ASSTT. CIT -CIRCLE-3(4), MUMBAI vs. M/S. LUPIN LTD., MUMBAI

Appellant/Assessee by : Shri Rajan Vora, Shri Pranay Gandhi & Ms. Palak Mehta, CA Revenue/Respondent by : Ms. Manju Thakur, Sr. DR Date of Hearing : 13.03.2024 Date of Pronouncement : 18.03.2024 O R D E R Per Bench: These appeals of the assessee and the revenue and the Cross Objection (C.O) of the assessee are against the order of the Commissioner of Income Tax (Appeals)-57, Mumbai dated 17.11.2020 [for short 'the CIT(A)] and against the order of rectification passed by the CIT(A) under section 154 of the Income Tax Act ( (the Act). The CIT(A) has passed the impugned orders against the final order of assessment passed by the Assessing Officer (AO) under section 143(3) r.w.s. 144C(13) of the Act. The issues contended in these appeals and the C.O are common and therefore these appeals are heard together and disposed of through this common order.

Issues ITA No. CO No. No.77/M/21 1242/M/21 1241/M/21 1/M/22 General C.O. No.1 Disallowance of Ground No.1 depreciation on unverified purchases and other expenses Disallowance of Ground No.2 depreciation on goodwill on amalgamation Transfer Pricing Ground No.3 Adjustment on letter of comfort Initiation of penalty Ground No.4 proceedings u/s 271(1)(c) Mark to market loss Ground No.1 C.O. No. 2 to allowed as deduction 4 under section 37(1) Disallowance of sales Ground No.2 promotion expenses Expenditure on Ground No.3 C.O. No. 5 Employee's stock option Weighted deduction u/s Ground No. 4 Ground 35(2AB) & 5 No.1 to 3 Pre-commencement Ground No.6 C.O. No. 6 expenses Deduction u/s 10AA Additional Ground No.5 Deduction of Education Additional Cess Ground No.6

Sr. No. Particulars Amount (Rs.) 1 Depreciation on unverified purchases and other 1,07,57,943 expenses of capital nature 2 Disallowance of Mark to market loss 1,18,20,185 3 Disallowance of sales promotion expenses 82,30,32,740 4 Disallowance of expenditure on ESOP 34,65,39,003 5 Disallowance of pre-commencement expenses 2,89,59,855 incurred at Pithampur SEZ-Plant II and Nagpur SEZ Plant 6 Disallowance of weighted R&D deduction under 49,94,52,208 section 35(2AB) of the Act 7 TP adjustment on account of Corporate 41,13,867 Guarantee and Letter of comfort

6. Aggrieved the assessee filed further appeal before the CIT(A) partly allowed the appeal by granting relief to the assessee in respect of the following:  Disallowance of Mark to market loss of Rs. 1,18,20,185  Disallowance of sales promotion expenses amounting to Rs. 82,30,32,740  Weighted Deduction under Section 35(2AB) of the Act on Clinical & Analytical Charges of Rs. 49,94,52,208;  Weighted deduction under Section 35(2AB) of the Ac other R&D expenditure of Rs. 8,17,46,000 (through rectification under section 154 of the Act)  Disallowance of ESOP expenditure of Rs. 34,65,39,003 not debited to P&L  Pre-commencement revenue expenses incurred at Pithampur SEZ Plant II and Nagpur SEZ Plant of Rs. 2,89,59,855  Additional depreciation on asset put to use less than 180 days of Rs.7,42,63,633;  Addition of tax on non-monetary perquisites to book profits under section 115JB of the Act of Rs. 2,95,87,707  Transfer Pricing Adjustment on account of Corporate Guarantee Fees of Rs.28,67,419 The CIT(A) upheld the following additions/disallowances  Disallowance for depreciation on unverified purchases and other expenses of Rs.1,07,57,943  Transfer Pricing Adjustment on Letter of Comfort of Rs. 12,46,488  Provision for Leave Encashment of Rs. 10,33,01,542  Depreciation on goodwill on amalgamation of Rs. 21.81 Crore 7. Aggrieved by the order of the CIT(A) both the assessee and the revenue are in the appeal. – Assessee's appeal Disallowance of Depreciation on unverified purchases and other expenses – Ground No.1

8. During the assessment proceedings pertaining to AY 2006-07 to AY 2011- 12 under section 143(3) r.w.s. 144C(13) r.w.s.153A and for AY 2012-13 under section 143(3) r.w.s. 144C(13), depreciation was disallowed on certain unverified purchases and expenses which were capitalized in the books of accounts. The AO called on the assessee to furnish the depreciation on the written down value of the disallowed purchases for the year under consideration and accordingly disallowed the depreciation on said unverified purchases for the AY 2013-14 also. The ld. AR submitted that the Co-ordinate Bench of the Tribunal while considering the issue of disallowance of depreciation on unverified expenses capitalized for AY 2009- 10 (ITA No.1920/Mum/2020, and C.O. No. 129/Mum/2021 dated 03.02.2023) has deleted the disallowance and has remitted the issue of depreciation on unverified purchases back to the file of the AO for fresh examination. The ld AR further submitted that since for the year under consideration the disallowance is towards the consequential depreciation the issue is covered by the decision of Co-ordinate Bench in assessee's own case for AY 2009-10 and therefore prayed for a similar direction.

10. We have heard the parties and perused the material on record. In assessee's case depreciation on unverified purchases were disallowed for AY 2006-07 to AY 2012-13 and the Co-ordinate Bench has given relief to the assessee towards depreciation unverified purchases capitalized and the issue of depreciation on 7 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited unverified purchases was remitted back to the AO for fresh examination. We notice, that the disallowance made by the AO towards unverified purchases and expenses is the consequential depreciation on the written down value of the assets. The relevant observations of the coordinate bench are extracted below –

Unverified Expenditure “6.4 In our view, we may leave aside the issue as to whether the said retraction is valid or not, since the assessee is supporting its stand for not disallowing these expenses on merits. In our view, the stand of the assessee, in the facts and circumstances of the case, merits acceptance. First of all, there is no dispute that the amount of Rs.48,89,052/- is not in the nature of commission expenses, i.e., the assessee has admitted that it has booked bogus expenses by way of commission payments only. Secondly, it has furnished the details of materials purchased through these bills, delivery challans etc., to prove receipt of materials. The assessee has also explained the reason as to why these expenses were not added to the total income while computing total income. We notice that the tax authorities have ignored all these aspects on merits, but placed their reliance on the statement made u/s 132(4) of the Act. The provisions of sec.132(4) enables the assessing officer to presume that the admission made in the statement “may be” used in the assessment proceedings. It is well settled proposition of law that it is a rebuttable presumption, meaning thereby, the deponent could show that the admission made by him in the statement was wrong. In the instant case, in our view, the assessee has rebutted the admission by furnishing evidences in support of the expenses. The very same fact that a sum of Rs.9,86,470/- out of the above said expenditure amount of Rs.48,89,052/- represents Capital expenditure (which fact has also been accepted by the AO) would show that there is merit in the submission of the assessee. For booking bogus expenses, it is unlikely that anyone will account for bogus capital expenses. Accordingly, we are of the view that the explanation given by the assessee on this aspect merits acceptance. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and direct the AO to delete the addition of Rs.39,02,582/-. Accordingly, we hold that the consequential disallowance of depreciation on the capital expenditure amount of Rs.9,86,470/- is also not warranted and we direct the AO accordingly.” Unverified purchases “7.3 We heard the parties on this issue and perused the record. We notice that the assessee has submitted that it has revised VAT returns under protest on 8th July, 2011, after Sales tax survey, since it would not get input VAT credit on the alleged bogus purchases. It is stated that on the basis or revised sales tax returns, it has 8 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited agreed to surrender Rs.58.80 crores during the course of search towards bogus purchases in various years, which included Rs.10.00 crores pertaining to the year under consideration. However, it is stated that the assessee has noticed that the most of the vendors were not included in the final list of suspicious dealers published by MVAT authorities in its website. Hence, the assessee has re-revised its VAT returns after verification on 26th June, 2012, i.e., subsequent to the date of search. According to the assessee, the rerevised VAT returns has since been accepted by the VAT authorities. Accordingly, it was submitted that the surrender of income towards alleged bogus purchases was made on the basis of incomplete information and further on the reasons that the assessee was not able to prove the genuineness of purchases at that point of time. 7.4 With regard to the statement given by one of the vendors Shri Naresh Kantilal Shah, which was referred to by the AO, the assessee submitted that it has not made any purchases from the concerns belonging to the above said person during the year under consideration. On legal aspects, the assessee has contended that the addition could not be made merely on the basis of statement given on oath. 7.5 The ld D.R, on the contrary, supported the orders passed by tax authorities on this issue. 7.6 We notice that the assessing officer has entirely placed his reliance on the statement given by the employees and directors of the assessee u/s 132(4) of the Act. Besides the above, the AO has also placed reliance on the statement given by Shri Naresh Kantilal Shah, one of the accommodation entry providers and also the statement given by the Vice President (Taxation). However, we notice that the surrender made by him was not added by the AO. We notice that the assessing officer did not examine the explanations of the assessee as to why it was constrained to make surrender towards alleged bogus purchases. Though there was no specific retraction of the surrender so made, yet we have noticed earlier that the surrender made in the statement recorded u/s 132(4) of the Actcan be rebutted by producing evidences against the surrender. In the instant case, the additional evidences relied upon by the assessee to rebut the surrender are:- (a) Re-revised VAT returns. (b) VAT orders passed by the VAT authorities accepting the rerevised VAT returns, The question of suspicious dealers came to fore only on the reason that these dealers did not deposit VAT tax after issuing accommodation bills. If the assessee could get VAT credit against these bills, then it may be possible to presume that the suppliers are genuine. Under these set of facts, it is claimed by the assessee that the surrender towards bogus purchases was made on the technical reason that the said suppliers have not paid VAT amount, which would disentitle the assessee to claim VAT credit and hence the assessee cannot effectively prove the genuineness of purchases. If the re-revised VAT returns have been accepted by the VAT authorities and the assessee got the credit of VAT amount, it is submitted that the entire foundation on which the surrender was made got demolished. It is also submitted that these suppliers are not included in the list of suspicious dealers by MVAT authorities. 7.7 Under these set of facts, we are of the view that the assessee may be provided with one more opportunity to prove the genuineness of purchases. Accordingly, this issue requires fresh examination at the 9 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited end of the AO, since the AO has not examined these factual aspects. In order to prove the genuineness the assessee may also furnish documents/details, on sample basis, to show that the relevant goods have been received and used by it. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and restore the same to the file of AO for examining it afresh in the light of discussions made supra.

Therefore respectfully following the above decision, we direct the AO to delete the disallowance of consequential depreciation on unverified expenses and the issue of consequential depreciation on unverified purchases is remitted back to the AO with similar directions. Needless to say that the assessee be given a reasonable opportunity of being heard. This ground of the assessee is partly allowed for statistical purposes.

Disallowance of depreciation on goodwill on amalgamation – Ground No.2

11. There was an amalgamation approved by the Board of Directors and the Hon'ble Bombay High Court of the assessee-company and its wholly owned subsidiaries namely Lupin Pharmacare Ltd., Lupin Herbal Ltd. and Novodign Ltd. w.e.f. 01.04.2009. The amalgamation was accounted in the books of the assessee as per pooling of interest method prescribed by Accounting Standard-14. In terms of the scheme all Assets & Liabilities of the transferor company have been transferred to the assessee-company at their respective book value and all intercompany balances were canceled. Since the transferor companies were wholly owned subsidiaries of the assessee, the shares held by assessee in the transferor company were cancelled and no shares were issued to effect the amalgamation. After giving effect the accounting treatment in terms of the scheme the balance lying in the investment account of the assessee aggregating to Rs. 21.81 crores pertaining to purchase of Novodign Ltd. was shown as goodwill in the accounts of the assessee company. The said amount is arising out the acquisition of shares of 10 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited the said company by the assessee at a higher price in earlier years. The assessee amortized the goodwill over a period of five years in the books of accounts beginning from AY 2010-11. The assessee claimed the depreciation on the goodwill through a note to the revised return of income. The AO denied the depreciation by relying on the decision of Goetz India Ltd. (284 ITR 323) stating that the assessee has not made the claim by filing the revised return but only through a note. The CIT(A) though admitted the claim of the assessee disallowed the depreciation by relying on the order of his predecessor for AY 2010-11.

(a) there is cash payment by the company (b) it in a case of fresh acquisition and not acquisition in lieu of investments already made. (c) the excess payment was made voluntarily. (d) such excess payment was a conscious decision, i.e, the buyer should be visualizing some business advantage and hence it was paying higher consideration that the value of net assets. (e) The business advantage so visualized by the assessee is considered as an intangible asset eligible for depreciation. 7.8 In the instant case, the assessee has acquired its subsidiary companies by taking over their assets and liabilities in lieu of investments made by it. The above said short fall shall be termed as "goodwill" as per accounting principles. The question is whether such kinds of goodwill would fall under the category of business or commercial rights as mentioned in section 32(1)(ii) of the Act, which was interpreted by Hon'ble Supreme Court in the case of Smiffs Securities Ltd (supra). Hence it is imperative for the assessee to show that the good will, being short fall in the value of investments, would also rank at par with the good will which was considered as business or commercial rights as mentioned in sec. 32(1)(ii) of the Act. However, the fact remains that both the tax authorities have not examined this aspect. 7.10 We noticed that the learned CIT(A) has taken support of the sixth proviso to section 32(1) of the Act to reject the claim of depreciation on the good will. However, on a careful perusal of the sixth proviso to sec. 32(1) of the Act, we noticed that the same is applicable only in a situation where the amalgamation takes place in the middle of the year i.e. the said proviso states that the aggregate amount of depreciation claimed by the amalgamating companies and amalgamated company for that year should not exceed eligible amount of depreciation of that year. In the instant case the amalgamation has taken place on 1.4.2009 and not in the middle of the year. Hence the sixth proviso to section 32(1) will not apply to the facts of the present case. Accordingly we set aside the reasoning given by the learned CIT(A) for confirming the disallowance of depreciation of goodwill. 7.11 We noticed earlier that both the tax authorities have not examined the factual aspects relating to the goodwill amount of Rs.21.81 crores and also the depreciation claimed thereon. Hence the assessee also did not get opportunity to put forth its contentions before them. Under these set of facts, we are of the view, that this claim of depreciation on good will requires examination at the end of the AO by duly considering all the relevant factual aspects. Accordingly, we set aside the order passed by the learned CIT(A) on 12 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited this issue and restore the same to the file of the Assessing Officer for examining it afresh by considering the discussions made supra.”

TP Adjustment on letter of comfort (LOC) – Ground No.3

14. The assessee has issued a letter of comfort towards credit facilities sanctioned by ANZ Banking Group Ltd. to assessee's subsidiaries Multicare Pharmaceuticals Philippines Inc. The TPO treated the said transaction as international transaction and proceeded to bench mark the same. The TPO placed reliance on the decision of the Hon'ble Bombay High Court in the case of Everest Canto (58 taxmann.com 254 (Bom.)) and the decision of Co-ordinate Bench in the case of Glenmark Pharmaceuticals Ltd. (ITA No. 5031/Mum/2012 dated 13.11.2013) to make an adjustment of 1.5% towards Guarantee Commission. The relevant observations of the TPO are extracted below:

v) In view of the detailed discussion above, following the recent decision of Hon'ble Bombay High Court in the case of Everest Kanto, and Mumbai ITAT in Glenmark Pharmaceuticals Ltd. in dated 13.11.2013 (A.Y. 2008- 09), a downward adjustment to the naked quotes of the rates of bank Guarantee has been done in this year, while benchmarking the transaction. It is seen that the bank guarantee rates vary generally between 1% to 3% giving an average of about 2.0%. Accordingly, it would be appropriate to charge 1.5% from the AΕ (average bank guarantee fee charged by bank less 0.50%).

15. On further appeal the CIT(A) upheld the TP Adjustment by stating that the letter of comfort given by the assessee is nothing but the guarantee given by the 13 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited assessee and that the assessee is having a financial obligation to the Bank. Therefore, the CIT(A) held that it is an international transaction warranting a TP Adjustment.

17. We heard the parties and perused the material on record. The assessee has given a letter of comfort to ANZ Bank towards a loan facility extended by the said bank to the AE of the assessee. The contention of the revenue is that what the assessee gave is not a letter of comfort but is a letter of guarantee and accordingly warrants a TP adjustment. The ld AR drew our attention to the terms mentioned in the letter of comfort to submit that the it does not tantamount to assessee giving any financial guarantee to the Bank towards the loan. The letter of comfort is extracted below in this regard for reference –

15 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited 18. From the perusal of the terms in the above letter of comfort it is clear that the assessee is giving a comfort to the ANZ bank that the AE would be operated and maintained in such a way to be in a financial position to repay its obligations and not to take any action that would hinder the operations of the AE. The assessee also gives the commitment that assessee's stake in AE will not go below 51%. Therefore we see no merit in the contention that the assessed has to repay all outstanding to the bank if it reduces its capital below 51% in its AE. Our view is further strengthened by the relevant clauses in the letter of offer given by ANZ to the AE i.e.borrower as extracted by the CIT(A) in his order which is reproduced below - “I have gone through the above and TPO's order, It can be held that it would depend on the nature letter of comfort issued to a bank to give a finding that a particular transaction constitute a guarantee or not. Therefore to held letter of comfort as international transaction/ transaction providing guarantee, it has to be seen whether the letter of comfort cast any additional obligation on the assessee and whether there could be any financial liability on the assessee. In the present case........ The appellant have issued a letter of comfort to ANZ Manila, Philippines. In the Letter of Offer, the following two clauses address the aforementioned issue. In Clause 1, dealing with the Conditions Precedent, one of the conditions is "Lodgment of other documentary requirements to ANZ's satisfaction including the issuance and delivery of letter of comfort from Lupin Limited." In addition, in Clause 3 detailing Mandatory requirement, it is stipulated that the Borrower shall prepay all outstanding or provide cash cover (as appropriate) under the facility if the appellant ceases to own at least 51 percent effective share capital in the Borrower.

16 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited The above terms in the letter of offer creates an obligation on the borrower that the borrower shall prepay the loan in case the assessee ceases to hold 51% stake in the borrower company. Therefore the financial obligation is cast upon the borrower and not the assessee as has been contended by the revenue. The basic difference is that in the Letter of Comfort, the party issues only a letter that the AE would comply term of financial transaction without any obligation to indemnify whereas in case of corporate guarantee, the party issuing guarantee is under obligation to the lender. Considering the terms agreed in the letter of comfort and the terms of the letter of offer we are inclined to hold that what the assessee has given to ANZ towards loan facility granted to its AE is only a letter of comfort and not a guarantee. We notice that Rule 10TA of Safe Harbour Rules for International Transactions defines "corporate guarantee" as explicit corporate guarantee extended by a company to its wholly owned subsidiary being a non-resident in respect of any short-term or long-term borrowing and does not include letter of comfort, implicit corporate guarantee, performance guarantee or any other guarantee of similar nature. In the facts and circumstances of the present case, we are of the considered view that the letter of comfort given by the assessee cannot be treated as letter of guarantee warranting any TP adjustment. Accordingly the adjustment made by the TPO is hereby deleted. This ground is allowed in favour of the assessee.

17 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited Allowability of deduction under setion 10AA of 100% of profits derived from Export Oriented Unit before considering the additions/deletions 20. The assessee through additional ground is contending that the deduction under section 10AA of the Act with respect to Pithampur SEZ Unit should be allowed on the commercial profit and not on the profit after the deductions/additions. In support of the admission of this additional ground, the learned A.R. submitted that it involved only adjudication of legal issue and no fresh facts were required to be examined. The learned Departmental Representative opposed the admission of additional ground. Keeping into consideration the entire conspectus of the facts and circumstances of the case and the additional ground raised before us we are convinced that its adjudication does not require any fresh investigation of facts and involves only legal issue. Respectfully following the judgement of the Hon’ble Supreme Court in the case of National Thermal Power Company Ltd. Vs. CIT [(1998) 229 ITR 383 (SC)] we admit this additional ground for disposal on merits.

18 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited 23. We heard the parties and perused the material on record. We notice that the coordinate bench in assessee's own case for AY 2009-10 has considered a similar issue and held that – 12 The assessee has raised an additional ground with regard to the claim for deduction u/s 10B of the Act. In this ground, it is contended that the deduction u/s 10B of the Act should be computed with reference to Profits and gains derived by 100% Export Oriented Units (Pril, Oral and Goa) from M/s. Lupin Limited 21 exports without deducting allowances under the Income tax Act, i.e., the claim of the assessee is that the deduction should be allowed on commercial profits. In this regard, the assessee has placed its reliance on the decision rendered by co-ordinate bench of Tribunal in the case of Reliance Industries Ltd (ITA No.7299 & 136/Mum/2017 dated 10th November, 2020). The Ld D.R submitted that the above said issue is a new ground taken by the assessee before the Tribunal. Inviting our attention to sec.10B(6) of the Act, the ld D.R submitted that this sub-section contemplates that the depreciation and other allowances should be allowed and even if the assessee did not claim deduction u/s 10B in any of the year, then the depreciation and other allowances are deemed to have been allowed. Accordingly, the Ld D.R submitted that the intention of the legislature is that the depreciation and other allowances are to be deducted from the profits and the deduction shall be allowed thereon. Accordingly, the ld D.R submitted that this issue may be restored to the file of AO for examining it. 12.1 We heard the parties on this issue and perused the record. Since the assessee is raising an altogether new issue, which has not been examined by the tax authorities, the ld D.R submitted that this claim of the assessee requires examination at the end of AO. We agree with the submission made by Ld D.R. Accordingly, we restore this issue to the file of AO for examining this claim of the assessee.

19 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited I.T.A. No. 1242/Mum/2021 – Revenue's appeal Allowability of mark to market (MTM) loss under section 37(1) – Ground No.1

20 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited receivables. The same resulted in a loss of Rs.3.39 crores and it was claimed by the assessee has deduction. The AO disallowed the claim by placing reliance on CBDT Instruction no.3/2010 and holding it as notional loss. The Ld CIT(A) noticed that an identical disallowance made by the AO in AY 2008-09 has been deleted by the Tribunal in ITA No.7513 & 7274/Mum/2014 and the same has been affirmed by the Hon'ble Bombay High Court in ITA No. 1532 of 2017 dated 2nd April, 2019. Accordingly, the Ld CIT(A) deleted this disallowance. The revenue is aggrieved. 13.1 We heard the parties on this issue and perused the record. It is the submission of the assessee that the forward contracts have been entered to cover future export receivables. The break-up details of above said loss are given as under by the assessee: M to M Loss in relation to effective portion of Forward Contract outstanding on 31.3.09 - 42,53,527 M to M Loss in relation to ineffective portion of Option contract outstanding on 31.3.09 - 39,97,341 M to M Loss in relation to derivative asset w/off relating to Option Contract - 2,66,20,000 3,48,70,868 Less: Reversal of M to M Loss in relation to Ineffective portion of Option contract - 8,99,687 ---------------- 13.2 The Ld A.R submitted that an identical issue has been examined by the Tribunal in the assessee's own case in AY 2008-09 and it has been decided in favour of the assessee following the decision rendered by Hon'ble jurisdictional Bombay High Court in the case of CIT vs. M/s D Chetan & Co (ITA No.278 of 2014 dated 01-10-2016)( [2016] 75 taxmann.com 300 (Bombay)). We also notice that the decision rendered by the Tribunal in the assessee's own case has since been upheld by Hon'ble Bombay High Court, vide its order dated 2nd April, 2019 in ITA No. 1532 of 2017. In the case of M/s D Chetan & Co. (supra), the Hon'ble Bombay High Court held as under:-

21 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited "5. Being aggrieved, the Revenue preferred an appeal to the Tribunal. The impugned order of the Tribunal upheld the finding of the CIT (Appeals) that the loss incurred by the Respondent Assessee was a revenue loss and not connected with any speculation activities. The Tribunal found that the transaction of forward contract had been entered into for the purpose of hedging in the course of its normal business activities of import and export of diamonds. Thus, the Revenue's appeal was dismissed by the impugned order of the Tribunal.

23 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited 27. The issue for the year under consideration being identical, we restore the issue to the AO with similar directions. The ground raised by the Revenue is disposed of accordingly.

Allowability of ESOP expenses - Ground No.3

12.1 We noticed that an identical claim made by the assessee was disallowed in A.Y. 2009-10 by the AO. This issue was examined in detail by the Tribunal in read with order passed in M.A. No. 193/Mum/2023 arising out of ITA No. 395/Mum/2021 relating to A.Y. 2009- 10. The final decision rendered by the Tribunal is extracted below by culling out relevant observations from the main order and the order passed in the Miscellaneous Application filed by the assessee:- From Main Order:- “15.1 The Ld CIT(A) allowed the claim of the assessee following the decision rendered by Special bench of Bangalore ITAT in the case of Biocon Ltd vs. DCIT (144 ITD 21). It is pertinent to mention that the decision rendered by the 24 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited Special bench has since been upheld by the Hon’ble Karnataka High Court in 430 ITR 151. 15.2 The Ld D.R submitted that the Circular no. 9 of 2007 issued by CBDT has not been considered by the Special bench or by the Hon’ble High Court of Karnataka. 15.3 We heard Ld A.R and perused the record. It is well settled proposition that the Circular issued by CBDT is binding only on tax authorities and it will not bind on the Courts. The Hon’ble Karnataka High Court has dealt with this issue as under in the case of Biocon Ltd (supra) as under:- “9. In the instant case, the ESOPs vest in an employee over a period of four years i.e., at the rate of 25%, which means at the end of first year, the employee has a definite right to 25% of the shares and the assessee is bound to allow the vesting of 25% of the options. It is well settled in law that if a business liability has arisen in the accounting year, the same is permissible as deduction, even though, liability may have to quantify and discharged at a future date. On exercise of option by an employee, the actual amount of benefit has to be determined is only a quantification of liability, which takes place at a future date. The tribunal has therefore, rightly placed reliance on decisions of the Supreme Court in Bharat Movers supra and Rotork Controls India P. Ltd., supra and has recorded a finding that discount on issue of ESOPs is not a contingent liability but is an ascertained liability.

25 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.” Continued in MA order:- “15.4 We notice that the Special bench has recognised that the discount on ESOP arises on two occasions, viz., (a) First type of discount arises at the time of granting and/or vesting of ESOP options and it represents the difference between fair market value on the date of granting/vesting date and the price at which shares are offered to the employees. This discount is usually amortised over the vesting period. The employee need not exercise option at the time of vesting itself. (b) The second type of discount arises at the time of “actual exercise of option” by the employees and it represents the difference between the fair market value of the equity shares on the date of vesting of option and the date of exercise of option. In the instant case, the amount of Rs.5,74,85,066/- claimed by the assessee represents the second type of discount mentioned in (b) above, i.e., the additional discount arising at the time when the employees actually exercise option. It is the submission of the assessee that the first type of discount did not arise in the instant case, since there was no difference between market price of equity shares and the price at which the shares were offered to the assessee. As per the decision rendered by the Special bench of Bangalore ITAT in the case of Biocon Ltd (supra), the second type of discount arising at the time of actual exercise of option by the employees is also allowable as deduction. This is clear from the discussions made by the Special bench in paragraph 11.1.6 of its order, more particularly, the discussion made in respect of “Situation II” explained by way of illustration by the Tribunal. Accordingly, the above said claim of the assessee is allowable as deduction. 15.5We noticed that the assessee has claimed this amount as deduction before the AO during the course of assessment proceedings and it is the case of the AO that the assessee has not accounted for the same in the books of account. It is the submission of the assessee that the first type of discount is required to be accounted in the books of account and the second type of discount is not required to be accounted. We notice that the requirement of accounting second type of discount has been examined by the Special bench in paragraphs 11.2.8 and 11.2.9 of its order. We notice that the Special bench has stated that the SEBI guidelines did not discuss about the accounting of second type of discount. Accordingly, the Special bench held that the deduction of additional discount has to be allowed as per taxation principles. For the sake of 26 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited convenience, we extract below paragraphs 11.2.8, 11.2.9 and 11.3 of the order passed by the Special bench:- “11.2.8. The plea now raised before us by the ld. AR, relying on the case of Challapalli Sugars Ltd.'s case, was also taken up before the Hon'ble Supreme Court in the case of Tuticorin Alkalis (supra). Dealing with the same, the Hon'ble Supreme Court held that : "The question in Challapalli Sugars Ltd.'s case [1975] 98 ITR 167 (SC) was about computation of depreciation and development rebate under the Indian Income-tax Act, 1922. In order to calculate depreciation and development rebate it was necessary to find out "the actual cost" of the plant and machinery purchased by the company. This court held that "cost" is a word of wider connotation than "price". There was a difference between the price of a machinery and its cost. This court thereafter pointed out that the expression "actual cost" had not been defined in the Act. It was, therefore, necessary to find out the commercial sense of the phrase..............The judgment in Challapalli's case [1975] 98 ITR 167 (SC), goes to show that the court was not in any way departing from legal principles because of any opinion expressed by the Institute of Chartered Accountants." From the above observations there is not even an iota of doubt in our minds that there can be no question of following the accounting principle or Guidance notes etc. in the matter of determination of total income. 11.2.9. The trump card of the ld. AR to bolster his submission for assigning the status of binding force to the SEBI Guidelines is the order in the case of SSI Limited (supra) which came to be affirmed by the Hon'ble Madras High Court in PVP Ventures (supra). We have noticed above that the said case dealt a situation falling within one of the three years of the vesting period, in which it was held that one third of the total amount of discount computed on the basis of the market price of the shares at the time of grant of option, is deductible. It is evident from the SEBI Guidelines that these deal with the deductibility of discount in the hands of company during the years of vesting period. These Guidelines are silent on the position emanating from variation in the market price of the shares at the time of exercise of option by the employees vis-à-vis the market price at the time of grant of option. In other words, the SEBI Guidelines prescribe accounting treatment only in respect of the period of vesting of the options and the situation arising out of unvested options or vested options lapsing. The very reference by the Chennai Bench of the Tribunal in SSI Limited (supra) to the SEBI Guidelines is indicative of the fact that it dealt with a year during which the options were vesting with the employees and the company claimed discount during the vesting period. The Hon'ble Madras High Court in the case of PVP Ventures (supra) has upheld the view taken by the Chennai Bench in 27 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited the case of SSI Limited (supra). The granting of the binding force to the SEBI Guidelines by the Hon'ble Madras High Court should be viewed in the context of the issue before it, which was about the deductibility of discount during one of the vesting years. In the earlier part of this order, we have held that the deductibility of discount during the vesting period, as prescribed under the SEBI Guidelines, matches with the treatment under the mercantile system of accounting. To that extent, we also hold that the SEBI guidelines are applicable in the matter of deduction of discount. Neither there was any issue before the Hon'ble Madras High Court nor it dealt with a situation in which the market price of the shares at the time of exercise of option is more or less than the market price at the time of grant of option. It is a situation which has also not been dealt withby the Guidelines. Accordingly, the afore noted taxation principle of granting deduction for the additional discount and reversing deduction for the short amount of discount at the time of exercise of option, needs to be scrupulously followed 11.3. We, therefore, sum up the position that the discount under ESOP is in the nature of employees cost and is hence deductible during the vesting period w.r.t. the market price of shares at the time of grant of options to the employees. The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing options at the appropriate time. However, an adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option. No accounting principle can be determinative in the matter of computation of total income under the Act. The question before the special bench is thus answered in affirmative by holding that discount on issue of Employee Stock Options is allowable as deduction in computing the income under the head `Profits and gains of business or profession'.” We notice that the assessee has also paid “fringe benefit tax” on the second type of discount (referred supra). It is well settled principle of taxation that the entries made or otherwise in the books of account are not relevant for computing total income, i.e., the total income has to be computed as per the provisions of Income tax Act. If the deduction is otherwise allowable as deduction in computing total income, the same is allowable irrespective of the fact whether the same is accounted in the books of account or not. We notice that this principle has been applied by the Special bench with regard to second type of discount. Accordingly, we are of the view that the Ld CIT(A) was justified in allowing the deduction of Rs.5,74,85,065/- claimed by the assessee. Accordingly, we uphold the order passed by Ld CIT(A) on this issue.”

12.2 Since the facts are identical in this year also, following the above said order passed by the Tribunal, we hold that the learned CIT(A) was justified in allowing the ESOP expenditure claimed by the assessee. Accordingly we uphold the order passed by the learned CIT(A) on this issue.

Weighted deduction under section 35(2AB) – Ground No.4 & 5

12. We may record that question 'E' in the appeal memo is an additional question which has an element of above noted question. We have, therefore, not separately reproduced the same in this order. The issue is whether the assessee who has incurred expenditure for scientific research, which was not in the in-house facility, could be covered for deduction under section 35(2AB) of the Income Tax Act, 1961.

30 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited 13. More or less, facts are not in dispute. The assessee carried out scientific research in its facility approved by the prescribed authority. It incurred various expenditure including on clinical trials for developing its pharmaceutical products. These clinical trials were conducted outside the approved laboratory facility. The Revenue holds a belief that such expenditure not having been incurred in the approved facility cannot form part of the deduction provided under section 35(2AB) of the Act. The Tribunal observed that the term 'in-house' used in section 35(2AB) of the Act must be viewed in the context of which it has been used. If by utilizing the staff or resources of an organization, research is conducted within the organization rather than through utilization of external use of resources or staff, it can be stated to be an in-house research. On such basis, the Tribunal rejected the Revenue's contention that merely because an expenditure which was not incurred in the in-house facility cannot be discarded for the weighted deduction under section 35(2AB) of the Act. Learned counsel for the Revenue, however, strongly relied on the certificate issued by the Prescribed Authority, which segregated the expenditure in two parts, that incurred in in-house facility and that incurred outside.

31 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited 16. The whole idea thus appears to be to give encouragement to scientific research. By the very nature of things, clinical trials may not always be possible to be conducted in closed laboratory or in similar in-house facility provided by the assessee and approved by the prescribed authority. Before a pharmaceutical drug could be put in the market, the regulatory authorities would insist on strict tests and research on all possible aspects, such as possible reactions, effect of the drug and so on. Extensive clinical trials, therefore, would be an intrinsic part of development of any such new pharmaceutical drug. It cannot be imagined that such clinical trial can be carried out only in the laboratory of the pharmaceutical company. If we give such restricted meaning to the term expenditure incurred on in-house research and development facility, we would on one hand be completely diluting the deduction envisaged under sub-section (2AB) of section 35 and on the other, making the explanation noted above quite meaningless. We have noticed that for the purpose of the said clause in relation to drug and pharmaceuticals, the expenditure on scientific research has to include the expenditure incurred on clinical trials in obtaining approvals from any regulatory authority or in filing an application for grant of patent. The activities of obtaining approval of the authority and filing of an application for patent necessarily shall have to be outside the in-house research facility. Thus the restricted meaning suggested by the Revenue would completely make the explanation quite meaningless. For the scientific research in relation to drugs and pharmaceuticals made for its own peculiar requirements, the Legislature appears to have added such an explanation.

33 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited “We have considered rival contentions and perused the case law placed on record. In the decision of Concept Pharmaceuticals ltd (supra) the Coordinate bench did not allow the expenditure spent outside the R & D unit but the Bench has not considered the explanation introduced with reference to ‘Clinical Trials’. By very nature, the Clinical Trials cannot alone be done within research facility as they require cooperation from the Medical Doctors, Hospitals, Volunteers and patients, therefore such expenditure has to be necessarily spent outside the facility, but for the purpose of ‘in-house’ research. This issue was examined by the Coordinate Bench which was subject matter of appeal before the Gujarat High Court and Gujarat High Court has approved the same…..” Accordingly, following the decision of Hon’ble Gujarat High Court, we hold that the amount spent by the assessee on clinical trials outside the approved in- house facility is eligible for weighted deduction u/s 35(2AB) of the Act. Since the facts are identical in this year also and since the decision rendered by Ld CIT(A) on this issue is in accordance with the decision rendered by the co- ordinate bench in AY 2009-10, we uphold his order passed on this issue.

Pre-commencement Expenses – Ground No.6

I.T.A. No. 1242/Mum/2021- Revenue's Appeal

14.5 The next question is Whether the weighted deduction u/s 35(2AB) could be allowed during the year under consideration, even if the expenditure has not been certified by DSIR in Form no.3CL?. The ld D.R placed her reliance on the decision rendered by Hon’ble Karnataka High Court in the case of Tejas Network Ltd (2015)(60 taxmann.com 309)(Kar), wherein it was held that the AO cannot sit in judgment over the report submitted by prescribed authority. Accordingly, the Ld D.R submitted that the AO has to necessarily 35 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited follow the report given by the prescribed authority. The Ld D.R submitted that, in the instant case, the DSIR (Prescribed authority) has not certified the expenses incurred outside the in-house facility and the AO could not sit in judgment over the said report. Accordingly, the Ld D.R submitted that the unapproved expenses cannot be allowed deduction u/s 35(2AB) of the Act. 14.6 The next question is whether expenditure incurred prior to the date of approval could be allowed as deduction? Both these questions are answered together. 14.7 The legal sanctity of Form no.3CL was examined by the Pune bench of ITAT in the case of Cummins Ltd vs. DCIT (ITA No.309/Pun/2014 dated 15.5.2018 relating to AY 2009-10). It was held as under:- "45. The issue which is raised in the present appeal is that whether where the facility has been recognized and necessary certification is issued by the prescribed authority, the assessee can avail the deduction in respect of expenditure incurred on in-house R&D facility, for which the adjudicating authority is the Assessing Officer and whether the prescribed authority is to approve expenditure in form No. 3CL from year to year. Looking into the provisions of rules, it stipulates the filing of audit report before the prescribed authority by the persons availing the deduction under section 35(2AB) of the Act but the provisions of the Act do not prescribe any methodology of approval to be granted by the prescribed authority vis-à-vis expenditure from year to year. The amendment brought in by the IT (Tenth Amendment) Rules w.e.f. 1-7-2016, wherein separate part has been inserted for certifying the amount of expenditure from year to year and the amended form No. 3CL thus, lays down the procedure to be followed by the prescribed authority. Prior to the aforesaid amendment in 2016, no such procedure/methodology was prescribed. In the absence of the same, there is no merit in the order of Assessing Officer in curtailing the expenditure and consequent weighted deduction claim under section 35(2AB) of the Act on the surmise that prescribed authority has only approved part of expenditure in form No. 3CL. We find no merit in the said order of authorities below.

No.10.1, 10.2 and 10.3 are allowed." 14.8 The question of allowing deduction u/s.35(2AB) of the Act was considered by the Hon'ble Delhi High Court in the case of CIT v. Sadan Vikas (India) Ltd. [2011] 335 ITR 117 (Del) where AO refused to accord the benefit of the weighted deduction to the assessee under s. 35(2AB) on the ground that recognition and approval was given by the DSIR in February/September, 2006, i.e., in the next assessment year and, therefore, the weighted deduction cannot be allowed. In this case, the CIT(A) confirmed the order of the AO. The Tribunal held that the assessee would be entitled to weighted deductions of the aforesaid expenditure incurred by the assessee in terms of the s. 35(2AB) of the Act and in coming to this conclusion, the Tribunal relied upon the judgment of Gujarat High Court in CIT v. Claris Lifesciences Ltd. 326 ITR 251 (Guj). In its decision the Hon'ble Gujarat High Court had held that the cut-off date mentioned in the certificate issued by the DSIR would be of no relevance. What is to be seen is that the assessee was in indulging in R&D activity and had incurred the expenditure thereupon. Once a certificate by DSIR is issued, that would be sufficient to hold that the assessee fulfils the conditions laid down in the aforesaid provisions. The Hon'ble Delhi High Court followed the decision of the Hon'ble Gujarat High Court and upheld the decision of the Tribunal. The Hon'ble Delhi High Court quoted the following observations of the Hon'ble Gujarat High Court and agreed with the said view: "7. ... The lower authorities are reading more than what is provided by law. A plain and simple reading of the Act provides that on approval of the research and development facility, expenditure so incurred is eligible for weighted deduction.

8. The Tribunal has considered the submissions made on behalf of the assessee and took the view that section speaks of : (i) development of facility; (ii) incurring of expenditure by the assessee for development of such facility; (iii) approval of the facility by the prescribed authority, which is DSIR; and (iv) allowance of weighted deduction on the expenditure so incurred by the assessee.

9. The provisions nowhere suggest or imply that research and development facility is to be approved from a particular date and, in other words, it is nowhere suggested that date of approval only will be cut-off date for eligibility of weighted deduction on the expenses incurred from that date onwards. A plain reading clearly manifests that the assessee has to develop facility, which presupposes incurring expenditure in this behalf, application to prescribed authority, who after following proper procedure will approve

37 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited the facility or otherwise and the assessee will be entitled to weighted deduction of any and all expenditure so incurred. The Tribunal has, therefore, come to the conclusion that on plain reading of s. itself, the assessee is entitled to weighted deduction on expenditure so incurred by the assessee for development of facility. The Tribunal has also considered r. 6(5A) and Form No. 3CM and come to the conclusion that a plain and harmonious reading of rule and Form clearly suggests that once facility is approved, the entire expenditure so incurred on development of R&D facility has to be allowed for weighted deduction as provided by s. 35(2AB). The Tribunal has also considered the legislative intention behind above enactment and observed that to boost up research and development facility in India, the legislature has provided this provision to encourage the development of the facility by providing deduction of weighted expenditure. Since what is stated to be promoted was development of facility, intention of the legislature by making above amendment is very clear that the entire expenditure incurred by the assessee on development of facility, if approved, has to be allowed for the purpose of weighted deduction." From the above discussion it is clear that prior to 1-7-2016 Form 3CL had no legal sanctity and it is only w.e.f 1-7-2016 with the amendment to Rule 6(7A)(b) of the Rules, that the quantification of the weighted deduction u/s.35(2AB) of the Act has significance. Further, the date of approval shall not be cut off date for allowing scientific research expenditure u/s 35(2AB) of the Act.

Cross Objection No. 01/Mum/2022 – Assessee's

38 /21, 1241 to 1242/M/ 2021 & C.O. 01/M /2022 Lupin Limited with regard to those issue while adjudicating revenue's appeal is mutatis mutandis applicable to the cross objections of the assessee. It is ordered accordingly.

Order pronounced in the open court on 18-03-2024.