2014 (12) TMI 261 - HC - Income Tax

Entitlement for deduction u/s 35(1) Research activity carried on as per section 43(4) Held that - Assessee claimed huge amount as expenses for research and development u/s 35 of the Act The Tribunal held that the activity carried on by the respondent did constitute research u/s 43(4) of the Act - The assessee had also claimed expenses as royalty as it was appointed as distributor in respect of software packages of two companies Following the decision in Deputy Commissioner of Income-tax (Asstt.) Versus Mastek Ltd. 2012 (9) TMI 264 - GUJARAT HIGH COURT wherein it has been held that Section 35(3) of the Act requires a reference to be made by the Board to the prescribed authority when a question arises as to whether and if so to what extent, any activity constitutes or constituted or any asset is or was being used for scientific research. If an assessee puts forth a claim of deduction u/s 35(1) for expenditure incurred on scientific research and if the AO is not inclined to accept such a claim, the question can be stated to have arisen - at no stage, right up to the Tribunal and even during the pendency of these appeals before the High Court, any such attempt was made by the revenue - Secondly, in the meantime, more than 20 years have passed since the assessee incurred the expenditure. Expecting the assessee to now produce minute details of the research activity undertaken would be unreasonable - the Commissioner held that a substantial portion of such expenditure was in any case of revenue nature and in respect of the provision of section 37(1), the assessee was entitled to claim full deduction - such conclusion of the Commissioner was not disturbed by the Tribunal though the revenue had specifically preferred an appeal in this respect Decided against revenue.

Summary

Issues:
1. Challenge to judgment and order by the Income-tax Appellate Tribunal for assessment year 1995-96.
2. Substantial questions of law regarding research activities and deduction of expenditure under sections 35(1) and 43(4) of the Act.
3. Disallowance of expenses claimed by the respondent for research and development.
4. Disallowance of expenses claimed as royalty.
5. Interpretation of section 35(3) of the Act regarding seeking opinion of the Central Board of Direct Taxes.

Analysis:

1. The appellant-Revenue challenged the judgment and order of the Income-tax Appellate Tribunal for the assessment year 1995-96. The High Court framed substantial questions of law related to research activities and deduction of expenditure under sections 35(1) and 43(4) of the Act. The Tribunal had allowed the respondent's appeal based on grounds related to the development of a new product through scientific research and the requirement for the Assessing Officer to refer questions to the Board regarding scientific research activities.

2. During the assessment proceedings, the respondent claimed a significant amount as expenses for research and development under section 35 of the Act. The Assessing Officer disallowed the claim based on the previous year's order, which was upheld by the Commissioner (Appeals). However, the Tribunal reversed the order, stating that the activities constituted research under section 43(4) of the Act. The respondent also claimed expenses as royalty, which the Assessing Officer disallowed, considering it as an acquisition of know-how. The CIT(A) allowed the claim, leading to the Revenue's appeal before the Tribunal, which was dismissed.

3. The High Court emphasized the importance of seeking the opinion of the prescribed authority under section 35(3) of the Act when questions arise regarding the nature of expenditure incurred for scientific research. The Court noted that the Assessing Officer cannot reject such claims without referring the matter to the Board for opinion. The Court cited decisions from various High Courts to support the requirement for seeking the prescribed authority's opinion in cases of scientific research expenditure.

4. The Court concluded that the Tribunal was justified in reversing the orders of the revenue authorities that rejected the assessee's claim for deduction. It held that the Tribunal should not have decided the issue without the prescribed authority's opinion and that the revenue should have sought a reference before the Board. The Court declined the revenue's request to seek such a reference at a later stage due to the time elapsed since the expenditure was incurred and the lack of new evidence presented by the assessee.

5. Ultimately, the Court dismissed the Tax Appeals, answering the substantial questions of law in favor of the assessee and against the Revenue. It reiterated the importance of following the procedure outlined in section 35(3) of the Act and upheld the Tribunal's decision to allow the deduction claimed by the assessee for scientific research expenditure.