2018 (5) TMI 1683 - AT - Income Tax

Purchase of Research & Development Assets - Claim of deduction u/s 35 - expenditure incurred on in-house R&D facility - Expenditure on improvement and upgrading of products - Capital or Revenue - Held that - The expenditure that is sought to be excluded u/s.43(4)(ii) of the Act is an expenditure which the assessee incurs in acquiring rights in or arising out of scientific research already done by somebody. - The objective behind the exclusion clause in section 43(4)(ii) of the Act appears to be that expenditure on scientific research should be on the research actually carried out by the assessee in-house and it should not merely spend money in acquiring rights in OR arising out of scientific research carried out by some other person. In any event, there is no distinction as to whether the expenditure incurred is capital or revenue, because while the provisions of section 35(1) of the Act allows deduction of revenue expenditure, the provisions of section 35(1)(iv) of the Act allows deduction in respect of capital expenditure. - thus respectfully following the decision of the Hon ble Karnataka High Court in the case of CIT Vs.Talisma Corpn (P) Ltd. 2013 (12) TMI 1419 - KARNATAKA HIGH COURT AO is directed to allow the deduction claimed by the assessee under Section 35(1)(iv) - Decided in favor of assessee. Disallowance of interest expenditure u/s 14A incurred on earning exempt income - Held that - Taking into consideration the fact that the assessee had earned exempt dividend income of ₹ 7,13,70,554, the disallowance as computed under Rule 8D(2)(ii) at ₹ 52,53,500; which works out to approx. 7.36% thereof is reasonable in the facts and circumstances of the case in the year under consideration and is therefore upheld - thus AO is directed to delete disallowance under Rule 8D(2)(ii) sustained by the learned CIT(A) and uphold the disallowance made by the authorities below under Rule 8D(2)(iii) - partly allowed in favor of assessee.

Issues Involved:
1. Disallowance of claim under Section 35(1)(iv) for purchase of Research & Development Assets.
2. Disallowance under Section 14A of the Income Tax Act, 1961.

Detailed Analysis:

1. Disallowance of Claim under Section 35(1)(iv) for Purchase of Research & Development Assets

Ground Nos. 1 to 5:
The assessee challenged the order of the CIT (Appeals) upholding the disallowance of their claim under Section 35(1)(iv) read with Section 35(2)(ia) for deduction of ?2,91,97,333 incurred towards the purchase of tangible assets for research and development purposes.

Facts:
- The assessee, a company engaged in the manufacture and sale of hydraulic machinery, claimed a deduction for expenses incurred on tangible assets for its in-house R&D facility.
- The Assessing Officer (AO) disallowed the claim, arguing that the expenses led to the acquisition of rights and were therefore capital in nature.
- The CIT (Appeals) upheld the AO's decision, stating that the R&D process resulted in new products and patents, which constituted intellectual property rights (IPR).

Arguments:
- The assessee argued that the expenditure was for scientific research and should be deductible under Section 35(1)(iv) as it was incurred for the prosecution of scientific research.
- The assessee also contended that the AO and CIT (Appeals) misinterpreted Section 43(4)(ii), which excludes expenditures incurred in acquiring rights arising out of scientific research.

Tribunal's Findings:
- The Tribunal referenced the case of Tejas Networks Ltd. and the Hon'ble Karnataka High Court's decision in CIT Vs. Talisma Corpn. (P) Ltd., which allowed similar deductions under Section 35(1)(iv).
- The Tribunal held that the exclusion under Section 43(4)(ii) applies to expenditures incurred in acquiring rights from third parties, not to in-house R&D activities.
- The Tribunal directed the AO to allow the deduction claimed by the assessee, concluding that the expenditure was indeed for scientific research and not for acquiring rights from others.

Conclusion:
The Tribunal allowed the assessee's appeal on this issue, directing the AO to allow the deduction under Section 35(1)(iv).

2. Disallowance under Section 14A of the Income Tax Act, 1961

Ground Nos. 6 to 9:
The assessee contested the CIT (Appeals)'s decision to uphold a disallowance of ?36,57,621 towards interest expenditure under Rule 8D(2)(ii) and ?52,53,500 under Rule 8D(2)(iii).

Facts:
- The AO observed that the assessee earned exempt dividend income and made a suo moto disallowance of ?73,976 for administrative expenses.
- The AO invoked Section 14A read with Rule 8D, computing a total disallowance of ?92,73,634, which included ?40,20,134 under Rule 8D(2)(ii) and ?52,53,500 under Rule 8D(2)(iii).
- The CIT (Appeals) reduced the disallowance under Rule 8D(2)(ii) to ?36,57,621 but upheld the disallowance under Rule 8D(2)(iii).

Arguments:
- The assessee argued that no disallowance under Rule 8D(2)(ii) was warranted as they had sufficient interest-free funds to cover the investments.
- The assessee also contended that the average value of investments was incorrectly calculated by the CIT (Appeals).

Tribunal's Findings:
- The Tribunal noted that the assessee had sufficient interest-free funds to cover the investments, as established in a previous Tribunal order for the same assessment year.
- The Tribunal directed the AO to delete the disallowance under Rule 8D(2)(ii) of ?36,57,621.
- Regarding the disallowance under Rule 8D(2)(iii), the Tribunal found no basis to restrict it to ?73,976 as claimed by the assessee and upheld the disallowance of ?52,53,500, considering it reasonable given the exempt dividend income earned.

Conclusion:
The Tribunal directed the AO to delete the disallowance under Rule 8D(2)(ii) and upheld the disallowance under Rule 8D(2)(iii).

Final Order:
The assessee's appeal for the Assessment Year 2008-09 was partly allowed, with the Tribunal directing the AO to allow the deduction under Section 35(1)(iv) and to delete the disallowance under Rule 8D(2)(ii). The disallowance under Rule 8D(2)(iii) was upheld.

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