2016 (4) TMI 1406 - AT - Income Tax

Expenditure relatable to R D grants - nature of expenditure - revenue or capital expenditure - contention of the assessee was that its expenditure relatable to the grant received was incurred for design and development of weaponary for aircraft combat aircrafts avionics for combat aircrafts development of light utility helicopter and for developing a fifth generation fighter aircraft to replace the aging jaguar and MIG 29 - alternate pleading of the assessee that it had to have been allowed deduction under Section 35(1)(iv) - HELD THAT - As admitted by the assessee that expenditure incurred out of the grants received from the government would result in acquisition by the assessee of a capital asset in the form of indigenous and self-reliant technology for the manufacture of LCH / LCA which were required for the defence of the country. Conditions of the Grant required the assessee to utilise it for the R D of the LCA and LCH and related technology. Thus the expenditure incurred by the assessee using such grant which were debited to its profit and loss account were such that it would result in acquisition of a capital asset in the nature of indigenous self-reliant technology for manufacture of combat aircrafts and helicopter. As noted by the lower authorities such expenditure would be a part of the capital workin- progress and could not have been claimed by the assessee as revenue outgo. Before the AO assessee itself has stated that once the LCA was developed and certified it would be commercially produced and at that time revenue would be offered to tax. Thus there is an indirect admission by the assessee that expenditure incurred out of the grant resulted in acquisition of a capital asset. Once it is considered so in our opinion assessee could not claim such expenditure as revenue out go. Eligibility for deduction u/s.35(1)(iv) - Assessee having claimed the expenditure as part of revenue outgo through its P L account when the AO found that such claim was not allowable considering it to be a capital out go in our opinion he ought have allowed a deduction as mandated u/s.35(1) of the Act. Section says assessee which satisfies the conditions set out therein shall be allowed and there is no condition therein which disentitles an assessee from getting this benefit for want of a specific claim. Nevertheless we find that CIT (A) has given a finding that assessee was not doing any scientific research but only R D. We are unable to appreciate this finding of the CIT (A). Development of avionics for modern LC air-craft and helicopter radar systems for fighter aircrafts requires considerable scientific research and cannot be considered as mere R D expenditure. As question as to what could be the amount of scientific research expenditure on which assessee is eligible for claim of deduction u/s.35(1) of the Act require verification since it need not be equal to the grant amount received by the assessee. It could be either more or less. This aspect in our opinion requires a fresh look by the lower authorities. Thus though assessee s claim that expenditure against government grant were wholly allowable as Revenue outgo is incorrect it cannot be denied deduction available to it under section 35(1)(iv) of the Act if it can show that other conditions set out therein are satisfied. Thus we uphold the order of the lower authorities in so far as disallowance of expenditure is considered. However vis-a-vis claim of the assessee it ought have been given deduction u/s.35(1)(iv) of the Act to the extent it was eligible we set aside the orders of the lower authorities and remit it back to the file of AO for consideration afresh in accordance with law. Ground 2 of the assessee is dismissed whereas ground 3 is allowed for statistical purpose Disallowance u/s 14A r.w.r. 8D - HELD THAT - For the assessee to say that no expenditure was incurred even when it was holding substantial investments was prima facie incorrect. What we note is that AO had made disallowance under Rule 8D(2)(iii) of the IT Rules only for indirect expenditure. Argument of the assessee that the investments were for strategic purpose has not been substantiated and even if true it cannot be disputed that it had earned substantial dividend during the relevant year. We are alive to the judgment of the Hon ble Delhi High Court in the case of Maxopp Investments Ltd 2011 (11) TMI 267 - DELHI HIGH COURT where it was held that AO necessarily had to express his dissatisfaction on the inadequacy of the expenditure disallowed suo motu by the assessee before invoking Section 14A of the Act. However this judgment cannot be stretched to include in its fold cases where no expenditure was claimed to have been incurred despite substantial holdings in investment despite substantial change in investments and despite earning of substantial dividend income. We are therefore of the opinion that disallowance of 0.5% the average investments made under Rule 8D(2)(iii) of the Rules was justified.

Summary

Issues Involved:
1. Treatment of grants received from the government for R&D as capital receipts.
2. Whether the related expenditure should be considered as capital expenditure or revenue expenditure.
3. Eligibility for deduction under Section 35(1)(iv) of the Income Tax Act.
4. Disallowance under Section 14A of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Treatment of Grants Received from the Government for R&D as Capital Receipts:
The assessee, a public sector undertaking involved in aerospace R&D, received grants from the government and treated these as capital receipts. The AO agreed with this treatment, noting that the grants were intended for the development of indigenous technology for defense purposes. The Tribunal upheld this treatment, referencing its earlier decision in the assessee's own case for AY 1995-96, where it was held that such grants, used to develop technology for defense equipment, were capital in nature. The Tribunal emphasized that the grants were for creating capital assets like technology and designs for aircraft and helicopters.

2. Whether Related Expenditure Should Be Considered as Capital Expenditure or Revenue Expenditure:
The AO contended that the expenditure related to the grants should be treated as capital expenditure and added back to the total income, as it resulted in the creation of capital assets. The CIT (A) supported this view, stating that the expenditure led to the development of prototypes and advanced technology, which were capital assets. The assessee argued that the expenditure was revenue in nature and should not be added back. However, the Tribunal upheld the lower authorities' decision, noting that the expenditure resulted in acquiring capital assets like indigenous technology for manufacturing aircraft and helicopters.

3. Eligibility for Deduction under Section 35(1)(iv) of the Income Tax Act:
The assessee claimed that if the expenditure was considered capital, it should be eligible for deduction under Section 35(1)(iv) for scientific research. The CIT (A) rejected this claim, stating that the assessee did not file a revised return to claim this deduction and that the expenditure was for R&D, not scientific research. The Tribunal disagreed with the CIT (A), stating that developing avionics and radar systems for aircraft involved scientific research. The Tribunal remitted the matter back to the AO to verify the eligible amount for deduction under Section 35(1)(iv), emphasizing that the assessee should be allowed the deduction if it meets the conditions specified in the section.

4. Disallowance under Section 14A of the Income Tax Act:
The AO disallowed ?15,18,810/- under Section 14A, applying Rule 8D(2)(iii), as the assessee claimed exempt dividend income but did not attribute any expenditure to earning it. The CIT (A) upheld this disallowance. The assessee argued that the investments were strategic and no expenditure was incurred for earning the dividend. The Tribunal noted that there was a substantial change in investments and significant dividend income, justifying the AO's application of Rule 8D. The Tribunal upheld the disallowance, stating that the AO was justified in applying Rule 8D(2)(iii) without needing to express dissatisfaction with the assessee's claim of no expenditure.

Conclusion:
The appeal was partly allowed for statistical purposes, with the Tribunal remitting the matter back to the AO to verify the eligible amount for deduction under Section 35(1)(iv). The Tribunal upheld the treatment of grants as capital receipts, the related expenditure as capital expenditure, and the disallowance under Section 14A.