2015 (8) TMI 328 - AT - Income Tax

Late-filed Revenue appeal heard after condoning delay, Tribunal overturns CIT(A) on expenses, directs R&D review. Appeal partly allowed.

The Revenue's appeal, despite being filed late, was admitted for hearing after the delay was condoned. The Tribunal reversed the CIT(A)'s decision on ... Capital expenditure - revenue expenditure - deduction under Section 37(1) - deduction under Section 35(iv) - enduring benefit - feasibility expenses for establishing subsidiary - pilot mill R&D validation - remand for verification of contractual and technical recordsCapital expenditure - revenue expenditure - deduction under Section 37(1) - feasibility expenses for establishing subsidiary - enduring benefit - Allowability as revenue expenditure of professional and legal fees incurred in connection with feasibility and formation of a wholly owned subsidiary in China - HELD THAT: - The Tribunal examined payments made for consultancy and legal services incurred to study feasibility and to form a new wholly owned subsidiary in China. The Assessing Officer treated these payments as capital, on the ground that they related to establishing a new company and conferred an enduring benefit. The CIT(A) had allowed the claim under Section 37(1) treating the expenditure as incurred in the ordinary course of the assessee's business and for expansion. The Tribunal found that the payments were made to determine feasibility and to establish a separate manufacturing unit abroad, were not for exporting existing products from India, and were not shown to have been abandoned so as to negate creation of a new asset. The Tribunal held that expenditure incurred to bring into existence a new manufacturing establishment abroad gives an enduring benefit and is capital in nature; accordingly such expenditure is not allowable as revenue deduction under Section 37(1). The CIT(A)'s allowance was reversed as having not appreciated these facts in proper perspective. [Paras 9, 14, 15]The addition disallowing the professional and legal fees relating to the China greenfield project is sustained as capital expenditure and not allowable under Section 37(1); the CIT(A)'s order is reversed on this issue.Deduction under Section 35(iv) - pilot mill R&D validation - remand for verification of contractual and technical records - Allowance of capital expenditure claimed under Section 35(iv) for machinery installed in a pilot mill for R&D purposes - HELD THAT: - The Assessing Officer disallowed the claim on the ground that the pilot mill machinery was leased to a third party (Super Sales India Ltd.) which operated the mill, purchased raw materials, employed staff and sold the yarn; the assessee received feedback reports and performed modifications but did not directly use the machinery in its manufacturing. The CIT(A) allowed the deduction after considering agreements and R&D validation reports filed before it, finding that the assessee's staff monitored trials and improvements in mill conditions leading to commercialization. The Tribunal observed that the record before it did not include the agreements or the technical reports relied upon by the CIT(A), and the assessee's counsel did not place those documents or explain the precise R&D activities conducted by the assessee on machinery used by the third party. Given these lacunae, the Tribunal set aside the CIT(A)'s allowance and remanded the issue to the Assessing Officer for detailed examination of the terms of the agreements, the supplementary agreement(s) and the technical reports, and for fresh decision in accordance with law as to whether the machinery was actually used by the assessee for R&D within the meaning of Section 35(iv). [Paras 22]The CIT(A)'s allowance is set aside and the matter is remanded to the Assessing Officer for detailed verification of agreements and technical records and for fresh adjudication under Section 35(iv).Final Conclusion: The Tribunal allows the Revenue's appeal in part: (i) payments for feasibility and formation of the proposed China subsidiary are capital and not deductible under Section 37(1); (ii) the claim for deduction under Section 35(iv) in respect of pilot mill machinery is remanded to the Assessing Officer for verification of agreements and technical reports and fresh decision. Appeal partly allowed for statistical purposes. Issues Involved:1. Condonation of delay in filing the appeal.2. Addition of Rs. 67,24,547/- as capital expenditure.3. Deduction of R&D expenses amounting to Rs. 4,56,43,185/-.Detailed Analysis:1. Condonation of Delay in Filing the Appeal:The Revenue's appeal was filed late by six days. The Assessing Officer filed an affidavit requesting condonation of the delay. The assessee's counsel did not seriously object to this request. Consequently, the delay was condoned, and the appeal was admitted for hearing.2. Addition of Rs. 67,24,547/- as Capital Expenditure:The assessee, a textile machinery manufacturer, incurred expenses of Rs. 67,24,547/- for professional charges paid to Pacific Consultants for a Green Field Project in China and legal fees of Rs. 51,00,000/- for establishing a subsidiary in China. The Assessing Officer disallowed these expenses, treating them as capital expenditure since they were related to forming a new subsidiary and not directly related to the assessee's business in India.The CIT(A) allowed the expenses under section 37(1) of the Income Tax Act, stating they were incurred for expanding the existing business and were necessary for the trade. The Tribunal, however, disagreed, concluding that the expenses were for establishing a new company in China, providing an enduring benefit, and thus should be treated as capital expenditure. The Tribunal reversed the CIT(A)'s order, allowing the ground raised by the Revenue.3. Deduction of R&D Expenses Amounting to Rs. 4,56,43,185/-:The assessee claimed a deduction for R&D expenses incurred on installing machinery in a pilot mill. The Assessing Officer disallowed the claim, noting that the pilot mill was leased to Super Sales India Limited (SSIL), which used its resources to manufacture yarn and provided feedback to the assessee. The Assessing Officer concluded that since the machinery was used by a third party, it was not directly used for R&D by the assessee.The CIT(A) allowed the claim, stating that the machinery was used for scientific research related to the business, and the feedback from SSIL was used to improve the machinery. The Tribunal found that the CIT(A) did not properly examine the facts and agreements between the assessee and SSIL. The Tribunal set aside the CIT(A)'s order and directed the Assessing Officer to re-examine the issue, considering the agreements and technical reports to determine if the machinery was indeed used for R&D activities by the assessee.Conclusion:The appeal of the Revenue was partly allowed for statistical purposes, with the Tribunal reversing the CIT(A)'s decision on the capital expenditure and directing a re-examination of the R&D expenses.