FIRST Income Tax OFFICER vs KANTILAL MANILAL and CO.

Per M. A. Ajinkya, Accountant Member - This is an appeal by the department against the order of the CIT (Appeals) dated 2-11-1985 directing the ITO to allow the assessees claim for a sum of Rs. 47,49,530 as loss on account of its transaction with M/s. Madura Coats Ltd.

Certain relevant facts may briefly be stated. The assessee is a registered firm. Its accounting year for the year under appeal is S. Y. 2037. In the course of assessment proceedings. It claimed deduction of certain amounts on the ground that the assessee was required to import pharmaceuticals and chemical items and had incurred certain expenses in the process of importing such pharmaceuticals and chemicals. It would appear that the assessee had obtained licences of the value of Rs. 58,74,665 from a company called M/s. Madura Coats Ltd. (hereinafter referred to as the limited company) by paying a guarantee margin of profit amounting to Rs. 17,62,399. The said limited company had issued a letter of authority in favour of the assessee to permit the assessee to import drugs and liquid paraffin. On the strength of such letter of authority the assessee had placed necessary orders with the suppliers abroad for import of goods. In the meantime, the Chief Controller of Imports & Exports orders that there was a possibility that the import licence were forged. This authority, therefore, confiscated the goods and initiated enquiry. The assessee filed an application in the Bombay High Court, obtained an interim stay against the customs authorities, got some of the goods released against the bank guarantee and incurred considerable expenses. The assessee claimed before the ITO that the amount paid by way of guaranteed margin of profit to the limited company and other expenses incurred should be allowed as a loss in the year of account. The ITO rejected this claim on the ground that the transaction was not reflected in the assessees trading and profit and loss account, only the account of the limited company was reflected in the balance-sheet, the matter was pending in the court and the transaction could not be said to have been completed and, therefore, the question of allowance of loss during the year did not arise. In this view of the matter, the ITO rejected the entire claim.

Before the CIT (Appeals), the assessee claimed the loss of Rs. 47,49,530 in respect of two transactions. The details of this loss as given by the CIT (Appeals) in paragraph 12 of his order are as under :

(a) Drug import

Asst. Year

Expenditure

Narration

1981-82

14,75,621

Amount paid as guaranteed margin of profit.

1982-83

26,36,555

Bank charges for documents pertaining to specified drugs including opening of letters credit, clearing charges, customs duty, warehousing charges, etc.

1983-84

2,226

Warehousing charges and legal fees.

41,14,402

(b) Liquid paraffin import

1981-82

2,97,383

Guaranteed margin of profit

1982-83

3,37,745

Opening of Letters of Credit and charges paid to the Bank

6,35,128

It was the case of the assessee before the CIT (Appeals) that this sum represented expenditure incurred by the assessee in connection with its business. The assessee would have to bear this loss in any event when the decision is taken by the Court. It had filed an irrevocable bond with the Government. The CIT (Appeals) allowed this claim by observing that import of goods under a recognised licence was a part and parcel of the assessees business. It was an admitted fact that the payments, as per the details given above, had actually been made by the assessee and therefore, constituted an outgoing with regard to the imports undertaken by it under this licence. The learned CIT (Appeals) has apparently absolved the assessee of any irregularity on this issue. He observed that the fact that the assessee had filed a suit against the limited company was indicative of the assessees bona fides. On the other hand, the ITO, had not brought on record any independent evidence. This transaction was taken with the limited company at arms length. The ITO had erroneously denied the claim of the assessees claim for deduction shall be allowed. It is against this finding of the CIT (Appeals) that the present appeal by the departmental is filed.

Shri R. Raju, the learned Departmental Representative, argued that the claim for deduction was premature, the transaction was not complete, the sale of the goods had not been effected and therefore, it was not possible to determine the margin of profit on these sales. The case filed by the assessee against the limited company was still pending before the High Court. It was not clear as to who had forged the documents constituting import licences.

Therefore, the CIT (Appeals) was not justified in allowing the assessees claim for deduction.

Shri Dastur for the assessee that this is not a case where the deduction is claimed on account of penalty. The assessee had opened the Letter of Credit for clearing the goods on the basis of import licences which it believed or had reason to believe to be bona fide and genuine import licences. It had paid an amount of Rs. 17,73,004 as mentioned in the letter of authority issued by the limited company and, therefore, what was claimed by way of deduction was an amount which had been therefore, justified in the decision that he took.

We have considered the submissions made by both sides and have gone through the three paper books filed. Certain relevant facts need to be restated. The limited company wrote two letters to the assessee-company on 29-9-1980 in both of which reference was made to the letter of authority given by it to the assessee on 29-9-1980. In the first of such letters, the limited company stated, inter alia, as under :

"In this connection, we also confirm that the ownership of the goods imported by you against the above licences will rest with you. However, this is conditional to your payment to us of Rs. 2,95,845 as per Debit Note referred hereinabove.

We authorise M/s. Kantilal Manilal & Company to dispose of the imported items/consignments to the Actual Users, issue the bills. Receive payments from them, deal with the Customs and any other authorities, made payments of the foreign bills, customs duties, etc., and clear the consignments, store the same with them and deal with any other matter in the manner they deem fit. After disposal of the imported items/consignments M/s. Kantilal Manilal & Co. will provide us the photostat copy of the Industrial Certificate/Licence issued by the Director of Industries, or the DGTO or any other Industrial Licencing Authority from each of the Actual Users to whom the imported items/consignments will be disposed of and also photostat of the receipted Delivery-Challan from each of the Buyers (the Actual Users). The photostat of triplicate copy of the Bill of Entry is to be forwarded to us by M/s. Kantilal Manilal & Company for each consignment imported, after the clearance of the same. We have no claim of any nature whatsoever on giving L/A to M/s. Kantilal Manilal & Company."

In another letter of the same date, the limited company called upon the assessee firm to make a payment of Rs. 14,66,554 as compensation for two licences. Thus in terms of these two letters, the limited company demanded a total amount of Rs. 17,62,399 as compensation for utilisation of the import licences held by it. The Dy. Chief Controller of Imports & Exports, by his two different orders dated 15-1-1981, cancelled the licence dated 1-11-1978 and the additional licence dated 14-12-1979. Similar order were passed by the same authority on 31-1-1981 and 7-2-1981 cancelling several other licences issued to the limited company and given by them under a letter of authority to the assessee for exploitation. Copies of these orders have been filed. The assessee by its letter dated 6-8-1981 addressed to the Secretary, Ministry of Finance and other connected authorities like the Dy. Chief Controller of Imports & Exports, Collector of Customs, etc., called upon them to withdraw and/or cancel the orders cancelling the aforementioned licences and to release the goods seized under the various seizure memos and permit it to clear the consignment of drugs and other goods. In the meantime, the assessee filed a Writ Petition against the Union of India and others and an order on the said Writ Petition being Writ Petition No. 1131/1981 was made by the High Court of Judicature at Bombay on 29-11-1984. In this Writ Petition, the limited company was entered in as the fifth respondent. The Court held that the petitioners (the assessee herein) were not served with any notice to show cause and that the orders were passed by the Dy. Chief Controller of Imports & Exports without hearing them. The Court discussed some of the provisions of the Imports & Exports (Control) Act, 1947 and section 147 of the Customs Act, 1962 and observed that these provisions sufficiently indicate that considerable and adverse civil consequences could result to the letter of authority holder by cancellation of the import licence in respect of which the authority has been given to him. It consequently quashed the two orders dated 15-1-1981 and the orders dated 31-1-1981 and 7-2-1981 passed by the Cy. Chief Controller of Imports & Exports. It appears that on the basis of an interim order dated 15-10-1981, the drugs had been cleared upon the petitioners furnishing bank guarantee. In the present order, the Court did not discharge the bank guarantee, but kept it alive until the Dy. Chief Controller of Imports & Exports decides whether or not the licences should be cancelled. On these facts Shri Dastur argued that the assessee had done all that it could to correct the situation arising out of the cancellation of import licences. The goods that the assessee expected to import by full exploitation of these licences could not be imported. The entire transaction had been arrested consequent to the confiscation of goods by the customs authorities and that what was paid by the assessee for getting the right to exploit the licence and consequently to import the drugs in the process of exploitation of such licences was a commercial outgoing, which was rightly allowed by the CIT (Appeals).

Shri Raju, on the other hand, argued that the claim for deduction on account of these expenses was premature, the licences had not been fully exploited, the goods were seized, a bank guarantee was furnished, the seized goods were yet to be auctioned and therefore, the claim for deduction of expenses made by the assessees and allowed by the CIT (Appeals) was a premature claim.

We have considered the submissions made on behalf of both the parties. In the course of the hearing, the Bench put certain queries about the manner in which the goods imported by the assessee-firm prior to the confiscation of the licences were utilised. It transpired in the course of the queries raised in this behalf that the assessee would sell the goods so imported and credit the sale proceeds to the account of the limited company, who had got the licences in its hand and made over the same to the assessee under a letter of authority for exploitation. Such sale proceeds were not credited to the trading account. On being questioned as to why this procedure was followed by the assessee, Shri Dastur explained that this was the normal system of accounting followed by the assessee. In support of this argument, he failed a copy of the M/s. Pacific Exports to show that all expenses inclusive of guaranteed profit and those required to be incurred for retirement of documents, customs duty, etc., were debited to the account of the limited company, which gave the letter of authority to the assessee for exploitation of the licences held by it and the sale proceeds realised on the sale of such imported goods were credited to the same account and the difference between the credit and debit was shown as profit or loss when the transaction was complete. When asked as to why in the present case while making the claim for deduction of losses the fact that goods, which were imported, were sold and the further fact that the sale proceeds were credited to the account of the limited company, was not brought to the notice of the revenue authorities. Shri Dastur argued that this transaction had interrupted consequent to the confiscation of the licences, institution of legal proceedings, the order by the court in a Writ Petition, and, therefore, it was not possible to arrive at the difference between the sale proceeds realised and the expenses incurred.

We have carefully considered the submissions made by Shri Dastur. In our opinion, the assessee has not been quite consistent in its conduct. Whereas on the one hand it has claimed deduction of amounts like guaranteed profit, expenses in the course of import of goods, it has chosen not to adjust the sale proceeds realised on sale of goods, which were imported till the point of time the licences were seized and cancelled. On further enquiries from the Bench it transpired that the assessee had realised goods worth Rs. 20,11,243 in one accounting year and goods worth Rs. 8,17,548 in another accounting year and had credited such sale proceeds to the account of the limited company. At our instance copy of such account has been filed and put on record. Therefore, it would appear that the assessee has realised by way of sale proceeds a total sum of Rs. 28,28,791 which fact has not been noticed either by the ITO or by the CIT (Appeals) but came to light in the course of the hearing before us on queries put by the Bench. Therefore, the claim for deduction in respect of these transactions, if at all admissible, can be only to the extent of Rs. 19,20,237, which would be the difference between the amount actually claimed by the assessee and the sale proceeds of Rs. 28,28,791 realised by the assessee and not adjusted against the expenses incurred. Therefore, at best, the assessee can get deduction only of an amount of Rs. 19,20,237. In view of what has been stated above, in our opinion, the CIT (Appeals) has grievously erred in allowing the assessees appeal and directing the ITO to allow the entire claim of Rs. 47,49,530 without looking into the facts which have been discussed above. At best, the assessees claim for deduction can be restricted to Rs. 19,20,237. We, however, find that the ITO had not the occasion to look into the manner of accounting and particularly examining the accounts of the limited company filed before us. We also find that the nature of transaction is such that the assessee may still realise a certain amount on sale of confiscated goods. Shri Dastur, of course, was fair enough to point out that the assessee face the prospect of being saddled with a liability for penalty for importing goods under a forged document. On these facts, we would make the following order :

(i) The claim of the assessee for deduction during the year should be restricted to Rs. 19,20,237 subject to verification of the account of the limited company, viz., M/s. Madura Coats Ltd. For ascertainment of the exact amount of sale proceeds realised on sale of imported goods :

(ii) Any reduction in the liability in this behalf consequent to the outcome of the litigation would be assessable at usual rate as provided u/s 41(1); and

(iii) Any future liability on account of penalty, if any, etc., which may arise to the assessee on the outcome of the litigation would be admissible on examination of the case on merits in the year in which such liability arises.

Subject to the above remarks, this appeal by the department will be treated as allowed in part.