to foreign

commission receipts as being not acceptable. The ITAT further held that

the formula adopted by the AO in estimating the Foreign Income was

reasonable and scientific and concurred with the AO's estimation of


ITA 264/2002 & 415/2004                                          Page 7 of 19
Foreign Income for the purposes of deduction under Section 80-O of the

Act. Following the aforesaid decision for AY 1993-94, the ITAT allowed

the Revenue's appeal for AY 1997-98 by an order dated 10th February,

2004.


12.     Aggrieved by the decision of the ITAT, the Assessee has filed the

present appeals. These appeals, ITA 264/2002 and ITA 415/2004, were

admitted on 7th October, 2002 and 6th August, 2004 respectively and the

following questions of law - which is common to both appeals - was

framed:


       "Whether on the facts and in the circumstances of the case the
       conclusion recorded by the Tribunal on the apportionment of
       the net income eligible for deduction under Section 80-O of the
       Income-tax Act, 1961, is bad in law, being wholly inconsistent
       with the evidence on record?"

13.     We are informed that the Revenue also filed appeals before the

ITAT for AY 1995-96 and 1996-97 which have since been disposed of by

the ITAT by directing the deduction under section 80-O of the Act be

computed in accordance with the decision of this court in the present

appeals.



Submissions




ITA 264/2002 & 415/2004                                          Page 8 of 19
14.     Mr Piyush Kaushik, learned counsel appearing for the Assessee

contended that the AO and the ITAT had grossly erred in not considering

the submissions made by the Assessee and its computation of Foreign

Income had been rejected without assigning any reasons. He further

submitted that the AO had been inconsistent in the methodology adopted

for computing the deduction under Section 80-O of the Act and the same

was not considered by the ITAT.        Mr Kaushik then referred to the

decision of this Court in CIT v. EHPT India P. Ltd.: (2013) 350 ITR 41

(Del) and on the strength of that decision contended that in cases where

there is no statutory or fixed formula for allocation of expenditure

between exempt and non-exempt income, the method of allocation of

expenditure should be one which is consistently accepted by both the

parties - the assessees and the Revenue - in the past; the method should

be reasonable; and one which does not distort profits.



15.     Next, he referred to the written submissions filed before the ITAT

and contended that if the method adopted by the AO for computation of

Foreign Income is accepted, it would imply that Assessee's domestic

business had a profit margin of 41.73% in AY 1993-94 and 56.32% in

AY 1997-98. This, according to him, established that the method of

allocation of expenditure adopted by the AO indicated distorted profits


ITA 264/2002 & 415/2004                                         Page 9 of 19
from domestic business and, therefore, could not be accepted. Mr

Kaushik then referred to the decision of the Supreme Court in CIT v.

Bilahari Investment P. Ltd.:(2008) 299 ITR 1 SC in support of his

contention that the AO could not reject the method adopted by the

Assessee unless he recorded a finding that the same has resulted in

distortion of profits. He submitted that since no such findings had been

recorded, the ITAT's decision was erroneous. Mr Kaushik also relied

upon the decision of the Supreme Court in CIT v. Realest Builders &

Services Ltd.: (2008) 307 ITR 202 SC and contended that it was

incumbent upon the AO to give facts and figures to demonstrate that the

method of accounting followed by the Assessee had resulted in under-

estimation of profits. He also referred to the decision of the Supreme

Court in CIT v. McMillan & Co.: 33 ITR 182 SC to contend that the

method of accounting adopted by the Assessee must be scrutinised

carefully and such power should be exercised reasonably and judicially.



16.     Next, Mr Kaushik referred to the decision of the Supreme Court in

CIT v. Woodward Governor India P. Ltd.: 312 ITR 254 SC and the

decision of this Court in CIT v. Jagatjit Industries Ltd.: 339 ITR 382 SC

in support of his contention that the method of accounting adopted by the




ITA 264/2002 & 415/2004                                         Page 10 of 19
Assessee could not be changed unless the AO finds the same to distort

profits.



17.     Lastly, Mr Kaushik referred to the decision of the Supreme Court

in Lalchand Bhagat Ambica Ram v. CIT: 37 ITR 288 (SC) and of the

Madras High Court in CIT, Chennai v. M/s Matrix Intel Pvt. Ltd.

Chennai: 2006-TIOL-389-HC-MAD-IT and contended that it was

incumbent upon the ITAT to consider all the facts, both for and against

the Assessee, before rejecting the contentions or material submitted by

the Assessee. He also relied on the decision of this Court in CIT v.

Satish Kumar Chandna: 311 ITR 276 (Del) in support of the aforesaid

contention.



Reasoning and Conclusion


18.     The question of law before us is a limited one and, that is, whether

the conclusion of the ITAT with regard to the apportionment of expenses

to determine the Foreign Income for the purposes of deduction under

Section 80-O of the Act, is inconsistent with the evidence on record. The

evidence in question, which is relied upon by the Assessee is the average

profit margin of 11.5% from Assessee's domestic business determined by



ITA 264/2002 & 415/2004                                           Page 11 of 19
averaging the profit margins for a period of 10 years prior to

commencement of the new line of business. It was urged that on the

aforesaid basis, the expenditure on domestic business could be reasonably

estimated at 88.5% of domestic receipts. And, if the expenditure so

estimated was reduced from the total expenditure incurred by the

Assessee during the relevant previous years, the resultant figure would be

the expenditure that could be attributed to Foreign Income.


19.     A close examination of the aforesaid formula as canvassed on

behalf of the Assessee clearly indicates that the same results in all fixed

expenditure being allocated to domestic businesses and only the increased

marginal expenditure is allocated towards computing the Foreign Income.

The average profit margin of 11.5% attributable to domestic business has

been calculated by averaging the profit margin for AYs 1978-79 to 1987-

88, that is, during the period when the Assessee did not carry out the

business resulting in Foreign Income. Plainly, the computation of this

profit margin of 11.5% takes into account all costs - including fixed costs

and variable costs - which constitute 88.5% of the gross domestic

receipts. Now, if the method as canvassed by the Assessee is accepted, it

would mean that all fixed costs would be allocated to the domestic




ITA 264/2002 & 415/2004                                          Page 12 of 19
business and no part of it would be allocated towards earning Foreign

Income.



20.     In Cost Accountancy terms, all costs incurred by the Assessee for

carrying on its business can be classified into Fixed Costs, Semi-variable

Costs and Variable Costs. Fixed Costs are such costs which have to be

incurred by the Assessee irrespective of whether the Assessee earns any

income or not. Typically, such costs include costs for basic infrastructure,

office space, etc. and such costs do not vary with the volume of business

carried on by the Assessee. Variable costs are typically costs that vary in

direct proportion to the volume of business carried out by the Assessee.

These costs typically include costs such as costs for direct raw material

that is incorporated in or consumed to produce the final product. Semi-

variable costs are such costs which have elements of both fixed costs and

variable costs. Such costs would vary with the volume of business but not

in direct proportion. Typically, such costs may be costs such as electricity

charges which have a fixed component of line charges and variable per

unit cost for electricity consumed. In the method as adopted by the

Assessee, no part of the fixed cost is allocated to foreign business and at

best, only the marginal variable costs are sought to be attributed to

earning Foreign Income. This, in our view, would plainly result in a


ITA 264/2002 & 415/2004                                           Page 13 of 19
distorted apportionment of net profits of the Assessee between domestic

income and foreign income.



21.     To illustrate the above point, let us consider a hypothetical case of

an assessee who's revenue receipts from business (Existing Business) in a

particular year is Rs.1,00,000/-. He incurs office rentals and

establishment costs of Rs. 60,000/-and other variable expenses of Rs.

20,000/-; thus declaring a profit of 20,000/- (translating to a net profit

margin of 20%). In the next year, he expands his business by

commencing a new activity (`New Business') from the same

establishment which results in additional revenues of Rs. 50,000/- for

which he incurs incremental variable cost of Rs. 10,000/-. Assuming that

the revenues from existing business remain static and there are

inflationary pressures on costs; the assessee would earn a profit of

Rs. 60,000/- and his overall net profit margin would increase to 40% (i.e

60,000/150,000). If the method as canvassed by the Assessee is accepted,

and the costs are allocated to the Existing Business based on the profit

margin prior to commencement of New Business, the entire office rentals

and establishment costs of Rs. 60,000/- would be allocated to the Existing

Business even though the same establishment was used for carrying on

the New Business. The result would be that while the profit margin of the


ITA 264/2002 & 415/2004                                            Page 14 of 19
Existing Business would continue to be assumed at 20% and the profit

margin of the New Business would be reflected at 80%.



22.     During the course of hearing, we had put the above fallacy in the

method adopted by the Assessee to Mr Kaushik and had also adjourned

the hearing to enable him to respond and advance contentions in support

of the method adopted by the Assessee. However, Mr Kaushik did not

advance any contention in support of the method as canvassed by the

Assessee and limited his submissions to contend that the ITAT had not

provided any such opportunity to the Assessee.



23.     We may note that Mr Kaushik also did not dispute that the method

as adopted by the AO - that is, to allocate expenses on proportionate basis

- was in principle unfair or flawed. He merely contended that the same

had resulted in the profit margins of the domestic business being

computed at very high rates (41.73% for AY 1993-94 and 56.32% for AY

1997-98). This objection, in our view, is clearly without any merit as it

fails to consider the result on the profit margin of foreign business. If the

methodology as adopted by the Assessee is accepted, then the profit

margin of the domestic business would remain 11.5% but that of foreign

business would be 83.36% [(Rs.1,30,12,925/1,56,10,011)x100] for AY



ITA 264/2002 & 415/2004                                            Page 15 of 19
1993-94 and 87.86% [(Rs.3,68,69978/4,17,66,477)x100] for AY 1997-

98. It is the Assessee's case before the CIT(A) for AY 1995-96 that it did

not incur any specific expenditure for earning the commission from

foreign principals in respect of the said consolidation business. The

Assessee also contended that "Assessee has a running business

establishment all over the country in regard to its original business i.e.

clearing agency with branches in different parts of the country and the

receipt of the commercial information regarding probable imports are

merely incidental which are transmitted to foreign principals interested

therein.". Thus, ceteris paribus, the profit margins of the domestic

business would clearly be expected to increase with the incremental

revenue's being generated by way of commission from the existing fixed

establishment.


24.     It is also relevant to note that the average profit margin of 11.5% of

domestic business, which is the bedrock of the Assessee's contention, has

been calculated by averaging profit margins for AYs 1978-79 to 1987-88

which are several years prior to the AYs in question.


25.     Turning to the decisions referred to by Mr Kaushik, it is clear that

most of them are wholly inapplicable in the facts of the present case. In



ITA 264/2002 & 415/2004                                             Page 16 of 19
EHPT India P. Ltd. (supra), this Court was concerned with

apportionment of common expenses between income exempt under

Section 10A of the Act and non-exempt income of the Assessee. In that

case, the ITAT had upheld the allocation of common expenses on the

basis of headcount of employees, which had been followed on a

consistent basis. In that case, the Assessee had recorded common

expenses separately for various costs centres and the same were

apportioned in the ratio of head counts of the exempt and non-exempt

units.    This Court found that the method for apportioning common

expenses between exempt and non-exempt units was not unreasonable

and had been followed consistently by the Assessee in the past. However,

in the present case, we are unable to accept that the method as canvassed

by the Assessee is reasonable or results in a fair computation of domestic

and Foreign Income. Further, the Assessee itself had not followed a

consistent method for apportionment of expenses between domestic

business and foreign business. Whilst for AY 1993-94, the Assessee had

claimed deduction under Section 80-O of the Act on gross income, in AY

1997-98 the Assessee had deducted 80% of expenses relating to postage,

telegram, telephone and fax etc. and 10% of the expenses relating to

salaries from gross foreign commission to compute the Foreign Income.







ITA 264/2002 & 415/2004                                         Page 17 of 19
26.     Similarly, the decisions in the case of Bilahari Investment P. Ltd.

(supra) and Realest Builders & Services Ltd. (supra) also do not support

the Assessee in any manner. This is so because in the present case, it is

apparent that the method of apportioning of expenses as canvassed by the

Assessee does not lead to acceptable results.



27.     Although, the ITAT ought to have discussed the method of

apportionment as urged by the Assessee and articulated its reasons for

rejecting the same, we are not inclined to remand the matter as the

method of apportionment of expenses between domestic business and

income from foreign commission is clearly unacceptable in the given

facts of the case. Further, the ITAT has concurred with the view of the

AO that the method provided by the Assessee was not acceptable as the

expenses would vary from year to year. Finally, the ITAT had accepted

the methodology adopted by the AO to compute Foreign Income to be

reasonable and scientific and we find no infirmity with this view.



28.     In view of the above, the question framed is answered in the

negative, that is, in favour of the Revenue and against the Assessee.




ITA 264/2002 & 415/2004                                           Page 18 of 19
29.     The Appeals are, accordingly, dismissed. The parties are left to

bear their own costs.




                                                  VIBHU BAKHRU, J



                                                  S.MURALIDHAR, J
APRIL 26, 2016
RK/pkv




ITA 264/2002 & 415/2004                                        Page 19 of 19

 
 
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