2013 (8) TMI 298 - AT - Income Tax

Deduction u/s 80IB - Small scale industry - Held that - There is no condition that new definition of small scale industry is applicable to the new units only - Amount of investment has to be seen as on the last date of previous year - last date of the preceding year is 31.3.2007 and the new limit of Rs. 5.00 crore was applicable from 2.10.2006. Therefore, as on 31.3.2007 the assessee was clearly covered by the new definition - Decided against Revenue. Capital expenditure - Disallowance of Expenditure on machines - Spare part or machine itself - Held that - Certificate from professional state that TUP is a wearable and Breakable part and it require replacement is case of excess wear and breakage. It has got no link in the increase of capacity of Drop Hammer - Assessing Officer s conclusion is not based upon any specialized knowledge of the production process or any thing to suggest that he spare parts were actually a machine by itself - No other material has been brought to show by the revenue that the TUP is not a spare part - Decided against Revenue. Disallowance of interest - Interest paid at higher rate to person u/s 40A(2)(b) - CIT deleted addition - Held that - funds borrowed from bank and financial institutions are subject to number of restrictions and are more than secure whereas money borrowed from the relatives was unsecured and generally interest rate is more in case of unsecured loans - Decided against Revenue. Disallowance of expenses u/s 14A - Held that - the disallowance u/s 14A is based on Rule 8D which has been noted was applicable during the year under consideration and which is in consonance with the decision of Hon ble Bombay High Court. - Decided in favor of revenue. Disallowance of interest on advances given for capital assets - Held that - after 1.4.2004 if the interest expenditure has been incurred for the purpose of acquisition of capital asset then the same is not allowable. Since the advances have been made admittedly for the purpose of acquisition of capital asset i.e. land, building etc. interest incurred for acquisition of such asset is not allowable. - Decided in favor of revenue.

Issues Involved:
1. Deduction under Section 80IB for Small Scale Industrial (SSI) unit status.
2. Treatment of expenditure on machinery as capital or revenue expenditure.
3. Disallowance of interest paid to specified persons under Section 40A(2)(b).
4. Disallowance under Section 14A read with Rule 8D for expenses incurred on exempt income.
5. Disallowance of interest under Section 36(1)(iii) for advances given for capital expenses.

Detailed Analysis:

1. Deduction under Section 80IB for Small Scale Industrial (SSI) unit status:
The Revenue challenged the deduction allowed under Section 80IB, arguing that the assessee's unit lost its SSI status due to exceeding the investment limit of Rs. 1 crore in plant and machinery during the assessment year 2006-07. The Assessing Officer (AO) contended that the new limit of Rs. 5 crore, effective from October 2006, applied only to new units. The assessee argued that the definition of SSI, as per Section 80IB(14)(g), should be considered as on the last day of the previous year, and since the unit met the criteria on 31.03.2007, the deduction was valid. The CIT(A) agreed with the assessee, stating that the unit's status as SSI on the last day of the previous year entitled it to the deduction. The Tribunal upheld the CIT(A)'s decision, noting that the investment limit should be assessed as of the last day of the previous year, and the assessee met the criteria.

2. Treatment of expenditure on machinery as capital or revenue expenditure:
The AO disallowed Rs. 3,44,772 claimed by the assessee as repairs and maintenance, treating it as capital expenditure. The assessee argued that the expenditure was for maintaining existing machinery and involved spare parts without a separate identity. The CIT(A) accepted the assessee's argument, supported by a certificate from the machinery manufacturer, and allowed the expenditure as revenue expenditure. The Tribunal upheld the CIT(A)'s decision, finding no evidence to contradict the claim that the expenditure was for spare parts.

3. Disallowance of interest paid to specified persons under Section 40A(2)(b):
The AO disallowed interest paid at 15% to relatives of the assessee, arguing that the interest rate exceeded the 12% paid to financial institutions. The assessee contended that unsecured loans from relatives justified a higher interest rate and that such payments had been accepted in previous assessments. The CIT(A) agreed, noting that unsecured loans typically attract higher interest rates due to the risk involved. The Tribunal upheld the CIT(A)'s decision, finding the interest rate reasonable and justified.

4. Disallowance under Section 14A read with Rule 8D for expenses incurred on exempt income:
The AO disallowed Rs. 5,38,360 under Section 14A, applying Rule 8D, for expenses related to investments in mutual funds and equity funds. The CIT(A) deleted the disallowance, stating that the AO failed to establish a direct connection between the interest paid and the exempt income. However, the Tribunal reversed the CIT(A)'s decision, citing the applicability of Rule 8D for the assessment year 2008-09 and the need to apportion expenses between taxable and exempt income.

5. Disallowance of interest under Section 36(1)(iii) for advances given for capital expenses:
The AO disallowed interest on advances given for capital expenses, citing the proviso to Section 36(1)(iii) effective from 01.04.2004, which disallows interest on borrowings for the acquisition of capital assets until the asset is put to use. The CIT(A) deleted the disallowance, but the Tribunal reinstated it, emphasizing that the amended Section 36(1)(iii) prohibits such interest deductions for capital asset acquisition.

Conclusion:
The Tribunal upheld the CIT(A)'s decisions on the issues of SSI status under Section 80IB and the treatment of machinery expenditure as revenue expenditure. It also confirmed the CIT(A)'s decision on the reasonableness of interest paid to specified persons. However, it reversed the CIT(A)'s decisions on disallowances under Section 14A read with Rule 8D and Section 36(1)(iii), reinstating the AO's disallowances. The Revenue's appeals were dismissed in part and allowed in part.

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