Court rules on shareholding changes and loss carryforward: ABL retains control despite reduced shares.

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Case Name:

Commissioner of Income Tax Vs. Amco Power Systems Ltd. (High Court of Karnataka)

ITA No. 766 of 2009 C/w ITA No. 769 of 2009, 1046 of 2008, 765 & 767 of 2009

Date: 7th October 2015

Key Takeaways:

• The court clarified that the ability to carry forward losses is tied to voting power, not just shareholding percentage.
• ABL’s control over its subsidiary, APIL, allowed it to maintain the necessary voting power despite owning only 6% of shares.
• The ruling emphasizes the importance of control in corporate governance and tax law.

Issue

Can a company carry forward business losses incurred in previous years if there has been a change in shareholding, specifically when the controlling entity retains 51% voting power?

Facts

• ABL was the holding company of APIL, which was a wholly owned subsidiary.
• Over the years, ABL’s shareholding decreased from 100% to 6%, while APIL held 45% and TAFE held 49%.
• The case revolved around whether Amco Power Systems could set off losses from previous years against its income for the assessment year 2003-04, given the change in shareholding.

Arguments

• For the Revenue: The argument was that ABL’s reduction in shareholding below 51% meant it could not carry forward losses as per Section 79 (of Income Tax Act, 1961), which states that losses cannot be carried forward if there is a change in shareholding.
• For Amco Power Systems: The defense argued that despite the reduction in shareholding, ABL retained control over APIL, thus maintaining the necessary voting power to qualify for loss carryforward.

Key Legal Precedents

• Section 79 (of Income Tax Act, 1961): This section prohibits the carry forward of losses if there is a change in shareholding unless 51% of the voting power is retained by the same shareholders who held it when the losses were incurred.
• The court referenced past cases, including Commissioner of Income Tax V/S Italindia Cotton Private Limited, which established that a change in shareholding does not automatically imply a change in control.

Judgement

The court ruled in favor of Amco Power Systems, allowing it to carry forward its business losses. The reasoning was that ABL, despite its reduced shareholding, still controlled 51% of the voting power when combined with its subsidiary, APIL. Therefore, the provisions of Section 79 (of Income Tax Act, 1961) were not applicable, and the company could benefit from the carryforward of losses.

FAQs

Q1: What does this ruling mean for companies undergoing shareholding changes?

A1: Companies can still carry forward losses if the controlling entity maintains the necessary voting power, even if its shareholding percentage decreases.

Q2: How does voting power affect loss carryforward?

A2: Voting power is crucial; as long as the controlling entity retains 51% voting power, the company can carry forward losses despite changes in shareholding.

Q3: What is Section 79 (of Income Tax Act, 1961)?

A3: Section 79 (of Income Tax Act, 1961) restricts the carry forward of losses in cases of shareholding changes unless the same shareholders maintain 51% voting power.

Q4: Can a company with less than 51% shareholding still control its subsidiary?

A4: Yes, as demonstrated in this case, control can be maintained through voting power, allowing for the carryforward of losses.

The present appeals are filed by the Revenue against the order of the Tribunal for the assessment years 1999-2000, 2000-01, 2001-02, 2002-03 &

2003-04. One question is common in all the appeals and other question is related to the assessment year 2003-04 alone, for which, ITA No.1046/2008 has been filed. As such, we shall treat ITA No.1046/2008 as the leading case, in which both the questions have been raised.

2. The respondent-assessee M/s. AMCO Power Systems Limited is a Company engaged in the manufacture and sale of storage batteries. By an agreement dated 01.03.1998 between M/s.AMCO Batteries Limited (for short ‘ABL’) and the respondent-assessee-M/s. AMCO Power Systems Limited (for short

‘APSL’), the former had agreed to transfer the technical know-how and grant of non-exclusive license with effect from 01.03.1998 to the respondent-assessee to manufacture and sell Pocket Plate Nicad Batteries on payment of lumpsum consideration of Rs.5.00 crores for the licence and right to use the technology. According to the said agreement, the payment was to be made as per the following schedule:

1. Before 31/5/1998 Rs. 10 lakhs

2. Before 31/5/1999 Rs. 25 lakhs

3. Before 31/5/2000 Rs. 25 lakhs

4. Before 31/5/2001 Rs. 25 lakhs

5. Before 31/5/2002 Rs. 25 lakhs

6. Before 31/5/2003 Rs. 100 lakhs

7. Before 31/5/2004 Rs. 100 lakhs

8. Before 31/5/2005 Rs. 100 lakhs

9. Before 31/5/2006 Rs. 90 lakhs

3. However, admittedly the payment for the

entire consideration was not made by the

assessee-APSL to ABL strictly as per the schedule but

according to the details given herein below:

i. 31/05/1998 Rs. 10,00,000

ii. 01/09/1999 Rs. 50,00,000

iii. 16/03/2002 Rs. 5,00,000

iv. 31/03/2002 Rs. 40,00,000

v. 25/04/2002 Rs. 5,00,000

vi. 17/01/2003 Rs. 5,00,000

vii. 03/04/2004 Rs. 30,000

viii. 13/04/2004 Rs. 1,60,000

ix. 13/07/2004 Rs. 1,00,000

x. 27/07/2004 Rs. 2,00,000

xi. 06/09/2004 Rs. 3,00,000

xii. 10/12/2004 Rs. 5,00,000

xiii. 09/03/2005 Rs. 10,000

xiv. 31/01/2006 Rs. 3,72,00,000

Total Rs. 5,00,00,000

4. For the assessment year 2003-04, the facts

of which are alone being considered in this appeal, the

respondent-assessee filed its return of income on

28.11.2003 wherein NIL income was shown after setting

off losses brought forward from earlier years. The said

return of income was processed under Section 143(1) (of Income Tax Act, 1961) of

the Income Tax Act, 1961 (hereinafter referred to as ‘the

Act’ for short) and accepted on 06.02.2004.

Subsequently, the case of the assessee relevant to

assessment year 2003-04, was taken up for scrutiny

and assessment under Section 143(3) (of Income Tax Act, 1961), which

was completed on 28.02.2006 and the income of the

assessee for the said year was determined at

Rs.1,34,03,589/-. This was done so, primarily because

the deduction under Section 35AB (of Income Tax Act, 1961), as

claimed by the assessee, was disallowed and the lease

rentals paid were also disallowed. The said assessment

order also did not allow the setting off of losses of the

previous years by invoking Section 79 (of Income Tax Act, 1961).

5. Similarly, for the earlier four assessment

years 1999-2000, 2000-01, 2001-02 and 2002-03, the

case of the assessee was reopened under Section

147/148 of the Act and the benefit granted in such

years under Section 35AB (of Income Tax Act, 1961) was disallowed.

However, because of limitation, the assessment for the

assessment year 1998-99, in which also the benefit of

Section 35AB (of Income Tax Act, 1961) had been claimed and granted,

could not be reopened.

6. Aggrieved by the order of assessment passed

under Section 143(3) (of Income Tax Act, 1961), the assessee preferred

an appeal before the Commissioner of Income Tax

(Appeals) for the assessment year 2003-04, primarily on

two grounds:– (1) disallowance of Rs.83,33,333/- (being

1/6th of Rs.5.00 crores claimed as deduction under

Section 35AB (of Income Tax Act, 1961)) in respect of the expenditure

incurred for acquiring technical know-how; (2) denial of

set-off of brought forward business loss on the ground

that the provisions of Section 79(a) (of Income Tax Act, 1961) are not

complied. By an order dated 09.03.2007 passed by the

Commissioner of Income Tax (Appeals), the appeal of

the respondent-assessee was partly allowed and benefit

of deduction claimed under Section 35AB (of Income Tax Act, 1961) was granted;

but respondent-assessee was not found to be entitled to

set-off of the brought forward losses, considering the

change in beneficial holding of 51% or more, as

provided under Section 79 (of Income Tax Act, 1961).

7. Being aggrieved by the order of the

Commissioner of Income Tax (Appeals), the assessee as

well as Revenue, both filed appeals before the Income

Tax Appellate Tribunal, Bangalore, Bench-B.

(hereinafter referred to as ‘the Tribunal’ for short). The

assessee challenged disallowance of the benefit claimed

regarding set-off of brought forward losses, whereas the

Revenue filed an appeal challenging the grant of

deduction under Section 35AB (of Income Tax Act, 1961) to the

assessee. The assessee had also challenged the

disallowance of lease rentals paid by it to the extent of

Rs.2,08,080/-. The Tribunal, however dismissed the

appeal of the Revenue, and partly allowed the appeal of

the respondent-assessee by allowing the benefit of

set-off of brought forward losses, but did not give the

benefit of lease rentals paid by the assessee.

Challenging the said order of the Tribunal, the Revenue

has filed this appeal raising two substantial questions of

law, which, by consent of learned counsel for the parties

are re-framed as under:

1. “Whether the Tribunal was correct in

holding that the assessee would be entitled to

carry forward and setoff of business loss

despite the assessee not owning 51% voting

powers in the company as per Section 79 (of Income Tax Act, 1961) of

the Act by taking the beneficial share holding

of M/s. Amco Properties & Investments Ltd.,?

2. Whether the Appellate Authorities were

correct in holding that the assessee would be

entitled to claim deduction in accordance with

Section 35AB (of Income Tax Act, 1961) in respect of the sum

of Rs.5 crores for transfer of technical know-

how, which amount was payable in

installments between 31.5.1998 to

31.5.2006?”

8. In ITA No.1046/2008 relating to the

assessment year 2003-04, both the questions are

raised, whereas in the remaining appeals relating to

other assessment years, it is only the second question

that has been raised.

9. We have heard Sri.Jeevan J Neeralgi and

Sri.K.V.Aravind, learned counsel for the Revenue in all

the appeals; and Sri.A.Shankar, learned counsel

appearing for the respondent-assessee in all the

appeals, and have perused the records.

10. Question No.1:

This question relates to whether the respondent-

assessee would be entitled to carry forward and set-off

of business losses even though, as per the Revenue, the

voting power of the respondent had been reduced below

51% of the shareholding, and consequently voting power

of the respondent Company had reduced to less than

51%.

11. Admittedly, upto the assessment year

2000-01, all the shares of the respondent-Company

were held by the ABL. In the assessment year 2001-02,

the holding of ABL was reduced to 55% and the

remaining 45% shares were transferred to a subsidiary

of ABL, namely AMCO Properties and Investments

Limited (for short ‘the APIL’). In the assessment year

2002-03, ABL further transferred 49% of its remaining

55% shares to Tractors and Farm Equipments Limited

(for short ‘the ‘TAFE’) and consequently ABL retained

only 6% shares and its subsidiary APIL held 45% shares

and the remaining 49% shares were with TAFE. Similar

shareholding continued for the assessment year

2003-04. For easy understanding, shareholdings of the

respondent-Company for the relevant assessment years

is given in the chart below:

Financial Year 31/3/1999 31/3/2000 31/3/2001 31/3/2002 31/3/2003

Assessment Year 1999-2000 2000-01 2001-02 2002-03 2003-04

Share holding Pattern

a) ABL 100% 100% 55% 6% 6%

b) TAFE Nil Nil Nil 49% 49%

c) APIL Nil Nil 45% 45% 45%

12. The relevant Section 79 (of Income Tax Act, 1961) reads as under:

S.79: “Carry forward and set off of losses

in the case of certain companies”

Notwithstanding anything contained in

this Chapter, where a change in shareholding

has taken place in a previous year in the case

of a company, not being a company in which

the public are substantially interested, no loss

incurred in any year prior to the previous year

shall be carried forward and set off against

the income of the previous year unless-

(a) on the last day of the previous year the

shares of the company carrying not less than

fifty-one per cent of the voting power were

beneficially held by persons who beneficially

held shares of the company carrying not less

than fifty-one per cent of the voting power on

the last day of the year or years in which the

loss was incurred.

Provided........

Provided further .........

(b) [omitted w.e.f. 01.04.1989]

(emphasis supplied)

13. The said Section provides that where there is

a change in shareholding of a Company, no loss

incurred in any year prior to the previous year shall be

carried forward and set-off against the income of the

previous year, unless on the last day of the previous

year the shares of the Company carrying not less than

51% of the voting power were beneficially held by

persons who beneficially held shares of the Company

carrying not less than 51% of the voting power on the

last day of the year or years in which the loss was

incurred.

14. The contention of the learned counsel for the

Revenue is that, upto the assessment year 2001-02

there was no dispute that the ABL continued to have

51% or more shares as its shareholding. In the said

assessment year, the ABL was holding 55% shares and

that its subsidiary APIL was holding 45% shares. For

the assessment year 2002-03, when the ABL transferred

49% shares (out of its 55%) to TAFE, then ABL was left

with only 6% shares, meaning thereby, it was left with

less than 51% shares. It is contended that,

consequently its voting power was also reduced from

55% to 6%, and the remaining 94% was divided between

TAFE and APIL at 49% and 45% respectively. It is,

thus, contended that the Company would hence not be

entitled to claim carry forward and set-off of business

losses in the assessment years 2002-03 and 2003-04.

Learned counsel has submitted that even though the

APIL may be wholly owned subsidiary of ABL, but both

the companies would be separate entities and cannot be

clubbed together. By transfer of its 49% shares to

TAFE, the shareholding of ABL was reduced to 6% only,

and the submission thus is that the provisions of

Section 79 (of Income Tax Act, 1961) would be attracted for denying the

benefit of carry forward losses to the respondent-

assessee.

15. Per contra, Sri.A.Shankar, learned counsel

appearing for the respondent-assessee, has submitted

that it is not the shareholding which has to be taken

into consideration, but the voting power which was held

by a person or persons who beneficially held shares of

the Company, and has thus contended that because the

ABL was holding 100% shares of APIL, which was a

wholly owned subsidiary of ABL and fully controlled by

ABL, even though the shareholding of ABL had been

reduced to 6%, yet the voting power of ABL remained

51% and as such, the provisions of Section 79 (of Income Tax Act, 1961)

would not be attracted in the present case.

16. The Tribunal, after accepting the submission

of the assessee, held that 51% of the voting power was

beneficially held with the ABL during the assessment

years 2002-03 and 2003-04 also, and would thus be

entitled to carry forward and set-off of business losses

for the previous years.

17. The fact that ABL is the holding Company of

APIL, which is the wholly owned subsidiary of ABL and

that Board of Directors of APIL are controlled by ABL, is

not disputed. The submission of the learned counsel for

the respondent-assessee that the shareholding pattern

is distinct from voting power of a Company, has force.

Section 79 (of Income Tax Act, 1961) specifies that “not less than 51% of

the voting power were beneficially held by persons who

beneficially held shares of the Company carrying not less

than 51% of the voting power.” Since the ABL was

having complete control over the APIL, which is the

wholly owned subsidiary of ABL, in our view, even

though the shareholding of ABL may have reduced to

6% in the year in question, yet by virtue of being the

holding Company, owning 100% shares of APIL, the

voting power of ABL cannot be said to have been

reduced to less than 51%, because together, both the

companies had the voting power of 51% which was

controlled by ABL.

17. The purpose of Section 79 (of Income Tax Act, 1961) would

be that benefit of carry forward and set-off of business

losses for previous years of a company should not be

misused by any new owner, who may purchase the

shares of the Company, only to get the benefit of set-off

of business losses of the previous years, which may

bear profits in the subsequent years after the new

owner takes over the Company. For such purpose, it is

provided under the said Section that 51% of the voting

power which was beneficially held by a person or

persons should continue to be held, then only such

benefit could be given to the Company. As we have

observed above, though ABL may not have continued to

hold 51% shares, but Section 79 (of Income Tax Act, 1961) speaks of 51% voting

power, which ABL continued to have even after transfer

of 49% shares to TAFE, as it controlled the voting power

of APIL, and together, ABL had 51% voting power.

Meaning thereby, the control of the company remained

with ABL as the change in shareholding did not result

in reduction of its voting power to less than 51%.

18. While dealing with a case under Section

79(a) and (b) of the unamended Section [Clause (b) was

deleted w.e.f. 01.04.1988] and while relating to Clause

(a) of Section 79 (of Income Tax Act, 1961), the Apex Court in

Commissioner of Income Tax V/S Italindia Cotton

Private Limited (1988) 174 ITR 160 (SC), held that the

Section would be applicable only when there is change

in shareholding in the previous year which may result

in change of control of the Company and that every

such change of shareholding need not fall within the

prohibition against the carry forward and set-off of

business losses. In the present case, though there may

have been change in the shareholding in the

assessment year 2002-03, yet, there was no change of

control of the Company, as the control remained with

the ABL as the voting power of ABL, along with its

subsidiary Company APIL, remained at 51%. The

Supreme Court further observed that the object of

enacting Section 79 (of Income Tax Act, 1961) appears to be to discourage persons

claiming a reduction of their tax liability on the profits

earned in the Companies which had sustained losses in

earlier years. In the present case, the control over the

Company, with 51% voting power, remained with ABL

and, as such, in our view, the provisions of Section 79 (of Income Tax Act, 1961)

of the Act would not be attracted.

19. Accordingly, we answer the first question in

favour of the assessee and against the Revenue, and

confirm the finding of the Tribunal in this regard.

20. Question No.2:

This question relates to the entitlement of the

assessee for grant of deduction under Section 35AB (of Income Tax Act, 1961) of

the Act, in respect of payment of Rs.5 Crores for

transfer of technical know-how, which was transferred

on 01.03.1998, and as per the agreement, the amount

was payable between 31.5.1998 and 31.05.2006; and

had actually been paid within time though not strictly

as per the instalments provided in the agreement, the

details of which have already been given earlier in this

order.

21. The submission of learned counsel for the

appellant-Revenue is that the benefit can be claimed

only when the actual payment is made, and since no

payment was made on the date of transfer of the

technical know-how (which was 01.03.1998), as the first

payment was made only on 31.05.1998, which was in

the financial year 1998-99, the benefit of Section 35AB (of Income Tax Act, 1961)

of the Act could not be availed by the assessee-

respondent. It is contended that “paid” for the purpose

of Section 35AB (of Income Tax Act, 1961) would be as per the definition

of “paid” provided in sub-section (2) of Section 43 (of Income Tax Act, 1961) of the

Act, according to which, it would be actual payment

made or liability incurred. According to the appellant-

Revenue, the liability of the assessee arose on the date

when it was responsible/liable to pay as per the

agreement, and not on the date of transfer of the

technical know-how.

22. Per contra, learned counsel for the

respondent-assessee has submitted that the liability to

pay would arise on the date of the agreement, when the

know-how had been transferred, even though the

assessee may be required to pay the amount on a later

date, as per schedule in the agreement. It is contended

that the ‘liability to pay’ is different from the ‘liability to

discharge such liability’ in terms of the contract. It is

submitted that the moment the know-how was

transferred on 01.03.1998, in terms of the agreement of

the same date, the ‘liability to pay’ arose, and as such,

the assessee would be entitled to the benefit of Section

35AB of the Act, as there is no dispute about the fact

that the assesseee was following the mercantile system

of accounting and not the cash system.

23. For the purpose of deciding the question,

the relevant Sections of the Income Tax are: S.32(1)(ii)

(relating to depreciation); S.35AB (relating to

expenditure on know-how); S.43(2) (relating to

definition of paid); and S.43(B) (relating to certain

deductions to be made on actual payment). The said

Sections are reproduced below:

“Depreciation.

S.32(1)(ii) In respect of depreciation of—

(ii) know-how, patents, copyrights, trade marks,

licences, franchises or any other business or

commercial rights of similar nature, being

intangible assets acquired on or after the 1st day

of April, 1998, owned, wholly or partly, by the

assessee and used for the purposes of the

business or profession, the following deductions

shall be allowed—

(i) in the case of assets of an undertaking

engaged in generation of generation and

distribution of power, such percentage on the

actual cost thereof to the assessee as may be

prescribed;

(ii) in the case of any block of assets, such

percentage on the written down value thereof as

may be prescribed.

Provided.....”

S.35AB. Expenditure on know- how

(1) Subject to the provisions of sub- section (2),

where the assessee has paid in any previous

year [relevant to the assessment year

commencing on or before the 1st day of April,

1998] any lump sum consideration for acquiring

any know-how for use for the purposes of his

business, one- sixth of the amount so paid shall

be deducted in computing the profits and gains of

the business for that previous year, and the

balance amount shall be deducted in equal

instalments for each of the five immediately

succeeding previous years.

Definitions of certain terms relevant to

income from profits and gains of business or

profession S.43(2): In sections 28 to 41 and in this section,

unless the context otherwise requires-

(2) “paid” means actually paid or incurred

according to the method of accounting upon the

basis of which the profits or gains are computed

under the head “profits and gains of business or

profession”

Certain deductions to be only on actual

payment S.43B- Notwithstanding anything contained in

any other provision of this Act, a deduction

otherwise allowable under this Act in respect of -

(a) any sum payable ....

(b) any sum payable ....

(c) any sum referred ...

(d) any sum payable.....

(e) any sum payable....

(f) any sum payable......

shall be allowed (irrespective of the previous year

in which the liability to pay such sum was

incurred by the assessee according to the method

of accounting regularly employed by him) only in

computing the income referred to in section 28 (of Income Tax Act, 1961) of

that previous year in which such sum is actually

paid by him.

24. The brief history of the law relating to grant

of depreciation with regard to know-how may be first

explained. Prior to 01.04.1998, know-how was not a

depreciable asset. But after 01.04.1998, because of

amendment in Section 32 (of Income Tax Act, 1961), know-how is now a

depreciable asset. Know-how acquired after 01.04.1998

would be a depreciable asset. For the purpose of this

case, it may be noted that know-how was acquired on

01.03.1998, which was prior to 01.04.1998, and hence

the assessee would not be entitled to benefit of

depreciation. The corresponding amendment was

brought in Section 35AB (of Income Tax Act, 1961), wherein it was

provided that the benefit of the said Section, which was

with regard to expenditure on know-how, would be only

when the assessee has paid (as lump sum

consideration) for the know-how, prior to 01.04.1998.

Before 01.04.1998, transfer of know-how was treated as

a capital expenditure, covered by the provisions of

Section 35AB (of Income Tax Act, 1961). After 01.04.1998, by virtue of

amendment brought in Section 32 (of Income Tax Act, 1961), treating

know-how as a capital asset, depreciation was allowed

on the amount spent on transfer of know-how.

Intangible assets, such as know-how, patent rights etc.,

were included for depreciation only after 01.04.1998,

which was by the amendment in Section 32 (of Income Tax Act, 1961).

25. In the present case, there is no dispute

about the fact that know-how was acquired on

01.03.1998, which was prior to 01.04.1998. It is also

not disputed that payment for acquiring such know-how

was made only in instalments after 01.04.1998. The

question now would be as to whether the benefit of

Section 35AB (of Income Tax Act, 1961) would be available to the

assessee, which provides that if the assessee has, prior

to 01.04.1998, paid any lumpsum consideration for

acquiring the know-how, then 1/6th of the amount so

paid shall be deducted in computing the profits and

gains of the business for that year and the balance

amount shall be deducted in equal instalments for each

of the five immediately succeeding years.

26. For this, we have to analyze what would the

word “paid” mean in the context of the present case.

Sub-section(2) of Section 43 (of Income Tax Act, 1961) defines “paid” to

mean as ‘actually paid’ or ‘incurred’. ‘Actually paid’

would be as per the cash system of accounting, and

‘incurred’ would be for the mercantile system of

accounting. Admittedly, the assessee was following the

mercantile system of accounting. The crucial word thus

would be “incurred”. According to the appellant-

Revenue, the assessee would incur such liability to pay

only as per the schedule given in the agreement, which

was between 31.05.1998 and 31.05.2006. It is

contended that the dates given in the schedule would be

the relevant dates, as it was only when payment was not

made (as per the schedule) that the assessee could be

said to have become liable for making payment.

According to the Revenue, the liability to pay would

occur or arise on such date due for payment, as per the

schedule, and not earlier.

27. Learned counsel for the respondent-

assessee has however submitted that the liability to pay

would arise on the date when the technical know-how

was transferred, which was 01.03.1998; and merely

because the payment had been deferred, it cannot be

said that the liability had not incurred on such date, as

the assessee was following the mercantile system of

accounting and not the cash system. Learned counsel

has also submitted that ‘actual payment’ is different

from ‘incurring of liability to pay’. For this, reliance has

been placed on Section 43 (of Income Tax Act, 1961) B of the Act which provides

for certain deductions to be given only on actual

payment even in case of accounts being maintained as

per mercantile system, meaning thereby that the

Statute also recognizes there is a difference between the

‘actual payment’ and ‘incurring of liability to pay’.

28. Liability to pay would also be different from

due for payment or due for disbursement. Once the

know-how has been transferred, meaning thereby, it

has been acquired by the assessee and the assessee has

started using the know-how, it would become liable to

pay on such date of transfer of know-how, even though

the payment for the same may be due on a deferred

date.

29. The payment, in the present case, had been

deferred to such dates as provided in the agreement,

which have been reproduced herein above. The Act itself

contemplates certain deductions to be given only on

‘actual payment’ (as in case of Section 43B (of Income Tax Act, 1961)), even in

case where mercantile system of accounting is followed.

Such is not the case for Section 35AB (of Income Tax Act, 1961), where “paid” has

to be considered in terms of the definition provided

under sub-section(2) of Section 43 (of Income Tax Act, 1961), which,

provides for actually paid or incurred the liability to pay.

The moment there is liability to pay, which in our

opinion, would be on the date of transfer of the

technical know-how, the provisions of Section 35AB (of Income Tax Act, 1961)

would be attracted.

30. In the present case, for the assessment year

1998-99, such benefit was given and has not been

withdrawn. However, for the subsequent four years i.e.,

for assessment years 1999-2000, 2000-01, 2001-02,

2002-03, the cases have been re-opened, and the

benefit which was granted by accepting the return

under Section 143(1) (of Income Tax Act, 1961) has been withdrawn;

and for the assessment year 2003-04 the same was

denied by the Assessing Officer itself.

31. In support of their submissions, learned

counsel for both parties have relied on the following

three decisions of the Apex Court:

i) Keshav Mills Ltd. –vs- Commissioner of Income

Tax (1953) 23 ITR 230

ii) Morvi Industries Ltd., -vs- Commissioner of

Income Tax (1971) 82 ITR 835

iii) Commissioner of Income Tax –vs- Gajapathy

Naidu (1964) 53 ITR 114

32. In the case of Keshav Mills (supra), in

paragraph-13, the Apex Court has held as under:

“The mercantile system of accounting or

what is otherwise known as the double entry

system is opposed to the cash system of book

keeping under which a record is kept of actual

cash receipts and actual cash payments, entries

being made only when money is actually

collected or disbursed. That system brings into

credit what is due, immediately it becomes legally

due and before it is actually received and it

brings into debit expenditure the amount for

which a legal liability has been incurred before it

is actually disbursed. The profits or gains of the

business which are thus credited are not realised

but having been earned are treated as received

though in fact there is nothing more than an

accrual or arising of the profits at that stage. They

are book profits. Receipt being not the sole test of

chargeability and profits and gains that have

accrued or arisen or are deemed to have accrued

or arisen being also liable to be charged for

income-tax the assessability of these profits

which are thus credited in the books of account

arises not because they are received but because

they have accrued or arisen”

(emphasis supplied)

It has further been held in paragraph-16 of the

judgment that “it follows from the above that the

mercantile system of accounting treats profits or gains as

arising or accruing at the date of the transaction

notwithstanding the fact that they are not received or

deemed to be received and under that system, book

profits are assessed as liable to tax”.

33. In our view, the ratio of the decision would

go in favour of the assessee and not the Revenue, as the

moment a legal liability to pay arises, and before the

actual disbursement is made, the assessee has incurred

the liability to pay the amount, which, in the present

case, would be on the date of transfer of know-how,

which was on 01.03.1998.

34. The observations made by the Apex Court in

the case of Morvi Industries (supra) would also go in

favour of the assessee and not the Revenue. In

paragraph-12 of the said judgment, it has been

observed as follows:

“The appellant-company admittedly was

maintaining its account according to the

mercantile system. It is well known that the

mercantile system of accounting differs

substantially from the cash system of book

keeping. Under the cash system, it is only actual

cash receipts and actual cash payments that are

recorded as credits and debits; whereas under

the mercantile system credit entries are made in

respect of amounts due immediately they become

legally due and before they are actually received;

similarly, the expenditure items for which legal

liability has been incurred are immediately

debited even before the amounts in question are

actually disbursed. Where accounts are kept on

mercantile basis, the profits or gains are credited

though they are not actually realised, and the

entries thus made really show nothing more than

an accrual or arising of the said profits at the

material time. The same is the position with

regard to debits made.”

35. As such, accrual of income would be

different from receipt of income and the moment the

income accrues, the party gets the vested right to claim

such amount and conversely the moment the liability to

pay arises, such liability is incurred by the assessee.

36. The ratio in the case of Gajapathy Naidu

(supra) would also go in favour of the assessee as it

has been held that “an income accrues or arises when

the assessee acquires right to receive the same” and it is

further held that the mercantile system of accounting

“brings into credit what is due immediately it becomes

legally due and before it is actually received; and it

brings into debit expenditure the amount for which a

legal liability has been incurred before it is actually

disbursed”.

37. In the present case, the assessee, following

the mercantile system of accounting, had in its books of

account shown the amount of Rs.5 crores as liable to be

paid, or as liability to pay on the date on which it

acquired the technical know-how, which was

01.03.1998, as the legal liability had been incurred even

before it was actually disbursed.

38. Much emphasis has been laid by learned

counsel for the Revenue on the phrase ‘lumpsum

consideration’ in Section 35AB (of Income Tax Act, 1961). It is

contended that the payment, or the incurred liability to

pay, should be in lumpsum and if the payment is not

made in lumpsum, but in instalments, as in the present

case, the benefit of Section 35AB (of Income Tax Act, 1961) would not be given to

the assessee. The said issue was considered by the

Jharkand High Court in the case of Tata Yodogawa

Ltd., -vs- Commissioner of Income-Tax (2011) 335 ITR

53 (Jharkhand) and in paragraph-16 of the said

judgment it was held that “the word “lumpsum” as used

before the word “consideration” in Section 35AB (of Income Tax Act, 1961), only

exclude periodical or turnover based payments like

royalty etc., and in one time payment for the know-how

would fall within the expression “lumpsum” and if it is

fixed and specified in the agreement, although it may be

payable in instalments”.

39. We are also of the opinion that the

expression “lumpsum consideration” used in Section

35AB of the Act, in the facts of the present case, would

only mean that the liability to pay the entire amount or

“lumpsum consideration” had occurred on the date of

the agreement and transfer of know-how, even though

the payment may not have been made in lumpsum, but

deferred over a period of time.

40. While dealing with the said Section, the

Bombay High Court, in the case of Commissioner of

Income-Tax –vs- Raymond Ltd., (2012) 71 DTR (Bom)

258, which was also based on facts similar to the

present case, where “the second agreement was entered

into by the assesseee on 1st October 1993 for acquisition

of technical know-how for upgrading agreement was to

be valid for three years and a total consideration of US

$9,00,000 was payable @ US $ 3,00,000 per year”, it

was held that “the expression "paid" must be understood

in the context of the provisions of Section 43(2) (of Income Tax Act, 1961) which

defines it to mean actually paid or incurred according to

the method of accounting upon the basis of which the

profits or gains are computed under the head ‘Profits and

gains of business or profession’. In a judgment of a

Division Bench of this Court in Additional Commissioner

of Income-tax Vs. Buckau Wolf New Indian Engineering

Works Ltd. (1985) 46 CTR (Bom) 200: (1986) 157 ITR 751

(Bom), the issue arose in the context of an agreement

under which an assessee was to pay an amount of

Rs.1,00,000/- to its German collaborators in annual

instalments of Rs.20,000/- and the question which was

referred was whether the entire amount of Rs. 1,00,000/-

represented revenue expenditure deductible while

computing the total income of the assessee for the

Assessment Year 1967-68. The Division Bench noted that

the question which was required to be considered was

whether there was accrual of liability in the assessment

year, though with a facility of a deferred payment. The

Court held that it was an admitted position that the

assessee kept its accounts on the basis of the mercantile

accounting system, and if the terms of the agreement

were construed it would have to be held that the

assessee had incurred the entire liability for the payment

of Rs.1,00,000/- in the assessment year under

consideration though the actual payment was spread

over five years. The judgment of the Division Bench also

followed a decision of the Supreme Court in Kedarnath

Jute Mfg. Co. Ltd. Vs. CIT (1971) 82 ITR 363 (SC) in

holding that the issue as to whether the assessee is

entitled to a deduction will depend on the provisions

under which it is claimed and not on the existence or

absence of entries in the books of account which would

not be conclusive or decisive. In the present case, there is

a finding that though the payment of the consideration

under the agreement dated 1st October 1993 was to take

place by installments it would still constitute a lump sum

consideration since the amount was fixed and was not

variable on the basis of other unforeseen eventualities.

The assessee had evidently incurred the liability to pay

the entire amount under the agreement dated 1st October

1993. In that view of the matter the finding of the CIT(A)

that the assessee would be entitled to a deduction of

one-sixth of the entire amount in respect of which the

assessee had incurred a liability in the previous year

relevant to the Assessment Year in question is correct.

The finding is also justified having regard to the meaning

of the expression "paid" in Section 43(2) (of Income Tax Act, 1961)”.

41. In Bharat Earth Movers –vs-

Commissioner of Income Tax (2000) 245 ITR 428 (SC),

the Supreme Court has categorically held that “if a

business liability has arisen in the accounting year, the

deduction should be allowed even if such liability may

have to be quantified or discharged at a future date”.

42. In a recent judgment of Taparia Tools Ltd.

–vs- Joint Commissioner of Income Tax (2015) 372

ITR 605 (SC), the Supreme Court was dealing with a

case where the assessee-Company had given two

options to the debenture holders, to either receive

interest periodically, or to opt for one time upfront

payment of Rs.55 per debenture. In such facts, the

Apex Court held that “the moment the second option was

exercised by the debenture holder to receive the payment

upfront, the liability of the assessee to make the payment

in that very year, on exercising of this option, has arisen

and this liability was to pay interest at Rs.55 per

debenture.” While considering the definition “paid” in

sub-section(2) of Section 43 (of Income Tax Act, 1961), it was held that

“even if the amount is not actually paid but ‘incurred’,

according to the method of accounting, the same would

be treated as ‘paid’ ’’.

43. In the facts of the present case and in light

of the law laid down in the aforesaid case, we are of the

opinion, that the assessee would be entitled to claim

deduction in accordance with Section 35AB (of Income Tax Act, 1961) in

respect of sum of Rs.5 Crores for transfer of technical

know-how, even though the amount was payable and

paid in instalments on subsequent dates. This we say

so, also because the law is well settled that while

interpreting the provisions of taxing statutes, where two

views are possible, the one which is in favour of the

assessee should be adopted.

44. As such, for the forgoing reasons, we answer

question No.2 also in favour of the assessee.

45. Consequently, both the questions of law are

answered in favour of the assessee and against the

Revenue and the appeals are, accordingly, dismissed.

No order as to costs.

Sd/-

JUDGE

Sd/-

JUDGE