2014 (6) TMI 942 - AT - Income Tax

Deduction in respect of R&D expenses - revenue v/s capital expenditure - Held that - It is admitted that AO in this case has not verified the allowability of the expenditure. He has specifically asked the Ld. CIT(A) that the same will be done if directed by him. It is not a case that the Ld. CIT(A) has himself examined the nature of these expenses and examined the allowability of these expenses as to whether the same were incurred wholly or exclusively for the purpose of business. As a matter of fact that Ld. CIT(A) has not even mentioned about the quantum of R&D expenses in his appellate order. There is no mention about the examination about nature of expenses. In these circumstances, in our considered opinion, interest of justice will be served if the matter is remitted to the file of the AO. The AO is directed to examine the issue of allowabilty of R&D expenses, after giving the assessee proper opportunity of being heard.

Summary

Issues:
- Allowance of deduction for Research and Development (R&D) expenses
- Proper reasoning and opportunity provided by Assessing Officer (AO)

Analysis:

Issue 1: Allowance of deduction for Research and Development (R&D) expenses
The case involved a company engaged in supplying telecom hardware to customers in India. The Assessing Officer (AO) attributed 100% of the business profits from these supplies to the company's Permanent Establishment (PE) in India. The company appealed against this, and the CIT(A) upheld the existence of the PE but attributed only 50% of profits to it. The CIT(A) directed the AO to allow deduction for all expenses incurred inside and outside India related to the PE. The AO allowed deduction for selling and administrative expenses but did not allow deduction for R&D expenses. The company appealed this decision, arguing that R&D expenses were necessary for innovation and product development. The CIT(A) found that the AO did not provide any reason for disallowing R&D expenses and ordered the AO to allow them on a proportionate basis. The Revenue appealed this decision.

Issue 2: Proper reasoning and opportunity provided by Assessing Officer (AO)
The Revenue contended that the AO did not provide proper reasoning for disallowing R&D expenses and did not give the company an opportunity to explain the purpose of these expenses during assessment proceedings. The CIT(A) noted that the AO's order lacked reasoning and directed the AO to allow R&D expenses, emphasizing the necessity of these expenses for the company's business. However, the ITAT found that the AO had not verified the allowability of R&D expenses and had not examined whether they were incurred wholly and exclusively for business purposes. The ITAT remitted the matter back to the AO for proper examination and determination of the allowability of R&D expenses after providing the company with a fair opportunity to be heard.

In conclusion, the ITAT allowed the Revenue's appeal for statistical purposes, emphasizing the importance of proper examination and reasoning by the AO regarding the allowability of expenses, particularly R&D expenses, in relation to the company's PE in India.