2016 (12) TMI 1917 - AT - Income Tax

Project development expenses allowed as revenue expenditure under section 37(1) after tribunal finds adequate substantiation

Reliance Lifestyle Holdings Ltd. Versus Dy. Commissioner of Income Tax Range 3 (1), Mumbai

ITAT Mumbai allowed the assessee's appeal regarding project development expenditure disallowance under section 37(1), holding that expenses comprising ... Disallowance of Project Development Expenditure u/s 37(1) - HELD THAT:- Expenditures consisted of Salaries and wages, Employees welfare and other amenities, travelling and conveyances, legal and professional fees and other interest paid which appeared to be apparently of revenue expenditure. In our opinion the submissions of the ld. AR carry weight that in order to claim expenses the manner, mode and mere entries in the books of account and final presentation in the balance sheet is not material. We further find that the issue in hand stands covered in favour of the assessee by the decision of M/s Reliance Footprint Ltd. [2013 (12) TMI 161 - ITAT MUMBAI] as held it cannot be said that assessee did not provide the necessary details. By furnishing these details, the assessee had placed on record prima facie material to substantiate the query raised by Ld. CIT(A). Without pointing out any defect and without brining any adverse material on record, Ld. CIT(A) has observed that assessee has failed to prove that the expenditure was made wholly and exclusively for the purpose of business of the assessee. Thus there is no basis for recording such finding. Therefore, even for the additional reasons described by Ld. CIT(A), the disallowance cannot not be upheld. Disallowance u/s 43B(f) in respect of reversal of provision for leave encashment - HELD THAT:- As submitted before us during the course of hearing the provision for leave encashment was not claimed as deduction in the year of creation of the said provision and therefore in the year of reversal/writing back of leave encashment due to non-claim of leave encashment by the employees who have consumed leave period of the same could not be offered to tax. We are of the considered opinion that if at the time of creation of provision of leave encashment, deduction was not claimed, the AO was not justified to bring to tax the amount written back out of the said provisions for leave encashment. Therefore, we find merit in the argument of the ld.AR that reversal could not be taxed on the ground that the same were not claimed as deduction in the earlier year in which the same were created. The issue is required to be examined at the end of the AO and it would be fair and reasonable if the matter is set aside and restored back to the file of AO to examine whether the amount written back was claimed as deduction or not and decide the issue accordingly as per fact and law. Issues Presented and ConsideredTwo core legal questions were considered by the Tribunal:1. Whether the expenditure of Rs. 1,05,89,163/- claimed by the assessee as revenue expenditure under section 37(1) of the Income Tax Act, despite being shown as Project Development Expenditure under Work-in-Progress (WIP) in the books of account, is allowable as a deduction or is rightly disallowed as capital expenditure by the Assessing Officer and confirmed by the Commissioner of Income Tax (Appeals) (CIT(A)).2. Whether the reversal of provision for leave encashment amounting to Rs. 36,40,709/- is taxable under section 43B(f) of the Income Tax Act when the provision was not claimed as deduction in the earlier years at the time of creation, and whether the CIT(A) was justified in confirming the addition made by the AO.Issue-wise Detailed AnalysisIssue 1: Allowability of Project Development Expenditure as Revenue Expenditure under Section 37(1)Relevant Legal Framework and Precedents: Section 37(1) permits deduction of any expenditure (not being capital expenditure or personal expenses) incurred wholly and exclusively for the purpose of business. The Supreme Court in Arvind Mills Ltd. v. CIT held that expenditure incurred on a capital asset does not lose its capital character merely because it ensures efficient running of the business. Further, decisions such as CTR v. Granite City Steam Ship Co. and Ashoka Hotels v. CIT establish that expenditure incurred for acquisition, creation, or bringing into existence of an asset or enduring benefit is capital expenditure.Court's Interpretation and Reasoning: The AO disallowed the claim on the ground that the expenditure was shown as Project Development Expenditure under WIP in the balance sheet, indicating capital nature since the project was not completed during the year. The CIT(A) upheld this view relying on the principle that capital expenditure cannot be converted into revenue expenditure merely by accounting treatment. The Tribunal, however, examined the nature of expenses in detail and noted that the expenditure mainly comprised salaries, wages, employee welfare, rent, rates and taxes, travelling, legal and professional fees, interest, and general administrative charges. These are typically revenue in nature.The Tribunal emphasized that the mode of accounting or classification in the books of account is not decisive for the allowability of deduction under the Income Tax Act. It referred to a coordinate bench decision in the case of the assessee's sister concern, which held that expenditure incurred for expansion of business, even if shown as capital in books, is allowable as revenue expenditure if it does not create any enduring benefit or asset.Key Evidence and Findings: The assessee furnished detailed breakup of expenses with job descriptions and nature of work performed by employees, substantiating that these expenses were incurred wholly and exclusively for business operations and expansion. The Tribunal found no adverse material negating these claims.Application of Law to Facts: Applying the legal principle that the substance of the expenditure governs its character rather than the form or accounting treatment, the Tribunal held that these expenses were revenue in nature and allowable under section 37(1). The Tribunal distinguished the facts from the cited Supreme Court decisions, which dealt with genuine capital expenditures.Treatment of Competing Arguments: The Revenue argued that the expenditure was capital as per books and was part of WIP, indicating an unfinished project. The Tribunal rejected this contention, holding that the accounting classification cannot override the true nature of expenditure. The Tribunal also noted that the assessee had disallowed certain amounts under other sections and claimed only the balance, further supporting bona fide claim.Conclusions: The Tribunal reversed the orders of the AO and CIT(A) and allowed the deduction of Rs. 1,05,89,163/- as revenue expenditure under section 37(1).Issue 2: Taxability of Reversal of Provision for Leave Encashment under Section 43B(f)Relevant Legal Framework and Precedents: Section 43B contains a non-obstante clause mandating that certain deductions shall be allowed only on actual payment basis, irrespective of the method of accounting. Leave encashment provisions fall under this section. The Supreme Court decisions in CIT v. Vinay Cement Ltd., CIT v. Maruti Udyog Ltd., Berger Paints India Ltd. v. CIT, and others have held that deductions under section 43B are allowable only on actual payment.Court's Interpretation and Reasoning: The AO disallowed the reversal of provision for leave encashment of Rs. 36,40,709/- on the ground that it was not allowable as deduction under section 43B since the provision was reversed and not paid. The CIT(A) confirmed the disallowance relying on the overriding effect of section 43B and relevant judicial precedents.The assessee contended that the provision for leave encashment was created in earlier years but was not claimed as deduction in those years. During the year under consideration, the provision was reversed due to employees consuming leave without encashment, and hence the reversal reduced the current year's expenditure. The assessee argued that since the provision was never deducted earlier, the reversal should not be brought to tax now.Key Evidence and Findings: The Tribunal noted that the provision had an opening balance carried forward from earlier years and that the reversal was out of this opening balance. The assessee's contention that the provision was not claimed as deduction in the year of creation was supported by records.Application of Law to Facts: The Tribunal observed that if the deduction was not claimed in the earlier years when the provision was created, it would be unjust to tax the reversal in the current year. The principle of matching income and expenditure and avoiding double taxation applies.Treatment of Competing Arguments: The Revenue relied on the strict provisions of section 43B and judicial precedents to support the disallowance. The Tribunal, however, found merit in the assessee's argument and considered that the matter required factual examination as to whether the deduction was claimed earlier or not.Conclusions: The Tribunal set aside the issue to the file of the AO for fresh examination of facts regarding whether the provision was claimed as deduction in earlier years and directed the AO to decide accordingly. The appeal was partly allowed for statistical purposes.Significant HoldingsOn the first issue, the Tribunal stated verbatim:'In our opinion the submissions of the ld. AR carry weight that in order to claim expenses the manner, mode and mere entries in the books of account and final presentation in the balance sheet is not material.'Further, relying on the coordinate bench decision, the Tribunal held:'These expenditures did not create any asset and also did not provide enduring benefit to the business of the assessee so as to say that the expenditure was capital in nature. Therefore, we hold that expenditure are allowable in the year under consideration irrespective of the fact that assessee has given dual status to such expenditure in its books of account vis-`a-vis computation of income filed alongwith return.'On the second issue, the Tribunal held:'We are of the considered opinion that if at the time of creation of provision of leave encashment, deduction was not claimed, the AO was not justified to bring to tax the amount written back out of the said provisions for leave encashment.'However, the Tribunal directed:'...the matter is required to be examined at the end of the AO and it would be fair and reasonable if the matter is set aside and restored back to the file of AO to examine whether the amount written back of Rs. 36,40,709/- was claimed as deduction or not and decide the issue accordingly as per fact and law.'Core principles established include:The character of expenditure for tax deduction purposes is determined by its substance and nature, not by its classification or treatment in the books of account.Expenditure incurred for expansion or maintenance of existing business which does not create capital asset or enduring benefit is revenue expenditure allowable under section 37(1).Under section 43B, deduction for leave encashment is allowable only on actual payment; however, reversal of provision not previously claimed as deduction cannot be taxed without examining facts.The AO must verify whether deduction was claimed at the time of provision creation before taxing reversal of such provision.Final determinations:The disallowance of Rs. 1,05,89,163/- as capital expenditure was reversed and the amount was allowed as revenue expenditure under section 37(1).The addition of Rs. 36,40,709/- on account of reversal of leave encashment provision under section 43B(f) was set aside and remanded to the AO for fresh consideration based on factual verification.