2025 (5) TMI 751 - AT - Income Tax

ITAT deletes section 14A disallowance, grants R&D deduction relief, removes TDS disallowance for overseas testing services

Atul Limited Versus ACIT, Cir. 1 (1) (1) Ahmedabad.

The ITAT Ahmedabad allowed the assessee's appeal on multiple grounds. The disallowance under section 14A and Rule 8D was deleted as the AO failed to ... Disallowance u/s 14A r.w. Rule 8D - addition to book profits u/s 115JB - contention of the assessee that it had already made a suo motu disallowance based on a scientific and reasonable basis, and that no further disallowance was warranted - HELD THAT:- There is no discussion or rebuttal of the assessee’s specific computation nor is any reason assigned as to why the same was incorrect or unacceptable. The jurisdictional requirement under section 14A(2), as interpreted by various courts is that the AO must record dissatisfaction with reference to the accounts of the assessee, and not merely on general assumptions. It is equally well-settled that the AO is not duty-bound to apply Rule 8D in every case; he is merely empowered to do so, subject to recording cogent dissatisfaction with the assessee’s working, as a condition precedent. Absent such dissatisfaction, Rule 8D cannot be invoked. This view also finds support from several judicial precedents relied upon by the assessee. We also note that in the assessee’s own case in a prior year, the Coordinate Bench had directed that disallowance under Rule 8D be restricted only to investments which yielded exempt income, in view of the decision of the Special Bench in Vireet Investment (P) Ltd. [2017 (6) TMI 1124 - ITAT DELHI] and the Revenue was unable to point out any contrary binding decision or deviation in facts. Though in that year the assessee had not presented the same elaborate arguments as in the current year, the underlying principle remains supportive of the assessee’s claim. In fact, if not for the absence of proper satisfaction u/s 14A(2), we would have inclined to restore the matter to the Assessing Officer with a direction to recompute the disallowance by excluding investments that did not yield any exempt income, consistent with the settled legal position. However, the statutory violation of section 14A(2) gives us the legal foundation to accept the assessee’s working in totality. In the light of the above, we find that the action of the Assessing Officer in invoking Rule 8D in the absence of proper satisfaction is not in accordance with law. The assessee’s methodology of disallowance is reasonable, based on actual data, and has remained accepted in earlier assessments. Disallowance u/s 14A to the book profit computed u/s 115JB - A conspectus of the judicial pronouncements would lead us to safely conclude that the scheme of Section 115JB, particularly in relation to Clause (f) of Explanation 1 therein, does not envisage any addition of disallowance computed under Section 14A of the Act to calculate MAT as per Section 115JB of the Act. Rather, both the provisions stand separately as no correlation exists between them for the purpose of determining the taxable income. The addition of the concerned disallowance made by the AO while computing MAT is dehors the provisions of the Act and hence, cannot be sustained. In view of the clear finding of the coordinate bench in the assessee’s own case, supported by the judgement of the Hon’ble High Court in Moon Star Securities [2024 (3) TMI 667 - DELHI HIGH COURT] the adjustment made to the book profit under section 115JB is without legal foundation and is accordingly directed to be deleted. Accordingly, both the disallowance under section 14A and the consequent addition under section 115JB are directed to be deleted. Disallowance of deduction under section 35(2AB) and alternate claim u/s 35(1)(iv) - We note that the assessee has furnished a detailed item-wise listing of its R&D capital assets in Annexure I to Form 3CLA (refer PB page 398), including descriptions, amounts, and dates of capitalization. The reconciliation statement provided by the assessee also demonstrates that the amount disallowed by the AO corresponds to this detailed claim. There is no material brought on record by the AO to dispute the nature or genuineness of this expenditure. The summary rejection of the claim in the final order, without any factual inquiry or contradiction of the evidence, cannot be sustained. We also note that the AO has not doubted the R&D facility itself, which was duly approved by DSIR, nor has there been any finding that the capital expenditure in question was not incurred for scientific research. Therefore, in the absence of any factual infirmity, and considering the consistent judicial view that DSIR certification is not a prerequisite for claiming deduction u/s 35(1)(iv), we hold that the alternate claim of the assessee merits acceptance. However, to the extent the claim under section 35(2AB) exceeded the amount approved in Form 3CL, the disallowance of the weighted deduction under that section stands, and we see no reason to interfere with that part of the order. The relief is limited to allowing the said amount of Rs. 73,20,990/- under section 35(1)(iv) at 100%, in lieu of 200% under section 35(2AB). Accordingly, we direct the AO to allow the deduction u/s 35(1)(iv), being capital expenditure incurred wholly and exclusively for scientific research in the assessee’s approved R&D facility. This ground of appeal is allowed to the extent indicated above. TDS u/s 195 - Non- Deduction of TDS on Testing Charges - payments made to non-resident vendors - HELD THAT:- We find that the services rendered by Eurofins Analytics, Atul Europe Ltd., Commodity Inspection Services BV, and Bioagri Laboratories Ltda. were purely in the nature of certification/testing services carried out abroad for meeting foreign compliance requirements. The testing did not involve any transfer of technical knowledge or experience, nor was any technical plan or design made available to the assessee. The services were entirely utilized for export transactions. Accordingly, u/s 9(1)(vii)(b), such income does not accrue or arise in India. Moreover, in terms of respective DTAAs the payments do not qualify as “fees for technical services” in the absence of “make available” clause being satisfied. None of the recipients have a permanent establishment in India. Thus, on DTAA interpretation also, the income is not taxable in India. Disallowance u/s 40(a)(i) is not sustainable. AO is directed to delete the disallowance. The grounds raised by the assessee are accordingly allowed. The primary legal issues considered in this appeal pertain to the validity and quantum of disallowances and additions made by the Assessing Officer (AO) and upheld by the Dispute Resolution Panel (DRP) under various provisions of the Income Tax Act, 1961, specifically sections 14A, 35(2AB), 35(1)(iv), 40(a)(i), and 115JB. The core legal questions examined include:Whether the disallowance under section 14A read with Rule 8D(2)(iii) was correctly made without recording the mandatory satisfaction under section 14A(2), and whether the consequent addition to book profits under section 115JB was legally sustainable;Whether the weighted deduction claimed under section 35(2AB) for in-house R&D expenditure was rightly disallowed due to absence of DSIR approval in Form 3CL, and whether the alternate claim under section 35(1)(iv) for capital expenditure on scientific research should be allowed;Whether the disallowance under section 40(a)(i) for non-deduction of tax at source on payments to non-resident entities for testing charges was justified, considering the nature of services and applicability of section 9(1)(vii) and relevant Double Taxation Avoidance Agreements (DTAAs);General challenge to the legality of the assessment order passed pursuant to directions of the DRP.Issue-wise Detailed Analysis:1. Disallowance under Section 14A read with Rule 8D(2)(iii) and Addition under Section 115JBThe legal framework mandates that before invoking Rule 8D to compute disallowance under section 14A, the AO must record satisfaction under section 14A(2) that the assessee's own computation of expenditure in relation to exempt income is incorrect or inadequate. The AO's failure to record such satisfaction invalidates the application of Rule 8D. The Supreme Court in Maxopp Investment Ltd. clarified that strategic investments yielding exempt income are subject to section 14A disallowance; however, the procedural precondition of recording dissatisfaction remains imperative.The AO disallowed Rs. 8,26,43,616/- by applying Rule 8D(2)(iii) based on 1% of average investments, rejecting the assessee's suo motu disallowance of Rs. 8,25,900/- which was computed on a detailed, scientific basis allocating expenses such as sitting fees, salaries of treasury and finance personnel, conveyance, and administrative costs. The DRP upheld the AO's disallowance.The Court noted that the AO's order lacked any specific or objective recording of dissatisfaction with the assessee's computation, relying instead on general assumptions about the size of investments and indirect expenditure. The principle of natural justice and statutory mandate require a reasoned satisfaction, which was absent. The assessee's methodology was consistent with prior accepted assessments and supported by detailed evidence.Regarding the addition to book profits under section 115JB, the Court observed that section 115JB is a self-contained code, and disallowance under section 14A does not automatically translate into an addition to book profits unless the expenditure is debited to the profit and loss account. Reliance was placed on judicial precedents including the assessee's own prior decisions and the Delhi High Court's ruling in Moon Star Securities Trading & Finance Co., which held that such addition is not warranted.The Court concluded that the disallowance under section 14A and the consequent addition under section 115JB were not sustainable and directed their deletion.2. Disallowance of Weighted Deduction under Section 35(2AB) and Alternate Claim under Section 35(1)(iv)Section 35(2AB) permits weighted deduction for in-house scientific research expenditure, subject to approval and certification by the Department of Scientific and Industrial Research (DSIR) via Form 3CL. The AO disallowed Rs. 1,63,54,602/- claimed under this section as the amount was not certified in Form 3CL, despite the genuineness of expenditure not being disputed.The assessee argued that the disallowance was based on procedural grounds, not on the nature or genuineness of the expenditure, and pressed for allowance of the amount under section 35(1)(iv), which provides 100% deduction for capital expenditure on scientific research, independent of DSIR approval. The AO rejected the alternate claim without factual verification, contrary to DRP's direction to examine it.The Court examined the statutory provisions and found that section 35(1)(iv) operates independently and does not require DSIR certification. The assessee provided detailed item-wise capital expenditure listings and reconciliations, which were undisputed. The AO's summary rejection without examination was unsustainable.The Court held that while disallowance under section 35(2AB) stands to the extent of non-certification, the alternate claim under section 35(1)(iv) for Rs. 73,20,990/- must be allowed as capital expenditure incurred wholly and exclusively for scientific research.3. Disallowance under Section 40(a)(i) for Non-Deduction of Tax at Source on Testing ChargesSection 40(a)(i) disallows expenditure where tax is not deducted at source as required under section 195 on payments to non-residents. The AO treated payments of Rs. 3,99,455/- made to foreign laboratories for testing services as 'fees for technical services' (FTS) under Explanation 2 to section 9(1)(vii), attracting tax deduction obligations. The DRP upheld this view.The assessee contended that the services were rendered wholly outside India, involved no transfer of technical knowledge or skill, and were for export compliance purposes. Therefore, under section 9(1)(vii)(b), the income does not accrue or arise in India, negating the tax deduction obligation. The assessee relied on judicial precedents where similar payments for testing and certification services abroad were held not to be taxable in India or attract TDS.The Court analyzed the facts, noting the services were performed outside India, by non-resident entities with no permanent establishment in India, and were used solely for export compliance. The Court held that such payments do not constitute taxable income in India under section 9(1)(vii) or under applicable DTAAs, and thus no TDS was required.The disallowance under section 40(a)(i) was therefore not sustainable and was directed to be deleted.4. General Challenge to the Legality of the Assessment OrderThe assessee's general ground challenging the assessment order's legality was not supported by any specific argument or independent infirmity apart from substantive issues discussed above. The Court deemed this ground academic and did not adjudicate separately.Significant Holdings and Core Principles:'The jurisdictional requirement under section 14A(2), as interpreted by various courts, is that the Assessing Officer must record dissatisfaction with reference to the accounts of the assessee, and not merely on general assumptions.''Section 115JB is a self-contained code. It applies notwithstanding other provisions of the Act. There is no scope for any allowances or deductions under any other section from what is deemed to be the total income of the company.''Section 35(1)(iv), read with section 35(2)(i), allows deduction for capital expenditure (not being expenditure on land) incurred for scientific research related to the assessee's business, even if the expenditure is not eligible for weighted deduction under section 35(2AB). This provision is substantive in nature and does not depend on approval from the DSIR or the contents of Form 3CL.''Payments made to non-resident entities for testing services rendered wholly outside India for export compliance purposes do not constitute 'fees for technical services' under section 9(1)(vii) and are not taxable in India, negating the requirement for tax deduction at source under section 195.'Final determinations on each issue are as follows:The disallowance under section 14A and consequent addition under section 115JB are deleted due to absence of mandatory recording of satisfaction and lack of legal foundation for addition to book profits;The weighted deduction under section 35(2AB) is disallowed to the extent not certified by DSIR, but the alternate claim under section 35(1)(iv) for capital expenditure of Rs. 73,20,990/- is allowed;The disallowance under section 40(a)(i) for non-deduction of tax on payments to non-resident testing service providers is deleted as the payments are not taxable in India;The general challenge to the assessment order is dismissed as academic.