2014 (12) TMI 298 - AT - Income Tax

Applicability of section 35(3) - Expenses incurred on product development with reference to scientific research activity - Claim of product development expenditure being interest on loans and cost of consumables u/s 37(1) Held that - The Tribunal in its order dated 31st July, 2013 held that the assessee will not get benefit of deduction u /s. 35(1)(i) - the plea of the assessee was also that if the expenditure is not allowable u/s. 35(1)(i) then the expenditure is nothing but scientific R & D expenditure and, therefore, allowable u/s. 35(1)(iv) u/s 35(1)(i) deduction is to be allowed in respect of any expenditure of capital nature of scientific nature relating to business carried on by the assessee Following the decision in Enem Nostrum Remedies (P.) Limited. Versus Assistant Commissioner Of Income-tax, Circle 8 2008 (8) TMI 384 - ITAT BOMBAY-E - there is difference in the language of clause (iv) of section 35(1) and section 43(4)(iii)(a) because the reference in the former section is to scientific research related to the business carried on by the assessee and in the definition clause of section 43, the language used is scientific research related to a business or class of business to include any scientific research which may lead to or facilitate an extension of that business or as the case may be, all businesses of that class - the molecules when successfully developed will yield patent rights to the assessee - the assessee will be inventor of such product and, therefore, the expenditure is for scientific research and eligible for deduction u/s. 35 of the Act - the process of development of molecule to the stage of vaccine i.e., medicine is the process involved in scientific research - the proper course of action for the AO is to refer the matter as directed u/s. 35(3) - The Tribunal cannot decide the claim against the assessee or in its favour without following the procedure laid down in the Act thus, the matter is remitted back to the AO with a direction to refer the claim of deduction u/s. 35 according to the procedure laid down u/s. 35(3) Decided in favour of revenue.

Summary

Issues Involved:
1. Allowability of deduction under section 35(1) of the Income-tax Act, 1961 for product development expenditure related to scientific research.
2. Classification of the expenditure as capital or revenue in nature.
3. Applicability of section 35(3) of the Income-tax Act, 1961.

Issue-Wise Analysis:

1. Allowability of Deduction under Section 35(1):
The primary issue in these appeals was whether the product development expenditure incurred by the assessee qualifies for deduction under section 35(1) of the Income-tax Act, 1961. The assessee claimed deductions for product development expenditures, including interest on loans and cost of consumables, under section 35(1) for the assessment years 2006-07, 2007-08, and 2008-09. The Assessing Officer disallowed these claims, arguing that the expenditures were capital in nature as they were capitalized in the books of account and provided enduring benefits to the assessee. The CIT(A) allowed the deductions, stating that the expenditures were incurred in the course of the assessee's scientific research activities and should be treated as revenue expenditures under section 35(1)(i). The Tribunal initially upheld the Assessing Officer's decision but later reconsidered the applicability of section 35(3) following the assessee's Miscellaneous Applications.

2. Classification of Expenditure:
The Assessing Officer classified the expenditures as capital in nature, arguing that they resulted in obtaining patent rights and provided enduring benefits to the assessee. The CIT(A) disagreed, stating that the expenditures were for developing new vaccines and bio-pharmaceuticals, which involved multi-stage development processes and did not necessarily result in enduring benefits. The CIT(A) argued that the expenditures were related to scientific research and development, thus qualifying as revenue expenditures under section 35(1)(i). The Tribunal, in its initial order, held that the expenditures were for setting up facilities for commercial production and did not qualify as scientific research expenditures under section 35(1)(i) or (iv).

3. Applicability of Section 35(3):
The Tribunal, upon reconsideration, focused on the applicability of section 35(3) of the Income-tax Act, 1961, which mandates that any question regarding the nature of scientific research expenditures should be referred to the Central Government or prescribed authority. The assessee argued that the Assessing Officer should have referred the matter under section 35(3) instead of disallowing the claims. The Tribunal agreed, stating that the Assessing Officer did not follow the correct procedure as outlined in section 35(3). Consequently, the Tribunal set aside the issue to the file of the Assessing Officer with a direction to refer the claim of deduction under section 35 according to the procedure laid down in section 35(3).

Conclusion:
The Tribunal allowed the appeals for statistical purposes, directing the Assessing Officer to follow the procedure under section 35(3) to determine the nature of the expenditures and their eligibility for deduction under section 35. The final decision on the allowability of the deductions will depend on the outcome of the reference made under section 35(3).