2015 (3) TMI 233 - AT - Income Tax

Disallowance of R&D expenses - Capital expenditure or Revenue Expenditure - Held that - Assessee is a company in existence for last more than twenty years doing the same business. During the year under consideration it incurred the expenditure on R & D for developing prototypes of the products to be supplied to specific customers strictly as per the specifications and samples given by them. It is further a matter of record that if the prototype so developed does not conform to the samples supplied by the customer, no orders can be expected, in which case the expenditure so incurred on developing the prototypes constitutes a sheer loss. It is still further relevant to note that the manufacturing of products from such developed prototypes was meant only to the customers who had given sample and the products so manufactured could not be sold to anyone else. These facts clearly indicate that it is not the case that the assessee set up its business for the first time on the basis of prototypes developed by spending on R&D during the year in question. It is in the same business for more than two decades. The expenses incurred by the assessee during the year under consideration were only to conform to the specifications of customers so as to get the supply orders in the regular course of business. Further such prototypes were of limited use meant only for manufacturing the products for a specific customer. All the four items, namely - Custom duty/expenses on importing of free samples; Consultancy charges; Cost of material used for in-house development transferred from Raw material cost; and Cost of direct labour transferred from labour cost - are in the nature of revenue expenses. No shred of such expenses can be construed as capital expenditure. The fact that the assessee incurred total R&D expenses as above has not been disputed by the AO. Rather, the undisputed nature of such expenses has been reproduced in the assessment order. The above discussion shows that the assessee incurred R&D expenses in relation to its business and these were of the revenue nature. Going by the mandate of section 35(1)(i), such amount is eligible for deduction - Decided against Revenue.

Summary

Issues:
Deletion of addition of R&D expenses treated as capital nature.

Analysis:
The appeal by the Revenue concerned the deletion of an addition of Rs. 14,10,032/- made by the AO, treating R&D expenses as of capital nature. The assessee, engaged in manufacturing musical instruments, claimed deduction for R&D expenses related to developing prototypes for specific customers. The AO disallowed the amount, considering it capital expenditure, as no orders were received during the period for the prototypes developed. However, the CIT(A) ordered the deletion of the addition.

The Tribunal noted that the assessee, in existence for over twenty years, incurred R&D expenses during the year to develop prototypes strictly as per customer specifications. If the prototypes did not match the samples, no orders could be expected, resulting in a loss. The prototypes were solely for specific customers, indicating the expenditure was to conform to customer specifications for regular business orders, not for setting up a new business. Section 35 allows deduction for R&D expenses not of capital nature, related to business, as revenue expenditure.

Upon examining the breakdown of R&D expenses, the Tribunal found all items - custom duty, consultancy charges, material cost, and direct labor cost - to be revenue expenses, not capital. The nature of these expenses was undisputed, and they were clearly related to the business as revenue expenditures. Therefore, the Tribunal upheld the CIT(A)'s decision, stating that the R&D expenses were eligible for deduction under section 35(1)(i).

In conclusion, the Tribunal dismissed the appeal, affirming that the R&D expenses incurred by the assessee were revenue in nature, related to the business, and thus eligible for deduction under section 35(1)(i).