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TMI Blog2018 (6) TMI 604X X X X Extracts X X X X X X X X Extracts X X X X ..... and accordingly the notice issued u/s 148 deserves to be quashed and, we hold accordingly. “Reasons to suspect” rather than “reasons to believe” which fact was impliedly accepted by the Learned Commissioner wherein he has attributed the issuance of notice on the ground that “excessive deduction claimed may be sufficient for formation of requisite belief to initiate proceedings u/s 147 of the Act”. Re-assessment proceedings are not valid and consequently the additions / disallowance made therein do not stand in the eye of Law. R & D expenditure and ESOP expenses - apportionment of cost to the units which claimed exemption u/s 10B, 80IB and 80IC - Held that:- both AO as well as CIT (A) have proceeded on presumption that R & D expenses will benefit the exempted units in the long run overlooking the fact that there is nothing on record to show that all the R & D inventions / patents were never sold in outside market but only captively utilised in the exempted units. Respectfully following the decision in Bush Boake Allen (India) Pvt Ltd vs. ACIT (2003 (12) TMI 10 - MADRAS HIGH COURT), we are of the view that the Revenue has not made out a case for apportionment of R & D expenditure and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de order dated 30.11.2012 passed u/s 143(3) r.w.s 144C(5) of the Act. While passing the said assessment order, A.O. admittedly apportioned the indirect expenses such as corporate overheads etc., to various units on the basis of turnover of units, based on the conclusion reached by the ITAT, Hyderabad Bench in the assessee's own case for the assessment year 2003-04. 4. The assessment made on 30.11.2012 was sought to be reopened by the Assessing Officer u/s 147 of the Act, on the ground that the assessee booked loss of ₹ 3.88 Crs as business loss from the 100% generic EOU which was not reported earlier. According to the Assessing Officer, unreported loss needs to be adjusted against the exempted income of that year. 5. Besides, it was observed that certain expenditure like R & D expenditure and ESOP, claimed in the computation of income, were not apportioned to the special units of the assessee in respect of which deductions u/s 10B, 80IB and 80IC were claimed. This non-apportionment has resulted in huge anomaly in the percentage of the profit ratio, which has the effect of enhancing the exempt income and reducing the taxable profits. According to the Assessing Officer, the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee for the exempted and non-exempt units. The A.O therefore concluded that there was failure on the part of the assessee in not disclosing fully and truly the information before the Assessing Officer. Therefore, he proceeded to complete the re-assessment proceedings on merits. At this stage, the assessee contended that as per proviso to section 147, reopening is not permissible since the assessee produced books of account and other evidence before the Assessing Officer during original assessment proceedings from which the Assessing Officer would have duly considered the issue. The Assessing Officer rejected the contention of the assessee. According to him, the material required in connection with R & D was not furnished and therefore proceeded to reopen the assessment. 9. At this stage, it may be noticed, originally the assessment was stated to be reopened on the ground that the assessee booked a loss of ₹ 3.88 Crs which was not reported whereas during re-assessment proceedings it was noticed that by virtue of mixing of computation of total income, profits of all business units falling under the same head are aggregated first, irrespective of the fact whether they are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was of the opinion that the expenditure not apportioned to non-exempt units has to be apportioned against all the units, including taxable unit. Accordingly, assessment was completed on a total income ₹ 363.90 Crs. 12. It may be noticed that in respect of AYs 2009-10 and 2010-11, the only reason mentioned for issuing a notice u/s 148 was the non-apportionment of R & D expenditure and ESOPs to special units of the assessee wherein deduction u/s 10B, 80IB and 80IC was claimed resulting in huge anomaly in the percentage of profit ratio returned. According to the Assessing Officer, this anomaly has the effect of enhancing the exempt income and reducing the taxable profits. A.O. also accepted that R & D expenditure and ESOPs are indirect expenses. In his opinion, the same has to be apportioned to special units. In respect of A.Y. 2009-10 and 2010-11, the returns of income were filed on 30.09.2009 and 04.10.2010 respectively and the assessments were completed on 26.12.2013 and 23.02.2015 whereas the notices were issued u/s 148 of the Act on 31.03.2014 and 31.03.2015 which is beyond the period of four years from the end of relevant assessment years. As noticed in the order for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Officer accepted the contention of the assessee and dropped this observation and did not proceed for reassessment on this ground. It can thus be seen that the A.O. has no reason to believe that income has escaped assessment, on this aspect. 16. The second reason given was that certain expenditure like R & D expenditure, ESOPs etc., are not apportioned to special units which resulted in huge anomaly in the percentage of profit ratio. In this regard, Learned Counsel for the Assessee submits that in the scrutiny assessment proceedings, the assessee furnished all the necessary documents pertaining to deduction claimed under sections 10B, 80IB and 80IC of the Act. The assessee also furnished Form No. 3CM and 3CL pertaining to claim of expenditure on R & D and after considering the record, the A.O. completed the assessment u/s 143(3) of the Act. Under these circumstances, if an assessment has to be reopened beyond four years, it is the duty of the Assessing Officer to prove that there is some new material available on record or there was omission or failure on the part of the assessee so as to issue a notice for reassessment. 17. It was contended that both the conditions are conspicuou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fact, the R & D carried out in the IPDO may or may not see the light of the day. Thus there is no direct link / nexus between R & D work carried out in the IPDO and the products manufactured in the other unit, so as to apportion the R & D expenditure. Assessee relied upon a decision of the Hon'ble Bombay High Court in the case of Zandu Pharmaceutical Works Ltd (350 ITR 366) wherein the Court accepted a similar contention. In this regard, the Court observed that unless the expenditure incurred on R & D works relates to the undertaking / unit in question, the same cannot be apportioned. Reliance was also placed upon a decision of the ITAT Mumbai Bench in the case of Wockhard Ltd (ITA No.6323/Mumbai/2010, dated 13.04.2012). 21. It was also stated that the allocation of R & D expenditure to special units on a presumptive basis, on the ground that the profits of these units were skewed is fallacious. Profit percentage of each unit is independent, based on the type of product produced, targeted market of the product, product mix etc. Hence the A.O. is not right in proceeding with the allocation of expenditure on such a presumptive basis. 22. Even hypothetically assuming that new produ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce. The word "reason to believe" does not mean a subjective satisfaction on the part of the Assessing Officer but if the AO has a cause or justification to think or suppose, he can initiate proceedings. 25. Ld. CIT(A) observed that the justification of his belief is not to be judged from the standards of proof required for coming to a final decision. A belief, though justified for the purpose of initiation of proceedings u/s 147, may ultimately stand altered after hearing the assessee or on the basis of intervening enquiry. In otherwords, the Assessing Officer is not required to base his belief on any final adjudication of the matter. According to the Ld. CIT(A), the case law relied upon by the assessee are distinguishable since, in the instant case there is a reason to believe that income has escaped assessment. 26. The next issue is with regard to fulfilling the second condition i.e., whether there is failure to disclose fully and truly all material facts so as to enable the Assessing Officer to issue a notice u/s 148 of the Act. 27. Ld. CIT(A) observed that the narration of the Assessing Officer with regard to non-reporting of the loss would be sufficient to reopen the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ruly all material facts and once there exists reasonable ground for the A.O. to form a belief, that would be sufficient to cloth him with jurisdiction to issue notice though the reasons may not be adequate. 29. With regard to the change of opinion, the Ld. CIT(A) observed that in the instant case there is no discussion on the issue in the original assessment order and no details were called for by the Assessing Officer or filed by the assessee on the issue. Thus, there is no question of change of opinion which contemplates formation of some opinion at an earlier stage. A wrong application of Law cannot be held as permissible view and that can always be changed for appreciating correct legal position. In his opinion, cases of excess deduction / exemption would warrant formation of requisite belief to initiate proceedings even in a case where full disclosure was made. Though the document / claims were supported by Form No. 10CCB, but the Assessing Officer having not called for any details of R & D expenditure, except with regard to claim of weighted deduction, it cannot be held that the Assessing Officer has applied his mind to the issue. It was only during the re-assessment proceed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e taken into consideration; he observed that section 80IC, among other similar provisions, speaks of allowing deduction in respect of profits and gains "derived" by certain undertakings or enterprises. In otherwords, the assessee is under legal obligation to compute "profits and gains of eligible undertakings" separately and that of the others separately. 33. Ld. CIT(A) rejected the contention on the ground that profits and gains of eligible undertaking implies that profit has to be arrived at after deducting all the expenses, both direct and indirect, among all the operating units. Further, the devices adopted to reduce or inflate the profits of eligible business should be rejected in view of the overriding provisions of section 80IA(5) of the Act. 34. All direct expenses have to be adjusted from the profits and gains of eligible business and while computing the profits and gains of an eligible business, the Assessing Officer has to compute as if such eligible business were the only source of income of the assessee which implies that common or head office expenditure should be assumed to have incurred for such eligible business as if it is only a source of income of the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e fact that the said units are self-sustaining units and such allocation is not required in terms of sections 10B, 80IB and 80IC of the Act. In respect of Assessment Years 2008-09 and 2010-11, it was also contended that no R & D expenditure was incurred, during the previous years relevant to the assessment years under consideration, on products manufactured from these undertakings. With regard to ESOP, connected to R & D, similar plea was raised before us. 37. At the time of hearing, Learned Counsel for the Assessee elaborately contested the validity of reopening of assessment as well as the validity of apportionment of R & D expenditure as well as ESOP to the exempted units and thereafter placed before us summary of his arguments which is extracted for immediate reference:- Summary of Arguments S. No Particulars AY 2008-09 AY 2009-10 AY 2010-11 ITA No.1844/H/2017 ITA No. No.1845/H/2017 ITA No. No.1844/H/201 7 1 Financial year ending 31.03.2008 31.03.2009 31.03.2010 2 Date of filing of ROI 30.09.2008 30.09.2009 04.10.2010 3 Date of filing of revised ROI 31.3.2010 31.03.2011 NA 4 Relevant submission with respect to R&D expenses filed before the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o special units is a mere change of opinion. Hence, the proceedings u/s 148 of the Act are void ab initio and deserves to be quashed. 1.4 In this regard, we rely on various case laws as referred to in the case law compendium. Without prejudice to the above. on merits we submit as under:- Without prejudice to the above, on merits we submit as under:- 2.1 The Appellant Company is engaged in the manufacture and trading in formulations, Generics, Active Pharmaceuticals Ingredients (APls), Bio-Technology and Custom pharmaceutical services in its various units. The company also carries out its research and development work (R&D) in a specified unit namely Integrated Product Development Organization (IPDO). The Appellant has incurred most of R&D expenses to develop branded formulations, generic drugs and niche products such as bio similar and new chemical entities. The Appellant has also incurred ESOP expenses during the years under consideration. 2.2 During the re-assessment proceedings, u/s 148 of the Act, AO is of the opinion that R&D expenditure and ESOP expenses are general in nature and hence the same needs to be allocated to special units. The AO has allocated the R&D expen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enunciated below: • Finished Dosage Formulations (FDF), where our Research and Development activities are directed at the development of product formulations, process validation, bioequivalence testing and other data needed to prepare a growing list of drugs that are equivalent to numerous brand name products for sale in the highly regulated markets of the United States and Europe and emerging markets such as Russia, India etc., • Biologics: Research and development activities are directed at the development of biologics products for the emerging as well as highly regulated markets. Unlike traditional "small-molecule" drugs, biologic drugs cannot be manufactured synthetically, but typically must be produced from living plant or animal microorganisms. • Pharmaceutical Services and Active Ingredients (API) Research and Development activities concentrate on development of chemical processes for the synthesis of active pharmaceutical ingredients and intermediates ("API") for use in our Global Generics segment and for sales in the emerging and developed markets to third parties. Our research and development activities also support our custom p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t Company manufactures Formulations, Generics, and APIs etc., in its various units with the R&D activity of the Appellant Company being carried out separately in an independent unit (IPDO). The Appellant Company also exports some of the products to regulated markets like the US, Europe and semi regulated markets like Russia for which mandatory approvals are obtained from US FDA and respective regulatory authorities for such units. Lack of such approvals prohibits the sale in these geographical locations. The R&D carried out in the IPDO has no nexus with any of these products which are under manufacture in the other units including the special units as it is geared for the development of new products which may or may not see the light of day. 2.9 Therefore, in the absence of any direct link or nexus between the R&D work carried out in the IPDO and the products manufactured in the other units, the question of apportioning the R&D expenditure to these units does not arise. In this regard, we rely on the following cases: • Zandu Pharmaceuticals Works Limited vs. CIT (350 ITR 366) held that only expenditure directly relating to such eligible activity would be deductible. R&D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on before the Assessing Officer all account books or evidence from which material evidence could, with due diligence, be discovered will not necessarily amount to disclosure. However, if the material is subject matter of consideration in the first stage, on mere change of opinion, proceedings cannot be initiated. 42. In the instant case, the assessee submits that it has not only furnished complete details but they were also considered by the Assessing Officer during the course of original assessment proceedings. This fact can be noticed from the original assessment order wherein the Assessing Officer called for the details of R & D expenditure for the purpose of considering the claim of weighted deduction and, allocation of expenditure to exempt and non-exempt units was also considered vide para XV of his order wherein the Assessing Officer followed decision of the ITAT and held that corporate overheads have to be apportioned between taxable / non-taxable units. In fact the assessee gave a detailed note with regard to R & D expenditure. Page 27 (Schedule-20) refers to the note on R & D expenditure which reads as under:- "Revenue expenditure on research and development is expense ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ads, and other expenditure claimed in the computation are not apportioned to the special units. Thus it is found that this non-apportionment of expenses to special units has resulted in huge anomaly in the percentage of the profit ratio returned. It is noted that this anomaly has effect of reducing the taxable profits returned." 44. A plain reading of the reasons recorded by the AO speaks of failure on the part of the assessee in not disclosing fully and truly the loss incurred by the assessee of ₹ 3.88 Crs. It was later dropped because the allegation that the assessee has not fully and truly disclosed the loss was found to be incorrect. The other reason mentioned in the notice was that the expenditure like R & D, corporate overheads and other expenditure claimed in the computation are not apportioned to special units. It deserves to be noticed that the issue of corporate overheads was already considered in the assessment made u/s 143(3) and with regard to the R & D expenditure etc., it is not the case of the Assessing Officer that it was on account of non-disclosure - fully and truly - of the particulars of income or material facts; rather it was based on the apprehension t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he part of the Assessing Officer while issuing a notice u/s 148 of the Act. In otherwords, as rightly pointed out by the Learned Counsel for the assessee the notice issued u/s 148 is based on information already available on record at the time of original assessment and therefore, re-assessment proceedings are purely based on change of opinion and not attributable to the failure on the part of the assessee to disclose fully and truly all material information. Therefore, even under the amended provisions, we are of the firm opinion that the notice issued by the Assessing Officer cannot be said to have been based on "reasons to believe that income chargeable to tax has escaped assessment"; He has proceeded mainly on the ground that there is a "huge anomaly in the percentage of profit ratio apportioned" which implies that there is a subjective approach and not objective approach on the part of the Assessing Officer. We are of the view that the Assessing Officer has not satisfied the pre-conditions specified in section 147 of the Act, in order to assume jurisdiction for reopening of assessment, and accordingly the notice issued u/s 148 of the Act deserves to be quashed and, we hold acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t R & D activities were in relation to new products and there is nothing to indicate that in the event of assessee commercially exploiting the benefits of R & D works, the products would be manufactured by the said units. Since the Revenue's stand is based on hypothetical basis that the said products would be manufactured by each of them or any one of them, the Court concluded that it is an erroneous presumption that the benefit of any R & D activity can be exploited by an enterprise, by utilising the same in its manufacturing activity. The Court also noted that an enterprise can always assign the benefit thereof to a third party. It can grant a license in respect of any patent or design to a third party in which event the other units would not derive any benefit and thus there can be no nexus between R & D units and the units wherein the assessee is carrying on activity with regard to the existing products. Similar view was taken by the Hon'ble Madras High Court in the case of Bush Boake Allen (India) Pvt Ltd vs. ACIT (273 ITR 152) wherein the Court observed that there cannot be any presumption that any technology about new flavours or essence will automatically be utilised in oth ..... X X X X Extracts X X X X X X X X Extracts X X X X
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