Madras H.C : The provisions of s. 40(c)(ii) and not s. 40A(5) should be applied in allowing the deduction in respect of salary, perquisites, etc., made to the managing director

High Court Of Madras

CIT vs. Premier Cotton Mills Ltd.

Sections 40(c), 40A(5), 80J

Asst. Years 1979-80, 1980-81, 1981-82

R. Jayasimha Babu & Mrs. A. Subbulakshmy, JJ.

Tax Case Nos. 394 to 397 of 1992

19th February, 1999

Counsel Appeared

S.V. Subramaniam for Ms. Chitra Venkataraman, for the Applicant : G. Sarangan for Srinath Sridevan, for the Respondent.

ORDER

R. JAYASIMHA BABU, J. :

Two questions have been referred to us at the instance of the Revenue. The first relates to the asst. yr. 1979-80 while the second question relates to the asst. yrs. 1980-81 and 1981-82. The two questions are :

“(1) Whether, on the facts and in the circumstances of the case, the Tribunal is right in holding that the provisions of s. 40(c)(ii) and not s. 40A(5) should be applied in allowing the deduction in respect of salary, perquisites, etc., made to the managing director ?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in confirming the orders of the CIT(A) by holding that the assessee would be entitled to a deduction under s. 80J for the asst. yrs. 1981-82 and 1980-81 ?”

So far as the first question is concerned we may straightway refer to the decision of the Supreme Court in the case of CIT vs. Indian Engineering & Commercial Corporation (P) Ltd. (1993) 112 CTR (SC) 56 : (1993) 201 ITR 723 (SC) : TC 18R.587. It was held by the Supreme Court in that case that both ss. 40(c) and 40A(5) of the IT Act apply to employees who also happen to be directors and that “In the case of directors who are also employees. both the provisions will be attracted—the higher of the two ceilings has to be applied.”

The first question refers to the salary, perquisites paid to the managing director. It is not in dispute that the managing director is also an employee as though he is a director of the company, he receives salary from the company and also enjoys the perquisites given to him by the company after the company had secured the approval required under the Companies Act for paying the salaries and perquisites for managing director.

The Tribunal was not right in holding that s. 40A(5) of the Act is not applicable to the managing director. As observed by the Supreme Court both ss. 40(c) and 40A(5) of the Act apply to the employees-directors, the higher of the two ceilings mentioned in those provisions being applicable to such employees-directors. We, therefore, while answering the first question in the negative, direct the AO to recompute the extent of deduction to be made after applying the ratio of the decision of the Supreme Court rendered in the case of CIT vs. Indian Engineering & Commercial Corporation (P) Ltd. (supra).

The second question concerns the extent of the assessee’s entitlement to claim deduction under s. 80J of the Act for the two asst. yrs. 1980-81 and 1981-82. The assessee made the claim for such deduction on the ground that the assessee had completed substantial expansion of spindles by the asst. yrs. 1980-81 and 1981-82 and that the assessee was entitled to the benefit of the deduction under s. 80J of the Act for a period of five years commencing from 1980-81. The assessee’s claim was that it had by July, 1981, increased its capacity from 32,400 to 50,200 spindles and that increase in capacity was by way of substantial expansion of its production facilities, that it had erected separate sheds; had installed carding room, had constructed godowns; and all those facilities taken together would show that a new production unit has been brought into existence though that was done by way of substantial expansion.

The assessee had relied on the fact that it had obtained on industrial licence in the year 1975 for such substantial expansion and it had completed that programme of substantial expansion by July, 1981. The assessee-company was established in the year 1960. It had installed capacity of 29,892 spindles by 31st March, 1977, which went up to 50,000 spindles by July, 1981.

The ITO rejected the assessee’s claim only on the ground that substantial expansion did not amount to the establishment of a new industrial undertaking and that unless a new industrial undertaking was established, the deduction under s. 80J of the Act could not be granted. The assessee’s appeal against the orders of the ITO having been allowed by the appellate authority, the Revenue took up the matter in further appeal to the Tribunal. The Tribunal in the course of its order passed on those appeals has recorded its finding with regard to the expansion so effected by the assessee : “In this case there is no dispute that the assessee had substantially increased the capacity, separate factory buildings have been erected, new plant and machinery had been purchased and installed and new facility like godown, etc. including a carding room have been found installed and the entire expansion is an independent unit and capable of functioning as such.” There is no dispute regarding the correctness of that finding of the Tribunal.

8. We have to consider the arguments advanced by the learned counsel for the Revenue in the background of that finding of the Tribunal. It was contended by the learned senior counsel for the Revenue Mr. S.V. Subramanian that s. 80J of the Act cannot at all be invoked by the assessee which had not established new industrial undertaking and that the scope of s. 80J of the Act is limited to new industrial undertaking and does not extend to expansion of existing undertakings. The further submission was that as the expansion was not accomplished within a single year, but was spread over a longer period of time additional spindlage having been added over a period of five years, the benefit if any, found to be permissible under s. 80J of the Act could only be confined to the spindlage added in the previous year relevant to the assessment year.

Mr. Sarangan, learned senior counsel for the assessee, on the other hand, submitted that if such a restrictive view was taken of s. 80J of the Act, it would defeat the purpose of the statutory provision which was placed on the statute book with the avowed object of encouraging economic growth by offering incentives by way of the deductions under that provision for installing new production facilities for the manufacture of goods and articles. The purpose of the section is to help bring into existence additional production capacity by the installation of new production facilities. The test to be applied is not as to whether the production facility is an independent undertaking or an addition to an existing undertaking. If the production facility is newly installed whether independently or as addition or by way of expansion existing facility to the extent such addition or expansion is capable of being regarded as industrial undertaking and goods and articles are manufactured with the aid of the newly installed machineries such expansion would qualify for the benefits under s. 80J of the Act. Having considered the matter in the light of the provisions of the statute, the purpose for which the provision was enacted and the decisions of the Supreme Court to which our attention was invited, we are of the view that the submissions made for the assessee merit acceptance.

In s. 80J of the Act, before it was omitted by the Finance (No. 2) Act, 1996 w.e.f. 1st April, 1989, provided for deduction in respect of profits and gains from newly established industrial undertakings or ships or hotel business in certain cases. Though the heading of the section refers to newly established industrial undertakings, in the body of the section, there is no requirement that the undertaking should be ‘new’. Sub-s. (4) of 80J provides : “(4) This section applies to any industrial undertaking which fulfils all the following conditions, namely : (i) it is not formed by the splitting up, or the reconstruction, of a business already in existence; (ii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose; (iii) it manufactures or produces articles, or operates one or more cold storage plant or plants, in any part of India, and has begun or begins to manufacture or produce articles or to operate such plant or plants, at any time within the period of thirty-three years next following 1st day of April, 1948, or such further period as the Central Government may, by notification in the Official Gazette, specify with reference to any particular industrial undertakings; (iv) in a case where the industrial undertaking manufactures or produces articles, the undertaking employs ten or more workers in a manufacturing process carried on with the aid of power, or employs twenty or more workers in a manufacturing process carried on without the aid of powers:”

The first two conditions are in negative terms. They require that the industrial undertaking in respect of which the deduction is claimed under s. 80J of the Act is not one which is formed by the splitting up, or the reconstruction, of a business already in existence; and is also not formed by the transfer to a new business of machinery or plant previously used for any purpose. These two provisions indicate that it was not the bringing into existence of separate legal entity or the commencement of a business as a new business that render the undertaking eligible for the benefits under s. 80J of the Act. The second condition under s. 80J(4) of the Act clearly indicates that the use of plant and machinery which was already in use, but in a different unit will not be sufficient. What is more important is that the plant and machinery which forms part of the industrial undertaking is installed for the first time in that undertaking. The third condition laid down in s. 80J(4) is that the industrial undertaking manufactures of produces articles. It is not necessary to note the other parts of sub-cl. (iii) of 80J(4). The fourth condition is that workmen employed there is not less than the number specified. There is, thus, no requirement in s. 80J of the Act that the undertaking in respect of which the deductions can be claimed must have been set up as an independent unit. As noticed earlier, the unit being independent by itself will not entitle such an unit to claim the benefit. The essential requirement for claiming the benefits under the provision is the installation of plant and machinery and the manufacture or production of articles with the aid of such plant and machinery. The plant and machinery so installed is not to be the plant and machinery transferred from an existing business.

The requirements of section are met if the assessee is able to demonstrate that the assessee has established an industrial undertaking which manufactures or produces articles with the aid of plant and machinery newly installed in that undertaking. The term ‘industrial undertaking’ is not defined in s. 80J of the Act. The word ‘undertaking’ is not to be equated with the legal entity which may own undertaking. A single legal entity may own and operate more than one industrial undertaking and the fact of common ownership does not render undertakings which are otherwise capable of being separated into common undertaking. What is of relevance is the existence of all the facilities including factory buildings, plant, machinery, godowns and things which are incidental to the carrying on of manufacture or production, all of which when taken together is capable of being regarded as an industrial undertaking. When an existing industrial undertaking is substantially expanded and the manner of such expansion is such that the newly installed plant, machinery and other facilities such as factory buildings, godowns, etc., when taken together is capable of being regarded as an industrial undertaking, the requirements of section are met. The fact that the industrial undertakings so established by way of substantial expansion is at a location which is adjacent to the existing undertaking would not in anyway render such an undertaking anyless new undertaking for the purpose of determining its eligibility under s. 80J of the Act. When substantial expansion of industrial undertaking is embarked upon such expansion cannot be expected to be completed overnight or within the same assessment year. The size of the expansion, the amount of investment required, the extent of the construction that may be involved, the lead time required for securing the new machinery, the source of the supply, the extent of finance available and the speed with which such finance can be obtained are all factors which along with other relevant factors cumulatively determine the extent of time within which the expansion can be completed. All these factors are no doubt relevant even when a new undertaking is established for the first time by a newly constituted or legal entity or by an individual who proceeds to set up a new industrial undertaking. The fact that the expansion is completed in stages by adding spindles to existing spinning mills does not on that score alone render such addition incapable of being regarded as part of the establishment of an industrial undertaking for the purpose of s.80J of the Act. The addition though made in stages is part of a larger plan of substantial expansion which plan is only implemented in stages over a period of time having regard to the various factors which affect the installation of new machinery and the addition of the facilities required such as factory buildings, godowns, etc. In this case, the industrial licence was obtained by the assessee for a substantial expansion on the 20th Aug., 1975. The licence enabled the assessee to increase the number of spindles which was apparently less than 20,000 as on the date of that licence, to 50,000. The assessee had added the additional spindlage after securing that licence and had completed the programme of expansion by July, 1981.

17. The claim for deduction under s. 80J was made thereafter and the claim so made cannot be regarded as one which is impermissible under the provisions of s. 80J of the Act. The stipulation in s. 80J(4)(iii) to the beginning of manufacture or production of articles or the operation of the plants must in cases of substantial expansion be regarded as the time at which the substantial expansion was completed in such a way as to render the expanded production facility capable of being regarded as an industrial undertaking.

18. The Supreme Court in the case of Textile Machinery Corporation Limited vs. CIT 1977 CTR (SC) 151 : AIR 1977 SC 1134 : TC 25R.490 construed s. 15C of the Indian IT Act, 1922 which provision is similar to s. 80J of the Act of 1961.

The Supreme Court inter alia, held that “Sec.15C is an exemption section. The words ‘capital employed’ in the principal clause of s. 15C are significant, for fresh capital must be employed in the new undertaking claiming exemption. There must be a new undertaking where substantial investment of fresh capital must be made in order to enable earning of profits attributable to that new capital.”. The Court also observed that “The principal object of s. 15C is to encourage setting up of new industrial undertakings by obtaining tax incentives…..”. “Manufacture or production of articles yielding additional profit attributable to the new outlay of capital in a separate and distinct unit is the heart of the matter to earn exemption of tax liability under s. 15C”……….Regarding the effect of substantial expansion, the Court observed: “The true test is not whether the new industrial undertaking connotes expansion of an existing business of the assessee, but whether it is all the same a new and identifiable undertaking separate and distinct from the existing business. No particular decision in one case can lay down an inexorable test to determine whether a given case comes under s. 15C or not.”

In the case of CIT vs. Indian Aluminium Co. Ltd. (1977) 108 ITR 367 (SC) : TC 25R.547, the Supreme Court upheld the claim of assessee for benefits under s. 15C of the IT Act, 1922, inter alia in respect of expansion of its existing factories by setting up units side by side with the old units and adding to the respondent’s total output.

In the case of CIT vs. Orient Paper Mills Ltd. (1989) 176 ITR 110 (SC) : TC 25R.540, the apex Court upheld the decision of the Calcutta High Court which had held that the assessee which had set up a plant for the manufacture of caustic soda housed in a separate building after obtaining a separate industrial licence was entitled to relief under s. 15C of the Indian IT Act, 1922.

In the case of Municipal Commissioner, Chinchwad New Township, Municipal Council vs. Century Enka Ltd. AIR 1996 SC 187, the Court reiterated the law laid down in the cases of Orient Paper Mills Ltd. (supra) and Indian Aluminium (supra).

In this case, the Tribunal has recorded a specific finding that the entire expansion undertaken by the assessee “………..is an independent unit and capable of functioning as such”……It is no doubt true that what is manufactured with the aid of newly installed machinery is the same article as the one that was being manufactured by the assessee in its existing unit. There is no requirement in s. 80J of the Act that the article produced in the newly established industrial undertaking should be different from the one produced by the assessee in its existing undertaking. What is material is the bringing into existence by investing fresh capital, an unit which is capable of functioning as an independent unit and is capable of being regarded as an industrial undertaking engaged in the production of articles. That test having been satisfied in this case, the assessee is entitled to the benefit of s. 80J of the Act.

We, therefore, answer the second question referred to us in favour of the assessee and against the Revenue.

24. The assessee shall be entitled to costs in the sum of Rs. 2,000 (Rs. two thousand only).

[Citation : 240 ITR 434]

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