DCIT -CC-5(2) , MUMBAI vs. M/S. USV PVT. LTD, MUMBAI

These are two appeals filed by the Revenue arising from the order of the Learned Commissioner of Income Tax (Appeals)-53, Mumbai [hereinafter referred to as ‗the CIT(A)‘], for the Assessment Years 2014-15 and 2015-16. The appeals were heard together as they involved identical issues and are, therefore, being disposed of by way of common order. Though the appeals were filed after the expiry of period of 60 days prescribed in Section 253(3) of the Act, the same are being treated as being filed within limitation as the appeals have been filed within the extended time allowed by ITA No. 2575 & 2576/Mum/2021 Assessment Year: 2014-15 & 2015-16 the Hon‘ble Supreme Court vide order, dated 23.03.2020 and 27.04.2021 passed in the Suo Motu Writ Petition (Civil) No. 3 of 2020 read with order, dated 23.09.2021, passed in M.A. No. 665 of 2021 in Suo Motu Writ Petition (Civil) No. 3 of 2020. 2. We would first take appeal preferred by the Revenue for the Assessment Year 2014-15 which is directed against the order of the CIT(A) passed on 29.01.2021 passed in appeal against the Assessment Order, dated 25.11.2016, passed under Section 143(3) of the Income Tax Act, 1961 [hereinafter referred to as ‗the Act‘].

The Revenue has raised following grounds of appeal:

The Assessee is a private limited company engaged in the business of manufacturing and marketing of pharmaceuticals products and bulk product. For the relevant assessment year, the Assessee had in-house Research & Development units at Govandi, Mumbai and Shirvane, Navi Mumbai (hereinafter referred to as ‗R&D Facilities‘) which were approved by Department of Scientific & Industrial Research (DSIR). During the relevant previous year the Assessee incurred Research & Development Expenses (‗R&D Expenses‘ for short).

The Assessee filed return of income for Assessment Year 2014-15 on 24.11.2014 declaring total income of INR 181,23,43,120/- under the normal provisions of Act and book profits of INR 544,78,26,802/- under Section 115JB of the Act. The case of the Assessee was selected for scrutiny. Assessment was framed on the Assessee under Section 143(3) of the Act was framed on the Assessee vide order dated 25.11.2016 at income of INR 219,79,35,930/- under the normal provisions of the Act after making, inter alia, disallowance INR 34,05,83,000/- in respect of weighted deduction for the following expenses claimed by the Assessee under Section 35(2AB) of the Act:

Foreign Consultancy 1,07,30,000

Difference in research & development 41,05,000/- expenses not reflected in the annual report

Security Charges 25,19,000

QC/Testing /Entertainment 2,54,58,000

Contract Labour Charges 1,40,16,000 Total 34,05,83,000 Assessment Year: 2014-15 & 2015-16

Being aggrieved, the Assessee carried the issue in appeal before CIT(A). Vide order, dated 29.01.2021, the CIT(A) allowed weighted deduction at the rate of 200% under Section 35(2AB) of the Act for Clinical Trial Expenses (INR 16,69,10,209/-) , Consultancy Fee (INR 74,19,078/-), and Quality Control/Testing Expenses (INR 2,54,29,652/-). The CIT(A) also allowed the additional ground raised by the Assessee and allowed deduction in respect of R&D Expenses on gross basis without netting of the income earned from sale of R&D products and assets. Further, the CIT(A) also allowed deduction for education cess paid by the Assessee under Section 37(1) of the Act.

Being aggrieved, the Revenue is in appeal before us challenging the order passed by the CIT(A) granting the above relief to the Assessee on the grounds specified in paragraph 3 above.

The Learned Departmental Representative appearing before us relied upon the order passed by the Assessing Officer whereas the Learned Authorised Representative for Assessee supported the order passed by the CIT(A). We have considered the rival submission and perused the material on record including the judicial pronouncements referred to and relied upon by both the sides during the course of the hearing.

By way of Ground No. 1 the Revenue has challenged the order of CIT(A) allowing weighted deduction at the rate of 200% under Section 35(2AB) of the Act for Clinical Trial Expenses (INR.16,69,10,209/-) and Quality Control/Testing Expenses (INR.2,54,29,652/-) raising the contention that weighted deduction Assessment Year: 2014-15 & 2015-16 at the rate of 200% should not have been allowed by the CIT(A) in respect of the aforesaid expenses under Section 35(2AB) of the Act as, firstly, the aforesaid expenses were not approved by DSIR and, secondly, the same have been incurred outside the R&D facilities. We note that both the aforesaid contentions raised by the Revenue have been considered and rejected by the Tribunal and/or Hon‘ble High Court in various decisions and following the same the CIT(A) has granted relief to the Assessee.

In the case of ACIT vs. Crompton Greaves Ltd.:[2019] 111 Taxmann.com 338 (Mumbai-Trib.), the Tribunal has held:

The operative phrase here is "on in-house research and development facility as approved by the prescribed authority..", the word "facility" has been hereby show us to emphasis the point that it is the unit which requires approval of the prescribed authority under this provision. Further, in the memorandum, explaining the provision of section and the notes on the clauses issued at the time of insertion of section 35(2AB) in the Act, copies of both of which have been filed on record before us by the assessee, it has been clearly provided that the deduction would be available to the assessee's having an approved in- Assessment Year: 2014-15 & 2015-16 house R&D facility by the prescribed authority. Undisputedly, there is no mention or approval of the quantum of expenditure. xxx xxx

It would also be apt to reproduce here-under the provisions substituted in clause (b) of sub rule (7A) of Rule 6, as brought in by the amendment effective from 01.07.2016 as above: "The prescribed authority shall furnish electronically its report,- (i) in relation to the approval of the in-house research and development facility in Part A of Room No. 3CL; (ii) quantifying the expenditure incurred on in-house research and development facility by the company during the previous year and eligible for weighted deduction under sub-section (2AB) of section 35 of the Income Tax Act, 1961 in Part B of Form No. 3CL."

Hitherto, the provision was as follows: "The prescribed authority shall submit its report in relation to the approval of in- house facility and development facility in Form No. 3CL to the Director General (Income-tax Exemptions) within sixty days of its granting approval." The above also makes it amply clear that prior to the amendment, i.e., upto 30.06.2016, it was not required to quantify the expenditure and it was only w.e.f. 01.07.2016 that this mandate has been put in place.

The year under consideration is A.Y. 2009-10 and, for this year, the amendment was not applicable. Therefore, the assessee is right in contending that the non approval of the expenditure claimed by CSIR did not entitle the A.O. to make the disallowance and the ld. CIT(A) to confirm the same.‖ (Emphasis Supplied)

Following the above decision of the Tribunal, the CIT(A) concluded that for the relevant assessment year for allowing weighted deduction under Section 35(2AB) of the Act the requirement was that the in-house R&D facility should be approved by DSIR. As held by the Tribunal, prior to 01.07.2016 there was no requirement that the quantum of expenditure should also be approved by DSIR. We Assessment Year: 2014-15 & 2015-16 note that the decision of CIT(A) is in conformity with the order of the Tribunal in the case of Nirmal Industries Control Private Limited vs ACIT: ITA No. 4488/Mum/2019 cited by the Learned Authorised Representative for Assessee. Therefore, the contention raised by the Revenue that weighted deduction for R&D Expenses should not be allowed under Section 35(2AB) of the Act since the expenses are not approved by DSIR is rejected.

We note that the deduction for Quality Control/Testing Expenses under Section 35(2AB) of the Act was restricted to 100% by the Assessing Officer solely on the ground that the aforesaid expenses were not approved by DSIR. The CIT(A) overturned the decision of the Assessing Officer on this issue and allowed the claim of the Assessee for weighted deduction at the rate of 200% under Section 35(2AB) of the Act. We note that the above decision of the Tribunal in the case of Crompton Greaves Ltd. (supra) has also been followed by the Mumbai Bench of the Tribunal in the case of Laxmi Organic Industries Ltd. v. DCIT [ITA No. 38/Mum/2020] cited by the Learned Authorised Representative for Assessee. In view of the aforesaid and our findings in paragraph 11 above , we do not find any infirmity in the order passed by the CIT(A) in allowing weighted deduction at the rate of 200% in respect of Quality Control/Testing Expenses of INR.2,54,29,652/-. Therefore, the challenge of the Revenue to the order of the CIT(A) on this issue is rejected.

As regards Clinical Trial Expenses, we note that the Assessing Officer had denied weighted deduction in respect of the same for the reason that the same were not approved by DSIR and also for the reason that the Clinical Trial Expenses were incurred outside the in-house R&D Facilities. The CIT(A) had allowed the claim of the Assessee holding that since the R&D Facilities were approved there Assessment Year: 2014-15 & 2015-16 was no requirement of expenditure being approved following the decision of the Tribunal in the case of Crompton Greaves Ltd. (supra) and therefore, in view of our findings in paragraph 11 above, we do not find any infirmity in the order passed by the CIT(A) on this count. On the issue of Clinical Trial Expenses having been incurred outside the R&D Facilities, the CIT(A) concluded that the weighted deduction for Clinical Trial Expenses is to be allowed under Section 35(2AB) of the Act even if the same have been incurred outside the R&D Facility by following the decision of the Tribunal in the case of the Assessee for the Assessment Year 2008- 09 (ITA No.4248/Mum/2013) and 2009-10 (ITA No. 6747/Mum/2012) wherein the Tribunal had allowed weighted deduction for Clinical Trial Expenses incurred outside R&D Facilities under Section 35(2AB) of the Act by following the judgment of the of Hon‘ble Gujarat High Court in the case of CIT vs. Cadila Healthcare Ltd.: 263 CTR 686 (Gujarat) (20.03.2013). The relevant extract of the aforesaid decision of the Tribunal reads as under:

An identical issue was also there in assessment years 2006-07 and 2007-08 wherein similar additions have been made. The matter travelled upto the Tribunal and the Tribunal in ITA Nos. 4517 & 5582 for A.Y. 2007-08 and has decided this issue against the assessee and in favour of the Revenue. The Ld. CIT(A) has confirmed the findings of the AO following the order of the Tribunal.

Before us, the Ld. Counsel for the assessee stated that now this issue has been decided in favour of the assessee and against the revenue by the Hon‘ble Gujarat High Court in the case of CIT Vs Cadila Healthcare 263 CTR 686. The decision of the Tribunal for A.Y. 2007-08 is dt. 4.7.2012 and the decision of the Hon‘ble Gujarat High Assessment Year: 2014-15 & 2015-16 Court is dt. 20.3.2013. Thus it is clear that the decision of the Hon‘ble Gujarat High Court was not before the Tribunal when it was deciding this issue. The Hon‘ble High Court explained the explanation to Sec. 35(2AB)(1) as under:

Now we are confronted with a situation where on the one hand there are decisions of the Tribunal which are in favour of the Revenue and against the assessee and on the other hand we have a decision of the Hon‘ble High Court which is in favour of the assessee and against the Revenue. Which decision should get precedence? The answer lies in the decision of the Tribunal Ahmedabad Bench in the case of Kanel Oil & Export Inds. Ltd. Vs JCIT 121 ITD 596 wherein the Tribunal has held as under:

Before us, the decision of the Tribunal in assessee‘s own case is against the assessee but as pointed out elsewhere the decision of the Hon‘ble Gujarat High Court was pronounced later on and therefore the Tribunal did not have the benefit of the decision of the Hon‘ble Gujarat High Court. Now that we have the benefit of the decision of the Hon‘ble Gujarat High Court as mentioned hereinabove, we are following the decision of the Hon‘ble Gujarat High Court and accordingly we set aside the findings of the Ld. CIT(A) and direct the AO to allow the claim of weighted deduction u/s. 35(2AB) in respect of clinical trials as claimed by the assessee. Ground No. 1 is accordingly allowed.‖

Respectfully following the decision of the co-ordinate Bench of the Tribunal in the case of the Assessee for the Assessment Year 2008- 09 and 2009-10, we refrain to interfere with the order passed by CIT(A) allowing weighted deduction at the rate of 200% in respect of Clinical Trial Expenses of INR.16,69,10,209/-. Assessment Year: 2014-15 & 2015-16

The Assessing Officer had restricted the deduction claimed by the Assessee under Section 35(2AB) of the Act to 100% of expenses in respect of Consultancy Fee Expenses (INR 74,19,078/-) incurred by the Assessee. The CIT(A) allowed the claim of the Assessee for weighted deduction at the rate of 200% under Section 35(2AB) of the Act by following the decision of the Tribunal in the case of the Assessee for the Assessment Years 2007-08 (ITA No. 4517 & 5582/Mum/2010, dated 04.07.2012), and the decision of the Tribunal in appeals in the case of the Assessee for the Assessment Years 2008-09 and 2009-10 (common order, dated 25.02.2015). The relevant extract of the aforesaid common order, dated 25.02.2015, disposing appeals for the Assessment Year 2008-9 & 2009-10 reads as under:

In so far as patent filing fees which is not according to the patent Act and PCT, we find that the same is allowable as per the decision of the Hon‘ble Gujarat High Court in the case of Cadila Healthcare (supra). Respectfully following the findings of the Hon‘ble Gujarat High Court, we direct the AO to allow the claim of weighted deduction on patent filing fees which is not as per patent Act and PCT. Ground No. 2 is accordingly allowed.‖(Emphasis Supplied) Assessment Year: 2014-15 & 2015-16

In view of the above and respectfully following the decision of the Tribunal in the case of the Assessee for the preceding assessment years, we refrain to interfere with the order passed by the CIT(A) allowing weighted deduction at the rate of 200% in respect of Consultancy Fee Expenses of INR.74,19,078/-.

In view of the above Ground No.1, 2 and 3 raised by the Revenue are dismissed.

Ground No. 4 to 7 raised by the Revenue are directed against the order of CIT(A) allowing the claim of the Assessee, raised by way of additional ground in appeal before CIT(A), for deduction of R&D Expenses on ‗gross basis‘ without netting off the income from sale of R&D products and assets. We note that the CIT(A) accepted the aforesaid claim of the Assessee by relying upon the common order, dated 05.03.2021, passed by the Tribunal in the case of the Assessee for the Assessment Years 2010-11 and 2011-12 (ITA No. 4845, 4914, 4816 & 4915/Mum/2017) wherein allowing the additional ground raised by the Assessee, as is the case in the present appeal, it was held by the Tribunal as under:

Before us, the Ld. counsel submits that the assessee had undertaken sale of scrap of certain plant & machinery, office equipment and furniture of the R&D unit during the year under consideration amounting to Rs.1,34,227/- which were no longer required by the unit. Further, it had also earned certain income amounting to Rs.33,84,325/- on sale of products from R&D unit to assessee‘s viable customers (business development) for their further analysis testing to make sure if assessee‘s product emanating from the R&D meets their requirement or not. Based on their analysis and testing, customers sometimes choose to enter into contracts with the assessee for further commercial sale of larger batch sizes. Such income is recorded under this head.

On the other hand, the Ld. DR relies on the order of the AO and submits that in its claim statement with DSIR, the assessee has claimed similar amount as reflected in Tax Audit Report and as claimed in the return of income. Despite these facts, DSIR has restricted the claim to the extent of amount certified and reported in the annual report. It is stated that in absence of any details/clarification on the DSIR certificate, it needs to be considered that DSIR has intentionally not allowed such expenses and assessee would need to refer the matter back to DSIR for the purpose of certifying the claim of the said difference amount as claimed by the assessee. Thus it is stated that the AO has rightly not allowed the claim of the assessee for weighted deduction u/s 35(2AB) in respect of Rs.1.41 lacs towards market research related activities and interest and Rs.2,52,85,664/- on foreign consultancy charges and correctly restricted to 100% only u/s 35(1)(i) and 35(1)(iv) as against 150% claimed by the assessee. Thus it is stated that the AO has correctly disallowed the excess claim of deduction of Rs.1,27,13,332/- for which there is no approval of the specified authority.

We have heard the rival submissions and perused the relevant materials on record. In the case of Microlabs Ltd. (supra), the Tribunal has held that where the assessee-company engaged in the business of pharmaceuticals received ‗product development charges‘ which were credited the profit and loss account as a part of normal sales, same was not to be reduced from expenditure incurred by the assessee on carrying out scientific research on which section 35(2AB) deduction had to be allowed. The Tribunal held as under :

On perusal of above decision of the Tribunal, it is clear that the Tribunal has decided the issue in favour of the Assessee after taking into consideration the decision of the Tribunal in the case of ACIT Vs. Wockhardt Ltd : ITA No. 71/Mum/2007 and in the case of DCIT, LTU Vs Microlabs Ltd.: [2015] 62 taxmann.com 60 (Bangalore - Trib.).

We note that the Tribunal has in the case of DCIT, LTU vs. Mircolabs Ltd. has held as under:

The Commissioner of Income-tax (Appeals) in his order passed under section 154 of the Act has not quoted the first sentence of the guideline 5(vii) (given above in bold letters), which in our opinion, is very material. The above guideline only means that in the process of carrying out the research and development work, if the assessee acquires any assets or products that should not be disposed of without the approval of Secretary, Department of Scientific and Industrial Research. If such assets are sold, the sales realisation arising therefrom are to be set off against the research and development expenditure of the research and development centre which is claimed as deduction under section 35(2AB). It is evident from the above guideline that it is only sales realisation arising out of the assets sold that should be offset against research and development expenditure. In respect of sale of products acquired emanating out of research and development work done in an approved facility, the sale proceeds need not be reduced from the research and development expenditure. In our view, the reason for not including sales realisation arising out of products emanating out of research and development work done and sold is because such sales would be reflected as receipts by the assessee in its books of account and income from business would be computed treating such sale as part of business receipts. The receipts arising out of sale of products will not go to reduce the expenditure on research and development, whereas the assets acquired in the process of carrying out the research and development if they are sold, such sales realisation would go to reduce the expenditure on scientific research and that is why sales realisation arising out of assets sold is required to be offset against research and development expenditure. The Assessment Year: 2014-15 & 2015-16 above explanation will be sufficient to hold that the order passed by the Commissioner of Income-tax (Appeals) under section 154 of the Act is unsustainable. Nevertheless, we will also examine as to what is the exact nature of receipts from sale of products.‖(Emphasis Supplied)

On perusal of the above, it is clear that in the case of Mircolabs Ltd.(supra) the Tribunal has concluded that only sales realisation arising out of the assets sold that should be offset against research and development expenditure, whereas sale realization arising out of the research and development products sold need not be reduced from the research and development expenditure. Similarly, we note that in the case of Wockhardt Ltd. (supra) also the Tribunal has held that income of INR 6.45 Crores earned by the Assessee in that case in respect of clinical research project should not be reduced from the research and development expenditure while computing weighted deduction under Section 35(2AB) of the Act. In the appeal pertaining to the Assessee for the Assessment Year 2008-09 and 2009-10 disposed of by way of common order dated 20.02.2015, the Tribunal had remanded matter back to the file of Assessing Officer with the direction to verify and allowed the claim of the Assessee in light of the decision of the Tribunal in the case of Wockhardt Ltd. (supra). During the course of hearing the Learned Departmental Representative had contended that the issue be remanded back to the file of the Assessing Officer for verification in view of the decision of the Tribunal in the case of Bosch Ltd. Vs ACIT, LTU, Banglore: (2016) 74 Taxmann.com 161 (Banglore – Trib). We note that in that case the remand to the assessing officer was for determining whether the receipts reduced by the assessee were in the nature of reimbursement of expenses. However, in the present appeal it is admitted position sale proceeds of INR 9,22,898/- arising from sale of R&D products and sale proceeds of Assessment Year: 2014-15 & 2015-16 INR 14,32,019/- arising from sale of R&D assets have been realized during the relevant previous year. Accordingly, we hold that CIT(A) was justified in holding that sale proceeds of INR 9,22,898/- pertaining to sale of R&D products would not be reduced from R&D expenses while computing weighted deduction under Section 35(2AB) of the Act. However, in view of the decision of the Tribunal in the case of Microlab (supra) the sale proceeds arising from sale of assets would have to be reduced from research and development expenses while computing weighted deduction under Section 35(2AB) of the Act. The aforesaid view also draws support from the decision of Mumbai Bench of the Tribunal in the case of M/s. Centaur Pharmaceuticals Pvt. Vs. ITO: ITA No. 7401/Mum/2019 (04.08.2022).

In view of the above, Ground No. 4 to 7 raised by the Revenue are partly allowed.

Ground No. 8 raised by the Revenue is directed against the order of CIT(A) allowing deduction for Education Cess under Section 37(1) of the Act. We note that by way of Finance Act 2022 Explanation 3 has been inserted in Section 40(a)(ii) of the Act with retrospective effect from 01.04.2005 which clearly provides that the term ‗tax‘ includes and shall be deemed to have always included any surcharge or cess, by whatever name called, on such tax. Therefore, in view of the same no deduction is allowable in respect of Education Cess for the Assessment Year 2014-15 in terms of Section 40(a)(ii) of the Act read with Explanation 3 thereto. Accordingly, Ground No. 8 raised by the Revenue is allowed. Assessment Year: 2014-15 & 2015-16

Both the sides agreed that except for Ground No. 8 raised by the Revenue in the appeal for the Assessment Year 2015-16 all the other grounds raised by the Revenue in the present appeal were identical to the grounds raised in appeal for the Assessment Year 2014-15. Given the identical factual matrix, our findings on grounds raised in appeal for Assessment Year 2014-15 shall apply mutatis mutandis to the corresponding grounds raised in appeal for the Assessment Year 2015-16. 25. Accordingly, Ground No. 1 to 3 raised by the Revenue are dismissed in view of our findings in paragraph 11,12,14,16 and 17 above. Ground No. 4 to 7 raised by the Revenue are partly allowed in view of our findings in paragraph 21 and 22 above. Ground No. 9 raised by the Revenue is allowed in view of our findings in paragraph 23 above.

Now we would take up Ground No. 8 raised by the Revenue which read as under:

The Assessing Officer determined gross tax liability of INR 123,12,16,158/- under normal provisions and gross tax of INR 1,04,58,19,717/- under Minimum Alternative Tax(MAT) provision contained in Section 115JB of the Act. Assessing Officer restricted the MAT Credit granted to the Assessee under Section 115JAA of the Act to INR 18,53,96,441/- being difference between the gross tax Assessment Year: 2014-15 & 2015-16 under normal provisions (INR 1,23,12,16,158) and gross tax under MAT provision (INR 1,04,58,19,717) by excluding surcharge and education cess. The CIT(A) allowed appeal of the Assessee on this issue and held that for computing MAT Credit in terms of Section 115JAA of the Act surcharge and cess would have to be included. Being aggrieved the Revenue in now in appeal before us.

The Learned Departmental Representative appearing before us relied upon the decision in the case of Richa Global Exports Pvt. Ltd. vs ACIT: [2012] 54 SOT 185 (Delhi), whereas the Ld. Authorised Representative for the Appellant relied upon the following decision - Consolidated securities Limited vs. ACIT [2018] 96 taxmann.com 418 (Delhi-Trib.), Bhagwati Oxygen Ltd. vs. ACIT [ITA No. 240/Kol/2016], Netmagic IT Services Pvt. Ltd. vs. DCIT [ITA No. 5346/Mum/2017], and Tata Motors Ltd. vs. DCIT [ITA No. 2397/Mum/2019].

Savita Oil Technologies Ltd., v. ACIT (ITA No. 3066/Mum/2015, dated 07.02.2017) held as under:

Further, we note that in the case of Tata Motors Limited (supra) the Mumbai Bench of the Tribunal, after taking into consideration the above decisions of the Tribunal as well as the decision of Delhi Bench of the Tribunal in Richa Global Exports Pvt. Ltd (supra) cited by the Learned Departmental Representative, has held as under:

In all the above decisions, the Tribunal has, though for somewhat different reasons, held that surcharge and education cess are to be included for determination of the amount of MAT credit in terms of Section 115JAA of the Act. Accordingly, respectfully following the above decisions of the Tribunal we refrain to interfere with the order passed by the CIT(A) on this issue. Ground No. 8 raised by the Revenue is, therefore, dismissed.

In result, both the appeal filed by the Revenue are partly allowed.