2018 (10) TMI 2054 - AT - Income Tax

Nature of expenditure - Products Registration expenditure - capital or revenue expenditure - HELD THAT - The issue involved in the present appeal is squarely covered by the order passed in the assesses own case for A.Y. 2011-12 2018 (3) TMI 951 - ITAT MUMBAI . No infirmity emerges from the well reasoned order of the CIT(A) who had rightly concluded that the product registration expenses were allowable as a revenue expenditure. We thus uphold the order of the CIT(A) and dismiss the appeal of the revenue.

Summary

The primary issue before the Tribunal was whether the product registration expenditure (PRE) of Rs. 39,81,96,235/- claimed by the assessee was a revenue expenditure deductible under the Income-tax Act, 1961, or a capital expenditure, which would only allow depreciation. This core legal question arose from the Assessing Officer's (A.O.) disallowance of the PRE as revenue expenditure, characterizing it as capital expenditure, and the subsequent allowance of the same by the Commissioner of Income Tax (Appeals) [CIT(A)]. The revenue challenged the CIT(A)'s order before the Tribunal.

Another related issue was whether the depreciation previously allowed on the product registration assets should be deleted following the disallowance of the PRE as revenue expenditure.

These issues were considered in light of the facts that the assessee was engaged in trading agrochemicals and related products and incurred PRE to obtain regulatory approvals necessary for marketing these products in various countries. The question of the nature of the expenditure-capital or revenue-was central to the appeal.

Issue-wise Detailed Analysis:

1. Nature of Product Registration Expenditure: Revenue or Capital?

Relevant Legal Framework and Precedents: The determination of whether an expenditure is capital or revenue in nature depends on the purpose and nature of the expenditure rather than its size or mode of payment. The Apex Court's decision in MK Brothers Private Ltd. emphasized that the real nature and quality of the payment is decisive. If the payment is to acquire a capital asset, it is capital expenditure; if it is incurred in the course of business operations, it is revenue expenditure. The Bombay High Court in Bhor Industries held that book entries or prior treatment do not conclusively determine the nature of expenditure.

Further, the Calcutta High Court in Edward Keventer (P) Ltd. held that the business needs must be judged from the perspective of the company as a prudent businessman, not the tax officer. The "benefit" to the company is broadly construed and not necessarily quantifiable in monetary terms.

Decisions of the Delhi High Court and Gujarat High Court in Panacea Biotech Ltd. and Cadila Healthcare Ltd. respectively, supported the view that PRE should be allowed as revenue expenditure. The Gujarat High Court in Cadila Healthcare Ltd. observed that product registration charges do not create a new asset but are necessary regulatory costs before marketing a product.

The Apex Court in Empire Jute Mills clarified that even if an expenditure results in an advantage of enduring benefit, it may still be revenue expenditure if it facilitates trading operations without affecting fixed capital. The test of enduring benefit is not conclusive and must be applied considering the commercial nature of the advantage.

Court's Interpretation and Reasoning: The Tribunal noted that the assessee was a trader, not a manufacturer, and did not own brand or patent rights over the products. The PRE was incurred to comply with regulatory requirements to enable exports. Without these registrations, sales in foreign markets would not be possible. The expenditure was thus closely linked to the day-to-day business operations of selling and marketing.

The Tribunal observed that the PRE was recurring in nature, incurred year after year in substantial amounts, indicating it was not a one-time capital investment but a regular business expense. The prior practice of capitalizing the expenditure and claiming depreciation was not decisive, as book entries do not determine the legal nature of expenditure.

Key Evidence and Findings: The assessee's explanation that PRE was necessary for regulatory approvals in multiple countries, the recurring nature of the expenditure, and the absence of any creation of a tangible or intangible capital asset were key factual findings. The Tribunal also relied on earlier orders in the assessee's own case for earlier assessment years where similar disallowance was vacated.

Application of Law to Facts: Applying the principles from the cited case law to the facts, the Tribunal concluded that PRE did not create an enduring capital asset but was incurred to enable the assessee's trading business. The expenditure facilitated the conduct of business rather than acquiring a capital asset.

Treatment of Competing Arguments: The revenue's contention rested on the enduring benefit test and the long duration of the registration process, arguing that the expenditure was capital in nature. The Tribunal rejected this mechanical application of the enduring benefit test, emphasizing the commercial reality and the nature of the assessee's business. The Tribunal also rejected reliance on prior capitalization and depreciation claims as determinative.

Conclusion: The Tribunal upheld the CIT(A)'s order allowing the PRE as revenue expenditure.

2. Deletion of Depreciation on Product Registration Expenditure:

The revenue also challenged the CIT(A)'s deletion of depreciation allowed on the product registration assets following the disallowance of the PRE as capital expenditure by the A.O. However, since the Tribunal upheld the CIT(A)'s conclusion that the expenditure was revenue in nature, the question of depreciation did not arise. The Tribunal implicitly confirmed that no depreciation was allowable as the expenditure was not capitalized.

Significant Holdings:

"The answer to the question as to whether an amount paid is a revenue expenditure or capital expenditure depends not so much upon the fact as to whether the amount paid is large or small or whether it has been paid in lump sum or by installments, as it does upon the purpose for which the payment has been made and expenditure incurred. It is the real nature and quality of the payment and not the question or the manner of the payment which would prove decisive."

"The legitimate business needs of the company must be judged from the view-point of the company itself and from the view-point of a prudent businessman. It is not for the Income-tax Officer to dictate what the business needs of the company should be."

"There may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test."

Core principles established include:

• The nature and purpose of the expenditure, rather than its size or mode of payment, determine its classification as capital or revenue.
• Recurring expenditures necessary for regulatory compliance in trading activities are revenue expenditures.
• The enduring benefit test is not conclusive and must be applied with regard to commercial realities.
• Book entries and prior treatment by the assessee do not conclusively determine the nature of expenditure.
• The business needs must be assessed from the perspective of a prudent businessman, not the tax authority.

Final determination was that the product registration expenditure was revenue expenditure deductible in the year of incurrence, and the revenue's appeal was dismissed accordingly.