SAKTIJIT DEY (JM)- This is an appeal filed by the assessee against the order dated 22.03.2013 passed Under Section 263 of the Income Tax Act 1961 by Learned CIT(LTU), Mumbai for the Assessment Year 2007 – 08.
2. Assessee has raised the following grounds: -
(1) On the facts and circumstances of the case and in law, the Learned Commissioner of Income tax (LTU), Mumbai {“the CIT”} erred in passing the order under section 263 of the Income Tax Act, 1961 (“the Act”) on the alleged ground that the assessment order assed by the Deputy Commissioner of Income Tax (LTU), Mumbai (“the AO") was erroneous to the extent of the claim under section 35 of the Act claimed and allowed by the AO and as such was prejudicial to the interest of the revenue.
(2) The Appellant prays that the direction given in the order under section 263 of the Act to modify the assessment order under section 143(3) of the Act for disallowing the claim Under Section 35 of the Act be held ab-initio and / or otherwise void and bad-in-law.
3. Briefly the facts are, assessee a domestic company, is engaged in the business of manufacture and sale of organic chemicals. For the assessment year under dispute assessee filed its return of income on 22.10.07 declaring loss of Rs. 11,32,03,970/- under normal provisions and book profit of Rs. Nill Under Section 115JB. The assessment in case of the assessee was completed Under Section 143(3) r/w section 144(C) of the Act vide order dated 25.01.2011.
4. After calling for and examining the assessment records of the assessee for the impugned assessment year, learned CIT (LTU) being of the view that the Assessment Order passed is erroneous and prejudicial to the interest of the revenue on account of allowance of assessee’s claim of deduction of capital expenditure amounting to Rs. 1,24,87,064 Under Section 35(1)(iv) of the Act, exercised his power Under Section 263 of the Act, by issuing a show cause notice to the assessee calling upon it to explain why the Assessment Order should not be revised.
5. In response to the show cause notice, though, the assessee accepted that the revenue expenditure incurred on Research and Development (R&D) activities were on behalf of its parent company in US and has been reimbursed by them, however, as far as the capital expenditure is concerned, it was claimed that such expenditure related to assessee’s own business. Hence, deduction claimed is allowable. In support of its contention assessee relied upon a number of decisions.
6. Learned CIT after considering the submissions of the assessee observed that as per assessee’s own admission it has conducted R&D activities on behalf of Foreign clients and income earned on account of such activities are credited to the Profit and Loss Account. From the copies of the monthly reports filed before him by the assessee, Ld. CIT found that the process of R&D activities has been continuing regularly and were done for the benefit of foreign clients / associates enterprises abroad. Ld.CIT was of the view that for claiming the deduction Under Section 35(1)(iv) of the Act, the R&D activity must be connected with the business of the assessee. Since, the capital expenditure claimed by the assessee was in connection with the R&D activities carried on for the benefit of other entities, Ld.CIT held that the assessee is not eligible to claim deduction Under Section 35(1)(iv) of the Act. Since, the Assessing Officer has allowed assessee’s claim u/s 35(1)(iv), Ld.CIT holding the Assessment Order passed by the Assessing Officer to be erroneous and prejudicial to the interests of the revenues set it aside with a direction to disallow assessee’s claim of deduction Under Section 35(1)(iv) of the Act in respect of the capital expenditure incurred of Rs. 1,24,87,065/-
7. Reiterating the stand taken before the Revisional authority, Ld.AR submitted, assessee has in-house scientific research facilities approved by the Central Government. He submitted, the assessee itself is engaged in developing and manufacturing of products which requires scientific research. He submitted, the capital expenditure relating to R&D activities was in respect of assessee’s own business activities and not related to the business activities of its holding company. The Ld.AR submitted, the assessee is in manufacturing and sales of products, hence, utilized the benefit of research for its own business. The result obtained from research is not sold to the parent company, rather, is used to enhance its own products. He submitted, the assessee does not carry research on job work or contract basis as it is engaged in product manufacturing and selling activities. He submitted no production is undertaken by the parent company on the basis of the reports of the assessee. No formulation is formed on basis of the order placed by the parent company. He submitted, for claiming deduction Under Section 35(1)(iv) of the Act there is no express condition that the assets should be owned by the assessee. He further submitted the deduction Under Section 35(1)(iv) of the Act is allowable even if benefit is availed by a third party. Only condition being, expenditure incurred on R&D activities should be related to the business. To lay emphasis on his contentions, Ld.AR took us through various documentary evidences submitted in the paper book, such as audited financial accounts, approval of its R&D unit as well as agreement with the parent company for carrying out R&D activities. He also relied upon the following decisions: -
(i) Indian Telephone Industries Ltd v. IAC (10 ITD 338) Bangalore Tribunal)
(ii) CIT v. Sandoz India Ltd (74 Taxman 225) (Bombay High Court)
(iii) ACIT v. Consolidated Energy Consultants Ltd (63 SOT 10) (Indore Tribunal)
(iv) CIT v. Samsung India Electronics Ltd
(v) CIT v. U.P Electronic Corporation (145 Taxman 494) (High Court of Allahabad)
(vi) Ayushakti Ayurved (p) Ltd V. ACIT (Mumbai Tribunal)
8. The Ld. DR on the other hand, strongly supporting the reasoning of the CIT, submitted that the facts on record clearly establish that the entire expenditure relating to R&D activities was for the business of its parent company and other entities and not for its own business. In this context Ld. DR took us through various clauses of the R&D agreement with parent company as submitted in the paper book. The Ld.DR submitted, the assessee itself has admitted that the revenue expenditure relating to R&D activities was incurred for the business of the parent company hence, was fully reimbursed. Therefore, the capital expenditure relating to the very same R&D activities arising out of the same contract cannot be in relation to assessee’s business. He submitted as per the terms of the agreement the discoveries and inventions made as a result of R&D project would accrue to the parent company. He submitted, as per the terms of the agreement not only the parent company bears all costs relating to the R&D activities but also pays the markup of 15% over the costs to the assessee. He submitted, as per the terms of the agreement all risk relating to success / failure of the R& D work undertaken by the assessee shall lie with the parent company and only on request by the assessee the parent company may grant license to the assessee for use of R&D project results in India, subject to payment of royalty. Thus, it was submitted, the R&D activities carried on by the assessee being in connection with the business of the parent company, assessee is not eligible to claim deduction Under Section 35(1)(iv) of the Act. In support of such contentions Ld.DR relied upon the following decisions:-
i. Ciba(P). Ltd v. Income Tax Officer, 9(1)3, Mumbai [2009] ITD 94 (Mumbai)
ii. Enem Nostrum Remedies (P.) Ltd v. Assistant Commissioner of Income-tax, Circle 8(1), Mumbai [2009] 119 ITD 427 (Mumbai)
iii. Deputy Commissioner of Income-tax, Circle – 1(3), Hyderabad v. Bharat Biotech International Ltd. [2014] 42 Taxmann.com 204 Hyderabad- Tribunal.
9. We have carefully and patiently heard the rival contentions and perused the material on record. We have also applied our mind to the decisions relied upon by both parties. The core issues which arise for consideration before us are whether CIT was justified in exercising his jurisdiction Under Section 263 of the Act and secondly whether assessee’s claim of deduction Under Section 35(1)(iv) of the Act is permissible. As far as the first issue is concerned, on perusal of the Assessment Order passed Under Section 143(3) of the Act we have noted that, there is no observation of the Assessing Officer on the issue relating to assessee’s claim of deduction Under Section 35(1)(iv) of the Act. Moreover, nothing has been brought on record to demonstrate that in course of the assessment proceedings the Assessing Officer has either examined or enquired into the issue relating to claim of deduction Under Section 35(1)(iv) of the Act. At least, no documentary evidence have been brought to our notice by the Ld.AR to indicate that the Assessing Officer has either raised any query or in any other manner has enquired into the deduction claimed Under Section 35(1)(iv) of the Act. Notably, the assessee itself in its accounts has not claimed revenue expenditure relating to the R&D activities, since, such expenditure was reimbursed to the assessee by the parent company as it was incurred for the business of the parent company. Thus, when the revenue expenditure relating to R&D activity was not claimed as deduction since it was incurred on behalf of the parent company and related to the business of the parent company, it should have triggered an enquiry by the Assessing Officer to verify whether the capital expenditure claimed as deduction Under Section 35(1)(iv) of the Act relates to assessee’s own business or was incurred on behalf of the parent company. Absence of any enquiry by the Assessing Officer to ascertain the veracity of assessee’s claim in respect of capital expenditure on R&D activities certainly has made the Assessment Order erroneous and prejudicial to the interest of the revenue. In view of the aforesaid facts, Ld. CIT was justified in exercising power Under Section 263 of the Act as both the conditions enshrined in the said provision are fulfilled. Having held so, now we may proceed to examine assessee’s claim of deduction Under Section 35(1)(iv) of the Act on merits. Before we proceed to decide the issue, it is necessary to look into the provision contained Under Section 35(1)(iv) of the Act which reads as under:-
“in respect of any expenditure of a capital nature on scientific research related to the business carried on by the assessee, such deduction as may be admissible under the provisions of sub-section (2)”
10. A plain reading of the aforesaid provision makes it clear that capital expenditure incurred on scientific research is allowable as deduction to assessee subject to fulfillment of two conditions. Firstly, such capital expenditure must be incurred on scientific research and secondly, such scientific research must be related to the business carried on by the assessee. Keeping in view the aforesaid legal position we have to examine the facts of the present case. On perusal of the audited Profit and Loss Account of the assessee for the year ended 31 March 07 it is noticed during the relevant previous year assessee has received an amount of Rs. 164.63 lakhs from its parent company towards research and development fees. As per assessee’s own admission out of the aforesaid amount an amount of Rs. 1,38,22,122/- is towards revenue expenditure incurred on R&D activities carried on for the parent company. It is very much clear from the audit financial statements of the assessee, it has not claimed any deduction on account of revenue expenditure on R&D in respect of its own business. Whereas, the entire capital expenditure on R&D activities has been claimed as deduction Under Section 35(1)(iv) of the Act on the plea that it relates to it’s own business. We fail to understand when the assessee has not claimed any revenue expenditure on R&D for its own business, how the capital expenditure on R&D can relate to its business. As could be seen, assessee on 01.01.2003 had entered into a research and development agreement with SI Group US which is engaged in the development and manufacture of chemical products. For developing new products and enhancing quality continuous R&D activity is required. Since, the assessee has the facilities for research and development of new and enhanced chemical products, SI Group US entered into a research and development agreement which was subsequently renewed vide agreement dated 01.01.2007. As it appears from the terms of the said agreement, the assessee is to render research and development services to SI Group, US for the purpose of enhancing the chemical products and creating new chemical products. As per the terms of the agreement assessee shall provide SI Group, US with detailed written quarterly reports on the research and development work carried out. The Assessee is also required to inform SI Group US of any cost over runs as compared to the budget. It is also provided, SI Group US may at any time require the assessee to alter the R&D project and its implementation. As per Article 3 of the agreement, SI Group, US shall pay to the assessee all costs involved in the R&D project including the salaries to employees, variable costs, VAT with a markup of 15%. Even, as per the terms of the agreement the variable costs shall include cost of material and supplies, cost of equipment repairs and maintenance and depreciation etc. Article 4 of the agreement indicates that SI Group, US shall become the owner of all results of each R&D project developed by the assessee and all risk related to the success / failure of the R&D project will be with SI Group US. The Assessee is permitted to use the R&D project results in India subject to grant of license by SI Group US and on payment of royalty. Thus, from the overall reading of the agreement between the assessee and SI Group US it becomes abundantly clear that the entire R&D activity is carried on for the benefit and development of business of SI Group US and does not pertain to the assessee’s business. The assessee is permitted to use the result of the R&D product only if the SI Group US grants license which is also subject to payment of royalty. These factors clearly demonstrate that the entire R&D activities carried on by the assessee is for the business of SI Group US and not for itself. This fact is further proved from assessee’s own admission that the entire revenue expenditure relating to R&D activities was reimbursed by SI Group US. Keeping in perspective the aforesaid factual positon, it is hardly believable that the revenue expenditure on R&D relates to the business of the parent company whereas, the capital expenditure on R&D relates to the Assessee.
11. We fail to understand how the assessee incurs only capital expenditure on R&D relating to its own business without incurring any revenue expenditure on R&D. Therefore, when the assessee accepts that the revenue expenditure on R&D is relating to the business of the parent company logically it must follow that the capital expenditure on R&D also belongs to the parent company. The assessee cannot blow hot and cold at the same time by claiming capital expenditure on R&D on its own account and revenue expenditure on R&D in the account of its parent company. In any case of the mater, the assessee has not brought any evidence before us to conclusively prove that the capital expenditure claimed a deduction Under Section 35(1)(iv) of the Act is related to R&D activities carried on for assessee’s own business. In that view of the matter, one of the conditions of the section 35(1)(iv) of the Act is not fulfilled. In other words, the assessee has failed to prove that the scientific research in relation to which capital expenditure was incurred is carried on for assessee's own business. That being the case, assessee is not eligible to claim deduction Under Section 35(1)(iv) of the Act. Resultantly the Assessing Officer was in error while allowing deduction claimed Under Section 35(1)(iv) of the Act which has caused prejudice to the revenue. Therefore, CIT was justified in revising the Assessment Order by invoking his powers Under Section 263 of the Act. Before parting we may briefly analyze the decisions cited before us. In case of CIT v. Sandoz India Ltd. (74 Taxman 225) (Supra), the claim of capital expenditure was in respect of an approach road to the R&D facilities of the assessee. The department disallowed assessee’s claim of deduction Under Section 35(1)(iv) of the Act on the reasoning that the road can be used not only by assessee but by others also. In this context the Hon’ble High Court held that primarily the expenditure incurred for the approach road was related to the business of the assessee. The fact that the approach road may benefit third parties would not dis-entitle the assessee from claiming the deduction. However, the facts in assessee’s case are different. As discussed by us earlier, the entire R&D activities was carried on by the assessee for the benefit of its parent company and not for itself. Therefore, one of the basic conditions of Section 35(1)(iv) of the Act is not fulfilled. Similarly, in case of the ACIT v. Consolidated Energy Consultants Ltd (63 SOT 10) (Indore Tribunal), it was found as a fact that the assessee was doing research in the field of development of wind power on its own which was used for the benefit of public. Therefore, it was held that the assessee was eligible for deduction Under Section 35(1)(iv) of the Act. However, the facts are different in case of the assessee, as the assessee is not doing anything for the benefit of the public. On the other hand, in case of Ciba India (P.) Ltd v. Income tax Officer, 9(1)3, Mumbai (Supra) the Tribunal held that assessee is not entitled to claim deduction Under Section 35(1)(iv) of the Act as the capital expenditure on scientific research related to its subsidiaries. The other decisions cited by the Ld.AR were found to be factually distinguishable, hence, not applicable to the assessee’s case. In view of the aforesaid upholding the impugned order of Ld.CIT we dismiss the grounds raised by the assessee.
12. In the result assessee’s appeal is dismissed.