2012 (5) TMI 449 - HC - Income Tax

Pre-operative expenses - revenue or cpaital expenditure - Non deduction of TDS - testing charges paid to the US Company - Disallowance u/s 40(a)(i) - fee for technical services under Section 9(1)(vii)(b) - held that - the fees for technical services are taxable in the hands of the US Company under the provisions of the Act. The question to be considered then would be whether there is anything in the agreement for avoidance of double taxation between India and USA which would exempt or reduce the burden of taxation in respect of the fees for technical services received by the US Company. This aspect of the matter has not been examined by the Tribunal, though raised before it by the assessee, since there was no occasion for the Tribunal to do so on account of the view it took regarding the taxability of the fees for technical services under the Act. It is axiomatic that if the receipt is not taxable under the Act, then there is no need to examine whether it would fall under any of the provisions of the agreement for avoidance of double taxation. - Decided against revenue. Pre operative expenses - held that - The fact that in the books of account the assessee had capitalised the expenses does not prevent the assessee from claiming them as revenue expenses since the question of allowance of expenses has to be considered in the light of the legal position and the accounting treatment cannot be conclusive. - Decided in favor of assessee and against the revenue. Expenditure relating to fully convertible debentures - whether related to issue or shares or merely related to issue of debenture - held that - It is well settled that expenditure incurred in connection with the issue of debentures or obtaining loan is revenue expenditure. - The question before us however, is whether it is a debenture issue or an issue of share capital involving the strengthening of the capital base of the company. Though it prima facie appears that there are sufficient facts to indicate that what was contemplated was an issue of shares to the Mauritius Company under the Investor Agreement which would result in strengthening of the assessee s capital base, having regard to the judgments cited on behalf of the assessee India Cements Ltd. v. CIT 1965 (12) TMI 22 (SC) , in which it has been held that despite indications to the effect that the debentures are to be converted in the near future into equity shares, the expenditure incurred should be allowed as revenue expenditure on the basis of the factual position obtaining at the time of the debenture issue - Decided in favor of assessee.

Issues Involved:

1. Applicability of Section 40(a)(ia) of the Income-tax Act, 1961 to testing fee paid to a US company.
2. Allowability of pre-operative expenses as revenue expenditure.
3. Classification of expenditure on fully convertible debenture issue as revenue or capital expenditure.

Issue-wise Detailed Analysis:

1. Applicability of Section 40(a)(ia) of the Income-tax Act, 1961 to testing fee paid to a US company:

The assessee paid Rs. 14,71,095/- to M/s. CSA International, Chicago for testing services without deducting tax at source under Section 195 of the Act. The Assessing Officer (AO) disallowed the payment under Section 40(a)(ia), asserting that the payment constituted fees for technical services under Section 9(1)(vii) of the Act and the Indo-US Double Taxation Avoidance Agreement (DTAA). The CIT (Appeals) upheld the AO's decision. The Tribunal, however, held that the services were utilized for export purposes and not for business activities in India, thus falling under the exception in Section 9(1)(vii)(b) of the Act, and deleted the disallowance.

Upon appeal, the High Court disagreed with the Tribunal, stating that the source of income from export sales was located in India, not outside. The Court emphasized that the source of income and the receipt of monies are distinct, and the source of income should be outside India to fall under the exception. The High Court restored the issue to the Tribunal to examine the applicability of the Indo-US DTAA and the consequent applicability of Section 40(a)(ia).

2. Allowability of pre-operative expenses as revenue expenditure:

The assessee incurred Rs. 2,31,253/- as pre-operative expenses for a project at Haridwar. The AO treated these expenses as capital expenditure, arguing that the new unit was independent of the existing business. The CIT (Appeals) upheld this view. The Tribunal, however, found interlacing and intermingling of funds and common management between the existing and new units, thus treating the expenses as revenue in nature.

The High Court agreed with the Tribunal, noting the factual findings of interconnection and interdependence among the units. The Court referenced the test of interlacing and interdependence from the House of Lords case of Scales v. George Thompson & Co. Ltd., concluding that the expenses were for the expansion of an existing business and thus revenue in nature.

3. Classification of expenditure on fully convertible debenture issue as revenue or capital expenditure:

The assessee issued fully convertible debentures and incurred Rs. 92,67,841/- as related expenses. The AO disallowed the expenditure as capital in nature, citing the conversion of debentures into equity shares. The CIT (Appeals) and the Tribunal allowed the expenditure as revenue, referencing the Rajasthan High Court's decision in CIT v. Secure Meters Ltd. and other judgments, which held that the nature of the expenditure should be determined at the time of debenture issuance, not future conversion.

The High Court upheld the Tribunal's decision, noting the predominant judicial view that expenditure on debenture issues is revenue in nature, even if the debentures are later converted into shares. The Court referenced several judgments supporting this view and concluded that the expenditure was revenue in nature.

Conclusion:

The appeals filed by the Revenue were disposed of with no order as to costs. The High Court ruled in favor of the Revenue on the first issue, restoring it to the Tribunal for further examination, and in favor of the assessee on the second and third issues, affirming the Tribunal's decisions.

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