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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