2013 (11) TMI 1336 - AT - Income Tax

Validity of action of CIT u/s 263 of the Income Tax Act Assessee was engaged in the business of production of films had shown two films i.e. welcome and Full N Final as being under production during the year and the one film i.e. Phir Hera Pheri had been released during the year - Examination the letter of intent of IDBI bank makes it clear that bank had advanced foreign currency loan specifically for the purpose of meeting the part of the cost of production of these two films and the loans were secured as first charge on the negatives of the proposed films and there were also some conditions prescribed which included a separate laboratory agreement for film processing with undertaking that no print of the film could be released to any firm or company unless authorized by the bank in writing and physical progress of production was to be intimated to the bank from time to time and work had to be carried out in accordance with the time schedule prescribed in the agreement Held that - Foreign currency loan had been taken specifically for the production of two films and could not be utilized for any other project - Order passed by AO was erroneous and prejudicial to the interest of revenue as he accepted the explanation of assessee that the loans were of general purpose loans without any examination and application of mind - The interest on borrowings which had been specifically taken for the production of two films has to be considered as part of cost of production in view of definition of cost of production given in the Explanation to Rule 9A. Therefore allowing the interest as deduction even though the films were not released during the year was erroneous and prejudicial to the interest of revenue CIT has correctly applied section 263 of Income Tax Act Decided against the Assessee. Mandatory application of Rule 9A Held that - Rule 9A is the rule framed by the board for computation of income from exhibition of feature films - Such rules framed by the board are binding on the authorities below and therefore it could not be said that such rules are not to be followed mandatorily As per Hon ble Supreme Court in case of Joseph Valakuzhy 2008 (5) TMI 3 - Supreme court , it has been held that such rules framed by the board are binding on the authorities below and therefore it could not be said that such rules are not to be followed mandatorily.

Summary

Issues Involved:
1. Allowability of interest deduction on loans taken for film production.
2. Applicability of Rule 9A for computation of income from film production.
3. Determination of whether the assessment order was erroneous and prejudicial to the interest of revenue.
4. Examination of whether the film is considered a capital asset or stock in trade.

Detailed Analysis:

1. Allowability of Interest Deduction on Loans Taken for Film Production:
The assessee, engaged in film production, claimed interest deductions on loans taken for producing two films, "Welcome" and "Full-N-Final," which were under production during the assessment year. The CIT noted that these loans were specifically for film production and secured against the films' negatives. The CIT concluded that the interest should be part of the cost of production and not allowable as a deduction since the films were not released during the year. The assessee argued that the interest was allowable under Section 36(1)(III) and cited various judgments to support that film production is a manufacturing activity, thus making the interest deductible. However, the tribunal upheld the CIT's view, stating that the interest on loans specifically taken for film production should be considered part of the cost of production as per Rule 9A.

2. Applicability of Rule 9A for Computation of Income from Film Production:
Rule 9A governs the computation of income from film production, mandating that the cost of production be amortized and allowed as a deduction according to specific provisions. The CIT held that the interest on loans for film production should be included in the cost of production and carried forward to the next year if the films were not released. The assessee contended that Rule 9A was not mandatory and that the AO's decision to allow the interest deduction was one of the possible views. The tribunal, however, found Rule 9A to be mandatory, supported by the Supreme Court's judgment in Joseph Valakuzhy, which upheld the rule's constitutional validity. The tribunal concluded that the AO's failure to apply Rule 9A constituted an incorrect application of law, making the assessment order erroneous and prejudicial to the revenue's interest.

3. Determination of Whether the Assessment Order Was Erroneous and Prejudicial to the Interest of Revenue:
The CIT invoked Section 263, arguing that the AO's order was erroneous and prejudicial to the revenue's interest because it allowed interest deductions based on incorrect facts and without proper examination. The tribunal agreed, noting that the AO accepted the assessee's explanation without verifying the specific use of the loans for film production. The tribunal emphasized that an order based on incorrect assumptions or without proper enquiry is erroneous and prejudicial to the revenue. The tribunal upheld the CIT's decision to set aside the assessment order and direct the AO to reassess the interest as part of the cost of production under Rule 9A.

4. Examination of Whether the Film Is Considered a Capital Asset or Stock in Trade:
The CIT referred to the Bombay High Court's judgment in Sadichha Chitra, which held that a film is a capital asset for the producer. The assessee countered with the Bombay High Court's judgment in Mukta Arts, arguing that a film in production is stock in trade. The tribunal noted that the High Court in Mukta Arts did not address whether a film is a capital asset or stock in trade and that the earlier judgment in Sadichha Chitra was not considered. The tribunal concluded that the interest on loans for film production should be treated as part of the cost of production under Rule 9A, regardless of whether the film is a capital asset or stock in trade.

Conclusion:
The tribunal upheld the CIT's order, confirming that the AO's assessment was erroneous and prejudicial to the revenue's interest. The tribunal emphasized the mandatory application of Rule 9A for computing income from film production and directed that the interest on loans specifically taken for film production be included in the cost of production and carried forward if the films were not released during the assessment year. The appeal by the assessee was dismissed.