2011 (9) TMI 588 - AT - Income Tax

Deduction under 35E - Business of Prospecting Exploring and mining of Diamonds and also Consultancy - Total Expense 23,64,44,196 Suo motu disallowed 1,20,06,438 and expenditure of 5,39,57,120 deductible under 37(1) - Show cause why entire expenditure not to be capitalized under 35E - Consultancy income Rs. 98,42,810 - a reasonable ratio of 30% of the income can be allowed as deduction for earning the income of Rs. 98,42,810 - Held That - Survey Exploration expenses have been rightly capitalized. Assessee inter alia engaged in mining activities all expenses are to be treated as Eligible under 35E is an incorrect approach. The application of matching principle , based on the quantum of earnings, is wholly devoid of any merits. One cannot invoke the matching principle to restrict the deductibility of a part of expenses as a result of the expenses being too high in proportion to quantum of expenditure; it can at best be invoked to spread over the costs over entire period in which revenues as a result of those costs are generated. We are of the considered view that the Assessing Officer was indeed in error in capitalizing the expenses which were not directly attributable to the prospecting of diamonds as also in restricting the deductibility of expenses to 30% of the consultancy revenues received by the assessee. Decided in favour of assesee.

Summary

Issues Involved:
1. Disallowance of expenses related to prospecting activity.
2. Limitation of expenses allowed to 30% of consultancy income.

Detailed Analysis:

1. Disallowance of Expenses Related to Prospecting Activity:
The appellant challenged the correctness of the CIT(A)'s order which confirmed the Assessing Officer's (AO) action of disallowing expenses amounting to Rs. 5,10,04,277. The AO had determined that these expenses were related to prospecting activities and should be accumulated and claimed as deductions under Section 35E of the Income Tax Act, 1961, from the year in which commercial production begins. The appellant argued that out of the total expenses of Rs. 23,64,44,196, Rs. 5,39,57,120 were eligible for deduction under Section 37(1) as they were not wholly and exclusively for prospecting purposes. The AO, however, was not satisfied and held that any expenditure for prospecting eligible minerals must be capitalized under Section 35E. The Tribunal noted that Section 35E requires expenses to be incurred "wholly and exclusively on any operations relating to prospecting" and found that the appellant had correctly capitalized expenses directly related to prospecting activities. However, other expenses, such as salaries, professional fees not connected with exploration, and administrative charges, were rightly claimed under Section 37(1). The Tribunal concluded that the AO's approach was incorrect and directed the deletion of the impugned disallowance.

2. Limitation of Expenses Allowed to 30% of Consultancy Income:
The appellant also contested the CIT(A)'s confirmation of the AO's decision to allow only 30% of the expenses against consultancy income of Rs. 98,42,810, disallowing the balance. The AO had reasoned that the expenses of Rs. 5,39,57,120 were disproportionate to the consultancy income and allowed only 30% as a reasonable deduction. The Tribunal found this approach devoid of merit, stating that the matching principle cannot restrict the quantum of deduction based on the proportion of expenses to income. The Tribunal emphasized that as long as the expenses are incurred for business purposes, they should be allowed even if they result in a loss. The Tribunal noted that the appellant had commenced its business, evidenced by consultancy income, and therefore, the deduction of expenses could not be declined based on the mismatch between income and expenses. The Tribunal directed the AO to delete the restriction on the admissibility of deduction based on consultancy income.

Conclusion:
The Tribunal allowed the appeal, directing the AO to delete the disallowance of expenses related to prospecting activities and not to restrict the deduction of expenses based on the quantum of consultancy income. The judgment emphasized the correct application of Section 35E and the matching principle in the context of business expenses.