Short Overview  Where AO did not record any satisfaction with regard to genuineness of the claim of the assessee before invoking the powers under section 14A read with rule 8D, disallowance was invalid because recording of satisfaction by AO is sine qua non for invocation of power under section 14A read with rule 8D, that having regard to the accounts of the assessee it is not possible to arrive at the satisfaction with regard to the correctness of the claim of the assessee.

Issue was as regards validity of disallowance made by AO under section 14A. Case of assessee was that AO did not record any satisfaction prior to making disallowance under section 14A. 

It is held that Sub-sections (2) and (3) of section 14A of the Act read with rule 8D of the Rules prescribe a formula for determination of expenditure incurred in relation to income, which does not form part of the total income under the Act in a situation where the AO is not satisfied with the claim of the assessee. The sine qua non for invocation of power under section 14A of the Act read with rule 8D of the Rules is the recording of satisfaction by AO that having regard to the accounts of the assessee it is not possible to arrive at the satisfaction with regard to the correctness of the claim of the assessee. In instant case, AO did not record any satisfaction with regard to genuineness of the claim of the assessee before invoking the powers under section 14A of the Act read with rule 8D of the Rules. Thus, disallowance was invalid.

Decision: In assessee s favour.

IN THE KARNATAKA HIGH COURT

ALOK ARADHE & H.T. NARENDRA PRASAD, JJ.

Hindustan Aeronautics Ltd. v. Asstt. CIT

ITA No. 404 of 2016 c/w ITA No. 468/2016

9 December, 2020

Appellants by : Aravind K.V., Advocate

Respondent by : T. Suryanarayana, Advocate

Alok Aradhe, J.

ITA No. 404/2016 has been filed by the assessee, whereas, ITA No. 468/2016 has been filed by the revenue under section 260A of the Income Tax Act, 1961 (hereinafter referred to as the Act for short) being aggrieved by the Order, dt. 22-4-2016 passed by the Income Tax Appellate Tribunal (hereinafter referred to as the tribunal for short). The subject matter of the appeals pertain to the assessment year 2009-10. Since, both the appeals arise out of the same order, they are heard analogously and are being decided by this common judgment.

2. ITA No.404/2016 was admitted by a bench of this Court vide Order, dt. 13-6-2017 on the following substantial questions of law:

Whether on the facts, in the circumstances and on the grounds and contentions urged:

(i) the Tribunal was right in holding that expenses to the extent of Rs. 570,61,55,000 incurred towards research and development is capital in nature?

(ii) the Tribunal was correct in upholding the disallowance made under section 14A of the Act?

3. ITA No.468/2016 was admitted by a bench of this Court vide Order, dt. 13-6-2017 on the following substantial question of law:

Whether on the facts and in the circumstances of the case, the Tribunal was justified in directing the assessing officer to allow the claim of deduction under section 35(i)(iv) of the Income Tax Act, 1961 even though the assessee had not claimed the same in return of income and ignoring the principle laid down by Apex Court in case of Goetze (India) Ltd. (2006) 284 ITR 323 (SC) : 2006 TaxPub(DT) 1528 (SC) and also in the decision of this Hon ble Court in case of BAE Hal Software Ltd. in ITA No.1336/2010 dt. 1-3-2011?

4. Facts leading to filing of these appeals briefly stated are that the assessee is public sector undertaking of Government of India and is engaged in the business of design, development, manufacture and maintenance of aircrafts and avionic systems. The assessee caters to the requirement of defence establishment in India. The assessee for the purposes of manufacture of aircrafts and avionic systems undertakes various research and development activities in its Research and Development Centers. In the assessment year 2009-10, the assessee received grants to the tune of Rs. 570,61,55,000 from Government of India for conducting defence related research. The assessee also received dividend income of Rs. 32,77,838 and Rs. 29,40,000 from BAe HAL Software Ltd. and Indo-Russian Aviation Ltd. Respectively. The assessee filed the return of income for the assessment year 2009-10 and claimed the grant as capital receipt. Thus, not forming part of the income chargeable to tax. The assessing officer by an Order, dt. 29-11-2011 passed an order by which he reduced an amount of Rs. 570,61,55,000 from the deductible expenditure on the ground that the same was capital in nature. The assessing officer also made a disallowance under section 14A of the Act.

5. The assessee thereupon filed an appeal before Commissioner (Appeals) who by an Order, dt. 24-12-2012 upheld the order of assessment. The assessee thereupon approached the Tribunal by filing an appeal. The tribunal by an Order, dt. 22-4-2016 though upheld the order of Commissioner (Appeals) in respect of finding that expenses of Rs. 570,61,55,000 to be capital in nature. However, the tribunal accepted the alternative contention of the assessee that it was entitled to deduction under section 35(1)(iv) of the Act and remitted the issue back to the assessing officer for consideration afresh in accordance with law. The tribunal upheld the disallowance made under section 14A of the Act. In the aforesaid factual background, the assessee has filed this appeal to the extent the tribunal rejected its contention that Research and Development expenses were revenue in nature and so far as disallowance of its claim under section 14A of the Act was made. The revenue has filed an appeal being aggrieved by the order of the tribunal granting the alternate relief to the assessee for Research and Development expenses under section 35(1)(iv) of the Act.

6. Learned counsel for the assessee submitted that the authorities under the Act ought to have appreciated that the expenses incurred on account of Research and Development expenses are revenue expenses and the same ought to have been allowed as deduction under section 37 of the Act. It is also urged that the tribunal erred in placing reliance on the decision of the tribunal in the case of the assessee for assessment year 1995-96 and in holding that the grants received in the nature of capital receipts not chargeable to tax. It is also urged that the aforesaid order no where states that revenue expense incurred out of such grants would be allowable. It is also contended that nature of expenses are clearly revenue. In support of aforesaid submissions, reliance has been placed on decisions of the Supreme Court in Empire Jute Co. Ltd. v. CIT (1980) 3 Taxman 69 (SC) : 1980 TaxPub(DT) 1083 (SC) and Taj Mahal Hotel v. CIT (1967) 66 ITR 303 (AP) : 1967 TaxPub(DT) 0260 (AP-HC).

7. Alternatively it is submitted that alternatively if the expenses are held to be capital expenditure, then in terms of section 35(1)(iv) of the Act, the same would be allowable as a deduction since, it is incurred on scientific research and the expression scientific research in section 43(4) of the Act means any activity for extension of knowledge, in the field of natural or applied science including agriculture, animal husbandry or fisheries. It is also pointed out that the tribunal has recorded a finding of fact that the expenses have been incurred by the assessee towards scientific research and the aforesaid finding has not been challenged by the revenue. The only grievance of the revenue is that the claim of the assessee under section 35(1)(iv) of the Act was not put forth in the return of income and is not allowable. It is pointed out that there was a claim in the return of income for the aforesaid amount under section 37 of the Act and only when the same was not accepted by the assessing officer, the assessee made an alternate claim under section 35(1)(iv) of the Act before the Commissioner (Appeals) and alternate claim can be considered by appellate Authority. In support of aforesaid submissions, reliance has been placed on decisions in National Thermal Power Co. Ltd. v. CIT (1998) 229 ITR 383 (SC) : 1998 TaxPub(DT) 0342 (SC) and Jute Corporation India v. CIT (1990) 53 Taxman 85 (SC) : 1991 TaxPub(DT) 0505 (SC). It is also pointed out that for assessment years 1994-95 to 2004-05 no disallowance of the expenses was made by the assessing officer and for the first time a disallowance was made for the assessment year 2009-10.

8. With regard to claim of the assessee under section 14A of the Act, it is pointed out that assessee had earned dividend income from two companies, in which it had made strategic investments, which was exempt under section 10(34) of the Act and since, no expenses were incurred to earn the exempt income, the assessee did not make any disallowance under section 14A of the Act. The assessing officer made a disallowance under section 14A of the Act by applying rule 8D(iii) of the rules on 0.5% of the investments without recording any satisfaction as to incorrectness of the claim of the assessee and in the absence of recording of the satisfaction, rule 8D of the rules could not have been invoked. In support of aforesaid submissions, reliance has been placed on decisions in Godrej & Boyce Manufacturing Company Ltd. v. DCIT (2017) 81 taxmann.com 111 (SC) : 2017 TaxPub(DT) 0968 (SC) and Eicher Motors Ltd. v. CIT (2017) 86 taxmann.com 49 (Del) : 2017 TaxPub(DT) 4495 (Del-HC).

9. On the other hand, learned counsel for the revenue submitted that the assessee in his submission made before the assessing officer on 14-11-2002 has clearly admitted that expenditure incurred result in acquisition of capital asset and therefore, the tribunal on the basis of admission made by assessee has rightly held that the expenditure incurred by the assessee is capital in nature. It is also argued that if any expenditure incurred results in any acquisition of the asset, the same would constitute capital expenditure. It is urged that the assessee had claimed dividend of Rs. 62.18 Lakhs exempt under section 10(34) of the Act. However, the assessee claimed that it had incurred no expenditure in earning the dividend income. Therefore, the assessing officer rightly invoked Rule 8D(iii) of the rules and disallowed a sum of Rs. 15,80,810 and the Commissioner (Appeals) as well as the tribunal has affirmed the same. It is also submitted that in view of decision of the Supreme Court in Maxopp Investment Ltd. v. CIT (2018) 402 ITR 640 (SC) : 2018 TaxPub(DT) 1403 (SC), the rule 8D of the rules applies for the assessment year 2009-10 and the assessing officer has rightly invoked rule 8D of the rules to disallow the expenditure incurred for earning the exempt income. It is also submitted that Supreme Court in the case of Godrej & Boyce Manufacturing Company Ltd. supra has held that disallowance under section 14A read with rule 8D of the rules is applicable to the dividend income and disallowance of expenditure in terms of rule 8D is justified.

10. Learned counsel for the revenue in ITA No.468/2016 submitted that finding of the tribunal allowing the claim under section 35(iv) of the Act for the first time before the appellate authority without revising the return of the income is incorrect and is contrary to provisions of section 139(4) of the Act. It is submitted that Supreme Court in Goetze Ltd. v. CIT (2006) 127 Taxman 1 (SC) : 2006 TaxPub(DT) 1528 (SC) has held that assessee can amend or modify the return of income only by filing revised return of income. It is submitted that the interpretation placed by the tribunal on the aforesaid judgment that the principle of law laid down in the aforesaid decision is applicable only for assessing authority and not for appellate Authority is incorrect. It is also submitted that reliance placed on National Thermal Power Co. Ltd. supra has no application to the fact situation of the case as the same does not provide for making fresh claims other than through return of income. It is also urged that if such an interpretation is to be accepted, the entire purpose of providing revised return of income under section 139(5) of the Act would be defeated and the finding of the tribunal is contrary to judgment of this court in ITA No.136/2010 dt. 1-3-2011 in CIT v. M/s Baehal Software Ltd.

11. We have considered the submissions made by learned counsel for the parties and have perused the record. The Supreme Court in Empire Jute Co. Ltd supra has held that it is not a universally true proposition that what may be a capital receipt in the hands of the payee must necessarily be capital expenditure in relation to the payer. The fact that a certain payment constitutes income or capital receipt in the hands of the recipient is not material in determining whether the payment is revenue or capital disbursement qua the payer. It has further been held that whether a transaction is capital expenditure would have to be determined having regard to the nature of the transaction and other relevant factors. In the instant case, the total research and development expenses incurred by the assessee was to the tune of Rs. 67,478.1 Lakhs, which includes expenses towards raw materials, direct expenses, salaries, interest, depreciation and other expenses. Out of the aforesaid amount, the assessing officer has disallowed a sum of Rs. 570.61 Lakhs on the ground that the same was made out of the grants given by Government of India. The expenses incurred by the assessee were towards research and development and therefore, the same were revenue in nature and ought to have been allowed as deduction under section 37 of the Act. The fact that the expenses incurred by the assessee towards research and expenses have been met out of the grants given by the government, which is treated as capital receipt is immaterial. The Tribunal erred in placing reliance on the case of the assessee for assessment year 1995-96 as the Tribunal failed to appreciate the aforesaid order, as the order no where states that the revenue expenses incurred out of the grant would not be allowed as deduction under section 37 of the Act. It is pertinent to mention here that the nature of the expenditure has to be seen and not the nature of receipt and purpose for which such expenditure is made is a relevant criteria. The expenditure was incurred by the assessee for research and development for manufacture of aircrafts, which were to be sold. Thus, the expenditure was incurred for the purpose of business of the assessee and the same ought to have been allowed under section 37 of the Act instead of Secrtion35(1)(iv) of the Act.

12. So far as the claim of the assessee under section 14A of the Act is concerned, sub-section (2) and (3) of section 14A of the Act read with rule 8D of the rules prescribe a formula for determination of expenditure incurred in relation to income, which does not form part of the total income under the Act in a situation where the assessing officer is not satisfied with the claim of the assessee. The sine qua non for invocation of power under section 14A of the Act read with rule 8D of the rules is the recording of satisfaction by the assessing authority that having regard to the accounts of the assessee it is not possible to arrive at the satisfaction with regard to the correctness of the claim of the assessee. In the instant case, the assessing officer has not recorded any satisfaction with regard to genuineness of the claim of the assessee before invoking the powers under section 14A of the Act read with rule 8D of the rules.

In view of preceding analysis, the substantial questions of law involved in ITA No.404/2016 are answered in favour of the assessee and against the revenue, whereas substantial question of law involved in ITA No.468/2016 is answered against the revenue and in favour of the assessee. In the result, the order of the Tribunal dt. 22-4-2016 in so far as it pertains to disallowance of the claims of the assessee under section 37 and Section 14A of the Act is hereby quashed. In the result, the appeals are disposed of.