ATUL LIMITED,AHMEDABAD vs. THE ACIT, CIRCLE-1(1)(1), AHMEDABAD

The assessee company, Atul Ltd., is engaged in the business of manufacturing dyes, specialty chemicals, agrochemicals, bulk drugs, commodity chemicals, and power generation. For AY 2017–18, the assessee filed its return of income on 29.11.2017 declaring total income of Rs.168,29,62,390/-. The case was selected for scrutiny under CASS and reference was made by the AO to the Transfer Pricing Officer (TPO), Ahmedabad, under section 92CA(1) in respect of specified domestic transactions including inter-unit sale of electricity 3 and steam. The TPO passed an order dated 30.01.2021 under section 92CA(3) proposing an adjustment of Rs.37,77,80,391/-. The Assessing Officer thereafter issued the draft assessment order dated 24.09.2021 under section 143(3) read with section 144C of the Act, computing the total income at Rs.216,01,40,460/- and book profits under section 115JB at Rs.396,95,81,602/-. The assessee raised objections before the Hon’ble DRP, which issued directions under section 144C(5) on 16.06.2022. Thereafter, the Assessing Officer passed the final assessment order dated 26.08.2022 under section 143(3) r.w.s. 144C(13), determining total income at Rs.178,23,60,063/- as against the returned income of Rs.168,29,62,390/-, after making the following additions:

Being aggrieved by the additions and disallowances confirmed by the Assessing Officer in pursuance of the DRP’s directions, the assessee has preferred the present appeal before us raising following grounds: 1. The order passed by Assessing Officer pursuant to direction of Hon'ble DRP is bad in law and required to be quashed Tax Effect: N.A.

Ground No. 1 is a general ground challenging the legality of the assessment order passed by the Assessing Officer pursuant to the directions issued by the Hon’ble DRP. No specific arguments were advanced during the course of hearing in support of this ground, nor is any independent infirmity shown in the final assessment order except for the substantive issues raised in other grounds of appeal. Accordingly, this ground is rendered academic and requires no separate adjudication.

The assessee has challenged the action of the Assessing Officer and the DRP in making a disallowance of Rs.8,26,43,616/- under section 14A of the Act read with Rule 8D(2)(iii), and further in increasing the book profits under section 115JB of the Act by the said amount. It is the contention of the assessee that it had already made a suo motu disallowance of Rs.8,25,900/- in the return of income, based on a scientific and reasonable basis, and that no further disallowance was warranted. It is further contended that the Assessing Officer failed to record the requisite satisfaction under section 14A(2) before rejecting the assessee’s working and

The Assessing Officer, in the assessment proceedings, noted that the assessee had earned exempt income of Rs.26,77,78,121/- during the year under consideration and had made investments in shares and mutual funds aggregating to Rs.434.49 crore as on 01.04.2016 and Rs.513.52 crore as on 31.03.2017. The AO rejected the assessee’s contention that no indirect expenditure was incurred for earning such exempt income and invoked Rule 8D(2)(iii), computing 1% of the average value of investments at Rs.8,34,69,516/-, and after reducing the amount already disallowed suo motu by the assessee, made a net disallowance of Rs.8,26,43,616/-. This amount was also added back to the book profits under section 115JB while computing minimum alternate tax.

The DRP, in its directions, upheld the AO’s action in invoking Rule 8D(2)(iii), observing that the assessee’s passive investment activity could still attract expenditure, and the disallowance made was in accordance with law. The DRP also affirmed the addition of the disallowed amount to the book profits under section 115JB.

During the course of hearing before us, the learned Authorised Representative (AR) took us through the paper book and referred to the extensive documentation submitted before the lower authorities. The AR submitted that the Assessing Officer as well as the DRP erred in invoking Rule 8D to compute disallowance under section 14A without recording any dissatisfaction with the method of computation adopted by the assessee. The assessee had voluntarily made a disallowance of Rs.8,25,900/- under section 14A based on a scientific and reasonable estimate, duly supported by a detailed working. It was 7 explained that the assessee had not incurred any direct expenditure for earning exempt income, and the indirect expenditure incurred was minimal and had been determined with due rationale. The allocation was made based on time involvement of key personnel from the treasury, legal, accounts, and finance departments as well as sitting fees of directors and other administrative costs, applying proportionate keys to arrive at the disallowable sum. A breakdown of the allocation across expenditure heads was provided and it included the following items: Amount Sr. Description No. (Rs.) Sitting fees to members of Investment 56,000 1 Committee 2 Sitting fees of Board of Directors 36,800 Salary Cost – various departments 3 7,04,931 (proportionate) 4 Conveyance and Fuel 3,265 25,503 5 Other administrative expenses Nil 6 Interest Expenses 8,25,900 Total 12. The AR further submitted that such scientific computation was accepted by the Department in earlier assessment years including AYs 2006-07, 2011-12, and 2013-14, and that the same working methodology had been consistently followed. In support of this submission, copies of CIT(A) orders for those years were furnished as part of the Paper Book. It was contended that the DRP erred in rejecting this working without pointing out any specific error, and in mechanically invoking Rule 8D by merely stating that the assessee had investments from which exempt income arose. The AR placed reliance on several judicial precedents to submit that:

The AR also referred to investment analysis placed in the Paper Book which included graphical and tabular details evidencing that a large portion of investments were strategic or made in earlier years, and that no major cash outflow had occurred during the year under appeal for the purpose of earning exempt income. The total exempt income earned during the year as tabulated was Rs. 17.01 crore, and the total investment portfolio as on 31.03.2017 was Rs.530.78 crore, out of which only Rs.429.31 crore pertained to investments that actually yielded dividend income, as per Table C (PB Page 444).

The Learned DR supported the findings of the Assessing Officer (AO) and the directions of the DRP. He submitted that the AO has duly recorded dissatisfaction with the correctness of the assessee’s working of expenditure in relation to exempt income under section 14A, after considering the details and explanation furnished. He drew attention to the assessment order where the AO observed that the assessee had incurred indirect expenditure and that the method adopted by the assessee lacked objective quantification or cogent basis. In view thereof, the AO proceeded to invoke Rule 8D and compute disallowance at Rs.8,26,43,616/-

The DR further contended that the DRP has rightly upheld the disallowance under section 14A, and the consequential adjustment under section 115JB, following the binding judgment of the Hon’ble Supreme Court in Maxopp Investment Ltd. v. CIT [(2018) 402 ITR 640 (SC)], wherein it was held that section 14A applies even to strategic investments if they yield exempt income. It was also submitted that the Rule 8D mechanism is mandatory where the AO, after due consideration, is not satisfied with the assessee’s working, as is the case here. Therefore, the disallowance made under section 14A read with Rule 8D and its addition to book profit under section 115JB was justified in law.

The Assessing Officer, however, rejected the assessee’s computation and invoked Rule 8D, computing a disallowance of Rs.8.26 crore. The DRP upheld the same. During the course of hearing, the learned DR submitted that the Assessing Officer had recorded dissatisfaction and correctly applied Rule 8D, relying heavily on the Hon’ble Supreme Court’s ruling in Maxopp Investment Ltd. [(2018) 402 ITR 640 (SC)] for the proposition that investments held for strategic purposes are not outside the purview of section 14A. On perusal of the assessment order, however, we find that there is no specific and objective recording of dissatisfaction as mandated under section 14A(2). The Assessing Officer merely proceeded on a presumption that since investments were large and strategic management was done by personnel in other departments, some indirect expenditure must necessarily be attributable. There is no discussion or rebuttal of the assessee’s specific computation of 11 Rs.8,25,900/-, nor is any reason assigned as to why the same was incorrect or unacceptable. The jurisdictional requirement under section 14A(2), as interpreted by various courts is that the Assessing Officer must record dissatisfaction with reference to the accounts of the assessee, and not merely on general assumptions. It is equally well-settled that the Assessing Officer is not duty-bound to apply Rule 8D in every case; he is merely empowered to do so, subject to recording cogent dissatisfaction with the assessee’s working, as a condition precedent. Absent such dissatisfaction, Rule 8D cannot be invoked. This view also finds support from several judicial precedents relied upon by the assessee.

We also note that in the assessee’s own case in a prior year, the Coordinate Bench had directed that disallowance under Rule 8D be restricted only to investments which yielded exempt income, in view of the decision of the Special Bench in Vireet Investment (P) Ltd. [(2017) 165 ITD 27 (Del) (SB)], and the Revenue was unable to point out any contrary binding decision or deviation in facts. Though in that year the assessee had not presented the same elaborate arguments as in the current year, the underlying principle remains supportive of the assessee’s claim.

In fact, if not for the absence of proper satisfaction under section 14A(2), we would have inclined to restore the matter to the Assessing Officer with a direction to recompute the disallowance by excluding investments that did not yield any exempt income, consistent with the settled legal position. However, the statutory violation of section 14A(2) gives us the legal foundation to accept the assessee’s working in totality.

As regards the addition of the disallowance under section 14A to the book profit computed under section 115JB, we find such adjustment to be legally untenable. Clause (f) of Explanation 1 to section 115JB(2) provides for addition of the amount of expenditure relatable to any income to which section 10 (other than provisions contained in clause 38 thereof) or section 11 or section 12 apply. In this regard, we draw support from the coordinate bench’s decision in assessee’s own case for A.Y. 2010–11, where in paragraphs 46 to 51, the Bench categorically noted that the provisions of section 115JB are self-contained and that disallowance made under section 14A read with Rule 8D does not automatically warrant an adjustment to the book profit unless specifically falling within the scope of Explanation 1. It is pertinent to note the decision of the Hon‘ble Supreme Court in the case of Indo Rama Synthetics (I) Ltd. [2011 SCC OnLine SC 121], to understand the nature and scope encompassed in Section 115JB of the Act. Paragraph no.14 of the said decision succinctly encapsulates the position of Section 115JB in the following words: -

This legal position is further fortified by the decision of the Hon’ble Delhi High Court in the case of PCIT v. Moon Star Securities

A conspectus of the aforementioned judicial pronouncements would lead us to safely conclude that the scheme of Section 115JB, particularly in relation to Clause (f) of Explanation 1 therein, does not envisage any addition of disallowance computed under Section 14A of the Act to calculate MAT as per Section 115JB of the Act. Rather, both the provisions stand separately as no correlation exists between them for the purpose of determining the taxable income. The addition of the concerned disallowance made by the AO while computing MAT is dehors the provisions of the Act and hence, cannot be sustained.

In view of the clear finding of the coordinate bench in the assessee’s own case, supported by the judgement of the Hon’ble High Court in Moon Star Securities (supra), the adjustment made to the book profit under section 115JB is without legal foundation and is accordingly directed to be deleted.

Accordingly, both the disallowance under section 14A and the consequent addition under section 115JB are directed to be deleted. Grounds 2(a) to 2(d) are allowed.

During the assessment proceedings for A.Y. 2017–18, the assessee claimed weighted deduction under section 35(2AB) of the Income Tax Act, 1961, in respect of expenditure incurred on in-house research and development (R&D) amounting to Rs.1,63,54,602/-. The assessee’s R&D facility located at Atul, Gujarat, was duly approved by the Department of Scientific and Industrial Research (DSIR), 14 Government of India, and continued to enjoy recognition under the relevant guidelines. The Assessing Officer examined the claim and noted that while the assessee had submitted Form 3CM indicating DSIR’s approval of the facility, the corresponding Form 3CL issued by DSIR—which certifies the quantum of eligible expenditure—did not include the aforesaid amount of Rs.1,63,54,602/-. On that basis, the Assessing Officer disallowed the weighted deduction claimed under section 35(2AB), stating that the amount was not approved or certified by DSIR and, hence, not eligible for deduction. No adverse findings were recorded with respect to the genuineness of the expenditure or its nexus with the assessee’s R&D activities.

The assessee, in its submissions before the DRP, explained that the entire expenditure pertained to scientific research undertaken in the approved in-house R&D facility and was incurred during the period for which DSIR recognition was valid. It was argued that absence of this amount in Form 3CL may be procedural or due to timing of certification, but the deduction should not be denied when the core conditions under section 35(2AB) stood satisfied. It was further emphasized that the amount was incurred wholly and exclusively for the purpose of scientific research and that DSIR has not withdrawn the approval or disputed the nature of the expenditure. The assessee also made an alternate plea that even if the weighted deduction under section 35(2AB) was not allowed, the expenditure of Rs.1,63,54,602/- be allowed as deduction under section 35(1)(iv) read with section 35(2), which provides for 100% deduction of capital expenditure incurred for scientific research. The DRP, however, upheld the Assessing Officer’s disallowance, concurring that in absence of approval or certification by DSIR in Form 3CL, the weighted deduction under section 35(2AB) could not be granted. The 15 DRP also did not examine or adjudicate the alternate claim made by the assessee under section 35(1)(iv). Accordingly, the assessee is in appeal before us challenging the disallowance of Rs.1,63,54,602/- under section 35(2AB) and pressing for allowance under section 35(1)(iv) as an alternative.

The AR submitted that the Assessing Officer erred in disallowing the claim of Rs.73,20,990/- under section 35(1)(iv) of the Act, on the ground that the said amount related to “building” and hence was not eligible for weighted deduction under section 35(2AB). In doing so, the AO relied solely on Form 3CL issued by the DSIR, wherein the capital expenditure certified was Rs.12,12,43,000/- as against the assessee’s claim of Rs.12,85,63,990/- as per Form 3CLA. The differential amount of Rs.73,20,990/- was disallowed in full. The AR contended that this disallowance is misconceived and fails to appreciate the scope of section 35(1)(iv), which provides for 100% deduction in respect of capital expenditure (other than on land) incurred for scientific research, irrespective of DSIR approval. The disallowed amount of Rs.73.21 lakh does not pertain to land and is clearly supported by evidence on record. In fact, the DSIR has wrongly included Rs.679.87 lakh as land and building expenses (as per Form 3CL), whereas the assessee had claimed only Rs.606.66 lakh towards building (no amount towards land). The discrepancy of Rs.73.21 lakh between Form 3CL and 3CLA is fully reconcilable and stems from this classification error. The assessee submitted that since the amount of Rs.73,20,990/- represents eligible capital expenditure (other than land), incurred wholly and exclusively for approved in-house research and development, it is allowable at least under section 35(1)(iv), even if not eligible for weighted deduction under section 35(2AB). The DRP itself directed the AO to examine and allow the claim under section 16 35(1)(iv), and the assessee furnished a complete item-wise breakdown in Annexure-I to Form 3CLA (PB pg. 398) substantiating the capital nature of expenditure. The AR further contended that the AO, however, in the final assessment order, disallowed the claim altogether by holding that it is not of capital nature without any verification or appreciation of the evidence already on record. This action is contrary to the DRP’s direction and inconsistent with the factual position. Accordingly, it was submitted that the full claim of Rs.73,20,990/- must be allowed under section 35(1)(iv). In the alternative, even if some portion is held ineligible under section 35(2AB), it must be allowed under section 35(1)(iv) at 100%, as per the express statutory scheme.

The learned DR relied on the assessment order and DRP directions, contending that the Assessing Officer rightly restricted the deduction under section 35(2AB) to the amount approved by the prescribed authority (DSIR) in Form 3CL. It was submitted that, as per Rule 6(7A) of the Income-tax Rules and the amended provisions of section 35(2AB) effective from 01.04.2016, the weighted deduction is allowable only to the extent approved by the DSIR. The DR emphasised that the explanatory notes to the Finance Act clearly lay down that the deduction is subject to fulfilment of prescribed conditions and approval by the competent authority. Since the DSIR excluded Rs. 73.21 lakh of capital expenditure as building cost and did not approve it, the AO had no jurisdiction to allow the claim beyond what was certified in Form 3CL. It was submitted that the AO acted strictly in accordance with law, and no interference is called for in the disallowance made.

The assessee submitted that the aforesaid amount formed part of the total capital expenditure of Rs.12,85,63,990/- claimed in Form 3CLA. In Form 3CL issued by the DSIR, only Rs.12,12,43,000/- was approved, thereby excluding Rs.73.21 lakh. The assessee explained that this difference arose due to a classification error by DSIR, which wrongly recorded the expenditure on land and building at Rs. 679.87 lakhs, whereas the actual claim towards building was Rs. 606.66 lakhs. This discrepancy, it was contended, does not affect the eligibility of the expenditure under the Act, since the amount of Rs. 73.21 lakhs relates to eligible R&D capital outlay and does not pertain to land.

The assessee submitted that although this amount was not approved for weighted deduction under section 35(2AB) in Form 3CL, it nonetheless represents capital expenditure on scientific research and hence qualifies for deduction under section 35(1)(iv) read with section 35(2)(i), which operates independently of DSIR certification. The DRP had also acknowledged this position in its direction and 18 advised the Assessing Officer to consider the allowability under section 35(1)(iv). However, the AO, in the final assessment order, summarily rejected the alternate claim on the ground that the expenditure is not capital in nature, without verifying the underlying facts or examining the assessee’s documentation.

We find merit in the assessee’s contentions. Section 35(1)(iv), read with section 35(2)(i), allows deduction for capital expenditure (not being expenditure on land) incurred for scientific research related to the assessee’s business, even if the expenditure is not eligible for weighted deduction under section 35(2AB). This provision is substantive in nature and does not depend on approval from the DSIR or the contents of Form 3CL.

On a perusal of the record, we note that the assessee has furnished a detailed item-wise listing of its R&D capital assets in Annexure I to Form 3CLA (refer PB page 398), including descriptions, amounts, and dates of capitalization. The reconciliation statement provided by the assessee also demonstrates that the amount disallowed by the AO corresponds to this detailed claim. There is no material brought on record by the AO to dispute the nature or genuineness of this expenditure. The summary rejection of the claim in the final order, without any factual inquiry or contradiction of the evidence, cannot be sustained. We also note that the AO has not doubted the R&D facility itself, which was duly approved by DSIR, nor has there been any finding that the capital expenditure in question was not incurred for scientific research. Therefore, in the absence of any factual infirmity, and considering the consistent judicial view that DSIR certification is not a prerequisite for claiming deduction under

However, to the extent the claim under section 35(2AB) exceeded the amount approved in Form 3CL, the disallowance of the weighted deduction under that section stands, and we see no reason to interfere with that part of the order. The relief is limited to allowing the said amount of Rs.73,20,990/- under section 35(1)(iv) at 100%, in lieu of 200% under section 35(2AB).

Accordingly, we direct the Assessing Officer to allow the deduction of Rs.73,20,990/- under section 35(1)(iv), being capital expenditure incurred wholly and exclusively for scientific research in the assessee’s approved R&D facility. This ground of appeal is allowed to the extent indicated above.

During the relevant previous year, the assessee made a payment of Rs.3,99,455/- to a non-resident entity towards testing charges. The payment was made in foreign currency to a foreign laboratory for testing services conducted outside India. No tax was deducted at source under section 195 on this remittance. In the course of assessment proceedings, the Assessing Officer treated the said expenditure as “fees for technical services” within the meaning of Explanation 2 to section 9(1)(vii) of the Act. According to the AO, since the services were technical in nature and were used by the assessee for its business in India, the payment constituted income deemed to accrue or arise in India in the hands of the non-resident recipient. Accordingly, in the absence of deduction of tax at source, the AO disallowed the said amount under section 40(a)(i) of the Act. Before 20 the Dispute Resolution Panel (DRP), the assessee submitted that the testing services were performed entirely outside India and the non- resident recipient had no business connection or permanent establishment in India. It was contended that the payment did not constitute income chargeable to tax in India and hence no obligation to deduct tax under section 195 arose. However, the DRP upheld the disallowance by affirming the AO’s view that the payment amounted to “fees for technical services” taxable under section 9(1)(vii), and that the assessee had failed to deduct tax thereon. Accordingly, the final assessment order sustained the disallowance of Rs.3,99,455/- under section 40(a)(i), forming the subject matter of Ground No. 4 in the present appeal.

During the course of hearing, the learned AR pointed out the detailed submission made before DRP where it was contended that the said amount represented testing charges paid to a non-resident laboratory located outside India for certification and quality testing services in respect of exported products. The services were rendered entirely outside India, and no part of such services was performed in India or involved any technical personnel deputed by the non-resident to India. The AR submitted that the payment in question did not involve any transfer of technical knowledge, experience, skill, know- how, or processes, nor did it enable the assessee to apply such knowledge independently. The services availed were in the nature of standardised testing and certification carried out abroad for compliance with overseas client requirements and quality specifications. Accordingly, the payment did not fall within the definition of “fees for technical services” under Explanation 2 to section 9(1)(vii) of the Act. Further, even assuming without admitting that the payment was of the nature of technical fees, the AR submitted 21 that the exception carved out under clause (b) to section 9(1)(vii) squarely applied to the facts of the case, since the testing services were utilised for the purposes of earning income from a source outside India, i.e., export business. As such, the payment was not deemed to accrue or arise in India in the hands of the non-resident, and therefore no obligation to deduct tax at source under section 195 arose.

In support of the above proposition, the AR relied on the decision of the Co-ordinate Bench in the case of Anjani Synthetics Ltd. v. DCIT [ITA No. 3594/Ahd/2015], wherein it was held that testing and certification services obtained from a Swiss entity (Testex AG) did not amount to “fees for technical services” under the Act or the DTAA, and the disallowance made under section 40(a)(i) on account of non- deduction of tax was deleted. Reliance was also placed on the decision of the Agra Bench in Metro & Metro v. ACIT [ITA No. 393/Agra/2012], where payments for leather testing services to a German entity were held to be not taxable in India either under the Act or under Article 12 of the India–Germany DTAA, in the absence of “make available” of any technical knowledge or skill.

The learned DR relied on the assessment order and DRP directions pointing out the amended provisions of section 9(1)(vii) of the Act.

We have carefully considered the rival submissions, perused the assessment order, the directions of the DRP, and examined the detailed documentary and legal submissions placed in the paper book. The issue for adjudication is whether the payments made by the assessee to certain non-resident entities towards testing services were liable for deduction of tax at source under section 195 of the Income Tax Act, 1961, failing which disallowance under section 40(a)(i) would 22 stand attracted. The assessee, a manufacturer and exporter of dyes and chemicals, engaged the following foreign entities to undertake testing of its products for regulatory compliance in the destination countries where export sales were being made:

It is the consistent case of the assessee that these testing services were rendered and utilized wholly outside India for the purpose of meeting export compliance norms of foreign jurisdictions, and therefore, in view of section 9(1)(vii)(b) of the Act, the income does not accrue or arise in India and is not chargeable to tax. Accordingly, the assessee contends that no deduction of tax at source was warranted under section 195 and hence, no disallowance under section 40(a)(i) is called for.

The Assessing Officer, however, held that the services fall within the scope of “fees for technical services” (FTS) as defined in Explanation 2 to section 9(1)(vii) and since the assessee is a resident, tax should have been deducted under section 195. The DRP affirmed this view relying on the reasoning that the assessee, being a resident, utilized the services for business carried out from India and thus the exception in clause (b) to section 9(1)(vii) does not apply.

In support of its contention, the assessee has relied upon judicial precedents where it was collectively and consistently held that when the technical services are utilized outside India for the purpose of earning income from a source outside India, the deeming fiction under section 9(1)(vii) does not apply in view of the exception carved out in clause (b).

In the present case, we find that the services rendered by Eurofins Analytics, Atul Europe Ltd., Commodity Inspection Services BV, and Bioagri Laboratories Ltda. were purely in the nature of certification/testing services carried out abroad for meeting foreign compliance requirements. The testing did not involve any transfer of technical knowledge or experience, nor was any technical plan or design made available to the assessee. The services were entirely utilized for export transactions. Accordingly, under section 9(1)(vii)(b), such income does not accrue or arise in India. Moreover, in terms of respective DTAAs the payments do not qualify as “fees for technical 24 services” in the absence of “make available” clause being satisfied. None of the recipients have a permanent establishment in India. Thus, on DTAA interpretation also, the income is not taxable in India.

In light of the above findings, and consistent judicial precedent, we hold that the disallowance of Rs.3,99,455/- under section 40(a)(i) is not sustainable. The Assessing Officer is directed to delete the disallowance. The grounds raised by the assessee are accordingly allowed.

Accordingly, in view of the foregoing discussion and findings on each ground, we direct the Assessing Officer to delete the disallowance made under section 14A while computing book profit under section 115JB, allow the deduction of Rs.73,20,990/- under section 35(1)(iv) being eligible capital expenditure on scientific research and delete the disallowance of Rs.3,99,455/- made under section 40(a)(i) in respect of payments made to non-resident vendors, as such payments are not chargeable to tax in India either under section 9(1)(vii)(b) or under the applicable DTAAs.

In the result, the appeal is partly allowed.