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Income Tax Appellate Tribunal, “A’’BENCH: BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI B.R. BASKARAN
PER B.R. BASKARAN, ACCOUNTANT MEMBER:
The revenue has filed this appeal challenging the order dated 29.10.2019 passed by ld. CIT(A)-4, Bengaluru and it relates to the assessment year 2001-02. The grounds of appeal urged by the revenue read as under:- 1 “The Order of the Ld. CIT(A), in so far as it is prejudicial to the interest of the Revenue, is opposed to law and the facts and circumstances of the case.
2. Whether the Hon'ble CIT(A) is correct in allowing the assessee's claim in respect of Capital Expenditure of Rs.6,61,92,319/- u/s 35(1)(iv) of the IT Act though the machines were purchased for the purpose of R&D but were never a part of scientific research.
M/s. Kennametal India Ltd. Bangalore Page 2 of 6 3. Whether the Ld., CIT(A) is right in law in not appreciating the efforts made by the AO in conducting survey action u/s 133A and additions made based on the findings of the survey.
4. Based on the facts and circumstances of the case, whether the Ld. CIT(A) is right in law in not considering the disallowance under section 35(1)(iv) made by the AO when the machines were used for commercial production and R&D activity is confined to quality control testing of limited samples from each batch? 5. Whether the Ld. CIT(A) is right in allowing the assessee's appeal and emphasizing on the point that "put to use" is not a precondition for claiming 35(1)(iv) benefit without commenting on any other facts of the case? 6. The Learned CIT(A) has agreed in para no. 5.6 of the order that machinery in question was used for normal production as well as R&D, however, the Ld. CIT(A) erred in law in accepting that the normal production had no bearing on profits or business of the company.
Whether the Ld. CIT(A) is right in law that incurring the expenditure for the purpose of R&D is sufficient to claim the deduction in respect of the expenditure on scientific research u/s 35(1)(iv) when such capital asset isnever used for the purpose it was incurred for.
8. The appellant craves leave to add, alter, amend and / or delete any of the grounds that may be urged.”
The above grounds of appeal relate to the decision of Ld. CIT(A) in allowing the capital expenditure of Rs.6.61 crores incurred by the assessee u/s 35(1)(iv) of the Income-tax Act,1961 ['the Act' for short].
The facts relating to the issue are stated in brief. The assessee is engaged in the business of manufacture of hard metal and hard metal products. The assessee claimed deduction u/s 35(1) of the Act in respect of scientific research expenditure to the tune of Rs.72.17 crores. The above expenditure, inter-alia, included capital expenditure incurred on purchase of following machineries:- 1. Plasma Nitriding Machine (Rs.10929610/-) 2. Bernex Coating furnace (Rs.50982439/-)
M/s. Kennametal India Ltd. Bangalore
Page 3 of 6 3. Turntable injection blasting machine (Rs.4280270/-)
The A.O., during the course of assessment proceedings, enquired as to whether the above machines were imported specifically for the purpose of carrying out “R&D activities” or they are being used for commercial purposes also. The assessee replied that all the above machines were imported for the purpose of R&D i.e. for development of new grades and for improving the tool life. It was further submitted that after establishing the process, the equipment is used for production purpose also. It was also submitted that all the 3 machines are located in production department in order to avail the infrastructure facilities such as gas connections for operating the machines and also considering safety and environmental requirements.
In order to verify the claim of the assessee, the A.O. conducted survey u/s 133A of the Act. With regard to Plasma Nitriding machine, it was submitted that R&D activity was conducted to achieve surface hardness of >650Hvi. However, the A.O. took the view that the assessee has realized the target of >650Hvi with the help of normal setting up of machinery parameters. When specifically asked about the R&D activity, the assessee submitted the breakup of utilization of machinery as under:-
Nov.00 to Mar 01 Apr 01 – Mar 02 For R&D 21% 10% Production 70% 74% Idle 9% 16% However, the A.O. observed that there is no evidence to show that 21% of the machines hour was utilized for R&D purposes. The A.O. also observed that assessee does not have any record of scientific research except the inspection reports, which were claimed by the M/s. Kennametal India Ltd. Bangalore
Page 4 of 6 assessee to be R&D activity. Accordingly, the A.O. took the view that the superior features of the product claimed by assessee have been achieved by virtue of inherent capability of the machine and not on account of R&D activity. He further observed that the assessee has used the machines only for the purpose of carrying on commercial production and the socalled R&D activities are confined to producing “Product Performance Test”. Accordingly, the A.O. took the view that the cost of Rs.1,09,29,610/- relating to Plasma Nitriding Machine is not allowable as deduction u/s 35(1)(iv) of the Act. Accordingly, he disallowed the said claim. However, he allowed depreciation @ 25% on the cost of the above said machines.
With regard to the Bernex coating furnace and Turntable injection blasting machine, the A.O. took the view that the assessee has undertaken the normal efforts in order to achieve product quality and such efforts cannot be termed as R&D. Accordingly, he disallowed the claim of deduction u/s 35(1)(iv) of the Act in respect of the above said two machines also and allowed depreciation at normal rates.
7. The Ld. CIT(A) however, deleted the disallowance and hence, the revenue has filed this appeal before us.
We heard the parties and perused the record. We notice that the A.O. has taken the view that the machineries have not been used for carrying out research & development activities. According to the AO, whatever activities that were claimed to be R&D activities by the assessee are normal efforts put up by anyone in order to achieve the desired product quality, i.e., the A.O. has taken the view that such efforts cannot be termed as falling under research & development activity.
M/s. Kennametal India Ltd. Bangalore
Page 5 of 6 9. On the contrary, the Ld. CIT(A) has taken the view that the “purpose for which the machineries were acquired and put to use by the assessee” is the deciding factor for allowing u/s 35(1)(iv) of the Act. He has also expressed the view that the above said machineries were used partly for R&D and partly for production purposes and there is no bar u/s 35(1) of the Act for putting the machineries for production purposes also. We notice that the Ld CIT(A) has not addressed the view of the AO that these machineries were not purchased for R & D purpose at all.
We have gone through the provisions of section 35 of the Act and notice that one of the conditions prescribed u/s 35(3) of the Act for allowing deduction u/s 35(1) of the Act is that the assessee should enter into an agreement with the prescribed authority for cooperation in such research & development facility and for audit of accounts maintained for that facility. Hence, in our view, the purpose of machinery could be ascertained from the agreement entered by the assessee with the prescribed authority, viz., Whether they have been purchased specifically for the purpose of carrying out research & development activity or for the purpose of using them for normal production purposes.
We notice that this important fact is not emanating from the orders passed by the A.O. as well as Ld. CIT(A). In this view of the matter, we are of the view that this issue requires fresh examination at the end of the A.O., who shall examine the agreement entered by the assessee with the prescribed authority in order to ascertain the purpose for which the machineries was purchased. There should not be any doubt that, if the prescribed authority has accepted that these machineries are meant to be used for research & development activities, then the assessee would be eligible for deduction u/s 35(1)(iv) of the Act. Since this fact requires verification, we set aside
M/s. Kennametal India Ltd. Bangalore Page 6 of 6 the order passed by Ld. CIT(A) on this issue and restore the same to the file of the A.O for examining the claim of the assessee afresh in the light of discussions made supra. We also direct the assessee to furnish the necessary information and explanations required to support its claim and also that may be called for by the A.O. After providing adequate opportunity to the assessee, the A.O. may take appropriate decision in accordance with law.
In the result, the appeal filed by the revenue is treated as allowed for statistical purpose.
Order pronounced in the open court on 29th Apr, 2022.