2018 (8) TMI 2169 - AT - Income Tax

Disallowing the provision for leave encashment by invoking the provisions of section 43B(f) - HELD THAT - There cannot be any doubt that leave encashment liability is an eligible deduction available to the assessee. But in view of the clear-cut provisions of the law that from 1 April 2002 leave salary payable by the assessee as an employer to his employees is brought within the purview of section 43B of the act However the relaxation contained in the 1st proviso is available. On further it is clarified that once deduction of the provision made in an earlier year s is allowed no deduction is permissible in respect of the same amount once again on payment basis. Therefore if the assessee has made the provision of leave salary which has not been paid on or before the due date prescribed under the income tax act for filing of the return of income then such provision cannot be allowed as deduction in the year in which the provision is made but the payment has not been made before the due date of filing of the return of income. In view of this we do not find any infirmity in the order of the lower authorities. Hence ground number 1 of the appeal of the assessee against the disallowance of provision of leave encashment by invoking the provisions of section 43B (F) is dismissed. Disallowance of the bad debt written off - assessee claimed the bad debts written off being the tax deduction at source by the customers of the assessee for which neither the certificates were received nor claimed as advance tax in the return of income - HELD THAT - It is apparent that assessee has not been issued the tax deduction at source certificate by the customers. In view of this the amount becomes receivable from the debtors only. It is not the case of the revenue that assessee has not shown the income portion arising out of that sum in its profit and loss account for the amount of tax deduction at source not received from the customers of same have not been written off to the profit and loss account. In view of this we do not find any merit in the reasoning of the learned CIT - A that the appellant had not cared to take the credit of TDS deducted and therefore it cannot be recovered from the concerned customer. Unless the tax deduction at source sum is deposited by the debtor then only the above sum is recoverable by the assessee towards his tax liability from the government of India and adjusted against the pre-existing liability otherwise the same sum is recoverable from the debtor only. We find that the assessee should have been allowed the deduction of the amount t on account of Tax deducted by the customers towards tax deduction at source but no such deduction certificates has been presented to the assessee as bad debt. Nature of expenditure - disallowance of the expenditure incurred on computer software treating the same as capital expenditure - HELD THAT - The assessee s major expenditure was also because of the annual renewal of the software licenses. Assessee has also made the software development expenditure for bringing up the relevant software used for the day-to-day business needs of the assessee. In view of this it cannot be said that the software has given any benefit of enduring nature to the assessee or are capital expenditure in nature. In view of this is the expenditure incurred by the assessee on software expenditure is day-to-day routine expenditure and annual renewal charges only we are of the opinion that it is revenue in nature. We direct AO to delete the disallowance made by the AO because of software expenditure holding the same to be capital expenditure. Disallowance being the expenses incurred on late cancellation charges holding that the same cannot be treated as business expenditure allowable u/s 37 (1) - HELD THAT - The claim of the AR that the above expenditure is compensatory in nature and therefore when certain meetings etc. are cancelled and the cancellation charges charged by the various agencies these expenditures are incurred. Therefore these are incurred for the purposes of the business. However in absence of the proper details of such expenditure whether those are incurred for the purpose of the business of the assessee or not cannot be ascertained. Despite repeated opportunities available to the assessee before the learned assessing officer as well as before the CIT - A the assessee has not submitted the complete details but merely submitted the ledger account of those expenditure. In absence of complete details of the expenditure the same has rightly been disallowed by the lower authorities. Denial of deduction allowed u/s 80HHE - claim of the assessee is that 90% of the rental income to be reduced from the eligible profit of the business should also further be reduced by the proportionate depreciation on the building of the assessee - HELD THAT - As relying on ACG Associated Capsules P Ltd 2012 (2) TMI 101 - SUPREME COURT we direct the learned assessing officer to allow the claim of the deduction under section 80 HHE of the income tax act by reducing only 90% of the net interest income and net rental income from the eligible business. In view of this ground number 8 of the appeal of the assessee is allowed.

Summary

Issues Presented and Considered

The primary legal questions addressed in the appeals for Assessment Years 2003-04 and 2004-05 include:

• Whether the provision for leave encashment can be disallowed under section 43B(f) of the Income Tax Act, 1961, when such provision relates to accrued leave not yet payable.
• The correctness of remanding back to the Assessing Officer (AO) for verification of provisions for leave encashment reversed and warranty expenses reversed during the year, despite full details being produced before the Commissioner of Income Tax (Appeals) [CIT(A)].
• The validity of disallowance of bad debts written off relating to tax deducted at source (TDS) not recovered from customers.
• Whether expenditure incurred on acquiring computer software should be treated as capital expenditure or revenue expenditure.
• The allowability of expenses incurred on late cancellation charges as business expenditure under section 37(1) of the Act.
• The computation of deduction under section 80HHE of the Act, specifically the treatment of gross rental and interest income versus net income after depreciation and interest expenses.
• The legitimacy of transfer pricing adjustments made by the AO and Transfer Pricing Officer (TPO), including the selection and adjustment of comparables, application of the arm's length principle, and the availability of the +/-5% range under proviso to section 92C.
• The power of the CIT(A) to remit issues back to the AO for verification or recomputation post the omission of the power to set aside assessments under section 251(1)(a) of the Act.
• The initiation of penalty proceedings under section 271(1)(c) of the Act.
• The applicability of deductions under sections 10A and 80HHE on increased profits due to disallowances.

Issue-wise Detailed Analysis

Provision for Leave Encashment and Section 43B(f)

Legal Framework and Precedents: Section 43B(f) mandates that any deduction for sums payable by an employer in lieu of leave to employees shall be allowed only in the year such sum is actually paid. The Supreme Court decision in Bharat Earthmovers Ltd. (245 ITR 428) held that provisions for leave encashment represent accrued liabilities and are deductible when made. However, the statutory amendment effective from 1 April 2002 brought leave salary payable within section 43B, subject to provisos.

Court's Interpretation and Reasoning: The Court noted that the assessee's provision for leave encashment was not paid during the year and thus remained outstanding. Although the liability is accrued, the amended section 43B(f) requires actual payment for deduction. The assessee's contention that only employees who resign can claim leave encashment and thus the provision is for accrued leave, not payable sums, was rejected because the provision remained unpaid as on the due date for filing the return.

Application of Law to Facts: Since the provision was not paid before the due date of filing the return, the deduction was rightly disallowed under section 43B(f). The Court distinguished the pre-amendment position and upheld the AO and CIT(A) orders.

Conclusion: The disallowance of the leave encashment provision under section 43B(f) was upheld for both assessment years.

Remand for Verification of Provisions for Leave Encashment and Warranty Expenses

Legal Framework: The CIT(A) remanded certain issues to the AO for verification despite complete details being submitted.

Court's Reasoning: The Court observed that the AO, upon verification, allowed the claims for provisions reversed during the year and warranty expenses. It found no infirmity in the CIT(A)'s direction to verify calculations and facts, noting that the power to set aside assessments was omitted by the Finance Act, 2001, but verification for factual accuracy remains permissible.

Conclusion: Grounds challenging remand were dismissed as the relief was granted upon verification.

Disallowance of Bad Debts Written Off Relating to TDS Not Recovered

Legal Framework: Deduction of bad debts is allowable if the debt is related to business and is irrecoverable. The TDS written off represents amounts deducted by customers but not credited to the assessee due to non-issuance of TDS certificates.

Court's Interpretation: The CIT(A) disallowed the claim since no TDS certificates were produced and the assessee did not claim credit for TDS. The Court found the CIT(A)'s reasoning flawed, emphasizing that the amount becomes a receivable from debtors if TDS certificates are not issued and the sum is not credited to the assessee's tax account.

Application of Law to Facts: The assessee showed the income in profit and loss and wrote off the amount as bad debt. The Court held that the amount qualifies as bad debt since the TDS certificates were not received, and thus the sum is recoverable only from the debtors.

Conclusion: The disallowance was set aside, and the bad debt claim allowed.

Expenditure on Computer Software: Capital or Revenue Expenditure

Legal Framework: Capital expenditure relates to acquiring an asset with enduring benefit, while revenue expenditure is for day-to-day operations. Software expenditure can be capital or revenue depending on nature.

Court's Reasoning: The AO and CIT(A) treated the entire software expenditure as capital and allowed depreciation at 60%. The assessee produced detailed evidence that the expenditure mainly comprised annual maintenance contracts and license renewals, which do not provide enduring benefit.

Application: The Court held that the software expenditure was recurring and revenue in nature, not capital.

Conclusion: Disallowance was deleted, and depreciation reversed.

Expenses on Late Cancellation Charges under Section 37(1)

Legal Framework: Business expenditure under section 37(1) must be incurred wholly and exclusively for business purposes and adequately substantiated.

Court's Analysis: The assessee claimed late cancellation charges as compensatory business expenses but failed to furnish complete details beyond ledger accounts despite repeated opportunities.

Conclusion: Disallowance was upheld due to lack of adequate evidence.

Deduction under Section 80HHE and Computation of Profits

Legal Framework and Precedents: Section 80HHE provides deduction for profits from export business. Explanation (baa) defines "profits of the business" as profits computed under sections 28 to 44D, reduced by 90% of certain receipts like brokerage, commission, interest, rent, etc. The Supreme Court in ASG Associated Capsules (343 ITR 89) clarified that the deduction applies to 90% of net receipts included in profits, not gross receipts.

Court's Interpretation: The AO and CIT(A) reduced 90% of gross rental and interest income without reducing proportionate depreciation and interest expenses, contrary to the Supreme Court ruling.

Application: The Court directed the AO to allow deduction by reducing 90% of net rental and net interest income from profits.

Conclusion: Deduction under section 80HHE was allowed as per Supreme Court precedent for both years.

Transfer Pricing Adjustments

Legal Framework: Transfer pricing adjustments under sections 92CA and 92C require determination of arm's length price (ALP) using comparables and adjustments for differences in risk, working capital, etc. The +/-5% range under proviso to section 92C is generally available as a safe harbor.

Court's Reasoning: The CIT(A) upheld the AO/TPO's adjustments including disregarding the assessee's transfer pricing study, subjective selection of comparables, and denial of working capital and risk adjustments. However, subsequent to the CIT(A) order, the AO, pursuant to CIT(A)'s directions, deleted the transfer pricing additions after verification.

Conclusion: Grounds challenging transfer pricing adjustments became infructuous and were dismissed.

Power of CIT(A) to Remand Issues to AO Post Amendment of Section 251(1)(a)

Legal Framework: The power to set aside assessments was omitted by Finance Act, 2001, effective 1 June 2001. CIT(A) can confirm, reduce, enhance, or annul assessments but cannot set aside.

Court's Analysis: The CIT(A) directed AO to verify and recompute certain expenses and adjustments. The Court held that such directions to verify calculations or facts do not amount to setting aside but are permissible to ensure correctness.

Conclusion: The CIT(A)'s directions were upheld, and the revenue's appeal dismissed.

Initiation of Penalty Proceedings under Section 271(1)(c)

Legal Framework: Penalty proceedings require completion of assessment and establishment of concealment or furnishing inaccurate particulars.

Court's Reasoning: The appeals against penalty initiation were premature at the assessment stage.

Conclusion: Grounds against penalty initiation were dismissed as premature.

Additional Grounds Regarding Deductions under Sections 10A and 80HHE on Increased Profits

Legal Framework: Deductions under these sections are computed on eligible profits, which may increase due to disallowances.

Court's Interpretation: The Court admitted these grounds and directed the AO to follow CBDT Circular No. 37/2016, which prescribes a formula for proportionate enhancement of deductions when profits increase due to disallowances.

Conclusion: Additional grounds were allowed and remanded for compliance with the circular.

Significant Holdings

"As per provisions of section 43B(f) of the act any deduction otherwise allowable under the act in respect of any sum payable by assessee as an employer in lieu of any leave at the credit of his employees shall be allowed irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him only in computing the income referred to in section 28 of the previous year in which some such sum is actually paid by him."

"The amount becomes receivable from the debtors only. It is not the case of the revenue that assessee has not shown the income portion arising out of that sum in its profit and loss account for the amount of tax deduction at source not received from the customers of same have not been written off to the profit and loss account."

"Out of the total expenditure of Rs. 6,714,164/-, most of the expenditure has been incurred by the assessee towards the software annual maintenance charges... it cannot be said that the software has given any benefit of enduring nature to the assessee or are capital expenditure in nature."

"In the absence of complete details of the expenditure, the same has rightly been disallowed by the lower authorities."

"Only ninety per cent. of the net amount of any receipt of the nature mentioned in clause (1) which is actually included in the profits of the assessee is to be deducted from the profits of the assessee for determining 'profits of the business' of the assessee under Explanation (baa) to section 80HHC."

"The CIT(A) is not prohibited in directing the learned assessing officer to verify certain calculations and facts."

"The additional grounds of appeal of assessee are admitted and the learned assessing officer is directed to follow the circular number 37/2016 and if the eligible income for deduction increases on account of any disallowance to the business income made by that industrial undertaking, then the learned AO is directed to enhance the deduction proportionately according to the formula prescribed under the respective sections."

Final Determinations

• The disallowance of leave encashment provisions under section 43B(f) was upheld for both years.
• The remand to AO for verification of provisions and warranty expenses was justified and relief granted post verification.
• The bad debts claim relating to TDS not recovered was allowed.
• Software expenditure was held to be revenue expenditure; disallowance and depreciation reversed.
• Late cancellation charges disallowance was upheld due to lack of substantiation.
• Deduction under section 80HHE was allowed on net rental and interest income following Supreme Court precedent.
• Transfer pricing additions were deleted after verification; related appeals dismissed.
• CIT(A)'s directions for verification were held valid despite omission of set-aside power.
• Penalty proceedings challenge was premature and dismissed.
• Additional grounds regarding deductions under sections 10A and 80HHE were admitted and remanded for compliance with CBDT circular.
• Appeals by the assessee were partly allowed; appeals by revenue were dismissed.