Commissioner of Income Tax vs Davangere Cotton Mills Ltd.

V.K. Singhal, J.—The Income Tax Appellate Tribunal has referred the following questions of law arising out of its order dated May 25, 1993, in respect of the assessment year 1984-85 :

"1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in upholding the decision of the Commissioner of Income Tax (Appeals) that the amount of Central and State subsidy received by the assessee should not be reduced from the cost of the assets for the purpose of allowing depreciation ?

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in upholding the decision of the Commissioner of Income Tax (Appeals) deleting the commission and brokerage paid by the assessee to the indenters from the purview of disallowance envisaged u/s 37(5A) of the Income Tax Act ?"

The facts of the case are that the assessee is a limited company and was in receipt of Rs. 1,75,900 being Central and State subsidies. While framing the assessment order, the Assessing Officer considered a sum of Rs. 38,619 as the assessee''s income u/s 41(1) and deducted the balance amount of Rs. 1,37,281 from the cost of the assets for the purpose of allowing depreciation. The Commissioner of Income Tax (Appeals) allowed the appeal filed by the assessee against the abovementioned action of the Assessing Officer and directed that the amount of Rs. 1,37,281 be not deducted from the cost of the assets for the purpose of calculation of depreciation. The Tribunal confirmed the above-mentioned decision of the Commissioner of Income Tax (Appeals) by relying on the decision of this court in the case of Commissioner of Income Tax Vs. Diamond Dies Manufacturing Corporation Ltd., . The Assessing Officer considered a sum of Rs. 36,64,629 being commission and brokerage paid to indenters for the purpose of disallowance u/s 37(3A) of the Act. He was of the view that the amount constituted sales promotion expenses. The Commissioner of Income Tax (Appeals) deleted the above addition of the Assessing Officer. The Tribunal also upheld the decision of the Commissioner of Income Tax (Appeals) by relying on the decision of the Calcutta High Court in the case of Commissioner of Income Tax Vs. Sutlej Cotton Mills Ltd., , in which it had been held that commission and brokerage payments cannot be equated with sales promotion expenses and accordingly any expense of this nature cannot be disallowed u/s 57(3A).

So far as the first question is concerned the matter is governed by the judgment given in the case of Commissioner of Income Tax, Hyderabad Vs. M/s. P.J. Chemicals Ltd., , wherein the apex court has held as follows (headnote) :

"Where Government subsidy is intended as an incentive to encourage entrepreneurs to move to backward areas and establish industries, the specified percentage of fixed capital cost, which is the basis for determining the subsidy, being only a measure adopted under the scheme to quantify the financial aid, is not a payment, directly or indirectly, to meet any portion of the ''actual cost''. The expression ''actual cost'' in Section 43(1) of the Income Tax Act, 1961, needs to be interpreted liberally. Such a subsidy does not partake of the incidents which attract the conditions for its deductibility from ''actual cost''. The amount of subsidy is not to be deducted from the ''actual cost'' u/s 43(1) for the purpose of calculation of depreciation, etc."

The first question is accordingly, answered in favour of the assessee and against the Revenue.

In respect of the second question it may be observed that the expenditure which is sought to be disallowed u/s 37(3A) is if the expenditure is u/s 37(3B). The first entry in Section 37(3B) refers to advertisement, publicity and sales promotion. If the expenditure is incurred in respect of these three items then Section 37(3A) would be applicable, if the aggregate expenditure is more than the limit specified therein. The word "advertisement, publicity and sales promotion" refers to the activities by which a product is brought in the market and in order to boost the sales, advertisement, publicity or sales promotion campaign is organised. It does not refer to any commission or brokerage which is paid to indenters. The Calcutta High Court in Commissioner of Income Tax Vs. Sutlej Cotton Mills Ltd., , observed that the expenditure incurred as and by way of commission paid to the sales agent and advertisement agents do not attract the disallowance u/s 37(3A) read with Section 37(3B). Such expenditure for maintaining circulation was ordinary selling cost and could not be said to be of the nature provided u/s 37(3A). The Kerala High Court in Commissioner of Income Tax Vs. Veneers and Laminations (India) Ltd., , also held that the commission paid on export sales was not for sales promotion activities and the reference was not even called for. The Madhya Pradesh High Court in Commissioner of Income Tax Vs. Mohd. Ishaque Gulam, , considered that the brokerage and commission paid for selling goods would not come within the mischief of the phrase "advertisement, publicity and sales promotion" as employed in Section 37(3A). The expenditure contemplated u/s 37(3B) which is to be disallowed u/s 37(3A) for advertisement, publicity and sales promotion normally refers to expenditure which is incurred before the sale, so that sales may be increased. If the expenditure is incurred at the time of effecting sales or in connection therewith, then it is purely a selling expenditure. The commission which has been paid to the agents was for the service rendered by them for procuring the orders and not in respect of any publicity, advertisement, etc. The expenditure being in the nature of services rendered for effecting sales could not be considered as pertaining to advertisement, publicity and sales promotion. The decision relied on by learned standing counsel for the department in Smith Kline and French (India) Ltd. Vs. Commissioner of Income Tax, , has no application to the facts of the present case as in that case samples were given free by the drug manufacturer which could obviously be for promotion of the sales and not in respect of the sales which are also effected.

In these circumstances, we are of the view that the Tribunal was not (sic) justified in upholding the decision of the Commissioner of Income Tax (Appeals) deleting the commission and brokerage paid by the assessee to the indenters from the purview of disallowance envisaged u/s 37(3A) of the Income Tax Act

The ITRC stands disposed of with the above observations.