ITA No. 689/Bang/2014

N. V. Vasudevan, JM And Jason P. Boaz, AM, JJ.

For the Petitioner : Shri Arvind Sonde, Adv.
For the Respondent : Shri S Radhakrishna, CIT-III (DR)

ORDER

N. V. Vasudevan, Judicial Member-This is an appeal by the Assessee against the order dated 28.3.2014 of the Commissioner of Income-tax-III, Bangalore [CIT], passed u/s.263 of the Act, relating to assessment year 2008-09.

2. The Assessee is a company engaged in the business of development and export of various software products for the telecommunication industry. The Assessee filed its return of income on 29.9.2008. In the return of income the Assessee declared loss of Rs. 63,51,65,765/-. The provisions of Minimum Alternate Tax u/s.115JB of the Act were applicable to the case of the Assessee and therefore the book profit of Rs. 1,71,29,916 was declared by the Assessee. The same was revised to Rs. 8,12,01,900 in a revised return filed by the Assessee on 3.12.2009. A copy of the computation of total income showing loss of Rs. 63,51,65,765 is at page-45 of the Paper book-I filed by the Assessee. The loss under the head "Profits and gains of business or profession" has been arrived at by the Assessee by taking the profit as per profit and loss account and thereafter, some additions and deductions have been made to arrive at the loss of Rs. 63,51,65,765/-. In this appeal, we need to focus only on two items of deducted from the profit as per profit and loss account viz.,(i) Exchange gain on FCCB reinstatement of Rs. 60,75,80,000/- (ii) Deduction u/s.35D of the Act of Rs. 11,36,59,330/-.

3. The provisions of Sec.35D of the Act, in so far as it is relevant for the purpose of deciding the issue in this appeal read thus:-

Sec.35D : Amortisation of certain preliminary expenses.
(1) Where an assessee, being an Indian company or a person (other than a company) who is resident in India, incurs, after the 31st day of March, 1970, any expenditure specified in sub-section
(2), -
(i) before the commencement of his business, or
(ii) after the commencement of his business in connection with the extension of his Industrial undertaking or in connection with his setting up a new Industrial unit,

the assessee shall, in accordance with and subject to the provisions of this section, be allowed a deduction of an amount equal to one-tenth of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the Industrial undertaking is completed or the new Industrial unit commences production or operation:

Provided that where an assessee incurs after the 31st day of March, 1998, any expenditure specified in sub-section (2), the provisions of this sub-section shall have effect as if for the words "an amount equal to one-tenth of such expenditure for each of the ten successive previous years", the words "an amount equal to one-fifth of such expenditure for each of the five successive previous years" had been substituted.

(2) The expenditure referred to in sub-section (1) shall be the expenditure specified in any one or more of the following clauses, namely :……..

(3) Where the aggregate amount of the expenditure referred to in sub-section (2) exceeds an amount calculated at five per cent-

(a) of the cost of the project, or
(b) where the assessee is an Indian company, at the option of the company, of the capital employed in the business of the company,
the excess shall be ignored for the purpose of computing the deduction allowable under sub-section (1) :

Provided that where the aggregate amount of expenditure referred to in sub-section (2) is incurred after the 31st day of March, 1998, the provisions of this sub-section shall have effect as if for the words "two and one-half per cent", the words "five per cent" had been substituted.

Explanation : In this sub-section,-
(a) "cost of the project" means-
(i) in a case referred to in clause (i) of sub-section (1), the actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the business of the assessee commences;

(ii) in a case referred to in clause (ii) of sub-section (1), the actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the extension of the Industrial undertaking is completed or, as the case may be, the new Industrial unit commences production or operation, in so far as such fixed assets have been acquired or developed in connection with the extension of the Industrial undertaking or the setting up of the new Industrial Unit of the assessee;

(b) "capital employed in the business of the company" means-
(i) in a case referred to in clause (i) of sub-section (1), the aggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the business of the company commences;

(ii) in a case referred to in clause (ii) of sub-section (1), the aggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the extension of the Industrial undertaking is completed, or, as the case may be, the new Industrial unit commences production or operation, in so far as such capital, debentures and long-term borrowings have been issued or obtained in connection with the extension of the Industrial undertaking or setting up of the new Industrial unit of the company;

(c) "long-term borrowings" means-
(i) any money borrowed by the company from the Government or the Industrial Finance Corporation of India or the Industrial Credit and Investment Corporation of India or any other financial institution which is eligible for deduction under clause (viii) of sub-section (1) of section 36] or any banking institution (not being a financial institution referred to above), or

(ii) any money borrowed or debt incurred by it in a foreign country in respect of the purchase outside India of capital plant and machinery, where the terms under which such moneys are borrowed or the debt is incurred provide for the repayment thereof during a period of not less than seven years.

(4) …….
(5) .……
(6) ……."

4. In the audit report u/s.44AB of the Act filed in Form No.3CD, the auditors has in column 15(b) highlighted amount claimed as deduction u/s.35D of the Act but not debited in the profit and loss account of Rs. 11,36,59,330. The narration further provides that the claim for deduction is 1/5th of the FCCB & GDR issue expenses incurred during AY 07-08 and that the claim for deduction u/s.35D of the Act in AY 08-09 is the second year of claim. The computation of deduction u/s.35D of the Act given in AY 07-08 is at page-7 of Paper book No.1 filed by the Assessee. The same is given as ANNEXURE-1 to this order. There is a variation in the figure of deduction claimed u/s.35D of the Act in AY 07-08 and in AY 08-09. This may not be very material because the dispute not on the variation in the quantum.

5. It is not in dispute that the Assessee after commencement of his business incurred expenditure set out in Sec.35D(2) of the Act in connection with setting up of a new industrial unit and was entitled to claim deduction of 1/5th of such expenditure by amortizing the said expenditure over a period of 5 years in accordance with proviso to sec.35D(1) of the Act. It is also not in dispute that the quantum of such expenditure was more than the limits specified in Sec.35D(2) of the Act and therefore the deduction u/s.35D of the Act had to be restricted to the limits laid down in Sec.35D(3) of the Act. The Assessee chose the option of claiming deduction of 5% of capital employed in the business of the company as provided in Sec.35D(3)(b) of the Act.

6. The expenditure in question was incurred in connection with acquiring shares of two companies by name M/S.Azure Solutions Ltd. (later known as Subex Azure (UK) Ltd., and M/s. Syndesis Ltd. (Later known as M/s. Subex Americas Inc.). The controlling interest in these two companies was acquired by the Assessee consequent to acquisition of shares of the aforesaid two companies. The claim of the Assessee was therefore u/s.35D(1)(ii) of the Act viz., "incurring of expenditure after the commencement of business in connection with setting up a new Industrial unit.

7. The capital employed by the Assessee for the purpose of the said acquisition of shares was as follows:-

8. The return for AY 08-09 was taken up for scrutiny. The AO issued a show cause notice dated 11.11.2011 in which he called for details of deduction claimed u/s.35D-Claimed on what expenses? It is very important to notice that the AO did not call for any explanation with regard to the basis on which the Assessee opted for deduction u/s.35D of the Act, viz., 5% of capital employed in the business of the company as provided in Sec.35(3)(b) of the Act. The AO also did not enquire as to what is the Exchange gain on FCCB reinstatement of Rs. 60,75,80,000/-. We have already seen that the Assessee issued FCCBs for the purpose of acquisition of shares of Acquisition of M/s. Syndesis Ltd. (Later known as M/S. Subex Americas Inc.). Due to favourable fluctuation of foreign exchange, the liability of the Assessee to repay FCCBs became less and the consequent gain was not offered to tax as it was a gain on capital account.

9. The Assessee in reply to the show cause notice of the AO dated 11.11.2011 sent a reply dated 22.11.2011 in which on the question of on what expenses deduction u/s.35D of the Act is claimed, pointed out that it is on expenditure for issue of GDR's and FCCBs incurred by the company during the financial year ending 31.3.2007. The AO by another letter dated 30.11.2011 called upon the Assessee to clarify and furnish the following information:-

"The company has claimed a sum of Rs. 11,36,59,330/- as deduction u/s.35D. Please clarify whether your company is an "industrial undertaking" for the purpose of claiming deduction u/s.35D as it stood prior to 1.4.2009. Since the word "industrial" is removed only w.e.f.1.4.2009 applicable to AY 2009-10, the claim appears to be incorrect. Please clarify. However, it is requested that complete details of the expenditure incurred towards issue of GDRs and FCCBs may be furnished."
10. The Assessee vide reply dated 9.12.2011 gave the details of expenditure on which deduction was claimed u/s.35D of the Act. The Assessee also clarified that it was an Industrial undertaking engaged in the manufacture of computer software.

11. The AO passed an order of assessment for AY 08-09 u/s.143(3) of the Act dated 28.12.2011. In the said order there is no discussion whatsoever on the claim of the Assessee for deduction u/s.35D of the Act nor regarding the Exchange gain on FCCB reinstatement of Rs. 60,75,80,000/-. There is no disallowance of the aforesaid two claims made by the Assessee. By implication both the aforesaid claims were accepted by the AO.

12. The CIT in exercise of his powers u/s.263 of the Act was of the view that the aforesaid order of the AO was erroneous and prejudicial to the interest of the revenue. In his show cause notice issued u/s.263 of the Act dated 12.09.2013, the CIT was of the view that (a) deduction u/s.35D of the Act has been allowed in excess of what the Assessee is entitled to. (b) The Exchange gain on FCCB reinstatement of Rs. 60,75,80,000/- ought to have been treated as income and brought to tax.

13. In the course of hearing before CIT on 26.9.2013, the CIT expressed the view that deduction u/s.35D has been allowed in excess as follows:-

"A) Total amount eligible for deduction under section 35D would be the actual expenditure of INR 577,890,354 incurred by the assessee, as restricted to the higher of:
a. 5% of the cost of project, or
b. 5% of the capital employed in the business.
B) The cost of project has been considered as NIL, as the assessee has shown the amount so invested as 'Investments' and not as fixed assets being plant and machinery, etc.

C) For the purpose of computing capital employed, only the amounts invested to the extent raised through the issuance of Global Depository Receipts ('GDRs') has been considered. Furthermore, only the amount equivalent to the face value of the GDRs aggregating to INR 117,287,280 has been considered and the share premium aggregating to INR 6,125,210,911 has been ignored.
Further, the amount raised from Foreign Currency Convertible Bonds (FCCBs) aggregating to INR 7,807,500,000 has been ignored in totality.

D) Thus, the amount eligible for deduction under section 35D is being computed as under:

Actual expenditure of INR 577.890,354. restricted to higher of:
- 5% of the Cost of Project being NIL or
- 5% of Capital employed, in this case, the amount being 5% of the face value of GDRs (i.e., 5% x 117,287,280 = INR 5,864,364)
Thus the excess deduction allowed under section 35D would amount to INR 112,486,457, as computed below:

14. The gist of the CIT's calculation as above is :-

(1) that deduction u/s.35D(3)(b) is calculated on the basis of 5% of capital employed and Sec.35D(3)(a) will not apply because the acquisition was of shares which were treated as investments by the Assessee in its books of accounts therefore "cost of project" was irrelevant consideration. For Sec.35D(3)(a) to apply the expenditure should be for acquiring land buildings etc., which are essentially fixed assets. Therefore only provisions of Sec.35D(3)(b) is applicable; and

(2) for computing "Capital Employed" share premium ought to be ignored as it is not "Issued share capital". FCCBs are not in the nature of Debentures or long term borrowings.

15. The CIT also expressed his view that foreign exchange gain on restatement of FCCB liability ought to have been taxed as income and as revenue receipt.

16. The Assessee in reply to the show cause notice u/s.263 of the Act, vide its letter dated 30.9.2013 submitted as under:-

(1) Regarding its claim for deduction u/s.35D(3)(a) on "Cost of Project", the assessee submitted as follows:-

"1.7 As regards computation of 'cost of project', your honour will appreciate that the assessee had incurred the said expenditure towards issue of GDRs and FCCBs and was related to the extension of the industrial undertaking of the assessee.

1.8. There is no definition of the word "extension" under the Act. The assessee wishes to draw reference to P. Ramanatha Aiyar's Law Lexicon Second Edition which shows that although the word "expansion" was considered as related to different fields, yet, the one in relation to industrial activity gives the meaning as "extension". Thus going by the meaning assigned to the word "extension", quite apart from the horizontal expansion in the industrial undertaking, vertical expansion also stands included within the meaning of the term 'extension" of the industrial undertaking.

1.9 The assessee has incurred the aforesaid expenditure for the purpose of acquisition of Subex Americas Inc. and Subex UK Limited. Hence, the same was incurred for the purpose of expansion of the business of the assessee. This is evident from the very fact that the assessee's gross revenue through these subsidiaries over the last two years has increased from 3,710 million to 5,408 million, being 46% increase in sales.

1.10 Further, with reference to the computation of the cost of project', it would not be appropriate to hold in a narrow manner that the assessee has not shown any investment in fixed asset/land and building in order to opt for 'cost of project'. It ought to he appreciated that the assessee had in fact expanded its business operations. Such acquisition could have been by direct acquisition of fixed assets outside India or through acquisition of subsidiaries, which offer benefits like ringfencing of liabilities qua the Indian company, undue exposure to foreign taxation, etc. The assessee submits that the term 'being' used in the definition of 'cost of project' should be understood in a manner which supports the purpose and intention of the said section. The meaning of the term thus not restricted only to land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings).

1.11 The assessee wishes to place reliance on the decision of Madhya Pradesh High court in the case of Commissioner of Income tax v. Shree Synthetics Ltd [1986] 162 ITR 819 (Copy of the decision enclosed as Annexure 2) which was rendered in the context of section 35D (2) of the Act wherein it has been held that:

"The word 'being' has been used in section 35D(2)(c)iv by way of illustration and is not restricted only to the words 'underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus"
(emphasis supplied)

1.12 In view of the above discussions, the assessee has rightfully claimed the aforesaid expenditure as 'cost of project' for the purpose of acquisition of Subex Americas Inc and Subex UK Limited.

1.13 In light of above, the 'cost of project' for the purposes of computing the deduction under section 35D ought to be INR 14,223,443,668.

(2) With regard to computation of "Capital Employed", the Assessee took a stand Share premium should also be treated as part of "issued Share capital" as per Sec.78 of the Companies Act, 1956. The Assessee also relied on a decision of the ITAT Ahmedabad Bench in the case of JCIT Vs. Sirhind Steel Ltd. 97 ITD 502(Ahd.) wherein in the context of Sec.35D, the Bench took the view that Share premium has to be considered as part of "Issued Share capital".

(3) On the question of whether FCCBs can be treated as "Debentures", the Assessee submitted that Sec.2(12) of the Companies Act, 1956 defines "Debentures" to include debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. FCCB is bonds and therefore Debentures within the meaning of the terms u/s.35D. The Assessee also pointed out that FCCBs were issued under the Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 wherein the meaning of FCCBs is given as "bonds issued in accordance with the said scheme and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments". The Assessee therefore submitted that FCCBs should be equated with Debentures for the purpose of computing capital employed u/s.35D of the Act.

(4) With regard to treating "unrealized foreign exchange gain" as income chargeable to tax, the Assessee submitted as follows:-

"2.1 During the course of the hearing, your honour relying on the decision of the Honorable Supreme Court in the case of Woodward Governor (supra) (A copy of the decision is enclosed herewith as Annexure 5), mentioned that the unrealized foreign exchange gain amounting to INR 607,500,000 should be treated as income for the year under consideration.

2.2 In this context, we submit that the Hon'ble Supreme Court in the instant case has analyzed the tax treatment of unrealized foreign exchange gain/loss arising out of restatement of liabilities, incurred for revenue purposes/purchase of capital assets, denominated in foreign currency. The implications have been analyzed in two baskets:

- In the first category. the exchange differences arising on revenue items; and
- In the second category, the exchange differences arising on liabilities incurred for the purpose of acquiring capital assets.

2.3 In this connection, the Apex court held that any revenue loss suffered by the assessee on account of exchange difference would be deductible in computing the total income of the assessee inasmuch as the assessee complies with acceptable accounting standards.

2.4 As regards, restatement of foreign exchange gain/loss arising on liabilities incurred for the purposes of acquiring capital assets, the same would have to be adjusted as per the provisions of Section 43A of the Act.

2.5 In the present case, the foreign exchange gains arising on account of the restatement of liability with respect to funds sourced are for the purposes of making investments outside India and related to expansion of business of the assessee. The details of investments as appearing in the audited annual report for the financial year ended March 31, 2008 is enclosed as Annexure 6.

2.6 Therefore, any exchange gain/loss arising on account of reinstatement of liability with respect to the funds sourced for investments would have to be adjusted in accordance with Section 43A of the Act.

2.7 Further, in terms of Section 43A, any foreign exchange gains/losses would be adjusted to the cost of asset at the time of making the payment of the said liabilities.

2.8 Thus, in the instant case, any exchange gains arising on account of restatement of foreign exchange liabilities with respect to the investments made outside India ought to be adjusted only against the "Cost of Investment" in the year of payment.

2.9 Furthermore, the assessee has suo-motu added back an amount of Rs. 1.929,600,000 being foreign exchange loss on restatement of such liability arising in connection with investments made outside India in its return of income for ÀY 09-10. A copy of relevant extract of computation of income of ÀY 09-10 is enclosed herewith as Annexure 7.

2.10 Accordingly, in view of the above, the assessee prays that the unrealized gains ought not to be treated as income for the year under consideration."

(5) On the question whether jurisdiction u/s.263 of the Act could be exercised in a case such as the Assessee, the Assessee submitted as follows:-

"2.11 It is apparent from a bare reading of the provisions of section 263 of the Act that the prerequisite to exercise jurisdiction by the Commissioner of Income-tax ('CIT') is that the order of the Assessing Officer is erroneous in so far as it is prejudicial to the interests of the Revenue. The CIT has to satisfy the twin conditions, namely,

- the order of the AO sought to be revised is erroneous; and
- it is prejudicial to the interest of the revenue.
2.12 It is only when an order satisfies both the above conditions, that section 263 would get attracted.

2.13 The expressions 'erroneous', 'erroneous assessment' and 'erroneous judgment' have been defined in Black's Law Dictionary, Sixth Edition, page 542. As per the definition -
- 'Erroneous' means' involving error', 'deviating from the law'.
- 'Erroneous assessment' refers to an assessment that deviates from law and therefore invalid.

2.14 In the present case, the assessee has provided detailed explanations before the AO regarding the deduction claimed under section 35D vide letters dated November 22, 2011 and December 9, 2011. Copies of relevant extracts of these submissions are enclosed herewith as Annexure 8.

2.15 In light of above, it can be said that the explanations/clarifications offered by the assessee has been accepted by the AO and hence, the AO has applied his mind and allowed deduction under section 35D after considering the same and therefore, the order cannot be said to be erroneous in any manner on the said issue.

2.16 As regards, gains on restatement of liabilities, the assessee had specifically provided the details in the computation of income submitted to the learned AO vide letter dated October 26,2010.

2.17 Thus, where the AO examines the accounts, makes enquiries, applies his mind to the facts and circumstances of the case and determines the income either by accepting the accounts or by making some estimates himself it can be said that the AO has arrived at a conclusion and such a conclusion cannot be simply be termed erroneous because the Commissioner does not feel satisfied with the conclusion.

2.18 Reliance can be placed in the case of CIT v Ganpat Rain Bishnoi (2008) 296 ITR 292 (Raj), wherein it was held that where it is found that the assessing officer has made the assessment after making relevant enquiries and considering all aspects of the matter, then invoking of any proceedings under section 263 is unsustainable. (A copy of the decision is enclosed herewith as Annexure 9).

17. The Assessee gave computation of deduction u/s.35D of the Act at page-219 and 220 of paper book-1. The same is given as Annexure-II to this order.

18. The CIT dealt with the aforesaid submissions of the Assessee, as follows:-
Issue No.1

18.1 With regard to exercise of jurisdiction u/s.263 of the Act, the CIT was of the view that the AO did not verify the claim of the Assessee for deduction u/s.35D of the Act, by taking note of the definition of capital employed and as to whether share premium can be considered as part of the capital employed and whether FCCBs can be considered as debentures and taken as part of capital employed for the purpose of allowing deduction u/s.35D of the Act. Though the claim for deduction u/s.35D of the Act was subject to scrutiny by the AO while concluding the assessment, there are several perspectives to allowing deduction u/s.35D of the Act and the perspective pointed out in the show cause notice u/s.263 of the Act were not verified by the AO and therefore his order was erroneous and prejudicial to the interest of the revenue. In coming to the above conclusion the CIT placed reliance on the decision of the Hon'ble Karnataka High Court in the case of CIT Vs. Infosys Technologies Ltd. 341 ITR 293 (Karn.). In the aforesaid decision, the assessee claimed certain reliefs in terms of DTAA. The assessing authority had indicated that, deductions on such amounts were in terms of double taxation agreement relief in existence between our country and the countries of Canada and Thailand and allowed reliefs as claimed by the assessee. The CIT revised the said order u/s.263 of the Act and directed the AO to examine the terms of the DTAAs with Canada and Thailand and ascertain the exact relief that the assessee can claim under art. 23(2) of the DTAA with Canada and art. 23(3) of the DTAA with Thailand. The assessee being aggrieved with the revisional orders passed by the CIT, preferred appeals to the Tribunal. Assessee urged, among other grounds, that the CIT could not have exercised jurisdiction under s. 263 of the Act for the reason that the order which was sought to be revised was neither shown to be erroneous nor prejudicial to the interest of the Revenue and in fact, it is virtually a case of the CIT opining differently from the assessing authority and therefore, was not amenable to the revisional jurisdiction. The Tribunal agreed with the submission of the Assessee and quashed the order u/s.263 of the Act. On further appeal by the Revenue, the Hon'ble Karnataka High Court held:-

"20. Though it is either vaguely or loosely described by the authorities, even including the Tribunal that the CIT lacked jurisdiction to exercise revisional powers in a situation of the present nature, as it was virtually in the nature of change of opinion on the part of the CIT, taking a different view from the view taken by the assessee to the effect that the authority taking the view that the assessee was entitled for deduction in full, but the CIT doubting that, that in itself does not become a situation of the order being erroneous, the question is not one of the order being erroneous directly with reference to the specific statutory provision but could be on a procedural aspect also.

21. In the present case, while there is no doubt that the assessee is entitled to claim deduction in terms of the arts. 23(3)(a) and 23(4) of the agreements between India with Canada and Thailand respectively, the question is one of what exactly was the entitlement ? In the absence of any discussion either in the assessment order or in the computation claim, particularly as the extent of relief that can be claimed under these two articles is only after a specific exercise and though Sri Sarangan has very vehemently urged that it is not necessary for the assessing authority to make all these things explicit, so long as he is satisfied, on the strength of the authority of the Supreme Court not only in the case of Electro House (supra) and more so on the basis of the observations and law as declared in the case of Malabar Industrial Co. Ltd. (supra), we are fully satisfied that a situation where a deduction of the present nature is allowed or in the sense deducted from out of the tax liability of the assessee without indicating the basis, can definitely be construed as an order both erroneous and prejudicial, as this is definitely a possibility and it is only because it is per se, not discernable in the revisional order, but definitely gives rise to a situation where the CIT may consider the order as erroneous and prejudicial and the CIT having remanded the matter to the assessing authority, we are of the clear opinion that it cannot be characterized as a situation beyond the realm of s. 263 of the Act, as the order being erroneous and prejudicial is a clear possibility particularly the assessing authority not disclosing the basis.

22. To test this proposition, if an order which is explicit is passed by the assessing authority and indicating that the assessee is entitled to a particular extent of relief, but if it is with reference to relevant articles of the DTAA and if it is not either a proper computation or not fully in consonance with the same and if it has resulted in a situation of granting a greater relief than the assessee is otherwise entitled to under these agreements and if the CIT can revise such an order without any hassle in the exercise of revisional jurisdiction under s. 263 of the Act and can correct the order which is erroneous and prejudicial to the interest of the Revenue, just because the assessing authority does not spell out the reasons and therefore can avoid scrutiny under s. 268 of the Act, is an argument which is not logical or rational and not acceptable and at any rate on the authority of the Supreme Court in the case of Malabar Industries Co. (supra) is not an acceptable submission.

23. Though learned counsel for the assessee have placed strong reliance on two judgments of the Bombay High Court and the Delhi High Court in the cases of Gabriel India Ltd. (supra) and Ashish Rajpal (supra) respectively and the Delhi High Court, in fact, has made reference to the decision of the Supreme Court in the case of Max India Ltd. (supra), with great respect, we are unable to apply the ratio of these two decisions to the present circumstance and we are quite satisfied that the law declared by the Supreme Court not only in the case of Electro House (supra) and also in the case at Malabar Industries Co. (supra) fully covers the situation, no further need to discuss with any greater elaboration on the view expressed by the Bombay and the Delhi High Courts."

Issue No.2
18.2 On the question whether the Assessee can be allowed relief on the basis of "Cost of Project" u/s.35D(3)(a) of the Act, the CIT held that the definition of cost of project in Explanation (a) below Sec.35D(3) of the Act referred to "actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the Assessee"….. The CIT held that the cost of acquisition of the two businesses were shown as "Investments" by the Assessee in its Balance sheet and the same cannot be called "Fixed Assets" and therefore the claim in this regard by the Assessee cannot be accepted. Issue No.3

18.3 With regard to including Share Premium as part of the Issued Share capital and treating FCCBs as Debentures while computing "Capital Employed", the CIT held that share premium cannot be regarded as part of capital employed. In coming to the aforesaid conclusion, the CIT placed reliance on the decision of the Hon'ble Delhi High Court in the case of Berger Paints India Ltd. Vs. CIT 292 ITR 658 (Del.). In the aforesaid decision the Hon'ble Delhi High Court was concerned with a question as to whether share premium can be considered as part of the capital employed for the purpose of allowing deduction u/s.35D of the Act. The Hon'ble Delhi High Court held that as per Explanation to sub-s. (3) of s. 35D, capital employed in the business of the company is the aggregate of three distinct components namely, share capital, debentures and long-term borrowings. It does not include reserves and surplus of the company. Therefore, premium, if any, collected by the company on the issue of its share capital does not constitute a part of capital employed in the business of the company for the purpose of quantification of deduction under s. 35D.

Issue No.4

18.4 With regard to the question whether FCCBs can be considered as "Debentures" and taken as part of capital employed for allowing deduction u/s.35D of the act, the CIT held as follows:-

"4.5. The Assessee also contended that the Foreign Currency Convertible Bonds are documents which creates or acknowledges a debt and should be equated with debentures but not produced any evidence to support its claim. In the absence of evidence, the Assessee's claim is rejected."
Issue No.5

18.5 With regard to the question whether unrealised foreign exchange gain should be treated as "Income" or not, the CIT(A) was of the following view:

"4.7. The Assessee on one hand states that any exchange gain/loss arising on account of restatement of liability with respect to the funds sourced for investments would have to be adjusted in accordance with the Sec.43A of the Act. On the other hand states that it has suo-motto added back an amount of Rs. 192,96,00,000 being foreign currency loss on restatement of such liability arising in connection with the investments made outside India in its return of income for AY 2009-10. The Assessee statement appears contradictory. In the absence of full evidences, the assessee claim could not be verified. The Assessing Officer is directed to examine the same and to bring the gain to tax accordingly."

19. Aggrieved by the order of the CIT, the Assessee has preferred the present appeal before the Tribunal. The submissions made by the learned counsel for the Assessee are substantially the same as were made before the CIT in the proceedings u/s.263 of the Act. The learned DR's stand was similar to the stand taken by the CIT in the impugned order u/s.263 of the Act.

20. We have very carefully considered the rival submissions. We will deal with each of the issues raised before us.

21. The first issue to be considered is as to whether exercise of jurisdiction u/s.263 of the Act, in the facts and circumstances of the present case was justified? On this issue the main argument of the learned counsel for the Assessee was that the AO did make enquiry regarding deduction u/s.35D of the Act before completing the Assessment. Though the aspect with regard to "capital employed" or "foreign exchange gain on restatement of the FCCB liability" was not specifically gone into by the AO, it must be presumed that he had applied his mind to all aspects of deduction u/s.35D of the Act and as to whether the foreign exchange gain is to be taxes as income or not. The learned counsel for the Assessee placed reliance on the decision of the Hon'ble Delhi High Court in the case of CIT Vs. Sunbeam Auto Ltd. 332 ITR 167 (Del). In the aforesaid decision the Hon'ble Delhi High Court held that there was a distinction between "lack of enquiry" and "inadequate enquiry". If there is an enquiry, even inadequate, that would not by itself give occasion to the CIT to pass order under s. 263, merely because he has a different opinion in the matter. Such a course of action is open only in cases of "lack of enquiry". Contention of the Revenue that the AO did not consider as to whether the expenditure in question was capital or revenue expenditure cannot be accepted. Although apparently the assessment does not give any reasons for allowing the entire expenditure as revenue expenditure, that by itself would not be indicative of the fact that the AO has not applied his mind to the issue. AO is not required to give detailed reason in respect of each and every item of deduction in the assessment order. AO had called for explanation regarding this very item and the assessee had furnished its explanation. It cannot be said that it is a case of 'lack of enquiry'. Further reliance was also placed by him on the decision of the Hon'ble Delhi High Court in the case of CIT Vs. Anil Kumar Sharma 335 ITR 83 (Del) wherein the facts were that the CIT came to the conclusion that the issue relating to taxability of compensation received by the assessee was not examined by the AO and held that the order of the AO is erroneous and prejudicial to the interest of the Revenue. The Tribunal has arrived at a conclusive finding that though the assessment order does not patently indicate that issue of the taxability of the compensation has been considered by the AO, the record shows that the AO had applied his mind. The Hon'ble Delhi High Court held that it is not a case of lack of enquiry even if the enquiry was inadequate and the CIT was not justified in passing the order under s. 263.

22. We have considered his submissions and are of the view that admitted case before us is that the AO while completing the assessment did not go into the question of computation of capital employed for allowing deduction u/s.35D of the Act. The enquiry made by the AO was only with regard to the details of expenditure incurred on which deduction u/s.35D of the Act was claimed. The computation of deduction u/s.35D(3) of the Act did involve looking into the definition of "capital employed" and coming to a conclusion whether "Share Premium" or "FCCBs" can be considered as "Issued share capital" or "debentures" respectively, for the purpose of inclusion as part of capital employed. There are different perspectives to the claim for deduction u/s.35D of the Act and if one of the perspectives had not been looked into by the AO while completing the assessment, then on that perspective, if there is a loss to the revenue, the jurisdiction u/s.263 of the Act can be invoked. The decision of the Hon'ble Karnataka High Court in the case of Infosys Technologies Ltd. (supra), clearly supports the stand of the revenue in this regard. The view expressed by the Hon'ble Karnataka High Court, which is the jurisdictional High court, therefore supports the plea of the Assessee. The view expressed by the Hon'ble Delhi High Court, in the decisions referred to by the learned counsel for the Assessee, is therefore, held to be not binding.

23. The learned counsel for the Assessee, however, pointed out that the ITAT Bangalore Benches in the case of Vanashree Builders & Developers (P) Ltd. Vs. CIT (2013) 40 taxmann.com 75 after considering the decision of the Hon'ble Karnataka High Court in the case of Infosys Technologies Ltd. (supra) has held that if AO made enquiries and applied his mind than the CIT cannot revise the order u/s.263 of the Act. In the present case, We have already seen that the AO did not apply his mind to the aspects set out by the CIT in the order u/s.263 of the Act. Therefore the decision referred to by the learned counsel for the Assessee does not support the plea of the Assessee in this regard.

24. The next submission of the learned counsel for the Assessee on the first issue was that the deduction u/s.35D is to be allowed over a period of 5 years. The first year in which the Assessee was entitled to claim deduction u/s.35D of the Act was AY 07-08. In that year in proceedings u/s.143(3) of the Act, the AO had allowed the claim of the Assessee. In the subsequent 4 years, the claim has to be allowed as the investigation of eligibility of claim can be examined in such cases only in the 1st year of eligibility. In the subsequent years the deduction cannot be varied or withdrawn unless the 1st year in which the claim was made is also altered. In this regard, it was fairly admitted by the learned counsel for the Assessee that in AY 07-08, the AO has after the proceedings u/s.263 of the Act for AY 08-09 (impugned order), rectified the order of assessment for AY 07-08 in proceedings u/s.154 of the Act and had modified the deduction u/s.35D of the Act, in tune with the decision rendered by the CIT u/s.263 of the Act in AY 08-09 which order is impugned in this appeal. The learned counsel for the Assessee submitted that the said order u/s.154 of the Act is also under challenge by the Assessee before the 1st appellate authority. His submission was that as on the date when the order u/s.263 of the Act was passed, the position was that the 1st year in which the claim u/s.35D could have been varied or disallowed i.e., in AY 07-08 stood allowed. He relied on the following decisions for the proposition that once deduction u/s.35D is allowed in the first year of its claim, it cannot be disallowed in the subsequent years for which the deduction is to be allowed:-

ACIT Vs. J.V. Strips Ltd., ITA No.364/Del/2012 order dated 5.7.2013.
Gujarat Narmada Valley Fertilizers Co. Ltd. Vs. DCIT (2014) 45 Taxmann.com 38 (Gujarat)
CIT Vs. Paul Brothers (1995) 79 Taxman 378 (Bom.)

25. We have considered the submissions of the learned counsel for the Assessee. We find that in the present case, the 1st year in which relief was allowed u/s.35D of the Act has since been modified. Though such modification happened after the order u/s.263 of the Act, which order is impugned in this appeal, it cannot be said that the 1st year of allowance of deduction u/s.35D of the Act stands allowed as claimed by the Assessee. In none of the decisions relied upon by the Assessee, it has been held that even if the 1st year of allowance of a claim is withdrawn at a later point of time, still the revisional order would be bad in law on the ground that the 1st year a claim had been allowed. We are of the view in such circumstances, the exercise of jurisdiction cannot be attacked on the ground that it is only in the 1st year of allowance of a claim which is to be allowed over a period of time that jurisdiction u/s.263 can be exercised. We therefore reject this argument of the learned counsel for the Assessee.

26. Thus issue No.1 is answered against the Assessee.
27. The second issue to be considered is as to whether the Assessee can be allowed relief on the basis of "Cost of Project" u/s.35D(3)(a) of the Act?

28. On the above issue, the CIT held that the definition of cost of project in Expln. (a) below Sec.35D(3) of the Act referred to "actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the Assessee"….. The CIT held that the cost of acquisition of the two businesses were shown as "Investments" by the Assessee in its Balance sheet and the same cannot be called "Fixed Assets" and therefore the claim in this regard by the Assessee cannot be accepted. On the above issue, the learned counsel for the Assessee reiterated submissions as were made in reply to the show cause notice u/s.263 of the Act.

29. We have considered the submissions of the learned counsel for the Assessee and are of the view that the same is not acceptable. The Assessee chose the option of claiming deduction of 5% of capital employed in the business of the company as provided in Sec.35D(3)(b) of the Act and never opted to claim 5% of the "cost of the project u/s.35D(3)(a) of the Act. Cost of Project has been defined in Expln. (a) (ii) as :-

(ii) in a case referred to in clause (ii) of sub-section (1), the actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the extension of the Industrial undertaking is completed or, as the case may be, the new Industrial unit commences production or operation, in so far as such fixed assets have been acquired or developed in connection with the extension of the Industrial undertaking or the setting up of the new Industrial Unit of the assessee;

30. A reading of the above shows that it is only the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are acquired or developed in connection with the extension of the industrial undertaking or the setting up of the new industrial unit of the Assessee that should be considered. The Assessee issued GDRS and FCCBs and incurred expenditure in this regard. The proceeds of the issue were used to acquire shares of two foreign companies and thereby gain control of the two foreign companies. Therefore there were no fixed assets that were acquired or developed in connection with the extension of the industrial undertaking or setting up of the new industrial unit of the Assessee. The argument of the learned counsel for the Assessee cannot therefore be sustained and shares acquired cannot be treated by any stretch of imagination as land or building, plant or machinery etc., and treated as "cost of project" for the purpose of allowing deduction u/s.35D of the Act. This issue is accordingly decided against the Assessee.

31. The third issue that arises for consideration is the issue as to whether Share Premium can be regarded as part of the Issued Share capital while computing "Capital Employed"? The CIT held that share premium cannot be regarded as part of capital employed. In coming to the aforesaid conclusion, the CIT placed reliance on the decision of the Hon'ble Delhi High Court in the case of Berger Paints India Ltd. Vs. CIT 292 ITR 658 (Del.). In the aforesaid decision the Hon'ble Delhi High Court was concerned with a question as to whether share premium can be considered as part of the capital employed for the purpose of allowing deduction u/s.35D of the Act. The Hon'ble Delhi High Court held that as per Explanation to sub-s. (3) of s. 35D, capital employed in the business of the company is the aggregate of three distinct components namely, share capital, debentures and long-term borrowings. It does not include reserves and surplus of the company. Therefore, premium, if any, collected by the company on the issue of its share capital does not constitute a part of capital employed in the business of the company for the purpose of quantification of deduction under s. 35D.

32. The contention of the learned counsel for the Assessee was that the ITAT Ahmedabad in the case of JCIT Vs. Sirhind Steel Ltd. 97 ITD 502(Ahd.) in the context of Sec.35D, the Bench took the view that Share premium has to be considered as part of "Issued Share capital". The Delhi High Court in the case of Berger Paints (supra) has however taken a contrary view. According to him the issue was debatable and two views were available on the issue and therefore no fault can be found in the order of the AO to warrant exercise of jurisdiction u/s.263 of the Act. The learned counsel for the Assessee also submitted that the decisions that come later in point of time and on the date when jurisdiction u/s.263 of the Act was exercised cannot obliterate the existence of debate on the date when order of assessment was passed. The issue was debatable. In this regard he relied on the following decision: Kishanchand J. Bhavnani (HUF) Vs. WTO 29 ITD 383 (Bom.) wherein it was held that subsequent decision of jurisdiction High Court cannot give raise to a mistake apparent on the face of the record warranting rectification u/s.254(2) of the Act. He also relied on the decision of ITAT Ahmedabad Bench in the case of Kanel Oil & Export Inds. Ltd. Vs. JCIT 121 ITD 596 (Ahd.) (TM) wherein it was held that decision of the non-jurisdiction High Court if it is shown to be rendered in ignorance of certain statutory provisions that are directly relevant is not binding. In this regard the argument was that Sec.78 of the Act was not considered by the Hon'ble Delhi High Court in the case of Berger Paints (supra) whereas the ITAT Ahmedabad Bench in the case of Sirhind Steel Ltd. (supra) had considered those provisions to arrive at a conclusion that Share premium has to be considered as part of "Issued Share capital" while allowing deduction u/s.35D of the Act.

33. We are of the view that the aforesaid decision rendered in the context of Sec.254(2) and the regular assessment proceedings, cannot be applied in the context of provisions of Sec.263 of the Act. The power u/s.263 of the Act is a supervisory power and protection of the interest of the revenue owing to an erroneous order is the salutary purpose of those provisions. The provisions of Sec.78 of the Companies Act, 1956 on which the decision of Sirhind Steel Ltd. (supra) proceeded provides for a limited fiction of treating share premium as part of paid up capital for the purpose of reduction of the same. Sec.78(2) of the Companies Act, 1956 prohibits use of share premium for any purpose other than the purposes set out therein. Can it be said that share premium could be employed in the business of the Assessee as share capital? In our view therefore there is no merit in the contention of the learned counsel for the Assessee that share premium should be regarded as part of the "issued share capital" for allowing deduction u/s.35D of the Act.

34. We are of the view that the plea of the learned counsel for the Assessee cannot be accepted. Thus issue No.3 is also decided against the Assessee.

35. The fourth issue that arises for consideration is as to whether question whether FCCBs can be considered as "Debentures" and taken as part of capital employed for allowing deduction u/s.35D of the Act?

36. On the above issue, we find that Sec.2(12) of the Companies Act, 1956 defines "Debentures" to include debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. FCCB is bonds and therefore Debentures within the meaning of the terms u/s.35D. The FCCBs were issued under the Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 wherein the meaning FCCBs is given as "bonds issued in accordance with the said scheme and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments. On the above issue, the CIT held the Assessee has not produced any evidence to support its claim that FCCB were to be equated with debentures. We are of the view that the conclusions of the CIT are unsustainable. In the light of the definition of Debentures as contained in the Companies Act, 1956 to include Bonds and in the light of the fact that the FCCBs in question are in the nature of bonds as defined in the Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 wherein the meaning FCCBs is given as "bonds issued in accordance with the said scheme and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments, we are of the view that FCCBs are to be regarded as debentures and consequently be considered as part of "capital Employed" for allowing deduction u/s.35D of the Act. We hold and direct accordingly and decide the issue in favour of the Assessee.

37. The last issue that arises for consideration is as to whether unrealised foreign exchange gain should be treated as "Income" or not?

38. The stand of the Assessee in this regard was that the gain is on capital account and cannot be regarded as income. The Assessee also pointed out that in the subsequent year, there was a loss on account of restatement of the Assessee's liability on account of adverse fluctuation of foreign exchange and consequent liability on account of FCCBs and in that year the Assessee did not claim the loss as it was on capital account. The Assessee has therefore been consistent and not inconsistent as has been observed by the CIT in the impugned order u/s.263 of the Act. The learned counsel for the Assessee has before us placed reliance on the decision of the Hon'ble Supreme Court in the case of Woodward Governors 312 ITR 254 and the decision of the decision of the Hon'ble Madras High Court in the case of CIT Vs. PVP Ventures Ltd. (2012) 23 Taxmann.com 286 (Mad.).

39. The factual position that the exchange fluctuation is owing to restatement of FCCBs is not disputed. The admitted position is that FCCBs were issued for purpose of acquisition of a new industrial undertaking and was therefore on capital account. The Hon'ble supreme Court in the case of Woodward Governor (supra) laid down the principles in this regard. The Hon'ble Court in Para-4 of its judgment observed as follows:-

"At the outset, for the sake of convenience, we may state that in this batch of civil appeals broadly we have before us two categories. In the first category, we are concerned with exchange differences arising in foreign currency transaction on revenue items. In such category, we are concerned with the assessee(s) incurring loss on revenue account. In that category, we are concerned with the provisions of ss. 28, 29, 37(1) and 145 of the IT Act, 1961 ("1961 Act"). In the second category of cases, we are concerned with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets. In other words, in the second category of cases, we are concerned with the assessee(s) incurring liabilities on capital account. In such cases, we are required to consider the provisions of s. 43(1), 43A (both, before and after amendment vide Finance Act, 2002)."

Thereafter in para 22 of its judgment it dealt with cases where the fluctuation is on account of capital items as follows:-

"Facts in M/s Honda Siel Power Products Ltd.
(Civil Appeal arising out of SLP(C) No. 7632/08)
Capital account case :

22. The main issue which arises for determination in this batch of civil appeals is : whether the assessee was entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance sheet date pending actual payment of the varied liability. In this batch of civil appeals, we are concerned with increase in the existing liability on account of foreign exchange fluctuations on "capital account"."

40. After considering the provisions of Sec.43A of the Act, the Hon'ble Supreme Court held that Sec. 43A(1) applies where as a result of change in rate of exchange there is an increase or reduction in the liability of the assessee in terms of Indian rupees to pay the price of any asset payable in foreign exchange or to repay moneys borrowed in foreign currency specifically for the purpose of acquiring the asset. 43A(1) has no application unless the asset is acquired and the liability existed, before the change in the rate of exchange takes effect. Increase or decrease in liability for repayment of foreign loan should be taken into account to modify the figure of actual cost in the year in which the increase or decrease in liability arises on account of fluctuation in the rate of exchange, irrespective of the date of actual payment in foreign currency.

41. In the case of PVP Ventures Ltd. (supra), the facts were that the Assessee gained from exchange fluctuation. The fluctuation was on foreign exchange received pursuant to issue of shares in the form of GDS. The assessee kept a part of the money abroad. When the money was brought to India, due to strong dollar position, the assessee gained on the repatriated amount. This was claimed as a capital receipt. The amount had direct nexus with the capital raised and consequently the assessee contended the same was a capital receipt. The Commissioner of Income Tax pointed out that there was no dispute with regard to the fact that the exchange fluctuation income related to the deposit of money raised by the assessee from the GDS issue. Pointing out the printed prospectus to the issue of GDS, the Commissioner viewed that the aggregate net proceeds received were used principally to fund the establishment of offshore software development and the balance was used for working capital and for other general corporate purposes. The Commissioner viewed that the assessee had kept FDs of the GDS proceeds on its own and not because of any compulsion. Consequently, the amount received on account of exchange fluctuation to the tune of Rs. 16,35,77,977/- was to be treated as revenue receipt and the Assessing Officer erred in reducing it in the income of the assessee while computing the deduction under Section 80HHE. The Hon'ble Madras High Court held that the claim of the revenue was unsustainable. The Hon'ble Court held that since the amount had direct nexus with the capital raised, the assessee's claim that the same was capital receipt and hence not taxable was correct.

42. In our view the facts of the case in the decision of the Madras High Court in the case of PVP Ventures Ltd. (supra), is identical to the facts of the case of the Assessee in this appeal. FCCBs are instruments issued to investors for raising funds which is repayable after certain period. It is a debt instrument. The increase or decrease in liability on account of fluctuation in foreign exchange as on the date of the Balance sheet would increase or decrease the liability of the Assessee and such liability would be on capital account. Therefore the gain or loss would be on capital account and not taxable. We accordingly hold in favour of the Assessee on this issue.

43. In the result appeal of the Assessee is partly allowed.