THE DCIT, CIRCLE-1(1)(1), VADODARA vs. GUJARAT STATE FERTILIZER & CHEMICAL LTD, VADODARA

CO No. 9/Ahd/2021 (Assessment Year: 2016-17) Gujarat State Fertilizers & The Deputy Commissioner of Vs. Chemicals Ltd., Income-tax, PO Fertilizernagar, Circle 1(1)(1), Vadodara, Gujarat-391750 Vadodara [PAN : AAACG 7996 C] (Appellant) .. (Respondent & Cross-Objector) Assessee by : Shri Manish J. Shah, Shri Jimi Patel and Shri Rushin Patel, ARs Revenue by: Shri Durga Dutt, CIT (DR) & Shri B.P. Srivastava, Sr. DR Date of Hearing 27.11.2024 Date of Pronouncement 17.12.2024 O R D E R PER DR. B.R.R. KUMAR, VICE-PRESIDENT : These two appeals - one filed by the assessee being and other filed by the Revenue being ITA No.538/Ahd/2020, are cross appeals which are directed against the order of learned Commissioner of Income-tax (Appeals)-1, Vadodara (“CIT(A)” in short) dated 04.03.2020 for Assessment Year 2016-17 and the same are ITA No. 348 & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 2– being disposed of along with Cross Objection filed by the assessee being CO No.9/Ahd/2021. ITA No. 348/Ahd/2020 – Assessee’s appeal 2. The Assessee has taken following grounds of appeal:- “1. The order passed by the learned CIT(A) is erroneous and contrary to the provisions of law and facts and therefore requires to be suitably modified. It is submitted that it be so held now.

2. The learned CIT(A) erred on facts and in law in upholding disallowance of administrative expenditure of Rs. 2,50,39,551 made by the Assessing Officer ("AO") in accordance with Rule BD of the Income- tax Rules, 1962 ("the Rules") read with Section 144(2) of the Income- tax Act, 1961 ("the Act"). It is submitted that it be so held now.

3. The learned CIT(A) erred on facts and in law in confirming the disallowance/ capitalization of interest of Rs. 25,22,37,355 as allegedly attributable to Capital Work- in-Progress (CWIP) made by the AO. It is submitted that it be so held now.

4. The learned CIT(A) erred on facts and in law in confirming the disallowance of Rs. 40,21,000 under Section 35(2AB) of the Act. It is submitted that it be so held now.

5. The learned CIT(A) erred on facts and in law in confirming the disallowance of amount of Rs. 1,51,29,735 as expenses incurred on Corporate Social Responsibility. It is submitted that it be so held now.

6. The learned CIT(A) erred on facts and in law in upholding the action of AO in not allowing contribution of Rs. 2,85,00,000 to GSFC Education Society under Section 80G of the Act. It is submitted that it be so held now.” Department’s appeal

3. The Revenue has raised following grounds of appeal:- “1. (1) (a) Whether on the facts and in the circumstances of the case, the learned CIT(A) erred in deleting the disallowance of Rs.1,78,76,443/- under section 8D(2)(ii) without appreciating the fact that the assessee could not link its investment with its own fund? & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 3– (1)(b) On the facts and in the circumstances of the case, the learned CIT(A) erred in deleting the disallowance of part of interest under section 14A by not following the decision of Hon’ble Supreme Court in the case of Maxopp Investment Ltd. v. CIT(Civil Appeal No.104-109 of 2015) wherein it is held that when funds utilized by the assessee are mixed funds, then principles of apportionment is applicable.

2. Whether on the facts and in the circumstances of the case and in law, the ld. CIT(A) was justified in holding that adjustment made on account of disallowance u/s 14A of the Act in computation of Book Profit u/s 115 JB of the Act is not as per law without appreciating that the amount disallowable under section 14A is covered under clause (f) of Explanation 1 to section 115JB(2) and it is required that any expenditure in relation to the exempt income also to be taken into consideration while computing the book profit under section 115JB, thus, said amount has to be added back while computing amount of book profits?.”

4. The brief facts of the case are that the Assessee is engaged in the business of manufacturing and selling of fertilizers and chemicals. The Assessee filed its return of income on 29.11.2016 declaring income of Rs.4,53,30,15,020/- and book profit of Rs. 5,38,85,05,347/- and paid tax on normal income while filing return of income. The Assessing Officer has passed the assessment order under Section 143(3) of the Act making several additions in the normal computation of total income and book profit which resulted into a total disallowance of Rs. 54,57,00,943/- under normal provisions of the Act, and accordingly calculated tax liability of the assessee.

Appeal of the assessee on this ground is partly allowed. & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 5– Capitalization of interest-WIP :

9.1 The Ld. AR submitted that the assessee had closing balance of Capital Work in Progress amounting to Rs. 40,344.52 lakhs as on 31/03/2016 and had incurred total interest amounting to Rs. 25,22,37,355/- during the year under consideration. The interest expenditure debited to the statement of Profit and Loss comprises of interest on short-term borrowings and interest on term loan, being External Commercial Borrowings. It was argued that External Commercial Borrowing (ECB) are taken only for the purpose of acquisition of shares of a foreign company which are not secured by charge on immovable properties, movable assets and hypothecation of movable properties, both present and future. It was submitted that the assessee had already disallowed the interest on term loan while computing the income under head ‘Profits and gains from business or profession’ and had claimed the same while computing income under head ‘Income from Other Sources’. Disallowing the interest on ECB once again will lead to double disallowance.

9.2 Ld. AR argued that the assessee only has a cash credit facility which is secured by hypothecation of stock of raw materials, finished products, packing materials, general stores, spares, book debts etc. and not against & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 6– the immoveable properties of the assessee and the Assessing Officer has not provided any basis in respect of disallowance on interest on such short- term borrowings. It was argued that the total interest received by the Company exceeds the total amount of interest paid, thereby there is no net interest expenditure incurred by the assessee that should be allocated to CWIP. The Ld. AR submitted that where own funds exceed the amount of investments/capital expenditure, the presumption is that own funds have been utilized for making investments/capital expenditure.

9.3 Reliance is placed on the decision of the jurisdictional High Court in Tax Appeal No. 900 of 2018 in assessee’s own case for AY 2008-09. We find that the judgment was delivered in the context of 14A.

9.4 On the other hand, Ld. DR, Shri Durga Dutt vehemently argued that the provisions of the Act are very clear with regard to capitalization of interest. The Ld. DR argued that the loans taken by the assessee and funds available with the assessee are mixed one and there is no nexus established by the assessee with regard to loans and utilization. Hence, the Revenue Authorities have rightly capitalized interest on Capital Work in Progress. The Ld. DR argued that assessee didn't deny the fact of having mixed funds. With regard to placing of reliance on the decision of Hon'ble Supreme Court in the case of Reliance Utilities (supra) and other decisions for the proposition that if own funds are more than the investments the presumptions should be that the same funds were used, it was argued that the decision rendered were in the contest of Sec.36(1) (iii) of the Act. It was argued that the assessee was projecting the net increase in working capital and short-term borrowings to claim that there was no interest cost to & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 7– capital work in progress which cannot be accepted. Concluding his arguments, the Ld. DR submitted that the assessee failed to prove the fact of not borrowing funds or not utilizing the funds for capital work in progress with any evidence, hence the addition made by the Assessing Officer be upheld.

9.5 We have gone through the facts on record. We find that the assessee had term loan of External Commercial Borrowing (ECB) taken for acquisition of shares of a foreign company, namely, Kamalyte Resources Inc., Canada and the loan is secured by pledge on shares of the said company. The Assessee also had as short-term loan from Gujarat State Financial Services Ltd. for a period of 90 days for the purpose of financing working capital. Further, it can be found from the record that the assessee had cash credit account, overdraft facility, commercial paper, buyers’ credit, bill discounting, etc. for the purpose of financing working capital.

9.6 We have examined the details of the loans taken, nature & purpose of utilization and the payment of interest by the assessee. The details are as under:

Particulars of Interest Nature and Purpose Expense Amount in Rs. 3,83,60,656 For Working Capital Interest - Inter Corp. Deposit (Short Term - 90 days) 1,05,34,019 Overdraft Interest for working Interest - Short Term Deposit capital 6,13,06,364 Interest On Cash Credits Charged CC Interest for working capital Interest - Sales Bill Discount 21,84,045 Interest on Bill Discounting - working capital & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 8– 2,65,75,802 Interest on Bill Discounting - Interest - Purchase Bill Discount working capital Interest on C.P. 3,22,20,500 Interest on Commercial papers - working capital 1,28,14,287 External Commercial Borrowing Interest Rate Swap - Loss A/c Interest 5,48,45,719 External Commercial Borrowing Interest Rate Swap - Floating Interest A/c Interest 23,88,41,392 Total Interest on borrowings 5,93,080 Disallowed in computation of Interest On Income Tax Payment Income Interest - Others 1,28,02,883 Majority is Interest on security deposit paid to customers Total Interest on others 1,33,95,963 Total Interest cost 25,22,37,355 9.7 The provisions of the Act pertaining to capitalization of interest are as under:

36(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in Section 28 – (i) & (ii)** ** ** (iii) the amount of the interest paid in respect of capital borrowed for the purpose of the business or profession:- Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not) for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.

& 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 9– 9.8 From the detailed examination of the borrowings of the assessee and payment of interest since no loan amount has been raised and utilized for the purpose of Capital Work in Progress, no addition is called for in this account. The notional interest calculated by the Assessing Officer computing 12% on the closing balance of CWIP cannot stand test of legal scrutiny.

In the result, this ground of appeal of the assessee is allowed.

Disallowance of CSR Expenses:

Particulars Amount (Rs.) Rejuvenation of Ajwa Garden 44,83,461 Cultural events, film screening and 23,83,000 awareness Digging of pits and soil refilling 9,41,350 Education and related activities in 3,82,110 surrounding areas Upliftment of farmers 4,82,075 Other miscellaneous expenditure 64,57,739 Total 1,51,29,735 10.1 Before us, the Ld. AR argued that if there was to be an outright exclusion of CSR expenses from the scope of section 37(1), then the language of Explanation 2 would have been "any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall be deemed to be not an & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 10– expenditure incurred by the assessee for the purpose of the business or profession."

10.2 The Ld. AR succinctly argued that unlike Explanation 1, there is no phrase in Explanation 2 stating "and no deduction or allowance shall be made in respect of such expenditure.” The Ld. AR submitted that the assessee is not in the business of making gardens, event organizing, education, etc. but are incurred for the purpose of its business. Therefore, the expenditure is also not adversely hit by Rule 4(1) of the Companies (Corporate Social Responsibility) Rules, 2014 as alleged by the Assessing Officer.

10.3 On the other hand, the Ld. DR relied on the order of the Ld. CIT(A). For the sake of ready reference, the operative portion of the relevant part of the order of the Ld. CIT(A) is reproduced hereunder:

“I have carefully considered the material facts of the case and the submissions of the assessee. First of all, the assessee claimed the entire expenditure being donations and contributions and debited the P & L Account. However, a major part of it was disallowed and added back by the assessee. The amount which was spent for the above was treated as the expenditure for business purpose and claimed as deduction before the AO. It is clear that the amounts were contributed or donated and hence claimed as incurred by the company. It is not made clear that the expenditure narrated above were spent by the company itself or contributed to other persons. The submissions given by the assessee are in general in nature and not established how such expenditure helped in business prospect of the company. No comparative study or report giving the improvement in business before and after the expenditure was met by the company was furnished to establish that the said expenditure was in fact helped the assessee in its business. The expenditure claimed to have been incurred were not incurred in the vicinity of the assessee company or in the residential complex of employees of the assessee company. It is fairly admitted by the & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 11– company that the case laws relied upon by it were rendered before insertion of explanation 2 of section 37 of the Act. I have also gone through the decisions and found that they are not squarely applicable to the facts of the present case. The Hon'ble ITAT Mumbai in the case of Nicholas Piramal India Ltd. considered the fact of spending money for providing street lights on the road which leads to the assessee's factory, providing ambulance for meeting medical emergencies for residents of village Tarsadi and public garden improvement. The Hon'ble Tribunal followed the decision of the Hon'ble High Court of Madras in the case of Madras Refineries Ltd. and allowed such expense as expense for business purpose u/s 37(1) of the Act. The Hon'ble Madras High Court considered the expenditure of providing drinking water and establishing or improving schools meant for the residents of the locality in which the business was situated and held the same was allowable u/s 37(1) of the Act. The Hon'ble Tribunal considering the same fact allowed the deduction in the above said case. These facts are distinguishable compared to the facts of the present case. The expenditure claimed to have been incurred by the assessee was not in the vicinity/precinct of the business premises of the assessee. The assessee neither established not proved that the Ajwa Garden is abutting the factory premises or otherwise. The assessee also failed in giving the details of miscellaneous expenditure which is a major component and also digging of pits and soils and where such activity was undertaken. In view of these facts, the decisions of the Hon'ble Madras High Court and also the Hon'ble ITAT Mumbai cannot be applied to the facts of the case. Similarly, I have also perused the decision of the Hon'ble ITAT Chennai in the case of Velumanickam Lodge on which the assessee placed reliance and found the same is also not applicable to the facts of the case. In that case, the Ld. CIT(A) during the appellate proceedings, found some evidence as filed by the assessee with regard to getting contracts soon after the assessee agreed to construct the hockey stadium. Hence, the allowance was given by the Hon'ble Tribunal. In the present case, there is no such evidence, as stated above, filed by the assessee to prove that the business of the assessee increased subsequent to the said expenditure incurred by the assessee. Hence, this ratio is also not applicable to the facts of the case and all these case laws are rendered before insertion of explanation 2 of section 37(1) of the Act and hence, on this count also, these ratios cannot be applied to the facts of the case. Section 37(1) r.w. Explanation 2 clearly speaks that any amount spent by the & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 12– company towards CSR is not to be considered as the expenditure for the purpose of the business. The expenditure incurred by the assessee is in the nature of CSR and as per section 37(1) the same is not allowable as deduction. The Hon'ble ITAT Chennai in the case of Hyundai Motor India Ltd. (62 taxmann.com 42) held that the expenditure incurred by car-manufacturer on gifts of cars to State police department was held not an eligible expenditure under section 37(1) as it was found not incidental to carrying on business and there was no commercial expediency in incurring this expenditure.

The Hon'ble High Court of Kerala in the case of Wipro Ltd. (41 taxmann.com 190) held that where assessee claimed expenditure incurred for community development, in view of fact that it had not placed any materials on record in support of its claim of expenditure so as to apply test of commercial expediency, expenses incurred by assessee for community development was not allowable under section 37(1) of the Act. The relevant head note is as under:

I Section 37(1) of the Income-tax Act, 1961-Business expenditure - Allowability of [community development) - Assessment years 1986-87 1987-88 and 1992-93- Assessee claimed expenditure incurred for community development in a backward area where their factory was situated Assessing Officer disallowed expenditure on ground that those were in nature of charity and was not connected with business Whether expenditure towards religious funds, charitable institutions, social clubs or for charity did not stand to test of commercial expediency Held, yes Whether since assessee had not placed any other materials on record in support of their claim of expenditure over community development, so as to apply test of commercial expediency, expenses incurred by assessee for community development was not allowable under section 37(1)- Held, yes The assessee has failed in establishing the facts to consider the said expenditure was meant for the purpose of business and hence, respectfully following the above decisions and material facts, the addition made by the AO is hereby confirmed and the ground raised by the assessee is dismissed.

& 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 13– 10.4 We have gone through the facts of the issue and the legal position thereof. The Explanation 2 to section 37(1) provides that, "any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purpose of the business or profession." It states that, CSR expenses shall not be deemed to be expenditure for the purposes of business. The language of the Act is very clear and unambiguous hence does not call for any interpretations of the statute or inferences contrary to the legislative intention.

In the result, the appeal of the assessee on this ground is dismissed.

Disallowance u/s 35(2AB) :

11.1 The Rule 6(7A)(b) of the Income-tax Rules, 1962 reads as under:-

[(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 :— ….. ….. & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 14–

(b) The prescribed authority shall submit its report in relation to the approval of in-house Research and Development facility in Form No.3CL to the Director General (Income-tax Exemptions) within sixty days of its granting approval:’ 11.2 It was argued by the Ld. AR that owing to smallness of amount, the assessee did not approach the DSIR requesting for reason/justification as to why the revenue expenditure incurred for the approved DSIR facility is lower than that actually incurred by the company. It was argued that the provisions in respect of quantification of expenditure eligible for deduction under Section 35(2AB) were prescribed by modifying Rule 6(7A)(b) of the Income-tax Rules, 1962 by the IT (Tenth Amendment) Rules, 2016 w.e.f. 01.07.2016. Accordingly, the provision of the said rule is applicable from AY 2017-18 and onwards. The Ld. AR placed reliance on the orders of the Tribunal in the case of CIT v. Crompton Greaves [2019] 111 taxmann.com 338 (Mum.) & Cummins India Ltd vs. DCIT [2018] 96 taxmann.com 576 (pune).

11.3 On the other hand, Ld. DR relied on the order of the Ld. CIT(A).

11.4 We find that the orders quoted by the Ld. AR pertained to the period before the amendment brought with effect from 01.07.2016. Hence cannot be considered to be applicable to the present case as it pertains to AY 2016- 17. We have examined the adjudication of the ld. CIT(A) on this issue which is as under:-

“This ground relates to the disallowance of an amount of Rs.40,21,000/- by holding that the DSIR has not confirmed such expenditure to be in the nature of scientific research eligible for deduction under section 35(2AB) of the Act. & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 15– The AO allowed 100% of the expenditure and not allowed the weighted deduction.

The appellant submitted that for the AY 2016-17, there is no need or requirement to get certificate from DSIR on expenditure incurred towards scientific research. Rule 6(7A) (b) of IT Rules as amended were effective 01.07.2016 and hence, the certificate from the DSIR regarding expenditure is not mandated for the assessment year under consideration. The facility was already approved by DSIR which is the requirement for granting deduction including weighted deduction prior to the amendment and the appellant company fulfilled the said condition and hence, requested to delete the addition made by the AO. The appellant relied on the decision of the Hon'ble ITAT Mumbai and Pune as referred in its submission and stated that the addition made by the AO is not warranted.

I have carefully considered the facts of the case and provisions on the issue. Section 35(2AB) of the Act was amended by Finance Act 2015 and the amendment was with effect from 01.04.2016. As per sub section 3 of that section, from 01.04.2016, the company has to fulfill conditions with regard to maintenance of accounts and audit thereof and also furnish reports in the prescribed manner. Prior to the amendment, sub section 3 speaks about audit of accounts maintained for the facility. Rule 6 of IT Rules were amended with effect from 01.07.2016 to enable the provisions amended in section 35(2AB) of the Act were carried. Amendment to section 35(2AB) of the Act was a substantive amendment and the appellant was put to notice the requirement of the law to claim deduction under that section by virtue of Finance Act, 2015 w.e.f. 01.04.2016 well in advance. The requirement of maintenance of accounts and getting it audited and also furnishing report was brought in the statute and this in the knowledge of the appellant. Rules are procedural one and the enabling Rule was put in place w.e.f. 01.07.2016 and thereby the appellant was having enough time to adhere to the Rule and to claim the deduction as per that section. As per the amended Rule the appellant has to get the certificate even on the expenditure incurred on in house research and development facility from DSIR to claim deduction. The report is required to be submitted by the appellant to the concern authority before the due date for filing of return. In view of these facts, the expenditure claim of the appellant for the year under consideration has to be seen from the certificate given by the competent authority regarding the expenditure incurred and eligible to claim deduction including weighted deduction. Simply because the rules were notified on 01.07.2016, the appellant cannot take the stand that the expenditure incurred by it has to be allowed in toto & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 16– ignoring the expenditure certified by DSIR. The procedural law/rules must be applied to the pending assessment and hence, the Rules prescribed under Rule 6(7A) (b) of the Rule being a procedural one and the same is available during the pendency of assessment order, it is incumbent upon the AO to follow and apply the same while discussing the issue of allowability of deduction u/s 35(2AB) of the Act. The Hon'ble High Court of Punjab & Haryana in the case of Mrs. Manjula Sood(227 ITR 873) held that where there are any amendments or alterations in procedural law in course of assessment proceedings, altered procedural law would be applicable. Respectfully following the above decision and also having regard to the facts of the case, it is held that the appellant is not entitled to claim weighted deduction and the addition made by the AO is hereby confirmed. The ground raised by the appellant is hereby dismissed.

Having gone through the order of the Ld. CIT(A) in detail, we find no reason to interfere with the order of the Ld. CIT(A).

In the result, the appeal of the assessee on this ground is dismissed.

GSFC – Donation 80G / 37(1) :

In the result, the appeal of the assessee is partly allowed. & 538/Ahd/2020 & CO No.9/Ahd/2021 Gujarat State Fertilizer & Chemical Ltd Asst. Year : 2016-17 - 17–

This ground has been dealt along with Ground No.1 of the assessee’s appeal. In the result, the appeal of the Revenue on this ground is dismissed.

In the result, appeal of the Revenue is dismissed.

Order is pronounced in the open Court on 17.12.2024 (SIDDHARTHA NAUTIYAL) VICE-PRESIDENT Ahmedabad; Dated 17/12/2024 **btk