Supreme Court Clarifies Deductible Expenses for Sugar Cooperatives: CIT vs. Tasgaon Taluka (2019)

Date of the Judgment: March 5, 2019
Citation: 2019 INSC 195
Judges: A.K. Sikri, S. Abdul Nazeer, M.R. Shah
Can a cooperative sugar factory claim the entire amount paid to sugarcane farmers as a business expense, or does a portion of it count as profit sharing? The Supreme Court of India addressed this complex issue in a recent case involving the Commissioner of Income Tax, Bombay, and Tasgaon Taluka Sahakari Sakhar Karkhana Limited. This judgment clarifies how to determine the allowable expenditure for sugarcane purchases by cooperative societies, especially when payments exceed the minimum price set by the government. The bench comprised Justices A.K. Sikri, S. Abdul Nazeer, and M.R. Shah, with the judgment authored by Justice M.R. Shah.

Case Background

The case revolves around Tasgaon Taluka Sahakari Sakhar Karkhana Limited, a cooperative society involved in sugarcane production and sales. For the assessment year 1998-99, the society initially declared a ‘NIL’ income, carrying forward a loss and unabsorbed depreciation. They later revised their return, showing a significant business loss. The Income Tax Department questioned the society’s claim of expenses, specifically regarding the price paid for sugarcane to its members, arguing that a portion of it was actually a distribution of profit.

The society had paid sugarcane growers more than the minimum price set by the Central Government under the Sugar Cane (Control) Order, 1966. This order allows for a minimum price (SMP) and an additional price based on the society’s profits (SAP). The Assessing Officer (AO) argued that the difference between the SMP and the SAP was essentially a distribution of profit and not a legitimate business expense. The AO disallowed the excess amount, leading to the dispute.

Timeline

Course of Proceedings

The Assessing Officer (AO) disallowed the excess sugarcane purchase price, treating it as a distribution of profit. The Commissioner of Income Tax (Appeals) [CIT(A)] reversed this decision, relying on a Special Bench decision of the Mumbai ITAT. The Income Tax Appellate Tribunal (ITAT) upheld the CIT(A)’s order. The High Court also upheld the ITAT’s decision, citing a previous ruling in a similar case. The department then appealed to the Supreme Court.

Legal Framework

The core of the dispute lies in the interpretation of the Sugar Cane (Control) Order, 1966, and its impact on allowable business expenditure under the Income Tax Act. Specifically, the following provisions are relevant:

• Clause 3 of the Control Order, 1966: This clause empowers the Central Government to fix the minimum price of sugarcane (SMP) to be paid by sugar producers. The factors considered include the cost of production, returns to growers, consumer prices, sugar prices, and sugar recovery rates. “the Central Government may, after consultation with such authorities, bodies or associations as it may deem fit, by notification in the official Gazette, from time to time, fix the minimum price of sugarcane to be paid by producers of sugar or their agents for the sugarcane purchased by them.”
• Clause 5A of the Control Order, 1966: Introduced in 1974, this clause mandates an additional price (SAP) to be paid to sugarcane growers, calculated based on a formula in the Second Schedule of the Control Order. This additional price is linked to the profitability of the sugar factory. “where a producer of sugar or his agent purchases sugarcane, from a sugarcane grower during each sugar year, he shall, in addition to the minimum sugarcane price fixed under Clause 3, pay to the sugarcane grower an additional price, if found due in accordance with the provisions of the Second Schedule annexed to the Control Order, 1966.”
• Section 37(1) of the Income Tax Act: This section allows for the deduction of expenses incurred for business purposes. The dispute is whether the excess payment for sugarcane is a legitimate business expense or a distribution of profit.
• Section 40A(2)(a) of the Income Tax Act: This section disallows expenses that are considered excessive or unreasonable, especially when paid to related parties.

Arguments

Department’s Arguments:

• The department argued that the difference between the SMP (fixed by the Central Government) and the SAP (fixed by the State Government) includes a component of profit.
• The department contended that the SAP is determined at the end of the financial year when accounts are settled and includes an element of profit sharing.
• The department relied on the case of Maharashtra Rajya Sahkari Sakkar Karkhana Sangh Limited vs. State of Maharashtra, 1995 Supp. (3) SCC 475, to argue that the additional price under Clause 5A is based on profit sharing.
• The department also argued that some societies paid sugarcane prices that were excessive and unreasonable, even beyond the SAP, which should not be allowed as a deductible expense under Section 40A(2) of the Income Tax Act.

Assessee’s Arguments:

• The assessee argued that the society is obligated to pay the sugarcane price as determined by the Central and State Governments.
• The assessee argued that even if the society incurs a loss, it is still required to pay the additional purchase price determined by the State Government, making it a necessary expenditure.
• The assessee relied on Section 9 of the Sale of Goods Act, stating that the price is determined at the time of purchase.
• The assessee contended that the higher price is paid to both members and non-members, and therefore, it cannot be considered a distribution of profit.
• The assessee also pointed out that the State Government, a 10% shareholder, does not receive any profit share, further arguing that the additional price is not a distribution of profit.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether the sugarcane purchase price paid by the assessee-society to its members/non-members above the SMP determined under Clause 3 of the Control Order, 1966, and as per the price determined by the State Government under Clause 5A of the Control Order, 1966, can be considered as sharing of profit and therefore is to be included in the return of income?
2. Whether any amount of sugarcane purchase price paid by the society to its members/non-members above/beyond the price even determined as per Clauses 3 & 5A of the Control Order, 1966, and which is found to be unreasonable and in excess of the fair market value, can be said to be the sharing of the profit and is required to be included in the total income of the assessee?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• The Supreme Court relied on Maharashtra Rajya Sahkari Sakkar Karkhana Sangh Limited vs. State of Maharashtra, 1995 Supp. (3) SCC 475* to understand the mechanism of determining the additional price under Clause 5A of the Control Order, 1966. The Court observed that the additional price is paid at the end of the season and includes a profit component.
• The Court referred to Clause 3 of the Sugar Cane (Control) Order, 1966 to explain the process of how the Central Government fixes the minimum price of sugarcane (SMP).
• The Court referred to Clause 5A of the Sugar Cane (Control) Order, 1966 to explain the process of how the State Government fixes the additional price of sugarcane (SAP).
• The Court referred to the Second Schedule of the Sugar Cane (Control) Order, 1966 to explain the formula for calculating the additional price payable under Clause 5A.

What weighed in the mind of the Court?

The Supreme Court’s decision was influenced by several factors. The Court recognized that while cooperative societies are obligated to pay sugarcane growers as per government regulations, the additional price (SAP) determined under Clause 5A of the Control Order, 1966, includes a profit component. This profit component, the Court reasoned, cannot be treated as a business expense. The Court also emphasized the need to analyze the specific accounting practices of each society to determine the exact profit component in the SAP. The Court aimed to strike a balance between allowing legitimate business expenses and preventing the distribution of profits in the guise of sugarcane purchase prices.

Fact:Law Ratio

The court’s reasoning was primarily based on the legal interpretation of the Sugar Cane (Control) Order, 1966, and the Income Tax Act. While the factual aspects of the case were considered, the legal framework played a more significant role in the court’s decision.

Key Takeaways

• The Supreme Court clarified that the difference between the minimum sugarcane price (SMP) and the additional price (SAP) includes a profit component, which is not deductible as a business expense.
• The Court emphasized that assessing officers must analyze the specific accounting practices of each cooperative society to determine the actual profit component in the SAP.
• The Court remitted the cases back to the assessing officers to conduct this analysis and determine the allowable expenditure.
• This judgment provides clarity on the tax treatment of sugarcane purchase expenses for cooperative societies, ensuring that profits are not disguised as business expenditures.

Directions

The Supreme Court quashed the orders of the High Court, ITAT, CIT(A), and assessing officers and remitted the matters back to the respective assessing officers. The assessing officers were directed to undertake the exercise of determining the profit component in the SAP, after giving an opportunity to the respective assesses.

Development of Law

The ratio decidendi of this case is that while the entire difference between the SMP and SAP cannot be considered as a distribution of profit, the profit component within the SAP is not a deductible expense. This clarifies the position of law regarding the tax treatment of sugarcane purchase expenses for cooperative societies. This judgment clarifies that the additional price paid to the sugarcane growers includes a profit component and only that component is to be considered as sharing of profit. The rest of the amount is to be considered as deductible as expenditure.

Conclusion

In conclusion, the Supreme Court’s judgment in Commissioner of Income Tax, Bombay vs. Tasgaon Taluka Sahakari Sakhar Karkhana Limited provides a nuanced understanding of how to treat sugarcane purchase expenses for cooperative societies. While the societies are obligated to pay the prices determined by the government, the profit component within the additional price (SAP) is not considered a deductible business expense. This decision ensures that cooperative societies cannot use sugarcane purchase prices to distribute profits in a tax-advantageous way. The cases have been remitted back to the assessing officers for a more detailed analysis of the profit component in each case.