2025 (4) TMI 1422 - AT - Income Tax

Disallowance of Depreciation on the assets pursuant to the scheme of demerger - concept of grouping all assets having similar rate of depreciation in a single block - assessee continued to claim depreciation on the WDV of various block of assets without excluding the assets so transferred under the scheme of demerger to the above said company - HELD THAT - Identical issue was considered by the co-ordinate bench in AY 2003-04 2024 (5) TMI 1563 - ITAT MUMBAI noticed that it is a recurring issue every year. Further it noticed that another co-ordinate bench has reached a compromise formula in AY 2008-09 2022 (12) TMI 168 - ITAT MUMBAI wherein the AO was directed to treat the opening WDV of assets transferred to the above said company as loss of assets. Hence the co-ordinate bench held in AY 2003-04 that in order to give effect to the above said direction given by the Tribunal in AY 2008-09 the depreciation claimed by the assessee in AY 2003-04 should be allowed. Accordingly the co-ordinate bench deleted the disallowance of depreciation made by the AO in AY 2003-04. Accordingly we also direct the AO to delete the disallowance of depreciation made on the assets transferred to M/s Ciba Specialty Chemicals (India) Ltd in this year also. Addition made by enhancing the value of closing stock as on 31.3.2004 by the amount of estimated secondary freight cost - HELD THAT - The co-ordinate bench vide its order passed 2024 (3) TMI 1438 - ITAT MUMBAI has deleted this addition as held that the consistently followed method of valuation of stock which has been accepted by the departmental authorities earlier should not be disturbed since a stray departure in one year tends to upset the calculations. Following the above said decision we set aside the order passed by Ld CIT(A) on this issue and direct the AO to delete this addition. Disallowance of claim relating to Voluntary Retirement Scheme compensation - HELD THAT - As the provisions of sec. 35DDA are related to lump sum compensation paid since the question of amortization shall arise only in respect of lump sum payments. The purpose of spreading the deduction into five years is to avoid distortion of the profits in one year and also collection of income tax. Accordingly we are of the view that the provisions of sec.35DDA shall not apply to the pension payments. In the instant case the incremental liability is related to pension payments. Hence we are of the view that the provisions of 35DDA shall not be applicable to pension payments which are recurring in nature. Accordingly we reject the view taken by the tax authorities on the applicability of sec. 35DDA to the case of the assessee. Claim for deduction of incremental liability - We notice that the Ld CIT(A) has also taken different stand in the earlier years i.e in some years the Ld CIT(A) has confirmed the disallowance of provision for VRS compensation and in some other years it has been deleted. A provision for expenses is created for a known liability under the accounting principles. Hence the said claim made by the assessee is in principle allowable as deduction since it is a provision created for a known liability. Hence the AO was not right in treating it as a contingent liability. Hence the Ld CIT(A) was right in allowing the same as deduction. However if the provision so made is not allowed as deduction in any of the years by the AO or the appellate authorities then the actual payment made out of that provision is allowable as deduction. It is the submission of the assessee that Rs. 3, 89, 26, 463/- represents actual payment made in this year. Hence if the relevant provision amount had been disallowed in any of the prior years then the actual payment should be allowed as deduction. However the relevant details are not available on record. Hence the claim of the assessee requires verification at the end of the AO. Accordingly we restore this alternative ground of the assessee in all the three years under consideration to the file of the assessing officer for examining the same in the light of discussions made supra. Nature of expenditure - software expenses - revenue or capital expenditure - HELD THAT - We set aside the order passed by Ld CIT(A) on this issue in all the three years and direct the AO to allow software expenses as revenue expenses. Disallowance of travel expenses on visit of foreigners - HELD THAT - We notice that disallowance of identical expenses has been made in the earlier years also. The Tribunal has deleted the identical disallowance made in AY 2002-03 2024 (3) TMI 1438 - ITAT MUMBAI wherein it has followed the decision rendered by the co-ordinate bench in the assessee s own case in AY 1997-98 2016 (1) TMI 1491 - ITAT MUMBAI . In all these years the Tribunal noticed that the foreigners are the executives specializing in the business carried on by the assessee and they visit India for business purposes only. Accordingly the Tribunal has deleted the identical disallowance made in the earlier years. Thus direct the AO to delete the disallowance made in both the years mentioned above. Disallowance u/s 14A - CIT(A) has confirmed disallowance to the extent of 2% of dividend income in AY 2004-05 - HELD THAT - We set aside the order passed by Ld CIT(A) on this issue in AY 2007-08 and direct the AO to restrict the disallowance u/s 14A to 2% of the dividend income. Addition made by loading unutilized Modvat credit amount to the value of closing stock - as submitted that the AO should be directed to adopt the same method for the opening stock as on 1.4.2004 and that the method of determining the value of stock should be identical both for closing stock and opening stock of any year - HELD THAT - Accordingly we direct the AO to adopt the value of closing of one year as the opening stock of the succeeding year. Disallowance of advances written off - HELD THAT - We notice that the amount so written off is allowable as deduction u/s 28 or u/s 37(1) if the said advances had been given for revenue purposes. In our view the question of examining the amount so written off u/s 36(1)(vii) shall not arise in this case. A.R submitted that the assessee is having relevant details relating to the advances so written off. This issue requires fresh examination at the end of the AO in both AY 2004-05 and 2006-07. Accordingly we set aside the order passed by CIT(A) on this issue in both the years under consideration and restore the same to the file of the AO for examining afresh. The assessee is also directed to furnish the details of advances and show that those advances were given for revenue purposes. Determination of Profits of business for the purposes of deduction u/s 80HHC - HELD THAT - In the instant case in our view the royalty receipts are independent source of income. Accordingly we are of the view that the Ld CIT(A) was justified in confirming the action of the AO in excluding 90% of royalty income from profits for the purpose of computing profits of business as per Explanation (baa) to sec.80HHC of the Act. With regard to other receipts the Ld A.R submitted that they are covered by the decisions rendered by the Tribunal in earlier years. Accordingly we direct the AO to follow the decisions rendered by the Tribunal in respect of other receipts. The order passed by Ld CIT(A) is modified accordingly. The matter is restored to the file of the AO for computing deduction u/s 80HHC. Assessment of notional value of rent for the property used by the demerged company - HELD THAT - We notice that the AO has adopted adhoc rate for determining the Annual letting value. We notice that the said methodology is not in accordance with law laid down by Hon ble Bombay High Court in some of the cases. We also notice that the assessee has also raised similar contentions before the tax authorities. Accordingly we are of the view that the determination of Annual Letting value (ALV) requires fresh examination. Accordingly we restore this issue to the file of AO in AY 2004-05 and 2006-07 for determining ALV in accordance with the decisions rendered by Hon ble Bombay High Court. LTCG - determination of fair market value as on 1.4.1981 for the land sold by the assessee - HELD THAT - We notice that an identical issue has been considered by the co-ordinate bench in AY 2002-03 and 2003-04. When the appeal of AY 2002-03 was pending the DVO report was brought to the notice of the Tribunal. The DVO had determined the fair market value as on 1.4.1981 at Rs. 71.12 per sq ft. Accordingly the Tribunal directed the AO to compute the long term capital gains on sale of land by adopting the fair market value as on 1.4.1981 as per the rate determined by the DVO. There should not be any dispute that the long term capital gains has to be computed for the area of land which is actually sold by the assessee. Accordingly we direct the AO to compute the long term capital gains on the actual area sold by the assessee and for that purpose the AO should adopt the fair market value of rate per square feet as on 1.4.1981 as determined by the DVO. Disallowance of adjustment by way of excess/short amount in respect of the year end provision made for expenses - HELD THAT - There is no dispute that the provision for expenses were made on the basis of estimates made with reliable data. Whatever may be the degree of estimation there bound to be some difference when the actual bill is received and hence the same would require adjustment on account of excess/short provision. Such adjustment would be a recurring feature and they are considered as current year s expenses as per the accounting principles. Hence there is no reason to disallow the same. Accordingly following the order passed by the co-ordinate bench in the hands of the assessee in AY 2008-09 2022 (12) TMI 168 - ITAT MUMBAI we set aside the order passed by Ld CIT(A) on this issue in all the three years viz. AY 2004-05 2006-07 and 2007-08 and direct the AO to delete this disallowance made. Interest u/s 234C is required to be computed on the returned income. Accordingly we restore this issue to the file of the AO for computing interest u/s 234C as per the provisions of the Act. Charging of Dividend Distribution Tax - contention of the assessee that the rate prescribed under relevant DTAA shall be applicable to Dividend distribution tax also - HELD THAT - We notice that the above said claim of the assessee is against the decision rendered in the case of DCIT vs. Total Oil India (P) Ltd 2023 (4) TMI 988 - ITAT MUMBAI (SB) Accordingly we reject this ground of the assessee. Addition made u/s 50C - HELD THAT - As all the relevant factual aspects which are necessary for the purposes of sec.50C have not been furnished by the assessee to the tax authorities. Hence we are of the view that this issue requires fresh examination at the end of the AO. If the assessee is able to show that it has received part consideration on the date of the entering of agreement for sale in the manner provided in the proviso to sec.50C of the Act then the assessee would get the benefit of the proviso. In that case the stamp duty value as on the date of agreement should be compared with the actual consideration.

Summary

Several appeals relating to assessment years 2004-05, 2006-07, and 2007-08 were consolidated and adjudicated together due to the similarity of issues. The core legal questions considered include the treatment of depreciation on assets transferred pursuant to a demerger, valuation of closing stock including secondary freight costs, deductibility of Voluntary Retirement Scheme (VRS) compensation, characterization of software expenses, disallowance of travel expenses related to foreign visitors, applicability and quantum of disallowance under section 14A of the Income Tax Act, valuation of closing stock with unutilized Modvat credit, deductibility of advances written off, computation of profits for deduction under section 80HHC, assessment of notional rent for property used by a demerged company, determination of fair market value for capital gains computation, treatment of adjustments in year-end provisions, computation of interest under section 234C, applicability of Double Taxation Avoidance Agreement (DTAA) rates to Dividend Distribution Tax (DDT), jurisdictional issues regarding additional commissioner, and applicability of section 50C in property sales.

Depreciation on Assets Transferred in Demerger

The assessee claimed depreciation on asset blocks without segregating assets transferred to the demerged company. The Assessing Officer (AO) disallowed depreciation proportionate to assets transferred, a view confirmed by the Commissioner of Income Tax (Appeals) (CIT(A)) but with a direction to adopt the written down value (WDV) as per IT records for AY 1997-98 for depreciation calculation. The Tribunal referred to coordinate bench decisions, which held that the opening WDV of assets transferred should be treated as loss of assets, allowing depreciation on the remaining assets. Following this precedent, the Tribunal directed deletion of the disallowance of depreciation for all three years, thereby reversing the AO and CIT(A) decisions.

Valuation of Closing Stock and Secondary Freight Costs

The AO enhanced the closing stock value by estimated secondary freight costs, upheld by CIT(A). However, coordinate bench decisions in prior years favored the assessee, holding that consistent stock valuation methods accepted earlier should not be disturbed by a stray departure. Accordingly, the Tribunal deleted the addition for AY 2004-05 and extended this reasoning to AY 2006-07 and 2007-08, directing the AO to delete the addition and ensure consistent valuation for opening and closing stock.

Deductibility of Voluntary Retirement Scheme (VRS) Compensation

The assessee claimed deduction for incremental VRS liability based on actuarial valuation, which the AO disallowed treating it as contingent liability, and invoked section 35DDA for amortization over five years for AY 2006-07 and 2007-08. The Tribunal observed that the VRS scheme was instituted in 1993, prior to insertion of section 35DDA in 2001, and that the incremental liability related to recurring pension payments rather than lump sum payments. The Tribunal held that section 35DDA, which applies to lump sum payments to avoid distortion of profits, does not apply to recurring pension payments. It further held that provisions created for known liabilities are allowable deductions under accounting principles and rejected the AO's treatment of the provision as contingent liability. The Tribunal allowed the deduction for incremental liability but restored the alternative claim relating to actual payments to the AO for verification, given lack of details.

Software Expenses

The AO treated software expenses as capital expenditure, disallowing deduction but allowing depreciation, a view confirmed by CIT(A). The Tribunal, relying on coordinate bench decisions and precedent, held that application software becomes obsolete quickly and should be treated as revenue expenditure. Therefore, the Tribunal set aside the disallowance and directed allowance of software expenses as revenue expenditure for all three years.

Travel Expenses on Foreign Visitors

The AO disallowed 25% of travel expenses incurred on foreign visitors, considering them unrelated to business. CIT(A) deleted this disallowance following earlier Tribunal decisions. The Tribunal upheld CIT(A)'s deletion, noting that the foreigners were executives specializing in the assessee's business and their visits were for business purposes. The alternative contention for depreciation on capitalized expenses was dismissed as infructuous.

Disallowance Under Section 14A

The AO disallowed expenses under section 14A due to exempt income earned by the assessee. The Tribunal noted that Rule 8D, prescribing specific formulae for disallowance, came into effect only from AY 2008-09. For earlier years, the Bombay High Court held that Rule 8D could not be applied. The Tribunal confirmed disallowance at 2% of dividend income for AY 2004-05 and modified CIT(A)'s order for AY 2006-07 accordingly. For AY 2007-08, the Tribunal set aside the order applying Rule 8D and directed disallowance at 2% of dividend income, in line with judicial precedents.

Valuation of Closing Stock Including Unutilized Modvat Credit

The assessee challenged the AO's loading of unutilized Modvat credit to closing stock value without applying the same to opening stock. The Tribunal directed the AO to adopt consistent valuation methods for opening and closing stock, ensuring uniformity in stock valuation.

Deductibility of Advances Written Off

The AO disallowed advances written off on the ground that conditions under section 36(1)(vii) read with section 36(2) were not fulfilled, and rejected alternative claim of business loss. The Tribunal observed that if advances were trade advances given for revenue purposes, the write-off should be allowable under sections 28 or 37(1). The Tribunal set aside CIT(A)'s order and restored the issue to AO for fresh examination, directing the assessee to furnish details proving advances were for revenue purposes.

Computation of Profits for Deduction Under Section 80HHC

The AO excluded 90% of certain receipts including interest on employee loans, sales tax set-off claims, liabilities written back, income from royalties, exchange gains, and miscellaneous income while computing profits for deduction under section 80HHC. CIT(A) confirmed this exclusion. The Tribunal accepted the assessee's submission that all receipts except income from royalties are part of business profits, referencing earlier Tribunal decisions. However, it rejected the claim regarding income from royalties, holding it to be an independent source unrelated to the export business. The Tribunal upheld exclusion of 90% of royalty income but directed AO to follow earlier Tribunal decisions for other receipts, restoring the matter for recomputation accordingly.

Assessment of Notional Rent for Property Used by Demerged Company

The AO assessed notional rent on premises used by the demerged company, treating recovery of actual costs as irrelevant and computing annual letting value (ALV) based on market rent, a view confirmed by CIT(A). Earlier Tribunal decisions had deleted such additions considering use of premises as business use facilitating demerger. The Tribunal noted that since demerger occurred long ago, facilitation no longer applies and the demerged company is a separate entity, so use of premises cannot be considered for assessee's business. The Tribunal held that recovery of municipal taxes paid by the assessee can be appropriated towards ALV but recovery of water and electricity charges cannot be treated as rent. The Tribunal restored the issue to AO for fresh determination of ALV in accordance with Bombay High Court decisions, with appropriate adjustment for municipal taxes recovered.

Determination of Fair Market Value for Land Sold

The AO rejected the valuation reports submitted by the assessee and recomputed fair market value (FMV) as on 1.4.1981 by converting rates from per square meter to per square feet, relying on stamp valuation. The Tribunal referred to coordinate bench decisions where the Departmental Valuation Officer (DVO) had determined FMV at Rs. 71.12 per sq ft, directing AO to adopt DVO's valuation for computing long-term capital gains. The Tribunal directed AO to compute gains based on actual area sold and DVO's FMV, setting aside AO and CIT(A) orders.

Adjustment for Excess/Short Provision for Expenses

The AO disallowed adjustments made for excess or short provisions at year-end. The Tribunal relied on Supreme Court precedent, which recognized that provisions are liabilities measured by estimation and adjustments for differences between estimated and actual amounts are recurring expenses allowable under accounting principles. The Tribunal deleted the disallowance for all three years.

Computation of Interest Under Section 234C

The assessee contended that interest under section 234C was charged on assessed income rather than returned income. The Tribunal restored the issue to AO for recomputation of interest strictly as per statutory provisions, i.e., on returned income.

Applicability of DTAA Rates to Dividend Distribution Tax (DDT)

The assessee contended that DTAA rates should apply to DDT. The Tribunal rejected this ground, noting it is contrary to Special Bench decision in a recent case, thereby upholding the tax authorities' position.

Jurisdiction of Additional Commissioner

The assessee raised jurisdictional objections regarding the Additional Commissioner passing assessment orders. The Tribunal declined to adjudicate this ground, leaving it open for appropriate proceedings.

Applicability of Section 50C on Property Sale

The AO invoked section 50C to adopt stamp duty valuation exceeding the sale consideration for capital gains computation on land sale. The assessee contended that the sale agreement was approved under Chapter XXC prior to section 50C's insertion, and thus section 50C should not apply. The Tribunal distinguished a precedent where delay in registration was due to genuine reasons and full consideration was received prior to section 50C's applicability. In the instant case, no reasons for delay or receipt of consideration were furnished. The Tribunal noted that the no-objection certificate under Chapter XXC is irrelevant for section 50C purposes. The issue was restored to AO for fresh examination to verify receipt of part consideration at agreement date and applicability of provisos to section 50C, directing the assessee to furnish all relevant information.

Revenue Appeals and Cross Objections

The revenue's appeals and assessee's cross objections largely mirrored issues already adjudicated. The Tribunal disposed of these accordingly, reversing or upholding orders as per the detailed analysis above.

Significant Holdings

"The provisions of sec.35DDA shall not apply to pension payments, which are recurring in nature."

"Application software usually become outdated in no time and hence they cannot be treated as capital expenditure."

"A provision is a liability which can be measured only by using a substantial degree of estimation and such provision can be allowed as deduction when (a) an enterprise has a present obligation as a result of past event; (b) it is possible that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation."

"The income from royalties is received on licensing some rights to a third party and the same is not connected with the business or business of exports carried on by the assessee and hence is an independent source of income."

"The no-objection certificate issued by the appropriate authority under Chapter XXC is not relevant for the purpose of sec.50C of the Act."

The Tribunal emphasized adherence to consistent valuation methods, proper application of statutory provisions, and reliance on coordinate bench and higher court precedents. Issues requiring factual verification were restored to the AO for fresh examination with directions to the assessee to furnish necessary details. The appeals and cross objections were partly allowed in terms of the detailed directions provided.