ITAT allows R&D expense deduction under section 35(2AB) without Form 3CL requirement before 2016 amendment

The ITAT Ahmedabad allowed the assessee's appeal on three issues. First, regarding R&D expenses under section 35(2AB), the tribunal held that the AO erred in curtailing weighted deduction claims for non-submission of Form 3CL report, as no prescribed procedure existed before the 2016 amendment. The disallowance was made without proper application of mind. Second, disallowance under section 40A(2)(b) for commission payments was deleted, following precedent from the preceding year with identical facts. Third, depreciation on electrical installations was allowed at 15% as plant and machinery rather than 10% as furniture and fittings, since the installations had no independent use and were laid solely for machinery installation purposes.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Appellate Tribunal (AT) include:

• Whether the order passed ex-parte by the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi, without granting opportunity of virtual hearing under Clause 12(3) of the Faceless Appeal Scheme 2021, was legally valid.
• The correctness of restricting the claim of weighted deduction under Section 35(2AB) of the Income Tax Act for scientific research expenditure on in-house R&D facility based on quantification by the Department of Scientific and Industrial Research (DSIR) in Form 3CL, particularly for Assessment Years (AY) 2015-16 and 2016-17, considering the amendment to Rule 6(7A)(b) of the Income Tax Rules, 1961 effective from 01.07.2016.
• The validity of disallowance under Section 40A(2)(b) of the Act of commission payments made to sister concerns, including the genuineness of such payments and compliance with procedural requirements.
• The appropriate classification and rate of depreciation allowable on electrical installations claimed by the assessee, specifically whether such installations should be treated as part of Plant and Machinery (eligible for 15% depreciation) or as Furniture and Fittings (eligible for 10% depreciation).

2. ISSUE-WISE DETAILED ANALYSIS

Ex-Parte Order and Virtual Hearing Opportunity:

The assessee challenged the ex-parte orders passed by the CIT(A) without granting virtual hearing as mandated under Clause 12(3) of the Faceless Appeal Scheme 2021. Although the grounds were raised, the Tribunal's detailed reasoning on this procedural issue is not extensively elaborated in the judgment. However, the appeals were admitted and decided on merits, indicating that procedural objections did not preclude adjudication.

Weighted Deduction under Section 35(2AB) of the Act:

Legal Framework and Precedents: Section 35(2AB) allows weighted deduction for expenditure incurred on in-house scientific research and development facilities approved by the prescribed authority (DSIR). Prior to the amendment effective 01.07.2016, the Income Tax Rules did not mandate quantification of eligible expenditure in Form 3CL by DSIR. The amendment introduced Rule 6(7A)(b), requiring DSIR to furnish quantification of expenditure eligible for weighted deduction.

Multiple judicial precedents were cited, including ITAT Ahmedabad decisions in the assessee's own case for AY 2013-14 and AY 2014-15, the ITAT Mumbai decision in Crompton Greaves Ltd., and the Gujarat High Court ruling in Sun Pharmaceutical Industries Ltd., which collectively establish that prior to 01.07.2016, non-quantification of expenditure in Form 3CL could not be a ground for disallowance of weighted deduction under Section 35(2AB).

Court's Interpretation and Reasoning: The Tribunal emphasized that the statutory provision requires approval of the in-house R&D facility, not the quantum of expenditure. The amendment to Rule 6(7A)(b) introducing quantification applies only from AY 2017-18 onwards. Therefore, for AY 2015-16 and 2016-17, the Assessing Officer's restriction of weighted deduction based on partial quantification by DSIR was erroneous.

Key Evidence and Findings: The assessee submitted DSIR certificates approving the R&D facility and claimed weighted deduction on expenditure exceeding the amounts quantified in Form 3CL. The Assessing Officer disallowed the excess, relying on the non-quantification. The Tribunal found no material to justify such disallowance and noted the statutory amendment timeline.

Application of Law to Facts: The Tribunal applied the legal principle that prior to 01.07.2016, Form 3CL's quantification requirement was not applicable. The assessee's claim, supported by DSIR approval of the facility and auditor certification of expenditure, was thus allowable in full for weighted deduction.

Treatment of Competing Arguments: The Departmental Representative relied on the Assessing Officer's and CIT(A)'s orders restricting deduction. The Tribunal distinguished these by reference to the amendment timeline and binding precedents favoring the assessee.

Conclusion: The Tribunal allowed the weighted deduction claim for AY 2015-16 and 2016-17, reversing the disallowance.

Disallowance under Section 40A(2)(b) of the Act for Commission Payments:

Legal Framework and Precedents: Section 40A(2)(b) disallows expenditure if payment is made to specified persons without adequate justification or at excessive rates. The genuineness of the payments and services rendered must be established by the assessee.

Court's Interpretation and Reasoning: The Tribunal examined the facts that the Assessing Officer disallowed commission payments to several related parties, alleging these were dummy transactions to inflate expenses. However, the assessee produced detailed evidence including invoices, ledger accounts, TDS certificates, and income tax returns of the recipients demonstrating receipt and declaration of commission income.

Key Evidence and Findings: The Tribunal noted that the Assessing Officer did not conduct further investigation or verification to disprove the genuineness of payments. Prior ITAT orders in the assessee's own case for AY 2013-14 and AY 2014-15 had deleted similar disallowances based on identical facts.

Application of Law to Facts: The Tribunal applied the principle that in absence of any material disproving genuineness, disallowance under Section 40A(2)(b) is unwarranted. The assessee satisfactorily explained the nature of services rendered and substantiated payments.

Treatment of Competing Arguments: The Departmental Representative relied on the Assessing Officer's and CIT(A)'s orders confirming disallowance. The Tribunal overruled these in light of the evidence and prior consistent ITAT decisions.

Conclusion: The Tribunal deleted the disallowance under Section 40A(2)(b) for commission payments for the years under consideration.

Depreciation on Electrical Installations:

Legal Framework and Precedents: Depreciation rates under the Income Tax Act depend on classification of assets. Electrical installations forming an integral part of Plant and Machinery are eligible for 15% depreciation, whereas electrical fittings under Furniture and Fittings attract 10% depreciation.

Court's Interpretation and Reasoning: The Tribunal found that the electrical installations were integral and intrinsic parts of the chemical reactors and plant machinery, having no independent use. Reliance was placed on the Ahmedabad Tribunal's earlier decision in the assessee's own case and the Gujarat Chemical Port Terminal Co. Ltd. case, which allowed 15% depreciation on electrical installations classified as Plant and Machinery.

Key Evidence and Findings: The assessee's submissions and prior judicial decisions supported the classification of electrical installations as Plant and Machinery. The Assessing Officer and CIT(A) erred in treating them as Furniture and Fittings.

Application of Law to Facts: The Tribunal applied the established principle that assets forming an integral part of machinery qualify for higher depreciation rates applicable to Plant and Machinery.

Treatment of Competing Arguments: The Departmental Representative relied on lower authorities' orders restricting depreciation. The Tribunal rejected this in view of binding precedents and facts.

Conclusion: The Tribunal allowed depreciation on electrical installations at 15% for the years under consideration.

3. SIGNIFICANT HOLDINGS

"The operative phrase here is 'on in-house research and development facility as approved by the prescribed authority .......', the word 'facility' has been hereby shown to emphasize the point that it is the unit which requires approval of the prescribed authority under this provision. Further, in the memorandum, explaining the provision of section and the notes on the clauses issued at the time of insertion of section 35(2AB) in the Act, copies of both of which have been filed on record before us by the assessee, it has been clearly provided that the deduction would be available to the assessee's having an approved in-house R & D facility by the prescribed authority. Undisputedly, there is no mention or approval of the quantum of expenditure."

"The Finance Act, 2015 as amended to sub section (3) of section 35 w.e.f. 01.04.2016, providing for furnishing of reports in the manner to be prescribed. It is, thus, w.e.f. 01.04.2016 that the provision has been made for approval of quantum of expenditure, for the first time."

"Where the assessee had already obtained approval of its in house research and development facility in form 3CM, Commissioner could not revise assessment framed by Assessing Officer allowing deduction u/s. 35(2AB) of the Act merely on the ground of non-submission of report of prescribed authority under form 3CL."

"During the course of assessment, the assessee has explained the specific services rendered by the parties to whom the commission was paid along with the detail of their expenses and TDS on the transaction of commission payment. The Assessing Officer has not demonstrated any material or information gathered to disprove the genuineness of the expenditure incurred on commission payment... Therefore, we do not find any merit in the decision of ld. CIT(A) and the appeal of the assessee is allowed."

"Electrical installations are part of Plant and Machinery, having no independent use and have been laid only for the purpose of installation of machinery (chemical reactors in the case of the assessee). Accordingly, depreciation on such electrical installations may be allowed @ 15%."

The Tribunal's final determinations were:

• The ex-parte orders without virtual hearing did not prevent adjudication on merits.
• The weighted deduction under Section 35(2AB) cannot be restricted based on non-quantification in Form 3CL for AYs 2015-16 and 2016-17, as the requirement was introduced only from AY 2017-18.
• The disallowance under Section 40A(2)(b) of commission payments to related parties was unsustainable in absence of evidence disproving genuineness and was deleted.
• Depreciation on electrical installations forming part of Plant and Machinery was rightly allowable at 15%, and the lower authorities' restriction to 10% was reversed.

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