2024 (10) TMI 1659 - AT - Income Tax

Disallowance of expenditure recorded as bad debts - trade receivable from NHAI in Nashik PO - NHAI subsequently held that the assessee raised invoices at a higher amount than the original contract rate and therefore realized only less amount than the invoice amount resulting in short settlement - HELD THAT - We are of the opinion that if really the assessee took the entire amount into consideration and offered the same to tax during the relevant Financial Year and subsequently there was short payment there of on verification of this fact from the books of the assessee the AO has to allow the amount as deduction. While following the view taken for the AY 2021-22 we restore the issue to the file of the learned Assessing Officer for verification as stated above and to allow the deduction since otherwise it amounts to taxation of amount that was never received. Disallowance towards consultancy charges - According to the assessee was incurred towards legal fee paid to defend the action of NHAI in debarring the assessee from participating in any work connected with NHAI for a period of one year on account of deficiency in services rendered in Pali highway - The opinion of NHAI was not final as to whether the assessee really committed breach of contractual terms and conditions or services to be rendered or violated the terms of contract cannot be taken as final and any attempt of the assessee to get it tested in a judicial forum cannot be termed as defendant s offence. Here we have to keep it in mind that payment of fine or penalty is different from incurring a litigation expense before such penalty or sentence is finally passed. After the judicial forum speaks finally confirming the penalty the subsequent payment alone can be treated as sentence for offence but not litigation expense. Litigation expenses incurred by the assessee to defend their stand against the Circular passed by the NHAI debarring the assessee from participating in any work connected with NHAI for a period of one year for breach of contractual obligation is allowable expense. Disallowance claimed towards expenditure for third party vendors claimed towards direct expense recorded as business development expense - We are of the opinion that when once the assessee engaged third parties in order to avoid certain management problems by engaging permanent staff on their own when the need ends and contract with third parties gets terminated it would be but natural that the professional relationship between the assessee and the third party service providers would end and whether or not the assessee could trace out the whereabouts of such third party service providers becomes a question of fact. When the assessee pleaded that only skeleton staff remained at the project office after the project work is accomplished it would be natural for them to take more time to trace out the erstwhile service providers and to obtain the confirmations and information from them. We accept the contention of the assessee and restore the issue to the file of the AO to receive the confirmations to be filed by the assessee and to seek any further information so required and to take a view according to the law. Addition claimed as direct expense recorded as business development expense in the financial statements and disallowance u/s 44C - found that if the assessee proves that certain expense was exclusively incurred for the Indian project by the head office and such expense is not in the nature of overheads the Revenue has to examine the time sheet on daily basis for each employee in the organization by recording the manhours on daily basis and if such exclusive nature of such expenditure is established then such expense has to be excluded from the purview of section 44C of the Act. In this case it is evident from the record that since the authorities have taken a stand that salaries and perks to the employees fall under section 44C of the Act and did not proceed further to verify the evidence in the light of the decisions of Samsung Engg. Co. Ltd. 2010 (11) TMI 840 - ITAT MUMBAI we deem it just and proper to restore this issue to the learned Assessing Officer to verify this fact and if it is found that such expenses were exclusively attributable to the Indian project not to make any disallowance under section 44C. Appeal of the assessee is allowed for statistical purpose.

Summary

The core legal questions considered by the Tribunal in this appeal concern the allowability of various expenditure claims made by the assessee under the Income Tax Act, 1961, specifically for the assessment year 2020-21. The issues presented and adjudicated are:

1. Whether the disallowance of bad debts amounting to Rs. 16,97,639/- relating to trade receivables from NHAI can be sustained, given that the assessee had offered the amounts to tax in earlier years and subsequently faced short payments.

2. Whether legal expenses of Rs. 46,40,500/- incurred to defend against a debarring action by NHAI can be allowed as a deductible expense, or whether such expenditure falls within the ambit of non-allowable expenses under section 37 of the Act as being connected to an offence.

3. Whether the disallowance of Rs. 32,43,680/- claimed as project expenses paid to certain third-party vendors is justified due to lack of confirmations and substantiation.

4. Whether the disallowance of Rs. 1,81,67,730/- claimed as business development expenses, recorded as direct expenses in the financial statements and disallowed under section 44C of the Act, is sustainable.

Issue 1: Disallowance of Bad Debts of Rs. 16,97,639/-

The legal framework involves the principle that amounts previously offered to tax cannot be taxed again, and that bad debts can be claimed as deduction under the Act if amounts earlier included in income are subsequently irrecoverable.

The assessee contended that the disputed amounts were already offered to tax in Financial Years 2014-15 and 2015-16, supported by sales ledgers, profit and loss accounts, and prior income tax returns. The short payments by NHAI arose due to invoicing above contract rates and alleged breach of contract by the assessee. The assessee relied on a precedent from the assessment year 2021-22, where the Tribunal held that if the amounts were verifiably offered to tax earlier, subsequent non-receipt should be allowed as bad debts.

The Revenue argued that the short payments resulted from breach of contract and therefore amounted to penalties, which are not deductible.

The Tribunal reasoned that if the assessee had indeed included these amounts in income in earlier years, taxing them again would amount to double taxation. The question of whether the amounts were offered to tax must be verified from the assessee's books. The Tribunal restored the issue to the Assessing Officer for verification and directed that if the amounts were previously taxed, the bad debt deduction should be allowed.

Issue 2: Disallowance of Legal Expenses of Rs. 46,40,500/-

The legal question was whether litigation expenses incurred in defending against a debarring circular by NHAI constitute allowable business expenditure or fall within the non-allowable category of expenses connected with an offence under section 37 of the Act.

The assessee submitted that these expenses were incurred to defend its position against the debarring action, which was not a final adjudication of breach of contract or offence. The litigation expenses were incurred before any penalty or sanction was confirmed by a judicial forum.

The Revenue contended that since the expenses related to defending an action for deficiency in services, they were akin to penalties and thus not deductible.

The Tribunal analyzed the distinction between payment of fines or penalties and litigation expenses incurred to contest such penalties. It held that until a penalty is finally confirmed by a judicial authority, expenses incurred in defense are allowable. The NHAI's circular debarring the assessee was not a final determination of breach, and the assessee's attempt to challenge it cannot be treated as an offence. Therefore, the litigation expenses are deductible.

Issue 3: Disallowance of Rs. 32,43,680/- Paid to Third Party Vendors

The issue revolved around the failure of four third-party vendors to provide confirmations for payments made, leading to disallowance of the claimed expenses by the Revenue.

The assessee explained that the project at the relevant location (Chhattisgarh PO) was completed, and only skeleton staff remained, making it difficult to obtain confirmations from erstwhile service providers. The assessee had obtained confirmations from other vendors and was willing to produce further evidence if given an opportunity.

The Revenue pointed out that confirmations were not furnished during assessment, first appeal, or remand proceedings, justifying disallowance.

The Tribunal recognized the practical difficulties in tracing former vendors after project completion and accepted the assessee's explanation. It restored the matter to the Assessing Officer for further verification, allowing the assessee to produce confirmations and other evidence before a final decision.

Issue 4: Disallowance of Rs. 1,81,67,730/- Business Development Expenses under Section 44C

The legal framework involves section 44C of the Income Tax Act, which provides for the deduction of certain expenses incurred by a foreign enterprise's permanent establishment in India, with specific provisions excluding certain salary and overhead expenses.

The assessee argued that these expenses were incurred exclusively for the Indian project, supported by detailed time sheets recording man-hours spent, and thus should be excluded from the purview of section 44C disallowance. The assessee relied on precedents including decisions of coordinate benches and High Courts that allowed exclusion of expenses exclusively attributable to Indian projects when adequately substantiated.

The Revenue contended that the expenses were salaries and perks falling under the exclusion in section 44C and thus disallowable. Additionally, the Assessing Officer had disallowed a portion under section 40(a)(i), but the assessee did not challenge that disallowance, implying acceptance.

The Tribunal observed that the Revenue did not verify the assessee's evidence in light of the cited precedents. It held that if the assessee proves exclusive attribution of the expenses to the Indian project with supporting time sheets, such expenses must be excluded from disallowance under section 44C. The Tribunal restored the issue to the Assessing Officer for verification accordingly.

Significant Holdings and Core Principles

On the bad debts issue, the Tribunal emphasized that "if really the assessee took the entire amount into consideration and offered the same to tax during the relevant Financial Year and subsequently, there was short payment thereof... the learned Assessing Officer has to allow the amount as deduction," to avoid double taxation.

Regarding litigation expenses, the Tribunal clarified that "payment of fine or penalty is different from incurring a litigation expense before such penalty or sentence is finally passed," and hence "litigation expenses incurred by the assessee to defend their stand... is allowable expense."

On third party vendor expenses, the Tribunal recognized the practical challenges in obtaining confirmations post-project completion and allowed the assessee an opportunity to produce evidence, directing the Assessing Officer to verify genuineness before final disallowance.

Concerning business development expenses under section 44C, the Tribunal stated that "if the assessee proves that certain expense was exclusively incurred for the Indian project... the Revenue has to examine the time sheet on daily basis... and if such exclusive nature of such expenditure is established then such expense has to be excluded from the purview of section 44C."

All disputed issues were remitted to the Assessing Officer for fresh consideration in accordance with the directions, and the appeal was allowed for statistical purposes.