Professional fees for R&D setup are capital expenses under Section 37(1); travel expense deduction disallowed under Section 35(2AB) &DExpenditure

ITAT Mumbai held that professional fees paid for setting up the R&D unit were capital expenditures and not deductible under section 37(1). The amount of INR 14,00,000 was directed to be treated as part of the building cost, allowing depreciation accordingly. However, weighted deduction under section 35(2AB) for travel expenses related to a visit abroad was disallowed due to lack of supporting evidence. The appeal was partly allowed, confirming the disallowance of travel expenses but permitting depreciation on capitalized setup costs.

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ISSUES:

Whether professional fees paid to a consultant for execution of a research project phase qualify for deduction under Section 37(1) of the Income Tax Act, 1961, when not claimed under Section 35(2AB).Whether professional fees paid for management advisory services related to obtaining approval for an R&D Unit qualify for deduction under Section 37(1) or should be treated as capital expenditure.Whether travelling expenses incurred in connection with the in-house R&D Unit are eligible for weighted deduction under Section 35(2AB) without adequate supporting documentation.Whether capital nature expenditure disallowed under Section 37(1) can be allowed depreciation if not claimed under Section 35(2AB).

RULINGS / HOLDINGS:

Professional fees of INR 12,00,000 paid to a consultant for execution of Phase III of an R&D Project are deductible under Section 37(1) as the expenditure was not for in-house research but for execution phase, and thus should be allowed despite not being claimed under Section 35(2AB).Professional fees of INR 14,00,000 paid to a management advisory firm for obtaining approval of the R&D Unit relate to capital expenditure for setting up the R&D Unit and are not deductible under Section 37(1); however, the amount should be treated as part of the cost of building and allowed depreciation accordingly.Travelling expenses of INR 1,11,445 incurred for foreign travel related to review of machinery for the R&D Unit are not eligible for deduction under Section 35(2AB) due to lack of adequate supporting documents and failure to prove the purpose and nature of the visit.Expenditure disallowed as capital in nature under Section 37(1) but not claimed under Section 35(2AB) may still be eligible for depreciation if properly classified as part of capital assets.

RATIONALE:

The Court applied the Income Tax Act, 1961, specifically Sections 35(2AB) and 37(1), distinguishing between revenue and capital expenditure and the scope of weighted deductions for R&D activities.Section 35(2AB) provides weighted deduction for in-house R&D expenditure but excludes capital expenditure such as cost of land and building, which must be treated separately.The Court emphasized the necessity of proper classification of expenses and the maintenance of separate books of accounts for R&D projects to claim deductions under Section 35(2AB).The Court noted the absence of supporting documentary evidence for travelling expenses claimed under Section 35(2AB) as a valid reason for disallowance.The decision reflects a doctrinal clarity that professional fees for execution phases distinct from in-house R&D may be allowable under Section 37(1), whereas expenses related to setting up R&D infrastructure are capital in nature.The Court directed the Assessing Officer to allow depreciation on capital expenditure disallowed under Section 37(1) but not claimed under Section 35(2AB), addressing a lacuna in the earlier orders.

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