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2018 (8) TMI 675

pment Expenditure (RCS)) - Indirect Expenditure - Overhead expenditure - sale was made of trial/demo machines and the rent was received when the project was in the development stage - assessee is engaged in the development of Machine 2 Machine (M2M) and Register Control System (RCS) and whatever expenses incurred were debited to Capital Work-in-progress including the Project Development Expenses. - Held that:- Revenue has not doubted the development of products by the assessee and allowed capitalization of expenses but at the same time the Revenue has chosen to treat the sale of demo machines to the tune of ₹ 59, 20, 849/- and recovery of rent amounting to ₹ 64, 200 as revenue receipt and added the same to the income of the assessee after allowing the expenses of ₹ 14, 75, 553/-. The case of the assessee also finds support from the Guidance Notes issued by the Institute of Chartered Accountants of India on treatment of expenditure during construction period, which provides that if any revenue is realized during the trial run or product development stage, the same should be set off against the expenditure incurred in connection with the said project/products. - .....

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to Capital Work in Progress, ought to be allowed as deduction in taxing the receipt on sale of 3 Alygn Machines as revenue receipt. 3. Without further prejudice to Ground 1 above, the Learned CIT(A) has erred in confirming the action of the AO in adopting the cost of purchase 3 Alygn machines sold at ₹ 7, 22, 853/- as against ₹ 16, 12, 630/- being actual cost of purchase incurred by the appellant. On facts and circumstances of the case, the purchase cost ought to be taken at ₹ 16, 12, 630/- and not ₹ 7, 22, 853/- adopted by the AO. 4. Ld. CIT(A) has erred in confirming the disallowance of expenses of ₹ 51, 15, 880/- made by the AO by treating these expenses as relatable to Capital Work in Progress (CWIP) and thus, capitalising the same to CWIP. On the facts and circumstances of the case and in law, the said expenses ought to be allowed as revenue expenditure. 3. The issue raised in ground no.1 is against the confirmation of the action of the Assessing Officer in holding the receipt on sale of 3 Alygn Machines for ₹ 59, 20, 849/- and rent of ₹ 64, 200/- as revenue in nature and liable to taxed. According to the assessee the same were capital .....

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enses of ₹ 14, 75, 553/- made net addition of ₹ 45, 09, 496/-. 4. In the appellate proceedings, the CIT(A) also confirmed the addition made by the Assessing Officer by observing as under: 5. I have considered the facts of the case and submissions of the assessee. Product development is a continuous process of the assessee and it keeps on going, whereas, A.O. has rightly observed that the machine sold must have been either complete and required no further development or they must have been at a stage which could be commercially or industrially used by the buyer and, therefore, sale of the machine should be treated as income of the assessee and need not be reduced from cost of the products. The claim of the assessee that it has given a different treatment in the books of account will have no impact on the taxability of any such receipt because assessee can give any treatment as it likes or as may be recommended by accounting bodies but for income-tax purposes it is not necessary that the same view is followed. The sale consideration is clearly taxable. The case law cited by the assessee have already been dealt by the A.O. and I fully agree with the A.O. on this issue that .....

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e the quality of the product and enhance the product reliability. The learned AR argued that the sale of 3 Alygn machines to three parties viz. M/s. Raja Biscuits, M/s. Cole and M/s. Esdee during the year, were in fact trial/demo machines, which were part of product development process of the assessee and, thus, were sold so that further improvement could be made on these machines and the product which is finally developed as finished product is of high standard so that assessee could establish its name in the market. The learned AR submitted that even a slight defect or malfunctioning of the machine could lead to product failure, which may cause huge damage to the reputation of the assessee and entail huge financial loss. The learned AR also brought to the notice of the Bench the classification of the said expenses as Capital Work-in-progress including Product Development Expenses shown under the head Fixed Assets and the amount during the year was ₹ 5, 67, 66, 727/- viz-a-viz ₹ 2, 09, 38, 494/- in the corresponding previous year. While referring to page 257 of the paper-book, the learned counsel submitted that the said fact was duly disclosed by the assessee by way of .....

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nditure incurred on product development, which was in progress during the year. While relying on the decisions of the Tribunal in the case of International Seaports (Haldia) Pvt. Ltd. in ITA No. 1194/Kol/2010 for A.Y. 2004-05 and Gujarat State Fertilizers & Chemicals Ltd. in ITA No. 3228 & 3358/Ahd/2003 for A.Y 1999-2000, the learned AR pleaded that the order of the CIT(A) may be set aside and the Assessing Officer be directed to reduce the amount of sale of Alygn machines from the three parties as also the rental receipts from the Project Develop Expenses account as has been claimed by the assessee. 6. The learned DR, on the other hand, heavily relied on the orders of the authorities below and submitted that the sale of three machines to three different parties represented regular sales and not sale of trial/demo products during the Product Development as the assessee has fully developed the machines and the same were altered and tuned to the requirements of the respective buyers. The learned DR also distinguished the decisions relied upon by the learned AR by submitted that the facts of these cases are different and, therefore, the same are not applicable to the case of t .....

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ble on record. The ld. AR submitted the paper book which is running from pages 1 to 113 and highlighted that to make the berth ready for commercial operations the assessee was to undertake the responsibility of completing the work in accordance to the agreement of building the berth 4A. As per the agreement trial run was the precondition before the start of the commercial operation. The assessee treated the trial run of vessels as preoperative handling of the plant and income generated from such preoperative handling has been treated as preoperative income . In the books of account of the assessee for the previous year relevant to the assessment year under dispute, such preoperative income has been set off against the preoperative expenses of ₹ 3, 17, 02, 632/-, which consisted of berth hire charges in the sum of ₹ 16, 84, 562/- and ₹ 3, 00, 18, 070/- being cargo handling charges and the balance amount was capitalized to be apportioned to fixed asset. The specious finding of the AO that loading and unloading of cargo during the period from 07.12.2003 to 13.01.2004 on trial basis was commercial activity of the assessee and the receipts earned there from was assesse .....

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plant and machinery. Thus, the interest was a capital receipt which would go to reduce the cost of the asset and Ld AR relied on the decision of Hon ble Supreme Court in the case of CIT v. Karnal Co-operative Sugar Mills Ltd. (2000) 243 ITR 2 (SC) and C.I.T. Vs. Bokaro Steel Limited.(1999) 236 ITR 315 (SC) 9. From the aforesaid discussion, we find that the assessee has made some income during the period of trial run and the same was adjusted against the pre-operative expenses. The AO rejected the working of assessee and held that the income generated during the trial run income period cannot be adjusted against the preoperative expenses and the same was confirmed by the Ld. CIT(A). However, we observe that it was the condition in the agreement that the trial run has to be carried out before the beginning of commercial operation. The ld. AR drew our attention on pages 17, 18, 19, 20, 21 of the Paper Book where the requirement for the trial run was requested before the beginning of actual operation. The purpose of the trial run was to check whether there is any flaw in the system or not so that remedial action can be taken well in time in the event of any flaw in the system. So it i .....

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l production started, i.e. in the assessment year 1999- 2000 and, therefore, would be extendable up to the assessment year 2003-04. On appeal : Held, that the initial assessment year, for the purpose of section 80-IA, was the assessment year relevant to the previous year in which the industrial undertaking begins to manufacture or produce articles or things . The trial production began on March 20, 1998, as per the details given in the audit report furnished by the assessee along with its returns of income for the assessment years 2003-04 and 2004-05. There was no dispute that the first sale was made on April 23, 1998, which would be the period relevant to the assessment year 1999-2000. Merely because some closing stock was shown as on March 31, 1998, that would not lead to the conclusion that there was commercial production as well. Even for the purpose of trial production material would be needed and there would be production which would result in stock of finished goods. The evidence produced by the assessee was accepted by the tribunal as well, from which it was clear that there was only a trial production in the assessment year 1998-99 and commercial and full-fledged productio .....

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of the section presupposes that profits are capable of being earned. Hence, until an assessee reaches a stage where it is in a position to decide that a final product which can be ultimately sold in the market can be manufactured it cannot be said to have started manufacture of the articles. If it becomes necessary for an assessee to produce a trial product at an earlier stage to verify whether it can be used ultimately in the manufacture of the final article, the commencement of operation for the manufacture of the trial product would not constitute commencement of manufacture of articles for the purposes of section 15C. The assessee-company undertook a project for the manufacture of penicillin. It started actual operations for the manufacture of crude penicillin in December 1954. The first samples of crude penicillin were required to be sent to U.S.A. and U.K. for obtaining certificates as to their qualities. The certificates were obtained in June, 1955, and the assessee started regular production of sterile penicillin, the only product that could be sold in the market, in August, 1955. On the question when the manufacture of sterile penicillin had started and whether the assesse .....

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from capital work-in-progress. Hon'ble Apex Court in the case of Bokaro Steel Vs. CIT, 236 ITR 315 held that if the assessee receives any amount which are inextricably linked with the process of setting up its plant and machinery, such receipts would go to reduce the costs of assets and would be receipt of a capital nature, which cannot be taxed. In the case under consideration, undisputedly and as found by the Id. CIT(A), the plant is under testing for its efficiency prior to commencement of commercial production and the inputs and outputs have already been netted by GSFC and the net result has been capitalized. Considering the facts and circumstances of the case and the guidelines of the ICAI, we are in agreement with the Id. CIT(A) that any attempt to tax the production, which is already accounted for as input for the fertilizer plant and the captive inputs of other units utilized in Ammonia IV Plant, if not allowed to be set off against the production of the plant, would lead to a distorted picture of the accounts of M/s. GSFC. In these circumstances, especially when Revenue have not placed before us any material contrary to the aforesaid findings of the Ld. CIT(A) in so fa .....

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ee replied to the show cause notice, which did not find favour with the Assessing Officer and he worked out the disallowance of ₹ 51, 15, 880/- and added it to the total income of the assessee, the details thereof is given in para 6.3 of the assessment order. 11. In the appellate proceedings, the learned CIT(A) affirmed the assessment order by observing and holding as under: I have considered the facts of the case and submissions of the assessee. If common expenses have been apportioned by the assessee itself in the ratio of 9:1 between product development expenses and the income received during the year then logically the other expenses should have also been incurred in the same ratio and, therefore, I agree with the A.O. Hence, this ground of appeal is rejected. 12. Before us, the learned AR vehemently submitted that the facts of the case were totally misconstrued by the ld CIT(A) by approving the disallowance. He drew our attention to the written submissions filed before the CIT(A), which contain a very comprehensive explanation as regards allocation of expenses to the Profit & loss account and Project Development Expenses. The learned counsel submitted that on each it .....

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