2016 (11) TMI 288 - AT - Income Tax

Interest paid on loans taken - whether amount should be capitalized and added to the value of the closing stock of the assessee or not? - Held that - We are of the considered opinion that the AO was wrong in changing the method of valuation of closing stock. This method is being followed by the assessee, year after year and has been accepted by the Revenue. Loading of interest cost to closing stock is definitely changing the method of valuation of stock. Interest expenditure incurred on loans used for acquiring current assets, which includes closing stock, is allowable u/s 36(1)(iii). Respectfully following the propositions laid down by the Hon ble Bombay High Court in the case of Lokhandwala Constructions 2003 (1) TMI 93 - BOMBAY High Court to the facts of this case, we direct the AO to exclude the interest incurred on loans from the valuation of closing stock and allow the same as deduction u/s 36(1)(iii) of the Act. Grants received from Government of Uttar Pradesh - Held that - The amounts received by the assessee from Government of UP cannot be taxed as income of the assessee. The AO is directed to exclude the same from the taxable income of the assessee. See case of Lucknow Development Authority, Gomti Nagar, Lucknow 2013 (9) TMI 570 - ALLAHABAD HIGH COURT Ad hoc disallowance of 56% of the development expenses - Held that - When the matter was taken up before the first appellate authority, the same was dismissed without addressing the contention of the assessee that no reason whatsoever was mentioned in the assessment order for making this disallowance. As the AO has failed to give any reason whatsoever, for disallowing 56% of the development expenses, and as the ld.CIT(A) failed to address this issue, the disallowance in question is hereby deleted and this ground of the assessee is allowed.

Summary

Issues:
1. Valuation of closing stock - Interest paid on loans
2. Treatment of grants received from Government of Uttar Pradesh as revenue

Issue 1: Valuation of closing stock - Interest paid on loans
The appeals were filed by the assessee against the orders of the CIT(A) for the assessment years 2003-04, 2004-05, and 2005-06. The common issues in all appeals were the disallowance of interest pertaining to closing stock and the treatment of grants received from the Government of Uttar Pradesh as revenue. The first issue revolved around whether the interest paid on loans taken should be capitalized and added to the value of the closing stock. The AO had included the interest on loans taken for development schemes in the valuation of closing stock, which the assessee had disclosed as development expenditure. The first appellate authority upheld the AO's decision, stating that the interest expenditure was relatable to the stock held by the assessee. However, the tribunal disagreed, citing previous judgments where similar expenses were allowed as revenue expenditure and not capitalized to the value of closing stock. The tribunal directed the AO to exclude the interest incurred on loans from the valuation of closing stock and allow it as a deduction under section 36(1)(iii) of the Act.

Issue 2: Treatment of grants received from Government of Uttar Pradesh as revenue
The second common issue was whether the grants received from the Government of Uttar Pradesh should be treated as revenue. The amounts received were directed to be spent on the development of infrastructure by the assessee. The CIT(A) upheld the AO's decision, considering the funds as taxable income. However, the tribunal, after considering relevant case laws and the jurisdictional High Court's judgment, held that the amounts received from the government could not be taxed as income of the assessee. The tribunal directed the AO to exclude the grants from the taxable income of the assessee. Additionally, for the assessment year 2004-05, where an ad hoc disallowance of 56% of development expenses was made by the AO without providing any reason, the tribunal deleted the disallowance as the AO failed to justify the decision. Consequently, the appeals of the assessee for all three years were allowed based on the above findings.