Section 54G urban area test and withholding disallowance principles applied to shifting, road expense, and contractor payments.

For section 54G, "urban area" was construed by reference to the Central Government's declaration and the statutory purpose, so Chemmenchery Village was treated as urban and the shifting conditions were found satisfied on the facts of the new unit at Koppur. On road construction expenses, the evidence was doubtful, but complete disallowance was considered excessive because some access work was necessary; a partial estimate was therefore applied. For section 40(a)(i), payments were made to Indian entities for work actually executed by resident contractors with tax deducted at source, so the precondition for invoking withholding-based disallowance was not met.

---

---

Issues: (i) Whether Chemmenchery Village was an "urban area" for the purpose of section 54G of the Income-tax Act, 1961 and whether the assessee had established an industrial undertaking at Koppur Village so as to satisfy the shifting requirement under section 54G; (ii) Whether a part of the road construction expenditure claimed as business expenditure could be disallowed in full on the basis of doubtful supporting evidence; (iii) Whether disallowance under section 40(a)(i) was justified in respect of payments made in connection with the Mass Alkali Flushing work.

Issue (i): Whether Chemmenchery Village was an "urban area" for the purpose of section 54G of the Income-tax Act, 1961 and whether the assessee had established an industrial undertaking at Koppur Village so as to satisfy the shifting requirement under section 54G.

Analysis: The expression "urban area" in the Explanation to section 54G(1) is controlled by the Central Government's declaration. The Notification dated 2 April 1996 declared municipal areas, including Madras, as urban areas for the purpose of section 54G. The State Government's later notification was treated as recognising an existing expansion of Chennai's city limits rather than creating urban character for the first time. The surrounding statutory context, including the urban land tax regime and the material showing payment of urban land tax, supported the view that Chemmenchery formed part of the urban area. On the facts, the acquisition of land at Koppur, the machinery purchases, and the registration and licensing materials showed that an industrial undertaking had been set up there. The statutory time window for purchase of new assets and establishment of the shifted unit was also met.

Conclusion: The issue was decided in favour of the assessee. Chemmenchery Village was treated as an urban area, and the assessee was held to have satisfied the shifting condition under section 54G.

Issue (ii): Whether a part of the road construction expenditure claimed as business expenditure could be disallowed in full on the basis of doubtful supporting evidence.

Analysis: The evidence produced for the entire claim was not fully reliable because the persons shown as contractors denied executing the work and denied their signatures. At the same time, the assessee was admittedly carrying out substantial project work at remote sites where temporary access roads were necessary for transporting heavy equipment and commencing construction. The authorities did not dispute that some road access work would have been required. In the circumstances, complete disallowance was considered unjust, but the claim was also found to be exaggerated. A partial estimate was therefore adopted to balance the competing features of the evidence.

Conclusion: The issue was decided partly in favour of the assessee. The claim was not allowed in full, but only 25% of the total disallowance was sustained.

Issue (iii): Whether disallowance under section 40(a)(i) was justified in respect of payments made in connection with the Mass Alkali Flushing work.

Analysis: The work order was originally addressed to a non-resident concern, but the actual execution was through two Indian entities to whom the assessee made payments after deducting tax at source under section 194C. Since the assessee did not make direct payments to the non-resident and had complied with withholding obligations in relation to the resident contractors, section 195 was held inapplicable. On that footing, the precondition for invoking section 40(a)(i) was not made out.

Conclusion: The issue was decided in favour of the assessee. The disallowance under section 40(a)(i) was deleted.

Final Conclusion: The appeal succeeded to a substantial extent, with relief granted on the capital gains exemption issue and the section 40(a)(i) issue, and only a portion of the road expenditure claim being restricted.

Ratio Decidendi: For section 54G, the expression "urban area" must be construed in light of the Central Government's declaration and the statutory object of facilitating shifting from congested urban locations; and section 40(a)(i) is attracted only where a sum chargeable under the Act is paid to a non-resident and tax was required to be deducted under section 195.

---