2018 (3) TMI 2060 - AT - Income Tax

Assessee allowed 10A deduction, revenue expenses, forex loss u/s 37(1); 271(1)(c) penalty deleted, 14A, 40(a)(ia) upheld

Mahindra Engineering Services Ltd. Versus The Dy. Commissioner of Income Tax, Circle 2 (2), Mumbai & The Asstt. Commissioner of Income Tax, Range-2 (2), Mumbai And (Vice-Versa)

ITAT Mumbai allowed the assessee's claim for business development expenses as revenue expenditure, following its earlier decision in the assessee's own ... Disallowance of business development expenses - capital expenditure for creation of intangible asset OR revenue expenditure incurred for the purpose of business of the Appellant - HELD THAT:- We notice that the assessee had debited expenses amounting to Rs. 239 lacs incurred in US for the purpose of business development. During the course of assessment proceedings as well as during the appellate proceedings, the assessee contended that the expenses were incurred for the purpose of business development mainly in the form of salary paid to an employee developing new clients in US and other business development related expenses including travelling and hospitality. However, the authorities below rejected the contention of the assessee and disallowed the claim. As pointed out by the Ld. counsel, the co-ordinate Bench of the Tribunal has dealt with the identical issue in the assessee’s own case for the assessment year 2006-07 [2012 (3) TMI 736 - ITAT MUMBAI] held it is clear that there is no case of shifting of expenditure of the STP unit to the non STP unit for the year under consideration because the STPI has been set up in the year under consideration and that too in the month of Jan 2006. When the operating profit as well as net profit of the non STP unit is considerably higher than the earlier year and even the expenses were also less in the year under consideration in comparison of the earlier year, therefore, we do not see any reason of manipulation in the accounts of reducing of profit of non STP unit. Even otherwise, the Assessing Officer has not made out any specific instance of shirting of expenditure or any defect in the accounts of the assessee or in the method adopted by the assessee for computing the income of the respective units. Disallowance u/s 10A - AO has denied the deduction mainly on the ground that by setting up the STPI Unit, the appellant had not started a new business - CIT(A) observed that findings of the AO are based on an inadequate premise as the AO has based his findings on the purchase order dated 15.10.2004 and the nature of services in the pre existing non STPI unit and the comparable rates of pre STPI and STPI jobs - HELD THAT:- We find that the observations of the Ld. CIT (A) are based on the evidence on record. As observed by the Ld. CIT (A) the purchase order dated 15.10.2004 was in connection with only a Pilot Project mounted to test the ability of the appellant company to do business on a magnitude and level compatible to the expectations of ITEC. The work given for the Pilot Project was initially for a sum of Rs. 9.3 crores, however, after signing the contract with International Truck and Engine Corporation (ITEC), the STPI unit earned revenue of Rs. 42.74 crore. As per para 2.3 of the Agreement, with the commencement of joint Venture, the purchase order dated stood terminated. Hence, in our considered opinion, the findings of the Ld. CIT (A) are based on the evidence on record and in accordance with the settled principles of law. No reason to interfere with the findings of the Ld. CIT (A). Accordingly, we uphold the findings of the Ld. CIT (A) and dismiss both the grounds of the revenue’s appeal. Penalty u/s 271(1) (c) - disallowance of business development expenses - Since, we have decided the quantum appeal in favour of the assessee and deleted the addition, the penalty order under challenge does not survive. Disallowance of foreign exchange fluctuation on the ground that it was notional loss - We have perused the material on record. In Woodward Governor India P. Ltd. [2009 (4) TMI 4 - SUPREME COURT] has held that the Loss suffered by the assessee in respect of a revenue liability on account of exchange difference as on the date of the balance sheet is an item of expenditure allowable under s. 37(1) in the year of accrual. Since, this issue is covered by the judgment of the Hon’ble Supreme Court, the Ld. CIT (A) has wrongly confirmed the disallowance made by the AO on account of foreign exchange fluctuation loss. We therefore allow this ground of appeal of the assessee. Disallowance u/s 14A read with Rule 8D - We notice that the AO has calculated the disallowance as per the provisions of Rule 8D of the Income Tax Rules. AO has made addition of 0.5% of the average investment of the assessee in accordance with the provisions of rule 8D (2)(iii) of the Income Tax Rules. Since, the AO has made the addition in accordance with the provisions of law, in our considered opinion the Ld.CIT (A) has rightly upheld the addition made by the AO. We therefore do not find any infirmity in the findings of the Ld. CIT (A) to interfere with the same. Accordingly, we dismiss this ground of appeal of the assessee. Disallowance u/s 40(a)(ia) - assessee had made less deduction of source at source and failed to appreciate that section 40(a)(ia) is applicable for lower deduction of tax at source - HELD THAT:- CIT (A) has decided this issue in favour of the assessee relying on the decision of the ITAT, Kolkatta in the case of M/s S.K. Tekriwal [2011 (10) TMI 10 - ITAT, KOLKATA] as held that the conditions laid down u/s 40(a)(ia) of the Act for making addition is that tax is deductible at source and such tax has not been deducted if both the conditions are satisfied then such payment can be disallowed u/s 40(a)(ia) of the Act but where tax is deducted by the assessee, even under bonafide wrong impression, under wrong provisions of TDS, the provisions of section 40(a)(ia) of the Act cannot be invoked. ISSUES PRESENTED AND CONSIDERED 1. Whether expenses of business development incurred in the US (salaries, travel, hospitality) are revenue in nature and deductible, or capital expenditure creating an intangible asset and to be disallowed. 2. Whether deduction under section 10A is permissible for profits of a newly formed STP/STPI unit or is precluded because the STP unit is a continuation/splitting/reconstruction of the existing non-STP undertaking. 3. Whether reopening of assessment under section 147 is valid where deduction under section 10A was earlier examined and allowed. 4. Whether penalty under section 271C (formerly cited as 271(1)(c) in record) is sustainable where additions giving rise to penalty are deleted in quantum appeal. 5. Whether foreign exchange fluctuation loss (provision for exchange difference as on balance sheet date) is a notional/contingent loss disallowable, or an allowable revenue expenditure under section 37(1). 6. Whether disallowance under section 14A (expenditure related to exempt income) can be made where Rule 8D is applied and AO computes percentage-based disallowance. 7. Whether disallowance under section 40(a)(ia) is permissible where tax was deducted but under a bonafide but incorrect understanding of TDS provisions. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Characterisation of US business development expenses (capital v. revenue) Legal framework: Distinction between capital and revenue expenditure governed by principles of what creates enduring benefit/asset vs day-to-day business expenses; allowable deductions for revenue expenditure under relevant provisions. Precedent treatment: Tribunal's coordinate bench decision in the assessee's own earlier assessment year held similar US business development expenses to be revenue in nature and allowable. Interpretation and reasoning: Authorities below treated the expenses (Rs. 2.39 crores) as capital, reasoning they created an intangible asset. The Tribunal, however, examined the nature of payments (salaries to employee developing clients, travel, hospitality) and relied upon the coordinate bench's detailed factual and comparative analysis showing separate identification of expenses and absence of manipulation or shifting of costs between units. The Tribunal found the expenses were incurred for carrying on business (marketing/client development) and did not create an enduring intangible asset that would necessitate capitalisation. Ratio vs. Obiter: Ratio - where expenses are for salaries and ordinary business development activities separately identifiable and not creating a distinct enduring asset, they are revenue and deductible; the Tribunal applied and followed its previous ratio in the assessee's case. (Observations about account comparisons and lack of manipulation are operative to the decision.) Conclusion: Disallowance upheld by lower authorities was set aside; AO directed to allow the claim and delete the addition. Issue 2 - Eligibility for deduction under section 10A for STP/STPI unit (new unit v. continuation/splitting/reconstruction) Legal framework: Conditions for section 10A deduction require that the new undertaking not be a result of splitting up or reconstruction of an existing business; tests in jurisprudence (investment of fresh capital, employment of requisite labour, separate and distinct identity, profits attributable to new undertaking) define whether a unit is genuinely new. Precedent treatment: Tribunal and appellate authorities have applied Supreme Court tests (Textile Machinery thesis) to determine whether splitting/reconstruction has occurred; coordinate bench decision in assessee's own case accepted STP unit as new based on these tests. Interpretation and reasoning: The CIT(A) and Tribunal reviewed the factual matrix - fresh scale, different jobs, fresh investments, distinct manpower and contracts (engineering service agreement), termination of prior purchase order upon joint venture commencement, and substantial revenue earned by STP unit - and applied the established tests. The AO's reliance on an earlier purchase order and comparable rates was held to be an inadequate basis to treat the STP unit as continuation. The Tribunal found that the STP unit met the statutory and judicial tests for being a new undertaking. Ratio vs. Obiter: Ratio - where a purported new unit demonstrates fresh capital, distinct operations, different personnel and profits attributable to the new unit, it will qualify as a new undertaking for section 10A; such factual determination is binding on appeal unless rebutted. (Followed coordinate bench precedent.) Conclusion: Deductions under section 10A restored for the STP unit; additions based on denial of section 10A deleted and revenue's appeals on this point dismissed. Issue 3 - Validity of reopening assessment under section 147 where section 10A deduction was previously examined and allowed Legal framework: Section 147/148 permits reopening on satisfaction of reason to believe about escaped income; reopening invalid if no jurisdictional satisfaction or if issues finally adjudicated; however, factual sufficiency of belief is generally for AO to record subject to appellate scrutiny. Precedent treatment: The Tribunal accepted that reopening was upheld by CIT(A) but proceeded to examine merits of section 10A claim relying on factual findings; coordinate bench precedent supporting eligibility was applied. Interpretation and reasoning: Although reopening was sustained by CIT(A), the Tribunal found on merits that the STP unit qualified for section 10A. The Tribunal did not invalidate the reopening per se but directed restoration of the deduction consistent with factual findings and prior appellate conclusions. Ratio vs. Obiter: Obiter concerning procedural propriety of reopening (since the Tribunal did not overturn reopening) - the operative ratio is that reopening does not preclude a facts-based grant of deduction where evidence establishes eligibility. Conclusion: Even if reopening was sustained, deduction under section 10A was to be restored on merits; AO directed to allow the deduction. Issue 4 - Penalty under section 271C consequent to deleted additions Legal framework: Penalty provisions are contingent upon sustained findings of concealment or inaccurate particulars; deletion of underlying additions often renders penalty unsustainable. Precedent treatment: Where quantum additions are deleted, appellate authorities have routinely quashed concomitant penalties unless independent culpability established. Interpretation and reasoning: The Tribunal deleted the quantum addition relating to business development expenses (Issue 1); since the penalty was predicated on that addition, the Tribunal held the penalty did not survive. Ratio vs. Obiter: Ratio - penalty founded solely on an addition that is subsequently deleted must be deleted unless separate evidence of concealment or inaccuracy exists. Conclusion: Penalty under section 271C deleted and appeal on penalty allowed. Issue 5 - Allowability of foreign exchange fluctuation loss (provision for exchange difference) as revenue expenditure Legal framework: Section 37(1) permits deduction of business expenditure not otherwise disallowed; mercantile accounting recognises provision for known losses at year-end; Supreme Court precedent addresses exchange difference treatment. Precedent treatment: The Hon'ble Supreme Court in Woodward Governor held that exchange difference loss on revenue liability as at balance sheet date is allowable under section 37(1). Interpretation and reasoning: The Tribunal followed the Supreme Court in Woodward Governor: exchange fluctuation loss provision is an item of expenditure allowable in the year of accrual; the CIT(A)'s characterization of the loss as contingent/notional was held to be contrary to that binding precedent. Ratio vs. Obiter: Ratio - exchange difference loss accruing on a revenue liability at balance sheet date is allowable under section 37(1) (Supreme Court binding authority). Conclusion: AO/CIT(A) disallowance of foreign exchange fluctuation loss set aside; appeal allowed on this ground. Issue 6 - Disallowance under section 14A and Rule 8D computation Legal framework: Section 14A read with Rule 8D permits disallowance of expenses in relation to exempt income; Rule 8D prescribes formulae including specified percentages applied to average investments. Precedent treatment: Application of Rule 8D by AO to compute notional disallowance accepted where AO follows statutory formulae. Interpretation and reasoning: The AO computed disallowance by applying Rule 8D (0.5% of average investments per clause invoked) and the Tribunal found that the AO had acted in accordance with the provisions of law. The assessee's contention that AO failed to record satisfaction that exempt income was relevant did not overturn the statutory formula's applicability in this record. Ratio vs. Obiter: Ratio - where AO computes disallowance in accordance with Rule 8D, appellate interference is unwarranted absent material irregularity. Conclusion: Disallowance under section 14A upheld as computed under Rule 8D; assessee's ground on this point dismissed. Issue 7 - Disallowance under section 40(a)(ia) where tax was deducted under a bonafide but incorrect provision Legal framework: Section 40(a)(ia) disallows expenditure where tax is deductible at source and has not been deducted or not paid on or before due date; separate treatment under section 201 (assessee as deductor in default) may apply where tax was deducted but not correctly or timely paid. Precedent treatment: ITAT Kolkata (S.K. Tekriwal) held that section 40(a)(ia) has two limbs and cannot be invoked where tax was deducted though under a bonafide wrong impression; then recourse is to section 201 rather than automatic disallowance under 40(a)(ia). Interpretation and reasoning: The CIT(A) relied on S.K. Tekriwal (ITAT Kolkata) and concluded that where tax had been deducted (though possibly under wrong provision) and there was bona fide dispute, invoking section 40(a)(ia) to disallow expenses is inappropriate. The Tribunal found no contrary binding decision and therefore upheld the deletion of the 40(a)(ia) addition. Ratio vs. Obiter: Ratio - disallowance under section 40(a)(ia) is inappropriate where tax has been deducted but there is bonafide dispute or wrong provision invoked; default and recovery matters are to be pursued under section 201 and related provisions (following cited tribunal authority). Conclusion: Deletion of addition under section 40(a)(ia) sustained; revenue's appeal on this point dismissed.