DY. COMMISSIONER OF INCOME TAX, CIRCLE-1(1), PUNE, PUNE vs. INDUS BIOTECH LIMITED, PUNE

Aggrieved, the assessee filed appeal before the Ld.CIT(A)/NFAC, challenging the above disallowance of Rs. 2,48,18,076/- made by the Ld.AO u/s. 35(1)(iv) of the Act. Before the Ld.CIT(A)/NFAC the assessee filed detailed submissions in support of its claim, which is reproduced by the Ld.CIT(A)/NFAC in para 4 of his impugned order. After considering the assessee‟s submission and the documents filed in support of its claim, the Ld.CIT(A)/NFAC allowed the appeal of the assessee on the impugned issue by observing as under:

Dissatisfied by such order of the Ld.CIT(A)/NFAC, the Revenue is in appeal before the Tribunal raising the following grounds of appeal:

The Ld.DR. relied on the order of the Ld.AO and submitted that since the assessee did not furnish complete details about the R&D

The Ld.AR, on the other hand, supported the order of the Ld.CIT(A)/NFAC. He submitted that the third party payments have been made in respect of research conducted on clinical trials. He referred to clinical study report placed on pg. 109 of the factual paper book in support thereof. The Ld.AR submitted that the clinical testing/trials done by the third parties forms an integral part of the in-house research conducted by the assessee and, therefore, the expenditure has been incurred for the business of the assessee.

Referring to page 82-120 of the factual paper book, the Ld.AR submitted that before the Ld.AO the assessee had filed detailed submission in respect of the payments made by the assessee to third parties towards tests and trials along with the copies of sample reports of some of the third party service providers. To substantiate its above submission/assertion, the Ld.AR placed on record a copy of the e-filing acknowledgment together with the detailed e-filed submission made before the Ld.AO in response to the show cause notice dt. 18-12-2022. Accordingly, he submitted that the clinical trial reports relied upon by the Ld.CIT(A)/NFAC were duly and timely submitted before the Ld.AO during the course of assessment proceedings. He further submitted that before the Ld.AO, the assessee has raised only an alternate contention that if at all the disallowance has to be made, it should be restricted to the amount of Rs. 2,48,18,076/- which is paid to third party institution. The Ld.AR therefore, submitted that all the relevant details/documents were duly furnished before the Ld.AO, and only after examining the same, he disallowed the assessee‟s claim of deduction u/s. 35(1)(iv) of the Act

Further, relying on the following decisions, the Ld.AR contended that expenditure incurred on scientific research related to the business carried on by the assessee even if capital in nature, is eligible for deduction u/s.35(1)(iv) of the Act and there is no embargo/restriction in the section to claim the deduction: [2003] 263 ITR 453 (Gujarat HC); ii. (Karnataka HC); iii. Mahle Behr India (P.) Ltd. vs. DCIT, ITA No. 795/Pun.2017 (Pune Tribunal); iv. Escorts Ltd. vs. ACIT, ITA Nos. 567 & 1562/Del/2005 (Delhi Tribunal)

We have heard the Ld. Representatives of the Parties and perused the material available on record, the paper book(s) filed by the Ld.AR on behalf of the assessee and the judicial precedents relied upon by the Ld.AR. We find that the Ld.AO, vide his order dt. 27-12-2022 passed u/s.143(3) r.w.s. 144B of the Act assessed the total income of the assessee at Rs. 44,40,28,340/-, thereby disallowing the deduction amounting to Rs. 2,48,18,076/- claimed u/s.35(1)(iv) of the Act in respect of payment made to third parties for testing/clinical trials of the products. On appeal, the Ld.CIT(A)/NFAC allowed the assessee‟s appeal on the impugned issue for the reasons which we have already stated in the preceding paragraphs. We find that the Ld.AO has disallowed the assessee‟s claim primarily for the reason that the assessee has not furnished complete details about the research and development activities and evidences in support of payments

The above contention of the assessee is also supported by a copy of the e-filing acknowledgment of the reply filed by the assessee which is placed on record by the Ld.AR. This makes it abundantly clear that the clinical trial repots relevant to the scientific research under consideration were duly furnished by the assessee at the time of assessment proceedings

In view of the discussion above, we do not find any merit in the contention of the Revenue. In our view, payment made to third parties for clinical trials/testing claimed as deduction u/s.35(1)(iv) of the Act forms an integral part of the in-house research and development activities carried out by the assessee. We also find force in the contention of the Ld.AR that expenditure of capital nature on scientific research related to the business carried on by the assessee is eligible for deduction u/s.35(1)(iv) of the Act.

We find that an identical issue had come up for consideration before the Hon‟ble Karnataka High Court in the case of CIT vs. Talisma Corporation (P.) Ltd. (supra). The Hon‟ble High Court decided the impugned issue in favour of the assessee and against the Revenue, holding as under:

We find that the Co-ordinate Bench of the Pune Tribunal in the case of Mahle Behr India (P.) Ltd. vs. DCIT (supra) has also allowed the assessee‟s claim of capital expenditure incurred on scientific research u/s.35(1)(iv) of the Act. The relevant extract of the aforesaid decision is reproduced below:

As per the pre-existing clause (b), the prescribed authority was supposed to submit only its report in relation to the approval of in- house R&D facility to the Director General (Income-tax Exemptions). The stipulation of quantifying the eligible expenditure by the competent authority for the purposes of weighted deduction u/s 35(2AB) was not there. The only requirement was to submit the report in relation to the approval of in-house R&D facility. Any amount of expenditure incurred in respect of in-house R&D facility qualified for the deduction whether or not approved by the prescribed authority. Only the existence of approval and incurring of the expenditure were relevant considerations in the pre-amended era and not the amount quantified by the prescribed authority. The new stipulations came to be introduced w.e.f. 01-072016. As the assessment year under consideration is 2011-12 and the approval was granted by DSIR on 07-12-2010, the amended sub-clause (b) of Rule 6 (7A) coming into vogue even after the passing of the assessment order can have no applicability. We, therefore, hold that the Id. CIT(A) was not justified in restricting the amount of weighted deduction to the quantification done by the prescribed authority. The impugned order is reversed on this score.

The ld. CIT(A) also held that the capital expenditure in the nature of Intangibles incurred by the assessee could not qualify for the weighted deduction. For this purpose, he relied on the 'Guidelines for approval in Form 3CM of inhouse R&D Centres recognized by DSIR' dated May 2014. Para 4 of such Guidelines contains 'Conditions subject to which approval is given. Clause (xi) of para 4 runs as under:

It can be seen from the above that the capital expenditure of intangible nature has been made ineligible for the weighted deduction. However, it is crucial to note that this ineligibility has been introduced by means of Guidelines issued in May 2014. The predecessor Guidelines of May 2010 did not contain any clause similar to clause (xi) of the 2014 Guidelines. Since the assessment year under consideration is 2011-12, the Guidelines issued in May, 2014 can have no application to the case. We, therefore, overturn the impugned order on this score.

Now we come to the expenditure incurred outside India for which the assessee raised a claim of weighted deduction u/s.35(2AB) that was not allowed by the AO. The Id. AR claimed that the assessee was entitled to such deduction, which contention was strongly countered by the Id. DR. In order to appreciate the rival contentions, it would be befitting to have a glance at the relevant part of section 35(2AB) which is as under: "(2AB)(1) Where a company... 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... of the expenditure so incurred: Provided..."

A cursory look at the above provision deciphers the conditions for the weighted deduction, inter alia, that an eligible company incurs any expenditure on scientific research (other than cost of land or building) on in-house research and development facility as approved by the prescribed authority. The key words in the provision are incurring of expenditure on in-house R&D facility as approved by the prescribed authority. Unless a particular R&D facility is approved by the prescribed authority, no weighted deduction can follow. On a pertinent query, the ld. AR admitted that the prescribed authority approved the inhouse R&D unit of the assessee situated at "Gat No.626/1/2 and 622/1/0, 26 Milestone, Pune-Nasik Highway, Village Kuruli, Tal: Khed, District Pune". On a further query, the ld. AR submitted that the assessee's approved R&D facility was engaged in designing and developing of Engine cooling systems and HVAC systems for vehicles. During the designing and development phase, engine coolant and HVAC systems are required to be put in Performance Evaluation Testing in variant weather conditions artificially created, for which sophisticated technology and set up is required that is not available in India. It was for such Performance Evaluation Test under variant weather conditions artificially created that the assessee availed services from its three AEs situated abroad. It was pointed out that the three AEs conducted the needful tests for which the assessee incurred total cost of Rs.9.61 crore tabulated under Column "Outside India", which was accepted by the TPO at ALP.

From the above discussion, it is abundantly clear that the total sum of Rs.9.61 crore incurred by the assessee outside India has not been incurred on inhouse R&D facility as approved by the prescribed authority. What to talk of inhouse R&D facility of the assessee approved by the prescribed authority, here is a case in which the assessee incurred these costs for availing services from the R&D facilities of its AEs. Since the R&D facilities for which the assessee incurred costs outside India are neither of the assessee nor approved by the prescribed authority, there can be no question of granting any 15 weighted deduction on the expenses incurred outside India. To sum up, it is held that the assessee is entitled to weighted deduction u/s 35(2AB) on total amount of expenditure incurred in India amounting to Rs5,45,58,297. Resultantly, no weighted deduction is admissible in respect of expenditure incurred butside India amounting to Rs.9,61,80,237/-

At this juncture, it is pertinent to note the mandate of section 35 with the caption Expenditure scientific research. Clause (iv) of section 35(1) provides for deduction of expenditure on scientific nature "in respect of any expenditure of a capital nature on scientific research related to the business carried on by the assessee, such deduction as may be admissible under the provisions of sub-section (2)." Sub- section (2) of section 35, in turn, provides through sub-clause (ia) that for the purposes of clause (iv) of sub-section (1): 'in a case where such capital expenditure is incurred after the 31 day of March, 1967, the whole of such capital expenditure incurred in any previous year shall be deducted for that previous year". The proviso provides for not allowing deduction in respect of expenditure incurred on acquisition of any land. On a conjoint reading of section 35(1) (iv) read with section 35(2), it is manifested that any expenditure of capital nature incurred on scientific research, other than the cost of land etc., qualifies for full one time deduction in the year of such incurring. Unlike sub-section (2AB), sub-section (1) does not require any specific approval from the prescribed authority for this purpose. Further, there is no stipulation that the expenditure should be incurred in India or outside or in-house R&D facility or otherwise, save and except as provided in other clauses of sub-section (1) of section 35. However, the amount of deduction u/s.35(1) is equal to the amount of capital expenditure on scientific research.

Coming back to the amount of expenditure incurred by the assessee outside India amounting to Rs.9,61,80,237/-, we find that the expenditure of revenue nature, namely, Rs.74,95,427/- was claimed by the assessee as revenue expenditure and accordingly allowed also. It is only the remaining capital expenditure of Rs.8,86,84,811/- [Rs.3,39,60,518/- being sub-total (A) and Rs.5,47,24,293/- being sub-total (B)] that qualifies for deduction u/s.35(1)(iv). We order accordingly.

The ld. DR took strong exception to the claim of the Id. AR for granting deduction of the capital expenditure on scientific research and development incurred outside India u/s.35(1)(iv). He submitted that no such ground has been taken by the assessee. It is apparent that the assessee raised a claim for weighted deduction on such an amount u/s.35(2AB) of the Act. We have held hereinabove that the amount does not qualify for the weighted deduction. The fact that the claim of the assessee cannot be entertained under one provision does not oust it from consideration under any other provision, if it is otherwise allowable under such latter provision. We have noticed that the amount of capital expenditure incurred on research and development outside India is eligible for deduction u/s.35(1)(iv). The same, therefore, has to be allowed as such. The Id. DR's contention in this regard is sans merit and hence repelled.

To summarize, the entire amount of R&D expenditure incurred in India is eligible for weighted deduction u/s 35(2AB); revenue R&D expenditure incurred outside India as claimed by the assessee got allowed in the assessment itself; total of capital R&D expenditure incurred outside India will be eligible for deduction u/s 35(1)(iv) of the Act."

Respectfully following the decision of the Co-ordinate Bench of the Tribunal in assessee's own case, we hold that the entire amount of R&D expenditure incurred in India is eligible for weighted deduction u/s 35(2AB); revenue R&D expenditure incurred outside India as claimed by 16 the assessee got allowed in the assessment itself; total of capital R&D expenditure incurred outside India will be eligible for deduction u/s 35(1)(iv) of the Act.

In the result, the appeal filed by the assessee is allowed.”

We find that similar view has been taken by the Delhi Tribunal in the case of Escorts Ltd. vs. ACIT (supra), wherein the Tribunal dismissed the Revenue‟s appeal on the impugned issue, by observing as under:

Ground No. 8 of the grounds of appeal of the Revenue is as under: On the facts and in the circumstances of the case and in law, the CIT(A) has erred in deleting the disallowance of Rs. 41,48,896 made by the AO on development of existing products ignoring that such expenditure imparted a benefit of enduring nature and as such was of capital nature. The CIT(A) also ignored that the assessee had separately claimed deduction under Section 35(1) (iv) of Rs. 23,93,88,410 as capital R&D expense and treated this expenditure of Rs. 41,48,896 only as pre- operative expense.

The said ground taken by the Revenue is against the action of the CIT(A) in deleting the disallowance of Rs. 41,48,896 made by the AO representing expenditure on development of existing products of the assessee-company. The facts are that the assessee had claimed in its return of income the impugned expenses on its R&D activity undertaken to improve the quality of its products. The AO rejected the claim and held that the expenditure was capital in nature on the ground that it resulted in imparting of enduring benefits to the assessee-company. In appeal before the CIT(A), the assessee contended that it has got R&D division which continuously undertakes research activity, and that the impugned expenditure has been incurred consistently even in the earlier assessment years. That no disallowance was made in any of the assessment years on this count. The CIT(A), after considering the facts and the pleas of the assessee, allowed the claim of the assessee for treating the impugned expenditure as revenue expenditure. The CIT(A) found that even if the expenditure was to be considered as a capital expenditure, yet the same being in the nature of R&D expenditure, it was an allowable deduction in terms of Section 35(1)(iv) of the Act. Revenue is presently in appeal against the aforesaid finding of the CIT(A).

Before us, the learned Departmental Representative has relied on the order of the AO in support of her submissions. The learned Counsel appearing on behalf of the assessee has defended the orders of the CIT(A) reiterating the submissions made before the lower authorities. Our attention was invited to p. 113 of the assessee's paper book with regard to the details of expenditure. It is submitted that the impugned expenditure has been incurred by the assessee in its engineering division in relation to various products being manufactured namely, tractors, agricultural machinery, etc.

Having considered the rival submissions and the orders of the lower authorities with reference to the material on record, in our view, the conclusion drawn by the CIT(A) is justified on facts and in law. Insofar as the nature of expenditure is concerned, there is no dispute that the same relates to the developmental activities carried out by the assessee in its R&D division. The question whether the expenditure is revenue or capital, loses its significance while considering its deductibility because the nature of expenditure is on account of Research and Development. In terms of Clause (iv) of Sub-section (1) of Section 35, any expenditure, being in the nature of capital expenditure incurred on research related to the business carried on by the assessee, is an admissible deduction.

Based on the factual matrix of the case and legal position set out above, and in the absence of any contrary material/judicial precedents brought on record by the Revenue, in our view, there is hardly any substance in the grounds of appeal raised by the Revenue. We do not find any infirmity in the order of the Ld.CIT(A)/NFAC which we hereby confirm. Accordingly, the grounds raised by the Revenue are dismissed.

In the result, the appeal filed by the Revenue is dismissed.

The concerned Pr.CIT, Pune

DR, ITAT, „A‟ Bench, Pune 5. ग र्ड फ ईल / Guard file. आदेशानुसार/ BY ORDER, ////