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Income Tax Appellate Tribunal, “D” BENCH, MUMBAI
Before: SHRI B.R. BASKARAN & SHRI SANDEEP SINGH KARHAIL
PER SANDEEP SINGH KARHAIL, J.M.
The present appeal has been filed by the assessee challenging the impugned order dated 17/03/2023, passed under section 250 of the Income Tax Act, 1961 ("the Act") by the learned Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi [“learned CIT(A)”], for the assessment year 2014–15.
In this appeal, the assessee has raised the following grounds:–
“1. The learned CIT (A) has erred in upholding the disallowance of claim of deduction of R$ 2,12,85,590 under section 35(2AB) of the Income-tax Act, 1961.
Marksans Pharma Ltd. ITA no.1717/Mum./2023
The learned CIT(A)ought to have held that the expenditure of Rs 2,12,85,590/- is allowable under section 35(2AB) of the Act. 3. The appellant craves leave to add, amend, alter and/or modify, withdraw all or any of the foregoing grounds of appeal.”
The brief facts of the case pertaining to this issue, as emanating from the record, are: The assessee is a company and is engaged in the business of manufacturing and trading drugs and pharmaceutical formulations, chemicals, and solvents. For the year under consideration, the assessee filed its return of income on 30/11/2014 declaring a total income of Rs. 13,49,81,938. The return filed by the assessee was selected for scrutiny and statutory notices under section 143(2) as well as section 142(1) of the Act were issued and served on the assessee. In its return of income, the assessee claimed weighted deduction under section 35(2AB) of the Act of Rs 40,27,49,180 being 200% of revenue expenditure incurred on scientific research amounting to Rs. 19,75,62,590 and 200% of capital expenditure incurred on scientific research amounting to Rs. 38,12,000. In support of the claim made under section 35(2AB) of the Act, the assessee furnished the copy of the order of approval in Form No. 3CM given by the Department of Scientific and Industrial Research (“DSIR”) and certificate issued by the Chartered Accountant justifying the claim of deduction. However, during the assessment proceedings, the assessee could not furnish a copy of Form No. 3CL being the report to be submitted by the prescribed authority to the Director-General of Income Tax (Exemptions) under section 35(2AB) of the Act. Accordingly, the assessee was asked to justify the claim of a deduction section 35(2AB) of the Act read with Rule 6(7A) of the Income Tax Rules, 1962 (“the Rules”). In response thereto, the assessee submitted that it is taking steps for obtaining a copy of Form No. Page | 2
Marksans Pharma Ltd. ITA no.1717/Mum./2023 3CL, and upon receipt of same it shall be submitted. The assessee further submitted that the submission of Form No. 3CL is not a prerequisite condition for granting deduction section 35(2AB) of the Act once the in-house facilities are duly approved by the prescribed authority. The Assessing Officer (“AO”) vide order dated 29/12/2016 passed under section 143(3) of the Act did not agree with the submissions of the assessee and held that under section 35(2AB) of the Act, the expenditure as approved by the DSIR in the certificate given by them in Form No. 3CL is to be granted weighted deduction. Thus, it is not for either the assessee or the assessing authority to decide on the expenditure which will be entitled to weighted deduction section 35(2AB) of the Act. The AO further held that in the present case, since the assessee has not furnished the copy of Form No. 3CL, the claim for weighted deduction section 35(2AB) of the Act in respect of expenditure incurred on in-house research facility is not allowable. However, in case the assessee furnishes Form No. 3CL subsequently, the assessment order shall be rectified to the extent that the weighted deduction section 35(2AB) of the Act is allowed by DSIR in the certificate given by them in Form No.3CL. Accordingly, the assessee was allowed revenue expenditure incurred by it and depreciation in respect of capital expenditure.
Subsequently, the assessee filed the rectification application dated 04/03/2017 along with a copy of Form No. 3CL in relation to granting of weighted deduction section 35(2AB) of the Act. Since the DSIR approved scientific research expenditure of Rs. 1800.89 lakh being the aggregate of revenue expenditure incurred of Rs. 1762.77 lakh and capital expenditure of Rs. 38.12 lakh, the AO vide order dated 30/06/2017 passed under section 154 Page | 3
Marksans Pharma Ltd. ITA no.1717/Mum./2023 of the Act restricted the allowance of weighted deduction section 35(2AB) of the Act to Rs. 1800.89 lakh as approved by the DSIR and disallowed the unapproved expenditure of Rs. 212.85 lakh for the purpose of weighted deduction section 35(2AB) of the Act.
The learned CIT(A), vide impugned order, dismissed the appeal filed by the assessee and upheld the disallowance of Rs. 212.85 lakh under section 35(2AB) of the Act. While coming to the aforesaid conclusion, the learned CIT(A) placed reliance upon the decision of the Hon’ble Karnataka High Court in Tejas Networks Ltd v/s DCIT, [2015] 60 Taxmann.com 309. Further, the learned CIT(A) also upheld the conclusion of the AO that the DSIR allowed the claim of the assessee only limited to Rs. 1800.89 lakh and therefore the assessee is entitled to claim weighted deduction section 35(2AB) of the Act only to that extent. The learned CIT(A) further held that the assessee has not placed on record any evidence that it has carried out any R&D activity outside the approved in-house R&D facility and expenditure of Rs. 212.85 lakh was in respect of same. Being aggrieved, the assessee is in appeal before us.
We have considered the submissions of both sides and perused the material available on record. The only dispute raised by the assessee, in the present appeal, is against restricting the claim of weighted deduction under section 35(2AB) of the Act. The assessee has an approved R&D facility at L-82 and L-83, Verna Industrial Estate, Verna, Goa. Till the original assessment proceeding stage, the assessee had not received Form No. 3CL issued by DSIR and therefore the AO disallowed the weighted deduction claimed under section 35(2AB) of the Act. It is undisputed that the assessee though furnished the
Marksans Pharma Ltd. ITA no.1717/Mum./2023 copy of the order of approval in Form No. 3CM given by DSIR during the assessment proceedings. Subsequently, the DSIR issued Form No. 3CL and accordingly, the AO passed an order under section 154 of the Act allowing weighted deduction section 35(2AB) of the Act only to the extent of expenditure of Rs. 1800.89 lakh (i.e. capital expenditure of Rs. 38.12 lakh and Revenue expenditure to the extent of Rs. 1762.77 lakh) appearing in Form No. 3CL. In respect of the remaining revenue expenditure of Rs. 212.85 lakh not approved by DSIR, the claim of the assessee under section 35(2AB) of the Act was disallowed.
Before proceeding further, it is pertinent to analyse certain provisions of the Act and the Rules, which are relevant for the adjudication of the issue raised in this appeal. Section 35(2AB)(1) of the Act, as it stood in the relevant year, reads as under:-
“(1) Where a company engaged in the business of bio-technology or in any business of manufacture or production of any article or thing, not being an article or thing specified in the list of the Eleventh Schedule]] incurs any expenditure on scientific research (not being expenditure in the nature of cost of any land or building) on in-house research and development facility as approved by the prescribed authority, then, there shall be allowed a deduction of a sum equal to one and one-half times of the expenditure so incurred. Explanation.—For the purposes of this clause, "expenditure on scientific research", in relation to drugs and pharmaceuticals, shall include expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority under any Central, State or Provincial Act and filing an application for a patent under the Patents Act, 1970 (39 of 1970).”
The relevant rules in so far as it concerns deduction under section 35(2AB) of the Act are provided in Sub-Rule (1B), (4), (5A) and 7A of Rule 6 of the Rules. These rules read as follows:
Marksans Pharma Ltd. ITA no.1717/Mum./2023 “(1B) For the purposes of sub-section (2AB) of section 35, the prescribed authority shall be the Secretary, Department of Scientific and Industrial Research.”; “(4) The application required to be furnished by a company under sub- section(2AB) of section 35 shall be in Form No.3CK.”; “(5A) The prescribed authority shall, if he is satisfied that the conditions provided in this rule and in sub-section (2AB) of section 35 of the Act are fulfilled, pass an order in writing in Form No. 3 CM: Provided that a reasonable opportunity of being heard shall be granted to the company before rejecting an application. “(7A) Approval of expenditure incurred on in-house research and development facility by a company under sub-section (2AB) of section 35 shall be subject to the following conditions, namely:- (a) The facility should not relate purely to market research, sales promotion, quality control, testing, commercial production, style changes, routine data collection or activities of a like nature; (b) The prescribed. authority shall submit its report in relation to the approval of inhouse Research and Development facility in Form No. 3CL to the Director General (Income Tax Exemptions) within sixty days of its granting approval; (c) The company shall maintain a separate account for each approved facility; which shall be audited annually and a copy thereof shall be furnished to the Secretary, Department of Scientific and Industrial Research by 31st day of October of each succeeding year; Explanation:-For the purposes of this sub-rule the expression "audited" means the audit of accounts by an accountant, as defined in the Explanation below sub- section (2) of section 288 of the Income-tax Act, 1961. (d) Assets acquired in respect of development of scientific research and development facility shall not be disposed off without the approval of the Secretary, Department of Scientific and Industrial Research"
Firstly, the basis on which the disallowance of Rs. 212.85 lakh under section 35(2AB) of the Act was made by the AO and upheld by the learned CIT(A) was that the said expenditure was not approved by the DSIR for weighted deduction under section 35(2AB) of the Act. It is pertinent to note that there was an amendment with effect from 01/07/2016 to Rule 6(7A)(b) of the Rules, whereby it has been laid down that the prescribed authority, i.e., DSIR shall quantify the expenditure incurred on in-house research and Page | 6
Marksans Pharma Ltd. ITA no.1717/Mum./2023 development facility by the company during the previous year and eligible for weighted deduction under section 35(2AB) of the Act in Part-B of Form No. 3CL. Prior to the aforesaid amendment, the provisions of Rule 6(7A)(b) of the Rules merely provided that the prescribed authority shall submit its report in relation to the approval of the in-house R & D facility in Form No.3CL to the DGIT (Exemption) within 60 days of its granting approval. Therefore, prior to 01/07/2016, there was no legal sanctity for Form No.3CL in the context of quantifying the expenditure eligible for weighted deduction under section 35(2AB) of the Act. We find that the coordinate bench of the Tribunal in Cummins India Ltd v/s DCIT, [2018] 96 taxmann.com 576 (Pune-Trib.) held that there is no merit in the order of the Assessing Officer in curtailing the expenditure and consequent weighted deduction claimed under section 35(2AB) of the Act on the surmise that the prescribed authority has not approved part of the expenditure in Form No. 3CL, prior to the amendment in 2016. The relevant findings of the coordinate bench, in the aforesaid decision, are reproduced as under:-
“45. The issue which is raised in the present appeal is that whether where the facility has been recognized and necessary certification is issued by the prescribed authority, the assessee can avail the deduction in respect of expenditure incurred on in-house R&D facility, for which the adjudicating authority is the Assessing Officer and whether the prescribed authority is to approve expenditure in form No.3CL from year to year. Looking into the provisions of rules, it stipulates the filing of audit report before the prescribed authority by the persons availing the deduction under section 35(2AB) of the Act but the provisions of the Act do not prescribe any methodology of approval to be granted by the prescribed authority vis-à-vis expenditure from year to year. The amendment brought in by the IT (Tenth Amendment) Rules w.e.f. 01.07.2016, wherein separate part has been inserted for certifying the amount of expenditure from year to year and the amended form No.3CL thus, lays down the procedure to be followed by the prescribed authority. Prior to the aforesaid amendment in 2016, no such procedure / methodology was prescribed. In the absence of the same, there is no merit in the order of Assessing Officer in curtailing the expenditure and consequent weighted deduction claim under section 35(2AB) of the Act on the surmise that Page | 7
Marksans Pharma Ltd. ITA no.1717/Mum./2023 prescribed authority has only approved part of expenditure in form No.3CL. We find no merit in the said order of authorities below.”
The coordinate bench, in the aforesaid decision, further held that for deduction under section 35(2AB) of the Act, the first step was the recognition of the facility by the prescribed authority and entering an agreement between the facility and the prescribed authority. It was also held that once such an agreement has been executed, under which recognition has been given to the facility, then thereafter the role of the Assessing Officer is to look into and allow the expenditure incurred on in-house R&D facility as weighted deduction under section 35(2AB) of the Act. As noted above, in the present case, the prescribed authority has already passed an order granting the approval in Form No. 3CM. We find that in various other decisions relied upon by the learned AR, the coordinate benches of the Tribunal rendered similar findings that prior to the aforesaid amendment from 01/07/2016 once the facility is approved by DSIR, the assessee is entitled to weighted deduction under section 35(2AB) of the Act and there is no requirement that expenses also need to be approved by the DSIR in Form No. 3CL. Therefore, since the aforesaid amendment is not applicable to the assessment year under consideration, we are of the view that the AO erred in restricting the weighted deduction under section 35(2AB) of the Act to the expenditure mentioned in Form No. 3CL.
Further, as regards the decision of the Hon’ble Karnataka High Court, in Tejas Networks Ltd (supra), relied upon by the learned CIT(A) in the impugned order, we find that in that case the DRP held that certain provisions of the Act exclude certain expenditure from the purview of section 35 of the Act, and the Page | 8
Marksans Pharma Ltd. ITA no.1717/Mum./2023 report of the prescribed authority cannot be considered as far as such excluded expenditure is concerned. In this factual background, the Hon’ble Karnataka High Court analysed the provisions of section 35(2AB) as well as section 43(4) of the Act and held that if any question arises as to what extent, any activity constitutes or constituted or an asset is or was being used for scientific research, then the AO would be required to refer such question to the Board under section 35(3) of the Act for being referred to the prescribed authority and the decision of the prescribed authority would be final. The relevant findings of the Hon’ble Karnataka High Court, in the aforesaid decision, are as under:-
“28. It is in this background, sub-section (4) of Section 43 will have to be considered, which defines as to what activities would constitute "scientific research" as indicated under the said Section namely, Section 43(4). As to whether any expenditure incurred in the acquisition of rights in or arising out of scientific research as indicated in clause (ii) of sub-section (4) of Section 43 is an issue which requires to be examined by the prescribed authority itself and it would not be in the domain of the assessing authority to undertake such an exercise. When Section 35(2AB), Section 35(3) and Section 43(4) of the Act are read harmoniously, the irresistible conclusion that has be drawn would be that assessing officer cannot sit in judgment over the report submitted by the prescribed authority in Form No. 3CL. This view is also supported by the judgment of the High Court of Gujarat in Mastek Ltd.'s case (supra).”
Therefore, we are of the considered view that the factual basis of the findings of the Hon’ble Karnataka High Court, which is relied upon by the learned CIT(A) in the present case, is completely different from the factual basis of the present appeal under consideration before us. Thus, the reliance upon the aforesaid decision by the learned CIT(A) is completely misplaced. In this regard, the following observations of the Hon’ble Supreme Court in CIT v/s Sun Engineering Private Limited, [1992] 198 ITR 297 (SC), become relevant:
Marksans Pharma Ltd. ITA no.1717/Mum./2023 “It is neither desirable nor permissible to pick out a word or a sentence from the judgment of the Court, divorced from the context of the question under consideration and treat it to be the complete 'law' declared by the Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before the Court. A decision of the Court takes its colour from the questions involved in the case in which it is rendered and while applying the decision to a latter case, the Courts must carefully try to ascertain the true principle laid down by the decision of the Court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by the Court, to support their proceedings.”
The learned CIT(A) further held that the expenditure of Rs. 212.85 lakhs is not in respect of the in-house research and development facility as approved by the prescribed authority and the same was in respect of out-house expenses. As per the assessee, it has incurred expenses on clinical trials outside the approved in-house R&D facility and the same is also eligible for weighted deduction under section 35(2AB) of the Act. Further, during the hearing, the learned AR furnished the break-up of the allocation of expenditure on clinical trials incurred outside the approved in-house R&D facility. From the perusal of these details, we find that the expenditure of Rs. 184.95 lakh out of the aforesaid expenditure of Rs. 212.85 lakh, was incurred in respect of bio- equivalence study for the drugs and pharmaceutical formulations manufactured/traded by the assessee. We find that the Hon’ble Gujarat High Court in CIT v/s Cadila Healthcare Ltd, (2013) 263 CTR 686 (Guj.) held that the benefit under section 35(2AB) of the Act is also available in respect of expenditure on clinical trials outside the approved in-house R&D facility. The relevant findings of the Hon’ble High Court, in the aforesaid decision, are reproduced as under:-
“11.Revenue has also suggested following question : "D. Whether the Appellate Tribunal has substantially erred in holding that the expenses incurred outside the approved R&D facility would also get weighted Page | 10
Marksans Pharma Ltd. ITA no.1717/Mum./2023 deduction based on the word under "on in house" interpreting contradictorily to the finding of coordinate bench in Concept Pharmaceuticals Ltd. v. ACIT (ITAT, Mum) reported at 43 SOT 423?" 12. We may record that question 'E' in the appeal memo is an additional question which has an element of above noted question. We have, therefore, not separately reproduced the same in this order. The issue is whether the assessee who has incurred expenditure for scientific research, which was not in the in-house facility, could be covered for deduction under section 35(2AB) of the Income Tax Act, 1961. 13. More or less, facts are not in dispute. The assessee carried out scientific research in its facility approved by the prescribed authority. It incurred various expenditure including on clinical trials for developing its pharmaceutical products. These clinical trials were conducted outside the approved laboratory facility. The Revenue holds a belief that such expenditure not having been incurred in the approved facility cannot form part of the deduction provided under section 35(2AB) of the Act. The Tribunal observed that the term 'in- house' used in section 35(2AB) of the Act must be viewed in the context of which it has been used. If by utilizing the staff or resources of an organization, research is conducted within the organization rather than through utilization of external use of resources or staff, it can be stated to be an in-house research. On such basis, the Tribunal rejected the Revenue's contention that merely because an expenditure which was not incurred in the in-house facility cannot be discarded for the weighted deduction under section 35(2AB) of the Act. Learned counsel for the Revenue, however, strongly relied on the certificate issued by the Prescribed Authority, which segregated the expenditure in two parts, that incurred in in-house facility and that incurred outside. 14. In our opinion, the Tribunal committed no error. Section 35(2AB) of the Act provides for deduction to a company engaged in business of bio-technology or the business of manufacture or production of any article or thing notified by the Board towards expenditure of scientific research development facility approved by the prescribed authority. Such deduction at the relevant time was one-and- a-half times expenditure which has now been increased to twice the eligible expenditure. We may notice that explanation to section 35(2AB)(1) which was introduced by the Finance Act 2001 with effect from 1.4.2002 reads as under: "Explanation - For the purposes of this clause, "expenditure on scientific research" in relation to drugs and pharmaceuticals, shall include expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority under any Central, State or Provincial Act and filing an application for a patent under the Patents Act, 1970 (39 of 1970)." 15. Such explanation thus provides that for the purpose of said clause, i.e. clause (1) of section 35(2AB), expenditure on scientific research in relation to drugs and pharmaceuticals shall include expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority under the Central, State or Provincial Act and filing an application for a patent under the Patents Act, 1970. 16. The whole idea thus appears to be to give encouragement to scientific research. By the very nature of things, clinical trials may not always be possible to be conducted in closed laboratory or in similar in-house facility provided by the assessee and approved by the prescribed authority. Before a Page | 11
Marksans Pharma Ltd. ITA no.1717/Mum./2023 pharmaceutical drug could be put in the market, the regulatory authorities would insist on strict tests and research on all possible aspects, such as possible reactions, effect of the drug and so on. Extensive clinical trials, therefore, would be an intrinsic part of development of any such new pharmaceutical drug. It cannot be imagined that such clinical trial can be carried out only in the laboratory of the pharmaceutical company. If we give such restricted meaning to the term expenditure incurred on in-house research and development facility, we would on one hand be completely diluting the deduction envisaged under sub-section (2AB) of section 35 and on the other, making the explanation noted above quite meaningless. We have noticed that for the purpose of the said clause in relation to drug and pharmaceuticals, the expenditure on scientific research has to include the expenditure incurred on clinical trials in obtaining approvals from any regulatory authority or in filing an application for grant of patent. The activities of obtaining approval of the authority and filing of an application for patent necessarily shall have to be outside the in-house research facility. Thus the restricted meaning suggested by the Revenue would completely make the explanation quite meaningless. For the scientific research in relation to drugs and pharmaceuticals made for its own peculiar requirements, the Legislature appears to have added such an explanation. 17. In the case Dy. CIT v. Mastek Ltd. [2012] 210 Taxman 432/25 taxmann.com 133 (Guj.) and connected matters, a Division Bench of this Court had touched on the aspect of what can be termed as scientific research. In the context, certain observations made by the Bench may be of some relevance. "25. It can thus be seen that the term scientific research in the context of the deduction allowable under section 35(1) of the Act would include wide variety of activities. It can also be appreciated that every scientific research need not necessarily result into the ultimate goal with which it may have been undertaken. Often times in the field of research and invention, the efforts undertaken may or may not yield fruitful results. What is to be ascertained is whether any scientific research was undertaken and not whether such scientific research resulted into the ultimate aim for which such research was undertaken. It can be easily envisaged that the scientific research undertaken often times would completely fail to achieve desired results. That by itself does not mean that no scientific research was undertaken. What the Legislature desired to encourage by granting deduction under section 35(1) of the Act was a scientific research and not necessarily only the successful scientific research undertaken by an assessee." 18. We are, therefore, of the opinion that the Tribunal committed no error. Merely because the prescribed authority segregated the expenditure into two parts, namely, those incurred within the in-house facility and those can were incurred outside, in our opinion, by itself would not be sufficient to deny the benefit to the assessee under section 35(2AB) of the Act. It is not as if that the said authority was addressing the issue for deduction under section 35(2AB) of the Act in relation to the question on hand. The certificate issued was only for the purpose of listing the total expenditure under the Rules. Therefore, no question of law arises.”
Therefore, respectfully following the decision of the Hon’ble Gujarat High Court, we are of the view that the assessee is entitled to claim weighted
Marksans Pharma Ltd. ITA no.1717/Mum./2023 deduction on expenditure of Rs. 184.95 lakh under section 35(2AB) of the Act in respect of the clinical trial expenses incurred outside the approved in-house R&D facility. As regards, the balance expenditure of Rs. 27.90 lakh, as per the assessee the same was in relation to electricity expenses, which are directly related to the R&D centre at the Goa unit. Thus, we are of the view that the said expenditure is also eligible for weighted deduction under section 35(2AB) of the Act in view of the aforesaid findings.
Further, as regards the decisions of the coordinate bench of the Tribunal in DCIT v/s Ajeet Seeds Ltd, [2023] 199 ITD 600 (Pune-Trib.), Saarloha Advanced Material Private Limited v/s DCIT, [2023] 201 ITD 254 (Pune-Trib.) and the decision of the Hon’ble Kerala High Court in Apollo Tyres Ltd v/s DCIT [2021] 133 taxmann.com 284 (Kerala), relied upon by the learned DR, requisite approval under section 35(2AB) of the Act from the prescribed authority was not available with the taxpayer during the relevant period and therefore the weighted deduction claimed under section 35(2AB) of the Act was denied in the aforesaid decisions. However, as noted above, in the present case the assessee furnish a copy of the order of approval in Form No. 3CM given by DSIR during the assessment proceedings. Thus the decisions relied upon by the learned DR are factually distinguishable.
Therefore, in view of the aforesaid findings, the impugned order passed by the learned CIT(A) is set aside and the AO is directed to grant weighted deduction on the revenue expenditure of Rs. 212.85 lakh under section 35(2AB) of the Act. Accordingly, grounds raised by the assessee are allowed.
Marksans Pharma Ltd. ITA no.1717/Mum./2023 17. In the result, the appeal by the assessee is allowed. Order pronounced in the open Court on 22/08/2023
Sd/- Sd/- B.R. BASKARAN SANDEEP SINGH KARHAIL ACCOUNTANT MEMBER JUDICIAL MEMBER
MUMBAI, DATED: 22/08/2023 Copy of the order forwarded to: (1) The Assessee; (2) The Revenue; (3) The PCIT / CIT (Judicial); (4) The DR, ITAT, Mumbai; and (5) Guard file. True Copy By Order Pradeep J. Chowdhury Sr. Private Secretary Assistant Registrar ITAT, Mumbai