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Income Tax Appellate Tribunal, DELHI BENCH ‘B’ : NEW DELHI
Before: SHRI R.S. SYAL & SHRI KULDIP SINGH
Order : 25.11.2016 O R D E R PER KULDIP SINGH, JUDICIAL MEMBER : Since common questions of facts and law have been raised in both the aforesaid cross appeals, the same are being disposed off by way of consolidated order to avoid repetition of discussion.
The Appellant, Deputy Commissioner of Income-tax, Circle 11(1), New Delhi (hereinafter referred to as ‘the revenue’) in by filing the present appeal sought to set aside the impugned order dated 31.01.2014 passed by the Commissioner of Income-tax (Appeals)-XIII, New Delhi qua the assessment year 2010-11 on the grounds inter alia that :-
“1. On the facts and circumstances of the case and in law, the CIT (A) has erred in deleting the addition of Rs.6,91,42,261/- made u/s 35(2AB) in respect of research and development expenditure.
2. On the facts and circumstances of the case and in law, the CIT (A) has erred in deleting the addition of Rs.2,10,00,000/- made on account of disallowance of provision for warranty in excess of actual warranty claims being the same as unascertained liability.
3. The appellant craves leave to add, alter or amend any ground of appeal raised above at the time of hearing.”
3. The Appellant, M/s. Eicher Motors Limited (hereinafter referred to as ‘the assessee’) in by filing the present appeal sought to set aside the impugned order dated 31.01.2014 passed by the Commissioner of Income-tax (Appeals)- XIII, New Delhi qua the assessment year 2010-11 on the grounds inter alia that :-
“1. That the learned Commissioner of Income Tax (A)-XIII, New Delhi has grossly erred on facts and in law in confirming the disallowance of notional expenses of Rs.26,97,608/- u/s 14A of the Income Tax Act allegedly relating to dividend income.
2. That the learned Commissioner of Income Tax (A)-XIII, New Delhi has grossly erred on facts and in law in confirming the disallowance of normal expenses of Rs.26,97,608/- u/s 14A while computing book profit u/s 115JB of the Income Tax Act.
The appellant craves leave to add, alter or amend any ground of appeal raised above at the time of hearing.”
Briefly stated the facts necessary for adjudication of the issues involved in both the aforesaid cross appeals are : during the scrutiny proceedings qua Assessment Year 2010-11, Assessing Officer noticed that the assessee has claimed deduction of Rs.10,37,13,391/- on account of research and development expenditure under section 35 (2AB) of the Income-tax Act, 1961 (for short ‘the Act’) @ 150% of the total expenses to be incurred under nomenclature weighted deductions, the details of which has been furnished by the assessee as under :-
S.No. Particulars Amount (Rs.) 1 Capital expenditure on R&D claimed u/s 35(1)(iv) 59,50,354 2 Revenue expenditure on R&D claimed u/s 35(1)(i) 6,31,91,907 3 Additional deduction on capital expenditure on 29,75,177 R&D u/s 35(2AB) 4 Additional deduction on revenue expenditure on 3,15,95,953 R&D u/s 35 (2AB) Total deduction u/s 35 / 35 (2AB) 10,37,13,391
Finding the submissions made by assessee not tenable, AO came to the conclusion that since the assessee has failed to fulfill the conditions contained under Rule 7A (a) of the Act, no such weighted deduction can be allowed as the assessee is purely doing R&D for the purpose of their sales by producing the items that can be sold in domestic or overseas markets and thereby disallowed the additional deductions claimed by the assessee to the tune of Rs.6,91,42,261/- under section 35(2AB).
AO, from the P&L account, further noticed that the assessee has made a provision for warranty at Rs.3.67 crores and the assessee was called upon to explain as to why excess provision of Rs.3.67 crores should not be disallowed being not ascertained liability. Assessee filed comprehensive reply. AO came to the conclusion that since no scientific basis has been furnished, it is clear that provision was only made on estimate basis and not as an ascertained liability and thereby disallowed the excess actual warranty claims amounting to Rs.2,10,00,000/-.
AO further observed that the assessee has claimed to have earned dividend income of Rs.15,82,84,580/-. Assessee was called upon to explain as to why the expenses incurred in earning dividend should not be disallowed u/s 14A of the Act and to furnish the working of disallowance in view of Rule 8D of the Income-tax Rules, 1962 (for short ‘the Rules’). Ld. AR for the assessee submitted that there is neither any interest nor any administrative expenses relating to the dividend income, as such no disallowance u/s 14A is required. AO has disagreed with the submissions raised by the assessee and worked out disallowance under Rule 8D to the tune of Rs.318,84,938/-. However, ld. CIT (A), in view of the revised working of the average investments and assets, worked out the disallowance of interest and administrative expenses and restricted the same to Rs.26,97,608/- u/s 14A of the Act.
Assessee carried the matter before the ld. CIT (A) by filing the appeal who has partly allowed the same. Feeling aggrieved, the revenue as well as assessee has come up before the Tribunal by way of filing present cross appeals.
We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case.
GROUND NO.1 of ITA NO.2228/DEL/2014
The ld. DR for the revenue challenging the impugned order contended that since the assessee has failed to comply with the conditions contained under Rule 6 (7A)(a) of the Rules, which states that, “the facility should not relate purely to market sale promotion, quality control, testing, commercial production, style changes, etc.”, the disallowance has been rightly and validly made by the AO and relied upon the assessment order.
However, on the other hand, ld. AR for the assessee to repel the argument advanced by ld. DR contended that since the AO has himself admitted that the assessee has approved R&D centre and all the conditions have been examined by DSIR at the time of according approval, the CIT (A) has rightly deleted the addition.
Undisputedly, the assessee has claimed weighted deduction at 150% of the scientific research expenditure pertaining to its R&D centre at Chennai to the following effect:-
(i) Capital expenditure on plant, furniture, Rs.59,50,354 equipments, vehicles etc. (ii) Revenue expenses debited to profit and Rs.6,31,91,907 loss account (iii) Additional deduction at 50 percent in Rs.3,45,71,130 respect of aforesaid capital and revenue expenses under section 35 (2AB) Total Rs.10,37,13,391
It is also not in dispute that the AO disallowed weighted deduction at 50% amounting to Rs.34,57,130/- claimed by the assessee u/s 35(2AB) of the Act on the ground that assessee has failed to fulfill the conditions laid down under Rule 6 (7A)(a) of the Rules.
To examine the issue in controversy, the provisions contained under Rule 6(7A)(a) of the Rules are reproduced as under for ready perusal :- “6. ……
(7A) Approval of expenditure incurred on in-house research and development facility by a company under sub-section (2AB) of section 35 shall be subject to the following conditions, namely:-
(a) the facility should not relate purely to market sale promotion, quality control, testing, commercial production, style changes, routine data collection or activities of a like nature.”
Bare perusal of the provisions contained under Rule 6(7A)(a) of the Rules specifically demarcate the area for which in- house research and development facility is to be used by a company i.e. the expenditure of R&D should not be incurred purely for market research, sales promotion, quality control, testing, commercial production, style changes, routine data collection and activities of a like nature.
In the instant case, assessee company claimed to have incurred R&D expenditure to bring down the noise level by redesigning intake and exhaust system; to reduce environmental pollution on account of unburnt gases by combustion chamber redesign, after treatment of exhaust system (e.g. hot tube engine management system); carburetor redesign, engine management system, throttle sensor. Undisputedly, after examining the objectives of the R&D facilities used by the assessee company at Chennai, Department of Scientific and Industrial Research (DSIR) accorded approval u/s 35(2AB) in respect of Chennai centre of the assessee company first time on 11.08.2005, renewed from time to time on the basis of physical inspection and remained intact till 04.10.2012. Order of approval of in-house research and development facilities u/s 35(2AB) of the Act, in form no.3CM dated 18.12.2008 renewed up to 04.12.2012 are available at pages 54 to 60 of the paper book. Bare perusal of the orders of approval u/s 35(2AB) passed by DSIR go to prove that the approval has been accorded to the assessee company to carry out in-house R&D facilities at Chennai centre only when it has fulfilled of the conditions laid down u/s 6(7A)(a) of the Rules.
Moreover, when the R&D centre at Chennai has been established by assessee company on 11.08.2005 and R&D expenditure have been continuously allowed on the basis of approval accorded by DSIR, no material has come on record to depart from the rule of consistency by the AO.
Moreover, when the AO has himself admitted that the R&D centre at Chennai approved by DSIR is carrying out its research and development activities, by disallowing the weighted deduction at 50%, the remaining expenditure of Rs.34,57,130/- cannot be disallowed. Moreover, the conjoint reading of section 35(2AB) and Rule 6(7A)(a) leads to the conclusion that the fulfillment of the conditions to carry out R&D activities are to be examined by DSIR and it is not within the purview of AO. So, in case, there is escalation of sales of the product produced by the assessee company, it may be due to the consequence of research and not because of the fact that R&D facilities have been used for market research and sales promotion. So, we are of the considered view that the CIT (A) has rightly and validly deleted the addition of Rs6,91,42,261/-. So, ground no.1 is determined against the revenue.
GROUND NO.2 OF ITA NO.2228/DEL/2014
AO disallowed an amount of Rs.2,10,00,000/- being excess of actual warranty claimed out of Rs.3,67,00,000/- made as provision for warranty by the assessee company on the ground that it was not ascertained liability. CIT (A) vide impugned order deleted the disallowance of Rs.2,10,00,000/-.
The ld. AR for the assessee relied upon the order passed by coordinate Bench of the Tribunal in order dated 04.01.2016 for AY 2009-10 in assessee’s own case and contended that there is no change of circumstances and the said order has not been further challenged by the revenue. For facility of reference, Paras 31, 32 & 33 of the order (supra) are reproduced as under for ready reference :-
“31. Undisputedly, assessee is engaged in the business of manufacturing and sale of commercial vehicles, tractors, two wheelers and gears. Ld. A.R. contended that various products of the company are sold along with warranty and assessee is under obligation to replace any component bearing manufacturing defect free of cost and at the end of the relevant previous year, assessee had made aggregate provisions for warranty at Rs.7,38,00,000/-.
Ld. D.R. relied upon the order passed by Assessing Officer. However, Ld. A.R. relied upon the order passed by L. CIT(A) and contended that the assessee only claimed regarding deduction of amount earmarked for provision for warranty, has been allowed by the Revenue during the Assessment Years 2002-03, 2003-04, 2006-07 and 2007-08 and no appeal has been filed by the Department against Ld. CIT(A)'s order. Ld. A.R. also relied upon the decision delivered by Income tax Appellate Tribunal Delhi Bench 'B', New Delhi in assessee's own case entitled DCIT Vs M/s. Eicher Motors Ltd. in order dated 18.09.2009. Ld. A.R. also relied upon the judgment of Hon'ble Supreme Court in the case entitled Rotork Controls India Pvt. Ltd. Vs CIT, 314 ITR 62 (S.C.). The ratio of judgment (supra) is that estimated provisions for warranty are allowable for deduction. Operative part of the judgement (supra) is reproduced below for facility of reference: "Held, reversing the decision of the Hon'ble High Court, that the valve actuators, manufactured by the assessee, were sophisticated goods and statistical data indicated that every year some of these were found defective; that valve actuator being a sophisticated item no customer was prepared to buy a valve actuator without a warranty. Therefore, the warranty became an integral part of the sale price: in other words, the warranty stood attached to the sale price of the product. In this case, the warranty provisions had to be recognized because the assessee had a present obligation as a result of past events resulting in an outflow of resources and a reliable estimate could be made of the amount of obligation. Therefore, the assessee had incurred a liability during the assessment year which was entitled to deduction under section 37 of the Income tax Act, 1961.
The present value of a contingent liability, like the warranty expense, if properly ascertained and discounted on accrual basis can be an item of deduction under section 37. The principle of estimation of the contingent liability is not the normal rule. It would depend on the nature of the business, the nature of sales, the nature of the product manufactured and sold and the scientific method of accounting adopted by the assessee. It would also depend upon the historical trend and upon the number of articles produced. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when: (a) an enterprise has a present obligation as a result of a past event: (h) it is probable that an outflow of resources will be required to settle the obligation, and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized. The principle is that if the historical trend indicates that a large number of sophisticated goods were being manufactured in the past and the facts show that defects existed in some of ht items manufactured and sold, then provision made for warranty in respect of such sophisticated goods would be entitled to deduction from the gross receipts under section 37. "
The coordinate bench of Income tax Appellate Tribunal by relying upon the judgement cited as Rotork Controls India Ltd. (supra) in the assessee's own case for the Assessment Year 2002- 03 held that assessee had estimated the provisions for warranty on the basis of past history. The estimate of warranty made by the assessee on the basis of past history cannot be treated as a provision for any ascertained liability and allowed the provision for warranty as deduction. Following the law laid down by Hon'ble Supreme Court in the judgement (supra), decision of coordinate bench in the assessee's own case, we find that there is no infirmity or perversity in the findings returned by Ld. CIT(A) in allowing the ascertained liability as allowable expenditure u/s 3 7( 1) of the Act. So, ground No.3 is determined in favour of the assessee.”
Following the order passed by the coordinate Bench in assessee’s own case for AY 2009-10 (supra), by following the judgment passed by the Hon’ble Supreme Court in case of Rotork Controls (supra), we find no illegality or perversity in the deletion of disallowance of Rs.2,10,00,000/- by the ld. CIT (A) vide impugned order. So, ground no.2 is determined against the revenue.
Undisputedly, assessee company has earned dividend income of Rs.15,82,84,580/- from the investments held in its various subsidiary companies and mutual funds claimed to be exempted u/s 10(33 / 34) of the Act. AO, by invoking the provisions contained u/s 14A read with Rule 8D disallowed an amount of Rs.3,18,84,938/- (subsequently reduced to Rs.30,25,000/- vide rectification order). Taking note of the incorrect computation of disallowance u/s 14A, CIT (A) has restricted the disallowance u/s 14A read with Rule 8D(2) to Rs.26,97,608/- instead of Rs.30,25,000/- computed by the AO.
Ld. AR for the assessee challenging the impugned order contended inter alia that AO without returning the findings that the assessee has actually incurred expenses having proximate nexus with earning of the exempt dividend income and it is for the AO to prove the proximate/direct nexus of expenses with the earning of the exempt income to make the disallowance; that in case AO is dissatisfied with the claim of the assessee that no expenditure in relation to exempt income has been incurred by the assessee only then provisions contained u/s 14A Rule 8D can be invoked; that unless and until there was actual expenditure for earning the exempted income there cannot be any disallowance u/s 14A; that during the year under assessment, no fresh investment falling in the purview of section 14A were made; that there is no nexus of borrowed funds with such investments nor such facts have been established during the assessment completed u/s 143(3) of the previous years; that assessee has got sufficient cash flow during the year under assessment and no investment has been made in the securities earning tax exempt income; that ld. CIT (A) have also erred in considering all the aforesaid contentions rather affirmed the addition made by the AO and relied upon judgment cited as Maxopp Investment Ltd. vs. CIT - 347 ITR 272 (Del.), CIT vs. Hero Cycles Ltd. - 320 ITR 518 (P&H) and SIL Investment Ltd. Vs. ACIT – 148 TTJ 213 (Delhi Bench).
“12. The ratio of the judgment cited as Maxopp Investments Limited (supra) passed by the Hon’ble jurisdictional High Court is that “under section 14A(2,) it is a condition precedent for Assessing Officer to determine amount of expenditure incurred in relation to exempt income; that he must record his dis-satisfaction with correctness of claim of expenditure made by the assessee or with correctness of the claim made by the assessee that no expenditure has been incurred and that determination of amount of expenditure in relation to exempt income under Rule 8D only come into play when AO rejects claim of assessee in this regard.”
Hon’ble Punjab & Haryana High Court in judgment cited as Hero Cycles Ltd. (supra) also held that disallowance u/s 14A can only be made if the AO establishes proximate nexus of expenditure with exempt income. ITAT, Delhi Bench in case of SIL Investment Ltd. (supra) also held that the AO cannot make disallowance u/s 14A without brining any evidence on record to establish that any expenditure had been incurred by the assessee for earning exempt income.
In the light of the settled proposition laid down in the judgments (supra) discussed in the preceding para, when we examine the disallowance worked out by the AO under Rule 8D, reproduced hereunder, the AO has not brought on record any evidence to establish if any expenditure has been incurred by the assessee for earning exempt income :-
Sl.No. Particulars Amount in Rs. A Employees Cost Basic Salary 7,085,205 House Rent Allowance 3,095,189 Other taxable Allowance 11,658,649 Leave Encashment 11,745 Bonus/Rewards 26,942 Provident Fund Contributions 12,649 Leave Travel Allowance 657,545 Transport/Vehicle Expenses 246,796
Medical Reimbursements 449,792 Staff Welfare 109,246 Sub total (A) 23,353,758 B Overheads Consumables 1,010,868 Freight & related expenses 231,069 News Paper / Magazines 439,579 Loss on sale of Fixed assets 116,728 Repairs & Maintenance 2,462,515 Electricity Insurance 2,417 Maintenance Charges Vehicle Expenses 479,702 Printing & Stationery 62,987 Computer consumables 227,746 Courier Expenses 41,727 Telephone 198,306 Travelling Expenses 5,292,203 Conveyance Expenses 103,735 Professional & Consultancy 15,442,622 Other expenses 131,912 Books & Periodicals 72,148 Membership Fees 441,096 Recruitment/Joining Expenses 51,314 C Development Expenses Inspection & Testing 2,390,014 Product Development Expenses 15,057,518 Sub Total (C) D Depreciation 15,770,484
E Grand Total 83,380,447
F Less :- Excluded in Computation of Income a. Depreciation 15,770,484 b. R&D work in progress of FY 4,031,328 2008-09, charged off c. Loss on sale of Fixed Assets 116,728
G Revenue expenditure on R&D 63,191,907 debited to P&L Account (E-F)
The entire exercise to work out the disallowance under Rule 8D done by the AO is on the basis of imagined expenditure based upon the average value of the investment whereas the expression “expenditure incurred” refers to actual expenditure and not imagined expenditure. AO without recording his dissatisfaction of the correctness of the claim of expenditure made by the assessee and without arriving at the conclusion that the claim of assessee that “no expenditure has been incurred is incorrect” proceeded to invoke the provisions of section 14A read with Rule 8D. At the same time, AO has not disputed the audited books of account of the assessee in respect of investment and earning dividend income which are available at page 5 to 49 of the paper book.
So, when from the balance sheet available at page 16 of the paper book, produced before AO as well as CIT(A), it has come on record that assessee has sufficient cash flow during the year under assessment; the AO has failed to prove any nexus of borrowed funds with various investments held by the assessee; the AO without recording his dissatisfaction of correctness of the claim of expenditure made by the assessee nor AO has rejected the claim of the assessee that no expenditure has been incurred in earning the dividend income, the provisions contained under section 14A read with Rule 8D are not attracted. So, we are of the considered view that AO as well as CIT (A) have erred in disallowing / confirming the disallowance of normal expenses of Rs.26,97,608/- while computing the book profit u/s 115JB of the Act. Consequently, grounds no.1 & 2 are determined in favour of the assessee.
In view of what has been discussed above, Appeal, filed by the revenue stands dismissed and Appeal, , filed by the assessee is allowed. Order pronounced in open court on this 25th day of November, 2016.