TMI Blog2015 (3) TMI 535X X X X Extracts X X X X X X X X Extracts X X X X ..... ct appears to be that expenditure on scientific research should be on the research actually carried out by the assessee in-house and it should not merely spend money in acquiring rights in or arising out of scientific research carried out by some other person. If the interpretation sought to be placed by revenue / authorities below is to be accepted, then the benefit sought to be conferred by the provisions of section 35(1)(iv) of the Act would be virtually denied in all cases by invoking the exclusion clause in section 43(4)(ii) of the Act. Such a consequence would never have been intended by the Legislature. As already stated, the object behind the provisions of section 35 of the Act is to encourage scientific research so that the benefit of such research would be available to all. In the given facts and circumstances of the case as discussed above, we are of the view that the claim of deduction under section 35(1)(iv) of the Act is to be allowed. In any event, there is no distinction as to whether the expenditure incurred is capital or revenue, because while the provisions of section 35(1) of the Act allows deduction of revenue expenditure, the provisions of section 35(1)(iv) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat:- The assessee's contention is that it has sufficient funds to make investments and that the interestbearing borrowed funds were not used for making the investments in MFs during the period under consideration. This aspect of the assessee's contention, in our considered view, requires verification. - Decided in favour of assessee for statistical purposes. Disallowance of “interest” - inclusion of finance charges like factoring and other charges, bill discounting charges, etc. as part of interest charges - contention of the assessee that the computation made by the Assessing Officer is erroneous, since such finance charges cannot be included as “interest” for the purposes of Rule 8D of the IT Rules, 1962 - Held that:- As find from the record that the learned CIT(A) has already directed the Assessing Officer to exclude these charges from the computation of interest and hence no adjudication is called for at this stage. - Decided in favour of assessee. - I.T.A. No.1684/Bang/2012, I.T.A. No.10/Bang/2013 - - - Dated:- 31-12-2014 - SHRI N.V. VASUDEVAN AND SHRI JASON P. BOAZ, JJ. For The Assessee : Shri K.R. Vasudevan, Advocate For The Respondent : Shri Farhat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Assessment Year 2008-09 and have preferred appeals before the Tribunal raising the following grounds :- Assessee's grounds of appeal (ITA No.10/Bang/2013) 1. Product Development expenditure - ₹ 279,754,476 1.1 The learned Commissioner of Income-tax (Appeals) - III, Bangalore erred in confirming the disallowance of product development expenditure amounting to ₹ 279,754,476. 1.2 The learned CIT(A) and learned AO erred in treating product development expenditure of ₹ 279,754,476 (capitalised in the books) as not eligible for deduction under section 35(1)(iv) read with section 35(2) of the Act, on the basis that it is not in the nature of scientific expenditure. 1.3 The learned CIT(A) and learned AO erred in holding that the expenditure incurred is covered under the exclusion to the definition given in subsection 4(ii) to section 43 of the Act which states that the scientific expenditure excludes any expenditure incurred in the acquisition of rights in, or arising out of, scientific research . The learned CIT(A) and learned AO erred in not appreciating that the expenditure incurred by the assessee is towards scientific research expendit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accepting the appellant s contention that the interest on OD and term loans incurred by it during the year was for the purposes of working capital and not for the purposes of making investments. The Appellant craves leave to add, to alter or amend all or any of the aforestated grounds of appeal. For the above and any other grounds which may be revised at the time of hearing, it is prayed that the order of the learned CIT (A) be set aside. Revenue s grounds of appeal (ITA No.1884/Bang/2012) 1. The order of the learned CIT (Appeals) is opposed to law and facts of the case. 2. On the facts and in the circumstances of the case the learned CIT (Appeals) has erred in holding that the product development expenses of ₹ 10,25,89,836 is an allowable expenditure u/s.37(1) without appreciating the fact that the A.O. has disallowed this expenditure on the ground that it represents expenditure on incomplete projects and also the same cannot be capitalized as no new products have been developed by the assessee. 3. For these and other grounds that may be urged at the time of hearing, it is prayed that the order of the CIT (Appeals) in so far as it relates to the above grou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s.35(1)(iv) r.w.s. 35(3) of the Act in the computation of income. 5.2.2 The Assessing Officer, while examining these claims of the assessee, called for various details and also recorded the statement on oath u/s. 131 of the Act of the Chief Technology Officer of the assessee company on various aspects of this issue. The Assessing Officer observed that the Research and Development activities involved four processes, namely; design cycle, prototype cycle, software cycle and product verification. According to the Assessing Officer, to the extent of the expenditure incurred in the design cycle on salaries to the engineering teams, basic raw materials and other expenses incurred on running the R D facility, it is expenditure on scientific research, but in later cycles, no scientific research is carried out. In effect, the Assessing Officer has categorized the process into two parts; one being the development of basic designs and the other being the development of the product and held that the process of product development does not involve scientific research. The Assessing Officer concluded that the said expenditure is not on scientific research but gives rise to patents, which are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on on the issue of the exception provided for in section 43(4)(ii) of the Act are different from those before the Bench of the Tribunal; (v) The Assessing Officer is right in treating the expenditure as incurred for acquisition of an intangible asset in the form of intellectual property rather than on scientific research, for deduction u/s.35(1)(iv) r.w.s. 43(4)(ii) of the Act; (vi) The fact that the process of R D and its attending expenditure resulted in vesting of an IPR in the hands of the assessee, quite clearly point to the acquisition of those rights. 5.4.1 Against this decision of the learned CIT (Appeals) both Revenue and the assessee are in appeal before us. Revenue is aggrieved against the decision to allow deduction of ₹ 10,25,89,563 by treating it as revenue expenditure and the assessee is aggrieved against the disallowance of the amount of ₹ 27,97,54,476 claimed as deduction under section 35(1)(iv) of the Act. 5.5 The learned Departmental Representative vehemently argued that the learned CIT (Appeals) had erred in relying on the decision of the co-ordinate bench of this Tribunal in the assessee's own case for Assessment Year 2002-03 (supr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AR, we are of the view that expenditure is allowable u/s.35(1)(iv), even if the same is to be held as capital. 5.6.2 The learned Authorised Representative of the assessee also submitted that the Hon'ble Karnataka High Court has confirmed the above decision of the co-ordinate bench of this Tribunal in its order dt.25.8.2014 in ITA No.813 of 2007 and pointed out that at paras 11 to 14 thereof the Hon'ble Court has held as under :- 11. In the light of the aforesaid facts and the rival contentions, it is clear that the assessee is in the business of developing and selling leading edge optical networking products for worldwide customers. It has developed software differentiated, next generation products that enable telecommunication carriers to build converged networks. The life span of this product is hardly a year. Because of competition in the market, the assessee has to come out with new features every year if they want to be in the field. Therefore, there is a constant upgradation of the original product. It is in that context substantial amount is spent towards employees cost and the upgradation also includes use of components purchased every year. In fact, those c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rapid strides in science and technology in the field should make us a little slow and circumspect into readily pigeon-holing on outlay such as this as capital .. The improvisation in the process and technology in some areas of the enterprise was supplemental to the existing business and there was no material to hold that it amounted to a new or fresh venture. The further circumstance that the agreement pertained to a product already in the line of the assessee's established business and not to a new product indicates that what was stipulated was an improvement in the operations of the existing business and its efficiency and profitability not removed from the area of the day-today business of the assessee's established enterprise. 14. We are of the view the aforesaid statement of law equally holds good in the area of telecommunication, may be with more force. Having regard to the facts of this case, the expenditure that is claimed is for upgrading the existing product. Therefore, the product so upgraded goes on changing as time progresses, keeping in mind the requirement and the competition in the market. The Tribunal rightly held that the expenditure is not in the natur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee's contentions, the learned Authorised Representative placed reliance on the following decisions :- i) CIT V Talisma Corporation Pvt. Ltd. in ITA No.515 of 2007 (Kar) dt.30.10.2013. ii) DCIT V TCIL Bell South Ltd. (2003) 130 Taxman 37 (Del) (ITAT). 5.7.1 We have heard the rival contentions and perused and carefully considered the material on record, including the judicial decisions cited. The primary issue for consideration / adjudication before us is the interpretation of the definition of scienitific research as per the provisions of section 43(4)(ii) of the Act; and particularly the exclusion to the definition given in clause (ii) to sub-section (4) of section 43 of the Act which states that scientific research expenditure excludes ...any expenditure incurred in the acquisition of rights in, or arising out of, scientific research. The stand of the Revenue seems to be that the expenditure incurred on in-house R D also needs to be excluded from the definition of scientific research if it leads to any intellectual property rights. Per contra, the stand of the assessee is that the expenditure incurred on in-house R D does not fall under the exclusion clause ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pellate Authority as well as the Tribunal have held. Accordingly, we answer the substantial questions of law in favour of the assessee and against the Revenue. 5.7.3 In the case of Talisma Corporation Pvt. Ltd. (supra) cited above, the tax payer had acquired Intellectual Property Rights (IPR) which were capitalised in the Books of Accounts. The tax payer spent further amounts in developing and improving the same. The expenditure incurred on improvement were also capitalised in the books of account. While the amount spent on acquiring the IPR were not allowed as deduction u/s. 35 of the Act, the expenditure incurred in-house for improvement of the same was allowed as deduction u/s.35 (1)(iv) of the Act, even though it was capitalised in the Books of Account. 5.7.4 Section 43(4) of the Act defines scientific Research for the purposes of the Act and the definition reads as follows :- 43 (4) (i) scientific research means any activities for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries; (ii) references to expenditure incurred on scientific research include all expenditure incurred for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h type of expenditure carried out by somebody else and such right is acquired by the assessee, that is sought to be disallowed. The objective behind the exclusion clause in section 43(4)(ii) of the Act appears to be that expenditure on scientific research should be on the research actually carried out by the assessee in-house and it should not merely spend money in acquiring rights in OR arising out of scientific research carried out by some other person. If the interpretation sought to be placed by revenue / authorities below is to be accepted, then the benefit sought to be conferred by the provisions of section 35(1)(iv) of the Act would be virtually denied in all cases by invoking the exclusion clause in section 43(4)(ii) of the Act. Such a consequence would never have been intended by the Legislature. As already stated, the object behind the provisions of section 35 of the Act is to encourage scientific research so that the benefit of such research would be available to all. In the given facts and circumstances of the case as discussed above, we are of the view that the claim of deduction under section 35(1)(iv) of the Act is to be allowed. In any event, there is no distinction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that while the decisions cited by the assessee relate to expenses covered by section 35(1)(iv) of the Act and their relation to unabsorbed depreciation, whereas in the assessee's case the entire expenses has been shown as revenue expenditure and claimed as deduction in the various years in question and therefore, claiming the benefit of capitalised expenditure u/s. 35(1)(iv) of the Act for the same years for the purposes of carry forward losses is not tenable. Therefore, the learned CIT(A) upheld the action of the Assessing Officer in denying the carry forward of the expenses. 6.3 The learned Authorised Representative of the assessee was heard in support of the grounds raised and reiterated the submissions made before the authorities below. It was also submitted that the Assessing Officer has not computed the 51% of share holding of the assessee company for the various years correctly. In this regard, the learned Authorised Representative submitted the details of the shareholding, which as per the counsel, show that the assessee has satisfied the condition of change in the shareholding being not more than 51% as stipulated under section 79 of the Act. It was also submitted t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lier years under consideration, as compared to the Assessment Year 2008-09. 6.5.3 As regards the first part / component of the issue, the assessee's contention that the unabsorbed scientific research expenditure is on par with unabsorbed depreciation is based on its reliance on the decision of the ITAT, Mumbai Bench in the case of Mahyco Vegetable Seeds Ltd. (supra). In that case, the expenditure in question was unabsorbed capital expenditure incurred on scientific research claimed as deduction under section 35(1)(iv) of the Act. The scientific research had been capitalised and it was held that the unabsorbed capital expenditure on scientific research has the same effect as unabsorbed depreciation. Therefore, for applying the above cited decision to the facts of the case, it is necessary that the scientific research expenditure should have been capitalised and deduction claimed under section 35(1)(iv) of the Act. If the expenditure has been claimed as revenue expenditure, as mentioned by the learned CIT(A), then the assessee cannot claim otherwise for the purposes of carry forward of the losses. If the assessee has treated the scientific research expenditure as revenue expen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the average value of the investment, as disallowance towards expenditure for earning exempt income as per clause (iii) of sub-Rule (2) of Rule 8D of the IT Rules, 1962. The Assessing Officer, however, made disallowance of further amount of ₹ 1,39,55,097 towards interest expenditure to be disallowed under Rule 8D, for the following reasons :- i) the assessee had adequate funds for carrying on the business without approaching the banks for loans. ii) the necessity to go for secured loans has arisen only on account of diversion of business funds to the investments; iii) the interest incurred can be indirectly attributed to investments and therefore the interest expenditure needs to be disallowed. 7.2 On appeal, the learned CIT(A) confirmed the decision of the Assessing Officer, holding that the assessee is unable to prove that all the interest payments are attributable to only the use of business funds. The learned CIT(A), however, held that discounting and factoring charges are in the nature of finance charges and therefore cannot be considered as part of interest for the purpose of computing the disallowance under section 14A of the Act and directed the Assessing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he file of the Assessing Officer to examine the issue in the light of the assessee's submissions and the guidance rendered in the judicial decisions cited (supra). 8.1Without prejudice to the above ground of appeal, the assessee had submitted that the Assessing Officer had erred in computing the disallowance of interest in that he had included finance charges like factoring and other charges, bill discounting charges, etc. as part of interest charges. It is the contention of the assessee that the computation made by the Assessing Officer is erroneous, since such finance charges cannot be included as interest for the purposes of Rule 8D of the IT Rules, 1962. 8.2 We have heard the rival contentions of both the learned Authorised Representative of the assessee and learned Departmental Representative for revenue and have perused and carefully considered the material on record. We find from the record that the learned CIT(A) has already directed the Assessing Officer to exclude these charges from the computation of interest and hence no adjudication is called for at this stage. 9. In the result, the assessee's appeal for Assessment Year 2008-09 is partly allowed an ..... X X X X Extracts X X X X X X X X Extracts X X X X
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