THE COMMISSIONER OF INCOME TAX, V. M/S. MOTOR INDUSTRIES CO LTD.,

ITA/1064/2008

AI Insights

The case revolves around the appeal by the Commissioner of Income-Tax against the Tribunal's decision favoring M/s. Motor Industries Co. Ltd. The primary issues included the method of valuing work-in-progress and finished goods, the treatment of expenses incurred during a buyback of shares, and the computation of deductions under Section 80HHC of the Income Tax Act. The Tribunal had earlier set aside the findings of the lower authorities, which had revalued the closing stock and treated certain expenses as capital in nature. The High Court's judgment affirmed the Tribunal's decision, emphasizing the need for consistency in the valuation of opening and closing stocks and recognizing the revenue nature of the buyback-related expenses.

• Counselvise Citation: [2014] 140 COUNSELVISE.COM (IT) 701828 (HC-KARNATAKA)
• Appeal Type: Others
• Pronouncement Date: 31-10-2014
• Assessment Year: misc
• Other Referred Cases: CIT vs. Corporation Bank Ltd., VKJ Builders & Contractors (P) Limited vs. Commissioner of Income Tax, Chainrup Sampatram vs. CIT, Dalmia Investment Company Limited vs. CIT, General Insurance Corporation vs. CIT, Melmould Corporation vs. CIT, Carborandum Universal Limited vs. CIT
• Laws Referred To: Income Tax Act, 1961, Accounting Standard-2, Companies Act
• Result in Favour of: Others
• Court: HIGH COURT
• Department Lawyers: S E DASTUR; PERCY PARDIWALA
• Assessee Lawyers: K V ARAVIND
• Keywords: Buy back of shares; Capital expenditure; Revenue expenditure; Valuation of inventory; Change in method of valuation
• Section: 80HHC; 260-A; 77A; 77AA

Judgement Text

" IN THE HIGH COURT OF KARNATAKA AT BANGALORE DATED THIS THE 31st DAY OF OCTOBER 2014 PRESENT THE HON'BLE MR. JUSTICE N. KUMAR AND THE HON’BLE MR. JUSTICE B. MANOHAR ITA No.1064 OF 2008 BETWEEN; 1. The Commissioner of Income-Tax, LTU, JSS Towers, 100 Ft. Ring Road, Banashankari 3rd Stage, Bangalore-560 085. 2. The Asst. Commissioner of Income-Tax, Circle-12(1), C.R. Building, Queens Road, Bangalore ...APPELLANTS (By Sri.K.V. Aravind, Advocate) AND: M/s.Motor Industries Co. Ltd., (Bosch Limited), Hosur Road, Adugodi, Bangalore-30. ...RESPONDENT (By Sriyuths. S.E. Dastur and Percy Pardiwala, Senior Advocates for M/s.King and Partridge) 2 This appeal is filed under Section 260-A of I.T. Act, 1961 arising out of Order dated 12.6.2008 and Corrigendum dated 18.8.2008 passed in ITA.No.335/BNG/2005, for the assessment year 2000-01 to formulate the substantial questions of law stated therein and to allow the appeal and set aside the order passed by the ITAT, Bangalore in ITA.No. 335/ BNG/ 2005, dated 12.06.2008 and Corrigendum dated 18.08.2008 and confirm the order of the Appellate Commissioner and confirm the order passed by the Assistant Commissioner of India Tax, Circle-12(1), Bangalore. This appeal coming on for admission this day, N. KUMAR, J. delivered the following:- J U D G M E N T The revenue has preferred this appeal against the order passed by the Tribunal granting relief in favour of the assessee. 2. The revenue has raised the following substantial questions of law for consideration by this Court:- “1. Whether the Tribunal was correct in reversing the finding of the Assessing Officer that the assessee had valued the work in progress at material cost (closing stock) contrary to Accounting Standard-2 as opined by the assessee’s statutory Auditor that profit before tax and profit after tax are understated by the 3 assessee by Rs.137 million (Rs.48.1 crores) and Rs.87 million (Rs.31.1 crores) which was brought to tax? 2. Whether the Tribunal was correct in holding that once the valuation of closing stock is changed, the corresponding opening stock also has to be changed by ignoring the judgment of this Hon’ble Court in CIT .vs. Corporation Bank Ltd., 174 ITR 616? 3. Whether the Tribunal was correct in holding that expenses incurred towards professional charges press announcements statutory fees etc., incurred towards buying back the assessee’s shares from its share holders is an allowable deduction? 4. Whether the Tribunal was correct in holding that the proceeds from sale of raw material, stores etc. should be excluded from the total turnover for the purpose of computation of deduction under Section 80HHC of the Act by following the view of its earlier order? 5. Whether the Tribunal was correct in setting aside the finding of the lower authority 4 that the interest component for allowing deduction under Section 80HHC should be computed as per Explanation i.e. at 90% to Section 80HHC of the Act by following the view of its earlier order?” 3. The assessee is a public limited company manufacturing fuel injection pumps, spark plugs and automotive products. The assessee has been following the method of valuation of work-in-progress at material cost and of finished goods at prime cost (i.e. direct material + direct labour) from its inception consistently. The statutory auditor in his report qualifying the final accounts of the assessee for the year ending 31.3.2000 has stated in para(d) as under:- “As stated in Note 3, the company has determined the cost of work-in-progress considering material cost only and in the case of finished goods, material cost and direct labour for the purpose of valuation. This practice is contrary to Accounting Standard 2, which requires cost of 5 both work-in-progress and finished goods to be determined considering material cost, direct labour and appropriate overheads, including duties. As a result, inventories, current liabilities and provisions are understated by Rs.764 million, Rs.53 million and Rs.220 million respectively while loans and advances are, overstated by Rs.93 million. Consequently, profit before tax and profit after tax are understated by Rs.137 million and Rs.87 million respectively.” 4. The assessing authority after hearing the assessee held that the assessee’s method of valuation of inventory comes under Situation 2 mentioned in the accounting standards and it is not in accordance with the Accounting principles, the accounting standards, Companies Act and Income Tax Act. The profit admitted by the assessee is not true profit, but distorted profit. The cost of unsold goods has been neutralized completely by incorrect valuation of stock. Thereby, cost of unsold goods has been added to the cost of goods sold, resulting in suppressed profits. The profits of the business arrived by the assessee by this 6 method of valuation of inventory is not acceptable as it is not reflection of the true profits arising from current sale of goods. Therefore, the assessing authority proceeded to determine the correct profits of the assessee for the current year. He gave the benefit of current closing stock in the subsequent year, and held that correct profits from unsold goods as in the current year is assessable. He has also rejected the contention of the appellant that if the closing stock were to be revalued according to AS2, then the opening stock should also be revalued on uniform basis and finally the accounting policy of the assessee with regard to valuation of inventory was rejected. He proceeded to assess the income to the best of his judgment, based on the material gathered during the course of hearings. After computation of the correct consumption of material, he computed the correct and true profits and the additional profit of Rs.48,26,21,428/- arising from current year’s sales was brought to tax. 7 5. During the relevant year, the assessee formulated a proposal to buy back equity shares from existing share holders on a proportionate basis and through a tender. In this connection, the company had incurred expenses towards professional charges, press announcements and statutory fees amounting to total of Rs.27,82,411/- and an expenditure by way of professional fees of Rs.6,01,250/- as a consequence thereof. The assessee claimed the entire expenditure as revenue expenditure on the ground that it was incurred exclusively for the purpose of the business. However, the assessing authority rejected the said claim on the ground that the said expenditure is incurred in connection with restructuring of share capital and with a view to improve return on equity over a period of time and this is an enduring benefit sought to be achieved from buy back of shares. Therefore, total expenditure of Rs.33,83,661/- incurred directly in relation to and in consequence to buy back is treated as capital expenditure and was disallowed. 8 6. The assessing authority included in the total turnover, sale of raw material, scrap. etc for the purpose of computation of deduction under Section 80HHC. Similarly, the interest component for allowing deduction under Section 80HHC was also included in the total turnover. 7. Aggrieved by this order, the assessee preferred an appeal to the Commissioner of Income-Tax (Appeals) who dismissed the appeal confirming the findings of the appellate authority. Aggrieved by the said order, the assessee preferred an appeal to the Tribunal. The Tribunal by the impugned order held that though the assessing authority was justified in changing the valuation of closing stock, he was not justified in refusing to change the valuation of opening stock. It held that at the instance of the assessing authority, the closing stock is changed. Consequently, to determine the profits, valuation of the opening stock also should be changed. As regards the expenditure incurred in connection with the buy back scheme was held be in the 9 nature of revenue expenditure following the judgment of the Apex Court. In respect of the benefit under Section 80HHC, the orders of the authorities were set aside following the view taken in the assessee’s case itself in the earlier years. Aggrieved by this order, the revenue is in appeal. 8. Substantial questions of law 1 and 2: The basis for the assessing authority to change the closing stock was the auditor’s report where it was stated that the company has determined the cost of work in progress considering the material cost only and in the case of finished goods, material cost and direct labour for the purpose of valuation. This practice is contrary to Accounting Standard 2, which requires cost of both work-in-progress and finished goods to be determined considering material cost, direct labour and appropriate overheads, including duties. As a result, inventories, current liabilities and provisions are understated by Rs.587 million, Rs.42 million and Rs.170 million respectively while loans and advances are overstated 10 by Rs.64 million. All the three authorities are of the view that the practice adopted by the assessee is contrary to the Accounting Standard 2 as stated by the auditor’s report. It is in that context, the assessee contended in the alternative that in case the method of valuation of closing stock is changed by the assessing authority then the opening stock also has to be revalued on the same basis which argument has been accepted by the Tribunal and the relief is granted to the assessee. 9. The learned counsel for the revenue assailing these findings contends relying on several judgments of various High Courts that there is no obligation to change the valuation in the opening stock because valuation of closing stock is changed. In support of his contention, he relied on judgment of the Madras High Court in the case of Commissioner of Income Tax .vs. Carborandum Universal Limited [149 ITR 758] where at Paragraph 15 it has been held as under:- 11 “Further, even though the change of the method has resulted in a detriment to the Revenue in the year in question, since the method is to be followed consistently year after year in future, this apparent detriment to the Revenue will get adjusted and disappear. Therefore, in view of the findings of the Tribunal that the change of the method is bona fide and is intended to be followed in future, year after year, the change has to be accepted by the Revenue, notwithstanding the fact that during the assessmenr year which is the first year when the change of method is brought about it has resulted in a prejudice or detriment to the Revenue. So long as the method of valuation adopted by the assessee gets recognition from the practicing accountants and commercial world for valuation of stock-in-trade, the adoption of that method cannot be questioned by the Revenue unless the adoption of that method is found to be not bona fide or restricted for a particular year.” 12 10. The Bombay High Court in the case of Melmould Corporation .vs. Commissioner of Income Tax [202 ITR 789] has held as under:- “Thus, the value of the closing stock of the preceding year must be the value of the opening stock of the next year. The change, therefore, has to be effected by adopting the new method for valuing the closing stock which will, in its turn, become the value of the opening stock of the next year. If, instead, a procedure is adopted for changing the value of the opening stock, it will lead to a chain reaction of changes in the sense that the closing value of the stock of the year preceding will also have to change and correspondingly the value of the opening stock of that year and so on.” 11. This Court in the case of Commissioner of Income Tax .vs. Corporation Bank Limited [174 ITR 616] held as under:- 13 “7. On the application of the principles laid down by the Supreme Court in the leading case of Chainrup Sampatram .vs. CIT (supra), two principles appear to be well settled, i.e., that the assessee is entitled to value, the closing stock either at cost price or market value, whichever is lower, and that the closing stock must be the value of the opening stock in the succeeding year. It is thus clear that irrespective of the basis adopted for valuation in the earlier years, the assessee had the option to charge the method of valuation of the closing stock at cost or market price, whichever is lower, at any time, provided the change was bona fide and followed regularly thereafter. The contention of the Revenue is that in order to reflect the true profits, change in the method of valuation of stock should be applied to both opening stock as well as closing stock and it is not open to the assessee to apply new method to the closing stock alone without reference to opening stock. The value of the closing stock in the previous year must be the value of opening stock in the succeeding year and, therefore, if the 14 argument of the Revenue is accepted, there cannot be change in the valuation at all. However, the effect of the ruling in Chainrup Sampatram .vs. CIT (1953) 24 ITR 481(SC):TC2R.124 is that there is no rule that the opening stock and closing stock of the same accounting year must necessarily be valued on one and the same basis. It is permissible, therefore, for the assessee to adopt either market value or at cost price to value the closing stock as long as such change in the method of valuation is adopted bonafide and is thereafter continued year to year. In a year where the opening stock value adopted is in one method and closing stock is another, there is bound to be some anomaly in the year of change, but that will get ironed out and absorbed in course of time as the new method of valuation of stock is going to be applied on a permanent basis thereafter in later years. I derive support for this view from CIT .vs. Carborandum Universal Ltd. (1984) 39 CTR (Mad) 272: (1984) 149 ITR 759 (Mad); TC2R.366 and British Paints India Ltd. .vs. CIT (1978) 111 ITR 53 (Cal): TC2R.122.” 15 12. The Apex Court in the case of VKJ Builders & Contractors (P) Limited .vs. Commissioner of Income Tax [318 ITR 204] at Paragraph 4 has held as under:- “It is the fundamental principle of accountancy that the figure of the closing stock of the earlier year has to form the opening stock of the next accounting year. In the present case, we find that after the alleged suppression of the work-in-progress came to be detected, a declaration was filed under the KVSS on the basis of the order passed by the AO on 27th Feb., 1998 which declaration was accepted by the designated authority (presumably after obtaining the report from the AO). In the circumstances, the AO ought not to have rejected the application of the assessee under S. 154.” 13. In the booklet called “Valuation of Stock and Work-In- Progress-Normally Accepted Accounting Principles”- brought out by Indian Merchants’ Chamber Economic Research & Training Foundation and written by 16 Shri G.P. Kapadia, at Page 4, there is discussion about the change from one valid basis to another valid basis. 14. Relying on these judgments it was contended that though the assessee is at liberty to change the valuation in the closing stock, it does not follow that the valuation of the opening stock also requires to be corrected. All these judgments are cases where the assessee has changed the valuation of the closing stock. The department has accepted it as it was a bonafide one. Therefore, the said closing stock has become the opening stock for the subsequent year. Where a change from one valid basis to another valid basis is accepted, certain consequences normally follow. The opening stock of the basis year of change is- valued on the same basis as the closing stock. Whether the change is to a higher level or to a lower level, the revenue normally does not seek to revise the valuation of the earlier years. It neither seeks to raise additional assessments, nor does it admit relief under the ‘error or mistake’ provisions. It is not 17 possible to define with precision what amounts to a change of basis. It is a convenience, both to the tax-payer and to the Revenue, not to regard every change in the method of valuation as a change of basis. In particular, the Revenue encourages the view that changes which involve no more than a greater degree of accuracy, or a refinement, should not be treated as a change of basis, whether the change results in a higher or a lower valuation. In such cases the new valuation is applied at the end of the year without amendment of the opening valuation. This principle is accepted by all the Courts and therefore in the aforesaid judgments it was held there is no need to change or amend the opening valuation. If such a change in the closing valuation is not bonafide, the revenue is under no obligation to accept it. They could insist on the valuation without the change. 15. But the question now is whether such a change is on account of assessing officer not accepting the valuation 18 given by the assessee. As in this case, if the valuation made by the assessee is not in accordance with the accounting standards 2 and it requires to be brought in conformity with the same then is it necessary to correct the valuation of the opening stock. It is in this context, reliance is placed on the judgment of the Bombay High Court in the case of Commissioner of Income Tax, Bombay .vs. Ahmedabad New Cotton Mills Co.,[AIR 1928 BOMBAY 510] wherein it has been held as under:- “Now what is common ground is that at any rate the stock at the end of the year 1925 was undervalued in the company’s return. The company says it was also undervalued at the beginning of the year. That has not been strictly proved, but the whole case depends upon it, and therefore for the purposes of the present case we propose to assume that this is the case. Now what the Commissioner has done is this. He has rectified the value of the stock at the end of the year by substituting the true value of the stock as at that date, but he has declined to make the correspondent alteration as regards the stock at 19 the opening of the year. He says that that ought not to be done because under a well-known principle of accountancy the opening value must be taken at precisely the same figure as the closing value for the previous year, viz., 31st December, 1924, and that if anything to the contrary is done you would get into great difficulties, and would also open the door to frauds on the public revenue.” 16. The Privy Council affirming the view of the Bombay High Court in the aforesaid case has in the case of Commissioner of Income-Tax, Bombay Presidency .vs. Ahmedabad New Cotton Mills Co. Ltd., reported in AIR 1930 PC 1526 held as under:- “If the method of altering both valuations is not adopted it is perfectly plain that the profit which is brought forward is not the real one. It may be more or it may be less, but it has no relation to the true profit if the stock is valued on one basis when it goes out without considering the value of the stock when it comes in. When, therefore, there is undervaluation at one end, the 20 effect is to cause both a smaller debit in respect of the stock introduced into the next account and a larger sum for profits realized by the sale, change in market values being immediately reflected in the price obtained for the goods that sold, in these circumtances to contend that there should be undervaluation at one end and not at the other is to raise an argument which their Lordships cannot accept.” 17. The Calcutta High Court in the case of Commissioner of Income Tax .vs. Bengal Jute Mills Co. Ltd. (1992) 107 CTR 0034 at paragraph 5 held as under:- “Section 4 of the IT Act, imposes a charge on the total income of the previous year of every person. If any income has escaped assessment in an earlier previous year, then the ITO may reopen the assessment for the purpose of bringing into tax the income that has escaped assessment. The escapment may be due to undervaluation of stock in the earlier years. But because the income of the earlier year has escaped assessment is not ground for assessing the current year’s profit at a distorted figure. The 21 general rule of accountancy is that the value of the closing stock of a year becomes the value of the opening stock of the next year. But in a case like this where the ITO has made an allegation of undervaluation and has valued the closing stock at the market rate rejecting the assessee’s valuation, then to arrive at the correct figure of profit, the ITO must also value the opening stock in a similar fasion. If the assessee’s method of valuation of the opening stock is accepted and at the same time that method is rejected for valuation of the closing stock, then a highly distorted figure of profit will emerge. This will be beyond the scope of the charging section.” 18. The Apex Court in the case of Chainrup Sampatram .vs. Commissioner of Income-Tax, West Bengal [(1953) 24 ITR 481] stated as under:- “The true purpose of crediting the value of unsold stock is to balance the cost of those goods entered on the other side of the account at the time of their purchase, so that the cancelling out of the entries relating to the same stock from both sides of the account would leave only the 22 transactions on which there have been actual sales in the course of the year showing the profit or loss actually realized on the year’s trading.” 19. From the aforesaid judgments, it is clear that the method of valuation may change in two circumstances. The assessee may change the method of valuation of the closing stock though the opening stock was valued in a different method. If the change is bonafide and is accepted by the revenue then the question of changing the opening stock would not arise. If such a change is not bonafide, it will be open to the Revenue not to accept such a change in valuation and assess without such valuation. Once the said change in the valuation is accepted by the Revenue, the consequence is the value of the closing stock in the previous year would become value of the opening stock in the succeeding year. In a year where the opening stock value adopted is one method and closing stock is another, there is bound to be some anomaly in the year of change, but that will get ironed out and absorbed in course of time as the new 23 method of valuation of stock is going to be applied on a permanent basis thereafter in coming years. 20. But if the assessing authority rejects the assessee’s valuation of the closing stock then to arrive at the correct figure of profit, the assessing authority should value the opening stock in a similar fashion. If the assessee’s method of valuation of the opening stock is accepted and at the same time his valuation of the closing stock is rejected then a highly distorted figure of profit will be arrived at. This will be the scope of charging section. Section 4 of the Income Tax Act, which is the charging Section, reads as under:- “4(1) Where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions (including provisions for the levy of additional income-tax) of, this Act in respect of the total income of the previous year of every person: 24 Provided that where by virtue of any provision of this Act income-tax is to be charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly. (2) In respect of income chargeable under sub- Section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act.” As is clear from the charging Section, the income tax shall be charged for the year in respect of total income of the previous year of the very person. Therefore, if the basis for arriving at the valuation at the end of year is changed by the assessing authority without correspondingly changing the valuation of the opening stock then it results in charging income on a distorted figure which is not permissible in law. Therefore, when the assessee changes the valuation of the closing stock, there is no necessity to change the opening stock. But when the assessing authority changes the closing stock it becomes obligatory that the opening stock valuation 25 has to be correspondingly changed on the basis of which the valuation of the closing stock is changed in order to arrive at correct figure of tax which is chargeable as tax under Section 4 of the Act. Therefore, the order passed by the Tribunal holding that the opening stock should also be revalued cannot be found fault with. Accordingly, the substantial questions of law 1 and 2 framed are answered in favour of the assessee and against the revenue. 21. Substantial question No.3:- The facts are not in dispute. The assessee formulated the proposal to buy back equity shares from existing share holders on a proportionate basis and through a tender. The sum of Rs.33,83,661/- was incurred as expenditure towards professional charges, press announcements and statutory fees etc. Now the question is whether this expenditure is capital in nature or revenue in nature. It was contended by the revenue that as this expenditure was incurred to buy back equity shares it has resulted in expansion of the capital 26 base and is of enduring nature. Therefore, the expenditure is capital in nature and is not allowable as deduction. In support of this contention, reliance was placed on the judgment of Brooke Bond India Ltd. .vs. Commissioner of Income Tax [225 ITR 798(SC)] wherein it has been held as under:- “It is no doubt true that before the AAC as well as before the Tribunal it was submitted on behalf of the assessee that increase in the capital was to meet the need for working funds for the assessee-company. But the statement of case sent by the Tribunal does not indicate that a finding was recorded to the effect that the expansion of the capital was undertaken by the assessee in order to meet the need for more working funds for the assessee. We, therefore, cannot proceed on the basis that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for working funds for the assessee to carry on its business. Though the increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the 27 company and may also help in the profit-making, the expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company. On the facts and in the circumstances of the case, the Tribunal was right in sustaining the disallowance of Rs.13,99,305/- being expenses incurred in connection with the issue of fresh lot of shares.” 22. Countering the said argument, it was contended by the assessee that the aforesaid judgment was rendered with reference to a case where issue of fresh lot of shares which resulted in the expansion of the capital and therefore, it was rightly treated as the capital expenditure. But in the instant case, the effect of buy back of shares resulted in shrinking of the capital. Therefore, there is no expansion of the capital structure of the company and as such that expenditure is revenue in nature. In support of this contention, reliance was placed on the judgment of the Apex Court in Commissioner of Income-Tax .vs. General 28 Insurance Corporation [(2006) 286 ITR 232(SC)] where it was held as under:- “The capital base of the company prior to or after the issuance of bonus shares remains unchanged. Issuance of bonus shares does not result in any inflow of fresh funds or increase in the capital employed, the capital employed remains the same. Issuance of bonus shares by capitalization of reserves is merely a reallocation of the company’s funds. As observed earlier, the issue of bonus shares by capitalization of reserves is merely a reallocation of company’s funds. There is no inflow of fresh funds or increase in the capital employed, which remains the same. If that be so, then it cannot be held that the company has acquired a benefit or advance of enduring nature. The total funds available with the company will remain the same and the issue of bonus shares will not result in any change in the capital structure of the company. Issue of bonus shares 29 does not result in the expansion of capital base of the company.” 23. The Apex Court in the case of CIT .vs. Dalmia Investment Company Limited [(1964) 52 ITR 567] held as under:- “…. In other words, by the issue of bonus shares pro rata, which ranked pari passu with the existing shares, the market price was exactly halved, and divided between the old and the bonus shares. This will ordinarily be the case but not when the shares do not rank pari passu and we shall deal with that case separately. When the shares rank pari passu the result may be stated by saying that what the shareholder held as a whole rupee coin is held by him, after the issue of bonus shares, in two 50 NP. Coins. The total value remains the same, but the evidence of that value is not in one certificate but in two.” 24. Following those judgments, the Delhi High Court in the case of Commissioner of Income Tax .vs. Selan 30 Exploration Technology Ltd. (2010) 199 TAXMAN 1 has held at paragraphs 10 and 11 as under:- “10. It is clear from the aforesaid judgments that a fine distinction is made by the Supreme Court in classifying the expenditure under two categories: (a) When the expense incurred relates to the issue of fresh shares, which leads to an inflow of fresh funds into the company, such expenditure is to be treated as capital expenditure, (b)On the other hand, where no such flow of funds or increase in the capital employed, the expenditure incurred would be revenue expenditure, as in such a case the company would not acquire benefit or addition of enduring nature. 11. In the present case, consultancy fee for advisory services was paid by the assessee company for buyback of shares. Instead of increase in the share capital, it was going to result in the decrease in funds with the buyback of the shares. In these circumstances, the Tribunaly rightly held that the assessee had not acquired the benefit or addition of enduring 31 nature because after the buyback, benefit or addition of enduring nature would not arise as capital employed had, in fact, gone down. The expenditure incurred had not resulted into bringing into existence any asset. Therefore, it was rightly held to be an expense of revenue nature.” 25. In this context, it is equally useful to refer to Section 77(A) of the Companies Act in particular Section 77A(7) which reads as under:- “77A(7)Where a company buy-back its own securities, it shall extinguish and physically destroy the securities so brought-back within seven days of the last date of completion of buy- back.” Similarly Section 77AA reads as under:- “77AA.Transfer of certain sums to capital redemption reserve account.-Where a company purchases its own shares out of free reserves, then a sum equal to the nominal value of the share so purchased shall be transferred to the 32 capital redemption reserve account referred to in clause(d) of the proviso to sub-section(1) of section 80 and details of such transfer shall be disclosed in the balance sheet”. From the aforesaid Sections, it is clear that if the company purchases its own shares out of free reserves then the sum equal to the nominal value of the share so purchased shall be transferred to the Capital Redemption Reserve Account and after the company buys back its own security, it shall extinguish and physically destroy the securities within seven days after the completion of buy-back. 26. The increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit-making. The expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company. Issue of bonus shares does not result in the expansion of capital base of the company. 33 It does not lead to any inflow of fresh funds into the company. The capital structure is not expanded. On the contrary the consequence of such buy-back of shares is the capital base of the company gets reduced and the capital structure will go down. It is not of an enduring effect so as to bring the expenditure incurred in this regard as capital expenditure. Where there is no flow of funds or increase in the capital employed, the expenditure incurred would be revenue expenditure. Therefore, rightly the Tribunal held that it is in the nature of revenue expenditure and allowed the same. 27. Insofar as substantial questions of law 4 and 5 are concerned, in the assessee’s case itself, in ITA.No.734/07 decided on 1.8.2014, the said substantial questions have been answered in favour of the assessee and against the revenue. Following the said judgment, those two questions are answered in favour of assessee and against the revenue. 34 28. For the foregoing reasons, we do not see any merit in this appeal. Accordingly, the appeal is dismissed. Parties to bear their own costs. Sd/- JUDGE Sd/- JUDGE *alb/-. "