2018 (8) TMI 1851 - AT - Income Tax

Tribunal decision on Section 14A disallowance and pre-operative expenses upheld.

DCIT-1 (3) (2), Mumbai Versus Tata Lockheed Martin Aerostructures Ltd.

The Tribunal set aside the CIT(A)'s decision to reduce the disallowance under Section 14A read with Rule 8D and directed the Assessing Officer to ... Disallowance of expenses u/s. 14A read with Rule 8D - HELD THAT:- AO has not recorded its satisfaction by giving specific reasons as to the correctness of the claim of the assessee, therefore, we set aside the order of CIT(A) and remit the matter back to the file of AO with a direction to verify regarding the claim of assessee that no expenses were incurred for earning the exempt income, having regard to the accounts of the assessee. AO shall also verify any other claim if so raised by the assessee, and thereafter pass afresh order of assessment. It is needless here to mention that before passing the order of assessment, the AO shall provide sufficient opportunity of hearing to the assessee. Pre-operative Expenses - AO concluded that no manufacturing activity was carried out by the assessee during the entire previous year relevant to impugned assessment year under consideration and the assessee is merely at a pre-operative stage which led the AO to hold that the expenses are pre-operative expenses being capital in nature which cannot be allowed as Revenue expenses - HELD THAT:- The assessee claims that it kept highly technical and supervisory staff to oversee these activities including reviewing of assembly operation sheets supplied by Lockheed Martin Aerostructure Corporation, USA but in our considered view these are normal requirements in connection with setting up of manufacturing / assembly unit at Hyderabad for manufacturing/assembly of center wing box and empennages for C130/C130J aircraft , which is highly technical and complex activity requiring highly specialised technical staff. The activities of assembly and manufacturing of center wing box and empennages for C130/C130J aircraft being highly complex , technologically sophisticated activity involving guarded technology need highly specialised , experienced and technical personnels , and the assessee cannot afford to appoint necessary staff only after the unit becomes operational as by the time unit goes into production, the assessee ought to have all specialised, trained, experience and technical staff with it ready and well versed/trained to handle actual manufacturing/assembly of center wing boxes and empennages for C130/C130J aircrafts. The appointing of technical and specialised staff prior to unit being installed and ready to commence production will not make the same as revenue expenses even though these technical and specialised staff were reviewing the assembly operation sheets for manufacturing/assembly of center wing boxes and empennages for C130/C130J aircraft for which order was already received by the assessee from Lockheed Martin Aerostructure Corporation, USA, as all these are pre-operative expenses which needed to be capitalised as part of the cost of the project because there was no possibility of commencing production/manufacturing/assembly unless the unit is ready to commence production which in the instant case even by the year end unit was neither installed nor trial runs commenced. Thus, based on our detailed reasoning and discussions as set out above, we do not find any merits in the contentions of the assessee and thus, the appellate order of learned CIT(A) is set aside and additions as were made by the AO are sustained with the conclusions and reasoning as are arrived at by us as above. The ground no 2(a) to 2(c) are allowed. Issues Involved:1. Disallowance under Section 14A read with Rule 8D.2. Allowability of pre-operative expenses as revenue expenses.Issue 1: Disallowance under Section 14A read with Rule 8DThe Revenue challenged the CIT(A)'s decision to reduce the disallowance under Section 14A read with Rule 8D from Rs. 39,84,218/- to Rs. 22,37,456/-. The assessee received dividend income of Rs. 1,11,87,282/- claimed as exempt under Section 10(34). The AO invoked Section 14A read with Rule 8D, disallowing Rs. 39,84,218/- as expenses related to earning the exempt income. The CIT(A) partially upheld this disallowance, reducing it to Rs. 22,37,456/- based on an ad-hoc estimation of 20% of the exempt income.The Tribunal noted that the issue was covered by its previous decision in the assessee's own case (ITA no. 2144/Mum/2016 for AY 2011-12), where it remitted the matter back to the AO for fresh adjudication. The Tribunal directed the AO to verify the assessee's claim that no expenses were incurred for earning the exempt income, having regard to the accounts of the assessee, and to pass a fresh order after providing an opportunity for hearing. Consequently, the Tribunal set aside the CIT(A)'s order and restored the matter to the AO for re-adjudication in line with its earlier directions.Issue 2: Allowability of Pre-operative Expenses as Revenue ExpensesThe Revenue contested the CIT(A)'s decision to allow the deduction of Rs. 2,10,11,032/- claimed by the assessee as revenue expenses. The AO had treated these expenses as pre-operative and capital in nature, disallowing them on the grounds that the assessee's business had not commenced during the relevant year.The assessee argued that it had commenced business activities, including securing orders, executing purchase orders for tooling, and employing technical staff for reviewing assembly operation sheets. The CIT(A) accepted the assessee's contention, allowing the expenses as revenue expenses, stating that the business had commenced during the year.The Tribunal, however, disagreed with the CIT(A). It concluded that the assessee's activities, such as manufacturing tools and jigs under a sub-contract from Lockheed Martin Aerostructure Corporation, USA, were directed towards setting up its own manufacturing unit at Hyderabad, which was under construction and had not commenced production by the year-end. The Tribunal held that these activities were part of the capital expenditure for setting up the manufacturing unit and did not constitute a separate business activity. Therefore, the expenses were pre-operative and capital in nature and not allowable as revenue expenses.The Tribunal set aside the CIT(A)'s order and upheld the AO's disallowance of the expenses as capital in nature. The appeal of the Revenue was partly allowed.