DEPUTY COMMISSIONER OF INCOME TAX v. LYKA LABS LTD
[Citation -2007-LL-1123-6]

Citation 2007-LL-1123-6
Appellant Name DEPUTY COMMISSIONER OF INCOME TAX
Respondent Name LYKA LABS LTD.
Court ITAT
Relevant Act Income-tax
Date of Order 23/11/2007
Assessment Year 1998-99
Judgment View Judgment
Keyword Tags profits and gains of business or profession • mercantile system of accounting • interest on borrowed funds • transfer of capital asset • cash system of accounting • disallowance of interest • rent-free accommodation • lump sum consideration • administrative office • computation of income • interest-free deposit • product manufactured • right to manufacture • goodwill of business • method of accounting • revenue expenditure • cost of acquisition • ad hoc disallowance • allowable deduction • condition precedent • sole selling agent
Bot Summary: 23rd Aug., 2000, asked the assessee to substantiate the above claim and also file the copy of the agreement with US Vitamin Ltd. In response to the same, the assessee submitted the copy of the agreement and also the note for treating the receipt as capital receipt. On reading of the agreement, it was noted by the AO that the consideration of Rs. 6 crores had been received on two accounts Transfer of marketing information and know-how; and Refraining to compete with USV directly or indirectly by not carrying on business of marketing of Nitroglycerine based product, Angispan T R. After going through the agreement and the notes submitted by the assessee, the AO took note of the following facts: The assessee company was engaged in the business of marketing product which is used for the treatment of cardiac disease through its marketing team comprising of nearly 300 medical representatives and 1,000 stockists for t h e last 10 years. The contention of the assessee before the AO was that the above information and data were a self-generated asset with no cost and therefore the amount received by the assessee for giving up such asset was in the nature of capital receipt not chargeable to tax. Further, as per the agreement, the assessee was not the sole selling agent as claimed by the assessee. Ltd. vs. IRC 12 Tax Cases 586, wherein the test laid down was is the transaction in substance a parting by the assessee with part of its properties for a purchase price, or is it a method of trading by which the assessee acquires money as part of its profits and gains of that trade Thus, as per both the decisions, there must be parting of asset for a price in the sense that the transferor cannot make any gain out of the same either forever or for an enduring period. According to him, the sundry debtors had disputed the debit notes of interest issued by the assessee and therefore to avoid the practical difficulties the assessee switched over to cash system of accounting. Where the AO is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-s. or accounting standards as notified under sub-s., have not been regularly followed by the assessee, the AO may make an assessment in the manner provided in s. 144.


These are cross-appeals by assessee as well as Revenue pertaining to asst. yr. 1998-99 which have been heard together and are being disposed of by common order for sake of convenience. Assessee s appeal: first ground raised by assessee in this appeal reads as under: "1.The learned CIT(A) erred in upholding action of AO in considering sum of Rs. 6 crores received from US Vitamins Ltd. in consideration of transfer of marketing information and clinical data and allied rights, and agreeing to refrain from directly or indirectly competing with them, to be in nature of revenue receipt. Briefly stated, facts relating to above issue are these. assessee company is engaged in business of manufacturing of bulk drugs and formulations of pharmaceutical products, which are sold both in domestic and export market. In addition, assessee was also marketing Nitroglycerine based product named Angispan TR , manufactured by another company named Sidmak Laboratories India Ltd. In course of assessment proceedings, it was noticed by AO that there was credit entry of Rs. 6 crores in P&L a/c on account of receipt for transfer of marketing and clinical data and allied rights. In computation of income filed along with return of income, assessee company claimed deduction in respect of above receipt on ground that it was capital receipt not chargeable to tax. In note No. 13 to computation of total income, assessee explained as under: "During year company has entered into agreement with US Vitamin Ltd. company shall not compete with US Vitamin Ltd. directly or indirectly or through it affiliates in promoting, distribution and selling activities of formulation made from bulk drug Nitroglycerine. company has received consideration sum of Rs. 6 crores towards non-compete fees. It is submitted that consideration received in pursuance of agreement in restrict of trade is capital receipt. Therefore, it is excluded from total income. In this connection, company relies on decision of Gillanders Arbuthnot & Co. Ltd. vs. CIT (1964) 53 ITR 283 (SC)." AO, vide letter dt. 23rd Aug., 2000, asked assessee to substantiate above claim and also file copy of agreement with US Vitamin Ltd. (USV). In response to same, assessee submitted copy of agreement and also note for treating receipt as capital receipt. On reading of agreement, it was noted by AO that consideration of Rs. 6 crores had been received on two accounts (i) Transfer of marketing information and know-how; and (ii) Refraining to compete with USV directly or indirectly by not carrying on business of marketing of Nitroglycerine based product, Angispan T R . After going through agreement and notes submitted by assessee, AO took note of following facts: "The assessee company was engaged in business of marketing product which is used for treatment of cardiac disease through its marketing team comprising of nearly 300 medical representatives and 1,000 stockists for t h e last 10 years. assessee company was established player in business of marketing above product i.e. Angispan TR and had specialized knowledge and expertise which was necessary to market and distribute product. assessee company had State-wise database of users such as doctors, hospitals, institutions, which recommended above product. assessee company was in possession of certain clinical data, scientific details, clinical trials, carried on over period of 8 years which had enabled them to develop substantial expertise and consumer information required for distribution of above product. US Vitamins Ltd. i.e. USV is also engaged in business of manufacturing, marketing and distributing various cardiac products and was desirous to expand its market so also market share by expanding its activities in field of Nitroglycerine based formulation. product Angispan TR, as stated above, is also Nitroglycerine based. Hence, vide above agreement dt. 20th Jan., 1998, assessee company under onetime obligation disclosed above scientific and marketing know-how, developed/generated in course of business to USV. In addition to transfer of above know-how, Lyka was also restricted from making available/assigning said information to third party for period of 3 years. Further for period of 5 years Lyka or its affiliates are restricted from competing with USV in sale and distribution of formulations made from Nitroglycerine or having same as its main ingredient." contention of assessee before AO was that above information and data were self-generated asset with no cost and therefore amount received by assessee for giving up such asset was in nature of capital receipt not chargeable to tax. Reliance was placed on Supreme Court judgment in case of CIT vs. B.C. Srinivasa Setty (1981) 21 CTR (SC) 138: (1981) 128 ITR 294 (SC). It was also contended that there was non-compete clause in agreement and therefore consideration for same also amounted to capital receipt in view of Supreme Court judgments in cases of Gillanders Arbuthnot & Co. Ltd. vs. CIT (1964) 53 ITR 283 (SC) and CIT vs. Best & Co. (P) Ltd. (1966) 60 ITR 11 (SC). Reliance was also placed on two judgments of Hon ble Madras High Court in cases of CIT vs. Saraswathi Publicities (1981) 132 ITR 207 (Mad) and CIT vs. Late G.D. Naidu By LRs (1986) 51 CTR (Mad) 256: (1987) 165 ITR 63 (Mad). It was also contended that Board Circular No. 763, dt. 18th Feb., 1998 was not applicable since what assessee had sold was marketing information and know-how and not right to manufacture product or process any article or thing which is covered by circular. According to AO, amount received by assessee constituted revenue receipt for reasons given hereafter: (i) agreement is not for onetime complete transfer of so-called marketing information and know-how, since, imparting of such information and know-how was only for period of 3 years. Similarly, non-compete clause was only for period of 5 years. (ii) trading structure of assessee remained unaffected despite above agreement since, assessee continued to market products manufactured by itself. agreement related to only one item i.e. Angispan TR. other items manufactured by assessee were sold through same trading infrastructure and turnover rather increased from Rs. 131.39 crores in last year to Rs. 139.90 crores during this year. What assessee had lost was profit from marketing of above products for short period of three to five years and not source of income. Hence, consideration received was revenue receipt chargeable to tax and consequently could not be considered as capital receipt. Reliance was placed on judgment of Hon ble Bombay High Court in case of CIT vs. Ralliwolf Ltd. (1983) 32 CTR (Bom) 79: (1983) 143 ITR 720 (Bom) wherein it was held that if imparting of know- how is really in nature of services rendered without anything more, then receipt must be treated as revenue receipt. However, if consideration is received for imparting know-how in association with disposal of capital asset then receipt will be treated as capital receipt. (iii) Since, in present case, supply of information was for short period, it amounted to licence to use information and could not be considered as parting with of any capital asset. Reliance was placed on decision of Bombay High Court in case of CIT vs. Gilbert & Barkar Manufacturing Co. 1977 CTR (Bom) 347: (1978) 111 ITR 529 (Bom) for proposition that if supply of know-how is on licence basis, then receipt would be revenue in nature. (iv) That definition of income in s. 2(24) of IT Act (the Act) is inclusive definition which would include any receipt which can properly be described as income. Reliance was placed on Supreme Court judgment in case of CIT vs. G.R. Karthikeyan (1993) 112 CTR (SC) 302: (1993) 201 ITR 866 (SC). In view of above reasons, it was held by him that sum of Rs. 6 crores received by assessee was revenue receipt chargeable to tax. Accordingly, addition was made. matter was carried in appeal before learned CIT(A) before whom following submissions were made: (i) that marketing information and knowledge developed by assessee during course of its engagements in business, constituted self- generated asset. Therefore, consideration received was capital receipt not chargeable to tax; (ii) even assuming that capital receipt is chargeable to tax under s. 45 of Act under head Capital gains , capital gain cannot be computed inasmuch as no cost was incurred in acquiring such asset as it was self- generated asset and therefore no income can be brought to tax in view of judgment of Hon ble Supreme Court in case of B.C. Srinivasa Setty (supra); (iii) that s. 55(2) of Act was amended so as to tax various capital receipts i.e. receipts on account of goodwill of business, tenancy rights, loom hours, stage carriage permits and right to manufacture produce or process any article or thing. legislature treated cost of acquisition as nil in respect of above items and therefore receipts in respect of above items become chargeable to tax. However, no such amendment was made relating to receipt on account of transfer of marketing information and knowledge and therefore decision of Supreme Court in case of B.C. Srinivasa Setty (supra) still applies. Consequently, no income can be taxed on basis of above judgment. That Circular No. 763, dt. 18th Feb., 1998, is applicable only with reference to right to manufacture produce or process any article or thing and therefore said circular cannot be applied to transfer of marketing information and knowledge; (iv) in support of his submissions, assessee further relied on various Tribunal decisions namely, Jayaprakash Mady vs. ITO (2004) 89 TTJ (Bang) 943: (2001) 79 ITD 1 (Bang), Dy. CIT vs. Chander Mohan (1999) 65 TTJ (Chd)(TM) 240: (2000) 242 ITR 1 (Chd)(TM)(AT) and Balkrishna V. Doshi vs. ITO (1986) 24 TTJ (Ahd) 424: (1986) 15 ITD 262 (Ahd); (v) regarding non-compete clause in agreement it was submitted that n y consideration received on account of non-compete clause is to be considered as capital receipts in view of Supreme Court judgment namely Gillanders Arbuthnot & Co. Ltd. s case (supra) and Best & Co. (P) Ltd s. case (supra) as well as Madras High Court judgment namely Saraswathi Publicities case (supra) and G.D. Naidu case (supra). It was also submitted that case law relied upon by AO were distinguishable on facts. learned CIT(A) was not satisfied with submissions of assessee. According to him, word know-how connotes certain degree of expertise, special skill or invention which is peculiar to person who possesses it. act of marketing product cannot, by any imagination, be called such special skill. It was also noted by learned CIT(A) that assessee was not only selling Angispan TR manufactured by Sidmak Laboratories (India) Ltd., but was also marketing its own products. Further, as per agreement, assessee was not sole selling agent as claimed by assessee. In view of same, learned CIT(A) was of view that amount received could not be considered as capital receipt. It was also observed by him that marketing rights were acquired by assessee in normal course of business with help of its marketing staff and thus expenditure had been incurred in acquiring such rights. Consequently, it would be taxable under head Capital gain even assuming it to be capital receipt. addition made by AO was therefore upheld. Aggrieved by same, assessee is in appeal before Tribunal. learned counsel for assessee has reiterated stand of assessee before AO as well as learned CIT(A) and therefore, same need not be repeated. However, he has also relied on decision of Tribunal in case of PL Chemical Ltd. vs. Asstt. CIT (2004) 86 TTJ (Mad) 745: (2003) 86 ITD 46 (Mad) as well as decision of Calcutta High Court in case of CIT vs. A.S. Wardekar (2005) 199 CTR (Cal) 255: (2006) 283 ITR 432 (Cal). On other hand, learned Departmental Representative has also reiterated reasonings given by AO as well as learned CIT(A) and therefore, same need not be repeated. However, it has been submitted by him that in case of USV, amount paid to assessee has been held to be revenue expenditure by Tribunal. decision of Tribunal in case of USV Ltd. vs. Jt. CIT (2007) 106 TTJ (Mumbai) 535. Rival submissions have been considered carefully in light of material placed before us. question for our consideration relates to nature of receipt in hands of assessee i.e. whether capital or revenue. In order to appreciate controversy, it would be appropriate to refer to terms and conditions set out in agreement between assessee and USV. In our opinion, entire agreement is relevant and therefore, same is being reproduced below: "Agreement This agreement made at Mumbai on 20th Jan., 1998 by and between LYKA Labs Ltd., company incorporated under Companies Act having its registered office at 4801/B and 4802/A, GIDC Industrial Estate, Ankleshwar, Gujarat 393 002 and administrative office at 77, Nehru Road, Vile Parle East, Mumbai 400 099 (hereinafter referred to as LYKA ) (which expression shall unless repugnant to context or meaning thereof, be deemed to include its successors and assignees) of one part; and USV Ltd., company incorporated under Companies Act and having i t s registered office at B.S.D. Marg, Govandi, Mumbai 400 088 (hereinafter referred to as USV ) (which expression shall unless repugnant to context or meaning thereof, be deemed to include its successors and assigns) of other part. Whereas A. LYKA has been engaged inter alia in business of distributing and selling formulations made from bulk drug Nitroglycerine (hereinafter referred to as formulations ); and B. LYKA has invested substantial resources in generating certain market/product related information connected with marketing of formulations which is of vital importance to marketing of products to doctors, institutions etc. so as to answer queries related to both bulk drug/formulations of Nitroglycerine and also to further educate doctors in new developments, side effects, contraindications, etc. of formulations; and C. LYKA is possessed of certain clinical data, scientific details, reports on clinical trials carried on by LYKA in last few years and has also developed substantial expertise in ethical promotion of formulation and is in possession of valuable market information pertaining thereto; and D. USV is also engaged in business of manufacturing, marketing and distributing inter alia various cardiac products and desires to expand its market, increase its market share and expand its activities in field of Nitroglycerine based formulations; and E. At request of USV and for consideration mentioned herein, LYKA h s agreed to provide to USV aforesaid clinical data, scientific details, reports on clinical trials carried on by LYKA in last few years, valuable market information more particularly set out in schedule hereunder written (hereinafter referred to as scientific and marketing know-how); and F. LYKA has represented that it is not restrained under any law or contract to disclose aforesaid clinical data, scientific details, reports on clinical trials carried on by LYKA in past few years and valuable market information. Now this agreement witnesseth and it is hereby agreed by and between parties hereto as under: (1) On or before 28th Feb., 1998 LYKA shall supply and provide to USV clinical data, scientific details, reports on clinical trials carried on by LYKA in past few years, valuable market information more particularly set out in schedule hereunder written (hereinafter referred to as scientific and marketing know-how). (2) In consideration of obligations undertaken by LYKA, USV shall on or before execution of this agreement pay to LYKA sum of Rs. 6,00,00,000 (rupees six crores only) receipt whereof LYKA hereby acknowledges and accepts. (3) obligations undertaken by LYKA hereunder shall not be assigned by LYKA to any third party without prior written consent of USV. (4) LYKA undertakes not to disclose data, details and scientific and marketing know-how referred to herein to any third party for period of at least three years from date hereof. (5) LYKA shall not disclose to any third party any information pertaining to business of USV which comes in its possession in course of discharging its obligations hereunder unless same is in public domain. (6) With view to enable USV to make full use of scientific and marketing know-how to be proved and supplied by LYKA to USV under this agreement, LYKA undertakes, if requested by USV, to assist USV for consideration to be mutually agreed upon. (i) planning campaigns with doctors, cardiologists, institutions; (ii) conducting Continuous Medical Education (CMS), etc.; (iii) devising sampling strategies, promotional schemes for formulations; (iv) conducting market surveys; (v) training medical representatives and other field force of USV engaged in promotion of formulation. (7) USV undertakes to use data, details and scientific and marketing know-how furnished by LYKA hereunder only for its own business and/or business of its affiliates with respect to business activities relating t o formulations and shall not disclose or divulge same to any other person without prior written consent of LYKA. (8) For period of 5 years from date of this agreement LYKA shall not compete with USV directly or indirectly or through its affiliates in promoting, distribution and selling activities of formulations made from bulk drug Nitroglycerine i.e. formulations whose major ingredient is bulk drug, Nitroglycerine. Schedule referred to above Scientific and marketing know-how (a) Clinical data, scientific details and reports on clinical trails carried out by LYKA in respect of formulations based on bulk drug Nitroglycerine. (b) Source of manufacture of formulations from bulk drug Nitroglycerine. (c) Break-up of State-wise list of wholesalers, stockists and dealers of formulations. (d) Break-up of State-wise sales of formulations for last 5 years. (e) Break-up of State-wise list of specialists, doctors, cardiologists and institutions as shortlisted by LYKA with respect to formulations referred to in above agreement. (f) Visual aid designs, copies of promotional material used. Sd/- (Mr. N.I. Gandhi for Lyka Labs Ltd.) Sd/- (Mr. P.K. Tewari for USV Ltd.)" perusal of above agreement reveals following facts and obligations: (1) that assessee had been in business of distribution and selling formulation made from bulk drug Nitroglycerine, apart from manufacturing of drugs manufactured by it. (2) in course of its business, it acquired certain information relating to formulation made from bulk drug Nitroglycerine. (3) assessee agreed to provide certain marketing information relating to such formulations which are mentioned in schedule to agreement as well as not to compete with USV directly or indirectly in promoting, distribution and selling activities of such formulation against consideration of Rs. 6 crores. (4) assessee undertook not to disclose such information to any third party for period of three years from date of agreement. obligation regarding non-compete was for period of five years. Considering agreement as whole, it is found that consideration received by assessee is on two accounts (i) for transferring marketing information relating to formulation made from bulk Nitroglycerine and (ii) for not competing with USV in promoting, distributing and selling activities of such formulation for period specified therein. consideration received was composite one and no apportionment was made in respect of above activities. First, we take up issue relating to transfer of information regarding Nitroglycerine based formulation. There is no dispute that assessee had been in business of manufacturing of various drugs and formulations and sale thereof as well as marketing of Nitroglycerine based formulation known as Angispan TR manufactured by Sidmak Laboratories India Ltd. Further, it had huge distribution network for marketing its own manufactured product as well as product manufactured by other parties. In course of such business, it came to possess certain marketing information relating to Nitroglycerine based formulation. USV was manufacturer of Nitroglycerine based formulation, who intended to market its product in India. To facilitate its marketing process, it entered into agreement with assessee to procure certain information relating to Nitroglycerine based formulations subject to obligation of assessee mentioned in agreement. On these facts, question is whether there is transfer of capital asset so as to treat consideration as capital receipt? In our opinion, there is no transfer of capital asset for reasons given hereafter and therefore consideration relatable to imparting of information by assessee cannot be considered as capital receipt. There is no hard and fast rule to determine character of receipt. It would depend on facts of each case. nomenclature given to transaction by parties is also not relevant. true nature of transaction has to be ascertained from covenants of contract [National Cement Mines Industries Ltd. vs. CIT (1961) 42 ITR 69 (SC)]. receipt can be said to be capital when it is relatable to transfer of capital asset other than stock-in-trade. capital asset may be tangible or intangible. In case of tangible asset, asset must be physically transferred from one person to other person. Dispossession of asset from transferor is condition precedent. Such transfer may be once for all by way of sale or may be for enduring period. What would be enduring period would depend on facts of each case. On other hand, in case of intangible asset, possession may continue to remain with transferor such as know-how, expertise, invention, formulation etc. question arises as to when such asset can be said to be transferred so as to treat consideration relating to such asset as capital receipt. In our opinion, unless transferor is restrained to use such intangible asset as well as to transfer to other parties, consideration received cannot be treated as capital asset. For example, if assessee has made invention and same is transferred to another party for consideration but reserves his right to sell same to other parties or is not prohibited from selling to others, then it cannot be said that capital asset has been transferred since possession of same continues with assessee transferor and same can be sold to as many persons as he wants. In such cases, money is received without disposing of intangible asset and therefore, in our opinion, it would be case of revenue receipt. On other hand, if assessee transfers such intangible asset once for all to exclusion of others and assessee is also prohibited to use same, then it would be case of transfer of capital asset and consideration would be capital receipt. dispossession of asset in manner mentioned above, in our opinion, is condition precedent for constituting receipt as capital receipt. Reliance can be placed on judgment of House of Lords in case of Rolls Royce Ltd. vs. Jeffrey (Inspector of Taxes) (1965) 56 ITR 580 (HL). In that case, assessee possessed technical knowledge/know-how. same were sold to various parties. question arose whether consideration received by assessee was capital or revenue receipt. Court held that assessee was not parting with its asset but was trading in them. Hence,the receipt was held to be revenue receipt. Reliance can also be placed on judgment in case of British Dye Stuffs Corpn. (Black Lay) Ltd. vs. IRC 12 Tax Cases 586, wherein test laid down was is transaction in substance parting by assessee with part of its properties for purchase price, or is it method of trading by which assessee acquires money as part of its profits and gains of that trade ? Thus, as per both decisions, there must be parting of asset for price in sense that transferor cannot make any gain out of same either forever or for enduring period. Before adverting to facts of present case, it would also be useful to refer to judgment of Supreme Court in case of CIT vs. Chari & Chari Ltd. (1965) 57 ITR 400 (SC), wherein it has been held that compensation paid for cancellation of contract is normally capital receipt but if such payment does not affect trading or profit making structure of assessee s business nor deprives him of source of income, then it would be revenue receipt. Now, coming to facts of case, we find that assessee has simply parted with information regarding its marketing structure such as list of wholesellers, stockists and dealers of formulations, State-wise sales figures of such formulation for last 5 years, list of specialists, doctors, cardiologists and institutions, who recommend such formulation, promotional materials and clinical data as is apparent from schedule to agreement. Even after imparting such information, it always remained with assessee company. marketing structure of assessee remained intact. only obligation of assessee is that it shall not disclose such information to other parties for period of 3 years. Further, assessee is not restrained from using this information for marketing its own manufactured goods or goods manufactured by other companies. Further, assessee can provide such information to other parties after 3 years. This shows that assessee has simply allowed aforesaid information to be used by other party for period of 3 years. There is no parting of information either forever or for enduring period. Thus, considering case law mentioned by us, it has to be held that neither assessee has parted with information nor marketing structure of assessee has been impaired. information nor marketing structure of assessee has been impaired. Hence, consideration relatable to this part of agreement has to be held as revenue receipt. decisions relied upon by learned counsel for assessee are quite distinguishable. In case of Jayaprakash Mady (supra), know-how was sold by assessee for all times to come for lump sum consideration and assessee was not entitled to sell same to others. Then, in that case, there was complete sale of know-how and assessee could not either use or sell t o others while in present case, assessee had simply passed information for period of three years and assessee was not prohibited to use same in its own marketing business and further could transfer same after 3 years. Hence, that decision is quite distinguishable. decision of Tribunal in case of Balkrishna V. Doshi (supra) is not applicable since in that case question was whether there was any cost for acquiring know-how. This decision would be applicable only when it is held that there is transfer of capital asset. Since in present case, it has been held that there is no transfer of capital asset, that decision is inapplicable. For similar reasons, decision of Tribunal in case of Chander Mohan (supra) cannot be applied to facts of present case. Moreover, in that case, it was sale of patent which is not case before us. In view of above discussions, it is held that imparting of information relating to marketing of Nitroglycerine formulation for period of 3 years did not amount to transfer of capital asset and on contrary it was case where assessee allowed other party to use information for period of 3 years without affecting trading/marketing structure of assessee. Hence, payment allocable to such business of imparting of information amounted to revenue receipt chargeable to tax. other contentions by assessee s counsel are therefore no more relevant. order of learned CIT(A) on this aspect of issue is therefore upheld. As far as other aspect of issue is considered, we are in agreement with contention of assessee s counsel that payment relatable to non-compete covenant amounts to capital receipt in view of Supreme Court judgment in case of Gillanders Arbuthnot & Co. Ltd. (supra) as well as various other decisions of Tribunal. There is no dispute that assessee was marketing Angispan TR Nitroglycerine formulation for various years. USV wanted to enter market in respect of its own formulation and therefore intended to avoid competition. Hence, there was loss of source of income for period of 5 years. Thus, in our opinion, receipt was capital receipt not chargeable to tax. order of learned CIT(A) is therefore set aside on this aspect of issue. Since payment received is composite one and part of same has b e e n found to be revenue receipt, receipt has to be bifurcated and apportioned. In absence of any material on aspect of valuation, we think it appropriate to remit matter to file of AO for adjudication of issue of valuation of non-compete fee and then tax amount relatable to imparting of information relating to marketing of Nitroglycerine formulation. Ground No. 2 relates to addition of Rs. 1,70,22,528 on account of interest on overdue sundry debtors. Briefly stated, facts are that assessee was consistently declaring income on account of interest on overdue sundry debtors in past after following mercantile system of accounting. In year under consideration, assessee decided to recognize interest income on accrual basis upto June, 1997 and thereafter on receipt basis. note was appended to statement of accounts in this regard wherein, sum of Rs. 47,86,703 was shown as interest income on accrual basis and for remaining period interest income was to be shown on receipt basis. Thus, there was loss of Rs. 1,70,22,528 on account of not showing interest income on accrued basis in respect of three parties as under: Antibiotics Stores Ltd. Rs. 1,07,98,248 Pharmawell Center Rs. 27,74,156 Krishna Sales Corporation Rs. 33,59,081 Miscellaneous parties Rs. 91,043 Miscellaneous parties Rs. 91,043 Rs. 1,70,22,528 explanation before AO was that debtors had disputed debit notes which had remained unsettled and therefore, as prudent accounting system, income was being switched over from mercantile system to receipt basis. However, AO was not satisfied with explanation of assessee since income should have been declared on accrual basis as assessee was following mercantile system of accounting. Consequently, addition of Rs. 1,70,22,528 was made by AO. matter was carried in appeal before learned CIT(A) before whom it was contended that choice of system of accounting to be followed is with assessee provided it is consistently followed. Further, it was contended that change in method of accounting is permissible if it is for bona fide reasons. reliance was placed on Bombay High Court judgment in case of CIT vs. Citibank N.A. (1994) 119 CTR (Bom) 383: (1994) 208 ITR 930 (Bom) for proposition that hybrid system of accounting can also be followed. Reliance was also placed on Supreme Court judgment in case of UCO Bank vs. CIT (1999) 154 CTR (SC) 88: (1999) 237 ITR 889 (SC) for proposition that in case of sticky loans, assessee is permitted to change method of accounting from accrual to cash basis. Certain other decisions were also relied on, which are mentioned in order of learned CIT(A). learned CIT(A) found that income on accrual basis was not booked b y assessee since concerned parties had not accepted claims and therefore method of accounting was changed from mercantile to receipt basis. It was also seen by learned CIT(A) that objection of AO related to change in method of accounting which was not consistent. It was also found by learned CIT(A) that assessee was claiming deduction in respect of interest paid on accrual basis by following mercantile system of accounting but method was changed only in respect of interest income from sundry debtors. learned CIT(A) also took note of amendment made in s. 145 of Act, which was effective from 1st April, 1997 i.e., asst. yr. 1997-98. According to amended provisions of s. 145, assessee either could follow mercantile system or receipt system and no other method was permissible. This amendment was brought to nullify hybrid system of accounting. Therefore, applying amended provisions, learned CIT(A) held that assessee could not follow different methods, i.e., mercantile system in respect of interest paid and cash system in respect of interest to be received. Therefore, interest income was chargeable to tax on accrual basis since assessee was following mercantile system of accounting for all other purposes. It was also observed by him that assessee can claim such income as bad debt in subsequent years on account of non-recovery. Aggrieved by same, assessee is in appeal before Tribunal. Both parties have been heard. contention of learned counsel for assessee remains same as contended before learned CIT(A). According to him, sundry debtors had disputed debit notes of interest issued by assessee and therefore to avoid practical difficulties assessee switched over to cash system of accounting. Since change in method of accounting was bona fide and followed consistently, it was contended that addition was not justified. Reliance was also placed on judgments cited before learned CIT(A). On other hand, learned Departmental Representative has relied upon order of learned CIT(A). After hearing both parties, we do not find merit in ground raised by assessee on this issue. submissions made by learned counsel for assessee were relevant only to pre-amended provisions. There is no dispute that prior to asst. yr. 1997-98, hybrid system of accounting was held to be permissible by Hon ble Bombay High Court in case of Citibank N.A. (supra). In view of that judgment, assessee could follow mercantile system of accounting in respect of interest liability and cash system of accounting in respect of interest income. legislature perhaps found difficulty in accepting such system of accounting as it would depict distorted picture of income of assessee. Accordingly, legislature made amendment by substituting old provisions of s. 145. amended provisions effective from 1st April, 1997 i.e., from asst. yr. 1997-98 read as under: "145. (1) Income chargeable under head Profits and gains of business or profession or Income from other sources shall, subject to provisions of sub-s. (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by assessee. (2) Central Government may notify in Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income. (3) Where AO is not satisfied about correctness or completeness of accounts of assessee, or where method of accounting provided in sub-s. (1) or accounting standards as notified under sub-s. (2), have not been regularly followed by assessee, AO may make assessment in manner provided in s. 144." bare reading of above provisions makes it clear that from asst. yr. 1997-98, assessee was permitted to follow either cash system of accounting or mercantile system of accounting. No third method is permissible as per amended provisions. Such amended provisions nullify effect of judgment of Hon ble Bombay High Court in case of Citibank N.A. (supra). learned CIT(A) has found as fact that assessee was claiming deduction on account of interest on basis of mercantile system of accounting. Even otherwise, assessee was following mercantile system of accounting in past. Therefore, switching over to cash system of accounting only in respect of interest income is not permissible in view of amended provisions. Perhaps, one can contend successfully that assessee is permitted to change method of accounting either from mercantile to cash system or vice versa for bona fide reasons. But, in our opinion, assessee cannot be permitted to contend that part of income can be booked on mercantile basis while other part of income on cash system of accounting. Therefore, considering amended provisions of s. 145, we do not find any merit in ground raised by assessee on this issue. order of learned CIT(A) is therefore upheld on this issue. Ground No. 3 raised by assessee reads as under: "3. learned CIT(A) erred in confirming addition of Rs. 13,50,000 being interest @ 18 per cent on deposit of Rs. 45,00,000 (out of total deposit of Rs. 75,00,000) being deposit kept with director for providing him rent-free accommodation as per terms of his appointment." Briefly stated, facts are that assessee had given interest-free deposits of Rs. 75 lakhs to Mr. N.I. Gandhi, managing director of company. AO noticed that assessee had paid interest of Rs. 11.56 crores (approx.) on borrowed funds. assessee was asked why interest relatable to above deposit should not be allowed. assessee vide letter dt. 9th Jan., 2001 submitted that as per agreement with managing director, it was obligatory for assessee to provide housing accommodation. Since managing director had his personal accommodation at 3-C, Ridge Apartment, B.G. Kher Marg, Malabar Hill, Mumbai-400036, same was taken on rent by company and in turn it was provided to managing director for his accommodation. special resolution was also passed by general body meeting. It was also submitted that if company had arranged for any other accommodation for managing director, then it would have been necessary to keep security deposit with landlord and therefore going by market practice and considering locality, interest-free deposit was given to managing director. Thus, said deposit was given wholly and exclusively for purpose of business and consequently, interest paid by assessee was allowable deduction under s. 36(1)(iii) of Act. On appeal, learned CIT(A) following his earlier order for asst. yr. 1997-98, confirmed disallowance but on quantification it was held that deposit to extent of Rs. 30 lakhs was reasonable and consequently disallowance was rejected with reference to balance amount of Rs. 45 lakhs. Still aggrieved, assessee is in further appeal before Tribunal. After hearing both parties, we find that this issue is now covered in favour of assessee by decision of Tribunal in assessee s own case for asst. yr. 1997-98 in ITA No. 1596/Mum/2001. said decision has been further followed by Tribunal in assessee s own case pertaining to asst. yr. 1999-2000 copy of which is placed on record. Following same, issue is decided in favour of assessee. Order of learned CIT(A) is therefore modified and entire disallowance sustained by him is deleted. Departmental appeal first ground relates to disallowance of interest of Rs. 3,07,589. Briefly stated, facts are that assessee had acquired property at Marol against consideration of Rs. 61,68,688 for setting up administrative and distribution office out of borrowed funds. interest on borrowed funds amounted to Rs. 3,07,589 which was capitalized. However, while computing income, interest paid was claimed as deduction under s. 36(1)(iii) of Act. AO disallowed same on ground that such interest was capitalized by assessee itself and therefore would form part of actual cost of property. On appeal, learned CIT(A) held, following his earlier order for asst. yr. 1997- 98, that claim of assessee could not be disallowed merely because expenditure was capitalized. If expenditure is of revenue nature, then it was allowable deduction under s. 36(1)(iii) of Act. Aggrieved by same, Revenue is in appeal before Tribunal. After hearing both parties, we find that this issue is covered in favour of assessee by Tribunal (vide its order) dt. 22nd Jan., 2007 in assessee s own case for asst. yr. 1997-98, wherein it has been held that interest payment was allowable deduction under s. 36(1)(iii). Since facts are identical, said decision would apply to present case. Following same, order of learned CIT(A) is upheld on this issue. next and last issue relates to ad hoc disallowance of Rs. 2,00,000 out of miscellaneous expenses. This ad hoc disallowance has been made by AO out of total expenditure of Rs. 5,35,969. learned CIT(A) has deleted ad hoc addition since no defect has been pointed out by AO, and on contrary, books of account were duly audited. After hearing both parties, we do not find any infirmity in orders of learned CIT(A) on this issue. In result, appeal of assessee is partly allowed while appeal of Revenue is dismissed. *** DEPUTY COMMISSIONER OF INCOME TAX v. LYKA LABS LTD.
Report Error