Manufacturing company wins on scientific research deduction and liquidity damages while obsolete stock provision remitted for verification

ITAT Bangalore ruled on three issues for a manufacturing company. For obsolete stock provision, the tribunal held provisions are allowable in principle but remitted the matter to AO to verify proper valuation at cost or market price, whichever is less, and prevent double deduction. Regarding scientific research expenditure under section 35(2AB), uncertified amount of Rs. 7.94 crores was allowed as business deduction under section 37. For liquidity damages, the tribunal upheld CIT(A)'s decision allowing compensation for breach of contractual obligation as ordinary business expense, distinguishing it from penalties for law infraction.

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Issues Involved:
1. Disallowance of provision for obsolescence of inventory.
2. Allowability of expenditure on scientific research under Section 35(2AB) of the Income-tax Act.
3. Allowability of liquidity damages for delay in supply of goods under Section 37(1) of the Income-tax Act.

Summary:

Issue 1: Disallowance of Provision for Obsolescence of Inventory
The assessee claimed a provision for obsolescence of inventory amounting to Rs. 7,74,99,000/-, calculated using a scientific method approved by the Board of Directors. The AO disallowed this claim, stating that the assessee failed to provide reasonable certainty and documentary evidence as required under Section 37(1) of the Act. The CIT(A) confirmed this disallowance. The Tribunal noted that the provision for obsolete stock is allowable in principle but remitted the matter back to the AO to ensure that the valuation is done based on the principle of cost or market price, whichever is less, and to verify that no double deduction is claimed. The appeal was partly allowed for statistical purposes.

Issue 2: Allowability of Expenditure on Scientific Research under Section 35(2AB)
The assessee claimed expenditure on scientific research, including Rs. 7.98 crores as capital expenditure and Rs. 46.56 crores as revenue expenditure. The AO allowed the capital expenditure but disallowed Rs. 7.94 crores of the revenue expenditure not certified by DSIR. The CIT(A) allowed this amount under Section 37 of the Act, and the Tribunal upheld this decision, stating that the expenditure was incurred for the purpose of business. The appeal by the revenue was dismissed.

Issue 3: Allowability of Liquidity Damages for Delay in Supply of Goods under Section 37(1)
The assessee claimed Rs. 1,74,74,000/- as liquidity damages for delay in supply of goods. The AO disallowed this claim, considering it as a penalty for infringement of law. The CIT(A) allowed the claim, distinguishing it as compensation for breach of contractual obligation, not for infraction of law. The Tribunal upheld this decision, referencing the Gujarat High Court's judgment in Principal CIT Vs. Mazda Ltd., which differentiates between penalty for infraction of law and damages for breach of contract. The appeal by the revenue was dismissed.

Conclusion:
The Tribunal remitted the issue of provision for obsolescence back to the AO for fresh consideration, upheld the CIT(A)'s decision on the allowability of scientific research expenditure under Section 37, and confirmed the allowability of liquidity damages for breach of contract. The appeals were partly allowed for statistical purposes and dismissed respectively.

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