2018 (8) TMI 675 - AT - Income Tax

Treatment of expenditure and revenue during Construction period - Nature of sale of machines - revenue receipt or capital receipt - determination cost of Capital Work in Progress (Product Development Expenditure (RCS)) - Indirect Expenditure - Overhead expenditure - sale was made of trial/demo machines and the rent was received when the project was in the development stage - assessee is engaged in the development of Machine 2 Machine (M2M) and Register Control System (RCS) and whatever expenses incurred were debited to Capital Work-in-progress including the Project Development Expenses. Held that - Revenue has not doubted the development of products by the assessee and allowed capitalization of expenses but at the same time the Revenue has chosen to treat the sale of demo machines to the tune of ₹ 59, 20, 849/- and recovery of rent amounting to ₹ 64, 200 as revenue receipt and added the same to the income of the assessee after allowing the expenses of ₹ 14, 75, 553/-. The case of the assessee also finds support from the Guidance Notes issued by the Institute of Chartered Accountants of India on treatment of expenditure during construction period, which provides that if any revenue is realized during the trial run or product development stage, the same should be set off against the expenditure incurred in connection with the said project/products. - No addition - Decided in favor of assessee. Disallowance of certain sum paid treating the expenses as relatable to Capital Work-in-progress - Held that - the assessee has explained with reasons the apportionment of expenses into revenue and capital account in which no defects or deficiencies were pointed out. After perusing the said reply we certainly feel that the apportionment of expenses were made correctly. Moreover there is no materials brought before us by the revenue to take a view supporting the order of CIT(A). The Assessing Officer has also treated the expenditure as capital in nature without giving any reasons which is highly subjective and whimsical. The assessee has rightly apportioned the expenses depending upon the nature and purpose of expenses with adequate reasoning. - Decided in favor of assessee.

Summary

Issues Involved:
1. Nature of receipt from the sale of 3 Alygn Machines and rent.
2. Deduction of indirect expenses while treating the receipt on sale of 3 Alygn Machines as revenue receipt.
3. Adoption of the cost of purchase of the 3 Alygn Machines sold.
4. Disallowance of expenses by treating them as related to Capital Work in Progress (CWIP).

Issue-wise Detailed Analysis:

1. Nature of Receipt from the Sale of 3 Alygn Machines and Rent:
The assessee argued that the receipts from the sale of 3 Alygn Machines (?59,20,849) and rent (?64,200) were capital in nature, as the machines were trial/demo products sold during the development stage, and the rent was received while the project was still in development. The Assessing Officer (AO) treated these receipts as revenue, asserting that the machines sold were fully developed and commercially usable. The CIT(A) upheld the AO's decision, stating that the product development is a continuous process and the sale of machines should be treated as income. The Tribunal found that the revenue had inconsistently treated the expenses and receipts, allowing capitalization of expenses but treating receipts as revenue. Citing the Guidance Note by ICAI and relevant case laws, the Tribunal concluded that the receipts from the sale of demo/trial products and rent should be set off against the development expenses, thus treating them as capital in nature.

2. Deduction of Indirect Expenses:
The assessee contended that indirect expenses (?44,21,635) should be allowed as a deduction while treating the receipt from the sale of 3 Alygn Machines as revenue. The CIT(A) rejected this claim, stating that indirect expenses are overheads not directly connected to the machines sold. The Tribunal did not specifically address this issue separately, as it had already decided that the receipts were capital in nature and thus should be set off against the development expenses.

3. Adoption of the Cost of Purchase of the 3 Alygn Machines Sold:
The assessee claimed that the actual cost of purchase was ?16,12,630, whereas the AO adopted ?7,22,853. The CIT(A) upheld the AO's adoption, suggesting that any mistake should have been rectified under section 154, which the assessee did not pursue. The Tribunal did not dwell on this issue separately, as the primary issue of the nature of receipts had already been decided in favor of the assessee.

4. Disallowance of Expenses by Treating Them as Related to CWIP:
The AO disallowed expenses of ?51,15,880, treating them as related to CWIP and thus capitalizing them. The CIT(A) upheld this disallowance, agreeing with the AO's rationale. The assessee argued that the allocation of expenses was justified and explained in detail, with specific reasons for different ratios of apportionment. The Tribunal found the assessee's explanations reasonable and noted that the AO's disallowance was subjective and without adequate reasoning. Consequently, the Tribunal directed the AO to delete the disallowance, recognizing the expenses as appropriately apportioned between revenue and capital accounts.

Conclusion:
The Tribunal allowed the appeal partly, setting aside the CIT(A)'s order on the primary issue of the nature of receipts and the disallowance of expenses, directing the AO to treat the receipts as capital in nature and delete the disallowance of expenses. This comprehensive analysis ensures that the significant legal terminology and phrases are preserved, providing a thorough understanding of the judgment.