2024 (5) TMI 1563 - AT - Income Tax

Depreciation on assets pursuant to the scheme of demerger - assessee company has transferred its fixed assets pertaining to the Speciality Chemicals business to M/s Ciba Speciality Chemicals Ltd as per Schedule A to the scheme of arrangement - HELD THAT - We found that the issue in respect of value of block of assets has been already considered in the assessee s own case for the A.Y 2002-03 2024 (3) TMI 1438 - ITAT MUMBAI wherein held that the assets in the block has to be evaluated every assessment year and as per provision 43(6)(C)(B) it clearly indicates that the value has to be reduced of the moneys payable in respective of any assets falling within that block which is sold/discarded/demolished or destroyed. In the given case the block does not consist the assets which are transferred in the demerger in the A.Y. 1997-98. These particular assets are not in existence in the beginning of the year and it can be considered as discarded in the provisions with NIL value. This issue needs to end some point of time. In that case the value of the assets has to be written off this year and to be claimed as loss in the statement of income (instead of depreciation). Therefore we are inclined to direct the AO to treat the opening balance of the assets to the extent of assets which was already transferred to the demerged company as loss of assets or discarded. Accordingly we follow the judicial precedence and direct the AO to allow depreciation and the ground of appeal is allowed in favour of the assessee. Disallowance of expenditure on computer software licence fees - HELD THAT - As relying on the earlier year A.Y. 2002-03 2024 (3) TMI 1438 - ITAT MUMBAI that the expenditure was revenue in nature. Thus we direct the AO to allow the deduction of expenditure on computer software licence fees and this ground of appeal of the assessee is allowed. Advance written off predominantly Modvat credit claims receivables - HELD THAT - The advance written off predominantly Modvat credit claims receivables was first time raised by the assessee in this assessment year in comparison to A.Y.2002-03 were the claim was only for advances written off and was allowed by the Honble Tribunal. AR relied on decision of Wackhardt International Ltd. 2009 (2) TMI 138 - BOMBAY HIGH COURT We are of the opinion that the assessee should not suffer for non filing of material information and the Assessment order does not discloses these facts of Modvat issue. Accordingly to meet the ends of justice we restore the disputed issue to the file of the Assessing officer to examine verify and allow the claim taking into consideration the assessee own case and judicial decisions. Assessee should be provided adequate opportunity of hearing and shall cooperate in submitting the information and we allow this ground of appeal of the assessee for statistical purposes. Excluding 90 per cent of receipts from Interest on employee loans Interest on overdue debtors Sales tax set off claims Insurance claims realized Scrap sales income cash discount exchange gains other miscellaneous write back of liabilities discounts etc cost of services recovered Profit under Section 41(3) on sale of R D assets while working out the profits of the business - HELD THAT - We respectfully follow the decision of the Hon ble ITAT in the assessee s own case for earlier year assessment year and direct the AO to delete the addition and we allow this ground of appeal in favour of the assessee. Capital gains arising from transfer of the plot adopting the fair market value lower than the value adopted by the assessee - As following the judicial precedence as in earlier year A.Y.2002-03 2024 (3) TMI 1438 - ITAT MUMBAI and direct the AO to adopt the fair market value as determined by the D.V.O as on 1-04-1981.Accordingly we allow the ground of appeal of the assessee .

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal include:

• Whether depreciation is allowable on assets transferred pursuant to a scheme of demerger, specifically assets vested in a demerged company, and whether any consideration flowed to the transferor company for such transfer;
• Whether expenditure on computer software and license fees qualifies as revenue expenditure or capital expenditure;
• The allowability of advances written off, predominantly related to MODVAT credit claims, as business expenses under relevant provisions;
• The treatment of various receipts (interest on employee loans, overdue debtors, sales tax set off claims, insurance claims, scrap sales, cash discounts, exchange gains, miscellaneous write backs, cost recoveries, and profits on sale of R&D assets) for the purpose of computing profits of business under section 80HHC;
• The correctness of computing income from house property on a notional basis, including the applicability of municipal rateable value and the method of computation of annual value;
• The determination of capital gains on transfer of land, specifically the adoption of fair market value as on 01.04.1981;
• The determination of arm's length price (ALP) in international transactions with associated enterprises, including the use of Comparable Uncontrolled Price (CUP) method and consideration of +/-5% variation permitted under section 92C(2);
• The computation of interest under section 234C based on revised return of income;
• Other ancillary issues including treatment of advertisement film production expenses, freight components in stock valuation, incremental VRS interest, foreign travel expenses, expenditure on foreign visitors, excess/short provisions, claim of deduction under section 80M, depreciation on DLP projector, delayed payments to provident fund and labour welfare fund, and unavailed MODVAT credit.

2. ISSUE-WISE DETAILED ANALYSIS

Depreciation on Assets Transferred Pursuant to Scheme of Demerger

Legal Framework and Precedents: Section 32 of the Income Tax Act allows depreciation on the written down value (WDV) of the block of assets. Section 43(6) defines "written down value" and prescribes adjustments to the block of assets for assets sold, discarded, or demolished. The question was whether assets transferred under a demerger scheme should be treated as sold/discarded for the purpose of depreciation, and whether consideration flowed to the transferor.

Court's Interpretation and Reasoning: The Tribunal relied on its own earlier decisions in the assessee's case for earlier assessment years (AY 1997-98, 2000-01, 2001-02) and relevant judicial precedents including the Supreme Court decision in Kasturi & Sons. It was held that the demerger was not a sale transaction and no actual money was received by the assessee for the transfer of assets; the shareholders received shares in the demerged company. The Tribunal distinguished between book value and tax WDV and directed that the WDV as per income tax records should be reduced from the block of assets. Further, for subsequent years, the Tribunal observed that since the assets were no longer in existence with the assessee, the opening WDV of such assets should be allowed as a one-time loss instead of depreciation.

Key Evidence and Findings: The scheme of demerger sanctioned by the Bombay High Court, the absence of monetary consideration to the assessee, and the continuity of business operations through the demerged entity were key factual elements. Earlier Tribunal orders and the assessee's own submissions were considered.

Application of Law to Facts: The Tribunal applied the statutory provisions and judicial principles to hold that depreciation was allowable on the WDV of the block less the WDV of assets transferred to the demerged company. The assets transferred were to be treated as discarded with nil value for subsequent years, allowing the opening WDV as a loss.

Treatment of Competing Arguments: The revenue argued that consideration had flowed and that the assets were not available for depreciation. The Tribunal rejected this, holding the demerger was not a sale and no actual money was received by the assessee. The assessee's reliance on earlier favorable decisions was accepted.

Conclusion: The Tribunal allowed depreciation on the block of assets after reducing the WDV of transferred assets and directed the Assessing Officer to allow the depreciation claimed for the year under appeal.

Expenditure on Computer Software and License Fees

Legal Framework and Precedents: The distinction between capital and revenue expenditure on software is well settled, with application software generally considered revenue expenditure due to its short useful life, and system software or software integral to hardware treated as capital expenditure. The Tribunal relied on its own precedents in the assessee's case for AYs 1991-92, 1995-96, 2001-02, and 2008-09 and judicial decisions including Raychem RPG Ltd. and Asahi India Safety Glass Ltd.

Court's Interpretation and Reasoning: The Tribunal observed that the expenditure was on application software and license fees which get outdated quickly and thus do not have enduring benefits. Therefore, such expenditure should be allowed as revenue expenditure and not capitalized.

Key Evidence and Findings: Details of software expenses, nature of software (off-the-shelf application software), and treatment in earlier years were considered.

Application of Law to Facts: Following the principle of consistency and earlier Tribunal decisions favoring the assessee, the Tribunal directed the Assessing Officer to allow the expenditure as revenue expenditure.

Treatment of Competing Arguments: The revenue argued for capital treatment based on enduring nature of benefits, but the Tribunal rejected this on the basis of judicial precedents and earlier consistent practice.

Conclusion: The ground of appeal was allowed in favor of the assessee.

Advances Written Off Predominantly MODVAT Credit Claims

Legal Framework and Precedents: Provisions under section 36(1)(vii) and 36(2) govern the allowability of bad debts. However, advances written off can be allowed as business expenditure under section 37(1) if incurred wholly and exclusively for business. The Tribunal relied on its own precedents and decisions of Bombay High Court and other Tribunals.

Court's Interpretation and Reasoning: The Tribunal noted that the advances written off were mostly in the nature of trade advances and MODVAT claims outstanding for long periods. Such losses were incurred in the course of business and hence allowable under section 37(1) alternatively as business loss under section 28.

Key Evidence and Findings: The assessee's submissions and inability to furnish details during assessment were noted. The Tribunal observed that the assessee should be given an opportunity to furnish details and the matter was restored to the Assessing Officer for fresh examination.

Application of Law to Facts: The Tribunal applied the principle that advances lost in course of business are allowable as business expenditure and directed reassessment.

Treatment of Competing Arguments: The revenue relied on provisions under section 36 and disallowed the claim. The Tribunal held that the lower authorities erred in rejecting the claim solely on this basis.

Conclusion: The issue was restored for fresh adjudication with a direction to allow the claim if substantiated.

Treatment of Various Receipts for Deduction Under Section 80HHC

Legal Framework and Precedents: Section 80HHC provides deduction for profits derived from export of goods. Explanation (baa) defines "profits of business" by excluding 90% of certain receipts such as brokerage, commission, interest, rent, charges or other receipts of similar nature. The Tribunal relied on decisions of the Bombay High Court in CIT vs Sudarshan Chemicals Industries Ltd., the Supreme Court in Punjab Stainless Steel Industries, and other relevant judicial pronouncements including CIT vs Pfizer Ltd. and CIT vs K. Ravindranathan Nair.

Court's Interpretation and Reasoning: The Tribunal held that receipts like sales tax and excise duty should be excluded from total turnover for computing deduction under section 80HHC. Receipts such as insurance claims related to stock-in-trade, scrap sales arising from manufacturing, cash discounts, cost recoveries from associated enterprises, and profit on sale of R&D assets are integral to business and not independent incomes; hence, they should not be excluded. However, interest on income tax refund and sales tax refund were held to be independent incomes and thus subject to 90% exclusion. The Tribunal emphasized the need to avoid distortion in export profits by excluding only independent incomes unrelated to export turnover.

Key Evidence and Findings: The Tribunal analyzed the nature of each receipt, its nexus with business operations, and the statutory provisions.

Application of Law to Facts: The Tribunal directed recomputation of deduction under section 80HHC excluding sales tax and excise duty from total turnover and including relevant receipts as profits of business.

Treatment of Competing Arguments: The revenue argued for inclusion of all receipts in total turnover and exclusion of 90% of various receipts. The Tribunal rejected this broad approach and applied judicial precedents to distinguish receipts integral to business from independent incomes.

Conclusion: The Tribunal partly allowed the ground of appeal, directing recomputation consistent with the principles laid down.

Computation of Income from House Property on Notional Basis

Legal Framework and Precedents: Section 22 of the Income Tax Act provides for taxation of income from house property based on actual rent received or annual value. The Tribunal relied on its own precedents in the assessee's case for AY 2001-02 and judicial decisions including M.V. Sonavala vs CIT.

Court's Interpretation and Reasoning: The Tribunal observed that the property was jointly owned and used by the assessee and the demerged company pursuant to the demerger arrangement. The demerged entity paid proportionate expenses but no rent was charged. The Tribunal held that since the property was used for business purposes and the arrangement was to facilitate demerger, notional rent could not be charged. The principle of consistency was applied as earlier assessments did not tax notional rent.

Key Evidence and Findings: The arrangement between the assessee and the demerged entity, recovery of expenses, and prior assessment orders were considered.

Application of Law to Facts: The Tribunal held that the property was used for business and not let out; thus, income from house property could not be computed on notional rent basis.

Treatment of Competing Arguments: The revenue contended that notional rent was chargeable under section 22 as no rent was reflected in accounts. The Tribunal rejected this, relying on facts and consistency.

Conclusion: The Tribunal allowed the ground of appeal and deleted the addition on account of notional rent.

Capital Gains on Transfer of Land - Adoption of Fair Market Value

Legal Framework and Precedents: Capital gains computation requires determination of cost of acquisition, often based on fair market value as on 01.04.1981 for long-term assets. The Tribunal relied on valuation reports from independent valuers and the District Valuation Officer (DVO).

Court's Interpretation and Reasoning: The Tribunal found the initial valuation reports submitted by the assessee defective due to erroneous conversion rates. The DVO's valuation was considered neutral and reliable. The Tribunal directed adoption of the DVO's valuation of Rs. 71.12 per sq. ft. as the fair market value for capital gains computation.

Key Evidence and Findings: Valuation reports from Knight Frank, Poonager Bilimoria & Co., and DVO's report were examined.

Application of Law to Facts: The Tribunal applied the principle of adopting fair and correct valuation and directed reassessment accordingly.

Treatment of Competing Arguments: The assessee sought acceptance of higher valuation; the revenue relied on lower valuations. The Tribunal preferred the neutral DVO valuation.

Conclusion: The ground of appeal was allowed directing computation of capital gains based on DVO valuation.

International Transactions and Transfer Pricing Adjustments

Legal Framework and Precedents: Section 92C(2) permits a variation of +/-5% in determining arm's length price (ALP). The Tribunal considered the Transfer Pricing Officer's (TPO) findings and the assessee's submissions on the Comparable Uncontrolled Price (CUP) method.

Court's Interpretation and Reasoning: The Tribunal noted that the additions were of small amounts and that the assessee did not contest the adjustments vigorously. The grounds relating to CUP method adjustments and +/-5% variation were treated as not pressed.

Conclusion: The grounds relating to transfer pricing adjustments were dismissed as not pressed.

Computation of Interest under Section 234C

Court's Interpretation and Reasoning: The Tribunal observed that interest under section 234C should be computed based on the revised return of income filed by the assessee.

Conclusion: The Tribunal directed the Assessing Officer to recompute interest accordingly and allowed the ground.

Other Ancillary Issues

The Tribunal upheld the CIT(A)'s deletion of disallowance of advertisement film production expenses following the assessee's own precedents. It dismissed the revenue's appeal on freight components in stock valuation, applying the principle that freight outwards are selling expenses and not part of stock cost, consistent with earlier Tribunal decisions. Incremental VRS interest was allowed to the extent of actual payments made, rejecting actuarial valuation claims as contingent liabilities. Foreign travel expenses disallowance was deleted following earlier favorable decisions. Disallowance of expenditure on foreign visitors was upheld due to lack of details. Excess provisions were adjusted considering past years and cross-year expenses. Deduction under section 80M was restricted proportionately to net dividend income. Depreciation on DLP projector was restricted to plant and machinery rates. Delayed payments to provident fund and labour welfare fund were disallowed under section 43B. Unavailed MODVAT credit was adjusted under section 145A.

3. SIGNIFICANT HOLDINGS

"The demerger was not a sale transaction and no actual money was received by the assessee on account of the transfer of assets to the demerged company. Therefore, the depreciation is allowable on the written down value of the block of assets after reducing the written down value of the assets transferred pursuant to the scheme of demerger."

"Expenditure incurred on application software and license fees, which get outdated quickly and do not have enduring benefits, is to be treated as revenue expenditure and allowed accordingly."

"Advances written off predominantly comprising MODVAT credit claims, being losses incurred in the course of business, are allowable as business expenditure under section 37(1) or alternatively as business loss under section 28, subject to proper verification."

"For the purpose of computing deduction under section 80HHC, sales tax and excise duty are to be excluded from total turnover, and receipts integral to business operations such as insurance claims related to stock-in-trade, scrap sales, cash discounts, and cost recoveries are to be included in profits of business and not excluded under Explanation (baa). However, independent incomes such as interest on income tax refund and sales tax refund are subject to 90% exclusion."

"Where immovable property is jointly used by the assessee and the demerged entity pursuant to demerger arrangement, with cost recoveries but no rent charged, the property is deemed used for business purposes and not let out, and income from house property cannot be computed on notional rent basis."

"For capital gains computation, the fair market value as on 01.04.1981 is to be adopted based on neutral valuation reports such as those from the District Valuation Officer."

"Interest under section 234C is to be computed based on the revised return of income filed by the assessee."

"Transfer pricing adjustments involving minor amounts and issues not pressed by the assessee are dismissed."

"The Assessing Officer is directed to allow depreciation on assets transferred pursuant to demerger as per earlier Tribunal decisions, allow expenditure on computer software as revenue expenditure, restore the claim of advances written off predominantly MODVAT credit claims for fresh adjudication, recompute deduction under section 80HHC excluding sales tax and excise duty from turnover and including relevant receipts, delete addition on notional rent income from house property, adopt DVO valuation for capital gains, and recompute interest under section 234C."