THE COMMISSIONER OF INCOME TAX vs. M/S MICROLABS LTD

THE COMMISSIONER OF INCOME-TAX, LTU, JSS TOWERS, BSK III STAGE, BANGALORE – 560 085.

THE DEPUTY COMMISSIONER OF INCOME-TAX, LTU, JSS TOWERS, BSK III STAGE, BANGALORE – 560 085.

We have heard Mr. Aravind, learned counsel appearing for the appellant - Revenue.

On the first question, the observations made by the Tribunal in the impugned order from paragraph Nos.12 to 17 are as under:

The CIT(A) in his order passed u/s. 154 of the Act has not quoted the first sentence of the guideline 5(vii) (given above in bold letters), which in our opinion, is very material. The above guideline only means that in the process of carrying out the R&D work, if the assessee acquires any assets or products that should not be disposed of without the approval of Secretary, DSIR. If such assets are sold, the sales realization arising therefrom are to be setoff against the R&D expenditure of the R&D centre which is claimed as decuction u/s.

A copy of license and supply agreement which was filed by the assessee before the AO as well as CIT(A) is at pages 5 to 26 of the assessee’s paperbook. The sale of products is nothing but the sale of Dossiers by the assessee to persons not associated with the assessee or its directors. In the course of carrying out the scientific research, the assessee prepares elaborate documents regarding the products that would emanate from carrying out scientific research. This would also include the requirement of health authorities for grant of license to approve the products for human use. The assessee gives the Dossiers so prepared to entities outside India, who are interested in getting the marketing authorization for the product in a particular territory. They pay to the assessee the Dossier charges and apply for license to market the products for human use in their respective territories. On getting the license, they get marketing authorization from the assessee. The person who takes the Dossier (knowhow) takes it for the limited purpose of registration of product in other countries and after registration sale of the products in their country. If they get any order M/s. Micro Labs will manufacture and sell them at agreed price. So the knowhow given to them is only for

All intellectual property rights, title and interest of any kind whatsoever in and/or to the Dossier and the Products shall be the exclusive property of MICRO LABS (the Assessee). MICRO LABS i.e., the Assessee may sell the Dossier to any third party, including its clients without the consent of foreign entity buying the dossier. However, MICRO LABS (the Assessee) shall notify the person acquiring the dossier of the transfer or sale of the Dossier to such third party and shall undertake that such third party respect the terms and conditions of the agreement with the other third party who buys dossier from the Assessee.

DSIR guidelines no. vii has specifically provided that assets acquired if any out of R & D work shall be disposed with approval of DSIR. The assessee has been submitting yearly audit reports & accounts of approved R

It is clear from the sample copy of the license and supply agreement filed before us that the product development charges received by the assessee will not be covered under clause 5(vii) of the DSIR guidelines. As we have already seen, these receipts are credited to profit & loss account are part of normal sales. They are, therefore, not to be reduced from the expenditure incurred by the assessee on carrying out scientific research on which deduction u/s. 35(2AB) has to be allowed. We are, therefore, of the view that there is no merit in ground No.2 raised by the revenue and that the order passed by the CIT(A) DATED 9.4.2014 U/S. 154 of the Act cannot be sustained and the same is hereby reversed. Thus, ITA No.764/B/14 by the assessee is allowed, while ground No.2 raised by the revenue is dismissed.”

In our view, the approach to the issue considered by the Tribunal is appropriate. In any case, no substantial question of law would arise for consideration as canvassed.

For the second question, the observations made by the Tribunal in the impugned order reads as under:

The assessee earned dividend income of Rs.38,75,857.

The break-up of the sum of Rs.3,22,426 is not specifically given, but is stated to be relating to management fee, legal & professional charges, security transaction charges and NSDL charges. It is thus clear that the assessee by implication had claimed that there was no expenditure incurred by way of interest, either directly or indirectly, which is attributable to the borrowed funds which were used for the purpose of investment which yielded tax free income.

The AO observed that Schedule G to the Financial Statements of the assessee had shown investment to the tune of Rs.28,45,29,937 in shares mutual funds of various companies. He was of the view that such investments cannot be made routinely. No prudent businessman would make any investment without applying the resources wisely. Obviously this entails expenditure, direct as well as indirect. He thereafter

Aggrieved by the assessment order, the assessee preferred appeal before the CIT(Appeals).

Before CIT(A), the assessee submitted that interest bearing loans were borrowed for specific purposes and not for investment purposes and in support of the above contention, the Assessee filed copies of balance sheets as on 31.03.2003 upto 31.03.2009 to show that the various loans availed from banks were all taken for specific purposes and could not have been utilized for making any investments out of which exempt income was earned. These loans include short term loans from IDBI Bank, Exim Bank, Barclays Bank and Standard Chartered Bank in respect of which it was explained that the loans could not have been used for making any long term investment. Copies of some communications from banks regarding sanction of the loans were also filed before me to substantiate the nature of the loan. In respect of IDBI loan, it was submitted that the same

On consideration of the above submissions and on perusal of the relevant documents, the CIT(A) was of the view that the claim of the Assessee was not evidenced from the documents submitted in view of the loans and other sources of funds being mixed up in the common pool of funds. The CIT(A) further held that the burden of proof in this matter clearly continues to rest with the Assessee and that it was not enough to merely show that surplus funds were available or that bank loans had been availed for specific purposes including short term reasons. A one- to-one correlation must also be established to prove that the loans were absolutely utilized for the purpose for which they were claimed. The CIT(A) also held that there was no utilization certificate from the bank filed before the AO nor was such evidence furnished before the CIT(A). The CIT(A) also held that the documents submitted from the bank during the course of appeal only refer to the disbursal of the loan and even these specify certain conditions required to be met. The date-wise actual disbursal and utilization is not proved from the ledger copies as submitted. The CIT(A) also referred to the decision of Mumbai

Aggrieved by the order of CIT(A), the assessee has raised ground No.2.

We have heard the rival submissions. A copy of the availability of funds and investments made was filed before us which is at pages 38 to 42 of the assessee’s paperbook and the same is enclosed as ANNEXURE-III to this order. It is clear from the said statement that the availability of profit, share capital and reserves & surplus was much more than investments made by the assessee which could yield tax free income.

The Hon’ble Bombay High Court in Reliance Utilities & Power Ltd. 313 ITR 340 (Bom) has held that where the interest free funds far exceed the value of investments, it should be considered that investments have been made out of interest free funds and no disallowance u/s. 14A towards any interest expenditure can be made. This view was again confirmed by the Hon’ble Bombay High Court in CIT v. HDFC Bank Ltd., ITA No.330 of 2012, judgment dated 23.7.14, wherein it was held that when investments are made out of common pool of funds and non-interest bearing funds were more than the investments in tax free securities, no disallowance of interest expenditure u/s. 14A can be made.

In the light of above said decisions, we are of the view that disallowance of interest expenses in the present case of Rs.49,42,473 made under Rule 8D(2)(ii) of the I.T. Rules should be deleted. We order accordingly.”

In view of the above observations, the appeal is dismissed.