M/S. ALPHA DESIGN TECHNOLOGIES PRIVATE LIMITED,BANGALORE vs. INCOME TAX OFFICER, WARD - 1(1)(2), BANGALORE

Per Bench All these files are filed by the assessee against the separate orders of the CIT(Appeals)-1, Bengaluru dated 01.03.2019 for assessment years 2009-10 [passed u/s. 143(3) r.w.s. 263 of the Act] & AYs 2011-12 to 2015- 16 [u/s. 143(3) of the Act]. which were heard together and disposed of by this common order for the sake of brevity and convenience.

2. The Ld CIT(A) has disallowed the claim as revenue expenditure on a wrong notion that the expenditure are spent for development of new product. 3. The Ld CIT(A) has failed to appreciate the fact that, the appellant is in one line of business and the nature of the business requires huge R&D expense to be relevant in the business field, for being updated and competitive, which do not result in advantage of enduring nature, and hence the R&D expenditure incurred by the appellant are to be allowed as revenue expenditure. 4. The Ld CIT(A) while disallowing the expenditure has failed to recognize the fact that the Hon'ble ITAT in appellant's own case for AY 2007-08 and 2008-09 having the same facts had allowed the R&D expenditure as revenue in nature. 5. In similar cases, the Hon'ble ITAT has ruled that Research & Development Expense is revenue in nature when the same does not result in new product or new line of business. ( ITA 2229 / 2011 ITAT —Hyderabad Dr.Reddy's Laboratories Ltd vs Addl CIT, ITA 584/PN/2011 ITAT — Pune Opus Software Solutions Pvt Ltd vs ACIT, ITA 1711/PN/2012 ITAT Pune DCIT vs Autoline Industries Ltd). For the above and other grounds that may be urged at the time of hearing of the appeal, your appellant humbly prays that the appeal may be allowed and justice rendered.

“5.4.11 Considering all the above, I am not convinced, with the appellant’s submission that the expenditure under scrutiny is reverie in nature, reason being, that the expenditure is incurred for creating the new products which fall in the category of new inventions giving rise to intellectual property to the appellant and thus it would be an 'Intangible Asset'. The appellant itself accounted in the books of account under the head `R & D Project' and carried to the balance sheet directly. This entire expenditure is considered as capital expenditure and categorised as 'Intangible Asset'. Despite the fact of claiming the same as revenue expenditure in the computation of income, these assets remained as assets under the head 'R & D Project' and no adjustment/deletion made in the balance sheet. 5.4.12 Since all the input costs including salaries, Professional charges, materials imported, finance cost, etc., going to develop a new capital asset where in appellant recognises intellectual property, giving rise the enduring benefit to the appellant, they cannot be considered by splitting and examining input cost separately, lest the outcome would totally defeat the very purpose. 5.4.13 Even the appellant in its financials and the AO in the impugned order and also the CIT(A), have dealt the entire expenditure in one basket(incurred towards the creation of new intangible asset (capital product) development). 5.4.14 Thus, I am of the view that-the expenditure incurred for developing the. project proto types by the appellant relating to development of intangible asset cannot be weighed or assessed based on the input costs. It has to be treated as one item only. The expenditure incurred by the assessee on such projects is liable to be treated as capital expenditure as the same has resulted in giving rise to enduring benefit to the assessee by bringing into existence a totally new product upon which the appellant has recognized the intellectual property. The position of the settled law that "the expenditure resulting in advantage of enduring nature is a capital expenditure", is not disturbed or reversed by any judicial fora.”

a. Financial Statement for the six assessment years. b. Statement of Computation of Income for the six assessment years. c. ITRs for the six assessment years. The Assessing Officer disallowed the said claim for each A.Y. as 13. follows:-

A.Y R & D Expense 2009-10 1,95,00,144 2011-12 17,32,84,974 2012-13 19,65,08,727 2013-14 14,04,48,321 2014-15 10,57,08,949 2015-16 12,31,60,586

“16. From the aforesaid judgments of the Supreme Court, it is apparent that merely because the amount spent has been used for construction of a building or structure of permanent nature is not the decisive test for holding the expenses to be capital out-lay or revenue out-lay. The two tests emerging from the aforesaid decisions are that firstly where the building or construction of any permanent structure is brought into existence is by itself not sufficient to hold the expenses to be capital nature invariably. Where such construction does not result in acquisition of any capital assets to be trade of assessee or the property does not become the property of the assessee, it does result in acquisition of capital assets of the enduring nature by the assessee. Secondly, it is also clearly discernible that if such expenses is incurred for the purpose of business for deriving any benefit whether to preserve the business or to facilitate the running of the business more smoothly or to make business more profitable or to secure any other advantage for the assessee’s business or incurring expenditure by seeking exemption from or reduction in incurring of other expenses which would have been ordinarily allowable as revenue expenditure of assessee’s business, such expenses are to be treated as having been incurred wholly and exclusively for business of the assessee and revenue expenditure. Such expenses cannot be construed as a capital expenses. ……………..

22. The principle was considered by the Supreme Court in Empire Jute Co. Ltd. vs. CIT (1980) 124 ITR 11. In the said case, the Court observed that there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit may none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consist merely in facilitating the assessee’s trading operations or in enabling the management in conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case.”

19. In the instant case, as noticed above, the assessee did not want spread over of this expenditure over a period of five years as in the return filed by it, it had claimed the entire interest paid upfront as deductible expenditure in the same year. In such a situation, when this course of action was permissible in law to the assessee as it was in consonance with the provisions of the Act which permit the assessee to claim the expenditure in the year in which it was incurred, merely because a different treatment was given in the books of account cannot be a factor which would deprive the assessee from claiming the entire expenditure as a deduction. It has been determinative or conclusive and the matter is to be examined on the touchstone of provisions contained in the Act (See – Kedarnath Jute Mfg. Co. Ltd. vs. CIT (1971) 82 ITR 363 (SC); Tuticorin Alkali Chemicals & Fertilizers Ltd. vs. CIT (1997) 227 ITR 172/93 Taxman 502 (SC); Sutlej Cotton Mills Ltd. vs. CIT (1979) 116 ITR 1 (SC) and United Commercial Bank vs. CIT (1999) 240 ITR 355/106 Taxman 601 (SC).

i) Opus Software Solutions Pvt. Ltd. vs. ACIT (ITA 584/PN/2011) ii) DCIT vs. Autoline Industries Ltd. (ITA 1711/PN/2012) (Pune) iii) Dr. Reddy’s Laboratories Ltd. vs. Addl. CIT (ITA 2229/Hyd/2011 & 85/Hyd/2013) (Hyderabad).

“10. In our considered opinion, the aforesaid proposition of the Revenue is absolute alien to the business realities under which the assessee is operating Quite clearly, the assessee is in the business of software development which entails fast technological changes and in that view, there is no permanence attached to any product developed. In fact, it is quite understandable that the business of the assessee is exposed to volatility of new and upcoming technological advances and the products developed by it may not be sustainable over a period of time to compete in the market place. Therefore, in this background one has to examine as to whether the expenditure incurred on development and launching of new products in the same line of business results in an advantage in the revenue field or in the capital field. Hon’ble Supreme Court in the case of Empire Jute Co. Ltd.(supra) has held and accepted that the expenditure results in an enduring benefit to the assessee, , yet following discussion by the Hon’ble Supreme Court would show that each and every incidence of enduring benefit would not result in classification of expenditure as a capital expenditure: “There may be cases where expenditure even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may breakdown. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be of revenue account, even though the advantage may endure for an indefinite future.” In the present case, in our view, the expenditure on development of new product in the line of business being carried out by the assessee is an expenditure related to such business and benefit to the assessee is in the revenue field, inasmuch as it seeks to improve the profitability of the assessee and the enduring benefit cannot be regarded to be in the capital field. The parity of reasoning laid down by the Hon’ble Apex Court in the case of Empire Jute Co. Ltd. (supra), as extracted above, clearly supports the stand of the assessee, inasmuch as the expenditure in question merely results in development of new products by the assessee in its existing line of business. Even otherwise, it is noteworthy that none of the expenditures in question are of capital nature and in fact, the expenditure which has been referred to by us in the earlier paragraph clearly are such expenditure , which are incurred in the course of carrying on of business.”

11. The other objection of the Revenue that the assessee had treated the impugned expenditure as a deferred revenue expenditure in the books of account and claimed it as a revenue expenditure in the computation of income, is of no consequence. The Hon’ble Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd (supra) and also thereafter in the case of Tuticorin Alkali Chemicals vs. CIT 227 ITR 172 (SC) and Sutlej Cotton Mills Ltd. vs. CIT 116 ITR 1 (SC) has supported the proposition that the entries in the books of account cannot be demonstrative of the true nature of a transaction. The true nature of a transaction is to be assessed not on the basis of the entries in the books of account alone, but having regard to the realities of the transaction. In this view of the matter, the aforesaid objection is of no consequence.

“10. The assessee for the year under consideration had developed a technique for reducing the weight of machinery, which in turn was approved by M/s. Tata Motors for manufacturing and was used by the assessee for manufacturing the body parts for the said concern. It is an admitted fact that because of the aforesaid expenditure incurred by the assessee in the year 2009-10 being revenue of Rs.4.20 crores received by the assessee in the year 2009-10 being the sharing benefit on account of reduction in weight for the first 1,20,000 vehicles. The first aspect of the issue is that where the assessee had claim the said expenditure by way of deduction in its computation of income? The law on this account of any person or how it is reflected in the balance sheet and/or the Profit & Loss Account is of no consequence, in determining whether the said expenditure is an allowable deduction or not. The law on the issue is that the accounting treatment given by the assessee in its books of account is not determinative whether or not the expenditure is allowable as a deduction. In order to be eligible for deduction, it has to be seen whether the expenditure is revenue in nature, then in such circumstances, the said expenditure is to be capitalized in the hands of the assessee. Looking at the nature of expenditure incurred by the assessee, we are of the view that the same is revenue expenditure allowable as deduction in the hands of the assessee either under the provisions of section 35(1)(i) or 37(1) of the Act. The expenditure having been incurred by the assessee by way of research, which resulted in reduction in the weight of body parts and also generation of revenue in the hands of assessee to the extent of Rs.4.20 crores cannot be said to be capital expenditure. Even if the expenditure is of enduring benefit, but having not been incurred in the capital field, is to be allowed as deduction in view of the ratio laid down by Pune Bench of Tribunal in Opus Software Solutions (P) Ltd. vs ACIT(supra). As referred by us in the paras hereinabove, the nature of expenditure is not such that it can be said to be capital expenditure and in the absence of product developed by the assessee having been patented, we find no merit in the order of Assessing Officer in this regard. Upholding the order of CIT(A), we dismiss the ground of appeal

No. 1 raised by the Revenue.”

28. Further, the Ld. AR submitted that in the case of Dr. Reddy’s Laboratories Ltd. vs. Addl. CIT (supra), the Tribunal held that an expenditure for developing new drug in the same line of business of the assessee is to be allowed as revenue expenditure.

A.Y Salary Cost Rent Travelling Finance Purchase of Technical Mainte- Total expenses charges materials fee/ nance Professional and other charges expenses 2009-10 52,98,797 47,64,800 18,53,541 1,18,588 72,82,587 - 1,81,831 1,95,00,144 2011-12 5,48,55,459 1,49,14,943 1,96,00,420 2,53,73,399 2,93,35,600 1,97,42,385 89,62,788 17,32,84,974 2012-13 7,86,21,614 90,00,000 1,05,18,275 - 7,73,08,394 1,77,98,554 32,61,890 19,65,08,727 2013-14 8,55,26,000 90,00,000 92,15,000 - 2,56,38,821 76,50,000 34,18,500 14,04,48,321 2014-15 3,52,00,000 1,58,50,000 - - 1,88,08,949 3,58,50,000 - 10,57,08,949 2015-16 75,00,000 - - - 5,36,60,585 6,20,00,000 - 12,31,60,586

(i) One of the guidelines for distinguishing revenue expenditure from capital expenditure is that if the expenditure is incurred for obtaining an advantage of enduring benefit it would be capital expenditure. But, the test of enduring benefit is not a certain or conclusive test and it is not be applied blindly and mechanically. In other words every advantage of enduring nature acquired by an assessee is not covered by the said concept. In a given case, the test of enduring benefit might break down. The idea of once for all payment and enduring benefit are not something akin to statutory conditions; nor are the notions of capital or revenue a judicial fetish. Concepts of capital/revenue expenditure are not eternal verities, but are flexible ones.

(ii) What is material in this regard is to consider the type, nature and character of the advantage in a commercial sense on one hand and on the other to look in to the aim, intended object, effect of the expenditure and in the larger context of necessity and expediency. Legal rights secured in the process are also relevant in deciding the issue. (iii) If the expenditure is related to the carrying on or conduct of the business or is intrinsically connected with the running of a business the expenditure is to be regarded as revenue expenditure even though the advantage may endure for some indefinite future.

(iv) A payment made with a view to obtain the benefit of technical assistance for running the assessee's business more efficiently so as to earn more profits and 'not by way of transfer of fruits of research once and for all', can be treated as an item of revenue expenditure. (v) Expenditure incurred in connection with the profit earning apparatus would be revenue expenditure. (vi) Where the advantage is on the capital filed the expenditure would be treated a capital Expenditure. If the advantage leaves the fixed capital untouched, the expenditure would be on revenue account. (vii) Expenditure in the acquisition of a concern would be capital expenditure; expenditure in carrying on the concern would be revenue expenditure. (viii) An expenditure cannot be considered to be capital expenditure merely on the ground that the amount involved is large. The quantum of expenditure involved cannot alter the nature and character of the expenditure. (ix) The source or manner of the payment are of no consequence in deciding the issue. (x) The question whether a particular payment made by an assessee under the terms of an agreement forms a part of capital expenditure or revenue expenditure, would depend upon several factors., namely, whether the assessee obtained a completely new plan with a complete new process and completely new technology for manufacture of the product or the payment was made for the technical know-how which was for the betterment of the product in question which was already being produced; whether the improvisation made is part and parcel of the existing business or a new business was set up with the so-called technical know-how for which payments were made; whether on expiry of the period of agreement the assessee is required to give back the plans and designs which were obtained, but the assessee could manufacture the product in the factory that has been set up with the collaboration of the foreign firm; the cumulative effect on a construction of the various terms and conditions of the agreement; whether the assessee derived benefits coming to its capital for which the payment was made. If from the terms of the agreement between the parties it transpires that the purpose be the acquisition of an asset/a right of a permanent character was a pre-requisite to the commencement or continuance of the business, the expenditure would be a capital expenditure. (xi) 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 fall in the category of capital expenditure. (xii) If the amount is spent for preserving and maintaining the present asset in existence, it cannot be said that the expenditure so incurred is capital in nature. (xiii) Where the object of incurring an expenditure is to effect a capital structure as a result of which certain incidental advantage flows, the expenditure will be of capital nature. Capital expenditure can be incurred after a company is floated or after it starts its business. (xiv) Ordinarily, the word capital expenditure refers to the expenditure which is of a permanent nature or for securing tangible or intangible property, corporeal or incorporeal right.

a) AYs 2009-10, 2011-12, 2012-13 & 2013-14 (4 years) “5. INTANGIBLE ASSET: The Know-How, Technical Knowledge, Designs and other intellectual properties acquired and developed are stated at cost less the accumulated amortization and accumulated impairment losses. The cost includes the Purchase price, duties and taxes and any directly attributable expenditure on making the asset ready for its intended use. The cost of self generated Intangible asset will include the cost of material and services used, the salaries and other employee costs of personnel directly engaged in generating the asset, other directly attributable expenditure and the overheads necessary to generate the asset. The intangible asset will be amortized over its useful life.” b) AY 2014-15 “e) INTANGIBLE ASSET: The Know-How, Technical Knowledge, Designs and other intellectual properties acquired and developed are stated at cost less the accumulated amortization and accumulated impairment losses. The cost includes the Purchase price, duties and taxes and any directly attributable expenditure on making the asset ready for its intended use. The cost of self generated Intangible asset will include the cost of material and services used, the salaries and other employee costs of personnel directly engaged in generating the asset, other directly attributable expenditure and the overheads necessary to generate the asset. f) RESEARCH AND DEVELOPMENT COST Revenue expenditure on research and development is expensed off under the respective heads of account in the year in which it is incurred.

Expenditure on development activities, whereby research findings are applied to a plan or design for the production of new or substantially improved products and processes, is capitalised, if the cost can be reliably measured, the product or process is technically and commercially feasible and the Company has sufficient resources to complete the development and to use and sell the asset. The expenditure capitalised includes the cost of materials, direct labour and an appropriate proportion of overheads that are directly attributable to preparing the asset for its intended use. Other development expenditure is recognised in the Statement of Profit and Loss as an expense as incurred. g) AMORTIZATION Intangible assets are amortised in the Statement of Profit and Loss over their estimated uses lives, from the date that they are available for use based on the expected pattern consumption of economic benefits of the asset. Accordingly, at present, these are being amortised on straight line basis. An intangible asset is derecognized on disposal or when no future economic benefits are expected from its use and disposal. Losses arising from retirement and gains or losses arising from disposal of an intangible asset are measured as the difference between the net disposal proceeds and the carrying amount of the asset and are recognized in the Statement of Profit and Loss.” c) AY 2015-16 f) INTANGIBLE ASSET: The Know-How, Technical Knowledge, Designs and other intellectual properties acquired and developed are stated at cost less the accumulated amortization and accumulated impairment losses. The cost includes the Purchase price, duties and taxes and any directly attributable expenditure on making the asset ready for its intended use. The cost of self generated Intangible asset will include the cost of material and services used, the salaries and other employee costs of personnel directly engaged in generating the asset, other directly attributable expenditure and the overheads necessary to generate the asset. g) RESEARCH AND DEVELOPMENT COST Revenue expenditure on research and development is expensed off under the respective heads of account in the year in which it is incurred. Expenditure on development activities, whereby research findings are applied to a plan or design for the production of new or substantially improved products and processes, is capitalised, if the cost can be reliably measured, the product or process is technically and commercially feasible and the Company has sufficient resources to complete the development and to use and sell the asset. The expenditure capitalised includes the cost of materials, direct labour and an appropriate proportion of overheads that are directly attributable to preparing the asset for its intended use. Other development expenditure is recognised in the Statement of Profit and Loss as an expense as incurred. h) AMORTIZATION Intangible assets are amortised in the Statement of Profit and Loss over their estimated uses lives, from the date that they are available for use based on the expected pattern consumption of economic benefits of the asset. Accordingly, at present, these are being amortised on straight line basis. An intangible asset is derecognized on disposal or when no future economic benefits are expected from its use and disposal. Losses arising from retirement and gains or losses arising from disposal of an intangible asset are measured as the difference between the net disposal proceeds and the carrying amount of the asset and are recognized in the Statement of Profit and Loss.”

A.Y. Capital Revenue Expenditure Expenditure 2007-08 35,83,346 105,79,544 2008-09 91,68,575 269,98,8243

10. In the light of the above position of law, and considering the facts before us, we have no hesitation in directing the AO to allow the claim of assessee to the extent of Rs.1,05,79,544/- for assessment year 2007-08 and Rs.2,69,98,843/- for assessment year 2008-09 as revenue expenditure and allow depreciation on the capital items worth Rs.35,82,436/- for assessment year 2007-08 and Rs.91,68,575/- for assessment year 2008-09 after verifying class of asset in which these fall, as per law. Ordered accordingly.

Pronounced in the open court on this 27th day of January, 2021.