2020 (12) TMI 679 - HC - Income Tax

Nature of expenditure incurred towards research and development - Addition u/s 35 or 37 - HELD THAT - In the instant case, the total research and development expenses incurred by the assessee which includes expenses towards raw materials, direct expenses, salaries, interest, depreciation and other expenses. Out of the aforesaid amount, AO has disallowed a sum on the ground that the same was made out of the grants given by Government of India. The expenses incurred by the assessee were towards research and development and therefore, the same were revenue in nature and ought to have been allowed as deduction under Section 37. The fact that the expenses incurred by the assessee towards research and expenses have been met out of the grants given by the government, which is treated as capital receipt is immaterial. The Tribunal erred in placing reliance on the case of the assessee for Assessment Year 1995-96 as the Tribunal failed to appreciate the aforesaid order, as the order no where states that the revenue expenses incurred out of the grant would not be allowed as deduction under Section 37 - nature of the expenditure has to be seen and not the nature of receipt and purpose for which such expenditure is made is a relevant criteria. The expenditure was incurred by the assessee for research and development for manufacture of aircrafts, which were to be sold. Thus, the expenditure was incurred for the purpose of business of the assessee and the same ought to have been allowed under Section 37 instead of Section 35(1)(iv) Disallowance u/s 14A - Non recording of satisfaction by AO - HELD THAT - Sub-Section (2) and (3) of Section 14A of the Act read with Rule 8D of the Rules prescribe a formula for determination of expenditure incurred in relation to income, which does not form part of the total income under the Act in a situation where the Assessing Officer is not satisfied with the claim of the assessee. The sine qua non for invocation of power under Section 14A of the Act read with Rule 8D of the Rules is the recording of satisfaction by the Assessing Authority that having regard to the accounts of the assessee it is not possible to arrive at the satisfaction with regard to the correctness of the claim of the assessee. In the instant case, the Assessing Officer has not recorded any satisfaction with regard to genuineness of the claim of the assessee before invoking the powers under Section 14A of the Act read with Rule 8D of the rules. Revenue appeal dismissed.

Issues involved:
1. Determination of whether expenses towards research and development are capital or revenue in nature.
2. Validity of disallowance made under Section 14A of the Income Tax Act.
3. Justification of allowing deduction under Section 35(1)(iv) of the Income Tax Act without revising the return of income.

Analysis:

Issue 1: Expenses towards research and development

The case involved a dispute over the nature of expenses incurred by the assessee towards research and development. The Assessing Officer disallowed a significant amount, considering it capital in nature. The High Court held that the expenses were revenue in nature and should have been allowed as a deduction under Section 37 of the Act. The Court emphasized that the nature of expenditure, not the nature of receipt, is crucial. The expenses were incurred for the business purpose of the assessee, specifically for research and development for manufacturing aircraft, which were to be sold. Therefore, the expenses were deemed to be incurred for the business and should have been allowed under Section 37 of the Act.

Issue 2: Disallowance under Section 14A of the Act

Regarding the disallowance made under Section 14A of the Act, the Court highlighted the necessity of the Assessing Officer to record satisfaction with regard to the correctness of the claim of the assessee before invoking the powers under Section 14A of the Act. In this case, the Assessing Officer failed to record any satisfaction regarding the genuineness of the claim of the assessee. Consequently, the disallowance under Section 14A of the Act was found to be unjustified.

Issue 3: Deduction under Section 35(1)(iv) without revising the return of income

The Court addressed the validity of allowing the claim under Section 35(1)(iv) of the Act for the first time before the appellate authority without revising the return of income. The revenue argued that such a claim should only be made through a revised return of income. However, the Court held that the alternate claim can be considered by the appellate authority, citing relevant case law. The Court found that the tribunal's interpretation of the law in this regard was incorrect and ruled in favor of the assessee.

In conclusion, the High Court ruled in favor of the assessee on the substantial questions of law involved in the appeals. The order of the Tribunal regarding the disallowance of claims under Section 37 and Section 14A of the Act was quashed, and the appeals were disposed of accordingly.

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