2019 (2) TMI 631 - AT - Income Tax

Disallowance of Research & Development capital expenditure - no documentary evidence of any real R&D activity by the assessee, was furnished - Held that - We find that the assessee claimed to have incurred capital expenditure of ₹ 1,26,100/-. Despite the AOs requirement, the assessee could not produce any evidence to show that it was really engaged in doing some research activity. Similar position prevailed before the CIT(A). As recorded that no documentary evidence on real Research & Development activities was furnished. The position is no better before us as well. On a specific requisition, the ld. AR could not draw our attention towards any cogent material or evidence to demonstrate that it was engaged in carrying out any real research activity. Under such circumstances, action of the authorities below in allowing depreciation @15%, as against 100% claimed by the assessee on the capital expenditure, is unimpeachable. This ground is not allowed. Disallowance of Warranty expenses - Held that - For the year under consideration, when the amount of sales dipped to ₹ 3.78 crore, amount of provision increased multifold from ₹ 9 lakh to ₹ 22 lakh as against the actual expenditure incurred on repairs standing only at ₹ 11,39,474/-. This narration of facts amply proves that the creation of warranty provision was not based on any scientific calculation but was rather an ad hoc exercise. Under such circumstances, we cannot grant deduction in respect of warranty provision. Once it is held that the creation of provision cannot be allowed as deduction, it is further clarified that the reversal of provision should also not be brought to tax, if the creation of such provision was earlier not allowed as deduction. To put it simply, neither the creation of provision nor its reversal, if earlier not allowed as deduction at the time of making it, would lead to deduction or taxability of any sum but the actual expenditure incurred by the assessee on repairs on year to year basis would qualify for deduction. With these observations, we set aside the impugned order to this extent and remit the matter to the file of AO for deciding the issue in accordance with our above directions. Research & Development capital expenditure cannot be allowed as deduction @100% but depreciation should be allowed at the eligible rate. Similarly, in so far as warranty provision is concerned, it is held that provision for warranty should not be allowed as deduction; reversal of the provision in the year, if not allowed as deduction at the time of its creation, should not be charged to tax but the actual expenditure incurred should be allowed as deduction.

Summary

Issues involved:
1. Disallowance of Research & Development capital expenditure.
2. Disallowance of Warranty expenses.
3. Interpretation of warranty provision deductions.
4. Disallowance under section 14A of the Act.

Analysis:

Issue 1: Disallowance of Research & Development capital expenditure (A.Y. 2007-08):
The appellant claimed deduction for Research & Development (R&D) capital expenditure, but the Assessing Officer (AO) disallowed it due to lack of evidence of actual R&D activity. The AO allowed only 15% depreciation instead of the full deduction claimed by the assessee. The Appellate Tribunal noted that under Section 35(1) of the Income-tax Act, capital expenditure on R&D should be allowed as a full deduction if it can be proven to be related to the business. As the appellant failed to provide evidence of engaging in real research activities, the Tribunal upheld the AO's decision to allow only 15% depreciation on the capital expenditure, denying the full deduction.

Issue 2: Disallowance of Warranty expenses (A.Y. 2007-08, 2008-09, 2010-11):
The AO disallowed a portion of the warranty expenses claimed by the assessee, citing inconsistencies in the provision amounts and actual repair expenditures. The Tribunal referred to the Supreme Court judgment in Rotork Controls India (P) Pvt. Ltd. Vs. CIT, emphasizing that warranty provisions must be made on a scientific basis to qualify for deduction. In this case, the Tribunal found that the warranty provision was not based on scientific calculations but was an ad hoc exercise. Therefore, the Tribunal held that the warranty provision could not be allowed as a deduction. It further clarified that neither the creation nor reversal of the provision, if not allowed as a deduction initially, should impact the tax liability. Only the actual repair expenditures should qualify for deduction.

Issue 3: Interpretation of warranty provision deductions (A.Y. 2008-09, 2010-11):
The Tribunal reiterated that warranty provisions must be made scientifically to be deductible. It emphasized that historical trends, nature of sales, and actual expenditure are crucial factors. The Tribunal held that the provision for warranty should not be allowed as a deduction if not based on scientific calculations. It directed that the actual repair expenditures should be considered for deduction, rather than the provision amount.

Issue 4: Disallowance under section 14A of the Act (A.Y. 2010-11):
The last ground regarding disallowance under section 14A of the Act was not pressed by the appellant's representative and was dismissed accordingly. The Tribunal partially allowed the appeal for statistical purposes in each assessment year.

This judgment clarifies the criteria for deductions related to R&D capital expenditure and warranty provisions, emphasizing the need for scientific calculations and historical trends to support such claims. It also highlights the importance of providing evidence and following proper accounting practices to substantiate expenditure claims for tax purposes.