ASSISTANT COMMISSIONER OF INCOME TAX, CIRCLE- 4(1)(1), BANGALORE vs. M/S. KARNATAKA STATE POLICE HOUSING & INFRASTRUCTURE DEVELOPMENT CORP LIMITED, BANGALORE

PER B.R. BASKARAN, ACCOUNTANT MEMBER:

These cross appeals are directed against the orders passed by Ld CIT(A)-9, Bangalore and they relate to the assessment years 2012- 13 to 2015-16. All these appeals were heard together, since common issues are urged by both the parties. Accordingly, all these appeals

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Page 3 of 16 are being disposed of by this common order, for the sake of convenience.

3.1 The facts relating to the above said issue are set out in brief. The AO noticed that the assessee has earned interest income on deposits, but did not declare the same as its income. It was the case of the assessee that it is receiving grants from State Government of Karnataka and it was a condition that, if any part of the grant is kept in deposits, the interest earned thereon would also be treated as grant. Accordingly, the assessee did not declare interest income and treated the same as part of grant received from Government of Karnataka.

3.2 The AO did not agree with the contentions of the assessee. The view expressed by the AO in AY 2014-15 is extracted below:- “3.4 As regards the Government Order dated 05/01/2012, it was at the behest of the DGP and CMD of KSPHC that the order was issued as the

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Page 4 of 16 DPG & CMD vide his letter dated 29/11/2011 had requested the decision of the Government on the issue of treatment of interest income of KSPHC and the Government of Karnataka vide its order dated 05/01/2012 ordered that the interest earned on the grants received from Government should not be treated as income of the Corporation. Whether a particular receipt is income or not and whether such receipt/income is chargeable to income tax or not is to be determined by the provisions of the Act and the Government of Karnataka cannot override the provisions of the Act and hold that a particular receipt/receipt should not be treated as income of the Corporation. The order dated 10/02/2012 only speaks about the utilization of interest accrued. The order granting the funds were issued much earlier and by the Government of Karnataka order dated 05/01/2012, it is ordered that the interest on the grants should not be treated as income. While granting the funds to KSPHC, no such condition was laid. Such condition laid now vide Government of Karnataka order dated 05/05/2012 is an after thought to avoid income tax as propounded by the proposals dated 06/05/2008 of the CMD. 3.5 There are no provisions under the Act where interest income earned from FD and SB are treated as exempt. Even as per the Show Cause Notice, the question was put forward. However, as per the reply furnished, the submissions are silent on this matter. Hence, any interest income becomes taxable u/s 56 of the Act……….” Accordingly, the AO assessed interest income earned on fixed deposits in all the years under consideration. The details are tabulated below:- INTEREST ASSESSMENT YEAR INCOME (IN Rupees) 2012-13 10,0811,729 2013-14 11,50,60,757 2014-15 8,00,05,567* 2015-16 15,06,55,029

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Page 5 of 16 (* Interest income of Rs.13,68,35,991/- (less) Expenses incurred on additional works amounting to Rs.5,68,30,424/-)

3.2 The Ld CIT(A) agreed with the contentions of the assessee that the interest earned on fixed deposits should be treated as funds of the Government. The observations made by Ld CIT(A) in AY 2014-15 are extracted below:- “8…… The assessee has treated such interests received from depositing the unutilised grants also part of grants and thereby provided that the interest so received will not attract any income tax liability as per orders of the Government of Karnataka. 9. Further out of the received interest of Rs.13,68,35,991/- corporation had undertaken additional work amounting to Rs.5,68,30,424/-. The same was allowed by the AO. However, the remaining amount of Rs.8,00,05,567/- was added to the income of the appellant. The appellant contended that this income did not belong to him and the entire income vested in the government and consequently the appellant was not liable to be assessed. He further argues that the interests earned on Fixed Deposits out of unutilised grants never reached him. Even if the appellant were to collect interest, it does so, no as part of its own income, but for and on behalf of the person to whom it is payable. 10. Further, the appellant has claimed that vide Government order No.HD 173 EFS 2010, Bangalore dated 05.01.2012, the Government of Karnataka directed that the interest earned on the grants released by the Government to the appellant Corporation shall be treated as funds of the Government, and shall be used only for taking up additional works, other related development works and meeting the costs of escalation. The appellant has further submitted that vide Government Order No. HD 173 EFS 2010, Bangalore dated 10.02.2012, the State Government further clarified that the interest accrued on grant funds should be utilised only for the purpose of the scheme for which the funds were granted and that such interest should not

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Page 6 of 16 be diverted or utilised for any other purpose. The same is scanned and examined below……”

3.3 The Ld CIT(A) also referred to the decision rendered by jurisdictional Karnataka High Court in the case of CIT & Anr. Vs. Karnataka Urban Infrastructure & Finance Corporation (284 ITR 582), wherein the Hon’ble High Court held that interest accrued on bank deposits could not be treated as income of the assessee as interest was earned out of money given by Government of India for purpose of implementation of Mega City Scheme and interest earned was also utilised for implementation of Mega City Scheme. The Ld CIT(A) also referred to the decision rendered by Hon’ble Karnataka High Court in the case of Karnataka Municipal Data Society vs, ITO, wherein the Hon’ble High Court held that Government money was released to assessee society for utilizing it in Government schemes and interest was accrued on grant money. In such case neither grant amount nor interest thereon could be held as income of assessee as Assessee-society held fund only as a custodian and full command for utilisation remained with Government. The Ld CIT(A) also noticed that similar judgement is pronounced in the case of Commissioner of Income tax vs. Karnataka State Agricultural produce processing & Export corporation Ltd. Accordingly, the Ld CIT(A) deleted interest income earned on fixed deposits made out of grants, assessed by the AO in all the years under consideration.

3.4 We heard the parties and perused the record. We notice that the Ld CIT(A) has referred to various orders issued by Government of Karnataka, wherein it has been mentioned that (a) the interest earned on the grants received from Government should not be treated as income of the corporation. This order shall come into effect from the financial year 2011-12 onwards

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Page 7 of 16 and until further orders (Government order no. HD 173 EFS 2010, Bangalore dated 05-01-2012) (b) the interest accrued on Government funds given for specified scheme with Karnataka State Police Housing Corporation Limited, Bangalore should be utilised for the same specific scheme under any circumstances should not be diverted or utilised for any other schemes without prior approval of the Government (Government Order No. HD 173 EFS 2010, Bangalore dated 10-02-2012). We also noticed that the Ld CIT(A) has also followed the ratio laid down by the jurisdictional Hon’ble Karnataka High Court in various cases (referred supra), wherein the interest earned on deposits made out of Government grants was held to be not income of the assessee. Since the Ld CIT(A) has deleted this addition in all the years following the binding decision rendered by jurisdictional High Court, we do not find any reason to interfere with his decision rendered on this issue in all the years under consideration. The Ld D.R submitted that the interest income assessed in AY 2013-14 was Rs.11,50,60,757/-, whereas the Ld CIT(A) has erroneously mentioned the figure of Rs.15,06,55,029/- in his order. Since it is a typographical mistake, we order that the amount mentioned in paragraph 19 of order passed by Ld CIT(A) for AY 2013-14 should be substituted by Rs.11,50,60,757/-.

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Page 8 of 16 (A) Assessment year 2012-13:- (a) Disallowance of bad debts claimed by the assessee (b) Disallowance of Repairs & Maintenance expenses. (B) Assessment year 2014-15:- (a) Disallowance of Skill development expenses (b) Disallowance of bad debts claim (c) Disallowance of Repairs & Maintenance expenses (d) Disallowance of provision for leave encashment (C) Assessment year 2015-16:- (a) Disallowance of Repairs & Maintenance expenses 6. We notice that a common issue is urged in all the three years, ie., disallowance of Repairs and Maintenance expenses. The claim of the assessee under the head repairs and maintenance in all the three years referred above, was disallowed by the AO holding it as capital in nature. The Ld A.R contended that these expenses are in the nature of replacement of air conditioners, construction of car and two wheelers garages in leased premises, repair & renovation of premises etc. Accordingly, the Ld A.R contended that these expenses are in the nature of revenue expenses only.

6.1 On the contrary, the Ld D.R submitted that the assessee has brought into existence new assets by way of constructing vehicle garages and other civil structures. The assessee has also installed new air conditioners. He submitted that the air conditioner machines are independent machines and they could function independently. He submitted the capital expenditure incurred in leased premises is also treated as capital expenditure only and depreciation is allowed therein under Explanation to sec.32 of the Act. Accordingly, he submitted that the Ld CIT(A) was justified in confirming the disallowances made by the AO.

6.2 We heard the parties and perused the record. The principles relating to “current repairs” has been explained by Hon’ble Supreme

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Page 9 of 16 Court in the case of CIT vs. Saravana Spinning Mills Ltd (293 ITR 201)(SC) as under:-

“11. An allowance is granted by clause (i) of Section 31 in respect of amount expended on current repairs to machinery, plant or furniture used for the purposes of business, irrespective of whether the assessee is the owner of the assets or has only used them. The expression "current repairs" denotes repairs which are attended to when the need for them arises from the viewpoint of a businessman. The word "repair" involves renewal. However, the words used in Section 31(i) are "current repairs". The object behind Section 31(i) is to preserve and maintain the asset and not to bring in a new asset. In our view, Section 31(i) limits the scope of allowability of expenditure as deduction in respect of repairs made to machinery, plant or furniture by restricting it to the concept of "current repairs". All repairs are not current repairs. Section 37(1) allows claims for expenditure which are not of capital nature. However, even Section 37(1) excludes those items of expenditure which expressly falls in Sections 30 to 36. The effect is to delimit the scope of allowability of deductions for repairs to the extent provided for in Sections 30 to 36. To decide the applicability of Section 31(i) the test is not whether the expenditure is revenue or capital in nature, which test has been wrongly applied by the High Court, but whether the expenditure is "current repairs". The basic test to find out as to what would constitute current repairs is that the expenditure must have been incurred to "preserve and maintain" an already existing asset, and the object of the expenditure must not be to bring a new asset into existence or to obtain a new advantage. In fact, in the present case, in the balance sheet the assessee, viz, M/s Saravana Spinning Mills has indicated the above expense as an item incurred for purchase of a New Asset. In our view, the High Court had erred in placing reliance on the report of SITRA in coming to the conclusion that the textile mill is a plant under Section 31(i). As stated above, each machine in a segment has an independent role to play in the mill and the output of each division is different from the other "Repair" implies the existence of a part of the machine which has malfunction. If the argument of the assessee herein before us is to be accepted it would result in absurdity and it would make the provisions of Section 31(i) completely redundant. According to Shri R. Venkataraman, learned senior counsel for the assessee, the textile plant consists of about 25 machines. One of such machines is the Ring Frame. If the argument of the assessee is to be accepted, it would mean that periodically one machine out of 25 would be replaced, and on that basis, from time to time, each of these 25 machines in the textile plant would be entitled to claim allowance under Section 31(i). In our view, the A.O. was right in holding that each machine including the Ring Frame was an independent and separate machine capable of independent and specific function and, therefore, the expenditure incurred for replacement of the new machine would not come within the meaning of the words "current repairs". In the present case, it is not the case of the assessee that a part of

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Page 10 of 16 the machine (out of 25 machines) needed repairs. The entire machine had been replaced. Therefore, the expenditure incurred by the assessee did not fall within the meaning of "current repairs" in Section 31(i).

"The simple test that must be constantly borne in mind is that as a result of the expenditure which is claimed as an expenditure for repairs what is really being done is to preserve and maintain an already existing asset. The object of the expenditure is not to bring a new asset into existence, nor is its object the obtaining of a new or fresh advantage. This can be the only definition of "repairs" because it is only by reason of this definition of repairs that the expenditure is a revenue expenditure.

If the amount spent was for the purpose of bringing into existence a new asset or obtaining a new advantage, then obviously such an expenditure would not be an expenditure of a revenue nature but it would be a capital expenditure, and it is clear that the deduction which the Legislature has permitted under section 10(2)(v) is a deduction where the expenditure is a revenue expenditure and not a capital expenditure."

In our considered view, the claim of repair and maintenance expenses has to be examined on the basis of principles explained in the above said case. Before us, the Ld A.R placed his reliance on the decision rendered by Hon’ble Karnataka High Court in the case of CIT vs. Sagar Talkies (325 ITR 133). We have gone through the said decision. In the above said case, the assessee was running a theatre installing mono sound system. The assessee replaced mono sound system with Doby system and claimed the expenses incurred on such replacement as revenue in nature. The Hon’ble High Court accepted the plea of the assessee and held as under:- “In this background, we have to consider whether the expenditure incurred by the assessee for replacing the sound system to its theatre amounts to revenue or capital in nature. This Court has to consider whether the change

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Page 11 of 16 of sound system has increased the revenue or not. Admittedly, the old sound system was in existence for several years and due to use of the very sound system for several years, the old system was worn out. If the assessee has provided certain amenities to its customers by replacing the old system with a better sound system and by introducing such system if the assessee has not increased its income in any way, therefore we cannot consider such change of sound system as capital in nature. According to us, instead of repairing the existing old stereo system, the assessee has installed Dolby stereo system. This has not benefited the assessee in any way with regard to its total income since there is no change in the seating capacity of the theatre or increase in the tariff rate of the ticket.” The Hon’ble Karnataka High Court noticed that the assessee has replaced only worn out sound system, which formed integral part of a Cinema theatre, i.e., without sound system, a Cinema theatre could not be run. Further, the said expenditure did not result in any additional benefit by way of increase in revenue. In our view, the reasoning adopted in the above said case could not be applied in the present case.

6.3 Accordingly, in our considered view, this issue requires fresh examination at the end of the AO applying the principles explained by Hon’ble Supreme Court in the case of Saravana Spinning Mills Ltd (supra) in all the three years under consideration. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and restore this issue to the file of AO in all the three years.

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Page 12 of 16 that the assessee has written off a sum of Rs.2,27,56,882/-, being excess expenditure incurred in respect of “Additional Housing Scheme 1 (AHS 1), since the Government of Karnataka did not reimburse above expenses. The assessee wrote off the above said amount as expenditure. The AO noticed that the Government of Karnataka has directed the assessee to meet the above expenses out of interest earned on deposits. Since the assessee has claimed that the interest income also partakes the character of “grant” and hence not taxable, the AO held that the expenditure which is required to be met out of such interest income cannot be claimed as deduction. The Ld CIT(A) also confirmed the same.

8.1 We heard the parties on this issue and perused the record. We have earlier upheld the claim of the assessee that the interest income earned on deposits made out of Government grants is not taxable in the hands of the assessee, since the said interest income is also treated as “government grant” only, as per the directions of Government of Karnataka. Further, the above said view has also got support of Hon’ble High Court of Karnataka.

8.2 With regard to the expenditure of Rs.2,27,56,882/-, the Ld A.R explained that the assessee has incurred extra expenditure on construction projects, which were met out of grants given to it by Government of Karnataka. However, the Government refused to reimburse excess expenditure and hence the assessee has claimed the same as deduction against its business income.

8.3 We heard Ld D.R and perused the record. Before us, a translated copy of proceedings of meeting of Principal secretary (homes) were produced and the same reads as under:-

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Page 13 of 16 “3. To repay the additional amount under the Repayment Scheme of AHS- 1 Scheme (Plan) In relation to AHS-1 Scheme, the additional amount of Rs.227.00 lakhs has been brought to the notice. The economic and physical development is good. But, the Principal Secretary has stated that the additional amount spent is to be managed from the interest earned on the amount of deposit.” We have earlier noticed that the interest earned on deposits has been directed to be treated as part of grant amount. Hence, on a combined reading of various directions given by the Government of Karnataka, it is discernible that the Government, instead of reimbursing the additional amount, has directed the assessee to offset the same against interest earned on deposits, which was also considered to be Government grant. In effect, the Government of Karnataka has actually reimbursed the additional amount out of interest income (grant amount). Hence, we are of the view that the tax authorities are justified in holding that the assessee cannot claim the additional expenses separately. Accordingly, we confirm the order passed by Ld CIT(A) on this issue.

9.1 The Ld A.R submitted that the children of police personnel are trained in skills on masonry, carpentry and other works connected with construction activities. Hence these children could be employed

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Page 14 of 16 with the Civil Contractors. Accordingly he submitted that the skill development expenses are related to the business activities of the assessee. He further submitted that the CSR expenses have been held to be not deductible only in subsequent years. On the contrary, the Ld D.R submitted that this expenditure is not related to the business activities of the assessee.

9.2 We heard the parties and perused the record. The assessee could claim this expenditure u/s 37(1) of the Act, as per which the expenditure should be laid out or expended wholly and exclusively for the purpose of business. We notice that the tax authorities have given a specific finding that this expenditure is not related to the business activities of the assessee, viz., construction of buildings for police and allied departments and project monitoring. The contentions of Ld A.R are that the children trained under skill development scheme could be employed by the Civil Contractors, which will in turn facilitate the business activities of the assessee. In our view, the connection with the business activities of the assessee sought to be established by Ld A.R is far fetched one. Accordingly, we are of the view that the assessee has failed to show that this expenditure has been incurred wholly and exclusively for the purpose of business. Accordingly, we confirm the order passed by Ld CIT(A) on this issue.

ITA Nos.1267 & 1349/Bang/2019 ITA 142, 143, 144. 185, 186 & 187/Bang/2020 M/s. Karnataka State Police Housing & Infrastructure Development Corporation Ltd., Bangalore Page 15 of 16 10.1 Before us, the Ld A.R submitted that the assessee has written off unrealised advance given to the contractors. However, we notice from the orders of tax authorities that they have disallowed only “Provision towards bad debts”. Admittedly, the provision for bad debts is not allowable as deduction under the provisions of Income tax. Accordingly, we confirm the disallowance made by the tax authorities.

Sd/- Sd/- (N.V. Vasudevan) (B.R. Baskaran) Vice President Accountant Member

Bangalore, Dated 25th Nov, 2021. VG/SPS

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Page 16 of 16

Copy to:

Asst. Registrar, ITAT, Bangalore.