FRONTIER TEXTILES (P) LTD. ,HOWRAH vs. DCIT,CIR-1(1), KOLKATA, KOLKATA

ORDER / आदेश This is the appeal preferred by the assessee against the order of the Ld. Commissioner of Income Tax (Appeals)- NFAC [hereinafter referred to as ‘Ld. CIT(A)’] dated 13.06.2023 for the assessment year 2014-15.

Assessment Year:2014-15 Frontier Textiles (P) Ltd. of Defense and other PSUs like Indian Oil Corporation Ltd, Bharat Petroleum Ltd , Oil & Natural Gas Corporation Ltd and Ordnance Factories Ltd etc. Therefore it is imperative for the assessee to get these specialized garments tested from time to time by Research & Development Department of the Ministry of Defense, Govt of India namely DRDO to check suitability for strategic end-use of the fire retardant overall (FR). The said fire retardant overall (FR) has to be regularly modified and upgraded in accordance with the requirements of Defense and other departments and required to undergo testing by DRDO/government designated agencies. During the year the assessee paid a sum towards testing fee to DRDO a government department for testing these products which were to be manufactured by the assessee for Defense and other Government PSUs. According to AO, the expenses of Rs. 8,27,250/- charged under the head knowhow constituted capital expenditure and accordingly the same was disallowed as capital expenditure and added the same to the income of the assessee.

“5.2. Grounds of appeal no. 2 is against disallowance of expenses on knowhow of Rs. 8,27,250/-. 5.2.1 I have considered the facts of the case, perused the assessment order, submission of the appellant and available materials on records. During the time of assessment proceedings, the AO had noticed that the appellant had debited an amount of Rs. 8,27,250/- under the hand knowhow. The assessing officer asked the appellant company to explain as to why this expense should not be treated as capital expenditure since know how falls under intangible assets. As the appellant could not offer satisfactory explanation on this issue, therefore, the Assessing officer treated the same as capital in nature and added back in the return of income of the company. During the appellate proceedings, the appellant company filed response on this issue which is reproduced as hereunder: “The Assessing Officer has wrongly disallowed a sum ofRs. 8,27,250.00 debited under the Head “KNOW-HOW” treating the same as capital in nature and added back to thetotal income of the assessee. It is submitted that this company is manufacturing specialized work-wear for the Ministry of Defense - Army, Navy & Air- force and it is necessary and-imperative for us to test these specialized garments jointly and in conjunction with various R&D department of Ministry of Defense to suit the strategic end use of the work-wear. The above referred amount represents amount paid to Defence Bio-Engineering and Electro Medical Laboratory (DEBEL), a constituent laboratory of the Defence Research and Development Organisation (DRDO), Ministry of' Defence, Government of India, being their laboratory and testing charges fortesting of the FR(Fire Resistant) quality of flying overalls for Indian Air-Force. The above referred expenditure cannot betreaed as Capital

Assessment Year:2014-15 Frontier Textiles (P) Ltd.

Expenditure but is a Revenue Expenditure. There is no acquisition of any asset but the expenditure is only to test the quality of the Fire Resistant Garment. Reliance is placed on the following judgments wherein it has been held that research &development expenditure of an existing cannot be treated as Capital expenditure.

on this issue are not allowed and decided in the favour of the revenue.”

5. After hearing the rival contentions and perusing the material on record, we find that the nature of manufacturing carried on by the assessee is such that it requires for testing the products to check its suitability of endues which are made for defense services and various PSUs as these are specialized in nature which can withstand the particular condition/temperature. We observe that for this purpose the assessee has to get the product approved from the DRDO , the requisite Govt. Agency for which testing fees was paid to it during the year. We note that these expenses were recurring in nature and also that this is not the first time to introduce new products in the manufacturing lines of the assessee. Therefore by no stretch of imagination the expenses charged by the assessee of Rs. 8,27,250/- can be treated as capital expenditure. In our opinion, the expenses are of revenue nature which are incurred in the normal course of business and is wholly and exclusive for the purpose of business. In other words only after testing the products manufactured by the assessee for defense services, these can be supplied to the defense forces and other Govt Bodies as the satisfaction of the products is pre-requisite and a contractual condition. Therefore we are not in a position to sustain the order of Ld. CIT(A) on this issue. The Ld. CIT(A) also relied on the decision of Honda Siel Cards India Ltd. (supra) however we note that the said decision has been rendered by the Hon’ble Apex Court in the Assessment Year:2014-15 Frontier Textiles (P) Ltd. context of product launched by the company for the first time. Therefore the decision of the Hon’ble Apex Court in clearly distinguishable. In view of these facts, we set aside the order of the Ld. CIT(A) and direct the AO to delete the addition.

6. Issue raised in Ground no. 2 challenged by the assessee is against the confirmation of disallowance of Rs. 2,13,086/- by the Ld. CIT(A) as made by the AO in respect of PF/ESI u/s 2(24)(x) read with Section 36(1)(va) of the Act.

Relevant extract of the said judgment is reproduced as under: “• The deduction made by employers to approved provident fund schemes, is the subject matter of Section 36(1) (iv). It is noteworthy, that this provision was part of the original IT Act; it has largely remained unaltered. On the other hand, Section 36(1)(va) was specifically inserted by the Finance Act, 1987, w.e.f. 01-04-1988. Through the same amendment, by Section 3(b), Section 2(24) – which defines various kinds of "income" – inserted clause (x). This is a significant amendment, because Parliament intended that amounts not earned by the assessee, but received by it, - whether in the form of deductions, or otherwise, as receipts, were to be treated as income. The inclusion of a class of receipt, i.e., amounts received (or deducted from the employees) were to be part of the employer/assessee's income. Since these amounts were not receipts that belonged to the assessee, but were held by it, as trustees, as it were, Section 36(1)(va) was inserted specifically to ensure that if these receipts were deposited in the EPF/ESI accounts of the employees concerned, they could be treated as deductions. Section 36(1)(va) was hedged with the condition that the amounts/receipts had to be deposited by the employer, with the EPF/ESI, on or before the due date. The last expression "due date" was dealt with in the explanation as the date by which such amounts had to be credited by the Assessment Year:2014-15 Frontier Textiles (P) Ltd. employer, in the concerned enactments such as EPF/ESI Acts. Importantly, such a condition (i.e., depositing the amount on or before the due date) has not been enacted in relation to the employer's contribution (i.e., Section 36(1)(iv)).

• The significance of this is that Parliament treated contributions under Section 36(1)(va) from those under Section 36(1)(iv). The latter (hereinafter, "employers' contribution") is described as "sum paid by the assessee as an employer by way of contribution towards a recognized provident fund". However, the phraseology of Section 36(1)(va) differs from Section 36(1)(iv). It enacts that "any sum received by the assessee from any of his employees to which the provisions of sub-clause (x) of clause (24) of section 2 apply, if such sum is credited by the assessee to the employee's account in the relevant fund or funds on or before the due date." The essential character of an employees' contribution, i.e., that it is part of the employees' income, held in trust by the employer is underlined by the condition that it has to be deposited on or before the due date.

• The differentiation is also evident from the fact that each of these contributions is separately dealt with in different clauses of Section 36 (1). All these establish that Parliament, while introducing Section 36(1)(va) along with Section 2(24)(x), was aware of the distinction between the two types of contributions. There was a statutory classification, under the IT Act, between the two.

• There is no doubt that in Alom Extrusions, this court did consider the impact of deletion of second proviso to Section 43B, which mandated that unless the amount of employers' contribution was deposited with the authorities, the deduction otherwise permissible in law, would not be available. This court was of the opinion that the omission was curative, and that as long as the employer deposited the dues, before filing the return of income tax, the deduction was available. A reading of the judgment in Alom Extrusions, would reveal that this court, did not consider Sections 2(24)(x) and 36(1)(va). Furthermore, the separate provisions in Section 36(1) for employers' contribution and employees' contribution, too went unnoticed.

• When Parliament introduced Section 43B, what was on the statute book, was only employer's contribution (Section 36(1)(iv)). At that point in time, there was no question of employee's contribution being considered as part of the employer's earning. On the application of the original principles of law it could have been treated only as receipts not amounting to income. When Parliament introduced the amendments in 1988-89, inserting Section 36(1)(va) and simultaneously inserting the second proviso of Section 43B, its intention was not to treat the disparate nature of the amounts, similarly. As discussed previously, the memorandum introducing the Finance Bill clearly stated that the provisions – especially second proviso to Section 43B - was introduced to Assessment Year:2014-15 Frontier Textiles (P) Ltd. ensure timely payments were made by the employer to the concerned fund (EPF, ESI, etc.) and avoid the mischief of employers retaining amounts for long periods. That Parliament intended to retain the separate character of these two amounts, is evident from the use of different language. Section 2(24)(x) too, deems amount received from the employees (whether the amount is received from the employee or by way of deduction authorized by the statute) as income - it is the character of the amount that is important, i.e., not income earned. Thus, amounts retained by the employer from out of the employee's income by way of deduction etc. were treated as income in the hands of the employer. The significance of this provision is that on the one hand it brought into the fold of "income" amounts that were receipts or deductions from employees income; at the time, payment within the prescribed time – by way of contribution of the employees' share to their credit with the relevant fund is to be treated as deduction (Section 36(1)(va)). The other important feature is that this distinction between the employers' contribution (Section 36(1)(iv)) and employees' contribution required to be deposited by the employer (Section 36(1)(va)) was maintained - and continues to be maintained. On the other hand, Section 43B covers all deductions that are permissible as expenditures, or out-goings forming part of the assessees' liability. These include liabilities such as tax liability, cess duties etc. or interest liability having regard to the terms of the contract. Thus, timely payment of these alone entitle an assessee to the benefit of deduction from the total income. The essential objective of Section 43B is to ensure that if assessees are following the mercantile method of accounting, nevertheless, the deduction of such liabilities, based only on book entries, would not be given. To pass muster, actual payments were a necessary pre-condition for allowing the expenditure.

• The distinction between an employer's contribution which is its primary liability under law – in terms of Section 36(1)(iv), and its liability to deposit amounts received by it or deducted by it (Section 36(1)(va)) is, thus crucial. The former forms part of the employers' income, and the later retains its character as an income (albeit deemed), by virtue of Section 2(24)(x) - unless the conditions spelt by Explanation to Section 36(1)(va) are satisfied i.e., depositing such amount received or deducted from the employee on or before the due date. In other words, there is a marked distinction between the nature and character of the two amounts – the employer's liability is to be paid out of its income whereas the second is deemed an income, by definition, since it is the deduction from the employees' income and held in trust by the employer. This marked distinction has to be borne while interpreting the obligation of every assessee under Section 43B.

• The non-obstante clause in section 43B would not in any manner dilute or override the employer's obligation under section 36(1)(va) to deposit the amounts retained by it or deducted by it from the employee's income, unless the condition that it is deposited on or before the due date, is correct and justified.

Assessment Year:2014-15 Frontier Textiles (P) Ltd. The non-obstante clause has to be understood in the context of the entire provision of Section 43B which is to ensure timely payment before the returns are filed, of certain liabilities which are to be borne by the assessee in the form of tax, interest payment and other statutory liability. In the case of these liabilities, what constitutes the due date is defined by the statute. Nevertheless, the assessees are given some leeway in that as long as deposits are made beyond the due date, but before the date of filing the return, the deduction is allowed. That, however, cannot apply in the case of amounts which are held in trust, as it is in the case of employees' contributions- which are deducted from their income. They are not part of the assessee employer's income, nor are they heads of deduction per se in the form of statutory pay out. They are others' income, monies, only deemed to be income, with the object of ensuring that they are paid within the due date specified in the particular law. They have to be deposited in terms of such welfare enactments. It is upon deposit, in terms of those enactments and on or before the due dates mandated by such concerned law, that the amount which is otherwise retained, and deemed an income, is treated as a deduction. Thus, it is an essential condition for the deduction that such amounts are deposited on or before the due date. If such interpretation were to be adopted, the non-obstante clause under Section 43B or anything contained in that provision would not absolve the assessee from its liability to deposit the employee's contribution on or before the due date as a condition for deduction.”

Respectfully following the decision of Hon’ble Supreme Court (supra) which squarely covers the grounds taken by the assessee against it , the ground taken by the assessee is hereby dismissed.

Order is pronounced in the open court on 14th December, 2023