2010 (1) TMI 1195 - AT - Income Tax

Tribunal allows product expenses as revenue, affirms depreciation recomputation.

The Asst Commr of Income Tax Range 10 (1), Mumbai Versus M/s Kellogg India P Ltd

The Tribunal upheld the CIT(A)'s decision, allowing product development expenses under section 37(1) as revenue expenditure for the assessment year ... - 1. ISSUES PRESENTED AND CONSIDERED 1. Whether expenditures described as product development, pre-trial production and sensory/market research expenses (Rs. 36,97,528) are capital in nature or revenue expenditures deductible under section 37(1). 2. Whether depreciation for the year under consideration should be recomputed on the written down value (WDV) as on 1.4.1997 by taking into account the lesser depreciation actually allowed for assessment year 1999-00. 3. Whether reopening of assessment under section 147/148 is justified where adjustment arises from the effect of a confirmed assessment order in an earlier year (AY 1999-00) on computation of WDV for the year under consideration. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Nature of product development/pre-trial production and sensory/market research expenses (capital v. revenue) Legal framework: Revenue law distinguishes capital expenditure (incurred for acquisition of an enduring asset or new business) from revenue expenditure (incurred in carrying on existing business and deductible under section 37(1)). Expenditure enabling the assessee to remain competitive or to improve existing products may be revenue in nature; expenditure that creates a new asset or a new line of business is capital. Precedent treatment: Relevant tribunal and high court decisions were considered: a decision where expenditure not crystallised in the year and therefore disallowed (distinguished on facts); decisions where expenditure incurred in development/introduction of new variants in existing FMCG business were held revenue in nature were followed. Specific precedents relied upon by the Tribunal (as applied) treated similar product-improvement and market/sensory testing expenses as revenue, distinguishing cases where expenses created new assets or new business lines. Interpretation and reasoning: The Tribunal accepted that the expenditure related to upgrading existing cereal/flakes products - paying for market research, conducting sensory tests, development of new flavours/variants and pre-trial production - and not to acquisition of new machinery or setting up a new line of business. The expenditure was taken into Profit & Loss account and had crystallised during the year. The Tribunal reasoned that such expenditures merely enable the assessee to remain competitive, retain customer preference and improve existing product specifications; any spillover of benefit into future years was not conclusive to treat the expenditure as capital. The Tribunal distinguished authority where the issue turned on non-crystallisation in the relevant year and relied on authorities holding product-development/launch expenditure in the same business as revenue. Ratio vs. Obiter: Ratio - Expenditure on pre-trial production, market research and sensory testing incurred to develop variants of products within the assessee's existing line of business is revenue in nature and deductible under section 37(1) when incurred and reflected in the P&L account. Distinguishing obiter - The line of cases where expenditure related to creation of a new line or acquisition of enduring assets (or where expenditure had not crystallised) do not apply on these facts. Conclusion: The Tribunal confirmed the appellate authority's finding that the Rs. 36,97,528 claimed as product development expenses are revenue in nature and allowable under section 37(1); the department's ground challenging that finding was dismissed. Issue 2 - Recompute depreciation on WDV as on 1.4.1997 taking into account depreciation actually allowed for AY 1999-00 Legal framework: Depreciation under section 32 is to be computed on the block of assets using the WDV as prescribed, and prior years' depreciation (and any forced or disallowed amounts) affect subsequent WDV computations. Judicial decisions may determine whether depreciation can be claimed or forced for particular prior years, thereby impacting computations for later years. Precedent treatment: The assessee had not claimed depreciation for earlier years in reliance on a Supreme Court decision; assessments in earlier years, including AY 1999-00, were completed and the depreciation position contested and litigated with mixed outcomes. The Tribunal and appellate authority applied the principles that depreciation cannot be forced for years where the assessee validly did not claim it in reliance on binding precedent, except where an assessment order for a specific year has conclusively allowed or imposed depreciation. Interpretation and reasoning: The assessee had not claimed depreciation from FY 1996-97 onwards because of a controlling Supreme Court decision. The assessment for AY 1999-00 however had resulted in depreciation being allowed/forced via assessment order that was later confirmed at successive appellate stages up to the Tribunal. The appellate authority held that years where depreciation was not claimed due to the Supreme Court decision could not be retrospectively forced except for those years where depreciation had actually been allowed/disallowed by a final order. Consequently, for computing depreciation in the year under consideration the correct approach was to recompute on the basis of WDV as on 1.4.1997 but taking into account only the actual disallowance/allowance for AY 1999-00 which had been finally determined. Ratio vs. Obiter: Ratio - Depreciation for the year under consideration should be computed on WDV as on 1.4.1997, incorporating only those adjustments in prior years' depreciation that have been actually and finally determined against the assessee (e.g., AY 1999-00 as confirmed). Obiter - Broader statements on forcing depreciation for years where the assessee claimed none in reliance on higher judicial authority are contextual to these facts. Conclusion: The Tribunal confirmed the CIT(A)'s direction that recomputation of depreciation for the year under consideration should reflect the actual depreciation allowed for AY 1999-00; the assessee's ground was allowed in part and the appellate authority's finding was confirmed. Issue 3 - Validity of reopening assessment under section 147/148 when adjustment arises from effect of earlier year's confirmed assessment Legal framework: Section 147/148 permits reopening of assessment where the assessing officer has reason to believe that income has escaped assessment, subject to procedural conditions and the nature of the reason(s) recorded. Where adjustments arise solely from giving effect to an order in an earlier year, questions of jurisdiction and whether reopening serves any operative purpose arise. Precedent treatment: The Tribunal observed that where the effect of a confirmed assessment order in an earlier year must be given for the purposes of computing a later year's WDV, the issue of reopening can become academic if doing so would merely give effect to the earlier order without independently justifying reopening on new reasons. Interpretation and reasoning: The assessing officer reopened the year under consideration citing that depreciation allowed for AY 1999-00 had not been reduced by the assessee and therefore income escaped assessment. The Tribunal noted that because the Tribunal had confirmed the thrusting upon (i.e., adjustment of) depreciation for AY 1999-00, the correct approach was to give effect to that confirmed order in computing WDV for the year under consideration. Thus, the question whether reopening under section 147/148 was valid became academic because the substantive adjustment flowed from a confirmed earlier-year order and had to be given effect irrespective of the procedural posture of reopening the assessment for the year under consideration. Ratio vs. Obiter: Ratio - Where the only effect sought by reopening is to give effect to a confirmed assessment order in an earlier year for correct computation of WDV in the later year, the question of validity of reopening may be rendered academic and need not be adjudicated separately. Obiter - The decision does not lay down a general rule limiting the scope of reopening in all contexts; it is fact-specific where the earlier year's order has been finally determined. Conclusion: The Tribunal treated the reopening issue as academic in light of the confirmed earlier-year order and declined to adjudicate the validity of reopening separately; the appeals were disposed of accordingly.