2023 (11) TMI 385 - AT - Income Tax

Provision for obsolete stock - AO observed that this expenditure cannot be allowed since the assessee has not proved with the reasonable certainty as given in the provisions of section 37(1) of the Act and not provided documentary evidence in this regard - Assessee is a manufacturing company engaged in manufacturing of heavy earth moving equipment and railway rolling stock having plants all over the country - HELD THAT - The contention of ld. A.R. is that the assessee has debited the net provision for obsolescence of stock to the P L account and same has been claimed as a deduction. However, it was not demonstrated before us that there was no under- valuation of this inventory and the excess provision, if any, was written back in the succeeding year or in year of sale of obsolete stock, etc. nor was it demonstrated that obsolete stock was valued at lower of cost or net realizable value. In principle, we hold that the provision for obsolete stock is allowable but it requires to be satisfied that the value of obsolete items of inventory is valued on the cost or market price, whichever is less. In the circumstances, we remit the matter back to the file of AO with a direction that the provision for obsolete stock be allowed as a deduction subject to satisfying himself that the valuation is done based on the principle that at cost or market price or not realizable value, whichever is less. Further, there cannot be double deduction in one assessment year when the provision is made and another time when it was actually written off in its books of accounts of assessee. Decided partly in favour of assessee for statistical purposes. Expenditure on scientific research u/s 35(2AB) - Department of Scientific Industrial Research ( DSIR ) has not quantified the same in that certificate - HELD THAT - Admittedly, there was no dispute that the assessee has incurred capital expenditure of Rs. 7.98 crores on scientific research which is entitled for weighted deduction u/s 35(2AB) of the Act and the balance amount of Rs. 46.56 crores, which was revenue expenditure spent on scientific research. Out of this, assessee claimed only a sum of Rs. 38.62 crores u/s 35(2AB) of the Act and the balance amount of Rs. 7.94 crores cannot be claimed u/s 35(2AB) of the Act on the reason that it was not certified by DSIR. However, this expenditure of Rs. 7.94 crores has been incurred by the assessee for the purpose of business and this fact is not disputed by the AO and in our opinion, assessee is entitled for deduction on this amount u/s 37 of the Act. This view of ours is fortified by the judgement of order of the Tribunal in the case of Auto Ignition Ltd 2022 (1) TMI 327 - ITAT DELHI Allowability of liquidity damages for delay in supply of goods - Claim disallowed by AO on account of non- compliance of terms conditions of the contract u/s 37(1) - HELD THAT - As seen from the facts of the issue, the above expenditure has been incurred as a compensation for breach of contractual obligation. In our opinion, there is a difference between penalty for infraction of law and damages for breach of contract in the context of deduction u/s 37(1) of the Act and this issue was considered by Hon ble Gujarat High Court in the case of Principal CIT Vs. Mazda Ltd. 2017 (9) TMI 1038 - GUJARAT HIGH COURT wherein held that whenever damages are to be paid by an assessee for a breach of contract, such damages are treated to be normal expenses of business. It was further held that where an assessee has to pay damages to other party to fulfill the contract entered into by him in the ordinary course of his business, the amount of damages to be paid is allowable deduction if it is in the ordinary course of business and is not opposed to public policy - CIT(A) is justified in allowing the claim of the assessee in respect of compensation paid for breach of contractual obligation.

Summary

Issues Involved:
1. Disallowance of provision for obsolescence of inventory.
2. Allowability of expenditure on scientific research under Section 35(2AB) of the Income-tax Act.
3. Allowability of liquidity damages for delay in supply of goods under Section 37(1) of the Income-tax Act.

Summary:

Issue 1: Disallowance of Provision for Obsolescence of Inventory
The assessee claimed a provision for obsolescence of inventory amounting to Rs. 7,74,99,000/-, calculated using a scientific method approved by the Board of Directors. The AO disallowed this claim, stating that the assessee failed to provide reasonable certainty and documentary evidence as required under Section 37(1) of the Act. The CIT(A) confirmed this disallowance. The Tribunal noted that the provision for obsolete stock is allowable in principle but remitted the matter back to the AO to ensure that the valuation is done based on the principle of cost or market price, whichever is less, and to verify that no double deduction is claimed. The appeal was partly allowed for statistical purposes.

Issue 2: Allowability of Expenditure on Scientific Research under Section 35(2AB)
The assessee claimed expenditure on scientific research, including Rs. 7.98 crores as capital expenditure and Rs. 46.56 crores as revenue expenditure. The AO allowed the capital expenditure but disallowed Rs. 7.94 crores of the revenue expenditure not certified by DSIR. The CIT(A) allowed this amount under Section 37 of the Act, and the Tribunal upheld this decision, stating that the expenditure was incurred for the purpose of business. The appeal by the revenue was dismissed.

Issue 3: Allowability of Liquidity Damages for Delay in Supply of Goods under Section 37(1)
The assessee claimed Rs. 1,74,74,000/- as liquidity damages for delay in supply of goods. The AO disallowed this claim, considering it as a penalty for infringement of law. The CIT(A) allowed the claim, distinguishing it as compensation for breach of contractual obligation, not for infraction of law. The Tribunal upheld this decision, referencing the Gujarat High Court's judgment in Principal CIT Vs. Mazda Ltd., which differentiates between penalty for infraction of law and damages for breach of contract. The appeal by the revenue was dismissed.

Conclusion:
The Tribunal remitted the issue of provision for obsolescence back to the AO for fresh consideration, upheld the CIT(A)'s decision on the allowability of scientific research expenditure under Section 37, and confirmed the allowability of liquidity damages for breach of contract. The appeals were partly allowed for statistical purposes and dismissed respectively.