KEE PHARMA LTD.,NEW DELHI vs. ITO, NEW DELHI

This appeal filed by the assessee is directed against the order dated 2nd September, 2015 of the CIT(A)-5, Delhi relating to assessment year 2011-12.

The only effective ground raised by the assessee reads as under:- “On the facts and circumstances of the case, the learned CIT(A) has erred both on facts and in law in confirming the action of the ld. A.O. treating the amount incurred on account of research &development expenses of Rs.47,15,000/- as capital expenditure instead of revenue expenditure as claimed by the assessee.”

Facts of the case, in brief, are that the assessee is a company engaged in the business of manufacturing and trading of pharmaceuticals. It filed its return of income on 22nd September, 2011 declaring total income of Rs.1,42,670/-. The Assessing Officer during the course of assessment proceedings observed that the assessee has debited an amount of Rs.46,93,531/- under the head ‘Research & development charges.’ The Assessing Officer asked the assessee to file a note on research & development expenses to which the assessee replied as under:- “Kee Pharma Ltd. had entered into on an Agreement for Sale of Design for the Process to manufacture the drug Atorvastatin, with CBZ Chemicals Ltd., a UK based company, in May 2009. Under the Agreement, a total consideration of US $ 5,50,000/- would be payable by Kee Pharma Ltd, to CBZ Chemicals Ltd., in several stages, the payments being milestone linked. Kee Pharma Ltd. would do research and development activities on the Design to develop a unique patentable process which would ultimately lead to the production of the drug Atorvastatin. The patent for the process so developed would also be filed by Kee Pharma Ltd. in its own name. Under the schedule of payments; as detailed in the Agreement; vide Clause 4.d.i, an amount of US $ 1,00,000/- was payable to CBZ by Kee Pharma Ltd.”

From the reply furnished by the assessee, the Assessing Officer inferred that the design for the process to manufacture the drug ultimately make the company able to produce the drug in the forthcoming years and the benefit of the same will go on beyond the present financial year. He, therefore, asked the assessee to explain as to why the purchase of design should not be treated as capital expenditure. The assessee reiterated that the expenses should be allowed as revenue expenditure. However, the Assessing Officer was not satisfied with the explanation given by the assessee.

Before the CIT(A), it was argued that research and development is an ongoing process in a pharmaceutical company and it does not bring into existence any new assets, but, only helps the assessee to carry out business operations in a more efficient manner. The assessee furnished copies of drug agreement for sale of design for the process to manufacture the drug Atorvastatin dated 18th May, 2009.

However, the ld.CIT(A) was not satisfied with the arguments advanced by the assessee. Relying on the decision of the Hon'ble Delhi High Court in the case of CIT vs. J.K. Synthetics Ltd. reported in 309 ITR 371 (Del), he held that the Assessing Officer was justified in treating the R&D expenditure as capital in nature. While holding so, he further noted that in view of the ‘absolute transfer of all technical knowledge to the assessee, the right of the assessee to sell/resell/licence the design or the process to a third party as well as the exclusive right conferred on the assessee by the said agreements’ the impugned payments are to be held in the nature of capital expenditure. The argument of the assessee that similar expenditure of Rs.20,59,826/- incurred in the F.Y. 2008-09 relevant to assessment year 2009-10 was accepted by the Assessing Officer and no disallowance was made in the order passed u/s 143(3), was rejected by the CIT(A) on the ground that the principle of res judicata does not apply to income-tax proceedings and every year is independent.

Aggrieved with the order of the CIT(A), the assessee is in appeal before the Tribunal.

The ld. counsel for the assessee strongly opposed the order of the CIT(A). He submitted that the decision relied on by the ld. CIT(A) in the case of J.K. Synthetics Ltd. (supra) in fact supports the case of the assessee. The ld. counsel drew the attention of the Bench to clause (1) para 38 of the order which has been reproduced by the CIT(A) and which reads as under:-

He submitted that the Hon'ble High Court has laid down the test for certain expenditure to be classified as capital in nature only when the expenditure incurred towards initial outlay of business. Further, if the expenditure is incurred while the business is ongoing, it would have to be ascertained if the expenditure is made for acquiring or bringing into existence an asset or an advantage of an enduring nature for the business. If the expenditure is for running the business or working it with a view to produce profits, it would be in the nature of revenue expenditure. Referring to the decision of the Hon'ble Delhi High Court in the case of CIT vs. Priya Village Roadshows Ltd., reported in 332 ITR 594 (Del), he submitted that the Hon'ble High Court in the said decision, following various decisions has held that when expenditure incurred for preparation of feasibility report of a new project is in respect of the same business which is also carried on by the assessee even if it is for expansion of business, namely, to start a new unit which is same as earlier business and there is a unity of control and a common fund, then, such expenditure is to be treated as revenue expenditure. He accordingly submitted that since the assessee in the instant case is already in the business of manufacturing and trading of pharmaceuticals and similar expenditure was allowed in the past by the Assessing Officer in the order passed u/s 143(3) and 143(1), therefore, in view of the decision of the Hon'ble Delhi High Court in the case of CIT vs. Priya Village Roadshows Ltd. (supra), the expenditure has to be allowed as revenue expenditure. He accordingly submitted that the order of the CIT(A) be set aside and the ground raised by the assessee be allowed.

The ld. DR, on the other hand, heavily relied on the order of the CIT(A). She submitted that by incurring huge expenditure on R&D, the assessee has created a capital asset of enduring benefit, therefore, the CIT(A) was fully justified in upholding the action of the Assessing Officer in treating the same as capital expenditure and allowing depreciation on the same.

We have considered the rival arguments made by both the sides and perused the orders of the authorities below. We find the Assessing Officer treated the expenditure of Rs.46,93,531/- incurred by the assessee as research and development charges as capital in nature as against revenue in nature treated by the assessee on the ground that the design procured by the assessee company will be beneficial to the assessee for more than one year. We find the ld.CIT(A), relying upon the decision of the Hon'ble Delhi High Court in the case of J.K. Synthetics Ltd. (supra) upheld the action fo the Assessing Officer. It is the submission of the ld. counsel for the assessee that the assessee is an existing company engaged in the business of manufacturing and trading of pharmaceuticals and it has not made any investment in the initial outlay of business and has not made any payments for purchase of any plant or other similar assets. It is also the argument of the ld. counsel for the assessee that in view of the decision of the Hon'ble Delhi High Court in the case of Priya Village Roadshows Ltd. (supra), the expenditure incurred for preparation of feasibility report of a new project which is in respect of same business already carried on by the assessee, even if it is for expansion of business, namely, to start a new unit which is same as earlier business and there is unity of control and common fund, then, such expenditure has to be treated as a revenue expenditure.

We find merit in the above argument of the ld. counsel for the assessee. It is an admitted fact that the assessee was already in the business of manufacturing and trading of pharmaceuticals. Similar expenditure was incurred in the two preceding assessment years also. From the copy of the assessment order for assessment year 2009-10 passed u/s 143(3) on 5th December, 2011, a copy of which is placed at page 69-75 of the paper book, we find the Assessing Officer has not made any addition by treating the expenditure of Rs.20,59,826/- as capital in nature. Similarly, in the assessment year 2010-11, although the assessee has claimed similar expenditure, no addition has been made even though the order is passed u/s 143(1). There is nothing on the record to suggest that action u/s 147 or 263 have been initiated for the two preceding assessment years. The expenditure incurred is also not doubted by the Revenue and the same has been incurred in the regular course of business i.e., for the purpose of manufacturing pharmaceuticals. We find an identical issue had come up before the Hon'ble Delhi High Court in the case of Priya Village Roadshows Ltd. (supra). In that case, the assessee-company, which was already involved in the business of running cinemas, was pursuing owners of a cinema hall for taking over the cinema for conversion into a multiplex and operation and management thereof. In order to carry out technical and financial feasibility, the assessee availed services of an architect and paid him certain amount as fee in the preceding year. However, the project was not found to be financially and technically viable. The assessee, therefore, decided to drop the project and amount spent was claimed as revenue expenditure.

We note two judgments of other High Courts taking this view in identical circumstances. One case is decided by Gauhati High Court which is reported as Dy. CIT vs. Assam Asbestos Ltd. (2003) 185 CTR (Gau) 223 : (2003) 263 ITR 357 (Gau). In that case the assessee was in the business of manufacturing asbestos sheets. Contemplating to set up a mini cement plant, which was the same line of business activity of the assessee, a feasibility report was prepared. However, the project could not be undertaken as Government refused to grant required permission. The Court opined that no new capital asset came into existence and the expenses incurred on preparation of the feasibility report, same line of business, were in the nature of revenue expenditure. Rajasthan High Court had also occasion to deal with this issue in the case of Maharaja Shri Umaid Mills Ltd. vs. CIT (1988) 68 CTR (Raj) 187 : (1989) 175 ITR 72 (Raj). There also the expenditure incurred in obtaining survey and feasibility report for setting up polyethylene plant for manufacturing packing material was treated as revenue expenditure as the new venture was interconnected and formed part of existing business.

In the result, the appeal filed by the assessee is allowed.